Volcker Proved an Accessory to Self-Destructive Economic Policy / Reagan's Tax Cuts Shoved Accelerator as Volcker's Tight Money Hit Brakes

Article excerpt

President Reagan's victory in 1980 provided a new challenge for Paul Volcker as chairman of the Federal Reserve Board.

In addition to the problem of a runaway money supply and accompanying rising interest rates, he had to contend with a fiscal policy that many economists said was written in bright red ink.

The new president came into office fostering a revolutionary fiscal policy calling for a 30 percent reduction in federal income taxes and new tax breaks for businesses to spur lagging investment in the United States.

The program embodied supply-side economics, which held that individual tax rates had risen so high in the United States that they had retarded work effort, investment and job creation. Furthermore, some of the supply-side theorists who took high positions in the U.S. Treasury Department believed that the program would be relatively painless from a budgetary standpoint.

If enacted, they said, the program would generate an economic boom. As national income increased, this would bring in enough tx revenue to ensure that the budget deficit would not become a massive problem.

Volcker recognized instantly that the new program had the potential for causing big budget deficits and making his job of controlling inflation more difficult. On the other hand, he knew that a non-elected Fed chairman should not try to subvert the will of the American people.

In voting Reagan into office, the people had implicitly endorsed these tax reductions.

When the president announced his new program Feb. 18, 1981, complete with details of where he would like to see budget cuts made, he left the control of inflation up to the Federal Reserve. But what he outlined was clearly a gradualist policy.

If the Fed allowed its monetary targets, it said, inflation would fall softly from 11.1 percent in 1981 to 8.3 percent in 1982, 7 percent in 1983, 6 percent in 1984, 5.4 percent in 1985 and 4.9 percent in 1986.

``The administration supports the announced objective of the Federal Reserve to continue to seek gradual reduction in the growth of money and credit aggregates during the years ahead,'' the administration's proposal said. One administration official said gradualism was ``the only real shot we had of correcting inflation without a real recession.''

Gradualism died in 1981, but the jury is still out on whether Volcker conducted an act of premeditated murder or if its demise was accidental. The recession that began to develop in 1981 was the direct result of a historic economic policy mismatch.

Reagan's tax cuts pushed on the accelerator as Volcker's tight money pushed on the brakes. The brakes won, hands down, and the uncertainty caused by these powerful opposing forces added a few percentage points to interest rates, too.

Volcker did not place great faith in gradualism. It looked good on paper, perhaps, and at first blush it seemed to be a sensible course to follow. But to him, it offered a painless cure for inflation that did not seem plausible, and from a semantic standpoint it made the Fed's anti-inflation policy sound wimpish to money markets expecting strength and resolve.

He had seen economic surprises and attitude changes destroy such carefully designed plans in the past. Gradualism to him was akin to the kind of economic fine-tuning that had brought monetarist critics down on him earlier.

To Volcker, inflation in 1981 had reached crisis proportions, and to whip it called for strong, immediate and clear action.

Don't tap it gently. Whack it. Crisis management would demand no less.

In view of Volcker's reputation as a pragmatist who favored strong reactive moves to current economic problems, it was no surprise that he ran afoul of the more ideological economic thinkers that came to Washington with a new administration. …