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?
People are talking about this. But the practical aspects of implementing some of these programmes mean that we’re going to have to have a vendor and to ask the vendor to go ahead and execute for us. I don’t think there’s really any getting around that. If people want to talk about this, then I think we should talk about vendor management. The government, not just the Fed, has all kinds of vendors, and you could ask important questions about whether those are being handled appropriately as vendor relationships and whether they meet certain standards that would be set for those types of relationships. The Department of Defense, for instance, I’m presuming, has many hundreds of vendors. So, I think that’s maybe the sharper question to ask around this. As far as I know, BlackRock has behaved according to contract here, and I think it is an appropriate way for us to get our work done in this situation.
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.
The Fed 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
A lot of the cheap funding made available through quantitative easing seems to have been used by companies for share buybacks, rather than for capital investment. And investors that used to get a healthy yield from deposits at banks or investing in US Treasuries have been forced to take on more duration or credit risks to seek similar sorts of yields to what they received in the past. As the Fed’s balance sheet has now gone past $7 trillion, and quantitative easing really remains the primary policy action, are you worried about these side effects?
I know that share buybacks have been controversial. But I have to say, I’m a little sceptical of this entire argument. The firm has choices about how it wants to fund itself. One is to issue stock, another is to issue debt. It’s not all that clear to me that it should matter really one way or the other, as per the Modigliani-Miller theorem, although some say that does not completely hold. Also, the US tax code favours debt finance. I’m not quite sure why we do that, but we do. So, it might make sense in an era of low interest rates to want less equity finance and more debt finance because I don’t have to pay very much for the debt. So, the investor is sitting there with a share of Berkshire Hathaway. And then Berkshire Hathaway says: “OK, we’re going to give it back to you, Mr or Ms Investor.” Well, what are they going to do with it? They will invest somewhere else. It’s really an expression by the firm: we had this extra dollar, and we really couldn’t think of anything to do with this extra dollar, so we gave it back to the investor – and that shifts the decision over to the investor about what to do with it. So, I’m not quite sure, from the point of view of economists about how firms are funded, that this is really as tangible an issue as it seems in the political sphere.
But isn’t it just driving up asset prices, rather than driving investment in the real economy?
You would have to present evidence that investment has been damaged by the stock buyback programme, that there’s been less investment than there otherwise would be. But, again, if you hand the dollar back to the investor, that guy’s got to do something with it. If they’re going to consume it, I guess you could argue that there’s been less investment. But it seems like that’s probably not what they’re doing. They’re probably just investing in something else that they think has higher return.
The Bank of England appears to have shifted its view on negative rates. Last summer, its Monetary Policy Committee was not interested in negative rates, but, following the pandemic, top BoE officials have said they are not ruling them out. Has there been a similar change in perceptions on negative rates at the Fed?
I don’t think we’re going to be using negative rates in the US. It is not a good tool for us. We have a different short-term funding system than Europe or Japan. I think ours would be vulnerable to a negative-rates scenario: you might cause more problems than you solve with negative rates in the US. So, I think this is far down the list of possible actions by the Fed. Also, I’m not at all clear that negative rates have really ignited anything special in Europe or in Japan. And so I am not really seeing it as any kind of panacea for stimulative action to get better employment and inflation outcomes in the economy. It doesn’t look like it’s been all that successful in the international experiments that have been run. And in the US, I think we have a somewhat different short-term funding scheme that might not react well to negative rates. These are the main reasons that I see that the committee has publicly expressed doubts about going in this direction.
Has the Covid-19 pandemic resulted in the FOMC relying more on high-frequency or alternative data sources, things such as footfall data, text data, real-time estimates of GDP, and so on? High-frequency data can be a bit more volatile, and it’s not a perfect proxy, as there are some things that are just not captured by it. Have they been useful, and how much do you trust them when it comes to actual policy-making?
We have been using them, and they’ve been very useful during this pandemic period, because the scale of what is happening is so outlandish. Things are happening that are way out of the norm for the macroeconomic data in the post-war era. Exhibit number one would be the minus 30-plus percent growth in the second quarter at an annual rate, and that’s a crazy number. That shows you that this recession is very different from others. It’s also very fast-moving. Most likely, the recession was really just two months – March and April, even though it was extremely sharp. Also, it wasn’t really a recession in any kind of conventional sense. We told people that “you have to invest in the national health, you have to stay home and we are going to compensate through fiscal policy – we’re going to use our unemployment insurance scheme to get the money to you”. But it is a very different thing than demand dried up or your industry went out of business or something. It’s a very different situation.
