This Explains a Lot

Paul Volcker has been praised on this blog on a few occasions before, most recently in Past, Present and Future. This, without knowing much about him other than that he wasn't afraid to take away the punch bowl back in the 1980s, and that he has been critical of recent monetary policy.

This interview from 2000 sheds new light on why he may have said some of the things he has said in recent years. First of all, it turns out he isn't that crazy about Keynesian Economics:

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.

You gotta like that! A little skepticism is a healthy thing - we haven't had too much skepticism in the last ten years. Even when the Nasdaq bubble popped, after six months of blank stares, interest rates dropped like a rock, which begat the carry trade, the bond bubble, the mortgage bubble, hedge funds multiplying like rabbits, then finally, the mother of all bubbles - the world-wide real estate bubble. After a brief lull, everyone was too busy either making money from low interest rates or borrowing money at absurdly low rates to improve their lifestyle - there was no time to be skeptical.

On inflation (back in the days when there were no cheap imports from Asia, and the inflation calculation included house prices, food prices, and energy prices, but did not include quality adjustments):

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.

A novel approach - "a line in the sand about how much money and credit growth was appropriate". Well "appropriate" is a subjective term - to many, the money and credit growth of the last ten years may be entirely appropriate. That is if your intention is to create a series of asset bubbles in America while generating unprecedented economic growth and a job boom in Asia.

Now, this is the part that, given today's real estate madness, you have to stop and think - how could this have really happened? A Fed Chairman who reduced liquidity to the point that it hurt homebuilders? Surely he is joking - two-by-fours?

INTERVIEWER: Did you feel any sort of personal pressure? People were really hurting, weren't they? You were getting letters?

PAUL VOLCKER: Builders are always most affected by tight money, and they said, "We're not getting any use for these two-by-fours," so they sawed them all up and we used to get hundreds of two-by-fours delivered to the office making a plea to do something about this situation. Some of them were given as [a way to say] stop this recession and stop this inflation, reduce the money supply, which of course is what we were trying to do. The message had gotten through, but I remember quite clearly -- you remember these things, or you see these things through your own eyes. But even though the homebuilders were the most singularly, strongly affected industry, [there] was a clear sympathy, even there among their leaders, as for what we were trying to do. They would come in and see me frequently and understandably be disturbed, but their plea was, "Can we get this over with as soon as possible?"

Now it's been a long time since anyone's heard talk like this, from anyone working for anything with the word "Federal" in it - maintain the value of the currency?

INTERVIEWER: You saw inflation as a moral issue, to a certain extent?

PAUL VOLCKER: To some extent I think it is. Inflation is related to monetary policy. It's related to the issue of money. The issue of money is a governmental responsibility predominantly, and to use that authority in a way that leads to inflation is a system that fools a lot of people, and to keep fooling them you have to do it more and more; [that] is a moral issue. I put myself in that camp.

INTERVIEWER: But why a moral issue? What does it actually corrode?

PAUL VOLCKER: It corrodes trust, particularly trust in government. It is a governmental responsibility to maintain the value of the currency that they issue. And when they fail to do that, it is something that undermines an essential trust in government.

Makes me want to go get some platform shoes, put on a leisure suit, and fire up the disco ball.