Punchlines from Fed Chair Powell's interview on 1/14/21...
"Give me a bazooka so I don’t have to use it"; shy away from social judgments embedded in credit allocation; small biz need fiscal support, not more borrowing; inflation won't stay up...
Princeton economics professor Markus Brunnermeier interviewed Federal Reserve Chair Jerome Powell yesterday as part of the Markus Academy webinar series. They discussed the Fed’s new “average inflation targeting” regime, economic outlook, inflation/deflation trap, Covid vs. 2008 financial crisis, efficacy of Fed’s lending facilities in Covid, etc. Here are some of the main Q&A punchlines, edited by me for clarity.
Q: What are the new average inflation targeting regime and its implications?
The Fed’s dual mandates are maximum employment and stable prices. In 2019-2020, we had our first ever public review for the strategy to achieve the dual mandates. We wanted to review what has happened in the 10 years since the 2008 financial crisis, and we realized: interest rates have become substantially lower, which have significant implications for monetary policy. The flexible average inflation targeting regime, therefore, was adopted to adapt to the new normal of the low interest rate environment.
We still want inflation expectation anchored at 2%. But in order to achieve the inflation expectation at 2%, we think we would actually need to achieve 2% inflation on average over time. This means we will aim to achieve inflation above 2% for a period of time if we’re persistently below 2% for a while – hence the idea of “average.”
We use the word “flexible” to describe average inflation targeting – in the sense that we haven’t tied ourselves to a particular mathematical formula. We will continue to review a wide range of factors when setting policies.
Q: Did the Fed move away from the idea of a “natural rate of unemployment” a single r*?
That is clearly the case. But the natural rate of unemployment is only one of the factors we take into account when talking about maximum employment. We also look at labor force expectation, size of workforce, etc.
We’ll always write down estimates for non-accelerating inflation rate of unemployment (NAIRU), but going forward we will not raise interest rate after just looking at NAIRU. The transcript from the Fed’s discussions in 2015 indicated that there was a sustained period of low unemployment for a long time.
Q: In the debate of whether we will see inflation soon: we see Japan experiencing huge deflationary pressure, but some also worry about pent-up demand suddenly pushing up inflation. Will we be in either of the two extremes in America?
A one-time increase in price doesn’t lead to persistent high inflation because of the underlying dynamic in U.S. economy. We have a flat Phillips Curve now, meaning there is low persistence of inflation. Inflation doesn’t stay up, unlike back in the hyperinflation era in the 1970s, when there was a very steep Phillips Curve.
We also have a slack labor market, so inflation won’t come up anytime soon. If inflation were to move up in ways unwelcomed, the Fed will surely use tools to push it down. It’s the persistent low inflation that is more worrying.
Q: Will financial dominance threaten financial instability? Is there over-leveraging going on in the corprate sector?
Financial dominance is the reluctance of the Fed to tighten policy and push down corporate leverage.
The non-financial corporate sector did go into downturn with relatively high leverage, but interest payments are still at normal level; no big uptick in corporate defaults; not something we’re feeling as an issue.
When it’s time to raise interest rate, we will do that, but that is no time soon.
Q: Macroprudential tools in the U.S.?
It’s very difficult to have good time-varying tools where the Fed sees a worrying situation and can then intervene with certain tools for that particular situation. The history of such intervention hasn’t been too good. It’s hard to predict the right time to step in.
It’s much better to develop strong “through-the-cycle tools.” For example, the Fed conducts difficult stress tests that require banks to be resilient in the events of financial crises. “Better to build strong levies rather than predict hurricanes.”
We’re not seeking the kind of macroprudential tools seen in other countries, which have different political economies.
Q: Would some corporations use bond purchase programs to pay higher dividends? (Does the Fed feel the need to regulate such moral harzard?)
We shy away from anything to do with credit allocation. There are many social judgments embedded in credit allocation that are important and great, but that’s not the Fed’s role to judge, and elected officials should do that. We’re not in a position to demand what corporations should or should not do.
I would go a step further and interpret this response as a way of addressing the idea of Modern Monetary Theory, which believes that the Fed ought to intervene the economy with a more activist role, such as using its power to help solve climate change etc.
Q: Differences between Covid vs. 2008?
In 2008, the economy had a long buildup of unsustainable imbalances in the economy in the form of the housing market bubble. We had an under-capitalized banking system, failures in the non-banking part of the financial sector, and high household indebtedness.
