Sylvain Leduc and Dan Wilson: Are State Governments Roadblocks to Federal Stimulus?: Noted for August 4, 2013
Liveblogging World War II: August 4, 1943

Paul Volcker Will Not Quite Say What He Means…


Paul Volcker wants to say six things:

  1. The Federal Reserve needs to become the single centralized boss regulator of the American financial sector.
  2. If the Federal Reserve has a single mandate to maintain price stability, it is highly likely to also be able to conduct effective countercyclical policy to achieve maximum employment.
  3. If the Federal Reserve takes its "dual mandate" seriously, it is likely to fail at both parts of the objective.
  4. Both Quantitative Easing and forward guidance promising extremely low interest rates need to end soon.
  5. The Federal Reserve cannot compensate for failures of policy outside its proper domain and fix the problem that the economy is depressed, and should not try.
  6. The fact that the economy is depressed is principally the fault of the Republicans in congress blocking sensible fiscal policies.

But only if you already know that Volcker believes (6) will you understand that the bold-faced phrase in this sentence:

Asked to do too much--for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously the hypothetical circles of stability, growth, and full employment--it will inevitably fall short.

is (6).

Paul Volcker is no longer a Federal Reserve technocrat bound by convention to eschew partisan politics. Why won't he say out loud what he believes--that the principal reason the Lesser Depression continues to be so deep and drags on so long is the destructive behavior of the congressional Republicans blocking sensible fiscal policies, and the road to full economic recovery lies in either Republican losses of congressional seats or a transformation of the Republican Party?

It would be a public service if he would.

Paul Volcker:

The Fed & Big Banking at the Crossroads: The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity. Asked to do too much—for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously the hypothetical circles of stability, growth, and full employment—it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach.

Back in the 1950s… a period of remarkable economic success ensued, with fiscal and monetary policies reasonably in sync, contributing to a combination of relatively low interest rates, strong growth, and price stability. That success faded as the Vietnam War intensified, and as monetary and fiscal restraints were imposed too late and too little. The absence of enough monetary discipline in the face of the overt inflationary pressures of the war left us with a distasteful combination of both price and economic instability right through the 1970s—a combination not inconsequentially complicated further by recurrent weakness in the dollar. We cannot “go home again,” not to the simpler days of the 1950s and 1960s. Markets and institutions are much larger, far more complex. They have also proved to be more fragile, potentially subject to large destabilizing swings in behavior. There is the rise of “shadow banking”—the nonbank intermediaries such as investment banks, hedge funds, and other institutions overlapping commercial banking activities. Partly as a result, there is the relative decline of regulated commercial banks, and the rapid innovation of new instruments such as derivatives. All these have challenged both central banks and other regulatory authorities around the developed world. But the simple logic remains; and it is, in fact, reinforced by these developments. The basic responsibility of a central bank is to maintain reasonable price stability—and by extension to concern itself with the stability of financial markets generally….

With or without a numerical target, broad responsibility for price stability over time does not imply an inability to conduct ordinary countercyclical policies. Indeed, in my judgment, confidence in the ability and commitment of the Federal Reserve (or any central bank) to maintain price stability over time is precisely what makes it possible to act aggressively in supplying liquidity in recessions or when the economy is in a prolonged period of growth but well below its potential.

Credibility is an enormous asset. Once earned, it must not be frittered away by yielding to the notion that a “little inflation right now” is a good thing to release animal spirits among entrepreneurs and to pep up investment. The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives—up today, maybe a little more tomorrow, and then pulled back on command. But all experience amply demonstrates that inflation, when deliberately started, is hard to control and reverse. Credibility is lost….

The Dodd-Frank Act does establish a new Financial Stability Oversight Council, a coordinating mechanism chaired by the Treasury. However, the regulatory landscape has been little changed. The result is that, following Dodd-Frank, we are left with a half-dozen distinct regulatory agencies involved in banking and finance, each with its own mandate, its own institutional loyalties and support networks in Congress, along with an ever-growing cadre of lobbyists equipped with the capacity to provide campaign financing…. Beyond Dodd-Frank, a seeming consensus among the agencies and the Treasury on reform of money market mutual funds still has not resulted in satisfactory action even though no new legislation is required….

I know these issues raise old questions of regulatory organization, some of them apparent fifty years ago. I also know some of the current issues are complex and call for highly technical judgments. But none of that mitigates the fact that the current lack of agreement on key regulations and their enforcement is simply unacceptable to the financial industry, as well as harmful to effective governance. We also know that the present overlaps and loopholes in Dodd-Frank and other regulations provide a wonderful obstacle course that plays into the hands of lobbyists resisting change. The end result is to undercut the market need for clarity and the broader interest of citizens and taxpayers.

The simple fact is the United States doesn’t need six financial regulatory agencies—the Fed, the SEC, the FDIC, the CFTC, the Federal Housing Finance Agency, and the Office of the Controller of the Currency. It is a recipe for indecision, neglect, and stalemate, adding up to ineffectiveness. The time has come for change. As things stand today, I am told that can’t happen and won’t happen. However powerful the arguments for action, the vested interests—within the agencies, in Congress, and outside—are just too strong. I ask, can we let that view stand unchallenged?