Gianluca Benigno on the Basics and Policy Functionality of R** and the Dollar’s Imperial Circle

As financial stability considerations become more important, using r** as a policy tool could play a key role in measuring financial stress throughout the macroeconomy.

Gianluca Benigno is a professor of economics at the University of Lausanne and was formerly a senior staffer and economist at the Federal Reserve Bank of New York, an economist at the Bank of England, and worked at the London School of Economics. Gianluca joins Macro Musings to talk about financial conditions in r**, his work on *The Dollar’s Imperial Circle,* and more. David and Gianluca also discuss the importance of liquidity in a New Keynesian framework, the origins and purpose of the Global Supply Chain Pressure Index, the “Global Financial Resource Curse,” and a lot 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: Gianluca, welcome to the show.

Gianluca Benigno: Thank you very much. It's of course a pleasure to join you and I'm looking forward to our discussion.

Beckworth: Well, it's a real pleasure to have you on. Now, I was familiar with your work and I became aware of you in particular with your r** paper that you did because all of us in macro are familiar with r-star, and when there was an r**, you're like, "Wow, that sounds exciting and kind of neat." And I think it's really relevant, Gianluca, because the Federal Reserve has really been paying a lot of attention to financial conditions recently, as it does monetary policy, and your r** is, really, I think, a metric, if I understand it correctly, kind of gets at that very idea. So I'm looking forward to talking to you about that.

Beckworth: But then the other connection I have with you is Jon Turek, who I've gotten to know on Twitter and online. In fact, originally it was going to be you and Jon Turek on this podcast, but now Jon's working for some big shot Wall Street firm, so he has to be careful of what he says. And you are no longer at the Federal Reserve Bank in New York so you can speak openly. So an interesting turn of events there that allows you to come on this show. It's great to have you on. I'm glad you're now in a place where you can talk about your work and share your views on current events. Let's begin, Gianluca, with your career journey, how did you get into macroeconomics? Maybe tell us a little bit about your time with the New York Federal Reserve Bank.

Benigno: I've always been interested in macroeconomics since my undergraduate studies in Italy. And then I continued in that direction during my graduate studies in Berkeley. I was lucky enough there to have as an advisor, Maury Obstfeld, and he is an amazing researcher, scholar, and he transmitted to me his passion for international macro, which is the field in which I've been working on the most during my career. I first joined the Bank of England, initially, at the beginning of my career. And then I went on doing more academic work at LSE. But I've always been interested in policy issues and policy questions. So I've been always in contact with researchers and staffers at central banks and policy institutions.

Benigno: And I was lucky enough, actually, to go, first at the Federal Reserve Bank of New York during the global financial crisis. I was there, I arrived in August 2007 when things started going up. And it was a fascinating journey, I lasted there just one year and one month. I left, I think, at the peak just after Lehman collapsed. It was an amazing experience. I loved it. But at the time I thought I should go back to academia and do more research, even though I always felt that it was an amazing experience being at the New York Fed. And then I was lucky enough to be invited to go back there a few years ago. And I think it was the best time for me in terms of policy experience because I was more senior. Of course, I worked closely with the president and of course other senior members of the Federal Reserve. And also it was the best time in terms of what was happening, the questions. Personally, I felt grateful to the institution and I benefited in terms of creativity and what came out of it.

Beckworth: So that's interesting. So you picked the two most stressful but interesting times to work at the New York Fed, the great financial crisis and March 2020, the meltdown, and then the pandemic after that. So you went in at a time when many people may have maybe shied away from doing that, but you went in right in the heat of the battle. So very fascinating.

Benigno: I also came to Switzerland and now there is the issue of Credit Suisse.

Beckworth: Oh, good timing.

Benigno: Good timing, yeah, too. I'm reading and learning a lot about that too, but-

Beckworth: Yeah, very fascinating. And you mentioned you worked with the president, John Williams, which is fascinating because as I noted earlier, you have a paper on r**, financial conditions r-star version, and your boss or your president, John Williams, is well known for his r-star. Him and Thomas Laubach have this r-star model that's used widely. In fact, many data services pick it up now. Of course they quit publishing it. We'll come to this in a minute. They quit publishing it in the middle of a pandemic because it was showing some really big swings due to the big swings, I believe, in GDP. But the interesting thing, you got to work with John Williams, you're there during eventful times. So did you get to go down and visit the gold in the vaults of the basement of the New York Fed? Because I've always wanted to talk to someone who's done that. Is that you?

