The Federal Reserve: A Difficult Balancing Act – Part 2: Inflation, Independence, and the Volcker Era

Written by Larry Eppolito, MBA, CFP®

Greetings!

In Part 1, I discussed the Federal Reserve's difficult balancing act. Its mission sounds simple enough: promote full employment while keeping inflation under control. In practice, however, those goals can sometimes pull policymakers in opposite directions.

To understand why Fed officials often seem so concerned about inflation, it helps to revisit the economic turmoil of the 1970s. For many economists and central bankers, that decade serves as a cautionary tale – a period when inflation became deeply embedded in the economy and proved extraordinarily difficult to remove. The lessons learned during those years continue to influence Federal Reserve thinking today and help explain many of the debates surrounding interest rates, inflation, and economic growth.

The Fed's Independence

Political interference directly threatens the Federal Reserve's ability to maintain economic stability. When central banks face political pressure, they often prioritize short-term job growth over long-term price stability. This dynamic typically leads to higher inflation and weaker overall economic performance over longer periods of time.

Elected officials face regular election cycles and naturally tend to focus on the near term. Lower interest rates can stimulate economic activity, support employment, and generally make people feel better about the economy. As a result, politicians of both parties have, at times, expressed frustration with Fed policies and have occasionally suggested limiting the central bank's independence.

This is nothing new. President Trump has been much more public and persistent than most in his calls for lower interest rates, but presidents have been criticizing the Fed for decades. In the 1960s, Lyndon Johnson reportedly shoved Fed Chairman William McChesney Martin against a wall during an argument over interest rates. Many economists believe Fed Chairmen Arthur Burns and G. William Miller were too slow to respond to the inflationary pressures of the 1970s, contributing to an inflationary spiral that ultimately required painful medicine to cure. Burns later suggested that political pressure from the Nixon administration played a large role.

For this reason, the Fed's independence from the White House has long been considered a cornerstone of sound economic policy. The theory is simple: monetary policy decisions should be based on what is best for the economy over the long term, not what may be politically advantageous in the short term. Equally important, consumers, businesses, and domestic and foreign investors must have confidence in the Fed’s independence.

20% Interest Rates

An interesting case of non-interference occurred in the early 1980s. When President Reagan was first elected, he reportedly went to Fed Chairman Paul Volcker (a recent President Carter appointee) to ask him how to get rid of the inflation that had been dogging the US for nearly a decade. Volcker reportedly said something like, “I can get rid of it, but no one is going to like it.” As defeating double-digit inflation was the central pillar of his economic agenda, Reagan reportedly said, “I’ll back you” – meaning, “I won’t interfere.” (1)

Volcker and his FOMC colleagues continued the aggressive anti-inflation policies that had begun during the latter stages of the Carter Administration. The Reagan Administration largely supported those efforts despite the severe recession that followed. Interest rates rose to extraordinary levels, with the federal funds rate peaking at nearly 20% in 1981. (2)

Millions of people lost their jobs during the ensuing recession as unemployment doubled, with the construction industry among the hardest hit suffering an unemployment rate of nearly 20%. (3)

Volcker is Burned in Effigy

Volcker became one of the most vilified public officials in America. Building contractors shipped 2x4s to his office, angry farmers blockaded the Federal Reserve with their tractors and Volcker was famously burned in effigy on the steps of the Capitol. (4)

Inflation is Defeated

The medicine worked – but it was painful. The deep recession that followed cost millions of Americans their jobs. Volcker endured intense public criticism, yet the Federal Reserve stayed the course, and the Reagan administration generally refrained from interfering with the Fed's efforts despite the political risks.

Politics and Monetary Policy: Pushback

It’s worth noting that these events occurred early in Reagan's first term. Had the recession begun closer to an election, the political pressures on both the White House and the Federal Reserve might have been considerably greater.

It’s also worth noting that, although Carter appointed Volcker (an outspoken inflation hawk) specifically to tame inflation, the Carter Administration soon became uncomfortable with the economic consequences and began to push back. Why? Volcker’s prescription sent the economy into a deep recession – not long before the 1980 Reagan-Carter election.

