Paul Krugman’s reply to my post on Allan Meltzer’s and Paul Volcker’s critiques of monetary policy failed to mention what Paul Volcker has been saying. Yet Volcker’s views are important, especially since, as Krugman points out, he “deserves immense respect for past achievements.”
In his recent Economic Club of New York speech (which has been under-reported and deserves to be read carefully), Volcker argues that the “Beneficial effects of the actual and potential monetization of public and private debt, the essence of the QE program, appear limited and diminishing over time. The old ‘pushing on a string’ analogy is relevant. The risks of encouraging speculative distortions and the inflationary potential of the current approach plainly deserve attention. All of this has given rise to debate within the Federal Reserve itself. In that debate, I trust sight is not lost of the merits – economically and politically – of an ultimate return to a more orthodox central banking approach.”
Like many others, Volcker is pointing to a two types of risk: speculative distortions and inflationary potential. Inflation, even if down the road, is not the only problem. There are already distortions caused by the unprecedented interventions in the mortgage market, the Treasury bond market and the inter-bank loan market, including the multi-year zero interest rate administered by the Fed.
It is also important to note, as I did in my earlier post, that Volcker is critical of the Fed’s dual mandate, which he says is “operationally confusing and ultimately illusory: operationally confusing in breeding incessant debate in the Fed and the markets about which way should policy lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic; illusory in the sense it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel prize winners but by experience.”
During his chairmanship of the Fed, Volcker found a way to deal with this dual mandate and still run a reasonably predictable monetary policy. More recently the Fed has used the dual mandate to rationalize a less predictable and more interventionist monetary policy.
It’s unusual for former central bankers to speak about current monetary policy, yet Volcker is not the only one to do so. In a recent CNBC interview, Alan Greenspan also raised concerns about current policy saying: “The sooner we come to grips with this excessive level of assets on the balance sheet of the Federal Reserve, which everyone agrees is excessive, the better.” and “The issue is not only a question of when we taper down, but when do we turn? And I think that the markets may not give us all of the leeway we would like to do that.”