Review: Every monetary system needs a Paul Volcker

December 14, 2012

By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

William Silber’s biography of Paul Volcker is rightly sympathetic to the man whose determination and integrity conquered U.S. inflation. When needed, he overcame opposition from politicians and academic economists. Yet once his work was done, policy slid back and his abilities were wasted.

Silber traces Volcker’s career from his earliest days at the money market desk of the New York Federal Reserve. He was a Democrat when he served in the Treasury Department in the 1960s, but even then he was skeptical of the administration’s Keynesians and their inflationary policies. The Republican President Richard Nixon brought him in as Treasury undersecretary for monetary affairs, where he helped negotiate the end of the Bretton Woods system and expressed distrust of the Fed’s expansionist policies.

Volcker was not promoted by Nixon, who valued his intellect but distrusted his party affiliation and independence. So he returned to the private sector in 1974, only to be appointed president of the New York Fed the next year. It was there that he established his reputation as an unswerving proponent of anti-inflationary policy. President Jimmy Carter promoted him to run the whole Fed in August 1979.

He showed both intelligence and boldness there. With only a tenuous majority on the Federal Open Market Committee, Volcker announced a new policy on Oct. 6 that year: the Fed would track money supply growth, wherever that might lead interest rates. Initially, it led them steeply upward, from around 12 percent to a peak close to 20 percent in April 1980. When the money supply shrank after Carter introduced direct controls on consumer credit in March 1980, Volcker responded with sharp rate cuts, 10 percentage points in two months.

Volcker stayed firm while Carter wavered. The president removed credit controls in May 1980, money supply increased rapidly, and the Fed increased rates in October, possibly costing Carter re-election a month later. Volcker kept squeezing the monetary tourniquet; the federal funds rate peaked above 20 percent in January 1981 and was reduced painfully slowly, remaining at 14 percent in July 1982, by which time inflation was running below 5 percent and the U.S. economy was in the deepest recession between 1937 and 2008.

During this period Volcker had steadfast support from President Ronald Reagan, but not from his more pragmatic economic advisers. Curiously, Volcker was also opposed by Milton Friedman, generally thought of as the most distinguished inflation-hating monetarist around. Friedman accused the Fed chairman of steering the economy towards the rocks through over-tight policy. Then again, Friedman supported Fed Chairman Alan Greenspan’s loosening of interest rates after 1995; the high priest of monetary orthodoxy was himself less than orthodox.

Despite a strong recovery and a rising stock market, by 1987 the Reagan administration pragmatists had tired of Volcker’s independence and offered little opposition when he decided to retire for a more lucrative career in the private sector.

It was an opportunity missed. Volcker could now be in his ninth term as Fed chairman – a tenure shorter, after all, than that of several U.S. senators. Silber does not explore this fascinating alternate history possibility and does not give us the means with which to do so, never telling us what Volcker thought about Greenspan’s abandonment of monetary targets in 1993 and the post-1995 expansionism of Greenspan and his successor Ben Bernanke. Instead, he concentrates on Volcker’s efforts after 2009 to promote the Volcker Rule separating proprietary trading from commercial banking – in which Volcker was only an adviser, not a principal.

President Bill Clinton could have appointed Volcker Treasury secretary in 1992, but didn’t. In the end, there was demand for Volcker’s determined intelligence and steadfastness only in a crisis. If the Fed’s current ultra-loose policies have the same effect as the policies of the 1960s and 1970s, a similarly-minded successor may be needed.

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