Skanda Amarnath on Maximum Employment, Inflation, and the Fed’s New Framework

Skanda Amarnath is the executive director of Employ America and a former hedge fund economist. He rejoins Macro Musings to talk about the fate of the Phillips Curve, the inflation outlook, the Fed’s new framework, and his vision for a better monetary policy future. David and Skanda also discuss the Fed’s flawed assessment of maximum employment, how to modify the central bank’s Summary of Economic Projections, and the significance of capacity constraints vs labor utilization.

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: Skanda, welcome back.

Skanda Amarnath: Thanks for having me, David. Looking forward to our discussion today.

Beckworth: Absolutely. It's been fun conversing with you on Twitter, in-person, and you've made several visits to the show. I think the first time was back in Arlington, but you've done some since then. One thing that's changed since those first few visits is that your title is now executive director of Employ America, so before you were a research director. Congratulations, first off, but tell us about the change. What's going on at Employ America?

Amarnath: Thank you, thank you. So I guess I'm now the executive director. While it's certainly a promotion and a privilege, also not as much as substantively, we were all part of the same group that's helping to lead things together between, my colleagues, Sam Bell, Kim Steins, Arnab Datta and Alex Williams, so we are all in this together. Yes, the titles have shifted a bit, but it's also a little bit more… the substance has not changed as much, and we are still moving the same direction as we always have.

Beckworth: So what does Employ America do? I know I've asked this question before, but for new listeners, tell us about Employ America.

Amarnath: Sure, so we try to advocate for macroeconomic polices that can help to ensure tighter labor markets and better labor markets over time, so can we achieve higher rates of employment and better rates of wage growth over time, in a sustained manner, such that the tight labor market, let's say, of 2019, isn't just this fleeting macroeconomic moment but actually can be something that is replicated more sustainably over time with better management of monetary and fiscal policies and everything else that is encompassed by macroeconomic policy settings.

Beckworth: Yeah, I like to think of your group as trying to put into play what Karl Smith says, “give capitalism a chance.” Really run the economy hot but at a sustainable level, and really get people into the labor force, get them working, let's get full employment, so let's really try capitalism.

Amarnath: Karl is in some ways a good analog for some of our ideas in terms of, we are trying to let market economies reveal their strengths in terms of being participatory, in a way that businesses are competing for labor. That's not a bad thing. That's not anti-market. That's not anti-sort of a robust private sector, but there are certain demand policy settings that really shape whether that's happening or not. If we have really slack labor markets where that's not happening, that's also the kind of environment where you don't see a lot of investment, or you don't see the same kind of dynamism that, I think, has the chance to be replicated if we do get a more cooperative and coordinated set of policies across the board. And so we're trying to do our part. Obviously, macro policy isn't everything, but for us, maybe a little bit more so.

We are trying to let market economies reveal their strengths in terms of being participatory, in a way that businesses are competing for labor. That's not a bad thing. That's not anti-market. That's not anti-sort of a robust private sector, but there are certain demand policy settings that really shape whether that's happening or not.

Beckworth: Absolutely, good stuff you guys are putting out. In fact, you just put out a new piece with your colleague, Alex Williams, titled *Beyond the Phillips Curve: A Dynamic Approach to Communicating Assessments of 'Maximum Employment'.* I'm going to get to that, and that'll be the lion's share of our discussion today, but before we get to that, I thought we could motivate by first talking about the Fed's framework, because this is, in some ways, a critique of how the Fed's implementing its new framework. I know most of our listeners know what this framework is, but there's some new listener, again, who's just joined the show, or for the average person on the street, if they ask you, "Skanda, what is the Fed's new framework?" How do you explain it to them?

Explaining the Fed’s New Framework

Amarnath: It's either two major revisions to the Fed's framework that define it nowadays. The first that's pretty well-telegraphed was the notion that the Fed had to make up for past misses on its inflation targets. So the Fed has a 2% inflation target that it wants to achieve over time. The 2010s, that decade, was largely marked by inflation missing its target to the downside, so we've got lower inflation than 2%, and the Fed thinks it's really important to hit 2% over time, so now there is this kind of a little bit vague, flexible approach to allowing inflation to compensate for those misses.

Amarnath: That's the first part, I guess you could say, the headline thing that most market participants have fixated over, flexible average inflation targeting, so that flexible means we're not doing this in a mechanical manner, but we are trying to allow inflation to actually get above 2% to make up for all of our misses in the past. That's the one part. The second part that probably received less attention, but also was a bigger surprise in August of 2020, was the notion that the Fed was no longer going to try and land the labor market on a pin. They were not going to try and hit employment to a particular point, and then sort of optimize policy around it.

Amarnath: Before it used to be that the Fed would try to minimize deviations away from where they thought maximum employment was, whereas now they're just addressing shortfalls, so it's an asymmetric approach to aiming for particular labor market outcomes. Yes, there is a problem when the unemployment rate is really high. It's a problem when employment is really far from where it was before the pandemic. Is it a problem if we have employment that's exceeding their estimates of maximum employment? Is it really a problem if the unemployment rate is 3.5% but FOMC members think maximum employment is 4%?

Amarnath: That assessment is more contextual. It's something that we really try to highlight in our piece. The contextual nature of that is 3.5% might be inflationary, it might not. That's not actually something that's a given. We don't really know whether 3.5% unemployment was inflationary. It certainly didn't appear to be inflationary before the pandemic. Whether it's actually inflationary the next time we get to 3.5% unemployment is really not something that can be governed by a particularly systematic relationship, and the Fed has to be flexible to that. The framework seems to specify that kind of flexibility, to the Fed's credit, but the Fed's communications are still stuck in the old ways. That's part of what our piece tries to get at.

We don't really know whether 3.5% unemployment was inflationary. It certainly didn't appear to be inflationary before the pandemic. Whether it's actually inflationary the next time we get to 3.5% unemployment is really not something that can be governed by a particularly systematic relationship, and the Fed has to be flexible to that. The framework seems to specify that kind of flexibility, to the Fed's credit, but the Fed's communications are still stuck in the old ways.

Beckworth: It's interesting, you mentioned the Fed's communication is stuck in its old ways. I think many people are stuck in their old ways when thinking about inflation, this new framework, and so I think it's important to have these conversations to remind us, this is a new framework. And maybe the Fed can do a better job, as you suggest in your paper, but I think people in the markets have a hard time internalizing this as well.

Amarnath: Yeah, part of it is they've introduced this framework at a time when we've had historically volatile macroeconomic data. Where even with the disappointing jobs prints of the past couple of months, it's still historically strong. The inflation prints, according to the Consumer Price Index, have also been really strong. Oil prices were negative a little bit more than a year ago, versus now they're meaningfully significantly higher, I should say.

Amarnath: We’ve seen this big base effects, these big movements in prices, over the last 12 to 15 months. And so when you're introducing a framework about average inflation targeting, right in the middle of that, it's in the middle of the eye of the storm, it's really hard for people to make full sense of what actually am I supposed to be anchored towards. The Fed says they want to make up for past sins to the downside. But how they do so is really hard to actually calibrate and calculate if you're a market participant.

Beckworth: Absolutely, and I think it's important for politicians to understand it, as well as you and me, and other regular people in America, because I think it's easy to get freaked out. You look at the big deficits. You hear the Fed's not taking things seriously. I won't mention any names, but there's some very serious people, commentary out there, that I think completely misses what's happening about this change we are experiencing right now.

Beckworth: Let me ask a couple more questions about this framework before we move to your paper. So some of the parameters are not very clear, like how quick the fed will make up or how far back it will go, but one thing I think they did say, and I wanted to get your take on this, because I'm not sure I fully understand it, but they want to see 2% inflation for at least a year, as well as full employment, right? You can't just have... You're going above 2% for a year, and then you change policy. You could be going above 2% for a year and still not be at full employment, and you've still got to keep going, right, with easy policy? Is that right?

Amarnath: In September of 2020, that FOMC meeting, the first FOMC meeting after they released their new framework. They released forward guidance about what it would take for the Fed to start considering interest rate hikes. In that statement, there were three components to it. One was that the labor market had reached conditions consistent with FOMC members' assessment of maximum employment. The second necessary condition was that we would have inflation recover back to 2%, and the third condition was that you were actually going to have forecasts for inflation depth to exceed 2% for a sustained period, so this was not going to be a one-time recovery to 2% and then back down, but there was actually going to be the expectation inflation was going to have some kind of makeup for past misses.

Amarnath: Those three were cast as necessary conditions. Some of them are clearer than others, like returning to 2%, that's something we can observe very clearly. We can look at the headline PCE deflator, see it's past 2%, it has recovered. On the other hand, where the FOMC sees maximum employment is more opaque. Where do I go to look up what the maximum employment assessment is for each FOMC member? Sometimes there are members who say it in their speeches, very publicly. Some are a little bit more coy. And some just have an understandably hard time grappling with the complexity of what maximum employment really encompasses. Is this something that changes over time? How do we evaluate over multiple indicators? We know the unemployment rate is flawed, can we do better? What kinds of metrics should we be looking at?

Amarnath: So that complexity ends up reducing itself in the dot plot and the Summary of Economic Projections as what is the Fed’s… what is my longer-run projection for the unemployment rate. Most members are somewhere around 4%, based on that. And so that's really all we have to go off of, but even if all the members have a different view about what maximum employment really is over time.

Beckworth: Do you think the dot plots are still useful?

Tweaking the Fed’s Dot Plots

Amarnath: It has a lot of information in it, but it's also very difficult to process that information. Because of the lack of transparency about whose dot is whose and what projection is associated with which dot, and your ability to extract reaction functions is very limited, and you don't know who are the voting members of the FOMC, who are not. That can really color how much information you can actually extract from it. We know that most FOMC members are expecting, if all goes well, that they will be expecting to raise interest rates in 2023. Is that because they expect inflation to be out of control in 2023, or they expect it to be out of control over a longer horizon and they need to tighten rates in order to avoid that outcome? Is it because they see risk management considerations dominating their rate path? Is it because of a Taylor rule? Is it because of different frameworks?

Amarnath: Different members have very different approaches. That heterogeneity is very hard to capture in the current iteration, as much as they're trying to be transparent and communicative, and I appreciate that as a Fed watcher. I also fully understand that this is complex, and it's not necessary that more information leads to clearer information all the time.

Different members have very different approaches. That heterogeneity is very hard to capture in the current iteration, as much as they're trying to be transparent and communicative, and I appreciate that as a Fed watcher. I also fully understand that this is complex, and it's not necessary that more information leads to clearer information all the time.

Beckworth: Well, we'll get to your big recommendations on the maximum employment front in just a minute, but on the dot plots, would you recommend any tweaks to it. So there's some FOMC members who listen to the show. They're listening now, Skanda, so would you maybe reveal who is each dot plot, what's behind it, or any minor tweaks before we get to the big ones?

Amarnath: So I think that the dot plot could benefit from a little bit more transparency. That may be hard to achieve, because there are other considerations about making sure it's a committee-wide view and not just Jay Powell's dot that matters. But I would say that Fed President Neel Kashkari's approach to communication is something I actually quite admire, of explaining where he was setting his projections and how he was looking at the interest rate outlook. In a transparent way, following the release of the projections and the release of an FOMC statement, that kind of transparency's really helpful, because otherwise we're left not knowing whose dot is whose and what's motivating that dot. I think this last FOMC meeting is actually quite illustrative of what the challenges of interpreting what is meant by two hikes in 2023.

Amarnath: Is what meant by two hikes the notion that there are inflation risks that are not part of my modal forecast, in which case I need to just hedge against the tail risk that inflation surges, or is it because I think maximum employment has already been achieved, inflation is slightly above 2%, and my baseline forecast warrants two rate hikes in 2023? There's some texture there that's hard to parse. Even if the Fed did a perfect job in that sort of release of the Summary of Economic Projections, if it's left somewhat opaque to the observer, markets move really fast, and markets are trying to process a lot of information, and it's not necessarily the case that every detail gets parsed perfectly.

Amarnath: So I think that just having a little bit more transparency about who's saying what makes a big different, because then you can actually account for it accordingly. To what extent does your actual expectation, mean expectation, compare with what you think is your baseline forecast versus the set of risks around it. Because most of the FOMC members do see risk to the upside to their forecast, that's also probably playing at least some role in their projections.

Beckworth: So we want every FOMC-voting member to have a Medium post after every meeting… That would be great. I'd love to go read all the blog posts from the different FOMC members right after the meetings and see where they're coming from. So it has been great, and I'll confess, I haven't been following the Neel Kashkari posts. So he's still doing them? I did early on.

Amarnath: I don't think he's... I've not seen him publish one more recently. I suspect there's a heavy dose of effort to kind of get those out every single time.

Beckworth: Yeah. Absolutely.

Amarnath: But I did think at least as a model, maybe there's a quick and dirty version of that, but I did think it's very informative of, "This is how I voted, this is what's guiding my decision making, this is what would change about my views if the economic outlook changed." Because look, part of this is the macroeconomy is going to change in ways we don't expect. What's really important is actually to understand how members read and react to the information, than to just say, "This is my forecast. This is my point-based forecast, and so just take that at face value." I think there's some additional transparency that would make the dots more effective, and in the absence of that, I can understand why Chair Powell appears to be frustrated by what they actually communicate.

Beckworth: Okay, one last question, I promise, then we'll get to your article. Some people have said that this dot plot from the last FOMC meeting in June undermined the credibility of this new framework, at least to some extent. Do you think that's the case, but it's not that big of a deal, we'll get past this, or is it more serious?

Amarnath: I think it is to be determined whether this has damaged credibility or not. You have seen, in market pricing, that there's been a noticeable upwards in front-end rates. Not a huge shift, but the market was of a belief that the Fed was going to keep rates low for a long time, and now there is a greater risk that the Fed's going to have to raise rates, and that's largely attributable to 2023 dots moving up. So we do have the projection of interest rate increases. Whether the inflation is consistent with that and how credible the Fed is about managing this process, that's a question of whether you interpreted average inflation targeting to be looking through transitory inflation pressures, or whether transitory inflation pressures actually counted towards the average inflation target.

Amarnath: I would say the transitory inflation pressures should not really be guiding monetary policy that works pretty bluntly, and monetary policy that is supposed to be targeted towards a forecast should be calibrated towards achieving forward outcomes. If we know that there's going to be strong price pressures related to reopenings, some local bottlenecks that are expected to abate over the course of the reopening process, and if we do have the kind of fiscal pressures that are, let's call it one time in nature. Let's say the transfer payments related to stimulus checks, unemployment insurance, or the kinds of things that are going to expire. These are not the things that monetary policy should be particularly sensitive to, they should be more looking at what's the outlook in 2022, 2023.

I would say the transitory inflation pressures should not really be guiding monetary policy that works pretty bluntly, and monetary policy that is supposed to be targeted towards a forecast should be calibrated towards achieving forward outcomes.

Amarnath: So in that case, the flexible aspect of average inflation targeting and the Fed's framework warrants not overreacting to these types of dynamics. But I think this is a part where there's probably room for multiple interpretations, whether that flexibility is to accommodate transitory pressures, or is that flexibility supposed to actually count in and say, "Well, now we've overshot to the upside because used car prices are being bid up by CarMax." This is a very different-

Beckworth: Yeah.

Amarnath: What is it that we're actually after? Because prices can move around for a lot of different reasons, and it's true, the price increases right now are very strong. Some of them are for reasons that are pretty predictable, like in the case of oil, and some cases are less predictable. That's not necessarily the same thing as what sometimes we talk about in terms of nominal GDP targeting and the level targeting aspect of that, which is really about keeping institutions, incomes and balance sheets somewhat more whole and more predictable as a result, which is not really reflected in pricing power in the same way.

Beckworth: Yeah, all of this has just reminded me that I like a nominal income target to avoid all of this confusion at some level. We'll come back to this point in a bit, but I think it's important that we understand these issues, because it's the world we live in. We don't live in a nominal income targeting world, but if we did, it seems like life would be a whole lot easier for Fed watchers and Fed officials themselves, given there's data considerations in implementing such a target. But let's move to your paper, again the title is, *Beyond the Phillips Curve: A Dynamic Approach to Communicating Assessments of 'Maximum Employment'.* As you mentioned, one of the big changes in their framework is that they're now looking at shortfalls from maximum employment, whereas before, they would look at any deviation, above and below. So big, big change, and you and Alex Williams have this paper out. I'm just going to read a sentence early on in your paper, and you say, "The Fed's communication with respect to its assessment of maximum employment is overdue for a clarification." So help us out, Skanda, why is it overdue for a clarification?

Clarifying the Fed’s Assessment of Maximum Employment

Amarnath: I think it is, in large part, informed by the same dynamics that informed the Fed's framework review and forward guidance, and that's the late 2010s revealed why trying to pin the unemployment rate at a particular level is not actually a good guide for how to manage demand-side policy. And so the Fed, from 2015 to 2019... Or 2015 to 2018, to be fair, the Fed had a tightening bias. They thought somewhere between 4.5 and 5% was where maximum employment was. They slowly revised down that number, even as the unemployment rate made faster declines over that period, and brought in new people through labor force participation. So there was prime-age labor force participation started to recover over that same period, and the unemployment rate was also falling, and it wasn't in any obvious way inflationary. I don't think we could say that the 2015, 2019, if you tell people that inflation was a real risk, I think you'd have had a hard time selling people on that proposition.

Amarnath: Certainly not more so than in previous periods. In fact, probably the strongest inflation readings of the 2010s were early in the 2010s, 2011 or so, because of commodity prices. So there is a recognition that trying to land the unemployment rate at a specific point isn't really the right way to go, and if you sort of stick to that number, what might seem as dovish policy at first turns into really hawkish policy, because you're trying to target an unemployment rate. But in fact, what we learned is, there's more that can be achieved over time. The time dimension, the temporal dimension is really important for how we think about the macroeconomic trade-offs. If there's more achievable as more progress is made, it's something that... I think Jay Powell's press conference, he had noted that the labor market had made continuous upside surprises in that period of time. The Fed, I think, does want to accommodate them, hence the asymmetric nature of their labor market assessments, for the Fed framework.

Amarnath: But as long as they say that 4% is really what maximum employment is, or that's what the public gleans from their Summary of Economic Projections, it's always going to seem as if, once we get to maximum employment, the rate hikes are right around the corner, and the Fed's going to try to manage the labor market aggressively from the upside. I think it would be clearer to say, "This is where maximum employment is today. This is where we think maximum employment will be tomorrow." Maybe that's more static in periods when the inflation risks are elevated, and maybe that's more dynamic in periods where the inflation risks do not appear as elevated, but the notion that we can't achieve higher rates of employment, especially adjusted for age and demographics, over time….

Amarnath: Well, the US is actually the outlier in this case. So if we look at prime age, 25 to 54, employment-to-population ratios in other countries, they have managed to make new highs. Particularly advanced economies, so I'm talking about Canada, Australia, New Zealand, Germany, Sweden. These are all places where you can find new summits, new peaks in labor utilization over time. That's not because of any particular structural reform, it has everything to do with the business cycle extended long enough for new heights to be achieved. Whereas, in the US, we haven't achieved those same heights, and I think there would be more room to do so if there was more supportive policy and a more expansive view of what maximum employment can be over time. So taking more aggressive revisions when we get closer to maximum employment on their estimates, that's to say that what the constraint is today is not the constraint for tomorrow.

So if we look at prime age, 25 to 54, employment-to-population ratios in other countries, they have managed to make new highs...Whereas, in the US, we haven't achieved those same heights, and I think there would be more room to do so if there was more supportive policy and a more expansive view of what maximum employment can be over time. So taking more aggressive revisions when we get closer to maximum employment on their estimates, that's to say that what the constraint is today is not the constraint for tomorrow.

Beckworth: Yeah, probably the most surprising thing about these projections, the Summary of Economic Projections or SEP, is that they look very similar to what they were before the new framework came into play. I mean, you would think a redoing of your framework where you have meaningfully changed the full employment definition would somehow be reflected in the SEP as well, but what you're pointing out is that it's the same old long-run unemployment metric they had before.

Amarnath: Yeah, it is, implicitly at least, a Phillips curve view that says the natural rate of unemployment is 4%. It's going to be 4%, and therefore, when it gets below 4%, we've got to lean against it. That may not actually reflect all FOMC members' views in a precise and nuanced way, but that is what the public can easily glean from the document. And so even if there are other indicators that different members think are better, if they have more expansive definitions such that they think the 4% number may not capture it… Nevertheless, when the dots are released, markets move. When the dots are released, public and media write their stories.

Amarnath: If part of the way the Fed's using the framework is to recalibrate how expectations are set about monetary policy, then I think a more dynamic approach to what maximum employment can be, and what it is today, versus what it could be tomorrow, or in 2022, 2023, 2024… These are all very path-dependent. They're all kind of sensitive to what was achieved today can determine how much more can be achieved tomorrow. It is not the case that there's a sticky level of employment or the sticky level of unemployment that, over time, defines the capacity constraints of the economy at large.

Beckworth: Yeah, so you're effectively making the case for endogenous aggregate supply or reverse hysteresis. Running the economy hot enough, at least to see if that's possible, right, if those frontiers get moved out some.

Amarnath: Yes, that's not to be a denialist about capacity constraints and supply constraints that may emerge in various forms at various times. Right now, I wouldn't say it's constraining the economy as a whole, but the semiconductor shortage is constraining the auto sector. Auto production is being held back mostly because they cannot procure the requisite number of microchips. In the case of the '70s and the 2000s... I think 2000 is actually a very recent example, where we did have elevated commodity price inflation, and that elevated commodity price inflation, with respect to energy and food, was the kind of thing that the Fed had to balance. We did have some inflation that was above target on headline, and in retrospect, above target on core.

Amarnath: That does color the trade-offs, and then capacity has to expand and catch-up, and that also has to be accommodated, in some ways, but it also has to be balanced against the inflationary pressures. What we have right now, though, is if you take the rigid Phillips Curve view, and you sort of say 4% is the condition for maximum employment... Which, Jay Powell says the maximum employment is below 4% in his... Or he's suggested that he hopes it's well below 4%. I think even that little bit of color is not the kind of thing that gets communicated through the Fed's formal communications associated with their dot plot.

Beckworth: Let me ask you, because you are a former hedge fund economist. So when that dot plot came out, was your instant reaction, as it affects trades for example, tied to the dot plot or what happens in a press conference?

Amarnath: I think, also, the timing is different, so their dots and the statement get revealed half an hour before the press conference. And so if you want to trade the press conference, you can trade the press conference

Beckworth: I see, I see. Okay.

Amarnath: Depending on your trading horizon. In terms of what tends to occupy everyone's attention, in terms of market actors, it's the dot plot.

Beckworth: It's the dot plot.

