Sep 10, 2018

Adam Posen on Trade, Inflation Targeting, and Central Bank Independence

There are a number of key differences that exist between the Federal Reserve and the Bank of England.
David Beckworth Senior Research Fellow , Adam Posen

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Adam Posen is the president of the Peterson Institute for International Economics and was formerly senior fellow at the Bank of England, helping set monetary policy between 2009 and 2012. Adam has also worked at the New York Federal Reserve, has advised many central banks and governments, and is an accomplished scholar in the field of macroeconomics. Adam joins the Macro Musings podcast to discuss some of his research as well as the work of the Peterson Institute.

Read the full episode transcript:

Note: 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: Adam welcome to the show.

Adam Posen: Thank you for having me, David.

Beckworth: Oh, it's a real treat to have you, one. As I mentioned, you've done a lot of interesting work. We've followed it and I know there's many listeners dying today to hear your thoughts. I always ask my guests though, before we get going, how did you become an economist? What's your journey?

Posen:  My journey was kind of surprisingly straight forward in retrospect, though it didn't seem that way at the time. My parents had a huge influence on me intellectually, both explicitly what they wanted to convey from their life experience. So they were both physicists doing research, doing empirical research for government agencies. My father for the air force, my mother for the Saskatoon working for the space program.

Posen:  And so they brought me up with a very big emphasis on evidence on how hard it is to know something, how you don't wish something to be true that isn't true with the facts, but if something is well established, you trust it. They also conveyed the idea of relevance and you do stuff that actually affects the world. I mean not just like changes the whole world, but is tractable and relevant and the idea of research and intellectual honesty.

Posen:  So all those were inculcated, but also I took a lot from their experience and they would not say it this way, but they were both grew up in real poverty. My father had some very extreme hardships. My mother's childhood was not easy either. And it was nothing they did. It was nothing their parents did. Their parents, my grandparents came to Canada as immigrants 100 years ago.

Posen:  And so it just inculcated mean the idea that people's fates and wellbeing and their whole attitudes could be affected by factors that are social and economic, nothing they can control. And then I just sort of got in my head. And so bizarrely by the time I was 13, I apparently was already telling people, "I want to work at a research institution in Washington on international issues." Which is kind of ridiculous, but apparently it was true.

Beckworth: You were prophetic, I guess.

Posen:  I guess. I don't know. My wife laughs, she knows this, and she laughs about the fact that at that time I wanted to be a ballerina. She of course did other things. But anyway, and then at a later date, early in college, I ended up wandering into the Federal Reserve bank of Boston and their library for some reason. And so then I was like, "Oh, this central banking would be cool."

Posen:  And so I've been very fortunate in two senses. I got to do central banking and think tank work as an opportunity, but also it turned out to suit me well and I enjoyed it as much as I hoped.

Beckworth: Yeah. So you've worked at the New York Federal Reserve, Bank of England. We'll get to that in a minute. But you're also the president of a very prominent think tank here in Washington, D.C. And I'm curious if you can tell me about what it's like to be a president there. I mean, there's a lot of issues you face, you're a scholar. I guess that's what's fascinating to me. You're a scholar, you've done a lot of work, but now you're managing a big organization. How do you balance those two things?

Posen:  Well, for me from my point of view, I am better in some ways as a manager than I was as a scholar. I think if I hadn't been a serious scholar, I couldn't do this job well. But the think tank is, as you and I have said, it's like market to center or PIA. It's sort of like being an academic, except your audience is the public rather than the students for starter.

Posen:  And what I like to say, speaking for me and my team is, it's more important to be right than to be clever. So sometimes in academia, there's a premium on being original or using the latest techniques for its own sake. And sometimes it has benefits and sometimes it doesn't. But even though we have really top rate people, including people like Olivier Blendchard or Joe Gagnon who you've had on the program or Monica Taboola, the emphasis is on doing what's relevant and robust and right rather than what's necessarily clever or technical or spiffy.

Posen:  Anyway. But in terms of the think tank being a manager and the mission is to try to effect the public debate and policymaker decisions. And for us, it is to do that through evidence-based argument. And the ultimate goal, the vision we have is a world that's rules-based economics that provide sustainable growth for Americans and for everybody. Another way of putting it is, we're the intellectually honest pro-globalization people.

Beckworth: Okay. Yeah. And you guys do a lot of interesting to work including your own. And later in the show, we'll get to that. And as I tell my colleague Dan Griswold, and I'm sure President Trump has increased your workload. He's the full employment act for folks like you who think about globalization issues.

Posen:  Yeah. No, it's both, of course, disheartening as it is in our field and so many fields that they're throwing away established mainstream policies, certain bounds on policies that were well there for good reason, and that they're ignoring experts in evidence in a lot of ways. On the other hand, of course, it's hugely motivating. What we're doing feels so important and so light.

Beckworth: Right. Right. So, it's a double edged sword wherever we are today. But it is frustrating to see decades and decades of institutions have been built up since world war II being eroded away. The things that brought peace, prosperity for many, and that is the concern is that we're going to lose those important institutions. We'll come back to those in a minute.

Beckworth: I want to switch to your work at the Bank of England. We've talked a lot on this show about central banking and it's all been Federal Reserve focused, and it's just so I'm happy to have someone who's actually been a voting member at the Bank of England. So tell us about your position because the position I believe is called an external voting members. So how did you get that? What does that position, and then tell us about the Bank of England.

