Rich Clarida on Navigating Monetary Policy in Choppy Waters

Rich Clarida was the vice chair of the Board of Governors of the Federal Reserve System and is currently a professor of economics at Columbia University and a managing director at PIMCO. Rich returns to the program to discuss whether we give the Fed too little credit for its soft landing, the problem of persistent inflation, how the Fed should respond to rapidly succeeding negative supply shocks, the case for nominal GDP, the state of the Fed’s balance sheet, why a synthetic FOMC could help the real FOMC, and much more. 

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This episode was recorded on March 31st, 2026

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 with the Mercatus Center at George Mason University, and I’m glad you’ve decided to join us. 

Our guest today is Rich Clarida. Rich is a well-known academic, and from 2018 to 2022, he was the vice chair of the Board of Governors of the Federal Reserve System. He is currently a professor of economics at Columbia University and a managing director at PIMCO. Rich joins us today to help us navigate and think through the challenges that lie ahead for the Fed in these turbulent times. Rich, welcome back to the program.

Richard Clarida: Okay. I’m looking forward to it. Let’s go.

Beckworth: Yes, let’s do it. Now, we were talking before the show got started how you’ve actually been a part of this podcast, in some form, since its inception. I want to tell this story to the listeners and to you, Rich. I actually started the podcast back in 2016, so a decade ago. 

Clarida: Congratulations.

Beckworth: Thank you. Yes, you are like episode 540, I forget the exact number. One of the first guests was John Taylor. I worked for him at the US Department of Treasury. Many years later, we start the podcast. He comes on. He had a great time. He had such a great time, Rich, that he invited me to present a paper at his Hoover Monetary Policy Conference back in 2016. I presented a paper. It was a co-authored paper. It’s an update paper of the Hélène Rey, the Pierre-Olivier Gourinchas paper that looked at the US as a hedge fund to the world or a banker to the world.

During the Q&A, you spoke up. You were one of the first people that spoke up. You said, “I commissioned that paper. I’m glad that you updated the data.” Then, that evening, we sat together at supper because they do arranged seating. They randomly do it, so they mix people up. Had a great conversation. I got to know you at Hoover via John Taylor because of the podcast. 

Now, a few years later, it’s 2018, and we’re at a Cato Monetary Policy Conference. I see you, and you’re now the vice chair of the Fed. I’m thinking, “Man, I wonder if Rich remembers me.” You give your talk. I’m thinking, “What am I going to say to Rich? I got to go shake his hand. I’ve got to get his attention somehow.” Rich, you come up to me. You say, “David, you got a podcast.” You’d been listening to the show. Do you remember that?

Clarida: Yes. I do remember that. Not the exact quote, but I remember the conference and connecting there for sure.

Beckworth: Yes. Then, of course, you’re the vice chair of the Fed for a number of years. Finally, in ’24, we get you on the program. Had a great conversation about FAIT, about r-star, about inflation targeting, about your history. In fact, Rich, we talked a lot about your music career, and we did a bonus episode. Do you remember that?

Clarida: I do. Thank you for the plug.

Beckworth: You had another album coming out. We talked about your first album, Time No Changes. You mentioned you were working on a second album. Is that one released now?

Clarida: It is not. It’s like every year, I say it’s going to be ready next year, but this time, I really mean it. It will be out in 2026. It may be closer to December than April, but it’s on the home stretch, yes.

Beckworth: I encourage listeners to go back and check out both his first episode as well as his bonus episode. Your first album had 13 songs on it, and your second one has nine or 10. Is that right?

Clarida: It will be at eight plus some bonus tracks, yes.

Beckworth: Okay. That’s so amazing. Rich, the famous monetary economist, also the musician. We look forward to listening to your tunes coming forward.

Clarida: Thank you.

Persistent Inflation

Beckworth: Everyone, not only check out his podcast, but check out his albums as they become available. All right. Rich, we’re not here to talk about music, as much fun as that is. We’re here to talk about the Federal Reserve and what’s happening. I want to begin first with what’s been happening to inflation. For a number of years now, inflation has been above the targeted 2%. I think it’s understandable if you say ’21, ’22, the pandemic, things were moving fast. We can critique that as well, but let’s put that to the side because that was a truly unique period. From ’23 to the present, we see that inflation seems to be stickier, persistently above 2%. How do you make sense of what’s driving that? What do you think is behind it?

Clarida: I think that not only the Fed, but global central banks, in particular, have been focusing on advanced economy central banks. I’ll get into 2025 in a moment, but through 2024, it was about as close as you can get in the real world to a soft-landing disinflation, and in the US, core PCE peaked at around 6%, headline CPI was at 10%. Historically, in order to reduce core inflation by multiple percentage points, you need a deep recession. I believe there are some very prominent economists who said to get inflation down to the twos, you’re going to need 6% unemployment.