Amarnath: The dot plot is the thing. You can make all of the nuanced stories, "Well actually, the growth projections are revised up, and the inflation projections are revised this way. And actually, it's more hawkish." That's fine. I think this is probably what frustrates Jay Powell the most is like everyone is looking forward, did the median dot rise?

Amarnath: Okay, we expected it to be a 7-10 split, or a 9-7 the other way. I don't have to be in that game anymore. In some ways, it was fun, in some ways… I think it does start to get a little bit disconnected from what the Fed is actually trying to communicate. The two dots moving up was the story from June… Sorry, the two hikes. The median FOMC member now sees 2023 as the liftoff year. That's a story that's been priced into markets pretty coherently I would argue, and that's just something now we have to really say, "Well, why is that the case?" What are the economic outcomes that really align with that projection, and what are particularly dissonant and divergent from that projection for interest rate hikes?

The median FOMC member now sees 2023 as the liftoff year. That's a story that's been priced into markets pretty coherently I would argue, and that's just something now we have to really say, "Well, why is that the case?" What are the economic outcomes that really align with that projection, and what are particularly dissonant and divergent from that projection for interest rate hikes?

Beckworth: Yeah, so the SEP has become this kind of center of gravity for financial markets in terms of what to actually expect. It becomes something much more than was intended and obviously more than what Jay Powell wants it to be. I think it's your first point, and second point though, it really hasn't changed that much, right? Because markets are putting so much interest in making decisions based on the dot plots, we would've hoped to have seen something fundamentally different to reflect the new framework. Now you highlight in this paper, and you already have here, the full employment part. And you know my critique early on was the inflation part doesn't change much either. Until recently, it shows some catch-up, but even I have my doubts on the inflation front, I'll tell you, Skanda, because is that inflation above 2% simply base effects? Is it simply the pandemic? Now I know, depending on how you measure, it gets us back to 2% average, but I want to have a test run of this system in a normal period so I know for sure what I'm seeing is not base effects versus the actual policy at work.

Analyzing the Uptick in Inflation Numbers

Amarnath: Yeah, I think it is a communications nightmare, to be honest, because I think you have to bring up various different prices, and what's going on, and Jay Powell even talked about used cars and having to talk about specifically with hotel rates and airfares, and that is a lot of disaggregated understandings, and they're important. I actually think you do need to have some texture when you try to understand what's going on with inflation, in moment at least. But whether these actually sustain themselves… I think it'll be interesting next year in particular, when we've kind of come through this impulse, what's the inflation outlook really going to be if all the price increases were front-loaded but were going back to 2% or below 2% in 2022.

Amarnath: And if inflation sustains, I think that's probably an outlook where the Fed may feel more comfortable with their current projections, but I think it's also the case... And this is something John Williams said actually, in a speech recently, which was that, if we actually see all these price adjustments happen faster, we may not see the kind of inflation overshoot in subsequent years that... It depends on whether you think of 2021 as like, "Okay, we've overshot," or do we say, "Okay, actually, this was a one-time thing that is not really the product of the Fed's framework, it's just the product of we had a pandemic, we shut everything off… when they had to restock their inventories all at once, it led to some local bottlenecks." That's the other side of this. In which case, I don't think the framework itself deserves any great credit for leading to that inflation overshoot. You're back to square one of how do you reshape expectations.

Beckworth: Right, the accidental average inflation targeting Fed just happened to have a pandemic and a big fiscal package that kind of pushed it back to 2%. But yeah, that's the thing, going forward, is the credibility going to be there? Will markets understand this process, will the FOMC understand this process themselves? I think all of us are learning something as we try this new framework.

Beckworth: Let’s talk about your proposal. So there's a lot of issues. I think you've touched on some of them already. We need to know the difference between capacity constraints and labor utilization, is a point you bring up in the paper. Maybe just briefly tell us why is that? Why do we need to know that distinction?

The Significance of Capacity Constraints vs Labor Utilization

Amarnath: Because I think a lot of the constraints that are driving inflation are not always well cast in terms of labor market dynamics itself. Where you see the inflation may reflect the fact that the production capacity is deficient. I think one good example of this would've been in the mid-2000s. The bulk of the inflation in that period was not due to wage-price spiral. It was not due to labor being bid up or so scarce that it was driving the inflation itself, and wage growth was slowing through most of that decade, actually, if you look at the employment cost index. But in fact, it was because there was a shortage of capacity to produce the raw commodities that were part of the China boom, the EM boom, and the global commodity super cycle. It had some path through into core components, but when we describe the constraints here, then you have to really think about what is... Now, that may have implications for how to balance supply/demand trade-offs, that's true, but it doesn't say that there's a limit to what is an achievable rate of labor utilization over time.

Amarnath: It's one thing to say that there may be so much progress that's achievable today. If we try to go to a 1% unemployment rate economy in a day, and hire everyone, that's a lot of income that we're generating. That's a lot of income that can translate into spending for a particular thing, goods and services, and probably not be well-balanced with the stable prices part of the Fed's mandate. But it is through that over time more progress is achievable, and how we manage those processes is the kind of thing where what the summary statistic that I think some macroeconomists like to see themselves as macro, "I only look at the aggregated variable, don't tell me the sectoral story, don't tell me the disaggregated story." But it is really true that how you think about these capacity constraints, that's not a shortage of labor that we had inflation in the mid-2000s.

Amarnath: The reason we had price increases is because there was really strong demand globally for commodities, and there was a deficiency of inability to produce the necessary commodities there. With the advent of shale production methods, with advent of other investment in a lot of different areas, we had commodity over capacity for most of the 2010s. There was an overcapacity of copper, of oil, of a lot of agricultural commodities. So these particular dynamics, when you think about what drives inflation, that I think is a pretty critical point to make. Trying to say that because there's too much employment itself, or we can't achieve a rate of labor utilization beyond a certain point and that's a permanent ceiling, I think is misguided.

The reason we had price increases is because there was really strong demand globally for commodities, and there was a deficiency of inability to produce the necessary commodities there...So these particular dynamics, when you think about what drives inflation, that I think is a pretty critical point to make. Trying to say that because there's too much employment itself, or we can't achieve a rate of labor utilization beyond a certain point and that's a permanent ceiling, I think is misguided.

Beckworth: Let me dumb that down for myself here. It's a good point, but let me frame it maybe the way I would frame it, and I know I'm missing some of the granular points on this granular discussion. That is, it's the ability to see through supply-side shocks that affect inflation, and I know it's a little more complicated than that, but if I'm a macroeconomist looking at headline inflation, and I see inflation go up, 2008 is a good example, it's going up and it may be tied to capacity constraints, commodities, supply shortages, relatively speaking, then I might miss the underlying true trend of inflation. Is that the point you're making?

Amarnath: I think the true trend of inflation is probably better described in terms of income growth, but I think you're right that the supply shocks that are happening are not about the labor market itself being sort of overly hot. You can have inflation without having hot labor markets, and you can have hot labor markets without having inflation.

Amarnath: That is the part it takes a bit of parsing to get through, but it's true that these are two different phenomena. They have some relationship to each other, what relationship can be strong at certain points, and at some points it can be really weak. I think if you think that there is just a fixed level of employment that's achievable through business-cycle expansions, you are implicitly saying that trade-off is pretty stable. Once you get past a certain level of employment, the inflation risks emerge. This is actually the Paul Samuelson view of once you get to full employment, then all of the capacity constraints emerge, and you can't get past a certain point. Whereas the guts of this is we have to separate the two. There are supply shocks. They do influence inflation, but they may not actually be very informative for thinking about how to keep a stable path of inflation over time, a stable path of income growth over time, and sort of keeping labor markets reasonably tight over time.

I think the true trend of inflation is probably better described in terms of income growth, but I think you're right that the supply shocks that are happening are not about the labor market itself being sort of overly hot. You can have inflation without having hot labor markets, and you can have hot labor markets without having inflation. That is the part it takes a bit of parsing to get through, but it's true that these are two different phenomena.

Beckworth: I mean, the whole point of inflation targeting, and especially this average inflation target is to ground inflation expectations, right, over the long run. If anything, a credible average inflation target should give us more stability over the long run in terms of inflation, and we can forecast better, so a supply shock, a capacity constraint, we should definitely see through it if we are well-grounded in terms of the long-run path of inflation.

Amarnath: I think there's a good way to actually parse this even further, which is that 2008 and 2011, you saw commodity prices rise, but income growth was actually pretty weak. 2011, we were still in the aftermath of the Great Recession. It was still a really weak economy. Europe was brewing in turmoil. And 2008, we saw the housing crisis was also unfolding at the same time as the commodity price boom. And those certain circumstances, actually, the inflation outlook should've been guided more by what was going on with incomes and the business cycle, and not by commodity prices, supply-side issues. In the 1970s, nominal income growth was also high, which is something people forget about it. It's not just about prices itself. Yes, there were oil price shocks. Yes, there were ways it mattered, but it was also being reflected in the pace of income growth over a sustained period of time.

Amarnath: That is the part of it that, when we're thinking about how the Fed's supposed to be communicating what is a sustainable rate of income growth and a sustainable rate of labor market improvement, that's what has to really be separated out of it. These labor market outcomes can improve over time, the pace of that process may be slower or faster, depending on capacity constraints, and that has to be sort of taken into account accordingly, but it's not the same thing as saying, "Well, once you get past 4% unemployment, all hell breaks loose."

Beckworth: Yeah, so we've got to have a broader dashboard than 4% unemployment. In fact, let's use that to segue into your proposal. So you and Alex Williams come up with your version of the Summary of Economic Projections, so you modify it. Walk us through the changes that you would like to see incorporated into the SEP.

In the 1970s, nominal income growth was also high, which is something people forget about it. It's not just about prices itself. Yes, there were oil price shocks. Yes, there were ways it mattered, but it was also being reflected in the pace of income growth over a sustained period of time. That is the part of it that, when we're thinking about how the Fed's supposed to be communicating what is a sustainable rate of income growth and a sustainable rate of labor market improvement, that's what has to really be separated out of it.

Modifying the Summary of Economic Projections

Amarnath: In addition to the Fed's baseline outlook for GDP growth, for the unemployment rate, for core and headline inflation, I think it would be helpful to have a clear view, especially since policy is being anchored to this now, in terms of assessments and maximum employment. What are each member's assessments of maximum employment for 2021, 2022, 2023? Because those numbers could be different, they could be more similar, but it's actually not totally clear, especially as we move past the supply-side challenges of the current year, as more businesses reopen and go back to normal. We're going to probably see a very different picture in 2022 and 2023.

Amarnath: That could've been a one-way to really thread the needle on how the Fed saw maximum employment in the late-2010s, when we did get past 4.5% unemployment, and we weren't seeing the inflation from it. The Fed should've been knocking down their estimates of what's the sort of sustainable rate of unemployment over time. They should've been willing to revise that, and they could also accommodate those by saying there's more progress that's achievable as you move further in time, assuming no shocks, assuming no recessions. So taking a more dynamic approach, saying actually, "This is where maximum employment is in the current moment, but it doesn't have to be the ceiling in subsequent moments." That cuts both ways, obviously, but it should really cut in the asymmetric direction of saying these are shortfalls that we should be addressing today, but they don't necessarily guide us in terms of what maximum employment looks like a year, two years from now, in the same way.

Beckworth: Yeah, so I'm looking at your paper here, and you have, in this modified Summary of Economic Projections, you've got the existing long-run unemployment rate. You also have the employment-to-population for prime-age workers in there, and then you have the employment cost index.

Amarnath: Yes. And so I think there's something that the Fed talks about a lot, which is that you can't just summarize the labor market by one variable, and that's true. You can have high employment and not very strong wage growth, you could have low unemployment and sometimes somewhat stronger wage growth, so you want to capture that on multiple indicators. I think actually, from the perspective of really calling a labor market tight and hot, to quote Jay Powell, "You've got to see some heat. You have to see that there is the kind of wage growth that actually reflect a strong labor market." Are we seeing wage growth that is consistent roughly with productivity and broader nominal GDP growth? Are we seeing that there is that kind of bargaining power being exercised, and it's not just merely about getting to a certain level of employment.

Amarnath: We included the prime-age employment-to-population ratio, because at this point, the Fed really should be communicating labor utilization on a better indicator than the unemployment rate. There's some really good research about how the unemployment rate is so flawed that we don't actually do a good job of classifying who is unemployed and who is not participating in the labor force. The ability for surveys to accurately classify and consistently classify over time is not particularly good. This is actually a very blurry line. It's easier for me to say I'm employed or I'm not employed than for me to say whether I am unemployed or not participating. Respondents give very different answers at different times, and they're very confused about the definitions. As a result of that, I would think that the Fed, for that reason alone, should shift towards employment-to-population ratios as a way to communicate labor market health. You have to make the right adjustment for aging, so you can take 25 to 54, maybe something like 30 to 64, but there are ways to take a better age adjustment and still use an employment-to-population ratio to guide these judgements.

We included the prime-age employment-to-population ratio, because at this point, the Fed really should be communicating labor utilization on a better indicator than the unemployment rate. There's some really good research about how the unemployment rate is so flawed that we don't actually do a good job of classifying who is unemployed and who is not participating in the labor force. The ability for surveys to accurately classify and consistently classify over time is not particularly good.

Beckworth: Yeah, I think it'd be important for the Fed to sell this. I mean, it would be a new approach, right? Typically, we're used to the Fed doing the unemployment, as we've been talking about. I like what some have said in terms of the employment population for prime-age workers. That's a mouthful, so I've heard some call it the working-age employment rate. That's a nice, quick, succinct way of doing it.

Amarnath: I was going to say, there's definitely room for better branding. A snappier title than prime-age, 25 to 54 employment-to-population ratio. So any advice and suggestions on how to make it snappier, we’ll take.

Beckworth: But this is good, though, because you have three indicators of the labor market, and two of them are labor utilization, and the third is labor cost or labor wages, a measure of that. And I know that harkens back somewhat to both of our views on the desirability of looking at nominal income growth. But maybe talk about the ECI a little bit, why you included it.

Amarnath: Yeah, I think it's really important to have some guide for what income growth looks like in the economy. I think that's one part of it. I think it's good for both evaluation of the inflation outlook and informative about the outlook for maximum employment. It's like what the maximum is should be a function of what kind of bargaining power do we see exercised. It really also cuts through a lot of these structural unemployment rate discussions, where if we assume some people are structurally unemployed, we should expect to see that wages are going up for the people who are already employed in a more substantial way.

Amarnath: ECI is probably, even though it's released quarterly and not monthly, it probably does the best job of avoiding certain composition biases, so it's probably the best-in-class wage indictor we have, it's not without some flaws and head fakes, but it is probably the most robust between employment… So what you typically hear on jobs day, jobs Friday, is the average hourly earnings number. That is actually not a particularly great number of looking at wages. It can distort things in some pretty important ways, so if you lay off a bunch of your lower-wage workers, then technically wages go up for the average, and so it confuses average and marginal in really bad ways. Whereas ECI is a little bit more robustly measured and is trying to control for particular occupations and what kinds of wages are being paid over time. That would probably be the best guide.

Amarnath: The Fed, if you look at their green books, if you look at their Fed transcript materials, and if you look at the historic materials of how the staff forecasts. They do forecast what the employment cost index is supposed to look like over time. So in some ways the Fed staff's already got them started on producing forecasts for ECI should look like. Putting a maximum employment projection that would be associated with that does not strike me as particularly onerous, it strikes me as something that they're doing implicitly at least.

Beckworth: Yeah, so I encourage listeners to take a look at this proposed change to the SEP. We'll have a link to it up at the show page. So I want to switch gears here, so you've given us your concerns and your proposals to fix the full employment side of the mandate and the Fed's framework, but let's move to inflation. I know we've touched on it different ways, but let me ask a question about inflation just to start things off. We only have a little bit of time left here, so this will be the last part of our show. Does the Fed's new framework implicitly acknowledge that the Fed does not have a good working theory of inflation? I mean, isn't the whole approach to this framework, "We're going to wait until we see the white of the eyes of inflation, because our Phillips curve model did not do a good job predicting inflation."

Beckworth: Maybe they believe in the Phillips Curve, to some extent, as a theoretical construct, but they don't believe the measures they have or the inputs are good. Effectively, they're saying, "Look, we don't have a good working theory of inflation, so we're going to just wait until we see it." Am I being too harsh in my interpretation of that? Or is that fair?

The Fed’s Working Theory of Inflation (Or Lack Thereof)

Amarnath: I think that is pretty fair. I think, just to be clear, I think the Fed's view is not some sort of Phillips curve that is univariate. It is an expectations-augmented Phillips curve, and so they're looking at what their observed estimates of inflation expectations are telling them, and they're also trying to back out some assumption about what the unemployment rate would do to inflation over time. And then you do some risk management considerations on top of that. That would've been a pretty loose description of what the Fed's reaction function was prior to the framework review, or prior to 2019 at least.

Amarnath: Now, I think that they are waiting to see some signs of sustained inflation in a way that seems particularly replicable. That's the part that is hard to say, that the used car price increases of today are going to necessarily going to be predictive... It may not be used car price increases next year, but it may be a different set of prices the following year. It's certainly possible, but how you use that information is not actually clear. For as many instances of persistent inflation of the 1970s that are constantly evoked, there are a lot of examples of where we have had price volatility to the upside and the downside. That's also hard, because that doesn't necessarily sustain either.

Amarnath: I think the Fed is really searching for a good theory in some ways, and in a theory that they have to be accountable for, and that maybe those who are in other positions of influence, whether it be academic, or market practitioners, don't necessarily have to deliver on. It's a hard problem to resolve of how you keep yourself accountable to inflation on the upside in a way that's still managing business-cycle consideration and their dual mandate responsibly.

I think the Fed is really searching for a good theory in some ways, and in a theory that they have to be accountable for, and that maybe those who are in other positions of influence, whether it be academic, or market practitioners, don't necessarily have to deliver on. It's a hard problem to resolve of how you keep yourself accountable to inflation on the upside in a way that's still managing business-cycle consideration and their dual mandate responsibly.

Beckworth: That's why I want to see a nominal GDP level target one day, because it gets us away from worrying too much in the short run about inflation.

Amarnath: I think that's absolutely right, because you are seeing this now. It's a very turbulent time in the economy, for reasons that are very independent of the Fed, but implementing a new framework within it, you have to reference a whole set of prices that are idiosyncratic, and yet you're trying to make out what is the systematic component of all of this, and what matters, and that just seems so much cleaner if you are making projections and anchoring policy to what income growth looks like. If income growth is really strong in 2022, even without all of these sort of fiscal and reopening effects, if we see really strong income growth in 2022, I think that you can see the makings for more persistent dynamics. Right? But that's just something that's a hard judgment to make in 2021. As someone who did forecasts, forecasting is really hard, it's even harder if you're not really anchoring any of this stuff towards some view of what the income growth outlook is going to look like in nominal terms.

Beckworth: I agree, absolutely. So we need more work done on forecasts of nominal income growth in different sectors. All right, let me step back from all of this, because this conversation is kind of predicated on a view of inflation that is tied at some level to how much slack there is. If we have too much spending, and it's pervasive enough throughout the entire economy, eventually you're going to have inflation. So I guess my question to you is, what is your theory of inflation? We know the textbook Phillips curve theory of inflation. What would be your theory of what drives inflation?

Skanda’s Theory of Inflation

Amarnath: It is inherently both a monetary, macro phenomenon, but it is also a phenomenon that requires some assessment of capacity at a disaggregated level. So you could think of it disaggregated supply, aggregated demand, that might be my best way to put it, which is that you have to look at the particular capacity constraints that exist in the moment, and those are not easily summarized into a particular measure of natural rate of employment or capacity utilization at the aggregate level, but there were capacity constraints for which demand-side policy, sometimes, is not going to be the right remedy or can actually aggravate certain pricing power that's not actually resolving it.

Beckworth: Make it worse. Yeah.

Amarnath: Make things worse. If you look at the 1970s and the 1960s, we had a few things that were going on, and I think it's really important when you say there was a great inflation, there was also the great nominal income growth boom of that period. That was driven by not just strong household spending, but it was also strong capital spending, so real fixed investment was really strong during this period. So we will have some subsequent pieces on precisely the great inflation and making sense of it, because we had high inflation in the '50s and the '40s that subsided very quickly. Whereas, in the '70s, we did not have that kind of transitory phenomenon.

Amarnath: So when we distinguish what drives inflation, I would say it is, we have to be willing to make adjustments on the fly. We have to understand that some of this stuff is not visible by simple aggregate macro variables, and that means proceeding cautiously, somewhat humbly, and also having a view of, yes, supply constraints can emerge in different sectors in different times and affect the whole economy. The best we can do, at the aggregate level, is to really look at how are monetary and fiscal policy influencing income growth, aggregate spending growth, wage growth, labor market conditions. Those are things that are easily aggregatable. Saying that this is the point where you can't produce more things, this is the point where you can't, is not something that... I would actually say this is where you do want to have more information, more context, more knowledge. I think that's where the premium really is. That's more a short-form version. I realize this is a huge question.

The best we can do, at the aggregate level, is to really look at how are monetary and fiscal policy influencing income growth, aggregate spending growth, wage growth, labor market conditions. Those are things that are easily aggregatable. Saying that this is the point where you can't produce more things...I would actually say this is where you do want to have more information, more context, more knowledge. I think that's where the premium really is.

Beckworth: No, no, this is good, but you're staying in the here and now, if I'm the FOMC official, I need to get granular. Otherwise, I might make a mistake in my decision.

Amarnath: I think they all are getting granular. If you look at their speeches, they are trying to make sense of whether this is transitory or persistent. That is inherently a question about, do you think the price increases of today, like the information we have is really about composition. The Fed always does this, in a way, they're always trying to do headline versus core. The reason you separate out headline and core is because you think the non-core components are not very predictive of future dynamics, because ultimately, if the Fed reacts to every headline inflation dynamic and tries to curb inflation because of oil prices or food prices, they may not actually be responding to the thing that matter over the coming year or two years. Monetary policy should be forward-looking, it should not be purely reactive, because there are a lot of noisy bits of the information set that are not worth reacting to.

Amarnath: That's the same decision you're making right now. If you think capacity can quickly catch up in areas, then that's good, but if you think capacity is going to take a long time and it’s going to require a lot of investment and a lot of spending to happen, then the assessment does shift. I realize, I'm trying to summarize a lot of high-level ideas in a very short amount of time.

Beckworth: No, this is good stuff.

Ultimately, if the Fed reacts to every headline inflation dynamic and tries to curb inflation because of oil prices or food prices, they may not actually be responding to the thing that matter over the coming year or two years. Monetary policy should be forward-looking, it should not be purely reactive, because there are a lot of noisy bits of the information set that are not worth reacting to.

