50. PIPAV.
51. The year-over-year inflation rate in December 1980 was 12.4 percent, compared with 13.3 percent for December 1979.
52. The ten-year Treasury bond rate was 11.75 percent on September 24, 1980, compared with 12.43 on December 31, 1980.
53. The following conversation is based on three sources: Anderson, Revolution, pp. 250–51; the New York Times, January 24, 1981, p. 1; and the recollection of Paul Volcker. I deferred to Volcker’s version on crucial details. (He insists he was sitting on the president’s left, not on the right, as Anderson claims.)
54. New York Times, December 14, 1980, p. E5. Donald Regan’s complete quote is “Well, the Federal Reserve is tightening money. That’s the price we have to pay for the inflation that this country finds itself in. It’s the only game in town—it’s the only way that inflation can be stopped at the current moment. When this administration takes over we’ll have a new economic policy with which we’ll deal with inflation in several ways at once rather than just one way.”
12. The Only Game in Town
1. New York Times, January 20, 1982, p. A1 continued.
2. The Kemp-Roth tax bill, more formally known as the Economic Recovery Tax Act of 1981, was signed by the president on August 13, 1981.
3. Civilian Unemployment Rate, U.S. Department of Labor: Bureau of Labor Statistics, for January 1982 versus January 1981 (source: research.stlouisfed.org/fred2/).
4. The annual rate of inflation from December 1980 through December 1981 was 8.9 percent, compared with 12.4 percent for December 1979 through December 1980.
5. The Reagan Diaries, ed. Douglas Brinkley, vol. 1 (New York: HarperCollins, 2009), p. 65.
6. New York Times, July 26, 1981, p. F18. Schmidt was referring to Germany. Edward Hyman, an economist with the brokerage firm C. J. Lawrence, commented, “Believe it or not, real interest rates in the United States have been this high or higher before.” He cites 1920, 1921, and 1930.
7. On January 20, 1981, the ten-year government bond rate stood at 12.5 percent. On January 19, 1982, the ten-year bond rate was 14.8 percent.
8. The monthly payment on a 12 percent twenty-year mortgage of $100,000 is $1,100. If the rate were 14 percent, the monthly payment would rise to $1,243. The difference of $143 times 12 equals $1,716.
9. See Transcript, New York Times, January 20, 1982, p. A20.
10. The Conduct of Monetary Policy, Pursuant to the Full Employment and Balanced Growth Act of 1978: Hearings Before the House Committee on Banking, Finance and Urban Affairs, P.L. 95-523, 97th Congress, 1st Sess., July 14, 21–23, 1981, pp. 211 and 212.
11. Gonzalez threatened impeachment in July 1981 (see ibid.) but did not act until January 1983. See Congressional Record, 98th Congress, 1st Sess., January 6, 1983, p. 143.
12. New York Times, September 2, 1981, p. D2.
13. Monthly inflation for October, November, and December of 1981 measured 0.3, 0.4, and 0.3 percent, which translates into an annual average of 4 percent, while in the last three months of 1980 it measured 1.0, 1.1, and 0.9 percent, for an annual average of 12 percent.
14. In 1982 the survey measured expected inflation for one year forward, so the numbers do not match the long-term horizon that is relevant for the ten-year bond rate. The one-year-forward expected inflation in the fourth quarter of 1981 measured 7.52 percent compared with 9.37 percent in 1980. Expectations for all future time horizons should move in the same direction, although by smaller amounts. For example, a simple linear regression from 1992 through 2008 of quarterly changes in the ten-year inflation forecast versus changes in the one-year inflation forecast produces a statistically significant regression coefficient of .16. The Survey of Professional Forecasters began in 1968 and was conducted by the American Statistical Association and the National Bureau of Economic Research. The Federal Reserve Bank of Philadelphia took over the survey in 1990.
15. The structural deficit is the deficit that would prevail at full employment. Benjamin Friedman, “Learning from the Reagan Deficits,” American Economic Review 82, no. 2 (May 1992): 299–304, shows in Table 1 that the structural deficit measured 2.3 percent of GNP between 1981 and 1985 compared with 1.3 percent of GNP between 1971 and 1980. The 1984 Economic Report of the President, Washington, DC, p. 36, reports that the structural deficit jumped from $48 billion to $101 billion in fiscal year 1983 (which began in October 1982, a year after the tax cut was enacted). The Congressional Budget Office’s publication Budget and Economic Outlook: Fiscal Years 2011–2021 (available at www.cbo.gov/doc.cfm?index=12039) shows in Table E-13 that approximately two thirds of the increase in the deficit (without automatic stabilizers) came from reduced revenues between 1981 and 1985. I would like to thank Rudolph Penner for a discussion of these calculations.
