Jim Clouse on the Last 4 Decades at the Most Powerful Central Bank in the World

Jim Clouse is a veteran of the Federal Reserve System and is currently a fellow at the Andersen Institute. In Jim’s first appearance on the show, he discusses the evolution of monetary rules at the Fed, what happened at the Fed during Y2K, 9/11, the Great Financial Crisis, and the COVID Pandemic, the ever changing stigma of the discount window, Ted Cruz’s calls to end interest on reserves, and much more. 

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This episode was recorded on September 11th, 2025

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: Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow at the Mercatus Center at George Mason University, and I’m glad you decided to join us. 

Our guest today is James Clouse. Jim is a fellow at the Andersen Institute for Economics and Finance and a longtime veteran of the Federal Reserve System, including serving as the Deputy Director of the Monetary Affairs Division and the FOMC Secretariat. Jim joins us today to discuss his time at the Fed as well as some of his recent work. Jim, welcome to the show.

James Clouse: Thanks, David. It’s a pleasure to be here.

Beckworth: It’s great to have you on. I followed you from a distance, and I was real excited to learn that you would be willing to join us. You have just stepped down from the Federal Reserve. I have to say, you have an amazing career: 36 years at the Fed, a year at Treasury managing our debt, and four years in the Army. You are a true American hero. Some American heroes wear camouflage, black jackets, and carry rifles. Others wear suits, run models, and quietly safeguard the stability of our economy. Thank you for your service.

Clouse: Thank you very much. I appreciate that.

Beckworth: No, it’s great to have people like you do what you do. It’s often easy for people like me and others to criticize the Fed from the outside, but what you really do matters, and it’s easy to take it for granted. When everything is going well, you don’t appreciate all the hard work that you guys do at the Fed behind the scenes.

Clouse: You’ve talked with many Fed people, and, of course, there’s just hundreds of very dedicated, very smart, professional people all focused on achieving the mission. It’s a very gratifying place to work.

Beckworth: Yes. Now, before we get into your career, I want to hear the details. The other thing about your career, 36 years, you’ve lived through history. You experienced it firsthand. When I looked through all the things that you’ve done, I was just blown away. You probably could write an amazing book. I don’t know if it’s in your plans, but you should. 

With that said, so when you’re sitting there on the inside, and you were the Deputy Director of the Monetary Affairs Division, you were a staffer for a long time. You were in the FOMC taking minutes, transcripts, whatever you did there. You heard people like me on the outside, and others even more cantankerous than me criticizing. Did you ever feel frustrated because in your role you’ve got to keep your mouth shut. You’ve got to play the role of a good civil servant? Did you ever want to say, “No, Beckworth, that’s wrong”? Does it feel good to be on the outside now, be able to have a little more freedom to share your thoughts?

Clouse: It does feel good to be on the outside and have a little bit more freedom. You’re right, especially on the staff. Worked very hard, and lots of communication within the staff, but not a lot of communication with the broader public. I didn’t feel any particular frustration toward you, David, or toward anybody else. Of course, criticism is part of the game. In a broader sense, even sometimes it’s a little uncomfortable and a little messy. It is important for the broader public to have a sense of what the Federal Reserve is about. That probably, as we’ll discuss later, I think, the whole communications push over the last two decades has been a big part of that.

Jim’s Career

Beckworth: All right, well, let’s jump into your career. I mentioned you’re the Deputy Director of Monetary Affairs. You also oversaw the FOMC Secretariat. You spent a year at Treasury. Where did we start? When did you first begin at the Fed?

Clouse: I began at the Fed in July of 1989. I felt very fortunate to be hired at the Fed. As we were chatting earlier, I came out of the Army after serving a military obligation for four years. That’s a little bit of an unusual path into the economics profession. I was very pleased to be hired. I landed in a section that was focused on money numbers, the monetary aggregates, which at the time were an important policy guide. There was a little bit of a dichotomy, or I’m not sure how to frame it, but differences of views within the Board about just how important the money numbers really were. You probably know that people in research and statistics, they rely very heavily on a Phillips curve type of framework. The money side was money and velocity. There used to be a sign when you would walk into the building, and on one side, it would say PQ, and that would point to research and statistics, and then MV was pointing to monetary affairs.

Beckworth: That’s awesome. That’s fantastic. You came in right during the time where money began to fall out of favor because of this breakdown in the relationship between monetary aggregates and nominal income with a broader economy. I would say money still matters, but it’s hard to measure it. It’s hard to know what money demand is in real time, and every macro model has these unknown latent variables. A Phillips curve, you’ve got to know the output gap. A monetarist needs to know real money demand. You can’t observe that either. It’s tough. Central banking has moved on to mostly Phillips curves and thinking in terms of neutral equilibrium rates and such. That’s cool that you were there. You got a little taste of that, at least, during that period.

Clouse: My impression is that Chairman Greenspan probably had a little bit of the flavor you do, that he still thought in his heart of hearts that money or nominal magnitudes really did matter. The staff, especially in research and statistics, did focus more on the Phillips curve framework. The reality is, I think it’s, well, you probably know better than almost anybody, it’s just very hard to forecast inflation. There’s no model out there that’s a slam dunk.

Monetary Rules at the Fed

Beckworth: Yes, that’s why I’m a nominal GDP targeting fan, because I know it’s hard to use money as a guide and so money times velocity, or some would say velocity-adjusted money supply, but neither here nor there. You’re working at the Fed. You’re there at the tail end of when money was still being used. Do you remember the time where the McCollum rule was discussed? The Taylor rule, we’ll talk about that in a minute. It became very popular. The McCollum rule was this rule where you adjust the monetary base according to a nominal GDP rule. For a while, it had some attention, right?

Clouse: Yes. I have only a vague memory of that. I was very much in the trenches. I was really in the trenches. At that time, I wasn’t totally aware of all the debates going on in the literature. Since then, of course, have learned a little bit about the McCollum rule. I think those were starting to filter into the staff consciousness in the early ’90s. You’re right that there was some attention paid to it. Even the Taylor rule, it did take a while to be fully embraced. I think people like Donald Kohn, for example, you probably know well, and others were onto it right from the start, but I think that it took a little while to really filter into the staff’s way of thinking.