Of course, through the end of 2024, that had not happened. Inflation had fallen. I think it bottomed at 2.4%. Of course, that’s not equal to 2%, but it was on the trajectory down to 2%. The Fed felt comfortable enough to be cutting rates. Inflation expectations, thankfully, throughout this period remained anchored. I think the Occam’s razor, the simplest explanation, is that central banks were late to begin hiking. I think in retrospect, no one would deny that, but once they did begin to tighten policy, they did succeed in getting inflation on a trajectory to target.

What happened? I think in 2025, at least in the US, the tariffs were put in place. Now, it is true that in 2025, overall inflation did not increase, but neither did it fall. I think that was obviously a relevant factor in the US. You look at the eurozone, however, in the eurozone, inflation got pretty darn close to 2.0% in 2025. Similarly, in Canada, for example. I do think that broadly, the period through 2024 can be characterized as a refreshingly successful disinflation from a very, very bad initial condition, which was obviously the very not-transitory surge in inflation in ’21 and ’22.

I think the story in the US in 2025, to some extent, was tariffs pushing up the price of goods. That was offset by a decline in services inflation. Then, of course, in 2026, we have a sharp increase in global energy, oil, and natural gas prices due to the hostilities in the Middle East and the closure of the Strait of Hormuz. Certainly, that is a nonmonetary policy shock this year.

Beckworth: Things are looking great in ’24. We’re having a smooth landing, a soft landing, maybe a return to the great moderation had things gone differently, but we’re not. I’m wondering to what extent do you think also that fiscal policy in ’25 through ’26 has played a role, because we’re running big deficits. CBO is projecting primary deficits as far as the eye can see. Interest on debt is soaring. What role do you think that’s playing, if any?

Clarida: You’re absolutely correct that the fiscal deficits seem to be stuck at between 5% and 6% of GDP. Now, you and I, early in our career spent time at Treasury. In our day, that would have been a real eye-popping number in an economic expansion. Basically, anything over 2% or 3% is something you would get focused on. The traditional calculation that’s really relevant in a growing economy is not so much the deficit, as the net fiscal impulse. There’s reason to think coming into 2026, the net fiscal impulse will be positive because of the One Big Beautiful Bill.

I think that could, at the margin, be a factor this year. On the other side of the ledger, of course, some of the incremental stimulus, if you will, that we might see from the Big Beautiful Bill may be offset depending on how long oil and natural gas prices remain elevated. You’re absolutely correct that the US is and has been for some time on an unsustainable fiscal path. As Herb Stein, the legendary economist, once said, “Something that cannot go on forever will stop.” At some point, perhaps in the next decade, Washington will come to its fiscal senses, and we’ll get fiscal consolidation. I agree with you that doesn’t seem to be a near-term prospect.

Beckworth: Are you surprised that Treasury markets haven’t seen higher yields, given this fiscal outlook?

Clarida: I’ve done a lot of thinking about it, David, which doesn’t make it correct, but I’ve at least convinced myself that we already do see in the current constellation of yields, and not just in the US, but globally, higher yields. I attribute most of that to higher-term premium that bond markets require to hold sovereign bonds. During my time at the Treasury, even before the pandemic, when the Cal Fed was hiking rates, I think 10-year Treasury yields peaked at around 3%, and they’re now running, of course, in the mid-fours, and indeed, they’ve been averaging, I think, 4.25% for the last several years.

If you look at yields in Europe, as was documented at the time, at one point, I think in 2019, there was close to €20 trillion worth of negatively yielding eurozone debt because the ECB had a negative interest rate policy, as did the Bank of Japan. What I would say is, yes, the fiscal news is terrible, but markets have digested it and repriced and reset higher yields. I do think that the fiscal news, as I said, is bad, but markets more or less are being compensated for it. A very important point, which we may get to, but I’ll just tee it up, is everything I just said is conditional on the Fed and other central banks maintaining their inflation credibility in terms of longer-term inflation expectations remaining anchored.

If you combine 6% of GDP budget deficits with no meeting of minds in Washington about fiscal consolidation, and then you sprinkle on top of that a loss of central bank credibility, which we’ve not seen and which I hope we don’t see, then you get into a much more challenging situation. Right now, we have higher real rates. Back when you and I started our career, there really wasn’t a TIPS market, but now you can just look up on your screen what an inflation-adjusted real rate is, and it’s significantly higher than it was a decade ago. The bottom line is the fiscal news is bad, but investors are being compensated for it.

Inflation Expectations

Beckworth: Let’s talk about inflation expectations since you follow those closely. I know you were always somebody when you were at the Fed, even before you followed the break-evens closely, you’re someone who likes to look to the market to get the best estimate of what’s likely to happen going forward. The wisdom of the crowds, get all that collective wisdom together in one place, one price. If you look at bond market break-evens, there is reason to be comfortable, to be assured, I guess, they don’t see any runaway fiscal problem.

When you look at consumer surveys, and even something I like to look at, Google trend searches for inflation, it’s a little less assured. You see elevated consumer outlooks. They’re not going up high, but they’re not back to where they were pre-2020. Google searches for inflation are still up as well. How should we interpret that, I guess?