Covid, however, is a natural disaster. Before the Covid shock, there were no fundamental imbalances that threatened the long-run expansion. The banking sector was much better capitalized. We did see some non-banking part of the financial sector, but the problems weren’t as big as in 2008. Likewise with corporate leverage.
Most critically, both fiscal and monetary authorities responded quickly in a sustained way. This is a particular shock that calls for fiscal policy. The Fed can support market function and stimulate aggregate demand through accommodative monetary policy, but Covid was 20-30 million people becoming unemployed overnight, which is fundamentally different and requires fiscal policy, and we did get it quickly through the CARES Act.
Q: Lessons from the 2008 response?
In 2012, we didn’t know what the “new normal” would be. Would it be a return to 3% growth and 4% Federal Funds Rate? We just didn’t know. The Fed was doing QE3 in the recovery, but fiscal policy tightened a lot in 2013-2015 and dragged down the efficacy of monetary policy. The fiscal response ended too quickly.
This is different this time. We’re seeing follow-ups from fiscal authorities. We can return to pre-pandemic level output much sooner than feared initially, and we can hopefully avoid “labor market scarring.”
Q: Review of Covid crisis tools’ efficacy?
The Fed strongly intervened the market for 10-year Treasury. We weren’t the market marker per se, but we bought a lot of Treasuries and mortgage-backed securities (MBS). Restoring a critical market such as the Treasury market clearly ties to our role to keep financial stability. The Treasury market is central to all markets.
We want to foster the creation of safe assets and the use of dollar as a reserve currency. These aren’t direct goals of the Fed, but they benefit the U.S. and align with our goals.
The backstop effect of our facilities was strong. Hank Paulson said “give me a bazooka so I don’t have to use it” back in the 2008 financial crisis. (Paulson’s exact words were: “If you've got a bazooka, and people know you've got it, you may not have to take it out.”).
It didn’t work back in 2008, but it did this time in Covid. As soon as we announced these facilities, the markets started working right away. These facilities are very hard to set up given the legal nuances etc., but were quick because many of our people worked on them in 2008. The fact that there were no take-up for the corporate bond facility and low take-up for the municipal bond facility was a sign of success. The rates were low across the credit spectrum. The backstops really worked.
The Main Street Lending Facility was the one exception that didn’t work as well. It’s hard to reach non-financial small businesses that have no access to the bond market. The Fed also had no experience doing that. After all, we’re a bank regulator and worked hard over the last 10 years to make sure banks don’t make bad loans.
Particularly for smaller firms, they need fiscal support. The answer is not necessarily more borrowing. Many small businesses aren’t operating not because they can’t borrow; they don’t want to borrow because they don’t want to pay it back later.
Q: Swap lines establishing dollar as a leading currency in the world?
Dollar funding markets around the world benefit the U.S. economy substantially; they wind up being consumer or business lending in the U.S. Their stress also shows up in U.S. markets. We did a good job keeping the markets going, and that will keep the U.S. economy well.
Q: Helicopter money?
I will take a pass on that one.
Q: Liquidity trap?
We’re not in a liquidity trap. We have policy space for interest rate moves again.
Q: Is it too early to think about exit? Lessons from the 2013 Taper Tantrum?
The economy is far from our goals. We’re committed to keep using tools to achieve objectives. If we make good progress and are on track to continue making substantial progress, we will be very transparent when that moment comes. The 2013 Taper Tantrum highlights the sensitivities of markets on asset purchases.
General caveats: We should avoid an excessive focus on a likely, modal path of near-term monetary policy. Monetary policy is more about risk management away from downside cases. It’s not time-based but outcome-based.
Q: CBDC (central bank digital currency)?
Dollar is the global reserve currency after all. Don’t want to issue something that people only end up realizing that this is not really money. Look at it very carefully and investing heavily in technology. Will also do a great deal of outreach to every constituency interested in this. Determined to do this right; will take many years. Since it’s possible and private sector is already doing it, so we take it very seriously.
Q: Research advice for academics in light of Covid?
Near term: the priority is to understand what actually happened during the acute phases of the crisis, why something worked and didn’t work…
Medium term: labor market scarring and damage to output; what other countries’ labor market policies worked and didn’t work…
Long term: implication of climate change for the financial sector. The research on that front is still early stage.
Q: Ending on a positive note?
I was concerned in February about horrible outcomes, but now we’re no longer in that scary phase. We may return to pre-pandemic output level very soon. We may also bypass a lot of the damages we were concerned about for low-income people. A lot of optimism for U.S. economy.
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