Macro Musings is back with another bonus episode, as Sam Bell and Skanda Amarnath (Employ America) are joined by Julia Coronado (Macro Policy Perspectives) and David Beckworth (Macro Musings) to talk through the announcement of the Fed’s framework transition towards average inflation targeting. Specifically, this panel of guests discuss the implications of moving to an average inflation targeting regime, whether the shift may cause credibility problems for the central bank, how to continue to improve the Fed’s toolkit, and more.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
Sam Bell: Thank you so much for joining us on this morning of a new Fed framework. Let's see. Let me start by saying a lot's happening in our country, in our world. And we have many of our countrymen falling ill and dying of COVID. We have many millions unemployed. We have our black brothers and sisters living in fear. And so I just want to acknowledge those things at the top. And we're trying to bring to this and all conversations around monetary policy, a lightness, a festive atmosphere. Our goal there is just to make it inclusive and make it accessible and make it a bit of fun. But I also realize these are heavy times.
Bell: So, all right, with that, I don't want to do too much in terms of introductions because I think folks who are watching this probably know everyone, but we will post in the links the full bios. Julia's bio is so long, it would take like six minutes to get through it all. But let me dive in. We had Jay Powell give a speech this morning at the Digital Jackson Hole. And in addition to that, we had the Fed release a revised statement basically of their framework. And I think the ... Well, actually, Julia would you want to give a summary of what the major pieces are just for our listeners who might not have scrolled through Twitter?
Julia Coronado: Of the changes to the framework?
Changes to the Federal Reserve Framework
Coronado: So, I mean, I think that there was ... To me, the big picture here is this is the flipping of the order of operations here. The goal is now maximum employment. That takes precedence. That showed up in the statement in a few ways. They actually flipped the words inflation and employment when they were talking about their objectives. They moved the employment paragraph up in the statement. They included more words around what maximum employment means. So I think it really is an overarching emphasis on using an average inflation targeting framework, which we widely expected. That was the most socialized thing that we were expecting.
The big picture here is this is the flipping of the order of operations here. The goal is now maximum employment. That takes precedence...They included more words around what maximum employment means. So I think it really is an overarching emphasis on using an average inflation targeting framework, which we widely expected.
Coronado: We got it. We got it largely as expected. They're going to try to have inflation centered and averaging 2%, but that's a means to an end. And the end is a broad based and inclusive realization of full employment. And to me, that's the significance that was maybe less appreciated was ... And I mean, Sam, we've been talking about this for a long time. Jay Powell is about as dovish a labor market dove there is. I think he took Janet Yellen's lessons deep in his soul. He went out to the people and heard them. And I think his fingerprints are all over this.
Bell: Yeah. All right. So let me push you on that, on the employment side. And Skanda and I have been going back and forth about how satisfied should we be about this? And you never want to be in the position where you pushed for something significant and then don't recognize it. So we don't want to move the goalposts. At the same time, the speech itself and most of Powell's speeches now are really love songs to full employment, right? It's just like tight labor markets are the greatest thing ever, they do so much. I think, to give him credit, I think that his main innovation, I'd be curious David and Julia, if you think this is right, his main innovation in 2019 was to say, "We just don't know enough about our estimates of maximum employment to say we're beyond full employment."
Bell: And as a result, I'm not going to be the Fed chairman that tries to bring unemployment back up to some estimated level. Right. So props to him. That was big. I guess the question for us is if you're not actually targeting a labor market outcome, is that enough? Is our framework high powered enough to generate a more robust jobs recovery? I guess I'm curious for reactions to that. Julia, David, Skanda, should Employ America be happy about this, I guess is ... We're starting at a place where we have very high unemployment right now and we're about to hopefully start a recovery. So should Employ America be happy about this framework?
Evaluating the Change in Fed Framework
Coronado: David, do you want to take that first?
David Beckworth: Sure. I'll jump in. I'll say a big maybe. I think this is great and it's a step in the right direction. I've been calling for a long time for some kind of makeup policy, which would be level targeting. And this is a step in that direction. And why would that matter for labor markets? The way I look at it is make up policy is huge because it allows for some reflation in the economy, including labor income, or particularly labor income. If you don't encourage, you don't allow for reflation, which in plain English means dollar incomes growing rapidly to get back to where they would have been in the absence of a recession and spending, if you don't have that, you're not going to have these healthy labor markets. So this opens the door for that. It gives the Fed license.
I think this is great and it's a step in the right direction. I've been calling for a long time for some kind of makeup policy, which would be level targeting. And this is a step in that direction.
Beckworth: It also means if you get to a level target that provides powerful forward guidance, but I think makeup policy is the silver lining I see in this. I say a big maybe because I'm not convinced this is a terribly credible policy yet, and maybe things will come out. I think there's a lot to be done. I'll stop there. I can discuss some of those later, but I do worry whether this will be a credible policy, but it has the potential, Sam, to make you happy.
Bell: Okay. Skanda, what do you think? If we were doing this in 2008 or 2011, you just wrote a big piece about the dangers of inflation target, and you looked at 2008 and 2011. 2008 I think is ... Yeah. Anyway, how would average inflation targeting plus maybe more of an emphasis on, or a de-emphasis on sort of a natural rate of unemployment, have fared in those periods?
