Paul Volcker
Former chair of the US Federal Reserve
Born 1927 • Passed away 2019
Raised interest rates sharply to break the high inflation of the late 1970s and early 1980s, at significant short-term economic cost.
Biography
Paul Volcker was an American economist and central banker, born in Cape May, New Jersey in 1927 and raised in Teaneck, where his father was the township manager. He studied at Princeton, took a graduate degree at Harvard, and spent a year at the London School of Economics before joining the Federal Reserve Bank of New York as an economist in 1952.
His career alternated between the Treasury, private banking and the Federal Reserve for the next quarter century. As Under Secretary of the Treasury for Monetary Affairs he was closely involved in the 1971 decision to suspend the dollar's convertibility into gold, which ended the Bretton Woods system of fixed exchange rates. He then served as president of the Federal Reserve Bank of New York from 1975.
He is remembered for what happened after August 1979, when Jimmy Carter appointed him chair of the Federal Reserve. Consumer price inflation was running in double digits and had resisted a decade of attempts to bring it down. On 6 October 1979 the Fed announced it would target the growth of bank reserves rather than manage the federal funds rate directly, which meant accepting whatever level of interest rates that implied. Rates went far higher than any peacetime precedent, reaching roughly twenty percent in 1980 and 1981.
Inflation fell to around four percent by 1983 and did not return to the levels of the 1970s. The immediate cost was two recessions, the second of which pushed unemployment above ten percent, and the policy was deeply unpopular while it ran. Farmers drove tractors to the Federal Reserve building in Washington and encircled it; car dealers and homebuilders posted him the keys and lumber they could not sell.
He left the Fed in 1987 and remained in public life for three more decades, chairing inquiries into dormant Swiss bank accounts belonging to Holocaust victims and into the United Nations Oil-for-Food Programme. In 2009 he chaired President Obama's Economic Recovery Advisory Board, where he proposed separating federally insured deposit taking from proprietary trading, an idea adopted in modified form as the Volcker Rule in the 2010 Dodd-Frank Act. He passed away in 2019.
Career timeline
- 1927Born in Cape May, New Jersey.
- 1952Joins the Federal Reserve Bank of New York as an economist.
- 1969Becomes Under Secretary of the Treasury for Monetary Affairs.
- 1971Closely involved in the decision to end the dollar's convertibility into gold.
- 1975Becomes president of the Federal Reserve Bank of New York.
- 1979Appointed chair of the Federal Reserve, and shifts policy toward targeting reserve growth in October.
- 1983Reappointed as chair by Ronald Reagan, with inflation down to roughly four percent.
- 1987Leaves the Federal Reserve after eight years as chair.
- 2009Chairs the President's Economic Recovery Advisory Board.
- 2010The Volcker Rule is enacted in modified form within the Dodd-Frank Act.
- 2018Publishes the memoir Keeping At It.
- 2019Passes away at the age of 92.
How he thought about money and policy
Volcker treated the value of the currency as the thing a central bank exists to protect, and treated credibility as the mechanism by which it does so. His argument was that once households and businesses expect prices to keep rising, that expectation gets written into wages and contracts and becomes self-sustaining, so the expectation itself has to be broken rather than merely leaned against. That is why the 1979 shift was announced as a change of operating framework rather than as another increment of tightening.
He was explicit that this is expensive. His account of the period does not present the disinflation as a technical adjustment that happened to work; it presents it as a decision to accept a recession as the price of a result that gradualism had failed to deliver over the preceding decade. Whether an institution can sustain that choice against political pressure was, in his telling, the real question.
His later work followed from the same instinct rather than from a new one. The Volcker Rule proposal, and the inquiries he chaired, were about keeping institutions inside a defined purpose: a bank with a government guarantee on its deposits should not be running a trading book on its own account, because the guarantee and the risk taking sit badly together.
Key ideas
Tap any idea to expand a plain-English explanation, why it matters, and where to learn more.
Inflation expectations become self-fulfilling
Once people expect prices to keep rising, they price that expectation into wages and contracts, which makes it happen.
It explains why inflation persisted through the 1970s despite repeated attempts to slow it, and why breaking it required a change in what people believed rather than a small adjustment.
Wage agreements indexed to past price rises carry the previous year's inflation forward into the next one.
Central bank credibility is the instrument
A central bank that is believed can change behaviour with smaller moves than one that is not.
Credibility is built by following through on unpopular decisions, which is why it is expensive to acquire and cheap to lose.
Rates that stayed high through a recession signalled that the commitment was not conditional on the economy being comfortable.
Rates are the transmission channel
Monetary policy reaches the real economy through the cost and availability of borrowing, which hits housing, cars and business investment first.
It is why a policy aimed at prices shows up as a downturn in specific interest-sensitive industries before it shows up in the inflation figures.
Homebuilders and car dealers were among the loudest protesters against the policy, because they felt it first.
Deposit insurance and proprietary trading sit badly together
A bank whose deposits carry a public guarantee is taking risk on terms other firms do not have.
It is the reasoning behind the Volcker Rule: the guarantee exists to protect depositors, not to subsidise a trading book.
The rule as enacted restricts proprietary trading by banks with federally insured deposits, with defined exemptions.
