Before he goes down in history books as the man behind the “Volcker rule,” that is, behind the effort to banish speculative activity from investment banks, let us recall that Paul Volcker was a critical figure in the monetary history of the United States due to his eventful 8-year tenure as Chairman of the Federal Reserve (1979 – 1987). He was surely one of the good guys.
We should also recall (Volcker surely does) that before his appointment, indeed through the 1970s, the people of the United States had become accustomed to double-digit inflation (and to blaming it on oil rather than on central banking and a fiat currency).
The U.S. rate of inflation peaked and headed decisively downward during Volcker’s tenure. Using the figures from the Bureau of Labor Statistics, the actual peak was 1980, when prices rose by 13.5%. By 1983, largely due to Volcker’s leadership, that number was down to 3.2%. The U.S. has never since had to contend with the double digits. I don’t know whether Volcker can be credited with killing a dragon, but he at the least rendered it comatose.
What’s The Matter with Kids Today?
Volcker is obviously entitled to express his concerns when he senses that the well-educated young are unaware of just how nasty that dragon could be – after all, efforts are clearly underway to revive it.
So I note that this spring, in May, The Daily Princetonian published an interview with Volcker, an alum thereof (1949). In answer to a somewhat leading question about whether central bankers worry too much about inflation, Volcker gave an emphatic “no.”
“The responsibility of any central bank is price stability….They ought to make sure that they are making policies that are convincing to the public and to the markets that they’re not going to tolerate inflation.”
The interviewer – probably Jacob Donnelly, who gets the byline – then pressed the matter a little further, suggesting that perhaps if high inflation is “expected” than it doesn’t really matter. Volcker would have none of it.
“This kind of stuff that you’re being taught at Princeton disturbs me. Your teachers must be telling you that if you’ve got expected inflation, then everybody adjusts and then it’s OK. Is that what they’re telling you? Where did the question come from?”
Rather than answering that, the interviewer changed the subject, asking about the Fed as regulator. I’ll pass that by here.
A Shout-Out to Lucas
But the interview soon came back to the monetary questions, and started a question with, “given the trade-off between inflation and unemployment….” Volcker, to his credit, didn’t let that question go any further. It isn’t a given.
“That is a scenario and a delusion, which economists have gotten Nobel Prizes twenty years ago to disprove.”
That’s how the transcript reports his answer, anyway. Personally, I suspect he said “a snare and a delusion.” That’s the usual idiom, and the word “scenario” doesn’t make a lot of sense in that context.
The Nobel Prize reference is a shout-out in particular to the late Robert Lucas Jr., recipient of the Economics prize in 1995, who in fact gave his Nobel lecture on precisely this point. Lucas in that lecture said that “in order to see inflation and unemployment as lying on a negatively sloped curve, one needs to keep shifting the curve.”
Indeed, the interviewer’s two lines of questions about monetary policy seem mutually cancelling. If we seriously consider the possibility that “expected” inflation is harmless, then it is also impact-free, and can’t do anything about employment. To the extent it does have a stimulus value, this is because its extent does come as a surprise to some parties. And its character as a constantly renewed surprise is why one has to keep shifting the curve in order to map its supposed good effects.
The disutility of inflation isn’t speculative at all. It destroys existing savings and the incentive to create future savings, it undermines the information value of prices. Perhaps worst of all, it encourages unproductive “greater-fool” trading – or in other words, speculative bubbles. Further, the tendency to reach for a “hair of the dog” after the inevitable crash, to cure the post-bubble hangover by renewed inflation, is part of the problem, not part of any sane solution.
So let Volcker go into the history books as, among much else, the man who cautioned one young Princetonian about the “kind of stuff you’re being taught” with all of its snares and delusions.