Jan 7, 2019

Micro Foundations, Macro Questions

A Macro Musings Transcript
David Beckworth Senior Research Fellow , Julia Coronado

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth:     Our guest today is Julia Coronado. Julia is the president and founder of Macro Policy Perspectives, a Wall Street research firm. Previously, she was a chief economist for Graham Capital Management and a senior economist at BNP Paribas. Julia also served at the Board of Governors for almost decade. Julia, welcome to the show.

Julia Coronado:        Thank you very much.

David Beckworth:     So we're happy to have you on the show. You're an actual Wall Street practitioner, and you're going to set us straight on how the market and economy really works.

Julia Coronado:        All right, I'll do my best, David.

David Beckworth:     Okie doke. So Julia, with all my guests, I ask them how did they get into macroeconomics, and I'm dying to hear your story because you've been both an insider at the Federal Reserve and you're a practitioner on Wall Street. So tell us how you did it.

Julia Coronado:        Well, I was part of a, I guess, movement you could call it, in graduate school, of putting micro foundations to macro. So I was always interested in macroeconomics. As a graduate student, I wanted to study it, but there was this desire to do more micro level analysis with macro ... to answer macro questions. So, that was my thesis was looking at actually Social Security privatization and how that ... I looked at the case of Chile, and how that impacted aggregate savings and investments.

Julia Coronado:        So, that thesis was of natural interest to the Federal Reserve, so I interviewed with them and was hired by them right out of graduate school. At the time, Alan Greenspan was the chair, and was deeply involved in thinking about Social Security, and so my thesis was a natural fit for their interest ... as well as my focus on looking at household behavior and aggregating it up and into the flow of funds section at the Federal Reserve Board. I was looking at household financing and balance sheets and how that interacted with savings decisions with retirement preparedness.

Julia Coronado:        So I had a lot of focus in my research on household finance, pension fund finances, but and also being in the flow of funds group, which is looking at capital flows, credit behavior, borrowing behavior, credit risk, credit spreads, and trying to line it up with the real economy, and what are the signals and what are the interactions between financial markets and the real economy. That made it naturally easy to transition into Wall Street and the financial markets. I mean, that's what it's all about, right, is translating market developments into the real economy.

David Beckworth:     Right.

Julia Coronado:        So, I was recruited by Barclays Capital originally by some of my former Fed colleagues, Jean Mackey, Larry Kantor were who I worked with at Barclays. So, it was actually a wonderful transition.

Julia Coronado:        It's hard, you know, the Federal Reserve Board is a fantastic place to work because it's like getting another graduate education. You learn a macroeconomics that no academic department I know of teaches. It's very ... the rigor comes in application. Why is this interesting, why is this policy relevant, or is it? Everything you do, every analysis you do, you have to apply that question. And you have to learn the policymakers need to make policy decisions you cannot just fuss over all the caveats to your findings, or you have to come down off the fence and make a recommendation. This is our best guess. You have to use data very, very carefully and understand its imperfections.

Julia Coronado:        So it's just an incredible training that you get at the Fed that you don't get anywhere else, and it's a wonderful place to work. You have incredible colleagues. So, it's hard to leave the Fed, but on the other hand, what you end up finding a lot of people end up leaving the Fed because you know, you ultimately, there's hundreds of people poring over the forecast, you may want more ... you don't really have a voice. And what's wonderful about being in the private sector is that I'm in control of my forecast. I am not a member of the FOMC or the research director at the Fed. I can say, you know what, this is where I think the risks are gonna come out, and this is what I think is gonna happen.

Julia Coronado:        So you have a voice, and it changes the way you approach questions and your thinking. It adds a burden and an incentive to get things right. So, that's the biggest benefit of stepping into a market role is that you're calling the shots on your forecast, and it matters to people that are making real decisions with money. So, it's exciting, it's challenging. Getting things wrong is extremely painful. Getting things right is really wonderful. So, I've definitely enjoyed ... I have no regrets in having made that transition, and nor do I feel like I've sacrificed sort of my intellectual development. Because I have more responsibility for my forecast, I put a lot of work into it. I try to always learn from my mistakes, and we had a huge one. We had a huge forecasting mistake in the financial crisis.

