Mike Konczal on Expanding the Fed’s Monetary Toolkit

The Fed should be more forward thinking in response to the next recession and it has new tools it should use to drive policy.

Mike Konczal is a fellow at the Roosevelt Institute where he works on financial reform, unemployment, inequality, and a progressive vision of the economy. Mike joins the Macro Musings podcast to discuss the progress of financial regulation, the Federal Reserve’s performance over the past decade, and new tools the Fed could utilize to better stabilize the economy.

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: Mike, welcome to the show.

Mike Konczal:    I'm so happy to be here. I'm a long time listener, first time caller, and one of the first times I think we've met, so this is very exciting ...

Beckworth: No, it is.

Konczal: ... to talk in person. We've talked a lot online and email and blogs and whatnot.

Beckworth: No, it is. It's really great. We go pretty far back on the blogosphere. It seems like Twitter a little bit later, but I remember we had conversations about level targeting. I think, you were the one who found that great Roosevelt quote on bringing the level back.

Konczal: Yeah, it was actually one of the first fireside chats. I think it was a second fireside chat. It's actually incredibly wonky. I mean, the country's much more agricultural, so they probably think of it a little bit more day-to-day than a lot of workers do now, but he was very conscious of we're going to restore the price level, natural level above or below it. This is why I'm doing really big things in the banking sector in the first hundred days. Yeah, it's crazy to think that there was actually like this long history of talking very concretely about things like the price level in public debate.

Beckworth: Yeah. Well, it's very fascinating. I mean, we can spend a whole podcast about FDR's programs, but how he was very bold, very open to reflection where the fed and many people were not at the time, but very interesting find you put there. It was interesting to hear FDR effectively talking about a price level target way before it was in the literature, way before we were born. He was ahead of his time. We want to talk about your paper today. Before we do that though, I want to just briefly get the background of your journey into this area.

Konczal: Yeah, so I originally, I had graduated, I'm 38 now, so I graduated college in 2001, right into that recession. It wasn't too bad. I was a software engineer. I worked at Motorola for a long time, for about five years, four or five years. Then I wasn't quite sure what I wanted to do next. I had a background in math. I was talking to the mathematicians there. I was doing a lot of modeling of cell phone towers and things like that, which were very new and crazy at the time. Now everyone takes for granted that our whole lives are on our phones.

Konczal: I went back and I did a masters in finance at the University of Illinois where I did my undergrad. I knew a lot of professors there. We came up with this curriculum where I could do a little bit of an MBA and a lot of financial engineering, which was very much all the rage at the time. I learned all the Black Shoals models and a lot of stuff around bank loss reserving, which is what I ended up working professionally. After that, I always wanted to know more about economics, and so I stayed on and took a bunch of coursework. I talked about doing a PhD in finance. For veteran economic listeners, I was very much taught in a catch-up economics kind of way as opposed to economics of catch-ups. I'm very sympathetic to business school ways of talking about economics. I had thought about doing a PhD there. I stayed on to do coursework and realize I didn't, I was looking at career paths that I would likely take. They were all in the Bay area or they're all in tech or fin. Now we call it FinTech or math.

Konczal: I don't really need the PhD, which is mostly about how to do research past the master's level. Now of course, my career went in a completely different direction and the credential probably would have been useful. I got in. I worked in the financial sector in San Francisco doing a lot of Basel II compliance and loss reserving. There's way of using Black Shoals as a way of understanding equity, understanding the nature of the firm's balance sheet as an option theory, which has its own economics applications everywhere, I can option. It was a big '80s, '90s thing. We were doing that.

Konczal: Then the crisis happened. I was very interested in what was going on, as most people were. I had a way of communicating a lot about what was going on in the financial sector. I ended up reaching out to some people and said, "I would really like to work on what would become financial reform." This is also peak blogosphere, peak, I'll like move on, people coming up with the Obama and people coming up with this generation of people wanting to change everything. I reached out to people who had read me. Also I was being picked up by people like Felix Hammond, Ezra Kline, that had big voices and were amplifying mine. I said, "I have the bandwidth to take a year or two off my career to go work on what would become Dodd-Frank."

Konczal: There was a team in New York headed by Rob Johnson, who's an economist who was starting a team at the Roosevelt Institute, which is where I work, which is the nonprofit partner, the FDR Library. He's also starting something called INET, the Institute for New Economic Thinking, which maybe many of your listeners have heard of. Roosevelt sounded like a perfect match. I stayed there. I worked very intensely for a year on stuff surrounding Dodd-Frank. Then I just moved on to things around unemployment and the recovery. Later, got to work with Joe Stiglitz who's our chief economist on his big inequality project. I've been there since, about six or seven years. It's been a crazy ride ever since.

Beckworth: Yes, and we've had one of your scholars on previously, JW Mason. He had that great paper on what is the true potential of the economy and maybe we're underestimating it.

Konczal: Yeah, we'll definitely talk about that later when we're talking about this paper, which builds out of that one.

What Progress has Been Made Since 2008?

Beckworth: For sure. You've done a lot of work on financial reg in addition to this macro work we're going to talk about. Just briefly, since you're an expert in that area and you come from a more progressive perspective, what progress have we made in your perspective, since 2008 in the financial system?

Konczal: I think Dodd-Frank, I think when you think of it, I think it's a very good bill. I think it's very underappreciated and gets really thrown into a partisan framework very quickly. It gets thrown into a politics of like, I don't to say nihilism, but like the sense like you can't win against the bank, so we've not made any progress. I think it actually identified some very serious problems that were kind of known before the crisis, but how much of a problem they could have been, I think, was never really established. Then the crisis saying, "Well, it actually does have big consequences for people." I think it's done a very sensible way of carrying them out.

