Volcker taught the world how central banks should reconcile their multiple, sometimes conflicting mandates to effectively manage monetary policy.
When he became chairman of the US Federal Reserve in 1980, the US was suffering from stagflation, or stagnation + inflation, which economists previously believed was impossible to have at the same time.
The fear was that solving stagnation by lowering interest rates would drive higher inflation, possibly hyperinflation, but conversely that raising interest rates to solve inflation would exacerbate the stagnation, possibly into a depression.
Volcker showed that focusing on and killing inflation by raising interest rates, even to extreme levels (briefly up to ~20%), you end both inflation and stagnation. For one reason, low, steady, predictable inflation, better enables businesses to plan, hire and invest.
And that has been central bank policy ever since (though they arguably mistakenly deviated from it under the latter part of Greenspan’s tenure). As Bernanke said, “He personified the idea of doing something politically unpopular but economically necessary.” It’s rare to have such an impact on one’s field, especially under such adverse circumstances.
The alternative story I’ve heard is that “stagflation” happened to coincide with a massive surge in oil prices due to OPEC — which are an input to just about every product we use, hence increasing prices — and Volcker’s deflationary recession just happened to coincide with OPEC falling apart. But this alternative explanation seems so obviously different from the lesson in your post that it can’t be the full story, so I assume there’s some nuance.
This goes to a basic framing issue that crops up all the time in economics. [Situation] => [Authorities Do Something] => [New Situation] then everyone assumes that the authorities were primarily responsible for the change.
It seems like pretty intuitive logic but it doesn't make any sense on inspection; people adjust to changing economic circumstances much faster than the authorities can change things. The situation will change quickly even if the authorities do nothing. Lessons that get 'learned' about crises and responding to them are probably a build-up of rain dances rather than actual knowledge.
It is a situation primed to promote economic witchcraft. Nobody agrees with which parts of are the most cargo-culty because political groups generally support the stupid ideas which happen to favour them.
The nuance, if you want to call it that, is that you can't do controlled experiments with the actual world economy, so we don't know what caused stagflation or what caused it to end. We can't go back and re-run the experiment and do something different (don't raise interest rates, or keep OPEC from collapsing) to see if it changes the outcome.
It's notable that you use the word "story": that is exactly the right word. These are stories we tell ourselves to try to make sense of what happened. But we should not mistake them for actual knowledge that would allow us to predict what will happen in the future. It isn't.
The nuance is that fed chairs don’t criticize each other and with rare exception all come from the same elite club - much like Supreme Court justices. I think your assessment is more likely the actual reasons for the cause / end of simultaneous stagflation/inflation.
The increased oil prices were due to increase in the money supply after the Vietnam War. Money printing usually leads to increased prices of products. Nixon removed the fixed conversion of Dollar to Gold with the Nixon shock (https://en.wikipedia.org/wiki/Nixon_shock) which made it possible to print even more money. The gold price increased from less than 200 in 1977 to over 800 in 1981 as a response to a lack of faith in the dollar.
The economist Ha Joon Chang has written extensivly how a somewhat higher target interest rate, like 5-7%, is actually better overall than the super-low targets the fed has. Lower interest rates tend to favor financial incumbents because they make money anyway because they have more and can sit on it, which implies that the money isn't actually helping develop new value in the market.
> The economist Ha Joon Chang has written extensivly how a somewhat higher target interest rate, like 5-7%, is actually better overall than the super-low targets the fed has.
Better for what circumstances? The Fed doesn't start with interest rate targets, they start with a dual mandate on employment and inflation control and set interest rates based on expected results based on that mandate, which can at times be high and are now low (which is mostly, currently, a sign of monetary policy compensating for an extended period of defective fiscal policy.)
