Introduction:
Paul Volcker is an extraordinary figure in international monetary policymaking and inflation control. He played a central role in abolishing the Bretton Woods system of fixed exchange rates and managing the first developing country crisis in the early 1980s.

Volcker’s Early Career:
Volcker’s interest in central banking began early. He worked at the New York Fed in the private sector before returning to public service. Volcker held high-ranking positions at the Ministry of Finance under Presidents Kennedy, Johnson, and Nixon.

Volcker’s Chairmanship of the Federal Reserve:
Volcker was appointed Chairman of the Federal Reserve System by Jimmy Carter and reappointed by Ronald Reagan. His bipartisan support reflected his suitability for the role. He led an unprecedented battle against inflation in the aftermath of the second oil price hike.

Volcker’s Legacy:
Volcker’s actions helped stabilize the international monetary system and control inflation. He is widely regarded as one of the most successful central bankers in history.

Physical Appearance and Sports:
Paul Volcker had a towering figure and was known for smoking large cigars, making him a popular subject for political cartoons. While he was said to have played basketball at Princeton University, it seemed like he talked about it more than actually playing. Volcker’s physical presence made him easy to spot but difficult to question, according to journalists.

Dutch Roots and European Central Banking:
Volcker had German roots, with his grandfather being a German immigrant from near the Dutch border. The region of northwestern Europe where Volcker’s ancestors came from has produced several prominent central bankers, including Hans Tietmeyer of Germany and Wim Duizenberg of the Netherlands. Volcker may not have been fully aware of his Dutch heritage, as evidenced by his question about the number of divisions the Dutch had during a meeting on the dollar crisis in 1970.

Volcker’s Monetarism and Inflation Control:
Volcker’s unique approach to controlling inflation through operational targets for money growth led to the successful reduction of inflation in the United States, marking the start of monetarism in the country. His pragmatism in raising interest rates to over 20% had significant impacts on the exchange rate of the dollar and the stock market.

Election Year and Shock Therapy:
During the election year of 1980, Volcker’s courageous approach to reducing inflation required a severe adjustment process for the American economy. His shock therapy approach confirmed the importance of price stability and central bank independence in monetary policymaking.

Euro as a Logical Achievement:
Volcker expressed his support for the euro as a logical and crowning achievement for the European community, aiming to end nationalistic rivalries and add meaning to the European Union’s nomenclature.

Economic Benefits of the Euro:
Volcker believed in the real economic benefits of the euro, emphasizing practical advantages compared to theoretical models and the available alternatives.

Concerns Regarding Economic Policy Tools:
Critics raised concerns that adopting the euro would lead to the loss of individual European nations’ economic policy tools, including monetary policies, exchange rate adjustments, and fiscal flexibility. This could potentially result in regions experiencing sluggish growth and being unable to extricate themselves due to rigid labor markets and limited cross-border labor mobility.

Volcker’s Counterargument:
Volcker challenged the critics’ argument by emphasizing the European Central Bank’s responsibility to consider the needs of Europe as a whole rather than focusing solely on German-like monetary policies. He believed that conditions reflecting average European conditions would not necessarily be detrimental to individual countries.

Advantages of a Common Currency:
Enhances competition by eliminating price discrepancies within the single market. Promotes investment decisions based on economic factors rather than exchange rate instability. Reduces the threat of large transatlantic exchange rate swings.

Necessity of Flexibility and Innovation:
Emphasizes the importance of flexible markets, work incentives, and innovation for economic growth. Questions the effectiveness of devaluation as a solution to regional disparities, citing Italy’s Mezzogiorno as an example.

Challenges of Exchange Rate Fluctuations:
Criticizes the notion of gradual and smooth exchange rate adjustments as unrealistic. Highlights the negative impact of large and capricious exchange rate fluctuations on the single market. Compares the difficulties of a common currency to the unrealistic textbook model of smooth adjustments.