Konczal: I mean, let's think of a couple things. One is it was very hard by law to regulate very large financial institutions in a prudential way. Should we looking at something like Citi, the bank in Citi was very well-regulated or fairly well-regulated as an FTC institution, but across the hallway the broker dealers, across the hallway the hedge funds, across the hallway, the investment funds didn't necessarily have that same kind of prudential and logical set of regulations. Then there's also a whole world of, as a lot of people talked about, there's a whole world of institutions that were in the business of credit intermediation and maturity transformation that never understood themselves to be in that business.

Konczal: I think we've made real progress in putting a prudential framework around them. So money market mutual funds, a lot of the big, like Goldman Sachs now have to regulate themselves looking for how do they resolve themselves in a crisis, how do they make sure that they can, make sure just simple things like the fact that they're reporting their liquidity in a truthful manner. You look at Lehman before the crisis, and they're literally just making up numbers. They're lying to people. There's no framework, because no one is thinking Lehman needs to have a framework to describe, can it make payments for 60 days? I think that world, I think there's been real progress. You see it. No matter how you measure a capital's basically doubled at the largest institutions. Some of that was happening before Dodd-Frank passed. We can argue whether it would've happened anyway, but the way it's been locked in and the fact that I think it's built into a framework that works much better is very helpful.

Konczal: Consumer regulation is obviously a very hot topic and it still remains a hot topic. But before the crisis, you had 12 regulators, all of whom had consumer protection and enforcement as their third priority, which you don't have to be an advanced public choice person to think that's a recipe for no one doing it ever or doing it in a cynical way that just tries to build their enterprise but doesn't actually do it. There's a race to the bottom. Nobody develops expertise. Nobody has an incentive to do it well. Putting that in a dedicated place that then, and it is understood that it's their responsibilities. So banks don't have ... it takes pressure off banks to have to shop for their regulators, for their consumers and so forth.

Konczal: The derivatives market, I think, putting it through, making, pushing, nudging derivatives to go through clearing and price transparent exchanges, huge operation. It's so funny, because people are like, "Nothing happened," but it's like trillions of dollars in swaps now clear. That's a major shift of financial markets. There was a big fight in the '90s with Brooksley Born about whether or not uncleared and dark markets for swaps could be a problem. We think both, if there was a problem that fixing it is not a big problem. If anything, it's possible that the volume ad margins, the volumes going up and the margins have decreased, implying a market power among the previous dealers.

Konczal: I think Dodd-Frank, I'm sad that it doesn't get as much of a fair debate that it deserves. There's problems. Also, a lot of things have been cleaned up too. I mean people, it's gone through changes. It's evolved both legislatively and through the rule writing process. I think it's a pretty decent accomplishment. I think it does some good in the world.

Beckworth: Do you think there's still room for improvement? One of the things I think both left and right would agree on is that there was a need to fund more with capital, less leverage, right, in general in the financial system, banks in particular? We just had Neel Kashkari and his second in command, Ron Feldman. They presented the Minneapolis Plan, which would effectively double, if I understand correctly, the amount of funding through capital. Do you think we need to fund with more capital than we are currently doing?

Konczal: Yeah, I think so. I think you can make it more progressive, so it particularly touches the largest five or 12 institutions. I think for a variety of academic reasons, both in theory, and I think in practice it is a very cheap way to put a cushion around the banks. We think that it's not ... As we know from corporate finance literature, both in theory and in practice, the banks don't put the money in a vault somewhere. It's not like it's really being taken out. It's the way of how they fund themselves. They're taking on equity and substituting out debt. Certainly at the margins we're talking about, 15%, 20% equity, I don't think the cost is very high if it exists in any kind of meaningful sense. To the extent that it does, you need to take it compare it to the benefit, cost-benefit analysis, right? The benefit of a little bit more equity and particularly good equity in times of crisis is huge.

Konczal: One interesting fight, and it happened during the Obama administration, is how much do you want to come up with a safe means to have a bank fail versus how much cushion you want to put on them before they fail to maybe prevent the failure in the first place or make the failure much more soft before the fact, whatever the Latin word is. I'm blanking on it. I think there's been a lot of progress made towards an FDIC resolution of a large financial institution. There's a lot of people at the Hoover Institute and elsewhere who want to really try to do it through the bankruptcy code, which is interesting, but I think it also has a lot of problems. At the end of the day, I think people are not super confident on those procedures and would prefer all things equal to not try to do it that way, not try to put something like Goldman Sachs into, have a bankruptcy judge wake up one day and be like, "Good luck. “The financial markets are running everywhere and given how relatively cheap it is as a form of protection, I think that's very good.

Konczal: Now I think it's also important to emphasize that you could have a lot of equity but the debt is all overnight repo markets, and so it looks safe, but the debt is so short term that a hiccup could cause a big problem or that you have pretty good equity, but your assets are so risky. They're all like subprime mortgage, but the most junior part of subprime mortgage [inaudible] or something, that the equity is diluted relative to the riskiness balance sheet. You need a couple of different measures of capital and this is an internal fight in the community about can you just do one big headline rate or do you need two or three measures? Neel, I think, has two or three measures, which I think is the correct way. It's a really interesting point of debate, but I think in general, as you said, that the tendency especially tends to be, especially for the biggest players, tends to be on the higher side.

Beckworth: Yeah, the Minneapolis Plan, they're very clear, $250 billion or more in assets. You mentioned interestingly the liquidity versus salt and sea question. You might have lots of equity, but your liabilities are effectively, money liabilities. It could be a run on it. We were talking before the show about our friend Morgan Ricks, he's really focused on this issue. He wants to restrict any institution who issues money like liabilities to a certain type of charter. He would extend coverage at FDIC to that. The point is, you might still have a problem. You might have a run on your system, on your institution if you have short term liabilities, even if you have a lot of equity. Let's move on very ...