Skanda Amarnath: I think that the latter is probably more important for our purposes as far as de-emphasizing the whole idea of… I think one of the critical changes in the document that was released today was it changed from talking about avoiding deviations in unemployment to talking about addressing shortfalls. So it's effectively saying there's no such thing as too much employment. Now maybe there's some other problems that are associated with that that need to be addressed. But the notion that we're symmetrically optimizing the amount of employment in the economy is not actually true. Right? And that runs counter to a lot of the Fed forecasts that were effectively projecting that optimal policy would raise the unemployment rate. Right? So that, I think, was not something was widely talked about or expected coming into today. I think that's probably what Julia was saying, a very positive development.
One of the critical changes in the document that was released today was it changed from talking about avoiding deviations in unemployment to talking about addressing shortfalls. So it's effectively saying there's no such thing as too much employment.
Amarnath: I think the average inflation targeting point is one where I'm conflicted in the sense that I do understand that they're trying to be more accommodative to welcome or increase the probability of tight labor markets. As to what David was saying, there is a chance for reflation. You don't do preemptive tightening the way they did in 2015, '16 to '18. So you don't actually try to tighten the ... If the economy is running, don't try to choke it off in terms of trying to preemptively avoid future inflation. At least try to see some of it.
Amarnath: I do think it sort of misses the point that, to all the things that David was talking about, in my mind it's why not calibrate policy with that specifically in mind, specifically trying to raise dollar incomes? That seems like we're kind of doing this very indirectly through inflation to talk about labor markets. I get that there is a dovish overtone to some of this, but inflation can do very weird things in the moment. It can distract both FOMC members and financial markets. And I think 2008 and 2011 are the two examples, I think, of where there was divergence. This is also the 2011 particular was when David and Scott Sumner's ideas around market monetarism and nominal GDP targeting, I think kind of got into the popular discourse more so because inflation was doing something very different from the economy itself.
Amarnath: And I do worry while Jay Powell and people like Janet Yellen have a certain set of instincts that say, "We need to deliver accommodation when unemployment is high," I don't think that's necessarily what average inflation targeting implies all the time. Not everyone's going to have the same worldview or the same set of values. So it does lead to a more fragility in those types of environments. Again, it may not play out. So if we're talking about the sort of late 2010s, when we had both low inflation and low wage growth and low nominal GDP growth, and all those things are moving in the same direction, this is a helpful policy. But I think it is something where it does feel like a very oblique way of actually trying to attack the issue of labor market tightness.
If we're talking about the sort of late 2010s, when we had both low inflation and low wage growth and low nominal GDP growth, and all those things are moving in the same direction, this is a helpful policy. But I think it is something where it does feel like a very oblique way of actually trying to attack the issue of labor market tightness.
Bell: That's a little bit ... Just if I can add one more thing. Yeah. That's a little bit my concern is the framework is supposed to be a structure that persists across different FOMCs. And I kind of worry a little bit that we're calling it dovish because we're marrying it with the whole Powell emphasis on full employment, and when Don Jr appoints Judy Shelton to be Fed chair, will the framework be as robust? Well, we might have other problems in that scenario, but even in a lesser scenario, I guess are we over-weighting the dovishness of it because of the messenger and because we've just come off this period in 2019 where he did exactly this thing where the committee wasn't willing to push unemployment up. I don't know. Julia, you want to weigh in?
Coronado: Yeah. I mean, I agree with the points made. It's sort of a do no harm statement. It's not a guarantee. It's not a stated objective, but I will say, one of the reasons that might be the case is that it's not clear they have the tools. Their tool kit is increasingly not well suited to the job. They work through asset prices. The credit channel in an aging society characterized by extreme inequality, the credit channel is muted at best. It's there. Housing is doing well. It's there. But there's tons of people left out of that. And the asset price channel, even more people are left out of that.
It's sort of a do no harm statement. It's not a guarantee. It's not a stated objective, but I will say, one of the reasons that might be the case is that it's not clear they have the tools.
Coronado: So full employment is a truly macroeconomic outcome that, as Powell stresses, really means we're getting to the people that are the most vulnerable. They're the ones that suffer the most in a recession. They're the last to realize the benefits of an expansion. The Fed doesn't really have the best tools to get at that. David made the point earlier about they're going to kind of have to prove their credibility over time, right? And that's the danger of making a bolder statement about full employment objectives, which I'm extremely sympathetic to, is that they even lack of credibility even more than what they've done today.
Bell: Let me ask you, so on tools ... And David, we're going to come back to your ... In the chat, people are asking about credibility and we're going to come back to it. On tools, two questions. One is, I know you've thought a lot about tools. Three questions would be one, are there tools that they already have legal authority to do that they should be talking up more? Two, are there tools they should get legal authority to do that they don't currently have legal authority to do? And then three, my thing is should they be talking up more fiscal policy so everyone is socialized to the notion that we need fiscal policy to do more of the work? They could even call for more rule like fiscal policy, like automatic stabilizers or something like that. Anyway, do you want to take one or all of those?
Beckworth: Well, Sam, can I jump in? I want to go back to Julia's comment about do no harm. I think that’s key. I think that even if we acknowledged maybe that it doesn't have the tools that need, it still has the ability to do great harm. And the challenge is being able to let inflation rip, if it needs to temporarily, on the upside of a recovery. We want the economy to run hot. We want to get back to full employment. They want to have nominal incomes back to where they would be. And the danger, in my view, of this policy is it's going to be hard for policymakers, when we get 2% inflation, two and a half percent inflation, and pundits start crying out, the market starts worrying.
