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Interview with Paul A. Volcker

Paul Volcker, former Fed chairman, shares his views on Fed independence, international economics, trout fishing and more.

December 1, 1992


David Levy Vice President
Interview with Paul A. Volcker

Paul A. Volcker has been characterized as thoughtful and erudite—traits that served him well as chairman of the Fed's Board of Governors from 1979 to 1987. Volcker may best be remembered as the man who "broke the back" of inflation, which was rampant at the time of his appointment by President Jimmy Carter.

As testament to Volcker's non-partisan management of the Fed and his dedication to the commonweal, he was reappointed to the chairmanship by President Ronald Reagan.

Volcker has long fiercely defended Federal Reserve independence. Not only does he favor its independence from political influence, but he values the special role of the regional Reserve banks within the larger System.

Following nearly 30 years of federal government service at the Fed and the US Treasury, Volcker is currently chairman of James D. Wolfensohn Incorporated, a Wall Street investment firm, and is Frederick H. Schultz Professor of International Economic Policy at Princeton University.

Equally at home wading in a Montana trout stream as advising presidents on the nation's economy, Volcker shares some of his thoughts on both topics in the following interview.

Region: Our economists at the Minneapolis bank have argued over the last few years that deposit insurance creates a perverse incentive to take risk with the depositor's dollar. They've concluded that the solution requires some form of coinsurance.

Volcker: I agree, at least in a limited way. In many cases we have had 100 percent insurance, de facto. We probably can't retreat from that very far right at the moment. But I would like to introduce some form of coinsurance in calmer circumstances. How far you can introduce risk without undercutting one of the purposes of deposit insurance, which is to avoid banking panics and contagious banking panics, is a nice question. I think we ought to go a little distance in that direction, recognizing that right at the moment it's a bit difficult, to say the least.

Region: Since your days at the helm of the Federal Reserve, some of the debate has centered on the notion of zero inflation: not just low rates but that zero should be the ultimate goal of the Fed. How would you weigh in on this subject?

Volcker: I don't think we can expect to be accurate down to the last tenth of a percent or even to the last one percent. A lot of the consumer price index is a rather artificial construction. For instance, housing costs are measured by its rental equivalent—which is nice in theory but in practice depends upon an extrapolation of very few numbers. Prices of health care services are largely computed by indirect formulas. There are more problems in measuring quality in those areas than others. Moreover, some service prices will tend to go up faster than goods prices because historically there is greater productivity increase in manufacturing. So if we achieve stability in manufactured goods prices, which might be reflected in an unchanged producer price index, the consumer price index would go up a bit because of services.

I once said that we ought to be satisfied if ordinary people and businessmen don't feel they must assume prices are going to change when they're making their investment and spending decisions. That may roughly accord with stability in wholesale price index. I think Alan Greenspan cited a somewhat similar qualitative definition recently.

Can we get there? I think we've learned it's pretty hard to get that last mile. Not just in the United States, but in other countries. Why that is, is an interesting question which I've thought about a lot. How can people and nations deal with extreme inflation and do 90 percent of the job, or do 95 percent of the job, of getting back to price stability, while they very seldom get all the way there, even the way I defined it. That is true partly because in this day and age people don't really expect a deflation. Wage earners are not going to take reductions in wages generally, or forgo what they consider minimal increases. They do sometimes in particular firms, of course, in extremis, but not generally, when the economy, is growing and jobs are available. Productivity growth has been slow, which doesn't help. In any event, it's very hard to get down statistically that last little bit. But I think in the United States we can come pretty close to the general definition that I gave you.

Region: On the regulatory side at the Federal Reserve we are working on the implementation of the Federal Deposit Insurance Corp. Improvement Act (FDICIA). Some argue that it was the right medicine and others say, it's a clear example of regulatory overreaction. Most agree that it did little to change the nature of deposit insurance. What's your reaction to this new legislation and should it have included more reliance on market discipline?