Benigno: No, I haven't because of first, if I'm not mistaken, during COVID, that experience was not available. So there was a long period because the Fed actually was closed for quite a long time, I didn't go. And then at the end, I want to go back. So maybe there would be a chance. I mean, I’m staying in touch and working with people there, so there would be a chance, I'm sure, to go. I would love to.

Beckworth: I would love too sometime as well. So people who are listening at the New York Fed, we will plan a trip up there someday and we will make a visit to the gold vaults at the New York Fed. Okay, so you've worked at the Fed, you've done interesting work there. And while you were there, you've come up with several measures. I mentioned one, r**, you also came up with a Global Supply Chain Index, and we'll come back to that in a minute. But let's begin with this r**. And you had a paper titled, *The Financial (In)Stability Real Interest Rate, R**.* And you've also had several blog posts at Liberty Street Economics. I think there's one just recently... Well maybe it was a year ago, but you've had posts there as well on it. And you co-authored it with some colleagues. So maybe let's walk through and let's begin with a simple question, before we get to r**, what is r-star, the regular r-star? What is it?

Defining R-Star and its Policy Importance

Benigno: The simple way to define it is the interest rate that is consistent with macroeconomic stability. So it would be an equilibrium rate at which you are closing the output gap and there are no inflationary pressures. So that would be the way to think about r-star. And as I said it, I want to emphasize that I said macroeconomic stability. So that's where the idea came for from for thinking about r**, or r** as you say, we actually always call it r**.

Beckworth: I will call it that. Then I'll call it r** from here on out. Okay.

Benigno: That's what r-star is, yes.

Beckworth: And it was really popular, it seemed, or it became more important during the decade after the great recession, after the great financial crisis, because rates were so low. I just remember a lot of discussion about them. Remember Janet Yellen, this was a big deal. Where is the neutral rate? Sometimes they call it the neutral rate, the equilibrium rate, the real rate that leads to this macroeconomic stability. I remember she had a lot of conversations about it and speeches and I know different Fed officials, different Federal Reserve banks would have their own estimate of r-star and I guess John Williams, Thomas Laubach, probably the most famous one. But it was a big deal, I think, in part because we were in a low interest rate world and we wanted to know, is the Fed being accommodative enough? So I guess a key implication of this is if the Federal Reserve's target interest rate is different than the equilibrium or the r-star, then we are potentially creating destabilizing conditions. Is that right?

Benigno: I would say the standard way of thinking is to say that as you say, r-star is some sort of neutral measure for the interest rate. So thinking about the current interest rate, relative to r-star, you think in terms of the stance of monetary policy. What a policymaker would say is that to the extent to which the current real rate is above this neutral rate, you have a tightening or monetary policy is restrictive. On the other hand you would say that it is accommodative. But again, the old perspective there is just from a macro stabilization perspective.

Beckworth: Okay. And you would also say that, you look at that gap or look at the actual target federal funds rate in the case of the Federal Reserve, relative to the r-star, and that would tell you the stance of policy. Would you also look at the expected forward path of the two? So you look at the expected path of the r-star versus the expected path of the federal funds rate? In other words, we don't look just at the current rate, we look at where we think it's going to go in the future. Is that right?

Benigno: Yes. So that's the way to think about, more generally, the policy problem from a macro stabilization point of view. So you have a [inaudible] path in terms of how the current fed funds rate in real terms is relative to the neutral rate and to the extent to which you want to keep monetary conditions tight. For example, in the current environment, one of the messages that came out from yesterday’s press conference is the extent to which you want to have a restrictive… or tightening in terms of monetary policy. And that kind of concept is defined in terms of the relationship between the current fed funds rate and this equilibrium concept, which is r-star.

Beckworth: Okay. Now I mentioned Janet Yellen spoke about this a lot. Jay Powell did as well when he became chair. But if I read him correctly, I got this sense he began to lose some faith in r-star. He had his speech about navigating by the stars, Jackson Hole, 2018 and he said, "It's kind of hard to see some of these stars, if it gets cloudy, and maybe some of the stars are moving around.” And I believe that the historical context for that was the FOMC. The Federal Reserve was consistently overestimating, for example, where the u* was or maybe overstating where they thought r-star was. So the u* continued to drop down and that's the equilibrium unemployment rate. And consequently, similarly for r-star, they got their forecast wrong or they outlook wrong for it.

Beckworth: So my question then, Gianluca, is this, it's an important idea. I'm on board a hundred percent, I imagine most of our listeners are, but is it very useful? It's an unobservable variable, right? It's a latent variable. You have to estimate it. We mentioned the Thomas Laubach, John Williams… that's an estimated measure from a model. So how useful is it? And I want to ask you not only as someone who models it, but someone who was a policymaker, you were involved in the actual thinking through of monetary policy at the New York Federal Reserve Bank. How practical did you find it when you advised John Williams?

