Charlie Evans on the Past, Present, and Future of U.S. Monetary Policy

Charles Evans was a 31-year veteran of the Federal Reserve System, serving as a researcher, vice president, and, ultimately, president and CEO of the Chicago Fed from 2007 to 2023. Charles joins Macro Musings to talk about his past and ongoing work on US monetary policy. Specifically, Charles and David discuss his work as a regional bank president and a member of the FOMC, the creation and adoption of the Evans rule, the current path of R-star, the future of the Fed’s framework, and more.

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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: Charlie, welcome to the show.

Charles Evans: Thanks, David. It's great to be here.

Beckworth: Well, it is a real delight for me to have you on the show to talk about your work at the Chicago Fed, the FOMC, your current thinking on the Fed's framework, recent debates over R-star, and of course, the famous Evans rule. I'd be remiss if I did not bring up the Evans rule when talking to Charlie Evans. Let's begin, though, and talk about your career at the Fed. You've had quite the run. You were the president and CEO from 2007 to 2023, but before that you were also a vice president and a researcher at the Chicago Fed. How long have you been at the Fed in total?

Evans: Sure. I spent 31 years at the Fed. I went to graduate school at Carnegie Mellon, I taught at the University of South Carolina on the economics faculty for three years, and I got a call from my advisor, Marty Eichenbaum, who had moved to Northwestern University and he was going into the Chicago Fed as a consultant. Mark Watson was there and a bunch of other people, and I talked to them when I was on the market. So I moved to Chicago in 1991 as an economist in the research department. The value proposition was, instead of teach and do research, it was do policy analysis and research. Since my policy interests were for monetary policy, it was a really good fit.

Beckworth: So, Charlie, when I first became aware of you, it was through your work with Larry Christiano and Martin Eichenbaum, which you just brought up. You have this famous paper, or series of papers, and they call it the Christiano-Eichenbaum-Evans Framework, back in the '90s, where you did a number of VARs and you were identifying monetary policy shocks. It's neat to hear this connection, the Chicago Fed with Marty. Maybe for our listeners who aren't as old as I am, talk us through those papers, because as a grad student, in my time series class, we looked at those papers, we replicated those papers, but they were important at the time. Tell us why.

The Importance of the Christiano-Eichenbaum-Evans Framework

Evans: Sure, absolutely. Let me back up just a little bit and mention, when I was in graduate school and I worked with Marty Eichenbaum, he was on my dissertation committee, Ben McCallum was the chair of my dissertation committee, and they were really influential in helping me become a monetary economist, not just a macroeconomist but a monetary economist. In the '80s, I got to Carnegie Mellon in 1983, and all the rage in macroeconomics at that time was real business cycle theory. Finn Kydland was on the faculty there with Ed Prescott, they had written "Time to Build."

Evans: Working with models where economic fluctuations were caused by productivity shocks and monetary policy really had no role to play in stabilizing the economy. It was just really challenging, interesting. The techniques were fascinating, and it really got everybody studying economics as their interest. What got my attention in thinking about policy was most of the evaluation of those real models was in terms of second moment properties, highly filtered with the Hodrick–Prescott filter, and so you'd compare one good model against another by how they matched some lead-lag relationships, but it didn't give you policy experiments, readily.

Evans: And time series and vector autoregressions did that, and it got closer to something more like maximum likelihood estimation at some level and the full scope of the data. And so I was interested in time series analysis. It's also the case that Marty Eichenbaum and Ken Singleton wrote a paper for-- I don't know if it was the first NBER macro conference or the second one, but it was basically finding a role for money in a Granger causal sense, depending on how you filtered data, which Sims and others and Sargent had done things like that, but that became interesting.

Evans: So, one of the things I did at that time was, Ed Prescott had his Carnegie-Rochester paper from '86 where he took a measure of technology and that was reaffirming RBC models. I took that measure and just regressed it on a whole bunch of stuff and found that money and government spending and things like that had effects, significant statistical effects on that. And so that led to broadening out the models, allowing for labor hoarding and other factors. And then as you built in nominal rigidities and things like that, it just opened up a whole bunch of possibilities for policy evaluation.

Evans: So, what Marty and Larry and I were doing, and other people were doing that too, Ben Bernanke and Alan Blinder, but we were looking at fed funds and how that, in a VAR, kicked off changes in the US, economic activity, and inflation. One of the big things that we started off was the VAR with funds rate shocks had a problem in that you'd tighten policy and inflation would go up. There would be this price puzzle. That was indicative of not enough variables in the information set that the monetary authority was probably looking at. And so we started including commodity prices, and that helped clean up that type of process. That led to a bunch of features for the economy that an elaborate model of the economy should fit, the impulse responses. We worked on that for quite a while.

Beckworth: You mentioned Ben Bernanke and Alan Blinder's paper. They had a famous paper that really helped establish the federal funds rate as this target for the Fed, but I think your work did as well, that we just talked about. I think it's also interesting that it’s around the same time John Taylor's seminal paper on the Taylor rule comes out. You see this coalescing in the early to mid '90s of the federal funds rate as a target rate, and then the Taylor rule emerges, but it all comes together. They're all interrelated during that period.

Evans: They're definitely connected. They're definitely getting at the same issues. The issue about short-term interest rates and what they meant… I've forgotten the details, but Chris Sims had a 1983 paper in the AER: Papers and Proceedings where he had an interest rate shock, and he, at that time, said, "Well, this doesn't look monetary." I think that was one of the takeaways there. And so bubbling through all of this is trying to find out how to measure monetary policy, money. Money didn't seem to work very well with all of the financial innovations. That's why the Bernanke-Blinder [paper], I think, really more solidified interest rates in doing that.