Volcker: I don't follow these things as closely as I used to, so you're getting a little bit beyond where I can speak with any authority. I do have a sense, and I have testified a couple of times to that effect, that we do need more thoroughgoing reform of deposit insurance. That was just left out. How many deposits should be insured? When? How? Should there be new policies or arrangements with respect to how we protect bank depositors in the banking system?

I think some small change has been made, but the big issues were left out or carried over. So I think there's still some work to be done.

I do have a feeling in the pit of my stomach, now that I'm neither on the giving or receiving side of regulations, that there's an awful lot of rigidity in the new legislation: too many rules that are bound to be arbitrary. I understand why they're there. It's a reaction to a feeling that people didn't or couldn't act soon enough, decisively enough, in dealing with the problems as they emerged in the S&L and banking industries. I know that some discretion is left, but there are so many statistical guideposts, I think it is going to be hard for the regulators and supervisors not to be more arbitrary than necessary or desirable. So I worry about it.

Region: While working for the Treasury you were the principal U.S. participant in international negotiations during the transition from the Bretton Woods fixed exchange rate system to the more flexible system of floating rates. After two decades of "flexible" do you think serious consideration should be given to a return of the fixed rate?

Volcker: I don't really think the world is ready for, as you say, serious consideration of a return to fixed rates for the world generally. Obviously, there is serious thinking of fixing rates within Europe, and some particular countries want to fix their rate to other countries. I could foresee the day when Mexico might re-fix their rate to the dollar and perhaps even the Canadians will, although there are political as well as economic issues. But, when you talk about fixed rates generally, as at least in the idealized picture of the gold standard or the early days of the Bretton Woods system, I don't think it's going to happen for a long while, even though I personally would think that's a good way to ultimately organize the system.

Region: It's reported that you were initially reluctant to accept the argument for floating rates.

Volcker: Oh, I grew up in the Bretton Woods system, and I learned that was the best way to organize things and that those arrangements were a great achievement in international cooperation and organization. That's the way I was schooled. That's the way I learned it in the Treasury, and I very much was sorry to see the system break up. In the end I strongly advocated that we float for a while—suspend gold payments and float as a means of transition to a new system—but I was worried about the instability that might follow. I looked to an early reform of the system that would maintain fixed "par values" as the center of gravity of the system. That didn't work out, and, of course, we have had a great deal more instability in floating exchange rates than the advocates ever assumed would take place.

Region: Knowing that you are intimately involved in financial matters of Europe, we would be curious to hear your point of view on European monetary union. It appears to be falling apart. Should we be concerned?

Volcker: Twenty years ago I was more than a little skeptical about the Common Market. But my general feeling is that it's gone so far toward integration, and the implications for greater political cohesion are such that they ought to take the final leap toward monetary union. I am more supportive of that than many of my European central banking friends; I don't have to worry so much about the position of individual countries. It seems to me that if they really want a unified market, and if they really want to work more toward political unity, the obvious corollary of that is monetary union and the quicker they get there, the better.

The EMS [European Monetary System] may not be the worst of all worlds, but it is basically flawed the way it's operating. In concept, the E.C. members were quite determined to maintain stability, but yet they insisted upon maintaining independent currencies. That always left open the question that there would be changes in relative exchange rates. When the pressure becomes great, speculation begins and may accelerate, making it very difficult to maintain the fixed exchange rates that they say they want. If the Europeans really want fixed rates, then they might as well go to a common currency, a unified central bank, and get it done, and accept the corollary, which is a common monetary policy for all of Europe. Now, de facto, they have tended to have a common monetary policy dominated by one of the central banks, the Bundesbank. But at times the tensions get very great, and the stability breaks down. My sense is they better move forward toward a common currency or they're going to go backward toward more instability. Of course, in the last couple months they have gone backward.

Region: But not backward so far as that you'd say it's falling apart?