European Monetary Union:
Acknowledges the efforts to stabilize intra-European exchange rates within narrow margins. Highlights the emphasis on domestic price stability to support exchange rate stability. Views the abandonment of separate currencies as a logical step to relieve tensions and speculative attacks.

Delicate Transition and Economic Constraints:
Raises concerns about the challenging economic circumstances of sluggish growth and high unemployment. Emphasizes the constraints on monetary and fiscal policies due to stability criteria and the need to establish credibility for the new central bank.

Challenges for the European Central Bank:
Describes the unique enterprise of a central bank managed by independent countries. Questions how the potential tension between independence and accountability will be managed. Argues that central banks cannot operate outside a political context and must justify policies to the public and political leaders.

Euro’s Impact on the World Economy:
Acknowledges the significant economic weight of the European Union and its implications for the global economy. Highlights the ongoing debates and uncertainties surrounding the euro’s influence on financial markets.

Factors Influencing the Euro’s Strength:
Discusses the potential for more competitive and liquid financial markets in Europe with a common currency. Considers the impact of internal stresses, aging populations, and social program costs on the euro’s stability. Raises questions about the balance between supply and demand for the euro in global markets.

Unpredictability and Challenges:
Expresses uncertainty about the future of the euro and the global economy. Warns against complacency and the assumption that being a reserve currency guarantees a strong currency.

Stability Through Currency Reduction:
The creation of the euro will enhance stability by eliminating multiple currencies within Europe.

Transatlantic and Transpacific Stability:
Two large stable economic entities, the U.S. and the E.U., could potentially lead to stable transatlantic and transpacific exchange rates.

Narrow Margin of Currency Movement:
Strong central banks in both entities can keep inflation under control, leading to relatively narrow currency movements.

Slow and Predictable Changes:
Equilibrium exchange rate values would change slowly and predictably due to gradual shifts in relative competitive positions and price levels.

Interest Rate Adjustments:
Small adjustments in spot and forward exchange rates could accommodate cyclical fluctuations in interest rates.

Theoretical vs. Practical Reality:
The theoretical stability of exchange rates may not align with practical reality, as seen with the unstable dollar-yen exchange rate.

Indifference to External Value:
The European Central Bank and fiscal authorities may prioritize internal challenges over the external value of the euro, similar to the U.S. government’s approach to the dollar.

Ambiguity in the Maastricht Treaty:
The Maastricht Treaty creates uncertainty about the responsibility for exchange rate management. Governments may be reluctant to commit resources to exchange rate stability due to a lack of political support.

Risks of Neglecting Exchange Rate Stability:
Neglecting exchange rate stability can lead to large capital flows that capitalize on trends. The presence of two major economic powers (Europe and the United States) makes it challenging to achieve a political consensus on exchange rate management.

Potential for Impasse and Weakened International Authority:
The ambiguity and challenges in exchange rate management may lead to an impasse. The influence of international authorities like the IMF may be weakened.

Challenges in Managing Fiscal Policy:
The difficulty of managing fiscal policy flexibly may be exacerbated by exchange rate instability.

Relative Advantage over Multiple European Currencies:
Despite concerns about exchange rate stability, the situation is still preferable to having multiple European currencies.

Volcker’s Perspective:
Paul Volcker highlights the complexities of the international monetary system and the need for cooperation among major economic powers for exchange rate stability. He emphasizes the uncertainty surrounding the future of the euro and cautions against relying solely on one currency. Volcker questions the notion of Europe being a budget surplus area and points out the dilemma of maintaining a trade surplus and being a reserve currency.

Europe’s Current Account Surplus:
Europe is currently running a surplus on its current account, which raises concerns about potential tensions between Europe and the United States. Volcker expresses skepticism about Europe’s ability to sustain a large current account surplus while also experiencing high unemployment. He suggests that structural factors may prevent Europe from creating persistent problems in Europe-U.S. relations.

The Dutch Experience:
Volcker cites the Dutch experience as an example of a country that has managed to thrive within the constraints of a common currency and German interest rates. He attributes the Dutch success to the country’s flexible markets and reforms. Volcker argues that this model could be replicated by other European countries to achieve growth, low unemployment, and exchange rate stability.

