# James Bullard on the Fed’s policy review, FSOC and forecasting jobs data

St Louis Fed president discusses his support for average inflation targeting, his concerns about US Treasuries market function, non-bank regulatory weakness and negative rates, as well as the unexpected success in using Homebase data to predict highly volatile US job numbers

The US Federal Reserve’s actions to cut rates, increase asset purchases, launch emergency repo and other facilities played a critical role in restoring calm to the global financial markets in March and April. What were the most pressing concerns at the Fed, and how were they addressed? What have been some of the successes and failures made so far?

One aspect of this crisis was how fast the pandemic comes upon you. I think, even when Wuhan shut down, it was unclear whether the disease would spread or not outside of China. When Italy had severe problems, it really became clear that it was going to be a global crisis. I do think that the Fed acted appropriately and quickly during this phase. And, really, the March 15 meeting, which was a Sunday, just two days before a scheduled meeting – that shows you how time-critical everything was – we just went ahead and had the meeting on the Sunday, and took all the key actions. Certainly, moving the policy rate down to near zero, but also getting going on many of the 13(3) [lending] facilities and getting those in place. I think the core idea at that point was that the pandemic itself shouldn’t be allowed to morph into a financial crisis on top of the pandemic, because that would make things much, much worse, and possibly create something you wouldn’t be able to get out of. Whereas the pandemic itself, as bad as it’s been, it’s easy to understand. You say: “Well, we want to invest in the national health, we’re going to have to tell certain types of workers to stay at home for a while, certain types of businesses to shut down for a while, we’re going to try to compensate them through fiscal policy.” I think that actually worked well in the US. We have been able to, one way or another, use existing programmes to get funds to people – personal income was actually up in the US in the second quarter. I think that part has been very successful. And we did the right thing, certainly at the initial phases of the pandemic.

I think the concern now is that this is lingering longer than would have been envisioned in the March/April timeframe. Many people thought by the time we got to June/July, this would largely be behind us. But that isn’t the case. It’s more persistent. The seasonality is not helping, and you’ve got continuing contagion around the world. So, for that reason, these measures are going on longer than would have initially hoped. But I think we’re still on a pretty good track. We’ve got a good monetary policy response in place and a good fiscal response in place, so hopefully we can continue to grow in the second half of the year and stabilise the economy by the end of the year.

To what extent did the Fed’s emergency policy actions spill over to other countries in positive and negative ways? And was there any thought given to potential spillovers at the Federal Open Market Committee as it designed its response to the coronavirus pandemic?

One of the key aspects in the global environment is dollar funding. And when you’re in a crisis, dollar funding is critically important, both in Europe and in Asia. And we did take action. The FOMC took action to reopen our swap lines with many central banks, but we took another step in providing a facility at the New York Fed for other central banks that wanted to swap their Treasuries for currency. And I think that has been a welcome development. It’s always been a question: “Who gets the swap lines?” And: “Why?” And: “Do you want to have this arrangement with every central bank in the world?” And we have not done that, even during the last crisis or during this crisis. But this facility is a way to sidestep that issue and allow quite a bit of liquidity to flow all around the world and allow dollars to be where they’re needed around the world. You might remember in the last crisis, [European Central Bank then-president] Jean-Claude Trichet saying that the swap lines were absolutely critical in the European response to the crisis. I think something similar could be said here in helping us avoid a financial crisis on top of a pandemic. So, I think that’s a success story. And has kept us out of that situation so far.

There was a breakdown in the functioning in the US Treasuries market – often described as the most liquid in the world – in March. What were the most effective tools that were used to tackle the issues there, and are there underlying issues that still need to be resolved?

Personally, I thought it was alarming that there were liquidity problems in the US Treasuries market – you don’t usually expect that. And I think it showed the gravity of the situation and rapidity of the drop in output, in production, that was occurring, and this just really ramped up US and global uncertainty. Treasuries are extremely liquid, but a lot of Treasuries are off-the-run. If you’re trying to get rid of off-the-run Treasuries, they’re not as liquid as you might think. The response to this was just to have the Fed act as a ‘buyer of last resort’. And we did that. And that was very calming to markets, and is continuing to this day. But our liquidity measures have all returned, for several months now, to very normal levels. The St Louis Fed’s own financial stress index has returned to normal levels. So, I think we’re not in a situation of financial stress today, and I do think the purchases have been very helpful on that dimension.

