Commentary > Editorials
Bring Back The Old Paul Volcker
By Patrick Barron, For The Bulletin
Former Federal Reserve Bank Chairman Paul Volcker is an economic adviser to President Barack Obama. President Jimmy Carter appointed Mr. Volcker toward the end of his one-term presidency in the late 1970s when inflation and unemployment were in double-digit figures. This development should have spelled the end of Keynesian economic policy, which denied that such a thing could happen. According to the Keynesians, inflation and unemployment were “tradeoffs,” not complementary events. When prices rose to levels not acceptable to the public, the Fed could raise interest rates — slowing down the overheated economy and causing marginal businesses to fail. Unemployment would rise but prices would fall. When the public threatened to punish the political party in power for causing high unemployment, the Fed would pump up the money supply, which would drive down interest rates and spur another economic boom.
Unemployment would fall and, for a time, prices would remain stable. Eventually prices would start to rise again, and the Fed would start its machinations all over again. The Keynesians called this “fine tuning” the economy, and it seemed to work … for awhile.
But by the middle of the 1970s, the U.S. started to experience a phenomenon called stagflation, whereby both unemployment and inflation rose in tandem. The Fed was stumped. Our European allies, especially, became alarmed. The Soviet Union was building and deploying new ballistic missiles in what appeared to be a challenge to American nuclear superiority and a threat to our ability to protect both Europe and America. They demanded that the U.S. get its economy straightened out and that meant finding a Fed chairman with whom they had confidence. One man met that description — the president of the New York Fed, Paul Volcker.
Mr. Volcker’s prescription was simple yet harsh. He would end monetary expansion. He would no longer monetize the government’s debt or target the Federal Funds rate, the rate of interbank overnight borrowing of bank reserves. By ceasing the expansion of bank reserves — the so-called monetary base — businesses that could survive only through ever-expanding credit would fail. Interest rates rose and rose. When asked how far interest rates would rise, Fed Chairman Volcker replied that he did not know, that no one knew. Just as predicted, marginal businesses started to fail and unemployment rose higher yet, but this time the Fed did not reverse course. With Paul Volcker at the helm, the Fed allowed the economy to liquidate those businesses that could survive only through ever-greater credit expansion. The Prime Rate, the rate banks charge their very best business customers, went to 20 percent for a time! Unemployment remained very high. Ronald Reagan, running against Mr. Carter in the 1980 presidential election, dubbed the sum of adding the inflation rate to the unemployment rate as the “misery index.” Reagan crushed Mr. Carter at the polls.
But then a curious thing started to happen. Both the interest rate and the unemployment rate started to fall. Again, this development baffled the Keynesians. Reagan began his program of trimming non-defense spending and Congress had little choice. Since Mr. Volcker was not “monetizing” the government’s debt, meaning it was not printing money and handing it to the government in exchange for government bonds, Congress could not spend without causing the interest rate, which was no longer manipulated by the Fed, to rise and touch off another recession. Reagan won budget battle after budget battle, primarily because Paul Volcker would not expand the money supply to accommodate government’s increased spending. The rest, as they say, is history. American industry became lean and productive. GNP went to new heights. The inflation rate fell to almost zero. The Soviet Union collapsed — its shot at world domination thwarted by America’s military buildup and the resolve of Reagan, British Prime Minister Margaret Thatcher and Pope John Paul II.
Unfortunately, Paul Volcker was not re-appointed Fed chairman. Why? Probably because Congress knew that his policies spelled the end of its spendthrift ways and let it be known that they would not confirm his reappointment. Eventually the Fed’s new chairman, Alan Greenspan, quietly ended Mr. Volcker’s experiment with monetary non-intervention and returned Fed policy to setting targeted interest rates. Now, policy wise, we are back in the 1970s, maybe the 1930s!
Mr. Volcker knows how to build a strong, inflation free economy. A key, perhaps THE key, is ending monetary expansion. Without monetary expansion, Congress cannot spend and spend without it becoming obvious that it is crowding out private investment. Mr. Volcker knows this policy works.
He now is an economic adviser to President Obama. But … does an aging Paul Volcker have the courage to recommend that the government reprise his policies of the late 70s/early 80s? So far he has remained quiet, at least publicly. Mr. Volcker should demand publicly that the administration adopt his policies that ended stagflation 30 years ago. If it does not, he should resign and form a Shadow Open Market Committee to criticize Fed expansionist policies. He should do this for the same reason that his actions put the U.S. economy through such trying times 30 years ago — because his loyalty is to America and the world and not to any individual or political party. For all our sakes, I hope he does. He saved the American economy once. He can do it again.
