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Paul Volcker on popping asset bubbles

By www - Posted on 01 March 2009

This item from the WSJ Economics Blog was left over from last week, but it's just too good to be left behind. It seems that former Fed Chairman Paul Volker had a few unkind words for the policies of his successor during last week's Joint Economic Committee hearing.
The former Federal Reserve chairman weighed in on a debate over the role of government officials in popping bubbles. “The first and most fundamental lesson of the crisis is that future policy should be alert to, and take appropriate measures to deal with, persistent and ultimately destabilizing economic imbalances. I realize that is a large and continuing challenge of international as well as domestic proportions, but it is the essence of prudent economic management,” Volcker said.

He didn’t specifically mention the Fed, but discussion has been heating up over whether the central bank should act pre-emptively to pop bubbles. Volcker’s successor at the Fed, Alan Greenspan, famously stood against such a policy. “[T]he degree of monetary tightening that would be required to contain or offset a bubble of any substantial dimension appears to be so great as to risk an unacceptable amount of collateral damage to the wider economy,” Greenspan said in 2002.It's probably safe to say the theory behind the non-interventionist policy is now debunked.

Mr. Volcker is no "Johnny come lately" on this subject, penning the memorable Washington Post opinion piece "An Economy on Thin Ice" back in 2005.

The year before, as documented in this report, he went so far as to predict a 75 percent chance of a financial crisis within five years.

It turns out that was very prescient and quite bold. Anyone predicting a financial crisis in 2004 was routinely laughed off the stage - we had just entered a new era of seemingly limitless and endless "wealth creation" through "innovation" in financial products.

This week's cartoon from The Economist: IMAGE

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