Beckworth: When did you start seeing it widely discussed, say at FOMC meetings? When did it become important?

Clouse: I’m probably going to get the dates wrong here because I did look this up once, but I believe that the first briefing of the policymakers might have been in the ’93, ’94-ish timeframe. Pretty early on. Again, it was not universally accepted as the way of doing it. It’s still not, of course. People like to use rules, the standard Taylor rule or other rules, as a benchmark. Then all kinds of other considerations fold into their thinking. Still, it’s a very useful benchmark and encompasses some important principles of good monetary policy. I like to look at them as a starting point. I would say over time, the importance of rules became very important. Even for many decades, I would say that it was a little bit of an arms-length thing because nobody wanted to feel constrained by a rule either. It’s a very interesting push and pull.

Beckworth: Taylor had this paper in ’93, where he put out his Taylor rule, so it makes sense that you guys would start talking about it about that time. I went to a Hoover Monetary Policy Conference this year. John Cochrane, Michael Bordo, and John Hartley did a paper on the Taylor rule. In fact, they had it as a two-day conference. They had a day where it was dedicated to John Taylor, and the second day was a regular conference. They went through and they tracked all the citations to the Taylor rule. You’re right. You don’t see it a whole lot in the ’90s after he first released it, but it really takes off in the early 2000s. You see a lot more benchmarks. Yes, in terms of a benchmark, where do we start? We start with the Taylor rule and go forward. It’s interesting to see his legacy. They mentioned in this paper that the FOMC eventually starts to talk about it a lot, but it took some time, like you said. This all goes on about the same time as we see increasing transparency in the ’90s in the Fed. We see minutes for the first time. We see announcements. Talk about that.

Increasing Transparency at the Fed

Clouse: That was interesting, too. Again, I was very much in the trenches, but looking back on it now, I am very grateful to have been there at the beginning of the big trend toward transparency. When I first got there, of course, Alan Greenspan was the chair. There were all the stories about not being totally clear on intentionally. Over time, I think the profession moved toward the value of clarity. This was very much emphasized by Chairman Bernanke, of course. Actually, I think a big impetus for the Federal Reserve was criticism from the outside. There were some issues at the end of the ’80s, and I’m going to get some of this information wrong and the dates wrong, but there were some leaks associated with the FOMC that caused a lot of furor. There was Henry González. I don’t know if you remember him, but he was the chair of the House Banking Committee at the time. He was a fierce Fed critic, and was really pushing for more transparency from the Federal Reserve and on things related to the discount window and lending operations. He pushed and pushed and pushed. Eventually, the Fed started moving in that direction. 

The first statement, I believe, was issued in ’94. It took a while before it evolved into its current form. I think the first statement was issued as it wasn’t clear who owned the statement. I think it was very much Alan Greenspan’s statement. Then for a number of years, I think the committee actually only voted on one or two sentences in the statement, like the balance of risk. Then eventually, in the 2000s, they moved toward voting on the whole statement. The whole communications thing has been quite amazing moving from the traditional world of secrecy, which I think was partly related to political pressures, toward a more open process. Now, of course, press conferences, and statements and minutes out in three weeks, very different world.

Beckworth: That is so interesting. The initial openness where we start to actually know what the federal funds rate target is, we actually have a statement, was probably just Alan Greenspan’s view of how things turned out. Now, today, my understanding is that’s a very complicated process. In fact, maybe tell us about that. As a former secretariat, how do you get everyone to agree this represents what we said and did in the meeting?

Clouse: That is no small task. There’s a small army of staff people involved in producing the statement and in producing the minutes after the meeting is over. In the statement, usually there are drafts, initial drafts prepared by the staff. They’re carefully reviewed by the chair and some other leadership of the committee. It’s then vetted with the committee in advance of the meeting, so they take feedback from other policymakers and the staff. By the time they see the Teal Book, the staff document that goes to them with policy options, the statement is more or less locked down. Then they have their discussion at the meeting, and then the minutes get prepared. 

The minutes, as I learned in my years as secretary, are a whole process unto itself. It’s stressful, to be honest, because it just has to happen so quickly. The minutes are, the meetings themselves are immediately transcribed. They’re recorded, there’s a transcript prepared, and then we’ve got a small army of people furiously writing up summaries of the minutes over the space of a few days. There’s a whole process connected with that, of review at the staff level, review by the chair, review by the committee members with feedback, and is somewhat, can be quite painful at times. 

Oh, one of the things on the communication that has, I think, been a big change, is actually involves a lot, is the preparation for the press conferences. Chair Powell, to his great credit, he takes those very seriously. The staff has a very involved process in prepping him for those. There’s a document that’s lovingly called the War and Peace Document with literally hundreds of questions from all kinds of different corners of the Federal Reserve on supervision issues, monetary policy, of course, all kinds of political issues or political-related issues that could come up. The whole communications infrastructure has just gotten much bigger than it was when I first joined the Fed.

Beckworth: You see Chair Powell open that folder, and if he doesn’t remember, he’ll flip to the page, and you’ll see.

Clouse: It’s amazing that he can do that very quickly. One of the things that’s really good in the way he handles that is that there is the War and Peace Document, but then there’s the so-called hot list, which is what people view as the most likely things he’ll be asked. He does a good job of having a few questions that are just intended to be the general framing of things that he can use to answer a variety of questions. He often starts with that. There’s a process involved there, and he’s a very active participant in that process. It usually turns out quite well.

Beckworth: That’s remarkable because there’s not much time between the end of the meeting and that press conference, so you guys must be working hard to get the questions to him.

Clouse: Yes, but the process actually starts a couple of weeks before the meeting. These documents of questions, people start trying to anticipate the questions that could come up. While all the other stuff is going on, the preparation of the Teal Book, preparation of memos, preparation of the statement, there’s also the preparation for the press conference, and that’s a process unto itself. A lot of people are involved in that.

Beckworth: They’re doing this ahead of time. They’ve got to have questions for different scenarios, like if we raise rates, if we don’t raise rates, or cut rates, don’t cut rates. We’ve got to have questions for both scenarios, and you’ve got to play it out, huh?