Konczal: There's a ... We talk a lot about it. The range we're talking about for equity 20, er, 15% to 30%. There's a whole other argument about 100% equity funding, which is a very different conversation, which I think itself has merits. The fact that you can talk about those merits makes us think that bumping it at the 15% margin where we're at right now is probably not the biggest risk.

Expanding the Monetary Policy Toolkit

Beckworth: Not a big deal. There's many different approaches people are suggesting to get there. Minneapolis Fed being just one of them. Let's move to the paper that you wrote with JW Mason. The title is A New Direction for the Federal Reserve Expanding Monetary Policy Toolkit. We're putting on our macro hats now. I want to ask ...

Konczal: I'm so glad we have a place to talk about it. It's not the biggest headline in a year of crazy headlines. It's particularly fun to be able to talk about it.

Beckworth:         We have an audience that loves this, Mike. You're an ideal guest for the show. In this paper you have some new proposals. You say they're sorely needed. Let's go back and talk about the fed's performance during and since the crisis, how well have they done. Let's use that as a motivation to get us to your paper. What is your assessment of the performance of the fed over the past decade or so?

Konczal: Man, that's a tough one, right? You want immediately get in the glass half full, half empty. One thing I'm thinking a lot about now, and it's a controversial data point, but I think at a Peterson event a few months ago in fall 2017, Blanchard and Summers, so very respectable establishment economists, teased out a data point that said over a 12 year timeframe, from the beginning of the Great Depression to the beginning of the Great Recession. We're not there yet for the Great Recession, but projected over the next two to three years, which who knows. On the current trajectory, the Great Depression will have a better recovery and output per capita prime age adult.

Konczal: The data that feels a little juke because you're like really looking at very specific measures, but the conceptual apparatus of it, that in some ways the depression had a better return to a trend than we have is really provocative, and I think ultimately makes us think that the fed screwed up. It stopped a huge decline in unemployment. We were not debating whether the unemployment rate was 20% or 30%, but instead what it meant for it to be 10% for a short period of time. In terms of, you go into Fred right now and you just hit log real GDP and watch the trendline from the '40s on, there is such a break that happens in 2008. We just moved to a lower level and we go on, right?

Beckworth: Right.

Konczal: …all the Obama talking points were correct. We had the longest period of sustained job growth in a very long time, but it's just on a different path. It's just moved over. It's like a track shifted. Arguably, the distance actually got bigger with some time. This was one of the conclusions of my coauthor JW's paper from the summer, which is very controversial. We debated a lot with Democratic and Liberal economists about how to phrase in what we were thinking and how we came to a different conclusion than a lot of them. The trendline doesn't really lie. There's just a different track. We're in a different world. Certainly out here in 2018, it feels like a different world than sometimes. I think the fact that we didn't have that recovery, whether or not we could have never had it, whether or not hysteresis is real and forces us that there is no way to get back.

Konczal: If the second is true, then it's even more of an indictment. That's where my head is right now, that it's pretty amazing that we didn't have a collapse, which we could have. It's fantastic. We had someone like Bernanke and Yellen in place, people who were scholars to the Great Depression, Bernanke in particular at the time, people who took it very seriously.

Konczal: If we end up on this permanent other track, if the idea that we lost something from the Great Recession, this wasn't just a particularly bad recession, but instead something that really lowered our ability to have a full economy that works for everyone, I think that's a big problem. It's a big problem, because it means that we make fun of the quotes of the hubris from the mid where it's like, "We solve macroeconomic problems. We're sorry Milton Friedman. We'll never do it again. The Bernanke line." If true, I think that we really did fail, something did didn't happen that was supposed to.

Beckworth: I think that's a problem for the future too though, going forward, right? If we're content settling for a new trend, maybe we will be content next time settling for a new trend. I think it's the bigotry of these low expectations here that we could have done better. Hysteresis might be a real problem. I think your coauthor's other paper makes a fairly compelling case that the capacity economy truly was greater than we thought. I think some of the recent evidence was seen in labor markets. People come in off the sidelines, people on disability come off of disability. I saw some recent stats of the number of people on disabilities declining. Also we've had this discussion on Twitter with a number of individuals, the six change. There was this cry from many that we've reached the limits of the decline in unemployment. It's all cyclically squeezed out. It's only structural. Here we are several years later, and we actually did squeeze more out into the labor market. I think there's evidence and both historical precedent for believing we could've done better, although it could've been worse.

Konczal: Recoveries don't die of old age, so we don't know when the next recession will be. If you take for granted that as an opening bid, we'll need to lower the short term rate 5%, 5.5% as we did in 2007 and 2001 and 1993, we're not going to be able to do that. Maybe the fed rate is at 3% or 4% when the next recession happens. Who knows? It's not a ... Nobody bet on this or anything. The idea that the short term rate alone can do this, can do the work of the next recession I think is a very dangerous bet. The idea that I think where elite policymakers are now.

Konczal: There's two things there. There's also the element of just where do the elite policymakers around federal reserve policy view themselves right now. I think they think that they nailed it. They got it right. They got a fundamentally correct. Crucially, the short term rate and some QE is all they need and some more forward guidance is all they need to handle the next recession, which I think our broader community thinks is very dangerous and naive if you're not actually reexamining the target, if you're not actually reexamining the mechanisms of policy, can put us in a very dangerous place.

The Relationship between the Weak Recovery and the Rise of Populism

Beckworth: Do you think there's any relationship between this weak recovery, the potential hysteresis and the rise of populism? Do you think there's an economic story to be told and tied to that development?

