Farewell, Volcker

by Mr. Shahid Mahmood[i]

2019 was a harsh year for the world of economics since it lost four giants of the field – Paul Volcker, Martin Weitzman, Martin Feldstein and Alan Krueger. Their contributions not only shaped the policies of governments around the world, but also opened new avenues of intellectual query. Although intellectual honesty demands mentioning the work of all four, space limitation permits me to limit myself to discussing the work and legacy of Paul Volcker, the most well-known among these four economists.

Paul Volcker was the former Chair of the Federal Reserve (central bank of the US) in the Carter and Reagan years, best remembered for taming the beast of high inflation that had cast a pale gloom upon the US economy in the 1970s and 80s. An intellectual as well as a physical giant (he stood 6’ 7’’ tall), his contributions did not end with Reagan or the federal reserve but kept continuing till his death at the age of 92.

The 1960s had seen the US embark on a loose monetary policy (simply put, low interest rates to spur aggregate expenditures) that ushered in a wave of high inflation. The context of the loose monetary policy was both political as well as theoretical. A famous concept in economics, the ‘Phillips curve’, posits that inflation and employment have a positive relation (i-e, increase in inflation begets increase in employment). Not surprisingly, that is sweet music for politicians, whose votes and popularity often depends upon employment and economic performance. Yet by early 1970s, questions were increasingly lobbed at the concept since despite higher inflation, employment numbers did not show any marked improvement. Then came the oil shock in lieu of the 1973 Arab-Israel war. It pushed the inflation further up, but job creation all but died down or declined (this kind of a situation is technically termed as ‘stagflation’, something that Pakistan is passing through right now). By early 1980, inflation in the US had surged to 15 percent.

The situation had reached such despondency that when the Fed Chairman, Arthur Burns gave up the post in October 1979, he accepted that taming inflation may well be beyond the power of central bankers. Enter Volcker, who had served under three presidents before as member of US treasury and head of NY reserve bank, who proved him wrong after he took up the post. He embarked on the unpopular policy of higher interest rates and tighter money supply that significantly increased the cost of borrowing. The higher cost of borrowing, in turn slowed down aggregate economic activity, with the result that unemployment rate surged to 10 percent. Despite severe opposition by politicians and public demonstrations against him (by farmers, for example), he refused to budge.

To understand the complexity of the task and the enormity of the challenge that Volcker faced, it was not just the public and politicians whose wrath he had to face. Within economics, there were competing narratives on the usefulness of monetary policy, with one school of thought (‘rational expectations’) advocating that monetary policy has no effect upon the real economy (in other words, there is no use of a central bank).

By the end of Volcker’s tenure, there were not many who doubted that monetary policy can be effective. Decades of inflationary pressures had been routed, and new narratives on monetary policy and economics gained respect. For example, his era convinced the economic community of the importance of figuring in ‘inflation expectations’ in their models (something reflected in the expectations augmented Phillip’s Curve). The unorthodox decision to target money supply rather than interest rates was greeted with substantial skepticism, but it paid off spectacularly. His achievements lent credibility to the claim that central banks should be independent in their work. Above all, his tough line on inflation ensured that the US economy never had to face high inflationary episodes like the 1970s.

Volcker’s contributions to economics and public service did not end after he left the job as Federal Reserve’s chairman. About three decades ago, he and a few colleagues set up the ‘National Commission on Public Service’ (‘Volcker Commission’). He used his own earnings to set up and run the commission rather than ask for financial commitments or government subsidies (which he could easily have got). It was his sense of public duty and belief that governments can have tremendous impact upon the lives of its citizens that propelled him to take that initiative. Paul’s services were called upon by President Obama in the aftermath of the Great Recession (2008) that caused tremendous tumult in the global economics. He helped frame the laws that put a ceiling between investment and traditional banking in an attempt to discourage risk-taking behaviour.

There are some other lessons besides economics that one can learn from his life. What the public never knew was that he and his family had to sacrifice a lot to let him do what he did. On appointment as Fed’s Chairman, Volcker had to move into a small apartment being used by his daughter. His wife was forced to take up a menial job just to make their ends meet. In the apartment, Volcker would use discarded cardboard packs as his tables. Just imagine the fact that this was a person whose words moved global markets, and who could have made billions if he wanted to. Yet, Volcker dedicated his life to public service and ameliorating the ills afflicting US economy. And he never complained about it! It is quite humbling to realize that his family agreed to sacrifice their comfort for a greater cause. How many of us would be willing to do that?

But even more astonishing, at least for me, was the realization that his distaste for inflation was informed more by his moralistic bend than his technical knowhow. In his memoir (Keeping at It), he recalls how his mother used to bemoan the power of the government to debase citizens’ hard earned money. That lesson stayed with Volcker throughout his life, and was the basis of his dislike for loose monetary policies. This is a good reflection of the power of ideas inculcated at an early age that tend to remain unchanged throughout life of an individual.

Another name mentioned in the opening paragraph was that of the late Alan Krueger, Obama’s chief economist, who committed suicide at a relatively young age of 52. Here was a star economist, professor at MIT and a person with little or no financial troubles. Yet, despite all the monetary security and fame, he couldn’t find inner peace. This failure to quell his inner insecurities led him to end his life. Irrespective of profession, cast or ethnicity, it is a lesson for all of us that money or fame may help you get what you desire, but it does not necessarily buy you internal peace and satisfaction, which should be the most important aspect of our rather busy, entrenched lives.

Volcker’s name, along with the other three, will now forever be a part of economic lexicon.

[i] Mr. Shahid is a regular writer on economic issues since the last 6 years, in leading newspapers of Pakistan. This piece was originally published in the Friday Times: https://www.thefridaytimes.com/farewell-volcker/

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