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Home Publications Blogs Beat the Press The Trade Deficit Did Not Fall Under Volcker, It Soared

The Trade Deficit Did Not Fall Under Volcker, It Soared

Sunday, 11 November 2012 09:06

Former Federal Reserve Board Chairman Paul Volcker is a hero to the inside Washington crowd for having brought down inflation from its double-digit levels of the late 1970s. Never mind that this drop in the inflation rate occurred in every other country in the world also. We still must praise Volcker.

We also should not be bothered by the fact that his policy pushed the unemployment rate to almost 11 percent. This was necessary pain that those outside the elite just had to endure for the good of the country as a whole. We also are not supposed to be bothered by what his high interest policies did to heavily indebted developing countries.

But putting all this aside, the Volcker worshippers should at least be able to get the basic facts right. Steven Pearlstein flunks the test in a WAPO book review when he tells readers:

"By the time he stepped down as Fed chairman in 1987, Volcker had managed to wring inflation out of the American psyche and bring the country’s trade account and the government’s budget much closer toward balance."

This is not true, the trade deficit in fact soared during the Volcker years as shown below.


Source: Bureau of Economic Analysis.

Expressed as a share of GDP, the trade deficit went from 0.8 percent in 1979 to 3.0 percent in 1987. It really shouldn't be hard to get this one right.


In response to several comments below I have corrected the graph to show the "surplus" not deficit becoming more negative under Volcker. This was arguably the direct result of his Fed policy, since a predicted result of higher interest rates is a rise in the value of the dollar which makes U.S. goods less competitive internationally.

Comments (11)Add Comment
written by Stuart Levine, November 11, 2012 9:26
Dean--I'm a reasonably bright guy, but it took me a moment or two to realize that the fact that the line in the chart was moving down not up meant an increase in the trade deficit. I suspect that like many of your readers, my aging reptilian mind takes a bit of time to digest a chart that deals with an "increase in a negative." You may want to have the chart reflect an increase in the deficit as an upward movement in the trendline.

Just a suggestion. Your blog is a daily read. Keep up the good work.
written by skeptonomist, November 11, 2012 9:36
The inflation rate world wide actually began to fall in early 1980 when oil price stabilized, not after Volcker raised rates later that year to the plateau which held until 1982. The myth that Volcker conquered inflation and accomplished other heroic feats was invented post-facto not by "Washington insiders" but mostly by economists who still insist contrary to evidence that economies are controlled by monetary policy. The extent to which monetary policy controls international trade, as well as inflation, is still greatly exaggerated by most economists.
written by JSeydl, November 11, 2012 9:46
Never mind that this drop in the inflation rate occurred in every other country in the world also.

This is really important and something a lot of ppl miss. The reality is that the fall of the Bretton Woods system in the early 1970s lead to a global currency imbalance, which resulted in high inflation in many countries. Once the imbalances cleared, inflation fell. This happened largely irrespective of monetary policy actions.
Trade Balance, not Deficit
written by AlanInAZ, November 11, 2012 11:32
As mentioned earlier, I was thrown a bit by the chart. The chart should be labeled annual trade balance rather than deficit. Deficit implies a negative balance and would show a positive slope for increasing deficits.
written by sherparick, November 11, 2012 12:12
It is really an interesting insight into human psychology, an insight Benjamin Franklin remarked on in his autobiography, that we humams are not so much "rational" animals as "story telling" animals. Pearlstein, who is at least in his fifties, must have lived through the 1980s as an adult, now tells himself that besides "inflation," Volker brought "...the country’s trade account and the government’s budget much closer toward balance..." when in fact the big economic issues of Reagan's second term was the overvalued dollar ("The Plaza Accord"), the trade deficit resulting from the overvalued dollar, and the huge structural Fiscal deficit created Reagan's initial tax cut (since late eighties were a period of growth) which led to the Gramm-Rudman budget deal. But Pearlstein now tells himself a story where these issues did not exist. Kind of amazing.
written by JSeydl, November 11, 2012 12:46
BTW, Dean, not sure if you saw this video w/ Krugman and Stiglitz (http://www.youtube.com/watch?v...e=youtu.be). It looks like you changed Krugman's view on the debt overhang! At around minute 20, the discussion shifts to balance-sheet problems in the household sector, during which Krugman argues that the debt overhang isn't really much of an issue, because saving rates are already depressed historically.
Krugman responds to evidence
written by Dean, November 11, 2012 1:11
Thanks Joe,

I have had and will have disagreements with Krugman, but i think he is a reasonable person who will respond to evidence. in this case, the evidence is pretty straightforward. Consumption is high relative to disposable income, not low, so it is silly to imply that debt is somehow the problem.
written by skeptonomist, November 11, 2012 5:37
Do interest rates set by the Fed control the trade balance? Here is a plot of federal funds rate compared to trade deficit (upwards)as a percentage of GDP since 1960:


I plot, you decide. Long-term rates are not as bumpy, but reach a peak at about the same time, 1982.

Maybe if Harry Potter were Fed Chairman he could use his magic wand to do all the things that the Fed is supposed to be able to do, but interest rates just don't have those magical properties.
written by xteeth, November 12, 2012 5:46
The main thing that I remember about Volker is that under his reign the money supply tripled. If true, that would seem to be an important feature in the economics at this time.
Role of Energy Policy
written by bakho, November 12, 2012 5:56
Carter energy policy did much to reduce inflation. By the time Carter Energy policy was fully in place in 1983, Oil use in the US Plummeted over 20 percent from its peak in 1978. Oil consumption in the US did not return to its 1978 peak again until 2000. Oil conservation and efficiency put downward pressure on oil, a major driver of inflation. Did energy policy have more effect on inflation than Volcker interest rate policy? Why are the contributions of energy efficiency ignored? High interest rates made it more expensive to implement oil efficiency an add alternatives to oil. Regulatory and Fiscal policy are dismissed in favor of Monetary policy alone as the be all end all of economic policy.
Where's Dean?
written by fairleft, November 20, 2012 4:09
He hasn't published anything here since November 11. Hope he is well!

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.