What Led to the High Interest Rates of the 1980s? (2024)

FAQs

What Led to the High Interest Rates of the 1980s? ›

The reason interest rates, which ultimately are set by the Federal Reserve, exploded in 1980 was housings' arch nemesis, runaway inflation. The Fed funds rate, which is the rate banks charge each other for overnight loans, hit 20 percent in 1980, and 21 percent in June 1981.

The fed funds rate has never been as high as it was in the 1980s. The main reason is because the Fed wanted to combat inflation, which soared in 1980 to its highest level on record: 14.6 percent.

As we headed into the 80s, it's important to note that the country was in the middle of a recession, largely caused by the oil crises of 1973 and 1979. The second oil shock caused skyrocketing inflation. The cost of goods and services rose, so fittingly, mortgage rates did too.

The 12.5-percent increase in prices in 1980 was, like that in 1979, due primarily to increases in the food, shelter, and energy components, which accounted for more than two-thirds of the 1980 rise in the overall CPI.

In the 1980s, the financial sector suffered through a period of distress that was focused on the nation's savings and loan (S&L) industry. Inflation rates and interest rates both rose dramatically in the late 1970s and early 1980s.

When inflation is high, the government raises rates to deter borrowers from taking loans in an effort to reduce spending. The current price of goods might skyrocket by the time the borrower pays it back. This will reduce the lender's purchasing power. When the demand for credit is high, so are interest rates.

These factors included the large federal budget deficit, compara- tively volatile interest rates, and high inflation expectations. The large federal budget deficit put upward pres- sure on interest rates in 1983. Federal borrowing amounted to $212.4 billion in fiscal 1983, $77.5 billion more than in 1982.

In the case of the early 1990s recession, the causes were broadly linked to the excessive borrowing and spending during the 1980s, which prompted sharp rises in inflation and interest rates.

“However, the current housing market is similar to the market of the 1980s. History doesn't repeat itself, but it often rhymes.” He continued: “Home prices surged by over 14% in 1978, then flatlined as year-over-year growth slowed to just 1 percent by 1982.

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.

How much is a 1980 dollar worth today? ›

According to the Official Data Foundation, $1 from 1980 is worth $3.79 in purchasing power today. That means a dollar today buys only about 26% of what it could buy back in 1980.

The boom in high-yield corporate bonds in the 1970s and the 1980s was largely due to what was called fallen-angel companies.

1980s mortgage rate trends

Spurred by the Great Inflation, the 30-year fixed mortgage rate reached a pinnacle of 18.4 percent in October 1981, according to Freddie Mac. Once the Fed reined in inflation, the 30-year rate seesawed down to the 9 percent range, closing the decade at 9.78 percent.

An unprecedented increase in April tax payments and heightened uncertainty over corporate tax flows at other times during the year contributed to the volatility and uncertainty surrounding Treasury cash balances; tax flow patterns were distorted by adjustments to the Tax Reform Act of 1986.

Savings & Loan Crisis

Among those jailed were Charles Keating Jr., whose Lincoln Savings and Loan cost taxpayers $3.4 billion, and David Paul, who was sentenced to 11 years in prison for his role in the $1.7 billion collapse of Centrust Bank.

Inflation fell but was still high even as the economy recovered in the second half of 1980. But the Volcker Fed continued to press the fight against high inflation with a combination of higher interest rates and even slower reserve growth.

Lasting from July 1981 to November 1982, this economic downturn was triggered by tight monetary policy in an effort to fight mounting inflation. Prior to the 2007-09 recession, the 1981-82 recession was the worst economic downturn in the United States since the Great Depression.