A Vote for Paul Volcker

October 22, 2008

A lengthy front-page story in Tuesday’s Wall Street Journal reported that former Fed Chairman Paul Volcker has emerged as one of Barack Obama’s closest economic advisors in the presidential campaign and that he is likely to play key roles if Obama is elected both during the transitional period and/or as part of the next administration.

Volcker’s resume is as good as it gets, and he is actually 18 months younger than Alan Greenspan, who succeeded him. Volcker was Fed Chairman from August 6, 1979 until August 11, 1987. He had already been a member of the FOMC since 1975 in his capacity as president of the New York Federal Reserve Bank. Previously, he had served in the U.S. Treasury from 1962 to 1965 and again from 1969 to 1974, climbing to the post of Under Secretary for International Monetary Affairs, a capacity in which he played a key role arranging the transition from a fixed dollar system to a monetary system in which market forces set the dollar’s value. Volcker began is career as a research economist at the New York Fed, worked in two stints for a total of nine years as a Chase Manhattan Bank officer, and also taught a year at Princeton University before returning to the Federal Reserve System. In subsequent years, he has been a Chairman for an investment bank and led numerous advisory commissions. He graduated summa cum laude from Princeton and did graduate work at both Harvard and the London School of Economics.

Volcker is even better known for his achievements than his pedigree. He is revered among economists as the slayer of high inflation and a policymaker of highest principle, superb judgment and intellect, and good political instincts. Consumer price inflation had already climbed to 11.8% when he became Fed Chairman and peaked at 14.8% in March 1980. By December 1982, such had dropped back to 3.8%. Over his eight years at the helm, inflation averaged 5.9% per annum, and it was at 4.3% when he stepped down. On the FOMC, there was no doubt that Volcker was the leader, a style that Greenspan continued. The Volcker Fed adopted a quantitative approach to monetary policy in October 1979 just two months into his Chairmanship, targeting the money stock and letting market forces set interest rates. The Fed funds rate soared from 8.75% in May 1980 to around 20% in January 1981, and M1 growth slowed from 12.1% y/y in April 1981 to 4.2% six months later.

Volcker understood that only a recession strong enough to contain money expansion and break the back of expected double-digit inflation would rid the U.S. economy of inflation in a sustaining way. The 1973-5 recession had stunned inflation only temporarily because Fed policy had been too accommodating. The jobless rate of 5.9% in August 1979 climbed to 10.7% by end-1982, averaged 9.5% in both 1982 and 1983, but had settled back all the way to 5.9% by the time Volcker left office. The U.S. economy experienced a double-dip recession, first from January to July of 1980 and then from July 1981 to November 1982.  The Fed did not allow its sky-high discount rate to fall until the second recession was a year old. In the process, Fed credibility was restored as an institution that would safeguard the internal and external value of the nation’s money. Against the D-mark, the dollar recovered from 1.70 at the start of 1980 to 1.575 in August 1981 and 3.48 in February 1985. Over the whole eight years, real GDP and employment increased at average annual rates of 2.8% and 1.6%, which was not bad considering the situation Volcker inherited.

Two decades have passed since Paul Volcker was at the center of U.S. economic and political decision-making, but his return at another fragile moment in the nation’s economic history would lend an air of respectability that few fresh administrations are able to claim. More important than his varied experiences in the Federal government, central banking, commercial banking, investment banking, consulting and academia, Volcker is somebody with demonstrable leadership skills and visible success in the crucible of national crisis. If it is indeed fear of failure that is to be most feared, a role for Paul Volcker in the next government is too tempting an opportunity to be missed.



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