Volckerism: a Rough First Year

The Fed is still groping for a handle on the money supply

When President Carter last week admonished Federal Reserve Board Chairman Paul Volcker for pushing up the cost of borrowed money, he was not alone in the attack. Both at home and abroad, critics are taking a hard and skeptical look at the U.S. monetary policy that Volcker introduced Oct. 6, 1979. As part of a program to defend the dollar and fight inflation, he signaled a significant shift in strategy. Previously the Fed had attempted to keep interest rates steady and certain, but that led to an overexpansion of the money supply. Under the new monetary strategy, which was immediately dubbed Volckerism, the Fed pledged itself to a tighter control of money growth and promised that it would let interest rates go up or down much more freely in response to market forces.

A year after its introduction, Volcker's new monetary machinery is still full of bugs. Both money growth and interest rates have been on a twelve-month-long roller-coaster ride. At first, the cost of money soared; the prime rate for leading corporations rose from 15 1/4% to 20% by last April. The money supply then dropped precipitously, actually declining at an annual rate of 2.4% during the spring. At the same time, economic output dropped at a 9.6% annual rate, its steepest quarterly slump on record. Then in the summer, the Fed reversed course and began frantically pumping up the money stock. In the past three months, money growth has exploded at a 16.8% annual pace, and interest rates tumbled to a low of 11% in late July.

Such monetarists as the University of Rochester's Karl Brunner and Carnegie-Mellon's Allan Meltzer, who believe that excessive money growth is the main cause of inflation, argue that the Reserve Board is still paying too much attention to interest rates and has reneged on its promise to level off the expansion of money. And many economists in Europe, where confidence in the dollar is crucial, join in the critique. Grumbles Kurt Richebacher, the chief economist of West Germany's Dresdner Bank: "The volatility of the U.S. money supply is not just awful; it's gruesome."

The Federal Reserve contends that the wide swings of money growth and interest rates will balance out to a moderate policy. Says Anthony Solomon, president of the New York Federal Reserve Bank: "Over a longer time frame, we think there is a good chance that the policy will achieve stability." Fed Board Member J. Charles Partee asserts that more steadiness in policy was impossible during such economic turmoil. Says he: "We couldn't really push stable money growth in the face of unstable conditions in the economy. That's not an option open to us."

Whatever the shortcomings of Volckerism, the main lesson of the past year is clear: Paul Volcker needs help. Reports TIME Economic Correspondent William Blaylock: "Monetary policy alone cannot return the U.S. economy to a path of steady, noninflationary growth. The U.S. last week entered a new budget year, with spending estimated to be $45 billion in the red. Unions and management have done little to control the wage-and-price spiral. U.S. energy prices are still a hostage of OPEC. Volckerism was a needed step toward sound economic policy, but it is not an elixir that can solve all the nation's economic ills without the help of sound fiscal, wage and energy policies from the White House and Congress." sb

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