Clouse: Yes, I think that’s fair. Of course, usually, to be honest, by the time, usually it’s a pretty good sense of what the outcome will be, but still, to your point, the questions need to encompass a wide variety of angles that people could have. “You did this, but why didn’t you do that?” or “You did this, and why didn’t you do more?” A lot of things like that.

Beckworth: Even like now we’re recording this, and next week there’s an FOMC meeting and we all know pretty well what the Fed’s likely to do, so it’s not too difficult to come up with a scenario. It’s probably harder when there’s a crisis, something big, unexpected happens. Then you’re scrambling to come up with material.

Clouse: Yes, that’s true. I think when there are crises, it makes it much more challenging. The statement is so structured and formulaic, it’s often difficult to really have an expansive discussion of how something that has just happened is going to affect the outlook because, of course, nobody really knows at that instant in time. That’s where I think the press conferences are a very helpful addition to the communications toolkit because you can be more expansive. There’s a potential for back and forth, but it’s a continual challenge.

Beckworth: My observation from the outside is that it’s probably helpful that Chair Powell had been at the Board of Governors already, and so he had a knowledge base built up. Becoming chair, you already know some of the history behind some of these questions. As opposed to you bringing someone new from the outside, it’s going to be a steep learning curve just to catch up. Maybe they already know because they follow as they’re a Fed watcher, but it seems like it’s nice to have that experience behind you. Then also, I think his personality. We had a previous guest on the show. We talked about the importance of chairs and leaders of central banks in general across the world, but the Fed chair in particular, having the personality, the people skills to connect. Not just to be a rote answer, but one where you can connect with people when you talk. That seems to be one of his strengths.

Clouse: For sure. He’s the natural in that setting, so we’re very fortunate to have him there. He prepares very well. He’s a very active participant. It’s not just the staff handing him a bunch of stuff, but he’s editing and giving his views. He takes that very seriously. It was great. Your point about connecting with people, he really genuinely wants to hear from the staff as well as his other colleagues on the committee. Takes their opinion seriously. He tries to incorporate them in his own thinking. I think that’s really a valuable trait for the leader of the organization.

Y2K and the Fed

Beckworth: Okay. We were in the ’90s. We’ve come to the present. Let’s go back to the ’90s, some other developments that happened. You were involved with Y2K preparations and the discount window. Then you had 9/11. There’s a lot happening there. Let’s stick to Y2K. What was that like?

Clouse: That was a very interesting experience because, of course, that was a global effort. All the central banks in the world were, and all kinds of other agencies which were trying to prepare for all the terrible things that were going to happen on that day. The Fed spent a good year preparing on all kinds of fronts, on supervisory matters, on liquidity matters, operational matters, trying to get currency out in various places where it could be used quickly. The main thing I was involved in at the time were discussions around special liquidity arrangements with the discount window. There was a facility set up for that. All kinds of questions about how the credit unions would be addressed, and there was a special arrangement there. 

There were various special things done with open market operations too. You may recall there were options on repos. You could buy an option today to be able to execute a repo with the Fed at a fixed rate. Term repos conducted. All of this was intended to give people comfort that they would have liquidity around the century date change. At the Fed, there were hundreds of people involved in this effort. At the top of the Martin Building, there was a command center that was constructed with an elevated platform and it had all the screens from different parts of the world. It was quite amazing. I was there around midnight and nothing was happening anywhere else in the world. I got to midnight and nothing much was happening in the United States either. Everybody looked at each other and said, “Oh, well, it didn’t turn out to be such a big deal.” Of course, that was partly because of all the preparation that had happened beforehand.

Beckworth: I’m old enough to remember that very vividly. We were really worried things were going to shut down and not work. Fortunately, it was nothing, but that’s in part because people like you and others prepared for it to make sure. That’s kind of cool. I need to see a picture of this command center, terminals and people ready to go, like a war room.

Clouse: Exactly. That’s exactly what it looked like. It had clocks from different parts of the world. You knew what time it was in Japan when the date change happened.

Beckworth: I just think the worst-case scenario, if this did manifest in the way they expected, like Japan shuts down, and suddenly there’s a liquidity crunch there, and it runs on dollars overseas, and the euro dollar market has problems. 

Clouse: People definitely scared themselves. I was among those thinking about all these different scenarios that could happen in the lead up to Y2K. In the end, it proved to be not such a problem. Again, that was because of all the efforts involved.

Beckworth: What about 9/11? What was that like?

Clouse: 9/11 was such a tragic situation. Chairman Greenspan was in Europe, I believe. There were not that many other Board members around that day. Vice Chair Ferguson was there, and he provided great leadership. Governor Kohn was there, and he also provided great leadership during that terrible situation. I actually got into work a little bit late that day. The first plane had already hit by the time I got in, and then the second plane hit. I remember being in the offices of the division director at the time, and there were a lot of discussions going on. Virgil Mattingly, who was the general counsel of the Board at the time, was on one side of the table. All of a sudden, there was this huge noise and a big billowing black cloud. Virgil jumped to his feet. It was pointing across the river at the Pentagon.

Beckworth: You could hear it.

Clouse: Yes. Then after that it was all the rumors about other planes that are in the air, and truck bombs, and car bombs, and terrorists that will be roaming the streets. There was a real panic. I think people understood the situation. It wasn’t like people were panicked and not able to perform. One of the first situations that came about, of course, was that just operationally, it really destroyed a lot of infrastructure around liquidity. A lot of banks couldn’t make their usual transactions that they would normally be able to make. Some banks, when the payment system got disrupted, were left with very large funding positions at the end of the day. The Federal Reserve provided a lot of liquidity at the end of the day through the discount window.

I think that day, the discount window had outstanding something like $40 billion, which at the time seemed like just an astronomical quantity for discount window lending. Later on, of course, during the Global Financial Crisis, it was not seen as quite as large, but at the time, it was astonishing. There was a lot of liquidity provided through open market operations. Folks in New York were all over it, as usual. It was an incredible day, a tragic day. As usual, people across the Federal Reserve System rose to the occasion and trying to address it as best they could. Of course, there was some period thereafter where things were still disrupted. I would say within a week or two, things are more or less back online.

