On the Thursday following the Federal Reserve Board's stunning Oct. 6 credit-tightening moves, a uneasy-looking Paul A. Volcker took to an evening television interview show to reassure the nation that the economy wasn't headed for another 1929 crash.
Volcker wasn't having second thoughts about the board's sweeping actions, but he was distinctly worried about the enormous reaction they had provoked. The surprise crackdown the previous weekend had jolted the stock market into a tailspin, bond prices were tumbling and short-term interest rates were soaring.
Today, just three months later, the markets are far calmer and Volcker is confident the board's new policies have weathered the storm. Although the economy is headed into a recession, no depression is in the works. And the Fed has accomplished many of its aims with surprisingly little disruption or pain.
To be sure, interest rates still are high, mortgage money is tight and the housing industry is in for some rough sledding. But the credit-tightening has capped surging business loan demand. The money supply has slowed. And -- until the Soviet invasion of Afghanistan -- speculative fever in the markets had cooled.
The major question now is, how long will the Fed be able to stick with its new tight-money policies? If the central bank keeps credit tight too long, it may risk turning the mild recession that is forcast into a severe one. But, if it eases policy too soon, it could revive inflationary psychology.
Volcker is seriously concerned that the financial markets -- perverse as always -- may misinterpret any decline in short-term interest rates as a sign that the Fed has decided to relent. Rates have slipped since their October highs, as a result of ebbing loan demand -- yet the board has not changed policies at all.
Characteristically, Volcker carefully does not claim that the Fed's Oct. 6 policy-tightening has worked swiftly enough to claim credit for the slowdown in money supply growth. In fact, he believes, much of the slowdown would have happened anyway. But without the policy shift, rapid growth might have resumed.
The calm political acceptance of what, by historical standards, is harsh economic medicine has surprised many Fed officials as well as other government policy makers. Indeed, some high officials have had to bite their tongues occasionally to keep from criticizing the push to ever-higher interest rates.
In some ways, the Fed merely took advantage of an opportunity when it launched its crackdown Oct. 6. The combination of new inflation fears, the stubborn strength of the economy during 1979, and the need to give the ailing dollar a shot in the arm together gave it a long sought-after opening.
But the fact that Volcker took the lead -- not only in tightening credit, but also in launching a whole new image for the serious-minded former New York Fed president, who hadn't previously been regarded as that agressive.
Critics had complained earlier that Volcker often seemed too ready to defer to then-chairman G. William Miller in meetings of the policysetting Federal Open Market Committee, and not Federal Reserve Bank. The "hawks" in the financial community weren't sure he'd be tough enough.
Now, however, virtually all such critism have been stilled. Says one former critic, admiringly: "Volcker has taken the institution a number of giant steps in the direction it needs to go." Even liberals are satisfied, if not entirely pleased.
A thoughtful, intellectually open man with a rare understanding of both economics and markets, Volcker proved both his mettle and his political skill as undersecretary of the Treasury in the Nixon administration, where he almost single-handedly negotiated an over-haul of the world monetary system. h
He also won high marks during a stint as president of the New York Federal Reserve Bank, the system's second-most-important policymaking spot. (The New York bank serves as the boards principal operating arm in the money and currency markets. In effect, it handles the Fed's day-to-day transactions.)
Volcker's rise to the chairmanship wasn't a smooth one. The serious-minded New Jersey banker was Wall Street's first choice to replace Arthur F. Burns as Fed chairman, but Carter passed over him as too conservative, instead nominating the more-liberal Miller, then head of Textron, Inc.
By the time Carter needed to fill the Fed post again -- after firing Treasury Secretary W. Michael Blumenthal and shuffling Miller into his place -- the president was all but forced to name Volcker, as a symbol that he still was committeed to fighting inflation. Outsiders warned not to do so might fuel inflationary psychology.
Volcker today is clearly comfortable in his new job. Ironically, the Cape May, N.J., banker took a $57,500 pay cut in going from the New York Federal Reserve Bank to the chairmanship here. "I came to Washington to escape the New York state and city taxes," he joked to a luncheon group recently.
Volcker's relationship with the administration has been a cooperative, if not quite a warm one. The Fed chairman isn't brought into White House decisionmaking sessions, and contacts between him and Miller are infrequent. But there are discussions at other levels.
The other day at a National Press Club appearance, the Fed chief conspicuously refused an opportunity to chide the administration for proposing another budget deficit for fiscal 1981, shrugging that the $15 billion figure now expected "is not going to throw us off course" on monetary policy.
And Carter's own advisers, who previusly have voiced grave misgivings about credit-tightening steps by the Fed, have been surprisingly silent about the Fed's latest actions. (Carter did slip once the week after Oct. 6, criticizing interest rates as too high.)
Volcker has reinforced the Fed's "independence" as a quasi-autonomous inflation-fighter.
Indeed, even some of Volcker's supporters question whether some of his spectacularseeming success hasn't stemmed partly from the fact that with the Carter administration so immobile the Fed is running the only anti-inflation game in town.
Arnold R. Weber, the droll Carnegie-Mellon University labor economist who served as the Nixon administration's Cost of Living Council director, muses that "because no one else has done anything," Volcker has appeared to be "an economic Superman.
"Like the mild-manner Clark Kent," Weber cracks, "he's gone into the Federal Reserve's telephone booth and come out with tights and a big red M-1 on his chest. Now, everybody thinks he can leap tall buildings and is going to save the economy from disaster single-handedly."
Just the same, in many ways, the Fed still is facing its biggest test -- how long to remain firm if the economy appears to be sliding into a deep recession. "It's one thing to nip the markets as the Fed did in October," says one onlooker. "But the real question is how long it can hold on."
With inflation still roaring along, Volcker said in a speech here recently that the Fed will stay the course. "I can't imagine any evidence," he said, "that causes one to back off."
But the chairman's response is based on a rather complex explanation of the Fed's policies: Volcker's says the board will hold firm in limiting the growth of the money supply and bank reserves, but it may well allow interest rates to decline, particularly if credit demand turns soft in the face of a slump.
That distinction, representing a major departure from the Fed's past approach, was one of the basic changes in policy that the Oct. 6 action was designed to bring about. Previously, the board tried to achieve its goals mainly through manipulation of certain interest rates.
What the board faces now is the possibility that if interest rates fall -- as is likely now if the economy slides into a recession -- the decline may be interpreted, wrongly, as a liberalization of current policy. In the past, a drop in interest rates almost automatically meant an easing.
Volcker warns, however, that that simply would not be so -- that the new policy genuinely would allow interest rates to rise and fall in line with market forces. As long as the money supply and bank reserves remain in check, he says policy is still on track.