Evans: The Taylor rule paper is interesting. I know you hosted a fabulous conference for Ben McCallum's legacy, his history. He was my dissertation chair. I remember going to the Carnegie-Rochester conference after Marty, Larry, and I had started doing this VAR stuff. I think I made some interventions from the audience. I think Rich Clarida had a paper and he said, "Well, it's not surprising to me that you need to have a lot of variables in an international VAR to get sensible results." And Ben McCallum, in his typical fashion, got up and he said, "Well, John Taylor was at this conference just last year and he said you really only need two variables to capture what the Fed has done, an output gap and inflation." I'm just kind of like, "That's too simplistic." I hadn't seen the paper.

Evans: When you look at it, Taylor's paper, there's a lot of assumptions. It detrended GDP in order to get the output gap. It had a long period and it said, well, the gap between inflation and the Fed's target, which he took to be 2%, and this was in the early '80s, and I go, "There's no way that was what the Fed's target was, there." But when you do all of that, it caught the runup in the funds rate in the late '80s, and then the coming down, quite well, but it left behind all kinds of errors that were serially correlated. That's the kind of thing that you need in a VAR. It's definitely the case that there were lots of benefits to pursuing a Taylor rule policy reaction function as you brought this analysis into models. Because in a model, you need something that is sensible from a Fed reaction function, but it's also manageable. And so a Taylor rule with an output gap and an inflation gap, and a few lags or something, it's much more amenable than a six variable VAR with four lags and all of that, right?

Beckworth: Yes. The big takeaway, at least for me, is that it may seem strange to people today, but going back into that early '90s period, it was still being debated, what is the instrument of monetary policy? What should we use? People were still looking at money, as you mentioned, and all of your work, the Bernanke-Blinder work, and Taylor, they're all helping the profession solidify on an interest rate instrument. So, a fascinating history of thought for monetary policy, and you were a part of that. That's a nice segue into the actual practice of monetary policy. You worked at the Chicago Fed for a number of years, as you mentioned, and you became president in 2007 and you left in 2023. You made sure to be there just long enough to experience the great financial crisis and COVID, as well. You were there for some very interesting times, but I want to talk to you about your work as a president. Walk us through, what is it like to be a president, to run a big regional bank? Some of us, like myself, might imagine you sit around and think about monetary policy and do lots of data analysis, but we know it's much more than that. Walk us through all the responsibilities and challenges you face as a president.

Life as a Regional Bank President and as a Member of the FOMC

Evans: Sure. I had an advantage because I spent 15 years with the bank as an economist. Working in the research department, we would brief the president of the bank, first Silas Keene and then Michael Moskow. From the monetary policy standpoint, I had a good idea about how you want to have a talented research staff, you want to have them-- So recruiting a good research staff is an important part of making a Fed president effective, getting good advice. And so with the Chicago Fed, Dan Sullivan joined the bank a year after I did, he's a terrific labor economist, and he sort of helped out a lot with the micro-side structure of the economy.

Evans: I think that's sort of standard practice now in banks, that you just have a broad research staff. And so having people who can help advise you on monetary policy, that's an important part of it. There's a large bank supervision area in most reserve banks. Everybody has a supervision area, but in Chicago we had really a robust portfolio of banks from small community banks—we have a very large number in Iowa, Illinois, throughout the district— medium size regional banks, had a number there, and a couple of large banks, not the larger money center banks, but large banks. And so, the kind of supervision that takes place in Chicago goes from relatively straightforward community banking to the much more complicated aspects of that, plus after Dodd-Frank you have the central clearing parties, the CME Exchange and the Options Clearing Exchange, and also ICE Clear Credit. There's a backup supervisory authority where people are looking at that. So there's supervision, there's talent there, and trying to figure out how you interact with everybody else in the Federal Reserve System and other regulators.

Evans: There's also the payment side. When I got there, there were paper checks that were being cleared, being moved around the country in planes to all these check processing centers. We got rid of that. It's digitized. Some people write checks, but not that many anymore. Now the Fed is involved in FedNow, a real-time, settlement payment system. It's a very interesting portfolio of responsibilities. You've got a large staff, you've got all of the back office, you've got the human resources, leadership development for that. And so, coming into a Federal Reserve Bank, if you are coming in from the outside and you think, "Well, I'm just doing monetary policy, going to the FOMC," it is much more than that. Then it's got the added complexity of, there are 12 banks. There have been efficiencies over the over 100 years that the Fed has been there. There used to be independent fiefdoms where you did everything, but now the banks work together. Some reserve banks do back office activities on behalf of the entire Federal Reserve System. And so, it’s an interesting and rich environment in which to be an executive officer.

Beckworth: Let’s talk about what you did at the FOMC. You were one of the members there. Was it 15 years or 16 years in the FOMC?

Evans: 15 years.

Beckworth: 15 years. Again, I remember Jerome Powell, when you left, gave some words and he said you were the longest-serving member of the FOMC. So your tenure there, lots of institutional wisdom, experience to bring to bear. What was it like preparing and participating on the FOMC?

Evans: Yes, it was very interesting. We would get the staff together, you'd be paying attention to how the economy is going, you'd have your own experts advising us, advising me. We'd get together, we'd get a lot of briefing materials from the Board of Governors in Washington. You'd get a Tealbook forecast and other materials there. We had a lot to look at, bounce ideas off staff. My staff was really good. I feel like they were not shy about telling me, "I'm not so sure, Charlie. I'm not sure I would do that. Maybe we should think about that." Every now and then I'd pull rank and just say, "Well, no, this is what we're doing," and all of that. That's the nature of the job.

