Remembering Paul Volcker

Former Chairman of the U.S. Federal Reserve Paul Volcker addresses the Economic Club of New York May 29, 2013. REUTERS/Mike Segar (UNITED STATES - Tags: BUSINESS)
Editor's note:

Kohn delivered these remarks at a celebration of former Fed Chair Paul Volcker’s life.

To prepare for this event, I was reading the oral history Paul Volcker left at the Fed. I recommend it highly: 340 pages of detailed policy analysis, personal reflections, and invaluable history of post-war US and global economic developments, which he shaped in so many critical ways. My name pops up on page 148 in association with the 1979 Chrysler bailout, which was my first close working relationship with Paul, and it turns out I owe him even more than I thought. He says: “I assigned Don Kohn to the job (I thought my boss, Jim Kichline had something to do with it). I trained him; he got extracurricular training.” Followed by [laughter]. I’m still trying to interpret that [laughter].

Volcker was put on the loan board, over his objections, because Sen. William Proxmire didn’t trust the Treasury not to give away the store, and he knew Paul would be as frugal with taxpayer dollars as he was with his own. There were many aspects to my training in this role, but the most important was watching the master embrace and execute on a public policy objective. He knew the law had given him a very strong hand in the bargaining with Chrysler constituents and played that hand with full force in his discussions with Doug Fraser, the head of the United Automobile Workers (UAW). Paul had a goal for what the UAW needed to give up in terms of wages and he held to that in a very tough session with Fraser that I attended. I recall thinking that Fraser had some good points and just a little give would allow all sides to be winners, but Paul knew why he had been put on the board and what he had to do. There was no give, the UAW accepted the Volcker proposal, Chrysler hung on for a few decades, Fraser later said Volcker was the toughest bargainer he had encountered over his career, and Don Kohn had his extracurricular training.

I also worked with him on the domestic financial crises that followed the Volcker disinflation of the early 1980s. It turns out that rational, efficient markets in the 1970s did not anticipate the black swan of Paul Volcker, and the prices of speculative assets plunged in the 1980s as inflation came down and stayed down, with potential consequences for the financial system. Think about silver, the Hunt brothers and Bache; oil prices, Penn Square and Continental Illinois, and farmland and the Federal Farm Credit System. Here, the master’s lesson was to protect the system but not the sinner—and that required facts, analysis, and flexibility. The financial system wobbled, but stayed upright, while the Hunt brothers lost all as did the owners of Continental Illinois, and the Farm Credit agencies were reformed and reorganized under a newly empowered regulator.

Through the early 1980s, I was drafted into his battle to protect the scope of the Fed’s supervisory and regulatory oversight against the predations of Vice President George H.W.  Bush’s attempts to make sense out of the fragmented, overlapping financial regulation system in the US. Paul recognized the deficiencies in the system, and decades later the Volcker Alliance came up with a very clever re-organization scheme that, like the many before it, got no traction against the vested interests protecting the status quo. When the Bush task force was threatening we wrote speeches and went to inter-agency staff meetings armed with a few principles: The Fed will be held responsible in the legislature and the public for financial instability, even if it doesn’t have sufficient authority; banks were special and essential for preserving stability and well-functioning financial markets; therefore the Fed needed to have an important say in the oversight of banks; and, unspoken in public, the reserve banks needed to have something to do besides kibitz on monetary policy to justify their existence. In the end, the Bush recommendations for regulatory consolidation away from the Fed were not undercut by all that smart, well-researched Volcker analysis, but rather by an unexpected community of interest with an unlikely ally—Don Regan, who wouldn’t buy into the implications of the Bush plan for the Comptroller and the Treasury.

Of course, his best-known and most lasting accomplishment as Chairman was conquering inflation. I was too junior a staff member to be there at the famous October 6, 1979, meeting of the Federal Open Market Committee when it shifted from setting an interest rate to setting a money supply target, but I was involved in the aftermath. He was determined to reduce inflation, but no one knew how high rates would need to go to accomplish that. The incremental monetary policy process of voting on each rate decision probably wasn’t going to get to the right place and wasn’t credible in markets—especially after he only narrowly won board approval for a discount rate increase in mid-September.  There was enough evidence linking money supply to inflation over long periods to make a shift to a quantity-based target credible and likely to succeed over time. The shift to money and reserve targets provided a rationale for very large rate increases that was easier to implement in the Committee and easier to explain in public—it was the demand for money that was raising rates, not a deliberate decision by the Fed.

Nonetheless those were tough times—economically and politically. Interest rates of 20 percent and unemployment rates of 10 percent; rings of tractors around the board building; offices filled with 2x4s mailed in by builders; consumer demonstrations outside the building; talk of his impeachment in the Congress. In response to the consumer protests, he agreed to send board members and senior staff to meet with consumer groups around the country. It was a very unpleasant experience, marked by hostility, harassment, and demands for personal financial information. Paul recognized the sacrifice he had asked us to make and had a ceremony in his office awarding us purple hearts for wounds suffered in service to the central bank. I confess to a small degree of satisfaction when at the end of the round of meetings, the group came into the board room at the Fed and behaved in a way that earned the Chairman his own purple heart.

“[T]he decisions on when to shift away from particular strategies require an even broader perspective, a greater subtlety of thinking and analysis, and confidence in one’s own judgment and ability to convince others than the decisions to undertake those strategies in the first place. Paul Volcker had the required attributes in great abundance.”

I think we can draw a couple of lessons for public policy from his handling of the fight against inflation. First, once an important public policy goal and a course of action to achieve it are identified, stick to it, recognizing that the short-run costs will be far outweighed by longer-term gains. And, the Volcker disinflation set the stage for two and a half decades of almost uninterrupted growth.  But second, once that calculus of short-run costs and longer-run gains flips, back off. That’s what happened in the fall of 1982 when inflation had receded considerably and was still on the way down, and the high interest rates of previous years were threatening debt sustainability in Latin America and therefore the viability of several major US banks. His book is entitled “Keeping at It” and that’s a great description of his lifelong pursuit of key public policy goals. But sometimes, within that overall arc, the decisions on when to shift away from particular strategies require an even broader perspective, a greater subtlety of thinking and analysis, and confidence in one’s own judgment and ability to convince others than the decisions to undertake those strategies in the first place. Paul Volcker had the required attributes in great abundance.

When the news of his passing came out, I was in London and Brookings asked for a statement to give reporters. Here’s what I said: For me, he was mentor, role model and friend. He rejected some of the technology of modern central banking—the explicit inflation target, the transparency, the ease with new-ish financial instruments. But he had the essential elements of courage, integrity, devotion to public service and a laser like focus on price and financial stability that made him a great central banker. We were fortunate to have him among us.