Derek Tang is the CEO and co-founder of LH Meyer, and is part of the research team based in Washington, D.C. where he forecasts Fed policy developments, provides bespoke policy analysis to institutional investors, and also closely monitors and forecasts the Fed’s balance sheet. Derek joins David on Macro Musings to talk about Fed policy, Fed politics, and what to expect in 2023 and 2024. Specifically, David and Derek discuss numerous personnel changes at the Fed, the future of the central bank’s balance sheet, the upcoming Congressional agenda for the Fed, what the next framework review has in store, and more.
Read the full episode transcript:
Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Derek, thank you for joining the show.
Derek Tang: Thank you for having me.
Beckworth: Well, it's great to have you on. And I understand that you're in the same neighborhood as myself, in Washington DC. We're both in Arlington.
Tang: The best one.
Beckworth: Working hard on Fed policy. And you have an interesting job. You have a consulting firm for all things Fed. So talk about that. What do you guys do there and how did you get into it?
Tang: That's a really interesting question because in some sense, I sort of fell into it. So I went to college at Penn, and it's very much a Wall Street oriented university. And so the assumption is everyone just heads to New York after graduation. Of course, I graduate right in the midst of the financial crisis, and that didn't happen. But it just so happens that I was also involved in extracurriculars at school, including the College Fed Challenge, which is something that regional Feds and the Federal Reserve organizes for colleges and high schools. And that's where Larry Meyer, former Fed Governor, recruited from. They wanted someone who already had a propensity for these issues. So that's how I ended up at my first job, which was working for Larry at Macro Advisors as an RA, doing analysis work, a lot of research, quantitative research. And some of it was just data cleaning and not very glamorous, but a really good grounding for the modeling that came after that.
Tang: So I was at MA, which was since bought by IHS and then S&P Global. I was there for about six years. And then Larry and our team decided to spin off from that and start our own firm that was dedicated solely to Fed policy. And so that's what LH Meyer is, and that's been in existence for about seven years now. We're based in DC, we're a small team. We're focused exclusively on Fed policy. And the idea is being based here, we have our ears to the ground, and we're able to collect a lot about the mood, about what's going on and communicate that to our clients who are mostly in the financial sector. And so day-to-day, a lot of my job is tracking the data flow. Kevin, my colleague, does a lot of the forecasting, Phillips curve modeling, inflation modeling using FRB/US, their macro model. And then Larry is still very intimately involved, and he's more of a big-ideas person and talking about what the medium trends are or what he's seeing on the agenda. So all in all, it's been a really exciting career, and it's such a privilege to be sitting in the middle of this, especially in the last few years when the Fed has been such a big player in macro policy.
Beckworth: No doubt. What an exciting time to be a Fed watcher. And you've been there in the front lines in DC during 2020 and now during the inflation surge, and now on the other side of this coming down, the amazing Fed tightening cycle we've seen. And it's also interesting to learn that the Fed Challenge, that contest you participated in in college, pays off. It's not just about an extracurricular activity, it actually led to a job. So all those college students who are listening to the show, it's a good endeavor, continue to pursue it. And talk to Derek about how to win the contest.
Tang: Oh, I didn't win.
Beckworth: Well, you participated.
Tang: Well, I probably won the outcome in terms of my career, maybe not so much the actual challenge.
Beckworth: No, but great contest, great opportunity for college students. Alright, Derek, let's move on to some of the big developments and happenings at the Fed as an institution. And in particular, I want to first speak on the people, the personnel there. And there's been a lot of change, as you know. And let's first start at the top, the Board of Governors. So we got three new governors under President Biden. We got Lisa Cook, Philip Jefferson, Michael Barr. We had two new vice chairs, Michael Barr, he's still there, vice chair for supervision. And Lael Brainard got vice chair for the Federal Reserve itself overall. Of course, now she's leaving. And so, one of the big questions is what's going to happen to her slot? Who is on the short list for replacing her?
Detailing Fed Personnel Changes and the Next Framework Review
Tang: That's a really good question. And the interesting thing here is Brainard, Lael, now that she's at NEC, she actually has a say in who her replacement might be. So there's a little bit of circularity here. But we've had a number of names come out through reporting from the administration. The top two seem to be Karen Dynan and Janice Eberly, both of whom have been economists at the White House, Treasury, Fed in various positions. And they're both pretty interesting because it speaks to the White House's emphasis on diversity, although maybe not to the Hispanic diversity that Senator Menendez might want, but of course, having more of that female representation at the most senior levels. What is interesting there is both of them are sympathetic to the Democratic White House's political leanings and worldviews, but in slightly different ways.
Tang: Dynan is a little bit more disposed to the need to keep the Fed's credibility in play. That's not to say Eberly doesn't, but Dynan is very strong on that point that credibility is absolutely essential to make sure that the Fed's ability to keep inflation expectations while anchored remains complete. And to that end, she said some things that may not exactly be in the wheelhouse of some of the more progressive elements of that party. She said, "In the last 10 years, we've had really low interest rates. And so maybe back then, austerity wasn't the right answer. We should have made investments in different things, but now we're facing a different environment and that fiscal space might be smaller."
Tang: And that might not be music to their ears. Eberly, on the other hand, I think has the edge in part because it's a new name that's come up, at least for these senior Fed positions, but has views that actually could be very exciting to parts of the Democratic Party. Some of her research before COVID, before this inflation bout, when she talked about the benefits of a 3% inflation target or yield curve control, these are things that could be quite exciting. She's also subscribed to some of the views that Austan Goolsbee has expressed, which is, at these really high levels of interest rates, you might actually end up causing worse inflation because you're not increasing the supply on the other end. And that's a pretty nuanced argument, and we're not sure when it becomes operative. But I think it is interesting in light of perhaps growing Democratic unease over very tight monetary policy in the next few years.