The end of Bretton Woods
Suspending the dollar's convertibility into gold in 1971 moved the world onto floating exchange rates and currencies backed by policy rather than metal.
It is the change that made a central bank's inflation record the thing holding a currency's value, which is the problem he inherited eight years later.
Exchange rates between major currencies have moved continuously since, rather than being fixed and occasionally revalued.
Major contributions
- Led the Federal Reserve through the policy shift that ended the entrenched inflation of the 1970s.
- Served as Under Secretary of the Treasury for Monetary Affairs during the end of the Bretton Woods system.
- Served as president of the Federal Reserve Bank of New York before becoming chair of the Board.
- Chaired the independent committee investigating dormant Swiss bank accounts belonging to victims of the Holocaust.
- Chaired the independent inquiry into the United Nations Oil-for-Food Programme.
- Proposed the separation of insured deposit taking from proprietary trading, enacted as the Volcker Rule.
Major successes
- Appointed chair of the Federal Reserve in 1979 and reappointed by a president of the other party in 1983.
- Presided over the fall of consumer price inflation from double digits to roughly four percent by 1983.
- Held the policy through two recessions and sustained public protest rather than reversing it.
- Saw his proposal on bank proprietary trading written into law as part of the Dodd-Frank Act in 2010.
- Founded the Volcker Alliance in 2013 to work on the effectiveness of public administration.
Important books
- Keeping At It2018
His memoir, written with Christine Harper, covering the Treasury years, the Fed chairmanship and the later public inquiries.
- Changing Fortunes1992
Written with Toyoo Gyohten, a two-sided account of the international monetary system from the end of Bretton Woods onward.
Influence on investors
The 1979 to 1982 period is the reference case every later central banker argues from. Whether a modern tightening cycle is described as a Volcker moment or contrasted against one, the comparison is doing the same work: it asks whether an institution is willing to accept a recession to change what people expect about prices.
For investors the episode is the clearest demonstration available of how far the price of money can move, and of what that does to bonds, housing and equities at the same time. It is the reason long-dated fixed income is taught as an interest-rate exposure rather than as a safe asset.
Criticisms and debates
A balanced view includes the main criticisms and open debates, presented neutrally.
- The disinflation was achieved through two recessions, the second pushing unemployment above ten percent, and there is a continuing argument about whether a slower approach could have reached the same result at lower cost.
- Very high dollar interest rates raised the burden of dollar-denominated floating-rate sovereign debt and contributed to the Latin American debt crisis of the 1980s.
- The reserve-targeting framework was abandoned in practice by 1982, and economists disagree about whether money-supply targeting was the operating mechanism or mainly a device that allowed very high rates to be accepted without being explicitly chosen.
- Some argue the credit for ending inflation is shared with factors outside his control, including the later fall in oil prices and changes in labour bargaining.
- The Volcker Rule has been criticised from both directions, as too complex and costly for banks to implement, and as too weakened by exemptions to achieve what he proposed.
Lessons for investors
Plain-English takeaways. Context for learning, not advice to buy or sell anything.
- 1Treat an interest rate as a policy choice with consequences, not as a background condition that stays where you found it.
- 2Expect inflation to be about what people believe will happen next, not only about what has already happened.
- 3Notice that the industries hit first by tighter money are the ones that borrow, not the ones with the weakest businesses.
- 4Remember that a fixed-income holding is an exposure to rates, and rates have historically moved a very long way.
Notable quotes
“Inflation is thought of as a cruel, and maybe the cruellest, tax because it hits in a many-sided way.”
“The central bank's most important responsibility is maintaining confidence in the currency.”
Context: Written by a central banker who spent his chairmanship raising rates to break double-digit inflation. It reflects what that period taught him about institutional credibility.
Frequently asked questions
Who was Paul Volcker?
Paul Volcker was an American central banker born in 1927 who served as chair of the Federal Reserve from 1979 to 1987. He is best known for the policy that ended the high inflation of the 1970s. He passed away in 2019.
What was the Volcker shock?
The name given to the Federal Reserve's October 1979 shift to targeting the growth of bank reserves rather than managing the federal funds rate directly. It allowed interest rates to rise far higher than precedent, reaching roughly twenty percent in 1980 and 1981.
Did the policy work?
Consumer price inflation fell from double digits to roughly four percent by 1983 and did not return to 1970s levels. The cost was two recessions and unemployment above ten percent, and economists still debate whether a cheaper path existed.
What is the Volcker Rule?
A provision of the 2010 Dodd-Frank Act, based on his proposal, restricting banks with federally insured deposits from proprietary trading and from sponsoring certain funds. It was enacted in modified form with defined exemptions.
What was his role in ending Bretton Woods?
As Under Secretary of the Treasury for Monetary Affairs he was closely involved in the 1971 decision to suspend the dollar's convertibility into gold, which ended the postwar system of fixed exchange rates.
Why do investors still study this period?
It is the clearest available record of how far the price of money can move and what that does to bonds, housing and shares at once. It is history to learn from rather than a forecast about any current cycle.
Related quotes
Other people in the library writing on the same themes.
“The rate of interest expressed in money is high or low according as the standard of value is depreciating or appreciating.”
Irving Fisher“Stocks have historically been a better long-run hedge against inflation than bonds.”
Jeremy Siegel“Inflation is always and everywhere a monetary phenomenon.”
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