Beckworth: Did you have to evacuate the building?

Clouse: Yes. Most people were evacuated around, I want to say, 10 or so in the morning. A few people, I was there the whole day because of connections with the discount window. There were a lot of discussions. The home loan banks had some issues that day and were questions about what would need to be done if they needed liquidity. There were lots of issues like that. It was a privilege to be there during that time, trying to help out as best I could, along with many other people. Obviously, very tragic situation.

Beckworth: I don’t mean to make light of that day, but it’s interesting that it took 9/11 for many banks to get past their stigma fear of the discount window. I know that’s been a push that the Fed has tried to minimize. You don’t want increased moral hazard, but you also want to get it to be more of a regular part of daily use, right?

Clouse: Yes. I think that’s always been the challenge with the discount window. Of course, when they really need it, like in 9/11 or in the Global Financial Crisis, they will come knocking at your door because they literally have no other choice other than to go out of business. You don’t really want things to get to that stage. You’d like to have them feel more comfortable drawing in that liquidity beforehand to avoid exacerbating market upsets of one sort or another. 

Stigma, I’ve learned this from colleagues like Mark Carlson and Jonathan Rose, and some other historians—you’re an expert on these topics too. I think stigma around the discount window at the Fed has been around for decades. You can read accounts of people being reluctant to borrow at the discount window in the ’20s. I think the Fed sometimes has exacerbated the problem. In the ’50s, there was a tightening in regulations. It required there to be an appropriate reason to borrow, which then led to questions from discount officers. Sometimes it’s been seen as connected with the supervisory side of the Federal Reserve, which is not a good way to encourage people to borrow. 

I also think there’s just this inherent structural aspect to the discount window. If it’s meant to be not necessarily a lender of last resort, but not a lender of first resort, then there’s always going to be a question mark around, if somebody uses it, did they use it just because they had some operational problem, or did they use it because there was actually some more serious issue? Then if you’re a banker, knowing that, you’re not necessarily going to want to take the risk that people will conclude, if they find out that you might be one of the ones that has a problem. I think there’s just an asymmetric information market-for-lemons type of thing there that makes it very difficult to get rid of stigma completely. Nonetheless, it’s worth trying. The Fed, as you know, over the last decade or so and the last few years, has made some efforts to create a kinder, gentler feel to the discount window. I think that has helped some.

Beckworth: Bill Nelson, your former colleague, has been on a few times. I believe he was telling me, in the early 2000s, they really pushed hard to make the discount window more user-friendly. It’s something you can count toward liquidity requirements and such, but it was a challenge. Then comes up the Great Recession, and that completely reinforces the worst fears of the discount window, and they introduced TARP and stuff. 

Discount Window

Coming to the present, because you just stepped down, there’s been a lot of discussion about making the discount window, the collateral you have parked there, count toward some liquidity regulations, maybe your internal liquidity test, some even suggest a liquidity coverage ratio. Do you see that as being a fruitful endeavor? It’s been a big push, I think, across the Federal Reserve System and other bank regulators as well.

Clouse: I think there’s a couple of things going on there, and I’m a little dated in some of this. One issue is just on purely operational issue, having banks have collateral at the Federal Reserve in the appropriate safekeeping arrangement without any conflicts involved with home loan banks or other potential parties they may have, but lean on the collateral. Those kinds of operational issues can come up, and you want that to be settled beforehand so that when a need arises a bank can come in and borrow. 

Separate from that, I know Bill is a big proponent of this, there are thoughts about whether the discount window was left out in the cold, in effect, by the Dodd-Frank requirements that basically requires banks to self-insure against liquidity needs to a large extent possible by holding high-quality liquid assets. Then where does the discount window rank then? The discount window was designed to be something banks could turn to in the event of a liquidity event, but now a lot of the liquidity regulations really channel the banks more toward self-insurance with these liquid assets. There’s a lot of people that suggest, well, maybe it’s not the greatest thing for banks to be forced to hold a lot of low-yielding, low-risk assets, and isn’t that what the discount window is for anyway? Wouldn’t it be more efficient for banks to just get the collateral in place and be able to count some of that collateral toward your LCR-type requirement? I don’t know. It seems like it’s a complicated thing. 

I think probably, if Bill were here, he would be saying, “Yes, that’s exactly what should be done.” I do wonder, it does feel like the liquidity regulations are, in a way, helping some banks to, in any way, internalize the negative externalities that they may have with the system to the self-insurance and having to pay an implicit premium by holding these lower-yielding assets. There is a rationale for that, too. I sometimes think that the ex-post issue is important, too. If you have a bank that’s holding lots of reserves, say, and they suffer a run or some liquidity pressures, and they have to run down some of their reserves, a bank could survive that. If they have a discount window loan that’s sizable at the end of the day, and they can’t get out of it feels like a different deal. That would probably quickly become known. Some inferences are drawn, so I’m not sure, from a financial stability perspective, that they’re actually a one-for-one substitute. At least that’s my thought on it.

Beckworth: That’s interesting. Talking about the discount window there’s some interesting history going back to the late 1990s. I want to mention, I want to bring up with you. I’ve discussed this with Bill as well, but in the late ’90s, we were running down the actual debt. We were running budget surpluses, and at the Federal Reserves, there was some growing concern, “Oh my goodness, what are we going to have on the asset side of our balance sheet?” You looked, I say you, the Federal Reserve looked really hard at this, and one of the things they came up with, well, we need to do more discount window loans. That’s an asset. We can get more banks engaged. What I learned from Bill is what later became the Term Auction Facility (TAF), that was an idea that originated during this time, like this is something we could do. We could auction off these assets.

Clouse: You’re absolutely right. That was a fascinating episode. There was that period, as you know, in the very late 1990s, early 2000s, when there were surpluses, and just as you say, there were projections that would continue. It didn’t last very long. There was a big staff study commissioned, and they looked at all kinds of various alternative assets other than Treasuries. Agency debt would have been one. 