Clarida: When it comes to inflation expectations, they’re critically important. A theme that I emphasized as vice chair is, I thought it was very important, and I still do, for Fed officials and central bankers more broadly, not to have the degree of freedom or the leeway to pick and choose their inflation indicator. I used to look at everything. I’d look at break-evens, but I’d look at surveys. I would look at statistical models. That’s why I was very encouraged during my time at the Fed that the Fed staff got up and running a statistical model of what it called common inflation expectations, which essentially looks at a number of different indicators of inflation expectations.

Instead of picking one as the favorite, you essentially use a statistical procedure to average across them. I do look at, and I think very important to look at, market-based expectations. I do take the point that has been made forcefully by others, especially in 2021 and ’22, that it’s important to look at inflation expectations, as you said, at various horizons. Indeed, you can make a case that when it comes to price and labor market and wage setting, it’s really short-run inflation expectations that arguably, as a matter of theory, should be relevant.

If I’m negotiating my wage for the next year, or for some reason I’m not going to raise my price until next January, I’m really concerned about inflation in the next number of months, not the next five years. I do think you need to look at both. David, what makes this period challenging, of course, is that because of the adverse supply shock with higher oil prices and natural gas prices with the conflict in the Middle East, you would expect some upward movement in short-run inflation expectations. That’s not necessarily an indictment of the Fed. It may just be reflecting developments in financial markets. 

I think the thrust of your question is a good one. I agree with it. If I were back in my old job, I would be just as focused on shorter-term as longer-term inflation expectations. There are different surveys of the household. For example, you have got the well-known Michigan survey. I always do, used to, and still look at the Michigan survey. A bit of an issue with the Michigan survey right now is that, relative to its 40-year history, in about the last decade, the survey responses on the Michigan survey have been very sensitive not only to self-identified political party, but to self-identified political party and the political party in charge of the White House.

Sometimes, what they do in Michigan is they also ask people who are self-declared independents, and that also provides some useful information. The New York Fed has a survey of consumers. There are surveys of professional forecasters. Of course, then you need to also look at wage development. Atlanta Fed wage tracker adjusted for productivity, Employment Cost Index. Already up to probably a dozen or so.

Beckworth: Okay. Inflation expectations are still anchored. Do you worry, though, at all that there’s this kind of once bitten, twice shy psychosis in the American psyche that we went through the COVID inflation, therefore, we’re much more price sensitive, should we see a spike in inflation from tariffs or the war?

Clarida: Yes. I think it is a risk case. It would not be my base case. Honestly, it just compels me to say, I went back and read a speech I gave at a Boston Fed conference in 2010, in which one of the sections of the remarks, which later came out in the Journal of Money, Credit, and Banking, was, should we be confident that inflation expectations are anchored? I argued, possibly not. All we knew in 2010 was that inflation had been at or below 2% for a while, but it could simply be extrapolative behavior looking backward. In that issue, the issue was, suppose inflation is below 2% for a number of years, do inflation expectations stay anchored?

I think for the most part, they did in the 2010s. Although during my time at the Fed, 2018 and ’19, there were some governors, including myself and presidents, who did comment that measures of inflation expectations were operating at the low end of what we would consider to be consistent with price stability. Yes, I think given that it’s now ’21, ’22, ’23, ’24, ’25, we’re now going into the sixth year in which inflation will be above target. It’s certainly something I think policymakers need to be attuned and attentive to.

Beckworth: It is remarkable, though, looking back, how resilient inflation expectations have been, how resilient the US economy has been.

Clarida: Yes. Oh my.

Beckworth: There was talk a few years ago about a recession. We didn’t have that. Maybe we need to give more credit to inflation-fighting credibility of the Fed, the resiliency of the US economy. We got to be careful stewards, but we also need to be grateful that we have such a robust system in place.

Clarida: Yes, and to pick up on that point, there’s an old saying in baseball that sometimes you’d rather be lucky than good. I think if you’re a monetary policymaker, you want to be both good and maybe have some positive luck. I do think that one can make a case that the US has been lucky in two senses. One, we have an incredibly innovative, efficient, and successful tech sector, which is really the envy of the world. It’s also a sector that is able to tap capital markets and expand, do bricks and mortar. Remember, you and I remember back in the days when tech was part of the weightless economy, which was all ideas and software.

Now, part of the important reality of AI is, in order to train those large language models and to get a potential productivity boost, you need a lot of old-fashioned bricks-and-mortar capital spending in the economy. I think part of the resilience in ’24 and ’25 was that the headwinds, which might have been slowing growth from other dimensions, were more than offset by a boom in demand coming from the tech sector too. I think, again, that’s part of the US exceptionalism story is, yes, it was lucky that tech investment picked up when it did, but also it reflects on the fundamental strength of the economy.

