Jeanna Smialek on *Limitless: The Federal Reserve Takes on a New Age of Crisis*

The Federal Reserve has already evolved considerably throughout the 21st century, and the role it now plays in the macroeconomy is more critical than it has ever been.

Jeanna Smialek is a reporter who covers the Federal Reserve and the economy for the New York Times, and is the author of a new book titled, *Limitless: The Federal Reserve Takes On a New Age of Crisis.* Jeanna is also a returning guest to Macro Musings and rejoins the podcast to talk about her book and its implications for the future of the Federal Reserve system. David and Jeanna also discuss the credit allocation vs. liquidity support debate, the Fed’s definition of price stability, the Bank Term Funding Program, 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: Jeanna, welcome back to the show.

Jeanna Smialek: Thank you for having me.

Beckworth: Well, it's great to have you back on. And of course we follow your work in the New York Times, you're on the Fed beat. You also write columns about the economy, a lot of interesting things have been happening. And you have a new book out. It's an interesting read, and I know you've given a lot of talks already on this book. You've been on the speaking circuit going around talking about the book. And I guess the first question I have is: why write the book? What motivated you to do it? And then maybe tell us about how you did it, because I know you're a busy journalist. How did you find time to write a big book like that?

The Background and Motivations for Jeanna’s New Book

Smialek: Yeah. I had the idea for the book right at the start of the pandemic in 2020 because I think it's sort of faded into history now, but the Federal Reserve, it's really wild stuff right at the start of the pandemic. Some things that as a Fed journalist who had covered them for years at that point, I certainly wouldn't have expected them to do some things that I think they wouldn't have expected themselves to do, some things that they had pretty aggressively said they could not do. We saw some pretty interesting actions and I just thought... At the time, it was early lockdown. I was in a cabin in the middle of the woods covering all of this because we were all in stay at home mode and I was just thinking, this is going to forever change what the Fed is in our society. This is this moment that's just going to shift the relationship to the rest of the economy, to the rest of our democracy in a pretty fundamental way. And I thought that that was something that would be interesting to capture as a book.

Smialek: The book obviously evolved a lot over the time that I was writing it because when I was first writing it, we're in this sort of low inflation, low interest rates are here forever era. And then by the end of writing it, we were in a much higher inflation, maybe low interest rates aren't here forever era. Things shifted pretty drastically. But I actually think that that made for a fuller and more interesting book than I otherwise would've written. A lot of it was just kind of trying to balance the rewriting, making sure I was incorporating all of those new ideas and new developments into the writing as I was going. I didn't actually take a book leave, so I just kind of wrote it as I was working, but that actually worked out pretty well in the sense that this is what I cover on a day-to-day basis. So a lot of the stuff that was happening because I was at work and really had this front row seat to what was going on, I think it actually allowed me to give it a really sort of full and in-depth treatment that would've maybe been a little harder even if I were a little bit more removed.

Beckworth: So let me read a quote from page seven where you summarize the thesis, the central point of your book, I think very well, you say, "The Fed has fundamentally changed since its founding. A slow burning evolution that sped up in 2008 and came fully to bear in 2020. Now it is essential for democracy that the public understands just how far the Fed's authority reaches." So as you've traveled around, I know you've given talks on the book, you've done other podcasts. What has been the reception to this message of your book? Are people shocked? Are they aware of it? Are they bothered by it? What's the sense you get from it?

Smialek: Yeah, I think one thing that's been really interesting to me is, I talk to a lot of people who are pretty expert on the Fed and even some of them hadn't been quite aware of just how much the Fed could do and how much it could have done. I think a lot of people thought that some of the things it did in 2020 was enabled by Congress or had been enabled by the Treasury. And actually, legally, that wasn't true; it was that a lot of those things were sort of more Fed centric than I think people even sort of close to the matter understood. I think that was one really interesting takeaway. And the other one was just, I think at sort of a popular level, there actually is this growing appreciation that the Fed is really important and that people probably should understand what the Fed is.

Smialek: But I think there's also this real feeling that it's talked about in ways that are so complicated and it requires so much background knowledge to get into it that it can be a little bit difficult to feel like you understand the Fed. It can feel a little embarrassing to ask questions about it. I think that that's been one takeaway for me is just, I think, and this is a useful takeaway as the Federal Reserve reporter at the New York Times, I think there's a real appetite for simply explained, very conversant, very sort of not simplistic, but understandable, comprehensible coverage of this institution and what role it's playing in our society.

Beckworth: And your book does a great job of that. It provides great history. In fact, today I was talking to my wife about the podcast we're about to do now. She asked me, "What's it about?" And I explained who you were, your book, and I said, "Look, if you really want to get into the history of the Fed and where it is today, this is a great entry point. It has a great history, it's accessible, it's readable." And it's important, like you said, that the wider audience learns this. So I've received a lot of interest myself recently on some of these Fed issues. And it is interesting to see people, they get a one glimpse here or there. So for example, I've received a lot of people asking me about CBDC or FedNow and they get worried, they get a glimpse from maybe the news or a talk show and things like that pop up every so often and they can't put all the pieces of the puzzle together.

Beckworth: And I think your book does that nicely for it. And I want to read one other quote, Jeanna, from the intro and then we'll get into the history of the Fed and some of the issues facing it. But I thought it was a very telling quote because it's almost prophetic, if I can say that. Let me go ahead and read it from page nine you say, "While the Fed's actions in 2020 came in response to the unexpected global pandemic, the pages ahead will make clear that the financial vulnerabilities that necessitated huge Fed action were kindling awaiting a spark. They were known weaknesses and many of them still exist. It is somewhere between possible and likely that the Fed market interventions like the ones that took place during the pandemic will be required again in the future."