Julia Coronado:        Even though being on the financial market side of things we saw things a little bit more ahead of the average forecaster, it still was not ... we just didn't project the magnitude and the scope of what we saw. And so we had to ... I had to go back and say, okay, what parts of my tool kit still work, and what don't? And it was very humbling, and it was also very personally terrifying because I didn't have the safety net of a government job. I had real risk to job loss and income loss, so it was personally terrifying, it was professionally humbling, and I feel like I've learned a lot.

Julia Coronado:        So, it's an exciting time to be in markets and on the ground where that interplay is taking place. So, it's been a wild ride, but I am very pleased. I feel with any crisis it's scary at the time, but I feel like I've learned so much from having been on the front lines when that happened, and I find macroeconomic forecasting in the private sector to be a very exciting place to be.

David Beckworth:     It sounds like a fascinating journey and exhilarating at times. I mean, your part about the great recession, the financial crisis, where your job depends on how successful you are, that is something that academics don't worry about as much, although I know some academics did lose their jobs as well, but not like the private sector did during that time. So, that's an interesting story.

David Beckworth:     What's also interesting though about your career path, what I find interesting at least, is that you were both an insider at the Fed, and I know most of your work now is with Wall Street clients, but you also act in an advisory role to the New York Fed. So, you have seen it from both the inside and then you come back as a consultant. I mean, I've had some friends, for example, who used to work for the Defense Department. They quit, and then they come back as a consultant. So they see it from two different perspectives, and you have that as well. And I'm wondering if there's anything you want to share about that, that change in perspective.

Julia Coronado:        Yeah, definitely. Particularly during the financial crisis, I felt like my role in part was to be a translator between the Federal Reserve and financial market participants, because they see the world very differently, they speak different languages, and yet with all of the crisis liquidity functions and the development of QE, there was a lot of new things that had to be understood between the two.

Julia Coronado:        And so, you know, I learned how to do that, to let investors know how the Fed was seeing the world, how these facilities were working, what they were intended to do, and to then go to Fed officials and say, this is how the market is hearing what you're saying, here's how they're interpreting these actions. So, I served as a bit of a translator, and that's still somewhat the role of a Wall Street economist is to play that translation role. You know, interpreting Fed-speak isn't straightforward, and so having been inside the system, we have a better sense of how the words are chosen and crafted, and how they should be interpreted.

Julia Coronado:        And then also, to be honest, during the crisis, sometimes my role was to say, you know, that model is broken, guys. We have to bring some finance into this. You have to look at what's happening in terms of risk appetite and credit flows and global capital flows. Models do not evolve quickly, and the Fed is always so careful about the models that it develops and selects and uses and relies on, that they weren't quite as flexible in terms of understanding the outlook. It took them a while to grasp the gravity and the depth of the structural hit that we took ... so, whereas it was easier to see when you're in the middle of it.

Julia Coronado:        So, that was partly why I've moved into some of the ... you know, on the New York Fed's economic advisory panel, for example, is that I think they, certainly Bill Dudley, when he created this advisory group, understood that there was valuable perspectives to be had from not just ... the advisory panel is made up of both academics and private sector economists, because we come at things from a very different perspective, and that adds value for them to have that diverse set of perspectives. You can get a bit isolated at the Fed, and not be able to see what's happening in real time always. So, I think that they understand that that's value added for them to have those external perspectives, and I do look at the world very differently than I did when I was inside the Fed and thinking more in a conventional, academic style.

Julia Coronado:        So, it's great that the Fed seeks out different views, because I think that makes their policy decisions more robust.

David Beckworth:     Okay, well very interesting. So, one of the big things that have happened over the past few days, and we're recording this on December 5th, we've had the market go down quite a bit yesterday, several percentage points. There has been talk again about the yield curve inverting, there's been talk about what is the Federal Reserve communicating and are we a long way from neutral rates, are we just below neutral rates.

David Beckworth:     So, I get the sense there's a lot of uncertainty, and the markets don't seem very happy right now. So what is your take on recent economic developments?

Julia Coronado:        Well, in some senses, the market correction we're seeing, it's really a correction in risk appetite to some extent-

David Beckworth:     Okay.