Beckworth: Congress starts worrying, and it may be hard for the Fed to do no harm. They might be tempted to raise rates. So I think even before we get to the question of additional tools, can they constrain themselves from raising rates, like they did in the past. And our hope is, this policy does that. But I'm still not sure this goes back to credibility, I'm not sure though. We'll have to wait and see when they go through a true test of inflation going up.
Even before we get to the question of additional tools, can they constrain themselves from raising rates, like they did in the past. And our hope is, this policy does that.
Coronado: That's fair.
Bell: We have another question from folks about credibility. David said a few times, one of the main problems of Fed right now is credibility. What is the main change in that direction with average inflation targeting, instead of inflation targeting? Do you think there's a significant change here in terms of credibility?
The Fed’s Credibility with Average Inflation Targeting
Beckworth: Well, let me speak to this since I brought it up, but I'm sure the other two would like to respond as well. The two big credibility questions I see is one, this policy, as we've alluded to earlier, under it, you have to sell higher inflation as a good thing. You're going to tell people, "Hey, I know you just went through a recession and come through a pandemic, let me generate a little extra higher inflation it'll only be six months a year, but this is what you need for a fix."
Beckworth: And they're constrained to do that, because this is under the framework of an inflation target. I think Skanda was alluding to, it'd be a whole lot easier if we just said, "Look, but what we're really aiming to do is to restore normal incomes, or your dollar incomes. And as a byproduct, maybe there'll be some higher inflation temporarily." And I think that's where credibility comes in. I don't again think, and I worry that the Fed, when it comes to this point, may back down and not do no harm.
Beckworth: The other thing, another concern I have about credibility with this is, average inflation targeting, the parameters around it aren't defined very well. And they even said in the statement, and I think Powell mentioned it that we still reserve all the discretion. And I think in this case it's actually detrimental. If you don't define well what average inflation targeting is, it leaves a big open hole to make it up as you go along and therefore you get back to what we already have today. One of the benefits of a pure price level target is it really does tie the hands of the Fed and says, "You have to get it back up." But the fact that it's so vague and uncertain, I think that undermines its credibility as well.
Bell: Yeah. I thought they were going to anchor around the Bernanke proposal, which is however many quarters we are at the lower bounds, we're going to make it up with quarters above 2% inflation. I'm probably butchering it a little bit, but he had some metric around that. But yeah they kept discretion. I wonder if that was like an escape clause for financial stability.
Coronado: Yeah, they did strengthen the financial stability escape clause. They had one in there before. They added some language that strengthened it a little bit. So, I think credibility comes on a number of fronts. So I agree with David, if you're going to be truly credible, it would be a lot more effective to tie your hands. On the other hand, you might not still be fully credible, because there are these other dimensions that they do care about. And there have been times when, all else equal, they still prefer to use non-monetary tools to address financial stability. But they get nervous when markets get super frothy and debt starts piling up. And I don't think that that's necessarily something they should take off the table.
Coronado: Those are how imbalances that can be very detrimental to full employment over the cycle can develop. So I think it's just inherent to the institution and how they make decisions, that there's going to be some squishiness. And I agree that the proof will be in the pudding. And I think Powell has acknowledged this too, that this anchoring of inflation expectations, is something… if they want to re-anchor them a bit higher, it's going to take some time. They are going to have to prove themselves.
Coronado: I do think that in effect, what they've done with how they look at inflation is, look unless inflation is coming from wages, it's not going to be persistent. Supply chain driven pops, energy price pops, they look through those, they've done it before. They'll do it again. But, I think Sam, you mentioned that that requires that the personnel is that technocratic, credible people that want the right thing for the medium term interest of the economy. And if we follow that tradition of appointing types of people, then you'll get that outcome, but there's no guarantee. So, at the end of the day, the Fed is a political institution tied to the whims of Congress and subject to some of that malleability over time.
Amarnath: To that point into what David was saying about the political language. I think obviously with the political alignment right now of you have Congress, that's not really criticizing the Fed for being overly dovish. I don't think you're really seeing that side from maybe a couple of senators, but generally speaking, under Trump's presidency, we've seen actually a more dovish Republican party and the Democrats have not gotten particularly critical of the Fed for being overly dovish either.
Amarnath: But I think you can see the scenario where this language sounds very tone deaf. Where you say, "We are shooting for higher inflation." I think this is where like part of the political credibility, central banks do not operate, they may be independent, but they don't operate in a political vacuum. So there still is political pressures. If we think back to 2010, '11, '12, where there was a lot of scrutiny of the Fed in terms of, what are you actually trying to achieve here? Are you trying to debase the dollar? Are you trying to just create inflation and raise my cost of living? Or are you trying to achieve something?
Amarnath: The actual thing, I think to your point about... The inflation pressures, and I think a lot of FOMC members who are dovish are thinking about, are the ones that are wage driven. The ones that are income driven, not supply chain issues that should fall out of the system in 12 months time. But I think it's worth being explicit about that, because otherwise I feel like we're also going to get back to square one, where we're going to be talking, it's not that hard to see a scenario where you see the faster inflation, temporarily. And the question is what should the Fed do about it?