Responding to Negative Supply Shocks

Beckworth: Absolutely. Count our blessings here in the US of A. You mentioned luck, you mentioned developments that sometimes are unforeseen. I want to segue into negative supply shocks. At the last FOMC press conference, one reporter asked Chair Powell, “Do you think this is a whole new world of negative supply shocks?” and proceeded to list the litany of them from COVID to the Russia-Ukraine war, to the tariffs, now to the Middle East war. Powell responded, but do you think there’s anything different about the number or intensity of supply shocks? Then maybe we can talk about how to navigate them. Is this a different world, or are we just maybe more aware of them now?

Clarida: This is a fascinating question along a couple of dimensions. That’s one reason I love your podcast, because you tee up questions that appear to be pretty straightforward, but I think they’re pretty nuanced here. Yes, demonstrably, look, COVID is a once-in-a-century, exogenous public health catastrophe. Millions of people died. It was not clear there would be vaccines. I and others have written, and I think it’s pretty clear. It wasn’t clear in the fog of war in 2020, but I think in retrospect, it’s clear, and I’ve written and published papers on this. In retrospect, a big part of the challenge in navigating COVID, especially in 2021 and 2022, was the fact that it turned out to be a massive supply shock in that people physically just did not go to work. Labor force participation did not get back to the pre-pandemic level until 2023 or so. That was obviously an exogenous adverse supply shock.

Russia invading Ukraine and pushing up energy and natural gas prices, I’ll let geopoliticians say exogenous or endogenous, but really not part of the economic system. We’ve talked about US trade policy, and now obviously with hostilities in the Middle East. That’s basically four of those big, big adverse supply shocks in, I guess, five or six years. That’s not something we have seen. At a deeper level, though, I think one could make a case that perhaps what was unusual is the fact that we went about a dozen or plus years in the other direction when there were no adverse supply shocks. From 2008, oil prices peaked, they fell, they collapsed. There were a lot of things for folks to worry about during the decade of secular stagnation, slow growth in many parts of the world and lower inflation expectations.

The supply shocks were really not so much on the radar. I think you do have to acknowledge, and I and others have written about this, that we are going through a super secular change in not only the global trading system, but in approaches to global economic security and industrial policy. In Europe, a big focus on the green transition. Although the magnitude of this change in direction is difficult to estimate, the direction of travel is clear. Friend-shoring, on-shoring, making supply chains resilient, and all the rest are almost by definition going to put some upper pressure on prices and the cost structure.

If they didn’t, they would have been adopted earlier as part of the great globalization wave. I think we may be in a period where we don’t have these big multiple sigma adverse supply shocks, but we could be in an era—and I’ve written this with my colleagues at PIMCO, and I think we actually wrote this in 2023 for the first time—in an era in which shocks to supply are going to be as big a part as shocks to demand in terms of global business cycle volatility. One other thing.

Beckworth: Go ahead.

Clarida: I have a little soapbox issue here. Since you’ve got such a wide following, I’ll get on the David Beckworth soapbox here.

Beckworth: Let’s do it, yes.

Clarida: Now I’m putting on my professor’s hat, but you’ve got a very sophisticated listener audience. One thing that you’ll often hear, and I probably have said it myself in TV interviews, is that there aren’t things that central banks can do about supply shocks. Cutting rates is not going to create barrels of oil or natural gas or boost productivity. Factually, that’s demonstrably true, but importantly, whenever it’s about monetary policy, within five minutes, you’ll hear the word Milton Friedman appear. I’ve studied Friedman my entire adult life since college, and I teach a course in which he shows up almost every week.

One of the many insights of Friedman is that that’s really irrelevant at the first level because although central banks don’t influence supply, they ultimately can get the price level and inflation rate they want. When I hear about supply shocks as being a problem for policy, it is because it creates hard tradeoffs in terms of employment and the economy. I don’t want people to think that because central banks, by cutting rates or raising rates, can extract barrels of oil from the ground, that there’s not something that monetary policy can’t do about inflation.

It’s ultimately, over a period of several years, inflation and the price level is a choice, and whether or not the shocks that hit the economy are to supply or demand. The reality, and I think where this is relevant to central bankers, is that their jobs are much easier when the shocks are to demand. The discussion in the academic literature about divine coincidence, but the fact that your job is easier if shocks are to aggregate demand doesn’t mean that you can’t or shouldn’t do your job when the shocks are to supply. It just means the tradeoffs are more difficult. I know you understand that. I just wanted to get that out on the table.

Beckworth: No, that’s a great point. Well said. The Fed’s job, no matter what shock hits, is to keep inflation expectations over the medium-term anchored. It can do that. It has the ability to do that, given the mandate from Congress and such. It is a great topic you bring up. I’m glad you did because I want to go there with you, Rich. That is, how best can the Fed navigate these turbulent times? 

Again, you have written about this. You’re one of the chief architects of the new Keynesian model. There are ways to do this. One of the implications that come out of that is you need to look through supply shocks. Negative supply shocks or positive, but particularly negative supply shocks, because they raise inflation temporarily as long as we do have inflation expectations anchored. In some developing countries, as you know, because you do international finance as well, they don’t have that luxury. Right?

Clarida: No.