Beckworth: Well, here we are having just gone through the banking turmoil that started in March and has pushed the Fed once again into a bold new place with regards to its collateral policy. As you know, Jeanna, the new Bank Term Funding Program facility, which was intended to provide temporary support to banks, did so by taking Treasury collateral at face value, and that is a huge change that goes against a long history of taking collateral at market value and at a discount at the Fed. That change for some folks was another crossing of the Rubicon, at least in regard to the Fed's collateral policy. So that prophetic quote I just read from your book did not take long to come true. Or, to put a differently, Jeanna, the Bank Term Funding Program is another data point for your limitless thesis.

Beckworth: Alright, let's proceed into your book, and you do a great job going over the history of central banking in the US and I want to get to the Fed history, so I'll quickly summarize up to that point. But you go over the First Bank of the United States, the Second Bank of the United States, Civil War, the advent of the national banking system, you bring us to the 1907 crisis and the catalyst that served as a call for a central bank. And you walk through some key moments in the Fed's history, so the creation of the Fed in 1913, the New Deal, 1935, power was consolidated in DC and that leads us to 1951 and you have a chapter called, “The Fed's Second Act.” So explain what you mean by the second act. Because the first act is creation, and this is, it’s kind of coming into its own?

The Fed’s Second Act

Smialek: Yeah, so I think that what I meant by the Fed's second act is really sort of we've got this era when the Fed is starting to kick off. And then we get up to the Great Depression and we get to this point where the Fed gets fundamentally reformed. Marriner Eccles, who was a prominent banker at the time, is asked to potentially be Fed chair and he says, "Hey, hold up. The Fed is not very effective in its current format. I will do that on one condition, which is you allow me to reform the Fed." That happens, he and his colleagues and very many people across government write a bunch of reforms for the Fed. In 1935, those take effect. We see a real fundamental shift in the Fed.

Smialek: We see a situation where what was originally a very decentralized organization that had a lot of its power vested in the 12 regional Fed banks that sit around the country and are actually sort of quasi-private institutions, a lot of that power is pulled back from those private branches and placed at the public board, which is in Washington. And a lot of power is concentrated, not just among the seven governors at the Fed Board, but the one among those governors who is the chair. We see a much more effective chair. Prior to this, the chair was really an organizing function. It was like the chairman of any kind of board committee, but it wasn't necessarily the person who ran point on the entire system, didn't have a ton of power, and now suddenly the chair does have a lot of power.

Smialek: The Treasury had previously sat on the Fed board, which really sort of locked the Fed into the White House administration and the political sort of machinations of government. And that Treasury secretary is pulled… and actually the officer of the comptroller of the currency, they're both pulled off the Fed board. The administration is stripped off the board. The regional quasi-private banks are made much less powerful and the center power core is concentrated in that Fed chair and the board in Washington. These are all really important forms in the sense that they just make its power so much more concentrated that it can actually be much more effective. I think what I mean by this Fed second act is really when you get this situation where the Fed goes from being a pretty ineffectual, pretty dispersed body to being a pretty powerful, pretty concentrated body, one that can have a much bigger economic role as we move through the rest of the 20th century.

Beckworth: And then you go through the history of the Fed up to the present. You go through some important people, some important leaders, Paul Volcker, you go through Ben Bernanke, Janet Yellen, and you get to the current Fed chair, Jay Powell. And you tell a lot of interesting history including the years where President Trump really badgered him, really wanted him to be fired. In fact, he wanted to find a reason or way to revoke his chairmanship, which has never been done before by a president. I know presidents have pressured Fed chairs before, but Trump actually wanted to remove him. And in fact, I remember very vividly, Jeanna, we were both at Jackson Hole, August 2019, and I think Powell just gave his speech and Trump tweeted out, "Who's a bigger threat to the country, Xi Jinping or Jay Powell?" It's pretty shocking. Everyone's on their device looking at their phone instead of listening to the talks being given at the conference.

Beckworth: So that was a pretty intense time for Jay Powell, but Trump never removed him. But I wonder now if we could see that happen. And I bring this up, and again, I know you're not a lawyer/legal expert on this, but the Supreme Court recently has made some decisions that have removed people from power. In fact, I just recently had Mark Calabria on who was the head of the Federal Housing Finance Agency, and there was a Supreme Court decision that said, "Yes, you can get rid of a director of an agency,” also the Consumer Financial Protection Board, similar ruling. So do you have any sense of whether in the future we come to a moment like this again, there's a president who doesn't like the current Fed chair, that it would be more likely that we could have a removal?

Smialek: Yeah, like you said, I'm not a lawyer, so I am not going to judge on whether those Supreme Court cases are going to be applicable to the Fed. One thing that people will often tell you though when you ask about this is, the Fed is a weird animal. So when you try and take jurisprudence and apply it to the central bank, it doesn't always map out perfectly because of the sort of unusual role it plays, the unusual legality around some of the Fed. So I think this is probably likely still, as it has always been, somewhat of an open question. You could try it, you'd probably be challenged. It’s certainly the case that in 2020 or 2019, I believe, or maybe it was late 2018, I can't remember, I'm getting my years mixed up, but there was a point at which Trump seriously considered trying to remove Jay Powell from office, and I believe it was late 2018, he seriously considered trying to remove Jay Powell from office. And the White House did look into it and Mick Mulvaney came out on one of the morning shows and said he was interested, but we now realize it's not legally possible. So it seems to be the case that this question has been raised before and has been answered in the negative. As you said, as laws evolve and the Supreme Court makes decisions, those things can change, but I think it'd probably be still a relatively high hurdle.