Posen:  So the Bank of England put in place after it got independence from the government with this new system of what's called a monetary policy committee. In terms of function, it is equivalent to the FLMC. It's got a slightly narrow remit. There's a separate committee that deals with banking, financial stability issues whereas the FMC in the US deals with both that and monetary.

Posen:  The composition of the committee, which was designed in 1997 under Gordon Brown who was then the chancellor of the Exchequer. And Ed Balls who worked for him has written about this, is quite clever. The idea is that there are five internal members of the committee and these are full time employees of the bank on the org chart. So the governor, the deputy governors, the chief economist, again roughly equivalent to the chair and vice chair.

Posen:  And then there are four what are called external members who are paid by the bank and generally on lead from an academic institution or left a business role. They're also full time, but we're off the org chart. Your sole job is to participate in and be ready to vote and do relevant research, but more importantly, to learn what's going on in the British economy, in the world economy, and understand what's going on.

Posen:  And it's very interesting. I used to take people, including some FMC members or former FMC members who'd come to visit. It's a very different experience even though the product in a sense, interest rate decisions or QE decisions and forecast are the same. So if you ever go and you've talked, I know with many guests about this, you go to the Federal Reserve, the FLMC has meetings in this enormous room with an enormous imposing table, and all the FMC members plus the barons, the heads of departments and the head of the market desk at the New York fed sit around.

Posen:  And each FMC member has a few staff with them in the cheap seats and there's like 70 people in the room, and they have metal nameplates that are screwed into the table. And there's a set order and duh, duh, duh, duh. The NPC at the Bank of England and a lot of credit is due to Mervyn King who was governor when I was there, but he developed this whole set of processes is completely different.

Posen:  So there are nine members in the NPC. You meet in a very nice little room, but it's movable tables. The room sometimes gets used for other things. There are three staff in the room with the nine voting members and their job is to take notes. And once every three or four meetings, someone would ask a specific question for them to look up. But that's it. They're silent.

Posen:  And there's one representative of her Majesty's treasury who again his job is just to observe. If that person is asked a question, they respond, but they're not commenting, and it's very free flowing discussion. And so, it's just physically, emotionally, intellectually completely different experience. And this also shows up in the norms. So at the FMC, you essentially never have any members of the board voting against the chair, and you almost never have more than two or most three reserve bank presidents voting differently.

Posen:  Larry Meyer who was on the board wrote about this in his memoir, that there's sort of a defacto rule that you take turns dissenting if you want to dissent. The Bank of England, it's set up so the chair can be the governor can be out voted and it's not a cause for them to resign. It's not something you want to happen every time, but it emphasizes the fact this is, every meeting is alive meeting. It's a genuine discussion.

Posen:  I would like to think that this produces better results, more thoughtful results. I don't know if it actually does, but it was a very good experience and it's a very different experience than from what I understand being a member of the FMC is.

Beckworth: Do they release transcripts from the meetings at the MPC?

Posen:  So they didn't when I was there, there is recordings. They were used to write up things and then the recordings would be destroyed. A few years ago, the current governor, Mark Carney asked Kevin Warsh, a former member of the Federal Reserve board to do a LITA reexamination of transparency policies of the Bank of England. And now there are transcripts get released after, I forget what, it's five or seven years. So, we'll see how that plays out.

Beckworth: I'm curious because one of the critiques of releasing as you know the transcripts of FMC is that people are more guarded in what they say.

Posen:  I agree.

Beckworth: You don't have that free flowing exchange.

Posen:  No, no. I completely agree. I mean, I'm all for transparency. I don't think this is meaningful transparency. There's not going to be any secret conspiracy of anything that with there are witnesses in the room. That's not what we need to worry about, but you need to worry about exactly what you identify, David. That people worry about being embarrassed. People become afraid to float ideas and challenge each other, afraid to be seen as changing their mind.

Posen:  And so again, this is one of the reasons why I think this was not a great move by the Bank of England, but it's still going to be less fraught frankly than at the fed because for one thing, you don't have the perceived division between the reserve bank presidents and the other members. And second, the relationship between Congress and the fed, which I know you've talked about in other episodes, is very fraught and suspicious on the part of Congress towards the fed.

Posen:  Whereas in the UK, there is some parliamentary oversight, but it's not as drama driven. So I think there'll be less of a got you culture, but I totally agree. I think you want there to be accountability and you want there to be no secrets in any meaningful sense. But transparency is not necessarily served by just dumping everything out.

Beckworth: Right, right. There's a tradeoff there, and I like what I hear, what they do at the Bank of England is free exchange. Let's really just work this out, come to a good conclusion. Now you mentioned parliament. Do they have hearings like the Humphrey Hawkins?

Posen:  They do have hearings, but fundamentally they're less powerful with their sector of the bank. So the way independence is set up in the US as you know, and as I think you've spoken about, is that there's the Federal Reserve Act. And at any time a majority of Congress can reopen the Federal Reserve Act and change the deal.

Posen:  In parliament in the UK, that is also conceivable, but it's not really on the table. The idea was this was a pretty much a permanent shift. The second thing that's different is the hearings. So hearings, and this is not just true with respect to the fed. Hearings in the US Congress now in my experience have become really stage shows that aggrandized the Congress people.

Posen:  So I remember I was testifying after Paul Volcker at a hearing of, I think it was the joint economic committee once. And Paul Volcker of course, is a huge figure, both physically and stature. And it was in a Senate hearing room and you've got these incredible tiered huge wood and marble desks at which the senators come in and they come in and they ask their one question that's handed to them by a member of the staff on a note card. And then they listened and then they leave.

