Fighting inflation over the next 18 months could bring the same kind of pain it did in the 1980s: fewer jobs and expensive borrowing

• Inflation is starting to cool down, but the precedent set by the 1980s suggests the path forward will be a long and painful one.
• The Federal Reserve expects price growth to close in on its 2% target by the end of 2023.

The US might be over the inflation mountain, but if history is anything to go by, the path back to normal will be a long and treacherous one.

Prices have been rising at a faster-than-usual pace for a year and a half. Supply-chain tangles, geopolitical tensions, and extraordinary demand from Americans led firms to boost prices and lift inflation to the fastest pace since 1981.

Despite being four decades old, the inflation of the early 1980s teaches many lessons about what the next several months have in store. Chief among them: the return to normal price growth will still bring some economic pain.

After emphasizing for months that pandemic-era inflation was "transitory," the Federal Reserve stepped in to cool the surge in early 2022 by rapidly lifting interest rates to slow the economy down.

Progress has, so far, been encouraging. The year-over-year inflation rate slowed in July to 8.5%, according to the Consumer Price Index, offering Americans the first sign that the worst of the price surge was behind them. Gas, vehicle, and commodity prices continued to fall through August, signaling the next CPI print will come in even lower.

Policymakers broadly expect inflation to slow from here on out. Projections from the Fed see inflation easing to a 5.2% year-over-year pace through December and landing just above its 2% target at the end of next year.

If the forecasts hold true, the inflation cooldown will last 17 months, the same amount of time it took for price growth to crest. Yet precedent suggests the recovery won't be without its pitfalls. The inflationary spell of the 1970s and early 1980s was the last time Americans endured such crippling price surges, and the discomfort they felt through that cooldown hints at what households will experience over the next year and a half.

"We're past the hysterical stage and now we've just got to live with it," Mark Cohen, the director of retail studies at the Columbia Business School, told Insider. "It's what we've had to do — and have successfully done — in the past."

Brace for 'pain' on the way to normal

Fed Chair Jerome Powell put it plainly in August 26 remarks: the cooldown is going to hurt.

"While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses," he said. "But a failure to restore price stability would mean far greater pain."

The forecast, included in Powell's annual speech at the Fed's symposium in Jackson Hole, Wyoming, sums up the awkward spot the central bank finds itself in. Higher interest rates are the Fed's go-to weapon for fighting inflation, but one can't rapidly hike rates without some serious tradeoffs.

The labor market will feel the brunt of the it. Data out Tuesday showed job openings still exceeding available workers by two-to-one, extending a months-long trend of extreme imbalance in the job market. There will "very likely be some softening" in workforce conditions, Powell said, since that gap between worker supply and demand stands to keep inflation high.

The early 1980s saw massive layoffs and hiring slowdowns as the Fed, then chaired by Paul Volcker, aggressively lifted rates and hit the brakes on the economy. The unemployment rate nearly doubled from 5.6% to 10.8% between 1979 and 1982, giving a hint of what might come as the central bank once again combats sky-high inflation.

Volcker's example suggests that taking the employment hit earlier is better than waiting, Powell said. The inflation cooldown of the early 1980s followed several more modest attempts to curb price growth through the 1970s, and that delay required the Fed to lift rates to record levels — and trigger a recession — to finally defeat inflation. Powell indicated he aims to "avoid that outcome by acting with resolve now," but some labor market damage is inevitable.

"Until we start to see some significant job losses, it's going to be very difficult to cool the labor market," Christopher Schwarz, a professor of finance at the University of California Irvine, told Insider.

The inflation rate is falling, but some prices are still on the rise

The July inflation report showing inflation slowing down was encouraging, but it doesn't mean Americans are about to be pummeled by a barrage of discounts.

A slower inflation rate, meaning a slowdown in price hikes across many items, is welcome news, but only a few items in the CPI basket actually got cheaper that month. Prices for food, electricity, new vehicles, medical care, and housing all rose through July, and it was mainly a large decline in gas prices that pulled the headline rate lower.

The next 17 months are likely to look similar. Inflation is historically more volatile for food and energy prices, while prices for manufactured and packaged goods tend to rise at a steady, if usually slower, pace.

The recent CPI slowdown mirrored the decline that happened when the oil crisis of the 1970s calmed down. But just as some items kept getting more expensive through the 1980s, some goods and services won't see any discounts in the months ahead.

"Things get cheaper at the pump and in some parts of the grocery store, but price reductions don't become widespread," Columbia's Cohen said.

Higher rates will also make some large-scale purchases less affordable. The Fed's rate hikes have made mortgages, loans, and credit-card debt significantly more expensive than they were at the end of last year.

The housing market in particular will be in a tricky place. Price growth slowed broadly throughout the summer as buyer demand evaporated. Yet even if home prices start to decline — they already have in some cities — higher mortgage rates present a new hurdle for prospective buyers. Shoppers looking for a deal already have to foot a much larger bill for their monthly mortgage payment, offsetting any benefit that comes from falling home prices.

The news isn't all bad. Despite inflation needing to fall from four-decade highs, the downtrend should be faster than that seen after the early 1980s. Demographics are partially to thank, Schwarz said. The wave of household formation as the Baby Boomer generation entered their prime working and family-raising years in the early 1980s spurred massive demand at a time when the economy needed less spending. Today's population is an aging one, and that will allow inflation "to be cooled a lot faster than it was back in the 1980s," Schwarz said.

The unusual nature of the pandemic economy and its recovery could also lend a hand. Inflation soared higher in 2021 "faster than most predicted," powered by a nationwide reopening, record stimulus, and pent-up demand from months of lockdown, Cohen said. That's now working in the opposite direction. As long as the US can avoid shocks like a new virus variant or global trade snags, the fast-paced nature of pandemic-era economic shifts could be a boon over the next several months, the professor said.

"The velocity of change is greater than what was observed in the past," Cohen added. "That was bad news three months ago, but good news today. Now let's see if it lasts."