Paul Volcker death has given the opportunity to recall his essential role, since he was appointed at the presidency of the American central bank. He will be at the origin of the predominant role given to central banks in the U.S. as in Europe and in Japan, notably regarding the fight against inflation. This role is not without making us reminding that one the British economist, John Maynard Keynes, plaid, at the beginning of the Thirties to get the world out from the terrible crisis which affected it in 1929. He made accepted that the market was not able by itself to ensure the economic equilibriums especially regarding employment and he recommended that the State intervenes both through public receipts and expenditures. The concept of economic policy was born. Since that, two major schools are confronting each other: monetarists, from Chicago school, carrying since the Sixties Milton Friedmann thought, whose Paul Volcker was the first to put into practice, and Keynes successors, supporting budgetary policy. For a long time, monetarists won against Keynesians. Through a stunning history turnaround, monetary policies are under critics and Keynesians remedies are regaining their full actuality.
After having made his carrier at the Federal Reserve and at the Treasury department, Paul Volcker was nominated at the head of the Fed in 1979 August. The second oil shock has just happened, inflation is over 10% in the U.S., budget deficits are accumulating and the dollar sinks. Against the Franc, it falls under seven Francs for one dollar. The new chairman of the Fed will then wage a monetary policy whose brutality is without precedent through an interest rise above 15%. Results are not long to be obtained. Since 1980, the country falls into a recession, leading there the other developed countries, with the exception of France, we will come back to that point, and the dollar enjoys a spectacular rebound until 1985 when the Plazza Agreement is necessary to obtain its stabilization. Its value is, then, above 11 Francs for one dollar.
Nobody, in Europe, measures the consequences on the world economic equilibriums of the policy lead by Paul Volcker. The European Monetary System has been created in March 1979, a few months before his nomination at the head of the Fed. As a foreshadowing of the euro, the EMS imposes to the members States currencies to have fixed parities, fluctuating only inside very small margins. The dollar, as we saw, could fluctuate without any limits. It is in France that the consequences of this statutory structural difference will be the most important, despite the point that most of economists and historians have not yet understood its consequences. The coming into power of the left, in 1981 has, as a consequence, a radical change of the economic policy compared with the action of the Raymond Barre previous government. To slow unemployment rise, the new government employs an all-out revival policy: wages and social benefits increases, budget deficit augmentation. So France, to the opposite of Germany, avoids recession.
But tensions on the exchanges market, frequently inspired by politician considerations, are generating several currencies realignments inside the EMS, with among them, three devaluations of the Franc against the Deutschemark. They are, then, interpreted as the country weakening, whose responsibility lies in the new economic policy. France trade deficit has soared and this situation is attributed to the household consumption increase resulting from the revival policy. Reality was quite different. The trade deficit increase between 1981 and 1982 was caused, with a one billion Francs accuracy, to the rise of the oil bill, itself resulting from the dollar rise, that currency being used to price raw materials. Exports growth, despite their dynamism, even superior to household consumption, will not be enough to offset the supplementary burden generated by the American monetary policy. Germany will be much less affected because the country had large coal resources. So the responsible of the “rigor turnaround” in March 1983 in France was not Keynes, but Volcker…
Paul Volcker influence will be huge and will remain a long time after his departure from the Fed in 1987. The Maastricht Treaty architecture is still carrying his mark. The pressure is concentrated on public finances with ratios not to be passed regarding deficit and debt. As no trust is granted in the State action, it is given to the European Central Bank, whose independence is guaranteed against eventual political pressures, the main economic policy tool, the monetary policy. This model is adopted almost everywhere in the developed countries. Fight against inflation will remain, until the end of the Nineties, the priority of public action. That vision, yet, will rapidly become obsolete because structural factors are leading to the almost inflation disappearance we today observe. Globalization introduces a tough competition which weights on the prices of the products proposed to consumers. Innovation has allowed the discovery and the exploitation of new and huge natural resources. It has also lead to a transformation of production processes which provokes costs reduction for products as for services thanks to the creation of the platforms.
The mandate to fight inflation given to central banks becomes progressively without any purpose. What was an objective, the price stability, starts even to worry. Institutions which were in charge of that mission are today criticized and judged sometimes responsible for an insufficient growth rate and for the prospect of the “secular stagnation”. The very low and even negative level of interest rates is considered as dangerous. It threats financial stability and it may encourage inappropriate investment choices because they are artificially influenced by the level of these rates. They would also favor indebtedness excesses for some economic agents or speculative bubbles encouraged by too accommodative policies.
So the trend is reversing. In Japan, the Shinzo Abe government, in order to take his country out of its stagnation, has just launched a massive budgetary revival policy. In China, confronted with the slowing of growth, the Belt&Road Initiative has, as an objective, to finance infrastructures investments at home and in neighboring countries which will favor its national enterprises. In the U.S., we see a spectacular turnaround compared to the Volcker era.The President put pressure on the Fed in order to abstain itself from rates increases and makes the Congress voting budgets carrying deficits to support growth.
In Europe, at last, the new Commission will have to proceed in 2020 to a revision of its Stability and Growth Pact. The debate is promising to be animated. The budget rigor, which is imposed by the countries having surplus is harming growth in the whole euro-zone. To the opposite, very accommodating monetary policies are weighting on banks profitability and weaken them, along with affecting the return of the pension funds which finance German and Holland retirement systems.
The rebalancing of economic policies is really on the top of the agenda. So Paul Volcker is not anymore in favor and Keynes coming into grace is unavoidable and already perceptible.