Posen:  And they're peering down at poor Paul Volcker who normally towers over people because they're on this huge, raise, imposing Deus. And you've got the symbol of the Senate is the bounce, sticks, and acts like in Roman times, which is also the fascist symbol in Italy. And it's just a very different dynamic. In the UK again, there were I believe three times a year hearings of the, what was called the treasury select committee, which is roughly equivalent to Senate banking, although it was in the House of Commons, not the House of Lords.

Posen:  And they would always have the governor and one of the other internal voting members. And then one or two of the external voting members. And everybody seated literally, physically the same level. There are questions. All members of the committee stay for the entire hearing, the questions from the gamut from good to not so good. But most of them are pretty good.

Posen:  The members ask their own questions and are constantly being fed by staff, and it's much less theater and drama. But ultimately, it's just less threatening because you need ... the way a parliamentary system works, you need basically the government, what's called the government, the prime minister and cabinet to want to change the Bank of England law. The treasure committee has no threat.

Posen:  Whereas in the US, I find the fed is for understandable reasons, often quite frightened of Congress because there is a credible threat. They can do something.

Beckworth: Right. That's very interesting. So much more civil conversation.

Posen:  I don't want this to be sort of a Downton Abbey, "Oh, that's because the English are civil." No, no. This is really structural. It's a different philosophy of government. But also I want to emphasize this varies a lot around the world. A lot of my research prior to becoming head of PIE was on comparative central banking, comparative monetary policies, and you can see this at the European central bank.

Posen:  So the European central bank is actually the most independent central bank in the world because its independence is set up by the master treaty and international treaty. So there is no oversight. I mean they have to show up at the European parliament and people can try to embarrass them. But basically there is no threat of anybody taking away the independence or the budget or anything of the European center bank because it would mean reopening one of the fundamental trees of the European Union.

Posen:  And you can see this in the ECB behavior. I mean there is a certain amount of political accountability, legitimacy issues they have to take into account. But if the Bank of England is less frightened of political interference in the fed, the ECB is even further.

Beckworth: Interesting. I'd love to hear a conversation in a bar between Mario Draghi, Jay Pow, Mark Carney, see them compare notes and poor Jay Pow saying, "Man, you guys have it easy, you have it easy. You don't have to go through the grill and I do." Let me ask this question about Mark Carney. Now, he came from Canada. So is that typical?

Posen:  No. It's very atypical for large countries central banks. So there had been various small countries. Iceland, Hong Kong, some of the not small countries, the small economies in Africa where they would bring in a foreign expert to be either head of or deputy governor of a central bank. In fact, even recently, the deputy governor of the Central Bank of Ireland was a man named Stefan Gerlach, who's I believe Swedish and had worked for the Swiss national bank.

Posen:  But for the large economies, for US, UK, most of the major Western European economies, Japan, China, that was not in the cards. The most radical was the Bank of England, which would occasionally have a foreign member.

Posen:  The NPC, which included me. Yeah. And it's strange in two senses. So first is when you think about how anti-migrant and suspicious of foreigners the whole Brexit impetus has been in the UK right now. I look back and you know, I was there 2009, 2012, and literally I spoke, I think I totaled it up. If you add up all the public appearances I did in information sessions and visits, I probably spoke in front of 10,000 British citizens over the three years.

Posen:  And I literally only once got a question of someone saying to me, "You're a foreigner. What are you doing here?" And otherwise, people were totally gracious and open. And so that shifted. But also when I was appointed in the Bank of England, I was invited for reasons not worth going into. Historically, the British embassy in Washington holds a dinner for the FMC once a year. And Alan Greenspan encouraged this and it just continues.

Posen:  And so I was invited because I had just been named to the dinner for the FMC. And I know most of the FMC members, I'm not a member obviously, but I knew most of them. And literally, I counted, was three people out of the 12, 13 people there came up to me and said, "Can you imagine a foreigner at the Federal Reserve? The Congress would burn us down."

Beckworth: Absolutely. Yeah.

Posen:  Political culture's different.

Beckworth: Yeah. They'd have to be a US citizen. This blows my mind to see how they do that over there. Now you also went there at a very interesting time. So your time there, if I understand, was 2009 to 2012. So, you didn't pick a dull moment. You jumped right, sink or swim time at the Bank of England.

Posen:  Well, from a personal perspective, I probably timed it about right because I was appointed to start in September, 2009. So, I was after the very worst acute crisis, and obviously the people in all the major central banks were working around the clock under great pressure in the 2008, 2009 period. And I skipped that.

Beckworth: So you skipped some of the sleepless nights.

Posen:  Yeah, I skipped some of the sleepless nights and the really terrifying stuff. But it was still ... there was a lot of risk. There were a lot of bad things happening. Recession, worries about the effectiveness of policy or the ineffectiveness of policy, unexpected developments. And I want to stress that while in the US in large part thanks to Bernanki and the team at the Federal Reserve, the worst was already over by end 2009 or early 2010.

Posen:  For the UK and in part because of what was going on in Western Europe and in part because of its own banking system problems, the risks were very real of another worsening downturn of things getting worse all the way through 2011. So it was still a very interesting time. What one was doing you hoped was meaningful. And I ended up advocating for very activist expansionary policies.

Posen:  I came in after the Bank of England had engaged in the first round of quantitative easing, which was not quite but close to coordinated with the fed. But at that point, they were very reluctant to do another round to expand and extend it. And I spent a few months becoming convinced both because of the UK and because of the world at large that we were forgoing a lot of output and employment we didn't have to and the situation could get much worse and there were no downsides to more expansionary policy.