Evans: It was very interesting to take advantage of the business and community contacts that we had in our five-state district, talking to CEOs of corporations and business people, and trying to get the lay of the land, what they were experiencing on the ground, more of a Main Street feel. We talked to bankers, too, of course, and matching that against the national public data, and at some level, anecdotal data, there's a lot of anecdotal data. It doesn't always add up to what the national is, and there's a lot of twists and turns. But every now and then you see things at an earlier level and it seems to be masked in the national data. I think the current period is one where the Fed is sort of looking for signs of a little more easing in the economy, slowing down after very strong third quarter GDP growth. And so this is a point in time where things like the Beige Book and other information could say, “maybe we need to be a little more careful. I can see things where risk management would play.” So we would do all of that and then you would go to Washington and you'd have a meeting and those would be very exciting, too.

Beckworth: So if there were any big changes coming up, such as, say, QE3, was there a lot of negotiating or discussing it before you actually got to the meeting? I imagine you want to support the chair, and often that's the case. If there were any objections, would you discuss it before you got there so that when you got there it was a more efficient meeting?

Evans: Yes, there was a lead up to the meeting. Sometimes it would be the case that it takes a few meetings to come to a decision, too. So, maybe you have conversations with people in Washington between meetings, or maybe it's just a continuation of two or three meetings. I would say in the Greenspan era it was probably more of that type of trajectory where-- I remember Janet Yellen, not long after she took over in San Francisco as president, and somebody asking her, because she'd been on the Board of Governors as governor in the '90s, and she said, "Janet, was there ever a time where you said something at a meeting with Alan Greenspan where it made him change what he was thinking about doing?" My memory of her answering was, "Oh, no. No, not at a meeting, but you could say things which, with a little bit of time over the next meeting or two, would get integrated and could change the trajectory." 

Evans: I think in the Greenspan era, it was more of that. He was very confident in his views. I would say that under Bernanke, he was much more consultative. And they got to the point where they do regular phone calls ahead of the FOMC meeting just to hear what everybody is talking about. I would say on the big issues, there's an awful lot of staff work, which often is Washington and New York, but can also include other Reserve Bank participants, in putting memos together and large junctures. Going into the late '90s and 2000, it's hard to remember now, but the U.S. was running a budget surplus. There was this entire initiative devoted to, maybe we should understand how to do monetary policy when there's not a lot of debt out there. What if we don't have sufficient Treasuries? And they started looking at, well, you can buy agency debt because it's got the imprimatur of the government. It's okay for us to do that, Sallie Mae and things like that.

Evans: Of course, that was never necessary, but those earlier studies did help provide background for later, under the great financial crisis, when we started doing agency debt purchasing and mortgage-backed securities and all of that. So when you get into 2008, after Lehman Brothers, that was a very exciting time period because-- well, because everything was happening, but trying to find a bottom for how things were playing out. And I talked to a large number of companies at that time, and they were just having trouble-- they couldn't get access to their commercial paper. They couldn't get access to funds to make their payroll.

Evans: There was an FDIC program, which was the Temporary Liquidity Guarantee Program or something like that. That provided help for anybody who had access to a bank or a thrift, and there were certain commercial companies that actually had a thrift embedded in their operations. All of a sudden, they were fine. Then you talked to a competitor, and they didn't have that, and they weren't fine. Then the TARP money was able to provide the first loss cushion so that the Fed could do the commercial paper facility. That was what really broke things open, I mean, helped settle things down in the fall of 2008. And so, I think TARP was very important, the role of the FDIC and all of that, and all of the purchases that we did. There was background for how you might go about doing some of that from earlier time periods, plus all of the work and all of the liquidity programs that the Bernanke Fed was doing.

Beckworth: Let's talk a bit more about some of the big events during your tenure there at the FOMC from 2007 to 2023. Unfortunately, we don't have time to go through all of them, but I'll pick a few here that I'll throw at you. Let's start with the really big change in the way the Fed actually does monetary policy. 2008, we hit the zero lower bound, so we have to begin using the balance sheet, large-scale asset purchases. That was a big change. That inevitably led, ultimately, also to the change in the operating system itself, from a scarce reserve corridor to an ample reserve or floor system. Let's start with the big change from a very modest-sized balance sheet to a very large one, and one that's continued to grow over the decade that followed. Was that jarring for you, or did it make a lot of sense at the time? Did it grow on you? What was your experience with that transition?

Experiencing the Growth of the Fed’s Balance Sheet

Evans: I think that was jarring for mostly everyone. It certainly was the case that you had the experience of Japan and you had Ben Bernanke's expertise as well from when he was a governor and the research that he did before. He gave a speech in Japan in 2003 where he basically said, "Geez, you guys should be doing more." They were doing QE, and it was like, you should be doing a lot more QE. That whole idea was already in people's minds, and people were doing research on if you're going to do asset purchasing-- I remember Auerbach and Obstfeld having a paper and it was on Japan, and it was, well, if you're going to do this open market operation, how long do you hold on to this on your balance sheet is really important, because if you go up, and then you come down, then everybody's going to look at how you unwound that and it's not going to be as powerful. And so there were a whole bunch of issues floating through that. 

Evans: By the time you got to March 2009, and as you say, we're at the effective lower bound, the unemployment rate is going up, up and you can't quite see when it's going to stop and you needed more accommodation. You needed fiscal policy, which they provided some. The FOMC decided to do a very large QE1 program, 1.25 trillion dollars of MBS, additional agency debt and 300 billion of Treasuries, so it was large. That's jarring, and we certainly weren't in a scarce reserves environment. And so there were a lot of discussions after that. Critics were going, "Oh, my gosh, we're going to get double digit inflation from all of this money growth." There were a lot of debates about how to see that play out. That was very interesting, very jarring. It was way premature to start thinking about, “how do we bring this down?” That entire topic floated into later years where it's like, “are we going to be more accommodative? Are we going to start being restrictive in what's appropriate for the economy?” That was a big challenge.