I wanted to give an example of the usefulness of real-time data we have used at the St Louis Fed, the so-called Homebase data in the US, which is a survey of all kinds of businesses across the country and their employment levels. We have used that to predict the last three jobs reports. And it was uncanny how accurate it has been all three times. So, this is a situation where you may remember the May jobs report, where Wall Street was predicting minus eight million, and it turned out to be a huge plus instead. So, the miss was like 10 million jobs, which just way off the scale of anything that we’ve seen! But the Homebase data got that exactly right. And that’s been led by Max Dvorkin on our staff, and this has now become commonplace analysis all around Wall Street. There is something that was very successful, and it’s been successful again in the latest jobs report. So, wow, you know, we should probably be using this kind of real-time data all the time. But it can be volatile, and it can send a false signal. So, you have to be very careful about it. But in this situation, it’s been quite valuable.
Yes, if I recall correctly, the St Louis Fed’s prediction was pretty much bang-on, wasn’t it?
What was funny about that is that a couple of days before the jobs report, Max gave his presentation in a slide deck. And his attitude was: “We’re kind of messing around with this Homebase data to see what we get. If you do this, and you do that, you would predict that the May jobs report is going to be a big positive number.” And the reaction in the room was kind of like: “Oh, well, I guess there’s some more work to be done, because everyone knows there’s going to be a big negative number.” And then it turned out to be exactly right. After that, we formalised it a little bit more and put it out on the blogs.
When you have these very big changes in numbers, such as big jumps in unemployment, how do you factor that into your policy decision-making? Are there models for that?
I have been concerned that unemployment over the last four or five months is not the same thing as unemployment during the big ’80s recession or during the global financial crisis. Because of that, I think people may be misinterpreting – or badly misinterpreting – what’s happening, especially in the US, where we used the unemployment insurance programme as a way to get pandemic relief to disrupted households. One thing to emphasise here is that, normally, if you look at the unemployed, only 10–15% will describe themselves as on temporary lay-off. The other, bigger group will say: “My job went away and I’m going have to find something.” So, even at the peak of unemployment in the US after the financial crisis in October 2009, unemployment hit 10%, and 85% – maybe 90% – of those people said that they were on permanent lay-off. But if you look at it today, again, we’re at 10% unemployment, but here 60% or more are still saying that they’re on temporary lay-off. They’re basically at home, collecting the insurance, as their business is one that hasn’t opened up again, but they’re expecting pretty much to go back if it does open up again. And if you do get reopening, a lot of those people could get recalled, and the unemployment rate would come down quite a bit faster than anything we saw after the previous crisis. This different situation and the difference in the shock means we have to be mentally agile to understand what’s going on and what’s different this time. You know, after the last crisis, it took two years to bring the unemployment rate down just 1.2 percentage points from that peak. Here, you’ve got the unemployment rate going down that much in one jobs report. It’s just a very different animal and a very different situation that is much more fluid than was the case after the global financial crisis.
What is the status with the Fed’s policy review? When will a decision be unveiled?
Well, it’s up to the chair. We are drawing this to a close, and I think that’s appropriate. I initially thought that this would be a one-year process. It has kind of morphed and then extended some by the pandemic into 18 months or longer. I think it’s been very good, and a lot of good ideas are out there. The chair has said that a lot of what we can do is codify what’s actually happening in central banking and what’s actually informing the committee’s decisions. And we can do that in a better way than the existing framework does. And, so I don’t know quite how this is going to totally come down here – it’s going to be up to the chair to lead that. But I think we are getting close. And, to be fair, most members of the committee have made comments in various ways about things they’d like to see. So that gives you a pretty good idea about where the debate is, just based on the public discussion about it.
There has been quite a lot of discussion about an overshooting of the inflation target. We’ve seen a number of FOMC members and former chairs saying that this would be helpful in the current environment, in particular. It is something you have favoured in the past as well. What is your view of the optimal monetary policy framework for the Fed?
