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Andy Levin on Federal Reserve Reform
As the Fed’s role in the economy continues to change, reforms to its governance structure are needed now more than ever.
Andrew Levin is a professor of economics at Dartmouth College who previously served two decades as an economist at the Federal Reserve Board, and as an advisor in the research department at the International Monetary Fund. Andy has also had extensive experience with many other central banks including the European Central Bank, the Bank of Canada, and the Bank of Japan. Andy joins David on Macro Musings to discuss his experiences at the Fed and the need for more accountability. His ideas include increasing transparency, setting term limits, and fostering diversity of thought and background among its members.
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 [email protected].
David Beckworth: Andy, welcome to the show.
Andy Levin: Well, it's great to talk with you.
Beckworth: I want to begin by asking, how did you get into macroeconomics?
Levin: Well, actually John Taylor was my advisor in graduate school at Stanford and he really inspired me. I took his course my very first year as a PhD student and I worked with him as a research assistant a couple years later and he encouraged me to turn that into a dissertation. And I guess you would say the rest is history.
Beckworth: And you guys have done research together since then, is that correct?
Levin: Yeah. In fact, it was really an honor for me. Of course, every student dreams of someday writing a paper with their advisor. We wrote a paper about the Great Inflation, sort of what went wrong with monetary policy in the 1960s and '70s and pointed to some specific issues we can talk about now if you want but the main thing is it was really great to work with him.
Beckworth: Yes. I think I actually went to an American Economic Association meeting where you presented that paper and I believe Alan Blinder presented another paper at that same panel. And he told the supply shock story, you guys told the monetary policy story, and then the third paper were some Germans who got up there and showed what happened in Germany and I think that kind of clinched it for me. Germany did not have the Great Inflation we had so it couldn't be a supply shock story. Fascinating paper though, I read it. So I think that's the first time I saw you up front presenting as well. So John Taylor was your professor and from there where did you go? Straight into the Federal Reserve?
Levin: Well, let me just say that some of the themes that appear in John's seminal work have also ended up being themes in my own research and my thinking and even my work as an advisor at the Fed which is monetary policy can effectively stabilize inflation over time. So it's important for the Central Bank to have a clear inflation objective and to communicate that and to keep inflation expectations firmly anchored. Taylor's seminal work emphasized that monetary policy can affect the real economy and that there's in some cases trade offs between the stability of output growth and employment relative to the variability of inflation. And so with a sensible monetary policy strategy would systematically aim toward a balance of those objectives. And what went wrong in the Great Inflation was that the Fed didn't have a clear inflation goal and expectations just drifted upward with no real force to end it. So I was assistant professor at the University of California in San Diego for a couple years.
Levin: It's a beautiful place to live but I felt a little bit removed particularly from public policy. My intent of becoming economist was to try to help do something useful. And so it felt a little bit too much like an ivory tower. I also felt like everything I knew at that point was out of lecture, notes, and textbooks. I really hadn't had any real world experience. So I had an opportunity to go on leave to the Federal Reserve Board in D.C. Initially, it was one year then it turned into two years and I found it really fascinating and ended up deciding to stay longer. I always had the idea that someday I would go back to the academic world but I had certainly didn't realize in '92 that I would end up being at the Fed for more or less 20 years.
Beckworth: Well, tell us what it's like working at the Fed. So when you wake up in the morning, what does the typical Fed economist do? Do you get up, do you read the FT, the Wall Street Journal? What happens to a typical Fed economist?
Levin: Well, you have to imagine that I'm a pretty old guy. So in 1992, our source of news in the morning was news cables that were literally came out over a wire and were printed on a teleprinter and then cut with scissors. They made Xerox copies and then distributed them around to economists at the board. So this obviously pre-internet and really even pre email. So the idea of reading the FT online on my iPhone wasn't something we dreamed of in 1992. I worked for about eight years in the International Finance Division at the Board, that was a period that included the Mexico crisis and the Asia crisis. I worked a lot on trying to think about emerging market economies as well as advanced economies like the U.S. and Japan and Europe. That was a period where Europe was forming into the European Monetary Union so there were a lot of interesting global questions.
Levin: In the early 2000s, I moved over to the Monetary Affairs Department and started working more specifically on U.S. monetary policy strategy and communications. As I mentioned earlier, thinking about having a specific inflation goal, which at the time the Fed had been steering away from, and the benefits that that could have in anchoring inflation expectations, that was some of the research I did at the time. Another part of my research was looking at simple policy rules of the sort that John Taylor really pioneered and the extent of which those could be helpful in a world of uncertainty, where we don't know the true structure dynamics of the economy, having a simple rule of thumb that could be helpful guideposts for monetary policy.