Konczal: Yeah, I mean, I don't know if I want to over read it. Certainly in the corners of the EU, it's the most dangerous. I mean, there's like a genuine Neo-Nazi movement in Greece right now and you want to think of it in a couple of different ways. Certainly, there was a hard way for one, I don't want to do bar stool politics, you know?

Beckworth: Sure, sure.

Konczal: They're kind of like ... I certainly think that there's a way in which Trump, President Trump position himself as an outsider against elites. There is a really difficult way of talking about how the economy was in 2016, because elites really want to emphasize a very long stretch of job growth, wages finally starting to bump up a little bit. At the end of the day, it seemed like the economy kind of got back to where it was in 2007 where it didn't in and of itself did not feel so hot for a lot of working class people and did lead to a big wave election for Democrats, ironically. The extent to which things feel confident enough going forward doesn't really feel there. It doesn't feel like we've had ...

Konczal: One reason JW's estimates about the output gap differ with the way a lot of elite economists talk about it is because a lot of them view the late '90s, for instances, as an anomaly. This came up very quickly when we were trying to figure out where people disagreed. If you use your baseline as 2006-07 was a good baseline for workers, then 2017 doesn't seem so bad. If you think actually we could sustain things like the late '90s where unemployment was under 4%, where we had serious pickup in labor productivity and not serious inflation, well contained inflation. If you think that is actually something we could do right now, then it makes 2017 look a lot worse relative.

Beckworth: Yeah, so this all leads to your paper. You've already touched on some of the points, but the tool set that fed currently has will not be enough going forward. You mentioned you don't have the rate cuts we will need. You don't think QE will be enough or forward guidance will be enough, even negative rates will be enough. You're proposing a whole set of tools. There's a list of them. Any more thoughts on why what we have now is not enough?

Konczal: I mean, so a few things. One is that for a generation, people are still going to piece together the legacy of QE. It seems like it affected long rates a bit, but not a lot, and it's not clear how sustained. The fed had severe communications problems with it right out the door. This was known theoretically in the what kind of guidance you were doing, whether or not you are basically saying, "We need to do QE, because everything is so much worse than we thought," versus whether or not you were actually using it to guide. As much as the fed tried very hard to do that, it hit a lot of problems with the execution of QE3 in that dimension.

Konczal: You see it ... One way we think of this paper is that there's a lot of really great debate, if you're listening to this podcast, you are almost certainly following it, among what should be done about the target. Should there be a higher inflation target? How should that be understood as a ... how high should it go? Should there be an NGDP, a nominal GDP target? I have my nominal GDP mug.

Beckworth: That's right, which I'm very excited about getting for coming out here.

Konczal: How do you implement that given how GDP is revisioned and so forth? I think that's incredibly important debate. I love following it. I love participating in it. To me there's a corollary debate about how do you ... so you examine the target, right, in light of when we've learned. There's been a lot of great work on this. I think a lot of people are moving in your direction, which I think is fantastic. I think there's a corollary of how do you reexamine the tools, especially if you think that the inflation target didn't really work very well. The fed came forward, I think it was in 2011 or 2013 and said, "2% is the actual target." They never hit it. Was it a ceiling? Was it because they never really committed to their balance sheet. They felt like they couldn't even hit that target. A lot of policy we saw that the fed had some play with or things ...

Konczal: One thing that we talk about, we'll go through some of the things, but a lot of the things that we moved off the table of macro economic policy, like the maturity of treasury debt, suddenly came back with a vengeance and in a way that made us really have to think about, "Okay, so what are new ways of thinking about the tools with which the fed carries out in order to hit the targets that it wants to achieve?"

Beckworth: Yes. In other words saying that is, "Look, if we can't be credible with 2% inflation target, how can we take seriously a nominal GDP level target, a 4% inflation target if you can't even hit 2%." You're saying, "Well, exactly. Let's go to the tools that will empower us to hit our targets." Yes, have a conversation on the target, but also think about the tools. You have a nice long list. Let's work our way through them.

Konczal: Can we go back for one second?

Beckworth: Yes.

Konczal: Another thing is I came up through mid-aughts graduate economics education, right? There is a sense in which fed targets are magical. You know what I mean? There's a way of educating young economists. No, I never finished the PhD. I did learn the way to think that way in which the fed has an omnipotence to it, that the fed can really just by saying certain things make them happen very rapidly. I totally bought that at the time. I still think it's incredibly important now, but now that I look under the hood a little bit more and see what it looks like in the midst of a crisis, like, "Oh wait, all that evidence is from New Zealand for a few years," or a lot of places don't do that. The UK doesn't do that. Adam Hosein, I've been reading a lot of his works with UK. They are less for guidance but more on QE. They basically have the same results sort of, maybe. I mean there's a lot of debate about this. But suddenly it made me think, "Oh the target really does exist in a world of tools." I've never had to learn about the tools in a rigorous way during my academic education, so I'm going to spend some time educating myself. This paper comes out of me and JW his effort to do that.

Beckworth: Well, I do think the tools themselves are important, but they also have to be used. My view, and I think you're aware of my view, is that there's a reluctance and uncertainty by central bankers to maybe be really aggressive. In England, you mentioned in England, they actually tolerated some overshoot of inflation. They're the only advanced economy, central bank that has had inflation that's on average hitting its target where most other players, you see B, the fed hasn't. I think one of the problems is they've been real reluctant to go above their target or getting near to it, because it's just something you don't do. There's this built in expectation. They're cautious. They're very risk averse. We had Angel on the show from Peterson. He thinks it's basically a cognitive bias, you know? I do think tools are important. I also think, they go hand in hand with a target. You've got to be really credible. You've got to actually want it. I think England's a good example. They actually wanted to tolerate it.