Beckworth: Okay. Well let's move to the more recent history, 2008-2020. And that's really the core of your book, the limitless point, particularly in 2020, as you noted. The Fed really expanded what it could do and invoked emergency powers. Walk us through that evolution in its history.

The Recent Evolution of the Fed

Smialek: Yeah. I think it's really important. What happened in 2020 really started in 2008. When the Fed really sort of rolled out some powers, though we hadn't seen it used in any big way throughout most of the prior 70-75 years. So we actually have to rewind back to the Great Depression to really explain these. So back in the early 1930s, the Fed was given, under section 13(3) of the Federal Reserve Act, the ability to lend to non-bank entities in times of crisis. So unusual and exigent circumstances, it is allowed to make loans to a whole range of counterparties, and it never really made extensive use of those powers in the thirties. It did lend to some companies back in the thirties, some liquor companies, a marble company, some various firms. But it was never really a super heavily used function of the Fed, this sort of business lending and other types of lending.

Smialek: And it kind of faded into history. Every few decades we would make some little minor tweak to the 13(3) section that would allow the Fed to deal with some sort of counterparty in a time of crisis, but those tweaks were usually made after the fact, something blew up and we were like, "Oh, we should probably actually expand who's allowed to access 13(3)." And we would do that, but it would be after the crisis was over, so it would never end up getting used. We have this whole long history of accumulation of power happening in this 13(3) section. It's never really getting used. And then 2008 happens and markets are crashing and everything is going really badly and the Fed has to step in and do some sort of crazy things, save some banks, save some markets, try and stop the world from unraveling.

Smialek: And Ben Bernanke is the chairman of the Fed, and Bernanke is super familiar with these 13(3) powers because he is a scholar of the Great Depression. He and Scott Alvarez, who's the lawyer, top lawyer at the Fed at the time, and their colleague, really sort of roll out a bunch of emergency lending programs under this section 13(3) that save a whole range of markets. They help to do the bank bailouts that we're all very familiar with. They help to do the securitized debt market bailouts. They help to do commercial paper, money market mutual funds, a whole range of the market. We see this really expansive use of these powers in 2008. After the crisis ends, there is a whole lot of backlash to the way that these powers were used and Dodd-Frank, the financial reform that passed in 2010, slapped some restrictions on them. But those restrictions aren't actually all that intensive.

Smialek: The new restrictions are basically that the Treasury secretary has to sign off on whatever you're going to do with these programs and that they have to be available to a broad range of counterparties, which lawyers determined to mean at least five. It's not clear how big of a deal that's going to be, but we get up to 2020, the world's falling apart again, and it becomes clear pretty quickly that those restrictions aren't all that meaningful because Secretary Mnuchin, who's Treasury secretary under the Trump administration, signs off on everything the Fed wants to do. We see a whole range of rescue programs and they are broad-based, not individualized bank bailouts, but broad-based is a pretty squidgy term. Some of them are pretty bespoke to the problem at hand. So we see them for commercial paper, again, money market mutual funds. We newly see corporate bond bailouts or corporate bond rescues, but see the main street business lending program, which was something totally new. And we see just a range of programs including one from municipal bond markets. This is just a much broader use of 13(3) than we had seen even in 2008. And I think it really builds on this idea that once the Fed adds a power to its toolkit, that power is usually expanded in the future. And I think that's very much what we saw in 2020.

Beckworth: So I've had Lev Menand on the show before, I know you've talked to him a lot. You've used him in some of your articles and he had a lot of articles written during this time and he really called into question the Fed's use of this power and he makes the distinction that I like at least, between liquidity facilities and credit facilities. So the money market facility, commercial paper, the broker dealer facility, the dollar swap lines, all those things, you could make a great argument those are fundamentally about keeping liquidity in the system, keeping markets open. But then you get into other ones like the main street lending facility, those are more what he would argue are credit facilities. That's something fiscal policy should be explicitly doing or Congress should explicitly authorize.

Beckworth: He makes this distinction. And let me just be clear, his list... So he would put, for example, the municipal liquidity facility, the PPP liquidity facility, the main street liquidity facility or loan facility. And he also put the corporate bonds kind of in there as well. I think you could argue those might go in the liquidity facility, but he argues that group, at least, is more of a credit function than a liquidity function. What is your sense of where this debate falls down? Is there a lot of other people who share this concern or this observation that the Fed is going into credit allocation versus liquidity support?

The Credit Allocation vs. Liquidity Support Debate

Smialek: There's certainly some people who share that view. I think, off the top of my head, the ones who come to mind are Paul Tucker, who's a former Bank of England policymaker, and Christina Parajon Skinner, who is at the University of Pennsylvania's Wharton School of Business. Both had also raised similar issues. I think that it is, fortunately for me, not my job to have opinions on this matter, but I do think it's really interesting. I will, just for the record, state that the pushback that these people will often get when I'm moderating panels that they are on, which is how do you determine what is a liquidity facility and what is a credit facility? Because those lines are always going to be really fuzzy. I think that that challenge, there's a risk that if you set different standards for the two, you could always make it difficult to figure out which bucket anything goes into. If you make the standard much higher for a credit facility, for example, anything that you don't like, you can be like, "Oh, that's a credit facility," and try to make it impossible to do it. So I think that the differential treatment question is an interesting one. That's often the pushback you'll get for things like that.

Beckworth: But your critique is broader than the distinction they're making. Your critique is, "Look, they've just opened up all of these facilities and the Fed's expanding its reach far beyond anything imagined, whether or not it's liquidity or credit." You have a broader point.