Julia Coronado:        ... is long overdue. We had the fiscal stimulus masking what was an evolving global slowdown that's been proceeding throughout 2018, and yet markets were tightening everywhere in Asia, in Europe, in emerging markets, and the U.S. sort of stood alone as the market where everything was great. The stock market was pricing in what seemed to be a combination of record earnings and sort of permanently low interest rates. Something was bound to give. Either you're not gonna have record earnings, or the Fed is gonna have to raise interest rates more than you've got priced in, and we're sort of meeting in the middle there.

Julia Coronado:        So, it was more of a mystery why markets weren't tightening despite a global slowdown, despite the Fed continuing to tighten policy. Now we're starting to see the U.S. markets catch up. So, why is it happening? It's happening because global growth, which has been ... we had to synchronize global boom in the last couple of years. That is no longer the case. We have trade wars that are complicating the outlook, and the boost from the tax cut to earnings is now moving into the rear view mirror, and companies are starting to have to guide about 2019. All the low hanging fruit is gone, so we're seeing more sensitivity to what is a more mixed bag of news.

David Beckworth:     So Julia, what about the role President Trump has played in this? You've mentioned we've picked all the low hanging fruit, maybe in some ways we were doing better than should have been expected given global conditions. But it seems like President Trump's trade rhetoric or the false hopes that there was a truce in the trade war has played some role in this. What are your thoughts on that?

Julia Coronado:        Absolutely. So, we are seeing the markets become more sensitive to this news. This isn't a new development. We've been grappling with trade wars for a number of months. We've had tariffs put in place, we've had some retaliation, so we've had it, but again, markets had been immune. Now we're seeing markets more reactive to the news on the trade front because it is more material to the outlook. It's more moving more closer to us in terms of the horizon at which it's going to impact things.

Julia Coronado:        So, we are seeing that greater sensitivity. There is also a sense that there isn't a great strategy or an obvious end game in sight, and that's more concerning. If you think sort of broader brush, we've seen the profit share of GDP at record highs on the back of globalization for the last couple of decades, so companies have been able to tap into global supply chains, realize incredibly efficiencies and profitability, and we may be starting to see that unwind a little bit. And it's not just Trump, it's Brexit, it's populism everywhere, it's the rise of China, which is not an open free trade player in the sort of western sense.

Julia Coronado:        So, there's a lot of complications to global supply chains. Some companies are starting to guide, and in their guidance talk about turning towards more or planning for more localized supply chains to protect against political risk. And if that is a broad based development, that would certainly be meaningful at a macro level, because again, we've been riding a wave of globalization and efficiencies. If we're now going to unwind that to some degree so that we're having more political disruptions, making more less efficient decisions based on political risk that wouldn't be great news for current valuations, which are still pretty high.

David Beckworth:     Okay, so one of the things which has been fun to watch as well has been the Federal Reserve, and recently chair Jay Powell had several speeches that seemed to contradict each other. I alluded to them earlier. In October he had a speech, I think maybe it was a conversation actually, where he said-

Julia Coronado:        Right, it was a conversation.

David Beckworth:     A conversation with the Dallas Fed president, where he said he thought that interest rates were a long way from neutral, the point where they would stop raising them. And then just recently, he said rates were just below neutral. And the market responded favorably. They thought, "Oh great, there's fewer rate hikes." But there's been several takes on that; maybe that isn't what he meant. What is your take on that little communication story?

Julia Coronado:        My take on this is first of all when he said "a long way from neutral," if you were watching the speech or the moderated conversation where he said that, it was in the context of a conversation. He was asked about the likely path of interest rates. He used that phraseology, but it wasn't an ... I feel like it was over-interpreted. He wasn't trying to deliver a hawkish message, a message of strict discipline. He was sort of generally describing the Fed's current outlook, and a long way: what is a long way? It's a time, it was before the September rate hike, and they think neutral is about three percent. So were we a long way? We a 100 basis points, that's a long way. But again, it wasn't part of a crafted message, and I feel like the market overreacted to that.

