Volcker (61 page)

42
. William Shakespeare,
Timon of Athens
, Act 3, Scene 5.

43
. Transcript,
Issues and Answers
, ABC, August 30, 1981, p. 15.

44
. See Paul Volcker, “We Can Survive Prosperity,” Remarks at the Joint Meeting of the American Economic Association—American Finance Association, San Francisco, CA, December 28, 1983, p. 5.

45
. Inflation during the last three months of 1980 was 12.0, 13.2, and 10.8 percent per annum.

46
.
Chicago Tribune
, December 15, 1980, p. C2.

47
. Ibid.

48
.
Washington Post
, November 30, 1980, p. H1 continued.

49
. See Martin Anderson,
Revolution: The Reagan Legacy
(Stanford, CA: Hoover Institution Press, 1988), pp. 250–53, for his recollection of this incident. It differs from Volcker's. Anderson writes that Volcker did not want to come to the Oval Office to meet the president, while Volcker recalls that Anderson did not offer that option.

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.”

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 Perspectives
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.