How the US Got Out of the Early ’80s Recession
You might have noticed that things are getting more expensive, and if you’ve researched why, you know that inflation is at a 40-year high. The “40-year high” headline is so popular because that kind of historical perspective slams home just how bad things have gotten — prices haven’t risen this quickly for four decades.
The Recession of 1981-82
You might have also read that many economists and financial leaders believe the country is headed toward a recession. Just like rising inflation, that, too, harkens back to 40 years ago.
America has endured more than a dozen recessions since World War II, but mercifully, few were as bad as the one that crippled the economy in 1981-82. According to the Federal Reserve, those years witnessed the worst downturn since the Great Depression and remained so until 2008.
Unemployment flirted with 11% in ’82, the highest in the post-war era. The manufacturing, auto and construction industries took the brunt of it, suffering the worst damage by far.
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Familiar Themes: Inflation and Fed Action as the Building Blocks of Recession
If the country does enter a recession, as so many analysts have predicted it will, the recession will follow a controversial monetary policy that the Federal Reserve designed to curb rising inflation.
The events of 40 years ago played out much the same way.
In the 1960s and early ’70s, a philosophy that seems primitive by modern standards steered the Fed’s monetary policy. Back then, economists and policymakers believed that inflation and unemployment had a naturally inverse relationship — when one rose, the other would fall.
When unemployment got too high, the Fed would lower interest rates to loosen the money supply to stoke inflation and reduce joblessness. When the pendulum swung the other way and inflation got too high, the Fed would raise interest rates to tamp down inflation at the expense of jobs.
It was called the Phillips Curve tradeoff, and the turmoil of the mid-1970s debunked it as a viable long-term strategy when both unemployment and inflation began to rise at the same time.
Multiple energy crises, the rise of cheap foreign manufacturing and massive layoffs fanned the flames of soaring prices and widespread joblessness. While unemployment leveled off a little at the end of the decade, inflation hit 11% in 1979 and peaked at 15% in 1980.
Inflation as Public Enemy No. 1
In 1979, President Jimmy Carter appointed anti-inflation hawk Paul Volcker to lead the Federal Reserve. Just like today, the Fed tightened the money supply and raised interest rates in an effort to cool off the economy — only Volcker’s radical policies were like an economic anaconda, squeezing so tight that interest rates vaulted to historic highs near 20%.
Also like today, rising rates had the potential to overcool the economy and trigger a recession. According to the Fed, Volcker knew this perfectly well but was willing to accept a recession as collateral damage in his anti-inflation crusade.
The Recession of 1981 Broke the Economic Fever of the 1970s
During the 1970s, consistent hyper-inflation compelled labor unions to demand higher wages so workers could maintain their standard of living. That pumped even more money into the economy, forcing the inflation rate even higher and creating an endless cycle of economic pain.
According to The New York Times, the result was social dysfunction that transcended the country’s economic woes. There was a general sense that the system wasn’t working and society as a whole was coming unglued.
Industries like manufacturing and construction rely heavily on borrowing. But with interest rates near 20%, lending slowed to a trickle and the country entered a recession in 1981. Unemployment — already at a high 7.4% at the start of the recession — climbed into double-digits within a year.
As the situation worsened, Volcker faced intense pressure to loosen the money supply and lower interest rates.
He stayed the course, insisting that inflation was the root cause of the crisis and that letting up prematurely would only make things worse.
Volcker’s Dogged Persistence Pays Off
According to Volcker’s 2019 obituary in USA Today, the Fed chief was largely vindicated in 1982 when inflation fell, interest rates tumbled back down to earth, and the country got back to work.
The New York Times referred to the Federal Reserve’s victory as “a delicate economic pivot,” which the central bank is trying to replicate today.
The Times, USA Today and many respected economists conclude that it was Volcker’s insistence on maintaining a tight monetary policy — even if it meant tolerating the worst recession in 50 years — that eventually broke the back of inflation. When inflation was finally caged, the other pieces — unemployment, artificial wage hikes and economic stagnation — fell back into place, just as Volcker had predicted, setting the stage for the Reagan boom years.
So, Is This 1981 All Over Again?
America is not yet experiencing widespread unemployment — which is a key feature of a recession — but it is enduring an extended period of high inflation, a sputtering GDP and a stock market downturn, just as it was 40 years ago. The most striking similarity between now and then is the Federal Reserve’s response — tightening the money supply and increasing interest rates, even as the economy stumbles dangerously close to a recession.
In March, the Fed raised interest rates by a modest 0.25%, the first rate hike since the central bank slashed interest rates to 0% in March 2020. In May, the Fed upped the ante by raising rates again, this time by 0.5%. In June, the central bank added a jumbo 0.75% to the interest rate — the largest hike since 1994. One month later in July, the Fed announced yet another massive 0.75% rate hike as part of its Volcker-esque anti-inflation strategy.
Just as in the time of Volcker, the Fed appears to view the potential for recession as a necessary — or at least tolerable — evil on its mission to corral rising prices.
On July 28, just one day after the most recent interest rate hike, the second-quarter GDP report showed that the economy shrank for the second straight month — a telltale sign that a recession is imminent.
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