Under President Reagan, Fed Chairman Paul Volcker initiated an era of monetary policy called “the great moderation” which persisted through the first half of the tenure of his successor Alan Greenspan. It began dramatically. Under the louche monetary policy inherited from the Ford/Carter era, inflation ticked up to double digits. To “slay the inflation dragon” Volcker, once confident of having Reagan’s political support, raised interest rates to over 20% — and held them there until the fever of inflation broke.
This precipitated a sharp contraction in the economy — yet also brought inflation down from over 13% to, by 1986 under 2%. Except for an uptick from 1988-1991 in the 4% - 5% range, inflation has remained in the 2& to 3% range since.
Volcker provides many insights on his tenure in an extended interview conducted in September 2000 for PBS’s Commanding Heights
Volcker at the Fed: "Slaying the Inflationary Dragon"
INTERVIEWER: Did you feel that inflation was your number one, I think you used the phrase "dragon to slay"?
PAUL VOLCKER: I certainly thought that we had to deal with inflation, and the great advantage I had was [that] finally the country had more or less come to that [same] conclusion. There was this feeling of malaise, to use a term [popular] at the time. There was a kind of great speculative pressure. It was the years when everybody wanted to buy collectibles from New York. The market was booming, and other markets of real things were booming, because people had got the feeling that things were inflating and there was no way you could stop it.
INTERVIEWER: You used to talk about slaying inflationary dragons. What did you set out to do?
PAUL VOLCKER: I certainly thought that inflation was a dragon that was eating at our innards, or more than our innards, and if anybody was going to deal with this it was going to have to be the Federal Reserve. I saw a lot of roles, not just my personal role, but [also] the need was to slay that dragon.
INTERVIEWER: Can you in general terms explain what you did?
PAUL VOLCKER: That's a complicated story, but what we did, against a background of increasing unease about inflation and increasing unease about the performance of the economy, was to face up to the need and [take charge of] monetary policy and control of the money supply, to accept the proposition that at the end of the day inflation is dependent upon inflationary monetary growth, too much money growth, too much credit growth, and we set out to make that point and say that we've just got to stop this and draw some kind of a line in the sand about how much money and credit growth was appropriate. In doing so, the effect was to push interest rates up in the short run, because people were expecting inflation; they were perfectly willing to borrow. It was a good thing to borrow when you expect inflation, and the borrowing came up against a limited supply of money and credit. Interest rates were way up, and sooner or later that was bound to have an effect on the economy. It did, and we had a severe recession, but we came out of that recession with a very strong movement called price stability and also with strong economic growth.
Now my view always was, and has remained, that the way the economy was behaving, sooner or later you were probably going to have a recession. There was a feeling that the Federal Reserve created the recession. I think economic conditions created the recession. That created the underlying conditions and imbalances that sooner or later were going to give you a recession. Better to deal with it sooner rather than later.
INTERVIEWER: There was public concern about inflation, and yet you thought it gave you a mandate, as it were?
PAUL VOLCKER: Yes. Well, at least strong support, enough support to go through a very difficult period.
INTERVIEWER: And did you or anybody quite expect how tough a time it would be with inflation at 20 percent?
PAUL VOLCKER: If you had told me in August of 1979 when I became chairman of the Federal Reserve Board that interest rates, the prime rate would get to 21.5 percent, I probably would have crawled into a hole and cried, I suppose. But then we lived through it.
[Inflation] came to be considered part of Keynesian doctrine, although I don't think it was Keynes himself -- there's some debate about this -- [who said] that a little bit of inflation was a good thing. I was strongly lectured on that. I remember one particularly, one of my professors at Harvard [lecturing] about [how] in the postwar period people were worried about sluggishness and that a little bit of inflation is a good thing. Of course, what happens then [is] you get a little bit of inflation, and then you need a little more because it props up the economy. People get used to it, and it loses its effectiveness. Like an antibiotic, you need a new one; [then] you need a new one plus. That was a world... I was not part of. I was in the Federal Reserve, Treasury, a conservative guy who's always against inflation. The general tenor of the times was inflation was the least of evils, if it's an evil at all. What changed drastically in the 1980s and running through today is the presumption that inflation is bad [and that] the primary job of a central bank is to prevent inflation. That's taken for granted. The great ideology these days is that the central banks ought to be independent; they ought to have an inflation target, and an inflation target ought to be close to zero. That's a very different environment then the '50s and '60s and into the '70s.