EU Euro Eligibility Criteria:
Only one country, Luxembourg, strictly meets the Maastricht criteria for joining the Euro. The United States also performs well in meeting these criteria.

Strictness and Leniency in Applying Criteria:
Discussions exist among Europeans regarding which countries should join the Euro. Some argue for including all 11 eager countries, while others propose a selective approach.

Italy’s Economic Performance:
Paul Volcker visited Italy and met with Mr. Chompy, the minister of the treasury and budget. Chompy presented charts showing Italy’s improved economic performance. Italy’s budget deficit had declined and was on track to meet the 3% of GMP Maastricht criteria. Italy’s price performance surpassed that of Germany, France, and Holland. These positive economic indicators raised questions about the strictness of the Maastricht criteria. Italy expressed eagerness to join the Euro.

Utility of the Convergence Criteria:
Paul Volcker found some of the convergence criteria lacking in clarity and precision, particularly those regarding debt-to-GDP ratio and budget balance. He highlighted the arbitrariness of the criteria, such as the specific 3% ceiling for budget deficits, and the lack of consideration for economic factors such as the cyclical position of Europe.

Relevance of the Criteria:
Volcker emphasized the importance of certain criteria, such as price stability and exchange rate stability, as essential for economic stability. He acknowledged the need for fiscal prudence but argued that the strict numerical targets for budget deficits and debt-to-GDP ratio may not always be appropriate in light of economic circumstances.

Specific Challenges:
Volcker pointed to Italy as an example where the high debt-to-GDP ratio made it particularly vulnerable to interest rate increases, leading to a vicious cycle of higher deficits. He also noted the role of savings rates in influencing budget deficits, highlighting Italy’s high savings rate as a factor that somewhat mitigated its high budget deficit.

Expectations and the Italian Budget Deficit:
Volcker observed that Italy’s budget deficit was improving significantly due to expectations of lower interest rates as a result of joining the common currency. He characterized this improvement as a “windfall profit” that could be sustained if Italy successfully joined the currency union.

Complexity and Clarity:
Volcker acknowledged that determining precise numerical criteria for convergence was challenging. He stressed the need for clearer criteria and flexibility in their application, taking into account economic realities and circumstances.

Central Bank Independence:
Paul Volcker expresses concern about central banks being put on a pedestal and not having to communicate or defend their actions. He emphasizes the need for central banks to interact with political bodies to maintain accountability.

European Central Bank’s Unique Position:
The European Central Bank (ECB) has a unique level of independence guaranteed by the Constitution without a strong political body to interact with. The European Parliament has limited authority to interact with the ECB, making it less effective.

Creation of a European Political Body:
Volcker suggests the creation of a European political body to interact with the ECB, emphasizing that this body should not impair the ECB’s independence. He highlights the importance of interaction between the central bank and the government for transparency and accountability.

German Bundesbank as an Example:
Volcker cites the German Bundesbank as an example where the central bank has strong political support, enabling effective interaction with the government.

Importance of Communication and Explanation:
Volcker stresses the necessity for the ECB to communicate and explain its actions to the government and the public. He acknowledges that this process can be challenging for the central bank but views it as essential for maintaining public support.

European Solution for a European Problem:
Speaker 5 emphasizes the need for a European solution to address the ECB’s independence and accountability. They acknowledge the weak stability tradition and institutional framework in European countries, which necessitates a European approach.

ECB’s Role in Addressing the Problem:
Speaker 5 suggests that the ECB should take a more proactive approach in addressing the issue of its independence and accountability. They propose that the ECB should engage with the public and the parliament to maintain a connection with the people it represents.

Dutch Model as an Example:
Speaker 5 mentions the Dutch model as an example where the government has the ultimate responsibility but rarely exercises its power to give directives to the central bank. However, they recognize the need for a European solution due to the weak stability tradition and institutional framework in Europe.