Volcker: There are and will be strong pressures, but I think it's too much to say the European exchange rate system is falling apart since the central relationship between the mark and the French franc has held. That was under strong attack, as you know, but for the time being at least the pressures have been contained and dissipated.

Region: Here's a question on Fed independence and the role of district bank presidents. Do you think the bank presidents should be appointed by the president of the United States?

Volcker: I think the Federal Reserve is strengthened by the fact it has this regional structure and the bank presidents participate in monetary policy and other decisions. I think you would lose some of the sense of independence, frankly, if the president appointed the bank presidents as he appoints members of the Board of Governors. You might not lose it entirely, but certainly to some extent the tradition would be weakened. So I'd rather it stay as it is.

We actually had a constitutional challenge, you may recall, a few years ago, to the present arrangements, that required a lot of attention. In the end, the challenge was turned back, at least in district court, and the decision wasn't appealed. I hope the matter remains a legal matter. We still have the political question settled but Congress can always change it.

Region: And it does seem to pop up in legislative proposals.

Volcker: It does. The problem, in a way, is maybe less a constitutional issue, which I hope has been put to bed, than the seeming anomaly or peculiarity of private bankers or private businessmen serving on the boards of the regional banks taking the initiative in the appointment. I have wondered many times whether there's any other way of doing it, but I haven't come up with a better system. But if the present arrangements are to be sustained, it's very important that that responsibility, as other responsibilities at the regional level, be conducted in a way that doesn't raise any questions about integrity, probity or political influence.

Region: The Federal Reserve is in the process of consolidating its mainframe computers to just a few from at least one in each district. And in other areas, like the processing of savings bonds, a similar consolidation process is under way. Most would agree it's an organizational trend. Is it a good one in your estimation?

Volcker: I don't know precisely what the situation is now, but there have always been tensions, obviously, between centralization and regionalization. New technology, computerization and data processing, economies of scale have, I think, increased the arguments for centralization as a matter of efficiency. The consequence is reduced autonomy in some areas, but if it's more efficient, it's hard to say you shouldn't have some consolidation of these computers. The bigger question underneath is whether, in this day and age or if you were starting again, would you have 12 Federal Reserve banks on either efficiency or policy grounds?

Minneapolis is an interesting case. It's the smallest of the Federal Reserve banks. It probably has the strongest regional roots of any of them in my experience. There's great pride in Minneapolis in the local Federal Reserve bank, and the Federal Reserve bank is integrated into the community better than it is elsewhere. That kind of regional role I think is an important element in the strength of the System. So here you have the smallest of all the Federal Reserve districts in population, not in area, being a strong example of the role a Federal Reserve bank can play. When I look at the whole thing, I don't see the point in changing the system until it's more visibly broken than it is now, even though if we started from scratch we might not replicate exactly what we have today.

Region: Several years ago you began an essay by saying, "My perceptions of central banking have changed since the days I practiced that honorable profession." How would you describe that change?

Volcker: I'm not sure it's changed a whole lot. It is always true that when you're outside the central bank, and being regulated by the central bank or being regulated by anybody, you always think there is a tendency in banking or elsewhere to regulate too much and too arbitrarily. When you're inside the institution you may be concerned that you don't want to regulate too much or too arbitrarily, but the political pressure is usually to regulate more than necessary or desirable. However, I doubt that's what you had in mind when asking this question of me.

More broadly, interestingly enough except in the United States, much more emphasis is being placed on the need for central bank independence. We in the United States have one of the most independent central banks, but the question is raised sometimes as to whether we should curtail that independence somewhat. In most other areas of the world there has in recent years been more consensus on the importance of central banking independence and a tendency to strengthen it. You see that very strongly in the construction of the potential new central bank in Europe. There is great emphasis on the importance of price stability as a prime objective of the central bank, and that goes hand in hand with a strong and independent central bank. They plan for a strong and independent European central bank even before they have a European government, at least a government in the sense you'd think of it in a nation. In a way, that seems to put the cart before the horse.