Benigno: I think as you mentioned, and correctly, it's a latent in variable, it's something we do not observe. So there is a [inaudible] estimation procedure that is behind that. And there are different estimations, too, based on different also way of thinking about it. There is a bit of uncertainty and as you can see, different institutions, and also within the Fed systems, there are different estimates that are put forward at every FOMC meeting. It is a concept that I think is useful to the extent to which you believe also that the underlying way of thinking about macroeconomics is correct. And in some ways I would say that the underlying way of thinking relies a lot on the fact that true changes in the interest rate, you are able to affect the macroeconomy and stabilize it around what you think is the right objective. So in that sense, I think it's useful.

Benigno: It requires always, all these concepts in some ways put faith on some background, which is the way you think the economy works, that works. And I think that's the extent to which they're useful. Personally, I do think it that would be important in an institution, in central banking, to have more diversity of opinions and views in terms of how things work. Because otherwise we all tend to rely on the same framework, the same way of thinking. And that might lead, maybe, to mistakes. That happens because the economic environment changes and [inaudible] changes.

Beckworth: To be fair to any macro view of the world, there is always some unobservable variable. So I'm pushing, I'm picking on r-star because it is an unobservable and I do think we need to have some humility because we don't know in real time exactly where it is. But we have an idea and we can look across a number of models as you said, maybe come up with a median measure and use that as a guide, but we really don't know in real time. I think that is a fair critique of standard macro, the new Keynesian paradigm. But if you take any other paradigm, there's also an unobservable. I'm somebody who likes to take money seriously. There's a little bit of monetarism flowing in my veins here and I want to get to a paper of yours where you actually take money seriously in a new Keynesian model or at least liquidity in the new Keynesian model.

Beckworth: But even if you take a monetarist view, there's an unobservable that you’ve got to know. You’ve got to know real money demand and we don't know what real money demand is in real time. So it's also a problem. If you take the fiscal theory of the price level, if that's your model, you’ve got to know what the net present value of real primary surpluses from the future are. We don't know that either. However you want to slice this, there's always going to be some unknown, unobservable variable that you're just estimating and plugging it in and hoping that's the best measure. We need to have some humility but also understand everyone has the same challenge.

Benigno: I agree. Yes, there are two dimensions. One is the fact that there is faith in something, in a model and also within that, you know, you have to know something that… or estimate something or make assumptions on something that is not observable.

Beckworth: Yeah. Okay, so all of that is a lead up to r**. Okay. We've been talking about r-star. So tell us about r**.

Breaking Down R** and its Policy Functionality

Benigno: r** suffers from the same problems that we just discussed, but I think it is an interesting concept to think about something that is currently relevant and also has been relevant, of course, in the past, which is the idea that there are issues at times in terms of financial stability. And the idea of r** is very simple, which is to say, how can we measure financial stress? And the idea is to say we want to measure this financial stress in the interest rate space, in the sense that we want to have a measure that can be compared with the fed funds rate and also with the r-star as well. Because to the extent to which we move the fed funds rate can have implications not only for macro stability but also for financial stability.

Benigno: So that's the very simple idea of r**, how we can translate financial stress into a measure that is... And a measure that we can relate to a policy instrument, which is the interest rate. So that's the very simple idea. It came out from meetings, internal meetings, at the New York Fed. So it was a discussion on how interest rates and why interest rates are low. Low interest rates might create issues in terms of financial stability. And the idea is to say, we can't say if low interest rates are bad or good, we need to have some sort of benchmark. And our benchmark is this concept of r**. That's the idea.

Beckworth: It's very interesting because you developed it in the context of low interest rates and concerns about financial instability, financial asset prices probably getting out of hand. But today it'd be maybe the opposite. Are we tightening too quickly, too much? Are we going to create financial instability on the other side going down? Let me ask this question. How would you apply... Could you take r** and, say, plug it into a Taylor Rule? The Taylor Rule you have, that first term is like the neutral rate. Would you feel comfortable using it in that context or just something else? How would you put it to use in a policy sense?

Benigno: There are few ways in which you could use it. First of all, what we do in the work is that as we were discussing earlier, we have the model to formalize and conceptualize this idea and the model is limitation. So the important aspect that comes from our analysis and will be released actually pretty soon in a working paper, a new version, is that we can measure it somehow in a way that we discuss in the paper, but of course any faith in the model in making assumptions in terms of observables as well. But the point is that we come up with a measure and how can we use it from a policymaker point of view. There are several ways in which you can use it. The first is to think about where the current policy rate is in relation to what we are measuring, and that gives a sense of the policy space from a financial stability point of view. Because what can happen is that if you raise rates beyond a certain threshold, which is this r**, you might start experiencing episodes of financial stress.

