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Q&A: Former Federal Reserve chairman Paul Volcker '49

The Daily Princetonian spoke to former chairman of the Federal Reserve Paul Volcker ’49 following a panel discussion in which he participated, titled “Are financial institutions too big or too big to fail?” At the panel, Volcker criticized universities like Princeton for allegedly teaching students how to cheat the financial system.

The Daily Princetonian: Do you think the Federal Reserve went far enough in stabilizing the banking system?

Paul Volcker ’49: No, I’m not going to answer a question like that.

DP: Pretty recently, some economists have suggested that the central bankers took [the threat of] inflation too seriously.

PV: I’ll give you a simple answer. The responsibility of any central bank is price stability. I was at the helm at that time. Price stability is two percent inflation, which we can’t closely control anyway. They ought to make sure that they are making policies that are convincing to the public and to the markets that they’re not going to tolerate inflation.

DP: And does high inflation matter as long as it’s expected?

PV: It sure does, if the market’s stable. And if it is expected, then everyone adjusts, and it doesn’t do you any good. The responsibility of the government is to have a stable currency. This kind of stuff that you’re being taught at Princeton disturbs me. Your teachers must be telling you that if you’ve got expected inflation, then everybody adjusts and then it’s OK. Is that what they’re telling you? Where did the question come from?

DP: Okay. Could you talk a little bit about the justification behind the Volcker Rule and the effect you think it’s had on the market?

PV: The rule is that institutions that are protected by the government, implicitly or explicitly, should not be engaged in speculative activities that bear no real relationship to the purposes for which banks are protected. Banks are protected to make loans, they’re protected to keep the payments system stable. They’re protected so you have a stable place to put your money. That’s why banks are protected. They’re not protected to engage in speculative activities which led to risk and jeopardized the banking system. That’s the basic philosophy. I think it’s pretty well-accepted.

DP: And do you think there’s still a lot of work to be done?

PV: Not that I know of. You have a regulation environment standing in. It’s a pretty tough regulation. Like every regulation, it’s dependent on the ability and willingness of the supervisor to enforce it. And they have all the power and authority they need, if they’re willing to do it.

DP: Okay. And to get back to the central banking a little bit, given the trade-off between inflation and unemployment –

PV: I don’t believe that. That’s my answer to that question. That is a scenario and a delusion, which economists have gotten Nobel Prizes twenty years ago to disprove.

DP: And as far as moral hazard goes, do you think that in practice banks are going to recklessly avoid taking into account risk?

PV: That depends upon the regulatory system. And that goes back to compensation structures and so forth. So, I do think that it is a danger when big banks that are perceived as too-big-to-fail are taking advantage of the banks that are small ones.

DP: What are the most important things left to be done or to think about?

PV: In the area of financial regulation?

DP: Yes.

PV: A lot’s been done. What needs to be done is to enforce it. This business of the resolution process [of resolving the affairs of insolvent banks in an orderly fashion], whether you’re talking about the FDIC or the Federal Reserve, there’s a lot of work being done, and it’s not complete, but then again, otherwise, we’ve got to reorganize the supervisory system. There are too many holes, too many overlaps, too many opportunities for regulatory capture from the affected industries. That should be reformed.

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