The Volcker Mistake

I don’t remember this and cannot find confirmation on the internet.
Was there no Volcker mistake or will no one besmirch the Volcker legacy?

When Paul Volcker was appointed Fed Chair in 1979, he immediately set about ending the worst inflation the U.S. has seen since the end of World War II by raising rates.

Then the U.S. was hit with a recession in January 1980.

Unemployment rose to 7%. Inflation was still 14.7% in April 1980, but Volcker was under intense pressure to cut rates in the face of a recession and layoffs.

The Fed blinked. Volcker lowered the fed funds target rate by 7 percentage points.

The recession was over by July 1980, but inflation was not. Inflation at the end of 1980 was still over 12%. The Fed and Volcker had damaged their credibility as inflation fighters.

This became known as the infamous Volcker Mistake.

From there Volcker doubled down.

The point is that when Volcker lowered rates in 1980, the job of beating inflation was not done.

And obviously Powell would not wish to repeat that error.


This is what Wikipedia has to say about his legacy as Chairman of the Federal Reserve:

After G. William Miller’s confirmation as Secretary of the Treasury, President Jimmy Carter’s confirmation of Vice Chairman of the Federal Reserve Frederick H. Schultz’s role as Acting Chairman sent markets panicking. Carter resultingly sought a reassuring, qualified nominee who would confront inflation head-on, and nominated Paul Volcker to serve as chairman of the Board of Governors of the Federal Reserve System on July 25, 1979.[16][17] He was confirmed by the U.S. Senate on August 2, 1979, and took office on August 6, 1979.[18] President Ronald Reagan renominated Volcker to a second term in 1983.[19][20]

Inflation emerged as an economic and political challenge in the United States during the 1970s. The monetary policies of the Federal Reserve board, led by Volcker, were widely credited with curbing the rate of inflation and expectations that inflation would continue. US inflation, which peaked at 14.8 percent in March 1980, fell below 3 percent by 1983.[21][22] The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. The prime rate rose to 21.5% in 1981 as well, which helped lead to the 1980–1982 recession,[23] in which the national unemployment rate rose to over 10%. Volcker’s Federal Reserve board elicited the strongest political attacks and most widespread protests in the history of the Federal Reserve (unlike any protests experienced since 1922), due to the effects of high interest rates on the construction, farming, and industrial sectors, culminating in indebted farmers driving their tractors onto C Street NW in Washington, D.C. and blockading the Eccles Building.[24] US monetary policy eased in 1982, helping lead to a resumption of economic growth.


IIRC, Volker did repeat the mistake of his predecessor, Arthur Burns, of lowering rates too soon and having to raise them again. For Volker the second round was the one that worked. Of course, the economy went through two back-to-back recessions.


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“Investors now expect the rate that the ECB pays on bank deposits, currently at 2%, to rise to 3.4% next year, compared to a 2.75% peak priced in before last week’s decision.”


Yes, that’s right. You can see it in these charts. (Although the inflation rate and GDP are a little hard to see in the long sweep of history.)

There were two recessions, 1980-81 and 1982-83. But unemployment didn’t come down. It seemed like it would go on forever when I was living through it. Factories were going out of business, laying off employees, never to reopen. I wasn’t affected personally but I was in the middle of it.

It took a lot of backbone for Volcker to hold to his strategy in spite of tremedous pressure to ease.


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But the 1980 presidential election was.


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Interesting. The Republican proposal to reorganize the Federal Reserve Board would increase political pressure on the Fed.

Politics and the desire for the Fed chair to be re-appointed is already political enough.

Would more political levers help the Fed do a better job?


It would probably push Shiny-land closer to being a banana republic.



The Fed has the potential (occasionally achieved) to act independently from politics as an association of bankers charged with the structuring of the nations currency. Turning it into a political pawn is a recipe for (even) sillier behavior.



A couple of weeks ago, I started researching the backgrounds of the various Fed regional bank presidents and other top leadership of the Fed. I was pleasantly surprised to learn that most were academics, with perhaps some banking experience in their early careers. I don’t recall any of them coming from a political background.

That struck me as a pretty good way to mitigate the inevitable pressures from both the banking industry and politicians.

I think that independence is vital to the functioning of the Fed.