Benigno: So that's one way to think about it. But there is also another way which you can think about it, you can use this concept to make policy scenario analysis. So for example, you can try to see how different paths for the policy rate, what the Fed controls or the ECB controls, have implications for r** in the sense of [inaudible] regional financial stability or instability. So that's one way to think about that as well. So suppose we put in the current policy path of the ECB or the Fed or the Bank of England, then we can try to see what is the implication of that in terms of our financial stability interest rate. So that's one way to think about that. I wouldn't use it as a way to limit, if you want, or to design a policy rule, per se. But maybe if I think in terms of some sort of amendment of the Taylor Rule, as you're saying, I would say that that could be fought to the extent to which you don't want to create financial instability as some sort of threshold that you put up there. It's some sort of boundary that you have.

Beckworth: I've seen Taylor Rules in the past that they're normal and then they'll add like a measure of credit conditions, like another term. So this strikes me again, I may be off here, but this strikes me as another way to do that. You can do a Taylor Rule and just call it a financial stability Taylor Rule or something like that where that first term, that neutral interest rate term… and it's typically a nominal neutral rate so you would have to add some inflation expectation to your r**, but you'd plug that in there, it would get at the same spirit of things. And I understand what you're saying, at a minimum you could use it as a benchmark and compare where the path is actually going. Let me ask this question, Gianluca. So let's say we look at a world of barter versus a world where there's money. One way, at least, that i'm thinking about this, and again I may be wrong here, but in a barter world where there's no money, no liquidity premium, regular r-star is good enough, but a world with liquidity, financial risk, you want to look at r**. So the real world, I mean, in the real world, we need r**... I guess maybe to ask the question this way, if we look just at r-star, we could make a policy mistake because r** might be telling us something additional. Is that right?

Benigno: Yes. I think nowadays, in the world, it is becoming more and more relevant to look at measures of financial stability and r** is a concept that talks exactly to this issue. I would say that one way also to think about it is the following; suppose that we want, as a policymaker, to target r-star because we want to reach macroeconomic stability. One problem would be the situation in which r** is below r-star. So that, in that journey towards targeting macroeconomic stability, we eat financial stress. So that is a problem that is probably of current interest, I would say, because currently, macroeconomic stability, especially in terms of inflation stabilization, may require further tightening and the further tightening might be problematic or is being maybe already problematic in terms of financial stability consideration. So that's the important issue.

Benigno: And I would say also something else in reference to what we were saying earlier, the fact that most of the time when we think about the macroeconomic effect of interest rates, we tend to think very much in terms of the context of the new Keynesian framework. But in that framework, the baseline of course, and then there is a lot of work that it extended it, but the financial aspect, the financial factors are a sideshow and are neglected. But I would say that, probably now, we are in a situation in which the interest rate, in some ways, seems to have more implication from a financial stability perspective as opposed to a macro stability perspective. And let me say something more on this, I would say many times policymakers say that the interest rate operates and affects the most interest rate sensitive sector and many people think about the housing sector, but what I would say is that maybe it's the banking sector that is the most interest rate sensitive sector and that is telling to the extent to which maybe the financial stability channel through which interest rates work seems to be more important at times than the macro one.

Beckworth: So if we looked at r** right now, it would be very different, maybe, than r-star because in the US at least, we're seeing banking turmoil, financial stress. So it'd probably give you a different prescription for the target path than r-star, is that right?

Benigno: Yes, that is a possibility. That is something, definitely, that we can see some ways. In our research agenda we want to investigate all of this further. But this is where we're going, we want to understand more the relationship between financial stability and macroeconomic stability. And we want to understand also the relationship between r** and r-star itself, too. Because what happens also on the financial side might have an implication in terms of how you might want to stabilize the economy looking forward. So, there is a link between the two. This is something that we plan to address.

Beckworth: Yeah, that was my last question. We’ve got to move on because you’ve got other fascinating stuff we want to talk about. But my last question was that, it seems to me that to some extent the regular r-star is going to be endogenous or at least influenced by what happens with r**. If you have a severe recession, say 2008, and it's financial, then r-star's going to go down eventually. In other words, maybe put it this way, is r** a leading indicator of where r-star is going to end up going, maybe in extreme financial situations?

