The hero of the 1980s. The man who led the US through some of the worst economic conditions since the Great Depression. The average American would assume I was talking about President Reagan. Authorizing gigantic tax cuts, blowing the US government spending through the rough, it’s easy to see why people would assume that President Reagan was the hero of the bullish 1980’s. However, another man worked behind the scenes: Paul Volcker. Traditionally, there are two components to economic policy: fiscal policy and monetary policy. Fiscal policy is the one the average person knows about: taxation, government transfers, and general government spending. For example, the recent tax cuts implemented by the current US government administration would be considered part of fiscal policy. Social security, Medicaid, Medicare, and national defense spending would also be included. However, most people are not aware of the components of monetary policy: open market operations, reserve ratio, discount rate, and federal funds rate. Open market operations simply refer to the selling or buying of bonds, the reserve ratio is the percentage of deposits that banks are not allowed to loan out, and discount and federal funds rate are the interest rates that banks charge each other. Monetary policy often occurs behind the hood and is viewed by most people as economic voodoo that causes massive change. In reality, monetary policy causes logical, predictable changes to the economy based on human behavior. For example, when the Federal Reserve purchases money market securities, they pump money into the economy. When money enters the economy, more money is available to lend so the interest rate decreases, which allows people to take out more loans and enable greater spending in an economy. In the 1970s, the US experienced a supply shock. The 1973 oil crisis occurred when OPEC, the Organization of Petroleum Exporting Countries, decided to withhold oil from the United States, causing production to slam to a halt due to rising oil costs. A decrease in aggregate supply causes a phenomenon known as a stagflation, in which there is high inflation and low GDP, the total value of the output produced by a country. Economic policy usually functions well when dealing with either inflation or recessionary conditions as there is a trade-off between inflation and employment rates. When there is low GDP, there are usually low levels of inflation. When there is high inflation, there is usually also high GDP. Consequently, economic policy can afford to sacrifice either GDP or inflation in order to rectify the issue. Yet, economic theory is not equipped to deal with stagflation. Paul Volcker became chairman of Board of Governors of Federal Reserve System on August 6, 1979, serving until August 11, 1987. Initially, he started his career working as an economist of the Federal Reserve from 1952 to 1957. Later, he also worked at Chase Manhattan Bank. Jimmy Carter nominated Volcker to be the Chairman of the Federal Reserve due to the rise in inflation during the late 1970’s. Volcker was faced with an unprecedented dilemma: he dealt with low levels of output and high price level (inflation). He took leadership and made a decision: he would first attempt to curb the high level of inflation by drastically increasing the discount rate, the interest rate for banks borrowing through the Federal Reserve. Immediately, his policy worked. The inflation rate went from around 10.3% in 1981 to 6.2% in 1982 to 3.2% in 1983. Unfortunately, curbing the inflation rate resulted in a brief recession in 1980-81. Eventually, the real GDP started to climb back up as the inflation rate remained stable. While many people credit President Reagan with the economic success of the 1980s, the effectiveness of Chairman Volcker’s monetary policy is evident in the inflation rate over time in the 1980s. More recently, Paul Volcker was involved in implementing bank regulations following the financial crisis of 2007-2009. Most notably, he contributed to the Dodd-Frank Act. Part of the Dodd-Frank Act was the Volcker Rule, which restricts US banks from making speculative investments. Volcker believed that speculation was one of the primary causes of the financial crisis of 2007-2009. Ultimately, the rule prohibits banks from proprietary trading or owning/investing in a hedge fund, preventing the too-big-to-fail mentality from ruining the economy again. The measure was opposed by Goldman Sachs, Bank of America, and other large banks because it restricts what they can do. It came into effect on July 2, 2015, a delay costing the seven biggest banks $400 million. Five agencies were in charge of implementing the Volcker Rule: SEC, the Federal Reserve, FDIC, and the Office of the Comptroller of the Currency. The Volcker Rule has profoundly impacted US consumers: people’s deposits in banks are safer, as up to $250,000 will be insured by the FDIC, the probability of another mass bank failure is significantly lower, big banks will not be able to make the same risky investments as before, smaller banks will become more competitive compared to big banks, and some bankers were sent to jail for financial crimes. CitationsAmadeo, Kimberly. “6 Ways the Volcker Rule Protects You (And Why Banks Hate It).” US Economy, The Balance, 10 July 2017, www.thebalance.com/volcker-rule-summary-3305905. The Editorial Board. “Finally, the Volcker Rule.” The New York Times, The New York Times, 12 Dec. 2013, www.nytimes.com/2013/12/13/opinion/finally-the-volcker-rule.html. Federal Reserve. “Paul A. Volcker.” Federal Reserve History, Federal Reserve System, 2012, www.federalreservehistory.org/people/paul_a_volcker. Volcker, Paul. “Paul Volcker Interview.” The First Measured Century, PBS, 1987, www.pbs.org/fmc/interviews/volcker.htm. Suggested Readings
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