Amarnath: I think the problem with the level targeting stuff… And I think this is why some doves even, I read a Brainard speech from earlier this year, Governor Brainard talked about how, "I prefer a more flexible approach." It's not because she wants to withdraw accommodation necessarily in those sorts of environments. But let's say we did get some excess of the price level target itself. Does that necessarily warrant tightening? I think it really depends on what we're talking about. What kind of price level overshoot are we really seeing? Is this the kind of thing that is idiosyncratic, transitory, or is it actually driven by some persistent pressure?
Amarnath: And to me, all of these linguistic and credibility problems really would be better hammered out by moving away from the inflation-centric paradigm that the Fed has fenced itself into. And then it really depends on who is the personnel? And I think that gets away from the whole notion of a framework, which shouldn't really be highly depend... Personnel always matters, but to the extent it really turns on, who's the Fed chair? Or, who are the FOMC members. Maybe that's a better way to put it. What's the composition of the FOMC? I think to make that count, and moving away from this framework would actually be helpful to our Senate.
All of these linguistic and credibility problems really would be better hammered out by moving away from the inflation-centric paradigm that the Fed has fenced itself into.
Coronado: Well, I think there's scope for moving in that direction. Skanda, I think, again, if our understanding of inflation dynamics and persistent inflation dynamics is ultimately rooted in wage dynamics, there is some scope for, maybe in the next five year review, you'll get your wish.
Amarnath: Yeah. One thing that I wanted to bring up, given some of the things both of you talked about, was the framework review was supposed to also discuss tools, whether the Fed had the right tools. And it really did not get a lot of attention. Powell didn't really talk about it in his speech. And yet I can go both ways on this in the sense that we just see now, unpredictably a little bit that the Fed now has all these new authorities under the CARES Act to really lend to more of the economy. They have fenced themselves in, by certain rules that say we have to lend at a penalty rate. We can't be too generous with our lending. Some of this is just really a function of their choice, so they could actually do more if they were creative enough.
Amarnath: But some of it also does reflect like, "Look, credit channel is not the same as it used to be." And so it's the question of, are there other ways to explore new tools? It strikes me this would be a much better emphasis of their time than trying to toggle with, I don't know, a handful of basis points on inflation expectations. If we're talking about moving it back up to 2%, or targeting 2.2 or 2.3% on core and headline PCE, I'm not sure where these inflation expectations, calibration exercises, is that really worth their time for the past 18 months relative to the toolkit discussion? I think it's important to at least discuss the strategy, but it has to be rooted in, "Do we have the right tools to do the job too?"
Coronado: Amen. Woo. They spent so much time fine-tuning this little average inflation targeting thing. And when push came to shove in the recovery, it was all about the balance sheet. 150% about the balance sheet. And the statement still says their primary tool is interest rates. No, it's not. It's the balance sheet guys. Hello? The balance sheet is primary and interest rates are a companion to it. That's how I see it, in terms of sitting in financial markets, what has had the most impact in catching the falling knife when the COVID recession hit and market seized up? It certainly wasn't interest rates. That was part of it. But the balance sheet and then the credit facilities. And they're still, Powell, they're struggling. That's a lot that they were asked to take on in a very short period of time. I'm very sympathetic to the personnel and logistical issues.
They spent so much time fine-tuning this little average inflation targeting thing. And when push came to shove in the recovery, it was all about the balance sheet. 150% about the balance sheet. And the statement still says their primary tool is interest rates. No, it's not. It's the balance sheet guys. Hello? The balance sheet is primary and interest rates are a companion to it.
Beckworth: For Julia, maybe for Skanda too, and Sam you as well, why don't we have more healthy discussions about the tools? Is that itself a product of the political environment? Is the Fed hesitant to go there? Julia, you have some great ideas.
Coronado: Yeah, so do you.
Beckworth: Yeah, but you've been thinking about this longer than I have, but why haven't we seen this more openly discussed? Is it a function of the environment, or what?
Rethinking and Expanding the Fed’s Toolkit
Coronado: I think that there's also a function of personnel and it being new and it's a new front. And the Fed tends to have been a more academically based institution, where they want a theory and some evidence to make decisions based on, which is admirable. I'm not discounting that. But naturally speaking, when things change very quickly, it's hard for them to adapt quickly. And Bernanke, boy to get to QE2, that was such a heavy lift on the committee. And the staff is still... Love the staff, a little behind the curve on balance sheets.
Coronado: Really thinking about it, thinking about how it interacts with financial markets, the different dimensions. They're now moving, some of the more recent staff papers are using [inaudible] framework, they're more flexible. They're more open-ended about the channels through which this all works, and how it coordinates with interest rate policy and forward guidance. But it was really, really amazing to me, during the review that that wasn't right there in the middle. And there was a little presumption, and this was on the part of investors too, that, "Oh, the next recession will be more like a garden variety of risk."
Bell: Yes, yes, yes, yes.
Coronado: It was complacency. And it's amazing how quickly complacency returns.
Bell: Yes. I remember a significant former Fed official saying, "We shouldn't just assume that the next recession will be as big as the Great Recession." I was like, "We should assume that. It might not be, but we should." But Julia, can you say a few sentences on your two ideas for new tools, recession insurance and your, I forget what you call it, the direct deposits to households.
