LONDON (Reuters Breakingviews) - The Federal Reserve failed to anticipate the global financial crisis. Its hundreds of economists were too entranced by their abstruse mathematical models to see the storm clouds gathering. One central bank veteran, at least, was more alert. In April 2005, Paul Volcker publicly warned of “dangerous and intractable problems” besetting the U.S. economy. The lanky former Fed chairman remains famous for crushing the runaway inflation of the 1970s. His new memoir, “Keeping at It: The Quest for Sound Money and Good Government”, reveals the attributes that made him arguably America’s greatest central banker.
Volcker was born to public service. His father was the manager of a small town in New Jersey. Brought up during the Great Depression, his mother ran a frugal household. When the young Volcker arrived at Princeton in 1949, he paid his way by manning the hot dog stand at football games. At the time, the Federal Reserve, then under the thumb of the Treasury, was forced to keep interest rates low and inflation had started to pick up. Fatefully, Volcker’s senior undergraduate thesis was on the dangers posed by excessively low interest rates. In 1951 the Fed regained its independence under William McChesney Martin. The chairman, who once remarked that the Fed’s job was to remove the punchbowl when the party got going, remains one of Volcker’s heroes.
After graduate studies at Harvard and the London School of Economics, Volcker worked at Chase bank, the U.S. Treasury, Princeton and the New York Fed, becoming president in 1975. This broad experience prepared him for the top job when President Jimmy Carter made the call in the summer of 1979.
At the time, fears of hyperinflation and general economic collapse were in the air. It took great conviction and no little personal courage to slay the inflation dragon. The prime lending rate exceeded 20 percent and the unemployment rate climbed into double digits. There was public uproar. An armed intruder broke into the Eccles Building, threatening to kill members of the Fed’s Open Markets Committee. The resolute Volcker, who was provided with personal security, wasn’t deterred. In his own words, he remained “lashed to the mast” until the job was done.
Volcker shows himself to be more interested in the efficacy of monetary policy rather than its theory. Having avoided taking a course in econometrics, he distrusts the overly technical approach which has come to dominate the economics profession. As an undergraduate, Volcker was exposed to Austrian economics with its emphasis on the importance of money and the “natural rate” of interest. When Volcker later encountered the more fashionable Keynesians at Harvard, he was unimpressed. “It seemed to me the complexities of the economy couldn’t be reduced so easily to a few variables,” he writes.
At the Fed, Volcker targeted the growth in the money supply to bring inflation under control. Yet he contrasts his own “practical monetarism” with the ideological version peddled by Milton Friedman. During the battle against inflation the economics establishment - including Friedman - turned on Volcker. Yet after inflation turned down, Volcker quickly jettisoned monetary targeting. It had served its purpose. Like Martin, Volcker proved a staunch defender of the Fed’s independence. When Ronald Reagan’s Chief of Staff James Baker ordered him in the president’s presence to cut interest rates, Volcker walked out without uttering a word.
He left in 1987 with the central bank’s reputation greatly enhanced. Although he doesn’t criticise his successors, Volcker makes no bones about his dislike of the 2 percent inflation target that has swept the world of monetary policymaking. For a start, he says, it’s impossible to measure inflation with any accuracy. Nor does he see why central bankers should deliberately debase the currency, even by a small annual increment. More importantly, overblown fears of undershooting the target have justified an excessively loose monetary policy which poses a threat to financial stability and, in the long run, to price stability.
Volcker’s public standing is so elevated that whenever a great scandal has broken out he has been called to sort out the mess. He looked into how Swiss banks handled their wartime Jewish deposits (the Volcker Commission); examined the UN’s mismanagement of the Iraqi Oil-for-Food programme (the Volcker Committee); investigated corruption at the World Bank (the Volcker Panel); and contributed to post-crisis financial regulation (the Volcker Rule).
For Volcker and his family, public service has at times involved a deal of sacrifice. He took a large pay cut to join the Fed and was forced to leave his invalid wife Barbara in New York. To make ends meet, Barbara took a part-time job and rented out a room. Volcker says the “clear thread of his career has been the challenge and satisfaction of public service”. Believing in Alexander Hamilton’s dictum that “good government is dependent on good administration”, he established the Volcker Alliance to encourage training and education in public service, which he believes has been neglected by the top universities.
This fine memoir, written with the assistance of financial journalist Christine Harper, reveals Volcker’s personal traits. An amiable temperament. Great common sense. A clarity of thought and expression. An independence of mind without arrogance. Personal authority without self-importance. Rather, his natural disposition is one of wry self-deprecation. Volcker prizes loyalty and has striven to avoid conflicts of interest, so commonly abused nowadays on Wall Street and elsewhere. The possession of such personal integrity and old-fashioned civic virtues made Volcker an exemplary public servant. Now in his nineties, he is what the Japanese would call a “living national treasure”.
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