Beckworth: Did you use that when you were advising the chairman at the Fed? Did you bring that perspective to bear on different issues?
Levin: So in 2010, I was actually starting to think about ... I'd been at the Fed at that point for almost 20 years and think about I was ready to do something new. And Chairman Bernanke asked me to stay for a couple extra years as an advisor in the Office of Board Members partly because he wanted to have more diversity of views or more active debates rather than just hearing one viewpoint from the staff. I think that, as I've heard from colleagues, has become more and more part of the culture at the Fed now that there is a lot of active discussion and range of views from different staff. But one of the opportunities that I had when I became an advisor was that Chairman Bernanke asked Janet Yellen to head a new subcommittee to help improve the Fed's communications to the public on monetary policy. And Vice Chair Yellen asked me to assist her with that work. So I was the lead staff person assisting her subcommittee.
Levin: And that subcommittee did a bunch of really important steps. One was recommending that the Chair start giving quarterly press conferences, which have been continuing ever since.
Beckworth: We can thank you for that, huh?
Levin: Well, no, I wouldn't say that. What I would say is that it was remarkable that the whole committee, all of the members of the FOMC were supportive of it.
Levin: Even presidents who sometimes dissented, like Charlie Plosser and Jeff Blacker, thought it would be helpful for the discussion after an FOMC meeting to start by hearing first from the Chair. That the Chair's job is to present the rationale for the committee's decision and to explain the strategy. And then later presidents and others can come out and give their own points of view but using the Chair's remarks as a benchmark. And they all thought that that would be a really helpful step forward and I think it has been.
Beckworth: Okay. So you did that for a couple of years, that position where you were the special advisor to the Chair and the Vice Chair.
Levin: Let me say one more thing about it.
Levin: There was several accomplishments. One of them was that the FOMC established an inflation goal in January 2012, they've reaffirmed it every year since then, a specific inflation goal of two percent measured by the PNC price index. I think Chairman Bernanke has talked about that as an important part of his legacy. Certainly, I think Vice Chair Yellen was proud of the fact that they were able to accomplish that and I was proud of the fact that I worked behind the scenes in helping to develop the materials that helped make that happen.
Beckworth: Well, let me-
Levin: Another step forward they took was they had been producing macro forecasts for many, many years going back to the late 1970s, forecasts for unemployment, inflation, and GDP growth. Those projections had always been under each person's assessment of appropriate monetary policy but they had never revealed what those assessments were. I kind of viewed it as the ‘just trust me’ approach because you give some very nice projections for inflation around employment but you don't tell people what monetary policy is going to be needed to accomplish it. Ultimately, Ben Bernanke and Janet Yellen and others on the committee were very strongly in favor of becoming more transparent. And so in late 2011, they decided to start presenting the projections for the Federal Funds Rate, what's now called the dot plot.
Levin: And I actually was the one who designed the dot plot.
Beckworth: Oh wow.
Levin: Of course, under their oversight. We knew at the time that it was imperfect. We can talk more about the imperfections but I think it was certainly a step forward in transparency away from the just trust me to at least say, "Here's the policy assumptions that the committee participants are making when they make their forecasts for inflation and GDP growth."
Beckworth: Oh, very interesting. Those were fun times to be there and you sound like you had a good time, good experience, left your mark. So let's go ahead and talk about the dot plots and the press conferences. So you mentioned the press conferences accomplishment in your mind, do you ever hear this criticism though that sometimes it leads to more confusion or there's mixed signals that come out of press conferences? So what do you say to comments like that?
Evaluating the Fed’s Press Conferences
Levin: Well, okay, the first thing is they need to start having press conferences after every meeting.
Levin: That's what the ECB does, that's what the Bank of Japan does. It would just make sense. I mean, for example, tomorrow there will be a press conference but they're meeting again in early November and there won't be a press conference, which means that in principle they could make a significant decision in November but it would be harder. They'd have to call a last minute press conference, which could be disruptive or just not have a press conference which could be even more confusing. And so I think at the time that the Fed decided to start having quarterly press conferences, I certainly had in mind that that was a stepping stone to having them after every meeting. And I hope they will start to do that soon.
Beckworth: Now, do you think it'd be helpful if just Janet Yellen gave speeches? So maybe every press conference she gives speeches? Do you think it creates confusion when some of the regional presidents go out and give different conflicting signals to what the Chair is saying?
Levin: Absolutely not. I think that it's critical to the public that these decisions are made by a committee of diverse people.
