While today’s central bankers face a different task than the one Volcker took on, they would be well advised to pursue their goals with the same relentless commitment he brought to the Fed.
To understand why Volcker looms so large in the history of not only American, but also global, economics, you must start by wrapping your head around two numbers: 11.6 percent and 1.3 percent. The first number — the big one — is the rate that inflation peaked at in the third quarter of 1980, a few months after Volcker was appointed Fed chair. The other number is the most recent value of the same variable. Consider that a rate of inflation running at 11.6 percent cuts the buying power of your paycheck in half in about six months. At 1.3 percent, that takes more than four years.
As Bin Appelbaum shows in his recent (and compelling) history of economic policy, “The Economists’ Hour,” Volcker was born to take on inflation.
Appelbaum recounts that when Volcker’s older sister went to college in the late 1930s, their parents gave her a stipend of $25 a month. Ten years later, when Volcker went to Princeton University, his parents gave him the same stipend. He argued that the dollar had lost 40 percent of its purchasing power, a fact that failed to change their minds. But as the story reveals, the extent to which inflation erodes buying power was always personal to him.
Later, at grad school at Harvard, Appelbaum reports that Volcker “got a full dose of Keynesianism.” According to Keynesian thinking, the central economic problem is not inflation, but weak demand, too few jobs and persistent unemployment. Those lessons did not resonate with Volcker, who claimed that while his professors were opining that a bit of inflation helps grease the wheels, the word that went through his mind was “bulls---.”
Volcker made no secret of these feelings. So, when President Jimmy Carter appointed Volcker to chair the Fed, the president knew what he was getting. In fact, when Volcker warned him that what he was about to do about spiraling inflation “is not going to be popular at all,” Carter fatefully responded: “I need to get somebody in here who will take care of the economy — let me take care of the politics.”
Volcker did just that, by using the tools of the Fed to generate an increase in interest rates that would be unimaginable today. The “fed funds rate” — the central bank’s main tool to manage inflationary pressures — went from about 5 percent in the mid-1970s to 20 percent at its peak in the early 1980s.
Those of us who were around then remember something else about that period: the double-dip recessions, 1980-1982. Volcker successfully slew the inflation dragon, but he came close to breaking the economy in the process. He didn’t just step on the brakes. He slammed them, yanked up the emergency brake and shifted the car into reverse.
As the dust cleared, inflation fell steeply, as it had to, given what Volcker and the Fed had done to the cost of borrowing. People stopped borrowing to buy homes, cars and pretty much anything else that required credit. As demand collapsed, so did inflation. And so too did jobs. Overall unemployment reached 11 percent, and that of African Americans peaked at a stunning 21 percent. Confronted with jobless rates of that magnitude, Carter was far from able to “take care of the politics.”
Did a fifth of the black labor force really need to be unemployed to bring down inflation? Volcker believed the economic damage resulting from his program was necessary, and he wasn’t alone. From today’s perspective, in an economy where interest rates and inflation have become remarkably insensitive to the pressures that once prevailed, what Volcker did looks awfully extreme — and terribly costly to vulnerable populations.
But this is not the time to litigate that question. Instead, let’s consider how the job of central bankers has taken a 180-degree turn. Instead of soaring inflation, we’ve got sagging inflation. For almost a decade, inflation has been running far below the Fed’s 2 percent target. As I recently wrote, Volcker-era economics was “obsessed with preventing inflation.” Today’s economics is, or at least should be, “obsessed with getting to and staying at full employment.”
In that regard, our Fed officials would do well to act in the spirit of Volcker, even in pursuit of a goal antithetical to his life’s work of choking inflation.
Remember, today low inflation is occurring even as the jobless rate has fallen to lows — 3.5 percent last month — that predate Volcker’s reign. Such a weakened correlation between unemployment and prices gives our monetary authorities the opportunity to pursue maximum employment with the same single-minded vigor with which Volcker pursued low inflation. And they should do so with the unyielding spirit of the big man we just lost.