Are we back to the era of the “Volcker shock”? This is the question being asked by people worldwide as the pursuit of a credible inflation management framework heightens the risk of mass unemployment and a global recession.
Named after former Federal Reserve chair Paul Volcker, “The Shock” is a reference to the rapid rise in lending rates and seven quarters of negative growth that followed in the US economy between 1981 and 1982. It was a shock that not only caused thousands of manufacturing jobs to be lost, but according to University of Chicago economic historian Jonathan Levy “induced a recession [that] purged all sorts of unprofitable fixed capital and shifted capital investment into financial forms”.
The high interest and strong currency environment weakened the competitiveness of exports and made it difficult for firms to repay debt or borrow for new investment. Weakened consumer demand due to the hollowing out of the middle segment of the labour market was an added drag on profitability, a key determinant of fixed investment.
According to Levy, the Volcker shock gave rise to declining rates of investment in the type of fixed assets that create manufacturing jobs, and boosted demand for employment in social reproductive tasks such as home-based care, domestic and hospitality work.
In the past 40 years we have seen increasing financialisation of not just the US but even the SA economy. Does this mean the implications for jobs and growth in the even more integrated current global economy, which can transmit inflation beyond nation-state boundaries, might be more severe this time around? One can only speculate. The Volcker shock in a country as unequal as ours will undoubtedly have significant implications.
Two consecutive 75 basis point hikes in the lending rate suggest SA may be well on its way in that direction. Reserve Bank governor Lesetja Kganyago seems to think we are “at” rather than “behind” the curve, suggesting that since the late 1970s the art of central banking has become no different to replicating and anticipating the moves of the US Fed and complementing that with some shocks to the “gap” model.
Engaging drivers
At this stage, the gap model, and Fed chair Jerome Powell’s corps, are suggesting that regardless of the war in Ukraine and supply chain-driven causes of inflation the Fed “anticipates that ongoing increases in the target range will be appropriate”. The SA Reserve Bank’s monetary policy committee will undoubtedly follow suit, and we will not be spared the economic implications of this course of action.
How SA responds must also be informed by engaging the drivers of inflation that can be publicly controlled, but also balancing the trade-offs associated with the aggressive inflation management approach our central bank has adopted. While we cannot control the war talk in Europe, there are areas we can control but are seemingly subject to a reluctance to provide political guidance to state price-setting.
It was reassuring to see the short-term price management of the regulated fuel price earlier this year, despite the limitations and ultimate end of the fuel price reprieve. But fuel prices are not the only ones that are publicly set. How regulators and state-owned firms set electricity, port, rail, water and other tariffs, and how the path of macro-fiscal subsidies influences passenger rail and subsidised bus services, has to be part of any credible strategy to manage inflation and ease the cost of living crisis afflicting SA households and firms.
Without this, the “smash and burn” approach of hiking lending rates, by 1.5 percentage points in just two meetings, will worsen our problems, which predated the Ukraine-Russia crisis and Covid-19. The fallout from the shock in SA may be more severe than when Jimmy Carter and Ronald Reagan’s hatchet man gave the US economy the medicine that changed central banking and the sectoral composition of the US economy forever.
• Cawe, a development economist, is MD of Xesibe Holdings and hosts MetroFMTalk on Metro FM.
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