Volcker concluded that he would never tame inflation by increasing the Discount Rate, so he had to find another way to reduce the money supply; in effect Volcker was trying to find a practical way to carry out Milton Friedman’s argument that all the Federal Reserve really needed to do was to control the money supply. Volcker decided to directly regulate the level of bank reserves and let the federal funds rate go where it went. The shake-up came in October 1979, in large part because Volcker wanted to show his two immediate predecessors that they were wrong in their argument that the Fed was not able to curb the current level and type of inflation. Volcker was determined to show that the Fed could not only slow down inflation, but actually decrease inflation.
On 6 October 1979, Volcker called an emergency meeting of the Open Market Committee, and with only two exceptions, the OMC endorsed Volcker’s new plan for the Fed to attack inflation. Basically, Volcker set a money supply target using the Fed’s ability to buy and sell government securities/bonds. Also, Volcker knew how to give himself and the Fed some political cover since technically the Fed wasn’t directly setting its sights on increasing interest rates, but regulating the money supply.
Carter, ever the Populist, was certainly not pleased, knowing that banks were making out like bandits with interest rates in the upper-teens while borrowing money from the Fed at interest rates at least six point lower. Carter wanted to know why the Prime Rate was at 19% while inflation was at 13%, but Volcker refused to relent. Carter wanted to show the US that Volcker wasn’t the only anti-inflation show in DC, and on 14 March 1980, Carter made yet another nationwide address on inflation. Carter tried to impose controls on consumer credit, which negatively affected Volcker’s approach and would exacerbate the recession. While it was true that consumers had reached a high level of debt, the idea to restrict consumer spending by restricting consumer credit to increase savings undermined the Fed’s program.
But Volcker wanted to make the tightening of credit as minimal as possible, believing there was no actual consumer credit problem at all; it was another example in US History of politicians such as Carter not understanding economics. Carter even went so far as to preach to Americans that it was unpatriotic to use credit cards. Volcker feared that Carter’s plan would kill the momentum of the Fed’s plan, and soon and sure enough, consumption (consumer spending) fell off the table.
But unlike Volcker, Carter had to work in the realities of his principles on the one hand and the interests of very powerful people/groups arrayed, in most cases, against him. The US economy grew at 3.3% under Carter, and 3.5% under Reagan. Carter never did achieve his dream of a balanced budget, but that was due more to a lack of revenue than too much government spending. But Carter’s message to the American people from the beginning of his Presidency was that of sacrifice and pain, which would prove to be a political liability in 1980, compared to Reagan’s message of hope and optimism.
Volcker was very complimentary towards Carter, calling the former President courageous. Carter had the courage to make a tough decision that cost him politically, and even helped Reagan win re-election in 1984 in a historic landslide . . . but Carter’s decision to appoint Paul Volcker as Fed Chair has benefited the nation to this day.