The Education of Paul Volcker: The Austrian School vs. Keynesianism
INTERVIEWER: Can we talk a little bit about your early influences as an economist? Were you exposed at all to the Austrian School of economy?
PAUL VOLCKER: I happened to have been exposed when I was an undergraduate, because my first teachers of economic theory came from the Austrian School, and this was in the late '40s. They were not all enamored of Mr. Keynes and the Anglo-Saxon traditions of economics, so I had a pretty good exposure to the Austrian School and Mr. Böhm-Bawerk and all his friends.
INTERVIEWER: You went to the London School of Economics, didn't you? Did you find it a hotbed of left-wing thinking?
PAUL VOLCKER: No, all my friends to this day associated all those things with a hotbed of socialism, and that impression, of course, was created by Socialists. Harold Laski was a big influence, but not in the economics department. The economics department actually was quite conservative. People didn't believe that Hayek was a leading writer in the economics department in the London School of Economics for some years.
INTERVIEWER: Did you pick up some of the influences of Hayek?
PAUL VOLCKER: No, but I had read The Road to Serfdom when I was in college, I well remember. At that impressionable age it made a very considerable impact.
INTERVIEWER: How were you influenced by Hayek and The Road to Serfdom? How big an impact did it make on you?
PAUL VOLCKER: I don't know if I can quantify it, but it was a very persuasive argument -- the glories of a free-enterprise system, and at that time there was a pretty active debate about socialism, at least in the rest of the world, and to some degree it hit the United States. This would have been after World War II... and socialist thinking had gone pretty far. This was pretty big, this warning about where it might lead and possible excesses. I am not as conservative as Mr. Hayek's followers, but it was a very powerful story.
INTERVIEWER: When you were at Harvard you found that the orthodoxy was almost purely Keynesian, didn't you?
PAUL VOLCKER: At least part of it was. I had Alvin Hansen, who was a leading Keynesian disciple in the United States, as a professor at Harvard, as everyone did in the graduate school at that time, and that was straight Keynes, right down the line. It was all a debate then as to whether Keynes made sense. But the Hansen logic was very straightforward and very convincing.
INTERVIEWER: You said Keynesianism was almost a religion at Harvard when you were there?
PAUL VOLCKER: They did have other people there, you know. John Williams was the other macroeconomist there, certainly financial-side, and he was a very skeptical practitioner. He didn't spend all his time professing, and he advised the Federal Reserve back in New York at great lengths. I can't say everybody was Keynesian, but the younger school certainly was. It was Paul Samuelson, Jim Tobin, and all of them had grown up in the Keynesian climate. I didn't know them all, but they were all circulating. They were the bright young stars of Harvard at the time.
INTERVIEWER: When did you begin to have doubts? How early did you begin to become skeptical about things?
PAUL VOLCKER: I was already skeptical. I guess I'm skeptical about everything. I've gotten worse in my old age, but I was a little bit turned off by the precision and certainty that these people attached to the doctrine. The analytic framework was very convincing, but this feeling they had, that they could press the right buttons and manage the economy pretty exactly, for some reason it turned me off. I was very skeptical that they were not overselling the precision of this theory and the precision [with] which they could run policy.
INTERVIEWER: Was that a gut instinct, or was that something you picked up?
PAUL VOLCKER: It must have been a gut instinct. I don't know why, but I was just a little bit turned off by the sense of certainty that they had.
INTERVIEWER: You actually talked about the administrations of Kennedy and Johnson, and you used the word "hubris" in that context. Would you say that that kind of attitude reached a peak?
PAUL VOLCKER: Yes,. There's no question in terms of its policy application that that approach reached its peak in the Kennedy-Johnson years, when in the Harvard years it was still intellectual concept. It really hadn't permeated fully the political decision-making [process]. It hadn't reached its apogee, which it certainly reached in the Kennedy-Johnson days, and they felt they'd solved the problem in the business cycle. They'd solved a problem with macroeconomics; it was time to turn to other microeconomic things, [and] it was time to turn to welfare questions, because they'd solved the problem. I'm not exaggerating very much when I say that. They had a very long period of economic advancement, and things were going pretty smoothly. Productivity was high, and unemployment was low.