Posen:  And so I started arguing for it in early 2010. And I went through a number of votes where I was the one dissenter was eight one against me. And then after several months, close to a year, it became nine O in favor of further quantitative easing.

Beckworth: Interestingly, the tide turned and you convinced them and ...

Posen:  I played some role in convincing them.

Beckworth: You played the role in changing them.

Posen:  And it was meaningful and I played some role in pushing the how and the when and the size and why it was important. But obviously, it wasn't just me. There were also events -

Beckworth: Absolutely right. There were studies and conversations going on, but you definitely were an early catalyst moving in that direction. So something that's neat about the UK Bank of England is that for whatever reasons, and maybe you can explain why, they did not have the low inflation that the Eurozone, the US has had. They've actually had not ... and I've heard tax reasons, I've heard, but it's got to be also due to the Bank of England too to some degree, right? Or not.

Posen:  Well, it may be due to the Bank of England, but it certainly wasn't conscious in the sense that we, at least while I was there, and then my understanding of the forecast in the minutes and inflation reports have come out since then. I mean this was a surprise. Or putting it differently, I think all the major central banks, including bank of Japan, sort of went into this period saying, "Oh, if we do the following list of things, including quantitative easing and a bunch of other stuff and talk about our inflation targets and commit, we should be able to reverse the deflation pretty quickly and get inflation back up." And it turned out Bank of England ex-post ended up being-

Beckworth: The only one.

Posen:  Yeah. And even then, it wasn't by any means feeling very secure about it. It wasn't taken for granted. It wasn't easy, but just sort of exposed. It turned out we were the only ones that came close to that. So I think the intellectual and policy problem is still there is why didn't it work in these other places in terms of raising the inflation rate, not rather than just sort of stopping the downward fall.

Posen:  But also I want to emphasize, for the UK, there were some temporary factors. It is a smaller, more open economy than either the Euro area as a whole, the US, Japan. And so the sterling, the pound had declined by roughly 25% tray weighted in over the course of 2008 into early 2009. And that was sustained. And that actually did have an impact, helped to push up inflation.

Posen:  Whereas for the US even though the dollar for a while had declined a pretty large amount, it just didn't get passed through or result in the kinds of inflation in the US I think in part because the US is more closed and it's bigger. Actually that was one of the internal debates I was involved with at the bank. Was I forecast that the pass through to inflation, I didn't get it precisely right by any means, but I forecast the pass through to inflation would be on the order of six to one to eight to one.

Posen:  Meaning if you sustained a 25% decline in the pound, you would get between a sixth and an eighth of that on the target inflation rate. The Bank of England based on the previous 20 years, the staff and the insiders believed that was ridiculously high, that the inflation pass through it would be very low because they were so credible in their inflation target commitment. No one would pass it through.

Posen:  And so they had estimates of well below 10 to one going out to 21, and that was similar to the Federal Reserve. Ex-post in the UK, it turned out to be closer to what-

Beckworth: You were right.

Posen:  ... I had done. But in the US case it's remained very low.

Beckworth: That's interesting. You mentioned the openness maybe being a factor of the UK. Because if you look at the countries that in my view at least did the best, Australia, I mean small open economy, Israel to some extent did relatively well. And so maybe it's just easier in those countries.

Posen:  It is.

Beckworth: You're nimble, you're smaller, maybe less politics as well, and you have to open economy advantage, the exchange rate.

Posen:  I think it's a lot of things open economy vantage. I mean there are a lot of times when being a small open economy is harder because you're more subject to shocks, you have less control. But if you're a small open economy, you can sometimes benefit more from the global cycle or from adjusting your exchange rate and your monetary policy vis a vis others in a way that a China, Japan, a US, a Europe cannot.

Beckworth: Yeah. I mean the US is the reserve currency of the world. So it's really fighting somethings uphill battle trying to use that channel. But that's very fascinating. So I want to move to your research related because you've touched on it, but you wrote a very influential book about inflation target and you were the coauthor with Ben Bernanke and others. But the title I believe was Inflation Targeting: Lessons from the International Experience. And tell us about that book. What did you find and have your views changed since that book's been released?

Posen:  I was very fortunate to get involved in that project. I was economist just out of grad school at the New York fed, and Frederic Mishkin was then the only from Columbia was the chief economist and EVP at the New York fed. And Ben Bernanki was an outside advisor, thanks to Rick at the New York fed. And they came up with the idea, they had noticed that Australia and New Zealand and the UK had moved to this new form of monetary policy on inflation targeting.

Posen:  And they came up with the idea, we should do work on that and might be a good way for the US to preempt some crazy ideas that were running around about the fed. And so I, along with Thomas Laubach, who's now the head of the division of monetary affairs at the fed, but who then was a grad student of Ben Bernanki who came to work for me at the New York fed did all the case studies and developed a lot of the textural stuff.

Posen:  And Ben and Rick of course did the high level theory concept stuff. And we're very proud of that book. But speaking just for myself, not for my distinguished coauthors, I am a long way from where we were in '97. So we finished the book in '97. It got published in start of '99. And at that point, inflation targeting was seen as the state of the art.

Beckworth: I read it in grad school by the way.

Posen:  Yeah, no, I mean Ben Bernanki Rick Mission, Mishkin was a big deal. It was seen as to state the art and it was being promulgated across central banks around the world, and the fed was about the only major one that didn't formally move to. Well, actually that's not true. It wasn't the only major one. Every major central bank to some degree moved in this direction. Now, my take was always a little different than my coauthors.

