Vol. 01 – The Volcker shock
5
Iran and Iraq increased concerns about rising energy prices and the robust recovery from the 1980 recession had stoked inflation. In December 1980, inflation reached more than 12%. The fed funds rate reached 19% in December, with 6 percentage points of that increase coming in November and December alone (3) . The funds rate stayed elevated through July of 1981, although it dipped due to technical factors associated the Fed’s new reserve-targeting procedures and the introduction of nationwide NOW accounts in the spring. The FOMC understood that its tight policy risked a renewed recession, but Volcker argued that holding the line on inflation was warranted. Despite this, long-run interest rates continued to rise. The ten-year Treasury bond rate increased from about 11% in October 1980 to more than 15% a year later, possibly indicating that financial markets expected high inflation to return as the market believed the Fed would back down from its tight policy when unemployment rose (3) . Long-term inflation expectations appeared to many observers to be moving up, rather than declining in the face of a restrictive monetary policy. This time, however, Volcker was adamant that the Fed not back down. The economy officially entered a recession in the third quarter of 1981, as high interest rates put pressure on sectors of the economy reliant on
US - Recessions in %, GDP, peak to trough
World - Labor market flexibility in %
30 50 40 60 10 20 90 70 80
-4,5 -2,5 -3,0 -3,5 -4,0 -2,0 -1,5 -1,0 0,0 -0,5
Mild recession
Deep recession
0
1980
2020
1980
2020
2007
1973
1981
1980
1990 1960
1969
2001
Collective bargaining
Trade union density
Source: Rothschild & Co Asset Management Europe, March 2023
Source: WorldBank, Rothschild & Co Asset Management Europe, March 2023
(3) Source: World Bank, March 2023.
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