Beckworth: They don’t have anchored inflation expectations, so they’ve got to bite the bullet and raise policy. If you were back at the Fed now, what would you be thinking through, “How can I practically navigate what might be a supply-side shock minefield at this time?”

Clarida: I think there would be a couple of considerations. One is trying to understand—and again, it’s not really knowable, we’d have to draw an inference—if what is happening now is, for the foreseeable future, say three or five years, the price of oil is just going up from $70 to $110. There’s a level shift. In that world, eventually, the effect of the higher oil price is not inflationary because at one point, the year-over-year effects, and then at that point, you’re really talking about base effects, but you’re also talking probably about a pretty substantial hit to growth and employment.

I think that the more durable and persistent the Fed and other central banks believe this is, the more difficult is their job. Let’s think of the other case where the oil futures market is right. Right now, if you look at oil futures—again, futures traders can be wrong in oil markets just as they can in stock markets or the bond market—but if the oil futures are right and real people are betting real money on this, then the oil futures market says within a year, oil prices are going to be back down into the $70s or maybe low $80s for Brent, which is basically the level of oil prices in 2024 and 2025.

In that world, it’s transitory in two senses. In the sense that it will have a permanent effect on the price level, but it will be transitory in terms of inflation because the shock itself unwinds. See, at that point, if that’s the story, if the oil futures curve is right, then if you’re a central banker, you have a risk of hiking rates. The risk is you’re hiking rates into something that’s going to reverse pretty quickly. By the time your rate hikes take effect, your economy is not having to deal necessarily with the higher price of energy. You may need to think about even reversing it at some point. I went back and confirmed my recollection, and it was correct. Especially as a Fed official, and I’m not shy about saying this, as Powell and I and the other members of the committee were navigating 2018 to 2022, I would often go back and look at the Greenspan playbook or the Volcker playbook or the Bernanke playbook.

You try to look at playbooks of successful Fed chairs. I didn’t mention the G. William Miller playbook. In particular, if you look at the Greenspan Fed, in the late ’80s, early ’90s, when Greenspan came in, in ’87, and inflation was around 4%, it started to move up. Greenspan hiked rates aggressively into 1989. I think the funds rate got up to around 10%. We can check that in the transcript, but around 10% (The official peak was 9.85% in March of 1989). Then the Fed started to cut rates, and the economy was slowing. Then Saddam Hussein invades Kuwait, and oil prices double in the summer, in really August, September of 1990.

It’s very interesting. The Greenspan Fed kept cutting rates. A rate cycle had commenced. There was an adverse supply shock. They kept cutting rates. That’s one concrete example where the oil shock, in and of itself, did not detour or move the Fed away from doing what it was doing otherwise. Of course, Greenspan did not know in August of 1990 that there would be Desert Storm and that oil prices would retrace very quickly. There’s always an important element of judgment here. I do pick up, when I read the transcripts of the ECB meeting and commentary by Bank of England officials next week, it does look as though both of those central banks are on the verge of seriously considering at least one rate hike in this environment.

That’s probably due to two considerations. One, they’re single-mandate central banks, not dual-mandate central banks. Secondly, they’re much more exposed to higher energy prices than is the US, in part because the natural gas market is segmented, and also, obviously, because they import a lot more energy than the US does.

Nominal GDP

Beckworth: Great. Rich, as you know, one way that I like to approach this is to think through the lens of nominal GDP. I like it because it’s really simple, in this sense. Nominal GDP is made up of real GDP and inflation, and approximately two growth rates equal the sum up to the nominal GDP growth rate. If you think of nominal GDP as effectively an implicit aggregate demand target rate, if the Fed thinks potential real GDP is not going to change overnight, it’s growing around 2%, you want 2% inflation, all you got to do is make sure you’re not getting nominal GDP outside of that 4% or widely outside of that 4%.

Whatever happens to inflation, you got to look through it. You sell through it as long as you have nominal GDP somewhere near 4%, if that’s where you think potential real GDP is at 2%. What do you think about that approach?

Clarida: I think there are merits to nominal GDP. I’m not just saying this to flatter the host, but, David, you and I actually talked about this during my time at the Fed. I think, in fact, you visited my office in the Eccles building in 2019. At that time, and I’m sure still, you’re really doing the best work because part of the critique I had of some of the earlier attempts at thinking about nominal GDP is that they didn’t seem very practical in the real world, where you really don’t know trend GDP growth. You know the details, of course, but the approach that you were suggesting would be an approach that would essentially look at a long-moving average in order to give you a sense of the splits between real growth and inflation.

I will say this: If I were back at the Fed, I would spend more time looking at the implications for nominal GDP growth, the various Fed scenarios, than I did when I was there. In part, of course, half of the time I was there was the pandemic. When real GDP is going down 22% annualized, and 22 million people lose their jobs, you’re not really calibrating all that finely. The other thing I will say, and I think Jim Bullard—and I’m sure there are others, but I think of Jim’s work—Jim Bullard made the case in some theoretical papers several years ago that, at least in certain macroeconomic environments, you can actually have better outcomes if you stabilize nominal growth, even if it means some fluctuation in inflation because they’re occurring at the time that you want.