Coronado: Yeah, yeah. So I have a proposal with Simon Potter, the former markets group head at the New York Fed, and you all know who Simon Potter is. So to create a system of digital currency, digital payment providers, that's one thing that we... One, I think that the Fed, and they are moving in this direction and Brainard's recent speech definitely I felt was a pretty big move forward on the thinking of the Fed should absolutely be on the frontier of digital technology and delivering the benefits of digital technology to the public. It can provide a more inclusive, lower cost, more efficient, faster payment system. It can create better financial stability as a result and a more inclusive financial system. So that's one prong of it, is they should embrace it, they should work diligently to put that into place.
The Fed should absolutely be on the frontier of digital technology and delivering the benefits of digital technology to the public. It can provide a more inclusive, lower cost, more efficient, faster payment system. It can create better financial stability as a result and a more inclusive financial system.
Coronado: And then that would facilitate, with the blessing of Congress, it would have to be authorized by Congress. And we have a construct of recession insurance bonds where Congress authorizes a certain percentage of GDP that the Fed can deliver into these digital accounts in a recession. So it's money rains. It's just helicopter money direct to consumers. This is not a new idea. It's just operationalizing it. Simon is excellent on operational and plumbing issues, which matters so much to getting policy right. And again, I don't think enough policymakers weight that as heavily as they should. So that's what our proposal is about.
Coronado: And to me, one, it does belong… this isn't fiscal policy. Look, if we got automatic stabilizers, a la Claudia Sahm's proposal, I'm all for that, 100% supportive of that. But at the same time, this is a different way to operationalize that and it is arguably the domain of monetary policy because why did we develop an independent central bank over time to take decisions with a medium term view, but based on near term circumstances? Because fiscal policy gets stuck in the mud, only in the most extreme circumstances, it's too little too late.
Coronado: And if the Fed could have jumped in and deposited $500 into everyone's account in mid-March, then they may not have had to go as far in buying corporate bonds and because the people would be insured, and that's ultimately what businesses care about anyway, is the risk to consumer spending and the real economy. So if you can insure the consumer better, and again have lots of guard rails and to limit the Fed's reach into this area, that's imminently doable. And then you can deliver… And it's monetary. Ultimately something like this is a contraction in the money supply and the credit channel working in reverse, it's very disinflationary, deflationary. The Fed's goal is to reflate to consumers. So that's the idea.
Bell: And Julia, it strikes me that one thing coming out of this crisis, I can imagine Fed staff or Fed officials being like, "We'd rather give that Coronado idea some legs," versus having to set up a permanent municipal facility or...
Coronado: Yeah, right.
Bell: It would be interesting if this experience makes them more wanting to do this based on... Yeah. Based on where they have ended up. I don't think they are happy about where they've ended up in terms of all the things they are-
Coronado: I can imagine they are not.
Bell: -engaged in. David, do you have reaction to this? Or...
Beckworth: Well, I have a similar proposal as Julia's. I mean, very similar in spirit. I will invoke my few chances you've given me just bring up nominal GDP targeting again, only a few times, but I'll bring it up now. So I like Julia's idea and I agree, only in emergencies with guardrails, with sign off from Treasury secretary, all the proper checklist, I think helicopter drops tied to something like a nominal GDP level target. So again, we're doing this, but in a systematic fashion to the point, and we keep doing it until we reflate and restore incomes to where they should be, not just a one-time shot. That's the problem with what we solve, these checks that were sent out. It's a one-time shot, depends on the mood of Congress, the president. We want a systematic and whole process in place. So yeah, I'm very sympathetic to what Julia has outlined.
Bell: What about your colleagues, Scott? I think he would say, "Forget all that. Just keep buying stuff. Buy everything that Treasury puts out there, you can buy it all up. And when you get done with that, you buy every single corporate issuance. And when you're done with that, buy whatever else paper is around." Is there a distinction there?
Beckworth: I can't speak for him, but what I would probably say is, and I would agree at this point, just having a level target in place could go a long way. So it may not be enough, but having a level target so you're putting the proper guardrails in place. But you could do a thought experiment, which this is not very practical. Again, I would refer to the more operationally sound stuff with Julia suggested. But you can do a thought experiment where if the Fed could do this, why not buy up the whole planet?
Beckworth: At some point we would see inflation and demand kick in, but there are political constraints that kick in. There are assets supply constraints that kick in. And so I think there's probably a practical limit, but you can see the logic of the argument. But like Julia, I propose what I think is a middle ground, a practical middle ground, where... And I like the way Julia frames. The Monetarist in me likes to think in terms of quantities and what she's proposing is increasing the monetary base to the point that the economy's reflating.
Coronado: And Sam, I will say to add to that, again, given what we know and what we're seeing in terms of the distribution of wealth, reflating asset prices just doesn't get the job done anymore. And we'd already seen that before this crisis hit. The wealth effect on consumer spending, which in the nineties was a big thing. And I was at the Fed in the late '90s, early 2000s, we ran our consumer forecasting models based on the wealth effect. It was three to five cents of every dollar would go into the economy over the following six quarters, or come out of the economy in terms of wealth losses. And it died. It actually absolutely died.
Given what we know and what we're seeing in terms of the distribution of wealth, reflating asset prices just doesn't get the job done anymore. And we'd already seen that before this crisis hit.