Beckworth: I think IQ, EQ is a good example. Both the Fed and Bank of England did QE. The QE in Bank of England seemed to create more inflation than it did over here. I think that's because the Bank of England was willing to tolerate, so I guess going back to this point, no matter what tool you use, I do worry if a central bank is determined on low inflation. They're going to pull back on the reins. If suddenly this tool starts to work, they're going to let go, "Okay, we'll ease off." With that said though ...

Konczal: Absolutely.

Expanding the Toolkit: Longterm Interest Rates

Beckworth: With that said, let's look at the list of tools, the expanded toolkit that you suggest. Okay, so first one that you point out is the feds should use longterm interest rates. Tell us about that.

Konczal: Sure, so part of the goal, the paper, you'll see it in, in the way we site things, is a lot of these debates are happening, but they're happening in somewhat siloed way. There was a big debate about, we'll talk about them later, but about the treasury maturity that happened around 2013. There's actually a big wave of people talking about the federal government's credit policy in the recession. Starting about a year ago, year and a half now, the Bank of Japan is now just setting longterm interest rates. It had for a long time been doing a period of QE where it was saying, "We will buy a certain amount of yen at the 10 year mark. We'll set the date. We'll set the amount. We'll set the amount. We'll set the time." It required them to do a lot of purchases. There were still pretty volatile rates, all things equal. About a year and a half ago, they said, "We are going to target a 0%, 10 year rate." The amount that they purchased actually fell. The volatility definitely decreased. We're hoping to do some followup research to compare it much more quantitatively with QE3 and other QE efforts across Western countries. It certainly seems like it had, it hit the goal with less trouble, which is exactly what you want a QE instrument to do.

Konczal: There was a big, when we think about periods of QE in the United States, there was a huge amount of debate about what the fed was trying to do. There were big numbers involved that scared policy makers, even though they were asset swaps. Still, the fed just unilaterally doing these things freaked people out. And so if you could have actually, and many people like Joe Gagnon of the Peterson Institute to a formulate a fad, had been arguing for this. The treasury just said, "No, the 10 year treasury will be 2%. The 30 year mortgage will be 3%. Go ahead and try to fight us, but we're the fed." Crucially we'll set this in a way we set the short term rate, which has basically the fed just declares that. This will be able to ... if you can't lower the short term rate into negative territory, at least very deep into it, you can always lower the longterm rate and setting up more directly.

Konczal: I think, and Ben Bernanke himself has written about that this was on the table, but they ultimately didn't go with it perhaps because of the institutional and cognitive bias of the fed itself. Bernanke and others had talked about in the context of Japan and the early aughts. I think it's a very important thing for us to debate. I would love, people may hate this idea, but I would love to see people debate it more aggressively and kick it around, because I think that's definitely something, that one in particular will definitely be on the table in the next recession. It's better for us to do our homework in advance.

Beckworth: Okay, so how would this work? The fed would target 2%, 10 year treasury, you you said for example. It would do that until inflation got close to his target and employment, so as long as it still meant it was being hit, it would do that and then it would ease up. You wouldn't let go unilaterally, let 10 year float up on its own? How would it operationally look?

Konczal: That's a good question. I mean in practice it would look just like QE, right? In the same way like, I forget the specific numbers, but QE3 was what, 45 billion a month until conditions improved. There was sub categories in there, like 6.5% unemployment or 2.5% inflation, but one can easily think of putting boundaries around it. In some ways, in my head, it's another way of setting the rate once the short term rate can't be set any lower. In the same way the short term rate is set with dot plots and other kinds of communications to say we're going to keep rates this low until the conditions improve, you could have just as simple a set of conditions on it with that. Crucially, you could have it tied with a move to a 3% inflation target or 4% or an NGDP target or a trend target if we're at 0%, whatever the new condition is. It's a way of getting there more credibly. Even before we go into some of the more intense stuff that we propose, I think it's a way of doing what the fed has already wanting to do in a much more efficient way.

Beckworth: Yes, and you could even invoke the expectations theory that the longterm interest rate is essentially an average of the expected path of the short term. If you can't lower the short term, you can, in a round about way, do it by lowering the longterm. That's one of the, at least, justifications ...

Konczal: Absolutely.

Beckworth: ... doing that. Of course there's the term premium in there as well, but that's one of the stories if you can lower ... In fact, that was one of the arguments given for Operation Twist is "Look, we're effectively going to shorten the longterm rate, which is like the short rate over a longer period."

Konczal: Another thing we talk a lot about, talk about a lot in the paper you brought up Operation Twist is that a lot of the tools we're talking about were considered standard fed policy since the beginning of the fed, that they were not thought of as necessarily ... that when we think of them as unconventional, that they do have a history. Though the history might've been limited to specific circumstances, they're not brand new. The fed set long term interest rates during a World War II for instance. Now the economy is not going to probably look like what the economy looked like in World War II in the near future in terms of that level of government spending and all kinds of stuff going on. The idea that there isn't a history of using it is wrong. Operation Twist, obviously, is something that was a little controversial when Bernanke tried to do it. He points that we did in the '60s, because we had to get around Brettonwoods and a bunch of other stuff. In the '20s, more credit focused policies was very much in play. Obviously, there's a history of monetary failures in the late '20s and the '70s, but those are not necessarily just strictly off the tools.

Expanding the Toolkit: Increasing Support for Public Borrowing

Beckworth: Okay. Well, let's move to your next suggestion for expanding the toolkit. This one is increasing support for public borrowing. What is that?

