One of the most enduring clichés is the following: "Paul Volcker broke the back of inflation." Whoever came up with this is a marketing genius because people are still walking around today, 36 years later, repeating this ridiculous lie.
Every time I write an article about how higher rates equate to price increases and, thus, raise the level of inflation generally, people comment or email to "remind" me that Volcker broke the back of inflation by raising interest rates. Volcker did not break the back of inflation. He didn't break any backs. Just about the only thing he did was cause a major recession that needlessly put lots of people out of work.
I can't believe that no one has debunked this yet because the data is very clear. I am going to do it now. To do this analysis I will use the discount rate because that was the policy rate the Fed used in the 1970s and 1980s.
Starting in November 1970 when Arthur Burns was the Fed chairman the discount rate was 5.75% and inflation was running at 5.6% annually. By 1974 Burns had jacked up the discount rate to 8% -- a 60% increase -- and inflation had gone from 5.6% to 10% annually.
By November 1976 Burns had reduced the discount rate to 5.25% from 10% and inflation had fallen to 5% annually. Then by August 1979, which is when Volcker was appointed as Fed chairman, the discount rate was all the way back up to 10.5% and inflation had jumped to 11.8%.
Volcker continued to raise rates, pushing the discount rate to 13% by February 1980. The economy entered a recession in March of that year, but inflation was still running at 14%. Inflation would have kept on going and the recession, which at the time was the most severe in post-WWII history, would have deepened if rates had gone higher. However, other factors drove down prices: the deregulation of oil and gas industries; major oil discoveries in the North Sea and Alaska; and Ronald Reagan's firing of air traffic controllers plus the period it ushered in, which was the breaking of the labor unions.
By 1992 the discount rate had fallen to 3% and inflation was running at about 3%. Then, when the discount rate was raised to 6% in 2000, inflation bounced back, too, and came in at just under 4%.
As you can see there is a total correlation between rates and inflation and it is certainly not the inverse correlation that most people believe. It's a direct correlation. Raise rates and that raises the cost of goods and services and therefore it raises general price levels.
I have done articles showing that higher rates do not impede the growth of loans and credit. For example, in November 1976, when the discount rate was 5.25%, year-over- year loan growth was 7%. Yet in February 1980, when the discount rate was 13%, year-over-year loan growth was 13%.
The chart below, which tracks the Fed funds rate and annual changes in the Consumer Price Index, shows clearly that the relationship between interest rates and inflation are highly correlated and not in an inverse way.
So you see, it's practically a one-to-one correlation. You could pretty much superimpose these two lines.
Volcker did not break the back of inflation. He just broke the back of the economy.
