This is why Paul Volcker is a legend: When he became chairman of the Federal Reserve Board in 1979, he inherited a catastrophe. Half of the central bank’s job is to ensure stable prices, but inflation had reached 13 percent, destroying the value of people’s savings, eroding their standard of living, and driving up costs for businesses. So Volcker tightened the money supply, pushing short-term interest rates up to 20 percent.
The move stamped out inflation but unleashed back-to-back recessions in the early 1980s, a surge in unemployment to over 10 percent, and a bipartisan battle cry against the Fed. Home builders, furious that high interest rates (and thus fewer mortgages) were decimating the construction industry, mailed two-by-fours to the central bank. Farmers, crushed by debt, blockaded its Constitution Avenue headquarters with their tractors. The Senate majority leader pleaded with Volcker to “give us a little air, to get [the Fed’s] foot off the nation’s neck.” But Volcker didn’t budge. He kept rates high and allowed himself to be vilified, sacrificing his short-term reputation for the long-term good of the economy. Eventually, vindication: Inflation was down to 4 percent when Volcker left the Fed in 1987, and it receded further over the next decade. By setting the stage for more than two decades of stability interrupted by only mild recessions, economists say, he guided America through the dark.
Today’s chairman, Ben Bernanke, keeps one of those two-by-fours on a bookshelf in his office. If Volcker went to war for price stability, Bernanke went to war for the Fed’s other legal mandate: maximum employment. This part of the bank’s mission is to foster the kind of economy that will put people to work—a tough job during and after the worst financial crisis since the Great Depression. The bank bailout, the auto rescue, the 2009 stimulus bill, and the Fed’s low interest rates may have averted a deeper recession, but the job market remains moribund. Today, 7.9 percent of Americans are still unemployed, and millions of others have simply stopped seeking work, meaning they’re not even counted in the jobless rate.
So Bernanke got creative. He has done things that no Fed chairman had ever thought of. To pile-drive long-term interest rates, he bought Treasury bonds and mortgage-backed securities; replaced one kind of security in the Fed’s portfolio with another; and began describing the central bank’s long-term strategy so investors would know when they might expect higher rates. All of which has elicited a (mostly partisan) backlash to rival Volcker’s. Conservative economists, who at first congratulated the Fed for preventing deflation, now fear that Bernanke has set the stage for inflation and ignored the price stability Volcker fought so hard to ensure. On the campaign trail in 2011, Texas Gov. Rick Perry accused Bernanke of treason and even hinted that the chairman might face bodily harm if he visited Perry’s state. Republicans in Congress say the chairman has turned the Fed into a fourth branch of government and warn that he could induce another economic crisis by nurturing an asset bubble. In a hearing this week, Sen. Bob Corker, R-Tenn., called Bernanke soft on inflation. “I don’t think there’s any question that you would be the biggest dove, if you will, since World War II,” Corker said.
Volcker, at 6 feet 7, was a brusque, cigar-puffing behemoth who cowed congressional opponents of his inflation-fighting crusade. But Bernanke, who prefers to build consensus, is more diffident. He has sought—and failed—to win over skeptics by force of argument. He is no less steely in the face of criticism, but he has not been able to shut it down. So an old movement has revived to take away the Fed’s max-employment mandate. While Republicans mull how to clip Bernanke’s wings, the two-by-four in his office reminds him that unpopular decisions today don’t preclude absolution tomorrow. If you have the courage of your convictions, a lumber beat-down is just part of the job.
THE DUAL MANDATE
Economics is a soft science. Better models and controlled experiments have improved its accuracy over time, but in the postwar years, economists still relied heavily on correlation and guesswork. One theory popular in the 1960s and ’70s held that if policymakers were willing to tolerate higher inflation—say, 6 percent instead of 2 or 3 percent—they could hold down the jobless rate by keeping interest rates low and getting people to spend money. This turned out to be ruinously wrong: Surging prices made employers hesitant to hire, which is why stagflation (high inflation, low growth) crippled the country in the 1970s.
A corrective arrived in 1977, when Congress gave the Fed new marching orders: It was to seek both maximum employment and stable prices—a “dual mandate.” Right away, some economists worried that the two objectives could work at cross-purposes. At a meeting in 1978, Volcker, who was then head of the powerful Federal Reserve Bank of New York, said the instructions could leave the central bank in an “awkward position.”