Benigno: So what I would say is that there are two-way interactions between r-star and r**. Currently, in our work, what we have studied is one-way interaction. So the interaction that goes from r to r**, but we haven't looked at the other… So what we can say, which I think is relevant for what is happening or has happened in the recent past, is that when we have a regime of very low interest rates, these persistent regimes of very low interest rates tend to lower r**. So over time we see that the longer interest rates are low, the more r** becomes lower. So in some ways low interest rates, the way I say it, tend to reduce the space for policy because r** becomes lower. So monetary policy, low monetary policy, constrains itself in the future.

Beckworth: Okay, Gianluca, I want to go from that point you've made and jump ahead to a paper, and we'll spend a few minutes on this, but you have a paper, *Interest, Reserves, and Prices.* You were talking about the standard new Keynesian model and in this paper you add this perspective that liquidity matters as well. The standard new Keynesian model, it basically takes anything that's related to money... There is a money demand equation, but it kind of drops it. Money's not important. It's unnecessary, let's leave it out. And it's always been interesting to me because I've read people like Bennett McCallum, Edward Nelson, they would also use the new Keynesian model, but they would always stress, "Look, you can't ignore that money demand equation because over the long run, that anchors inflation." The Phillips curve is good for the short run, but long run... But you add another, I think, argument, if I read your paper correctly, you’ve got to expand that expectational IS equation to include liquidity because it can also have a bearing on short term output. Is that right?

The Importance of Liquidity in a New Keynesian Framework

Benigno: That's very correct. So the motivation for that work was indeed to try to think more seriously about how quantitative easing or, nowadays quantitative tightening, work. The standard new Keynesian framework was silent about that. Then, this is a work with my brother who's also an economist. We try to address this issue and we do that by thinking about central bank's liability of reserves and other liabilities in the real world as liquidity, and that provides utility. That's the idea. It's a bit of a shortcut somehow, but it's one way in which we can bring back these important, I think, elements into the analysis and try to see how those shape the functioning of the macroeconomic stabilization point of view. So what I want to stress in relation to that work that is a little bit of a first step and try to think about these issues, but there too, I think there is a lot to work on and to learn and there are several researchers that have started and have been working on this in past years in terms of thinking about these issues because that is also to do with the size of the balance sheet, what is the optimal size of the central bank balance sheet. The interaction between the policy tool, balance sheet policy tool and the standard interest rate policy tool. And also, which is not just a sideshow there, but is part of the problem, is the role of fiscal policy as a supplier of liquidity.

Benigno: There is a lot there in terms of elements and as I said, it's a first step in terms of understanding these issues. But what I want also to emphasize is when we think about this, for example, we abstract from what we just talked about, which are financial stability considerations, which can be another dimension through which all of this plays a role. And I do believe that, for example, when we think about quantitative easing or quantitative tightening, it's very important to keep in mind the role of liquidity for financial stability considerations as well. So, going back if I may in terms of the analysis that I was doing earlier for r**, one aspect that is important is that the vulnerability of the financial system depends indeed on the amount of safe assets that intermediaries have, and to the extent to which these safe assets decline, that vulnerability increases. So here we start seeing how that relation between policy that limits the supply of liquidity might have on financial stability considerations. So that's an important aspect to keep in mind when we think about that work.

Beckworth: Now you've done a lot of work on safe assets as well, and I'll use that as a segue. I'll jump ahead and again, we'll come back to the Global Supply Chain Index. But since you brought up the safe asset question, you've had some really interesting work over the past decade on this issue. I'll mention a few of your papers here. And by the way, that was really fascinating to learn that your brother is also a macroeconomist. It must be fun when you guys get together and you talk shop, you visit your family, your parents probably get tired of you talking about macroeconomics over dinner.

Benigno: We never talk about macroeconomics when we are together, just on the phone actually.

Beckworth: Okay. Alright, but you have these papers that speak to safe asset issues or issues surrounding them. You have a 2014 paper called, *The Financial Resource Curse,* another one, more recently, *[The] Global Financial Resource Curse.* If I understand them, you're viewing the US as suffering from a form of Dutch Disease almost, because we are the provider of safe assets to the world. So maybe walk us through the arguments in those papers and why is it important?

*The Global Financial Resource Curse*

Benigno: Yes, you summarize it perfectly. In particular, in *The Global Financial Resource Curse* paper, what we highlight is a form of Dutch Disease to which the United States is subject to, and this arises because of the special role that United States has in the context of the international monetary system and [its] ability to attract capital flows. The byproduct of that is to finance [its] big or relatively big external trade deficit. So what does this create? It create some sort of exorbitant duty from the perspective of the United States in the sense that in the medium run they suffer the consequences of these big deficits in terms of lower productivity. And this lower productivity translates into lower growth and also a low equilibrium real interest rate.

