Paul Volcker: The Man Who Helped Reagan Save the Economy
The 40th president refused to speak out even when Paul Volcker's austerity measures threatened his presidency. In the end, both were rewarded.
It is fitting that the nation should note with respect and appreciation the manifold achievements of Paul A. Volcker. Volcker, who died last Sunday at age 92, is most well known, and most highly praised, for smiting the burgeoning inflation that threatened the country’s economic future back in the late 1970s and early 1980s, when he served as Federal Reserve chairman.
It was a signal achievement. But his monetary policies, designed to wring inflation out of the economy by fostering high interest rates, also thrust the nation into a vortex of economic anguish. Two recessions can be directly attributed to Volcker’s policies, the second of which generated the highest unemployment rate since the Great Depression. Thousands of companies went out of business, and millions of Americans lost their jobs. As The Wall Street Journal put it in an editorial, “Volcker had an inner strength of character that helped him persevere through the bad times.”
But there was another American back then who demonstrated similar strength of character—with much more on the line than Volcker had. That was Ronald Reagan, who inherited the inflation monster upon taking office as president in January 1981 and who uttered nary a peep of protest as Volcker put the country through a wringer that could have crushed his presidency.
It is difficult, from this remove of nearly four decades, to imagine just how dangerous and scary those times were. During the week of Reagan’s inauguration, Time hit newsstands with a cover that pictured a crumbing dollar sign and the headline: “Reagan’s Biggest Challenge: Mending the Economy.” Newsweek blared that week: “The Economy in Crisis.”
The scourge of inflation had yielded an ominous new economic phenomenon called “stagflation”—simultaneous high inflation and stagnant or negative economic growth. The country’s gross domestic product had declined by 0.04 percent the previous year. Unemployment stood at 7.4 percent, with economists predicting even higher rates as Volcker’s monetary austerity rolled on. Inflation was approaching an unheard-of rate of 12 percent. Meanwhile, Volcker had the prime interest rate at a commerce-crunching 21 percent.
“What the Great Depression was to the 1930s,” said the prominent economist Walter Heller, “the Great Inflation is to the 1980s.”
It was amid this miasma of trouble and trauma that Reagan took the presidential oath of office and told his fellow citizens that their problems weren’t going away anytime soon. “But they will go away…” he added, “because we as Americans have the capacity now, as we have had in the past, to do whatever needs to be done to preserve this last and greatest bastion of freedom.”
Reagan’s answer to the crisis was to curtail federal spending (which he was never particularly successful at doing) and to cut marginal individual tax rates (which he got through Congress within eight months of taking office). His fiscal formula, novel and controversial at the time, fell under the rubric of “supply-side economics,” the notion that the economy was being stifled by high tax rates that suppressed economic initiative and verve. High marginal rates—those imposed on the last dollar earned—were sapping Americans’ zest for saving, working, and investing, argued the supply siders. Slash those rates, they suggested, and the economy would come roaring back.
The problem was that the imperatives of legislative compromise required that he delay the effective dates of three successive tax cuts, while the first year’s reductions were cut in half. Thus if Reagan’s tax regimen was to work at all (and skeptics were howling that it never would), it wouldn’t take effect for at least a year and a half. Meanwhile, Volcker’s powerful monetary machinery kept delivering what The New York Times called a kind of “shock therapy” that crushed economic activity.
By November 1982, as voters prepared to go to the polls for that year’s midterm elections, unemployment had risen to 10.8 percent. The country was headed for a 1.44 percent decline in GDP in 1982. When Republicans implored Americans to “stay the course,” Democrats retorted that it was more like “stay the curse.” Republicans, who had retaken the Senate in 1980 for the first time in 26 years, lost a single Senate seat that year. But they also yielded 26 House seats to Democrats. It was a political defeat for Reagan’s party, but not as large a blow as it could have been or as many had predicted.
That’s probably because both the Volcker austerity measures and Reagan’s tax reductions were beginning to show results. Inflation fell below 4 percent in 1983, which stifled many of the most strident anti-Volcker voices in the land. America under Reagan’s leadership also rebounded from the 1982 recession with a 7.9 percent surge in GDP. Subsequent years brought growth rates of 5.58 percent, 4.18 percent, 2.9 percent, 4.48 percent, and 3.8 percent. And those growth rates were achieved with minimal inflation throughout the remainder of the 1980s and beyond.
This dual success is a testament to the intertwined monetary and fiscal policies of Volcker and Reagan—and to the respect and regard each of these leaders harbored for the other. Not everyone, even today, appreciates how well this all worked. The New York Times obituary of Volcker doesn’t mention Reagan’s public silence as Volcker’s austerity measures threatened his presidency. It does suggest that Volcker’s early crunch policies probably contributed to President Jimmy Carter’s 1980 defeat, without noting that the inflationary surge necessitating Volcker’s actions commenced on Carter’s watch (though it should be noted that some of the root causes predated Carter’s presidency).
The Times also recounted an anecdote from Volcker’s memoir in which White House chief of staff James Baker, with Reagan present, warned against any interest rate increases leading up to Reagan’s 1984 reelection bid. Baker says he doesn’t remember the incident, though there is no reason to question Volcker’s memory. No doubt the president, having gone through the crucible of the 1982 recession and emerged with a surging economy, feared that Fed concerns about an overheating economy could lead to such a faulty policy. Volcker writes in his memoir that he had no intention of raising rates in the first place and never did.
But the key point is Reagan’s avoidance of any actions, public or private, designed to curtail Volcker’s austerity measures when they posed their greatest threat to his fledgling presidency. Perhaps Reagan had full confidence that the combination of Volcker’s monetary policies and his own fiscal initiatives would work in the end. Perhaps he simply understood the necessity of such harsh measures in the face of the greatest inflationary threat in the country’s history. Perhaps he just felt that he shouldn’t meddle in the Fed’s business.
Whatever the reason, Reagan’s actions, or non-actions, represented a noteworthy element of leadership—the leadership of silence.
Robert W. Merry, longtime Washington journalist and publishing executive, is the author most recently of President McKinley: Architect of the American Century.