Beckworth: Very interesting. And I will mention there was a tweet that went out, went sort of viral about Janice Eberly and this paper you mentioned she wrote in 2019. And it was part of, I believe, the Fed's review of its framework. She was a co-author with James Stock and Jonathan Wright. But I believe the paper's title was, *The Federal Reserve's Current Framework for Monetary Policy: A Review and Assessment.* And someone tweeted it out and said, "Hey, one of the names on the shortlist for the vice chair is an advocate of 3% inflation targeting." Now, the article doesn't come out saying definitely do it. It just says, "Hey, the Fed would've done better had they had a 3% target." But this is interesting, Derek, because she's at least open to the idea. And in a year, maybe a little over a year, sometime in 2024, we're going to start the next Fed review cycle, goes '24 to '25. So I wonder if you have any thoughts at what is at play during this next review?
Tang: That's a really good question because as we know, the last review really happened over the 2020 period. And they happen every five years. And officially, the policy regime does stay the same until the review and what's voted on by the committee. But of course, those ideas will seep in well before then, and dare say even this year, when they start arguing about how much further to raise the funds rate or when to start easing. And what's interesting this time is we have changes in the vice chair post. And the vice chair plays a very important role or has, Clarida is really the only precedent here, plays a really important role in shaping the agenda for the framework review. The last time they had the Fed Listens conference at the Chicago Fed, the Fed chair has a lot of control over who's invited to speak, to share those views, and having control of that agenda and who gets an audience.
Tang: So that's very interesting. Now, I think Eberly's paper is notable because she also co-wrote it with Stock and Wright, who are very accomplished economists in their own right. And I think people are understanding enough that we don't necessarily want to punish people for being intellectual explorers, for exploring things that might be new or novel. But at the same time, it is interesting that this particular issue comes up because there is perhaps some sympathy from other committee members as well. For example, Susan Collins who's now Boston Fed president, back at that same conference in 2019, before she was Boston Fed president, before this episode of inflation happened, she was a little bit disappointed that this 3% inflation target wasn't taken more seriously or wasn't under more serious consideration. And so you do see these attitudes. They certainly were there in 2019. Whether or not they are relevant for 2023, I think will be a really exciting matter.
Beckworth: Well, that's very interesting. So Janice Eberly could be the architect of the next review. So she could invite the people, as you said, and invite the topic. So Janice, if you're listening, please invite someone to discuss nominal GDP targeting as part of the review. I have to put a plug in. But I know that that's a long shot there, it's a moonshot, maybe for another term, but interesting. So she could shape the agenda, and at least in the past, she's expressed some sympathy toward 3% inflation targeting and there might be other people on the FOMC who are sympathetic to it as well. So do you see any big changes happening to FAIT, the Flexible Average Inflation Targeting framework? It took a beating, at least politically, during these past few years. I'm not sure if we can attribute all of the high inflation to it per se, but at least, appearance-wise, it looks to have taken a beating. And what does that mean for the review?
Tang: That's an interesting thing to think about because ultimately, even despite the debate that we think will happen with the 3% inflation target, that would be a huge step for them. And this is something that would require global coordination as well. We heard from Wada last night from the Bank of Japan. So I think what's probably more likely and probably our base case is they'll keep the 2% inflation point target, but the range around that might be loosened a little bit more. We might get a Bank of Canada style, 1% or 3%, in which case, in this episode, getting to 3% would mean you would wait for inflation to come down to 2% on its own, this opportunistic disinflation idea. Now, whether or not that's codified is going to be pretty interesting, how that's going to happen.
Tang: And of course, there are different parts to it as well. There's the framework regime itself, which is this January document they reaffirm every year. And then there's also the guidance, which is the application of that framework in what they actually say in the FOMC statement. And that's the part that President Kaplan from the Dallas Fed dissented against. There was unanimous agreement on the framework itself, and then he disagreed on how that was being operationalized in the FOMC statement. And so there are different layers where that disagreement could happen.
Beckworth: So on the 3% inflation target, we have a few more people joining the board potentially, and some that have already joined as regional Fed presidents, Austan Goolsbee and the Boston Fed President, who may be sympathetic to it. So that's fair. But you also hear a lot of talk from Fed leadership about credibility. We can no way raise the inflation target now because if we do, it will be seen as cheating, as convenience, as opportunistic inflation. So do you think that is weighing on their minds as well? They're worried about maintaining their inflation-fighting credibility to the extent they won't even go there, they won't even lay it on the table as something for consideration.
Tang: That's a timing issue, I think. I think they would hope that by 2024, 2025 when this rolls around, inflation will be definitively at 2% and that would create the space for that debate. If it's not, then I think you're absolutely right, there just won't be room for that and they won't have that luxury. I suppose the game theoretic point of view would say, "Okay, maybe then we really do want to get inflation back down to 2% as soon as possible so we can have that debate." But I don't think that's how they think. So I think that's absolutely right. We are seeing more to that end. It goes back to the dual mandate. We're so focused on the inflation side of it, but the FOMC is unusual among central banks where they also have a maximum employment mandate. And of course, I wouldn't say that's fallen by the wayside, I think it's because the labor market is so strong they haven't had to think about it, especially in light of high inflation.
Tang: But this year, the tide is turning very, very quickly. If you look at the Gallup polling, for example, inflation obviously became such a concern for Americans. It reached 1980s levels of anxiety. But then, for the first time last year, at the end of the year in November, December, the public started worrying a lot more about recession, the economy in general, and the prospect that they might lose their jobs from this. And that was exactly when the Fed slowed down the pace of rate hikes from 75 to 50, then to 25. And then this month, the recession fear has subsided and the inflation anxiety is still there. And so I think they are sensitive to public opinion, maybe not to the exact polling, but certainly to what the data is telling them.