Benigno: So the idea that comes from the paper is that… or the outcomes that come from the paper is that these external imbalances put pressure on the interest rate and tends to make global interest rates lower to the extent to which United States is the leading country in terms of the technological frontier. So that's a summary, a bit of that line of work. So it combines the central role of the United States with these imbalances that create an outcome that generates low productivity and low equilibrium real interest rates. So it somehow is a factor that could also help in explaining why low interest rates have been there for a long time, actually.

Beckworth: So it's interesting you called this the exorbitant duty as compared to what in the past we called the exorbitant privilege. So the privilege says, "Oh, we get this cheap financing, we get people paying for our deficits," but the flip side of that is an exorbitant duty that you outline in your paper. And this begs a bigger question, and I know you don't really get into this, but is it worth it? Is a trade-off worth it? Is that something you want to speak to or do you want to-

Benigno: It is something that requires examination in some ways. I think it is important because of course there are benefits in some ways from financial integration, but there are also costs and sometimes these costs have be neglected, more generally speaking. And what we offer in the paper is one perspective in which there might be a medium run cost associated with financial integration in terms of lower growth from the perspective of the United States. So there are trade-offs out there. And currently the whole discussion in terms of fragmentations, and coming maybe more from geopolitical consideration, I think it's important in terms of thinking that there might be trade-offs there too.

Beckworth: One last question on this area, so an implication of it as you mentioned, is the low interest rates being driven by the demand for safe assets, do you think this is going to continue to be an issue going forward? So we've had high inflation, rates temporarily have gone up. For the past decade prior to the pandemic, we were used to these low rates, to this phenomenon you described in your paper. And there's some debate today whether we'll return to it. So Olivier Blanchard thinks we will return to it, Larry Summers says "No, it's over." Do you have any thoughts on that? Are we going to return back to this Dutch Disease problem once we get to the other side of the pandemic and the inflation?

Benigno: The way I think about this Dutch Disease problem is something that is a relatively slow motion type of effect. It's just something that is there to the extent to which there are these external imbalances in the United States, is running trade deficits. That effect is there and is present and put pressure on low interest rates. And there are other secular forces even more secular than this effect that are playing a role on low interest rates. But of course, in the short run, there are other factors that are affecting equilibrium rates that can be relevant in terms of policy. So that's the way I think about this tension between these two arguments. There's slow motion factors that are still there, but there are also other forces that are shaping the current environment.

Beckworth: Well, I’ll lay my cards on the table. I think those slow-moving secular forces are going to return us to a world of low rates and probably low inflation as well, eventually. You mentioned safe assets, demographics, new regulations from Basel III, all those things I think are going to put us back and a few years from now we'll be discussing this very issue again more in depth. Okay, let's go back to the thing I was talking about earlier, the Global Supply Chain Index. That was really neat. You published that and you showed early on that this index did a good job of explaining, for example, producer price index inflation or the CPI goods inflation. Tell us about that measure and how did it come about?

The Origins and Purpose of the Global Supply Chain Pressure Index

Benigno: It came about because we were preparing some internal work and what we were thinking is about... As an international group we were thinking about what was running inflation globally. And there was a lot of discussion, more anecdotal, but was very lively in terms of supply chain disruptions. And one of the issues when we were looking to that was to try to understand how to measure that because we wanted to have an assessment of how these factors matter for explaining the behavior of US inflation, which was the focus of our analysis. One thing we noticed is that by looking at different reports and what was out there, people use different measures and then they make things complicated. But everything that we look at seems to have a say in terms of capturing an element or a dimension of the supply chain.

Benigno: Our idea there was pretty simple, and is to say, "How we can combine all these different aspects in one measure that could be helpful in summarizing what we are observing?" And that's the Global Supply Chain Pressure Index. It's just a device that combines the information that comes from different sources globally and gives us a sense on the extent to which we have disruption from a supply side perspective at the level of the global supply chain. Now, when we were thinking about that issue, it was in the middle of the pandemic, it was towards the end of 2021, or maybe in the middle, but well into the pandemic. The idea was to say, well, what is happening is that the people cannot go to work, factories have been closed, how can we capture all of that? We wanted to identify, really, the supply dimension of this problem. So that's why we call it a Global Supply Chain Pressure Index because the idea was to put out the demand component from all of our indicators that we use in the construction of the supply chain and say "This is what matters for different measures of inflation." And in our analysis that we published in a few blogs, we are looking at how this indicator is important for, in particular, I would say, as you noticed, the PPI and the goods price inflation.

