Paul Volcker Was Inflation’s Worst Enemy
As Fed chairman, he shored up the dollar and set the stage for decades of economic growth.
By John B. Taylor
Dec. 9, 2019 7:26 pm ET
Paul Volcker with President Reagan in the Oval Office, July 26, 1981. PHOTO: APPLEWHITE/ASSOCIATED PRESS
Paul Volcker, who changed the course of economic history dramatically for the better, died Sunday at 92. He was appointed chairman of the Federal Reserve Board in 1979 by Jimmy Carter and was reappointed in 1983 by Ronald Reagan. But his influence on policy wasn’t limited to his chairmanship of the Fed. In a public career spanning seven decades, he served the Nixon administration as undersecretary of the Treasury for international monetary affairs and advised President Obama during the aftermath of the 2008 financial crisis.
With his 6-foot-7 frame, his big cigar and his candid assessments, Volcker was one of the most colorful characters in American government during the latter half of the 20th century. Graduating summa cum laude from Princeton in 1949, he learned early on how to get things done—very big things—and get them done he did.
Volcker was at the August 1971 Camp David meeting where President Nixon decided to impose wage and price controls and abandon the international monetary system by closing the gold window. Soon after that meeting, Treasury Secretary George Shultz assigned Volcker to work out a strategy to fix what had been done to the monetary system. Milton Friedman’s ideas about flexible exchange rates were to be part of the plan: Countries would allow the value of their exchange rates to depreciate when they had a trade deficit and let their exchange rates rise when they had a surplus. The U.S. had an economic strategy, but Volcker implemented it by making other countries think it was their idea.
The approach worked, and the international monetary system was on its way to restoration. The course of economic history had been changed.
The job Mr. Carter gave Volcker in the late 1970s was even more important and more difficult. The wage and price controls imposed in 1971 had led to an inflationary monetary policy at the central bank under Chairman Arthur Burns. Inflation and unemployment skyrocketed and economic growth fell. That was the state of the economy when Volcker took the reins at the Fed in the summer of 1979.
Financial markets welcomed his appointment. Volcker’s Treasury experience was well known, and he convincingly argued against the view espoused in many academic circles that higher inflation rates would reduce unemployment. He said he wanted lower inflation. He said that monetary policy could do it. And he meant it.
Nevertheless, on Sept. 18, 1979, he only narrowly got support from his Fed colleagues for a decision to change monetary policy by raising the interest rate by a relatively small amount. This created doubts about his ability to change the Fed’s inflationary ways. Markets appeared to lose confidence.
So, reflecting on his experience at Treasury, he designed a whole new monetary policy aimed at marshaling consensus among his Fed colleagues. The policy was to raise the discount rate by 100 basis points, impose new reserve requirements on banks, and create a new procedure for setting interest rates that emphasized the money supply. His approach was to get buy-in from everyone on the Federal Open Market Committee. And he did. The FOMC approved the new policy unanimously, and it was announced Oct. 6, 1979.
With his emphasis on the money supply, Volcker could say that it was the market that determined the interest rate, and thus he could allow the interest rate to go higher, which he did. The federal-funds rate reached 20% in 1981.
In an off-the-record conversation I had during the early 1980s with Volcker and James Tobin, the Nobel laureate economist from Yale, Tobin asked Volcker to lower the interest rate. Volcker answered that he didn’t set the interest rate, the market did.
The higher interest rate did slow the economy, but Volcker showed a great deal of courage. Construction workers sent him two-by-fours in the mail. Farmers circled the Fed building. Yet Volcker stuck with it. He appeared on “Face the Nation” and was asked when he would stop fighting inflation. He simply answered that he couldn’t stop fighting inflation until he ended it. Volcker won Reagan’s support, and his efforts paid off. Inflation fell dramatically and created conditions for a quarter-century of strong economic growth. His successor at the Fed, Alan Greenspan, maintained Volcker’s focus on keeping inflation low.
Volcker deserves credit for slaying inflation in the early ’80s, and he was later called on frequently to serve in government. He worked hard to document and weed out corruption at international institutions such as the World Bank and the United Nations’ oil-for-food program in Iraq. He weighed in on the causes of the global financial crisis, arguing for higher capital requirements and for what would be called the “Volcker rule” to curtail proprietary trading.
“While zero interest rates may be necessary at the moment, they lead to some dangerous possibilities in terms of breeding more speculative excesses,” he told attendees at a Stanford University conference in 2009. He became an outside adviser to President Obama although, as his own experience had shown, change often comes from knowledgeable policy-making leaders on the inside.
The American economy still needs change. Despite tax and regulatory reforms, the federal deficit remains large and the federal debt is rising. The answers are as simple as they were in Volcker’s time: Get back to sound and predictable budget policy. Paul Volcker’s career shows the way. Good economics leads to good policy, which leads to good results.
Mr. Taylor is a professor of economics at Stanford, a senior fellow at the Hoover Institution, and co-author, with George P. Shultz, of “Choose Economic Freedom: Enduring Policy Lessons From the 1970s and 1980s,” forthcoming next month.
