Vale, Volcker
BROCKWAY, GEORGE P.
The Dismal Science VALE, VOLCKER BY GEORGE ? BROCKWAY A couple of years ago, Mayor Edward I. Koch was asked who was responsible for pulling New York City back from the brink of bankruptcy....
...Let's briefly examine the Volcker record in five areas— (1) inflation, (2) general welfare, (3) economic output, (4) foreign trade, and (5) the deficit— and then look more closely at his underlying theory...
...this was one of Reagan's arguments against Jimmy Carter...
...If the monthly deficit on current accounts falls a point or two, it is hailed as a triumph...
...but it jumped 26.81 per cent in the Volcker years...
...What really happened...
...Moreover, the loan isn't the only thing that bothers you, because what economists call the "opportunity cost" of the money you and others have invested in your business increases as well...
...His theory was that a controlled money supply would raise the interest rate, and that a drop in the inflation rate would take place...
...Everyone knows that our recent performance in foreign trade has been abysmal...
...Suppose the 1946 rate had been paid instead of the Volcker rate...
...By 1986 the debt had risen to 41.94 per cent of GNP...
...The GNP rose (in constant dollars) 32.19per cent from 1960 through 1972...
...He took office at the Fed in October 1979 and immediately began his attack...
...But such pseudo-logic can equally "prove" the opposite...
...I say them not only in sorrow but also in anger, because people have been hurt—have had their lives ruined—by the lordly mistakes of this big man, and because his smaller successor as chairman of the Federal Reserve Board, Alan Greenspan, is apparently ready to keep making most of the same mistakes (besides, when the wind is north-northwest, declaring his devotion to Ayn Rand and longing for the gold standard...
...If you are running a business and your friendly banker says he wants 20 per cent to renew your 10 per cent loan, your first defense is to increase your prices...
...Even a very severe depression (and Volcker made us one) will at best slow inflation...
...A significant aspect of these increases is that they are percentages...
...On October 19, 1979, shortly after taking office, Volcker proclaimed, "The standard of living of the average American has to decline...
...THE VOLCKER YEARS Annual percentage changes in the Money Supply (M1) and the Prime Rate related lo the following year's percentage change in the Consumer Price Index (CPI) Year Ml Prime CPI Year 1979 7.1 31.9 11.8 1980 1980 6.6 41.0 10.8 1981 1981 6.5 -26.8 3.5 1982 1982 8.8 -27.0 3.5 1983 1983 9.8 -4.3 3.3 1984 1984 6.0 0.2 3.6 1985 1985 12.2 -11.2 0.8 1986 Source: "Economic Reporl ol the President, 1987...
...This is what Volcker frankly worked for...
...There are a few ways a national debt is like a personal debt, and one of them is that the amount of debt a nation can bear is a function of its income...
...For something like a real wolf, we can go back to 1946, the last year of World War II, when the Federal debt held bythepublicwasl 13.62 per centof GNP...
...They should share it with Paul A. Volcker, for they couldn't have raised the interest rate to usurious heights without his help...
...The result is that, as Adam Smith observed in a little-noticed passage, prices are increased geometrically, whereas a wage increases pushes up prices only arithmetically...
...If there is validity to the notion that a high debt/GNP ratio induces or requires a high interest rate, the 1946 rate should have been wild...
...Second, let me make the much more important observation that speculation is vastly stimulated by volatile interest rates...
...Given that more families had multiple wage earners in 1985 than earlier, the drop in family income was even steeper...
...In 1979theFederaldebt held bythepublic(someof it, of course, is held by government agencies, mainly Social Security) was 26.33 per cent of GNP...
...1. Inflation...
...Well, I suppose someone has to get the credit, and it might as well be me...
...He had a lot of help from Ronald Reagan, from legions of people who were sure they were doing what the President would have wanted had he been paying attention, and —yes—from you and me...
...All this naturally contributed to the trade deficit and put Americans out of work...
...For true believers in the Volcker magic, when 1980's slight tightening of the money supply was followed by a slightly lower inflation rate, that "proved" the theory...
...It comes down to this: Volcker allowed interest rates to soar, partly to reduce the average American's standard of living, and partly to encourage foreign investment in government bonds...