Amarnath: This is a very complex and rich problem. We will have something out, hopefully within the next month or two, specifically on these points, but I think it's a tricky problem I think the Fed is grappling with. The common criticism here is mostly about communication and making sure that's appropriately dynamic and flexible to match what the Fed really is doing, I think.

Beckworth: Yeah, we're definitely going beyond the scope of your paper here. I'll just leave with this comment, and I'll give you the last word, Skanda. I have not been someone who's been concerned about runaway inflation. I'm definitely team transitory inflation. Part of it is tied to my theory of inflation. I think more in terms of quantities, and particularly, government debt, in order to get sustained higher-trend inflation, you'd have to have year after year after year of government spending growth rates up, and I just don't see that happening. I don't think it's in the political cards. That's trend, now what you're talking about is more short term, but I, from the get-go, wasn't convinced that we're seeing a fundamental change in the structure of how much government is going to be spending going forward on a trend path. Now, that may sound a little bit like a fiscal theory of the price level, but I think, in my view at least, it's important to think about that, whether we get worked up or not about inflation.

Amarnath: We see this actually quite similarly, even though we come from slightly different perspectives, which is that we have to think about the generators of income in the economy. Is it government spending, is it private credit creation in financial intermediation? Are we seeing something that's going to structurally change between now and next year, after we get through the reopenings and the initial fiscal impulse of the American Rescue Plan, which again, you send people checks once. This is not the same thing as sending people checks every year. Now, there may be changes in the fiscal policy structure over the coming six months. It seems like there's a lot of big legislation being discussed that can change the path, so all these outcomes are policy-contingent. As a forecaster, that's important to recognize. Your forecasts are contingent on a certain baseline policy outlook, and if the policy outlook changes, so too should your forecasts.

There may be changes in the fiscal policy structure over the coming six months. It seems like there's a lot of big legislation being discussed that can change the path, so all these outcomes are policy-contingent. As a forecaster, that's important to recognize. Your forecasts are contingent on a certain baseline policy outlook, and if the policy outlook changes, so too should your forecasts.

Amarnath: That's something to be really mindful of as we go into 2022 and 2023. I think of these types of dynamics you're describing, like government spending. Maybe it's the case that now the private sector has a stronger structural appetite for spending, and capital spending in particular, that actually does kind of accelerate the economy in both nominal and probably real terms too. And then, you're kind of in a different world. But again, there's a lot of stars that have to align for that to be the case, and I think that's just where I would say “to be determined”, at least.

Beckworth: Well, with that great advice, our time is up. Our guest today has been Skanda Amarnath. Skanda, thank you so much for joining us again.

Amarnath: Thank you so much.

Photo by Olivier Douliery via Getty Images

People: 
David Beckworth
Calendar Date: 
Jul 12, 2021
Podcast Series: 
External People: 
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Libsyn Podcast ID: 
19761068
Subtitle: 
Through replacing conventional and flawed measures of the unemployment rate, the Fed could improve its policy communication while more accurately achieving its mandate of maximum employment.

Employ America’s Webcast Panel on the Federal Reserve’s Updated Framework and Its Implications for Monetary Policy

Macro Musings is back with another bonus episode, as Sam Bell and Skanda Amarnath (Employ America) are joined by Julia Coronado (Macro Policy Perspectives) and David Beckworth (Macro Musings) to talk through the announcement of the Fed’s framework transition towards average inflation targeting. Specifically, this panel of guests discuss the implications of moving to an average inflation targeting regime, whether the shift may cause credibility problems for the central bank, how to continue to improve the Fed’s toolkit, and more.

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.

Sam Bell:  Thank you so much for joining us on this morning of a new Fed framework. Let's see. Let me start by saying a lot's happening in our country, in our world. And we have many of our countrymen falling ill and dying of COVID. We have many millions unemployed. We have our black brothers and sisters living in fear. And so I just want to acknowledge those things at the top. And we're trying to bring to this and all conversations around monetary policy, a lightness, a festive atmosphere. Our goal there is just to make it inclusive and make it accessible and make it a bit of fun. But I also realize these are heavy times.

Bell:  So, all right, with that, I don't want to do too much in terms of introductions because I think folks who are watching this probably know everyone, but we will post in the links the full bios. Julia's bio is so long, it would take like six minutes to get through it all. But let me dive in. We had Jay Powell give a speech this morning at the Digital Jackson Hole. And in addition to that, we had the Fed release a revised statement basically of their framework. And I think the ... Well, actually, Julia would you want to give a summary of what the major pieces are just for our listeners who might not have scrolled through Twitter?

Julia Coronado: Of the changes to the framework?

Bell:  Yeah.

Changes to the Federal Reserve Framework

Coronado: So, I mean, I think that there was ... To me, the big picture here is this is the flipping of the order of operations here. The goal is now maximum employment. That takes precedence. That showed up in the statement in a few ways. They actually flipped the words inflation and employment when they were talking about their objectives. They moved the employment paragraph up in the statement. They included more words around what maximum employment means. So I think it really is an overarching emphasis on using an average inflation targeting framework, which we widely expected. That was the most socialized thing that we were expecting.

The big picture here is this is the flipping of the order of operations here. The goal is now maximum employment. That takes precedence...They included more words around what maximum employment means. So I think it really is an overarching emphasis on using an average inflation targeting framework, which we widely expected.

Coronado: We got it. We got it largely as expected. They're going to try to have inflation centered and averaging 2%, but that's a means to an end. And the end is a broad based and inclusive realization of full employment. And to me, that's the significance that was maybe less appreciated was ... And I mean, Sam, we've been talking about this for a long time. Jay Powell is about as dovish a labor market dove there is. I think he took Janet Yellen's lessons deep in his soul. He went out to the people and heard them. And I think his fingerprints are all over this.

Bell:  Yeah. All right. So let me push you on that, on the employment side. And Skanda and I have been going back and forth about how satisfied should we be about this? And you never want to be in the position where you pushed for something significant and then don't recognize it. So we don't want to move the goalposts. At the same time, the speech itself and most of Powell's speeches now are really love songs to full employment, right? It's just like tight labor markets are the greatest thing ever, they do so much. I think, to give him credit, I think that his main innovation, I'd be curious David and Julia, if you think this is right, his main innovation in 2019 was to say, "We just don't know enough about our estimates of maximum employment to say we're beyond full employment."

Bell:  And as a result, I'm not going to be the Fed chairman that tries to bring unemployment back up to some estimated level. Right. So props to him. That was big. I guess the question for us is if you're not actually targeting a labor market outcome, is that enough? Is our framework high powered enough to generate a more robust jobs recovery? I guess I'm curious for reactions to that. Julia, David, Skanda, should Employ America be happy about this, I guess is ... We're starting at a place where we have very high unemployment right now and we're about to hopefully start a recovery. So should Employ America be happy about this framework?

Evaluating the Change in Fed Framework

Coronado: David, do you want to take that first?

David Beckworth: Sure. I'll jump in. I'll say a big maybe. I think this is great and it's a step in the right direction. I've been calling for a long time for some kind of makeup policy, which would be level targeting. And this is a step in that direction. And why would that matter for labor markets? The way I look at it is make up policy is huge because it allows for some reflation in the economy, including labor income, or particularly labor income. If you don't encourage, you don't allow for reflation, which in plain English means dollar incomes growing rapidly to get back to where they would have been in the absence of a recession and spending, if you don't have that, you're not going to have these healthy labor markets. So this opens the door for that. It gives the Fed license.

I think this is great and it's a step in the right direction. I've been calling for a long time for some kind of makeup policy, which would be level targeting. And this is a step in that direction.

Beckworth: It also means if you get to a level target that provides powerful forward guidance, but I think makeup policy is the silver lining I see in this. I say a big maybe because I'm not convinced this is a terribly credible policy yet, and maybe things will come out. I think there's a lot to be done. I'll stop there. I can discuss some of those later, but I do worry whether this will be a credible policy, but it has the potential, Sam, to make you happy.

Bell:  Okay. Skanda, what do you think? If we were doing this in 2008 or 2011, you just wrote a big piece about the dangers of inflation target, and you looked at 2008 and 2011. 2008 I think is ... Yeah. Anyway, how would average inflation targeting plus maybe more of an emphasis on, or a de-emphasis on sort of a natural rate of unemployment, have fared in those periods?

Skanda Amarnath: I think that the latter is probably more important for our purposes as far as de-emphasizing the whole idea of… I think one of the critical changes in the document that was released today was it changed from talking about avoiding deviations in unemployment to talking about addressing shortfalls. So it's effectively saying there's no such thing as too much employment. Now maybe there's some other problems that are associated with that that need to be addressed. But the notion that we're symmetrically optimizing the amount of employment in the economy is not actually true. Right? And that runs counter to a lot of the Fed forecasts that were effectively projecting that optimal policy would raise the unemployment rate. Right? So that, I think, was not something was widely talked about or expected coming into today. I think that's probably what Julia was saying, a very positive development.

One of the critical changes in the document that was released today was it changed from talking about avoiding deviations in unemployment to talking about addressing shortfalls. So it's effectively saying there's no such thing as too much employment.

Amarnath: I think the average inflation targeting point is one where I'm conflicted in the sense that I do understand that they're trying to be more accommodative to welcome or increase the probability of tight labor markets. As to what David was saying, there is a chance for reflation. You don't do preemptive tightening the way they did in 2015, '16 to '18. So you don't actually try to tighten the ... If the economy is running, don't try to choke it off in terms of trying to preemptively avoid future inflation. At least try to see some of it.

Amarnath: I do think it sort of misses the point that, to all the things that David was talking about, in my mind it's why not calibrate policy with that specifically in mind, specifically trying to raise dollar incomes? That seems like we're kind of doing this very indirectly through inflation to talk about labor markets. I get that there is a dovish overtone to some of this, but inflation can do very weird things in the moment. It can distract both FOMC members and financial markets. And I think 2008 and 2011 are the two examples, I think, of where there was divergence. This is also the 2011 particular was when David and Scott Sumner's ideas around market monetarism and nominal GDP targeting, I think kind of got into the popular discourse more so because inflation was doing something very different from the economy itself.

Amarnath: And I do worry while Jay Powell and people like Janet Yellen have a certain set of instincts that say, "We need to deliver accommodation when unemployment is high," I don't think that's necessarily what average inflation targeting implies all the time. Not everyone's going to have the same worldview or the same set of values. So it does lead to a more fragility in those types of environments. Again, it may not play out. So if we're talking about the sort of late 2010s, when we had both low inflation and low wage growth and low nominal GDP growth, and all those things are moving in the same direction, this is a helpful policy. But I think it is something where it does feel like a very oblique way of actually trying to attack the issue of labor market tightness.

If we're talking about the sort of late 2010s, when we had both low inflation and low wage growth and low nominal GDP growth, and all those things are moving in the same direction, this is a helpful policy. But I think it is something where it does feel like a very oblique way of actually trying to attack the issue of labor market tightness.

Bell:  That's a little bit ... Just if I can add one more thing. Yeah. That's a little bit my concern is the framework is supposed to be a structure that persists across different FOMCs. And I kind of worry a little bit that we're calling it dovish because we're marrying it with the whole Powell emphasis on full employment, and when Don Jr appoints Judy Shelton to be Fed chair, will the framework be as robust? Well, we might have other problems in that scenario, but even in a lesser scenario, I guess are we over-weighting the dovishness of it because of the messenger and because we've just come off this period in 2019 where he did exactly this thing where the committee wasn't willing to push unemployment up. I don't know. Julia, you want to weigh in?

Coronado: Yeah. I mean, I agree with the points made. It's sort of a do no harm statement. It's not a guarantee. It's not a stated objective, but I will say, one of the reasons that might be the case is that it's not clear they have the tools. Their tool kit is increasingly not well suited to the job. They work through asset prices. The credit channel in an aging society characterized by extreme inequality, the credit channel is muted at best. It's there. Housing is doing well. It's there. But there's tons of people left out of that. And the asset price channel, even more people are left out of that.

It's sort of a do no harm statement. It's not a guarantee. It's not a stated objective, but I will say, one of the reasons that might be the case is that it's not clear they have the tools.

Coronado: So full employment is a truly macroeconomic outcome that, as Powell stresses, really means we're getting to the people that are the most vulnerable. They're the ones that suffer the most in a recession. They're the last to realize the benefits of an expansion. The Fed doesn't really have the best tools to get at that. David made the point earlier about they're going to kind of have to prove their credibility over time, right? And that's the danger of making a bolder statement about full employment objectives, which I'm extremely sympathetic to, is that they even lack of credibility even more than what they've done today.

Bell:  Let me ask you, so on tools ... And David, we're going to come back to your ... In the chat, people are asking about credibility and we're going to come back to it. On tools, two questions. One is, I know you've thought a lot about tools. Three questions would be one, are there tools that they already have legal authority to do that they should be talking up more? Two, are there tools they should get legal authority to do that they don't currently have legal authority to do? And then three, my thing is should they be talking up more fiscal policy so everyone is socialized to the notion that we need fiscal policy to do more of the work? They could even call for more rule like fiscal policy, like automatic stabilizers or something like that. Anyway, do you want to take one or all of those?

Beckworth: Well, Sam, can I jump in? I want to go back to Julia's comment about do no harm. I think that’s key. I think that even if we acknowledged maybe that it doesn't have the tools that need, it still has the ability to do great harm. And the challenge is being able to let inflation rip, if it needs to temporarily, on the upside of a recovery. We want the economy to run hot. We want to get back to full employment. They want to have nominal incomes back to where they would be. And the danger, in my view, of this policy is it's going to be hard for policymakers, when we get 2% inflation, two and a half percent inflation, and pundits start crying out, the market starts worrying.

Beckworth: Congress starts worrying, and it may be hard for the Fed to do no harm. They might be tempted to raise rates. So I think even before we get to the question of additional tools, can they constrain themselves from raising rates, like they did in the past. And our hope is, this policy does that. But I'm still not sure this goes back to credibility, I'm not sure though. We'll have to wait and see when they go through a true test of inflation going up.

Even before we get to the question of additional tools, can they constrain themselves from raising rates, like they did in the past. And our hope is, this policy does that.

Bell:  Yeah.

Coronado: That's fair.

Bell:  We have another question from folks about credibility. David said a few times, one of the main problems of Fed right now is credibility. What is the main change in that direction with average inflation targeting, instead of inflation targeting? Do you think there's a significant change here in terms of credibility?

The Fed’s Credibility with Average Inflation Targeting

Beckworth: Well, let me speak to this since I brought it up, but I'm sure the other two would like to respond as well. The two big credibility questions I see is one, this policy, as we've alluded to earlier, under it, you have to sell higher inflation as a good thing. You're going to tell people, "Hey, I know you just went through a recession and come through a pandemic, let me generate a little extra higher inflation it'll only be six months a year, but this is what you need for a fix."

Beckworth: And they're constrained to do that, because this is under the framework of an inflation target. I think Skanda was alluding to, it'd be a whole lot easier if we just said, "Look, but what we're really aiming to do is to restore normal incomes, or your dollar incomes. And as a byproduct, maybe there'll be some higher inflation temporarily." And I think that's where credibility comes in. I don't again think, and I worry that the Fed, when it comes to this point, may back down and not do no harm.

Beckworth: The other thing, another concern I have about credibility with this is, average inflation targeting, the parameters around it aren't defined very well. And they even said in the statement, and I think Powell mentioned it that we still reserve all the discretion. And I think in this case it's actually detrimental. If you don't define well what average inflation targeting is, it leaves a big open hole to make it up as you go along and therefore you get back to what we already have today. One of the benefits of a pure price level target is it really does tie the hands of the Fed and says, "You have to get it back up." But the fact that it's so vague and uncertain, I think that undermines its credibility as well.

Bell:  Yeah. I thought they were going to anchor around the Bernanke proposal, which is however many quarters we are at the lower bounds, we're going to make it up with quarters above 2% inflation. I'm probably butchering it a little bit, but he had some metric around that. But yeah they kept discretion. I wonder if that was like an escape clause for financial stability.

Coronado: Yeah, they did strengthen the financial stability escape clause. They had one in there before. They added some language that strengthened it a little bit. So, I think credibility comes on a number of fronts. So I agree with David, if you're going to be truly credible, it would be a lot more effective to tie your hands. On the other hand, you might not still be fully credible, because there are these other dimensions that they do care about. And there have been times when, all else equal, they still prefer to use non-monetary tools to address financial stability. But they get nervous when markets get super frothy and debt starts piling up. And I don't think that that's necessarily something they should take off the table.

Coronado: Those are how imbalances that can be very detrimental to full employment over the cycle can develop. So I think it's just inherent to the institution and how they make decisions, that there's going to be some squishiness. And I agree that the proof will be in the pudding. And I think Powell has acknowledged this too, that this anchoring of inflation expectations, is something… if they want to re-anchor them a bit higher, it's going to take some time. They are going to have to prove themselves.

Coronado: I do think that in effect, what they've done with how they look at inflation is, look unless inflation is coming from wages, it's not going to be persistent. Supply chain driven pops, energy price pops, they look through those, they've done it before. They'll do it again. But, I think Sam, you mentioned that that requires that the personnel is that technocratic, credible people that want the right thing for the medium term interest of the economy. And if we follow that tradition of appointing types of people, then you'll get that outcome, but there's no guarantee. So, at the end of the day, the Fed is a political institution tied to the whims of Congress and subject to some of that malleability over time.

Amarnath: To that point into what David was saying about the political language. I think obviously with the political alignment right now of you have Congress, that's not really criticizing the Fed for being overly dovish. I don't think you're really seeing that side from maybe a couple of senators, but generally speaking, under Trump's presidency, we've seen actually a more dovish Republican party and the Democrats have not gotten particularly critical of the Fed for being overly dovish either.

Amarnath: But I think you can see the scenario where this language sounds very tone deaf. Where you say, "We are shooting for higher inflation." I think this is where like part of the political credibility, central banks do not operate, they may be independent, but they don't operate in a political vacuum. So there still is political pressures. If we think back to 2010, '11, '12, where there was a lot of scrutiny of the Fed in terms of, what are you actually trying to achieve here? Are you trying to debase the dollar? Are you trying to just create inflation and raise my cost of living? Or are you trying to achieve something?

Amarnath: The actual thing, I think to your point about... The inflation pressures, and I think a lot of FOMC members who are dovish are thinking about, are the ones that are wage driven. The ones that are income driven, not supply chain issues that should fall out of the system in 12 months time. But I think it's worth being explicit about that, because otherwise I feel like we're also going to get back to square one, where we're going to be talking, it's not that hard to see a scenario where you see the faster inflation, temporarily. And the question is what should the Fed do about it?

Amarnath: I think the problem with the level targeting stuff… And I think this is why some doves even, I read a Brainard speech from earlier this year, Governor Brainard talked about how, "I prefer a more flexible approach." It's not because she wants to withdraw accommodation necessarily in those sorts of environments. But let's say we did get some excess of the price level target itself. Does that necessarily warrant tightening? I think it really depends on what we're talking about. What kind of price level overshoot are we really seeing? Is this the kind of thing that is idiosyncratic, transitory, or is it actually driven by some persistent pressure?

Amarnath: And to me, all of these linguistic and credibility problems really would be better hammered out by moving away from the inflation-centric paradigm that the Fed has fenced itself into. And then it really depends on who is the personnel? And I think that gets away from the whole notion of a framework, which shouldn't really be highly depend... Personnel always matters, but to the extent it really turns on, who's the Fed chair? Or, who are the FOMC members. Maybe that's a better way to put it. What's the composition of the FOMC? I think to make that count, and moving away from this framework would actually be helpful to our Senate.

All of these linguistic and credibility problems really would be better hammered out by moving away from the inflation-centric paradigm that the Fed has fenced itself into.

Coronado: Well, I think there's scope for moving in that direction. Skanda, I think, again, if our understanding of inflation dynamics and persistent inflation dynamics is ultimately rooted in wage dynamics, there is some scope for, maybe in the next five year review, you'll get your wish.

Amarnath: Yeah. One thing that I wanted to bring up, given some of the things both of you talked about, was the framework review was supposed to also discuss tools, whether the Fed had the right tools. And it really did not get a lot of attention. Powell didn't really talk about it in his speech. And yet I can go both ways on this in the sense that we just see now, unpredictably a little bit that the Fed now has all these new authorities under the CARES Act to really lend to more of the economy. They have fenced themselves in, by certain rules that say we have to lend at a penalty rate. We can't be too generous with our lending. Some of this is just really a function of their choice, so they could actually do more if they were creative enough.

Amarnath: But some of it also does reflect like, "Look, credit channel is not the same as it used to be." And so it's the question of, are there other ways to explore new tools? It strikes me this would be a much better emphasis of their time than trying to toggle with, I don't know, a handful of basis points on inflation expectations. If we're talking about moving it back up to 2%, or targeting 2.2 or 2.3% on core and headline PCE, I'm not sure where these inflation expectations, calibration exercises, is that really worth their time for the past 18 months relative to the toolkit discussion? I think it's important to at least discuss the strategy, but it has to be rooted in, "Do we have the right tools to do the job too?"

Coronado: Amen. Woo. They spent so much time fine-tuning this little average inflation targeting thing. And when push came to shove in the recovery, it was all about the balance sheet. 150% about the balance sheet. And the statement still says their primary tool is interest rates. No, it's not. It's the balance sheet guys. Hello? The balance sheet is primary and interest rates are a companion to it. That's how I see it, in terms of sitting in financial markets, what has had the most impact in catching the falling knife when the COVID recession hit and market seized up? It certainly wasn't interest rates. That was part of it. But the balance sheet and then the credit facilities. And they're still, Powell, they're struggling. That's a lot that they were asked to take on in a very short period of time. I'm very sympathetic to the personnel and logistical issues.

They spent so much time fine-tuning this little average inflation targeting thing. And when push came to shove in the recovery, it was all about the balance sheet. 150% about the balance sheet. And the statement still says their primary tool is interest rates. No, it's not. It's the balance sheet guys. Hello? The balance sheet is primary and interest rates are a companion to it.

Beckworth: For Julia, maybe for Skanda too, and Sam you as well, why don't we have more healthy discussions about the tools? Is that itself a product of the political environment? Is the Fed hesitant to go there? Julia, you have some great ideas.

Coronado: Yeah, so do you.

Beckworth: Yeah, but you've been thinking about this longer than I have, but why haven't we seen this more openly discussed? Is it a function of the environment, or what?

Rethinking and Expanding the Fed’s Toolkit

Coronado: I think that there's also a function of personnel and it being new and it's a new front. And the Fed tends to have been a more academically based institution, where they want a theory and some evidence to make decisions based on, which is admirable. I'm not discounting that. But naturally speaking, when things change very quickly, it's hard for them to adapt quickly. And Bernanke, boy to get to QE2, that was such a heavy lift on the committee. And the staff is still... Love the staff, a little behind the curve on balance sheets.