16. Administration’s Fiscal Year 1983 Budget Proposal: Hearings Before the Senate Committee on Finance, United States Senate, 97th Congress, 2nd Sess. February 23, 1982, Government Printing Office, Washington, DC, 1982, p. 10.
17. See Second Concurrent Resolution on the Budget—Fiscal Year 1982: Hearings Before the Senate Committee on the Budget, United States Senate, 97th Congress, 1st Sess., September 16, 1981, Government Printing Office, Washington, DC, 1981, p. 137.
18. Administration’s Fiscal Year 1983 Budget Proposal: Hearings Before the Senate Committee on Finance, United States Senate, 97th Congress, 2nd Sess., February 23, 1982, Government Printing Office, Washington, DC, 1982, p. 180.
19. See Marvin Goodfriend and Robert G. King, “The Incredible Volcker Disinflation,” Journal of Monetary Economics 52, no. 5 (July 2005), esp. pp. 1012–13, for evidence of no greater stability in money supply growth during the Volcker period compared with earlier.
20. See the previous chapter describing how the Fed raised interest rates starting in September 1980 and tightened further after the election to rein in excess growth in the money supply. The combination of erratic money supply growth and compensatory adjustments in real interest rates characterized Volcker’s chairmanship of the Fed. See Goodfriend and King, “The Incredible Volcker Disinflation.” Goodfriend and King conclude (p. 1012), “During the [Volcker] disinflation, then, our sense is that the Volcker-led FOMC undertook a delicate balancing act. It sought to manage short-term interest rates and to respect monetary targets.”
21. See the previous chapter.
22. See New York Times, January 30, 1981, p. D2.
23. The quote is from Milton Friedman, Newsweek, September 21, 1981, p. 39.
24. See the quote in chapter 9 from Milton Friedman, “Burns on the Outside,” Newsweek, January 9, 1978, p. 52: “We have been having inflation … because … John Q. Public has been demanding inflation [by] … asking Congress to provide us with ever more goodies—yet not raise our taxes.”
25. Milton Friedman, Money Mischief: Episodes in Monetary History (New York: Harcourt Brace, 1994), p. 207.
26. All quotes are from the Second Concurrent Resolution on the Budget Fiscal Year 1982. Hearings Before the Senate Committee on the Budget, 97th Congress, 1st Sess., September 16, 1981, Government Printing Office, Washington, DC, 1981, p. 73.
27. See Rudolph Penner, ed., The Great Fiscal Experiment (Washington, DC: Urban Institute Press, 1991), p. 5; and Rudolph Penner and Alan Abramson, Broken Purse Strings: Congressional Budgeting, 1974 to 1988 (Washington, DC: Urban Institute Press, 1988), esp. chapter 5.
28. The following quotes are from Extension of the Temporary Limit on Public Debt: Hearings Before the Senate Subcommittee on Taxation and Debt Management Generally of the Committee on Finance, 96th Congress, 2nd Sess., April 2, 1980, Government Printing Office, Washington, DC, 1980, pp. 12–13.
29. This is known as the Ricardian equivalence argument, after David Ricardo (1772–1823), the English political economist. Ricardo mentions this possible response by savers but rejects it as unlikely. Robert Barro resurrected the argument and sums up the discussion in Robert Barro, “The Ricardian Approach to Budget Deficits,” Journal of Economic Perspective
s 3, no. 2 (Spring 1989): 37–54.
30. A summary of the most recent empirical evidence on the impact of deficits on interest rates appears in Thomas Laubach, “New Evidence on the Interest Rate Effects of Budget Deficits and Debt,” Journal of the European Economic Association 7, no. 4 (June 2009): 858–85. As discussed in the remainder of this paragraph, all empirical estimates suffer from a variety of errors in variables problems, which bias the estimated coefficients downward. Special thanks to Kenneth Garbade and Thomas Sargent for extensive discussions on this topic.
31. Penner actually quotes Henry Aaron (a budget expert at the Brookings Institution, not the baseball player) in Rudolph Penner, Errors in Budget Forecasting (Washington, DC: Urban Institute Press, 2001), p. 1.
