Saturday, April 18, 2009

What Happens When You Ignore a 6' 7" Financial Giant, Who Knows Where the Bodies Are Buried?

He starts digging up the bodies.

Of late, the financial press has been reporting on something that we have suspected for sometime. Barack Obama is ignoring Paul Volcker.

It does not appear that Paul Volcker, at 6'7" and recognized as the inflation slayer (although he really only knocked inflation out for a short period), likes being ignored. WSJ is reporting that Volcker, who is generally the diplomat that doesn't call out people in public, went after Fed vice-chair Donald Kohn, during a conference today:

Federal Reserve Vice Chairman Donald Kohn’s question-and-answer session at a Vanderbilt University conference Saturday was going as countless others surely have in his years as a top policy maker....

Until Paul Volcker raised his hand.

Then, Kohn was grilled over the Fed’s apparent effort to convey that it considers a roughly 2% inflation rate to be appropriate for the economy in the long term.

Former Fed Chairman Volcker, who along with Kohn was at a conference honoring former Fed governor Dewey Daane, questioned how the Fed can talk about both 2% inflation and price stability.

“I don’t get it,” Volcker said, leading to a lively back and forth between the two central-bank heavyweights.

By setting 2% as an inflation objective, the Fed is “telling people in a generation they’re going to be losing half their purchasing power,” Volcker said. And if 2% is the best inflation rate, and the economic recovery lags, does that mean that 3% becomes the ideal rate, he asked.

Kohn responded that by aiming at 2%, “you have a little more room in nominal interest rates … to react to an adverse shock to the economy.”

The Fed can’t get the nominal, or stated, interest rates it controls below zero. The economically important interest rate, however, is the inflation-adjusted rate. In recessions, the Fed traditionally pushes this inflation-adjusted rate below zero; when inflation is very low or even negative, the Fed can’t bring inflation-adjusted rates below zero.

“Your problem is two [percent] becomes three becomes four,” Kohn told Volcker.
Of course, Bernanke has his helicopter cruising at a level that will result in much higher inflation than 2%, or 3%, or 4%. But I do like Volcker a little PO'ed, he starts digging up the bodies real fast.

At the conference, Volcker also went after New York Fed President William Dudley. WSJ again:

If it’s any consolation for Kohn, he wasn’t the only one on the business end of Volcker’s barbs. Volcker told New York Fed President William Dudley, who also spoke at the conference, that he doesn’t understand what the Fed’s trying to accomplish by paying interest on excess reserves.

“Now I’m more confused,” Volcker said after Dudley addressed the topic in his speech. (Read the speech here.)

That led to another back-and-forth that ended with Volcker telling Dudley, “I get the impression you’re beginning to like this.”

The same, it seems, could be said for Volcker.

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