Coronado: Really thinking about it, thinking about how it interacts with financial markets, the different dimensions. They're now moving, some of the more recent staff papers are using [inaudible] framework, they're more flexible. They're more open-ended about the channels through which this all works, and how it coordinates with interest rate policy and forward guidance. But it was really, really amazing to me, during the review that that wasn't right there in the middle. And there was a little presumption, and this was on the part of investors too, that, "Oh, the next recession will be more like a garden variety of risk."

Bell:  Yes, yes, yes, yes.

Coronado: It was complacency. And it's amazing how quickly complacency returns.

Bell:  Yes. I remember a significant former Fed official saying, "We shouldn't just assume that the next recession will be as big as the Great Recession." I was like, "We should assume that. It might not be, but we should." But Julia, can you say a few sentences on your two ideas for new tools, recession insurance and your, I forget what you call it, the direct deposits to households.

Coronado: Yeah, yeah. So I have a proposal with Simon Potter, the former markets group head at the New York Fed, and you all know who Simon Potter is. So to create a system of digital currency, digital payment providers, that's one thing that we... One, I think that the Fed, and they are moving in this direction and Brainard's recent speech definitely I felt was a pretty big move forward on the thinking of the Fed should absolutely be on the frontier of digital technology and delivering the benefits of digital technology to the public. It can provide a more inclusive, lower cost, more efficient, faster payment system. It can create better financial stability as a result and a more inclusive financial system. So that's one prong of it, is they should embrace it, they should work diligently to put that into place.

The Fed should absolutely be on the frontier of digital technology and delivering the benefits of digital technology to the public. It can provide a more inclusive, lower cost, more efficient, faster payment system. It can create better financial stability as a result and a more inclusive financial system.

Coronado: And then that would facilitate, with the blessing of Congress, it would have to be authorized by Congress. And we have a construct of recession insurance bonds where Congress authorizes a certain percentage of GDP that the Fed can deliver into these digital accounts in a recession. So it's money rains. It's just helicopter money direct to consumers. This is not a new idea. It's just operationalizing it. Simon is excellent on operational and plumbing issues, which matters so much to getting policy right. And again, I don't think enough policymakers weight that as heavily as they should. So that's what our proposal is about.

Coronado: And to me, one, it does belong… this isn't fiscal policy. Look, if we got automatic stabilizers, a la Claudia Sahm's proposal, I'm all for that, 100% supportive of that. But at the same time, this is a different way to operationalize that and it is arguably the domain of monetary policy because why did we develop an independent central bank over time to take decisions with a medium term view, but based on near term circumstances? Because fiscal policy gets stuck in the mud, only in the most extreme circumstances, it's too little too late.

Coronado: And if the Fed could have jumped in and deposited $500 into everyone's account in mid-March, then they may not have had to go as far in buying corporate bonds and because the people would be insured, and that's ultimately what businesses care about anyway, is the risk to consumer spending and the real economy. So if you can insure the consumer better, and again have lots of guard rails and to limit the Fed's reach into this area, that's imminently doable. And then you can deliver… And it's monetary. Ultimately something like this is a contraction in the money supply and the credit channel working in reverse, it's very disinflationary, deflationary. The Fed's goal is to reflate to consumers. So that's the idea.

Bell:  And Julia, it strikes me that one thing coming out of this crisis, I can imagine Fed staff or Fed officials being like, "We'd rather give that Coronado idea some legs," versus having to set up a permanent municipal facility or...

Coronado: Yeah, right.

Bell:  It would be interesting if this experience makes them more wanting to do this based on... Yeah. Based on where they have ended up. I don't think they are happy about where they've ended up in terms of all the things they are-

Coronado: I can imagine they are not.

Bell:  -engaged in. David, do you have reaction to this? Or...

Beckworth: Well, I have a similar proposal as Julia's. I mean, very similar in spirit. I will invoke my few chances you've given me just bring up nominal GDP targeting again, only a few times, but I'll bring it up now. So I like Julia's idea and I agree, only in emergencies with guardrails, with sign off from Treasury secretary, all the proper checklist, I think helicopter drops tied to something like a nominal GDP level target. So again, we're doing this, but in a systematic fashion to the point, and we keep doing it until we reflate and restore incomes to where they should be, not just a one-time shot. That's the problem with what we solve, these checks that were sent out. It's a one-time shot, depends on the mood of Congress, the president. We want a systematic and whole process in place. So yeah, I'm very sympathetic to what Julia has outlined.

Bell:  What about your colleagues, Scott? I think he would say, "Forget all that. Just keep buying stuff. Buy everything that Treasury puts out there, you can buy it all up. And when you get done with that, you buy every single corporate issuance. And when you're done with that, buy whatever else paper is around." Is there a distinction there?

Beckworth: I can't speak for him, but what I would probably say is, and I would agree at this point, just having a level target in place could go a long way. So it may not be enough, but having a level target so you're putting the proper guardrails in place. But you could do a thought experiment, which this is not very practical. Again, I would refer to the more operationally sound stuff with Julia suggested. But you can do a thought experiment where if the Fed could do this, why not buy up the whole planet?

Beckworth: At some point we would see inflation and demand kick in, but there are political constraints that kick in. There are assets supply constraints that kick in. And so I think there's probably a practical limit, but you can see the logic of the argument. But like Julia, I propose what I think is a middle ground, a practical middle ground, where... And I like the way Julia frames. The Monetarist in me likes to think in terms of quantities and what she's proposing is increasing the monetary base to the point that the economy's reflating.

Coronado: And Sam, I will say to add to that, again, given what we know and what we're seeing in terms of the distribution of wealth, reflating asset prices just doesn't get the job done anymore. And we'd already seen that before this crisis hit. The wealth effect on consumer spending, which in the nineties was a big thing. And I was at the Fed in the late '90s, early 2000s, we ran our consumer forecasting models based on the wealth effect. It was three to five cents of every dollar would go into the economy over the following six quarters, or come out of the economy in terms of wealth losses. And it died. It actually absolutely died.

Given what we know and what we're seeing in terms of the distribution of wealth, reflating asset prices just doesn't get the job done anymore. And we'd already seen that before this crisis hit.

Coronado: If you run these models now, the wealth effect is zero because wealth is so concentrated and wealthy people save less and are less responsive. They buy what they want to buy regardless of sort of the fluctuations in their wealth. So that wealth effect on consumer spending is diminimous. And it doesn't matter if you break it out into housing wealth or financial asset wealth, it's basically zero.

Coronado: And so, it's already broken down. I think right now what the Fed's doing, it works very asymmetrically. It prevents a negative feedback loop. We all know that if asset markets were collapsing and the treasury market was seizing up, that would be unambiguously bad for the outlook. But now that we've got the S&P 500 at new highs and Tesla up, whatever, 6000% in a month, does that actually predict growth? No, it doesn't actually. So it's the impact of their policies through these asset price channels is very asymmetric and that's just not desirable over the longer run. I think we need to have a bigger, bluer sky discussion about tools.

Bell:  What do you think, Skanda?

Amarnath: Yeah, I think that Julia's ideas for sort of being able to do sort of functional helicopter drops, I think this is where institutional frictions really do matter just by increasing the amount of bank reserves in the system alone. That doesn't necessarily translate into more spending in the economy, right? There's more to the causal chain that goes missing. So I think when you heard the Fed two years ago, the sort of party line was, "Well, okay, we'll be at the zero lower bound. That seems kind of scary, but we also have forward guidance, we also have the ability to buy treasuries and agency mortgage backed securities, and we're going to kind of hope it's fine and maybe we need to do this sort of framework review. Sort of like a way to kind of buffer inflation expectations, and then we'll have lower real rates when we're at zero lower bound. That's going to be the solution."

Amarnath: This is wholly inadequate for this kind of crisis, right? And that's why we also have CARES act authority that's in place to allow the Fed to lend broadly, get more directly to businesses, to state and local governments to some extent, right? So now they actually do have some authority. It's probably not and optimal form of authority. I think direct payments to households will probably be both the more neutral and more broad based. So it seems like that's probably more optimal tool.

Amarnath: You have seen that the Fed… there's just this comfort level with thinking about things purely in interest rate terms, that they think about it as the models are all designed around what is the optimal interest rate that kind of gets you to full employment or gets you to whatever u* is, whatever sort of is, it gets you to the inflation target or whatever goal you have in mind, that the interest rate is kind of the key metric to toggle with. And the Fed just seemed very comfortable that sort of thing.

Amarnath: The discussion moves to tools, it feels political. It feels greasy, and they don't really want to get their hands dirty, but this is actually the thing that mattered the most. So I think there is room for robust discussion of the income target versus having an average inflation target versus an income target versus a different sort of framework. I think that's a really big part of this, but also the tools that make this all possible. It’s just sort of striking to me that the Fed spent so much effort on this when we really should be talking about what kind of tools helped to achieve those goals too. And I think the Fed just got very comfortable with that.

So I think there is room for robust discussion of the income target versus having an average inflation target versus an income target versus a different sort of framework. I think that's a really big part of this, but also the tools that make this all possible. It’s just sort of striking to me that the Fed spent so much effort on this when we really should be talking about what kind of tools helped to achieve those goals too.

Amarnath: And it seems just a little bit dissonant when like Jay Powell is talking, this is right in the middle of a recession. We're in the middle of a pretty big crisis and Jay Powell asked to kind of explain sort of New Keynesian macroeconomic modeling about how we're going to get the real rate low enough to get the inflation expectations are going to sort of change if we commit to higher inflation, but we're not going to really commit. This is all very arcane stuff. It's not really clear that they [understand] how arcane the discussion is. It's actually as powerful as sort of it's being hyped up to be.

Bell:  We make sure we're somewhat responsive to the comments in our YouTube chat. So Ernie Tedeschi, some guy on the internet. For those who don't know, Ernie is a friend of everyone on the program and the shadow Fed whisperer.

Coronado: And we cannot live without his labor market analysis.

Bell:  And we can't live without him or his labor market analysis. And he asked, "Do you all think U-3 based NAIRU is now dead as a policy metric, or will it live on? Or will it be replaced by a broader measure or a basket of measures?" And this is, I'll take the-

The Future of NAIRU as a Policy Metric

Coronado: Like Yellen’s dashboard.

Bell:  Yeah. Yeah, so Yellen had a dashboard, it's clear that from day one Powell sort of hated NAIRU. I think it was clear from day one. His first speech was about take taking aim at the stars. And I think he's been really dismissive, both in congressional testimony and his press conferences, about past estimates. But it's a very interesting question, what replaces it, if anything? So I'm curious. Yeah, I'm curious for everyone else to weigh in.

Coronado: Skanda has an idea, right Skanda?

Amarnath: I hope that u* is dead in terms of at least how it's functionally used in… I think you can make an argument that there's always an u* that's always that always exists if we have inflation too low, that means u*… We're not there yet. If you have inflation high, that means you passed u*. I have a post hoc analysis of what the natural rate of unemployment is.

Amarnath: But just functionally being the Fed, Jay Powell talks about this in his speech and I really enjoyed this part, which was these estimates kind of move grossly quickly, so we just kind of move them up and move them down really slowly so that the natural rate of unemployment, it's supposed to be the amount of structural unemployment and the economy or everything, it's not super bullish. And yet, this thing just moves around and we kind of just know what after the fact.

Amarnath: So then how much usefulness is there in saying, "Well, we know that the natural rate of unemployment is within... It's 5%." And then, oops, we actually find out later it's not. I find this to be a very backward way of thinking about maximum employment, right? And I think the changes suggest that the Fed's going to really think about employment from a standpoint of, there's obviously a problem when we have depressed employment when we do see these sort of asymmetric shocks and we need to address that. That requires addressing and I think that's all very good.

Amarnath: I think what's really weird about the last five years of 2010's expansion was that the Fed was talking about how unemployment is at risk of going too low, that we're actually going to have ... We need to get unemployment rate back up. And these are people who are historically considered more dove-ish, people like Eric Rosengren, Charles Evans, even ...

Coronado: John Williams.

Amarnath: … even into this direction that we've got to be worried about low unemployment because there is this sort of story that's been told.

Coronado: Bad things happen when unemployment gets too low.

Amarnath: Don't you see that we got unemployment really low in 1968 and '69? And then you started to see core inflation creep up and that's actually why you got the 1970s Great Inflation. Obviously, there are plenty people who disagree with that narrative, but it's a pretty powerful one within the Fed and within the institution about sort of the risks of keeping employment too high. And I think that they're getting rid of that, both in terms of politically, if the Fed wants to sort of maintain some political independence, I think that's important to kind of stamp that out, but also it's a very grim and incorrect view, I think, of how this is supposed to work. So I do think it's a positive. Whether it actually means the end of U-star, I think J. Powell is more dove-ish on this question than, say, the staff is. I think the Fed staff is more into the idea that we still have to find some sort of U-star to make these models work. And so ...

Coronado: It all comes back to the models.

Amarnath: Yeah. So I do think that it'll still exist in Fed models. It's not going away, but I think there's going to be more willingness to think dynamically about, okay, U-star is ...

Coronado: Oh, yeah. Inherently, the makeup strategy that comes in is a dynamic thing. Right? And so we've stepped decisively away from a Taylor rule, which even a forward-looking Taylor rule is kind of a spot estimate. Right? It's not as dynamic as thinking about things over the cycle. So we've stepped in that direction. I think, if you think about practically how the policy conversations are going to change with a de-emphasis of U-star I think we do start moving in the direction of talking about income and wages because what do we care about? How do we know where we are? And Powell was the one ... I mean, again, all kudos to Janet for starting this movement in this direction. And then Powell took it and that was the metric he said, like, "Look, we don't know what it is, but we'll know based on wage growth."

Bell:  You have to see the heat to call it hot.

Coronado: Huh?

Bell:  You have to see the heat to call it hot.

Coronado: You have to see the heat to call it hot. And so we're moving in the direction of our income target de facto, if you think about how this manifests itself in terms of policy decision making. When you're at the table and you're talking about, "What do we need to do to the setting of policy?" Well, where are we on the U3, the U6 participation, all the metrics on the dashboard and, at the end of the day, wage growth? And is it keeping up? Is it going beyond productivity? I mean, we never really got there in the last cycle. We were just starting to get there, not even really getting there. And so I think that the practical implication of stepping away is going to be powerful over time.

Beckworth: I hope you're right. And I think, again, going back to what's been said, it's difficult to know what these stars are in real time. I mean, you're playing God here. No one really knows these measures and that's another argument for nominal income or nominal GDP targeting. You kind of take a hands-off approach in the near term, but over the long run, you're still aiming for some kind of price stability, some kind of nominal anchor over the long-term, but in the short term, you say, "Look, we simply don't know. And we're just going to focus on stabilizing nominal income growth."

It's difficult to know what these stars are in real time... You're playing God here. No one really knows these measures and that's another argument for nominal income or nominal GDP targeting. You kind of take a hands-off approach in the near term, but over the long run, you're still aiming for some kind of price stability, some kind of nominal anchor over the long-term.

Amarnath: Yeah. I think this is sort of the market side of Powell showing up, as well, and that he is more mistrustful of latent variables ... That's what the whole 2018 Jackson Hole speech is about, "How am I supposed to know where any of these stars are?" And the kind of person who wants some price confirmation or some kind of evidentiary confirmation to say, "Okay, this is where the stuff is. So okay, if you want to keep your U-star and R-star-oriented models, it's fine, but there has to be some kind of check in real time for how we decide this stuff."

Amarnath: I hope the narrative that – the concern from Julia -- comes to fruition, I think, it'll be interesting to see how the Fed, as the personnel is involved in the Fed, what staff, FOMC members, whether they really take that to heart, whether they take it to heart that there is more to maximum employment than a low U3. There is more to maximum employment than a low U6. There is wage growth. There's all sorts of other measurements to sort of fold in. I think that, if we're really thinking about business cycle analysis and actually what totrack in real time, it hopefully will move towards something that's more like income targeting. Right?

Amarnath: That's a lot more reliable guide for where things are going in a way that ... I'm just afraid a little bit of, when we have this discussion, are we discussing wage growth or are we discussing income growth or are we going to end up discussing, well, cell phone prices, the methodology changed and all of a sudden go down that road. It can be a real false flag for what we should be focused on here. But it's very possible that all these sort of moves end up taking us to a much more constructive place. Hopefully, as I said, if we can get to de facto income targeting, that would be a big plus because the proof is in the pudding there.

If we can get to de facto income targeting, that would be a big plus because the proof is in the pudding there.

Bell:  All right. We're coming to the end. I want to ask one question that's a little bit more specific. So if you look in the strategy doc that the Fed put out, they have basically ... Well, let me back up. There's this thing called the divine coincidence, which basically says we'll get price stability when we close the output gap. There's no conflict between our goals around labor market growth and price stability. And the Fed says, "Well, that's not always true." So I'll just read here. "The committee's employment and inflation objectives are generally complementary. However, under circumstances in which the committee judges that the objectives are not complementary, it takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate."

Bell:  So here's my question and I'm particularly interested in David and Julia's answer. So we're going to take into account deviations and we're going to balance these kind of equally. We only have a target for one, not the other. How does that work? I guess, I'm curious, how should a layperson understand, when those two things conflict, how the Federal Reserve, which is this hugely powerful institution, sort of balances them against each other? Any thoughts on that question.

Balancing Inflation and Employment Objectives

Coronado: So it's trickier. I mean, obviously, that was one of the appeals of the sort of loss function framework that they basically had in words in the statement before was, "When they conflict, we will weight them equally and we'll calculate the loss and we'll weight it equally and a number will be set out as to which one." And that's the appeal of having a framework like that and that's the appeal of the modeling and all of that. It's much, much harder to not have those goalposts, but there's a reason we're stepping away from them. They led to mistakes. They led to significant policy mistakes and U-turns that hurt the Fed's credibility. And so there's no perfect solution to this. I think it's just...

It's much, much harder to not have those goalposts, but there's a reason we're stepping away from them. They led to mistakes. They led to significant policy mistakes and U-turns that hurt the Fed's credibility. And so there's no perfect solution to this.

Bell:  We're back to Chairman Deng sort of crossing the river by feeling the…

Beckworth: Yeah. I guess, following up on what Julia said, it depends on personalities, how they interpret this. And Sam, as you mentioned to me in an earlier exchange, 2021 is going to be a big part of this story. Right? The person who is going to end up at the Fed. Who's going to be chair? I mean, all of this discussion today could be for naught if they get some different personalities, but we hope there's continuation and progress on this front, but people do play a role. This is the real world. Politics are real. So we have to keep that in mind when we think about it.

Coronado: Yeah, absolutely.

Bell:  David, do you have parting thoughts for us on the framework, Powell's speech, anything else?

Beckworth: Yeah. I will quote the classic line from Dumb and Dumber. "So you're saying there's a chance." There's a chance for nominal GDP targeting. Again, this is a step, in my view, in the right direction. I think it would be hard for the Federal Reserve to do something really radical, like what I want, but I think we can make incremental moves in that direction. It's all about credibility in getting there.

Bell:  You have five years to get New Zealand to not only adopt an NGDP target, but actually see it work out successfully.

Beckworth: I don’t know about that, Sam.

Bell:  Julia, do you have any parting thoughts.

Coronado: I think that the next time that a congresswoman or man asks Chair Powell, "Do you have all the tools that you need to get the job done?" I think he should say, "Actually, I think a review of our toolkit would be a fabulous idea, not just an internal review, but a congressional review," and maybe some kind of commission or whatever and really, really think outside the box because I don't think that, in the world we live in of slower growth and lower inflation and all of this, that achieving their mandates is going to be easy with the toolkit that they have.

I think that the next time that a congresswoman or man asks Chair Powell, "Do you have all the tools that you need to get the job done?" I think he should say, "Actually, I think a review of our toolkit would be a fabulous idea, not just an internal review, but a congressional review," and maybe...think outside the box because I don't think that, in the world we live in of slower growth and lower inflation and all of this, that achieving their mandates is going to be easy with the toolkit that they have.

Bell:  You heard it here first. The February Humphrey Hawkins is going to have fireworks.

Coronado: It's going to be lit.

Bell:  Yeah. Skanda, closing thoughts?

Amarnath: Yeah. There was something David said earlier about the Fed playing God with some of these different major variables and we're going to talk about Congress' role in all of this. I mean, it does seem to me, while it seems like Congress isn't itching to get into any of these discussions, itself, it does seem like a part of what does a proper review look like of the Fed's goals and framework… should have some congressional and White House input.

Amarnath: It seems to me they have not really shown much interest in getting engaged in this discussion. I think there's a tendency to just defer to the Fed. Sometimes it's a good thing and sometimes it's not a good thing, but it seems like part of the process here, there is something a little bit ... If you look at other countries and how they go about reviews, this process isn't something that is done in a vacuum. The central bank just operates completely in a vacuum in deciding these goals.

Amarnath: And especially on things like the divine coincidence, is there just a point where, if we're at the inflation target, we're also at full employment? Is that actually how this stuff works? That's something that models have already predefined for you, but it seems like that's also inherently a political question, too. Right? So I do wonder what is the ... whether we see Congress try to say more, politics are going to change one way or another after this election. So that probably will color sort of what is the political feeling around what the Fed's done and whether the Fed needs to do more things in sort of any direction.

Bell:  Okay. Those are great thoughts. I've really enjoyed this. And I thank Julia and David in particular for coming on. We're always interested in new ways we can communicate and new forums we can host. So if you have ideas, I think the best thing it to tweet at us. @EmployAmerica is our handle. And I hope everyone has a good rest of the week.

Photo by Eric Baradat via Getty Images

People: 
David Beckworth
Calendar Date: 
Sep 2, 2020
Podcast Series: 
Publish to Announcements page?: 
Image: 
Publish to The Bridge?: 
Libsyn Podcast ID: 
15847163
Subtitle: 
The Fed recently announced its movement towards an average inflation target, but despite being a step in the right direction, it may cause problems for the central bank’s credibility.

Skanda Amarnath, Yakov Feygin, and Elizabeth Pancotti on Municipal Bond Market Intervention and the CARES Act as Responses to COVID-19

Skanda Amarnath is the Director of Research and Analysis at Employ America, Yakov Feygin is the Associate Director of the Future of Capitalism program at the Berggruen Institute, and Elizabeth Pancotti is a research assistant at the National Bureau of Economic Research and at Tufts University. Together, they have put together proposals on how to better address the challenges of the COVID-19 crisis at the state and local level. They join Macro Musings today to discuss these proposals for a municipal bond market and expanded unemployment insurance, as well as what it all means for making the US economy more of an optimal currency area.

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: Skanda, Yakov and Elizabeth, welcome to the show. 

Skanda Amarnath: Thanks for having us. 

Yakov Feygin: Thank you. 

