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An Unlikely Hero in the U.S.’s Last Battle with Inflation

Inflation might seem bad now, but this is not the worst the U.S. has ever experienced. Back in 1970, when President Richard Nixon was trying to win reelection, he pressured the Federal Reserve Chairman Arthur Burns to push down lending rates and spur the economy. It worked and Nixon went on to win the race, carrying 49 states.

But these artificially low rates didn’t come without repercussions. Inflation rose from 3.2 percent at the end of 1972 to over 11 percent by 1975 to over 14 percent in 1979. This had a disastrous effect on the economy. In January 1980, a recession had begun. By December unemployment was at 10.8 percent, the highest level since the Great Depression. To help bring life back to the sputtering economy President Jimmy Carter appointed a 6’7”, mild-mannered man named Paul Volcker as Chairman of the Federal Reserve.

When President Reagan won in 1980, thanks to his platform of fiscal conservatism, Volcker was given the freedom and protection to do what he thought was best for the economy: raise interest rates. But unlike today, where the Fed carefully weighs any rate increase with how the markets will react, Volcker did no such calculation. Working relentlessly to bring prices under control, Volcker raised the Fed’s benchmark interest rate from 11 percent to a record 20 percent to try to slow the economy’s growth and thereby slow inflation.

To say that this move had a lot of detractors is an understatement. Homebuilders put postage stamps on bricks and  2-by-4s and mailed them to the Fed to protest how super-high interest rates had wrecked their businesses. Auto dealers, stuck with lots full of unsold cars, did the same with car keys. Angry farmers, struggling with high debts, drove tractors to Washington and blockaded the Fed’s headquarters. There was no organized protest that I could find but I have to think that commercial real estate owners, facing unthinkable terms to finance their properties, didn’t think very highly of him either.

But despite the pain that this move caused, Volcker didn’t budge. The avid fisherman had a calm disposition and was “stubborn as he was tall.” And his austerity measures eventually worked. The economy cooled but more importantly, the dollar became less over-valued. The period of economic growth that the U.S experienced afterward was the beginning of what economists call the “Great Moderation.” The Great Moderation ended with the Great Recession of 2008. 

And who came in to help clean up after the subprime mortgage crisis? None other than Mr. Volcker, who was by then in his 80s. President Barack Obama recruited him as an economic adviser. In that role, Volcker pressed for restrictions on banks, requiring them to trade in financial markets with more of their own money, rather than their clients’. Volcker had little sympathy for big banks in the wake of the financial crisis, which required a taxpayer bailout of big Wall Street firms. He dismissed claims that deregulated financial institutions deserved credit for coming up with innovative products and services. According to him, the only useful financial innovation he’d seen in years was the ATM.

The regulations, known as the Volcker Rule, still limit the amount that banks can lend. It is said that this rule has limited the amount of money available for loans such as commercial mortgages. But the upside to a regulation that keeps banking institutions from needing a bailout is worth its effect on the lending market. Because now, just like back in 1980, we have to walk a fine line between boom and bust.

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