The Reagan Administration also eventually pushed back against Volcker. The high interest rates were extremely unpopular with Americans, but inflation was tamed well before the 1984 election. By then, the economy had begun to recover and Reagan was reelected.

Presidents Do Not “Manage” the Economy

Presidents are often credited or blamed for economic outcomes, whether deserved or not. As a result, the closer one gets to an election, the harder it can become to accept short-term economic pain – even when doing so may lead to better long-term outcomes.

As many of you know, I often argue that while certain policies can create economic headwinds or tailwinds, economic cycles are driven primarily by broader forces and tend to unfold largely independent of the executive branch.

The defeat of inflation helped lay the foundation for one of the most prosperous and stable economic periods in modern US history, although there were many forces acting as tailwinds that contributed to that success.

The episode serves as a reminder that the policies that are best for the economy over the long term are not always the policies that are most popular in the short term. Had policymakers yielded to public pressure and abandoned the fight against inflation, the long-term economic consequences might have been even more severe.

Put it to a Vote?

My suspicion is that if this prescription had been put to a national vote, it would have been rejected. The pain was immediate and visible; the benefits were delayed and uncertain. Yet the long-term cost of allowing inflation to continue unchecked may have been far greater.

Central Bank Credibility Is Paramount

To buy US assets, foreign investors must first buy dollars. The US dollar is the world's primary reserve currency – a currency that is widely held and trusted around the world for international trade, investment, and as a store of value. It is also heavily held by governments and central banks around the globe.

An independent Federal Reserve is one reason investors around the world have confidence that the United States will work to preserve the purchasing power of the US dollar and maintain price stability over the long run. That confidence makes it easier for the United States to borrow money during times of crisis and may help keep interest rates lower than they otherwise would be. Like many things in economics, this benefit is easy to overlook – until it is gone.

The dollar's unique role in the global financial system provides additional advantages to the United States. Economists sometimes refer to these benefits as the dollar's "exorbitant privilege." It's a fascinating topic I'll address in another letter.

In Summary:

• Dual Mandate: The Federal Reserve has a difficult job: promoting maximum employment while keeping inflation under control. These goals often complement one another, but at times they can conflict.
• The Fed's primary monetary policy tool is its ability to influence interest rates. Higher rates generally slow economic activity and help control inflation, while lower rates tend to encourage borrowing, spending, and investment – but may increase inflationary pressures.
• Monetary policy is determined by the 12-member Federal Open Market Committee (FOMC). While the Fed Chair sets the tone and helps build consensus, he or she has only one vote. Policy decisions are ultimately made by the committee as a whole.
• Inflation is more than rising prices. Left unchecked, it can affect business investment, employment, innovation, job opportunities, and even government finances for many years. If it becomes embedded in the economy, inflation can become self-reinforcing and difficult to eliminate without causing economic pain.
• Politics and Monetary Policy: Policies that are best for the economy over the long term are not always the policies that are most popular in the short term.
• Independence: Because elected officials face regular election cycles, they often focus on short-term economic conditions. The Fed's independence has long been viewed as essential to making decisions based on the economy's long-term health.
• Credibility: An independent Fed gives consumers, businesses, and domestic and foreign investors confidence that inflation will be controlled over the long run. That confidence can help protect the value of the US dollar and keep long-term interest rates lower and more stable than they otherwise might be. It also supports the US dollar's unique role as the world's primary reserve currency – sometimes referred to as its "exorbitant privilege."
• Monetary policy is part science, part art, and often requires difficult judgments under conditions of uncertainty. The challenge facing every FOMC member is the same: making decisions today based on incomplete information about an uncertain future. There are often no perfect answers – only trade-offs.

With that background, I'll soon send a letter that takes a brief look at the views and priorities of the Fed's new Chairman, Kevin Warsh.

I hope you’re enjoying the summer!

Best wishes,

Larry

6/30/2026

P.S. Please feel free to send this along to those who may benefit.

Larry Eppolito, MBA

Managing Partner, Eppolito, Carbone & Co.

Senior Financial Advisor, RJFS

CERTIFIED FINANCIAL PLANNER® Professional

Eppolito, Carbone & CO., LLC

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