Beckworth: Yeah, I'm glad to get you on. You all have exciting proposals, very timely ones. And as it turns out, the bill going through the Senate, and we hope by Monday, by the time the show comes out, that will be passed. In fact, this, for the record, the show is being recorded on March 27th, it'll be aired April 1st. So, some of these discussions might be enacted in law by the time this comes on air. But nonetheless, we will talk about them because they're timely and important. 

Beckworth: And before we do that though, I would like to hear a little bit about yourself. Tell our listeners who you are and what you're doing, and how are you coping? How have you adapted to the lockdown where you are? Now, Skanda, you've been on the show before, listeners know who you are. But for those who don't, tell us about yourself and maybe tell us about Employ America. 

Amarnath: So, I'm the Director of Research and Analysis at Employ America. And Employ America's mission is to get the macroeconomic policy mix right so that we can advance labor market outcomes, and really mitigate recession. So, that's a real focus, especially right now on what monetary and fiscal policy can do to mitigate this crisis, and hopefully get us back on track to tight labor markets, and better jobs and wages for all Americans. 

Beckworth: And how have you adapted, Skanda, to living with the lockdown? You're in New York City, the epicenter of the ... the hot zone, so to speak, here in the US. So, how has life changed for you? 

Amarnath: Relying a little bit more on delivery trying to stock up well ahead of time. So, on both sides it's been actually not so bad for me, but I have ... I live right by Broadway, and- 

Beckworth: Oh, wow. 

Amarnath:... I can see the foot traffic gradually diminish, which is good. But, it's obviously a pretty difficult time for a lot of people in the area. So, I really hope we can get through this- 

Beckworth: Right, absolutely. 

Amarnath: ... with minimal additional damage from here. 

Beckworth: Okay. Elizabeth, how about you? 

Elizabeth Pancotti: Thanks so much for having me, David. Yeah, I'm a research assistant at Tufts University and the NBER, so I'm more on the academic side. I partnered with Employ America to put out a policy proposal for unemployment insurance expansions, and what we can do to assist workers, a lot of whom are going to be losing their jobs over the next few months if they haven't already as governors put out shelter in place or orders or closing non-essential businesses. 

Pancotti: So, I partnered with them, they've been great partners to work with in doing this, and obviously have a great mission that's quite aligned and relevant right now. I am hunkered down in our very small apartment in Boston. So, my boyfriend and I live together with our two dogs. And normally we both work in separate offices, and our dogs have free range of our large couch, and they are quite irritated that we are encroaching on their space. 

Pancotti: But, we've both been remote for about two weeks now. So, somewhat adapting to this new reality and I think it would be helpful to know when it's going to end, to know when the light at the tunnel is coming. But for right now, just playing it by ear. Boston has been pretty empty. We live around the corner from MGH, and really the only people walking around on the streets here are people going to and from grocery stores or to and from work at MGH. But, we haven't noticed any big changes here in terms of other things. But traffic has certainly diminished, and lots of business closures. 

Beckworth: Okay. So, we got New York City covered, we got Boston covered. Now, Yakov, I understand you're on the West coast, is that right? 

Feygin: Yes, I am. So, I'm Feygin. I am the associate director of the future of capitalism program at the Berggruen Institute out in LA, which is where I'm calling in from. Our Institute is fairly new, especially the area of anything involving economics. I'm an economic historian who did a PG actually in the, kind of, monetary history of the Soviet Union, if that can be believed. It does happen. 

Beckworth: Wow. Yeah, fascinating. 

Feygin: And, I decided no one really ... well I care about it, but not as many people as I'd like to do. So, I kind of moved to policy. And I still do some academic research too. And, yeah, that's me. And, I'm adapting. It's been a little hard, honestly. I'm working from home. I'm actually self-quarantining right now fully because I've had a few symptoms over the last days, but I'm okay so far. LA is very shut down, but unfortunately my partner, my girlfriend still has to go to work because she's one of those people who the American economy isn't serving as well in this situation, because she's a semi necessary of service and still working hourly. And you keep going in to keep the insurance. So, we'll see how that turns out. 

Beckworth: Well, she is a hero in this war on the virus. 

Feygin: Yeah. Well, it's complicated. 

Beckworth: It's complicated. Okay. Well, thank you all, again, for coming on the podcast. As you know, we've been running a series of podcasts on the pandemic, what it means for policy. And I really like what we're going to do today with you three, because we're going to focus at the state and local level more. And, again, that's where we really see policy implemented. That's also where policy makers are more in touch with the local communities, and have a better sense of what can be done. 

Beckworth: And so, you have two bold proposals here that really help in that direction. And the first one is one that was written by Skanda and Yakov, and the title of it, I'll read the title and we'll talk about it. But the title is, "The Fed Can and Should Support State Government Efforts to Respond to COVID-19 Right Now." And this is about municipal financing challenges at the state and local level. 

Beckworth: And so, maybe you could walk us through that. What typically happens at times of business cycles, and at the state and local level in terms of financing. And then how can the Fed ... so this proposal really is directed at the Fed, and how the Fed could step in. And walk us through ... there's a lot of things here, but walk us through your proposal and what difference it can make. 

How the Fed Can Respond to Municipal Financing Challenges at the State and Local Level 

Amarnath: So, just to start off with, state and local governments are budget constrained, and are not afforded the same degrees of freedom that the US Treasury and the Federal government have. What I mean by that, especially in recessions, is we see that tax revenue goes down, but whereas the US Treasury just issues more debt to cover up for that budget shortfall, and has license to engage in countercyclical fiscal policy with the full knowledge that the Fed is also keeping rates low in recessions. That's not available to state and local government in the same way, at least based on how the Fed itself has positioned monetary policy. 

Amarnath: So, what ends up happening is, that state local governments, because of their budget shortfalls, are really dependent on the private market. They're dependent on the private financial market, private investors being willing to buy their debt. Private investors without any central bank backstop are really looking at the credit ratings of the state and local governments. Are they doing a good job of ... Moody's and S&P, if they view these state and local governments as being responsible, then they'll keep investing. But if they don't, then typically they'll get shut out of the bond market, or at least it'll become prohibitively costly. 

Amarnath: What we have right now, especially with the Fed not really engaged in the Muni market in a direct way, is when economies go into recession, and when sales tax revenue and other sources of revenue that are typically tied to the business cycle collapse, state and local governments then have to drastically cut back on other expenditures, whether that's infrastructure, whether it's public health expenditures. Public services are typically in higher demand in terms of business cycles.  

Amarnath: So, it's kind of getting hit from both directions, and without a release valve in terms of being able to finance your way through what is ultimately a temporary crisis in the sense that recessions do come to an end, and ideally you would want financial markets to be in a position to help tide over state and local governments. But what actually happens is, they're so fearful of a ratings downgrade and losing the investor base as a result of that, that they engage in sharp cutbacks. And we get the opposite response of what we want right now. 

Amarnath: Right now we want state governments to act ambitiously to take the necessary measures. And with interest rates in general being so low, we want them to be willing to issue debt to get through this as opposed to cutting back on other necessary public services, and deepening what's already proving to be a very deep economic crisis. 

Right now we want state governments to act ambitiously to take the necessary measures. And with interest rates in general being so low, we want them to be willing to issue debt to get through this as opposed to cutting back on other necessary public services, and deepening what's already proving to be a very deep economic crisis. 

Beckworth: Right. And so, we see it at the local level, for example, governments cutting back on teachers, on cops, on road work. And maybe you could walk us through a concrete example of this, the Great Recession. What happened then? 

Amarnath: So ... Yakov, you like to go ahead? 

Local Government Cutbacks During the Great Recession 

Feygin: Yeah, sure. What we saw coming out of the Great Recession is that, while there was quite a bit of federal fiscal stimulus, it wasn't enough to actually offset the spending cuts within the States. And you saw, first of all, large tax increases, which is not great for countercyclical policy in order to make the gap. And then you saw massive cutbacks. First of all in state services, including education, especially secondary education, which is one of the reasons you saw the debt market, kind of, go up. Because universities were forced to drive up their tuition because of the loss of state support. 

Feygin: You saw huge cutbacks in medical services for rural communities. You saw cutback in law enforcement services, any kind of service you can imagine. And that's not just a quality of life issue or a building out issue in the economy. It's an issue of a lack of spending. So, all the stimulus you're doing at the federal level, you're losing that traction because the states, which are responsible for something like at some point 70% of government spending actually in this country. I need to check the statistics, but it's in the article, are actually cutting their spending down. 

Amarnath: Yeah. I think what you're referring to there is about, sort of, infrastructure outlays itself is what they're ... they may be funded by the Federal government, but obviously when it comes to the actual control over expenditures, that's ultimately done at the state and local level. And this was a, sort of, overhang that existed even while we had the end of the recession around June, 2009, it was a very weak recovery, one where we, obviously, needed to start thinking a little more imaginatively about monetary frameworks, like  nominal GDP targeting. 

Amarnath: But it was also a period when we saw that elevated unemployment in large part driven by state and local government austerity policies. These are policies that were aggressively tightening state and local government spending, raising taxes as Yakov just mentioned. And that really didn't end until around 2012. Depends on the state, obviously. But, this was a three-year phase in which we really should have had all this sort of excess capacity room for stronger nominal GDP growth. And we didn't really get either. And one of the main mechanisms that was shut off at that time was, the state, local governments were not ... they were also, sort of, retrenching just as the private sector also was trying to be leveraged as well. 

Beckworth: Yes. That's interesting because for the casual observer, you don't think about this. You don't think about the state and local spending cuts. I suspect most people when they think back to 2008 through 2009 when they hear fiscal policy or government spending, they're thinking purely at the federal level, which they saw this big Obama's stimulus bill, and that's all they think about. 

Beckworth: Now, maybe if they're working at the state local level, they experience it, but it's important for us to grasp the enormity of what happens at the state and local level, and that often flies under the radar. So, I think it's a great point that you brought out that there was contraction at the state, local level up to 2012. The recession itself ended in 2009, so we're going three years after that. And there's a squeeze going on in the state and local level. 

Beckworth: And so, the bigger point here is that, state and local finances tend to be procyclical. They tend to exacerbate or strengthen the business cycle as opposed to work against it. So, you two have a proposal that's going to, hopefully, push us in that right direction, and hopefully some of those will be incorporated into the Senate bill that has passed the Senate and will be discussed Monday hopefully, and passed by the House. And maybe be passed by the time we have this show come up. But, walk us through what you would like to see done. Tell us about the legality of it, the innovation of it, and has it been tried before? 

Details of Skanda and Yakov’s Proposal 

Amarnath: Sure. So, on the Senate bill and what it achieves is relative to Fed authority. So, the Fed currently has actually through section 14 of the Federal Reserve Act, has the ability to buy short-term, state and local government debt as part of its open market operations. And I think Yakov can really speak to the history of this authority, and how the Fed has actually used this in the past. It's been a while, but they have. 

Amarnath: But, what the bill does is through this 454 billion dollar fund that Treasury is making available to the Fed to lend to, and that could obviously be leveraged up to a total lending amount from the Fed of about four and a half trillion dollars. Among those potential institutions that the Fed can lend to are state and local governments, or state-owned, or state-controlled corporations as well. 

Amarnath: So, that is an innovation, something they did not do in the global financial crisis. They are doing this through some of the Fed's emergency lending powers that are, again, I'm going to legal ease of this, but it's Section 13(3) of the Federal Reserve Act, which the Fed used for lending to all sorts of financial institutions during the financial crisis. 

Amarnath: So, this is an emergency power that the Treasury has ... if this bill passes, and the Treasury authorizes the Fed can lend to state and local governments directly for securities of all maturities, not just short term state and local government debt, which they can already do. 

Beckworth: So, Skanda, why are they waiting for Congress to fund off on this? You already mentioned they have the legal authority in Section 14(2)B. 

Beckworth: Why are they trying to go through section 13(3) to address the Muni situation? 

Feygin: I think I can speak to that a little bit, and maybe Skanda can add something. One of the reasons is, as far as we understand this, it feels like a very relatively new thing for the Fed to do, because in its modern history, the Fed has not used this authority. And the Fed is, by its very nature, a very conservative institution. 

It feels like a very relatively new thing for the Fed to do, because in its modern history, the Fed has not used this authority. And the Fed is, by its very nature, a very conservative institution. 

Feygin: And, my understanding of the politics of it is that the Fed it feels they might be overstepping the bounds between monetary and fiscal policy without congressional authorization. I don't necessarily think that's the correct view, to be honest. I think the line between monetary or fiscal policy is always thin and always changing over time with the larger cycles of how capitalism itself changes over time. 

Feygin: But for the Fed to do that, it requires some institutional learning. And I think that's where it's going to be very interesting, is how this might force some institutional learning beyond this crisis. 

Beckworth: Fair enough. And with 13(3) you get the sign off of the Treasury Secretary. 

Feygin: Yeah. 

Beckworth: So, it looks more credible. That's a great point. You're going into uncharted waters here. Where at 14(2)B, you'd really be doing something radical. So, well historically you're going to tell us it's not radical, but- 

Feygin: Yeah, it's not that radical at all. 

Beckworth: Why don't you go ahead and walk us through the history, because that's really fascinating. I was reading your piece on that, what a fascinating history. So, tell us how we at one point were using municipal bonds for the Federal Reserve, and then we didn't. And, what I got from your paper is really what you're proposing is to come full circle. To come back to from where we started. So, walk us through that. 

The History of the Fed and Municipal Bonds 

Feygin: Yeah. So, Peter Conti-Brown, who I know has been a guest on this show a before. I'm a fan. Honestly, he makes a really good point that the Federal Reserve really had three foundings, right? 

Feygin: In that famous paper of his. And that those foundings have changed the mission and particularly, kind of, the micro operations of the Fed quite a bit. So, the first founding of the Federal Reserve, which you start seeing 1913, it's an institution that's not thinking like a modern central bank is. It's an institution that's mostly copied on the Bank of England, which is having these real bill concerns. 

Feygin: And what the Real Bills Doctrine is, is that the Fed shouldn't be buying government debt necessarily, or any kind of long-term debt, or any debt that's not easily tied to commercial liquidation in the short run. Now, what's interesting about the US Federal Reserve is it's founded ... is it does include municipal debt... as one of the collaterals it's interested in. 

Feygin: And there is actually a bit of a debate about that in the Senate hearings about why it does that. Because, some of the senators justifiably feel like, "Look, this is going to mean that the monetary base of this new institution might be overly expanded by the states, and it's going to lose control." And the reason for the argument for why you would include this is multiple fold. 

Feygin: First of all, they're extremely important in the early 20th century, the late 19th century as instruments. They're actually somewhat of the safe asset of their day because there's not a lot of Federal debt, but these very short term bills are very attractive to large institutions such as trusts, banks and insurance companies because they're usually backed up by a tax flow. They're tax offset.  

Feygin: The other reason why is, it's a gold standard issue. These are really popular with foreign investors, and that because of that intervening in that market, at least in the hearings they say, is going to be useful for managing gold inflows and outflows. 

Feygin: Now, what I think is very interesting is, is almost as soon as those hearings end, those rationales are still there and they're still being used in these operations, but they kind of lose themselves on two levels. First of all, the Fed introduces regulation E in its original set of regulations, which says they can't actually buy municipal debt of any municipality under 10,000 people without approval of the board. And the regional banks can't. 

Feygin: But almost immediately, you see the board approving most of these things, partially because they understand that they want to support their member banks that deal with local small communities for political reasons, because they understand that that's something necessary to build legitimacy. 

Feygin: The next big shift is World War One. Almost as soon as the Fed is founded, and Perry Mehrling was actually one of my advisors, kind of, pointed this out in his book, its mission changes immediately. It's in uncharted territory. Because, instead of buying these short term real bills, it's now becoming the government's bank, right? The state's bank. 

Feygin: And, in 1917 just almost a year really after they started the first major wide-scale open market operations, they leave the municipal debt market. They explicitly say so in their yearly report. They say, because of this national emergency, we have to support the federal debt market, which is now actually for the first time, large enough for it to be a market. 

Feygin: After the war, they actually tried to go back into municipal market several times. Never on the scale they did before the war because of the need to discharge some of the federal debt, but they're back and they're buying local municipal debt until 1933, which should be a significant date because that's when the Fed starts to reorganize along the New Deal. 

Feygin: The year before that in 1932, they're actually thinking in one conference at least I found of using their power to buy municipal debt to support local fiscal stimulus during the great depression. But Marriner Eccles amongst others believes that that's not as effective as just building a bigger government infrastructure and supporting the RFC in doing that. They shift out of that, and by the 1950s, they've essentially established the doctrine where they're only buying short-term treasuries. 

Feygin: And that holds until 2008, which I would argue is an interesting thing. Because in 2008 we really ... we've had the end of Minsky and big government capitalism. And we're really in the world of money manager capitalism, financial globalization. Now wait, with QE, with the short term commercial paper facility in the swap lines, they've really, I think, figured out that they're working in a kind of multi ... what I call a multilevel governance world, and they've definitely taken care of the international level, but they haven't taken care of the regional level. And because we're in an era of globalization, the regional level isn't really synced up as tightly with the national level in all times in all places anymore. 

Feygin: The Fed should be, I think, thinking about coming back to its roots, and working on all these levels precisely because of the early 20th century is far more globalized than any time in the mid-20th century. 

Beckworth: That's a great history. There's a couple of observations. One, what you just ended on, the Fed really is coming full circle if it does go back to Munis. It started there, and you called that period if I got it correctly, the financial capitalism period. And then you went to big government capitalism, kind of, the New Deal, heavy handed government, post 1970s we're moving back more towards money manager capitalism. And we see maybe the full manifestation of that in 2008 when the Fed is backstopping every market except corporate and local municipal bond markets, which is when you think about it, you step back, what's kind of odd is, why leave that one out and save markets overseas, other big markets home. 

Beckworth: So, I think it is a kind of a recognition of coming full circle. The other thing though, just briefly, I don't want to spend too much time on this though. You mentioned a debate between Fed chair William McChesney Martin and New York president of the Fed Allan Sproul where Martin wanted to do the Treasury bill approach. She was, kind of, going along that path that the Fed was doing, but Sproul wanted to include municipal bonds and actually resigned when he realized he couldn't win that debate. 

Beckworth: And this made me think of, there's actually is a debate in central banking literature about what is a neutral footprint? And there's the German view, and I brought this up on the show before. There's the German view, and then there's the UK, US view. So, the German view is if the central bank is going to be buying securities, it should do so in a manner that matches or best replicates the average or typical investor, which would be a wide portfolio of assets. That's the German view. 

Beckworth: We see that reflected at the ECB, they can buy a wide range of assets. The US and UK view as well. You think that's neutral, the real neutral version is what we say, and what we say is, if we buy just treasuries from the consolidated balance sheet perspective, it's kind of canceling out, or we're minimizing our footprint because if we buy treasuries, it's an asset to us, liability to the treasury department. It's a wash. 

Beckworth: So, there's two views on what's a neutral footprint, the US, UK view, and then there's the German view. And I would suggest that, you know, maybe what you're suggesting here is more in line with the German view, which I actually I'm more sympathetic to myself. I think some of the proposals, for example, from George Selgin to open up and buy all types of assets makes more sense, of course, with haircuts and properly done. And along those, let's move into your actual proposal. So, walk us through how you guys would implement this, and address some of the concerns that might come up along the way. 

How to Implement the Proposal: Buying Short Term Municipal Debt 

Amarnath: So, our proposal is for the Fed to use its 14(2)B authority at least in terms of offering to buy short term municipal debt, specifically state and local government debt. And the Fed could make a preordained commitment to buy the securities for at least as long as is needed for the crisis response, and the recovery. Very similar to the timeline that the Fed ended up structuring for the commercial paper funding facility in 2008 to 2010. 

So, our proposal is for the Fed to use its 14(2)B authority at least in terms of offering to buy short term municipal debt, specifically state and local government debt. And the Fed could make a preordained commitment to buy the securities for at least as long as is needed for the crisis response, and the recovery.

Amarnath: So, the Fed effectively said, "We will roll over commercial paper issuance, and we will continue to keep this facility open." And they kept the facility open for at least 18 months, I want to say. And that is what was necessary. Even though it's three month instruments, commercial paper is typically issued on a one month or three month maturity. And if you have the confidence that you can keep rolling that over through a pretty turbulent period, that obviously opens up at least one important degree of freedom for those companies that relied on commercial paper issuance to fund their operations. 

Amarnath: Here, the challenge in some ways is that the municipal debt market tends to be a little bit more ... there's not a lot of short-term issuance out there. It's actually typically a longer term market because the liquidity conditions themselves are great for issuing short-term debt. So, it's a little bit of a chicken or egg situation where state, local government treasurers are more worried about the idea of issuing short-term debt because if you're a buyer, if the Fed were able to step in and backstop and constrain the yields on these securities, because mind you, all 50 state governments are investment grades, at least last I checked. 

Amarnath: I know Moody's and S&P are in the process of downgrading all sorts of different institutions, but all 50 state governments are investment grade. And if the Fed were able to step in and provide a backstop and facilities that the Fed would purchase short term debt as needed, I think one, you'd see a more liquid market, and also give state treasurers a little more confidence that they can issue debt to help deficit finance their way through this crisis, at least, to some degree. 

If the Fed were able to step in and provide a backstop and facilities that the Fed would purchase short term debt as needed, I think one, you'd see a more liquid market, and also give state treasurers a little more confidence that they can issue debt to help deficit finance their way through this crisis

Beckworth: Now, you mentioned in your proposal, one nice thing about this is that this wouldn't count towards their budget rules, or this wouldn't be considered as additional outline under their budget rules. 

Amarnath: So, there are balanced budget laws, and they vary just different degrees across States. And so, I'm not an expert on every single state's set of laws, but there's usually a few different exemptions at play that allow states when they really need to finance a service that they can. One is that there's exemptions for capital expenditures. So, typically in infrastructure projects, anything that, these are new equipment, or new buildings are all things that get exempted from those balanced budget laws. 

Amarnath: Second is  the statute itself in the Federal Reserve Act also allows the Fed to fund, are called special districts or what are now known as special districts by the census. And so, special districts in every single ... there are special districts in every single state that are typically dedicated to particular public services that need to be funded. 

Amarnath: And what this ends up allowing for is when states really need to prioritize funding for what's called fire services, a reclamation district, an irrigation district. They show up in every single state in various forms. The Fed has the authority to also lend to those special districts, which the state typically creates to make sure that essential services are able to be funded and are not constrained by those balanced budget laws. 

Amarnath: As I said, there are variants across the states, but typically California has a health and hospital district. In the case of Texas, it's a little harder to create a special district, but Texas also exempts for hospital financing, but that usually would be exempted under the capital budget. 