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Nixon's Suspension of Gold Convertibility, and Wage and Price Controls
INTERVIEWER: Can you tell us how the United States under President Nixon ended up with wage and price controls?
PAUL VOLCKER: That's a bit of a mystery, [but] I suppose [I can explain] at least to the degree to which we have done. You know the general background: There was a recession at the end of the '60s and the beginning of the '70s, and from a domestic standpoint, the recession wasn't all that severe. Inflation had begun creeping up, maybe more than creeping, and it continued through the recession. After the recession there was a great sense of disappointment that the inflation rate had not come down, even in the face of recession, and at the same time the underlying weakness of the dollar internationally had come to a head. The dollar is the center of the financial system, convertible into gold, with other countries having a fixed exchange rate against the dollar. That whole framework had come under great pressure, and it was clear that something had to be done.
The United States finally faced up to the fact that something had to be done about the international monetary system against a background of this continuing inflationary problem. So the two dimensions came together, the external dimension leading to a suspension of the gold convertibility of the dollar, which itself raised, in an orthodox way, inflationary questions with the devaluation of the dollar and stalled the depreciation of the dollar. There was a good deal of pressure for vigorous action to have some kind of controls, some kind of income policy, something. While the administration had opposed all this talking, when they finally bit on that particular hook they went all the way, and it was full-scale price and wage controls, and it lasted much longer than I had intended. I actually thought at the time that some kind of a freeze might be a good thing, like when we were devaluating. I had in my mind three months, but I suppose it lasted three years. Of course it wasn't three years, but it was more than three months, and it turned out to have all the problems that price controls have.
INTERVIEWER: At least we proved it doesn't work.
PAUL VOLCKER: Yes, it certainly was very difficult to sustain. I don't think we did all the things that were necessary in terms of fiscal policy or monetary policy to help make it work, but to help avoid a more severe depreciation of the dollar, it seemed reasonable to me at the time.
INTERVIEWER: Were you at Camp David the weekend when gold convertibility was suspended?
PAUL VOLCKER: Yes, I indeed was.
INTERVIEWER: What was the atmosphere like?
PAUL VOLCKER: It was a little bit mixed. Arthur Burns, who was then chairman of the Federal Reserve Board, argued strenuously enough to suspend gold convertibility. He was really the only one who vigorously took that view. I think most of the rest of us who were involved thought the time had come and some approach had to be taken, and that the only practical move internationally was to suspend gold convertibility, which would lead to a depreciation of the dollar. It was not a permanent solution, in my mind, but it was a necessary transitional step. The president, I think, had become pretty well convinced before he was up there. The surprise to me was the way it was politically shaped, with Mr. Nixon and Mr. Connally presenting it to the world as a great triumph. This was America exhibiting its strength and power, dealing with speculative pressures in an appropriate way and seizing the moment to deal with the price question at home, and at the same time there was actually a tax reduction on there. The economy responded favorably; the stock market responded favorably. There had been very ominous predictions of what would happen to the stock market. The stock market went up instead of down.
INTERVIEWER: What about the price controls? What was it that changed President Nixon's mind? He must be the last person you would think would do that.
PAUL VOLCKER: It was this combination of needing to do something about the international side and awareness that [it] might increase uncertainty. [It was] being presented as a defeat against a background of prices rising over 4 percent a year, which was higher than the historical norm. It was one of the highest peacetime inflations -- even at 4 percent, it was considered a lot in those days. I don't remember exactly what it was. This was his opportunity to respond to all the pressures to do something about that.
INTERVIEWER: And look strong?
PAUL VOLCKER: And look strong. I am sure that Mr. Connally [Democrat John Connally, Nixon's Treasury secretary, 1971-1972] had something to do with his thinking. His other advisors I don't think liked it much, but Connally and the Treasury were very dominant in policymaking at that moment, and the others were brought into the story rather late in the game.
INTERVIEWER: Whatever they tried to do wasn't a long-term fix, was it?
PAUL VOLCKER: It certainly was not a long-term fix, either internationally or domestically.
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Stagflation: An Inevitable Consequence of Keynesianism?
INTERVIEWER: The word used at the time I think was "stagflation." What does that word mean now?