Inflation is the only mandate. There’s been a lot of discussion about whether employment should play into their role. When it does creep in it’s around now outdated discussions about whether going beyond so called full employment causes inflation to rise. Clinton was the first to get a fed chair to admit there was no such thing as full employment and later it was Yellen who really pushed fed policy to ignore employment levels. There are some out there who say we are playing with fire by not targeting an employment number and that sometimes includes me but then I think about the woman in the street I saw about a year ago. At first I was worried she’d been robbed or attacked, she was yelling really loudly but as I got closer I realized she was yelling that she’d finally gotten a job. That would probably never had happened under a fed that targets an arbitrary 5% unemployment Figure and that is one of the many criticisms I’ve had for past fed actions that have ignored the little man by playing god up in their star chamber.
No, it's not. Under the Federal Reserve Act (specifically, 12 U.S.C. § 225A) there is actually a triple mandate, as monetary policy is to aim to acheive “maximum employment, stable prices, and moderate long-term interest rates.”
Inflation control (stable prices) is the second listed.
I think it's interesting that this definition of mandate came in 77 immediately ahead of Volker's appointment and he essentially ignored it. The fed have always had a bit of heart burn over whether their job includes employment. Even today, there is not an employment target, there is only an inflation target and its precisely because no one really knows or agrees on what the employment target should be. I think when greenspan acted to raise rates, like Volker, he was predominantly concerned about inflation rather than jobs even though raising rates did cool the economy and reduce jobs. And yet, neither man or policy was punished for essentially ignoring the employment component. Now in more recent years, Yellen has been out on the forefront of pushing the limits of what full employment means but her successor seems to be more interested in getting the fed back focused onto the issue of monetary policy. Hopefully this clarifies where I'm coming from...do you substantially disagree with this assessment or is it just the fact that I confused the issue by phrasing my argument in a way that seemingly conflicts with the statute?
> I think it's interesting that this definition of mandate came in 77 immediately ahead of Volker's appointment and he essentially ignored it
The Fed chair doesn't unilaterally set policy, and the Fed Board of Governors in Volker’s term didn't ignore the other parts of the mandate, it just saw inflation as the biggest risk, for reasons which are pretty easy to understand in the historical context, even if they were wrong in hindsight.
> Even today, there is not an employment target, there is only an inflation target and its precisely because no one really knows or agrees on what the employment target should be
That's not entirely true, it's more that it's because they have a very firm idea of what the employment target should be, but it's not a fixed employment level but the (dynamically shifting, in terms of employment measures) point at which further monetary stimulus has little further employment impact but great inflationary impact.
> I think when greenspan acted to raise rates, like Volker, he was predominantly concerned about inflation rather than jobs
Of course; the Board of Governors raises rates when inflation is the greatest concern, it lowers them when jobs are the greatest concern. They’ll admit that quite openly, you haven't made some stunning discovery. The understanding (somewhat simplified) is that there is a range (which moves dynamically based on other factors in the economy) in which easier money produces more employment with comparatively little inflationary effect, and a range (in interest rate terms, a lower level than the preceding range) in which it produces inflation with little jobs effect, as “full employment” has been reached (with the reverse effects in each range for tighter money). The Fed, again somewhat simplified, largely acts on interest rates based on which range it feels the current situation is in, aiming for the moderate inflation/“full employment” boundary.
>Lower interest rates tend to favor financial incumbents because they make money anyway because they have more and can sit on it
I think that's rather due to the Cantillon Effect, which posits that those who are closest to new money issuance (primary dealers, banks, etc) extract more value from it.
Same reason why the USSR collapsed, BTW. Oil prices collapsed by mid 80s, and the USSR couldn't survive for very long without those export revenues. Gorbachev took over just as oil prices have hit the bottom. And if you look at the same graphs, you will see that Putin's economic recovery was largely sustained by the upward trend in hydrocarbon prices. To this day Russia has not even begun to diversify its economy.