Beckworth: Great point. And if we don't see inflation continue to fall as is expected this year, and in 2024 we still have high inflation, we have some bigger fish to fry because that's quite a ways away still. And we would hope that all of these rate hikes and all of the Fed tough talk will have continued to put downward pressure on inflation by that time. So it's likely, at least, we'll be in a space, you're saying, to have a conversation about 3%. So very interesting. Well, we've been talking about new additions to the Board of Governors and we've spent some time on the vice-chair slot that could be filled. But any thoughts on the new other governors, Lisa Cook, Phil Jefferson, Michael Barr? Do they bring anything new to the table?
Tang: Absolutely. So let's start with Vice Chair Barr because the supervision role is extremely important at the Fed. It's a fairly new invention. Quarles was the first vice chair for supervision, but of course, Governor Tarullo took on a lot of those responsibilities and before Quarles, without the obligation to testify before Congress twice a year. And I think Barr is very anticipated right now because he said he would embark on this holistic review of regulation. And he's talked about looking at all aspects, including things like the countercyclical capital buffer, which has never been activated in the United States, including things like the supplementary leverage ratio, which of course exempted reserves and Treasury securities temporarily for a year during COVID, but not since then. What's interesting about the SLR is it was calibrated back in 2014 when obviously, the Fed had already embarked on QE1 and QE2 and Operation Twist, so the balance sheet was really big.
Tang: But the FOMC had not formally said, “we're moving to an ample-reserves regime,” even though it was completely obvious. They didn't actually say that until 2019. So the staff had to pretend as though that wasn't what they were going back to. They had to say, "Oh, actually, we're going to go back to this scarce-reserves regime and this is what it's been designed for." So there's a disconnect there that needs to be worked out. So Barr's exception is very interesting. We are now looking at the first full set of stress tests that are coming out of that. And of course, there's some changes there, some innovations. We have an additional exploratory scenario. We have this concept of multiple scenarios too, which is really interesting because that seems to be an idea that's come through from predecessor Tarullo, for example, that you need to assess a wider range of outcomes.
Tang: And we saw that last year with a stress test because the interest rate scenarios they had was not what happened, essentially. And so going forward, the really interesting thing is, you have these multiple scenarios for the stress test and so banks are subject to that. But you could also easily see that filtering through to how the FOMC does its monetary policy and thinking about, maybe we at least think about the SEP as a communications tool, whether this base case idea is still relevant in today's world where there's so much uncertainty, or whether we should be assessing these multiple scenarios, which would give us a better sense of what's going on.
Tang: They already do that with alternative scenarios, of course, in the Teal Book, but they don't publicize those. So Barr's actions this year will be extremely interesting, and of course with some of the other matters as well, with payments and CBDCs and crypto. And then the other governors, Cook and Jefferson have been really great additions to the board. Cook actually spoke at an event in DC about two weeks ago. And it was amazing listening to her because she comes with such rich experience, for example, from her work in Russia and Africa. And seeing how some of these emerging markets deal with some of the side effects of Fed policy in terms of how it impacts global economic policy. And adding that to the board would be very valuable in a world where we have this geopolitical risk.
Beckworth: Well, let's move on to another governor, Chris Waller. And I really enjoy listening to him when he talks and when he does Q&As. He's very impressive, he's very sharp. If you go back and look at his publication records, really deep papers, lots of modeling, lots of sophisticated analysis. He was a chair of, I believe, the Notre Dame Economics Department, at one time. He headed research at the St. Louis Fed, so a very sharp guy. He knows his stuff. In fact, in some ways he reminds me of Ben Bernanke, also a real strong academic who comes into the Board of Governors. So he's very impressive to watch and to follow. But he also has this bit of a streak where he's been going against the grain, he's been voting against what the rest of the board is doing. So he voted against this climate part, I believe, the stress test, which was pretty notable. And then, recently, him and Governor Miki Bowman voted against... Not against. But they abstained in voting for Austan Goolsbee as the president of the Chicago Fed. Now, my understanding is for political reasons or they thought maybe he was too partisan, but what does this tell us about what's happening at the board? Anything different going on there? Or is this just a new face but similar antics?
Tang: Well I think Waller has been, actually, a pretty big part of the FOMC even before he became governor because he was research director at the St. Louis Fed for Bullard. And I think his speeches, sometimes when I listen to them, they're like a breath of fresh air, his honesty and sincerity in assessing the situation. I think his prominence is, in part, due to the fact that he complements some of Powell's, I suppose, deficits a little bit. Because Powell is coming from a lawyer, business person background. He's not a PhD economist. Of course, he has a very good handle on these things now. And Waller is coming in with a fairly traditional academia research director background. And so that's a very good complement. I think it's also very interesting to listen to Waller in thinking about his background in macro modeling, his warnings about inflation and especially in the context of what role he might be playing in the FOMC four to six years from now.
Tang: If we get a Republican president and Powell doesn't stay on, I think Waller would be near the top of the list for who the Fed chair might be. And so as you alluded to, this is certainly someone to watch. I think his communication skills are... It's not like Powell's communication skills, which are a little bit more geared towards, I suppose, the high-end might not be the right word, but more intellectual audience or really for the power players of Congress and the financial community. Waller is a great ambassador for the Fed in terms of speaking to the American general public. In that sense, he is on the same wavelength as Mary Daly as well, though they might not agree on a lot of issues. But I think their communication styles really do resonate. And that's very important at a time when the Fed's credibility is at stake.
