Paul Volker at the Japan Society

Paul Volker and Alan Blinder spoke yesterday at the Japan Society.

Role of the Fed.
The Fed must protect the economy. Even if the market brought a problem upon itself the Fed must protect the market to save the economy.

There is not always a clear policy. There is only one clear instrument - interest rates.

New markets and regulation

The myth: Derivatives and securitization diversifies risk so that individual firms will not be harmed.

Proved untrue: see Merrill Lynch 5.4 billion writedown, DB 4 billion writedown etc.

Tradeoff between supervision & regulation. and protection.

Banks want want protection but not regulation.

Securitization's problem is that if banks immediately resell loans they will not care about credit.

At the second or third derivative nobody knows who the originator is.

No regulator was aware how big the problem was.

Did not know how big subprime mortgage business was 1.25 trillion.

Thought it was 100 200 billion.

Lessons

Big institutions provide stabillity

Small institutions at risk

What happens if problem comes when economy is not strong.

Need more regulation bt not clear what.

On Japan

Growth is not as bad as top line numbers might suggest.

Since population is not growing and is aging growth should not be as fast

But real damage occurred: Real estate, stock down 75 percent. US real estate at this point is only down a couple of percent.

Price Deflation did not harm spending.

Cpi at -1. 1 does not change how Ms Watanabe buys and sells.

Asset deflation harmed spending

Asset deflation is a big worry.

What to do about bubbles.

Inflation
Why is it not a worry

India
Disinflation from services still to come from India

Inertia
Inflation low everywhere

Inflation targeting

All central banks are targeting inflation.

Anyting that can be imported from china has not gone up in 10 years Other half of cpi is made up.