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Secrets of the Temple.

Secrets of the Temple.

I was granted an audience with Paul Volcker twice during his tenure as Federal Reserve Board chairman, and both times the opening ritual was the same. My colleague and I were ushered into his office, and we stood in silence while "the chairman," shrouded in cigar smoke, continued to work without raising his head or acknowledging our presence. I can't remember how long the silence lasted--perhaps only 10 or 20 seconds-- but it was long enough to make it clear that we were sand fleas in this man's universe. It was one of his many ways of arrogating power.

Paul Volcker has been widely praised as representing the best of "the Fed." He is a brilliant technocrat, and he is rightly credited with taming inflation at a time when few thought it could be done. But Volcker also represents what is most troubling about the Federal Reserve. Like his institution, he is aloof and disdainful of the messy ways of democratic government. He always operated in secret, and he was proud of his ability to give evasive answers that obscured the central bank's most important actions, even when those actions were sending shock waves through the lives of every American. In response to a reporter's question, Volcker once said gruffly: "We did what we did, we didn't do what we didn't do, and the result was what happened." The response typified his attitude towards an informed public.

Anyone who watched the Volcker Fed in action had to wonder: how can a government based on democratic principles allow so much power to be concentrated in the hands of such an autocratic individual? And how can the economic fate of the nation be entrusted to an institution run by unelected officials, accountable to virtually no one?

It is because of those questions that I was anxious to read Secrets of the Temple, a new book on the Fed written by William Greider, national editor of Rolling Stone magazine.* Much has been written about the central bank in the past, but for the most part, the authors have been economists or financial analysts, who are more interested in the mechanics of money than its politics. Greider promised a different view: an indepth look at how this enigmatic institution fits--or doesn't fit--into the fabric of democratic society.

* Secrets of the Temple. William Greider. Simon & Schuster, $24.95.

On one level, Greider's book fulfills the promise. As the title suggests, he reveals the "secrets" of the Fed. Central Bank officials were surprisingly candid in their discussions with him and enabled him to remove the veil of mystery surrounding monetary policy. He explains the arcane actions of the Fed in clear prose and faithfully traces the stark human consequences of those actions. He exposes the technocrats who guide Fed policy as ordinary mortals susceptible to their own errors, miscalculations, pride, and embarrassments. With admirable diligence, he delves deeply into not only the history of the Federal Reserve but also the history, psychology, and mythology of money, telling a series of fascinating stories that reveal the character of this unusual institution. Fed efforts to raise or lower interest rates, often taken in spite of strong opposition from the administration and Congress, have had the capacity to cause vast changes in economic fortunes, and immense human suffering. But as Greider shows in detail, Fed officials have seldom been called on to account for that suffering.

The most surprising revelation of the book is the story of an instance in 1984 when Volcker effectively overruled his own policy-making committee, empowered by law to set monetary policy. The chairman concluded that the Fed had raised interest rates too high earlier that year, threatening a premature end to the economic expansion. He wanted to ease policy and bring down interest rates, but the members of the policy committee --known as the Federal Open Market Committee--opposed him, fearing that lower rates might encourage inflation. Volcker instructed the New York Federal Bank to ease anyway, despite the committee's directive to the contrary.

"I knew what instructions he was giving the New York desk," Anthony Solomon, president of the New York Federal Reserve Bank at the time, told Greider. "And I thought he was not faithfully observing the instructions of the FOMC. He got his desk to take major action that went way beyond the framework of the directive. He was taking too much leeway personally."

Even Oliver North might have been shocked by that arrogant assumption of power. The laws governing the Fed required little accountability. Volcker didn't have to consult with or inform Congress or the administration when he planned to push interest rates up or let them down. He didn't have to tell any elected official that he was about to embark on a course that could result in widespread bankruptcies or unemployment. But he was required, under the law, to obey the consensus of the Open Market Committee (filled at that time with Volcker loyalists). Even that constraint proved too much for the independent-minded Volcker.

As it turned out, Chairman Volcker was right. The Fed had tightened too much in early 1984, and it was flirting with recession. The easier policy that the Fed chairman forced on his fellow central bankers was, in retrospect, the correct one. Nevertheless, the Fed chairman's autocratic action raises serious questions.

"Neither Congress nor the White House . . . could affect private lives with the immediacy and universal reach of the Federal Reserve's power, its ability to send instant signals rippling through every family's financial decisions, to change the incentives in virtually every business transaction," Greider writes. "The paradox for democracy was obvious: the Washington institution that was most intimately influential in the lives of ordinary citizens was the one they least understood, the one most securely shielded from popular control."

The stern father

Ironically, the Federal Reserve had its philosophical roots in the populist uprisings of the late 1800s, when farmers and small businessmen rose up against the power of the big banks. But the bankers managed to frame the new institution in a way that gave them effective control. Reforms made in the 1930s diluted the power of the banks over the Fed but left intact an unusual, hybrid government institution with little direct accountability to the public. The president appointed Fed governors, but they held 14-year terms that assured their independence. The chairman held only a four-year term, but that term was set so that one president could saddle his successor with an uncongenial central banker.

The unusual arrangement went unnoticed by most people. As Greider points out, the "money question" was the subject of great debate during most of the nineteenth century, when William Jennings Bryan stirred thousands with his famous "cross of gold" speech, calling for an abandonment of the gold standard. But in the twentieth century, the Fed succeeded in convincing the public that monetary policy was an arcane undertaking that need not concern the average American. Never mind that the Fed had the power to bankrupt thousands of small businesses, to erode a lifetime's savings, or to throw millions of people out of their jobs.

