How Gen X, millennials and Gen Z became the low-inflation generations

Paul Volcker stepped down as Federal Reserve chairman in 1987, but his legacy continued to shape the views of generations of Americans up until his death Sunday - and seems likely to continue to do so for the foreseeable future.

For millennials, Gen Z and Gen X, the risk of inflation posing a severe risk to the economy - and interest rates on things like home loans reaching double digits - barely registers.

But before Volcker's tenure, inflation -- or the annual change in the price of goods and services - was, at times, a scourge on American life. In the 1970s and early 1980s, when many baby boomers entered the labor market, it was normal for prices on everything from cookies to coal to rise 10% percent or more each year.

"An entire generation of young adults has grown up since the mid-1960′s knowing only inflation, indeed an inflation that has seemed to accelerate inexorably," Volcker said in 1979. "Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations," he added later.

To break the cycle, Volcker hoisted interest rates to around 20% and kept them high in the face of extraordinary public pressure and, in rapid succession, two recessions.

As a result, he not only broke inflation's back but seemed to cripple it forever.

Today's workforce barely remembers Volcker's titanic showdown with rising prices. Fewer than a quarter of today's working-age Americans were over age 18 at the time - and they're all baby boomers.

"There's a generation of both people and economic analysts who never experienced the monster that Volcker slayed," said Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities who served as chief economist to Vice President Joe Biden.

Overall, 6 in 10 working-age Americans haven't even seen inflation above 4%. A quarter of them haven't even seen a sustained stretch above 3%.

Pile it up for enough years and slow price growth becomes self-perpetuating. Compared with folks who lived through high inflation, those who experienced less inflation during their life will expect inflation to be lower in the future - even if they're looking at the same economy, according to an analysis of responses to the University of Michigan's long-running survey of consumers by economists Ulrike Malmendier of the University of California at Berkeley and Stefan Nagel of Stanford University.

For example, during the Volcker era, the inflation expectations of young Americans soared relative to those of their older peers who entered the workforce when inflation was lower. Those older peers had watched prices grow modestly during the 1950s and 1960s and lowered their expectations accordingly, Malmendier and Nagel write. Their widely cited study was published in the Quarterly Journal of Economics.

Since 1982, Americans' expectations for inflation in the year ahead have settled into a narrow band around 2 and 3%, a far cry from the double-digit levels they hit early in Volcker's term, according to that same Michigan survey.

It makes sense that adults today would pay much less - if any - attention to inflation compared to older Americans who came of age during economically volatile times, said Emi Nakamura, a UC-Berkeley economist whose research on prices recently helped earn her the John Bates Clark Medal awarded yearly to a top economist under age 40. That shift eases pressure on the Fed, Nakamura said, because even where there are deviations from the target of 2%, people's broad expectations are still very anchored.

"It puts the Fed in a very nice position in terms of not having to worry about very rapid changes in inflation expectations," Nakamura said.

"The fact is essentially that this goal of achieving stable inflation has been achieved," she added. "And I think most people attribute a large part of what happened to the tenure of Volcker."

Painful as it was at the time, Volcker's approach "opened the door for much longer, moderate expansions," said Diane Swonk, chief economist at the professional services firm Grant Thornton. More sustained periods of growth allowed Americans who hadn't benefited from shorter bursts of prosperity to get ahead.

"There are many problems in the broader economy, but long expansions are a gift," Swonk said. "Paul Volcker hit the reset button. "

Beyond just slashing inflation, Volcker upended many of the rules that had governed economic policy for years. For example, Bernstein said that in Volcker's day, an unemployment rate below 6% would kick-start worries about spiraling inflation. That was because economists worried that a competition for scarce workers would drive up wages, which would be passed on to consumers in the form of higher prices. The cycle would escalate until it pushed the economy into recession, they feared.

"Then six became five, five becomes four, and now, to be honest, we really don't know the lowest unemployment rate that's consistent with stable prices," Bernstein said. He noted that current Fed Chair Jerome Powell has often said that the central bank doesn't really know what full employment, or the situation in which almost everyone who wants a job has one, looks like.

The Fed has now mulled how far to let inflation rise. It has suggested in recent years that it is comfortable with a 2% inflation rate, but even that has been hard to achieve. Some argue that the Fed's preoccupation with inflation has made it less sensitive to the need to stimulate the economy and continue to drive down unemployment by keeping interest rates low and lending cheap.

"It's hard for people today to imagine inflation being a factor in their economic lives because we don't have any now, and nobody thought that was possible in 1979 when Volcker became chairman," said David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution.

"When Paul Volcker became Fed chairman, who could imagine a headline that says 'Federal Reserve trying to raise the inflation rate, and failing," Wessel said.

"The notion that it no longer enters into people's decision-making is a major change," Wessel said.

- - -

A note on methods: When we talk about how generations experienced inflation, we're measuring annual change in the average consumer price index for years ending in June to match Census Bureau population estimates . The numbers would be lower if you strip out the volatile categories such as food and gasoline, or if you used the Fed's preferred measure of inflation, based on personal consumption expenditures . This measure doesn't go back as far as CPI, which makes it harder to use for generational comparisons.

Sign up for the daily JWR update. It's free. Just click here.