Posen:  It was that the inflation targeting was a positive pragmatic compromise in two directions. First was that it was more transparent than in terms of providing information about big issues, the forecasts, the expectations for the economy, the desires of the central bankers than a lot of previous regimes in a very formal way. And it created a framework was the term we used for communicating these things in a consistent way that people could understand.

Posen:  And second that it was what I called a discipline discretion. Bernanki and Mishkin had a slightly different concept. They called a constraint discretion, which is what was used in the book. But anyway, as I know you've talked about in past episodes, and you're very aware of in your program here at Mercatus with Tyler and what Scott, this is debate over rules versus discretion and monetary policy.

Posen:  And I viewed inflation targeting as a midway point between rules and discretion. It was more disciplined than pure discretion, but it was not going probably roles. So I had a very pragmatic view. Now as is the case, often in economics, a bunch of theoretical work developed that sort of made idealization of inflation targeting. So there was the famous economists, Lars Fenson, who did all this stuff on inflation forecast targeting very formal models.

Posen:  There was Mike Woodford, the distinguished monetary theorist, who talked about how these expectations models created. Norman Alankus in various ways. But also as is the case with any seemingly successful institution, it becomes sticky and promoted beyond what it should be. And that's true I think of any institution that's a regime that succeeds. And so you had a very good run from the mid '90s through the mid 2000s in US in particular, but also UK and some other places.

Posen:  And central bankers, people like Alan Greenspan, Mervyn King and some others were very content to let people say, "Yes, our great monetary policy had enormous amount to do with this great outcome." And I think, again, not that any of my distinguished colleagues explicitly say this, but I think they contributed to an environment that the financial press and market people and some academics did, that there was this notion of very precise control of inflation.

Posen:  That if you were forecasting that inflation was going to be 2.4% rather than two percent of your target, you might think about adjusting your interest rate. And so both of these aspects, the formalization where then seeing it as a pragmatic compromise, emphasizing the transparency, and the over-hype of the specifics of various Saskatoon institution I was uncomfortable with from the start. And it just got worse over time.

Beckworth: What about the success of inflation targeting maybe being a hindrance over the past decade coming out of the great recession? By that I mean everyone come to expect low inflation as the norm, the public, Congress, financial press, even academics, and they become a slave to the regime to the extent that they can't tolerate a temporary inflation overshoot. So if you think of historically I've done this, looked at the data.

Beckworth: But typically if it's nominal income or if it's inflation, you typically ... there was a recession, it bounces back, and it kind of, then you'd go back to two percent of whatever your target is. But that wasn't tolerated. I wonder if that impart can be attributed to this religious affiliation.

Posen:  I think that's well identified, David. I think there is something of a religiosity to it. And again, the Fed's not the worst on this, but there are central banks like the bank of Japan for a while, until roughly 2013, the ECB until Mario Draghi came in where the German central bank was a voting member of the ECB. I've been very dogmatic on this.

Posen:  And what I realized over time, I agree with you that there ends up being, this may have hindered the recovery because it was never credible that central bank's really where we're going to allow an overshoot. And we can even arguably see that right now in the US the fed feels it has to raise rates ahead of inflation going up rather than as was sort of mooted by the previous chair at times of having an overshoot.

Posen:  Now with specific respect to inflation targeting, what I identified a few years ago and have since said is, I think one of the mistakes, one of the things we got wrong or didn't realize when we wrote the inflation targeting book was the inflation targets would in the end become like exchange rate targets in the following sense.

Posen:  If you set an exchange rate target and there are a lot of disadvantages to doing it. But once you do it, you almost never want to appear on the soft side, and you almost never adjust it so that the currency weekends because you're worried that sends a bad signal. And Barry Eichengreen has spoken about change rate pegs like heroin. Once you get on them, they're very hard to get off.

Beckworth: Great analogy.

Posen:  Yeah. It's a scary analogy, but it has some relevance. And so similarly what we've seen is once people set an inflation target and once it becomes commonly accepted, so like basically all the central banks, they have some differentiation in their specific inflation series or number. But basically they all say roughly two percent.

Posen:  And then nobody wants to deviate and say, "Well, we're going to raise the target." Now when Bernanki, Mishkin and Laubach and I wrote that book, you can go back to it and there is some discussion about no, you don't want to change the target all the time because you lose credibility, but you would want to change the target as the economy develops, as things change.

Posen:  And we didn't foresee what I think we should have, but ex-post I now realize we didn't foresee that it would have this aspect that once you set the target, it's seen as a huge credibility problem to say move it up even if only temporarily. And so, you end up with basically asymmetric inflation targets when all the arguments are that it should be symmetric. Like you said, there should be some overshooting.

Posen:  The second thing is, and this is stuff I'm working on right now, is I think generally there's been too much persistence in the central banking community and in the macro community of assuming what happened to the 1970s is of general relevance. So there's this belief that we learned in the '70s and early '80s, that if you're not really tough on inflation and preemptive of an inflation, it gets out of control.

Posen:  And I think Japan in particular, but also the events of the last 10 years in a number of other countries have shown us that's not true. And so part of the inflation targeting bias and the kind of thing you're talking about about the dogmatic resistance to overshooting is there is this, I think, ill-founded belief that it's asymmetric. That if you overshoot a little bit, it's just going to keep going up. And I don't think that's right.

Beckworth: Yeah, that's very interesting. And we have talked about that and I wonder if part of it is just a generational thing. Like you mentioned, a lot of prominent macroeconomists, central bankers, academics cut their teeth in 1970s, and it's just going to be next generation, young grad students, young practitioners today who see the mistakes that we're making now and hopefully will change moving forward.