Of course, at that time, I don’t think people were too eager to invest in a lot of agency debt. Chairman Greenspan, in particular, I think was eager to reduce the moral hazard issues generally associated with the housing agencies. This idea of an auction credit facility was one of the things that that group studied, and that, just as you say, it did come back later to be a very important thing that was actually implemented during the run. That was actually implemented early. That was implemented in late 2007, I believe, and there was quite a bit of take-up at it for a while.

Beckworth: Which is interesting because it’s really just a different form of the discount window, but it’s just, I can put a new name on it. 

Clouse: Yes, it’s like rebranding. I think the fact that it was an auction facility, it kind of had a different feel to it, and it didn’t settle right away. There was a couple of days lag between the auction and then when you got the funds. Some people point to that as a way of separating, like, I’ve got to have the funds right away. At one point, I think the minimum bid rate was set so low that you were essentially getting term funding at a pretty attractive rate. There wasn’t a big penalty to involved in borrowing

Beckworth: Okay, so they made it worth your while to come to it.

Clouse: Yes, exactly.

Beckworth: Well, it’s interesting because this is another thing that Bill has suggested that to make the discount window more regularly used, they need to bring back TAF or some version of that. Do the collateral thing at the discount window where banks can count it toward some regulations, but also have something like TAF just to make it a normal part of operations. It’s interesting to me, though, that this was motivated by the fact that we were running budget surpluses, so it was definitely was the good old days.

Clouse: Yes, they were.

Beckworth: Now we have the opposite problem. I worry more about things like fiscal dominance on the horizon, not about running budget surpluses. 

Global Financial Crisis

Let’s move forward to the Global Financial Crisis. We just touched on it with this TAF idea and the liquidity programs. The Fed went big; 13-3 was invoked in a way it never has been. Dodd-Frank made some changes to that ability because there were concerns about how it was used, but we still use it in 2020. What was it like living through it? I want to tell us, what was it like to live through those moments? Because it wasn’t just overnight. It gradually unfolded over a few years. Were there sleepless nights? Were there like, man, are we ever going to get through this kind of moments?

Clouse: Most definitely. That was just such an astonishing period. We were very fortunate that we had people like Chairman Bernanke and Don Kohn and Bill Nelson and other people who were really smart people that could figure a lot of things out, Bill English you may have talked with from time to time, and hundreds, literally hundreds of other people across the system. 

Just as you say, those pressures started to mount there in 2007. I think that’s when the initial breaking of the buck happened. Was it Reserve Fund in August, I think? That’s when the TAF started. Those liquidity pressures seemed to really become prominent in the eurodollar market, and term funding for banks became a really big issue. The TAF was implemented quite early and had a lot of take-up. Around the same time, I think the swap lines were put in place with a number of the foreign central banks because the global dollar funding pressures were getting hit really hard. 

I was amazed by this because usually at the Federal Reserve, new developments, new facilities, somebody has an idea, it gets shot down four times, then maybe there’s something, and then you study it for five years, and then maybe it’ll be implemented. Wow, after that, you were just on a totally different timeline. The PDCF and TSLF were put in place with lightspeed in early 2008, and then Bear Stearns happened, and that seemed like this momentous thing, and it was. That was the first use of 13-3 in a really long time. 

There was a very brief period, I think it was in April, when it seemed like things might be getting better, but then it just immediately went south again by the summer. Fannie Mae and Freddie Mac were in trouble, and Citibank was teetering, and later on, it was AIG, and it was just one thing after another. Then Lehman happened, and everything just shut down. You may not have been here, but there was a period a few years ago when there was an earthquake in the Washington, D.C. area, which I had never experienced before. I was sitting in the Board building thinking, what the heck is going on? I’ve never experienced anything. It felt like that. There was all this fog of war going on. What is going on, and how can you possibly address it all? 

The policymakers, with great leadership from Chair Bernanke and the staff, really, just legions of staff across the board, and New York, and across the system, really worked incredibly hard to try to make all those facilities come together. There are better historians than me, but I feel like the stress tests there in 2009 were a turning point. There was still a lot of bad stuff going on, but I feel like things started to get gradually, slowly better after that, when they got a little bit more confidence around the banks, the TARP injections of capital happened, and so once they got the banking system, not stabilized, but on a better footing, it seemed like I think things were on a better track.

Beckworth: I think this is where it’s important to do the right counterfactual. What could have been could have been far worse, right? If there hadn’t been these interventions, so it’s easy to criticize from the outside, and there’s a lot of criticisms the Fed received at this time. Not to say we would have gone all the way to the Great Depression, but the fact that it was possible, right, this financial system was crashing. 

Let me throw another counterfactual out there to you, and if you want to pass on it, I’m totally fine on this. But a critique I have of the Fed at the time, not so much the staff, but this is the FOMC in particular was that a number of FOMC members were really worried about rising inflation in 2008. And I remember gas prices, commodity prices were driving a lot of this. I remember I was just talking to my colleagues, we paid like $5 a gallon. It was awful. This was back in 2008, right, but there was a lot of concern about inflation during that time, and I believe in the August minutes, and definitely in the September FOMC meeting that year, Bernanke in his books, this is one decision he really regrets, is they didn’t cut rates because they were worried about rising inflation. If you looked at Fed Fund Futures, they were actually going up the second half of the year when the economy was going down, and to me, you can argue how important that was, but to me, that was like you weren’t looking through a supply shock. That’s, to me, a textbook case of like you have a negative supply shock, inflation goes up, you look through it, and you look to the broader economy, but any thoughts about that observation?

Clouse: Yes, I’m trying to remember the circumstances of all that, and a little bit of that is hazy. Certainly, in retrospect, the committee probably would like to have that one back to get a mulligan on that decision. There were some pretty hawkish members at the FOMC at the time. President Lacker and President Plosser and others were quite concerned about the potential for inflation, particularly after the large-scale asset purchases were going in place. I think people were quite concerned that this massive expansion in the monetary base was going to spur lots of inflation. There was very serious arguments, rifts within the committee on just how seriously to take those. That might be a point, certainly ex post to the information we have now where you would say that maybe that concern about inflation was misplaced.

