Volcker Shock - Federal Reserve Raises Rates to 20%, Recession Begins

On October 6, 1979, Federal Reserve Chairman Paul Volcker announced dramatic steps to combat inflation, fundamentally transforming monetary policy by switching from targeting interest rates to targeting the money supply. Appointed by President Jimmy Carter in August 1979 to replace William Miller, Volcker took office amid stagflation—a combination of slow economic growth and high inflation that had reached 14% by 1980, up from just 1% in 1965. Volcker’s radical policy shift raised the federal funds rate from an average of 11.2% in 1979 to a peak of 20% in June 1981, while the prime rate rose to 21.5% in 1981. These were historically unprecedented interest rates designed to break inflationary expectations by crushing economic activity.

The Volcker Shock successfully reduced inflation, which fell from a peak of 14.8% in March 1980 to below 3% by 1983. However, the aggressive rate increases triggered two severe recessions in 1980 and 1981-1982, causing significant economic contraction with GDP declining sharply. Unemployment peaked at approximately 10.8% in 1982 as high interest rates destroyed businesses and jobs across manufacturing and construction sectors. The policy also sparked debt defaults among developing countries in Latin America that had borrowed in U.S. dollars, creating a global debt crisis. The intentional recession was designed to discipline labor and break union bargaining power by creating a massive pool of unemployed workers desperate for any job at any wage.

The Volcker Shock marked a decisive turning point in the class war dimension of American economic policy, deliberately using recession and mass unemployment as tools to suppress wages and worker organizing. While framed as necessary medicine to cure inflation, the policy represented a conscious choice to make working people bear the costs of economic stabilization through job loss and wage stagnation rather than using alternative approaches like wage-price coordination, industrial policy, or progressive taxation. The shock restored Federal Reserve credibility with financial markets by demonstrating willingness to impose brutal austerity regardless of human costs, laying the groundwork for the Federal Reserve’s role as enforcer of capital discipline over labor. Combined with Reagan’s union-busting and deregulation agenda that began in 1981, the Volcker Shock helped cement the neoliberal transformation of American capitalism, shifting power decisively from workers to capital, from manufacturing to finance, and establishing unemployment as an acceptable policy tool for controlling inflation—a doctrine that would guide monetary policy for the next four decades.