When real growth is strong, inflation is low. When real growth is slow, inflation is somewhat higher. So long as nominal GDP approach is credible and understood—I think the challenge right now is all central banks, including the Fed, have spent 30 years focusing on inflation targeting. I think transitioning to nominal GDP targeting, at least initially, would be a challenge. At minimum, as I said, if I were back in my old job, I would spend more time than certainly I did looking, as the Fed does, at different projections and looking at the implications of policy path for nominal GDP growth. David, that’s probably about as much as you’re going to get from me on that.

Beckworth: Yes, and that’s all I’m suggesting too, is that the Fed cross-check itself. Stick to its normal metrics, its normal rules. Just cross-check yourself. One more way to say, “Hey, are we at least within the ballpark?”

Clarida: Absolutely. Let me be direct. I don’t have a photographic memory in terms of what we knew in real time, but ex-post nominal GDP growth in 2021, I think, was 12%. That was not going to be consistent with a 2% inflation target, unless you had 10% growth. The interesting thing about 2021 is I think GDP growth came in at around 6%, which is a pretty healthy number. I think, as of the middle of the year, the CBO and maybe the Fed, when the books come out, the Fed was probably thinking of real GDP growth of somewhere in the sevens. There’s already evidence there in that miss that there was a supply constraint. There was certainly no shortage of demand in 2021.

Beckworth: Right.

Clarida: We have had periods when the US economy has—if you look at 1983 and the Reagan administration—I think 1983 growth was around 8%. So we had periods with 8% growth and strong demand, but that was not the case in 2021. That would have been a period in retrospect in which cross-checking with the nominal GDP would have been quite helpful.

Beckworth: Yes. To be fair, in real time, this is difficult. There’s big data revisions to nominal GDP. I’m someone, as you alluded to earlier, I look at forecasts, moving average of forecast, which is better than looking backwards at the rear-view mirror. It’s important, I think, to look at forecasts. Also, I’m someone, like you, who believes in the importance of makeup policy. If we ever were one day to go in that direction toward something like a nominal GDP target, I would hope we would do something like a level target so we have the power of makeup policy. There are a lot of devils in the details to that, I know, but nonetheless, all I’m asking now is, hey, FOMC, just cross-check yourself. Make your life easier. Really, make your life a whole lot easier. 

Fed’s Balance Sheet

Rich, let’s transition into another area that’s received a lot of attention recently. It’s one that I’ve tried to be a part of on the podcast, and that’s the issue of the Fed’s balance sheet. This past week, we had a number of Fed officials and prominent people talk about this. We had Stephen Miran, who’s a governor, he had a speech on the Fed’s balance sheet. He also released a user’s manual, these are the concrete steps, things you could do.

Darrell Duffie, very prominent economist from Stanford, he had a talk as well at Brookings and went through some of the challenges of the financial system, like if we do keep the Fed’s balance sheet large, and he outlined some things. I also mentioned last week, I had Bill Nelson on. We chatted about his ideas for shrinking the balance sheet. We’ve also had Miki Bowman. She has expressed, made comments, at least in the past, about whether returning to something like a scarce reserve system or something smaller than what they currently have, is it a good idea or not. At a minimum, there seems to be more conversations than there have been in the past. How do you read that?

Clarida: I did a lot of thinking on this as a Fed official, and I’ve done even more. Let me keep this at a high level. I think when it comes to the balance sheet, it’s important to begin by recognizing a fundamental transformative change in monetary policy regime that occurred in 2008 and ’09. Not just in the US, but around the world. It was at that point that central banks were granted the authority by their fiscal overseers to pay market rate of interest on bank reserves. That has fundamentally changed monetary policy, in that, under a scarce reserve system, once you decide what you want your policy rate to be, that basically determines the balance sheet you have.

I won’t go through the macro there, but just trust me. When you can’t pay interest on reserves, once you are picking the federal funds rate, you’ve essentially then picked your balance sheet, subject to currency demand and some other things. On the one hand, that then adds a tool to the central bank toolkit. Ben Bernanke gave a famous speech and won a Nobel Prize, in part, for the new tools of monetary policy. I think it also increases the complexity of both managing and communicating policy. I’ll give you a couple examples. These are all going to be examples which lead me in a direction that I want to justify in a moment.

Again, I’ll take advantage of your viewer and listenership to get on the David Beckworth soapbox, but one thing that is absolutely fundamental about talking about the Fed’s balance sheet in a world in which bank reserves, settlement balances, pay a market rate of interest, which is the world that we’re in today, is that quantitative easing or purchasing Treasuries in the secondary market with bank reserves does not extinguish debt, nor does it eliminate coupon payments. It merely changes the maturity composition of a given stock of government debt determined by the Treasury from fixed to floating rate.