Patrick Barron is a consultant to the banking industry and lives in Pennsbury Township, Chester County. He can be reached at PatrickBarron@msn.com.
Unemployment would fall and, for a time, prices would remain stable. Eventually prices would start to rise again, and the Fed would start its machinations all over again. The Keynesians called this “fine tuning” the economy, and it seemed to work … for awhile.
But by the middle of the 1970s, the U.S. started to experience a phenomenon called stagflation, whereby both unemployment and inflation rose in tandem. The Fed was stumped. Our European allies, especially, became alarmed. The Soviet Union was building and deploying new ballistic missiles in what appeared to be a challenge to American nuclear superiority and a threat to our ability to protect both Europe and America. They demanded that the U.S. get its economy straightened out and that meant finding a Fed chairman with whom they had confidence. One man met that description — the president of the New York Fed, Paul Volcker.
Mr. Volcker’s prescription was simple yet harsh. He would end monetary expansion. He would no longer monetize the government’s debt or target the Federal Funds rate, the rate of interbank overnight borrowing of bank reserves. By ceasing the expansion of bank reserves — the so-called monetary base — businesses that could survive only through ever-expanding credit would fail. Interest rates rose and rose. When asked how far interest rates would rise, Fed Chairman Volcker replied that he did not know, that no one knew. Just as predicted, marginal businesses started to fail and unemployment rose higher yet, but this time the Fed did not reverse course. With Paul Volcker at the helm, the Fed allowed the economy to liquidate those businesses that could survive only through ever-greater credit expansion. The Prime Rate, the rate banks charge their very best business customers, went to 20 percent for a time! Unemployment remained very high. Ronald Reagan, running against Mr. Carter in the 1980 presidential election, dubbed the sum of adding the inflation rate to the unemployment rate as the “misery index.” Reagan crushed Mr. Carter at the polls.
But then a curious thing started to happen. Both the interest rate and the unemployment rate started to fall. Again, this development baffled the Keynesians. Reagan began his program of trimming non-defense spending and Congress had little choice. Since Mr. Volcker was not “monetizing” the government’s debt, meaning it was not printing money and handing it to the government in exchange for government bonds, Congress could not spend without causing the interest rate, which was no longer manipulated by the Fed, to rise and touch off another recession. Reagan won budget battle after budget battle, primarily because Paul Volcker would not expand the money supply to accommodate government’s increased spending. The rest, as they say, is history. American industry became lean and productive. GNP went to new heights. The inflation rate fell to almost zero. The Soviet Union collapsed — its shot at world domination thwarted by America’s military buildup and the resolve of Reagan, British Prime Minister Margaret Thatcher and Pope John Paul II.
Unfortunately, Paul Volcker was not re-appointed Fed chairman. Why? Probably because Congress knew that his policies spelled the end of its spendthrift ways and let it be known that they would not confirm his reappointment. Eventually the Fed’s new chairman, Alan Greenspan, quietly ended Mr. Volcker’s experiment with monetary non-intervention and returned Fed policy to setting targeted interest rates. Now, policy wise, we are back in the 1970s, maybe the 1930s!
Mr. Volcker knows how to build a strong, inflation free economy. A key, perhaps THE key, is ending monetary expansion. Without monetary expansion, Congress cannot spend and spend without it becoming obvious that it is crowding out private investment. Mr. Volcker knows this policy works.
He now is an economic adviser to President Obama. But … does an aging Paul Volcker have the courage to recommend that the government reprise his policies of the late 70s/early 80s? So far he has remained quiet, at least publicly. Mr. Volcker should demand publicly that the administration adopt his policies that ended stagflation 30 years ago. If it does not, he should resign and form a Shadow Open Market Committee to criticize Fed expansionist policies. He should do this for the same reason that his actions put the U.S. economy through such trying times 30 years ago — because his loyalty is to America and the world and not to any individual or political party. For all our sakes, I hope he does. He saved the American economy once. He can do it again.
Patrick Barron is a consultant to the banking industry and lives in Pennsbury Township, Chester County. He can be reached at PatrickBarron@msn.com.
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