Let’s Not Pursue the Volcker RuleRemarks at the 2010 U.S. Monetary Policy Forum, New York City, February 26, 2010Anil K Kashyap
University of Chicago Booth School of Business, NBER and Federal Reserve Bank of ChicagoI will not start by thanking myself for putting me on this panel. But I would like to thank DaveWessel, Governor Tarullo and President Evans for participating. The normal temptation for anacademic who gets an audience with such a distinguished group of policymakers is to promoteone’s latest and greatest new idea. But having tried that on numerous occasions with prettylimited success I am going to take a differ tact. Instead, I am going to say some things that Ithink many and perhaps most policymakers already understand and agree with, but perhaps feeluncomfortable pushing. So I am going speak primarily to the members of the audience who arenot policymakers and especially the press to try to change their thinking on the so-called Volckerrule.In particular, I will make a frontal assault on the wisdom of having the Volcker rule as theheadline feature of regulatory reform efforts. For these purposes I will define the Volcker rule asrestricting banks from making speculative investments that do not benefit their customers. Iwant to attack it on theoretical grounds, question its empirical relevance, and explain why Ibelieve it is even bad politics.Theoretical considerationsStarting with the theory, that there are fundamentally two theories of what banks do and whythey are special. One emphasizes the role that banks play in monitoring customers who want toborrow money. The other stresses the importance of offering liquidity on demand.
Whenthinking about regulating banks it is critical to decide which of the two motives matters. I wantto stress the liquidity provision theory and think about its implications.Let’s take perhaps the simplest version of that theory. It is based on the proposition that there isan underlying demand for payment services that someone must offer. It can be summarized assaying we have checking accounts because using them is much more efficient than carryingaround large amounts of cash. So there is an intrinsic demand for debit type payment options.Now let’s think about how this preference will be met. To successfully offer demand deposits, abank needs ready access to funds and to develop the infrastructure to predict when cash will bewithdrawn. But notice that solving this problem is identical figuring out when a customer mightdraw on a line of credit. For the bank, it makes little difference whether money is flying out the
These remarks are my own personal views and should not be associated with the organizations with which I amaffiliated.
A lot of recent work by my colleagues, Douglas Diamond and Raghu Rajan, try to put the two together.