PAUL VOLCKER: I don't remember just when that word started. It's an ugly word, but it became very popular over the 1970s, when you had this combination of inflation, which didn't go away and was getting worse, and the economic performance at the same time was getting worse. You had a very big recession by our postwar standards in 1975, and again the inflation rate didn't go down, at least [not] for any length of time. There was this feeling that we were caught in a box that we didn't know how to get out of, where you had international instability of the dollar, domestic inflation, domestic instability, rising unemployment, and low productivity. It was not a brilliant economic period.
INTERVIEWER: Would you see this period as an almost inevitable consequence of Keynesian or pseudo-Keynesian policies?
PAUL VOLCKER: An inevitable consequence of Keynesian policies I don't think is quite fair. What I thought at the time, and I wasn't alone in this, was the defeat of Keynesian policies took place in the mid-1960s, when there was recognition among most of the Keynesian policymakers that it was time to increase taxes and more reluctantly time to take money. That was resisted by President Johnson vigorously on political grounds. [Johnson was fighting the] War on Poverty and fighting the war in Vietnam at the same time, and the Vietnam thing was becoming more and more costly. In my view, he viewed a tax increase at that time as a kind of referendum on the war.
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Volcker at the Fed: "Slaying the Inflationary Dragon"
INTERVIEWER: At the end of the decade you find yourself being sworn in by President Carter. How did you feel about the job? Did it seem very daunting? Were you anxious, apprehensive?
PAUL VOLCKER: I suppose [I found it] inevitably daunting.... This all came about rather suddenly, so I didn't have a lot of time to worry about it. But in retrospect it wasn't such a terrible time to become head of the Federal Reserve, because everybody was unhappy with what was happening, and there was an opportunity to make things better. [When] things got better you would have felt some sense of accomplishment, but it was not an easy time then.
INTERVIEWER: Did you feel that inflation was your number one, I think you used the phrase "dragon to slay"?
PAUL VOLCKER: I certainly thought that we had to deal with inflation, and the great advantage I had was [that] finally the country had more or less come to that [same] conclusion. There was this feeling of malaise, to use a term [popular] at the time. There was a kind of great speculative pressure. It was the years when everybody wanted to buy collectibles from New York. The market was booming, and other markets of real things were booming, because people had got the feeling that things were inflating and there was no way you could stop it.
INTERVIEWER: What did you see of the risks? Were you concerned about the future of democracy if this went unchecked?
PAUL VOLCKER: I'm not sure I was worried about the future of democracy. I was certainly worried about the future of the United States in terms of its place in the world. I grew up in a generation where you naturally look upon the United States as being the last great hope of mankind. We were the dominant economic power, the dominant military power, [and] the dominant security power. By and large we were in favor of the right things, and [if] we weren't strong economically, we weren't going to be able to carry out what I saw as reasonable responsibilities in the world.
INTERVIEWER: You used to talk about slaying inflationary dragons. What did you set out to do?
PAUL VOLCKER: I certainly thought that inflation was a dragon that was eating at our innards, or more than our innards, and if anybody was going to deal with this it was going to have to be the Federal Reserve. I saw a lot of roles, not just my personal role, but [also] the need was to slay that dragon.
INTERVIEWER: Can you in general terms explain what you did?
PAUL VOLCKER: That's a complicated story, but what we did, against a background of increasing unease about inflation and increasing unease about the performance of the economy, was to face up to the need and [take charge of] monetary policy and control of the money supply, to accept the proposition that at the end of the day inflation is dependent upon inflationary monetary growth, too much money growth, too much credit growth, and we set out to make that point and say that we've just got to stop this and draw some kind of a line in the sand about how much money and credit growth was appropriate. In doing so, the effect was to push interest rates up in the short run, because people were expecting inflation; they were perfectly willing to borrow. It was a good thing to borrow when you expect inflation, and the borrowing came up against a limited supply of money and credit. Interest rates were way up, and sooner or later that was bound to have an effect on the economy. It did, and we had a severe recession, but we came out of that recession with a very strong movement called price stability and also with strong economic growth.
Now my view always was, and has remained, that the way the economy was behaving, sooner or later you were probably going to have a recession. There was a feeling that the Federal Reserve created the recession. I think economic conditions created the recession. That created the underlying conditions and imbalances that sooner or later were going to give you a recession. Better to deal with it sooner rather than later.