Beckworth: That’s why I champion nominal GDP targeting.

Clouse: There you go.

Beckworth: I had to squeeze it in there somehow. If you look at nominal income, now to be clear, GDP comes out with a lag. The numbers that year were revised dramatically. In real time, it’s not a great guide. If you look at that forecasts of nominal income or nominal GDP, at a minimum crosscheck. That’s the thing to say, crosscheck yourself. 

I don’t know if you remember Evan Koenig. He was from the Dallas Fed. He did a great piece. He applied this thinking because he was a champion of nominal GDP targeting to ’21, ’22. He said, is it time to tighten? He just looked at a consensus forecast of nominal GDP. He showed the gap between pre-COVID trend and post was closing, and it was going to go above. He said, “Yes, it is time to tighten when the Fed did tighten.” Just as a crosscheck. All I’m recommending is a crosscheck.

Covid Pandemic

Let’s keep going on because you have some amazing work you’ve done even since then. You dealt with the pandemic. Another amazing challenge.

Clouse: Again, along with a gazillion other people at the board and the Federal Reserve. That was just another absolutely astonishing episode. Again, the whole panoply of 13-3 programs and supervisory accommodations and monetary policy actions were in play at the time. I do have this one memory that sticks in my head. It was in March, I can’t remember the date. It was one of the meetings where, and I think it was a Board meeting, where the staff brought all these proposals. There must have been 15 things on that, and they were all major.

Chair Powell was at the end of the table and just calmly approved every single one of them. He had all guns firing at that point, and he was right. There’s a lot of criticism now about the inflationary episode and everything. At that time, he had no idea that that was going to be the case.

You’re looking at that point and seeing the unemployment rate going up to whatever it went up to, well above 10%, and not knowing how things were going to turn out. If somebody told you could get out of this, but you might have to put up with a couple years of inflation, you’d probably take that.

Beckworth: A lot of uncertainty for sure. Vaccines weren’t out also at the time. There’s a lot of things we did not know. We come out of a zero lower bound world right behind us, the previous decade, so it’s like, are we going to be stuck in this?

Clouse: All that was going on. I think the Federal Reserve really stepped up to that challenge in a major way. Congress came through too big time. You can argue about the wisdom of some of the actions that were taken, but the strong fiscal stimulus at that time, I think was helpful in a way that you wish had been there in 2008, 2009 too. I think that probably would have quickened the recovery to some extent.

Beckworth: I’m glad you bring that up because I’ve come to a place where I’m less critical of macroeconomic policy during that period because one, of uncertainty you mentioned. I think that’s huge. I think it’s easy to be a Monday morning quarterback. Two, I view it as a war effort. I got this from George Hall. He has a paper with Tom Sargent. He has several papers. They compare World War I, World War II, the pandemic.

Basically, it’s like a world of, I’ll say, fiscal dominance, but basically you got to throw everything at it. Fiscal policy comes swinging. Monetary policy comes swinging. You got to throw everything at it. When you have these emergencies like this, you break the rules. In my view, you don’t want to look at a Taylor rule in the midst of a pandemic.

Clouse: That’s for sure.

Beckworth: Now, you want to return to it. I think it’s good to go back and say, okay, why did we break the rule? It’s good to assess. Even the gold standard, they occasionally went off gold. Civil War, you went off the gold standard. Slowly worked your way back. I think it’s important to step back and say, okay, this was a true national global emergency. I guarantee if we have world war in the future, we will throw everything at it again.

Now, with that said, what makes it difficult is it did add a lot of debt. We’re now in peacetime, full employment, we’re still running up a lot of debt, and that makes it tricky. I do look back with that period with grace toward policymakers because it was uncertain and we’re fighting effectively a big war.

Clouse: Absolutely. I completely agree with your assessment. Just as you say, the uncertainty and the risks at that time were huge. They just mattered a lot to the actions that the policymakers were taking. I think the lessons from both 2008 and 2020 are when you have an emergency like that, you need to go big. I guess they didn’t really go big in 1932, and it was a lot of big problems.

I personally think that 2008 could have been right up there with the Great Depression had there not been a strong Federal Reserve reaction and at least some reaction from fiscal policy as well because it sure felt like that. I actually remember talking to my mother at the time. She made some comment about, “Oh, that little thing we had in 2008.” Of course, she grew up in the Depression.

Beckworth: Weird, small by comparison.

Clouse: I said, “Yes, but for actions that were not taken.”

Beckworth: You mentioned that 2008, 2009 could have been like 2021. We could have had a quick bounce back, a V recovery. We didn’t. We had this, I guess, L-shaped low, permanently below the previous trend path. Maybe it was some form of hysteresis, I don’t know. There’s permanent scarring. Again, I don’t want to beat this horse too much, but if you look at what happened to nominal income, it quickly popped back whether from fiscal policy, monetary policy in 2020, it did not. I think we live in a world of nominal debt contracts.

Why didn’t we have a major financial crisis in 2020, 2021? There were a lot of things that were done. There were mortgage modifications. I think one big contributing factor was nominal incomes were stabilized. I think you can say we went too far, but that’s where the uncertainty comes in. That, to me, is the positive lesson learned. If you can quickly restore and maintain nominal incomes on a stable growth path, a lot of the periphery stuff takes care of itself.

Clouse: I think having a strong fiscal response was very important there, and that certainly supported the nominal incomes. I think the fact that the banking sector was strong and able to withstand pretty good shock at that time helped a lot too. Had the fiscal response not been there and the economy tanked, and then there were loan losses, and then the banking system goes down, you could imagine some far worse scenarios. I think supporting nominal incomes, but also supporting the inherent strength of the economy and cutting off the feedback effects on the banking system were important.

Beckworth: Maybe a way to summarize this whole discussion here on 2020 is, do the right counterfactual. Could you really have threaded the needle better? I hope so, but I’m not sure that we could have. I think the option would have been what we had versus something far worse. I think realistically, if they’d been conservative and modest, it wouldn’t have been halfway between. It would have been a collapse like 2008.