...Wages are held down, and so price increases can be relaxed...
...A case can be made for many Volcker virtues, especially in impeding somewhat the rush to deregulate banking...
...nonetheless, it stands as a real fact in the real world...
...On the other hand, in 1985 the biggest jump in Ml was accompanied by a substantial fall in the prime and followed by the most dramatic fall in the CPI...
...Nevertheless, even if Paul Volcker wasn't, as the commentators liked to say, the second most powerful man in the world, he is, as they also say, a legend in his own time...
...Now consider this: During the Volcker years the Federal debt held by the public increased by $1,102 billion, and the interest paid on that debt amounted to $844 billion...
...From that December through December 1986, the Consumer Price Index (CPI) rose 51.06 per cent in constant dollars...
...That is, whoever invests in your business passes up the opportunity to make easy money by being a lender rather than a borrower...
...In comparison, the increase from 1972through 1979 was considerably greater, 73.50 per cent, but from 1964 through 1972 it was considerably less, 34.88 per cent...
...He was never able to keep Ml growth within the guidelines advocated by Milton Friedman...
...5. The Deficit...
...Again using constant dollars, we find that from 1964 through 1972 the median family income increased 25.46 per cent...
...and only 12.30 per cent in the Volcker years...
...The inflation rate is not a figure you read off an instrument, like barometric pressure...
...It also made it easier to sell American bonds—not goods but bonds— abroad...
...2. General Welfare...
...Every company below you in the production chain is adding a percentage to its prices, and you add your percentage on top of their inflated prices, and the companies above you in the chain do the same...
...But when 1984's greater tightening was followed by an increased inflation rate, that "proved" businessmen had expected the tightening and had moved to offset it...
...Volcker is admittedly not single-handedly responsible for the bad things—or the good things, if any—that can be pointed to in each case...
...I now make the heretical claim that his maneuvers with the interest rates indeed caused inflation to be greater than it might have been...
...Unhappily, I have some even less nice things to say...
...22.38 percent from 1972 through 1979...
...As we have seen, inflation was only slightly restrained...
...But speculation can always crowd out production, and that is what Volcker's policy has encouraged...
...At the same time, the debt/GNP ratio would have fallen to 22.46 per cent—hardly anything to get excited about (except as probably too low), and certainly below the urgent need for foreigners to invest in our bonds...
...and I don't mean merely that it wouldn't have seemed important if it hadn't been for the Kemp-Roth tax cuts...
...Consequently, interest rates and inflation rates have a tendency to go up and down together...
...Volcker never made a secret of the fact that his program was going to hurt...
...It's really what he stands for that I will talking about...
...Volcker's rationale for hurting people was that inflation would thus be controlled, and the rationale for controlling inflation was that prosperity depended on it...
...What's more, similar percentage increases are being made by everyone who supplies you with raw materials or rents you office space or provides shipping services for you...
...And there is no way on earth to deny that what he did reduced the standard of living of average Americans and forced millions more into poverty...
...and if interest rates remain high, the net pressure on prices will continue to be upward...
...Since the working-age population increased 8.19 per cent in the last period, and more people produce and consume more goods, the Volcker recovery has been overpraised...
...In one of his formerly frequent bright moments, he replied...
...But if the rates had been lower, the deficit would have been minuscule, and the foreign investors wouldn't have been needed...
...There is no doubt that Volcker's present fame is based on his claim to have been the tamer of the inflation dragon...
...It was supposed to stabilize international trade, and it sure made it fun to travel in Europe and to buy Volvos and Mazdas and madras shirts in the U.S...
...from 1972 through 1979 it increased 1.56 per cent...
...High interest rates simply gave a lot of money to rich foreigners—and to rich Americans, too...
...Volcker says that if the strong dollar weren't available to bring in foreign money, Federal borrowing would crowd producers out of the money market...
...Sooner or later, people can't afford the new prices...
...It is worth remembering that New York had been pushed to the brink by Walter B. Wriston's Citibank, David Rockefeller's Chase, Donald T. Regan's Merrill Lynch, and the rest, because in their self-advertised wisdom they thought it safer to lend our money to Argentina, Brazil and Mexico...