Beckworth: It was a big change for a lot of central banks. The Fed wasn't the only one who went to the large balance sheets and the floor system. It seems like it happened around the advanced economy world. Alright, let's talk also about another big change that happened during this time, and that's the Evans rule. Taylor has a Taylor rule, you’ve got the Evans rule named after you. This is a nice tie-in back to what we were discussing earlier about getting the FOMC to talk about a topic or an issue. I'm curious, how did the Evans rule percolate into the FOMC? Then we know in December, I believe, 2012, it was official. Just to be clear, correct me if I'm wrong, if I have my facts wrong here, but the idea was that the FOMC would hold rates at 0% until unemployment fell below 6.5% or inflation was above 2.5%. That was something you had articulated in speeches and talks before then. Walk us through, I guess, the process of getting everyone to support that idea at the FOMC.

The Evans Rule and its Adoption

Evans: Yes, sure. Let me provide a little bit more of context. I just mentioned earlier that the Fed did QE1. That takes place in 2009. Ben Bernanke, in the spring of 2009, says, "Oh, I see green shoots. Maybe this is good." You had high unemployment, you had a cratering economy. You're going to see it start to go up, even when it's got a big output gap. At any rate, by the time we got to the beginning of 2010, there was some expectation that the economy would be doing much better. Then it turned out by mid-2010, "Oh, no, this isn't going to work out very well." Inflation was low, the economy wasn't doing well enough. Ultimately, in 2010, the Fed embarked on QE2, buying an additional $600 billion of Treasuries.

Evans: You get into 2011, and it's like, we repeat the same process. "Oh, it looks like 2011 is going to be better," even to the point where by June of 2011, the FOMC articulated a set of exit principles. I mentioned earlier, we increased the balance sheet. Now, it's like, how do we take the balance sheet back down when we close all of this out? Turns out that was exceedingly premature, because just a couple of weeks after the minutes came out, it became clear, that first half of the year got revised, it wasn't as good. We really got more of a challenge.

Evans: By August of 2011, the FOMC ended up deciding, "Oh, gee, we'd stopped reinvesting maturing proceeds. We need to provide more accommodation." One thing that the committee agreed to do is to begin reinvesting maturing proceeds. Then there were three dissents at the August 2011 meeting. Things were happening very quickly. It was a one-day meeting, there really wasn't enough time to talk about everything that had to be done at that point. There was a suggestion at the meeting that, “well, maybe we should just go minimally this meeting, then at the next meeting we'll clean this up.”

Evans: I know that I objected to that. I said, "No, no we need to do more," and the committee ultimately decided, “yes, we indicated with calendar guidance that we expect the funds rate's going to stay at this level until mid-2013.” All of a sudden, you get the calendar coming into play, and three dissents on that calendar date guidance isn't very helpful. At that meeting, the board staff forecast was that unemployment's at 8% and we just don't see it getting better within the appropriate timeframe, and that was the context. After that meeting, I went back, talked to my staff, and the problem is, markets keep thinking we're going to raise the funds rate.

Evans: We just did exit principles, markets keep pricing in a higher funds rate, so what we're doing isn't having the same effect. Within a couple of weeks, before the next meeting, by Labor Day, I was going out and doing speeches where I said, "We need to provide guidance to markets and it should be state contingent." I don't think I said it quite that way, but it was sort of like, "Look, unemployment's high. We ought to tell them that we're certainly not going to raise the funds rate before unemployment goes below 6.5%," which was expected to be quite a long time, but of course, what I always said was, "I could be wrong." Maybe I got this wrong. If inflation were to go up to 2.5%, well, okay, alright, then we should be careful about that.

Evans: Those were the thresholds for the four-- Actually, when I first started, I was much more modest. I said 7% unemployment, and I did say 3% inflation because I thought that was just not very likely. By the time we actually got the committee to adopt this in December of 2012, we sharpened it, and it was 6.5 and 2.5. But I spent a year, from September 2011 until the fall of 2012, just pounding the table. "We really need more accommodation," and we had to go through 2012 where, oh, yes, it looks like the economy is still not doing very well. We ended up doing open-ended QE3, which was exceedingly helpful, and then in December we added the threshold forward guidance, the so-called Evans rule.

Beckworth: So there was deliberation over that, a year from when you first started talking about it. At FOMC meetings, would you bring it up? Would you just do one-on-one meetings, try to convince your colleagues to go this path?

Evans: Yes, I would routinely say, "We're not providing enough accommodation." What did we do in 2011? In 2011, the governors had been up to Capitol Hill and testifying. It's in the transcripts, you can read it. They would say, "I'm tired of being beaten over the head and shoulders over our asset purchases," because QE2 and QE1, we kept buying assets, and so the Fed was able to do this. We're not going to buy assets but we're going to change the maturity structure. We're going to sell the short maturity and buy long maturity, the size of the balance sheet will be the same, but the duration will be extended, and that's where all the payoff was supposed to be.

Evans: We were able to do that into, almost the fall of 2012. By the time you get into 2012, you realize, oh, the economy is not really doing as well. In January of 2012, the Fed stated, explicitly, that the inflation objective was 2% on the personal consumption expenditure index. By April, the chair, Ben, is having to answer questions. "Well, you guys said you're going after 2%. It doesn't look like you're going to get there, so what are you going to do?" In a press conference, and that's a hard question to answer, speaking for the committee, and the committee had not decided what they were going to do.