Julia Coronado:        The just below neutral came after the September rate hike, so we've got another 25 basis points, and it was part of his prepared remarks, so I think it was very intentional that they saw the market overreact to a conversational description of the outlook, and they decided to intentionally walk that back. I think the market got it right. Has it overreacted or not? That will depend entirely on the data. I think the market is still pricing in a December rate hike, and another rate hike next year, and that seems fair. Beyond that, it's going to be very data-dependent, and I think one of the reasons that the Fed is also carving out some optionality ... two reasons: one, they are getting closer to what they think neutral might be. It makes all the sense in the world if you don't know exactly what neutral is, and there are long lags in monetary policy, and that was to me another significant part of his recent speech, was he noted that the lags in monetary policy can be up to a year for interest rate hikes to actually take effect.

Julia Coronado:        If that's their assessment of lags, there's a lot of tightening that we haven't yet felt that is in the pipeline. So if you don't know where neutral is and you have these lags of monetary policy, it makes sense to slow down as you come in towards that neutral zone. That's one reason to carve out this functionality, to tell markets, "Look, we don't know beyond the next rate hike what's going to happen. It's going to be data-dependent. We may want to extend the pauses in between rate hikes." Now it's every other meeting. They might take an extra break in between, and so that makes sense, given the lags and where they are in the rate hiking cycle.

Julia Coronado:        The other reason is that they are responding to forward-looking indicators. The markets are telling them that the outlook has become less buoyant. Interest rate-sensitive sectors are telling them that their hikes are starting to have an effect, so the data are telling ... even though the employment data is still very strong, the labor market's doing great, consumers are doing great, but in this environment, late in the cycle, you're getting closer to neutral, you're looking at what are my forward-looking indicators? Interest rate sensitive sectors, financial markets that are forward-looking, the global conditions, and all of these say, "You may want that option. You may not. The U.S. may be resilient; fiscal stimulus may win the day. 2019 might look like 2018, but what if it doesn't?" And there are certainly plenty of indications it might not. Then you will want that option to pause.

Julia Coronado:        I think just structurally being closer to neutral, you want that option to pause, and then the data are telling you, you might want the option to pause. I think it was very intentional that he crafted that message to say, "We're just below neutral, we're not here to ... " There was a narrative in the market that the Fed was going to hike till something breaks.

David Beckworth:     Yeah.

Julia Coronado:        I don't understand where that narrative came from. Jay Powell was never describing things that way. He was always talking about data dependence, extending the recovery, exploring the potential for the labor market to heal further ... I never quite got why the market was telling that story of the Fed being sort of hell bent on hiking till something breaks. Why would they? Why would any central banker sitting in the seat make that decision?

David Beckworth:     This raises another interesting question, and that is this communication problem. The struggle with how to interpret the Fed, and Jay Powell has to be so careful in what he says. As you mentioned, the just below was his intent, and the long way was just the conversation, and so maybe we need to be more careful as observers. Is this the kind of the nature of the beast, or is there any way to improve the communication, the message from the Fed, so we don't have these miscommunications?

Julia Coronado:        I don't know that we can ever avoid the nature of the beast. We've been dealing with that with every Fed chair. It's not bad for me; it's why I have a job. It's up to me to tell investors, "You're not getting that right, or you are getting that right, or this was a conversation, that was a prepared remark." I've been inside the halls of the Fed, I know how obsessive they are about language. Language is like a mathematical equation. Every word is chosen very carefully, so they do their best to be transparent and clear, but they're human beings, number one, so sometimes they say things like, "Oh, we're a long way from neutral," sitting on the couch, having a conversation, not necessarily taking into account that thousands of investors around the world are going to freak out over that phraseology.

Julia Coronado:        Plus, with the Fed, and other central banks too, but you have the cacophony problem. You've got different people with different views. One of the other parts of that September/October shift, was that Governor Brainard gave a very hawkish speech, and so okay, where do we put her, and how much is she speaking for the chair? Is she speaking for the committee, or she speaking just about her personal view?

Julia Coronado:        It's always a bit of a challenge to know how to weight different views on the committee: the chair and the vice chair and usually the New York Fed president are what we call the troika. They're the most important to watch. But other voices can matter, and do matter, and so it's always ... that's a bit of a challenge to interpreting the Fed, is just there's so many voices. And we're in the transition. We've got new committee members; we've got a new Fed chair. That's also ... It takes a while to get to know him and his style of communication as it differs from the prior leadership. There's a lot going on; it's always challenging, and I think that they do the best they can, and truth be told, I don't think we can really ask for a better, clearer communicator, than Chair Powell. He is very clear, very plain spoken, so I think he's doing a pretty good job on that front.

