“This is a time of testing – a test not only of our ability to collectively develop coherent and intelligent policies, but also of our ability to comply with them.” — Paul Volcker, October 9, 1979
Paul Volcker and his colleagues on the Federal Open Market Committee (FOMC) deserve praise for sticking with their campaign to tighten monetary policy despite the painful recession of 1981-82. Their actions ended the brutal stagflation that plagued the country within the latter stages of the Great Inflation of 1965 to 1982. Forty years later, it is straightforward to forget that Volcker’s programs were much harder to defend as he blazed a path through the jungle when it comes to monetary policy.
The United States has suffered devastating depressions and financial panics throughout its history, but there has only been major inflation. To resolve this extraordinary crisis, the Federal Reserve needed to adopt untested measures that each one but assured a deep recession, a pointy decline in asset values, and a painful rise in unemployment.
Volcker spoke to the American Bankers Association (ABA) on October 9, 1979 to achieve their support for these policies, knowing that his prescription would inevitably cause pain and distress within the short term. He appealed to his listeners’ collective sense of responsibility and acknowledged the extraordinary burden that rested on their shoulders. After all, bankers, financiers and investment experts are stewards of the country’s creditworthiness, which was restored by Alexander Hamilton in 1790. The ability to take care of this credit standing has boosted the U.S. economy, saved it from economic crises, and guarded the nation from foreign threats.
The persistent inflation that Volcker sought to eliminate had damaged the country’s economic health. Why was inflation so persistent within the Seventies? One of the important thing reasons was the collective failure of policymakers to delay gratification. Unwilling to sacrifice his Great Society programs, contain the conflict in Vietnam, or harm his own re-election prospects, President Lyndon Johnson insisted that the Fed maintain overly accommodative monetary policy. President Richard Nixon pursued a similarly self-serving course, and inflation spread and have become endemic. Instead of asserting the Fed’s independence, Fed Chairs William McChesney Martin Jr. and Arthur F. Burns caved to political pressure.
By allowing inflation to fester for thus long, they made it even harder for his or her successors to tame it. Solving the issue required far greater economic pain than if the Fed had intervened decisively earlier.
Volcker recognized the damage done by the Fed’s wavering resolve but vowed to persevere.
“Some would say that as a nation we lack the discipline to deal with inflation,” he told the ABA. “I just don’t accept that view.”
On September 13, 2022, the US Bureau of Labor Statistics reported that the CPI rose at an annual rate of 8.3%This increases pressure on the Fed to reply aggressively. When Jerome Powell says the Fed will proceed to tighten rates until the job is completed, I firmly consider he means it. However, it stays to be seen whether the Fed’s actions in the approaching months will live up to those words. The first series of rate of interest hikes and quantitative tightening was relatively painless. It won’t be the following phase. If the Fed continues, the economy will shrink, unemployment will rise, and markets will fall. All this pain is needed to make sure that the present temporary inflation event doesn’t turn right into a repeat of the Great Inflation that will threaten our long-term prosperity.
During the Panic of 1907 J. Pierpont Morgan recognized the failure of the Trust Company of America could be a fatal turning point that might plunge the country from the economic abyss. Morgan famously said: “The trouble stops here” and started organizing a rescue. Even after the run on Trust Company of America was halted, panic continued to spread across Wall Street. Morgan spent the following three weeks attempting to win support from trust corporations, national banks, private corporations, politicians and other interest groups. Together, they pooled their resources and pulled the United States back from the brink. His timely leadership—coupled with politicians’ fear of the prospect of facing a future panic without J. Pierpont Morgan—inspired the creation of the Fed six years later.
Fed leadership is now facing an identical turning point. They must resolve whether or not they have the resolve to stop a second major inflation. But fighting inflation isn’t the Fed’s sole responsibility: In the moment now before us, everyone may have to make a decision whether to carry on to the excessive but unsustainable spoils of the current or to make sacrifices now for a richer one Building legacy for future generations.
I hope we decide the latter.
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Picture Courtesy of the Edmond J. Safra Center for Ethics. This file is licensed under the License Creative Commons Attribution 2.0 Generic License. Circumcised.
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