Volcker, Reagan & History
WASHINGTON -- It's important to get history right -- and economist and New York Times columnist Paul Krugman has got it maddeningly wrong.
Krugman recently wrote a column arguing that the decline of double-digit inflation in the 1980s was the decade's big economic event, not the cuts in tax rates usually touted by conservatives. Actually, I agree with Krugman on this. But then he asserted that Ronald Reagan had almost nothing to do with it. That's historically incorrect. Reagan was crucial.
In nearly four decades of column-writing, I can't recall ever devoting an entire column to rebutting someone else's. If there were instances, they're long forgotten. But Krugman's error is so glaring that it justifies an exception. It's also a subject about which I know something, having written a book on it: "The Great Inflation and Its Aftermath: The Past and Future of American Affluence." This column draws from that book.
For those too young to remember, here's background.
From 1960 to 1980, inflation -- the general rise of retail prices -- marched relentlessly upward. It went from 1.4 percent in 1960 to 5.9 percent in 1969 to 13.3 percent in 1979. The higher it rose, the more unpopular it became. People feared that their pay and savings wouldn't keep pace with prices.
Worse, government seemed powerless to defeat it. Presidents deployed complex wage and price controls and guidelines.
They didn't work. The Federal Reserve -- custodian of credit policies -- veered between easy money and tight money, striving both to subdue inflation and to maintain "full employment" (taken as a 4 percent to 5 percent unemployment rate).
It achieved neither. From the late 1960s to the early 1980s, there were four recessions.
Inflation became a monster, destabilizing the economy and destroying trust in national leadership. The Gallup Poll routinely asks respondents to select "the most important problem facing the country." From 1973 to 1981, the "high cost of living" ranked No. 1. People lost faith in the future, as they have now.
Krugman's story is simple. The Fed is "largely independent of the political process" and, under chairman Paul Volcker, "was determined to bring inflation down," he wrote. "It tightened policy, sending interest rates sky high, with mortgage rates going above 18 percent." The result was "a severe recession that drove unemployment to double-digits but also broke the wage-price spiral."
Indeed. By 1982, the gain in consumer prices had dropped to 3.8 percent. Volcker crushed inflation.
Story over? Not really.
What Reagan provided was political protection. The Fed's previous failures to stifle inflation reflected its unwillingness to maintain tight-money policies long enough to purge inflationary psychology. Successive presidents preferred a different approach: the wage-price policies built on the pleasing (but unrealistic) premise that these could quell inflation without jeopardizing full employment.
Reagan rejected this futile path. As the gruesome social costs of Volcker's policies mounted -- the monthly unemployment rate would ultimately rise to a post-World War II high of 10.8 percent -- Reagan's approval ratings plunged. In May of 1981, they were 68 percent; by January 1983, 35 percent.
Still, he supported the Fed. "I have met with Chairman Volcker several times during the past year," he said in early 1982. "I have confidence in the announced policies of the Federal Reserve."
This patience enabled Volcker to succeed, though it took about two years of tight money. It's doubtful that any other plausible presidential candidate, Republican or Democrat, would have been so forbearing. During Volcker's monetary onslaught, there were many congressional proposals, backed by members of both parties, to curb the Fed's power, lower interest rates or fire Volcker. If Reagan had endorsed any of them, the Fed would have had to retreat.
What Volcker and Reagan accomplished was an economic and political triumph. Economically, ending double-digit inflation set the stage for a quarter-century of near-automatic expansion (indeed, so automatic that it bred the complacency that led to the 2008-09 financial crisis -- but that's another story). Politically, Reagan and Volcker showed that leaders can take actions that, though initially painful and unpopular, served the country's long-term interests.
But their achievement was a joint venture: If either hadn't been there, the outcome would have been much different.
There was no explicit bargain between them. They had what I've called a "compact of conviction." Volcker later said of Reagan: "Unlike some of his predecessors, he had a strong visceral aversion to inflation." So did Volcker. Both believed the country could not flourish with high inflation. Both acted on that faith.
Volcker needed presidential support, because the Fed's formal "independence" is highly qualified by political realities. The Fed, Volcker has said, "has got to operate ... within the range of understanding of the public and the political system." Reagan widened that range.
To exclude him from this narrative is not history. It's fiction.
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