Beckworth: Adam, you've also written a lot about independence, the importance of independence. And you recently gave a speech, I believe it was at the Bank of England on ... Was it a 20 year anniversary?

Posen:  20 year. In 1997, the Bank of England was granted operational independence.

Beckworth: And during that speech though, if I read this correctly, you have a line there, the impact of central bank independence on economic outcomes is highly overrated.

Posen:  Yeah.

Beckworth: Tell us about that.

Posen:  Well, there's sort of an academic fundamental point and then there's some more specific empirical points. So the academic fundamental point, which is actually was the main subject of my doctoral dissertation back in 1994, '95, was that you couldn't just change an institution and everything would suddenly click into place, that the institutional changes had to reflect some kind of societal agreement both because otherwise you wouldn't get a major institutional change and because it wouldn't last.

Posen:  And so this was sort of here radical when I argued this in '95 ... '93 and '95 in my first publications. And my point was simply, yes, the operational independence in central banks matters, but it only comes up in societies where they've already decided they care a lot about inflation. And therefore also this isn't just a technical fix. This is a value statement that central bank independence is about being anti-inflationary because it reflects societies that have a bias or a consensus that way.

Posen:  And so when I say that it's overrated, what I'm saying is you can have the same nominal, I don't mean nominal in economic sense, the same de jure institutions, but they can change fundamentally their behavior depending on the political context. And it's the underlying political context that matters. If the central bank acts too independent against the wishes of people for too long, it simply will cease to be independent.

Posen:  And we can go into instances of where you've seen that. The more specific operational point is, again, going back to what you and I were just saying about the generational perceptions of the '70s everybody has Arthur Burns on the brain. That in the '70s, the US president, Richard Nixon put a lot of pressure on the fed to not raise rates when inflation was starting to pick up. And so that was part of the Genesis of the idea of why central bank independence was so important.

Posen:  But then in the end actually it just proves the point that the fed was just as legally independent then as it is now. And they got dominated. And we've seen throughout the world this kind of thing happened. So the leftover from '70s is that the central bank independence prior to inflation targeting was a nominal anchor. That it is not as much formerly as say a nominal GDP target, but it constrained the policymakers in a way that made it credible to people that inflation would stay low.

Posen:  And there was this whole literature based on Beryl and Gordon and Caitlyn and Prescott. That there was this inflation bias that societies and central banks would give into an inflation bias if you didn't constrain the central bank. And then Ken Rogoff did a famous theoretical paper in which he argued that you appoint a central banker who is more conservative in the sense of being anti-inflation than the mean person in society, because then it's credible that you won't have this inflation bias.

Posen:  Well, starting in the early mid '90s, Alan Blinder, Bennett McCallum, and I separately all started pointing out, "Well, this doesn't really make sense. No central bankers we know are inflation biased." Turns out it was pretty easy to get rid of this inflation bias once you just decide to do it. And so now we see the opposite, which is again, go back to Japan, because I think it's very interesting.

Posen:  Supposedly the bank of Japan gave up a lot of independence in the last few years. They openly coordinated with the government. They were admitting limits on what they could do. And there was a lot of chatter in the markets. "Oh, this is going to lead to inflation." Of course what's happened in Japan is they're still frustrated. Inflation hasn't gone up.

Posen:  So anyway, you want to have central bank independence in the sense, just like you want to have independent judiciary, you want to have generals who get to you don't have presidents telling generals where to put the tanks. You want to have expert operational decisions, but we shouldn't make a big thing out of it. It's not a cause of something fundamental.

Beckworth: I think it's a great point that price stability reflects deeper cultural institutional values, and I think that's real important whenever I hear someone want to call for returning to the gold standard as if it will magically change who we are. It won't.

Posen:  No. Exactly.

Beckworth: I heard a recent call for Turkey to adopt a currency board. And my first take was, that's not going to solve the problem. It's a bandaid on a deeper issue.

Posen:  I think you're exactly right, David. So just two specific examples. So currency board, which I'm sure your listeners know is essentially a even stiffer version of an exchange rate peg. You're only allowed to lay issue as much money as you have of that foreign currency you have on hand. So Argentina tried that 20 plus years ago, Argentina moved to a current support and that was supposed to solve the problem and for a few years things were going fine, but then all fell apart.

Posen:  And we know where Argentina is now today, and this influence, frankly, my view on these matters. That as long as there was a consensus in society in Argentina, things got out of hand, we got to hurl it in, then we'll use the currency board. But once it no longer suits us, we'll throw it off. It's like having a blanket on your bed. The blanket does help keep you warm, but you can throw off the blanket at any time once you decide you're too hot.

Posen:  And similarly, what you said I think was very apt, David, about you just can't change things like the gold standard. So one of the faulty premises of European Monetary Union was if we put a hard monetary stop on things, if we insulated completely, not just from national politics but make it supernational, then countries like Italy and Greece will have no choice but to become more fiscally disciplined, no choice but to do their reforms because this hard monetary thing they can't appeal. It's just the way it is.

Posen:  And in 1998 I gave a lecture in Frankfurt forecasting that Italy would not become Sweden just because you put up a Swedish like monetary system. So I think that's a very profound point.

Beckworth: That's powerful. The ECB, the Eurozone is a good example of why this doesn't work. It may be helped on the margin, but it's not going to fundamentally change a culture, a nation. And going back to this, I think this is relevance for the generational conversation we're having earlier. Maybe the aging population of the advanced economies is one reason. There's this consensus for low inflation.