Was the post-crisis regulatory reform a contributing factor to the intermediation breakdown in the Treasuries market? And do you see merit in recent calls to make the Fed’s April 1 temporary exclusion of reserves and Treasuries from the supplemental leverage ratio a permanent feature moving forward? Internationally, there are concerns that some of the rules are breaking down in different geographic regions, and it’s not seen as a great precedent if it is happening in the US. What’s your view?

My general view is that this was intended to be a temporary measure to handle a crisis situation. And I think at some point, we would want to meet the international standard again, and would return to the previous policy. You do want to be very careful in these situations – in the March/April timeframe, you could envision that financial intermediation would just break down, globally. Again, I think the various actions that we’ve taken have avoided that outcome. This was one of them. I’m not quite sure I’ve seen a quantitative study of exactly how effective this was compared to other things that we did, but this was one of a grab bag of many types of policies that we took on board to try to stay out of financial crisis. It’s not quite over yet. The pandemic has come under better control in the US. We have had a second wave, but infections are declining in recent days. Like with any crisis, things can take twists and turns, and you’re not quite sure exactly what direction things are going to go in during the second half of the year. I think we’re going to recover and get to a better situation, and then we could take this temporary policy off and return to the international standard.

Former Fed chair Ben Bernanke has described the Fed’s Covid-19 response as acting as a ‘market-maker of last resort’, saying it was a step well beyond those taken by the Fed during the 2008 crisis. What’s your view? And why does the Fed feel the need to be buying risky assets, whether they’re corporate, emerging market or junk bonds?

I don’t know if I agree with Ben Bernanke’s comment that this is well beyond 2007–09. In that era, we had special deals with individual companies. Bear Stearns, AIG and then others down the line, and I’m not sure we’re repeating that. Instead, we’re setting up 13(3) facilities, really backstop facilities to maintain market functioning for markets that looked like they weren’t functioning very well in the March/April timeframe, but now look like they’re perfectly normal, at least by ordinary liquidity measures. What’s happening is we set up these 13(3) facilities, but they aren’t really being used very heavily, because they’re priced to be backstops, and the pricing is not all that attractive for ordinary times. And, that’s exactly the kind of intervention that was designed to take place here. Now, if financial stress did ramp up in the second half of the year, we stand ready to handle that situation as a backstop provider. But I think many market commentators – and I would agree with them – are saying that the fact that you set up these facilities and showed that the Fed was ready to intervene if necessary and as a backstop, that in itself restored confidence in the markets. Actual purchase levels, which are quite low in most of these, don’t really matter that much; it’s really the expectation that the Fed will stand ready to be there if the situation gets worse. So, again, a success story I think.

Is it appropriate to use large participants in a specific market, such as BlackRock, for buying assets such as exchange-traded funds?

Former Fed chair Janet Yellen has highlighted shortcomings in regulation and supervision of the non-bank sector, an area that has required Fed intervention in both of the last two crises. What specific measures could help address some of these issues?

###### I have felt ever since 2008 and 2010, when the Dodd-Frank Act was passed in the US, that it was way too bank-centric

I would agree on that. I have felt ever since 2008 and 2010, when the Dodd-Frank Act was passed in the US, that it was way too bank-centric. If you know a little bit about financial intermediation in the US – I know many of your viewers and readers do – only 20% of the intermediation is going through the banking sector in the US. So, the regulatory framework, which really put so much emphasis on several of the very largest banks, is missing a bigger picture about how financial intermediation works in the US. And I wanted more focus on that. Now, Dodd-Frank did set up FSOC, the Financial Stability Oversight Council. And I was sceptical at the time, and remain sceptical, because it was populated by the heads of the various agencies. They are perfectly fine people and everything. But they have their own incentives, there is some politics involved, they’ve got their own institutions and turf to protect, and that is not the kind of group that’s naturally going to ring the alarm about major problems outside of their purview. I think that could be improved by being a more independent entity, and perhaps we could get a better enterprise-wide or country-wide view of financial intermediation, and then do a better job of identifying where the risks are and what the regulatory approaches should be to contain those risks.

