The Washington PostDemocracy Dies in Darkness

How Paul Volcker beat inflation and saved an independent Fed

Former Federal Reserve chairman Paul Volcker represented American democracy at its best.
Former Federal Reserve chairman Paul Volcker represented American democracy at its best. (Tim Chong/Reuters)
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After Paul Volcker retired from the Federal Reserve, a friend dropped by his office in New York. He began to regale Volcker with tales of how his son, who worked for a hedge fund, was making big money and living lavishly.

Volcker shot back, “I have something he doesn’t have.” The friend, puzzled, asked what it was.

Volcker answered in one word: “Enough.”

Volcker, who died Dec. 8 at 92, should be remembered for saying “Enough” to two U.S. presidents, two Treasury chiefs, his fellow Democrats in Congress and to Wall Street.

In the process, Volcker saved the U.S. dollar and preserved the idea of independent professionalism at executive and congressional agencies.

The strongest reason to mourn Volcker: He was willing to be unpopular

Volcker wasn’t a whistleblower. But he represented American democracy at its best.

The younger generation may have trouble believing how bad the economy was, how dark things seemed in the summer of 1979 when President Jimmy Carter appointed Volcker Fed chairman. Home mortgages were charging double-digit interest rates. Inflation was roaring at 1 percent — per month.

Wall Street not only distrusted the dollar, it distrusted paper of any kind. Gurus were telling people to sell their stocks and bonds and buy precious metals, oil, copper, jojoba beans — any commodity — as long as it wasn’t paper.

Investors heeded them. Stocks plunged below their level 14 years earlier. What good were stocks if they were denominated in depreciating dollars?

Although the Fed had a congressional mandate to preserve the value of the dollar, people had given up hope that it would do so. Just after Volcker’s appointment, in a major address in Belgrade, economist and former Fed chair Arthur F. Burns lamented that “central banking has lost its moorings.”

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Burns had run the Fed for most of the 1970s. Now, he was saying it was “illusory to expect central banks to put an end to the inflation” troubling industrial democracies. He meant that political pressure for cheap money was too powerful to resist. And for Burns, it had been.

When President Richard Nixon appointed Burns in 1969, he called him in for a chat and bluntly told him, “You see to it — no recession.” Nixon was worried that high interest rates would torpedo his chances for reelection and made a sneering crack to Burns about the “myth of the autonomous Fed.”

Burns complied with Nixon’s directive and ran an expansionary monetary policy. Nixon won reelection in a landslide. But by the mid-70s, inflation seemed uncontrollable — chronic even during periods of slow growth, a scary phenomenon known as “stagflation,” for which central bankers didn’t have a solution.

Then came Volcker. Six days after Burns’s address, Volcker announced that, instead of directly targeting interest rates, the Fed would target the volume of bank reserves in the system. And it would allow the federal funds rate to go as high as needed to reduce reserves.

‘We have a serious problem’: Paul Volcker is worried about something worse than inflation

By making the level of interest rates a dependent variable, Volcker bought himself a little political cover. He wasn’t the one raising rates; he was just following a formula.

But he knew that the financial system was awash in excess credit — and he knew that his approach would lead to sharply higher rates. When Volcker took over, the Fed funds rate was just under 11 percent. By June 1981, it was over 19 percent.

Think of paying 18 percent for a mortgage or an auto loan, and you will understand the distress of ordinary Americans. Volcker’s remedy engineered not one severe recession but two of them, back to back. Construction executives sent two-by-fours to Volcker in a menacing protest. Congress was furious. Rep. Henry González, a Texas Democrat, threatened to impeach him. Carter, a Democrat, lost the White House partly because of Volcker’s policies.

His successor, Ronald Reagan, who was of course a Republican, praised Volcker in public but quietly worked to undermine him, appointing governors to the Federal Reserve Board that voted against him. Reagan’s Secretary of Treasury, Don Regan, openly lambasted his policies.

Volcker didn’t back down. In congressional hearings, he was just as brusque as he was in private. Even after inflation had peaked, he refused to lower interest rates as quickly as Reagan wanted. And when Reagan offered to visit the Fed, Volcker said no thanks — it would cast a dubious light on the Fed’s independence.

Of course, the Fed wasn’t entirely independent. Congress created the Fed and ultimately holds the reins. Sarah Binder, co-author of a book on the Fed, says Volcker’s “independence” was built on his appreciation of the need to develop an initial base of support.

Volcker was a civil servant — inspired by his father, a town official in Teaneck, N.J. — who insisted on a sufficient distance from elected officials to pursue the public interest. In my experience, he was gruff because he was shy, slightly uncomfortable. His brusqueness was a shield he deployed to resist political pressure as well as public opinion, stock market traders included.

We owe much to Paul Volcker

His politics were less partisan than was sometimes assumed. His dedication to a sound dollar earned him the enmity of many Democrats. Later in his career, his revulsion for speculative trading turned him into a regulatory hawk and a scourge of Wall Street. Obituaries, citing his frugal lifestyle (cheap cigars, ill-fitting suits) write of his disdain for bankers.

The truth was more complicated. He did live modestly as a public servant, but he was a banker before and after various stints in government. In his later years, as chief executive of Wolfensohn & Co., he became wealthy. He was a good Fed chair not because he disliked bankers, but because he was a banker, of the old-school, profit-and-loss variety.

As early as 1960, as a banker at Chase Manhattan, he was monitoring the London gold price and worrying about a jittery dollar. A decade later, he was undersecretary for monetary affairs and warned the Nixon administration it had only two years to save the dollar.

In short, Volcker was a practitioner-expert. Today, Fed officials tend to be economists and academics. Most have never written a loan. Volcker represented the triumph of the bureaucrat-professional, exactly what President Trump is bent on destroying.

Volcker used the independence he created for himself to prescribe painful economic medicine in the quest of longer-term stability and the greater good. That took guts.

His accomplishment was monumental. No one born after Volcker took office has ever experienced serious inflation. And though none of the Fed chiefs who followed Volcker would be as frostily independent, every one of them, from Alan Greenspan to Jerome H. Powell, had an easier job because of him.