...Well, I suppose someone should get the credit for the mess our banks and the debtor nations are in, and it might as well be them...
...Volcker certainly isn't to blame for those...
...The fate of the poor was much more dramatic...
...That was one of the lowest ratios in years, but Reagan promised to wipe it out and Volcker strengthened the dollar to help him...
...This is a lot hairier than the 1979 animal, but even so it's not a real wolf...
...I have already said that Volcker's attack on the inflation dragon was not outstanding...
...rich people and rich countries can carry big debts...
...But true to Adam Smith, we see that when wages go down (empirically, when any cost—including interest—goes down), prices fall only arithmetically...
...so you have to raise prices to take care of that, too, and keep your colleagues from wanting to sell out...
...What few remember, however, is that the strong dollar was a deliberate objective of Volcker's policy, announced as early as October 17, 1979...
...Rhine used to "prove" extrasensory perception...
...He made it happen...
...The theory that I (and Adam Smith) have advanced (for a somewhat fuller exposition, see my note in the Winter 1986-87 Journal of Post Keynesian Economics) goes at least part way in showing why Volcker's theory was wrong...
...The United States' debt is always thought enormous by knee-jerk conservatives...
...perhaps it will be said that is why the recovery has been so lackluster...
...Of course, the intended decrease in the level of business follows sooner or later (it took Volcker almost three years to get things down to where he wanted them...
...The deficit question is a phony, and so is the problem of financing it...
...Poor people and poor countries have trouble with small debts...
...The interest bill would have been reduced by about $812 billion, while the debt itself would have increased only $290 billion...
...it will not stop it as long as interest rates remain high...
...There is a still more serious effect than either of these...
...And if we go back to the bad old days of Harry S. Truman, we find that the increase from 1948 (following the jump when wartime controls were suddenly ended) through 1952 was only 10.26 per cent...
...Yet in that year, three-month Treasury bills paid all of three-eighths of 1 per cent, and the prime was 1.5 per cent...
...First, let me make a minor observation...
...4. Foreign Trade...
...it held unchanged from 1972 through 1979...
...Volcker wanted the strong dollar because it made it easier to finance the American deficit—again a way to achieve a questionable result by imposing unquestionable hardship on millions of people...
...In short, there is no way on earth to construct a valid correlation of changes in the money supply, interest rates and inflation rates that will support Volcker's theory of what he was doing...
...That may have been, as Ring Lardner would have said, one of its charms...
...But the false legend of big Paul Volcker and the dragon is one that shouldn't be told to children—or to grown-ups, either...
...It's just as well...
...In general, the figures in the table can be made to support Volcker's theory only by appeals to "lags" and "anticipations" and other statistical gyrations of the sort J.B...
...It is a statistical construction, and one of its factors is the interest rate...
...Workers get laid off...
...but in the Volckeryears, from 1979through 1985 (the latest Economic Report of the President doesn't have 1986 figures for this), the median income fell 4.56 per cent...
...He is to blame, though, for crying wolf over the deficit...
...That may not be a nice thing to say about a man who is now retiring from government after many years of undoubtedly self-sacrificing service...
...The immediate impact of an increase in interest rates, therefore, is an increase in inflation...
...Unions get afraid to strike...
...But they don't deserve all the credit...
...On the record, Volcker, the great inflation tamer, turns out not to have been all that great...
...Businesses can't sell as much as they used to...
...Either way, Volcker's theory was a winner...
...3. Economic Output...
...Volcker's announced policy was to control the money supply (Ml) and let the interest rate take care of itself...
...The number of our fellow Americans living in poverty actually declined 32.13 per cent from 1964 through 1972...
...He was successful on both counts...
...As the table above shows, in 1981 a minor fall in Ml growth (one of only two such occurrences in Volcker's career) was accompanied, not by a rise, but by the second largest fall in the prime rate, and followed by the largest fall in the CPI...
...This is an arbitrary and possibly small effect, and one that could be eliminated by slight pressure on a computer key...
...Everyone knows, too, that the strong dollar of recent years has made it difficult for American industry to compete either at home or abroad...
Vol. 70 • June 1987 • No. 8