Beckworth: That that's what we want. That's what we're getting right now. And until a younger generation comes along that wants more flexible inflation. So it'll be interesting to see. Well, very fascinating. I could keep talking about this for a while, but I do want to get to your work on trade issues. As I mentioned earlier in the show, President Trump has kept you guys busy at the Peterson Institute for International Economics.

Posen:  Indeed, and here at Mercatus.

Beckworth: Yeah. My college as well. But you had some interesting pieces and I think they were important to talk about. I want to talk ... You had a couple of pieces. One, you had an op ed, an ill-advised trade work could turn out to be Trump's Afghanistan. And I think that's kind of self-explanatory. So I want to move to the piece you had in foreign affairs and you had a follow up piece online.

Beckworth: And this is about how Trump is repelling foreign investment. President Trump is actually affecting our long term capacity in economic growth in this economy. Tell us how that's happening.

Posen:  Well, I am not by background a trade economist. And so one of the responsibilities, and one of the benefits I have by being president of the Pearson Institute is I try to channel the work of our experts on trade policy and distill it. But also I have a platform and a responsibility to speak out on these issues. But what you're emphasizing, and I appreciate you're reading these and bringing these up, David, is that trade war is stupid, is bad in various ways, and we all know the economic arguments and we can go through it, and it's playing out exactly along the lines where you would expect from political economy point of view.

Posen:  But what I wrote for foreign affairs a few months ago and then followed it up is about what I called the post-American world economy, which is the idea that there are long term effects of this anti-globalization, anti-trade stance by the Trump administration. There are long term harmful effects for both the US and the world for the destruction of some of these institutions and norms at the international level that you were speaking about earlier in our conversation.

Posen:  And so the foreign affairs editors smartly came back to me a couple months ago and said, "All right, you forecast all these terrible things are going to happen and pointed out long term things that are not trained. We're glad you did, but is it already happening? How will we know?" And so I thought about it and I decided, hmm, what we call foreign direct investment actually should be a really good leading indicator of that.

Posen:  Because what we mean then our large multinational, or not even necessarily large, but multinational companies making what economists call lumpy or long term investment decisions. Am I going to build a plant? Am I going to acquire another company? Am I going to invest in creating an R&D facility somewhere? Am I going to tie up my business in a relationship? These are large investments that once you make them, you don't really reverse and their impact for your company is a 10, 20, 30 year horizon.

Posen:  So think of Toyota with an auto plant, Shell with an oil exploration, GE where they put a lab. It's not all manufacturing, although it's very visible obviously in issues of goods. And so, these are companies making up their minds about the long term viability of a place relative to other places they can do business. And so I said, "Okay, that should be a leading indicator. So let me go look."

Posen:  And I looked and there's commerce department data freely available on the website, and we have the link to it on our website, pie.com. And you can see that actually as you would expect, net foreign direct investment in the US went up after the global financial crisis and stayed up for a while. And then starting in late 2016 starts going down very steeply. And it's now as of the last available data, which is first quarter of 2018, it's down 75% over what it was in the first quarter of 2016.

Posen:  And then I did a little bit more work and I said, "Okay, what happens if we look in a moving average, smooth out?" Because sometimes individual big transactions do this. Maybe it's seasonal. And you get the same picture, this very steep drop off in foreign direct investment US. And right now with a young analyst at the institute, Ava Zhang, we are doing a more formal version of this and we'll publish that, I hope soon, and establish that if you control in more statistical terms, you end up with the same result.

Posen:  If not, I'll publish that too, it looks like you're going to end up with the same result. But anyway, this becomes very powerful because if you think about not only what the Trump administration says, but what's going on in the world in, foreign direct investment on net in the US should have been going up. For one thing, we are growing faster than most other countries. And even if this growth rate is unsustainable, it's still faster trend than a lot of other places.

Posen:  For another thing, companies that are worried about access to the US market might actually want to get in. I mean this is what Japanese companies did by investing a lot in the late '80 and early '90s in the US. They were worried about tariff barriers to their goods. So they move production to the US. And third and most importantly, the tax package passed by the Congress and the Trump administration had a bunch of provisions that should be encouraging of the relative attractiveness of the US as a place to do business. Most of all the statutory tax rate on corporate income.

Posen:  There is evidence in the literature that differences in that over time across countries should be a predictor of on average FDI trends. So all these things should have been increasing the net inflow to the US and it went down by a large amount. And so, my interpretation is that individual companies are looking at the US and saying, "This is not a place we want do business if we're not going to have access to other markets, if it's going to be more expensive to import goods and import foreign workers and less easy to track R&D and do things.

Posen:  It's not as good a place to be as it was if we are going to be like Harley Davidson or Kerry or subject to presidential tweets and arbitrary decisions, it's not as attractive place as it was." And so the statistical work we're doing will treat those as actual control variables rather than just pointing this out. But it's pretty clear.

Beckworth: That is very sobering. Discouraging because again, it's something that's hard to argue to a politician, to the president. If Larry Kudlow walked into president Trump's office and said, "Look, foreign investment in our country is going down. Long term, this is going to have a huge effect on the growth potential of our country." That's a tough argument to make because it's five, 10 years in the future, you see the fruits or the lack of fruit from this.

Beckworth: You don't see immediate change today. So it's a very slow, gradual change. It's very worrying and I think of that and you add on top of that, like the declines in our fertility rates, kind of the push back against even legal immigration. We need more people, we need more capital, we need to be more productive. And it seems like the pressures are pushing against those.

