US economy

Paul Volcker, central banker, 1927-2019

Paul Volcker was born in Cape May, New Jersey, on September 5 1927 into a family descended from German immigrants. A shy boy, he learnt a devotion to public service and discipline from an early age. Volcker was deeply proud of his father, who worked as municipal manager of Teaneck, New Jersey, from 1930 and who turned the town’s finances around. 

In public office his father went to considerable lengths to avoid any sign of family impropriety, according to Volcker’s biographer William Silber — to the extent of ordering that his son, then still at high school, be dismissed from a squad of part-time safety monitors who were engaged by Teaneck’s recreation director. 

After graduating with top honours from Princeton University, having written his senior thesis on the Federal Reserve, he continued his studies first at Harvard and then at the London School of Economics. He joined the New York Fed in 1952 as a junior economist, having earlier worked there as a research assistant. Two years later he married Barbara Marie Bahnson, his first wife, with whom he had two children, Janice and Jimmy. 

Barbara died in 1998 and, in 2010, Volcker married Anke Dening, his longtime executive secretary and adviser. 

A spell as a research economist at Chase Manhattan Bank in the 1950s gave him his first direct experience of the private sector, before he was recruited to the Treasury in the early 1960s by Robert Roosa, a mentor at the Fed. In 1963 he was named to the position of deputy under-secretary for monetary affairs, but he returned to Chase two years later. 

Volcker showed an early flair for policy analysis, which, allied to a subtle mind and an international vision, equipped him to deal with the pressures that were beginning to build up within the international currency system, with its fixed exchange rates. 

As new realities asserted themselves in the 1970s, with mounting dollar outflows, Volcker was among those who came round to the idea of ending the dollar’s link with gold and moving towards flexible exchange rates. As Treasury under secretary for monetary affairs, he attended the top secret meeting at Camp David in August 1971 at which President Richard Nixon approved the dollar devaluation that in effect ended the postwar monetary arrangements. But this dramatic move, along with the Smithsonian currency realignment a few months later, did not end the turbulence. 

Rather the opposite. World markets entered a period of even greater upheaval, nurturing Volcker’s view that monetary policy, to be effective, must be forcible and timely, and not merely a response to market events. This conviction would dominate his approach when, somewhat reluctantly, he moved back to the Fed in 1975 as president of its powerful operating arm in New York. 

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American economist Paul Volcker, US under-secretary of the Treasury, gives a press conference at the US Embassy in London over the dollar crisis, UK, 16th July 1971. (Photo by Pierre Manevy/Daily Express/Getty Images)
At a press conference at the US embassy in London during the dollar crisis in 1971 © Pierre Manevy/Getty

In 1979, President Jimmy Carter’s economic policy was in disarray. The dollar was weakening again and inflation surging in the wake of successive oil price shocks. In an inspired appointment, Mr Carter asked Volcker to take over from G William Miller as chairman of the Federal Reserve Board in Washington. 

It was an appointment that came at acute personal cost to Volcker: his wife Barbara chose to stay with his son in New York, where she was being treated for rheumatoid arthritis and diabetes. The new Fed chairman lived alone in an inexpensive one-bedroom apartment in Washington during the week, flying back to New York at weekends in economy class. 

Within a little over a month of his elevation in August 1979, Volcker raised interest rates not once but twice, and a month later he produced his “Saturday night special”, a swingeing package of measures to bring credit and money growth back under control. 

The package was accompanied by an announcement that the Fed would switch its monetary targeting from interest rates to money supply growth. Although Volcker was not a hardline monetarist, he believed that this switch would drive home the message that the Fed would not allow the dollar to be cheapened by excessive supply. He also believed that monetary targeting imposed additional discipline on the central bank itself, even one as independent as the Fed. 

However, the implication of the change was that interest rates would have to rise to whatever level was necessary to keep money growth in check, and they did — with the prime lending rate ultimately reaching a record 21.5 per cent in December 1980. 

The measures sparked protests — angry homebuilders sent pieces of unused lumber to the board — and they were slow to achieve their aims. It was more than two years before inflation subsided; by then unemployment was at record postwar levels and the Fed chairman had become a feared figure through much of America. “The leadership of the Federal Reserve really pulled together because everyone was against us: there was an emotional circling of the wagons. Volcker was at the centre,” recalled Ted Truman, who was the director of the Fed’s international finance division in the 1980s.