European Monetary Union and Fiscal Prudence:
The Stability Pact, agreed upon in Amsterdam, aims to ensure fiscal prudence and stability among EU member states.

Concerns about Moral Hazard and Excessive Borrowing:
The common currency may incentivize countries to borrow excessively, leading to potential abuse of the system.

Challenges in Defining Fiscal Prudence Statistically:
Budgets are sensitive to economic conditions, making it difficult to define a fixed deficit threshold that applies in all circumstances.

Balancing Strict Rules with Flexibility:
Setting benchmarks for fiscal prudence is important, but allowing room for judgment in exceptional circumstances is necessary.

Importance of Addressing Excessive Borrowing:
Mechanisms should be in place to address countries that take advantage of the common currency by borrowing excessively.

Stability Pact as a Second-Best Solution:
The Stability Pact is a compromise due to the absence of a European Ministry of Finance.

Condition for the Stability Pact’s Effectiveness:
The Stability Pact can be effective if member states return to a normal budgetary situation with balanced budgets.

Measuring Fiscal Prudence Accurately:
Defining fiscal prudence statistically is challenging due to difficulties in determining the budget under full employment conditions.

Overview:
A conversation centered around the European Central Bank’s (ECB) policy, the potential reserve currency status of the euro, and the instruments available to maintain price stability.

Instruments for Price Stability:
Central banks generally aim for price stability as their primary objective. Different central banks may choose various mechanisms or intermediate measures to suit their circumstances, targeting price stability. The money supply criteria, which the Bundesbank has focused on, is challenging to implement due to different European countries’ variations and instabilities. It may be difficult for the ECB to set a single money supply target for the whole of Europe, given the diverse economic conditions.

Inflation Targeting vs. Money Supply Approach:
There are two main approaches to achieving price stability: inflation targeting and money supply targeting. The German approach has historically favored the money supply approach, while the British approach has recently shifted towards inflation targeting. In practice, the difference between these approaches may not be as significant as often perceived. Central banks consider various factors, including exchange rates, economic conditions, and demand for money, when making policy decisions.

Adapting to Monetary Regime Changes:
The potential instability of demand for money in Europe as a whole poses challenges for the ECB. The ECB may initially adopt a money supply approach to leverage the Bundesbank’s credibility, but it will likely shift to an alternative approach if demand for money proves unstable.

Instruments for Influencing Short-Term Interest Rates:
The ECB will utilize traditional instruments to influence short-term interest rates, which are the typical tools available to central banks for monetary policy implementation.

Euro as a Reserve Currency:
The euro is anticipated to become a reserve currency to some extent, which is generally in the European interest. However, there is a common concern between Europe and the United States that the euro’s reserve currency status could lead to exchange rate instability. Volatility in the exchange rate between the dollar and the euro is a potential risk that both regions share an interest in mitigating.

Volcker’s Recommendations:
Paul Volcker expressed the need for stabilizing exchange rates between major economic blocs, such as Europe and the United States, to prevent instability and economic inefficiencies.

Benefits of Stability:
Stable exchange rates would reduce uncertainty for countries that peg their currencies to major currencies, such as the euro or the dollar, and promote economic stability.

Lack of Interest in Stability:
Volcker noted the lack of interest among policymakers and financial operators in stabilizing exchange rates, with some viewing it as impossible or futile.

Financial Operators’ Preference for Volatility:
Financial operators often prefer volatile exchange rates as they provide opportunities for speculative profits.

European Experience with Fixed Exchange Rates:
Volcker pointed to the successful experience of European countries in maintaining fixed exchange rates among themselves for 15 years, demonstrating the feasibility of stabilization.

The Importance of Commitment and Belief:
Volcker emphasized the need for governments to be committed to defending their exchange rate targets and to believe in the stability of the rates.

Market Response to Government Commitment:
Volcker believed that if governments demonstrated a strong commitment to defending their exchange rates, the market would respond by stabilizing speculation and supporting the rate.

