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Fifty year of
Central Banking

Paul Volcker, former Chairman of the Federal Reserve Board, delivered an entertaining and insightful address at a conference sponsored by the Federal Reserve Bank of New York in April 2002.  Here are a few excerpts.

It might be of some passing interest to share the observations I have made over the past 50 years. If nothing else, it will give you some reassurance that the kinds of problems you are worried about are not exactly new, although they certainly come in different packages

During the 1950s and 1960s, we did not just think about monetary policy and fiscal policy.  It was monetary policy, fiscal policy, and debt management.  As unlikely as it sounds today, debt management was considered to be an active “third leg’ of policy. 

When I was in Washington in the late 1970s and early 1980s, we embarked on some new approaches to monetary policy that depended upon control of money by the means of quantitative control of the reserve base. 

I can remember tossing and turning at night thinking whatever we do, the banks will try to game us. Could they use the same reserves to satisfy our reserve requirements at the end of the day and satisfy the reserve requirements in Asia and in England?

Since the early 1980s, I think it is fair to say that we have returned to a kind of approach that relies upon direct influence on the short-term rate and a much more fluid market situation

The 1990s, as you all know, have been regarded as the great glory days of monetary policy. There is a sense of conviction in the market that we can press a few monetary buttons and everything will be solved.  Of course, that is an illusion.

Operating monetary policy in open, liquid markets means that the transmission [to the economy] will inevitably be unstable: the market in effect is competing with you, and the central bank will find it necessary to adjust. All of the history I have recounted suggests that this will be a continuing struggle.  A fixed rule cannot solve the problem. I think that is the lesson of the past fifty years.

Indeed you sometimes might ask the question whether the Federal Reserve is driving asset prices and the exchange rate or whether the exchange rate and asset prices are driving the Federal Reserve. That is an uncomfortable question to ask when you are trying to run a central bank.

What is the endgame in all of this, of open markets: the free flow of capital around the world, a couple of hundred independent countries, some big, some small? I think the logical long-term result – extending far beyond my living horizon, but perhaps not yours – is a world currency. 

What I have not quite figured out is what the one remaining central bank will do, what instrument it will use, and how it will be controlled. But I think that is the direction in which economic and financial logic guides us.

For the complete address, go to Volcker Address.

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