Beckworth: Okay. Now, one question before we move to what the Senate bill is actually doing with this idea. Could the Fed work through a special purpose vehicle to have, say, these longer term securities securitize into a new asset that was shorter term that met the letter of the law? So, maybe it creates some, kind of, securitized bill that's- 

Amarnath: Yeah. 

Beckworth: ... backed by longer term bonds? Okay. 

Feygin: Yeah, I mean that was proposed. There's actually a history to that proposal. Right after the recession, I know there was a proposal, it almost became  law that New America put out to establish essentially a vehicle that repackages these things into acceptable- 

Amarnath: I think there's actually a lot of room for standardization in this market because the municipal bond market is quite fragmented. So, if you look at ... you can pull up a Rhode Island debt yield curve on Bloomberg, but it's just not ... there's not that much debt outstanding, and it's all on various maturities, and it's just a very thin market, fragmented and there's not enough standardization that ... honestly if the Fed ... the Fed could play a pretty constructive role here in making it more standardized, I would probably help to lower overall cost of borrowing, especially if these markets had a stable source of support. 

Feygin: Yeah, that's absolutely true. If you look at the buyers for this, it's not actually large institutions, a lot of is individuals looking for tax exemption on their buying, or very over the counter mutual funds. 

Beckworth: So, if they did securitize it, you might get more buyers into the market, is what you're saying? 

Feygin: Mm-hmm (affirmative). Absolutely. 

Beckworth: And the Fed could be a pivotal catalyst. So, let me just play devil's advocate here for all those out there who are freaking out like, "Oh my goodness, what are you guys doing?" Your proposal, though, sets clear guidelines and criteria. You're not saying the Fed will be in there 24/7, 365 days a year. You're saying only during a crisis period like the commercial paper facility, right? 

Feygin: Mm-hmm (affirmative). 

Amarnath: Yeah. 

Beckworth: So, how would you ... what would be the off switch? How would you- 

Amarnath: I think you want to set some parameters. And again, I kind of go back to how the commercial paper facility in 2008 to '10 was set, which was the Fed for the period when we have a national crisis, this sort of collateral damage to individual states is probably ... The reason why we're in this crisis is not because Illinois' public finances, their problems are pretty well documented. But that's not the reason why we're in this crisis. 

Amarnath: And, I think it makes sense to close these ... foreclose the option of buying state and local government debt when we exit the national crisis. And that's why there should still be some incentive for being fiscally prudent if we make this, sort of, unleashed for every single state and local government. Obviously, there are ways in which you can get unhinged, but it's also just not that smart to have this be ... have national crises that hit every single state, and then make the judgment that actually now we're going to create a new ... state and local government effectively gets shut out of bond markets as a result of this because it's not really a problem of one specific state's doing. And recessions are typically not cases where we have 25 states or 30 states in recession and 20 or 25 states out of recession. There usually is times when every state's in recession. 

Beckworth: Right, systematic. 

Amarnath: Exactly. 

Beckworth: Yeah. Walk us through the few minutes we have left on this part of the program dedicated to Muni markets. What is the status of the Senate bill, and how would it cover your proposal or come close to it? 

How Does the Recent Senate Bill Cover the Municipal Market Issue 

Feygin: Ambiguous? 

Amarnath: Yeah, that's exactly right. 

Beckworth: Okay. 

Amarnath: I think you can ... it's just a little bit of an amorphous black box because the 454 billion dollars that was dedicated to Fed facilities. The Fed has the option of lending to a variety of these facilities, but there's no strong allocation principles that decide what the Fed thinks is most important. 

Beckworth: Well, that's why you have the paper out, and that's why you're on the podcast. So, all the Fed officials who are listening, take it to heart. Okay. That's been a fascinating conversation. We'll have a link to the paper. Elizabeth, let's move to your fascinating proposal on unemployment insurance. And, why don't you walk us through what is unemployment insurance? I know some people know, but I learned a lot reading your proposal. I kind of knew the broad contours of what it is, but walk us through the current state of it, and what you proposed, and what the CARES Act will actually incorporate. 

Pancotti: Yeah, that's a lot to unpack. So, I'll break it into a couple of parts. 

Pancotti: So, first for anyone who has never been laid off, or has never gone through the unemployment insurance system, I'll do a quick overview of what that looks like on the worker side. And then I'll briefly cover how states and the Federal government play a role in designing those programs. And then we'll talk about what the CARES Act will do to that for the short term. 

Overview of Unemployment Insurance 

Pancotti: So, essentially a worker will get laid off, and then files for unemployment. In most cases they'll have to wait about a week before receiving a paycheck. And that's, sort of, a week to begin any verification and paperwork and all of that sort of stuff. A lot of governors in the past two weeks have waived those requirements, and the CARES Act plays a small role in that. 

Pancotti: And then, in most states they get to totally set how much workers get paid. So, on average workers make about 50% of their previous wages, but states establish their own maximums. These maximums vary widely. So, in Mississippi, the maximum is about $235 a week, which is a $12,000 per year salary. And in Massachusetts, the highest state is $823 a week, which is about $43,000 a year. The average is in the middle of that at $450 a week. 

Pancotti: So, what would happen is if you were a worker who made $50,000 a year, the state would multiply that by 50% and go to 25,000. And then if that in Mississippi, that would be over the maximum. And so, you would be cut down to their maximum. And in Massachusetts, that would be below their maximum, so you would receive 50% of your wages that those get paid out on a weekly basis. In most states, workers receive benefits for about 26 weeks. In previous times of economic downturns when in recession, the Federal government has stepped in and extended those benefits by 13, and then more, and then more weeks. And so, in most states during the recession, workers were eligible for 99 weeks of unemployment.  

Beckworth: Can I ask you a question about that briefly? 

Pancotti: Yeah. 

Beckworth: Who funds unemployment insurance? 

Pancotti: So, each worker when ... the cool thing about being a microeconomist, is that a lot of us have worked with this data. And so, the nice thing is that if you talk to labor economists writing papers right now, many of them will have used UI data. And a lot of people don't know what that means. And that's because what happens is employers submit payroll taxes for unemployment insurance for every worker. And the nice thing is it creates one, a funding source for when those people get unemployed, but two, it creates this really rich set of data where we know a lot about what workers make, where they work because states have to report that to then pay them. 

Pancotti: So, that money, let's say Amazon, for example, has a million employees. They then pay about 5% of their employees, and 5% to 6% of their employees’ wages into a fund that states then put into the unemployment trust fund. So, that sits at the treasury. I can talk more about specific numbers in that trust fund, but after the recession, a lot of those trust funds, their reserves were very low. 

Pancotti: And so, we have been in a funding issue, or a funding crunch for unemployment for a while. And it hasn't really mattered because unemployment has been very low in the past few years. As we face up to 20% unemployment in the coming months, it's a big issue. But it would have been a large issue even if these reserves were at 200% of what they would've been. So, we're in a pretty bad place for unemployment insurance. The nice thing is that the Federal government under the CARES Act has topped off some of those benefits. 

Pancotti: So, Senator Bennett proposed something more along the lines of my proposal, which was to top replacement rates up to 100% up to people making about $75,000 per year. The issue is that these states have not written the physical software code in the background in decades. And so, states said, "We have no way to adjust these replacement rates. Either one, they're written into our state laws, and it would be met with a lot of ... not resistance, but it would be a hassle to change them." And we would have to, in states like Texas where they meet every other year for six months, they're not in a legislative session versus in Massachusetts lawmakers are on Beacon Hill right now. 

The Details of the CARES Act 

Pancotti: So, changing those was a big process on the technology side and on the legislative side. So, then the CARES Act instead proposed whatever you would get under your state's proposal as an unemployed worker we will top that off and give you 600 additional more dollars a week for four months. So, now where you asked how do we fund these things? The Federal government's going to pay for all of that. It's also going to add 13 weeks of benefits. 

So, then the CARES Act instead proposed whatever you would get under your state's proposal as an unemployed worker we will top that off and give you 600 additional more dollars a week for four months. So, now where you asked how do we fund these things? The Federal government's going to pay for all of that. It's also going to add 13 weeks of benefits. 

Pancotti: So, in most states, workers get 26 weeks of benefits, now they'll get about 39. In some states they're as low as 13. I think in Georgia they're 13 or 14, and in Montana they're 30. Most states are in that 26 range. So, after this we'll see about 39 weeks workers are eligible for unemployment insurance. Additionally, the CARES acted a thing that we have not seen really. And it added benefits for people who don't normally qualify for them. 

Pancotti: So, most people have heard in the news about how they're focusing on gig workers and freelancers who are now covered. So, if you were an Uber driver and you can no longer drive for Uber, or if you own your own business, and you're just like a consultant, then you are now eligible for unemployment through this. It's a pandemic, it's like emergency unemployment insurance for the pandemic. 

Pancotti: But, this also allows people who need to use unemployment insurance as paid leave if they get Coronavirus, or if their children get Coronavirus, and therefore they have to stay home. If they, because a lot of school districts around the country are closing and they need to stay home with their seven-year-old children that no longer has school, they can receive unemployment benefits for that leave. And if they have to quit their job because of Coronavirus, they're now eligible. 

Pancotti: The way that those benefits will be determined, is that it's the average income in that state multiplied by 50% plus 600. So, it does mean that if you quit your job ... I saw a post going around Twitter last night, and it does mean that if you quit your job, you might actually receive more than you would have if you were laid off. And, it also ... some people would argue that it incentivizes people to either convince their employers to lay them off or to quit their jobs, especially because now the replacement rates can exceed 100%. Say if you were a waitress in Mississippi making $7.25 an hour, federal minimum wage, you quit, you would get half that. And you'll now $745 per week, whereas you would have made $145 per week under Mississippi employment, and about $290 per week when you were a waitress. 

Pancotti: So, we're giving people more money than they made when they were employed, and in some cases a lot more than they made when they were employed. There was some opposition to this. So, Senators Graham and Sasse and I think Scott all said, "Wait a minute, we're going to cause a bunch of nurses to quit so they can sit home and make $24 an hour." And I think there are some arguments to say that this bill creates more perverse incentives than we would have if we just topped replacement rates up to 100%. But in the sense that we, one, have to work very quickly to make sure that these workers are able to file for unemployment and get increased benefits. 

Pancotti: And two, we're able to cover things like paid leave for people who get Coronavirus and whatnot. I think this was the middle ground solution to say, we want these benefits to extend to everyone who could possibly need them, and we want them to be enough to pay the rent, and put food on the table while people can't work. 

Beckworth: Let me ask a question, and just to follow up what you said. You know, it's the fog of war to be pragmatic, and get something passed. Deliberate too long, and there might be people falling through the cracks. And that's really my question, does the expansion of unemployment insurance plus the $1,200 check ... I mean, are we going to capture most people, will there be people who still fall through the cracks? 

Will These Measures Be Enough? 

Pancotti: I think there will still be people who fall through the cracks. This doesn't include people who aren't working, who are considered not unemployed but just not working. So, very low income people, the homeless population for example, or very low income people who aren't counted in the labor force at all. Those people will maybe get $1,200 checks, but a lot of those people we know don't have bank accounts. And so, I think, don't file taxes because their incomes are so low. 

Pancotti: And in this bill, I think, it was either written into the bill or we saw an estimate somewhere, it would take about four months to get those $1,200 checks out. Whereas for people like you and me who file our federal taxes and the IRS has our direct deposit information, we'll get checks, or we'll get a direct deposit within a couple of weeks. Those people aren't going to see checks for four months, and it's very possible that we just don't know where these people live. We have no idea how to find them. 

We saw an estimate somewhere, it would take about four months to get those $1,200 checks out. Whereas for people like you and me who file our federal taxes and the IRS has our direct deposit information, we'll get checks, or we'll get a direct deposit within a couple of weeks. Those people aren't going to see checks for four months, and it's very possible that we just don't know where these people live. We have no idea how to find them. 

Pancotti: And so, I think the Federal government should use coordination between SNAP offices and WIC offices, and social services where these very low income people are already in the system. It would be probably advantageous to go through those roles and say, "Hey, have we missed anyone?" The good news is, we're doing the census right now. I wish we had the census data already, but it would be really nice to know who people are, and where they live. That data is coming in, but won't be collected for another year, and we've actually stopped in person collection. 

Pancotti: So, I think there are people who will still fall through the cracks here. I think lawmakers in Washington when they pass this bill, didn't realize, is that states are being just totally slammed with the amount of calls, emails and claims that they're getting right now. So, yesterday at a press conference, governor Baker in Massachusetts announced that the UI call center, which normally has about 50 people, has 300 people, and needed to increase to 400 or 500 more in the next week or two. 

So, I think there are people who will still fall through the cracks here. I think lawmakers in Washington when they pass this bill, didn't realize, is that states are being just totally slammed with the amount of calls, emails and claims that they're getting right now.

Pancotti: So, these offices are ramping up even for unemployed people. So, let's not even count the very low income people who aren't in the labor force, who aren't going to get on this from both of these measures. But, even the unemployed people who are now eligible States don't have the capacity to quickly go through these claims. I think especially for that self-worker piece in this, sort of, paid leave expansion of people who are eligible, states’ systems aren't built to process claims for those people. 

Pancotti: These systems were built to say, you received your unemployment insurance taxes over the past year, and we have record of your income and who you were. And as a result we can quickly process your claim and get you the amount of money. And we have the software and people in line to do all of that within a week. We have no idea. States don't have a process for doing that for all of these new people who are now eligible. 

Pancotti: So, I think it will take quite a bit of time to get those systems online. I hope the time is as short as it can be, but I'm worried that it'll be six to eight weeks before they'll ever see their unemployment insurance benefits even though we've now passed the legislation. 

Beckworth: Yeah, that's my concern in general about anything that's been going on is just the infrastructure capabilities, it's sending the checks out. Can the IRS get them out in a timely fashion? Because a lot of people, a lot of checks, it's the tax refund season already. Massive number of claims, unemployment insurance centers. So, that'll be something to watch, for sure. So, last question on this, is there anything else you would add or fix for the unemployment insurance programs? And we touched on this a little bit, but just imparting, what would you say is needed the most to make it as good as you would want it? 

How Can the Unemployment Insurance System be Fixed?  

Pancotti: So, I think two days ago I would have had much more to say about this. I personally did a lot for beefing up unemployment insurance. My plan called for higher benefits, longer benefit period, and leading weeks and expanding the pool of eligible workers and, CARES thankfully did all of that. We didn't see work share programs really mentioned. There is some federal funding who'll cover partial benefits. But we didn't see incentives for firms to keep people on even if they reduced their hours by 20% or 30% or 50% or 80%. 

Pancotti: So, in these states there are work share programs in place where essentially if I worked at Whole Foods and they cut my hours from 20, Whole Foods would consider continue to pay me for 20 hours a week, and then unemployment insurance would pay some of the gap. And that allows me to stay on my health insurance benefits or a vacation or paid sick time. It keeps me on the payroll in the books, and then after this is all over, they can increase the 40 hours as opposed to hiring an entirely new worker, and onboarding them and training them. 

Pancotti: So, I think it would have been very nice to see some, sort of, incentives for firms to keep people on payrolls, and for states and the Federal government to pick up the rest of that. I think there've been quite a number of proposals to give firms directly cash to keep people on payroll. And some money has been appropriated back, but not nearly enough. And I think business just don't have the cash reserves to pay two or three or six months of payroll without being open. 

I think it would have been very nice to see some, sort of, incentives for firms to keep people on payrolls, and for states and the Federal government to pick up the rest of that. I think there've been quite a number of proposals to give firms directly cash to keep people on payroll. And some money has been appropriated back, but not nearly enough. And I think business just don't have the cash reserves to pay two or three or six months of payroll without being open. 

Pancotti: And as UI offices are inundated with claims, we could basically pay firms to act as UI employees and keep them on payroll, and we could fund all of that as opposed to having them call a call center. That, I think, requires one a lot more thinking through. And so, it's probably a good thing to include it in this first round of legislation, or I don't think we would've seen it move as quickly as it did. But as we pass the fourth and maybe fifth and sixth phases of these stimuli bills, I think we should really think about how to support states and firms in doing those sorts of things. 

Pancotti: Finally, I would just say we should really have states eliminate work search requirements for unemployed workers right now. Many States have done this just through legislatures or governors. You don't have to look for work, but in most states you have to submit three or four job applications or prove that you went to a job fair. We probably shouldn't tell people with Coronavirus, or to write cover letters from hospital beds or to attend job fairs right now. So- 

Pancotti: I think that governors can take a very quick step to just say, "We don't expect you to write cover letters from hospital beds right now." 

Beckworth: Yeah, great point. Well, thank you Elizabeth. That's fascinating. And again, it'll be interesting to see how this all unfolds, and what happens a few weeks from now, these subsequent stages of policies have been passed. Well, this has been a great discussion. I want to step back. I mentioned earlier, I wanted to, kind of, frame this from a broader perspective, in particular the whole shifting of economic policy at the state and local level to more countercyclical perspective, versus its procyclical one. 

Beckworth: And, Skanda and I have talked about this before, but one of the reasons we have a dollar zone, or we have one size fits all monetary policy in the US, is we believe that the US is largely in line with what we'd call an optimal currency area. You can have a currency for one area if one or two of these conditions hold or bit of both. One is that, all regions have a similar business cycle. And that doesn't hold as much in the US as it may have in the past. 

Beckworth: There's definitely idiosyncratic shocks affect different states differently. In fact, we saw with unemployment claims, some states got hammered more than others, so we know things are happening at a different pace. But, if you don't have a perfectly aligned business cycle across the whole country, you can have shock absorbers built into place. And what you've been describing to me is an absence of them. 

Beckworth: Now, we have had in the US relative to Europe, some good shock absorbers but still not perfect. So, one of the shock absorbers is labor mobility. So, you're working in Michigan, Michigan is in a recession, Texas is in a boom, you could move from Michigan to Texas. Alternatively, if you are in Michigan, you can't move. People in Texas are doing better, their income goes up, they pay higher income tax, they send it to folks in Michigan. So, there's a fiscal transfer. 

Beckworth: So, maybe Skanda, maybe you can help me out here. How would your policies make the US more in line with an optimal currency era? I think we are closer than Europe, but there has been a decline in labor mobility in the US, which has pushed us away from not a lot, but a little bit away from being optimal currency area. Do you see your proposals, both your unemployment insurance proposal and your municipal bond market proposal pushing us closer to an optimal currency framework? 

Moving Closer to Being an Optimal Currency Area 

Amarnath: Well, I think it really helps on the risk sharing side in terms of it actually sharing risk across states and regions. Right now, it is an asymmetric shock in one sense because we have certain states that have much bigger burdens thus far from the Coronavirus. I think all 50 states have seen a pretty big surge in jobless claims actually including Alaska and Hawaii. 

Amarnath: So, it clearly has permeated across different states, but differentially and that I think just gets the fact that we're seeing how states and local governments who are in charge of administrating a lot of programs that are vitally necessary in recessions. So, especially if we think about what Elizabeth just went through on unemployment insurance, and how states have a lot of control, but have systematically under-invested in precisely the kinds of systems that are necessary in these moments. And when these moments come up, there's not necessarily the funding available. 

Amarnath: This is precisely the time when now we're hearing talk from any governor. DeWine talked about how there would need to be spending cutbacks in a number of areas in Ohio as they try to cope with what is a surging pandemic there too, surging number of cases of Coronavirus. So, the ability to actually offset the risks that different states bear at different times is really critical to have a system that works, and that's aligned on the right dimensions here. Because, we're going to have state control over these phenomenon, and to some degree there are some advantages to having that. 

Amarnath: But if it doesn't come with the appropriate financial flexibility to get through it, I do think it's going to be incredibly challenging not for this a crisis to get a lot worse in terms of state and local cutbacks, a lot of that pro cyclicality we talked about earlier from really exacerbating the chances of getting to a stable path for a national income, for people's livelihoods. That's something that we're seriously at risk of right now. 

If it doesn't come with the appropriate financial flexibility to get through it, I do think it's going to be incredibly challenging not for this a crisis to get a lot worse in terms of state and local cutbacks, a lot of that pro cyclicality we talked about earlier from really exacerbating the chances of getting to a stable path for a national income, for people's livelihoods. That's something that we're seriously at risk of right now. 

Amarnath: And, I think if we compare that to what's happened in the US and in Europe back in 2008 to '12 when you saw that the fiscal impulse was sort of disjointed in a way. At least, there was some federal support for state and local governments, but it was not enough. And the Federal Reserve really covered for that. So, the Federal Reserve was able to be extremely accommodative, and that really made a bad situation from getting much worse. But it wasn't a great set of outcomes in general, but we had a dollar depreciated for much of that period. 

Amarnath: We had a set of offsets that, at least, did a better job than what we saw in the Eurozone. You had no ... fiscal policy was even tighter there. But also on top of that you had an ECB that pretty much did not play any major role in providing accommodation until Mario Draghi really stepped up. So, that was ... I think those two are fairly important fiscally. If you think about fiscal and monetary policy working together to offset some of these business cycle shocks so that it is actually easy to absorb these risks, and you don't see the asymmetries getting exacerbated. 

Amarnath: What I think is actually worrisome in some ways because Congress ... we're putting a lot of the eggs in the basket of Congress in terms of getting fiscal policy right. And that is where during the 2009 stimulus there wasn't enough aid to states. So, you can see this in the state and local job growth data. And once the funds run out from that stimulus for state and local governments, they start to slash jobs in terms of cops, firefighters, teachers, they all saw significant employment cuts in those areas. 

Amarnath: And even now, we had 150 billion that was dedicated to state aid, and that is soon to be passed, it looks like. But, that 150 billion is probably going to fall well short of what's needed. And then the question is, do the States have any kind of financial flexibility after that? Do they have any financial flexibility, or do they have to keep relying on Congress to calibrate perfectly what fiscal policy should be for in terms of appropriations to states during these crises? So, I think there's just more room for institutional backstops that really help to reallocate risk across the states for these sorts of events. 

And even now, we had 150 billion that was dedicated to state aid, and that is soon to be passed, it looks like. But, that 150 billion is probably going to fall well short of what's needed. And then the question is, do the States have any kind of financial flexibility after that? Do they have any financial flexibility, or do they have to keep relying on Congress to calibrate perfectly what fiscal policy should be for in terms of appropriations to states during these crises?

Feygin: And you know, if you want to see those in action, actually, I just remembered look north of the border, Canada does have these kind of fiscal backstops that are much more aggressive than the US. And because of that you see the municipal market being much more liquid for Canadian provinces. 

Beckworth: Okay. We are nearing the end of the show. Our time has come to the end. Before I do that, any final thoughts from any of you? 

Pancotti: As we were on this call, the House passed the bill. So, a lot of things we just called for are now in action, hopefully. 

Beckworth: Wow, you guys are influential. Who knew? So, well, thank you to each of you. Thank you to Skanda, Yakov and Elizabeth for being on the show today. It's been a real treat. 