David Beckworth:     Yeah, and to be fair to him, I think all the chairs have some hiccups at some point. Bernanke I remember had a moment where he talked to Maria Bartiromo.

Julia Coronado:        Bartiromo, yeah.

David Beckworth:     He disclosed something to her.

Julia Coronado:        Over a glass of wine.

David Beckworth:     Right, right. So it's not the first time someone has had to learn on the job to keep their mouth shut.

Julia Coronado:        Right.

David Beckworth:     I remember-

Julia Coronado:        I guess-

David Beckworth:     Go ahead.

Julia Coronado:        Yellen's first press conference, right?

David Beckworth:     Yeah, right.

Julia Coronado:        When she was asked ... What was the phrase?

David Beckworth:     We can come back to that.

Julia Coronado:        What "some time" meant, I think it was? And some reporter just really pinned her to the wall, and she said, "It's six months." And that was ... Yeah. They learn on the job for sure. There's a steep learning curve in being in the public eye like that.

David Beckworth:     It is, and I guess for me, I still wrestle with this question though. And I know the Fed is a particularly important central bank. Reserve currency ... I know its actions affect many other countries. I've heard that the Bank of Canada, for example, they don't give as many talks, as many speeches. And they don't have ... My impression is, you don't hear the same cacophony. You don't have as much discussion over what do they exactly mean. Maybe this has to do in part with the nature of the beast. We're designed differently than the Bank of Canada here in the United States. We're also more consequential to world markets.

Julia Coronado:        Yeah.

David Beckworth:     We never get away from this issue, but it just seems to me sometimes, I wonder if all the speeches, the press conferences ... This next year, Jay Powell's going to have a press conference after every FOMC meeting. Is this going to create more signal or noise, and I'm not sure.

Julia Coronado:        Yeah, no, I don't know either. I've always felt like, given where we are in the cycle, and where we are in terms of the Fed's communication, that adding those press conferences wasn't going to change things in the near term, but it might become useful if and when the economy is softening or showing some recessionary signs.

David Beckworth:     Yeah, I know. Yeah.

Julia Coronado:        Because that will allow them to fine tune or shift their message more nimbly. Right now, we've been on kind of a steady as she goes message. There hasn't been a lot to say. In this environment, it's hard to imagine why we need a press conference at every meeting. But, let's say the markets are sensing some risks that are going to materialize in 2019, then having those press conferences can be helpful in signaling a shift, and saying, "You know what? We're seeing some things that worry us, and we're going to just be extra careful so that we take care of the recovery, and signal a pause." That's when the press conferences ... And in terms of where it sits with the cacophony, the more that the chair can control the message, the less inclined you are to respond to maybe regional Fed presidents or other Fed speakers that are saying something different, that are expressing a different view. If we hear more from the chair, the chair has more control over the message. That might make things smoother and clearer to hear more frequently and officially from the chair.

David Beckworth:     So Julia, speaking of improving communication, the Federal Reserve just released its financial stability report. And I'd like to hear your take on it. Is it useful? Could it be improved? Does it tell us anything about the Fed and what it wants to do with financial stability?

Julia Coronado:        The report is an effort at their desire to be more transparent and communicate better. It reveals to the public a framework that they've been putting into place, they've had in place for a number of years already. They put it into place in the aftermath of the financial crisis, and that is to have this very rigorous, systematic monitoring of financial stability issues and as a way of staying ahead of emerging risks that they may need to take into account in making policy. So they track two main tracks, well three main tracks. One is, is there excessive maturity transformation in the system: borrowing short and lending long, which is one of the things that led to the collapse of the banking sector. So they monitor that very carefully.

Julia Coronado:        The second prong is asset valuations: are they excessive relative to historical norms, are they fair? Do we see signs of irrational exuberance, if you will, in asset valuations?

Julia Coronado:        And then the third prong is debt: do we see excessive borrowing or leverage building in the system in a way that can cause more vicious dynamic if it unwinds? Like we saw with the housing bubble, it was particularly pernicious because those valuations, those excessive valuations, were being fueled and funded by excessive leverage. So when the unwind happens, there's that debt deleveraging dynamic, which can create a systemic risk.