Evans: I remember Binyamin Appelbaum asking him very pointedly, and I think Krugman had a very critical piece before, that which was reminding Ben that, “In 2003, you told the Bank of Japan that they needed to do more when inflation wasn't doing what they wanted it to do. Why aren't you doing that?” It's like, well, it's a little harder when you're actually having to do that. Binyamin asked a very pointed question, and he could point to the SEPs, because that's where you could see, from the Summary of Economic Projections, that the committee did not have an inflation outlook that was consistent with this new goal, at least over a period that people thought was relevant. At some point, I'm watching the press conference, and he is giving an explanation, and then at some point he goes, "Well Charlie Evans has an interesting thought about forward guidance,” and I'm just kind of like, "What?” Well, I mean, periodically you get these, "Oh, well, we do think about those things." Then you go to the next meeting and, "Yeah, we're not ready for anything like that. No."

Beckworth: But it kind of put it on the map. If someone didn't already know about the Evans rule, that mention was pivotal, because if the chair's thinking about it, markets need to think about it. Correct?

Evans: That's right.

Beckworth: I want to use that as a segue to think about some observations that people have had about the natural rate of unemployment and R-star during this period, so roughly 2008 to 2019, and if you look at the FOMC’s own long-run projections via the Summary of Economic Projections for the median federal funds rate or the median unemployment rate, it slowly moves down over time. Critics might say [that it’s] to catch up with reality, and to the extent those forecasts— again, I know those are conditional forecasts, conditioned on appropriate monetary policy, but given those forecasts turn out to be correct, was the Fed inadvertently a little too tight during this time, just because they didn't know what the true level of R-star was or U-star was?

Evans: Yes, I think that's right. So, R-star is a very technical way of trying to describe whether or not monetary policy is restrictive or not Wicksellian idea that the interest rate might be 5%, but it might still be accommodative if inflation's very high and all of that. If you weren't so inclined to be thinking in terms of an R-star type of concept, it still came down to, did you think the setting of monetary policy was really accommodative and you would be able to get inflation up to its objective? That's why the exchange between Binyamin Appelbaum and Bernanke, and just anybody, it's kind of like, “well, you're at zero but that's not really enough.” Maybe you need, whatever, an asset purchase… we’ve done a lot. We ended up doing open-ended QE3, so it was a lot more, but there were a lot of people who were going, “quantitative easing just isn't going to do as much as you think.” So we had lots of debates there.

Evans: It certainly was the case that when we thought that the natural rate-- Anybody who thought that the natural rate of unemployment was 6% wouldn't get as exercised at a 6.5% unemployment rate, whereas you thought it was 4 or 5, you would. So we had discussions about that, if that was the nature of the disagreement. But I would say that we were struggling to find a sufficiently accommodative monetary policy all the way until we finished closing out QE3. The trigger for that was, continue buying assets until the outlook for employment is better.

Beckworth: That's a fascinating decade, to think how R-star came down and we were catching up to that reality. I want to use that as a transition to where we are today. You recently gave a presentation at the Chicago Booth Conference in London. It's a conference on the global economy and financial stability. Your talk was titled, *R-star and Restrictive Monetary Policy.* It touches on the issue that's been highly debated of, where is R-star today? Has it gone up? Has there been this jump because of things that have happened during the pandemic, because of possible sustained larger future primary deficits? A number of issues have come up. Where do you think we are headed or where do you think R-star is? Maybe start with that.

The Current and Future Path of R-Star

Evans: It's a great question, and my task for that small conference was much more modest, which is, tell us a little bit about how people are thinking about R-star. One thing that I did was just to collect different estimates from Laubach-Williams, Laubach-Williams-Holston, [inaudible], and you get a range anywhere from like half a percent to 2, 2.2%. There's a lot of variability in some of these. The time-varying parameter VAR measure from the Richmond Fed is going to vary a little bit more, perhaps. Then, you can look at what markets are pricing out the yield curve five to 10 years on the real rate that should be providing information on that. There's a lot of uncertainty, so I also thought it was interesting, coincidentally, that the current funds rate target is about, on the low end, it's five and a quarter. I remembered that, in 2006, when the peak of the funds rate… it was at five and a quarter. And the question is like, how do you know that five and a quarter is restrictive? 

Evans: It's the same idea, is there an underlying real rate which tells me, yes, this is substantial enough to restrict the trajectory of the economy and bring inflation down as the FOMC in 2006 was wanting to do. But, you have to think about your outlook, your forecast. And so at that time, there was an early version of an R-star, which the board staff had produced, which is like a setting of the funds rate, which if maintained for three years, would close the output gap. That's basically that idea. It indicated that five and a quarter looked like it was restrictive. I also went back to May of 2000, where they did not have an R-star measure because of different analysis and things like that evolved over time. Again, do they see inflation coming down or not?

Evans: They actually saw inflation perhaps still going up with some uncertainty, but they, in May of 2000, ended up with six and a half percent on the funds rate, and they didn't increase the funds rate after that. And so It's just always hard to know if the rate that you're at now is sufficiently at peak so that it can bring down inflation. In the current environment, that's the nature of the question. Then it's like, most recessions come about because there's some shock that you never anticipated, right? So it could be the time where you have tight monetary policy, and boom, then something happens. So in 1990, '91, monetary policy was coming down, but still had been restrictive, and then the Iraq invasion, the first time, and consumers stopped spending. You had a shock that led to that. It ends up being quite a complicated calculation. You're undoubtedly going to be wrong if only because the nature of the exercise is, this is the setting that should achieve the appropriate landing if nothing else happens afterwards, and then something always happens afterwards. That's the nature of the complaints.

