But Volcker was no political babe in the woods. He also knew that this method provided more political cover than directly jacking up interest rates. He applied some legerdemain, although he forcefully argued it was not the political smoke screen some would later allege. As he admitted: “This was certainly an easier way to get public support. You can say that we’ve got to keep the money supply under control, that’s what we’re doing; we’re not directly aiming at interest rates. Everybody knows that money has something to do with inflation, and that’s what we’re controlling.” He knew he could never politically sustain directly raising rates to the high levels necessary to slay inflation. After his own radical strategy had worked, he was asked directly whether he was a monetarist. He replied with equal directness, “Nah, I just wanted to shake ’em up.”182
Volcker now had to make his policy work, and he found there were “many slips between fixing the supply of reserves and the actual money supply that come out at the other end of the sausage grinder.”183 He knew short-term interest rates would go up, but he hoped the new policy would have such a psychological impact that the markets and public would come to believe that the Fed really could control inflation. The central bank kept looking for a sign in long-term bond rates. If savers and investors were prepared to park their money in bonds over a period of years at a lower interest rate, it meant they expected inflation to go down and the cost of money along with it. That did not happen, and moreover, short-term rates became far more volatile than he feared, as Charlie Schultze had predicted.
Volcker certainly did not expect interest rates rising close to 20 percent in 1980, while the economy was still barreling along and inflation still sky-high. Volcker called me on April 1 to admit he did not know when interest rates would peak. It could be early, but the economy was still stronger than he thought. We are “caught between overkill and underkill and the two overlap.” He said, “I know you’re at a point where it hurts, but there is a question whether we have gone far enough.”184 He came face-to-face with embedded inflation psychology when Arthur Levitt, the president of the American Stock Exchange, brought a number of leaders of small and medium-size companies for a visit. Volcker gave the group a pep talk about the Fed’s innovative approach to fighting inflation, and the first businessman to respond said he had just agreed to a 13 percent wage increase for his employees over the next three years, and “I’m very happy.”185
The Carter administration certainly was not pleased. At an EPG meeting in early April 1980, after the Volcker policies had been in operation for half a year and we were heading into an election, I raised concerns that sky-high interest-rate hikes would lead to a deeper recession. Miller agreed and labeled the Fed’s last increases “macho.” He said he would talk to Volcker, but it came to no avail. On April 8 the legendary financier Felix Rohatyn of Lazard Frères told me he was “more scared than at any time in my career.” He explained that banks were fragile and losses in stock portfolios were staggering. He forecast widespread bankruptcies and appealed for a wage-price freeze or mandatory controls instead of Volcker’s policy: “His theology is wrong.”186
The banks meanwhile were making out like bandits, charging their best customers a prime rate of 19 percent while they could borrow the money in the market for half a dozen percentage points less. Carter wanted to know why the prime rate was 19 percent when inflation was 13 percent. Schultze’s answer was technical and complex, based on the squeeze we had placed on their loans. “Why can’t we jawbone the banks? Why do we need to condone the interest rate spread? We need to manage this carefully or we’ll have a massive recession,” the president said. Schultze and Miller spoke with Volcker, but he refused to talk down the prime rate and asked the administration not to do so either.187
CREDIT CONTROLS
Still, Carter felt he must show the country—and the electorate—that he was doing whatever he could to curb inflation, and that Volcker’s was not the only show in town. On March 14, 1980, the president made yet another nationwide address on inflation. His program contained many elements: a major cut to the budget he had just proposed; a revised wage standard recommended by his labor-management Pay Advisory Committee; and energy conservation measures to halve U.S. oil imports by 1990.
But one key part threw an unanticipated monkey wrench into Volcker’s plan. Carter tried to impose controls on consumer credit, which turned out to be a monumentally bad idea, causing a recession in the midst of the election campaign, and temporarily sidetracking Volcker’s new interest-rate policy.188
This was a pet idea of Fred Kahn’s, who argued that inflation was fueled by credit and consumers had gone too heavily into debt. His goal was to restrain consumer spending by restricting credit and thus encourage savings, a risky tactic in an election season.189 But this had come not only from Kahn. He persuaded others, myself included, that it would help relieve some of the worst pain of high interest rates, while not undermining the Fed’s program. And the president had the legal authority to ask the Fed to impose controls anyway.
When the president announced his credit control program, he linked the excessive borrowing that the government must do to fund its deficits with the borrowing individual Americans must do to make ends meet, and asserted that we could not beat inflation with borrowed money: “Inflation is fueled by credit-financed spending” and “Consumers have gone in debt too heavily.”