Levin: In fact, I think the committee ideally would be even more diverse than it is but certainly having a diverse committee, it's the same kind of confidence that we have in the Supreme Court. The decisions that the Fed makes affect all of us. Its decisions affect mortgage rates for homeowners, it affects credit card rates, it affects auto loan rates, it affects the levels of employment, levels of inflation, the value of the dollar. And so it's critical that these decisions be carefully thought through and as sensible as possible and you can't hand that over to a single person. It's much better, certainly the standard practice around the world now is to have a monetary policy committee made up of diverse people who have individual opinions. So that's not the problem. The problem is to explain more clearly the Fed's strategy. Just like the Supreme Court issues an opinion, a majority opinion explains decision. I think what the Fed needs to start doing is to issue a majority opinion that gives a clear, coherent explanation of their decisions, not a boilerplate statement of a few hundred words that are mostly vague, but a clear, coherent explanation.
Beckworth: Like a quarterly report or like the Bank of England does where they spell out why they did and what they did and maybe even account for past mistakes? Scott Sumner has this interesting idea. He goes, "The Federal Reserve will acknowledge its mistakes in the Great Depression but it won't acknowledge any recent mistakes, have no soul searching," and he would like to see some kind of quarterly report just as an assessment, their own internal looking back, what could we have done differently, and that's what you're suggesting here?
Levin: I think that this is something where the Fed could do it voluntarily. It may be the case that it has to be legislative by Congress to require it. I think that it would be appropriate certainly as a reporting requirement for Congress to ask the Fed to produce these reports. But the key point is that you would have a majority opinion, you can have concurring opinions which is people who broadly agree with the decision but maybe have some specific points that they disagree about and then you have dissenting opinions, which are people who have fundamentally different views about the appropriate policy. And the report should present all of that information to the public, that will increase the public's confidence that the decision was carefully considered.
Beckworth: Okay. One last question before we move on to some of the reforms, we've touched on them already here in our conversation. But you have a pretty thorough proposal filled with reforms but I want to ask you one last thing about your time at the Fed. And that is, what was it like working through the Crisis 2008, 2009? It must've been very intense, many nights without sleep. What was it like to be a Fed official during that time?
Life at the Fed During the Crisis
Levin: It's funny you ask that because actually I wasn't at the firing line during the Crisis itself.
Levin: I was in the Department of Monetary Affairs. My job was helping write speeches and congressional testimony, it was writing the minutes of FOMC meetings and preparing the materials for the FOMC. But we were not the ones who were up late at night on a weekend deciding how to prevent collapse of the financial markets. That's really a different group and a narrow group really. I think those decisions, many of them had to be made on very short notice and only involved a very few people.
Beckworth: I guess you saw a sense of stress that you hadn't seen before, a level of intensity. So any perspectives you want to share for what it was like to be inside that building during that time?
Levin: Well, I will say that I still have a lot of regret that I feel like the Federal Reserve and other agencies in other institutions missed the boat. You were asking about lessons learned and they're not just the Great Depression. When I saw the book, “The Big Short,” it's very clear in that book that there were people in financial markets in 2005 and 2006 and 2007 who could see these risks. And the extent to which those risks were downplayed by officials, government officials, and the Fed itself was way too complacent all the way up through the onset of the crisis itself. By the way, if you have a moment, take a look at the minutes and transcript from the September 2008 FOMC meeting. That meeting took place on a Tuesday two days after Lehman went bankrupt. So it was 48 hours after Lehman announced that they were going bankrupt. And you look at the transcript of that meeting, there's no discussion at all of the possibility that we might be heading over the brink.
Levin: The Fed's official statement indicated that there would be a temporary slowdown in economic growth with a pick up again a few quarters later. There was no discussion around the table of the possibility of a recession even until the very end of the meeting in Chairman Bernanke's closing remarks he mentioned that we might already be in a recession, which of course turned out he was exactly right. But the extent to which the Fed wasn't sufficiently alert at that time, there's an important lesson there, we can't let that happen again. We have to do everything we possibly can. Maybe there would've been things that could've happened in 2006 or 2007 that would've, if not prevented the crisis, at least mitigated it so that it wouldn't have been so severe.
Beckworth: I share that view entirely. I think the Fed fell asleep at the wheel for much of 2008 until the very end and they couldn't avoid seeing the catastrophe unfolding. And I have looked at that September FOMC release. If you look at just the release itself, they say they're just as concerned about inflation as they are about the economy. And I actually, for this interview, I printed out the August FOMC minutes and it's striking. I'm going to read just a few excerpts here from it and a couple paragraphs from the August 2008 FOMC meeting and it says, "Participants expressed significant concern about the upside risk to inflation, especially the risk that persistently high, heavily inflation could roll in an un-mooring of long-run inflation expectations." I'll skip down here. "The number of participants worried about the possibility that core inflation might fail to moderate next year unless the stance the monetary policy was tightened sooner than currently anticipated by financial markets." Then I'm going to skip down to the very last part. It says, "Although members generally anticipated that the next policy move would be a tightening," and it goes on.