Beckworth: So again, he might be like Bernanke, if he becomes a future Fed chair. If he's the academic, he comes in, brings the chops and then at some point in the future, may become a Fed chair if we have a Republican president. I will also mention along the lines of honesty and transparency that you found refreshing from him in his speeches that I recall him being one of the first people to say, "Had I known back then in 2021 what I know today in 2022, I would've voted very differently." And he said this at the Hoover Monetary Policy Conference, there at a panel. He was up there and he was like, "Yeah, we blew it. It was a mistake. We should have tightened sooner, but we didn't have all the data that we have today." So that was very refreshing. For me, it was really strange to hear the Fed admit a mistake so soon after. Usually, they're more careful and guarded. But Powell's done that too. Powell has also admitted, “we made a mistake in terms of, for example, our estimate of the natural rate of unemployment.” I remember AOC asked him in a hearing in Congress. So I do believe the Fed has really made big steps forward in terms of transparency and acknowledging when they do make mistakes. Okay, so we've touched on the Board of Governors. Any other things there we should note before we move on to the regional bank presidents or we covered it pretty well?
Tang: No, I think we've done a good overview of that.
Beckworth: Well, let's move then to the regional Fed presidents. A lot of change happening there. You've already mentioned Susan Collins replaced Eric Rosengren at the Boston Fed. Lorie Logan has replaced Robert Kaplan at the Dallas Fed. Austan Goolsbee has replaced Charlie Evans. And we're still waiting on the Kansas City Fed replacement for Esther George. So you've touched on Susan Collins a bit. Let's go to the Dallas Fed then. What does Lorie Logan bring to the table?
Tang: Yeah, that was a little bit of surprise. She's certainly super qualified for the role. But I think when that vacancy opened, we were expecting someone in a Texas mold, someone who maybe is from Texas, really involved in energy policy and perhaps comes from a Hispanic background. And she doesn't tick any of those boxes, but I think she really is someone that Dallas and state of Texas or that region really does welcome as president. I think what's interesting is the credibility she brings to the Dallas Fed, but also to the FOMC in terms of her experience from the New York Fed's markets desk. And if you look back, and this is something that not a lot of people know about, people pay so much attention to the FOMC minutes. But it's also true that the New York Fed posts minutes of its own board of director meetings. And of course, these are attended by Williams, New York Fed President and also they get reports from New York Fed staff, including the Markets Group, on what's going on.
Tang: If you look back to 2020 and 2021, reading between the lines, she was one of the first ones to sound the alarm on whether or not this asset purchase policy should be continuing all the way through 2021. So late 2020, she started sounding alarm bells, "It looks like a tech equity bubble, we might be seeing some signs there." And then it looked like in 2021, there was some presentation of alternative proposals to either slow down… taper asset purchases earlier or perhaps only continue in one asset class but not the other. So these are things that were on the table and didn't seem to filter through to, say, the FOMC minutes or the general discourse. So I think that's really interesting, and that's what she brings to bear at the Dallas Fed. Now, of course, as you mentioned, there's a lot of movement on the regional Fed spectrum. And Kansas City Fed, I think, is an interesting one to think about because they have this vacancy that they have yet to fill. And it's only made more obvious because they were on the same timeline as the Chicago Fed, because the original Chicago Fed President Evans and original Kansas Fed President George, I think they had the same birthday month. So they were subject to the same mandatory retirement date.
Beckworth: Ah, interesting.
Tang: But the Chicago Fed got the replacement filled in time and the Kansas City Fed still doesn't. So Chicago Fed, I think, is an interesting one because they chose Goolsbee, who's obviously a very good economist, but also seen as very partisan because he was such an effective spokesperson for the Obama Administration and their policies. And even throughout last year, we heard from Goolsbee agreeing that inflation was an issue, but he was also saying, "We really have to be careful not to over tighten because if we can't get inflation down, then all we're going to do is cause stagflation." And that's a really interesting viewpoint. Now, he has been pretty quiet since he's become Chicago Fed President, which I suppose is not unusual for a new president. But I think we're hearing from him in the next few weeks, and especially with the news that he might also be in the running for Fed vice chair. I think that's someone definitely to watch.
Beckworth: Let me go back to Lorie Logan. Kudos to her for being an avant-garde, the front of warning that maybe we need to slow down the asset purchases. I didn't know that about her. So good for her sound sounding the alarm early on. And in terms of Austan Goolsbee, I was a little surprised about the blowback he got, the partisan blowback. A lot of Fed officials come in with political baggage. Lael Brainard came in, Ben Bernanke, he was CEA chair for George W. Bush. So it's almost as if it’s the saying, "No good deed goes unpunished." Austan Goolsbee's a great communicator. So they put him out there on the front lines communicating for Obama. I know he would often go on to the Sean Hannity show just to argue the other side in a good, fun way. I think him and Sean, for example, are friends. So it just struck me as a little off that there was this big partisan concern about him. Everyone comes in with some set of priors politically. Maybe his are just much more explicit. What do you see as the driving difference?
Tang: Well, I think for him, it's because he's had such a close connection with the Democratic Party even after he left the White House, that he's really been on that side of policy throughout 2021, 2022 in terms of defending the Biden stimulus packages, for example. And one of the reasons it's a little bit of surprise for him to accede to the Chicago Fed is because I think former Vice Chair Quarles sounded a warning after he left. Maybe warning is a little strong, but he basically said, "The Fed is one of the only institutions left in DC that's really not that political." We don't see it in the same vein as Congress, certainly, and not even the Supreme Court. But it could trend in that direction where you could see parties trying to stack their people at these institutions. And so this looks a little bit like, "Oh, there's a Democratic representative on the FOMC to the extent that it hasn't been in the past."
