Contributor Post Created with Sketch. Paul Volcker, R.I.P.

 

Paul Volcker died today at age 92. A colossus of a man both physically (at 6’7″) and professionally, it sometimes seemed to me his achievements at the Federal Reserve were eclipsed by “maestro” Alan Greenspan who succeeded him in 1987. A full recounting of his career is impossible, of course, and he did much after leaving the Fed, a job he never asked for but served when asked.

In his biography of Greenspan, The Man Who Knew, Sebastian Mallaby notes that Volcker was deeply influenced by a speech in Belgrade in September 1979, weeks after his appointment. Arthur Burns gave the speech, a former Fed chair himself, who claimed that the independence of the Fed was over because monetary experts had too many questions to speak with one voice against political pressures. Mallaby argues that the desire to wring inflation out of the US system, characterized by the Saturday Night Special announcement that Fed policy was being fundamentally changed, was Volcker’s attempt to prove Burns wrong. (As I was writing this, Mallaby has released a version of this point in his retrospective of Volcker today.) Thus began the long disinflation that was the achievement of Volcker’s career.

Steve Hayward has provided an interesting excerpt from his biography of Reagan about Volcker’s reappointment in 1983. It’s worth reminding people that conflicts at the FED, so prevalent in today’s debates about economic policy, happened then too. The battle then, as now, turned partly on exchange rates which the Reagan administration wanted to manage through multilateral agreements including the Plaza Accord (July 1985, to manage a depreciation of the dollar versus the yen) and the Louvre Agreement (February 1987) in which then-Secretary of the Treasury James Baker had tried to push Japan and West Germany to stop the appreciation of their currencies. He was unsuccessful.

The Board of Governors was by this time fully appointed by Reagan and had in early 1986 actually voted 4-3 to cut rates with Volcker in the minority. Volcker was forced to go to Japan and Germany to get rate cuts there to coordinate, which weakened his position. It is quite clear to me that this was probably the end of any chance that Volcker would stay for a third term.

As Allan Meltzer notes in his magisterial History of the Federal Reserve,

[Baker] may not have understood that a central bank that targets an exchange rate cannot control money stock growth or domestic interest rates, but Volcker did. Volcker was reluctant to relinquish central bank independence that he had worked so diligently to restore. (p. 1191)

And it was important that this link be broken because a scant 19 months later, in October 1987, stock markets fell after interest rate increases had caused revaluation of asset prices. Exchange rates finally relented (the Deutschmark fell to 1.63 from 1.80 in the last quarter that year.) As Meltzer recounts, this gave the FED the ability to do what it does best: act as lender of last resort.

Markets did not function smoothly in the aftermath of the stock market decline. There was a scramble for liquid assets. The Federal Reserve satisfied the demand, helped markets to settle transactions, and prevented the devastating secondary effects of the 1929 stock market drop. Economic growth resumed after a brief pause. (p. 1193)

That period was the beginning of the Greenspan Fed, but the keys had been handed to him by Volcker. When in May 1988, candidate George H.W. Bush declared that “there is more room for the economy to grow without unacceptable increases in inflation,” Greenspan was determined to not let Volcker’s work be undone. They raised interest rates three months later, largely to the approval of the press and Wall Street. It would be two more years before a mild recession largely caused by a supply shock from the Middle East, and through it all, Greenspan protected the legacy of the Volcker disinflation.

Crossposted here.

Published in Economics
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  1. Gary McVey Contributor
    Gary McVey Joined in the first year of Ricochet Ricochet Charter Member

    A very intelligent post, KB, about something that I frankly don’t know enough about. Thanks. 

    • #1
    • December 9, 2019, at 4:50 PM PST
    • 3 likes
  2. Randy Webster Member

    King Banaian: Thus began the long disinflation that was the achievement of Volcker’s career.

    And he did such a wizard job of it. A dollar is worth 28% of what is was worth in 1979. If I was that successful in my job I’d be fired.

    • #2
    • December 9, 2019, at 5:35 PM PST
    • 3 likes
  3. The Reticulator Member

    Randy Webster (View Comment):

    King Banaian: Thus began the long disinflation that was the achievement of Volcker’s career.

    And he did such a wizard job of it. A dollar is worth 28% of what is was worth in 1979. If I was that successful in my job I’d be fired.

    That’s reasonably close to the rate that the current Fed is aiming for.

    • #3
    • December 9, 2019, at 6:13 PM PST
    • Like
  4. The Reticulator Member

    The Reticulator (View Comment):

    Randy Webster (View Comment):

    King Banaian: Thus began the long disinflation that was the achievement of Volcker’s career.