Technically the ussr collapsed because externally it had to settle accounts in the US dollar and low oil prices - it’s only export - couldn’t provide sufficient hard currency to do this but your point is still correct. Reagan knew this and leveraged it to the maximum even to the point of ruining our own oil economy and increasing our reliance on and strengthening our “allies” in the Middle East some of whom we later had to topple and some of whom we still struggle with today. It’s notable that this lesson wasn’t lost on China who long resolved that it would never run out of hard currency the way the USSR did. Russia on the other hand... as you point out they can’t seem to realize a diversified economy is one that collaborates and is open.
It's even worse than that. The ruling elite knows that on the one hand it's non-removable, but on the other its days are numbered (Putin is quite old and he won't live forever; what happens after he dies is anybody's guess), so they pillage and burn whatever they can while they can, with impunity. Diversifying the economy would require a long term view. The folks currently in power don't even realize anything is wrong per se - oil and gas money works pretty well for them.
I'm pretty sure criminals pay no taxes on their ill gotten gains in Russia. Heck, most "legal" businessmen there are forced by the extreme oil-oriented taxation regime to maintain "gray" books and only pay taxes on revenues that aren't under the table. Normal businesses can't really survive the kinds of taxes levied on oil/gas monopolies. It is far easier to pay off your local friendly government tax agent who would then miraculously buy a Maybach and a villa in Switzerland on $20K/yr government salary.
With stuff like this I always wonder if Volcker had such a great insight or if he was just lucky to have things come together at the right time. Greenspan was also considered a genius until he wasn't.
>was just lucky to have things come together at the right time.
Yes. In one interview Volcker recalls having told Carter "Yes, I can end inflation. But if I do, you won't get re-elected". Carter: "Do it anyway." (Can't find the reference now, anyone know it?)
Lots of people knew what had to be done, but Jimmy Carter was the rare sort of electee who would act in the country's best interests, even to the ruin of his own career.
And credit to Reagan for following through with it, and not just dismissing it as his predecessor's failed policy. Even through the 1982 recession that Volcker caused, which finally brought inflation down below 10% and almost cost him re-election.
The carter quote feels a bit like a myth but it was known that his advisors did tell him the risk with volker would be that he could very well cost him the election. However carter was influenced by the northeast elite on fed policy and went along with their recommendation to go with their man. Maybe no one remembers but it was Paul Volker, himself, who raised interest rates, twice, to high double digits in order to “slow” the economy. It was akin to fixing the economy by strangling it. The reason the economy recovered was Reagan. For the first time in nearly two decades people believed in the future.
But...it didn't recover for most people, whatever broad aggregate figures without distributional measures suggest. Reagan drove the nail in the coffin of the long post-WWII broad-based prosperity, and put the lie to the slogan favored by his campaign that a rising tide lifts all boats. Rather than trickling down, the gains in the economy since (and including) the Reagan years have been captured by an ever narrowing elite. And that's a direct result of government policy, centrally (though not exclsuively) tax policy, starting with the great tax shift under which Reagan oversaw, back to back, the largest tax cut in US history (on progressive taxes) and the largest tax increase in US history (on regressive payroll taxes.)
Go find ten random people who were adults in the 1980s and ask them if they wished carter would have gotten a second term or that Mondale Ferraro could have won in 84. Then come back and let me know if any of the could stop laughing hysterically to even answer the question.
I believe you said Reagan's policies didn't benefit most people at the time of his administration. If that were true, then I think people who were of voting age at the time likely would have had time to reflect on how they felt when they handed Reagan the largest landslide victory of all time and whether they still feel that way today. My guess, and I'm sorry if I came across as a jerk, but my guess is that most people, upon reflection would still say, given the alternatives of Jimmy Carter or Walter Mondale, they still benefited more under Reagan more than the other possible candidates. As for ending WWII prosperity, Vietnam and a couple of oil shocks took care of that long before Reagan became president.
My parents bought the house in which I grew up in 1985. They had a double-digit interest rate on that purchase at more than 3 times the current going rate and that was with paying points too.