I have my own research on it, ‘monetary policy for the masses’, and there nominal GDP targeting turns out to be the best policy. What I like about that result is that even if you don’t like my model, and you go to somebody else’s model, you often get something that is price-level targeting, or nominal GDP targeting, something like that turns out to be the optimal monetary policy. I think that for practical policy-making, you probably don’t want to go to some rigid formula of any kind, but you can make motions in that direction by talking about averages or trying to hit the inflation target on average over the medium term. I’d like to see that come out in the end in this framework review. But, again, it’s going to be up to the chair to make the final call on this. But if you look at many other members and just the central banking community, generally internationally, they have become much more receptive to the idea that this would be an improvement upon ordinary inflation targeting, because the zero bound issue or the effective lower bound issue is biasing actual inflation outcomes below target, and you’re seeing that in Europe, in Japan, and in the United States. You want to do something to combat that and make sure that whatever you say the target is, you’re going to actually hit the target on average. That will cement inflation expectations, get to better outcomes and leave us more policy space in the future. So, a lot of good things can be said about that, and have been said by various presidents and governors on this matter.
At the moment, it seems to be quite hard to get inflation up. In Japan, they’ve certainly been trying to do this for quite some time. It seems to be the same now in Europe. When people talk about overshooting, I understand it could change expectations, but there is also a risk if one fails to deliver. Is that a concern?
I think this is a big concern – that you try to make a change and then no-one listens to you and it’s not very credible. That can happen. I think that the 2% target, though, has been viewed as something of a ceiling. So, the idea has been – even in a staff analysis that is now public – if you’re below your inflation target, then the projection is you’re going to follow some policy that leads you right back to the inflation target, but monotonically from below, so you would just come back. And then this whole period you would miss on the low side, but only asymptotically would you actually hit the target. And the same thing if you were above target, you would start above target and come back asymptotically, so during this whole period you would miss to the high side. So, if you’re trying to be a little bit more aggressive and actually hit the target, in a reasonable timeframe, like three years or five years, you’re going have to go back to target faster, probably overshoot for a while and then come back to the target. I think this might help because we do have the perception in financial markets and to some extent in actual analysis that the inflation rate is some kind of ceiling. And as long as you’re below that, all is fine. The ECB’s guidelines are actually 2% or less, right? So, they’re actually codified in saying this. The US is not like that – we’ve said it is symmetric. But we need to do more to convince people that we really do want to hit the thing, on average, and we haven’t done a good job since 2012.
What is the best way to convince people?
One thing that would be helpful is the idea that the Phillips Curve relationship is not nearly as robust or as strong as it might once have appeared. The empirical evidence over the last 20 years has really dried up for rigid versions of Phillips Curve theories that said that when unemployment goes down to some level, mechanically you’re going to get higher inflation. That hasn’t really occurred in the US or other places around the world, such as Germany or Japan. Because of that, you’re probably able to run economies with lower unemployment rates than conventionally were considered acceptable. That’s great news for everyone in the economy, because we want to get everyone with a job to the extent possible other than just churn in the economy, and especially those that are less attached to the labour force. We certainly have minority unemployment very high – black unemployment very high for a long time and Hispanic unemployment in the US high for a long time. We’d like to get to a situation where you can get jobs to all those people and get them honing their skills and able to survive and thrive in the economy.
Joe Biden has raised the prospect of giving the Fed a third mandate to help correct racial inequality. What’s your view of such a move? And does the Fed and the economics profession have a diversity problem?
The Fed already has three mandates: stable prices, maximum employment and moderate long-term interest rates – so I guess we’re nailing that last one there. But to add on other mandates on top of that? Really, the only thing the Fed can do in the medium term is control the inflation rate. It’s true that during that process, you do affect the economy, but not in the long run. The long-run effects on the economy are more fundamental factors – inequality, productivity and other factors – that drive long-term growth. I think you don’t want to create confusion about what the Fed can do and what it can’t do. As far as being able to disaggregate better and think more carefully about how our policies are affecting everyone in the economy, I think that’s great. We have done that in the last five years, especially. So, that I would welcome, and we want to inspire confidence among everyone that we’re pursuing as good a policy as we can pursue to get the best economic outcomes that we can get. So, that part, I think, reporting, thinking about how different people are affected, I think that’s very important. But to really solve the inequality problem in the US would be a task far beyond any tools we have, and really belongs squarely upon Congress and the political system in the US.
The Fed already has three mandates: stable prices, maximum employment and moderate long-term interest rates – so I guess we’re nailing that last one there
Is there a real risk that, with multiple waves of Covid-19 lockdowns, there could be a tipping point that will force central banks to monetise fiscal debt at a time when economies are already suffering from declining productivity and there’s a major breakdown in global supply chains and global trade. The dynamics don’t look that great. Are you worried about that? Are we already in this situation or is it something that concerns you in the future?
