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Paul Volcker Interview

Paul Volcker was Chairman of the Board of Governors of the Federal Reserve System, 1979-87 and former Undersecretary of the Department of the Treasury and President of the Federal Reserve Bank of New York. He is Professor Emeritus of International Economic Policy, Woodrow Wilson School of Public and International Affairs, Princeton University. 

He is a co-author of Changing Fortunes: The World’s Money and the Threat to American Leadership and The United States and Japan: Cooperative Leadership for Peace and Global Prosperity. He is the author of Triumph of Central Banking.

Paul Volcker

Paul Volcker
Former Chairman of the Board of Governors, Federal Reserve System, 1979-87

QUESTION: How bad was the economic situation when you took office at the Fed in 1979? 

PAUL VOLCKER: Well, by the standards of a lot of countries, by Latin American standards, it wasn't so bad. But the inflation rate had gotten into double digits, more than 10 percent. Double-digit inflation is a terrible thing - and it got up to 14 or 15 percent on a monthly basis for a while, shortly after I became chairman of the Fed.

It was the biggest inflation and the most sustained inflation that the United States had ever had. We had had brief periods of inflation, but this had built up over more than a decade rather continuously. It was getting worse, rather than getting better. And so that rather infected people's thinking.

You could not buy a house in those days without just assuming that the house was not only a place to live, but it was a good investment, because it was going to keep up with inflation or get ahead of inflation, and it was just - that was America. You bought a house, and it went up in price.

QUESTION: Why is that bad?

PAUL VOLCKER: Well, it's not bad if that's all that happened. Housing is only one part of the economy. When people begin anticipating inflation, it doesn't do you any good anymore, because any benefit of inflation comes from the fact that you do better than you thought you were going to do. Once you begin anticipating it, it no longer has any stimulative impact.

QUESTION: It's good for short term, it's good for borrowers, but not for lenders?

PAUL VOLCKER: In the short term, it's good for borrowers and not for lenders. Once a lender begins anticipating it, that equation changes, because he's going to say, "I expect inflation, so I'm going to charge you more than I would otherwise charge you." And you get higher interest rates, and the interest rates keep up with the inflation. And in fact, human nature, they see inflation rising for a while, they begin anticipating still higher inflation. So they say, "I'm not only going to make up for today's inflation, but I'm going to anticipate tomorrow's inflation."

Take the wage process. The working man [reasons], "the union says prices are going up 4 or 5 percent a year, a rising rate; I'm going to depend a 7 percent increase." And that puts the squeeze on employers, it has no stimulating effect, and that whole process doesn't help the economy because it gives you more inflation.

QUESTION: Why did they say inflation is the cruelest tax?

PAUL VOLCKER: Inflation is thought of as a cruel, and maybe the cruelest, tax because it hits in a many-sectored way, in an unplanned way, and it hits the people on a fixed income hardest. And there's quite a lot of evidence, contrary to some earlier thinking, that it hits poorer people more than richer people, who have more maneuverability, more way to protect themselves - who own their houses, for instance.

QUESTION: What did you do at the Fed to fight inflation?

PAUL VOLCKER: Well, the Federal Reserve had been attempting to deal with the inflation for some time, but I think in the 1970s, in past hindsight, anyway, [it] got behind the curve. It's always hard to raise interest rates.

By the time I became chairman and there was more of a feeling of urgency, there was a willingness to accept more forceful measures to try to deal with the inflation. And we adopted an approach of doing it perhaps more directly, by saying, "We'll take the emphasis off of interest rates and put the emphasis on the growth in the money supply, which is at the root cause of inflation" - too much money chasing too few goods …- "so we'll attack the too-much-money part of the equation and we will stop the money supply from increasing as rapidly as it was."

And that led to a squeeze on the money markets and a squeeze on interest rates, and interest rates went up a lot. But we didn't do it by saying, "We think the appropriate level of interest rates is X." We said, "We think the appropriate level of the money supply or the appropriate rate of the money supply is X, and we'll take whatever consequences that means for the interest rate because that will enable us to get inflation under control, and at that point interest rates will come down," which, of course, eventually is what happened.