Beckworth: So in August, they were so worked up about inflation and many of them thought that the next meeting would be a rate hike. And I think that's evidence in the market, I know you've done work on break evens, inflation expectations, and if you look at those from about mid-2008, they're falling. They're falling down. The market was well aware something wasn't right. Fed Funds Futures, I've looked at those 12 months ahead, they were signaling the Fed wanted to tighten. So it's interesting to see this and my question to you would be, was the Fed overly concerned about inflation during that time? And if so, why?
Levin: Well, okay, we touched on a few different issues here.
Levin: One thing I want to start with is that when the statement's released at the end of the FOMC meeting, and it's brief. People always wonder, "Well, maybe behind closed doors people were much more concerned that the economy was sliding into a financial crisis but they just didn't want to say that because they didn't want to alarm the public." So what's important to me is that the Federal Reserve releases its transcripts after a few years and you can see from the transcript of the September 2008 meeting that they were not even concerned behind closed doors. They were just oblivious and they here, as the Federal Reserve officials and staff, were oblivious to the fact that the economy was heading over a cliff. Okay. So that's point one.
Levin: Point two is that I think that good policymaking involves scenario analysis and risk management.
Levin: So I think that ... I don't have an issue with the fact that they were concerned about the possibility that inflation could stay high and that inflation expectations could eventually become dislodged. I think that was certainly a plausible risk in mid-2008. The problem isn't that they identified that risk. The problem is that they were oblivious to the glaring risk, which they could've heard about from almost anyone in financial markets by mid-2008, which is the risk that risk premium were going to widen dramatically and that the economy was going to slow dramatically and that we were going to go into a crisis.
Levin: And so then if you did risk management and you say, "Look, here's scenario A, inflation goes up and long-run inflation expectations start to drift upward. And here's risk B, which is we go into a financial crisis in the next two or three months." Then they could have an intelligent discussion of the magnitude of those risks and what's the appropriate policy that balances those risks. And I think your instinct is right that at that time the sensible policy would have recognized that the risk of a dramatic slowdown was far more severe than the risk of inflation becoming unanchored on the high side.
Beckworth: Well, it's interesting because in those statements, and I haven't looked closely at the transcripts, I have looked at the minutes and the statements, and they often focus on the headline number. They're looking at the number that came out for the past month or for the most current period as opposed to looking at the break evens, forward looking. What is the bond market saying? What are asset prices saying? Those were screaming, "We're going over a cliff." But I know Fed officials do, they say they look at all these different indicators but it seems to me, and maybe I'm wrong here, that they weren't paying enough attention to what like the bond market was saying, what spreads were saying. Were they just hung up in a different way of thinking, an old way of thinking? Why not look at asset prices in real time to get a better sense of where our things are going?
Levin: Okay. So let's start with the narrow question and then we'll get to the broader question. The narrow question is that the index bond market was a pretty new market. It was only introduced in the early 2000s and it wasn't very liquid until around 2003, 2004, 2005. So one part of the answer to your question here is that in 2008 those break evens are moving but I think policymakers and staff wondered how much of that might be just liquidity or tactical factors. And that's maybe why they were putting somewhat less weight on it.
Beckworth: Let me ask you this question.
Levin: But the broader part of the answer to your question is that those break evens were a signal that market participants were worried about severe downside risks. And you don't need the break evens per se, you just go out on the street and talk to people.
Levin: And not just people in Wall Street, people in Main Street, were getting increasingly concerned that something's going wrong here. And as people become more concerned and more cautious, that creates a downward spiral. And so the fact that they missed the boat, as you said earlier, isn't just how much they should or shouldn't have been looking at break evens. The fundamental problem with the Fed, and it's true with many central banks and many other organizations, it's too insular, it's too inbred, there's too much group think. And people all come from a similar viewpoint and they easily persuade themselves that they're smarter than everyone else. And so traditionally, the Fed has been very dismissive of financial markets on many occasions. We could talk about other occasions but many occasions where Federal Reserve officials and staff have said, "Well, the financial markets are just a bunch of sheep and they need a shepherd and we're the shepherd and we just need to educate these investors. They're worried over nothing."
