By Tom Burnett CFA
According to the Federal Reserve History publication, dated November 22, 2013, the Recession of 1981-82 was the worst economic downturn since the Great Depression. Looking back, that period was burdened with double-digit inflation which led the Federal Reserve, under Chairman Paul Volker, to raise interest rates dramatically. The goal was to attack inflation by slowing the economy and lowering the demand for funds, goods and services.
The oil price increases of 1979-80 spurred by the revolution in Iran added to an inflationary environment that was already at the 7-8% level. Officially, the recession began in the fall of 1981 and lasted for more than one year. Volker was given political cover by the Reagan White House to raise rates and do whatever it takes to bring down inflation. At its peak, in 1980, inflation reached a year-over-year rate of 11%. Volker took a determined course of action and was not influenced by the opposing voices in Congress and the media as unemployment began to grow. Unemployment grew to 11%, the highest figure since the 1930’s and two industries were particularly hit hard—construction and auto manufacturing. By the fall of 1982, the unemployment rate in residential construction was 22 percent and the rate in auto manufacturing was 24 percent.
In his efforts to cool inflation, Volker engineered rate hikes and slower money supply growth. At the top, the Fed Funds rate approached 20% and rates on the 10-year Treasury rose to more than 15%. Over time, the strategy paid off with inflation falling to 5% by the end of 1982. Gradually, the Fed took its foot off the brakes and the Fed Funds rate fell to 9% in 1983 which allowed unemployment to decline to 8% in 1983-84. For the next 40 years, inflation stayed below 4% before erupting to the 8+% level in 2022. The Volker medicine was surely painful, but it was effective as inflation and unemployment both receded to modest levels after the 1981-82 recession was corrected.
Tom Burnett CFA is Director of Research