Posen:  I completely agree with you, David. And foreign direct investment, net inward foreign direct investment, but even the external is very important as colleagues of mine like Ted Moran and Lindsey O'Dansky have established, jobs that come out of foreign direct investment in the US tend to be higher paid, tend to be more research oriented or more tech oriented, tend to have spillover effects in creating other jobs and demand for US services.

Posen:  And in the very much the spirit, you said, it's about long term, it's stable capital. It's business choice. It's not some speculative thing. This is real stuff. And interestingly, along with your image of Mr Kudlow going into the white house and trying to explain this as a long term problem, the flows of foreign direct investment are a fraction of the daily flows back and forth, say, determining the exchange rate between China and the US.

Posen:  So even on the numbers, they don't determine interest rates or the dollar rate. In a sense, that makes it a better warning sign, I would argue, I mean both in the statistical sense that there isn't this endogeneity problem we have in monetary economics, is the central bank reacting? Are people reacting to central back? These are individual business decisions that cannot affect the economy as a whole in any short term. So it's a much clearer signal, but it is part of this whole story.

Posen:  And one of the things which a number of people have been working on in recent years, including Jason Furman, who I know you know well, who had been the last counsel economic advisor chair for President Obama and who's part-time with the Peterson mostly at the Kennedy school have been working on ... is a reduced dynamism in the US economy that there are signs we have lower rates of new business creation. We have obviously a much lower productivity growth rate. We have lower labor force mobility.

Posen:  And Jason and some of his coauthors including Peter Orszag, and then others from places like Stanford and MIT and other places, John van Reenen I think is another one at MIT. He was written about this, have noted that there seems to be just the slowdown in creative destruction and so there is something fundamentally wrong in the US economy right now. And that's not due to Trump, that was already happening.

Beckworth: But Trump is piling on top.

Posen:  Trump is piling on top of it. Exactly. That's my view. And that these changes to how the US interacts with the global economy and making itself more closed and more arbitrary interventions of government and less open the competition and less long term oriented, all those things are just going to make it worse.

Beckworth: Yeah. So even though we might see some temporary short run gains, the disturbing pattern we're seeing is more of a long term shift away from the productive growth of the US economy.

Posen:  Yeah. But I want to emphasize is there are always economists talking about, "Oh, you don't think about the long term," and sometimes maybe some of your listeners are people just out normal life say, "Yeah, we always hear that, and the long term never comes." People were worried about US deficits in the '80s, and people worry about trade deficits and nothing ever happened.

Posen:  I want to emphasize that this is a different beast. The things that have been happening to US economy over the last 10 years and have gotten worse under president Trump's regime are different kinds of things. This isn't just the debt, this is, we're now starting to see it in all the things you said. Less long term investment, lower returns on investment, lower productivity growth, lower workforce skills, lower rail wage growth. The real stuff is happening and so it's no longer-

Beckworth: So, we're in the long run right now.

Posen:  Yeah, yeah. The long run is there. It's no longer, there are ants in the foundation. It's, there are cracks in the walls. The ceiling hasn't fallen in yet, but you can see the cracks in the walls now if you go looking for them.

Beckworth: Man, Adam, this is becoming a very discouraging conversation. Like to end on a happy note here. But one or the other thing where I see this being a big problem is an area where I've had a lot of interest over the past few years, and that's in a safe asset shortage area. And the basic idea is there's a scarcity of safe assets as the world economy is growing faster than the capacity to produce it.

Beckworth: So the world turns to the US, we provide treasuries, which is great. I mean our ability to export debt is an interesting advantage we have. But what you're talking about threatens that, right?

Posen:  Yeah.

Beckworth: I mean we are the bankers of the world right now, have been, but if this post-American order continues to emerge, we continue to decline, we could face some real financing problems moving forward.

Posen:  Well, so I think you and others who've been about this safe assets issue are onto something very important. And so we have this ironic situation that's been true for the US for a while and which we're seeing right now. Which is even when the US government messes up or the US economy messes up, flight to quality means people still put money in the US, but like you said, they put it in treasuries or agencies or certain things, not in necessarily private sector or risk capital.

Posen:  And that's very sticky. At some point, it will flip. And we're seeing now in part because I argued previously in my foreign affairs article because Trump is breaking down what has been a relatively strong separation between economics and national security. It used to be that we didn't bully ... If you were bullying country, you generally didn't bully them on the commercial side even if you were bullying them on the national security side.

Posen:  So we're saw just this week the issue of president Trump piling onto Turkey when they were having a currency problem. Now again, I'm not saying anybody should be nice to the Erdogan government, that we shouldn't be looking after this American pastor who's being held there or the markets are wrong to sell off the Turkish Air. All that frankly fine.

Posen:  But the idea that an American president says, "Yeah, we want their currency to stop going down and we want the crisis and what's going on here and we're going to put tariffs on." When a time when an economy's in major trouble it's just batty, it's cruel, it's going to cause blow back. This is the equivalent of what they called blow back in the middle East, in other fields, and it just contributes to countries like Turkey and Russia and Iran and Venezuela and Cuba.

Posen:  I mean, they may all be regimes we don't like, but we have leverage over them because they and their citizens, their savers, their businesses all use the dollar, and all ultimately rely on the US financial system. And if at some point they all switch, then there's going to be even fewer safe assets for the world because people will be worried about political risk to them from the US, but there's nothing to replace it.

Beckworth: Wow. On that very sobering note, our time is up. Our guest today has been Adam Posen. Adam, thank you for coming on the show.

Posen:  Real pleasure to be here, David. Thank you.

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