Paul Volcker's "Experiment with Monetarism"

The presidential administration of Ronald Reagan coincided with reduced inflation in the American economy. President Reagan is sometimes credited with healing America's economy, which had been ailing for quite some time. However, the inflation problem was made less severe by a government entity separate from the executive branch: the Federal Reserve, which is autonomous in America's government.

Perhaps more deserving of credit for solving the inflation problem is Paul Volcker, the Chairman of the Federal Reserve from 1979 to 1987. In October 1979, soon after his ascension to the chairmanship, Volcker announced that the Federal Reserve was about to embark on an "experiment with monetarism."

This experiment would require that the Federal Reserve depart from a policy which had been practiced since the Federal Reserve's inception in 1913. From then until 1987, the Federal Reserve targeted the interest rate in order to fight inflation. The problem was that lowering the interest rate (which would reduce inflation in the short term) inevitably caused inflation to rise even higher in the long term. In short, the Federal Reserve's policy had succeeded only in gradually worsening inflation, and by 1979 this problem had become evident to Volcker.

Volcker changed the Federal Reserve policy, heeding the advice of economist Milton Friedman. Instead of monitoring the interest rate, the Fed targeted monetary aggregates, such as M1 and M2. The results of this change of venue were two severe recessions in 1980 and 1982, followed by a normal business cycle which featured surprisingly low inflation.

Thus, the lowering of inflation can be attributed to Paul Volcker. The Federal Reserve had manufactured two recessions in America's economy with the result of a lowered inflation rate. However, according to Mark Scousen, Chairman of Investment U:

"Volcker's experiment in monetarism ended in the mid-1980s when the relationship between the money supply and the global economy broke down, due to the deregulation of the banking system and the globalization of the economy."

Today, the Federal Reserve has returned to its policy of targeting inflation rates.

Sources: InvestmentU; Dr. Kenneth N. Townsend, Elliott Professor of Economics, Hampden-Sydney College