Julia Coronado:        Those three prongs are what they've developed as their monitoring framework. They've been monitoring this for years. They've been getting briefed every quarter on the state of financial stability, and now they're just letting us know exactly what they're looking at and what their assessment is. They've always revealed it in the minutes, in the discussion, so it's an evolution in their transparency.

Julia Coronado:        Is it useful? I think it is useful. I think we saw when markets earlier this year were excessively optimistic, that all else equal, that was a reason to lean ... The data were strong, and also it was coming with this excessive layer of optimism. Did it affect things at the margin? It was all else equal, a reason to keep going with rate hikes, and lean towards normalization, and now we might be seeing the reverse. You've got some rather pronounced dynamics and corrections in markets. It's still nothing worrisome yet, but it's something to keep an eye on, and maybe at the margin, lead you to err on the side of some patience in 2019.

Julia Coronado:        We'll see. I think it is useful. Did I learn anything new? Perhaps the most interesting or unexpected part of the report, because again, we've been familiar with the debt monitoring and the asset valuation monitoring, the maturity transformation ... They had an international section that was pretty developed, and that's another dimension that they have to be ... that they've learned to become much more rigorous and systematic about, factoring into their reaction function. They discuss the risks from Chinese leverage, the Chinese credit boom, the global slowdown, the emerging market issues ... There's a pretty good discussion of all of these global risks, and the fact that they do get that kind of a comprehensive global briefing, including global financial stability issues, I find reassuring.

David Beckworth:     Okay.

Julia Coronado:        I think it means they're well informed.

David Beckworth:     Okay, so they're taking it more seriously now. And I think that's pretty clear with also the regulations and all the changes that have been made. Well, let's move on to another topic I'm dying to ask you about, and that's inflation. One of the questions I have wondered about over this past decade is why has inflation been persistently below two percent? Now, it's gone above a few times, but on average, it's been hitting below two percent.

David Beckworth:     If we look at, for example, the core PCE deflator, and if I take the average since June 2009 once the recovery has begun it's just about 1.5 percent. And there's this two percent target and even before the target was officially announced in 2012, it was still an understanding of two percent. So what is your take on this? Why hasn't inflation been persistently low and is it just different now or is it something the Fed has done?

Julia Coronado:        So I think there's a number of things going on here. One, I think from a sort of broader perspective, we know that globalization has come with downward pressures on inflation. The Phillips curve dynamic that we sort of have always had as a cornerstone of inflation forecasting is muted by the fact that labor markets are now global. So domestic labor markets slack isn't necessarily the primary driver of inflation because workers have to compete on a global level. And so it's really we had this opening up of the global economy. Basically an opening up of labor supply that came with some downward pressures on wages and also came with some downward pressures on inflation.

Julia Coronado:        So that's been one sort of meta factor that's feeding into lower inflation in addition to obviously central bank's credibility. And that was sort of a hard fought development over recent decades not just in the US but globally with inflation targets and commitment to those targets. But as you note, the problem is no longer how to keep inflation down at your target but how to get inflation back up to the target. So there's a couple of new dynamics that I think are playing a role in the current performance of inflation. One is technology. We ... sort of the Amazon effect, which is that technology has brought a sort of brutal price transparency and that has made it harder for firms to raise prices because consumers can just shop around and get the best price.

Julia Coronado:        There's been some academic work that sort of looks at a granular level and confirms and identifies that, "Yes, there is an Amazon effect." And that Amazon effect has been sort of spreading out. It was first mainly in online shopping but now it's the disruption from ride sharing apps to taxi rides or Airbnb to hotel and motel pricing. And potentially moving forward going into things like health care where transparency could bring better pricing or more competitive pricing. So I think that is one new dynamic that these ... the tremendous transformation we've seen on the technology front is playing a role.

Julia Coronado:        And then I think also just the way our inflation is constructed. We measure housing inflation in the rental market. So we basically look at what rents are and if you own a home, it's like what you would pay to rent your home is what's measured in our inflation indexes. And what we saw in the housing crisis was, and if you look traditionally first of all, when you identify a Phillips curve, you can run a Phillips curve regression. That is how much slack is in the labor market to inflation on different components of inflation. And the Phillips curve has always been most pronounced in the transitive sector of housing. Not surprising, right?