Smialek: And I think of it less of as a critique and more as a note to society, like a bunch of things that you did and probably aren't that aware of. And I do think, without saying whether these are a good thing or a bad thing, I think it's worth saying that these are a thing and we should be conscious that they're happening because these made people a lot of money. There were real opportunities to profit off of these things. There were real opportunities for certain sectors of the economy to benefit and other sectors to not benefit. These were not sort of pure macro policy, where it works the same way for everybody. Literally, definitionally, 13(3) isn't macro policy like that. I think it's really important for our democratic society to be pretty conscious of what is happening in this domain because you could easily see, and I am not saying this, I'm not saying that this is what happened, but you could see a world in the future where this is susceptible to abuse if it's not widely understood, something that comes under scrutiny.

Smialek: If there's something this powerful that only a small and elite few know about or understand, I think that's just an invitation for problems. I think it's important to set civic education. This is like… I often will make the parallel to the Supreme Court. It's important that we all understand the Supreme Court. It's important that we all understand how it works because it's really powerful. And I don't think that's a controversial point. I think most people would agree with that. And my point is really, it's important to understand the Fed's emergency abilities because they're really powerful. As a point of civic education, we should all be conscious of these.

Beckworth: And this is interesting, because the history that you provided in the book, for example, going back to the Second Bank of the United States, there was a war, the Second Bank War between President Andrew Jackson and Nicholas Biddle, who ran the second bank. And it was a very similar point that you just raised. There was this fear of this big central bank. Andrew Jackson represented those who didn't understand it well and were concerned about it and concerned about power being centralized. And Nicholas Biddle was the kind of epitome of elite. He ran this elite institution, his background was elite, and you get this common theme. I guess it's an issue we'll have to wrestle with going forward, but your book is an attempt to help us focus back on that. As you say in the book, we shouldn't forget or lose to memory what happened in 2020. It was very dramatic. It was a very significant change.

Beckworth: Now let me add to that, though, another observation and tell me what you think, maybe in the case of the US central bank, this limitless point is inevitable. And I say that because we have the reserve currency of the world. We have a global dollar system, and not just Treasury bonds, but corporate bonds and bank accounts and, all around the world, the dollar is growing more and more. As you know, there's lots of articles right now about dollar dominance, is it fading, is it strengthening? And I think most practitioners, most people would say, "Hey, it's pretty solid. And if anything, it grows during crises." And that being the case, given there's global money markets, shadow banking around the world, the Fed almost has to step in it. Its hands are tied to some extent. Otherwise, we would have a very catastrophic response. It's the curse of being the leader. You have this huge burden to bear and it's confusing. It may look like a conspiracy to some people on the outside, but maybe the Fed was always bound for this limitless role and there's not much we can do about it. Or am I being too pessimistic here?

Evaluating the Limitless, Apolitical, and Transparent Nature of the Fed

Smialek: No, I agree with you and I actually don't think it's pessimistic. I feel like the point I try make in the book, and that I think I trace throughout the book, is that there's nothing nefarious about the Fed's evolution into being a very powerful organization. And it's not a conspiracy and it's not some sort of giant group of elites trying to take over the world. I explicitly try to counter that narrative. And I think that the reason that the Fed has become so powerful in the modern world is for a bunch of very obvious reasons. Markets are international, markets are huge, non-banks are huge, the shadow making system is huge. We need someone to back all of that up. And there's a good reason that power's been vested in the Fed because it's very nimble, because it's not going through some sort of democratic process.

Smialek: That said, the reason Congress trusted the Fed is to allow it to be nimble, but we also need somebody to be overseeing the Fed. The original idea was that Congress was going to be there keeping an eye on the Fed and that it was still going to answer to the democratic process in some way. And I think that everyone at the Fed would still agree with that point. They're like, "Yes, we do still want to answer the democratic process in some way." But I think a really important part of answering to the democratic process is people basically understanding what you're doing. If none of us, the public, understand what's going on at the Fed, it's much harder for the public's representatives to hold them accountable. I think that's the point I'm making, it's not that the Fed shouldn't be powerful, not that there's something inherently evil in having a very large, very concentrated, very powerful Fed. But to the extent that you have a really powerful and really concentrated institution, you need to have a lot of civic engagement, a lot of ability to understand that organization. That's sort of the point of the book.

Beckworth: And it's a great point and it's a nice segue to another question I have for you, and this also comes from your introduction on page eight, I'm going to read a quote here and you note, "Because the central bank is only distantly accountable to voters and because its role in our economy has expanded so much, society needs to pay attention to the Fed's abilities and experts, the media interests and groups and the broader public must keep pressure on lawmakers to appoint and confirm apolitical central bankers." Which I think is a great point, but I wonder how feasible is that? I mean, if you look back at a number of Fed leaders, Ben Bernanke, he was a prominent in the George W. Bush White House, CEA chair. Lael Brainard is well known on the Democratic Party side. Michael Barr worked, I believe, in the Obama administration. So how do you find people who are truly apolitical? Because it strikes me as, you're going to have to have some political connection to get to that high of a role in power.

Smialek: So I absolutely think that there's an important distinction to be made here between being apolitical in the sense that you're totally detached from the political process, which is probably not realistic for any of these positions as you're alluding to and just has never been the way it's ever been done, really, and being apolitical in the way you think about monetary policy. I think there's a distinction there. And I think that there has been a long tradition of appointing people who think that monetary policy should be set, not with the goal of reelecting the sitting party or with serving the partisan circle in some way, but with the idea of long run economic stability in mind. And I think that that has been a pretty sacred thing; certainly everyone from Lael Brainard to Ben Bernanke would've said that when they were in those positions.