Once you understand that, I think it completely changes the way you think about the size of the balance sheet, the composition of the balance sheet, because I think a lot of us, we’re of an age and of a vintage in which we’re very familiar with the world that existed for many, many decades and longer, maybe even centuries, in which bank reserves typically did not pay market rate of interest. Then it was okay, as a rule of thumb, to say, the Fed or the Bank of England is printing money because the Treasury has coupon payments are extinguished, but that’s simply not true.

On top of that change in monetary regime in 2008, I think appropriately and constructively, you had significant changes in the way the US and other countries regulate big, mega global banks. Banks are now required to hold a lot of liquid assets, something on the order of 20% to 25% of their assets have to be in liquid form. Importantly, the regulations themselves do not typically distinguish between a reserve deposit that a bank has and a T-bill. I’ll get to the exception in a moment, and here’s probably your conversation with Bill Nelson discussed on this.

In theory, we could operate in a world in which big banks met their liquidity requirements by holding T-bills. You could have a scarce reserve regime in which the liquid asset is a T-bill, which is a direct liability of the Treasury. What has happened in the US and other countries is that banks are meeting their liquidity requirements and choosing to meet their liquidity requirements by holding bank reserves. If we went to a scarce reserve regime, the banks would still have the high-quality liquid assets. It would just be direct claims against the Treasury.

Some advocates of ample reserves say, “Then it doesn’t really make a difference. The banks hold T-bills, or they hold reserves.” I’m going to make a case now that if I were back at the Fed, I would be making the following points. First of all, the actual amount of reserves that banks hold are elastic. We’ve seen an example of that with a very prominent mega financial institution substantially reducing its reserve settlement balances at the Fed. It is subject to a number of variables, some of which are under the control of the Fed. I think that’s the point that you saw in the Stephen Miran speech, and also some elements of Darrell’s paper, that there is some elasticity that would be responsive to policy.

If I were back on the Fed, I would be eager to explore that in an orderly, systemic, principled, and thoughtful way. I also think that, David, there is a real case to be made that, whatever the size of the Fed’s balance sheet is, in most times away from extreme circumstances like ’08 and 2020, I would be in favor of a Fed balance sheet, however large it was, that was largely invested at the very front end of the Treasury curve. If you go back and look at the data before 2008, half of the Fed’s portfolio, I think, was in bills, and 70% or 80% was only up to the five-year point.

I would never say never. There are certain circumstances where the Fed would want to take on a lot of duration risk. Remember that from the Fed accord in 1951 until 2008, the Fed ran monetary policy really without a large footprint, at least in terms of the amount of duration on its balance sheet. I think away from the zero bound and away from really extreme downturns, that would be my preference. 

The final thing I’ll say, and then I’ll shut up, but you see, you got me going on this one, one last point is, I think Darrell, not surprisingly, emphasizes this. He’s so good and thorough in his research on these topics. I should also say I’ve learned a lot over the years from Bill Nelson. Bill and I did not overlap. I arrived at the Fed after he had moved on, but I read everything that he writes. I am in the camp, and I was as a Federal Reserve official, I am in the camp that I think it’s important for the Fed, if it’s going to operate in an ample reserves regime, which I supported in 2019, moving to that, think long and hard, and then communicate clearly to the public about what success looks like with regard to the volatility and intraday dispersion of repo rates.

I believe then and still believe now that even the Treasury repo market, which is collateralized by Treasuries, is a very large and important market, but it’s very counterparty-intensive in equilibrium. There’s always going to be some cross-sectional dispersion of rates at which people borrow, and there’s going to be some volatility. Certainly, I’m in the camp that thinks you can have a successful monetary policy and some positive amount of repo volatility. I sense sometimes that the conversation often identifies any move in repo rates above the interest on reserve balances as something to be worried or concerned about. I would just like a more complete and thorough discussion of what successful monetary policy looks like. Since I don’t think it means zero repo rate volatility, I’d like to hear how folks on the committee are thinking about that.

Beckworth: Those are all great points. They suggest, at a minimum, it’d be nice to have a formal review, as you suggested. If you look at other central banks and advanced economies, they have done that—the ECB, Bank of England.

Clarida: ECB did that, yes.

Beckworth: Yes. Reserve Bank of Australia did that. I had a guest on, he used to work at the RBA. He talked about their review process. It would be great, and maybe that’s something Kevin Warsh can do, if nothing else, is to get a review of the operating system. Not just the target, but the operating system as well. I do think that these issues are so important, the footprint and the financial system. I think probably one of the most important reasons the Fed should take this to heart is it can affect Fed independence. 

If the Fed’s balance sheet is seen as something politicizing, you mentioned bank reserves or Treasuries, it’s just one form of government liability for another. However, it creates the perception, unfortunately, that banks are getting some kind of subsidy. That’s just added politicization. Also, the Fed’s large size, if that balance sheet can be used for political reasons, that’s also opening the Fed up. I do think it’s worth the Fed’s own interest, its own independence concerns, to take a look and do a review, as you suggested.

Clarida: Yes, agreed. I think, by extension, that you had this piece from Governor Miran. Fed staff have put out some very nice working papers on this in the last year. I think, based upon the public domain, it looks like it is an active area of exploration in the Fed. That’s a good thing.