Julia Coronado:        So when the labor market is very strong, you tend to see rents go up. We've had a disruption to that this time around. In the housing crisis, we saw this incredible decline, shock to home ownership, shift to rentals. So we saw, actually one of the reasons inflation didn't fall as much as forecasters were expecting in the immediate aftermath of the Great Recession was that rents were going up because everybody was like ... a huge wave of people shifted from home ownership to renting. We didn't have enough rental properties to rent them and so there was this upward pressure on rents even though we had 10 percent unemployment.

Julia Coronado:        And so that was a disruption to the normal cyclical inflation dynamic. And now we've had a multi-year, multi-family housing construction boom. We're actually starting to see millennials maybe dip their toes into home ownership so there's less demand for rentals. There's more supply of rentals and we're actually seeing rental inflation moderate at the peak of the cycle when purchasing power is doing well and the unemployment rate is below the natural rate. And you would expect upward pressures on inflation. We're not getting that acceleration in rents because the whole rental cycle has been disrupted. So that's another reason-

David Beckworth:     Okay.

Julia Coronado:        Peculiar to this cycle that we're not seeing more upward pressure on inflation from a cyclical standpoint.

David Beckworth:     So there's a number of developments that have occurred in other words that have led to this result. One question I have though is given that these things do create measurement problems, uncertainty in the near term. Is it Amazon? Is it globalization? Is it measurement issues? I can accept that that's something the Fed has a hard time wrestling with. I mean I would have a hard time too, no doubt.

Julia Coronado:        Yeah.

David Beckworth:     But I guess my question is on a persistent basis over a decade, it to me, the monetarist in me says maybe the Fed is doing something systematically wrong. Either it's incredibly unlucky or it's just really not doing its job. Am I being too harsh?

Julia Coronado:        Right. No, I mean I think ... look. I feel a fair assessment to say that because of the debt deleveraging dynamic of the aftermath of the Great Recession of this recovery, monetary policy has been less effective than usual, right? We didn't see ... you have the credit channel effectively shut down for households throughout the entire recovery. They're not responding to interest rates because they're cleaning up after a huge mess. So it's not an unfair criticism to say that monetary policy has been less effective.

David Beckworth:     Okay.

Julia Coronado:        And so I agree with that and I do believe at the end of the day that the Fed has the tools to generate inflation if it really wants to, right?

David Beckworth:     Right.

Julia Coronado:        But then the other complication is that quantitative easing is also generally thought to be less effective, definitely declining marginal benefit, right?

David Beckworth:     Absolutely.

Julia Coronado:        The first wave undeniably useful. The third wave less of an impact. And on top of that you have a political backlash to that sort of totally unprecedented decision that the Fed made and so they don't have the flexibility to maybe engage in as aggressive a policy as would be required to generate the inflation outcomes that they seek. And it may just be again that this cycle, because of that attenuated policy transmission, maybe it would be irresponsible to push policy to the extent you would need to generate inflation pressures. Maybe you just let the cycle play out with some patience. And I think that's kind of where we are right now.

Julia Coronado:        Where we are with policy is, "Okay, we were running so strong and inflation was picking back up and it seemed like the right thing to do and markets were a little crazy and it was the right thing to do to move to a more neutral stand." But now as you say, we're just not getting those kinds of cyclical inflation signals. We are closer to neutral. We're unwinding the balance sheet. Maybe it is right for the Fed to sort of be a little more cautious and patient here and not make a policy mistake of tightening too much so that those inflation pressures can continue to heal and normalize. That inflation dynamic can ... and I think that's what we're hearing from them. They've introduced symmetry.

David Beckworth:     Right.

Julia Coronado:        That's not exactly the same as a nominal GDP target. And it's not the same as a price level target. But it's sort of a baby step in that direction, right?

David Beckworth:     That's right. That's right, yeah.

Julia Coronado:        We're gonna allow ... we want some overshooting. We're not only gonna allow it, we welcome it. We're forecasting it. It's now in our baseline forecast. And that's another development lately. Inflation's been weak. Core inflation has sort of softened unexpectedly in recent months. It's come back down off two percent. And oil prices are now down quite a bit so that offsets perhaps some upward pressure from tariffs. So the inflation backdrop also says to the Fed, "Maybe you ought to be a little more caution here. Maybe you're closer to neutral than you think. Maybe you're just below neutral."

