Paul Volcker - The Inflation Warrior
Hello, it’s Bradley, Marci’s eldest, here with another of my obituary blog posts. You may have missed it in the news, (there were a few other pressing headlines in December) but on December 8th, 2019, former Chairman of the Federal Reserve, Paul Volcker, passed away at the age of 92. I thought that given the recent focus on the Federal Reserve and interest rates, it may be worth writing a few words about him.
Paul Volcker was born in 1927 in NJ, and so grew up during the Great Depression and World War II. In his senior thesis at Princeton, Paul criticized the failure of the Federal Reserve to restrain inflation following WWII (something that clearly influenced his later thinking). After several years working for the Federal Reserve Bank of New York and Chase Bank as an economist, he joined the Nixon administration as Under-Secretary for monetary affairs and was later appointed as president of the Federal Reserve Bank of NY, and finally to the Federal Reserve Chairmanship by President Carter in 1979.
When Paul Volcker took over the Federal Reserve, the United States was facing persistently high inflation, the increase in prices (or decrease in the value of the dollar) over time. These inflation levels were due in part to higher prices of oil due to the Arab oil embargo and Iranian Revolution.
High levels of inflation can be extremely detrimental to the economy, as they discourage saving (since the value of saved dollars decreases over time). In economics, inflation can be seen as too much money chasing too few goods, resulting in higher prices.
The usual antidote to inflation is a decreased money supply. And contracting the money supply is exactly what Volcker’s Fed did. Volcker increased the Federal Funds rate (the rate that banks lend money to each other; it is generally the lowest interest rate in the economy) to 20%! By comparison, the “tightening” of interest rates in today’s Fed reached only 2.5%. These high interest rates decreased the ability of individuals and corporations to borrow money, resulting in a decrease in the money supply and corresponding decline in inflation. This strategy also contributed to a recession (and unemployment rates of 10%), but by 1983 inflation had fallen to the Fed’s target of 3%.
Following Volcker’s term as Fed Chair, inflation has never risen to the same heights as in the 1970’s. This is due (in part) to the fact that Volcker’s Fed had convinced markets that if inflation were to rise again, the Federal Reserve would raise interest rates to squash it, and as in so many things in finance, expectations became reality. This collapse of inflation led to the incredible rates of economic growth in the 90’s, and later in the 2010’s. Later in his life, Volcker became an outspoken critic of banking consolidation, including support for the “Volcker Rule” requiring the separation of commercial banks from proprietary trading (a subject beyond the scope of this already too long blog post). We will all remember Paul Volcker as the inflation warrior he was.