FSOC has a reputation for being ineffective – it did nothing to tackle leveraged lending, pre-crisis, despite Fed warnings. Should the Fed, or a similar independent, largely apolitical body, be given responsibility for maintaining market function, so it can look into issues related to leverage, false liquidity promises, contagion risks, etc, related to the non-bank financial sector, which, ultimately it backstops?

I like your phrase a “more independent”, a “more apolitical group”. And if that could be designed and set up, I think that would create something more effective. And they could issue reports, perhaps on a quarterly basis, and identify risks and suggest remedies. What’s happening today is the Fed is providing quite a bit of support to FSOC, so some of the analysis is coming out of the Fed, anyway, and the FOMC gets briefed on a regular basis on the status of at least what the staff thinks about financial stability in the US, and quite a bit of it is public. I do think the radar at the Fed has improved. But the question in this area has always been: “What are you going to do about it?” And if you do identify something you think is running out of control, then what’s the next step beyond that? And I think at this point, we’re just identifying risks and maybe not addressing them very directly.

Is there a serious drive to come up with a better framework, or is it something that people would like to see, but maybe we’ll have to wait some time to see something happen?

That’s why I was a little bit upset when Dodd-Frank was going through because I felt like that was our one chance to set it up. I don’t know if this crisis will be big enough on the financial side to force Congress into more action. I just don’t know where that stands. These are powerful lobbies, and they certainly don’t want to be regulated. But the problem is, we all get in trouble if the financial intermediation doesn’t work effectively. That’s where it stands right now.

What do you make of efforts to ensure ‘big tech’ is on a level playing field, when it comes to financial services? Has any fundamental change been made in this area?

I think one of the major issues in central banking and in global finance is: what will be the role of big tech in finance going forward? And sometimes you hear some of the talk in Silicon Valley about completely dominating that business and taking it over. Other times, you hear about large financial institutions in partnership with tech and therefore able to wait for the development of new technology and then adapt that into the existing regulated area. I’m sceptical of that latter development actually occurring going forward – even though JP Morgan and the others will tell you that that’s exactly what’s happening. It’s very, very hard to change cultures that are sort of entrenched, plus the banking sector is heavily regulated. A lot of the technology development is regulatory arbitrage, it’s trying to provide the same services or very similar services without getting regulated. And, to some extent, you could argue that some of the firms are pretty successful already and that this could just lead to a wholesale breakdown of financial regulation. As in any kind of situation like this, there’s a lot of people talking from different angles. No-one knows exactly how the technology will develop. But these firms are so big and so powerful that they’re able to walk into new industries without really any knowledge of the damn industry, and then still take it over because their technology is a lot better than the existing technology in the industry. That’s been the hallmark of tech, and may apply also to financial services. So, I think this remains one of the very top issues in central banking going forward.

Do you agree with the view of former Pimco chief Mohamed El-Erian and others that the Fed is now effectively ‘captured’ by financial markets: whenever there is a major downturn, the central bank will be forced to intervene to ensure ‘market function’, effectively offering a ‘free Fed put option’ with pretty much no credit risk?

When I get this question – and I’ve talked to Mohamed about it – I say it is an equilibrium. I’m not sure it really resonates with people. But in my mind, it resonates. Because government policy is understood by the private sector. And, then jointly, the government policy with the private sector, pursuing their own self-interest, that creates the equilibrium when you add all that together. And it certainly is a matter of public policy that the Fed was founded to prevent financial crises, and is expected to intervene if there is a financial crisis – and that helps inform the equilibrium and determine the market pricing even when you’re not in a financial crisis. The logical endpoint of the notion that you wouldn’t intervene in a crisis is that you’re just going to suffer through the crisis and take the downturn that’s going to occur with that. We know it would take a long time to recover in that kind of situation. The US in the late 19th century was riddled with financial crises, and contemporaries didn’t like the outcome. They said that “this was too much” and we had to get something better to be able to smooth this out a little bit. And that was the founding of the Fed. And it was founded in a way that decentralised it across the country to provide input from everybody. But I think it’s partly by design to have the Fed intervening in a crisis situation.