Advice From Mr. Chairman Paul Volcker, Who Helped Whip Inflation As

By Lawrence Malkin, Paul Volcker

For eight years, as chairman of the Federal Reserve Board, Paul Volcker was perhaps the second most powerful man in Washington. There were no doubt times, as he squeezed the money supply and cost people jobs in his battle against double-digit inflation, when he was also one of the most unpopular. Volcker, 61, devoted more than three decades to public service; his first appointment after leaving Government in 1987 was as unpaid chairman of the National Commission on the Public Service, a private group trying to improve the lot of the nation's civil servants. Now, as chairman of the New York City investment bank James D. Wolfensohn Inc., Volcker is making big money for the first time in his life. With Administrations changing in Washington, Volcker sat in the study of his Manhattan apartment for a TIME interview with author Lawrence Malkin.

Q. Some of your devotion to public service comes from your father's career as city manager of Teaneck, N.J. What ideas did he pass on to you?

A. He did spend his whole life in the public service, and I suppose the impression I had as a kid was that he was doing something that, in the cliche of the day, "made a difference." When he took over, the town was on the verge of bankruptcy, and it was refinanced. And within a few years it had an A-1 credit rating.

Q. You stuck to public service when you could have made millions in private life as a banker or a trader.

A. Yeah, but trading for the Fed is a little different. You've got all the cards when you trade for the Fed. But I easily could have gone to law school. My indecision was resolved for me by getting a larger fellowship at what is now the Kennedy School ((of Government at Harvard)). And I often thought that if I'd gone to law school, I would have been representing a bunch of banks before the Federal Reserve Board in recent years instead of the opposite.

Q. You could have spent your life very comfortably as a senior Fed economist.

A. It wouldn't be much fun, though.

Q. People tend to forget that the astronauts went into space on Government paychecks. Do we get the "right stuff" in Government now?

A. I obviously have some doubts about it, and that's why we have this Commission on the Public Service. The attitude toward federal service has certainly changed. It's a matter of psychology and prestige. A feeling that civil servants get hammered by the political process, beginning with the last couple of Presidents. And after a while, you have enough people swearing at you, and you don't think it's a very promising career. Salaries are of some importance, ((but)) when you're talking about the federal civil service, this process of layering the career people with more and more political people has probably reached the point where it is quite important in discouraging somebody who someday wants to have a really responsible job: Why should I go into the civil service when I know I'm going to be truncated at a pretty low level?

Q. The Reagan Administration argued that the best and brightest should not be in Government but in the private sector creating wealth.

A. It seems to me the argument falls on its face. Just pick up any newspaper, on any subject. You have a great problem with the space program. You've got problems with AIDS. You've got problems with savings and loans. Now they're not all going to be rescued or prevented ((from failing)) just by having a more effective civil service. But to say that you can run the Government without any continuity, without any background, without any expertise, I think, logically is deficient.

Q. Do some of these problems arise from bad Government?

A. Just take the savings and loan thing, which I know something about. The absence of a strong spirit of professionalism and independence in the Home Loan Bank System and in the FSLIC ((which insures S and L depositors)) certainly had something to do with the weaknesses of the supervision and the regulatory effort. You can argue that's all great -- that we gave the S and Ls all this opportunity to go out and do it in the interest of entrepreneurship and a bright new financial world. But I think we've lost a little sense of balance. Hey, look at the Pentagon, which spends $300 billion a year. Are they doing a good job? And they're up against all these very sophisticated, aggressive business people. Are the people making those decisions getting the best professional advice? Why do we seem to make so many mistakes on procurement?

Q. Defeating inflation is generally regarded as the crown of your public career. How did you feel taking over the Fed in 1979, facing terrible economic problems?

A. In a way that's easier. There was a perception that things were going from bad to worse on the inflation side and that something ought to be done. The ((Carter)) Administration had got deeply concerned. They said to me they were scared of this exploding inflation and were willing to stand still for stronger measures than would ordinarily be the case. And that is a great advantage. If you can walk into a situation that is felt to be so severely out of kilter, you have greater freedom of action.

Q. Some say the Fed adopted monetarism and decided to target control of the nation's money supply in order to keep hands off interest rates and duck the inevitable political criticism as rates rose.

A. I don't think that's quite fair. Interest rates went up much further than I would have thought. But when the Federal Reserve System as a whole got the bit in their teeth, they wanted to carry out the monetarist doctrine to its fullest extent. We got pushed into an even more hands-off stance than I personally would have suggested in the beginning. But we really didn't go out of our way to try to moderate the rise in rates, because everybody got all caught up with this feeling that we wanted to demonstrate credibility and have some favorable effects on people's expectations ((that inflation would end)).

Q. High interest rates cost millions of people their jobs or hurt their businesses. What do you say to those people now?

A. That to some degree the length and strength of the present expansion, the < fact that we've gone as far as we have with as little inflation as we've had -- although I'm quite worried about the inflation rate now -- is not unrelated to what we went through early in the decade.

Q. What should the President expect from the Fed, and what should the Fed expect from the President?

A. I'm tempted to say silence from both sides. But, you know, so much of that depends upon personal relationships. I certainly think they owe each other a willingness to communicate and explain what they're doing on both sides. I do think that, under our system, in monetary policy the Federal Reserve has to go off and in the end make its own decisions.