Tang: Now, I'm probably overstating this. And of course, the news that Craig Torres from Bloomberg broke about the internal vote on Goolsbee. So as you know, regional Fed presidents need to be vetted by the Board of Governors in DC before they can actually be appointed. Now, this goes through a vote of all of the governors of which there are seven. But these votes aren't made public. So these are not votes on whether a bank can merge. And so journalists submit FOIAs for it. So Craig found out for that vote, Governors Waller and Bowman abstained from the vote. So they did not vote yes, which is usually what happens. It's just unanimous agreement. They did not vote no, but it was an abstention, so it clearly was not a yes. And what's notable about this is Governor Waller was chairing the Regional Fed Affairs Committee on the board.
Tang: So on the board, there are all these subcommittees that govern different things. And Waller was the person who was overseeing some of these matters. And as chair of that committee, if he was abstaining from this vote, then had this vote get through to the full board vote, I think that is an interesting question. Of course, the answer probably lies in the other members of that subcommittee, which are Vice Chair Brainard and Governor Cook. And so two against one. If that were the case, it would have made it possible for that vote to be brought to the full board, at which point, Powell and the rest of them voted for it. So I think that's interesting to think about and speaks to, especially, Brainard as vice chair at that time, sees a lot of things eye to eye with Goolsbee. They certainly overlapped in the Obama Administration, for example.
Beckworth: So Governor Waller chairs the committee that oversees the regional banks, right?
Tang: Yes. And so a lot of it is about admin matters, like oversight of those regional banks, making sure they have the right budgets and things like that.
Beckworth: But he's going to interact with Goolsbee quite a bit going forward. I know they do reviews, their reports, their statements and such going forward. So it just presents some awkward moments in the future, the one guy who abstained and that you now have to interact with on a regular basis.
Tang: Yes. Although, I don't think it's unprecedented. I think Nick Timiraos from the Wall Street Journal said that there was a vote in the past, I think Tarullo either abstained or dissented against Kocherlakota becoming Minneapolis Fed president. So it has happened before, but I think because Goolsbee is so prominent, it is an issue.
Beckworth: Well, very interesting. And I'm sure we will keep following this and see what happens going forward. Let's move on to some of the issues facing the Fed, and it's related to some of these regional banks. And in particular, the Kansas City Fed. So I've had a lot of folks on the show talking about Fed master accounts, FedNow. And they all seem to be centered around the Kansas City Fed, Derek. So walk us through those issues, and what does it mean for selecting a president there?
The Kansas City Fed Spotlight
Tang: So the Kansas City Fed still has the vacancy for president. They've been conducting the recruitment exercise basically on the same timeline as the Chicago Fed. And it hasn't been filled. And what's interesting is… I think there are a few things that are interesting about that. One is that my prior was that Governor Bowman would be interested in the position and it was a shoo-in for her in some ways.
Beckworth: Oh, interesting.
Tang: Since she's actually from the district and has some similarities with predecessor, Esther George, in terms of banking regulation and supervision. But Bowman is not Kansas City Fed president. And so the position is unfilled. And I suspect that this has something to do with the fact that Kansas City Fed is on the front lines of what could be hand-to-hand combat between the crypto industry or FinTech and the existing banking industry in the Federal Reserve. Not that they're necessarily all on the same side, but I think it is interesting to think about because Wyoming is in Kansas City Fed's district, Wyoming has positioned itself to be a state that's welcomed the crypto industry. This is a growth area for them. And they even have some legislation on the table that requires their state legal apparatus to litigate with the Federal Reserve if things don't go the way they want.
Tang: And so that's a very thorny position to be in, and you need someone who has that stomach to go up against that. And it might be a tall order. So I think that's perhaps one of the issues there. Of course, there is this lawsuit going on with Custodia that's still ongoing. And I think there are iterations of it almost every other week now. I think the Fed just announced that it was not going to reconsider the application, and then there's a new lawsuit filed. So for Powell, that's a very easy thing to answer in the testimony, "I don't comment on ongoing litigation." But there is a vacancy there. And operationally, they have it all in hand. There's continuity at every level other than the president. They're the first vice president, they have all their operations in place. But of course, the Kansas City Fed was also part of the reason why Sarah Bloom Raskin wasn't confirmed to be vice chair for supervision. There's an issue with purported contact between her and the Kansas City Fed, and then the subsequent approval or, essentially, endorsement of the Reserve Trust Company. And so that became a live issue. And so it seems like that might be one of the things that's holding that back.
Beckworth: So whoever does become the president of the Kansas City Fed, they're going to have to deal with these issues. And I'm wondering if you have a sense of who actually gets to make the decision at the end of the day in terms of Fed master accounts, which FinTech's going to get access to it? If one goes to the Kansas City Fed as president, do they actually have a choice? Can they make that decision? Or is it something that the board's going to have to approve or sign off on, Jay Powell's going to have to say yay or nay?
Tang: That's a really good question. I think just as a matter of governance, the board, the Federal Reserve system is trying to enforce a level of consistency across Federal Reserve Banks so that there's no arbitrage where if you move to a certain district, you would be treated differently. So I think that suggests that there is going to be some centralization at least of the standards and policies at the board. I think with respect to the centralization of policy, which I know wasn't your direct question, but it called to mind many years ago, I believe it was, maybe, 2015 timeframe, when there was something called the Triangle Document. And it was about the relationship between the New York Fed and the Federal Reserve Board in DC. And basically, it was bringing back a lot of the functions from the New York Fed back to the board here.
Tang: And so that might have an application in this context of where the nexus lies. And then, from the public point of view, of course, it also concerns the standing of banks or other stakeholders to seek this information or to seek recourse because of course, the Federal Reserve Board is treated differently in terms of government agency status than Federal Reserve Banks, which are quasi-public. So I think those are things that will probably be ironed out over a longer period of time. And it could open up a huge can of worms, which Powell does not need right now.
Beckworth: The Fed has a lot on his plate, and this is just one of the many things happening. One last question about issues facing the Fed, and we'll move on to Congress and what Congress is doing with the Fed, but the issue of the trading scandal. And last I heard it was unresolved, at least for some of the regional bank presidents who've been involved. What is your understanding of what's happening there?