The Lack of Urgency in the United States and Europe:
Volcker observed the lack of urgency among the United States and Europe to stabilize exchange rates due to the belief that the economic impact would be minimal.

Potential Negative Consequences of Instability:
Volcker warned that prolonged instability between Europe and the United States could lead to broader global economic inefficiencies and even political tensions.

The Japanese Case and the Dilemma of Stabilization:
Volcker acknowledged the risks associated with stabilizing exchange rates, citing the example of Japan in the late 1980s, where attempts to stabilize the yen led to an asset bubble and subsequent economic problems.

The Need for a Balanced Approach:
Volcker emphasized the need to strike a balance between stabilizing exchange rates and allowing for necessary adjustments to address economic imbalances.

Financial Transfers in the United States vs. Europe:
Volcker highlighted the different approaches to financial transfers between economically depressed areas in the United States and Europe, with the United States having mechanisms for such transfers while Europe has adopted a no-bailout clause.

Stability and Currency:
Paul Volcker emphasizes the importance of stability in currency systems.

European Currency Stability:
Volcker believes the Netherlands would be eager to maintain the Eurozone to preserve stability.

Fiscal Transfers in the US:
The US has more fiscal flexibility compared to Europe due to federal assistance and automatic stabilizers during economic downturns.

Limited US Fiscal Transfers:
Volcker argues that the image of significant US fiscal transfers to depressed areas is exaggerated.

Common Currency for Europe:
Volcker supports a common currency for Europe to enhance stability.

Common Currency for Northern Europe and North America:
Volcker advocates for stability between Canada, the US, and Mexico but does not explicitly endorse a common currency for this region.

Volcker’s Opinion on Mexico and Canada’s Currency Exchange Rates:
Paul Volcker believes that Mexico should not be forced to peg its currency to the dollar too strongly. However, he respects Canada’s decision to keep its currency relatively stable against the dollar, even though they would never publicly admit to doing so. He notes that Canada’s economy is heavily dependent on trade with the United States, which incentivizes them to maintain a stable exchange rate.

Volcker’s Ideal Exchange Rate Fluctuation Range:
Volcker would prefer if the exchange rate fluctuations between the U.S. dollar, the euro, and the Canadian dollar remained within a narrow range, similar to the stability between the U.S. dollar and the Canadian dollar. He believes that this level of stability is practical and beneficial for major currencies.

The Role of Market Expectations in Exchange Rate Stability:
Volcker emphasizes the importance of market expectations in maintaining exchange rate stability. When the market believes that a central bank is committed to keeping the exchange rate steady, speculators are more likely to align their actions with the central bank’s goals, rather than betting against them. This cooperation helps to reinforce the desired stability.

Closing Address:
Nout Wellink, Chairman of the Foreign Bankers Association (FBA), expressed gratitude to Paul Volcker for his insightful address on the single currency and to Wouter Dwelling, President of the De Nederlandsche Bank (DMB), for leading the discussion.

Volcker’s Speech:
Mr. Wellink acknowledged the significance of Volcker’s views as a distinguished figure with unique expertise in the subject of the single European currency.

Rocky Path to Implementation:
Wellink highlighted the demanding and challenging journey of preparing for and implementing the single currency, which had occupied much attention and focus.

Looking Beyond Immediate Difficulties:
He emphasized the importance of looking beyond the immediate challenges of preparation and implementation, as prompted by Volcker’s extensive experience and authority.

Encouraging Comments:
Wellink found Volcker’s comments broadly encouraging, despite acknowledging the uncharted and difficult territory that lay ahead in the longer term.

Appreciation and Gratitude:
On behalf of the FBA, Wellink presented Volcker with a book titled “But Give Me Amsterdam” by Jules Barber and the traditional FBA watch as tokens of appreciation for his excellent address.

Gratitude to the Stichting John Adams Institute:
He expressed gratitude to the Stichting John Adams Institute for collaborating in organizing the successful event.

Invitation to FBA Annual Drinks:
Wellink concluded his remarks by inviting attendees who had received invitations to join the FBA annual drinks reception.