Paul Volcker's Most Important Lesson: Echoes

It's difficult to recall now the seriousness of the U.S. economic slump at the end of the 1970s. Growth was weakening, the dollar was sinking and, even worse, inflation was accelerating rapidly. Confidence in U.S. economic leadership was plunging at home and abroad.

Then, on Aug. 6, 1979, Paul Volcker took over as chairman of the Federal Reserve Board. His appointment came as a relief to the markets because of his experience at the New York Fed and the Treasury, but more importantly because he questioned the common view that a higher inflation rate had favorable effects on employment. He was determined to bring price stability and better economic performance to the Fed.

A spate of bad economic news has revived fears of a "double-dip" recession. Since the Great Depression, such a calamity has only occurred once, when the country suffered through a short and shallow recession in 1980, followed by a long and severe one in 1981-1982.

Traditionally, these twin recessions have been laid at the feet of Paul Volcker, then chairman of the Federal Reserve and now an adviser to President Barack Obama. In particular, the Fed's relentless series of interest-rate increases are blamed for bringing the economy to its knees.

Is our economy headed back into a recession? A look at a past double-dip, the recessions of 1980 and of 1981-1982, suggests we are due. That double-dip also suggests the Federal Reserve should raise interest rates earlier and faster than you might think.

In fact, the 1980s experience points to something horrible: We need a recession to get a true recovery.

Here's a graphical look at how employment has historically recovered following recessions. Something to keep in mind as jobs come to dominate the national conversation in the months to come. Next week, we'll take a look at the recessions of the early 80s, and in particular the Fed's actions leading up to them. Send us your thoughts.

(Amity Shlaes, the author of this post, is a Bloomberg View columnist. The opinions expressed are her own. Ilan Kolet, who created this graphic, is a data editor for Bloomberg News.)

One of the least-covered aspects of the recession of 1937 is the then-new monetary law under which the country was operating. Marriner S. Eccles of Utah had agreed to be Federal Reserve chairman, but only on condition that President Franklin D. Roosevelt oversee passage of, and sign, new legislation redefining the Fed's job.

In 1935, at a luncheon of the National Republican Club in New York, Theodore Roosevelt, the son of the late president, criticized his cousin Franklin and predicted that the new law, the Banking Act of 1935, was another step toward dictatorship.

Fiscal and monetary policy aren't the only ways government affects the economy. In 1937 -- the year we've been discussing on Echoes since last week -- the issue nearly everyone was talking about was the audacious legislation that President Franklin D. Roosevelt had proposed in February of that year: his court-packing plan.

Roosevelt's attempt to neutralize the Supreme Court sparked a national outcry and a heated political struggle. Two recent books, "Supreme Power: Franklin Roosevelt vs. The Supreme Court" by Jeff Shesol and "Scorpions: The Battles and Triumphs of FDR's Great Supreme Court Justices" by Bloomberg View columnist Noah Feldman, take up this incident.

Last week, reader Chris Ryan wrote to say that in analyzing President Franklin D. Roosevelt's second inaugural address of 1937 my last column contained a "serious factual error." I noted that when Roosevelt said the U.S. sought "an instrument of unimagined power for the establishment of a morally better world," the instrument the president was referring to was the government. Mr. Ryan disagrees.

He argues that FDR wasn't referring to government in this section -- that the president had moved on to matters of the spirit. The suggestion here is that my column made Roosevelt look more aggressive than he was. Mr. Ryan says "such distortions of people’s words are dishonest."

I argued in my last column that the new political power that unions gained with passage of the Wagner Act gave them the confidence to push for higher wages from employers. This chart lays out the timing. The Wagner Act passed in the summer of 1935, giving unions in the industrial sector coequal status with management for the first time. Unions and voters both recognized that this would increase the value of unionizing tremendously, and millions of workers joined unions after the act's passage.

John L. Lewis and his Congress of Industrial Organizations saved their hardest punches until after President Franklin D. Roosevelt won his 1936 reelection campaign. With FDR safely in the White House, the unions increased work stoppages (strikes and other actions), employers recognized the unions' growing power and wages began rising significantly. The Supreme Court's affirmation, in April 1937, that the National Labor Relations Act was constitutional made it clear that union pressure was the new reality for companies.

Just as economists have debated the causes of the financial crisis, they are now debating the causes of the slow, almost non-existent, recovery. Topping my list of causes are the so-called stimulus packages -- which empirical work shows did little to stimulate -- and other government interventions, which have left an overhang of uncertainty impeding private investment.

As my colleagues Gary Becker, George Shultz, Michael Boskin, John Cogan and I explained last summer:

"If the gov't continues its spending etc. it means ultimate inflation and crash. If the gov't stops spending, balances the budget, it means bad business during the period of adjustment but ultimately a sound recovery. Either way the outlook is not promising." That sounds like a pundit commenting on Federal Reserve Chairman Ben Bernanke's speech yesterday.

It was actually written on Nov. 22, 1937, in the diary of Benjamin Roth, a lawyer from Youngstown, Ohio.