Volcker in the worst way did not want to implement even the limited authority given to him by the president; autos, housing, and durable goods—the principal objects of household credit—were exempt. But since Carter was showing great restraint in not opposing Volcker’s tough monetary policy, he felt he owed it to the president to go along, and Carter was “quite insistent.” He recalled: “The president hadn’t objected to our policy.… We could have said, ‘Well, Mr. President, you’ve authorized it, but screw you, we’re not going to administer it.’ But I thought that was an untenable position.”190 So he told his unhappy board that with the president sitting still for the Fed’s very high interest rates and vowing to cut the budget further, “we had to be part of the game and not refuse to do it. But I told everybody I would make it as mild as I could possibly make it.”191 He felt credit controls were a solution in search of a problem, and there actually was no consumer credit problem to be solved: Consumption had already leveled off. What he really feared was that credit controls would kill the momentum of his program. They brought on what Volcker described as “the strangest economic period that I’ve ever seen.” Consumption fell off the table.192
After Carter stressed the importance of limiting credit—his instinct to exaggerate was a characteristic trait—he managed to make the public feel it would be unpatriotic to use credit cards.193 People were so desperate to do their part to fight inflation, they tore up their credit cards as a patriotic act and sent the pieces to Kahn and the White House, accompanied by letters saying: “Mr. President, we will cooperate.” Others sent irate letters denouncing Sears, Roebuck for continuing to solicit new credit card accounts. Kahn would write back and say, “No, we don’t want you to throw away your credit cards; all we want you to do is restrict your increases.”194 But a policy that is too nebulous and cannot be easily explained is subject to misunderstanding and is not a good policy. So while general retail sales did not fall significantly, sales of big-ticket items fell off by 30 to 40 percent and helped produce a 9 percent collapse in the GDP, the largest single drop in any quarter since the Depression.
Schultze termed it “an absolute freak; it was that psychological reaction.”195 Volcker agreed. Interest rates plunged, frustrating the intent of the Fed’s tight money policy because it had to inject money into the banking system to stop the economy from dropping like a stone. Volcker said: “We had a devil of a time getting things back in control again.” The whole experience also demonstrated the limits of a short, sharp recession alone to drain inflation from the economy. When credit controls were suddenly imposed, interest rates dropped
precipitously to around 9 percent—and shot back into double digits when they were quickly removed. Growth jumped back up too, and inflation was actually higher than before.196
MORE BUDGET CUTS
Another key part of the president’s anti-inflation program was revising the budget he had just sent to Congress in January 1980, for fiscal 1981, beginning in October, just before the presidential election. This unusual exercise was required because the budget we sent to Congress was met with the proverbial Bronx cheer when our budget office estimated that the deficit for the current fiscal year would likely be twice what we had initially projected. There is nothing worse than fighting raging inflation during an election year, and for a president to tell the American people that his revised budget involves “costs [and] pain, but far less than the still worse permanent pain of constantly rising inflation.” When we began a marathon exercise to make additional cuts in the budget, it was as painful as tearing skin from your body. The original budget was already tight. Now, with Senator Kennedy challenging Carter for the Democratic nomination, we were nevertheless going to cut more. We needed to demonstrate even greater fiscal rectitude and remain in sync with Volcker’s tougher monetary policy, but we also needed to finance programs designed to protect the most vulnerable Americans, for which Mondale had fought throughout his political career.
Carter asked Volcker to join several of the budget meetings, which were eye-opening in their sharp deliberations. Volcker remained a largely silent observer, but he was particularly critical of my role. As the budgeters presented options for cuts, Carter agreed to most. But on a couple of the more important ones, Volcker noticed that I would object. Years later, as he rehearsed my own behavior back to me: “‘You know the Party’s against this, Mr. President, blah, blah, blah,’—and he [Carter] said, ‘Well, we’ll do it anyway.’ And I sat there and I thought what a brash guy: The President said he was willing to do it, and then Eizenstat comes back and tells him, ‘You really don’t want to do this, Mr. President,’ and he’d finally say, ‘Cut three-quarters of it,’ and you’d come back half an hour later, and he’d say, ‘All right, cut a quarter of it.’ He started out with cutting the whole thing, and he ended up with a quarter of a loaf. I thought, Well, this is a crazy business. He wanted to restrain but this guy Eizenstat keeps pulling him back.”197
I plead guilty in part, but it was hardly as dramatic as Volcker colorfully portrays. In the president’s message he was proposing cuts of more than $13 billion to an already stringent budget, mostly in domestic programs at a time we were trying to fend off Kennedy’s challenge from the left. This validated Mondale’s warning to me in the fall of 1978 that with Carter’s stringent budgets “it will be a hard two years with liberals.”198 This allowed the president to realize his wish to propose a balanced budget, even though it would inevitably end up in deficit because of poor economic conditions and congressional action to restore some of the cuts. With Miller and OMB director McIntyre, I helped lead round-the-clock negotiations for ten days with the Congress to sell the package of cuts in record time. They agreed to all the cuts but only delivered half in the end.199
Volcker remembers a humorous part of the president’s announcement, with himself sitting in the front row in the East Room of the White House, and thus implicitly embracing it. He had an advance copy of the text and noticed that Carter had lost one page, although luckily the previous page ended with a paragraph and the page after the missing one began with another paragraph—so “nobody except me ever realized it.” Actually, Miller and Gordon Stewart, the speechwriter, did notice; Carter’s usually reliable secretary, Susan Clough, had left the page on the Xerox machine.200
