Former Fed Chief Volcker `Not Worried' About Deflation

Paul Volcker
Paul Volcker, former chairman of the U.S. Federal Reserve. Photographer: Tim Boyle/Bloomberg

Former Federal Reserve Chairman Paul Volcker, an adviser to President Barack Obama, said he doesn’t expect a broad-based decline in prices.

“I’m not worried about deflation,” Volcker said today to reporters after a speech at a banking conference in Chicago. “I think we’re on a path to price stability.”

“I do not think we should be worried about and consumed by the problem of a potential deflation that doesn’t exist,” he said.

The Federal Open Market Committee said Sept. 21 that inflation is “somewhat below” levels consistent with the Fed’s congressional mandate for stable prices. The central bank said it’s “prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

Volcker didn’t comment on the appropriateness of the Fed’s stance. When asked whether the central bank should purchase longer-term Treasuries, Volcker said, “ordinarily we wouldn’t want to rely on that too heavily but under existing conditions I think it’s understandable.”

“Given present conditions I have no feeling this violates some Federal Reserve doctrine or ethic or whatever,” he said.

“We’re in a situation right now where we’ve got a sluggish economy, a lot of excess resources, a lot of unemployment,” he said. “This is not an atmosphere that’s inclined to produce inflation. I think we ought to be sure that we don’t take actions that down the road might lead to an inflationary situation.”

Change Role

Before talking to reporters, Volcker said in a speech about financial regulation that the U.S. mortgage market is “absolutely broken” and the government’s role must be changed.

There is “no ready-made, practical alternative” to the government’s role in the mortgage market through Fannie Mae and Freddie Mac, Volcker said in prepared remarks at the conference. Creating a new framework for the private mortgage market “is a matter of first priority,” he said.

The U.S. financial system has yet to be repaired, he said. “We know parts of it are absolutely broken like the mortgage market,” Volcker said at the 13th Annual International Banking Conference held at the Federal Reserve Bank of Chicago.

U.S. regulators are implementing the most sweeping overhaul of financial oversight since the Great Depression. Signed into law by Obama in July, the rules were prompted by a credit crisis that triggered the collapse of Lehman Brothers Holdings Inc. and pushed the U.S. economy into a recession.

Unwind Failing Firms

The regulatory changes, named after their principal authors, Connecticut Senator Christopher Dodd and Massachusetts Representative Barney Frank, give the government authority to unwind failing financial firms that may threaten the entire system, impose new rules on derivatives markets and create a consumer-protection agency at the Fed to monitor everything from home loans to credit cards.

The law includes limits to investments by commercial banks in private equity or hedge funds, known as the “Volcker Rule” because of Volcker’s advocacy for the change. Under a measure that may not take full effect for as long as a dozen years, banks can invest in private-equity and hedge funds, though they will be limited to providing no more than 3 percent of the fund’s capital. Banks also can’t invest more than 3 percent of their Tier 1 capital.

Positive Step

Volcker said the legislation regarding the Volcker Rule, though it did not go as far as he would have liked, is a positive step. “By and large the philosophy is embedded in that legislation and we’ll see whether it gets embedded in legislation in other countries,” Volcker said.

The use of derivatives has “far exceeded any pressing need for hedging in real markets or financial markets and has become a kind of speculative instrument,” the 83-year-old former central banker said.

The conference was attended by policy makers such as Bank of Thailand Governor Tarisa Watanagase and Jose De Gregorio, president of Chile’s central bank, and officials from the International Monetary Fund, including Jose Vinals, director of its monetary and capital markets department.

Volcker is chairman of the president’s Economic Recovery Advisory Board. As chairman of the Fed from 1979 to 1987, he raised interest rates to as high as 20 percent to tame inflation, triggering a recession.

Earlier this month at a separate conference in Calgary, Volcker said the U.S. and European economies may take years to rebound from the recession, while emerging countries such as China are undergoing “remarkable” growth.

“It’s going to take a long time to repair the basic disequilibrium in the economy,” Volcker said today.

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