Smialek: But I think that there is a real vein of thought in society that says, maybe that's not so important. Maybe it's okay if we set policy with a more political end. Maybe this separation from the White House isn't so essential. And I think that history has taught us that there are probably some pretty good reasons for the separation from the White House. That's more the point I'm making, is you want to appoint people who respect that separation because that separation was trial and error. We learned that this was the better way to do it and not just us. I kept this book very focused on the US because I didn't want it to be a thousand pages long. But I think that this is something that we've seen play out in economy over economy, history over history. This is a well-trod path.

Beckworth: Well, if I may say so, it strikes me that sometimes the Fed doesn't help itself in this matter. Sometimes it makes matters worse, and I think, in particular, when it appoints regional Fed Bank presidents. So it's a little mysterious, not transparent, and kind of feeds this concern that maybe there's politics or something going on. How did Neel Kashkari end up at Minnesota? How did John Williams get to the New York Fed? You touched on this a little bit in your book. But most recently, I'll bring this one up, Austan Goolsbee, he ended up at the Chicago Fed. We had two governors we've learned from Bloomberg that chose not to affirm him, they abstained from their votes, and then we learned that his wife was involved in the process as well. And it struck some as very partisan or not very open and transparent. Is there room for improvement there to make that process at least more of understood and predictable?

Smialek: To be clear, his wife worked at the firm that was involved in the process. I don't know that she was-

Beckworth: The recruiting firm, yeah.

Smialek: Yeah. I think that's an important distinction, probably. I think that... This isn't a place for me to have an opinion because I think it's a matter of active debate and I'm a journalist. But I think it is the case that we are certainly seeing a push for more transparency on the part of the Fed when it comes to these things. I think you hear it from both sides of the aisle that we've seen Republicans and Democrats co-sponsoring legislation related to Fed transparency recently. I actually think that this is something that will change within a relatively short timeframe. And that's not a hugely controversial statement in the sense that the Fed's entire modern history has been a history of becoming more transparent. They slowly get pulled out into the light, and I feel like that process is going to continue. I think there's always this resistance to disclosing things that you haven't previously disclosed because, oh, maybe it'll make the work life harder. Maybe it'll make it harder to do our jobs, et cetera. But I think at the end of the day, most things end up becoming more transparent and not less transparent with time.

Beckworth: Well, that's a great point. So some of the discomfort we see is just simply growth pains on the road to more transparency. So that's a great way of framing it. All right, well let's take this limitless idea of yours and apply it to some current issues. I'm going to go back to what I mentioned earlier, the Bank Term Funding Program. So that was, for some, a big deal, so walk us through that and maybe help us assess, is it really a big deal or was it just something they had to do at that moment to help the banking system?

Assessing the Bank Term Funding Program

Smialek: Yeah, first of all, we need to come up with a new name for this because like BTFP just does not roll off the tongue.

Beckworth: Exactly.

Smialek: I keep trying to make disco plus happen, but it hasn't worked; disco, being a reference to the discount window, which many practitioners short to disco, and this is kind of like the discount window but on steroids. So I would say that, what I affectionately call disco plus and no one else calls disco plus, was a big deal. I actually think it was a big deal in two ways, one way in which is often discussed and one which is rarely discussed. The first way is, it did something really unusual in that it basically said to banks, "Bring us your collateral, bring us your bonds, and we will value them at face value, not at the value in which they're trading in the market." And that's a big deal, partially because it's good news for the banks because a lot of them are sitting on a bunch of stuff that has become less valuable as interest rates have gone up and those [inaudible] bond values have gone down.

Smialek: So this means that they can borrow against that as though it were full priced. And it's just unusual because the Fed traditionally has made these lending programs pretty unattractive by design. The idea is, lend freely but at unattractive rates in times of trouble. This seems like a little bit of a violation of that very basic central tenant, but it was designed this way in order to make banks want to use it to try avert a bigger crisis. I think those are some really interesting changes relative to what we've seen historically. I think the other thing that's been talked about less but which is really interesting when it comes to disco plus, is we saw the Fed roll this out just as problems were starting to kick up, but before they had really fully materialized. I think this was a preemptive use of the Fed's emergency lending program facilities and that is very unusual. I don't think we've ever seen a preemptive emergency lending program before, in the sense that typically you already have to have a market in disarray to say, "Oh, unusual and exigent circumstances have arrived."

Smialek: But in this case, what we had were a couple of banks that had crashed, lots of indications that more banks would crash if nothing was done. But those other banks hadn't actually crashed yet, we did this before that the disaster played out. I think that's a real shift and potentially an important one in how these programs are used. I think that this opens the question… next time we start to have a market meltdown, do we roll out a money market mutual fund program before the money market mutual funds actually crash, but just when we think they're going to? Because you can tell these things are going to happen with some lead time. If you see a lot of people trying to redeem commercial paper, well you know money market mutual funds are all in commercial paper. So are you going to say, "Oh, well it's about to happen so we're going to roll out the program." And I feel like maybe that's a distinction that only matters to people like you and me, David-

Beckworth: Well, that is really fascinating. I hadn't thought of that. So it was preemptive. It is completely different than what we saw in 2008, 2020. Maybe that's an important lesson moving forward like you said. So I also like your disco plus framing, that maybe we should make that something they use. Disco plus, if you can call it that, to me, what was striking, in addition to what you've mentioned, is that it did lead to more discount window lending as well as this new facility. So, in the past, there's been stigma, so it worked, I guess, that's one accomplishment. We actually see more banks using the discount window lending than previously they would've maybe been comfortable doing.

Smialek: Yeah, it's tough to know, I think, in these moments because the banking system's still a bit of a mess, actually. I think you could be, on one hand, yes, there's less stigma. On the other hand, maybe things are just bad enough, the people finally-

Beckworth: They're desperate enough, they'll go to the discount window.

