War Stories from the Fed

A Macro Musings Transcript

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David Beckworth:     Our guest today is Craig Torres. Craig is a reporter for Bloomberg News and previously worked for the Wall Street Journal, including a stint as chief of the paper's Mexico City Bureau, where his work on the peso's collapse in the mid 90s made him a finalist for the Pulitzer Prize in International Reporting.

David Beckworth:     Craig has won several awards for his reporting with Bloomberg News on Fed policy, including his work that forced the Fed to disclose via court order the details of emergency lending and the Bear Stearns bailout. Craig joins us today to discuss these and other stories in his coverage of the Fed and the economy. Craig, welcome to the show.

Craig Torres: Great to be here.

David Beckworth:     Well, it's great to have you on. You have a lot of interesting war stories on the Federal Reserve and our listeners would love to hear some of them. Let's go back and start with the period leading up to the great recession and the financial crisis, the housing boom period. Anything you can share from that period that would shed light for our listeners on what happened.

Craig Torres: I think there are two interesting things. One, on the community affairs side which is quite extensive at the Federal Reserve, they had like a listening tour around the country and in that ... this is before the bust I mean. In that, they were getting first-hand information from, I would call them credit activists. Community activists who work on things like who gets credit and they were calling to the Fed's attention the fact that low income people were being abused by predatory lending and nothing happened. Part of the reason is, that whole apparatus was quite separate from monetary policy and even I would say regulatory policy.

Craig Torres: The Fed was still a pretty siloed place. The information it had did not feed into decision making. That was one problem and then the second idea at that time which the Richmond Fed was promoting, something was happening with the Fed's policy setting and that if you recall, savings rates were plunging to near zero.

David Beckworth:     Yup.

Craig Torres: We had home equity extraction and Marvin Goodfriend who Trump has nominated to serve as a Federal Reserve governor and his Fed president Al Broaddus were saying, something is wrong here. Our policy setting looks too low. People are spending forward, their income, they're extracting home equity. They aren't saving. This is telling us something about our interest rate and we conclude it's just too low but we had the conundrum of low inflation. Somehow they just couldn't put this together, these various components.

David Beckworth:     That's interesting so the pieces of the puzzle were on the table. They just couldn't put them all together to see the coherent whole.

Craig Torres: This transcripts also show I should say that Fed staff was not too concerned about the housing bubble. They didn't think you could have a national crisis. They thought you could have a regional one in the sand states and things like that but not a national crisis.

David Beckworth:     I think Craig that was a common view back then, that there couldn't be a national crisis. In some ways, the Fed staff was reflecting maybe the consensus because I heard that too. I heard that in many places that we haven't had a national crisis since the great depression, highly unlikely which is not good economic analysis in retrospect for sure. Going back to the regulatory failure, there was a governor at the Fed who was kind of up in arms about it, right?

Craig Torres: He was very concerned about subprime lending, partially because I think he thought it was predatory and abusive.

David Beckworth:     This is Governor Gramlich?

Craig Torres: Ned or Edward Gramlich, yeah.

David Beckworth:     Okay. I read one book where he actually tried ... one account where he actually tried to tell Greenspan about it but Greenspan was not concerned. Now, this may be just one side of the story but did he really make an effort to make this a bigger issue at the Fed?

Craig Torres: Yes.

David Beckworth:     Okay.

Craig Torres: Yes but I think the historical context is really important when we, in fairness really, when we look back. You have to remember that Greenspan and quite frankly your profession, economists, were very big on securitization and risk distribution and the reigning idea at that time was that risk was landing in institutions that could best hold it, hedge funds, investors, people who were supposedly intelligent and that's why it was ... the idea was diminished somewhat that okay, yeah, this is risky but isn't it great that we're distributing it around to people who are smart enough to hold it and it's not really in banks.

David Beckworth:     Yeah, so it was easy to fall into the trap that everything is okay, given the context of the times. It's also interesting you mentioned the Richmond Fed’s view that policy was too loose because later John Taylor makes this similar argument, it's too low for too long but his of course is kind of after the fact. I think 2007 he had a paper on this, at the Jackson Hall meetings and he has made this argument since and many others have been sympathetic to it but the Richmond Fed at the time was making that argument.

Craig Torres: Yes.

David Beckworth:     Including Marvin Goodfriend, very interesting. All right. Well, let's move forward. We're now in the crisis and things are blowing apart and we know the Fed did some very unconventional things at the time, now, they may seem more ordinary. One of the big things that they did was saved Bear Stearns which seem very radical at the time and you had an interesting war story from that experience. Tell us about it.

Craig Torres: Well, first of all, one of the most enjoyable stories I did was ... I called up Anna Schwartz who was one of Bernanke's heroes and asked her what she thought about it. Who better-

David Beckworth:     Bear Stearns?

Craig Torres: Yeah.

David Beckworth:     Okay.

Craig Torres: A Great Depression expert and she called it a rogue operation.

David Beckworth:     Really.