Beckworth: I guess, for me, the interesting part of this conversation is to think what will happen in the future since we really don't know where R-star is headed. Everything from the stance of policy, to how much debt is sustainable for the U.S. government, these all hinge on this idea. Going back and looking at where R-star had been, and it fell relatively sharply in 2008. It was a sudden fall to its low level. You mentioned the Laubach-Williams-Holston measure, it's still relatively stable, even going through the pandemic. But alternative measures show it jumping up high, so there's been this jarring drop in 2008 and then a sudden jarring spike, according to some measures today. That just seems very destabilizing or just very sudden.

Evans: Right. There's definitely a lot of uncertainty there. The nature of those calculations varies from one analysis to another as to whether or not it depends more on where inflation is going and closing that gap, or whether or not it's the output gap that's being closed and the nature of what structural output is. I think the question is, where is a neutral setting of the funds rate in the real economy? Where real interest rates are going to head over the next many years is important and very difficult. One fundamental I keep coming back to is that, the estimate of trend growth in the US is much lower now than it used to be, certainly in the 80s, right? Most estimates of trend growth in the U.S., for GDP, is on the order of one and three-quarters percent.

Evans: In the 80s, we enjoyed about three and a quarter percent growth when the economy was expanding. Growth is something that smooths out a lot of difficulties in terms of debt and things like that. In the 80s, it's interesting to go back to that, because that was the productivity slowdown. Growth was strong because the labor force was expanding, baby boomers were coming into the workforce, and women as well. Now, you look at this, and we've got the aging of the population, we've got labor force issues, and we have restrictive immigration policies as well, which is another way to sort of help out with the aging of the population, if you were to do that.

Evans: So, one and three-quarters percent growth comes from something like one and a quarter, one and a half for productivity growth, which is pretty good, actually. You would like higher productivity growth, but the productivity slowdown is less than that, and about three-tenths of a percent on labor input. That's not likely to change. So that anchoring for R-star is still there. Now, you're right, a lot of government debt, there's a lot of debt. So, to the extent that investors demand more compensation in order to fund that, that's going to increase real interest rates, and so that's going to be a compounding effect. That could change depending on different natures of risk appetite for investment, but there's a lot of competing influences there. But, I think that the aging of the population, and concerns about productivity growth, continue to weigh towards lower R-star than higher R-star.

Beckworth: Okay, let's move on to something near and dear to my heart, and that is the Fed's framework review, which will be happening '24-'25, [in the] next two years. You were a part of the original one, 2019-2020. I want to read an excerpt from a paper that you've written that speaks to this issue. The title of this paper is, *Implications for the Federal Reserve's Monetary Policy Framework in the Future.* I'm going to start at the beginning because you bring up an event that was also part of your experience, and that is the 2012 adoption of an explicit inflation target. You state, after talking about it over 10 years later, that's after the adoption of the official target, "Over 10 years later, it is difficult to overstate the importance of the explicit 2% commitment within the larger strategy statements." Then, later in the paper, you call it the North Star for anchoring inflation expectations. What was so important about making it explicit? You also note that it was implicitly there before that point. Why was it so important to make it explicit?

The Importance of an Explicit Inflation Target

Evans: Well, certainly, at the time that Ben Bernanke marshaled the FOMC to make a more explicit declaration of what the inflation goal was, prior to that, Alan Greenspan had preferred some vaguer definition, not explicit, not numerical, which was low and stable inflation that doesn't work its way into households and businesses' decision making, but they just know that inflation is going to be fine. That is basically what you would like. You would like that inflation variability doesn't influence and get in the confounding way of how resources are allocated and how households make decisions. It's just the case that with volatility… and just look at the current period where you have all these supply shocks, which all of a sudden lead to higher inflation, relative prices… and when does it become inflation? Well, if monetary policy is overly accommodative.

Evans: And so during the Greenspan era, it was possible to say, “inflation is too high and we want it to come down.” But once inflation got to the point where, “oh, there are downside risks to inflation,” in 2003, they sort of said that. It's like, well, then if inflation went up, what if it went up to 4%? You might go, “well, maybe they've given up on that commitment.” I think, during the period that Greenspan was in charge, it was entirely appropriate, and it worked out. But it was, in my opinion, easy to see, you could get to a point where there'd be tremendous benefit for being very clear that 2% is the objective. Then, that helps the committee think about making decisions for that. For markets, there's always a discussion about, do you want a point estimate or do you want a range? Gosh, you can't fine-tune, right? One and a half percent inflation, is that really so bad when you're going for two?

Evans: I would say, well, yes, if it were symmetric and every now and then we got to two and a half, but when we're always at one and a half, you begin to think that 2% is a lid, and you're not going to go above that. So, I think that as soon as you get into a discussion about, what are you guys actually trying to achieve, you need to be a little bit more explicit. And so 2%, that's the number that's been selected, pretty much globally. You can make that work. I think symmetry is very important, and making sure that whatever you're doing, inflation expectations are anchored. That seems to be the big payoff in terms of the most recent experience where, golly, CPI went up to 9%. The PCE was over 6%. A lot of people were going, “we're back to the 70s, we'll never get it down again.” But it turns out, longer-term inflation expectations were anchored, and it looks as if the supply effects are now rolling off and inflation is coming down without unemployment going up to what a lot of people thought it would have to, like 6% or higher, so a long transitory effect of those supply shocks. So, I think inflationary expectations are really important, and the Fed's policy is making sure that they were anchored.

Beckworth: So, in some small part, the explicit announcement back in 2012 is having an effect today in helping bring inflation down. There are supply-side shocks being worked through, the Fed's doing its part. But just having that explicit target, you're arguing, is important to the disinflation we've seen.

