“Secrets of the Temple”

This discussion focuses on a story from a book called, “Secrets of the Temple.  How the Federal Reserve Runs the Country”  At almost 800 pages, it isn’t really a good choice for assigned reading but it’s a wonderful look inside the most powerful economic organization in the world.  
 

The story is about President Carter and the horrible economic conditions we were facing in early 1980.  The President and Fed chairman were at odds over what to do and there was an election looming.  Inflation was at 17% and the prime lending rate was 16% and rising but no one would stop borrowing including the government.  Paul Volker, then the Fed Chairman, made a tradeoff deal with the President.  The President would draft a new budget, trimming $13 billion of deficit spending which would continue the borrowing, and Volker would impose an assortment of controls on lending.  Both doing something they didn’t want to do for the common good.  The President used Volker as a symbol of his sincerity and included him in meeting after meeting involving political decisions such as which programs should be cut.  Volker was ambivalent and thought credit controls on consumer spending was pointless as it had already began to slow.  The President insisted on the move because it was something the average person could understand.  Volker figured that the controls could be crafted in a way that minimized ill effects and gave him new opportunities to stiffen the terms for banks. 

Back at the Fed Board, this deal met with considerable opposition.  When they discussed the deal, they all agreed that legally they could go against the President but then Volker asked, “do you really want to go against the President?” and the opposition was faced with reality.  Henry Wallach asked, “But if not to go against a President, why do we get elected for such long terms?” 

In the end, it was probably the visibility and high profile conflict between the Fed and the President that gave special meaning to this decision.  So with the board’s approval Volker and the Fed technicians began drafting credit controls that would be as loose and innocuous as possible.  For example, the credit card restrictions exempted just about every major purchase that a family could make – auto’s, furniture, appliances, home improvement, etc.  The Fed’s broad guidelines by banks were purely voluntary.  The idea was to throw a little sand in the system, but not to stop it.

When the President and the Fed announced their initiatives most of the Fed was confident they were successful.  The joked among themselves that about the loopholes and were sure that the lenders and borrowers would find them.

Then with dramatic flourish only available to a President, Carter announced to the nation the urgent measures that were being taken.  “The actions I’ve outlined involve costs, they involve pain.  But the cost of acting is far less than the cost of not acting.  The temporary pain of inconvenience is far less for all of us together, than the still worse permanent pain of rising inflation”

The evening news carried the Fed’s decision along with the administration officials explaining the program and everyone was made fully aware of what was going on.  Pictures of cut up credit cards in front of American flags were the top story.  Well, for once America got the message.  If borrowing was unpatriotic, then so was spending.

The economy collapsed!  The recession, a long predicted fear of economists, finally began in earnest.  Within months GNP shrank 10%, the sharpest recession in 35 years.  For a time it looked like we were in free fall decent.

The Fed was as surprised as anyone.  The sudden move in the economy disrupted all its assumptions and their regulation of the money supply and the economy began to look like a roller coaster ride.

Consider the following:
1. What really went wrong with this plan?

2. What should the Fed have done in this situation?

3. What is the difference in the way the Fed acts today than the way they acted then?

4. Can you ever really separate politics from the decisions of the Fed?

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