Amol Agrawal
The year 2019 has seen deaths of quite a few economists and policymakers: Martin Feldstein, Martin Weitzman, Alan Krueger and Subir Gokarn (my tribute). Paul Volcker, former chairperson of the US Federal Reserve joins this unfortunate list as he passed away on December 8, 2019.
His death saw immediate tributes from Jerome Powell, current chair of the Fed, and Congresswoman Maxine Waters (D-CA), Chairwoman of the House Committee on Financial Services. In these times, when there is so much mistrust between the government and economic policymakers, any such tribute is great and also tells you the respect Volcker enjoyed across generations of economists and policymakers. In an earlier review on tenure of Mario Draghi, I wrote Draghi has established a new standard replacing Greenspan. I was wrong as Volcker is perhaps the only standard for central bankers.
Volcker has left an indelible mark in macroeconomics and central banking. In 1970s, the US, along with major economies, was struggling with high inflation. The high inflation was a result of loose monetary policy in the 1960s, which in turn was based on the belief in Philips Curve. The Curve implied that there was a trade-off between inflation and unemployment. This led the US polity trading off lower unemployment that led to higher inflation. The higher inflation in turn sparked higher inflation expectations and the likes of Milton Friedman and Edmund Phelps did warn against this trade-off business, but they were ignored. The higher expectations stoked much higher inflation and along with oil shocks, inflation hovered around 15 percent by 1980s.
Enter Volcker, who was appointed head of the Federal Reserve in August 1979. Interestingly, Volcker’s undergraduate thesis was titled ‘The Problems of Federal Reserve Policy since World War II’ where he criticised Fed’s policies to stabilise inflation in WW-II. Volcker shocked the system by tightening monetary policy significantly to lower inflation even at the cost of pushing US economy into a recession!
This approach to monetary policy that too in the world’s biggest economy was obviously not going to be ignored and became an immediate legend. No macroeconomics course can be complete without mentioning the legacy of Volcker. There are famous tales of agriculturists and businesses protesting against these rate increases even making the whole decision a stuff of animated discussion. US inflation declined by 1983 and has remained under control ever since. He showed in practice the importance of keeping inflation expectations under control and these lessons were then not lost out to subsequent central bankers. The monetary frameworks changed from monetary targeting to inflation targeting, but the basic idea of keeping inflation expectations anchored remained.
The impact of Volcker at the Federal Reserve was so great that he has been engaged in some public service or the other. In 2009, President Obama appointed Volcker to chair the President's Economic Recovery Advisory Board. More famously, he was the architect of Volcker Rules to restore confidence in the US financial system. The Volcker Rules build a Chinese wall between banking and investment banking activity. It prohibited banks from engaging in proprietary trading and from acquiring or retaining an ownership interest in or sponsoring a hedge fund or private equity fund. These rules were later incorporated in the Dodd-Frank Act which made sweeping -- and burdensome -- regulations for the US financial sector.
With every praise, there should be criticism as well. Some will argue that the Volcker era also led to the development of cult image of central bankers. This made central bankers and central banking look larger than life. Volcker was really tall which added to the overall aura as well. This image was further enhanced by Greenspan only to be shattered by the 2008 crisis.
However, there have been others who joined the race such as Draghi and even Raghuram Rajan who have been seen as central bankers who could do no wrong. This makes jobs of their successors really difficult and leads to unrealistic expectations from central banks. Reading a bit about Volcker, one is sure he himself would not be happy about this development.
In another criticism, Jerome Roos of the LSE (London School of Economics) recently tweeted how Volcker’s monetary policy resulted in a debt crisis in Latin America and was responsible for the socio-economic crisis in the region. These economies had borrowed money in US dollars. The higher US interest rates not just raised interest payments but also led to depreciation in Latin American countries, further fuelling the debt crisis.
Roos adds that President Ronald Reagan deployed the IMF (International Monetary Fund) as a lender of last resort to ensure Wall Street Bankers were paid in full! But should this criticism apply to Volcker alone as he was simply trying to control inflation and tighter monetary policy was the way to do it? In fact, the central lesson of any development is not to be greedy and overborrow. However, Latin American countries have repeated these mistakes throughout their history.
Overall, Volcker not just entered macroeconomics hall of fame but made a permanent place for himself. Former Fed chair Ben Bernanke paid tributes to Friedman on his 90th birthday saying: “I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.”
On Volcker’s death, taking a cue from Bernanke’s words, all the central bankers in the world -- past and present -- can give a joint statement: “We would like to say to Paul, regarding cause of inflation, you're right, we did it. We're very sorry. But thanks to you, we will try our best not to do it again.”
Amol Agrawal is faculty at Ahmedabad University. Views are personal.
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