Q. Jimmy Carter barely mentions you in his memoirs, which seems strange because he appointed you. Did you get the support from him you wanted?

A. What was remarkable is how little criticism ((of the Fed)) he had even in the midst of the election campaign. At one point he made some comments, which weren't all that devastating, about why the Federal Reserve didn't have to be as monetarist as they in fact were. And Reagan at the same time was criticizing us for being too easy. You know, some Democrats think we lost the election for Jimmy Carter. I've asked him about that. He never thought we were a net bonus to him. But I don't think he blames us for losing the election. I have great respect for the fact that he did not take the opportunity to criticize us more than he did. That changed a bit with some of the people around Mr. Reagan.

Q. Did you discuss this with President Reagan?

A. No, we didn't have much contact. I mean, we had increasingly less as the years passed. I don't think it was a very good idea, but I didn't see much to do about it. I never considered our give-and-take terribly productive.

Q. Do you think he understood what you were trying to do?

A. Not fully, no, because he was operating at a different level in some sense. You know, he had a few notions about what he would consider supply-side economics, although he only seemed to learn them during the election campaign in 1980. You've heard this a million times from people writing memoirs: it's a little difficult to engage him in a substantive debate. He had a few relatively simple and straightforward ideas. And in fact I didn't see him much as the second term progressed. ((Chief of staff)) Don Regan kept saying, "You've got to see him much more frequently. I'll arrange it." But he never did. When I saw him, it was probably as often as not at my initiative. But I didn't feel very comfortable about that. The President was really quite supportive, particularly given the pressures that he was under from his own people. He had some basic instinct that he didn't like inflation, which was a great help to us. He wasn't necessarily enthusiastic in his support, but he wasn't heavily critical.

Q. The main attacks came from the supply-siders. They said Volcker screwed up their policy.

A. Some of the more extreme people are totally unrealistic. They claim that they had some wonderful scenario in their mind that inflation was going to come down gradually, not too much and not too little, and everything was going to come out just great eight years later. Things don't work in that orderly a fashion. They ought to be happy that, from their standpoint politically, everything came out beautifully. They took their lumps in the first couple of years ((with a recession)) and by the 1984 election everything was going fine. Now they're rednecked about being blamed for the budget deficit.

Q. How did we fall into the habit of foreign borrowing to cover our deficits?

A. When I had some analyses presented to me in 1983 that showed a current account deficit rising up toward $100 billion, I said it's impossible, we can't borrow that much abroad. That's not going to happen. But things continue in Government unless you feel a crisis. In fact, we didn't have a crisis, so the deficit persisted.

Q. Here we've got another dilemma: a President who says "no new taxes" and a budget deficit that many people say can't be closed without them. How does the President get out of it?

A. I must confess what surprises me a bit about this ((the deficit)) is how it has persisted with less trauma than I thought was probable. Maybe it could persist another year or two years or three years. I don't think it can persist forever. Well, if you continue like this, I think we are gradually undercutting productivity and growth for the American economy, and I think we're undercutting our ability to lead in the world. It now is demonstrably harder for us to propose something and expect the rest of the world to follow. I think it is hard to expect other countries to do what we would like them to do in the trade area, in the economic policy area, as long as we stonewall them on what they think we should do about the deficit -- and in fact what most of us think we should do.

Q. Do you think that the danger to companies and banks that have become overstretched in the Wall Street buyout boom might inhibit the Fed from reining in the economy if it feels it has to?

A. Well, it may psychologically at some point. I think that's unfortunate, because if you're inhibited now, you may be maximizing the chances of a worse problem later on. The easiest time to deal with inflation is before it gets started. Just to make the contrast stark -- this is not a forecast -- if you had a choice between some small increase in interest rates now that was going to control or even lower inflation, and letting it get worse for two or three years so we return to the situation we had in the early 1980s, then these banks and companies would really be vulnerable. You've got to do what you ought to do at a reasonably early time without worrying too much about fragilities in the financial system, or you may find out you've only got more fragilities.

Q. Walter Wriston, former chairman of Citicorp, used to call you "the big nanny," and criticized you for "locking the wheels of the world" when you attacked inflation. What did you make of that?

A. He was the head of our most aggressive bank, and he didn't like surveillance by the regulatory authorities. That kind of criticism irritates me. What right does anybody have to think that inflation is going to go on? I don't think he was entitled to think that we were going to keep it going.

Q. A number of people, including your wife, say you're happiest when you're managing a crisis. Does that respond to something in your character?

A. Frankly, I am not very good at planning things way in advance, of doing great studies about what should be done over a period of time, because it all seems very abstract. And I find it very easy to be lazy unless something compelling comes along and says, look, goddammit, you've got to act. And it's on your desk and that's it. Then the adrenaline begins running. You're sitting there in the Federal Reserve where you're supposed to do things that aren't all that popular. And to the extent that you have an aura, if that's the right word, of professionalism, it makes it all that easier.

Q. Obviously public service is your lifeblood. Where do you go from here?

A. Right where I am, I think.