Prior to the 2007-09 recession, the 1981-82 recession was the worst economic downturn in the United States since the Great Depression. Indeed, the nearly 11 percent unemployment rate reached late in 1982 remains the apex of the post-World War II era (Federal Reserve Bank of St. Louis). Unemployment during the 1981-82 recession was widespread, but manufacturing, construction, and the auto industries were particularly affected. Although goods producers accounted for only 30 percent of total employment at the time, they suffered 90 percent of job losses in 1982. Three-fourths of all job losses in the goods-producing sector were in manufacturing, and the residential construction industry and auto manufacturers ended the year with 22 percent and 24 percent unemployment, respectively (Urquhart and Hewson 1983, 4-7).
The economy was already in weak shape coming into the downturn, as a recession in 1980 had left unemployment at about 7.5 percent. Both the 1980 and 1981-82 recessions were triggered by tight monetary policy in an effort to fight mounting inflation. During the 1960s and 1970s, economists and policymakers believed that they could lower unemployment through higher inflation, a tradeoff known as the Phillips Curve. In the 1970s, the Fed pursued what economists would call “stop-go” monetary policy, which alternated between fighting high unemployment and high inflation. During the “go” periods, the Fed lowered interest rates to loosen the money supply and target lower unemployment. During the “stop” periods, when inflation mounted, the Fed would raise interest rates to reduce inflationary pressure. However, the Phillips Curve tradeoff proved unstable in the long-run, as inflation and unemployment increased together in the mid-1970s. While unemployment trended down slightly by the end of the decade, inflation continued to rise, reaching 11 percent in June 1979 (Federal Reserve Bank of St. Louis).
Paul Volcker was appointed chairman of the Fed in August 1979 in large part because of his anti-inflation views. He had previously served as president of the New York Fed and had dissented from Fed policies he regarded as contributing to inflation expectations. He felt strongly that mounting inflation should be the primary concern for the Fed: “In terms of economic stability in the future, [inflation] is what is likely to give us the most problems and create the biggest recession” (FOMC transcript 1979, 16). He also believed that the Fed faced a credibility problem when it came to keeping inflation in check. During the previous decade, the Fed had demonstrated that it did not place much emphasis on maintaining low inflation, and public expectation of such continued behavior would make it increasingly difficult for the Fed to bring inflation down. “[F]ailure to carry through now in the fight on inflation will only make any subsequent effort more difficult,” he remarked (Volcker 1981b).
Goodfriend, Marvin, and Robert G. King. “The Incredible Volcker Disinflation.” Journal of Monetary Economics 52, no. 5 (July 2005): 981-1015.
Board of Governors of the Federal Reserve System. “Transcript, Federal Open Market Committee Meeting.” April 17, 1979, http://www.federalreserve.gov/monetarypolicy/files/FOMC19790417meeting.pdf.
Federal Reserve Bank of St. Louis. “Federal Reserve Economic Data (FRED).” Accessed October 29, 2013, http://research.stlouisfed.org/fred2/.
Federal Reserve’s Second Monetary Policy Report for 1982, Hearings before the Committee on Banking, Housing, and Urban Affairs, United States Senate, 97th Cong. (July 1982).
Schreft , Stacey L. “Credit Controls: 1980.” Federal Reserve Bank of Richmond Economic Review 76, no. 6 (November/December 1990): 25-55.
Urquhart, Michael A., and Marillyn A. Hewson. “Unemployment Continued to Rise in 1982 as Recession Deepened.” Bureau of Labor Statistics Monthly Labor Review, February 1983.
Volcker, Paul A., “Dealing with Inflation: Obstacles and Opportunities,” Remarks at the Alfred M. Landon Lecture Series on Public Issues, Kansas State University, Manhattan, KS, April 15, 1981a, https://fraser.stlouisfed.org/scribd/?item_id=8236&filepath=/files/docs/historical/volcker/Volcker_19810415.pdf.
Volcker, Paul A., “No Time for Backsliding,” Remarks to the National Press Club, Washington, DC, September 25, 1981b, https://fraser.stlouisfed.org/scribd/?item_id=8243&filepath=/files/docs/historical/volcker/Volcker_19810925.pdf.
Written as of November 22, 2013. See disclaimer.