    And he did such a wizard job of it. A dollar is worth 28% of what is was worth in 1979. If I was that successful in my job I’d be fired.

    That’s reasonably close to the rate that the current Fed is aiming for.

    Oops. It’s not. Bad math.

    • #4
    • December 9, 2019, at 6:14 PM PST
    • 2 likes
  5. J Climacus Member

    Unfortunately, Greenspan lost his courage in the first years of this century and dropped interest rates all the way to 1%, permitting the massive expansion of debt and leveraged speculation that lead to the 2008 financial crisis. Since then interest rates stayed near zero (!) for years, in addition to the Fed embarking on several rounds of “quantitative easing” (i.e. money printing). We’ve got the predictable out of control debt and gross economic distortions as a result.

    But then, Central Banks always end up in this place sooner or later, so if it wasn’t Greenspan, it would have been someone else.

    • #5
    • December 9, 2019, at 7:25 PM PST
    • 4 likes
  6. King Banaian Contributor
    King Banaian

    Let’s do a little math @TheReticulator.

    Average inflation rate of the ten years prior to Volcker’s installation at the FED: 7.14% per year
    That rate compounded over forty years = 1582.8%
    Actual rate over last forty years combined = 248.7% (this is implied by your 29% number.)

    Could be better, sure. But let me ask you this: Would you rather have whatever $100 could buy in 1979, or whatever $29 could buy today? We use CPI or PCE as if we are discussing the same basket of goods forty years apart. There are many things in the basket we buy today that we could not possibly have bought in 1979, like this tablet I’m typing on. So how are we actually measuring zero inflation?

    • #6
    • December 9, 2019, at 8:00 PM PST
    • Like
  7. Al Kennedy Member
    Al Kennedy Joined in the first year of Ricochet Ricochet Charter Member

    Personally, I think Volker eclipsed Greenspan as a Fed Chairman. Here is a link to an excellent biography: https://www.amazon.com/Volcker-Persistence-William-L-Silber/dp/1608190706/ref=tmm_hrd_swatch_0?_encoding=UTF8&qid=1575956059&sr=8-6

    • #7
    • December 9, 2019, at 9:41 PM PST
    • Like
  8. The Reticulator Member

    King Banaian (View Comment):

    Let’s do a little math @TheReticulator.

    Average inflation rate of the ten years prior to Volcker’s installation at the FED: 7.14% per year
    That rate compounded over forty years = 1582.8%
    Actual rate over last forty years combined = 248.7% (this is implied by your 29% number.)

    Could be better, sure. But let me ask you this: Would you rather have whatever $100 could buy in 1979, or whatever $29 could buy today? We use CPI or PCE as if we are discussing the same basket of goods forty years apart. There are many things in the basket we buy today that we could not possibly have bought in 1979, like this tablet I’m typing on. So how are we actually measuring zero inflation?

    Yeah, my math was way off, as I quickly realized. But it doesn’t really matter to me if some things I can buy now weren’t available in 1979. I don’t like inflation when it makes the rich richer and the poor poorer, and I’m not necessarily talking about money and purchasing power.

    I should add that we were rather poor when we lived in St. Cloud while I was at SCSU (prior to 1979) but those were good years. I had quit my teaching job to go to grad school there, and we went without health insurance. It was something that was risky then and would be unthinkable now. Our second child was born while I was there.

    • #8
    • December 9, 2019, at 10:01 PM PST
    • 3 likes
  9. Randy Webster Member

    King Banaian (View Comment):

    Let’s do a little math @TheReticulator.

    Average inflation rate of the ten years prior to Volcker’s installation at the FED: 7.14% per year
    That rate compounded over forty years = 1582.8%
    Actual rate over last forty years combined = 248.7% (this is implied by your 29% number.)

    Could be better, sure. But let me ask you this: Would you rather have whatever $100 could buy in 1979, or whatever $29 could buy today? We use CPI or PCE as if we are discussing the same basket of goods forty years apart. There are many things in the basket we buy today that we could not possibly have bought in 1979, like this tablet I’m typing on. So how are we actually measuring zero inflation?

    You’re right. I back-figured the rate from what an inflation-calculation site said a 1979 dollar would buy today. But the basket isn’t totally incongruent. In 1973 my brother and I rented a very nice two bedroom apartment in Goodlettsville, TN (a suburb of Nashville) for $160/month. I doubt you could rent that apartment for $800 today.