Konczal: That's the argument that ... The numbers are in the paper, but the idea is that the fed is supporting public borrowing through QE. The stated rationale for quantitative easing is there are multiple ones. One is to bring down, the term premium and try to help support longterm private spending. It doesn't effect support longterm public spending. It is, and there's a lot of ways to define helicopter money, but it is in some conceptual, it's a mini helicopter spending. The fed being much more conscious and declarative about how its inner plane with the federal government.

Konczal: Fiscal policy, I think, is very important. This is part of what we're trying to get at in this paper is that during the Great Moderation there is very good intellectual and economic basis for separating monetary and fiscal policy into two very different buckets. The fed handles output and the government handles spending and the budgetary gap in periods of secular stagnation. If we do stay in a period of very low interest rates and in a period where it seems harder to sustain full employment, those start to blur into each other. They do mechanically where what the deficit that the fed is running is going to be influenced by what the monetary reserve does with longterm rates, if it's willing, to say, keep them lower by buying them.

Beckworth: You're effectively just arguing for more explicit helicopter drops, I mean.

Konczal: Yes, explicitly.

Beckworth: I think, yeah, there's a way to do that that would make someone right of center like me more comfortable than just ...


Beckworth: My proposal is to do a helicopter drop tie to nominal GDP level target. I think that would add credibility to the target, but it'd be a way to doing that within some kind of framework. Just on the whole QE ...

Konczal: Having that conversation is what I want to happen.

Beckworth: Oh absolutely, yes.

Konczal: That's where I want us to be thinking is how do you make that operational. This isn't a blueprint that's like HR1, the new Congress go. It's more a blueprint for a bigger conversation that we really want to get started with.

Beckworth: Yeah, and I think part of making monetary policy more credible, in my view at least, is using the threat of the consolidated balance sheet of the government. Even if you don't actually have to use it. If you say, "Look, we will do helicopter drops to hit our targets, so be ready or not." I think credibility is a part of it. I think, I liked that, the spirit of that. I just will say this on QE. There is a part of QE, I agree with you, that was effectively a helicopter drop. That's the part of QE that ultimately becomes permanent. If the fed buys up debt and it's going to be permanent, forever, it's going to be holding a certain share of treasury on its balance sheet. A big part of QE is also temporary. As we know, they're going to shrink the balance sheet back down.

Konczal: Right, they are.

Beckworth: That kind of, I don't know, defeats the purpose of what you want to do, right, if it's temporary in nature. You'd want it to be more of a permanent injection. In fact, I've written it on this, if you really want to get some bang for your buck, you've got a signal that these injections ... I mean, helicopter drops to work have to be permanent, right?

Konczal: I mean I agree, but are they not permanent now? I mean, this is where macro hits that weird medium term problem. It's like ...

Beckworth: What's permanent?

Konczal: Yeah, I mean like it's been like how ...

Beckworth: Well, let me put it this way, Ben Bernanke in 2009 was saying this is temporary. He had an exit strategy in 2000. He's very clearly signaling this is going to be temporary. Maybe put it this way, there's always been a part of the growth of the monetary base that's been permanent. Accommodating the growth of currency demand implies a permanent buying up of the treasury. I think what you're saying is we want to go above and beyond that and be explicit about it. I'm just suggesting QE may not be the best way to go about doing it.

Konczal: Sure. Yeah, yeah, yeah, yeah. The first option is to move away from QE2. It does build on…

Beckworth: Carl Smith has a great proposal. He also sympathetic to nominal GDP level target. He wants to basically have cyclically adjusted payroll taxes, which would imply more debt if needed in certain circumstances. Let's move on for the sake of time.

Konczal: Yeah, we don't end up talking about automatic stabilizers in this though. There's a whole other range of interesting, cool people, Carl Smith, Jared Bernstein does a lot of work on this, on how to beef up automatic stabilizers, which I think ultimately make a really big difference and especially at the beginning of a crisis.

Expanding the Toolkit: Purchasing State and Local Debt

Beckworth: Absolutely. I think it would also tie in nicely to your support for public borrowing. Okay, this is probably one of your more controversial ones are purchasing state and local debt. Speak to that one.

Konczal: We want to get people talking a little bit about what this could look like. The federal government, for a country like the United States in secular face with its own currency and debt denominated in it's own currency doesn't seem to face very much short term fiscal pressures. We can have a big argument about whether or not they ever do or when they do or how they do, but certainly fiscal headroom for a country like the United States, especially in 2009 was pretty high. It was probably higher than a lot of people understood at the time.

Konczal: That's not true for state and local budgets, even state and local budgets that are pretty heavy, that are pretty in good shape, that they can't run deficits. If you look at the history, and we walk through the history of state and local debt at a high level, but for a few years they're able to run a deficit by basically juggling payments, by running down reserves. For sustained recession like this, within about three or four years, they're a net drag on GDP. They're about 10% lower than where they were before and probably where they could've been on a growth path.

Konczal: That's a real headwind. Is there a way to alleviate that headwind by allowing some borrowing mechanism from the fed directly? A big thing we talk about in the paper when we develop it through the middle of the paper is that you can impact that definitely by just lowering the rates and hoping financial institutions will then lend at these lower rates to various localities and municipal governments to then alleviate these kinds of credit constraints. If they don't, if the financial system is broken, if the rate that you are dropping rates is not as large as the rates financial institutions are dropping rates for whatever reasons, there's a whole separate discussion about that. One way would be just to bypass it directly.

