Paul A. Volcker

The Fed chairman who believed ‘no pain, no gain’

Paul A. Volcker, who defeated runaway inflation as Federal Reserve chairman in the 1980s, establishing the importance to the economy of an independent central bank, and whose “Volcker Rule” became a controversial element of post-crisis banking regulation in the Obama administration, died On December 08, at 92 years old. He became one of the most unpopular Fed chairmen in history for pushing interest rates as high as 20% to break the soaring inflation that consumed the U.S. economy in the 1970s. But his actions succeeded in bringing down inflation that has been in control ever since.

Paul Adolph Volcker Jr. the 12th chairman of the US Federal Reserve, was known for helping shape American economic policy for more than six decades, most notably by leading the Federal Reserve’s brute-force campaign to subdue inflation in the late 1970s and early ’80s. Volcker’s time in the spotlight began in August 1979 when President Carter, who was then struggling to salvage public confidence in his administration, decided to reshuffle his cabinet, plucking the Fed chairman G. William Miller to serve as Treasury Secretary. At that time, Volcker was serving as president of the Federal Reserve Bank of New York. President Carter tapped him as Fed chairman in August 1979 when America’s postwar economic hegemony was beginning to crumble.

When Volcker assumed the charge as Chairman Federal Reserve, inflation rate in the United States was exceeding 1 percent a month. It needs to be remembered here that rapid and unpredictable inflation encourages spending but discourages investment and this is the combination that creates economic instability and, often, political instability.

On Saturday, Oct. 6, 1979, Volcker announced a significant change in the conduct of monetary policy. Historically, the Fed had aimed to control interest rates — the price of money. Under the new policy, the Fed aimed to control the supply of money. Although limiting the supply of money causes interest rates to rise, the Fed would no longer aim for a specific increase. The central bank would determine how much money was available; markets would set the price.

The change was part of a broader shift in economic policymaking toward a greater reliance on financial markets. It marked the end of the postwar era in which disciples of the British economist John Maynard Keynes had argued that governments could deftly manage economic conditions, including interest rates.

The Fed under Mr. Volcker constricted the nation’s money supply, sending interest rates soaring. The U.S. economy experienced two recessions during his first term with unemployment peaking at 10.8% in 1983. Rates on conventional 30-year mortgages rose as high as 18.45% and rates on 3-month certificates of deposit topped out at 18.65% in 1980. The prime rate, which banks charge their most creditworthy customers, nearly doubled by Election Day 1980, peaking at 21.5 percent.

He delivered shock therapy, pushing interest rates as high as 20 percent, the WSJ writes, driving the economy into a deep recession but making him one of the most successful central bankers in history.

When inflation showed signs of accelerating and a deeper recession began, Volcker was obdurate as ever, insisting that the pain was necessary and ultimately worthwhile – harsh Fed policy contributed even to President Carter’s re-election defeat at the hands of Ronald Reagan. Unemployment rose to a peak of 10.8 percent in November 1982. But, it wasn’t until the summer of 1982 that he felt confident that he had broken the back of inflation. The inflation rate dropped to around 3% by the end of his first four-year term as Fed chairman.

Some economists continued to argue that the Fed could have brought inflation under control more gently but, in retrospect, it has also become clear that the developed world was on the cusp of an era of declining inflation, arriving as a result of the globalization of manufacturing and capital markets. Volcker’s triumph was undeniable: Inflation has remained under control ever since.