32. The paper by James Barth et al. and the comment by Frank de Leeuw in Penner, ed., The Great Fiscal Experiment, esp. p. 149, report that econometric models that “attempt to measure expected future deficits rather than actual current deficits” are more likely to show positive impacts of the deficit on interest rates. The phrase “each circumstance is unique” translates into an econometric problem where “initial conditions” matter a lot in estimation. For a similar problem with measuring the impact of fiscal policy, see Jonathan Parker, “On Measuring the Effects of Fiscal Policy in Recessions,” Journal of Economic Literature 49, no. 3 (September 2011): 703–18.
33. New York Times, September 11, 1981, p. D6.
34. New York Times, January 10, 1982, p. NES10.
35. William Greider, “The Education of David Stockman,” Atlantic Monthly, December 1981, pp. 16–17.
36. Goodfriend and King, “The Incredible Volcker Disinflation,” pp. 1001–2, describe the increase in long-term rates between January and October 1981 as “the second inflation scare.” They point to anti-inflationary statements at various FOMC meetings to support their point. But the fact that members of the FOMC worried about reducing inflationary expectations during this period, which they did, does not imply that increased inflationary expectations were responsible for the increase in long-term rates. Another possible source of the increase in the risk premium on real long-term rates in January 1982 compared with a year earlier is an increase in the volatility of short-term rates in the immediately preceding year. In fact, the reverse occurred. The daily standard deviation of percent change in the three-month Treasury bill rate during 1981 was 2.16 percent, compared with 2.49 percent during 1980.
37. See Administration’s Fiscal Year 1983 Budget Proposal: Hearings Before the Senate Committee on Finance, 97th Congress, 2nd Sess., February 23, 1982, Government Printing Office, Washington, DC, 1982, pp. 181–2. Meltzer ignores the “uncertainty over the deficit” explanation for high real interest rates in his A History of the Federal Reserve, vol. 2, book 2 (Chicago: University of Chicago Press, 2009), p. 1103. Instead, he blames the high rate of interest on the uncertainty that inflation will remain low after the economy rebounds from recession. That explanation is inconsistent with the decline in the price of gold from 1981 to 1982. Meltzer also cites foreign purchases of U.S. bonds and the failure of the deficit after 2001 to raise interest rates as evidence that the deficit did not raise interest rates in 1982. Circumstances were quite different in those two periods, however. Foreign purchases could certainly have financed the deficit without raising U.S. rates, but that would have been unlikely if foreigners had not been confident in the Federal Reserve’s stance against inflation.
38. Thomas Sargent describes the same confrontation as “a game of chicken.” See his “Interpreting the Reagan Deficits,” in Thomas Sargent, Rational Expectations and Inflation, 2nd ed. (New York: HarperCollins, 1993), pp. 211–26.
39. New York Times, January 10, 1982, p. NES10.
40. New York Times, August 28, 1981, p. D2.
41. See New York Times, January 28, 1982, p. D6, and January 30, 1982, p. 29.
42. See Record of Policy Actions of the Federal Open Market Committee, February 1–2, 1982, p. 3. “M1 [checking accounts plus currency] grew at an annual rate of 11½ percent in December and accelerated in January to a rate estimated to be above twenty percent.”
43. Ibid.
44. Transcript, Federal Open Market Committee Meeting, February 1–2, 1982, p. 41.
45. Ibid., p. 46.
46. Ibid., p. 90.
47. Ibid., pp. 90–91.
48. See Record of Policy Actions of the Federal Open Market Committee, February 1–2, 1982, p. 14.
49. See “Kennedy Urges End to Federal Reserve Autonomy,” New York Times, April 7, 1982, p. A24.
50. Transcript, Federal Open Market Committee Meeting, February 1–2, 1982, p. 104.
51. Interview with Murray Weidenbaum.
52. Based on Volcker’s Daily Planner for 1982 and an official White House photograph of Reagan and Volcker on February 15, 1982.
53. Douglas Brinkley, ed., The Reagan Diaries, vol. 1, January 1981–October 1985 (New York: HarperCollins, 2009), p. 110.