Smialek: It's hard to figure out what's de-stigmatization and-

Beckworth: I'll withhold judgment until we see more facts later on. All right, let's take this limitless idea to another hot issue I mentioned earlier, central bank digital currency. That's potentially going to be something even in the presidential campaign issues. We see Ron DeSantis talking about it. Republicans seemed really worked up about it. The Fed seems really reluctant. In fact, the last, I think, strong proponent of CBDC now has left the Fed, Lael Brainard. Several other governors have expressed skepticism and they've said, and Chair Powell said, "We're not going to do anything unless we get a mandate from Congress to do something about this." But is this an area, do you think, if they went into it, it would be another fulfillment of this limitless idea?

The Limitless Fed and CBDC

Smialek: Yeah. I think it'd be really interesting if the Fed chose to do this. I've seen zero indication that they are keen on doing it, as you have alluded to. It's actually interesting to me that this is coming up so much on the political stage because I do think this is a place where they've been unusually definitive. I feel like the Federal Reserve, as I have known it in my reporting life, is an institution that is extremely hesitant to rule anything out. They do not like saying, "Oh, no, we'd never do that." And the reason they don't like saying, "Oh, no, we'd never do that." Is because eventually they end up having to do things and they don't want to look like they said, "No, we can't do that," and then find out that later that, in fact, they could and they did. But we've gotten pretty close to them saying, "Oh no, we're not going to do that,” on CBDC.

Smialek: I mean they've been very clear they're not going to do it, unless they have some sort of very clear authorization from Congress. And it seems like we're not close to a place where they would get a clear authorization from Congress. So I think it's been really interesting to watch that evolve. There hasn't been a lot of appetite there. It's interesting to see the political cycle take off and say like, "Oh, the Fed's about to roll out a CBDC," which is like, it's just not true. That's not accurate. There is absolutely no chance the Fed is going to roll out a CBDC on its own. I think that's been pretty fascinating and I think it will be interesting to watch how this shakes out, plays out. I think a lot of these decisions, a lot of this work, is actually going to happen on an international stage.

Smialek: We've got a lot of other countries exploring CBDC, testing them out. And the Fed's position has kind of always been, "Good for them. Let them try that out, we'll sit back here and watch. We'll see how that goes. And if it goes well, maybe we'll try and do it too." I think the Lael Brainard argument often actually gets mis-portrayed relative to what she was actually arguing, which I always read to mean… And I think a close look at the text of her speeches makes this reading reasonable. I always read her as basically saying, we don't want to fall behind on the technology here. We don't want to get in a position where China and everybody else have come up with a CBDC, and we're not even close to knowing how to do that. We don't know what the implications of a CBDC are going be, and just want to make sure we're still at that technological frontier in case we discover down the road that actually there is a use case and actually we want to do this and we don't want to be behind, we just want to keep up on the tech.

Smialek: And I think that that's actually pretty much the view the Fed has embraced. They've been doing a lot of research onto how to operationalize a CBDC if you wanted to do it, how would it work? How would you do the cybersecurity? How would you do the digital wallet? Would it sit at the Fed, would it sit somewhere else? Et cetera, et cetera, all of those problems, a lot of technological problems, actually, when it comes to something like this. Is it blockchain? Is it some other technology? Et cetera. I think that the Fed is clearly working on that. They're working on… Boston Fed and MIT have a partnership. The board has been doing some research, and so those are the important questions. I think the practical issuance of one is a different question altogether.

Beckworth: Those are all great points. And again, this is an issue that I find, personally, in my life, a huge disconnect as well between what the Fed has said and what I hear from people asking me this, average people asking me about this issue. But circling back to the limitless point, and I won't push you any more, I'll just put my own two cents out here. If the Fed were to do this, this would open up the Fed's balance sheet to the public in a way it’s never been done before. If it was a retail CBDC, which they have said they don't want to do, but were they to go down this path, I think this would be another example of the Fed being limitless. Okay, let's move on to another potential issue, which could be, I think, a potentially big deal, and that's the debt default.

Beckworth: So it looks like this X date when the Treasury is truly out of money, so January 19th it hit the ceiling and now it's finding that it's running out of funds and cash receipts have been less than expected. So some people are saying June or July, and we are already seeing a gap between the one month and three month Treasuries, credit default swaps spreads are up. Of course those markets aren't very liquid, so you’ve got to take that with a grain of salt. But should that happen, I mean it wouldn't be all too different than, say, March 2020, if the Treasury market begins to collapse, what would the Fed do? And I know the Fed and Jay Powell himself has said this at FOMC press conferences where you were attending, as well as back in 2011, this is something Congress has to resolve on its own. And back in 2011, these minutes from the meetings, transcripts from the meetings, he said, look, we don't want to go out and get ahead of this and say we're going to backstop the Treasury market, but if the Treasury market were to collapse, we have a financial stability mandate.

Beckworth: So there's a tension there between staying in their lane, letting Congress do what it's supposed to do, but also fulfilling its financial stability mandate. But this strikes me, at least, that if push came to shove… and if this June, we had an outright debt default, I think it would be hard for the Fed not to step in and maybe take some baby steps. And there's a list of things they've come up with. But is that your sense as well? I mean, would the Fed be reluctant to let the Treasury market collapse because of a debt default?

The Fed and Debt Default

Smialek: Yeah, I think they probably would. I think we know from those transcripts that they talked a lot about doing things which they called… Jay Powell, I believe, at one point called them loathsome options.

Beckworth: Yes.