Region: It's an interesting thought. If you make it independent before you form the government, from what is it independent?

Volcker: I think the answer is they want to make it independent of the individual governments and the political pressures within those governments. In the design, they have tried to make the proposed central bank independent two or three times over. The heads of the national central banks will participate in policymaking as the regional Reserve bank presidents do in the United States, but the national central banks must themselves be independent of protections for the central body being independent. So you get independence built on independence.

Region: You have been working with the Russians to help them through the transition to a market economy. What role have you played?

Volcker: Working with the Russians is an exaggeration. I have an official title as advisor to the Russians, but it's been limited. I go over there once in a while and have good opportunities to consult with their leaders. In substance, if I've been helpful at all, it's been mostly in the area of their external debt and the problems of negotiating or renegotiating the terms of their debt. Otherwise I really can't say I'm deeply enough involved to claim any really significant contribution.

Region: In addition to your chairmanship of James D. Wolfensohn Incorporated, your current list of activities is long and impressive. You serve as chairman of the North American Committee of the Trilateral Commission, the Group of 30, the Advisory Boards for the Center for Strategic and International Studies, and the Arthritis Foundation. And that's not to mention the organizations for which you co-chair or serve as a director. Which of these has been the most engaging?

Volcker: Even with that list, you have left out a few things, which illustrates the problem. I try to do too many of these things, probably more than I can do effectively. I ought to cut down, but I don t seem to be disciplined enough to say no, enough is enough.

Region: In high office you served under five presidents. With whom did you have the greatest rapport?

Volcker: I was in quite different positions with the five presidents. I was a young man initially and had no real contact with President Kennedy. I did see President Johnson in action in a number of meetings, but there was no opportunity for personal rapport. As under secretary of the Treasury, I did at times have to deal with President Nixon, but I certainly wasn't close. The one I saw the most of in a substantive way, but for a limited period of time, was President Carter. The election oratory implying that everything that happened during the Carter years was bad irritates me a bit. The implication that Carter was a failed and ineffective president strikes me as overdone.

Region: Words commonly used to describe you are discreet, honest broker and pragmatist. What would be your self-characterization?

Volcker: One's impression of oneself may always differ from other people's impressions. I do think that I am discreet. I certainly am a pragmatist at times; I try to find a consensus solution or a way for people who may disagree to proceed. But I also think on some basic points that you better not be a compromiser. These may range from the importance of the central bank working toward price stability to the importance of government institutions—certainly including the Federal Reserve System—of maintaining integrity on a personal basis. There is no room for partisan political judgments in the decisions or operations of the Federal Reserve System in my opinion; if that kind of ethic breaks down in the regional banks, you're in trouble.

Region: When reading your biographical material, one comes across "little mysteries." One of them is about your studies at the London School of Economics when you were researching postwar British monetary policy for a doctoral dissertation. It's reported that instead of completing the research, you "found things other than economic research to do in London." For a man so dedicated to economics, what could have possibly have drawn your attention away from study?

Volcker: There's no great secret. I didn't make any trips to Moscow! I did make a few trips around Europe. But London was and is a huge, wonderful city. It was the first time I lived outside the United States. I guess it was the first time I'd been outside the United States other than Canada. I found a big world out there. I got interested in participating in student and other life in and around London. I didn't work as hard as I should have on my thesis. It remains undone. Maybe someday!

Region: Nothing particular, it was just exploring a new culture?

Volcker: I've never terribly regretted that. I guess the lack of a Ph.D. hasn't interfered with my career all that much. But it made a lasting impression to be put in another culture as a young man. Obviously the British culture (or language!) isn't 180 degrees different from the United States. I could have gone to much more different places than London or even the continent of Europe. But Britain was different, and did give me a new perspective. I know it's a cliche, but it does makes you appreciate the values and achievements of the United States more when you live abroad.

