Vol. 01 – The Volcker shock
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explicit inflation target, and have established a credible track record of achieving their targets. As a result, inflation – in particular, core inflation – has become much less sensitive to inflation shocks.
Lessons learned Overall, synchronous policy tightening around the world contributed to the global recession of 1982, but global inflation waned to 5.4% per year, on average, in the remainder of the 1980s (9) . Thus, a key lesson from the 1970s is that central banks need to act in a pre-emptive manner to avoid a loss of confidence in their commitment to maintaining low inflation, specified today in their inflation targets. It is also critical to avoid inflation de-anchoring where households and businesses would base their wage and price expectations on their recent inflation experience, which would enhance the risk of wage-price spiral. Incidentally, it remains to be seen if today’s almsot unprecedented global monetary tightening will also morph into financial instability as it was the case in the early 1980’s. Indeed, the Volcker shock set off a debt crisis in Latin America as many Latin American governments had borrowed from US banks, which charged far higher interest rates after Fed’s hikes. As a result, Mexico defaulted on its debts in 1982, with others to follow.
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(9) Source: World Bank, March 2023.
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