I do wonder what will happen if mortgage rates return to even their pre-Volcker level, much less the 1980s levels. Household incomes versus PITI on a 30 year mortgage places a ceiling on housing prices, so if interest rates go up, then the prices in currently hard-to-afford areas will have to go down.
You can already see that housing prices are inversely correlated with interest rates. Yes, this will reduce the sale price of houses in hard-to-afford areas, but the change on how affordable these houses are will not change as much as you might think.
E.g. $100k, 4%, 30y -> $477/mo, but $65k, 8%, 30y -> $477/mo. This isn’t the full picture, obviously, but in this hypothetical example, both scenarios are more or less equally affordable. (Again, this example is just illustrative. I know people who bought in the 1980s and then refinanced in the 1990s, which ended up being a pretty sweet deal.)
Yes! Also, long-term owners who bought while rates were high stood to benefit greatly as interest rates came down and home prices rose accordingly. (In your example, your $65k @ 8% house becomes a $100k house where you've refinanced down to 4%.)
Part of what drove housing price escalation was supply constraints. Housing starts tanked during the early 90s and climbed back out much slower. Lower interest rates opened up housing affordability to more people, but supply constraints kept prices high. So those who already had home equity were able to sell for a profit and buy bigger. New entrants weren't so lucky.
The down payment is a function of the sale price, and that makes housing completely unthinkable to a lot of people in high price areas. They could afford the payment. Sometimes the payment would be lower than rent.
Going under 20% down results in poor loan terms and extra expenses like mortgage insurance that ruin the economics.
So high sticker prices on homes really do make them unaffordable to first time buyers who don't have family help or a very high income.
mortgage insurance does suck, but it didn't ruin the economics for me, but I was lucky. When I bought with an FHA, if you got down to 20% by year 5, you could get rid of MIP. Now the rules are stupid, you are stuck with mortgage insurance for the life of the loan regardless, unless refi. That's just wrong
>You can already see that housing prices are inversely correlated with interest rates.
I do not think this is true. Everything I have seen shows that mortgage rates and house prices are positively correlated. Probably because they are both determined by the overall state of the economy.
When the economy is good, prices rise and interest rates rise. When the economy is bad, both fall.
> I do wonder what will happen if mortgage rates return to even their pre-Volcker level, much less the 1980s levels
It's a scenario that can't occur as far as the Federal Government's solvency is concerned.
Just 5% on $50 trillion in public debt, 20 years out = fiscally say goodbye to the US military and Social Security (or say hello to the highest taxes on earth). Even 3.x% on $35 trillion in ~10 years starts to become a figure impossible to manage as it explodes the budget. You can plainly see the limits on where the Fed can allow rates to rise to.
Instead, the Fed and government's only option is to do everything possible to hold rates down forever. The Japan model reveals some of what the US is going to face, most likely. It's also why US growth keeps persistently sliding lower as we keep taking on more public debt, the debt is putting our productive capital into perma cold storage, robbing the economy of dynamism until we hit zero expansion. That debt will gradually yield less and less, we'll have $40+ trillion yielding 1.x% eventually. Effectively a massive pool of permanently dead wealth stripped out of the economy that will never be put to productive use; and that process of removing money from the economy simultaneously is what helps prevent traditional inflation from soaring despite the low rates. Picture reversing that and rapidly injecting that $40 trillion of dead capital back into the economy and see what would happen in terms of inflation for example.
> Volcker showed that focusing on and killing inflation by raising interest rates, even to extreme levels (briefly up to ~20%), you end both inflation and stagnation.
Another thing jacked up was the unemployment rate - to 11%. Bad for the people doing the work and creating the wealth, good for the heirs receiving dividends from the expropriated surplus time if those who work.
Jacking the interest rate up to ~20% so that unemployment goes to 11% is not a stroke of genius, it's just something no one was politically capable of doing beforehand.
“In 2009 Paul Volcker, berating a banking industry that had taken finance to the brink of disaster, quipped that “the ATM has been the only useful innovation in banking for the past 20 years”.