Region: A little bit about your book, Changing Fortunes. The reviews I read seemed quite favorable.

Volcker: I hope it's available in Minneapolis.

Region: It sure is. We have a copy in our library.

Volcker: One copy?

Region: In our bank library, that is.

Volcker: You tell Gary Stern the bank should buy more than one copy.

Region: Yes sir ... How did that book come about?

Volcker: The question of writing a book had come up lots of times from friends, but I've never had any driving desire to write a book. But this arose quite by accident in the sense that Toyoo Gyohten, my co-author, was spending a year at Princeton after he left the Japanese Finance Ministry. I had known Toyoo for some time, and we were asked to give some lectures together basically reviewing post-war international monetary developments from the Japanese and American perspectives. I got the idea that if we were going to give the lectures, we might as well put a tape recorder in the room and record all these thoughtful words, put it together, and we'd have an easy book. So we did it. But of course if wasn't nearly as easy as my little illusion suggested. Toyoo was much more coherent than I, but the transcript needed a lot of revision. All the questions and answers were worked back into the lecture with the help of our editor. I realized it didn't read very well, so I put the whole thing aside for six months. The publisher finally got after me. I did a quick rewriting of the lectures. And that's the book.

I hope it provides some insights into what went on in the post-war period. Obviously the publisher wants to sell the book, but we were hoping that it might be used in courses in international finance at universities. I think it will be out in paperback shortly. So if it has a life in universities over the next few years, it will have served its purpose. But I must confess the reviews were exceptionally good.

Region: And the reaction to the book itself has been the same?

Volcker: I got some letters from friends that said they were delighted to read the book. I'm not much of a judge of these things, but I'm told it has sold well for a book of this sort. It was not heavily promoted, but it has sold up to the expectations of the publisher or beyond so far.

The main reaction I got was that I wasn't forceful enough in making my points in the book, and that I should have gotten more gossipy and more critical of people. I didn't perceive it as that kind of a book.

Region: During your career you were lured away several times from public service by Chase Manhattan Bank, but always returned. For some time now you have been in the private sector. Should we expect that you might soon be returning to the world of public policy?

Volcker: Public service? No, other than as an avocation. There are all these other things I get involved in.

Region: At the very end of most of your biographical information, your three grandchildren are mentioned. Tell us about them.

Volcker: On my three grandchildren, I'll say what you expect. But in this case it happens to be true! They're all sons of my daughter. The oldest one is now 9, and the youngest is 1. Their father is quite an athlete, and my daughter is interested in it, too, so they spend a lot of time—soccer, tennis, swimming and that kind of thing. The oldest one is obviously brilliant and the second is coming along!

Region: Do they get some quality time with grandpa every once in a while?

Volcker: Well, I'm not in Washington any more, so I see less of them and the 1-year-old is a bit of a stranger—he still doesn't feel very at home with grandpa. Leave him alone with grandpa, he's apt to cry, (Chuckle) But he's terrific. They all obviously have some of my genes, and they are well on the way to being a basketball team.

Region: It's reported that one change you've made since your days as the Fed chairman has been a serious upgrade of your fly fishing tackle. That must mean that fishing is still a great passion of yours?

Volcker: Well, I did more salmon fishing for a variety of accidental reasons than I've ever done in my life, including a week in Russia. They've just opened up some Atlantic salmon fishing in the Kola Peninsula, which is up between the White Sea and the Barents Sea, north of the Arctic Circle. It's the second year for a fishing camp built out of nowhere. It was an interesting experience to be out there in the wilds of Russia.

The salmon are a little bigger than the trout I occasionally catch in Montana. My connections with the Ninth Federal Reserve District were deepened by the fact that you've got the best trout fishing in the United States. I regret I no longer have a district Federal Reserve bank or branch to go visit, and just incidentally try to catch a fish or two.

Region: Thank you Mr. Volcker.