Coronado: If you run these models now, the wealth effect is zero because wealth is so concentrated and wealthy people save less and are less responsive. They buy what they want to buy regardless of sort of the fluctuations in their wealth. So that wealth effect on consumer spending is diminimous. And it doesn't matter if you break it out into housing wealth or financial asset wealth, it's basically zero.
Coronado: And so, it's already broken down. I think right now what the Fed's doing, it works very asymmetrically. It prevents a negative feedback loop. We all know that if asset markets were collapsing and the treasury market was seizing up, that would be unambiguously bad for the outlook. But now that we've got the S&P 500 at new highs and Tesla up, whatever, 6000% in a month, does that actually predict growth? No, it doesn't actually. So it's the impact of their policies through these asset price channels is very asymmetric and that's just not desirable over the longer run. I think we need to have a bigger, bluer sky discussion about tools.
Bell: What do you think, Skanda?
Amarnath: Yeah, I think that Julia's ideas for sort of being able to do sort of functional helicopter drops, I think this is where institutional frictions really do matter just by increasing the amount of bank reserves in the system alone. That doesn't necessarily translate into more spending in the economy, right? There's more to the causal chain that goes missing. So I think when you heard the Fed two years ago, the sort of party line was, "Well, okay, we'll be at the zero lower bound. That seems kind of scary, but we also have forward guidance, we also have the ability to buy treasuries and agency mortgage backed securities, and we're going to kind of hope it's fine and maybe we need to do this sort of framework review. Sort of like a way to kind of buffer inflation expectations, and then we'll have lower real rates when we're at zero lower bound. That's going to be the solution."
Amarnath: This is wholly inadequate for this kind of crisis, right? And that's why we also have CARES act authority that's in place to allow the Fed to lend broadly, get more directly to businesses, to state and local governments to some extent, right? So now they actually do have some authority. It's probably not and optimal form of authority. I think direct payments to households will probably be both the more neutral and more broad based. So it seems like that's probably more optimal tool.
Amarnath: You have seen that the Fed… there's just this comfort level with thinking about things purely in interest rate terms, that they think about it as the models are all designed around what is the optimal interest rate that kind of gets you to full employment or gets you to whatever u* is, whatever sort of is, it gets you to the inflation target or whatever goal you have in mind, that the interest rate is kind of the key metric to toggle with. And the Fed just seemed very comfortable that sort of thing.
Amarnath: The discussion moves to tools, it feels political. It feels greasy, and they don't really want to get their hands dirty, but this is actually the thing that mattered the most. So I think there is room for robust discussion of the income target versus having an average inflation target versus an income target versus a different sort of framework. I think that's a really big part of this, but also the tools that make this all possible. It’s just sort of striking to me that the Fed spent so much effort on this when we really should be talking about what kind of tools helped to achieve those goals too. And I think the Fed just got very comfortable with that.
So I think there is room for robust discussion of the income target versus having an average inflation target versus an income target versus a different sort of framework. I think that's a really big part of this, but also the tools that make this all possible. It’s just sort of striking to me that the Fed spent so much effort on this when we really should be talking about what kind of tools helped to achieve those goals too.
Amarnath: And it seems just a little bit dissonant when like Jay Powell is talking, this is right in the middle of a recession. We're in the middle of a pretty big crisis and Jay Powell asked to kind of explain sort of New Keynesian macroeconomic modeling about how we're going to get the real rate low enough to get the inflation expectations are going to sort of change if we commit to higher inflation, but we're not going to really commit. This is all very arcane stuff. It's not really clear that they [understand] how arcane the discussion is. It's actually as powerful as sort of it's being hyped up to be.
Bell: We make sure we're somewhat responsive to the comments in our YouTube chat. So Ernie Tedeschi, some guy on the internet. For those who don't know, Ernie is a friend of everyone on the program and the shadow Fed whisperer.
Coronado: And we cannot live without his labor market analysis.
Bell: And we can't live without him or his labor market analysis. And he asked, "Do you all think U-3 based NAIRU is now dead as a policy metric, or will it live on? Or will it be replaced by a broader measure or a basket of measures?" And this is, I'll take the-
The Future of NAIRU as a Policy Metric
Coronado: Like Yellen’s dashboard.
Bell: Yeah. Yeah, so Yellen had a dashboard, it's clear that from day one Powell sort of hated NAIRU. I think it was clear from day one. His first speech was about take taking aim at the stars. And I think he's been really dismissive, both in congressional testimony and his press conferences, about past estimates. But it's a very interesting question, what replaces it, if anything? So I'm curious. Yeah, I'm curious for everyone else to weigh in.
Coronado: Skanda has an idea, right Skanda?
Amarnath: I hope that u* is dead in terms of at least how it's functionally used in… I think you can make an argument that there's always an u* that's always that always exists if we have inflation too low, that means u*… We're not there yet. If you have inflation high, that means you passed u*. I have a post hoc analysis of what the natural rate of unemployment is.
Amarnath: But just functionally being the Fed, Jay Powell talks about this in his speech and I really enjoyed this part, which was these estimates kind of move grossly quickly, so we just kind of move them up and move them down really slowly so that the natural rate of unemployment, it's supposed to be the amount of structural unemployment and the economy or everything, it's not super bullish. And yet, this thing just moves around and we kind of just know what after the fact.