Levin: And I think that was part of the problem in 2005, '06, '07, and '08 was the Fed felt like the markets were dramatically overreacting and that what would happen is that everything would just calm down and everything would be fine.
Beckworth: All right. Well, that provides a nice segue into your proposed reforms for the Fed. And we can go online and look this up and we'll have it on our web page with the podcast but the proposal's called “A People's Fed: to serve the public interests, the Federal Reserve must become fully public, here's how.” And you go through and list some problems and some solutions, some of them we've touched on. But let's work our way through these problems you've identified. I'll list them out and you comment on them and then eventually we'll get to the solutions. So the first problem you have listed is the Fed is controlled by commercial and Wall Street banks. So speak to that.
The Fed Shouldn’t Have Private Owners
Levin: Okay. So literally there are 12 regional Federal Reserve banks. Each Federal Reserve bank has a board of directors. The Federal Reserve banks are private institutions owned by commercial banks. Those commercial banks get to choose six of the nine members of the board of directors. So when we say they're controlled by the banks, it's literally true. The banks own the Federal Reserve banks and the bankers get to choose six of the nine directors of the Federal Reserve banks. Now that approach, I think, made perfectly good sense 100 years ago because at that time the 12 regional Federal Reserve banks mostly served the banks. They were called the bankers to the banks. They lent money to the banks, they took in deposits from the banks, they did cash management and check clearing operations. We were under the gold standard so there wasn't really an active national monetary policy at that time.
Levin: Again, the Federal Reserve banks were essentially serving the bankers and so the fact that the bankers owned them and controlled their boards of directors was perfectly fine. But now we're in a different world, we're in a world where the Federal Reserve sets monetary policy that affects everyone. As I told you before, it totally affects all of us, car loan rates, mortgage rates, credit card rates, savings rates, exchange rates. And every other major central bank around the world is a fully public organization now. The Fed is the only one left that still looks the way it did 100 years ago.
Beckworth: Now during the crisis, there was a lot of criticism of the New York Fed and I'm wondering if this criticism that you're bringing up would apply to what happened during that time because Tim Geithner kind of spearheaded the bailout of some of the firms on Wall Street, one of them being AIG, the massive bailout that was taking place there and later was disclosed that the creditors of AIG got 100 cents on the dollar. And lo and behold, some of the creditors were the big banks on Wall Street, Goldman Sachs for example. And so there was this outcry, you're bailing out the very people who sit on your board, there's got to be a conflict of interest there. So was this part of the reason for the proposal you brought up? Is this what we saw in 2008?
Levin: Well, I think that are certainly these kinds of potential conflicts of interest. And so having an independent board of directors is a fundamental principle of good governance of every organization. And in many ways, the way to explain my proposal is that it's just trying to bring good governance principles to the Fed.
Beckworth: Okay. Your next proposal is to change the way that Fed officials are chosen, it's opaque, it's filled with conflicts of interest. So how would you change that process?
Reforming the Appointment Process for Fed Officials
Levin: Well, so the critical thing here is that particularly the Federal Reserve Bank president, let's just focus on them for the moment, those are the people who sit on the FOMC on a rotating basis they vote on the nation's monetary policy. These are key officials. I think they should be public officials. They shouldn't be CEOs of private institutions. They should be public officials. Now one approach to that, which some people have suggested, is to have each of them be appointed by the President of the United States and confirmed by the Senate. I think that approach has some drawbacks we could talk about. One reason I think it's difficult for it to move forward in Congress is because it would centralize the Fed more in Washington, D.C.
Levin: One of the strengths of the current Federal Reserve system is it's really a regional system where the regional Federal Reserve banks are centered in their regions. And so my proposal tries to preserve that characteristic. So I think the key thing is to have the presidents of the regional Federal Reserve banks be public officials who are selected through an open process within their region. We could talk about the details of that, I think there are different ways you could do it, but the key point is it should be a transparent, open process within the region that the Federal Reserve bank serves.
Beckworth: So you want to keep the 12 regional banks as is? There's been some proposals to shrink that, to realign them, but you're okay with the current 12 regional bank setup?
Levin: I think that there have been proposals to have a centennial commission that would look at the number of Federal Reserve banks and the district lines. I think that would be totally fine. I think that isn't part of my proposal, I think I actually mention it at the end. It's kind of a footnote at the bottom of the page that I can see a strong case for doing that. I just didn't see it as at the heart of the governance problems of the Fed. It's more of an efficiency question. Could you do with 8 or 10 or 7 instead of 12? Would you adjust the district lines so Utah's in the center district instead of the Pacific district? Those are certainly questions that a commission could look at and make recommendations about.
