De mortuis nil nisi bonum. The Latin injunction to speak nothing but good of the dead is sound advice. It should not justify, however, the complete falsification of history.
That is what former Reagan economic adviser William Niskanen tried to do in recent remarks about President Ronald Reagan’s economic legacy. “That tight money policy, first under (Fed Chairman Paul) Volcker … could not have been done without strong backing from the president,” Niskanen argued in a wire service story just after Reagan’s death.
The truth is quite different. The details of how it differs illustrate the complex relationships between the executive branch and the Federal Reserve that may come to the fore when the next president chooses a replacement for Fed chairman Alan Greenspan.
Ronald Reagan did offer strong verbal support for an anti-inflation policy. In his speeches, he also emphasized the importance of balanced budgets even as his administration submitted budgets with the largest deficits ever seen outside of wartime.
That sort of inconsistency is not unprecedented. Franklin Roosevelt strongly emphasized the virtues of balanced budgets in his 1932 campaign and then, luckily, forgot those promises once elected. Richard Nixon advocated letting the free enterprise system operate unfettered and then imposed the only peacetime wage-price freeze in history.
President Bush argues for a smaller federal government, but to the horror of true conservatives has presided over the largest increases in nonmilitary federal spending in decades.
The Reagan administration, like any other, disliked the high interest rates necessary to squeeze a decade of inflationary momentum out of the U.S. economy. Very high rates in 1982 badly hurt Republican congressional candidates in the fall election.
Rates would have been lower if the federal budget deficit had not been so large, but curbing that would have required sacrificing either expanded military spending or tax cuts — both high priorities of the Reagan administration.
Inflation and interest rates dropped substantially from 1982 to 1986, but Volcker, wary of inflationary pressures flaring back up, worked to keep short-term interest rates higher than desired by White House officials. They tried to pressure Volcker to support faster money growth.
In theory, Reagan should have been able to appoint only three of the seven Fed governors by that point. But because of retirements, he had named a majority of the seven-person board five years after his inauguration.
On Feb. 24, 1986, the Reagan appointees staged what came to be known as the “Palace Coup” against Volcker, unexpectedly ambushing him in a routine meeting to confirm the existing Fed discount rate. The attack was led by the most recent appointees, Wayne Angell and Manuel Johnson. Before their nomination, they had been grilled specifically by Reagan officials on their willingness to defy Volcker.
While the rebellious governors argued that their push for greater monetary expansion derived solely from their reading of what was best for the economy, it was clear that getting interest rates down well before the 1986 congressional election was uppermost in the minds of Reagan officials such as Donald Regan and James Baker.
The coup fizzled. Reagan’s four insurgents expected Volcker to back down to avoid the embarrassment of having been outvoted, a virtually unprecedented event. Instead, Volcker threatened to resign in the face of such blatant White House interference in Fed policy.
The Reagan-appointed governors and Reagan’s economic advisers backed away. Volcker agreed to a discount rate cut some weeks later. While no longer commanding a majority on the Board of Governors itself, he enjoyed greater support on the more broadly based Federal Open Market Committee, which includes five Federal Reserve District Bank presidents as voting members.
But this little-noticed attack on Volcker signaled the end of Volcker’s leadership at the board. Reagan officials made it clear that he could be reappointed as chair in 1987 only if he indicated a willingness to follow the administration’s line. A man of great integrity, Volcker instead resigned in 1987. Alan Greenspan was named to succeed him, and the rest is history.
Monetary historians may long argue whether Volcker’s 1986 tight money stance was as necessary as he thought. The facts of the case clearly are not of Ronald Reagan’s “strong backing” for Volcker’s anti-inflation policy, however. Instead, the Reagan administration orchestrated the most overt attempt to exercise political control over monetary policy in Fed history.
Why is this incident important? Circumstances already have allowed President Bush to appoint four governors, twice as many as the theoretical structure allows. All are well qualified; none is a political hack.
Nevertheless, if Bush is re-elected this fall, he will name a replacement for Greenspan in 2006. By that time, large federal deficits combined with the increasing reluctance of Japan and China to fund the U.S. national debt, may place substantial upward pressure on interest rates just in time for an off-year congressional election that usually is hard on incumbents.
With five Bush appointees on a board of seven, temptation will be enormous to pressure the Fed to keep rates low for political reasons.
© 2004 Edward Lotterman
Chanarambie Consulting, Inc.