Smialek: But they've talked about doing things like taking on the defaulted Treasury loans as collateral and perhaps a lending facility or swapping them out for CUSIPs, bonds that are already staying on the Fed's balance sheet. And the idea there would just be to make sure that the market still can still function basically, normally, to make… sort of siphon those bad bonds out of the market. And obviously the Fed can just do a lot of purchasing. It can just outright buy those bonds to make sure that people aren't just sitting on things that they don't feel comfortable holding anymore. There's a lot that the Fed can do. I think that the challenge there is the scope of the problem may be so large, if we actually are in a situation of default, that even whatever the Fed could do would be a bit of a band aid on a bullet wound.

Smialek: It may not be significant enough, or if it were significant enough, if the Fed went to sort of such dramatic lengths to stem the fallout you could get in a really unfortunate situation where the Fed is basically monetizing the debt. There lies the way to inflation and all kinds of other big problems that we have historically traced from monetizing the debt. Not a thing anybody thinks is a good idea to my knowledge. I think that we could really end up with some serious problems if those things happened, which I think is why the Fed is so extremely reluctant to talk about this. I think it’s the very obvious, of course the Fed doesn't want to talk about this because then people might feel comfortable and think if people feel comfortable, it increases the chances that it will happen. But I think there's also some element of, you just don't want to suggest that this is like talking about the end of the world, you don't want to suggest that these things could even happen. It's like a little too horrible to say. I think there's some element of that as well. So it could be a really interesting summer.

Beckworth: Let's hope not. Let's hope it's a boring, ordinary summer. I had David Wilcox on this show. He used to work at the Fed, as you know, and he's at Bloomberg now as a, I think, chief economist, he works them. Anyhow, and he wrote a piece and he has a model there where he kind of calculated what would happen if we actually hit this point. And it would be pretty catastrophic, as you said, it might be a band aid on a bullet wound because it wouldn't be just the Treasury market. It would be… the Federal government wouldn't be able to make payments to Social Security recipients or to veterans or to Medicare and maybe, you know, could prioritize some spending if it's technically feasible. But it would still be very disastrous and send a big loud signal. So hopefully we don't go there. Let me segue, in the time we have left, Jeanna, to something near and dear to my heart, and that's the Fed's framework.

Beckworth: And you cover that in your book as well. And I'm not sure this really is a limitless point, but I think it's a key part of your story and maybe it is, and maybe you could argue how we define price stability, is the Fed taking liberty or is it something not well-defined? And you go through the history of the Fed's 2% inflation target. You have several chapters that you touch on this, but you go through the story of how Alan Greenspan was reluctant to kind of nail down a precise number. And it was interesting to read how Janet Yellen kind of pushed him. "What does price stability actually mean, Alan?" And he was reluctant to engage on that. And it's not until Ben Bernanke, and then eventually 2012, that we get the 2% target. Was the Fed enabled by Congress to actually announce that 2% target it? Was that something the Fed should have done or should it have stuck to the Alan Greenspan definition of price stability?

Exploring the Fed’s Definition of Price Stability and the 2% Inflation Target

Smialek: Yeah. Actually, again, journalists don't have opinions about this. But I do think that there was a reason that Bernanke decided to introduce the 2% target, and there was a reason Greenspan resisted it before it happened. Greenspan's logic for not wanting to introduce a target is he thought it sort of enforced a false degree of precision. He didn't think that the Fed could hit a target that precisely. And he also thought it was just going to tie the Fed's hands, make it more difficult to maneuver, cause all kinds of problems, et cetera. Bernanke thought that if you laid out a target then it would do a lot of the work for you, that people would be like, "Oh, look, they're shooting for 2%, inflation's probably going to be about 2%." We would have more anchored inflation expectations and having anchored inflation expectations would actually be really helpful when it came to keeping inflation under control or getting inflation up a little bit, basically keeping inflation at that even keel around 2%.

Smialek: And so, that was a big part of the reason that they did that introduction is, they just set out the numerical targets and it helps people to adjust. It helps people to understand what you're doing. And in general, that has been a big rationale behind communication in general. You tell the market that you plan to keep the interest rate low for a long time because that helps them to adjust. Currently, in our current environment, you tell the market that you're going to keep interest rates high for a long time because that helps everybody to adjust and it actually means that you don't have to raise interest rates as high to slow the economy the same amount. So a lot of the pain, a lot of the work is done for you through your sort of talking operations.

Smialek: I think that's the rationale, this is why they decided to define the 2% target. I think it will be really interesting to see how it evolves going forward. We saw them sort of shift the 2% target in the 2020 review to an average annual inflation target. So instead of hitting 2% as the goal, we're always shooting for 2%, we shoot for 2% on average over time, which is a little bit more fuzzy. And I think it could be really interesting to see if we sort of add additional fuzziness with the next review. I think the hurdle for that will be if inflation is still very high at the next review, because you're not going to want to look like you're moving the goal posts at a moment when inflation is above your goal. So I think we've got this whole range of considerations here that they're going to be grappling with.

Smialek: So it's a really interesting point. The title, Limitless, for the book was really sort of related to the Fed's balance sheet, the idea that they can do so many things with that balance sheet, that… its sort of ability to come in and swoop in and save markets in times of crisis is very, very much sort of the amount of buying you can do once you pass all the legal hurdles. That is pretty limitless. But I don't think when it comes to the monetary policy side of the mandate, what you can do, how much you can control any given move in the economy, I don't think those things are limitless.

Beckworth: Well, let me use that as a segue into the Fed's balance sheet. So right now it's experiencing losses on the balance sheet, actual net income losses. There's also much larger unrealized losses from the valuation changes on the Fed's balance sheet. And this is something that's happening around the world in many advanced economies because interest rates are really high, they're losing interest income. Do you get a sense that there's any recoil, any apprehension among the central bank community about big balance sheets? Or is it just like, we have got to stick through this, kind of do our best, experience some losses? Are there any regrets, I guess, about being limitless, using large balance sheets, something they may want to avoid in the future? Or is it just, it's the fact of life we have to deal with it?