Beckworth: Your objective is to keep the diverse of views within the decision making process? So you want to continue having some regional representation when monetary policy decisions are made?
Beckworth: Okay. Along those lines, your next proposal is to get minority communities more involved to have a voice inside the Fed. So, tell us about that.
Increasing Diversity at the Fed
Levin: Well, the problem is that it's just a horrible problem really that there has never been in a hundred years with 12 Federal Reserve banks, over a hundred years, there's never been a single president of a Federal Reserve bank has been African American, there's never been a single president who's been Hispanic. I think to many people who look at that and hear about it, it sounds like a private club. It doesn't sound like a public institution in our modern world. Now, I think that by making the Fed transparent, by making the process fully public, by allowing grassroots organizations to have input into the process that would change. The exact number of people from which demographic group and which region, of course, just like in Congress and just like in the Supreme Court, it's going to evolve over time. But there's certainly room for improvement in the diversity of Federal Reserve officials from the 12 regional Feds.
Beckworth: But to be clear, you're not arguing here that monetary policy can fix some of the structural problems within minority communities, just give them a voice in the process of doing it?
Levin: Okay. So to rephrase your question.
Levin: You asked me why does diversity matter in decision-making and the answer is because you bring in different points of view, you question assumptions, you strengthen the process, and you strengthen the credibility of the process that all of us have a stake in this and we want to be sure that these different points of view are represented. So if you ask me why should the Federal Reserve be more diverse, the answer is because it'll be a better process that better serves the public.
Beckworth: This goes back to your whole governance point with transparency, diversity, you don't want group think which you mentioned earlier was the key problem 2008, 2009 when things unfolded, diversity of view would've made a big difference. Your last one, I think we really touched on it already is the Fed is shielded from public oversight and you want it to be more like any other government organization as well as the employees becoming truly federal employees. Tell us how that would happen.
Levin: Okay. I just want to mention that you skipped over one that's worth at least mentioning briefly which is to every Federal Reserve official should have a single, nonrenewable term of seven years.
Term Limits for Fed Officials
Levin: And the reason that's important is to insulate the Fed from political interference. This is a basic governance principle. Most other major central banks in the world have moved in this direction. The president of the ECB has a seven year term. The governor of the Bank of England has a seven year term. The governor of the Bank of Canada has a seven year term. The idea is to insulate the central banks decisions from political interference by giving the head of the central bank and other central bank officials long enough terms so that they're not part of the political cycle.
Levin: The central bank needs to be accountable to the public and to elected officials but not subject to political interference. And so there's a balance here which my proposal is trying to achieve of good governance which is no micromanagement. That's one part of good governance. But on the other side, accountability and transparency. If you want to have your boss trust you, then you got to communicate to your boss. And the Feds' boss is the public and the Congress. And so the last part of the proposal, which you mentioned, is for the Federal Reserve to become much more transparent and accountable. It should have regular annual reviews by the government accountability office just like other government agencies. The whole Federal Reserve system should be subject to the Freedom of Information Act. The role of the Inspector General needs to be strengthened. These are all key, sensible ways of strengthening the Fed's governance and accountability.
Beckworth: So how well has this been received by Fed officials and by other public officials?
Levin: Let me just say that I didn't expect that this proposal was going to change the world. I'm more realistic than that. I hope it's been a constructive contribution to this debate. It's an important debate. The Fed is a crucial, public institution. And so making sure that the Fed is effective as it can be, then strengthening the public's confidence in the Fed, these are really important goals that we should all be striving for. And so I hope that that proposal, as I say, is a constructive contribution to the debate. I view it as sensible and pragmatic and nonpartisan, I would defend that characterization. I don't think any of these elements I proposed are fundamentally progressive or conservative or Republican or Democrat. These are good governance and accountability for an important public agency.
Beckworth: Well, I would love to see them discussed in the presidential debates but I don't have my hopes set too high. But I think you're right. These would be great questions to consider moving forward. And I like your idea of having these regular reports that would allow the Fed to be introspective, to look back and to question, "What did we do right? What did we do wrong?"
Levin: So, David, let me just add something here.
Levin: Okay. So what I wanted to say is that what I would really like to see happen is next year there's an intelligent, carefully considered debate about how to reform the Fed in a sensible, pragmatic, nonpartisan way. And I think that this should attract members of Congress from both sides of the aisle because the Fed is such an important institution. And it could involve conservative think tanks like Mercatus and AEI and Cato as well as some progressive think tanks and progressive organizations. There should be a meeting of minds to try to think about how to move this forward. The problem is the Fed itself is very inertial and the Fed is perfectly happy with the status quo.