Evans: I think that's right, and I think that's monetary policy in the 21st century around the world, too, right? Other central banks are doing the same thing, and for the other central banks that struggled a little bit… the ECB had 0 to 2% initially, then they said under two, but close to two, and since then, they also talked a little bit more about symmetry.

Beckworth: So, in 2016, the inflation target is updated or amended to be symmetric and have language in the statement that says it's symmetric, because there was undershooting. In 2020, we get FAIT. Walk us through that change. How do you view it? What role has it played over the past few years?

The Fed’s Transition to FAIT and its Significance

Evans: I think that was a very ambitious adoption, to update the strategy. I think taking account of the fact that a long enough period of underrunning your inflation expectation could give rise to unhankering inflation expectations going down. During the previous years, we would see periods where TIPS market breakeven expectations would sort of move down, and the FOMC statement would reflect that, periodically. I would constantly sort of say that we need to update that, and a lot of times that was like, we've already got that in there. We don't want to continue to make a big deal about that. It's just very difficult to get inflation up during that time-period, and so I think Jay Powell and the committee, through all the discussions that we had, and the Fed Listens and the flagship conference in Chicago, I think we got to a point where I thought it was good, which was, we're going to try to average inflation over 2%.

Evans: And if you've got a significant period of time where you've been underrunning, you should contemplate. It should be okay to overshoot. One of the things that makes me worry that a 2% inflation objective is actually a ceiling, is when you're constantly talking about, we're going to get inflation up to 2%, and you don't talk about overshooting. Sometimes the best way to get to 2% is to aim higher, recognizing that something's going to happen and we don't actually get there, so anything that helps get the committee in a mindset where it's okay to overshoot. Central bankers are conservative by nature, right? “I've always thought it was okay to overshoot,” someone might say, “yes, sure, 2.1, 2.2, but 2.5, oh my gosh, that's really hard.” So I think that mindset seems to be-- That's a very vague way of saying things. I think that it's useful. And the flexible average inflation targeting, as expressed in the statement, was really very conservative. It said to moderately overshoot. You can find commentary from policymakers at the time where it's like, “oh, 2.3% might make me nervous, and so moderate was never 3%.” And so it was always something closer to two and a half or less.

Beckworth: So the two elements that made FAIT distinct, and to be clear, FAIT is flexible average inflation targeting from the previous flexible inflation targeting without the average part in there, is that it would make up policy from below 2%. Its sustained departure below would make up for that, as you mentioned. Then also, it had a change in the wording about deviations from maximum employment, which now became shortfalls from maximum employment. What role, if any, did this have, do you think, in the Fed falling behind the curve, as some like to call it? I know, and I agree with you, but I know you make the point that a lot of the high inflation was due to supply shocks, sticky prices, other things. To the extent the Fed did play a role, was the FAIT framework responsible in any degree for it?

Did FAIT Cause the Fed to Fall Behind the Curve?

Evans: I think that the flexible average inflation targeting framework, definitely, and the implementation of it in the September 2020 forward guidance, that's really-- In the strategy document, it talks about how you should contemplate overshooting. It's the 2020 statement that said, “here's how we're going to do it. We're not going to raise the funds rate until employment's consistent with maximum employment, inflation's at 2%, and then expected to be sustainably there and overshoot a bit.” That was a robust implementation of the strategy. Jay Powell said that publicly, and it certainly contributed to the delay in tightening monetary policy, especially with all of the quantitative easing that we continued to do, in 2020 and '21.

Evans: Now, I would say that the expectation from the previous year's experience was that, even with the Biden ARP fiscal stimulus, which was very large, that with a flat Phillips curve, you were still expecting inflation to gradually increase as the economy was pushed to an even lower unemployment rate, more vibrant labor market. And so you were expecting that you would see a slow progression, that it wouldn't just lurch up in that regard. So you were sort of expecting inflation to come through the front door with the Phillips curve. Then, you get to the spring of 2021, and you’ve got so many of the supply disruptions from the reopening of the economy as it continued to roll out the fact that consumers, households, really preferred goods more than before because you couldn't enjoy in-person services.

Evans: And so there were a lot of capacity constraints, and semiconductor chips and used car prices went up, 10%, 7% and 10% in three months, that's monthly, not annualized. And so, inflation is coming in the back door through relative price increases. It's very large, and you're certainly nervous as a policymaker. It's like, well, supply shocks, look through the first round and see how it gets into the second round. But then that first round is enormous, and you get into the summer and it starts coming down, and it's like, okay, it looks like goods, and it's coming up. Then you get to September and the fall, and no, this is really something. So yes, I would definitely say that the implementation of flexible average inflation targeting delayed the increase, and you're at the effective lower bound. The first 100 basis points of increases is still accommodation, in a large sense. You're just trying to move from less accommodation.

Evans: And so, it was challenging. It was challenging, I think, for the Fed to confidently recognize that inflation was really moving up in a big, sustainable way from supply shocks… Probably, the emphasis on maximum employment, so long, contributed to that. I think the playbook from asset purchases, the winding down through tapering, it would have been very difficult to sort of change that quickly. I mean, they could have. I was there during that period, but it was challenging. Then, eventually, the Fed got to the right spot. I think one thing that helped out was the aggressive response in 2022, though.

Beckworth: So, you mentioned looking through supply-side shocks or supply-side effects on inflation, at least the first round. That's like standard fare for central bankers, right? We worry about excess inflation created by demand pressures, look through the supply-side because we don't want to add any more damage to the economy. If we have a negative supply shock, like COVID, no point in adding further harm to the economy. But it was interesting to see Jay Powell, in a recent speech, throw a little bit of cold water on that thinking. He mentioned several things, but one thing he noted is that, maybe we need to be a little more careful next time, going forward, before we dismiss these big supply-side changes in inflation moving forward. With that in mind, what do you think might happen with this framework review coming up in 2024, 2025? Are they going to tweak FAIT, make it more symmetric? Any changes you foresee happening?