"There's an awful lot of power there held by unelected people," an "administration official" --apparently Treasury Secretary James Baker--is quoted as telling Grieder. "That's an awful lot of power with darn little accountability. I'm not sure it's good for a president to be held responsible for monetary policy when he has no control over it. There's a powerful counter-argument, which is that you don't want politicians messing around with monetary policy for their own benefit. But maybe there is a middle ground somewhere. If the president controlled monetary policy, at least you would have someone accountable for it. After all, the president does have to answer to the public."

Over the years, Congress had acquiesced to this undemocratic state of affairs. From time to time, members called for reforms that would restrict the Fed's independence. But in truth, the majority of members of Congress were reluctant to increase their own control over monetary policy. They knew that even small changes in policy could wreak havoc, and they were loath to take responsibility.

Greider shrewdly compares the relationship between Congress and the Fed to that between unruly children and a stern father. "As long as the stern father was present to indulge their excesses, to clean up their mistakes and restore order, the elected government would continue to act like children," he writes. "The creation of the Federal Reserve represented a great retreat from democratic possibilities. The maturing of self-government was forever stunted."

Greider's analysis breaks down, however, because of his insistence on seeing monetary policy as a class struggle. The debate over monetary policy, he writes, conceals "the deeper political conflict among classes of citizens. The money question was the political expression of a struggle over shares." The idea resurfaces repeatedly throughout the book and becomes more insistent as it progesses. By the end, he has worked himself into the conviction that a return to inflation is to be welcomed with open arms.

"Inflation encouraged the future and, if kept to reasonable proportions, it stimulated general optimism," he concludes. "Rising prices excited what Keynes called the 'animal spirits' of businessmen . . .. A return to inflation would begin again to discretely redistribute wealth in a positive direction."

There is an element of truth to this analysis. Especially in its early stages, inflation benefits debtors--who can pay back their debts in cheaper dollars--and punishes creditors--who are stuck with those cheaper dollars. And as Greider tells us repeatedly, only 10 percent of Americans own 86 percent of the nation's financial wealth. So why not use inflation to reduce the holdings of the wealthy and help the struggling debtor?

But in truth, inflation's winners and losers are not divided along neat class lines, as Greider suggests. Well-to-do homeowners, for instance, may benefit nicely from inflation, while renters suffer. Union members whose hefty paychecks are guaranteed by cost-of-living agreements might not feel the pinch of higher prices, but non-union workers can see their earnings gradually erode. Moreover, many of the distributional effects of inflation that Greider favors are only temporary. A lender won't continue to make loans at 10 percent, once he realizes that inflation has risen to 15 percent. The benefit to the borrower occurs only because the lender is temporarily fooled by inflation. Once he realizes that prices are going to rise at a 15 percent pace, he demands higher interest rates. To help a new borrower, inflation must rise even higher, say 20 percent, and trick the lender yet again. And to maintain this charade indefinitely, inflation must spiral ever upward at an accelerating pace, always staying ahead of the bankers' expectations. Even Greider, I suspect, would be a bit uncomfortable with that prospect.

Perhaps the most important failure of Greider's Marxist analysis, however, is that it ignores the effects of inflation on overall economic growth. In the short run, to be sure, inflation may stimulate growth. But as it accelerates, it creates tremendous uncertainty about the future. People and businesses become afraid to make the long-term investments that the economy needs if it is going to grow and if living standards are going to rise. As anyone who lived through the late 1970s in this country should know, inflation doesn't stimulate "optimism" or boost the "animal spirits" of businessmen. Instead, it does the opposite.

Greider is right to complain that the distribution of wealth and of income has become more unequal during the 1980s. Commerce Department figures show that the percentage of income going to the top 20 percent of families rose to 43.7 percent in 1986 from 41.6 percent in 1980--a big move in such a short period. At the same time, the income going to the bottom fifth dropped to 4.6 percent from 5.1 percent.

But it's wrong to finger Volcker's anti-inflation policy as the principal culprit in this change. What Greider fails to note is that the trend toward regressivity actually began in the late 1960s and took firm hold during the inflationary 1970s. The trend probably has far more to do with tax and budget changes than with monetary policy. If Greider wants to improve income distribution, he should look to tax policy and budget policy. Using monetary policy in an effort to redistribute wealth and income would be a wrongheaded and dangerous mistake.

The point here is that stable money is more than just an obsession of the "creditor class"-- as Greider suggests. And it is more than an anal obsession, or an oedipal rebellion--suggestions Greider also makes. Reasonably stable money is good economic policy. And while the American people may not have much say in the Fed's activities, the majority of them would agree that inflation is harmful to their way of life.

Greider chronicles the tremendous pain caused by Volcker's efforts to rein in inflation. The farm crisis, the Third World debt problems, and the plight of U.S. manufacturers were all largely results of Volcker's decision to boost interest rates to fight inflation. The human suffering that resulted from that decision was enormous.

But ultimately, that suffering isn't the cost of maintaining a stable money policy. Rather, it is the enormous cost of wringing inflation out of the economy once it has taken hold. The lesson of the last two decades is not that inflation is preferable to disinflation, as Greider suggests. Rather, it is that stable prices are preferable to either inflation or disinflation.
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Author:Murray, Alan S.
Publication:Washington Monthly
Article Type:Book Review
Date:Jan 1, 1988
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