My view isn't full of praise. My family was really affected by the recession he caused. The recession was brutal and lots of people never worked again - it caused a lot of pain and despair.
Everyone talks about how taming inflation is so wonderful. Taming mostly benefited the wealthiest - as interest rates have tumbled asset prices have soared in value. Ever since working people's salaries have stagnated. Ironically now people are worried about deflation.
Not sure if you know this, but dropping interest rates is a policy that is strictly speaking opposed to taming inflation. It in fact creates inflation. You might have your history wrong?
> Everyone talks about how taming inflation is so wonderful. Taming mostly benefited the wealthiest - as interest rates have tumbled asset prices have soared in value.
After Volcker's deflationary policy, the authorities got scared from a small bump, instituted a reactionary inflationary policy, and that inflation has helped the wealthiest.
> Ever since working people's salaries have stagnated.
> Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.
Or, to put it differently, inflation is necessary to cheat the working class out of the value of their money, in the name of posting good employment numbers. (https://en.wikipedia.org/wiki/Goodhart%27s_law on a societal scale)
> Not sure if you know this, but dropping interest rates is a policy that is strictly speaking opposed to taming inflation. It in fact creates inflation. You might have your history wrong?
Doesn't this depend on how much of the money supply is debt?
I agree that dropping interest below zero when 99% of the money is debt can be inflationary, but back then maybe most money was "real" (not debt) and then dropping interest would have been deflationary?
1) as to 'real'ness, which is not really I think anything I can comment on (or IMO, any honest economist can) writ large -- in the 80s we were well past nixon shock when the US detached from the Bretton Woods II.
2) Perhaps you're referring to reserve limits holding back the money multiplier to a maximum of 10x, which would make it realer than now, when the multiplier is unbounded?... Even if money is realer, if we have any debt at all (presumed by the notion of an interest rate lever) you are lowering the price of debt, which encourages borrowing, meant to or not, which will not pump M0 but will increase the amount of money that people think they have (presuming they can be paid back as creditors), or really, the amount of money that people think they have in their bank accounts that they think their banks can recover from their leveraged adventures.
3) now probably the real fake labor subjective value of money is neither true to the austrian nor the keynesian/chicagoan extremes, certainly not the smith/marx/ricardian absolute (I mean let's say you do something crazy like save the earth from an asteroid strike, how much was that one hour of looking at a photograph worth surely not the same as one hour of a worker in a nail factory), and not really a thing that depends entirely on M0 nor the velocity of money (an immesurable measurable if ever there was one) in which case who the hell knows. In the end we're all dead anyways. The three universal truths are death, taxes, and network splits.
If this[1] is to be believed, Volcker intentionally targeted working people's salaries.
> Volcker said that the prosperity of the 1950s and 1960s was a "hall of mirrors" and that the "standard of living of the average American must decline."
> Volcker angered Reagan officials by keeping interest rates too high. When they complained he would pull “out his card on union wages” and note that inflation would not come down permanently until labor “got the message and surrendered.”
I'm a software engineer, but I've started reading about this time period recently. I don't understand most of it, but what appears to be obvious, is that stagflation was largely a fight between capital and labor. Volker ruled in favor of capital, and crushed labor.
Inflation also benefits debtors at the expense of creditors. That's why the government likes having a certain amount. Benefits not as one-sided as you might think.
OT: Is that the best picture they could have used?
Your experience is anecdotal, and whether inflation helps or hinders is still up for debate by economists [0]. Remember that many of the poorest do not keep assets in banks, let alone in stocks or other assets that appreciate or keep pace with inflation. Every recession causes pain, and no one man can cause a recession. I doubt we'll ever have enough data to determine if a given policy during a past recession helped or hindered.