Konczal: Also there are reasons why the fed might be a useful counterparty in terms of debt restructuring, so as a partner to something like what's going on in Puerto Rico where they obviously need a serious debt restructuring and a real re-look at their country, but having vulture fund hedge funds who bought debt for pennies on the dollar be that financial intermediary puts much more pressure on the ability to have a good workout. This is probably where it's going to be the most left of center of all the proposals. I think there is an argument for having some sort of public counterparty that can step up into these things. You have to worry about bail outs and corruption and things like that. People do lend to governments all the time. The fed itself lent profitably to the financial sector in the crisis during much more constrained and difficult times. I think it's definitely something we want to be talking about and thinking about what kind of role we could have there.

Beckworth: Is your suggestion focusing on just cyclical needs or with Puerto Rico, it sounds more of a permanent one, so would the fed step in and buy state and local debt just during the crisis or would they continuing to it afterward?

Konczal: I would say during the crisis and during periods where zero, lower bound territory. Right now, perhaps not, there's a separate question about their role and distress which happens in all kinds of…

Beckworth: Environments ...

Konczal: ... but separate that off, which we talked about briefly, but focus on, if you think of the zero lower bound moments where we are concerned about our efficacy and getting the rates necessary to sustain a full level of investment to actual agents in the economy, what could be the role of an institution like the fed and dealing with credit with places like California, which hit a big constraint and essentially issued its own currency, maybe really illegally for 2010. You remember all that drama. What if the fed just helped them out for a brief period knowing that they could be paid back and that they'd be a super creditor to the feds. I'm curious about, I would like to get more of a conversation going around that.

Beckworth: Okay, so they would step in. They would buy up all kinds of debt. I mean, one of your other proposals, we can maybe tie this in, is open up the fed to buying more private assets. I mean, George Selgin from the Cato Institute also suggested something very similar. You're basically opening up the fed's ability to purchase different types of assets, so other private sector assets, also state and local and particularly so during a crisis when the risk premium's really high this way they can really ... You buy longterm treasuries, those are pretty safe. You want to go after the riskier, so you're eating up, er, chewing up that risk premium.

Konczal: Yeah. Joe Gagnon from Peterson talked a lot about how basically the fed can't buy the stock market, but in other countries they can right.

Beckworth: Japan.

Konczal: That's not necessarily the ... It would be interesting to think about the consequences of that. We talk a lot about energy and more sector specific debit, but that opening of what the fed does in terms of what it buys, it's sustained. It bought treasuries. It bought mortgage backed securities in part because the mortgage market was such a mess. They wanted to be able to get rates low enough to have refinancing and try to take some of the pressure off underwater homeowners. There are other social needs and especially now that it's not over over, but the housing crisis is more or less behind us, thinking less about how to bid up housing assets and more about how to sustain broader, more socially useful investments I think is really interesting.

Beckworth: Well, I'll just mention George Selgin's proposal. He calls it flexible open market operations and then effectively be like an auction facility like they had during the crisis. Any firm, any institution could come to the fed and say, "Hey, here's all the assets." You might have to discount them, but it would open it up to more private sector. It wouldn't be just treasuries. It could open up the array, so those who were really distressed and needed liquidity more so than the others, they could come and they could bid for it. It's interesting ...

Konczal: I'll check that out. That sounds really interesting.

Beckworth: Yeah, I like the idea of flexible open market operations. As you mentioned in your paper, the ECB, for example, takes a wider arrange of assets. Now, just again going back into the mechanics of this, so would the fed by an exchange traded fund, an ETF, backed up by state and local where they go directly after a particular state, particular locality?

Konczal: I don't know. This is why we want to investigate and get the conversation going. We're picturing more end agents. The idea is that our theory of the cases that the effectiveness of this gets lost in the intermediation. The closer you can get to end agents in the economy who are carrying out investment and other kinds of real activity, the better. We would prefer, the business themselves rather than an investment fund for the business. That said, let's get the conversation going and see what's most practical.

Expanding the Toolkit: Better Coordination between Treasury and Fed Policy

Beckworth: This is fascinating, because I think you and Selgin have very similar ideas in the sense that, he would have some kind of term auction facility where, again, the people who really needed it, could come and bid. They could bid for the funds from the fed directly. Part of his argument is the primary dealers system is antiquated. It clogs up this transmission mechanism. If you go strictly through the primary dealers, it's a select few big banks, institutions you can cut around that make it open. Again, the ECB, I think a lot of parties, a lot of counterparties are open to coming to the table. Okay, let's move on to coordination or better coordination between treasury and fed policy. We've already touched on this a bit, but go ahead spell it out.

Konczal: Yeah, I think it's ... We debated whether or not to open with that one in this, because to me it's such a useful understanding of what's changed. We're actually just building on a report done by Larry Summers and several other economists that came out of Brook gains. I think there's a big debate out of this in 2013. For a variety of reasons, the treasury ... The treasury department handles the maturity, the length of public debt. Of course, the central bank is, in theory, in charge of the interest rates, on the distribution of them. In normal times those don't really intersect. In zero lower bound times where the fed is actually very concerned about its ability to manipulate longterm rates, if the US government is releasing a lot of longterm debt, it pushes in exactly the opposite direction of what the fed is trying to do with QE.

Konczal: Greenwood from Harvard who was one of the authors of the paper we cite with Summers estimated that it might have offset about a third of the effectiveness of QE. We can debate that. Crucially though, and this is where the debate is, there's a conceptual thing about whether or not they should coordinate. There's a real, for obvious reasons and I think just for institutional reasons, I think it's a little bit to the cognitive stuff you had talked about earlier, that the fed wants to view itself as very independent. When it says independent, it doesn't just mean from like ideologues and populous. It means from having to talk to treasury or having treasury think about what it's doing and vice versa, this game theory between the two. From my point of view is going forward, if we're going to be in a high debt atmosphere, given changes in Congress and given the still very low rates compared to even 2007 or 2000, that's going to be a reality for the next decade or two. Thinking about how they can communicate and how they can coordinate in a way so that they are helping each other rather than weakening each other, I think is very important.