Amarnath: So then how much usefulness is there in saying, "Well, we know that the natural rate of unemployment is within... It's 5%." And then, oops, we actually find out later it's not. I find this to be a very backward way of thinking about maximum employment, right? And I think the changes suggest that the Fed's going to really think about employment from a standpoint of, there's obviously a problem when we have depressed employment when we do see these sort of asymmetric shocks and we need to address that. That requires addressing and I think that's all very good.
Amarnath: I think what's really weird about the last five years of 2010's expansion was that the Fed was talking about how unemployment is at risk of going too low, that we're actually going to have ... We need to get unemployment rate back up. And these are people who are historically considered more dove-ish, people like Eric Rosengren, Charles Evans, even ...
Coronado: John Williams.
Amarnath: … even into this direction that we've got to be worried about low unemployment because there is this sort of story that's been told.
Coronado: Bad things happen when unemployment gets too low.
Amarnath: Don't you see that we got unemployment really low in 1968 and '69? And then you started to see core inflation creep up and that's actually why you got the 1970s Great Inflation. Obviously, there are plenty people who disagree with that narrative, but it's a pretty powerful one within the Fed and within the institution about sort of the risks of keeping employment too high. And I think that they're getting rid of that, both in terms of politically, if the Fed wants to sort of maintain some political independence, I think that's important to kind of stamp that out, but also it's a very grim and incorrect view, I think, of how this is supposed to work. So I do think it's a positive. Whether it actually means the end of U-star, I think J. Powell is more dove-ish on this question than, say, the staff is. I think the Fed staff is more into the idea that we still have to find some sort of U-star to make these models work. And so ...
Coronado: It all comes back to the models.
Amarnath: Yeah. So I do think that it'll still exist in Fed models. It's not going away, but I think there's going to be more willingness to think dynamically about, okay, U-star is ...
Coronado: Oh, yeah. Inherently, the makeup strategy that comes in is a dynamic thing. Right? And so we've stepped decisively away from a Taylor rule, which even a forward-looking Taylor rule is kind of a spot estimate. Right? It's not as dynamic as thinking about things over the cycle. So we've stepped in that direction. I think, if you think about practically how the policy conversations are going to change with a de-emphasis of U-star I think we do start moving in the direction of talking about income and wages because what do we care about? How do we know where we are? And Powell was the one ... I mean, again, all kudos to Janet for starting this movement in this direction. And then Powell took it and that was the metric he said, like, "Look, we don't know what it is, but we'll know based on wage growth."
Bell: You have to see the heat to call it hot.
Bell: You have to see the heat to call it hot.
Coronado: You have to see the heat to call it hot. And so we're moving in the direction of our income target de facto, if you think about how this manifests itself in terms of policy decision making. When you're at the table and you're talking about, "What do we need to do to the setting of policy?" Well, where are we on the U3, the U6 participation, all the metrics on the dashboard and, at the end of the day, wage growth? And is it keeping up? Is it going beyond productivity? I mean, we never really got there in the last cycle. We were just starting to get there, not even really getting there. And so I think that the practical implication of stepping away is going to be powerful over time.
Beckworth: I hope you're right. And I think, again, going back to what's been said, it's difficult to know what these stars are in real time. I mean, you're playing God here. No one really knows these measures and that's another argument for nominal income or nominal GDP targeting. You kind of take a hands-off approach in the near term, but over the long run, you're still aiming for some kind of price stability, some kind of nominal anchor over the long-term, but in the short term, you say, "Look, we simply don't know. And we're just going to focus on stabilizing nominal income growth."
It's difficult to know what these stars are in real time... You're playing God here. No one really knows these measures and that's another argument for nominal income or nominal GDP targeting. You kind of take a hands-off approach in the near term, but over the long run, you're still aiming for some kind of price stability, some kind of nominal anchor over the long-term.
Amarnath: Yeah. I think this is sort of the market side of Powell showing up, as well, and that he is more mistrustful of latent variables ... That's what the whole 2018 Jackson Hole speech is about, "How am I supposed to know where any of these stars are?" And the kind of person who wants some price confirmation or some kind of evidentiary confirmation to say, "Okay, this is where the stuff is. So okay, if you want to keep your U-star and R-star-oriented models, it's fine, but there has to be some kind of check in real time for how we decide this stuff."
Amarnath: I hope the narrative that – the concern from Julia -- comes to fruition, I think, it'll be interesting to see how the Fed, as the personnel is involved in the Fed, what staff, FOMC members, whether they really take that to heart, whether they take it to heart that there is more to maximum employment than a low U3. There is more to maximum employment than a low U6. There is wage growth. There's all sorts of other measurements to sort of fold in. I think that, if we're really thinking about business cycle analysis and actually what totrack in real time, it hopefully will move towards something that's more like income targeting. Right?
Amarnath: That's a lot more reliable guide for where things are going in a way that ... I'm just afraid a little bit of, when we have this discussion, are we discussing wage growth or are we discussing income growth or are we going to end up discussing, well, cell phone prices, the methodology changed and all of a sudden go down that road. It can be a real false flag for what we should be focused on here. But it's very possible that all these sort of moves end up taking us to a much more constructive place. Hopefully, as I said, if we can get to de facto income targeting, that would be a big plus because the proof is in the pudding there.
