Paul Volcker served as Chairman of the U.S. Federal Reserve during a period of economic turbulence when his prescribed monetary policies helped tame double-digit inflation rates in the early 1980s. More recently, he served as chairman of President Barack Obama’s Economic Advisory Board from February 2009 until January 2011. A vocal advocate for banking reform, his eponymous Volcker Rule, due to come into force next year, is meant to prevent American banks from making big bets on markets with their own money or from backing private equity and hedge funds. In an interview with INSEAD Knowledge at the Lee Kuan Yew (LKY) School of Public Policy in Singapore recently, he discusses Europe’s response to the sovereign debt crisis, stagnant U.S. unemployment and shortfalls in banking legislation in the aftermath of the credit crisis.
Knowledge: As a former central banker, how would you handle the debt crisis today in Europe?
Volcker: The central bankers have been doing their best to maintain very low interest rates and a high level of liquidity in the face of a very sluggish economy and the potential for more economic disturbance, particularly in Europe, at the moment. Central banks are stretched as maybe never before in history.
Knowledge: What are the implications of Greece leaving the European Union?
Volcker: Nobody knows how it could leave the EU, if it wanted to leave the EU, because the monetary system in Europe is now very well integrated among the euro-zone. So this is all a fight to keep them inside the euro and restore some stability in that monetary area.
Knowledge: Is the euro at risk? Do you see devaluation ahead? Or could euro countries perhaps do an internal devaluation and lower wages?
Volcker: Europe has some imbalances within Europe that are a principle problem. You can’t have devaluations or revaluations within Europe—that is the essence of the common currency. So that has presented a particular challenge. It’s going to take some time to deal with. I don’t happen to think that a devaluation or revaluation - if that was possible, which it’s not, within Europe - would solve the problem either.
There is a basic economic adjustment that needs to be made between effective, efficient, growing parts of Europe and the relatively inefficient, over-committed, over-indebted parts of Europe. It’s not an easy thing to resolve. You watch it every day in the press. There are competing political interests, competing economic interests. I do think it’s a soluble problem, but they’re solving it inch by inch instead of by a general dramatic solution.
Knowledge: Are they on the right track?
Volcker: Principle points at issue have been identified and conceptually been dealt with to some extent – recapitalising the banks, providing funds to provide some assurance for Spanish and Italian financing, in particular, some debt relief in Greece. Those are all important things in the short run. Whether they’re enough and being implemented forcefully enough is the question. In the long run, or not-so-long run, they are going to have to find means of maintaining better discipline within Europe, which requires more integration and policymaking. I don’t think they can escape that and they understand that, but you can’t do that overnight.
Housing and recovery
Knowledge: How will the prolonged weakness of the U.S. housing market affect economic recovery?
Volcker: Well, it’s affecting it all right. Prolonged weakness of the housing is correct. Housing, construction, is flat on its back. It’s as low as its been in decades and there’s no immediate prospect of a big rebound because there are a lot of existing houses coming on the market because of foreclosures and the inability to pay the mortgage debt and so forth. That’s not our whole problem, but it is a big part of the problem. And it’s going to take time to resolve.
Knowledge: U.S. unemployment remains stubborn at nine percent. How do you create jobs while maintaining a handle on government debt? And why has it been so hard to restore employment in the U.S.?
Volcker: There’s obviously a lot of conflict about this, ideological and otherwise—the role of government spending, the role of taxation, the role of regulation. As in Europe, it’s a complicated economic and political situation.
Knowledge: What will it take for companies to start hiring again?
Volcker: It will probably take a little feeling of expansion. They would like to see a little demand. Companies, by and large, are in pretty good shape. They have been doing investment, but not as much as you would like to see. It’s been growing quite rapidly, but we’re still at a low level.
Knowledge: The Occupy Wall Street movement is creating quite a stir globally and is gaining momentum since its first protest in September. People are clearly frustrated. How big a force for change can this group be?
Volcker: I’m not one of the Occupy Wall Street people but it’s not terribly coherent in terms of what they want done. They are reacting to poor economic performance and high unemployment. They are reacting, in part, to a great concentration of income that has developed in recent years but I don’t know if they have any programme for dealing with any of these things.
More or less regulation?
Knowledge: You stated that new financial regulations - increasing government oversight of banks - is still nowhere near what is required. What more is required for banking reform?
Volcker: One, over time, is the mortgage market and housing situation. Another is money market mutual funds. Another is credit rating agencies. And the most important issue of all is how to deal with failures and incipient failures of large financial institutions where there is an approach, incorporated in law, in the United States, parallel thinking in Europe and other countries, but those ideas have not yet been tested. And there’s a lot of scepticism until we get it tested as to how effectively it will operate. We do have this one - I suppose - minor league incident in the United States recently, the failure of this semi-brokerage dealer firm which was over-extended, over-leveraged and failed. We’ve survived it but it’s a relatively small firm. The question is whether we can do that with a really big firm. [Volcker delivered a comprehensive commentary on financial reform during a recent speech that was part of The William Taylor Memorial Lecture Series. A transcript is available here.]
Knowledge: Thank you for being with us.
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