The meaning of Paul Volcker’s comeback

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In the opening chapter of his great history of the Federal Reserve, Secrets of the Temple, William Greider describes Jimmy Carter’s choice of Paul Volcker as Fed chairman in 1979 in epochal terms:

At that moment, few in the White House appreciated what would become obvious in the next few years, that this was the most important appointment of Jimmy Carter’s Presidency.

What the President also did not grasp was that he was inadvertently launching a new era and ceding his own political power. The choice had occurred by accident, driven by political panic and financial distress. In time, it would profoundly alter the landscape of American life, transforming the terms for virtually every transaction in the national economy and the world’s, creating a new order.

Barack Obama’s choice of the now 81-year-old Volcker as chairman of his new Economic Recovery Advisory Board isn’t nearly that big a deal. But given Volcker’s history, it is awfully interesting.

In 1979, inflation was running in double digits and bond investors had lost all confidence in Washington’s ability to get it under control. By grudgingly appointing Volcker, then the president of the Federal Reserve Bank of New York (the job that Treasury-Secretary-in-waiting Tim Geithner holds now), Carter reassured markets and, it turned out, put monetary policy in the hands of somebody who was willing to sacrifice just about anything–including Carter’s job and those of millions of other Americans–to get inflation under control. In Greider’s telling, it was the beginning of an era where Wall Street called all the shots.

That era now seems to have come to an end in another period of “political panic and financial distress,” and yet here is Paul Volcker again. He’s been advising Obama for months. There was even talk that he might get the post of Treasury Secretary. What does his presence in the Obama camp mean?

Obviously the appointment is meant partly, just as it was in 1979, to reassure markets. Somebody investors trust is, if not in charge, at least standing at the President’s side.

But I’d like to think there is more to it than that. Volcker is not an economist, but he seems to have internalized far better than most economics Ph.Ds the lesson that there is no free lunch. That’s my interpretation–a more generous one than Greider’s–of Volcker’s brutal stand against inflation from 1979 through 1981. In the 1960s many economists had come to believe that inflating the currency was a simple and relatively safe way to keep the unemployment rate down–that is, a free lunch. Volcker put an end to that failed experiment.

More recently, Volcker has been outspoken about the dangers of budget deficits and looming long-term commitments to Social Security and Medicare. He has worried a lot about U.S. dependence on capital flows from abroad. He has also studied how financial regulation should be organized in the future, although he’s hesitant to draw any strong conclusions just yet. Basically, he has been the voice of prudence and of discipline in an era largely devoid of both.

Whether he’ll be a truly influential voice in a new administration that’s planning to throw hundreds of billions–maybe even trillions–of dollars at the economy to keep it from collapsing is something we’ll find out over the next couple of years. But for now his role in the Obama team at least exudes the reassuring  vibe that maybe the grownups are about to take charge.

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