54. New York Times, February 19, 1982, p. A20.
55. The following conversation is based on an interview with Murray Weidenbaum.
56. See “Reagan’s ‘First Friend,’” New York Times, March 21, 1982, p. SM26.
57. Washington Post, March 30, 1982, p. A1.
58. Ibid., p. A1 continued.
59. Ibid.
60. New York Times, August 15, 1982, p. E4.
61. New York Times, October 24, 1982, p. 25 continued.
62. New York Times, August 15, 1982, p. E4.
63. Washington Post, August 7, 1982, p. A1.
64. Ibid.
65. See Washington Post, August 20, 1982, p. A1. The vote was 226–207 in the House and 52–47 in the Senate.
13. The End of the Beginning
1. The letter is from the Personal Papers of Paul Volcker.
2. The annual rate of inflation for the year ending August 1982 was 6 percent compared with 12.6 percent for the year ending November 1980.
3. The story is from an interview with Jerry Corrigan.
4. Time, March 8, 1982, and People, May 10, 1982.
5. Transcript, Federal Open Market Committee Meeting, May 18, 1982, p. 41.
6. Washington Post, August 7, 1982, p. A1, reported a 9.8 percent unemployment rate for July, “the highest in 41 years, since late 1941.” The total number of unemployed equaled 10.8 million for July 1982, according to the Bureau of Labor Statistics.
7. The unemployment rate reached a peak of 10.8 percent in November and December 1982, corresponding to twelve million unemployed workers.
8. Housing starts averaged 936,000 units from January through June 1982, compared with 2,020,000 units in 1978. See Economic Report of the President, February 1983, Washington, DC, Government Printing Office, p. 216.
9. See Joseph Treaster, Paul Volcker: The Making of a Financial Legend (New York: John Wiley, 2004), p. 5.
10. Washington Post, April 7, 1982, p. D7 continued.
11. The quotes in this paragraph and the next are from “Paying More for Money,” the cover story in Time, March 8, 1982.
12. PIPAV. Also see Andrew Tobias, “A Talk with Paul Volcker,” New York Times, September 19, 1982, p. 271.
13. The New York Mercantile Exchange had not yet launched its crude oil futures contract, but the International Monetary Fund published an average monthly price index of Brent, Dubai, and West Texas crude oil beginning 1980. The index reached a monthly peak of 73.71 in January 1981 and declined to 60.15 in August 1982 (source: www.imf.org/external/np/res/commod/index.asp).
14. Wall Street Journal, January 5, 1982, p. 34.
15. Transcript, Federal Open Market Committee Meeting, October 5, 1982, p. 19.
16. See Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, NJ: Princeton University Press, 1963), p. 434, “Federal insurance of bank deposits was the most important structural change in the banking system to result from the 1933 panic, and … the structural change most conducive to monetar
y stability since state bank notes were taxed out of existence immediately after the Civil War.” They also note (p. 437) that “The reduction in [bank] failures is not of course attributable to any correspondingly drastic improvement in the quality of bank officials or in the effectiveness of the supervisory authorities.”
17. Insurance was set at $2,500 per account in the original legislation and was raised in a series of steps to $100,000 in 1980. See Lawrence Ritter and William Silber, Principles of Money, Banking, and Financial Markets (New York: Basic Books, 1983), 4th ed., p. 106.
18. See chapter 17 for more on the financial crisis that began in August 2007.
19. PIPAV.
20. The document “U.S. Bank Claims on Mexico (end-1981: adjusted for guarantees),” Personal Papers of Paul Volcker, appears without a date but has a cover sheet that says, “Please Transmit Promptly to the Office of Chairman Volcker for Ms. Sandy Wolfe.” It is combined with a telegram dated August 18, 1982, from the Mexican minister of finance, Jesús Silva Herzog, to Edwin Truman at the Federal Reserve Board. Data on bank size is from History of the Eighties: Lessons for the Future, Federal Deposit Insurance Corporation, Washington, DC, 1997, p. 237.
21. See Washington Post, August 4, 1982, p. D7 continued. In History of the Eighties: Lessons for the Future, p. 237, Table 7.1 lists Continental as the eighth-largest in assets as of the end of 1981.
22. See chapter 6 in Irvine Sprague, Bailout: An Insider’s Account of Bank Failures and Rescues (New York: Basic Books, 1986), for a discussion of Penn Square.
23. The devaluation began on February 17, 1982, when Mexico allowed the peso to float versus the dollar. It traded at 27 pesos per dollar before February 17 and traded at 45 pesos per dollar on August 6, 1982. See Washington Post, August 7, 1982, p. D8.
24. See Joseph Kraft, The Mexican Rescue (New York: Group of Thirty, 1984), p. 8.
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