INTERVIEWER: You saw inflation as a moral issue, to a certain extent?
PAUL VOLCKER: To some extent I think it is. Inflation is related to monetary policy. It's related to the issue of money. The issue of money is a governmental responsibility predominantly, and to use that authority in a way that leads to inflation is a system that fools a lot of people, and to keep fooling them you have to do it more and more; [that] is a moral issue. I put myself in that camp.
INTERVIEWER: But why a moral issue? What does it actually corrode?
PAUL VOLCKER: It corrodes trust, particularly trust in government. It is a governmental responsibility to maintain the value of the currency that they issue. And when they fail to do that, it is something that undermines an essential trust in government.
INTERVIEWER: What seems to have happened over the last 15 or 20 years is that there's been a huge retreat of governments from the commanding heights of economy. Is that fair?
PAUL VOLCKER: Yes. One of the things that occupies me and one of my big concerns has always been monetary policy. The importance of government and the importance of good government are somewhat related to the inflation point. There's been enormous erosion of trust in government generally, including, in the United States, a lack of confidence in the government. It's hard to get people, good people, to serve in government. The United States always has a healthy skepticism about government, but it erodes into a cynicism, which isn't very healthy. I find myself getting cynical about it. Now, of all people, I spent 30 years in government, and I have great respect for the importance of government, and when I become cynical about it, it's a bad sign. Part of the difficulty may well be that there was too much hubris, [the] feeling the government could do everything and do it well and getting [control of] the parts of the economy that it turns out they couldn't do so well. They tried to do too much too soon and get into areas where performance fell way short of reasonable expectations, and now we've had a reversal, which I think to a considerable extent is a reaction of that and [is] probably healthy.
Paul Volcker, and his successor Alan Greenspan, presided over two decades of relatively successful management of monetary policy. Nevertheless, the economic expansion under Reagan and Clinton never reached a sustained 4% growth rate. The classical gold standard, as the empirical evidence from the laboratory of history shows, repeatedly sustained decade-long periods of 4% (and even better) growth. Mr. Volcker, observed that “I don't think we're going to go to a gold standard. Someday, but not in my lifetime, [and] not in your lifetime, we'll have a world currency or something looking like it,” this is an unsurprising sentiment on the part of one of history’s great technocrats.
Yet central planning for monetary policy is, on the evidence, as inherently inefficient and unstable as central planning of industrial policy… as the Great Recession decisively showed. As software titan Vivek Ranadive observed in a 2007 CNET column:
“ …four of the past five tightening campaigns (1973, 1980, 1990, 1994, 2001) initiated by the Federal Reserve resulted in recession.Only in 1994 did the Federal Reserve avoid recession and achieve the desired goal of a soft landing. Not exactly a record I would want to risk our economic future on....
Whether it be information on consumer spending, productivity or manufacturing activity, backward-looking data is only so helpful, especially given the complexity of today's global economy. Wouldn't it make sense for the government to really get online and connected like the corporations it tracks and supports? .... If the Federal Reserve were to combine the use of historical data with real-time feeds from a number of additional data sources, I believe there would be fewer policy blunders and a higher probability of achieving the Fed's statutory goals of maximum employment and stable prices.
The classical gold standard is only superficially archaic. It is the monetary policy of choice for the 21st century in that it provides the quintessence of “real-time feeds” and, relying on established principles of “group intelligence”, consistently demonstrates itself to be, in the words of Lehrman Institute founder and chairman Lewis E. Lehrman, “the least imperfect monetary system of the last two centuries, perhaps even of the past millennium.”
Next: The Bush-Obama Era
Previous: The Ford-Carter Era