The Volcker Years

Good exchanges on interesting topics deserve their rightful place in the world of economic blogging. Hence, I'm creating a direct link to the recent discussion on Paul Volcker and economic policy in the 80s that followed my last post (h/t: Goffredo, for the suggestion). No offense to Miles...

In regard to the specific discussion on whether monetary or fiscal policy was responsible for lowering the unemployment rate and solidifying the recovery in the mid-80s, I've decided to copy the following excerpt from an article by economist James Tobin:

...it was the Fed’s reversal of policy in late summer 1982 that turned the economy around. No doubt the Reagan fiscal stimuli, as they were phased in, gave a big push to aggregate demand. But the Fed nevertheless managed the recovery in 1983–1984, braking it when it seemed too fast, and relaxing the brakes when GNP growth faltered...

...Could we have had the same recovery, the same path of GNP and employment, under the much more moderate fiscal regimes of the pre-Reagan years? I think the answer is clearly “yes”; the Federal Reserve had plenty of room to lower interest rates further and faster. Would it have done so? That is more debatable. Although the Fed’s change of heart in 1982 signaled its willingness to adjust its policy to macroeconomic performance rather than to money supply targets, it is possible that residual monetarist concerns would have prevented the Fed from fully replacing fiscal stimulus absent or withdrawn.("How to think about the deficit", New York Review of Books, September 25, 1986) (my emphasis)

Although Tobin here first seems to give full credit to the Fed for the recovery, he later questions whether monetary policy alone was responsible. Most likely, Tobin concludes, it was the combination of monetary and fiscal policy that reinvigorated the economy in the 80s. A well-nuanced argument indeed.

Also, I thought it was relevant to link the following article by blogger Lord Keynes. It contains an interesting analysis on Volcker's first term at the Fed. I strongly recommend this article, as it captures my own position on the matter and highlights some key points made by (some of my favorite economists) Alfred Eichner and James Galbraith. Here's an excerpt:

What actually happened under Volcker is that his “floating” interest rate policy caused the federal funds rate to soar to 19% by June 1981, inducing two severe recessions, the first from January to July 1980, and the second from July 1981 to November 1982. This caused mass unemployment, crippled American manufacturing enterprises in the Midwest, and a Third World debt crisis (Galbraith 2009: 38), as the American recessions and high interest rates essentially caused a global recession (Eichner 1988: 548). The high interest rates in the US also lead to a damaging appreciation of the US dollar late in 1980, which hit US exporters hard (Eichner 1988: 549).

The recessions, the US demand contraction and steep fall in the price of oil (which can be seen in this graph) were the real reason US inflation fell from a peak of 14.8% in March 1980 to 4.6% in November 1982, and not because money supply growth rates were brought under control in the way imagined by monetarism or the quasi-monetarist targeting Volcker pursued.

Lord Keynes's point regarding the fall in the price of oil is in line with Warren Mosler's take on the Fed's actions in the early 80s. According to Mosler,

Volcker did not crush inflation. If anything, his rates added to business costs and unearned income long after inflation turned down. The positive supply shocks in the energy markets is what broke the back of inflation, led by the deregulation of natural gas in 1978 that did the lion's share of cutting the demand for crude for electricity generation.

Finally, I'm also including a link to Martin Feldstein's brilliant American Economic Policy in the 80s, published in 1995. The book contains excellent articles on that period, including an article and commentary by Michael Mussa, Paul Volcker and James Tobin on monetary policy in the 80s. Also, I'm linking an article by John Kenneth Galbraith on his preferred approach for dealing with inflation, one that does not rely on high interest rates.

Feldstein, Martin, American Economic Policy in the 80s,  (Chicago: NBER, University of Chicago Press, 1994.

Galbraith, J.K., Up from monetarism and other wishful thinking, New York Review of Books, August 13, 1981.

Saudi vs. Libyan Oil Production

So how do Libya and Saudi Arabia compare in terms of oil production? Based on recent media headlines, it sounds as though Saudi oil production wouldn't suffice if it became necessary for the Saudis to step in to make up for any possible reduction in the oil supply caused by the geopolitical problems in Libya. But looking at the data, we notice the two countries don't really compare.

According to the US Energy Information Administration, Libya currently only supplies about 1.7 million barrels a day whereas the Saudis supply over 8.5 million barrels daily (see charts 1 and 2). Also, in regard to production capacity, we see the Saudis could supply up to 12 million barrels a day (chart 3). With such a large unused capacity, the Saudis could very well fill the gap potentially created by a shortage in Libya. Thus, it seems unlikely that the world's oil supply will be highly and permanently affected by the current events in the Middle East.

Chart 1

Chart 2

Chart 3