“...to establish its credibility, the Federal Reserve had to demonstrate its willingness to spill blood, lots of blood, other people’s blood.” - Reagan’s economic adviser Michael Mussa on Volker
And while Blyth takes the opinion that Volker and Friedman were just the next steps in the evolution of capitalism, and I am still desperately lacking knowledge about this context, I can't help but have a feeling that if the future is continues with worsening inequality and political instability in a neoliberal context, we'll look back and be able to say it started with Volker.
It’s actually older and dates back to early 20th century ordoliberal ideology. Essentially, their idea was that it’s more important to protect global Capitalism than local democracy, so when the two come in conflict, global Capitalism should be made to prevail through parallel, extranational institutions. Quinn Slobodian wrote a whole book about it called “Globalists” and did a great synopsis interview about it on the Dig podcast:
Well said. As setpatchaddress highlighted downthread, Volker was responsible for undoing the socioeconomic order the New Deal put in place, setting the stage for our new gilded age and all the political and economic chaos that has come with it:
There was 'stagflation' then, which made things more expensive as jobs became more scarce. It was slowly strangling the wealth out of everyone.
After Volcker killed inflation, the economy boomed through the 80s and into the 90s. It was a great time, right up until the crash of 2000 stopped it all.
I'm sorry your family was negatively affected. But please know for most people (this is assuredly provable by Ronald Reagan's re-election margin) found the policies an improvement.
Thank you for posting this. While reading the obit I kept thinking, there is no way this guy could have been able to do what he did without having the backing of the neoliberal system.
'... erosion in what Alexander Hamilton insisted at the very beginnings of the republic would be the true test of government: “its aptitude and tendency to produce a good administration.”'
'We embarked on long, unnecessary, and ultimately unwinnable wars far from home. We failed to recognize the costs of open markets and rapid innovation to sizable fractions of our own citizenry. We came to think that inventive financial markets could discipline themselves.'
Volcker is overrated in my view. There is a good reason why so many people on Wall Street hold him in highest regard. I believe his perceived success enabled irresponsible monetary policies over the past 30 years. This is how we ended up with a 3% bound on a ten-year and trapped into perpetuity.
Not just waging war on inflation, but being the name behind the Volcker Rule, which prohibits banks from making certain speculative investments, and arguably inhibits some of the worst excesses of "casino capitalism"
Many here don't know who he was (I didn't) but nobody outside of our circles care about Paul Graham or Linus Torvalds, either. I'm sure almost every IB associate in NYC knows who Volcker is.
Whether I know them specifically or not, I think a former Fed chairman dying qualifies as news.
It's a bit weird to say "Welp, I've done a lot, all done now - never going to come back into the fray." because it can be often followed with, "Wait what's that? You need help suddenly!? Well, here i come!"
So it's unclear when to really dig into someone's accomplishments and share the interesting bits, that's why so many such investigations happen after death. I've always personally viewed obituaries of interesting people as more of a "Hey, here's some really interesting stuff you may have forgotten or may not have lived through" as a sort of starting point to dig a bit deeper into the interesting things - than a memorial, I'm sure the family and close friends appreciate the article highlighting his public history, but for most folks it only serves as a knowledge gateway.
When he became chairman of the US Federal Reserve in 1980, the US was suffering from stagflation, or stagnation + inflation, which economists previously believed was impossible to have at the same time.
The fear was that solving stagnation by lowering interest rates would drive higher inflation, possibly hyperinflation, but conversely that raising interest rates to solve inflation would exacerbate the stagnation, possibly into a depression.
Volcker showed that focusing on and killing inflation by raising interest rates, even to extreme levels (briefly up to ~20%), you end both inflation and stagnation. For one reason, low, steady, predictable inflation, better enables businesses to plan, hire and invest.
And that has been central bank policy ever since (though they arguably mistakenly deviated from it under the latter part of Greenspan’s tenure). As Bernanke said, “He personified the idea of doing something politically unpopular but economically necessary.” It’s rare to have such an impact on one’s field, especially under such adverse circumstances.