Clouse: I think that’s a good way of summarizing it. When there’s a crisis, you just have to respond. Fortunately, we had policymakers in place at the time that understood that principle and executed on it. It really required a change in mindset because, again, the Federal Reserve typically is a very analytical, fairly slow-moving agency, but when those things happened, to its great credit, it did move quickly.

Jim’s Current Research

Beckworth: Jim, we’ve been talking about your amazing career, and I look forward to your autobiography when it comes out one day. We’ll have you back on for that. I’ve planted a seed for the future book here.

You’ve had some really neat stuff that you’re doing at the Andersen Institute. I want to touch first on a note that you did in response to Ted Cruz’s call for ending interest on reserves. I think his efforts were well intended. He’s looking at all the deficits, fiscal pressures, but at the end of the day, he missed something important, didn’t he?

Clouse: Yes, he sure did. You recognize this, and Bill Dudley recognizes this, and other people immediately noted the issue. Under the Federal Reserve’s current operating procedures, the interest on reserves is the key tool that allows the Federal Reserve to control the level of short-term interest rates. If you eliminate interest on reserves, you’ve basically totally blown up current operating procedures.

There are other ways the Federal Reserve could operate, but to get there, you would have to shrink the size of the balance sheet a lot. In the end, what I tried to do in that note was just make the same point you made in, I think, one of your columns, and other people made too, is that the Federal Reserve would have to totally restructure its balance sheet, reduce it drastically in size. And the only thing that would really happen in the end is that the private sector would end up holding a lot more Treasury securities on which the Treasury is paying interest, and the banking system would have fewer reserves, but there wouldn’t be any real net benefit for the Treasury stemming from that.

That leaves out the other very important, just practical issue, is if you actually required the Federal Reserve to do something like that quickly, you’d have to sell a lot of Treasury securities. In doing so, you would probably force the Federal Reserve to sustain some losses, and that does hit remittances to the Treasury, and so that’s a double whammy. Very simple accounting points, but it does point out how slippery some of these issues are around the implementation of monetary policy.

Beckworth: Bottom line is there wouldn’t be all this net savings that they were hoping for. Senator Ted Cruz, again, I think he’s coming with the right intention. He envisioned, I think, $1 trillion over 10 years, and as you mentioned, no, the government would still be paying interest one way or the other. It looks like we’re paying all this money to banks, but the alternative, as you noted, is that banks, if they’re not holding reserves, they’ll be holding Treasury bills and Treasury notes, and guess what? The Federal government’s got to pay that, too.

The only thing I thought about, and I think you mentioned this, too, the only really meaningful point I think you can make is to the extent interest on reserves is higher than Treasury bill rates. I did a little math calculation, and it still isn’t that much. It’s something, but it’s not anything near $1 trillion.

Now, let me step back and ask another point related to this. There aren’t going to be the net savings because one way or the other, the government’s got to pay interest to the banks or to some part of the private sector. The other thing, though, is this, and I’m sympathetic to Bill Nelson’s arguments. In fact, I’ve become a fan of ceiling system, demand-driven ceiling system, like the Europeans are doing, but put that to the side. It is the case, at least it seems to me, that the floor system, on average, generates a lot more net income from the Fed than some other system does.

Yes, there’s losses now, depending on who you ask, how long it will take, but if I had run a scarce reserve system, a corridor system, say, somehow since 2008, somehow we were able to do that despite all the things we were doing, and I just compared net income over this whole period, added it up, I’m way ahead of any losses we’re experiencing now and probably will. Is that a fair assessment?

Clouse: I think so, yes. If you calculate all the remittances that the Fed Reserve has had over the last 15 years, I think they’re well over $1 trillion, so that’s a chunk of change. Just as you say, if the Fed Reserve has a very large balance sheet, it will be paying a lot of interest on those reserve liabilities, but it’s also earning a lot of interest on the corresponding assets, so a large balance sheet, assuming there’s some positive spread between the rate of return that the Fed is earning on its assets and its net funding costs, is likely to mean more Fed Reserve remittances to the Treasury.

Beckworth: I think you’ve got to look at the past as well as the future. If you’re going to make a decision on an operating system, you should at least acknowledge this point. I think that’s fair to say. There might be more variance. Whenever you get a zero lower bound and then rates, you don’t get that positive spread, I think that’s a fair point too. There might be more variance. Maybe a corridor system is more predictable, but lower net income.

I completely concede this point that the floor system, ample reserve system, is definitely going to generate more net income over the long run. Here would be my critique, independent of my preference for something different, is does that not make the Fed effectively a large fixed income hedge fund? It’s doing a wonderful thing in terms of making money, but do you see that as part of the Fed’s mandate?

Clouse: Of course, they’re not thinking about it in terms of acting like a hedge fund. They’re certainly not day trading. They’re just buying securities and holding them until they mature, so it’s a pretty boring hedge fund. They’re doing it to implement monetary policy effectively. It does have some issues, and you’ve pointed to some of them. The ample reserve system does result in excellent interest rate control across a wide variety of environments, even when the balance sheet is very large and when the Fed Reserve is conducting large-scale asset purchases, you can operate that system. It’s incredibly simple, both for the Federal Reserve and for the banks.

I don’t know if you had the joy of dealing with all the details associated with reserve requirements in the prior regime, but it’s mind-bogglingly complicated. There used to be this thing called the Reserve Maintenance Manual. It’s like 300 pages long with all the various details that are involved in it.

Beckworth: Because banks to find ways around those rules, right? Sweep accounts.

Clouse: All that. There are all kinds of adjustments and merger things and all kinds of complications. The current system is very effective, very simple, and I think they feel like it has been a great addition. I think one challenge is that, at least to my way of thinking, I just continue to be astonished by how large the quantity of reserves needs to be to get you to the floor. I would never have guessed that.

I probably shouldn’t admit this, but in the mid-2000s, we did estimates like that, like how many reserves would you need to really drive you down to a remuneration run on reserves. It’s like $50 billion or $100 million or something. A pretty small number, now you have this massive quantity of reserves. Even with that, you can still, if you run regressions, you can see some correlation in interest rates between changes in quantity of reserves and short-term rates.