Tang: So I think the last we heard of it was, long story short, Chair Powell and Vice Chair Clarida were cleared. But then on Presidents Kaplan and Rosengren, it seemed to be unresolved. And then Powell put in some new disclosure requirements and guidelines that are not retroactive, so they only apply from this point on. And so for that, I think the investigation is ongoing. I think what is a little awkward is that the Fed OIG reports to Powell. So it's not like it reports to someone else. And so it raises the question of is there a conflict of interest here, which I don't believe there necessarily is. That's not the issue at play. The issue is the optics, and whether it can be exploited politically, which I believe it can be. And so that's something that Republicans perhaps can hound Powell on in a few weeks' time. A lot of these things are... Fungible might not be the right word. But they can be bargaining tools for different things. So you might push Powell on one side of things to get him, or to try to get him to yield on other matters. So I think that's part of the interplay here.
Beckworth: That's interesting you mentioned the IG issue because that's been a big push from Andy Levin and Bill Nelson. They have a policy brief with us where they look at the Fed balance sheet losses. And they say, "Look, it was a decision, it was made in real time. Yes, we disagree with the Fed going on as long as it did, creating these losses." But that's water under the bridge. The issue is, who are they accountable to when they incur these losses? And it would be nice to have an independent IG who didn't report to Powell, who could do an assessment on its own and report to Congress. So I do think there'll probably be some push from Republicans, "Why don't you have an IG who's independent?" And this would be what you mentioned, just another reason that would motivate them along those lines. Let's move to Congress and let's talk about them. And let's start first with the Democrats. What's on the agenda for the Democrats in the Senate where they control the body in terms of the Fed?
The Congressional Agenda for the Fed
Tang: So I think one of the things that's top of mind for them, which we've talked a little bit about is appointments, personnel's policy and they're very concerned about who Biden is going to nominate to be vice chair, but more broadly how this is all working. And so the Democratic Party is not one monolith, they have different factions within them as well. And so for example, we've seen a pretty steady drumbeat from Menendez, for example, for more Hispanic representation. And so it was surprising that the White House has not put a name forward that would satisfy that. What's interesting is it's not just a fringe issue limited to Menendez anymore. You have, as Punchbowl reported, I think, moderates like Warner and also Brown, who's chairing Senate Banking, were also taking note of this issue and saying, "I'm talking to the White House about this. This is important."
Tang: But abstracting from appointments for a bit, there is going to be an increasing focus on labor. And the reason is, I think for the first time in a year, we're starting to see the focus not being solely on inflation. Of course, the job market still remains extremely strong, lots of jobs being created. But I think a lot of them were looking ahead to the rest of the year, and possibly next year when we could see more job losses and we could see a rising unemployment rate. And of course, this goes to this idea of a sacrifice ratio, how much pain must the economy endure for inflation to come down and whether or not that's worth it. And so that's going to be a huge sticking point for Democrats who say to the Fed, "You have a dual mandate, and understandably, you've been focused on inflation, and that makes sense when inflation is at 8%. But if inflation is at 3%, then don't you think you should focus on the labor market a little bit more?"
Tang: So that's a fundamental issue. And then there are all these fringe issues, which they're almost more meta in the sense that Republicans might argue with them and say, "We shouldn't be even litigating this at all,” which is, “the Fed should be paying more attention to climate issues, or the Fed should be paying attention to using their force for good in terms of social policy." And these are things that Republicans are in complete disagreement on, and whether the Fed even has the authority to dive into those measures. So I think those are some of the big themes.
Beckworth: So labor and appointments being the big ones for the Democrats. What about the Republicans?
Tang: I think for the Republicans, you're going to see a lot of focus on the Fed's extracurricular activities. That's sort of a euphemism, in the sense that the Fed's been more and more active in pursuing or exploring what it means to be a steward of the economy, not just in the narrow sense of monetary policy, but thinking about the big picture. And of course, a lot of that is about ESG and climate and how the Fed could be using its regulatory apparatus to lean on the banking system or lean on the flow of credit or the sectoral allocation of that. The Fed has not actually done that, but there is scope for them to do that. And I think it's a question of whether the Fed has a self-discipline to say, "No, that we're not going to wander into that," or whether it requires Republicans to come in and actually draw some bright lines and say, "No, you absolutely cannot do that."
Tang: But of course, a lot of it also goes to the fundamental issue of this inflation-fighting resolve, and getting back down to 2%. We talked a little bit about the inflation target, and that's one of the venues where that debate might occur. And we have Republicans like Andy Barr coming out and saying, "The Fed, you need to grow a back bone and you need to get all the way back down to 2%. You can't give up before you get there." And so that's going to be the mainstay.
Tang: One other thing is also, I think, for both parties, is trying to drag power into the debate about the debt limit, about the debt ceiling. And I know you've discussed this a lot on your show already. But of course, Powell has been fairly consistent in his remarks, like his predecessor yelling and saying, "The Fed can't really be seen as a backstop. We don't want the Fed to be seen as a backstop. If something like this happens, the Fed won't be able to fully offset the devastation from that." So I think that's also something he'll be questioned about.
Beckworth: Now, is there interest on the House side from Republicans in terms of crypto and stablecoins, things like that?
Tang: I think there are different views on that. The Fed, certainly, is very keen to have all the technology in place for that. With the project between the Boston Fed and MIT, and policymakers have been very clear, "We're not going to do anything without explicit approval from Congress, whether that comes in legislation or something that's very clear." I think what's interesting is when the Fed says, "Oh, we're not taking a stand on this, we're just doing the technical preparation. And we don't take a stand on this legislation whether or not it's about a dual mandate or about CBDCs." But when we look back, the Fed actually took a very strong stance for paying interest on reserves. And that was, I would say, a multi-decade effort. So it's actually not true that the Fed always stays out of these matters. But it is staying out of this one.