Levin: So you're never going to get Fed officials probably to be speaking aggressively in favor of any kinds of significant changes. And so if the significant changes are going to happen, they're going to have to happen coming from outside the Fed. And so again, I think you and your listeners can think about this and come up with some creative ways to move this from the level of just purely academic to what could be a real reform that could actually become into law.
Beckworth: That's a great idea and I'm hopeful we can do that maybe after the Presidential election settles down, as you suggest. But maybe, who knows, maybe we might see some discussion in the presidential race but we don't have much time left and we haven't seen much. All right. Let's move on to some of your research. We have some time left to go over that and I want to look at your research that you've done on the anchoring of inflation expectations. You've had several articles in great journals and you went around and looked at different countries, they're track record, who's been successful, who's been the quickest. Can you speak to that and tell us what you learned?
Anchoring Inflation Expectations in Monetary Policy
Levin: Sure. I think I alluded to this earlier that it's been found very helpful for the central bank to have a clear inflation goal. It uses as a centerpiece of its decision making and its communications to the public. Most central banks around the world have now done that. The Fed was one of the later ones. In 2012, the Fed had adopted a two percent inflation goal. Now I don't think the inflation goal can be or should be set in stone eternally. It's a technical decision what's the appropriate level for the inflation goal. I really like the Bank of Canada's approach.
Levin: The Bank of Canada has a process every five years they go through a systematic renewal of their framework in consultation with the government and consultation with academic economists and consultation with market participants and members of the public to ask, "Do we have the right framework? What kinds of changes could be helpful?" And I think it would be great if the Federal Reserve could kind of move on to that sort of systematic reconsideration of its framework rather than lurching suddenly or getting frozen in stone as we learn more about the world and how it works, the potential for improvement.
Beckworth: Now recently, John Williams, the San Francisco Fed had a talk or a note he's put out and I think it was along those lines. He suggested we should reconsider how we do things. Let's look at higher inflation target, let's look at nominal GDP targeting, let's evaluate what we're doing and see if there's ways to improve it. I assume you found that very refreshing to see.
Levin: Yeah, right. And I think that the Fed as an institution could do that and could do it in consultation with Congress and with the public. It shouldn't be done as an insular exercise, it should be done as an open exercise, and it should be done on a regularly scheduled basis.
Beckworth: Okay. Now you mentioned the importance of an inflation target for helping anchor inflation expectations and the role that's played in your research documents that well. What has been going on though in the past six, seven years? If you look in the U.S., the Fed seems to have consistently undershot its inflation target. Now I know the target only begins in 2012 but implicitly they've been targeting two percent, there's been some research that suggests that. And if you look at core PCE inflation, it's averaged about one and a half percent. So are they purposely missing or is there something that's preventing them from hitting a consistent two percent target? What are your thoughts?
Levin: Well, it's interesting because in some way this is also related to the work that John Taylor and I did on the Great Inflation. One of the things that we found is we were reviewing what went wrong was that in the '60s and '70s, the Fed’s decisions were too reliant on forecasts. And at that time they were essentially staff forecasts of the economy. At that time, the problem was that the Feds staffed the green book was persistently overoptimistic that inflation was going to come down. It was too high but the bottom line of the staff outlook was, "Don't worry, this is just temporary. We don't really need to change monetary policy. We don't need to change the strategy. The inflation pressures are going to subside and inflation will fall on its own." And so you might say that the last five years is sort of a mirror image of that because consistently the forecasts that have been feeding into the Fed's policy process have been too optimistic that inflation's going to pick up toward the target without a change in strategy and obviously in retrospect that was what's wrong.
Beckworth: So did they need a new target or just be more aggressive with the target they have? What would you recommend?
Levin: Well, I think that a change they've started to make in the last year is to downplay the forecasts in the decision making process and put more weight on outcomes. And of course the irony here is that that's exactly what the Taylor rule does. The Taylor rule doesn't place weight on a specific model of the economy or a forecast of the economy, it places weight on what's actually happening outside the window in terms of output and inflation. We could talk about variants of the Taylor rule and what their merits and disadvantages are but my point is that in Europe where there's a lot of uncertainty about the dynamics of the economy, the structure of the economy. That is a time when it makes a lot of sense to put more weight on outcomes and less on forecasts.
Beckworth: Okay. In Europe there's a similar issue, they've also persistently undershot their target. Now, their target's a little more vague. It's near two percent or so. But they've been even worse in terms of the inflation rate they've delivered. Would you say it's the same explanation for them?
Levin: Well, not completely.