    • #9
    • December 9, 2019, at 10:08 PM PST
    • 3 likes
  10. J Climacus Member

    It continues to amaze me that so many conservatives abhor government economic central planning, except in the singular case of Central Banking, where for some reason they celebrate it. As though when it comes to monetary policy central planners will magically have the wisdom and virtue they fail to show in every other instance of central planning. The history of the Federal Reserve shows that centrally planned money fails just like every other attempt at economic central planning, and for the same reasons: It’s impossible for the central planners to have the knowledge to be the Masters of the Universe they wish to be (an economy with millions of individual actors is far too complex for that), and even if they managed that, they end up being driven by political considerations in any case.

    • #10
    • December 10, 2019, at 4:24 AM PST
    • 2 likes
  11. Randy Webster Member

    The Reticulator (View Comment):

    Randy Webster (View Comment):

    King Banaian: Thus began the long disinflation that was the achievement of Volcker’s career.

    And he did such a wizard job of it. A dollar is worth 28% of what is was worth in 1979. If I was that successful in my job I’d be fired.

    That’s reasonably close to the rate that the current Fed is aiming for.

    I think the Fed shoots for 2% inflation, under the assumption that slow taxation by inflation is easier than raising tax rates.

    • #11
    • December 10, 2019, at 4:46 AM PST
    • 2 likes
  12. The Reticulator Member

    Randy Webster (View Comment):

    The Reticulator (View Comment):

    Randy Webster (View Comment):

    King Banaian: Thus began the long disinflation that was the achievement of Volcker’s career.

    And he did such a wizard job of it. A dollar is worth 28% of what is was worth in 1979. If I was that successful in my job I’d be fired.

    That’s reasonably close to the rate that the current Fed is aiming for.

    I think the Fed shoots for 2% inflation, under the assumption that slow taxation by inflation is easier than raising tax rates.

    Definitely easier. It doesn’t require a vote by elected officials. And, historically, inflation seems to be a regressive tax that protects the assets of most of the ruling class, so that makes it easier to enact, too.

    • #12
    • December 10, 2019, at 5:39 AM PST
    • 1 like
  13. Titus Techera Contributor

    This introduction of “what you can buy today” in the judgment of the worth of the dollar reveals, perhaps inadvertently, that this is all about political economy, where politics matters more than the economy, since politics is the end, economics the means.

    Which also means that thinking about money is not as important as thinking about how people want to live. The notion seems ridiculous to me that iPads &c. can make up for a country where 20-somethings don’t marry (first time in American history most adults are unmarried), don’t stay married, don’t have kids, feel forced to choose between living where there are jobs & living where they could afford to live, &c.

    What you can buy for your money has changed not just in the sense that now there’s new tech; also in the sense that a way of life people had the previous generation has disappeared quite suddenly; & owning property has been replaced, through tech, but silently, with renting access–your music, movies, cars, housing, & whatever else.

    • #13
    • December 10, 2019, at 7:04 AM PST
    • 3 likes
  14. RufusRJones Member

    Explain to me why anything should be going up in cost in a world where automation and globalized labor is destroying jobs and reducing wages.

    We need to worry about aggregate purchasing power and human capital development if this country is going to be successful. 

    • #14
    • December 10, 2019, at 7:09 AM PST
    • 1 like
  15. RufusRJones Member

    WHAT?

     

     

     

    • #15
    • December 10, 2019, at 7:23 AM PST
    • 1 like
  16. J Climacus Member

    RufusRJones (View Comment):

    Explain to me why anything should be going up in cost in a world where automation and globalized labor is destroying jobs and reducing wages.

    We need to worry about aggregate purchasing power and human capital development if this country is going to be successful.

    How does a loaf of bread cost more than it did 150 years ago, when agriculture was purely horse powered and the distribution system was horse and wagon? Farming is far more efficient than it was then, which helps to hide inflation since increasing efficiency tends to suppress prices. This typically isn’t mentioned when technological progress is used to justify inflation.

    • #16
    • December 10, 2019, at 9:22 AM PST
    • Like
  17. RufusRJones Member

    J Climacus (View Comment):

    RufusRJones (View Comment):

    Explain to me why anything should be going up in cost in a world where automation and globalized labor is destroying jobs and reducing wages.

    We need to worry about aggregate purchasing power and human capital development if this country is going to be successful.

    How does a loaf of bread cost more than it did 150 years ago, when agriculture was purely horse powered and the distribution system was horse and wagon? Farming is far more efficient than it was then, which helps to hide inflation since increasing efficiency tends to suppress prices. This typically isn’t mentioned when technological progress is used to justify inflation.

    I don’t see how we can keep doing this. It worked before the Soviet Union fell, markets opened up and computers and so forth, but not anymore. The Fed needs to run with deflation, not inflation. 

    • #17
    • December 10, 2019, at 9:26 AM PST
    • Like