That is a heat shield, and yes, you should have it in place.

I put mine in with a piece of wood -- put caliper on floor, align shield with the "notch" in the rim on the piston (hint -- this is a good way to make sure the piston in in the bore at the correct angle), then stick the board through the caliper and press the heat shield into the piston. Make SURE it's right, as it won't come back out intact.....

It protects the rubber piston boot from the heat radiating from the backing plate of the pad.

If the caliper is rubbing on the hub, you probably have the wrong caliper, it should not touch, only the pads should contact the rotor. Some older models used shims to align the caliper with the rotor, but even with them missing, I cannot imagine how the caliper could contact the hub or rotor if everything is installed corretlys.

Peter

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1972 220D ?? miles
1988 300E 200,012
1987 300D Turbo killed 9/25/07, 275,000 miles
1985 Volvo 740 GLE Turobodiesel 218,000
1972 280 SE 4.5 165, 000 - It runs!