Where the heck is that coming from? I think it’s still a little bit of a mystery, but there have been these various papers that I know you’re well acquainted with, but talking about a ratcheting-up effect in demand for reserves. I think that probably is part of it.

Beckworth: I’ve had on the show several times, Sam Schulhofer-Wohl. He’s really good on this. I’ve talked to him about what the Europeans are doing, Bank of England, RBA. They’re moving to a demand-driven, what I’d call ceiling system. They’re going to rely more on the upper part, the lending facilities. Of course, we’ve got a lot of challenges in the US to deal with it if we ever went that direction.

He made this great point. What they’re doing is, yes, they’re moving up, and the ceiling might be the benchmark right to set monetary policy, but the spread is so small. It’s not like a bank. It’s so small that you’re still pretty close to that floor, the deposit rate at the Fed. In his view, what they’re doing is not that different. I do like the idea of having banks demand-driven amount for reserves. That’s another long conversation. Maybe we’ll have you back on sometime.

I do want to go to one other item that you did research on, and it’s related to this. It’s good pushback against my stablecoin enthusiasm. My stablecoin enthusiasm has been about, oh, it’s going to increase demand for dollars, and dollar dominance is strengthened. It’s one thing Trump is doing right for dollar dominance. You raised a great point I had not thought about, and that is, it could dramatically reduce the demand for currency. It may increase demand for reserves depending on what these stablecoins do, what they back their stablecoins with. But if, in fact, it’s all reserves, well, guess what? Reserves are costly for the Fed, and they have to pay interest now.

Maybe there’d be some rules changes for stablecoins with an earned interest. I don’t know, but as it currently stands, currency, there’s no payments. There’s zero on it, right, and you’re going to lose that golden goose there?

Clouse: Yes. That is kind of the buffer for Federal Reserve income. You’ve got this perfect liability that pays no interest, and you get to hold interest-earning assets against it. It’s good for the United States, too. It’s a costless thing to produce, and it generates income. 

In effect, if it were the case that stablecoins really started to eat into what is the current demand for paper currency, the US Treasury would be losing on that deal. You’d be replacing seigniorage income they’re currently getting from the Federal Reserve with nothing. The seigniorage income would be going to the stablecoin issuers because they get to issue these zero interest-earning liabilities and hold the interest-earning assets instead.

It’s interesting. You, I’m sure, are acquainted with the history much better than I, but this idea of who gets to issue the thing that’s the medium of exchange? Is it narrow banks or is it free banks? Is it national banks? Now we seem to be landing on at least one corner of it where a type of medium of exchange is issued by a new type of nonbank entity, subject to some requirements.

Beckworth: I think the horse is out of the barn. I think stablecoins are happening. They’re going to continue to happen. The GENIUS Act makes it even more official. These things are going to happen. It’ll be interesting to see how does it affect the demand for currency because overseas that’s been a big thing, right?

Clouse: It’s a big deal. I don’t really know that much about stablecoins, but I would think if you were a stablecoin issuer and you looked over at the Federal Reserve and saw they’ve got this whole bunch of currency outstanding, you might want to try to think of things that would market it to people who are holding currency instead.

Beckworth: Maybe there’ll be people who still want to hold physical currency for privacy reasons because even though stablecoin is on the blockchain, you can’t see a name, but there is decreased privacy relative to physical currency. Maybe there’ll be some of that. Maybe not. To me, I do see the appeal of stablecoins: peer-to-peer transactions overseas, not constrained by some bad government.

Clouse: In a way, the threat to US currency might be almost broader than stablecoins. Just the whole evolution in the payment system that allows payments on Venmo and all kinds of these apps, why do we need to be carrying around a lot of physical paper currency? I thought the little bit I learned on that note was just looking at the experience in Sweden and Norway where they’ve mostly gone cashless, and thinking about what that would imply if things actually worked that way here.

It does seem like the demand for currency is pretty well entrenched right now, but on the other hand a lot of other things, seemed like they were kind of entrenched, and then they weren’t.

Beckworth: It got me thinking, and I don’t know that I have the answer to it and I’m not asking you to have the answer right now to it either, but what would this imply about the Fed’s operating system? What could it actually do if, in fact, currency in the limit goes to zero because of stablecoins? This would be way out there, but let’s say it does for the sake of argument. Then the only other part of the monetary base left is bank reserves, deposits at the Fed, and in order to have a profitable central bank, I’m not sure what it would imply, but it might get costly for the Fed.

Clouse: You’re raising a great point. In that kind of world, I think the ample reserves regime would still work the way it does now.

Beckworth: Yes, that’s what I was thinking.

Clouse: To your point, I think it would be the case that the Fed would run more frequently into situations where it has the deferred asset, where you have negative net income for a period. It would probably have to be more careful about what it invests in to make sure that it’s, or hopefully to invest in things that are longer-term and likely to earn a positive spread relative to the interest rate on reserves. It would be a bit of a different world.

Beckworth: On one hand, I could see it as an argument to keep an ample reserve system, but because you’d have this variance and sometimes you’d have losses, it might be an argument to shrink the balance sheet. You’re going to have losses maybe no matter what with stablecoins, so minimize it by holding the quantity of reserves less. I don’t know. I haven’t thought through all of it, but you definitely sparked some new ideas here.

Clouse: It would be great if there was a way for the Federal Reserve to implement monetary policy effectively with a smaller balance sheet. I do feel like the size of the balance sheet, whether it’s well informed or not, it does attract a lot of negative attention that I think is not helpful to the broader goals of maximum employment and stable prices.

Beckworth: For sure. I think it opens up the Fed to wanting to be manipulated by politicians like, “Oh, you’re telling me the size of the Fed’s balance sheet is independent of the stance of monetary policy now? Why don’t we do things with that?” That’s the danger I see more than anything.

With that, our time is up. It has been a fantastic conversation, Jim. Thank you so much. Our guest today has been Jim Clouse.

Clouse: Thanks so much for having me today, David. I really appreciate it.

Beckworth: It’s been great. Thank you.

Clouse: I enjoyed it very much.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth and follow the show @Macro_Musings.