We’ll Need Another Volker Within a Decade

When your house is burning, there is no sense fretting over painting the fence. With the U.S. economy mired in what will likely be a recession of historic proportions—and an outright depression in some industries—it would be foolish to get too worked up over future inflation concerns. Oracle-of-the-moment Nouriel Roubini, in his Forbes.com column, forecast the following for next year:

“The advanced economies will face stag-deflation (stagnation/recession and deflation) rather than stagflation, as the slack in goods, labor and commodity markets will lead advanced economies’ inflation rates to become below 1% by 2009.”

Paul VolckerHowever, it might not be a bad idea for policy-makers in Washington and other world capitals to ponder the future impact of all this government spending on price stability when growth returns to the global economy in the years ahead. For many, just conceiving such growth is hard enough right now. And in all fairness, it is probably optimistic to expect meaningful economic expansion to return for many quarters. However, the U.S. and global economy will begin expanding again at some point in the future. When growth returns and deflation ebbs as a major concern, it is reasonable to imagine that there will be a reckoning for the hand-over-fist government spending underway around the globe right now. Such spending and the resultant ballooning of governmental debt will inevitably lead to inflationary forces not seen around the world since the seventies.

After years of economic turmoil and painful adjustments, will politicians of any philosophical stripe have the courage to appoint men such as Paul Volker to deal with the monetary contagion of inflation? Will the American public, undoubtedly weary of upheaval and relative hardship, have the patience and stomach for the bitter medicine that will need to be prescribed to defeat the disease?

The traditional remedy for inflation is to tighten the money supply and ratchet interest rates up until such time that growth is slowed to a sufficient degree to wring inflation out of the system. In the late seventies and early eighties, Fed Chairman Paul Volker implemented this policy and, in conjunction with President Reagan’s tax cuts, inflation was eventually brought under control. In fact, these policies ushered in a long era of disinflation (a decrease in the rate of inflation) and generally robust economic expansion. However, the U.S. endured a double-dip recession during the early eighties that brought severe hardship to many Americans. Reagan’s tax cuts, in time, brought about a period of strong economic growth which had been lacking for over a decade. Recall, for much of the seventies, the nation endured stagflation (stagnant economic growth and inflation). But were it not for Volker’s steadfast resolve to “break the back” of inflation, the boom years of the 1980s and 1990s would not have been possible.

While it is logical to expect global economic policy over the next couple of years to rightly focus on staving off a depression and deflation, it is also wise to begin anticipating the next financial battle that will have to be fought. It is very likely that inflation will once again become a major concern for central bankers around the world sometime within the next decade. In the U.S., with the nation politically polarized and strained by the pain of adjusting to a new and different economic reality, will there be a Volker-like figure to call on? Taming inflation will require bitter medicine administered by a firm and resolute hand. It will require a thick skin and the courage of a lion. It might be a good idea for the incoming administration as well as Republicans who aspire to the Presidency in 2012 to be looking for the next Volker in the months ahead. For it is very likely that such a person will be needed once the current fire is doused.

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