This article first appeared in Forum, The Edge Malaysia Weekly on December 16, 2019 - December 22, 2019

The death of former US Federal Reserve Chairman Paul Volcker on Dec 8 saddens those of us who recognised the goodness and steely resolve of the man, and who understand his contribution to the incredible economic rebound he engineered. Volcker was appointed by Democratic President Jimmy Carter in 1979 and reappointed by Republican President Ronald Reagan in 1983. In between those appointments he demonstrated to Americans what “no pain, no gain” means in the world of business and economics.

In the 1970s, the US was shaken by an oil crisis (brought on mainly by an Organization of the Petroleum Exporting Countries oil embargo against the US due to its decision to support Israel in its war with Arab nations); a major political crisis, Watergate, which brought down President Richard Nixon; and the post-Nixon economic phenomenon known as “stagflation” — economic stagnation accompanied by high unemployment combined with high inflation. This condition, marked by simultaneous government policies of contraction and expansion, can lead to stagflation — something which is not supposed to exist in a normal economy.

When Volcker took the helm at the Fed, and throughout Carter’s last two years in office, inflation was a menace with which Americans were not familiar. Since the early 20th century, annual inflation increases averaged 3%, which facilitated healthy levels of business and personal borrowing. And since the 1950s, a robust housing market — where buyers could take out long-term loans for about 6% — was something Americans came to expect. For this to continue, however, banks and other lending institutions had to rely on relatively low rates of inflation so their long-term loans could continue to be profitable.

Volcker’s job as the new Fed chairman was simple — slay the inflation dragon. He did so by upping the Federal Funds rate, from 11.2% to 20%. This caused commercial rates to accelerate sharply. The prime lending rate topped out at 21.5%. And the cost of a home loan shot up to 20% or more, making such loans unrealistic for millions of potential homeowners.

Volcker’s frontal assault on inflation caused ordinary Americans, as well as financial analysts, anguish and fear — mainly because they had no assurance that his plan would work and no good guess as to whether double-digit interest rates would remain the norm, perhaps indefinitely.

But Volcker’s plan worked. In 1981, the inflation rate was 10.32% and by 1983, it was down to 3.21%. At the same time, housing loans steadily raced downward (from a high of 19% in 1981 to 6% to 8% over the last 25 years), as did business, personal and other loans. Volcker’s success ushered in an era of economic prosperity throughout the 1980s and 1990s. And since then, while economic slowdowns have sometimes burdened businesses and consumers, inflation has not. Since 1982, the annual inflation rate in the US has averaged 2.68%.

Volcker’s appointment came too late for some, though, especially savings and loan institutions — the most distinctive makers of housing loans. These “thrifts” were severely restricted by government with respect to their assets (loans) and liabilities (deposits). So when double-digit inflation hit, they struggled mightily as they were saddled with low-interest, long-term housing loans coupled with high-interest deposits. Many thrifts gambled by offering extremely high interest rates to savers, so as to survive in the short run, hoping things would return to normal. But that took too long for many savings and loans, about one-third of which became insolvent and collapsed. (Full-service banks were not burdened by such stringent requirements and, therefore, were protected by their diversified asset portfolios.)

The post-Volcker years should have taught all of us something very valuable about the limitations of monetary policy. While central banks are remarkably good at fighting inflation, as Volcker proved, they do not fare well when battling recessions or even mild economic slowdowns. This has been demonstrated numerous times in recent history. Take today’s situation: US economic growth (GDP) has hovered around 2% (exactly that in the third quarter) this year — despite the Fed’s long-standing policy of low interest rates and quantitative easing (which has the same effect as increasing the money supply). Such economic “sugar highs” last only a short while and do not improve economic conditions over the long haul.

The 6ft 7in giant who guided the US through a very dark economic era will be mourned by many of its citizens and leaders. But they also ought to reflect on the basic lesson he helped teach, which is that government’s ability to aid a national economy is limited and comes with a long-term price.

William G Borges is a professor in the American Degree Programme at HELP University. He is also co-author of the 1989 book, Saving the Savings and Loan: The US Thrift Industry and the Texas Experience, 1950-1988 by Praeger Publishers.

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