Synthetic FOMCs

Beckworth: Okay, Rich. In the time we have left, I want to have a little fun with you here. I want to go to a previous guest I had on the show, Tara Sinclair. She actually worked at Treasury in the Biden administration. She’s a professor at George Washington University now. She’s done some interesting work with AI and LLMs, large language models, on the FOMC. She had a co-authored paper where they created a synthetic FOMC. They created actual personalities. They created a synthetic Powell, a synthetic Waller, a synthetic Bowman.

Clarida: I’m feeling left out. I left too soon.

Beckworth: You left just a little bit too soon, but I do have an idea for this. I want to include you in it. They replicated some FOMC meetings in 2025. They were able to predict pretty close to what these people actually voted based on their speeches, based on economic releases.

Clarida: Okay.

Beckworth: Also, it was really fascinating. They allowed for political influence. These agents, there’s the Waller agent, there’s the Powell agent, all of them in the FOMC. They allowed time for water cooler talk so the agents could go talk to each other.

Clarida: Oh, wow.

Beckworth: There was political pressure. It was really fascinating. They ended up basically replicating what actually happened in some of the few meetings they looked at. She said there’s other ways to use this that she thought would be useful going forward. For example, what if you allowed more presidents to vote? What if the chair speaks last versus first? Just different dynamics on the FOMC. How would that change it? I suggested to her what would be really cool is to have an all-star FOMC agent. You would have a sim Volcker, a sim Bernanke, a sim Clarida up there.

Of course, you go on TV, and you can tell them what you think. Just looking at how these people voted in the past, looking at the transcripts, someone who may not even be with us, a Volcker, what would they tell you to do in this moment? Any thoughts about synthetic FOMCs, its usefulness, and such?

Clarida: I read the abstract, but I have not studied the paper, and certainly, now I will. I have seen other exercises which use AI agents, not on monetary policy, but especially in the area of geopolitics and war games and some such. Yes, I think the saying goes, the proof of the pudding is in the eating. I think one potential area where these models can be helpful is, as a social scientist, as we both are, there are important elements of group and committee dynamics that are, for the most part, completely left out of textbook Clarida, Gali, Gertler, DSGE models.

Alan Blinder gave a wonderful speech, or he wrote a paper 25 years ago, essentially making the point that if you really wanted to understand monetary policy, you’ve got to understand the social science and, if you will, anthropology of committee dynamics. I think what most academics do is they think it’s the Volcker Fed, so it’s a committee of one, or the Greenspan Fed. Committee dynamics are quite important, especially at turning points and when there are close calls. This is potentially an area where multiple simulations of models like this could give us some insights into thinking about committee dynamics, especially because these are repeated games. It’s not like you have a new FOMC each meeting. Right?

Beckworth: Yes.

Clarida: During my time, for example, the Fed benefited enormously from the fact that folks like Charlie Evans and Jim Bullard and Esther George and Eric Rosengren had been on the committee for a very long time and had a lot of institutional wisdom. Of course, by now, Jay Powell has been on the committee, I think, for approaching 14 years as well.

Beckworth: Yes. This is all so fascinating. As you said, it allows us to explore this other dimension we haven’t touched, and that is the politics, the anthropology of people coming together, a committee working. You could take a DSGE model, add it to the results that come out of this kind of sociology of the FOMC. I also think, though, Rich, this would be fun to resurrect Milton Friedman. He had that K% rule. I’m not saying we go to a K% rule, actually, but maybe take some Taylor rules, whatever your favorite rule is, get real-time data, have the AI run it, give you a daily update on what Fed fund rates should be at a point in time.

Clarida: I’ve seen, not with AI models, but there are folks out there who have proprietary daily activity indicators. There’s like the billion prices project with daily inflation.

Beckworth: Oh, yes.

Clarida: In some early work of mine from 20 years ago, I was using daily data on forward real interest rates to give a daily r-star estimate. Yes, especially once you acknowledge that central banks are always learning, and so every day, data is not only useful if you’re a central banker because it’s telling you about where the economy is, it’s actually helping you improve your inference about unobservable parameters like potential output or the neutral interest rate. This could be an extension of that.

Beckworth: Yes, it’s a great time to be alive. I recently saw a paper by some grad students from the University of Oxford, and they used LLM model to come up with daily estimates of the discounted present value of primary deficits.

Clarida: Yes, I read that paper. I saw it.

Beckworth: The holy grail of the fiscal theory of the price level, because that’s an unobservable you don’t really see, right?

Clarida: Yes.

Beckworth: Somehow, these youngsters came up with daily estimates. I was blown away.

Clarida: Yes, good stuff.

Beckworth: The same thing could be used in monetary policy. With that, our time is up. Our guest today has been Rich Clarida. Rich, thank you so much for coming back on the program.

Clarida: It’s been my pleasure. Keep up the great work. This is really a fantastic resource for the global economics and policy, financial markets community.

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.