Can we get there?
Stern: So, can we get from here to there, where commercial banks look much more like traditional commercial banks, and we leave things like proprietary trading and hedge fund activity and those kinds of things to other institutions? Can we get back to that kind of world?
Volcker: Well, I think we can, but obviously there’s a lot of opposition among banks. I actually don’t think it’s nearly as difficult as you might think. There aren’t many banks that own hedge funds or private equity funds. Where you do run into a problem is with trading, and there they’ll say, “We can’t serve customers; we can’t do underwriting without some trading activity.”
I think that’s right, but I think there’s a difference between that kind of activity—it’s probably a matter of scale—and what, let’s say, Goldman Sachs and some of the other banks are doing, where it has become a very major preoccupation, profitable or not.
I must say that when I talk to people in these institutions—people I know pretty well and trust—they say, yes, there is a difference between aggressive proprietary trading and the kind of thing that emerges in the context of customer relationships.
It’s only partly a prudential problem—particularly at a bank that has a large investment management business (and, of course, the big ones do). The problem is that it’s just an obvious conflict of interest between the hedge fund, the trading and the private equity business in what they’re doing advising their customers.
Economic knowledge and central banking
Stern: You’ve obviously been involved for a long time directly with the Federal Reserve, at senior levels, from the mid ’70s and even earlier than that in the Treasury as well. In your view, has macro policy or monetary policy changed significantly over those many years? Or are we still pretty much at the state of knowledge, and is the state of our responses pretty much where it was?
Volcker: [Laughter] It’s interesting you ask that question because I recently commented to some of my economist friends that I’m not aware of any large contribution that economic science has made to central banking in the last 50 years or so.
Our ability to forecast is still very limited. The old issues of the relative role of fiscal and monetary policies are still debated. Markets are certainly more complex, and some of the old approaches toward monetary control seem less relevant. Recent events have certainly illustrated limitations in our understanding of the economy.
The advent of floating exchange rates, which partly reflects a shift in academic thinking, has certainly been important, but the underlying problems of policy seem familiar.
Right now, we are in the midst of a very large unsettled question. Are the unprecedented Federal Reserve and other official interventions in financial markets a harbinger of the future? Is reasonable financial stability really dependent on such government support?
On the technical side, there has been continuing change in the approach of central banks to the market, away from more quantitative approaches like the volume of bank reserves to much more emphasis on precise control of short-term interbank interest rates. The point is that in establishing and conducting policy, you need some means of reaching operational decisions. Those approaches have differed and evolved. But none of that breaks new conceptual ground.