I was a bit surprised by the following toward the end of your post: "Sufficiently rapid interest rates tends to destabilise the financial system, which in turn can lead to a financial crisis. And a financial crisis is a great way to stop economic activity dead in its tracks. And since recessions tend to result in disinflation"...
Surely the rapid and extreme interest rate increases to a real rate of something like 10% in 1980-81 (peak of 21% nominal in Canada) caused a serious downturn due to very negative effects on financing construction, business investment and large consumer purchases. Debt burdens exploded leading to many bankruptcies. Unemployment soared. The result was the breaking of the wage-price spiral to the detriment of workers and inflation came down precipitously. This was not due to a financial crisis, which is not to say financial problems did not occur.
I know Warren Mosler has argued that gas prices were deregulated at the time and contributed to the decrease in inflation. Frankly this has always sounded to me like a single variable explanation for a more complex situation.
Randall Wray once said to me that it seemed like an interest rate increase of about 4%, all else equal, would begin to have negative macro effects notwithstanding the increase in income provided by higher interest rates from government bonds. It seems to me we are approaching that now...
I am taking a broader definition of “financial crisis” in that text. If I were to expand it, I would add more nuance. In the early 1980s, banking systems did have a lot of strains, since they were not even close to hedged. More generally, the real estate sector is going to be ground zero for interest rate sensitivity, and they are de facto part of the financial sector.
I think Warren attributes the fall in inflation during Volker era to more than one thing.:Falling gas prices , falls in other commodity prices, and Carter ensuring fiscal deficit fell. Am I mistaken?
Hello Brian,
I was a bit surprised by the following toward the end of your post: "Sufficiently rapid interest rates tends to destabilise the financial system, which in turn can lead to a financial crisis. And a financial crisis is a great way to stop economic activity dead in its tracks. And since recessions tend to result in disinflation"...
Surely the rapid and extreme interest rate increases to a real rate of something like 10% in 1980-81 (peak of 21% nominal in Canada) caused a serious downturn due to very negative effects on financing construction, business investment and large consumer purchases. Debt burdens exploded leading to many bankruptcies. Unemployment soared. The result was the breaking of the wage-price spiral to the detriment of workers and inflation came down precipitously. This was not due to a financial crisis, which is not to say financial problems did not occur.
I know Warren Mosler has argued that gas prices were deregulated at the time and contributed to the decrease in inflation. Frankly this has always sounded to me like a single variable explanation for a more complex situation.
Randall Wray once said to me that it seemed like an interest rate increase of about 4%, all else equal, would begin to have negative macro effects notwithstanding the increase in income provided by higher interest rates from government bonds. It seems to me we are approaching that now...
I am taking a broader definition of “financial crisis” in that text. If I were to expand it, I would add more nuance. In the early 1980s, banking systems did have a lot of strains, since they were not even close to hedged. More generally, the real estate sector is going to be ground zero for interest rate sensitivity, and they are de facto part of the financial sector.
I think Warren attributes the fall in inflation during Volker era to more than one thing.:Falling gas prices , falls in other commodity prices, and Carter ensuring fiscal deficit fell. Am I mistaken?