Tang: And I think a part of it is… Brainard's succession to NEC will be very interesting because Brainard's been on the side of a Fed CBDC, and there's very little, as vice chair, at the Fed that she could do to propel that without legislation. But at NEC, you could see there being a little bit more movement on that, especially if it comes in the form of an executive order. But of course, there's resistance at the board as well. Governors Bowman and Waller are very skeptical about that for various reasons, whether or not it's necessary. And even if we do need something like that, whether it should be the Fed. So I think those things are really up for debate.
Beckworth: It's my understanding the Republicans on the House side are very skeptical about that as well. And they're wanting to promote some regulation, some space where stablecoins could be implemented by the private sector. So it'll be interesting to see what happens in this policy space. Well, let's move on, as our time is running short here, to the Fed's balance sheet. Because this is one of your favorite areas, and you're probably dreaming about the Fed's balance sheet at nighttime. You dream about looking up those tables and the Fed releases them every week. So let's talk about the Fed's balance sheet. Any thoughts on the Fed's normalization plans? Is it going according to plan? How long will it take? What's our final destination? Those type of questions.
The Fed’s Balance Sheet Moving Forward
Tang: That's a really good segue because some Republicans have been paying more and more attention to this, in particular Rick Scott from Florida, saying the Fed seems to be behind on its normalization since it had these runoff caps of 90, 95 billion. And of course, because of high interest rate environments and slow MBS prepayments, that's not going as quickly. But otherwise, it's been going as planned. We're seeing financial markets essentially function. I think the big question from here on out is when runoff is going to stop. And the Fed is really taking a stronger stance in saying, "We don't think it's going to stop for a few years to come, because even though reserves are declining, we have this huge overnight reverse repo facility, all this liquidity that the market can redistribute according to their own needs. And so we're not as worried."
Tang: Now, I suspect some of that is posturing because they don't want the market to think that they're going to change runoff policy later this year because people are going to do a read-across and say, "Oh, that means the Fed is also going to ease funds rate policy." And so that's the last thing they want. But I think there is some truth in what they're saying, which is that we're facing a very different situation than we were in 2019. The balance sheet is much bigger, and the overnight reverse repo facility, the take-up of that could be much lower if banks choose to bid up for deposits, increase their deposit betas and increase deposit rates to compete to get those deposits back. And so the Fed's attitude seems to be, "What's the issue? There are all these market mechanisms. If you want it so badly, you can use the price to get it. The Fed is not here to help you out because you won't help yourselves.” So I think that's one aspect. I think the other aspect, which is more politically tied is the issue of profits. Of course, the Fed is not making a profit anymore for a few years because their carry has become negative, their net interest margin.
Tang: So they're paying a lot more to financial intermediaries in interest on reserve balances, for example, than they are earning from their securities. And of course, that's a natural consequence of the fact that they raised a policy rate, but also they bought all these securities when coupons, interest rates were much lower. Now, the real question for the United States is how this is going to happen going forward. This is the first test of that because the Fed has this accounting item called a deferred asset where it says, "Okay, we're not making money. And in fact, we would be losing money, we'd be going into negative equity if we had to mark these securities to market. But we don't do that. Instead, we're just going to delay sending money to Treasury for a few years."
Tang: And of course, that could be an opening for politicians to go after them for. But of course, this is just a result of the fact that the Fed remitted almost a trillion in profits after the financial crisis, and they weren't allowed to keep a capital buffer. If they were, then they could do what the ECB is doing right now, and they're saying, we're just using our provision against that. But they don't have that luxury. At the same time, even beyond the pecuniary aspects of the balance sheet, Powell could very easily point to the fact that the nation, as a whole, is much better off with us having done these asset purchases, because otherwise, the recovery last time would've taken a lot longer, the economy wouldn't have grown as much and tax revenue would've been a lot lower as well. So do you really want to do the math? Because I'm happy to.
Beckworth: Very interesting and very, potentially, political going forward, as you mentioned what's happening on the Fed's balance sheet. And the Rick Scott letter I saw, that was pretty amazing. I think one of the challenges, though, in making the Fed's balance sheet political for Republicans or anyone, is that it's very abstract for the average American. It's the Fed's balance sheet, it's not added to the deficit. You throw out total debt, total deficit. That's a big, scary number. And it's kind of an off balance sheet item of sorts. And so it's not, I think, as easy for Americans to wrap their minds around it. Now, I know you can talk about how much money the Fed's losing, and that might be more tangible. But I do think it's not an easy sell as some would make it out to be. Although, Andy Levin and Bill Nelson have this policy brief they've written for us, which I think is very interesting and does make this point that close to a trillion, estimated around 800 billion or so, will be lost over the next decade. And that is a big, scary number, but I just wonder how easy it gets across to the public.
Tang: I think that's a really good point because if you consolidate the Treasury and Fed balance sheets, essentially, then what it looks like, it's more of a duration swap. And these are complicated matters for people like us to understand. And so it's not something that's easily distilled into a 15-second PAC ad. But I think it puts the Fed in a very... Especially as a profits issue, I think, brings to the fore a potential... I don't know if it rises to a level of a constitutional issue, but really opens the question of, "Okay. Well, where is the line between monetary and fiscal policy?" And depending on where that line is, then we have to figure out, are the officials, who have authority over these decisions, are they elected or how much oversight we have over them. And I think that's really the crux here.
