Inflation or Recession? Paul Volcker Drew a Bad Hand His First Day on the Job

It says a great deal about Paul Volcker that he deliberately caused one of the worst recessions in postwar U.S. history yet is remembered today as a hero, one of our greatest public servants.

When he died on Sunday at 92, most Americans had never experienced double-digit inflation as an adult. They may not know how lucky they are, but they ought to know how much they owe Volcker.

When President Jimmy Carter nominated Volcker as Fed Chairman in 1979, he was the right person at the right time. The inflation rate that year would be 11.3%, the highest in decades, and it was headed upward.

Volcker hated inflation. He never stopped hating it. His undergraduate thesis at Princeton criticized the Fed for not clamping down on inflation after World War II, and his autobiography, published at age 91, is called Keeping at it: The Quest for Sound Money and Good Government.

In the world of economics, the job Carter had given him would become an epic battle of mythological proportions: a destructive beast raging through the world’s largest economy vs. the monster’s most vehement enemy.

Volcker faced a painful choice. Taming inflation required shrinking the money supply drastically, but that would almost certainly push the economy into recession. He nonetheless began the process in late 1979.

A recession followed almost immediately—yet inflation got even worse, 13.6% in 1980. He didn’t relent. That recession was brief and mild, but was followed in 1981 by a much deeper recession—16 miserable months in which unemployment hit 10.8%, the worst since the Great Depression, and unmatched even in the recession of 2008-2009.

But inflation was losing the battle. In 1983, with the recession over, it shriveled to just 3.2%.

Volcker had won. It was a stunningly large, rapid plunge in inflation, setting the stage for strong growth and the great bull market of the ’80s and ’90s. Just as important, it warned a generation of policymakers not to let inflation get out of hand again—not only to prevent its destruction of living standards for millions of people, but also to avoid the cruel necessity of punishing those people still more by causing a recession in order to crush the inflation.

Volcker left the Fed in 1987, when Alan Greenspan became chairman, and for the rest of his life he carried a moral authority rarely possessed by any public figure. He chaired many committees and commissions for finance-related causes and famously proposed the Volcker Rule, to prohibit deposit-taking institutions from engaging in risky finance, especially proprietary trading.

This one-sentence idea was incorporated into the Dodd-Frank law and eventually ran to 71 pages, plus 800 pages of supporting material.

Its effect is hard to judge.

Volcker’s post-Fed career included controversies. Many on Wall Street complained he didn’t really understand financial markets; his endorsement of Barack Obama for president inevitably had opponents.

None of that really matters. The reason he received honorary degrees from at least 22 colleges and universities is that he summoned the courage to resolve an economic crisis quickly, at high cost to be sure, yet with broad consensus that the cost was worth it.

At a time of hyper-partisanship when it seems broad consensus is gone forever, it’s an example worth remembering.