But Volcker made a telling point: “I always thought that a real part of the problem was that the president was getting too many diverse views pulling at him in the White House and taking him away from his basic instincts, which were to be fiscally conservative. He always seemed to be compromising between his own instincts and the forces in the party and in the White House pulling at him.”201 Volcker was right, up to a point. But he did not have to work in the hothouse of the West Wing to help the president temper that basic conservatism and hold his liberal base. I strongly supported budget restraint but also wanted to go after many of the federal benefits, from farm subsidies to trade restrictions, that pushed up prices and embedded inflation in our politics and our personal expectations. Kahn, the anti-inflation czar, viewed the traditional Democratic base as favoring constituency policies, particularly those espoused by labor unions, while not realizing that “Democratic inflations are always followed by Republican victories.”202
More broadly, Carter’s budget policies played little role in the stagflation. Carter’s budgets were tight. Mondale and I could only affect them at the margins. And as for the wage-price policies, John Dunlop, then the country’s leading labor economist and former Labor secretary in the Ford administration, scored some successes as chairman of Carter’s Pay Advisory Committee under a national labor-management accord we announced in late September 1979. But in his view, the accomplishments of voluntary guidelines and union-management dialogue under such extreme inflation conditions were “relatively minor.”203
AFTER THE TURNING POINT
After the election the president met with the economic team on December 17, for almost the last time.204 Even now Schultze reported that the economy was much stronger than expected, growing by 5 percent during the last quarter of his presidency. Carter said this was fairly good “compared to what the public thinks. But the whole emphasis is on interest rates, and we’re getting more blame than we deserve.” None of us could have realized that the American economy was at a turning point, and that the coming thirty years would bring stagnant wages and gross disparities in wealth. But there is also a more positive side to the story. In addition to ten million new jobs, while the general perception is that economic growth was terrible under Carter and great during Reagan’s “Morning in America,” in fact the U.S. economy grew at an almost identical rate during the two presidencies: 3.3 percent under Carter against Reagan’s 3.5 percent.205 Carter did not achieve his dream of a balanced budget, but that was mainly the result of too little revenue rather than too much spending. He added a smaller percentage to the national debt during his four years than did Reagan and the two Bush presidents.206 His highest budget deficit was almost half of Reagan’s lowest.
Yet from his first major national address calling for the “moral equivalent of war” in ending our dependence on imported oil to this last anti-inflation package, Carter’s message was sacrifice and pain. When he faced Reagan’s message of hope and optimism amid soaring inflation and interest rates, the very contrast itself was painful. And as interest rates mounted even higher after Reagan took office, the new president waved off their side effects and berated the press for writing about unemployment “every time some guy out in South Succotash loses his job.”
There is one other key factor in any objective view of the Carter economic performance. In my Yiddish vernacular it is called mazel, or luck, and is recognized throughout history; “I chose my marshals for their luck,” said Napoleon. And aside from one crucial but courageous choice in Volcker, Carter had no economic luck. He inherited stagflation, and sustained the second oil shock of the decade, a commodity price boom, and a slowdown in productivity that is still not fully understood, and is repeating itself today.
Against these forces, voluntary wage and price guidelines, which had been modestly effective in the Kennedy administration, stood no chance. Nor did the fiscal restraint Carter imposed on an unwilling party. But there was a page from President Kennedy’s playbook we should have taken when he faced the coal miners’ strike. Kennedy forced the steel companies to retreat from raising prices after granting a modest wage settlement—“My father always told me all businessmen were sons of bitches, but I never believed it until now.”207 Along with Volcker’s monetary medicine, Reagan’s toughness in firing striking air controllers can be c
redited with beginning to break the wage-price spiral, although the cost was the erosion of labor union power. These stand in stark contrast to our caving in to a huge wage settlement to end the 110-day coal miners’ strike. As Schultze reflected, it would have helped Carter to clobber some unions to show his willingness to be tough on inflationary wage hikes, but he did not feel comfortable doing so,208 and for better or worse, they were a key part of his Democratic electoral base.
But no set of short-term policies could have blocked the huge run-up in inflation arising from the second oil shock of the 1970s. And just as Nixon suffered double-digit inflation from the first oil shock in 1973, Carter suffered the same from the second in 1979–80.
Many of Carter’s economic programs and reforms benefited the country only after he left office, but by far the most important and lasting was his appointment of Paul Volcker. Carter knew there could be no equivocation, whether it meant splitting his party or even forestalling his reelection, both of which it did. It took too long for the president’s key economic advisers, Schultze, Blumenthal, and Miller, and certainly for Mondale and me, to come to the realization that in a high-inflation environment, we had given too little emphasis to monetary policy and too much to fiscal policy, failing to recognize that the Federal Reserve was the most important weapon we had to fight inflation and change public psychology.209 This is dramatically demonstrated by the low-inflation environments of the Reagan and George W. Bush years—even in the face of triple-digit budget deficits far larger than under Carter—because the Fed had assured the public it had inflation under control. Fiscal policies work slowly, and they must also work their way through an often recalcitrant Congress.
President Carter Page 43