Amarnath: Thank you. 

Pancotti: Thanks so much, David. 

Feygin: Thanks. 

Photo by Comstock

People: 
David Beckworth
Calendar Date: 
Apr 1, 2020
Podcast Series: 
Publish to Announcements page?: 
Image: 
Publish to The Bridge?: 
Libsyn Podcast ID: 
13793714
Subtitle: 
Passing the CARES Act and enabling the Fed to buy municipal bonds are two steps toward a robust response to COVID-19 and its adverse economic impact.

Sam Bell and Skanda Amarnath on Gross Labor Income Targeting

David Beckworth: Our guests today are Sam Bell and Skanda Amarnath. Sam and Skanda along with Kim Stiens are part of a new organization called Employ America, a new research and advocacy organization that aims to get better labor market outcomes. Sam was also known on FOMC Twitter as an influencer when it comes to nominations for the Board of Governors, we'll come back to that in a bit. And Skanda is a former hedge fund economist and a New York Fed research economist. Welcome Sam and Skanda. 

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.

Skanda Amarnath: Thank you. 

Sam Bell: Thanks for having us. 

Beckworth: Yeah, it's a real treat. Of course, we know each other through Twitter, online. I've actually interacted with Sam in person many times before. 

Beckworth: First time to have Skanda here in person, so it's great to have you on and you guys have a great story to tell. Before we get into the great economics we want to talk about today though, I noticed something else that we have in common besides Fed and economics, is a love of basketball. 

Beckworth: And I know that was Sam and I have talked before, we both played varsity basketball, we both liked to play pickup basketball in our old age still and we follow the NBA. And I think that's true for you too. Because in fact your handle on Twitter was Irving Swisher, right? Which is a play off of Irving Fisher, correct? 

Amarnath: Yes, yes. I’m a big NBA head, I am. 

Beckworth: Okay. Well I know we're supposed to talk about economics today, but can I ask who you guys are rooting for in the championship game, NBA? 

Amarnath: I'm rooting for the Warriors. 

Beckworth: Warriors? 

Bell: I'm rooting for the Raptors. 

Beckworth: Okay. 

Bell: Kawhi… Fred VanVleet is a beautiful player and I encourage all the young listeners out there to model your game... Even if you don't have the athletic prowess of Draymond Green or Kawhi Leonard you can just take some hope in Fred VanVleet who makes all the right plays and is by no means an athletic specimen. 

Beckworth: Okay, well I'm going to have to go with Sam. I apologize Skanda. But I live in Texas for five years and I was big Spurs fan. There's two Spurs with Toronto, so Danny Green and Kawhi Leonard. So any event, fun series. And let's move back to the economics and the Fed. Now you both are part of a new organization called Employ America. So tell our listeners, what is Employ America? What are you trying to do? 

Bell: So cast your eyes on the horizon, David, and just imagine tight labor markets stretching out as far as you can see. 

Beckworth: Nice. 

Bell: And that's our north star is, better labor market outcomes, so more employment, higher wages, better quality jobs. And we are doing research, we'll talk about Skanda’s paper, we're doing advocacy. At present, we’re interested in, focused on Fed nominations. Obviously personnel is hugely important. But we want to get involved in fiscal policy. You've had other guests talk about automatic stabilizers. Hopefully there'll be some legislation on that in the coming years. And all things labor market. I think we also want to be a hub for there's this boisterous, diverse crew of people on Twitter and elsewhere who are interested in better labor market outcomes. 

Bell: And we sort of want to be one of the hubs, one of the homes for those folks channeling some of the great ideas, some of the great discussion papers, et cetera. So North Star, tight labor markets. 

Beckworth: Okay. Very nice. And you have another colleague, Kim Stienswho’s not here, but she's a part of the organization as well, I want to mention her. And so you've got projects already. We'll mention Skanda's research project here, his proposal for new target, which probably many of you have seen already, but we'll get to that in a minute. And just briefly, Skanda you also testified to Congress yesterday is that right? 

Amarnath: Yes, so at least for subcommittee, we presented on sort of what the Feds currently reviewing through its framework review and the conference in Chicago. And comparing that with how the Fed probably ought to be held accountable, especially on labor market outcomes. So especially in terms of how they've defined maximum employment, how that's changed over time. So we were presenting there yesterday. 

Beckworth: Yeah. So one of your pushes I think is to take the dual mandate seriously, right? Not just one part of it. Right. So, yeah. Okay. Very nice. Well, let's go back to you guys individually. Sam, let's start with you and I'd like to hear about your career path to becoming FOMC Twitter influencer for governor nominations. And for listeners who don't know, Sam has been pivotal in dethroning some nominations along the way and I think Greg Ip called you a national treasure one time because of all the... Tell us what you do because it's a really interesting process you go through in terms of checking up the background of these nominations. 

Bell: Okay. Well, so I guess I'm not a trained macroeconomist, but I got really interested in macro issues after the Great RecessionObviously we had an unemployment crisis. It got me trying to figure out how is this happening and what can we do about it. And so I got really engaged on Fed policy debates. And in 2016, I started working halftime helping the ”Fed Up” campaign with some research. And in December of 2016, I went to Hoover event that included Kevin Warsh. And this was obviously after the election and I was talking to somebody who was sort of singing Warsh’s praises. And I said, well my understanding is he actually had a pretty hawkish record during the early years of their recovery. And since then, and this person who I respect greatly sort of wasn't clued into that. 

Bell: And over the following months, I got the sense that people who were gunning for Fed chair appointment, were going to be evaluated on the whole, I mean, the conversation seemed to be more about what are their current views of policy and who do they know, where do they sit? Are they close with Mike PenceAre they supported by Wall Street? And for me, it started with Warsh. I really wanted to make sure people were paying attention to the past record of nominees. So in the summer of 2017, I wrote a huge long piece about Kevin Warsh and his record through the years, what he was saying in 2009 about inflation coming and his objections to quantitative easing. And anyway- 

Beckworth: Was that in Politico? 

Bell: No, that was on Medium. You can find it at “Jared Kushner for Fed Chair on Medium. It got a little bit of coverage. Paul Krugman retweeted it and- 

Beckworth: Right, I remember it. 

Bell: Adam Tooze did a blog post about it and the FT featured it. Anyway and actually it got around Wall Street a bunch because there was for all of these nominees there's a huge demand for information about them, when there's news, oh, Kevin Warsh is going to meet with president Trump. There's a huge all of a sudden demand. 

Beckworth: Sure. 

Bell: But there's few people who have the time or inclination to actually have chased down all the information about, well, what was their record? And so that's sort of the public service. I don't know if I have any influence, but to the extent I do, the public service I'm trying to provide is what's the record and specifically around what I feel is like a great crisis that we had in this country around unemployment in '09, '10, '11, '12. 

Bell: So my process is very straightforward, read everything. I'm in DC, so I can go to the Library of Congress and get every media clip, they have the databases. So I can read every media clip, read every paper, read every speech. And- 

Beckworth: Is that where you do most of your research at the Library of Congress or do you do some from my computer in an office or? 

Bell: Yeah, for each I mean, I've been engaged on three nominees in particular. So Warsh, Marvin Goodfriend, who was nominated in 2017 for one of the open governor positions. And then Stephen Moore who was rumored to be nominated, but was never actually nominated. And yeah, for each of those I spent a good deal of time at the Library of Congress, but I also watched the whole Stephen Moore CSPAN archiveSo I did that late at night and while I was making dinner… 

Beckworth: So if someone works at the Library of Congress and they see you walk in, they say, Oh, someone's been nominated to the Board of Governors, huh?” 

Bell: Yeah, well, I don't know the folks at the Library of Congress that well, but yes. Yes. 

Beckworth: Okay. Now you were pivotal, at least somewhat important in like Marvin Goodfriends failure to get passed the Senate. Is that fair? 

Bell: I don't know if I was in particular, I mean, on two past shows David, you've said that Rand Paul was actually responsible for blocking… 

Beckworth: You listen too well to the show. 

Bell: I listened to all the episodes and I want to correct the record. So Rand Paul was opposed to Goodfriend on the issue of negative interest rates. Goodfriends long time written about negative interest rates, how would you make it feasible. But Rand Paul has only voted, in his entire Senate career, he's voted for a single Federal Reserve nominee, Randy Quarles. So of the whole board right now, he's only voted for Randy Quarles. 

Bell: So if you need Rand Paul's boot and you're a Fed nominee, you are- 

Beckworth: Already in trouble. 

Bell: A lot of trouble. 

Beckworth: Okay. 

Bell: So basically yeah, not a lot of attention was paid to the nomination. Marvin Goodfriend, he's not Eric Trump's golfing buddy. He's a serious scholar. But when you look at his actual record and what he was saying in 2009, he was already saying the Fed should be thinking about interest rate increases. In 2011 he gave Wall Street Journal interview where he says inflation scares are going to be a much bigger thing. The Fed has already sort of too easy. The thing that really I focused in on was when the Evans thresholds were announced. And to me the Evans thresholds were already sort of a lukewarm proposal. I mean the conversation at the Fed started with NGDP targeting actually in November, 2011 and they said, well, we're not going to switch to that yet. 

Bell: Maybe we should do these thresholds that Charlie Evans was talking about. And then they watered them down a little bit more because originally the thresholds were more like, I think five and a half [percent] unemployment, three percent inflation, ended up being six and a half [percent] unemployment two and a half [percent inflation]. Anyway, so I think it was a useful policy intervention. I'm not sure it was like the most aggressive thing they could have been doing, especially in retrospect. But Marvin Goodfriend went on Bloomberg and just blasted the Evans thresholds. This is irresponsible. Even if they by some heroic effort, got unemployment to seven percent. He said, we can't be sure that that's not beyond NAIRU. In other words the natural rate of unemployment may be above seven percent, which to me is like just a major failure in judgment. So a lot of the senators use the stuff I'd uncovered in the confirmation hearing and he never sort of explained himself. He never said, Well, in retrospect I was wrong. That's not true, he did say in retrospect I was wrong, but he never really explained himself. 

Beckworth: Well, I think, yeah, it was the tone, the way he carried himself, just a little bit of humility goes a long ways, right? 

Bell: Totally. 

Beckworth: Yeah. I mean just saying, “Look, I messed up. You're right. I messed up. And I think he didn't seem prepared in general for that. So maybe he was his own worst enemy in some ways. But the point is you brought to the surface these comments he had made and everyone was aware of what he had said during this period. 

Bell: Yeah. And I think, I mean, the thing that was in my view was really encouraging about the hearing was for so long the congressional hearings, the dynamic was people yelling at Ben Bernanke and Janet Yellen for doing too much, taking too many risks with inflation or trying too much in the way of stimulating the economy. And it was like the first hearing where the members were coming back at a Federal Reserve official or potential Federal Reserve official and saying, why were you so conservative? Small c conservative. Why are we so hawkish on this? Which I think is part of a more general mood in Congress these days. But from where I sit was encouraging that that was the direction. 

Beckworth: Okay. Well, let me ask this question then. So there were several people you've been involved with, you mentioned Stephen Moore, which was a great roller coaster ride while it lasted. But, have any of these people ever like, reached out to you and said, “Hey, give me a break, or have you got any blow back, maybe indirectly even. 

Bell: Oh yeah. I mean not folks directly but friends of people saying... A few categories of complaints, I mean, one is we could do so much worse than the person you're sort of tweeting about. Right? So why are you giving Marvin Goodfriend a hard time? We could end up with Stephen Moore, right? A Trump crony or something. Right? So that was one category of complaint. Another category of complaint is don't you ever, like, does everyone have to agree with you? Isn't there space for people to have been wrong but still be good nominees? In which case, and Skanda and I were just talking about this, but we have an example of someone who did that well, Narayana Kocherlakota who was very hawkish, maybe the most hawkish person on the committee in '09, '10 and the facts didn't end up justifying his position. 

Bell: So he changed his position. So we're embracing of converts, we are embracing of people who changed their mind with the data and we were the last people to say we have all the answers. So that was the second one. And then I guess the third one was around like, is this just a partisan exercise? In which case don't you just hate all of Trump's nominees? But I think Richard Clarida is doing a lot of great things. I didn't do a whole tweet storm about his nomination because even though there were pieces of it where he objected to Fed policy in ways that I didn't think were right on, overall, his body record was like really solid and I thought he was a good nominee. So those were the three sort of categories of complaints people had about my tweeting. 

Beckworth: Okay. One thing I remember about Richard Clarida from you is that he's a singer. I wouldn't have known that he has this entire recording album. He has an album. So listeners out there- 

Bell: We’re hoping for the Bank of Jamaica-Richard Clarida mash-up on inflation. 

Beckworth: No kidding. Just tell our listeners what that means if they don’t know the Bank of Jamaica. 

Bell: The Bank of Jamaica has a very creative communications strategy of making YouTube videos where reggae performers are basically singing about inflation targeting. And we're hoping that the outcome of this Fed review is also like a new Richard Clarida album where we get some monetary policy content. 

Beckworth: Okay. We'll look forward to his next album. Alright, let's go to you Skanda. Let's talk to you for a bit and before we get into your proposal, just, you worked on Wall Street during much of this period we've been talking about, the weak recovery, the slow growth. What was your sense of what the Fed was doing? Was your sense the Fed was being too timid? Was it being too cautious? What was your take because you were an economist from the frontlines. 

Amarnath: So, as you said, I worked as an economist at hedge fund, and I recently obviously joined Employ America, but I worked there for four years. But I've been following this pretty actively probably since sort of the fall of 2007 or something, or summer of 2007. And I think the bias that I think you've had that a lot of people have a lot of different stripes have had correctly was that this has been too slow of recovery. The errors have been one sided in terms of hawkishness, in terms of not pushing for stronger growth. Not recognizing the jobs crisis of 2009, '10, '11, '12 that we had really low rates of nominal and real growth and that we could've been doing better. 

Amarnath: Obviously there have been times that monetary policy has really stepped up to the plate, but there have also been other times that maybe have not been as keenly focused on where monetary policy could have done better. And so in that sense this has been one long story in sort of policy not quite getting it right and it's all been in one direction. It hasn't been a case of there've been times when the Fed was two dovish versus too hawkish. I think it's been a pretty systematic error at this point. 

Beckworth: Yeah, I completely agree with that. And of course I get push-back but I think over a decade, and I go before 2012 when I look at the inflation record because implicitly they were targeting two percent before then. And so to be generous, be charitable from the recovery to the present, it’s been close to 1.5 percent inflation. And the people were like, well, what's 50 basis points? Well to me, 50 basis points compounded as a symptom of short fall of demand growth, which, hysteresis effects, all kinds of effects in the labor market. So I do think this is an issue and I'm glad you guys are kind of maintaining attention on it, but I want to go back to kind of Wall Street view. So you got it. But in general, did Wall Street get it? I mean are economists and traders on Wall Street, are they as cognizant of this issue? 

Amarnath: So my previous role at a hedge fund, was sort of a hybrid role, is market economist and strategist. And so my job is to guess what the Fed will do. Right? And when you get into the game, and from the Wall Street perspective, there's a sort of, it's fun in the sense of trying to anticipate what the Fed's going to do. You look at their framework, you look at what they say, and then you just say, okay, financial conditions are here are the unemployment rate versus NAIRU is here. Okay, this is their bias and they're going to try and normalize here. That's a different set of questions than what they should do, right? So when you get really focused on getting the call right, there's a certain set of muscles you don't exercise either. 

Beckworth: So you lose sight of the big picture, then. 

Amarnath: Yeah. Or you're focused on your P&L day to day, which is important obviously, because that's how you get paid. But it's not necessarily the most important from the standpoint of actually criticizing the Fed, market participants are always going to complain, “Oh you misled me. You told me this, you did that.” But from the Fed's perspective, they're supposed to get things right for society, get things right for businesses and workers just as much or moreso than for market participants themselves. 

Beckworth: So the incentives aren't there to kind of have this big picture thinking, discussion. I mean some people do, but day to day you're focused on- 

Amarnath: From what I observed of sort of sell side economists in the early parts of the recovery there was the split of those who are really focused on inflationary pressures from QE, from a big balance sheet. 

Amarnath: And I think obviously that stuff didn't play out the way people were predicted. And then there were those who I guess like Goldman Sachs econ research group, those highlighting [that] there's a lot of slack in the labor market. And so in that sense they proved to be right in terms of the fact that Fed policy was easier. There was no inflationary pressure. More recently, especially at the hedge fund, it's been a different set of sort of failures in terms of the calls that this is the moment when we're going to see the inflation and the wage growth because unemployment rates have gotten so low, like there's clearly no more slack. Even if I do U-6, it's still very low. And yet those predictions have been also false. And I think now is also the time for a reckoning on that side too, which is that we need to update our priors and rethink the specifications by which labor markets and inflation to the extent they are related, how are they related? So this is an opportune time for that as well. 

Beckworth: Okay. Well that's a nice segue then into your proposal because you have a new proposal, new target for the Fed. And it's very interesting because it does kind of look at labor markets in a way that the Fed isn't currently doing. So tell us, what's the name of it and tell us all about it. 

Amarnath: Yeah. So I guess by a Twitter hashtags is FloorGLI. The idea is to put a floor under the gross labor income growth rate. Gross labor income refers to every employed person’s compensation cumulatively in this country, so the nation's paycheck. And so this is, I guess in some ways a variant on sort of national income. But it's focused on labor income, one because of the dual mandate since maximum employment is part of the dual mandate. 

Amarnath: And then also because it's actually pretty easy to measure. We get core PCE each month and we obsess over the different components and what they're doing. And is this transitory, is it not? And there's some really important information that's also in that same release that tends to not get played as much, which is a compensation of employees received, which is gross labor income. So the proposal is to really focus on putting a floor under that growth rate. That would be a better way to actually pursue maximum employment. So it really addresses that part of the mandate. I think it ends up being a much more robust indicator than inflation itself. So while we don't say don't look at inflation there's a time and a state of the economy where inflation sensitivity is important. In terms of robustness of indicators, inflation has the lag. 

Amarnath: Inflation's not very cyclical. Inflation methodology is always changing. And so in that sense you want to pick actually things for policymakers to focus on that are robust, right? That are things that are sensitive to the business cycle in real time. 2008, inflation was rising, 2011, inflation was rising. It was proved to be false signals in this grand scheme of things. We saw a pretty serious economic deterioration in 2008. And gross labor income growth was showing that in real time, month by month, same thing in 2011 and would have given them more timely signal for policy response as opposed to inflation, which a lot of people were getting sidetracked by. So this sort of obsession with inflation in some ways is, it sort of matters in a big picture sense. I don't want to minimize the costs of inflation, but we need to be very clear about, from a policymaker's perspective, what are robust indicators to look at for the purposes of calibrating policy. 

Amarnath: And then finally I'd say the floor aspect of it is also meant to really appreciate the asymmetry of policy and the political constraints. I had a discussion with Scott Sumner, I'm not sure he remembers is it now, but in 2011, one of the points he made that really stuck out to me was the superiority of nominal GDP targeting over inflation targeting when you're at low rates of nominal growth, which is.. it’s politically superior to say I want a faster output growth, faster income growth than it is to say I want higher inflation. 

Amarnath: So this takes it sort of the next step, which is to say what are the sort of politically superior targets and nominal anchors for different states of the economy?” So the way we've placed it as sort of a state contingent, nominal anchor. In low rates of nominal growth, you should be shooting for higher GLI growth. 

Amarnath: In high rates of nominal growth, you're shooting for sort of making sure the inflation target is met. So one of the criticisms obviously sometimes if nominal GDP targeting is, what if we have the late 90s scenario where we have high nominal growth but also higher real growth, right? Inflation was rather tame in '99 and 2000. We don't want to be tightening in that scenario. 

Amarnath: I know you guys have a reason for why that still makes sense, but from our perspective, we want to make sure that the costs of different states of the economy are appropriately considered. So it's a low nominal growth state. You want to focus on making sure that you're pursuing faster job growth and wage growth. In high nominal growth states, you want to be more sensitive to inflation, which may or may not show up and you kind of take it case by case, but it's still you're always sensitive to some nominal anchor, but it's a little bit more state contingent. 

Beckworth: So your proposal has two elements in it. It has inflation if the economy gets too hot, inflation gets more weight, it gets picked up, right? But it also has labor income or maybe it's wages, right? Kind of an aggregate measure of total labor income earned, right? And that provides the floor, if that gets too low, that takes more weight. And is that right? 

Amarnath: Actually, right. So especially we've been in a low nominal growth state for the last 20 years, really, or since maybe about 2000, 2001. That was when we've really seen that nominal growth rates have consistently shifted down for a variety of reasons, but that also puts more emphasis because that will inevitably imply you're going to have lower interest rates, you’re going to be closer to the zero lower bound. That naturally takes up more sensitivity. The '70s were marked by a period, obviously, of strong labor income growth, strong nominal output, nominal spending growth as well. 

Amarnath: In those environments obviously inflation makes sense and you're going to be in a different state of the world where that sensitivity makes a lot more sense. And from the political communications perspective, right, if the Fed needs to get new tools that have traction at the zero lower bound, because I think there is a decent amount of debate about how much traction they're going to have next time around when some of the things- 

Beckworth: Absolutely, yeah. 

Amarnath: -What's the better argument for having those tools? Is it that you're trying to pursue faster income growth, faster job growth, faster wage growth or is it that you're trying to pursue higher inflation? I think even for, whether the Democrats or Republicans, I think that message is probably going to be more politically effective that you're actually pursuing sort of the maximum employment side of that mandate in that circumstance as opposed to the academic exercise of we need to get inflation expectations anchored and that's why we need higher inflation itself. It's a technical argument, but it's a different one. 

Beckworth: Yeah, it's hard to tell people who have already lost their jobs, there’s uncertainty in the economy. Hey, we want to get inflation up. It's good for you. And they're like, “What? 

Amarnath: Yeah, we want a higher- 

Beckworth: “What are you smoking? And then Ben Bernanke saw this in Congress, right? In 2010, I believe 

Amarnath: Exactly. 

Beckworth: He got grilled because he said we can't get inflation up. In fact, he's using low inflation to justify QE2. 

Amarnath: Yeah. 

Beckworth: And he couldn't get anywhere. Okay. Very nice. So again, I may butcher this, but it's kind of a labor income target that it kicks in varying degrees based on the state of the economy, right? 

Amarnath: It's asymmetric in nature, right? 

Beckworth: A symmetric labor income target. 

Amarnath: Yes, so one of the things that I know people who've been at the Fed who have said, well, if you target wages, well, what happens when wage growth is strong? And our answer is okay, fine, but that's when you should look at inflation, right? That's when you should look at the costs of a high pressure economy, right? That it actually reflects the bad stuff of each economic state. Right? 

