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Wednesday, April 23, 2014
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Published: 7/24/2005

Interest-rate turmoil, a quarter-century ago and now

These are nervous times for consumers and business owners. We re all adjusting to the transition from 45-year interest-rate lows to a pattern of steadily increasing rates, being bumped up a quarter of a point at a time by the Federal Reserve.

This complicates the task of planning for the future.

Where will interest rates top out?

Should a small-business owner buy equipment now and take a chance the economy will improve enough to justify the expense?

Should a homeowner continue to tap a home-equity line, knowing the relatively benign rate now could turn into a monster if interest rates start raging?

But what we re going through now is just a ripple compared with the flood of interest-rate changes a quarter of a century ago, in 1980, when banks changed the prime rate the rate for their most credit-worthy customers 39 times.

The Fed tacked on rate surcharges a couple of times during that tumultuous year, and the prime rate soared to 20 percent early in April, dropped back in the summer, and then shot up to a record 21.5 percent just before Christmas.

Rates for 30-year mortgages rose to nearly 17 percent nationwide, and above 18 percent in some areas.

And savers never had it better, or so it seemed: Interest on three-month certificates of deposit topped 15 percent at times during 1980, but that was mostly gobbled up by inflation, which was double-digit most of the year, topping out at over 18 percent on an annual basis.

By comparison, things look positively heavenly now. The prime is at 6.25 percent, and even if Alan Greenspan and his Federal Reserve colleagues vote for the three or four more increases that experts expect for the rest of 2005, the rate could end the year at 7 percent or just over.

The average 30-year mortgage interest rate is 5.75 percent. And inflation is still in the low single digits (about 3 percent annually in recent months), despite high oil prices.

On July 24, 1980, exactly 25 years ago, many Americans breathed a sigh of relief when the prime rate dropped to just under 11 percent for the first time in 21 months.

They thought the ordeal was over, but it turned out to be just the calm between storms. Within a few months the prime rate was back over 20 percent.

In the late 1970s and early 1980s, Americans and the government were grappling with rampant inflation and an overheated economy.

And they were confused by mixed signals. From month to month and quarter to quarter, the economy seemed to be booming, or crashing.

The hot economy was followed by a rapid cool-down, and a recession in the second quarter of 1980 the gross national product fell 9 percent. Unemployment topped 7 percent.

By mid-year thousands of small-business owners were complaining that the credit squeeze caused by high interest rates was killing them. Big businesses, it seemed, just kept on borrowing, no matter what the rate.

Adding to the misery of 1980 was the 444-day Iranian hostage crisis that weighed heavily on the minds of most Americans.

It took several years to put the economy back on an even keel, but by the summer of 1982 at least one important segment was recovering nicely: The stock market bottomed out and started what would eventually become the greatest bull market ever (lasting until early 2000).

The credit for knocking down inflation and restoring sanity to the financial world goes to several people, chiefly Paul Volcker, Mr. Greenspan s predecessor as chairman of the Fed.

It was Mr. Volcker s tough tight-money policies that drove interest rates sky high and forced a nasty but needed recession.

The much-maligned President Carter who got a lot of blame for the country s economic woes was, ironically, the man who chose Mr. Volcker for the Fed job in 1979.

And the late President Reagan also deserves credit for giving Mr. Volcker the right of way in monetary policy (even though Mr. Volcker was at least a nominal Democrat), and encouraged him to stay the course.

It took a lot of powerful medicine to make the country well a quarter of a century ago.

We re taking our medicine now, too in small doses. Hopefully we ll feel better in a few months.



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