Beckworth: And it does present an opportunity to go take the other side of what I just said for Democrats and Republicans to get on board in terms of this. If we're paying more and more interest payments to banks, to Wall Street, to money market funds, that has a certain vibe to it that many progressives may not like. And they might jump on board with that. And then Republicans would talk about losses to taxpayers on the other side. So that could lead to something like we saw last year when Senator Warren, Senator Toomey came out together, for example, and supported a bill that would've required the regional banks to be subject to the FOIA acts more readily. So it's interesting to see what will happen. And I have to add this in here because I've had some exchanges with David Andolfatto, who used to be the St. Louis Fed. He's at the University of Miami now.
Beckworth: But we had a lot of exchanges in our DMs about this Fed loss on this balance sheet. And he made a point, which I think is fair, is that, "Okay, there's going to be a taxpayer loss." And if we round up, let's just say a trillion dollars, make it big and scary over the next decade from the Fed's balance sheet. He goes, "Taxpayers would've lost that anyways. If all of that had been financed with Treasury bills and bonds and taxpayers had been holding it, they would've lost it from what they were holding." So taxpayers are going to take a hit no matter what. It's the question of who's holding it, how do we see it, how is it visualized? And at that point, I would say, "Well, then it becomes a political question." And it becomes a question of who did Congress delegate the authority to for making these decisions, how we're going to handle losses of the taxpayers?
Beckworth: But that's maybe a different consideration than politics per se. But let me throw out a few things about the Fed's balance sheet that are interesting and I think fascinating. So Governor Chris Waller, again, he's making quite a few appearances on this show, Derek, and I think it speaks to his chops, his prowess on these issues. But he said in a recent interview we had earlier this year that for him, "How far can this balance sheet process go?" He wanted to see reserves get to about where they were in 2019, maybe a little bit above it. So they're around 8%, 9%, in terms of GDP, maybe clearer, 8%, 9%, 10% of GDP, maybe go up to 11% or 12%. But that's where he wants it to be. And currently, if I'm looking at the numbers correctly, they're around 21%. So there's ample room to come down still. And then to make these numbers concrete, I'm going to draw upon a recent study that was done by the Richmond Fed.
Beckworth: And they project the overall balance sheet from a high, close to nine trillion down to just below six trillion. And then it will start growing again. So that's where they see it going. They see reserves, to make it concrete, reserves and overnight reverse repos, so both of those liabilities, they had a peak just under six trillion. They'll be down, let's see, about two and a half when it's all said and done. And then things continue to grow. So we'll see a reduction they have to maybe 26, 27, and then it's going to pick up again. So it'll be fascinating to see where this goes because there were a lot of predictions made after the great financial crisis. The balance sheet would get much, much smaller. It did not. And I think that's part of the challenge of an ample reserve system is it's hard to know where that threshold is where you're in an ample reserve system versus going back into a corridor one. Any other thoughts on the Fed's balance sheet?
Tang: I think what Waller set out is basically their playbook. The difference this time is that they have the overnight reverse repo facility where they believe the take-up of that will fall over time as there's more certainty in the interest rate environment and banks start to claw back some of those deposits. That's something that remains to be seen. I think there is an attitude shift in the last month or so where they said, "Even if we see some of these rates spike, we wouldn't be too alarmed." It's not the same sense of emergency as they felt in 2019 just because they have new backstops in place. They have repo facilities, a standing one for domestic counterparties, a standing repo facility. And they also have a standing facility for foreign official accounts. So that would be big holders of Treasury securities, like China comes to mind.
Tang: So I think in that sense, they don't seem to be as worried as they have been. But again, I think a part of this is posturing, not just with respect to the fact that they don't want to look as though they're easing funds rate policy later this year. They also don't want to look like they're changing their balance sheet policy in anticipation of, or in response to, the debt limit episode, which is going to cause some wild swings in reserves. So for example, we're going to get an April tax date, and that will boost the Treasury General Account. And mechanically, then you might see reserves decline. But the Treasury then has to draw down that account because it needs to spend the cash, and then reserves look like they're more ample than they otherwise would be. So it's going to cause some volatility in there and make it a little bit more difficult to track.
Tang: And I think the subtext here is we're politically independent and we're not really affected by that. But as you mentioned before, the politics of paying banks interest on reserves, that could go up to 5% in a few months. It might not be palatable if it's framed that way. And I was looking at the testimony, because Powell's testifying, of course… with that is a very, very long monetary policy report that takes the Fed staff, I'm sure, months to prepare. And they have these special boxes that are in there to look at special topics or topics that they really want to clarify before testimony. And one of them, a few years ago, was why we pay interest on reserves. And the really strange thing about that box was they really didn't hold back with the tone. They're basically saying, "We need this. If we don't do this, then what happens is when we tighten monetary policy, we can't just tighten it in this really smooth fashion. We have to shrink the balance sheet really suddenly." And you don't want that. So I think that was pretty stark, and I think is along the lines of what Powell would be saying in a few weeks.
Beckworth: So you think all the new repo facilities will make their job easier than going forward in terms of doing QT?
Tang: Well, they say that, and I think that's the signal. So the facilities exist, they're not being used that much, which is natural at this stage. Now, what's interesting is in their own survey of reserve management practices, when they survey bank CFOs, for example, bank CFOs are actually not that keen on using these facilities. They ask them, "If you're short of reserves what would you do?" And we have these bright new shiny facilities. And they say, "Oh, well, we go to the market and we just bid up the price." And so that's not actually great news for the Fed. But despite that survey result, they're coming out and saying, "Oh, actually these facilities are here as backstops." And so I think that's an important signal to take.
Beckworth: And probably the true test of them will be a crisis. It's one thing for financial firms to act this way during normal times. Let's see what happens during a panic. Well, with that, our time is up. Our guest today's been Derek Tang. Derek, thank you so much for coming on the show and informing us about the Fed.
Tang: Thank you. It's been my pleasure.
Photo by Drew Angerer via Getty Images