David Beckworth:     Right. Well, that's a nice segue into the next topic in the time we have remaining. I want to touch on this review of strategies that the Feds gonna be doing over this next year. And they're gonna have a conference in June. That thing's gonna be kind of the highlight at this development.

Julia Coronado:        Right.

David Beckworth:     But all over this next year they're gonna be reviewing what they do, how they do it, how they communicate it. And one of the topics, one of the parts of this conversation is gonna be the monetary regime itself. So you alluded to this. What should the Fed be targeting? Should it be targeting a truly flexible inflation target? Some metric? Some would argue you have a higher inflation target. Others would say a price level target. Others like myself would love to see a nominal GDP level target.

Julia Coronado:        Right.

David Beckworth:     But what I would like to hear from you is your perspective and what you're hearing from Wall Street? When they hear this chatter about changing the regime, does it get them nervous? Are they excited about it? Indifferent? What is your take?

Julia Coronado:        That's interesting. So we do, my firm does a survey a market participants every quarter and we've been asking about inflation expectations and about investor's views of the Fed's view of inflation. Whether there's a ceiling and so on. What we have found through this survey is that a year ago investors were deeply skeptical that the Fed would achieve a symmetric two percent target. Deeply skeptical. The majority view was that they would never achieve it the way they say they want to. And that maybe they don't even ... maybe they do have implicitly a ceiling. So I think since then we've had the symmetry emphasis, the Fed actually forecasting above two percent inflation in its baseline outlook. And we've had improved inflation dynamics so there's some adaptive learning going on.

Julia Coronado:        And investor's expectations have changed a lot. They now are more ... they now believe the Fed that they can and will achieve a symmetric two percent inflation target. I think that that's-

David Beckworth:     Interesting.

Julia Coronado:        Great news for this discussion because before if you'd ask me a year ago about this conference and this whole reevaluation, I would have said I think the Fed is playing a dangerous game here because they might think, "Oh, we can do this nominal GDP targeting or price level targeting, whatever symmetric target, whatever the evolution is" but nobody believes them. You know?

David Beckworth:     Yes.

Julia Coronado:        And that's a dangerous place to go. And now I think they're actually starting from a position of strength that both the data and their own communication has set them up to have this discussion in a productive way. So I think investors are going to be listening to this and I think it may be overwhelmed by events. I mean we've seen inflation compensation in the market be extremely volatile lately. And with the energy prices and the global developments so I hope that that is not the case. I hope that they can have a productive discussion because I know you're sympathetic towards nominal GDP targeting. I'm sympathetic towards some version of that. Whatever is easiest to communicate, I think if they do it in a methodical, well-communicated way, there is scope to achieve ... well, ultimately the goal is to get inflation expectations up a bit so that they have more policy room over the long run. So I'm optimistic about the effort.

David Beckworth:     Okay.

Julia Coronado:        I think that they're ... I hope that the circumstances remain favorable for them to conduct this and I think that there are evolutions we can see that will give them that desired policy space.

David Beckworth:     No, that's a great perspective and you're right, let's hope nothing crazy happens between now and then. That will disrupt and take their focus off of this issue. Can you imagine, for example, a recession came along. That would definitely change their mind. I mean in 2011, the Federal Reserve had a conversation and I know they talked about nominal GDP level targeting in particular. I know they also talked about other issues and one of the concerns was we don't want to change horses mid-stream here.

Julia Coronado:        Right.

David Beckworth:     This would be a hard ... It'd be tough to do something when we're already facing low inflation and other problems. So I like your point. Now is a good time to do it assuming no other crisis emerges. They're in a good spot. Now's the time to do it. Now's the time to act. And from what you're saying, your surveys indicate Wall Street's also more receptive to these changes now.

Julia Coronado:        Definitely, yes.

David Beckworth:     Okay. Well, our time is up. Our guest today has been Julia Coronado. Julia, thank you for coming on the show.

Julia Coronado:        David, really seriously, thanks a lot.

David Beckworth:     Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app, and while you're there please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening.

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