If we can get to de facto income targeting, that would be a big plus because the proof is in the pudding there.
Bell: All right. We're coming to the end. I want to ask one question that's a little bit more specific. So if you look in the strategy doc that the Fed put out, they have basically ... Well, let me back up. There's this thing called the divine coincidence, which basically says we'll get price stability when we close the output gap. There's no conflict between our goals around labor market growth and price stability. And the Fed says, "Well, that's not always true." So I'll just read here. "The committee's employment and inflation objectives are generally complementary. However, under circumstances in which the committee judges that the objectives are not complementary, it takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate."
Bell: So here's my question and I'm particularly interested in David and Julia's answer. So we're going to take into account deviations and we're going to balance these kind of equally. We only have a target for one, not the other. How does that work? I guess, I'm curious, how should a layperson understand, when those two things conflict, how the Federal Reserve, which is this hugely powerful institution, sort of balances them against each other? Any thoughts on that question.
Balancing Inflation and Employment Objectives
Coronado: So it's trickier. I mean, obviously, that was one of the appeals of the sort of loss function framework that they basically had in words in the statement before was, "When they conflict, we will weight them equally and we'll calculate the loss and we'll weight it equally and a number will be set out as to which one." And that's the appeal of having a framework like that and that's the appeal of the modeling and all of that. It's much, much harder to not have those goalposts, but there's a reason we're stepping away from them. They led to mistakes. They led to significant policy mistakes and U-turns that hurt the Fed's credibility. And so there's no perfect solution to this. I think it's just...
It's much, much harder to not have those goalposts, but there's a reason we're stepping away from them. They led to mistakes. They led to significant policy mistakes and U-turns that hurt the Fed's credibility. And so there's no perfect solution to this.
Bell: We're back to Chairman Deng sort of crossing the river by feeling the…
Beckworth: Yeah. I guess, following up on what Julia said, it depends on personalities, how they interpret this. And Sam, as you mentioned to me in an earlier exchange, 2021 is going to be a big part of this story. Right? The person who is going to end up at the Fed. Who's going to be chair? I mean, all of this discussion today could be for naught if they get some different personalities, but we hope there's continuation and progress on this front, but people do play a role. This is the real world. Politics are real. So we have to keep that in mind when we think about it.
Coronado: Yeah, absolutely.
Bell: David, do you have parting thoughts for us on the framework, Powell's speech, anything else?
Beckworth: Yeah. I will quote the classic line from Dumb and Dumber. "So you're saying there's a chance." There's a chance for nominal GDP targeting. Again, this is a step, in my view, in the right direction. I think it would be hard for the Federal Reserve to do something really radical, like what I want, but I think we can make incremental moves in that direction. It's all about credibility in getting there.
Bell: You have five years to get New Zealand to not only adopt an NGDP target, but actually see it work out successfully.
Beckworth: I don’t know about that, Sam.
Bell: Julia, do you have any parting thoughts.
Coronado: I think that the next time that a congresswoman or man asks Chair Powell, "Do you have all the tools that you need to get the job done?" I think he should say, "Actually, I think a review of our toolkit would be a fabulous idea, not just an internal review, but a congressional review," and maybe some kind of commission or whatever and really, really think outside the box because I don't think that, in the world we live in of slower growth and lower inflation and all of this, that achieving their mandates is going to be easy with the toolkit that they have.
I think that the next time that a congresswoman or man asks Chair Powell, "Do you have all the tools that you need to get the job done?" I think he should say, "Actually, I think a review of our toolkit would be a fabulous idea, not just an internal review, but a congressional review," and maybe...think outside the box because I don't think that, in the world we live in of slower growth and lower inflation and all of this, that achieving their mandates is going to be easy with the toolkit that they have.
Bell: You heard it here first. The February Humphrey Hawkins is going to have fireworks.
Coronado: It's going to be lit.
Bell: Yeah. Skanda, closing thoughts?
Amarnath: Yeah. There was something David said earlier about the Fed playing God with some of these different major variables and we're going to talk about Congress' role in all of this. I mean, it does seem to me, while it seems like Congress isn't itching to get into any of these discussions, itself, it does seem like a part of what does a proper review look like of the Fed's goals and framework… should have some congressional and White House input.
Amarnath: It seems to me they have not really shown much interest in getting engaged in this discussion. I think there's a tendency to just defer to the Fed. Sometimes it's a good thing and sometimes it's not a good thing, but it seems like part of the process here, there is something a little bit ... If you look at other countries and how they go about reviews, this process isn't something that is done in a vacuum. The central bank just operates completely in a vacuum in deciding these goals.
Amarnath: And especially on things like the divine coincidence, is there just a point where, if we're at the inflation target, we're also at full employment? Is that actually how this stuff works? That's something that models have already predefined for you, but it seems like that's also inherently a political question, too. Right? So I do wonder what is the ... whether we see Congress try to say more, politics are going to change one way or another after this election. So that probably will color sort of what is the political feeling around what the Fed's done and whether the Fed needs to do more things in sort of any direction.
Bell: Okay. Those are great thoughts. I've really enjoyed this. And I thank Julia and David in particular for coming on. We're always interested in new ways we can communicate and new forums we can host. So if you have ideas, I think the best thing it to tweet at us. @EmployAmerica is our handle. And I hope everyone has a good rest of the week.
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