Select Committee on European Union Minutes of Evidence

Examination of Witnesses (Questions 140-147)



  140. And fuzzy enough for your purposes?

  A. And fuzzy enough? Sometimes I wonder whether about UK, and I understand very well and I can have no criticism because it is going on beautifully, is fuzzy enough. I look for that day when, let us say, the oil price is dropping for extraneous reasons, or the exchange rate is changing, and the inflation rate is dropping down to 1 per cent or zero, or 0.5 per cent, and the economy is moving ahead very rapidly. Do you ease money into those conditions and push up housing prices more, or whatever? I would say you do not. That situation has not arisen but I think it could arise and too literal an interpretation of price index seems to me a little odd.

Lord Lea of Crondall

  141. Can I follow up the very interesting question from my colleague Lord Marlesford some time ago about the exchange rate, just widening the question, and you, Mr Volcker, responded likewise, into the general relations between Europe and the United States. I am bit worried about trade relations once you have, and Lord Marlesford said it, 40 per cent from the peak to the trough, which is quite a lot. I think that on the one hand you have said that you are a bit concerned that policy makers were over-complacent about this, and, well, that is not our problem anyway, and so on. It is very hard to know what to do about it. I was wondering whether I could prompt you to say a little more about what you can do about it. Is it not perhaps that on the one hand you have some people in the exchange markets who do not want to do much about it? They make their living out of it, after all.

  A. That is precisely right.

  142. On the other hand, you have another lot of people who have rigged the markets by setting up a European monetary area that is rigging the markets. Two or three years ago, the Americans rigged the market by setting up a zone. Do you think there is a connection between this huge change of 40 per cent and the fact we have created a huge zone in Europe and we are starting to put reserves in there and so on? To narrow my question, could the United States and Europe ever really agree on such a policy area and how on earth would they do it? I suppose a footnote to that is: the UK is piggy in the middle of that at the moment and I was wondering if you could comment further.

  A. My simple answer is: with difficulty. My view of the matter has been that you ought to be able to reach some kind of consensus for these big monetary areas, both with very similar economies broadly speaking, both with diversified economies, both for some time with relatively stable prices. There have been no big sudden shocks, nor are there likely to be, that have a big differential effect. We ought to be able to arrive at some conclusion about what is a reasonable range of exchange rates that could be relatively accommodated and would give the market room to go up and down, as is thought appropriate. What am I talking about? It is about reaching agreement on some range which could be as wide as 20 per cent, 10 per cent up or down from some agreed figure. That sounds like a lot of fluctuation, and it is a lot of fluctuation, but it is only half of what we are actually seeing in practice and I think much less damaging. Can you sustain that? That is where the judgments differ. My own view is that the exchange markets presently have no sense of conviction about what is a sustainable equilibrium exchange rate. They take great pleasure in making money out of these fluctuations. In terms of political dynamics, the great difference in my professional lifetime has been that Wall Street was a great defender of stability and fixed exchange rates, but when they found out how much money they could make from instability, they are now the big proponents of no government intervention and instability, which makes it difficult to take action. But, without any sense of what the right exchange rate is, and the Government is completely agnostic about what the right exchange rate is by their performance, the markets just carried it to extremes. That is the way markets go. I would think if Governments were able to give some reasonable indication of what they thought was a kind of central tendency, the market would give some weight to that. You would have to build up some credibility over time. I do not think you can do that entirely by intervention by any means, but these last few years, when the dollar has been very strong, American policy makers have said how proud they are of a strong dollar. Entirely consistent with that policy, it seems to me that could have done quite a lot of buying of foreign currencies. As it turns out, they would have made a lot of money. The interest rate was higher abroad than in the United States by and large and they would have made money on all those holdings. When the market is strong, you would have made a lot of money, and that money would now be available to go the other way if you wanted it to do so. Instead, we just sat there passively and did nothing. Here you have these great countries that do not have really substantial exchange reserves, and less reserves than China has I guess. It does not seem quite appropriate to me but I am an outlier here. Occasionally you have to consider the implications for monetary policy. That is where the rub comes. Supporters of passivity say that the exchange rate might suggest policy go one way and internal consideration suggesting that policy should go the other way. That arises sometimes. I find more frequently the opposite. Take Europe today, or take the United States today. You are worried about deflation in Europe or whatever we call it—too much stability, too much sluggishness in the economy—and the euro is getting very strong. What is the matter with saying that the combination of circumstances—a strengthened euro together with the weakness of the European economies—reinforces the idea that we ought to make a change in the monetary policy? What is so bad about saying that? If you said that, I think the market might pay a little attention to it. The risk of a further big increase in the euro must be reduced. It probably would be reduced. I think that is the kind of situation that will arise at least as frequently as the so-called deflation situation.

