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  • Monetary Metamorphosis: The Volcker Fed and Inflation
  • Iwan Morgan (bio)

As the 1970s drew to a close, the inflation that had blighted America’s economy for much of the decade appeared out of control. Under Paul Volcker’s leadership, the Federal Reserve adopted a new policy of money-supply control to curb runaway price instability. This strategy precipitated the deepest recession since the 1930s in 1981–82, during which GDP fell 2.9 percent and some three million payroll jobs were lost—over two-thirds of them in manufacturing. 1 Despite coming under huge political pressure to ease, the Fed stayed the course until it could claim “mission accomplished” in the battle against inflation. Although the central bank expanded the money supply to boost recovery in late 1982, it kept real interest rates (actual rates minus inflation) high for the remainder of Volcker’s tenure as chair. The resultant strength of the dollar drew in cheap imports, causing further damage to America’s manufacturing sector even as prosperity returned to other parts of the economy.

To date, scholarly analysis of the late twentieth-century emergence of a conservative American political economy in place of the liberal one initiated by the New Deal has predominantly focused on the fiscal and deregulatory elements of the Reagan administration’s antistatist agenda. However, there is increasing recognition among historians and social scientists that the Volcker Fed played a critical role with regard to both the rightward turn of economic policy and the broader structural changes in the economy in this period. To some analysts, its draconian anti-inflation strategy completed the process whereby finance grew more significant and manufacturing underwent relative decline in the more open, increasingly internationalized economy of the 1970s. 2 For others, its success in stabilizing the value of money was the [End Page 545] prerequisite for the so-called financialization of the economy whereby business profits grew more dependent on the provision of capital than on production of commodities in the 1980s and beyond. 3

In line with the latter interpretation, this study regards the Federal Reserve’s stabilization of money as critical to the credit-driven economy that showed signs of emergence in the 1970s but whose full development occurred subsequently. In its assessment, the central bank oversaw a paradigm shift in American political economy in the 1980s. In essence, low inflation replaced high employment and rising wages as the primary index of national economic well-being, monetary policy replaced fiscal policy as the principal instrument of economic management, and the Fed chair replaced the president as the chief manager of prosperity. The analysis below considers the transformation in the Fed’s role under Volcker, its interactions with the Carter and Reagan administrations, and the historical significance of its monetary legacy.

The Fed Chair as an Institutional Actor

Created in 1913, the Federal Reserve System did not emerge in modern form until the Banking Acts of 1933 and 1935. 4 The first measure enhanced Fed control over the supply of money and credit, notably through establishment of the Federal Open Market Committee [FOMC] to coordinate buying and selling of government securities. The second authorized the president to appoint all seven members of the Fed’s Board of Governors, subject to Senate confirmation, and designate one to serve as chairman (a role hitherto performed ex-officio by the Secretary of the Treasury). The 1935 legislation also empowered the board to appoint the presidents of the twelve Federal Reserve Banks [FRB] located outside Washington, D.C., gave it effective control of the FOMC—whose membership henceforth consisted of the governors, the New York FRB president, and four other reserve bank presidents serving on a rotating basis (instead of just the twelve presidents as hitherto), and strengthened FOMC authority to set monetary policy.

Despite its authority being ill-defined in the New Deal bank reforms, successive chairmen built up their post to make its influence paramount in the monetary policy process. According to Berkeley economist Sherman Maisel, a Federal Reserve governor from 1965 to 1972, the chairman’s power derives from five elements of his role. As the Fed’s principal public spokesman, he is seen as its embodiment by the Washington...


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