Paul Volcker

I might note in passing that the amount of information provided in [FOMC] records probably sets a standard among the major central banks in the world, and represents a degree of openness entirely unknown to a central banker of an earlier generation. [Commenting on the decision to begin publishing expanded "policy records" of FOMC discussions shortly after the subsequent meeting.]

Back in the days when I was learning economics and central banking, the General Theory had cast fresh light on old problems. The intellectual contributions were immense. But popularized, bowdlerized, and pressed to extremes, it lost fashion for good reason.

The monetarists – emphasizing old truths in modern clothing – have provided a large service in redressing the balance. It is in pressing the point to an extreme that the danger lies – the impression that only money matters and that a fixed rate of reserve expansion can answer most of the complicated problems of economic policy.

In a way, I suppose full confidence in a simple, unified view of economic policy is a comforting thing: a kind of security blanket in an uncertain world. But Alfred North Whitehead, in a different context, once pointed to the danger: “There are no whole truths; all truths are half truths. It is trying to treat them as whole truths that plays the devil.”

He overstated the case. The practical man cut adrift from our sense of what is the greater truth – distinguishing, if you will, the one-eighth truths from the seven-eighths truths – will soon lose his way. But in assessing those truths, he can never afford to lose sight of the messy reality of the world in which we live.

We don't have a lot of room for maneuver and I don't think we want to use up all our ammunition right now in a really dramatic action.

A workable definition of “reasonable price stability” would seem to me to be a situation in which expectations of generally rising (or falling) prices over a considerable period are not a pervasive influence on economic and financial behavior.  Stated more positively, “stability” would imply that decision-making should be able to proceed on the basis that “real” and “nominal” values are substantially the same over the planning horizon—and that planning horizons should be suitably long.

“I apologize for the long delayed response. Perhaps it was my allergy to ‘Divisia monetary aggregates’ that accounts for the lapse.”

In the letter to William Barnett, a former Fed staffer who had worked on the Divisia aggregates at the Board.  Quoted by Barnett in the foreword to an interview with Volcker reprinted in " Inside the Economist's Mind: Conversations with Eminent Economists", co-edited by Barnett and Paul Samuelson.

It's almost gotten to the point where I don't know that we need all this apparatus of open market operations anymore. The chairman can go out and say, "We raised the federal funds rate by a quarter percent today", the market says, "Yes, sir" and up it goes or down it goes and the rest of you can go to sleep.

Well, in the interest of truth in speaking, I recall that I expressed certain reservations about that particular operation at the time, and I hold steadfast to my reservations about that particular operation, at that particular time for a variety of reasons, which I could go on about it at length but maybe I will refrain from doing so. Let me say, quite simply that this was not an institution that was even considered to be in the normal ambit of Federal Reserve supervision and oversight, at the time. It is not an institution that by law had access to Federal Reserve facilities. Now, technically, the Federal Reserve provided no money, in this case, is quite clear. But it did provide a convenient meeting room, which implied a certain degree of moral suasion, I think, in the process.

I have always been a great defender of the proposition that the Federal Reserve should be the leading regulator and supervisor of banks. There are other agencies involved, but when push comes to shove because of lenders' last resort position, in other words, Federal Reserve has a special responsibility and once you control the banking system, that was enough and the rest of the market ought to go on its own.

 Well, that was fine when commercial banks were 60% or 70% of the financial system and we're a long, long ways from that and in fact, what we still call the big commercial banks, aren't commercial banks anymore. That's kind of a subsidiary operation and they all want to become investment managers and investment banks and insurance companies and all sorts of things. Which really raises the question of whether the - what we have in law is the traditional supervisory distribution of authority, is really relevant.

I think we have ample authority today to satisfy the objectives we've been given for supervision regulation. I do think, though, that there's been enough change in the financial system over the last two decades or so, that we have to be prepared occasionally to reassess whether we've got the broad balance right. Whether this overall framework, ... where we have capital base supervision over a diminished and smaller share of the system as a whole, works in delivering the balance between efficiency and stability is so important. That's a judgment that we've got to be prepared to look at over time.

Leadership of the Federal Reserve is better, so we don't have to.

In response to a question about why he and other recent presidents of the New York Fed have not dissented from FOMC policy decisions, unlike some of their predecessors in earlier decades. 

I'm a little bit more worried about inflation than Mr. Corrigan, I mean, although he's best to worry. Not that it's high, not that it's going to go running away, but it's kind of creeping up.

And I am impressed by the degree of pressure, if that's the right word, psychological pressure, political pressure there is not to do anything about it. A lot of people out there on Wall Street and on Main Street are operating on the assumption that nothing very startling will happen in terms of the strength. And that's reflected in attitudes pretty globally. But once people are convinced that that's the case, it can creep up on you. And the more it creeps up on you, the more difficult it becomes to do something about it.

I always thought the high point of my career was once when I was testifying before the Congress in the Humphrey Hawkins saying and the headline {in one paper was} “Federal Reserve Tightens”. The headline in New York Times is “Federal Reserve Eases” and all I was trying to do was explain the complexity of the real world and people read into what you say, what they think in that particular case. I'm sure there were some monetarists who thought we -- I don't remember which side they were on -- who thought we were tightening or easing and some interest rate people who thought the opposite.

 So, it was what they read into the testimony, not what was said. But, I do think that actions speak louder then words and the words should as little as possible, confuse things.

But what concerns me about the present situation, of course it's very difficult. But I've reached a certain age where I can remember quite a few things, and there are some resemblances between the present situation and the period in the early 1970's, not in the late 1970's when inflation really got started.

