To Volcker Or Not-To-Volcker? That Is The Question

John M. Mason profile picture
John M. Mason


  • Yesterday, the Federal Reserve raised the range for its policy rate of interest by 25 basis points initiating a phase of policymaking more to the restrictive side of the chart.
  • And Chairman Powell and the Federal Reserve provided some information about how its policy rate of interest might move over the next two years.
  • Still, there is concern that these moves are not enough to really fight inflation and very little information was provided about how the Fed might reduce its securities portfolio.
  • Some analysts are comparing the current picture with the time, 40 years ago, when Fed Chair Paul Volcker was fighting inflation of a similar level.
  • At the current time, however, it seems unlikely that Mr. Powell will come anywhere close to leading the Fed in the way that Mr. Volcker did.

Fed Chair Jerome Powell And Janet Yellen Testify At Senate Hearing On COVID-19 And CARES Act

Alex Wong/Getty Images News

The Federal Reserve has moved.

The range for its policy rate of interest was raised by 25 basis points.

Furthermore, the Federal Reserve indicated that it will begin to reduce its holdings of securities "at a coming meeting."

And, the Fed indicated that it will raise its policy rate of interest six more times this year and then continue to raise them so as to achieve an increase in the range for its policy rate of interest up to 1.75 percent to 2.00 percent.

Let's see.

The Fed's own projection for inflation in 2022 is now 4.3 percent. This has been raised since its last projection for 2022, which was for a 2.6 percent rise in inflation.

These figures come from the economic projections of the Federal Reserve for March 2022.

Note that the Fed's projection for inflation in 2022 is above its projection for the "nominal" Federal Funds rate, so that the real rate of interest for this year will be negative.

This is going to slow inflation?

And, the Federal Reserve is going to begin to reduce the size of its securities portfolio.

On Wednesday, March 9, 2022, the securities portfolio totaled almost $8.5 trillion.

On Wednesday, March 25, 2020, just before the Fed began buying, outright, $120.0 billion a month in securities, the securities portfolio totaled just under $4.4 trillion.

Just what is the Fed going to do about the size of this portfolio and how is it going to do it? How far will the portfolio be reduced and how quickly will the reduction take place?

The Fed had kept the effective Federal Funds rate constant at 0.08 percent since September 1, 2021.

Fed chair said it was going to raise the Fed's range for the Federal Funds rate by 25 basis points on Wednesday and it did.

But I have been wondering how the Fed was going to move on beyond this. This is what investors really need to be worried about.

It seems as if the Fed faces a major dilemma as far as what it is going to do to fight inflation going forward.

Federal Reserve actions have overloaded the banking system with liquidity and it has kept interest rates at excessively low levels.

Now, it is faced with rapidly rising inflation and it must backtrack.

But, what is the extent to which this backtracking must go?

The Fed is not really saying anything on this.

The Inflation Rate At 40-year High

Let me say that again. The inflation rate in the U.S. is at a 40-year high.

That takes us back to the early 1980s.

And, who was the Federal Reserve chairman at that time?

Why, of course, the chairman was Paul Volcker.

The Federal Reserve, under the leadership of Chairman Volcker, fought the inflation at that time and has gone done in history as a hero in the halls of central bankers as a chairman that stuck by his beliefs and combated inflation with everything he had and returned the U.S. economy to a period of price stability.

Chairman Volcker also oversaw a Federal Funds rate that reached the low 20s. Wow! A Fed Funds rate of 20.0 percent or more! How could that be?

Well, the comparison in rates of inflation has resulted in people going back to the early 1980s and looking at what Mr. Volcker did.

And, people are now comparing Fed Chair Jerome Powell with former Fed Chair Paul Volcker.

And, the question is, will Mr. Powell move as Mr. Volcker did and reduce the inflation existing in the economy.

And, the fear is that Mr. Powell will not equal up to Mr. Volcker.

Mr. Volcker raised the Fed's policy rate of interest above the then-current rate of inflation, so that the "real" rate of interest became positive and, hence, it became restrictive.

If Mr. Powell does not do this, he is not really acting in a restrictive way at all.

The Stock Market

One thing that has changed is that the U.S. stock market is much more sensitive to what the Federal Reserve is doing now than it was during the time of Paul Volcker.

Stock prices are much more likely to move according to the way investors believe that the Federal Reserve is moving.

This close connection was achieved during the period of economic recovery following the Great Recession.

Then-Federal Reserve chairman Ben Bernanke led the Fed in the expansion by directing the Fed to stimulate stock prices so as to generate a wealth effect that would then spur on consumer spending, thereby driving the economy into economic growth.

Mr. Bernanke was very successful in achieving his goal.

And, Mr. Bernanke followed up the economic recovery by creating three rounds of "quantitative easing" that contributed to achieving the longest economic expansion in post-World War II history.

His efforts were continued under the leadership of Fed chair Janet Yellen.

The only tiny bumps in the recovery came when the Fed looked as if it were backing off from its market support, and stocks dropped for a while.

They dropped until the Fed was able to signal investors that the Fed was really not abandoning them.

And, this approach followed Ms. Yellen when Mr. Powell took over the reins at the Fed. Mr. Powell has been very careful to honor this stock market support.

And, Now

So, here we are now.

The Federal Reserve is starting to raise its policy rate of interest and is even threatening to reduce the size of its securities portfolio.

What is going to happen to stock prices?

Well, we have seen stock prices top out at the beginning of January as investors really started to believe that the Fed was "tapering" its monthly purchase of securities and was really going to raise its policy rate of interest.

The last historical high hit by the S&P 500 Stock Index was on January 3. Market prices have been on the decline since then.

But, what about now? Where is the stock market going to go given the information provided by Mr. Powell and the Federal Open Market Committee?

The S&P index closed up 96 points following the Fed's announcement of the information given above. This morning the index is up about 10 more points.

Investors seem to be taking the Fed's information positively.

But, the question still remains...what is the Fed really going to do moving forward.

Is Mr. Powell going to show his "Volcker-heritage"?

So, far, in my mind, Mr. Powell has shown us very little to compare him favorably to Mr. Volcker.

Unfortunately, I don't see much of Mr. Volcker in Mr. Powell as he moves forward from here.

Unfortunately, I seem to be closer to where the editorial board of the Wall Street Journal seems to be: Mr. Powell's moves are...

"...still not enough to absolve the Fed from the inflation mess it helped to cause and now must find a way to clean up."

This article was written by

John M. Mason profile picture
John M. Mason writes on current monetary and financial events. He is the founder and CEO of New Finance, LLC. Dr. Mason has been President and CEO of two publicly traded financial institutions and the executive vice president and CFO of a third. He has also served as a special assistant to the secretary of the Department of Housing and Urban Development in Washington, D. C. and as a senior economist within the Federal Reserve System. He formerly was on the faculty of the Finance Department, Wharton School, the University of Pennsylvania and was a professor at Penn State University and taught in both the Management Division and the Engineering Division. Dr. Mason has served on the boards of venture capital funds and other private equity funds. He has worked with young entrepreneurs, especially within the urban environment, starting or running companies primarily connected with Information Technology.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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