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As the economy began to recover, Volcker was presented with fresh problems from the stimulative economic policies introduced by the “supply siders” in the administration of Ronald Reagan, who had come to power in 1981. Tax cuts alongside undeliverable spending reductions had produced a dramatic widening of the federal budget deficit. Volcker issued repeated public warnings about the risks but they fell on deaf ears.

With the economy strengthening, the effect was to drive up the dollar, as foreign capital flowed in to finance the deficits. In 1985, G5 finance ministers concluded the Plaza accord to bring the currency down again, only to reassemble, along with Canada, at the Louvre in Paris two years later to stop it plunging too far. 

But this was not the only reason Volcker was unhappy under Reagan. Although he had accepted the president’s offer of a second four-year term, he lacked a personal rapport with the administration’s members. And he found his own board increasingly packed with Reagan appointees, who resisted his attempts to maintain monetary discipline and adhere to the Plaza commitment to international co-ordination. 

Volcker’s darkest hour came in February 1986, when he was outvoted on a cut to the discount rate. The event almost prompted his resignation but he managed to forestall the move for a few weeks while he consulted with his overseas partners. The following year he indicated to the Reagan administration that he did not want a third term, and after his retirement in the summer of 1987 he was replaced by Alan Greenspan. 

Although the focus of Volcker’s time at the Fed was the restoration of financial order to the US economy and the currency markets, it was also marked by successive banking crises: the eruption of the Latin American debt crisis and the failure of Continental Illinois Bank, one of the country’s largest lenders. These crises exposed the fragility of the banking system, although they were later eclipsed by the meltdown that would occur under Ben Bernanke in first decade of the new century. 

After leaving the Fed, Volcker extended his work in public service, serving on a committee probing alleged corruption in the UN’s oil-for-food programme in Iraq, as well as chairing a commission to settle claims against Swiss banks by Holocaust victims. Barack Obama, early in his presidency, appointed him to lead an advisory board examining ways of improving the economy in the teeth of the worst downturn since the Depression. 

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Among the outcomes of this work was the so-called Volcker rule, which attempted to restrict banks’ ability to engage in risky proprietary trading. The rule epitomised Volcker’s suspicion of financial innovation — a view that had been vindicated by the crisis. The Fed has recently been preparing to simplify the rule as it attempts to ease some of the burdens of post-crisis regulation. 

CHICAGO - NOVEMBER 26: President-elect Barack Obama introduces former Federal Reserve Chairman Paul Volcker (L) as the head of the newly created Economic Recovery Advisory Board during a press conference at the Hilton Hotel November 26, 2008 in Chicago, Illinois. Austan Goolsbee, a senior economic adviser to the Obama campaign, has been named the Economic Recovery BoardÔøΩs staff director and chief economist.This was ObamaÔøΩs third press conference in as many days as he works to assemble and introduce his economic team. (Photo by Scott Olson/Getty Images)
With Barack Obama in 2008, a year before Obama was elected president © Scott Olson/Getty

There is no doubt that Volcker, by instinct, was much more critical than Mr Greenspan of the role played by unfettered free markets — and, in particular, bankers — in the economic life of the nation. He was also more sympathetic to the importance of vigorous regulation and supervision of the financial sector. 

He left the public sector believing that his tasks were far from accomplished. The federal budget deficit remained as intractable as ever and, as he said in the book Changing Fortunes: The World’s Money and the Threat to American Leadership, which he authored with former Japanese official Toyoo Gyohten, “It is hard to believe we have found anything like an optimal set of international monetary arrangements.” 

Later, his concerns grew about public disenchantment and cynicism towards government. In an attempt to strengthen trust in public service, he founded the Volcker Alliance, a non-partisan think-tank, in 2013 to advance the effective management of government. In his final book, Keeping At It, published in 2018, he wrote of Washington DC: “What not so long ago was a middle-class, midsized city dominated by an ethic of public service today simply oozes wealth and entitlement.”

Volcker had to live with the pain he had caused to millions of Americans via the policies of the early 1980s. But he justified it in the following words: “In the end there is only one excuse for pursuing such strongly restrictive monetary policies. That is the simple conviction that, over time, the economy will work better, more efficiently, and more fairly, with better prospects and more saving, in an environment of reasonable price stability.” 

By demonstrating that a central bank could bring inflation under control in the US, his success laid the foundations for governments around the world to give greater independence to their central banks to pursue anti-inflation focused monetary policies.

The low-inflation era, which continues to this day, can be traced back, at least in part, to the rigorous example set by the Volcker Fed. 


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