Smialek: Yeah, I don't think I've heard much from within the central banking community, actually. I think if you talk to most central bankers, they're like, "This is life. This is what we did. We did what we had to do," et cetera. I will say it was really interesting at the IMF World Bank meetings this year, because I feel like for the first time I heard people within the mainstream, not just sort of people who are on the edges of the mainstream saying things like, "Some of these problems wouldn't have been so bad if we hadn't done so much bond buying.” We encouraged search for yield for such a long time, and that's part of the problem in the banking sector now. Look at some of this commercial real estate lending. It never would've happened if it hadn't been for all of those MBS purchases. So it was surprising to me because I think for… I've been doing this for a long time now, and for a long time you would get people saying those things, but they were mostly at the very sort of margins of the conversation. And now they're moving a little closer to the center, not yet close enough to the center to be at the central bank, but I think a little closer to the center than they previously had been.

Beckworth: I'm going to go out on a limb here and say this may be an issue moving forward and maybe we'll revisit this in the future, Jeanna, you'll correct me. But because there are losses in multiple places and because at least to taxpayer's perspective, it looks like a loss to them. And maybe the point of your book is maybe not all taxpayers are even cognizant of the Fed's losses. So that's another discussion. But if, in fact, this becomes political, the central bank balance sheet losses around the world, might there be a move to something like a tiered reserve system where only some of the reserves are remunerated and some central banks have this. And I've seen this suggested, and maybe it's the fringes of the mainstream that I'm following that suggest this, but it'll be interesting to see if that does happen.

Beckworth: Let me circle back, though, to the Fed's inflation target. So you mentioned in 2012, we had Ben Bernanke and the adoption and that was a process. 2016, we also remember it turned symmetric, the statement. And then 2020, as you mentioned, we adopted FAIT, and something that FAIT had was the average inflation part that you mentioned, but it also had this shortfall from maximum employment as opposed to deviation, which also was a big change. I guess my question is, going forward, you think that fuzziness is going to stick around, that flexibility, or might that be something they want to tweak given what's happened with the past few years?

Smialek: I do not know. I think we are not at the point where the ink is dry enough on what just happened for us to know the answer to that question. I think that it could be the case that inflation comes under control in a relatively rapid and straightforward way here. And then I don't think anything fundamentally changes about what they did to the 2020 framework. It could be the case that inflation is really sticky and that we have to really hurt the job market in order to bring it down, and that we spend the next couple of years thinking, what role does the Fed properly play in society and should they operate differently during peace time, so that we don't get into a moment like this, where they have to crush the economy in order to bring inflation under control. I think that's another possible scenario. And some people, I think many of the mainstream macroeconomists at Harvard and Princeton, would probably tell you that's the most likely possible outcome, that that's where we're headed.

Smialek: I don't feel like I have enough of a crystal ball to know the answer to those questions, but I think that whatever the answer to those questions is, however this plays out, is going to be really important to how we sort of move forward with the Fed’s framework. I think the one thing we can definitively say is the way they implement the framework is going to be a lot more cautious going forward. I talk about this a lot in the book, but I think that the real, maybe, I don't want to say problem, but the real dilemma that the Fed got itself into was not so much with the framework, but with the way they chose to put it in place in September 2020. Because they said all of these sort of, like you said, warm and fuzzies, in the framework, but none of those were very binding.

Smialek: But the way they implemented it in September 2020, was very binding. They were basically like, "We are not going to lift interest rates until we have inflation above 2% and we're back at full employment." Which is, that's a lot of “and,” it's a lot of weight. I think that that resulted in a pretty slow response when inflation took off. They would make the case that they were maybe three months, two or three months slow so that wouldn't have made a huge difference in the grand scheme of the universe. And I think there's probably some reasonable amount of weight you could attach to that argument. But I think that at the end of the day, everyone agrees they were kind of slow and they were slow because of the way they implemented the framework. And that's not it. I'm not saying something hugely controversial. Jay Powell has basically said that. But I think that we're probably going to see a lot more sort of humility around how they go about implementing frameworks in the future, just given that experience.

Beckworth: If that's one of my big regrets about adopting FAIT during the pandemic, is that they may be reluctant to engage it fully. I'm a big advocate of makeup policy, whether it's price level targeting, of course my favorite would be nominal GDP level targeting, but the ability to implement it and do it aggressively, which I think is important… You mentioned earlier, talking is half the battle. You talk monetary policy, so if you talk that we're doing a level target, then the market does a lot of the heavy lifting for you. But if you're timid and afraid because you got burned last time… That's my worry, is that this whole experience is going to undermine the future success of some version of level targeting. Well, we are at the end, but Jeanna, the last final words, what do you want people to take away from your book and about the Federal Reserve moving forward?

Smialek: Well, one thing that I hope they take away is, this is an institution that's worth learning about. If you are already an expert, that's great. There's probably still more you could learn. If you're not an expert at all, it's not impossible to learn about this institution, and it's actually pretty entertaining. It's pretty central to our society, and so it's worth knowing about. So I think that's the big takeaway. And I think that the sort of big conclusion of my book is, the Fed has changed a lot in the 21st century. This is a fundamentally different institution sitting in 2023 than it was in 2003, and it's likely to continue changing, and so I think it's really interesting. This is such a fascinating time to watch the Fed and it's going to remain so.

Beckworth: Alright, our guest today has been Jeanna Smialek. Her book is, Limitless: The Federal Reserve Takes on a New Age of Crisis. Jeanna, thank you for coming on the show.

Smialek: Thanks, David.

Photo by Olivier Douliery

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.