The Future of the FAIT Framework

Evans: I think that's a great question, and I think they've got a lot to talk about. Certainly, the Fed has received a lot of feedback, criticism on the long delay in raising rates, the flexible average inflation targeting as it was implemented. Maybe that wasn't such a good idea, right? There are a lot of people who didn't like it at the outset because it tended to… I mean, you could say it took preemptive monetary policy off the table. That's probably stronger than was true, but it certainly made it harder to do. You have to have faith in an inflation outlook where things are rising. So, to the extent that the committee can look at supply-ish type shocks that lead to increases in relative prices— broad-based increases in prices are clear, right? You know how to deal with that.

Evans: But, the fact that used car prices go up, right? Shelter goes up, but other things… Part of the problem is if they're relative prices, your problem is other prices don't go down, right? In microeconomics, when you teach it, right, it's like, sure, relative prices go up, and that's what clears the market. At a macro level, it's like, yes, but that whole entire index, did those other prices go down? What's the numeraire good, and all of that? The fact that you've got sticky prices is another way that it can find its way into inflation. You have to think about, is this going to be longer-lasting? I think the committee either has to think that they can get better at identifying that, “these are the supply shocks that are going to be more problematic, and these are the ones that aren't,” or they're going to be very conservative and just go, “oof, I'm going to have to be restrictive whenever I see a relative price shock.”

Evans: But that's going to lead to lower inflation when you do that. It's going to lead to less vibrant labor market conditions. And so I think that, in the current situation, again, anchored inflation expectations have been huge. The fact that the Powell FOMC was willing to pivot and do four 75 basis point increases in a row and make up for the delay, you might argue, you could argue, that where policy ended up in 2022 at the end of the year is not that different from where it might have been if you started earlier. It still would have been more restrictive if you started earlier, but they made up a lot of ground. It could be the case that you say, if we're doing flexible average inflation targeting, I think it's going to be slow coming through the front door, and then I find it coming through the back door.

Evans: I've got a threshold where it's like, okay, if inflation, in three months, goes up by three and a half percent, something's wrong, and you sort of backtrack on that, and you make that known to people. And so maybe you could have started earlier if you had something like that, some idea that, you want to provide confidence to the public that we're going to keep policy so that we can get inflation to where it ought to be. But, if things go in a different direction, we could be wrong and we'll pivot. That's a hard task. That's a hard task because you start stepping on your message. 

Beckworth: Messaging is key to 21st century monetary policy for sure. So, two things: one, I hope the Fed does not drop the makeup policy ball. I hope they continue to have some form of that in their framework, because I think that's key, is the lessons we learned from Japan in the past decade, some kind of level targeting or makeup policy, the strong forward guidance is key. The second-

Evans: Your own research is on that point, right?

Beckworth: Yes. That leads me to my last comment, and then I'll give you the final word here. This concern about supply-side driven inflation, in my view, can be best addressed through something like nominal GDP targeting, because if supply-side inflation, output and inflation typically go in the opposite direction, it's a negative shock, real GDP goes down, inflation goes up, and vice versa. What we're concerned about is demand-driven inflation, broad-based. I know we still have the sticky price problems you mentioned, but it strikes me as a much easier task simply to focus on total demand. Where is it going? Keep it on a stable growth path.

Beckworth: Eventually, over the medium term, you'll still get stable inflation. I know Michael Woodford, when he argued for nominal GDP targeting, he goes, “look, we're still effectively arguing for a medium-run inflation target when we're doing nominal GDP targeting.” But I know there's challenges with nominal GDP targeting, and I know there's, for some, a perceived communication challenge with it. So, I have to ask you, Charlie, is there any possibility that the Fed, the FOMC, will discuss nominal GDP targeting as a solution to some of these questions?

Is There a Future for Nominal GDP Targeting at the Fed?

Evans: I was right with you until you said solution. Will they discuss it? Yes, I think they will. I think they discuss all kinds of things, and I think, in the current environment, given what we've just gone through, an obvious takeaway, I think, is, you probably need to look at a whole bunch of different indicators of inflationary pressures than you did before. It's hard to imagine that they don't look at everything, so I guess it comes down to putting more weight on certain indicators, and realizing that the historical distribution of shocks, where you thought that these supply disruptions couldn't possibly last two or three years, actually, maybe they can. Very unusual, right? COVID, it's sort of like a wartime situation where you tell GM they've got to start making tanks and not cars, and then they can go get back to cars and things like that, but paying attention to that.

Evans: Nominal GDP targeting holds open that possibility that it just, more broadly, gets at the issues where supply is having one effect, and demand… they could be offsetting, in which case you wouldn't pay as much attention to it from the funds rate setting, or maybe it does. So, I think, trying to figure out how to use very good targeting indicators and how they would— you might adopt them or how you would consider them in altering the trajectory of your policy. I really prefer outcome-based solutions where a monetary policy is outcome-based. The instrument-based targets, like the Taylor rule, they provide you a guide, R-star and all of that, they provide you a guide towards whether or not policy is restrictive or not, but it doesn't tell you, “oh, yes, but, that intercept term is now so much lower than it used to be,” or does it actually deliver on your inflation objective? Is it calibrated appropriately? It's a hard question that often is sort of elided.

Beckworth: Well, with that, our time is up. Our guest today has been Charlie Evans. Charlie, thank you so much for coming on the program.

Evans: Thanks, David. It's a terrific podcast. I'm happy to participate.