Simply stated, the bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the marketplace. To meet the challenge, the Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long embedded central banking principles and practices.

When asked whether he predicts a ``dollar crisis,'' he said, ``you don't have to predict it, you're in it.''

As reported by Bloomberg News

What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: lend freely at high rates against good collateral; test it to the point of no return.

...

The extension of lending directly to non-banking financial institutions -- while under the authority of nominally `temporary' emergency powers -- will surely be interpreted as an implied promise of similar action in times of future turmoil.

As reported by Bloomberg News

The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices.

As reported by Bloomberg News

"Simply stated, the bright new financial system — for all its talented participants, for all its rich rewards — has failed the test of the market place.
... 

Mathematical modeling, drawing strong inferences from the past, has demonstrably failed to anticipate unexpected events of potentially seismic importance. ... Part of the problem, as I understand it, is that mathematical modeling simply cannot deal with markets where it is not random or physically determined events but human instincts that cause self-perpetuating waves of unwarranted optimism or pessimism.

As reported by Dow Jones Newswires

Since the credit crisis began last August, the Fed has expanded the volume and types of loans it is willing to make to banks and securities dealers -- loans that are backed by a wide variety of collateral from subprime mortgages to student loans...

Mr. Volcker, testifying on responses to the credit crisis at the Joint Economic Committee of Congress Wednesday, said such activity "has not been the tradition of the central bank and I think that is an issue for the long run for the independence of the central bank. If it is going to be looked to as the rescuer or supporter of a particular section of the market, that is not strictly a monetary function in the way it's been interpreted in the past."

As reported by the Wall Street Journal

Stanley Fischer said that advances in economics have had a huge impact on central banking...

Volcker announced his dissent from this party line. One problem was that economists changed their views so much! In 1950s, economists thought a little inflation was OK to secure full employment. Then came the Austrian School, and then came the monetarists, neo-Keynesians, etc.

 To be sure, it was important to have economists around but “you don’t have to have them on the Board”. They may be brilliant but that does not make them into good central bankers. This may be because much of what a central banker does is boring to economists – writing memos, giving speeches, talking with MPs and Congressmen. A central banker needs experience, judgment, breadth and above all guts. The central banking profession is not equivalent to or an extension of economics profession:

 “When I looked at Ben Bernanke’s CV, I was most impressed; why? Because I saw he had been head of his local school board - now that’s a really valuable qualification for a central banker. Then I read that Bernanke had said that inflation was something that central bankers had brought to the attention of economists rather than the other way round and that also impressed me!”

As reported by Central Banking Publication's "Newsmakers" coverage

In the U.S., the market took over. The market has flopped...Everybody is running back to Mother, the commercial banking system.

Money market mutual funds wishing to continue to offer bank-like services, such as transaction account services, withdrawals on demand at par, and assurances of maintaining a stable net asset value (NAV) at par should be required to reorganize as special-purpose banks, with appropriate prudential regulation and supervision, government insurance, and access to central bank lender-of-last-resort facilities.

Some banks are not only "too big to fail," Mr. Volcker said. Some are "too big to exist."

As reported by the Washington Times

{The G-30} Report implicitly assumes that, while regulated banking institutions will be dominant providers of financial services, a variety of capital market institutions will remain active. Organized markets and private pools of capital will be engaging in trading, transformation of credit instruments, and developing derivatives and hedging strategies, and other innovative activities, potentially adding to market efficiency and flexibility.

These institutions do not directly serve the general public and individually are less likely to be of systemic significance. Nonetheless, experience strongly points to the need for greater transparency. Specifically beyond some minimum size, registration of hedge and equity funds, should be required, and if substantial use of borrowed funds takes place, an appropriate regulator should be able to require periodic reporting and appropriate disclosure.

Furthermore, in those exceptional cases when size, leverage, or other characteristics pose potential systemic concerns, the regulator should be able to establish appropriate standards for capital, liquidity and risk management.

“I don’t get it,” Volcker said, leading to a lively back and forth between the two central-bank heavyweights.

By setting 2% as an inflation objective, the Fed is “telling people in a generation they’re going to be losing half their purchasing power,” Volcker said. And if 2% is the best inflation rate, and the economic recovery lags, does that mean that 3% becomes the ideal rate, he asked.

Kohn responded that by aiming at 2%, “you have a little more room in nominal interest rates … to react to an adverse shock to the economy.”

“Your problem is two [percent] becomes three becomes four,” Kohn told Volcker. But other central banks with a roughly 2% target haven’t had that problem, Kohn said.

Fed officials, Kohn added, “need to be clear about why we’re choosing the number we’re choosing.” He also said that while he doesn’t think deflation is much of a risk, “I can’t say the risk is zero” and the Fed must be mindful of the possibility that inflation expectations fall to the point that real interest rates rise.

...

Kohn and Volcker fought to a rhetorical draw, with each conceding that he wasn’t going to persuade the other.

As reported by Wall Street Journal's Real Time Economics Blog.

A certain degree of ambiguity...I would hope, could help temper moral hazard concerns.

As reported by Reuters.

Similarly, every banker I speak with knows very well what “proprietary trading” means and implies. My understanding is that only a handful of large commercial banks – maybe four or five in the United States and perhaps a couple of dozen worldwide – are now engaged in this activity in volume. In the past, they have sometimes explicitly labeled a trading affiliate or division as “proprietary”, with the connotation that the activity is, or should be, insulated from customer relations.