The world could do with another Paul Volcker

It was, perhaps, a less complex world when Paul Volcker employed his draconian approach to US monetary policy in the early 1980s, but some of his principles and values could be usefully applied in this post-crisis era of unconventional policies that produce meagre outcomes and plenty of unintended consequences.

Volcker, who died aged 92 in New York on Sunday, was the chairman of the Federal Reserve board who slew what had been double-digit inflation in the US after the two oil crises of the 1970s.

Paul Volcker was credited with breaking the back of inflation in the US by holding fast to his convictions despite ferocious criticism and abuse.
Paul Volcker was credited with breaking the back of inflation in the US by holding fast to his convictions despite ferocious criticism and abuse.Credit:Reuters

Before being succeeding William Miller as chair in 1979, Volcker famously told then US president Jimmy Carter, pointing to Miller, that “you have to understand, if you appoint me I favour a tighter policy than that fellow.”

He quickly followed through on his implicit promise to ratchet up US interest rates, with the prime lending rate – the rate banks charged their best borrowers – hitting 21.5 per cent in 1980.


The US plunged into recession and Volcker was the target of ferocious criticism and abuse but he held fast and was eventually credited with permanently breaking the back of inflation in the US.

In 1984 he was ordered by then White House chief of staff James Baker (with Ronald Reagan watching on) not to raise rates ahead of the US elections later that year. Given that he was considering lowering, not raising, them he was able to ignore the direction.

Ronald Reagan's chief of staff ordered Volcker not to hike rates in 1984 but the Fed chairman was able to ignore the direction.
Ronald Reagan’s chief of staff ordered Volcker not to hike rates in 1984 but the Fed chairman was able to ignore the direction.Credit:AP

In the current environment in the US – and not just in the US – where central bankers are under enormous pressure from politicians to pursue policies that might provide short term palliatives or prop up their electoral appeal, Volcker’s fierce independence and commitment to holding his course provides an example of political spine for his successors.

To Jerome Powell’s credit, the current Fed chair hasn’t been cowed by Donald Trump’s ceaseless personal abuse and threats or the withering criticisms of the Fed that he tweets regularly.

Trump wants low-to-zero US rates and more quantitative easing to lower the value of the US dollar, boost the US economy and improve his own re-election prospects.

It might appear obvious to most of us that a decade of experimentation with ultra-loose monetary policies – negative interest rates and quantitative easing through bond, mortgage and corporate debt purchases – has produced a mixed record.

Volcker's scepticism of the financial industry resulted in the passing of the
Volcker’s scepticism of the financial industry resulted in the passing of the “Volcker Rule” during the Obama era. The Trump administration is in the process of rewriting these regulations.Credit:AP

While the US has produced some relatively modest economic growth, the developed world is more indebted than ever – and the income in the lower and middle-income bands have remained flat, even as the incomes and wealth of the well off have rocketed as a direct consequence of central bank policies.

Ultra-low interest rates and the torrents of cheap liquidity generated by quantitative easing are designed to incentivise and/or coerce risk-taking in search of positive returns to generate trickle down wealth effects.

More than a decade after the experiment started it’s certainly encouraged risk taking: sharemarkets are at or near record levels, property markets are generally highly inflated and the world is drowning in debt. But it is generally only those who had risk capital to play with who have directly benefited.

Income and wealth inequality has generated social tensions and a rise in populism across the developed world.

Central bankers display a degree of paranoia about how financial markets might respond to a rate hike or a reduction of their balance sheets.

They created the problem of over-inflated asset prices but – unlike Volcker, whose predecessors knew they had a problem with inflation but couldn’t bring themselves to inflict the pain that was necessary to tame it – aren’t prepared to puncture the bubbles and risk the financial market tantrums and volatility and, potentially, near-term economic costs of acting.

Volcker was sceptical of financial institutions, financial innovation (he famously said the ATM was the peak of financial innovation) and financial markets.

That scepticism was given form, and him a contemporary legacy, by the post-crisis “Volcker Rule” (as named by President Obama), which bans big banks from proprietary trading.

However, that rule, along with other elements of the “Dodd-Frank” legislative response to the crisis, is being re-written by the Trump administration after heavy lobbying from the Wall Street banks.

While Volcker wasn’t opposed to some of the more modest proposed changes to his rule – in practice the banks and their regulators were sometimes finding it difficult to distinguish between principal trading and market-making in clients’ interests – he was very critical of the larger deregulation agenda the administration is pursuing.

In a letter to Jerome Powell earlier this year, he wrote that the new rules that will come into effect in January amplified risks in the financial system, increased moral hazard and eroded protections against conflicts of interests that were “so glaringly on display” during the financial crisis.

Volcker was a towering figure, both literally and metaphorically, in the world of central bankers. He had the courage to act on his convictions and not be swayed, even if the short term impacts were harsh and he drew the ire of the powerful. We could do with a few more like him.

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