I’ve been hinting that we probably need to reconsider how we think about federal debt. I don’t think that, as macroeconomists, our story about government debt has been a very good one, and has not predicted very well what would happen. We have a story that you can’t borrow too much because you’ll crowd out public investment and interest rates will rise. But Japan seems to belie that outcome with a debt-to-GDP ratio of over 200%. And the US and many other countries are now well exceeding Maastricht Treaty limits. So, I think we need to think more carefully about what is this federal debt, and is it is a more money-like object than the way it’s been treated in the macroeconomic literature? So, US federal debt and also Japanese and other major countries that don’t have other types of political stability problems, their debt is considered very liquid, very handy for trades in financial markets. So, it has a money-like feature. When you think about issuing currency, you know, you issue currency, but there is really no plan to unissue currency. You just put it out there and it circulates forever. Is government debt, or at least a fraction of the government debt, more like that, where you issue it and it just circulates because it has money-like features? I think that’s a core issue for macroeconomists. It is something that has not been central in the debate, but some of the theories I work on do begin to address that. I think that would be an important direction for the macro debate going forward.
Does the Fed have a framework for monetary financing, especially when faced with major crises? And if not, should it?
Usually, the monetary financing would be that you’re going to allow the money supply to run out of control because you’re going to buy up the debt, put the currency into circulation and you’re never going to retire the currency. In traditional monetarist theory, that would lead to lots of inflation. Actually, if you look at the M2 data, the growth rate has actually been about 6% over the last 25 years. And, you know, inflation came in, not too far from 2%. It actually doesn’t do too bad a job as a very long-run explanation of inflation. But today, the M2 growth rate is way up year over year, at over 20%. People are pointing to that chart and arguing that there might be a lot of inflation in the future. I don’t really think so. I think that’s a temporary blip in money demand that makes a lot of sense, given the gigantic nature of this crisis during the second quarter of 2020. But it does give food for thought that M2 growth has to be unwound and get back to normal levels to be consistent with the rest of the chart that I described.
What percentage would you assign for how the US will repay emergency fiscal costs and debt more generally, for the following four options: fiscal austerity, tax raising, inflating away the debt and default?
I would put the inflation category together with the default category because inflation is an implicit default – you promise 2% inflation, but you delivered something much higher and the value of those bonds goes down because they were priced for 2% inflation. I would view that as a type of default. I don’t think that the US is going to default. I don’t think there’s really any chance that you’d run inflation at high levels like we saw in the 1970s. I don’t think that’s going to occur in our inflation-targeting era. I do think what would happen is that there will be a day when growth is more rapid and issuance is curtailed, and the debt-to-GDP ratio will fall because of that. Hopefully, we’ll get to that situation very soon. But it can happen. I would just remind people of the late ’90s, when Ross Perot ran for president and got 19% on a platform of fiscal austerity. But what actually happened in the 1990s is we had a productivity boom, the US grew at a 4% real rate for four or five years in a row, and we were talking about paying off the entire national debt. It shows you how just a few percentage points and a little bit of productivity growth can really, really help you, if you’re concerned about high debt-to-GDP ratios. It can really help you a lot in a fairly short period time. I think that will happen at some point and that will bring the situation under control. But I would like also to see Congress and the president have a plan for long-run fiscal outcomes that makes sense because that would inspire confidence in financial markets. That would also be a good way to go.
James ‘Jim’ Bullard is president and chief executive of the Federal Reserve Bank of St Louis. He oversees the activities of the Eighth Federal Reserve District, including operations in the St Louis headquarters and its branches in: Little Rock, Arkansas; Louisville, Kentucky; and Memphis, Tennessee. He also participates on the US Federal Reserve Board’s Federal Open Market Committee.
Bullard joined the Federal Reserve Bank of St Louis in 1990 as an economist in the research division. Prior to becoming president in 2008, he was vice-president and deputy director of research for monetary analysis.
Bullard is an honorary professor of economics at Washington University in St Louis, a member of the Greater St Louis Financial Forum, the St Louis Regional Chamber’s board of directors, the University of Missouri–St Louis Chancellor’s Council, the St Cloud State University School of Public Affairs advisory council and the Central Bank Research Association’s senior council. He is also chairman of United Way’s US board of trustees.
A native of Forest Lake, Minnesota, Bullard received his doctorate in economics from Indiana University Bloomington. He holds BSc degrees in economics and in quantitative methods and information systems from St Cloud State University, Minnesota.
The text version of the interview with James Bullard on August 11 contains some light editing
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