Amarnath: That's a state of the world where we should be sensitive to inflation. It may or may not show up. In the '70s it did show up in the late '90s it did not show up I would say. So that's where trying to balance those in a way that is easy to communicate I think the other thing that's hopefully advantageous about gross labor income is that it's reasonably straight forward to understand. It is the cumulation of each person's paycheck. Inflation is actually a very complicated beast. 

Beckworth: No, it is. It's all these and there's lots of debates around it. Right. Because you mentioned and lots of cynics out there too, like shadow stats and others it's open to misinterpretation and stuff where this is not. 

Amarnath: Yes, I and I understand why the BLS and the BEA are making the changes they're making. They're trying to capture something economically consistent, but the state of the world is constantly changing that how much is my unlimited data plan worth for telecommunications prices, once you quality adjust them, there's a lot of sources of error and variance that you add in. 

Amarnath: I think from a policymaker's perspective, the question is how much should I be fixating over that? I feel bad for Jay Powell when he has to sort of explain the, oh, we think these components are transitory and these ones maybe there's something to them. It's getting so much into the weeds that I'm not sure it's effective from a monetary policy strategy. 

Beckworth: Right. When you get really low inflation, you do get hung up on these what's the relative change in this or that. So what has been the reception of your proposal? You've talked to people I know a lot, so what have they said? 

Amarnath: So I think that generally the feedback's been positive so far in terms of glaring errors, we haven't been pinned down of any sort. But I obviously people who are more experienced to have seen more naturally have a little bit more skepticism are trying to feel out some of them. 

Amarnath: There's a lot to sort of digest. We put a lot into the article he published and it's hard to capture everything all at once. So we're going to try and in various ways communicate these ideas differently hopefully in a little more digestible format. We wanted to make sure everything was all in one place. But now it's also about having sort of proper paper or having sort of slide decks to actually cover the communication strategy. But generally speaking, most of the concerns were about is this going to be a symmetric GLI target? There was some concern about whether this was actually sort of too asymmetric in nature because there's no sort of focus on sort of what do you do when you're in high rates of GLI growth? 

Amarnath: So I think generally speaking, we're pretty encouraged by the response we've received. It's a little, there's some complications when you're trying to talk about state contingency. And so the communication is always challenging. That's just the nature of monetary policy though too. So we're hopefully trying to keep it simple enough but appreciate the nuance. 

Beckworth: Okay. 

Bell: If I could add one thing? 

Beckworth: Sure. 

Bell: We've started the conversation with Congress as well. So we started talking to members yesterday and I'm relatively encouraged as Skanda said about the ease with which members can really wrap their because people are already asking Jay Powell about wages. If you watch a Humphrey Hawkins hearing, people are not asking about the inflation target, they're asking about jobs and wages so this sort of framework I think is going to be, I think, easy for members to sink their teeth into. 

Beckworth: Let me ask this question, why not just have a pure GLI target where you say, look, we're going to target gross labor income at a certain rate. And if it goes above it, we tie in and goes below. We tighten. Why have inflation and labor income? 

Amarnath: Yeah, so this is where I bring up the late '90s example. I think it's a little, and this is one that I've heard from, especially when I was an analyst working for economists at the New York Fed. And that's where I definitely heard it for like why the nominal GDP targets were a little bit... We've treated a little bit more lukewarmly in terms of a lukewarm manner, was that the late '90s example of where you have high nominal growth but also low inflation. Is that really in an environment where we want to tighten? The Fed actually did tighten in that environment too. 

Amarnath: So maybe that's a misgiving that in practice as an end up occurring. 

Beckworth: I see your point though. 

Amarnath: But it's like who are we to take away sort of potentially real growth in that process because inflation is lowShould we be pursuing a deflationary strategy when we have high nominal growth? We haven't had this search. This is an area last for very long. So it's- 

Beckworth: Of an academic question. 

Amarnath: More of an academic question. I do think it helps from the communications perspective, if the Fed wants better tools, the Fed should also be thinking of political positioning. I realized that they're politically independent, they are operationally independent, but they also don't exist in a political vacuum. And if they want to be able to communicate their policies clearly and not be accused of sort of shortchanging the labor market or even the past where it's about inflation itself, that they're clear with their communications about why they're tightening and why they're easing. And each macroeconomic variable does have certain value judgments embedded in them. We want faster output growth, we want faster income growth. We don't want faster inflation generally speaking, outside of economists, probably at the Chicago conference. 

Beckworth: Well let's go a little bit more on the politics. So you mentioned the political appeal of your proposal. Sam, you follow the politics closely. You've already touched on this a bit and you mentioned earlier how they are now questioning at least Fed nominees about whether they were too hawkish, but in general, what has changed in the Senate and in Congress? How has the tone changed since like President Trump? I had Adam Ozimek on the show. I remember you had a follow up comment. One things Adam said on the show was maybe Trump will make Republicans less averse to like an inflation overshoot or more flexible inflation targeting. And you were a little skeptical, but is there any change you see? 

Bell: Yeah, I think I do see a change. I mean, well first of all, 2017 Republicans held the House, the Senate and the presidency. And if you had been watching monetary policy hearings in 2011, '12, '13, you would have thought that the day that the Republicans got unified control, they would pass the format, they would legislate the Taylor Rule, they would take discretion away from the Fed. And that didn't happen. And I think it didn't happen. I don't know quite why it didn't happen. I don't think it's totally Trump. I think that's clearly a part of it. But there's very striking about face from many members of Congress. I mean, I'll point you to perhaps the most striking, which was in April the Senate Banking Committee chair who was pretty hawkish. I mean, he voted against Yellen because she was too dovish when she was nominated for chair in 2013 and this is Mike Crapo and he's had strong questioning of Bernanke and Yellen and he's, he's also like small c conservative in the sense that he's just... But in April he called for a 50 point rate cut, which I was shocked. 

Bell: And if you look at, or if you track Senator Shelby who was often one of the great Fed critics and you look at what he was saying in February he was celebrating Powell and not criticizing the pause. And at the same time you don't have Democrats. Well anyways, so I think Republican Party has switched big time with maybe the exception of Pat Toomey and maybe they exception in the Senate and maybe the exception of Andy Barr in the House. But I think overall there's been a pretty noticeable shift. 

Beckworth: One with their shift on deficits, it seems like. 

Bell: Yeah. One thing on the politics. I mean, I'm not sure how long we'll have both parties sort of pointing in the same direction for more dovish policy. But my hope with the review, I mean, one of the reasons I was excited about the Fed review happening and it coinciding with this dovish turn, right, where Republicans have shed some of their hawkishness and we haven't seen Democrats, for example, we didn't see in February, Democrats criticizing Powell for the pause. Right? So both parties more dovish this is the time for the Fed to stake out the ground it needs. So in the next downturn it can say, “Well, you guys already signed on to this. We had the Fed review. You didn't object. That's why we proposed these aggressive tools. That's why we updated our framework. Now's the time to claim that ground so you can use it later. So I hope the Fed realizes that the politics have shifted and that they- 

Beckworth: Now is the time to act. 

Bell: ... Opportunity, yeah, yeah. Really. 

Beckworth: Well, just to be clear to our listeners who don't know, I know many do, the Fed is doing a yearlong review of its strategy, tools, communication, and we're six months in. In fact, this is called the listening stage and right now as we speak, they're finishing up a conference at the Chicago Fed has been mentioned already and this conference is kind of a culmination of various papers, academics, practitioners talking about tools, communication strategies. So six months of listening and then the next stage is six months I guess of internal debate. They're going to come out more, I guess talking about their different views. And so I want to ask, what is your take you just said this is a great opportunity for them to be bold, right? This is a great politically, and I'll just remind our listeners in 2011 you mentioned this earlier too, they were thinking similar questions, nominal GDP level targeting. I got real excited back then and I was disappointed. And they decided to go with an inflation target. 

Beckworth: And the concern back then is we're coming out of a deep recession, we're kind of implicitly, we're doing inflation targeting. We don't want to do something to radical because the economy is unstable. Fair point. But now we're in a very different environment, now politically, economically, all the stars are aligned for some change to take place. And what is your take? Can we be hopeful of some kind of meaningful change, either of you? 

Bell: Well Skanda is the big cynic, so I'll let him be cynical. I think it's good that the Fed is doing the review. And I think there are a number of both Powell and Clarida have questioned the Fed's models, predicting inflation. Clarida has been talking about different aspects, labor share, et cetera, which I think are good. I think the narrow conversation about price level targeting versus average inflation versus status quo feels too narrow to us. I don't know if you want to say more on that score, but. 

Amarnath: Yeah, I think that it's narrow. I second Sam's thoughts though on the fact that it's good to have the review. It is a good opportunity for the Fed to think strategically about really if we have another recession for some exogenous reason, what's the Fed going to do? How are they going to have enough policy space to respond as it is, we are not that far from the zero lower bound and even now after 10 years of recovery after some "normalization" nevertheless their policy space is constrained. Inflation outcomes have undershot. 

Amarnath: I think inflation outcomes of undershot for a variety of reasons. Some of them are within the Feds control, some of them are without. But bigger picture nominal growth has still remained very low and that I think is where the focus should really be, which is we should be trying to solve that problem and the human costs that are associated with not solving that problem now. 

Amarnath: I think the discussion has been too narrow in the sense that we've been talking mostly about average inflation targeting. If you think about the papers that are presented in terms of their focus I would have hoped they'd been a little more ambition, at least in terms of how they more critically think about maximum employment. How they think more critically about pursuing more ambitious goals on the maximum employment side where I think they have generally focused instead on the fact that it's only 50 basis points of difference. How do we get that 50 basis points up in a manner that is sustainable? I think that's sort of too narrow and not really describing the problem well. 

Beckworth: Yeah. So I'm going to share with you a tweet by our friend Ryan Avent who's a columnist for The Economist magazine. He's been on the show a few times. He's also a big fan of nominal GDP targeting. And so he went on Twitter recently to commemorate the conference. And he starts with this tweet. I'll just read the first one and the second one. He goes, “Let's all take a moment to applaud the Federal Reserve for hosting a conference this week at which various experts will offer a critical look at the Fed's monetary policy framework.” And his next tweet, “This conference comes a mere 20 years after it became clear the zero lower bound might present difficulties for central banks, 10 years after the zero lower bound began to bind in the US and only just after the Fed inverted the yield curve with short rates under 2.5 percent. 

Beckworth: So good to see responsible technocrats responding with their appropriate urgency to serious problems. It's a very cynical take. I won't go that far and be that cynical. And in fact I replied, I said, this is far better than what the Fed did with the Great Depression. I mean it was Ben Bernanke in 2002 who said, we screwed up. We made a mistake. So on timescales is actually a vast improvement. But so where I'm concerned is that I see kind of a baked in outcome already. I think average inflation targeting is where they're going. It seems to be that the most of the discussions surrounding it, am I being fair or do you think something more ambitious will come along? 

Amarnath: That is consistent with my sources as well that average inflation targeting is the clear front runner for now and that this has been a bit of a race that feels like it's already been run behind the scenes. 

Beckworth: Yeah. And I understand politically why they might go to average inflation targeting. It's an easy next step. It's not that different if they go to Congress they can say, hey, we're still doing inflation targeting, but gives them the opportunity to make it. But I agree the lack of boldness maybe going outside the status quo thinking. 

Bell: I think there's an interesting... I was at an event recently where Sam Fleming from the FT asked Ben Bernanke why the recovery was so slow and he was defensive about it and sort of defended the pace at which there were job gains and in a way that was a little painful for me to hear because I wanted a stronger, quicker recovery. At the same time, I think it's useful to step back. And if you're in Ben Bernanke's shoes think about like, where were all of you in 2011 where I was just taking incoming fire and it felt like all the political forces were, maybe not all the Twitter forces, but all the political forces that he was up against were pushing the opposite way and that's part of why we're starting Employ America. 

Bell: Like we never want to be in a situation again where we have that sort of unemployment crisis and the political dynamics and the broader atmospherics are “”Oh, the debts out of control. Oh, the Fed's doing too much. Oh, this and that.” Because I have some sympathy for Bernanke now that we're down below four percent unemployment saying well, being a little defensive about it because we're in a different situation now politically and the atmospherics than we were in 2011. So at the same time, I think the Fed is too defensive about the recovery and I would just like them to make the simple statement that we could have done better on jobs and incomes. 

Beckworth: Well, we have to maybe wait a few decades based on the Great Depression. 

Amarnath: Yeah, I mean just to follow up on Sam's point, as far as 2011, obviously it was a time when there was a lot of political conflict and in terms of how Democrats, Republicans perceived the Fed and now is actually a moment when incrementalism should not be sort of satisfactory, I think. Right? This is the time when the political moment is ripe. You've had plenty of time to evaluate the recovery, the Fed's own performance, how their forecasts have had to deviate, how their estimates of different parameters have changed. So that's I think the bigger picture. This is a moment they could really seize. And they might still seize it, there's plenty of time in terms of their review, but we hope they do well. 

Beckworth: They got six months still so Employ America needs to get to work in the next six months. As you know I've been beating the drum here, Macro Musings and other places as well. Let's go to the present and in step back from this discussion about this review and talk about what they are actually doing in real time. So last December they raised rates may think it was a mistake in retrospect. The yield curve appears to be inverting and now there's more talk about the Fed possibly cutting rates pretty soon. At this conference, Jay Powell gave a talk where he used the phrase to act as appropriate that the market's interpreted it as we're going to be their support. 

Beckworth: Here's an article from Bloomberg. It says, Fed Inches Toward Rate Cut as Trade War Frays Patience. Do you see the Fed becoming more nimble, more agile, is it something that we should be thankful for? I mean even if they don't make a big radical change in strategy, are they becoming more sensitive to market conditions, to developments around them? 

Amarnath: I mean I think that if to the extent they do, and I think they are doing that now to some extent that's a positive development. It's also you can have the strategy and the framework, but ultimately it's about practice. It's about the actual implementation. So they can't really afford not to be negatives there, but they can't afford to sit on the sidelines here. Growth is slowing at least by a lot of different metrics. And in this situation you're seeing enough indicators to suggest that risks are emerging and the Fed has only limited policy space. So error on the side of caution is what I would- 

Beckworth: Be very explicit, explain to the listeners what you mean by limited policy space. We've touched on this several times, but explain like in concrete steps. Why are they limited? 

Amarnath: Yes. So I would say conventional policy space and by conventional policy, I'm talking about the Fed funds rate and where they feel comfortable lowering it. 

Amarnath: They feel comfortable lowering it to zero to 25 basis points. And beyond that negative rates are not a discussion for the Fed. For a variety of reasons that I can appreciate that it's a lot. There are a lot of other costs that might emerge in terms of pursuing a negative rate policy and even in terms of QE or forward guidance, these tools are, it's not quite clear how well they work. The reliability is just not as obvious as it is for lowering the Fed funds rate itself. 

Amarnath: So when you get to these more unconventional tools, obviously use them at to the extent you can, but it is obviously a much more straightforward question of what does 50 basis points mean to economic activity than it does how many assets you buy or how much you make in terms of a promise to keep rates low for a given period of time. 

Amarnath: Helpful policies but harder to calibrate. So conventional policy space is pretty valuable from that standpoint, but it's only valuable to the extent you also use it and use it efficiently. So I would say if there is a side to err on. I think the side to err on is the side of dovish business because let's say that they cut rates, but really the economy's fine. We really misjudged things. The room to actually raise policy rates back again because we have some surprising inflation that deserves some tightening is a reasonably straightforward calculation. 

Beckworth: Lots of space. 

Amarnath: Lots of this infinite space on the upside. But if, the Japanese mistake, which is one where you do not move fast enough to the downside is a pretty costly one because it's not clear even now, what's the sufficient set of tools that gets you out of this state of the effect of lower bound. So without those sorts of tools available, I think that at least until we have a sense of how to get out of that and Europe is now struggling with that as well as the Eurozone also has rates low for a very long time now. Until we figure that side of that out, I think the risks are asymmetric. 

Bell: Agree with all that.  

 

Beckworth: Okay. 

Beckworth: So in short, what you're saying is the Fed typically lowers it short term interest rate as a way to stimulate the economy whenever there's a recession. And usually it's around five percentage points. It has usually cuts and we're close to 2.5 percent. So it's going to run out of ammo pretty quick. And so that's kind of a crude way of saying it. It doesn't have much traditional ammo left in its weapons, guns. So we are in a bind that resort to QE faster and one of my fears resorting to quantitative easing faster is going to start taking out a lot of important Treasury securities that serve as collateral for the financial system. Let me ask this question. So I'm a little critical of the Fed for the December rate hike and I know in real time it’s hard to know what's right, what's wrong making these decisions and now we're seeing what looks like a sustained inverted yield curve. 

Beckworth: And what role did the Fed play in that? And I bring that up because the Fed itself was talking up inverted yield curve, no big deal last year. John Williams was kind of dismissing it out of hand even Governor Lael Brainard suggested it was okay. 

Beckworth: And if you look at the summary of economic projections, it kind of implied one. Obviously the yield curve inverted today has to do with the trade war most recent developments. But the Fed itself I think has some guilt in the yield curve inverting. Am I being too harsh? 

Amarnath: No in the sense that the Fed obviously controls one side pretty clearly of the yield curve, which is the short end through its policy rate. In the end, the term structure is meant to game out the expected path of policy. So right now we're anticipating cuts are on the horizon and day by day bringing in the time horizon for those cuts. 

Amarnath: I think that naturally will happen regardless of like whether the Fed decides to tighten or not. If market participants anticipate that growth's going to slow down, whether for reasons related to the Fed or otherwise. We've gotten to this lower growth state or we're seeing growth slowdown for a variety of reasons. 

Amarnath: Some within the Feds control, I'd say some may be a little more exogenous in nature. So I think that naturally happens, but the Fed should pay attention. I think that's the point you're making is we've seen this actually multiple times now where the yield curve inverts. They take an estimate based on a level slope term, premium model and say, oh, well this is all risk premiums and actually expected policy. Once you take into account the risk neutral rates, which is saying the expected path of policy, once we remove all this other noise is actually not inverted, right? The curve is not actually inverted. This is some exogenous…in a 2006, it was about all the sort of money flowing from petro, from oil states in the Gulf. They're the ones who are buying Treasurys. The Chinese are buying Treasurys, they're suppressing the long end of the curve. Otherwise we wouldn't have an inverted yield curve. So there's all these stories we say each time. 

Beckworth: It's different each time. Right? 

Amarnath: It's different this time our estimates show otherwise, but in the end, the market's actually just telling you that they're anticipating that the Fed's going to have to cut or the Fed has a preference to cut. I think he's a little bit of both in this case, right, that they're getting more open minded about the reaction function and the environment does look a bit ominous right now. Maybe not financial crisis level, but it's like financial conditions are still tightening in the sense that credit spreads are widening. We are seeing that signs of risk premium are sort of showing some of that stress a little bit. 

Bell: Now one thing about the December 2018 hike. I think it's interesting to think back to what you were saying earlier in the conversation about the Fed being nimble. I think one of the challenges is in 2018, I mean it seemed like we had the stars aligned for overheating. I mean many Fed officials were talking about the risks of overheating earlier in the year and even into the summer, trade tensions, synchronized global growth, loose fiscal policy, low unemployment. 

Bell: It seemed like... I mean Lael Brainard was talking about a year or two more of hikes. I think she gave that speech in April 2018. So it's a hard pivot to go from that seven months later to actually where we're pausing, right? But I think hopefully the Fed gets that and that's the sort of nimble, I mean, maybe there's a lesson to be learned about predetermining overheating and whatever, but even if you accept that that was a legitimate story, I think there's maybe a lesson and being nimble and being willing to flex between stories. 

Beckworth: Okay. And the time we have left, I want to go back to the Chicago Fed conference. They're having papers presented. It's kind of a who's who of American central banking there. If you been watching the live feed since I'm not there, that's what I've been doing, watching the live feed. I see my colleague Scott Sumner somewhere sitting in the back. 

Beckworth: But I'm here in DC with you guys watching the live feed. Maybe we should go to a sports bar and make it a thing. 

Bell: Yeah. 

Beckworth: In fact I have to mention our listeners Sam is organizing an FOMC watching event at some local bar at some point. The next meeting, right? 

Bell: Yep. The next meeting, I think it's June 18th or 19th. DM me if you're interested, it's going to be an interesting press conference. Maybe they'll cut rates, maybe they won't. But either way it's going to be entertaining. And I figure we all watch it anyway at our computers. Why not be together watching it and talking about it and digesting it together. 

Beckworth: Yeah. We all have that interest in watching FOMC live and doing so together, breaking bread and fellow-shipping. So well going back to the Chicago Fed conference, they've had a number of papers presented and again, you've heard my cynical take on the whole thing. But with that said, there's been some papers presented. Anything of interest that strikes you Skanda about the conference papers? 

Amarnath: Yeah, I think so on a big picture take away while there were some focus on maximum employment and Katherine Abraham's paper itself, I found it interesting. Still I think the focus has been on price stability to the point of there was a paper by Stock, Eberly, Wright about how the Fed could have tried to be more ambitious, but the ability to actually move inflation and inflation expectations would have still been challenged. 

Amarnath: At the same time I think when I said we could have you in certain sort of counterfactuals they wouldn't really have moved the inflation rate, but they could have achieved at least more labor market gains in terms of for a few tenths of a percentage point on the unemployment rate. And it's kind of viewed as a sort of like small thing in the grand scheme of the paper because it's not raising inflation expectations sufficiently. 

Amarnath: And to me to sort of, the mission of our organizations, that's actually still a big deal, right? That you could still get gains in terms of jobs, in terms of people who are earning labor income. That's still a win, right? That's still something that's important to highlight. I'd say obviously one of the other papers is from Lars Svensson is focused on the validity of sort of different inflation targeting approaches. How do you make up for past misses? And again, these strategies are very focused on inflation as if obviously they're all focused on the idea that Fed needs to get inflation up to target and keep it at target to get expectations two percent. I feel like we're still again missing the maximum employment side. We’ve had the Fed persistently and cyclically, I'd argue, bring down their long run unemployment rate projections. 

Amarnath: So the natural rate of unemployment keeps moving down in a rather cyclical manner. So we think about the estimates of structural unemployment are actually moving cyclically. I think that's something that the Fed does need to address. And it's not just a question of a parameter problem. There is some kind of specification problem at play here when you make these kinds of cereal errors. There's not really been much discussion of that. There's some discussion to maximum employment but I think there's still more room for discussion there that I wish we could have had at this conference. 

Beckworth: And that is why we have Employ America. Am I right? 

Bell: That's right. 

Beckworth: All right. Well, our time is up. Our guests today have been Sam Bell and Skanda Amarnath. Gentlemen, thank you for coming on the show. 

Bell: Thank you for having us. 

Amarnath: Thank you for having us. 

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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David Beckworth
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Jun 17, 2019
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A Macro Musings Transcript