The interest rate hike brings back the painful memories of the 1980s

In the summer of 1980, inflation in America approached 15%, and the unemployment rate rose to 7.5%. In 1981, Paul Volcker, who was chairing the US Federal Reserve, succeeded in overcoming inflation by adopting high interest rates and tightening monetary policy. Volcker convinced financial markets, companies and households that the Fed would do whatever was necessary to ensure a low and stable inflation rate in the future.

Paul raised interest rates to historical levels of regarding 20%, and succeeded in reducing inflation significantly, from 11% in 1979 to regarding 4% at the end of 1982.

True, Paul crushed inflation, but with it he also crushed negative macroeconomic growth.

Today, central banks realize that commitment to price stability, albeit relatively, is essential to good monetary policy, and most of them, including the Federal Reserve, have adopted specific inflation targets. As credible as they are, these inflation targets have re-established the foundations of monetary policy. In doing so, they have enhanced the transparency of monetary policy decisions and reduced uncertainty, which are now also understood as necessary precedents for long-term growth and maximum employment.

In order not to fall into the same old trap and negatively affect the growth of the economy significantly, as happened in the eighties, the US Federal Reserve today is trying to deal less severely with inflation, adopting a different monetary policy than its predecessor and adopting a gradual increase in interest rates by 0.5 basis points, which is the first time since 2000 .

The US Federal Reserve confirmed that policy makers will do what is necessary to curb the rise in inflation, acknowledging that this may cause “some pain”, as the US central bank used its strongest tightening policy in decades.

On Wednesday, the Fed raised interest rates by 50 basis points for the first time since 2000. Inflation and rate hikes will almost certainly cause economic problems. “Similar moves were on the table for June and July,” Powell said. “Inflation is very high and we understand the hardships it is causing.” And we are moving quickly to lower it once more.”

The US central bank confirmed that it is not considering a three-quarter percentage point (75 basis point) rate increase in the upcoming monetary policy meetings.

Federal Reserve officials, who also decided to begin reducing their holdings of Treasuries and mortgage-backed securities next month, are trying to curb the sharpest inflation since the early 1980s.

The cap will initially be set at $30 billion per month and following three months it will increase to $60 billion per month.

This time the Fed hopes that the combination of higher borrowing costs and a shrinking balance sheet will produce a slump that avoids stagnation while curbing inflation, although Powell noted that this may not be possible without hurting growth.

As for increases over the next two Fed meetings, Powell said additional increases of 50 basis points should be on the table.

It is noteworthy that this is the second time that the Federal Reserve has raised the interest rate since the outbreak of the Corona pandemic, and the first time it has raised the interest rate by 0.5% in 22 years.