Levin: But it's related. I think the problem is that once monetary policy is pressed, once the short-term interest rates fall close to zero, it becomes much more difficult for monetary policy to influence the economy and to influence the inflation rate. The central bank has to start to resort to other tools like large scale asset purchases or moving to negative interest rates, trying to provide for guidance but those tools are much less well understood and probably not as effective as the conventional monetary policy adjustments. And so I think a part of the problem that European central bank has been facing for the last few years and the Bank of Japan is they have a clear inflation goal, it's not that easy to push inflation up to the goal because the tools they have at their disposal aren't quite as powerful as they wish they were.
Levin: Now, what's the lesson for the U.S.? It's that that's a very serious risk. It means that an average shock that pushes the U.S. economy down and pushes U.S. inflation down further could be a shock that it's pretty hard to offset. So that means there's a stronger case for waiting longer, let inflation go up to two or even a bit above two before you really start to hit the brakes because you recognize that if you make a mistake in one direction it's easy to fix and if you make a mistake in the other direction it could be a real problem.
Beckworth: Okay. So the notion of a symmetric inflation target, which you just alluded to, you allow or you tolerate overshoots as long as on average. The whole idea of a flexible inflation target is over the medium term you hit your target, right? And it just seems from casual observation that many of the advanced economy central banks aren't doing that, they seem to be much more of a rigid inflation targeting and it's just been interesting, maybe frustrating to watch. This past year, the Fed raised its interest rate a quarter percent in December and there's talk of them wanting to do it again. And you mentioned maybe allowing inflation to drift a little bit over two percent, some overshoot, but they don't seem to be willing to do that. What would you recommend they do going forward? Allow some overshoots or try something different?
Levin: When we talk about many of these other countries including Switzerland and the European central bank and the Bank of Japan, the Bank of England, they're all in a situation where inflation's below their target and they're having trouble pushing inflation up to the target. It's not that they have a one-sided target, they just have limitations on the tools, the efficacy of the tools that they're using. So that's a little different situation than the U.S. where, as you said, the Fed has been actively pursuing a policy of tightening the stance of interest rates even though inflation's still been persistently below the target. And I think that approach is a lot harder to explain.
Beckworth: Okay. Well let's move on to some of your other work. You've worked with some other individuals, one of your colleagues there, Danny Blanchflower also Chris Pirsig, and you've looked at the amount of slack in the economy also what explains the decline in labor force participation rates and it kind of gets at this debate we've had over the past seven, eight years whether the slowdown is cyclical or is it structural in nature. So where would you place this now? Are we close to full employment or are we a ways off still? And of course that answer would help inform monetary policy and what it should do.
Current State of the Economy
Levin: Okay. So start with the big picture. We talked about the importance of diversity in decision making and the dangers of group think. A problem in macro is that the standard model is one where the unemployment rate is all that you need to worry about. The unemployment rate encapsulates the slack in the labor market. When Chris Pirsig and I started doing our research a few years ago, it seemed clear to us that that could be very misleading, that you could have a falling unemployment rate even though there's a lot of workers who are working part-time who want a full-time job which is certainly slack as these are people who are already in the workforce and want a full-time job. They're searching for a full-time job and they can't find one. That should be counted.
Levin: And there are people who are on the sidelines, they've dropped out of the workforce, they would be working during normal times and they're not working. And these are people say they're 20's, 30's, 40 years old in good health, who aren't home with small children, who aren't in school, they're not disabled that if the economy was doing well, these people would be in the workforce. And so the point of the paper that Chris Pirsig and I wrote was that that's an important part of the total shortfall in employment and it's an important thing that monetary policy should be considering. I think at the time, I can't speak for Chris, but I'll say for myself, I felt like we were kind of lone voices in the wilderness that all the Feds official statements and official analysis was framed in terms of the unemployment rate. Now little by little, thanks to lots of other academics and media correspondence, the recognition that labor force participation's too low for prime age workers and that the part-time employment's too high, I think, has certainly become a much bigger part of the debate in the last several years.
Levin: Now if you ask me where are we today, the answer is we've made a lot of progress. The measures that I constructed of the total employment gap have come down dramatically over the last few years. That's great news for American workers but we're not done. The estimates I have is that there's still equivalent of about two million full-time jobs shortfall relative to maximum employment. And so as I said earlier in the program, if you think about the fact that inflation's falling short of its target and employment is falling short of the maximum sustainable level, then both of those argue for maintaining the current stance of monetary policy rather than trying to tighten it.
Beckworth: Okay. On that happy note, we have to end. Our guest today has been Andy Levin. Andy, thank you so much for being on this show.
Levin: Great talking with you.