Beckworth: And that makes a lot of sense. The early part of the pandemic can be thought of as a supply side inflation, these disruptions to production, to ports, to getting goods to the market. But if you look at your measure now, it's come down a lot, right? It's actually, I think, negative or it's dropped below the pre-pandemic level. Can I interpret from that that the inflation we're still seeing is probably more demand-driven now, whereas the early part of the inflation was more supply-side-driven?

Benigno: Well, what I would say is the following, is that it is correct that supply... that the element of disruption that you capture to the index is now negative. And indeed I would say that if you look at goods price inflation, which is quite associated with that index, we see that that has moderated significantly, and I would say is also negative. We start seeing negative, at least, month to month data on that. And that matters... In terms of your question, when you think about this dichotomy between supply and demand, I would say that the first part is definitely supply-driven. I personally thought back then that there was also a demand component, which is important in the US. It was driven by the fiscal policy element.

Benigno: I wanted to capture that too. The problem is that when we look at it, the fiscal policy did something so big relatively speaking to what was happening before that it's hard to pin down in the way we're doing it from an econometric point of view. But in terms of what we experienced, I think that played a role too along with a shift in demand towards goods as opposed to services in the first part of the recovery. And now we are in the other side in terms of demand going more towards services, so we are seeing that. But my colleagues, ex-colleagues at the New York Fed, had a couple of blogs in which they also show that there is propagation of this factors to services inflation. So it's not just good inflation, but of course there are second round effects to the extent to which certain prices increase and propagates also in another sector. And that is, I think, part of what we have also seen recently, that eventually would hopefully moderate later on. That's the way I would think about it.

Beckworth: Okay. In the time we have left Gianluca, I want to get to the article that originally motivated me reaching out to you and that is your article, *The Dollar's Imperial Circle,* and you co-authored it with a number of people including Jon Turek, but really fascinating because I'm familiar with all the dollar dominant literature. What your article brings out is its real interaction on the real side of the economy through manufacturing and stuff. So walk us through the argument you make in that paper.

*The Dollar’s Imperial Circle* and its Potential Policy Implications

Benigno: First of all, I want to say that for me, working on the paper was a lot of fun and it was a lot of fun to work with Jon and I need to reach out to him too, now. We met each other, actually, on the internet via Twitter and I read his blog on the Imperial Circle too, and I found that a fascinating blog. As we were developing a new DSGE model, in the international group at the New York Fed, I thought that we should develop it in such a way to capture that description of what is going on that I felt was very eye opening for me in terms of the role of the dollar and how that shapes the global manufacturing cycle and the self-implication for the US economy.

Benigno: In short, the paper is actually... it captures a relatively simple idea and the idea is that the dollar comes... And that many people emphasize it as a dominant currency. What we are saying is that [it is] not just the dominant currency, but is a dominant macroeconomic variable. And this part here is somehow well known in the sense that it's known how the dollar has an impact on the global manufacturing cycle and on global commodities. But what is interesting and what we want to emphasize in the paper is that that is not just the end of the story, but there is a circle to it. And the circle to it is that these fluctuations in the dollar have also implications for the US economy, in the following sense that what is interesting in particular about the international monetary system is that while the US economy is becoming relatively smaller in terms of its role on the global growth, its size relatively to other countries, the role of the dollar is bigger.

Benigno: What's happening is that as the world economy suffers from a strong dollar, at the same time, that creates further appreciation for the dollar because the US economy is the one that is less exposed to the dollar. So this mechanism, as we say in the paper, is a self-reinforcing mechanism or this structure creates a self-reinforcing mechanism in terms of how the dollar affects the world economy. So there is amplification coming from this asymmetric structure. So for example, we think about what has happened in the current tightening cycle, we see that the dollar has appreciated, so that impulse coming from the Fed generated appreciation, but paradoxically who suffered the most, [inaudible] from this appreciation was the US economy. It says that this is the one that is less exposed to what's happening globally. So that's the story. So it is imperial because it governed macroeconomic outcomes worldwide and it's a circle because the dollar circled back to the US economy in this way. So it's a way to describe the functioning of the world economy from a real side point of view through lens of the dollar.