Beckworth: I think the fed was fighting an uphill battle with QE, particularly QE2, QE3 because of this. I mean the treasury is much bigger in terms of the supply of treasuries versus what the fed ... the fed held a nontrivial portion, but I've estimated around 20% or so of outstanding marketable treasuries. I mean, they're really, even though I've been told they are the largest single holder, they're still relatively small. There's still a huge treasury market outside of them. Their attempts to lower the yield, I think, is facing up against this huge treasury market out there.

Konczal: The treasury was actively lengthening the maturity structure throughout the Great Recession. It wasn't that it just didn't react. There was that it was actively increasing. I think it went from 48 months to 60 months, maybe, on average. Are there any ...

Beckworth: It was relatively small and the treasury was acting against it are contrary to what it was trying to shorten average maturity and treasuries extending the average maturity of the debt.

Konczal: There's also, we didn't lean into it too heavy in this paper, but there's a sense with the kind of secular stagnation, zero lower bound world, if we exist in that world going forward, the nature of fiscal policy and monetary policy will blur together naturally in a way that it won't be easy for us to say, "The fed, you take care of the business cycle. We'll take care of debt sustainability and fiscal policy and redistribution and all that stuff. You go do your thing. We're going to do our thing." That's the logic of central bank independence.

Konczal: Here in this kind of world, what the treasury does really does impact the ability of the central bank to do its job. How much should we be thinking about that? Can we just abstract from it or can the fed just ultimately push against it? Maybe. It's certainly, it's another headwind. It's another way of a problem that the fed will face and will continue to face in the future.

Expanding the Toolkit: Shifting to Credit Policy

Beckworth: Yep. Okay, I believe your last point or last toolkit is just to really more of a general one. That's shifting monetary policy from its focus on just setting interest rates and money to more of a credit policy. That's also pretty controversial, so go ahead and tell us that.

Konczal: Sure, so this is GW's big focus is that, there's always been a debate in fed policy going back centuries to David Hume about what is the fed doing? Is it acting through rates? Is it acting through credit? Is it acting ... Who are the players and how is it playing? Here is just to say the fed thinking of itself as much more involved with the credit process, that it is not just setting the baseline through a single rate, but it is instead playing a very active role in who ends up with credit across the board. This includes things like the fed's role in financial regulations, which is incredibly extensive and far more than I think people quite grasp and enforcement, having a much more conscious orientation towards that as a focus.

Beckworth: What does that mean in practice? We give some small suggestions, but I'm not sure if we know exactly where that ends up. Understanding that the way that the fed is playing out its actions will ultimately determine the fed thinking of itself in terms of the business of credit allocation. That's often been brought up in the context of a hawkish position. The idea that the fed is causing asset bubbles or reaching for yield or we should have tighter monetary policy to pop asset bubbles, which we don't agree with. The fact that the conversation comes up in that hawkish direction is very worrying. The hawkish implications don't follow naturally from it necessarily.

Konczal: At a minimum, you're saying, "Look, let's avoid the hawkish credit discussions." I think that probably the fear would be more the other direction. People who are listening to this might worry about the earlier suggestion of buying up state and local debt. Their fear might be, you're going to start on a cyclical basis by bailing out Illinois then instantly going to become a ... They're going to keep running to the fed, even though it's supposed to be cyclical. In general, just the fear that, we don't want to have our banks, our financial system end up looking like China's state owned enterprises, all these non performing loans. How would you respond to someone that's concerned about that?

Beckworth: Well, I'd say a few things. One is, not at least conceptually having it on the table is part of the institutional bias, that it's ultimately, that's one reason we're having trouble breaking out of the moment we're in is that it does, not even thinking it through does put a certain blinder on one set of things. The second is that the fed does do this all the time, right? It does it defacto through mortgage backed security purchases, through backstopping the financial sector as in the Great Depression, as in the Great Recession, the financial crisis, and de facto through the financial institutions as they exist now so that there's a lot of defacto and often explicit actions taking place. Third is a lot of the way the fed works is just through credit. It's not just through abstract monetary quantities, but through the way credit policy works in the United States.

Konczal: There was a great paper out of Brookings that said, maybe about 400 billion in stimulus in 2009, so when we're talking about why we didn't have a Great Depression came through federal credit policies, things like student loans, things like the absorption of the housing market when the financial sector collapsed. Ghanian and many others were very critical of President Obama's housing policies, because they were able to get interest rates very low, but the ability of underwater homeowners to refinance their loans when they were underwater was nil. It was nil essentially until 2012, 2013. Part of, and if you read the paper, it's going to be a little less radical, because we talk about Congress playing a much more active role in that, and maybe your listeners don't like Congress playing that role either, but there's a little bit more of a coherent check on it. The idea of the way credit ultimately ends up with people and monetary policy, I don't think can be separated going forward, especially in this kind of environment.

Beckworth: That's a good point. I mean, Congress and the fed are already in the credit business to some extent. I mean, you mentioned student loans, GSCs. I think what you're saying is make it more explicit, make it more transparent.

Konczal: Yes, I think that's correct.

Beckworth: Then it's just a suggestion, you want to get the conversation going so. Well, that's been very fascinating. Thank you so much, Mike, for coming in today.

Konczal: I'm so excited. I've been on this. Thank you so much for having me.

Beckworth: Oh, it's been great, great to meet you in person and have you on the show. Our guest today has been Mike Konczal. Mike, thanks a lot.

Konczal: Thank you.

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.