QUESTION: Did you feel personally bad that your policies were throwing people out of work?

PAUL VOLCKER: Yeah. I would get asked a question a lot about, "How can you conduct a policy that appears to throw people out of work, anyway?" And my answer to that, internally and externally, was twofold. First of all, in the short run, I was convinced that the economy was going to have a bad recession anyway. That there were so many distortions and so many excesses built into the inflationary process that sooner or later, a recession - likely to be a serious recession - was going to happen.

I remember very well when I took office that there were forecasts within the Federal Reserve, [that,] without any tightening of policy, there was going to be a recession. Actually, it didn't happen very quickly. But I also felt that in the long run, there wasn't any question that the economy was going to operate more efficiently; productivity would be greater; you would have less instability in the future if you could manage to stabilize prices. And on that score, I think the evidence is at least consistent with that view.

QUESTION: How long had you been on the Fed before you became chairman?

PAUL VOLCKER: Well, I started out in the Federal Reserve as a young economist and spent about five years in the Federal Reserve Bank of New York. And then I spent some years in the Treasury and had been undersecretary of the Treasury for Monetary Affairs during an extremely interesting period, including a period when inflation really got started, which made a big impression upon me. And then I went and became president of the Federal Reserve Bank of New York, which is the most important operating arm of the Federal Reserve System, in 1976, I guess. And then went to the chairman of the Federal Reserve Board in 1979.

QUESTION: The economy today is sometimes called the "Goldilocks economy" - it's not too hot, not too cold; it's Mama Bear, it's just about right. Do you buy that or do you think that is hubris?

PAUL VOLCKER: Well, there's a lot of shorthand talk about this very good economy in the 1990s as being a "Goldilocks economy," in the sense [that] the expansion has been neither too fast nor too slow. [But] actually, in the first half of the 1990s, the growth rate was actually fairly slow for a cyclical expansion. And the odd thing is, it's gotten relatively fast in the second half of the 1990s when most business expansions slow down.

I think it has been a remarkably successful economic performance. But [perhaps] it's been veering on the too-fast side in the past few years.

It's an odd thing to say, but the American economy has been assisted, I believe, in maintaining this very comfortable combination of good growth and low inflation rate by the fact that the rest of the world has been doing so poorly, and goods are very amply available. Anything that can move these days can be imported. And there is a big supply capacity in the world as a whole. But the European economy, until recently - and the Japanese economy, until very recently - have been very sluggish with a lot of excess capacity. So that's helped keep world prices steady; it's helped keep our prices steady.

At the same time the performance of the American economy has been so good, and the relative performance has been so poor in the rest of the world, much of the rest of the world. But investment pours into the United States and enables us to finance a lot of imports to keep our prices down.

QUESTION: In describing this "Goldilocks economy" and indicating that it is going to continue, some people have used the phrase, "a new paradigm," that this is a different economy; all the old rules are off. Do you buy that?

PAUL VOLCKER: I am suspicious of the idea of a new paradigm, to use that word, an entirely new structure of the economy.I think we have been fooled before. People thought there a new paradigm in the 1920s, too, and then they were caught short - to say the least - in the 1930s.

But I think there are obvious structural changes in the economy. This technological revolution is a revolution; there isn't any doubt about it. The speed of communication, the speed of information transfer, the cheapness of communication, the ease of moving things around the world are a difference in kind as well as degree. It's that kind of structural change.

But whether it produces perpetually a kind of prosperous, growing economy - which is what "a new paradigm" is meant to connote - I am very skeptical. This economy has got lots of points of vulnerability.

I do think that some elements in a technologically advanced, relatively rich economy may hopefully give [the U.S. economy] some greater stability and less reliance on big, heavy industry - steel, big machinery manufacturing - which has, I think, got some inherent instabilities. … [The new economy allows] better management of inventories, a relatively smaller need to hold inventory, because of computer information that's available and the speed with which reactions and production can be made; less emphasis on heavy industry.

Less emphasis on inventories, I think, may tend to dampen business cycles, because business cycles are typically in the grasp of inventory cycles and heavy industry cycles.


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