Beckworth: And that was new to me too, is seeing it through the real side of the economy, how the dollar interacts. Because I've heard lots of stories about how the dollar cycle gets reinforced and is procyclical from the financial side. So the Fed tightens, for example, the dollar appreciates, causes financial stress overseas and they cannot finance anymore in their own currency so they borrow more in dollars, so now they're more dollar indebted and then it comes back and makes them more susceptible to future dollar tightening. But you're telling a story where that circle works through manufacturing and because the US is less exposed, more service-driven, that it definitely does better and therefore the dollar gets stronger. So it's a vicious cycle. It just reinforces itself and continues to be a problem. Are there any policy implications to this? Because it's a global phenomenon, right? Is it just observing what is happening or [are] there any implications for policy?

Benigno: I think that one of the key policy implications or the possible discussions that comes as... many times when it comes to the dollar is the idea that there has to be some sort of cooperation. But what I would say is that our framework, in some ways, points out at how complex the issue is, and thinking about cooperation in this very asymmetric world is not that is easy. I also want to stress, as you emphasized, this is just one dimension along which the dollar operates in the international monetary system, but there is also another dimension which is financial, which is even stronger in some ways, and that also requires further thinking.

Benigno: We are actually working on that dimension too, the financial side dimension. So we plan to, soon, some workout in which we discuss the role of the dollar also from a financial side point of view, keeping into account these key asymmetries because we need to think about these key asymmetries. And most of the time, I have to say, in international economics, we always do analysis. Say there are two countries, and most of the time they're asymmetric and this happens, that happens. But the world is very asymmetric and when we need to think about cooperation and all of this, this is something that we need to keep into account. It's not easy to say cooperation and the dollar is definitely a fascinating topic from many perspectives. This is the real dimension [inaudible], the financial one that you highlighted before and the implication from a policy point of view, and what the Fed has done recently in terms of the swap line and the FIMA Facility, are a byproduct of this complex interaction. And it's a super fascinating topic also that is combined with financial stability consideration when we think about the dollar funding issue, deviation from covering interest rate parity, regulation. That has all played a role through these complexities that I just highlighted.

Beckworth: And this explains or at least helps explain why you can have a strong dollar in the US over the past few years but also have high inflation, or why the economy hasn't slowed down. So the strong dollar is affecting the rest of the world, but it's not really having the same bearing here in the US. The US economy continues to grow, so very fascinating. One last question on this, Gianluca, and that is, as a former Fed official and someone who's worked in the policy circles, it must be a little frustrating when you think about international coordination as one potential solution and you realize the Fed really only has a domestic mandate and politically it's hard for the Fed to say, "Hey, I want to keep in mind the effect the dollar is having overseas," or "I'm going to try to keep in mind my interest rate hikes and their bearing on economies overseas,” because it's hard for them to do that. They've got to think domestically and Congress is on top of them to take care of the US economy. So there is this tension between external balance and internal balance. Is that something that you think about when you wrestle with these issues?

Benigno: I always thought as an international macro that it's important to keep this interaction in mind. When it comes to the Fed, I agree with you, there is a lot of focus on what's happening domestically most of the time. I would say that as the world economy has changed in the past years and the role of China is becoming more and more relevant, of course there are other important considerations that are also looked at and always kept into account, they're out there, but the Fed mandate is domestic in nature. But what I would say based a bit on this paper through the dollar, but also the further work we're working on, the Fed is global, that is important. And this is super important, also, I think, in terms of thinking about the current tightening cycle because the Fed does its own tightening cycle, but that has implications for what happens in the other economies. Other policymakers… this is obvious for emerging markets, but also for other advanced economies, [they] cannot just leave it out there. They need to keep that into account. For various reasons, the first one is to the exchange rate, but also to other complexities that have to do with international financial planning, which is super relevant and demand responsive. So the Fed has a domestic mandate, but the Fed is global.

Beckworth: And maybe the best way to look at this is the Fed, when it sets policy, when it does this tightening cycle, it does think domestically. But because it does influence the global economy, it has set up all of these dollar swap lines, its FIMA Repo Facility, all of these things have to be put in place because if the Fed doesn't do that, the dollar system globally begins to go down, struggle, and it can feed back into the US economy. So the Fed is cognizant of it, it's not like the Fed isn't aware of what's happening, but it's also constrained politically. So these facilities, I think, play an important role in filling a gap there.

Benigno: They're crucial, I agree with you. These facilities are crucial and they're addressing these feedback effects that might come from the complexity of international financial integration and the role of the dollar in particular. So that's what is happening.

Beckworth: Okay, well, with that, our time is up. Our guest today has been Gianluca Benigno. Gianluca, thank you so much for coming on the show.

Benigno: Thank you very much and my pleasure.

Photo by Angela Weiss via Getty Images

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.