Lord St John of Bletso

  143. Taking the point of Lord Lea relating to the European currency market, do you not think the European Central Bank is doing a better job in preserving the integrity of the currency than the Federal Reserve has done under Greenspan? A second supplementary question is: do you have a view on who the lender of last resort should be in the eurozone?

  A. On the first question, the answer is: no, because both do a good job. On the lender of last resort, that is a good question and in Europe I think it has been fudged. I do not know what the answer to the question is. My understanding of the situation is that if you are going to act as lender of last resort, it would have to be the national central banks, but if they are acting as lender of last resort, obviously that has implications for monetary policy generally. So, should they do it under the agreement or under direction of the European Central Bank or do they make that judgment independently? It is a cloudy area, as I understand it. Fortunately, the situation has not arisen where we need to put that to the test. That needs clarification, in my judgment.

Lord Marlesford

  144. I am going to come back to the fundamental point on the remit of the two systems. It seems to me, from what you have said, that your remit in the Fed where the original words of course are "maximum employment, stable prices and moderate long-term interest rates" is more general and really gives you more freedom to manage the economy, in so far as it is up to you to do so, than the ECB has. The ECB has been held to account too much on the one thing that it has spelt out. Would you therefore feel that there is a case for the ECB modifying its remit to a more general remit?

  A. I guess I agree with that, but I would put it in a very limited context. I think the principal function of the Central Bank has to be concerned about stability. I do not want that statement interpreted, or for you to feel that the Federal Reserve interpreted that, in a way that would give them all that much leeway. They have to keep clearly in mind, in my opinion, the primacy of stability. If they have to interpret that in the light of what is happening in the economy, the exchange rates or whatever, OK, but never lose sight of medium term or even near term responsibility where you have stability. That is the danger of not having new legislation in the United States.

Lord Armstrong of Ilminster

  145. As I think you said earlier, that stability is wider than just price stability. It is a wider economic stability.

  A. Yes.

Lord Hannay of Chiswick

  146. On the exchange rate issue, do you in fact see any realistic possibility of a US Administration that was prepared to concert with the European Union and the Central Bank in the way you have suggested is desirable to avoid excessive volatility? It has been suggested in evidence to us that since there is not the slightest possibility of that, if the Europeans were to move in that direction alone, it would effectively tie their policy to the monetary policy of the Fed.

  A. Sadly, my answer to your question is that I do not see that possibility in the current or in the past American Administration, but I would say I have not seen that possibility in Europe either. In the Central Bank they are pretty dogmatic, in my view, in saying they are not going to pay attention to the exchange rate. What will change that is a crisis. Hopefully, we will not have a crisis.

Lord Geddes

  147. Mr Volcker, from your opening remarks, and I think on a number of occasions since, you have given me an impression that you do not think that the ECB will ever be able to work fully effectively without European political union. Is that a fair impression?

  A. I do not think I want to go that far. Without political union, it is hard to think of the institutional setting for a dialogue with immediately politically responsible officials, but I think its survivability is probably not in doubt. I do not think this question should dictate the question of political union in Europe. My impression is that you can continue as you are; you are off to a pretty successful start. It would be easier if you had political union, but that is not a driving argument on the political union front.

  Chairman: Mr Volcker, thank you very much indeed.

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