Craig Torres: Yeah. She was against it, the great Anna Schwartz and then once they did it, we asked if we could see the portfolio. We filed a Freedom of Information Act request. That was followed by another colleague of mine asking if we could see the discount window borrowings going into the crisis. They said no, on both counts. I think saying no about the Bear Stearns portfolio was really hard to defend. After all, this isn't their money. They were taking credit risk. Their claim was that these were all investment grade securities. We actually found someone who had a database of the securities they held once they showed it to us after they pursued the case all the way to the Supreme Court and the Obama Administration said, we're not going to support this.

Craig Torres: We're not going to file an amicus brief and the thing fell apart and basically, the court just said no. The lower court ruling stands, you got to show the public this. When we looked at it, guess what, they weren't all investment grade securities. The Fed was taking credit risk with taxpayer money.

David Beckworth:     You were involved in a case that went all the way to the Supreme Court, involving the Fed and disclosing what was actually happening in the midst of this crisis.

Craig Torres: Well, I got to hand it to Bloomberg News and especially our founder, Mike who said, this is ... accountability is at stake here and this is worth fighting for and these kinds of fights aren't cheap, that's all I got to say.

David Beckworth:     Yeah and you've talked before about how transparency over time has improved at the Federal Reserve and how things have changed and you've covered the Fed for a long time so maybe talk to us about that. I mean, has the Fed become more open, more transparent?

Craig Torres: When I was a young financial reporter in New York City in the late 1980s, I worked for Knight Ridder Financial News and I wrote about the bond market. The Fed had a borrowed reserve target. The money markets were really tight and the way you would tell, whether they were changing interest rates was how they conducted these big repo operations. This was the sum of Fed transparency. We had these data guys that sat off aside from the reporters and all of a sudden they would yell out, “three day system” and then you would call a bunch of economists and try and ...

David Beckworth:     What does that mean?

Craig Torres: What does that mean for money market interest rates? We didn't even have a Fed statement so boy, we've had leaps and bounds in transparency.

David Beckworth:     That's interesting.

Craig Torres: Yeah.

David Beckworth:     Was it '94 when they started releasing the actual target I believe?

Craig Torres: The dot plot you mean?

David Beckworth:     Not the dot plot but the actual like announced target, was it like the mid 90s, somewhere in that?

Craig Torres: Yeah, it was ... that started to develop after the '87 crisis.

David Beckworth:     Okay.

Craig Torres: Don Kohn, who worked in monetary affairs and later became vice chairman of the Fed and Greenspan both argued that market volatility about where the funds rate was going to be was not a positive thing, especially after this stock market shock. Yes.

David Beckworth:     Okay. Well, let's move forward to today and let's talk about the new Fed chair, his new wish. He's been in office for almost a year and he has brought a lot of change and I would think he has moved the transparency area forward some. Tell us about him, what does he done to the Fed and what might be his legacy?

Craig Torres: I'll tell you in terms of transparency, Jay Powell is off to a running start in an institution that has more work to do in winning hearts and minds with the public. Let's look at what he's done. His second press conference in June, he said, I'm going to be “plain speaking Jay”. No more wonk fest up here. He's not a PhD economist, you should say that. He said, he's going to be doing press conferences at every meeting so eight times a year instead of four. He pushed out the first ever supervision report. I think this is critical. It spoke to banks and let's not forget, banks are very important constituency of the Federal Reserve.

Craig Torres: They're actual shareholders of reserve banks. They sit on reserve bank boards. There's an advisory committee to the Board of Governors. President Wilson wanted that. I actually have seen the document where Carter Glass took down by hand the notes from Wilson on forming this bank advisory committee. It's critical that banks and the Feds speak to each other and he's telling them now, this is how we intend to regulate and supervise, this is what's on our mind. He's pushed out a financial stability report for the first time. This speaks to investors at large about what risk the Fed sees. I might add that his congressional contact calendar has been super intensive. We count more than 70 meetings since he became chairman in February.

David Beckworth:     That's amazing, he had that interview where he said he wanted to wear out the carpet on Capitol Hill.

Craig Torres: Yes, yes.

David Beckworth:     Which was amazing and apparently he has 70 points of contacts so that's quite an achievement and you think all of these developments are a Jay Powell result. I mean, had Janet Yellen stayed on, we wouldn't have seen as much change do you think or do you think it really is a personality difference that's playing a big role here?.

Craig Torres: I think within the Federal Reserve, among PhD economists, there's a bit of this attitude that if we just do our job and pursue our mandate and achieve that mandate over time, people will understand what we're doing and let's consider what's happening now. The president is attacking them on Twitter, in interviews. By the way, there is no evidence that that attitude they had, worked. There were several bills in the house leaning against their discretion, calling for audits so that ... let's call it wonky attitude that we're just a bunch of technocrats here doing our job, really didn't win public support.

Craig Torres: In my view, the Fed should much more basic in its communication like a press conference that begins with a very simple flip book. Here's our goals, here's our instrument. Here's what we're worried about. Here's how we respond. Something that high school teachers could download and talk to their classes about. I think that kind of very basic communication has been somewhat disregarded by them.

David Beckworth:     Jay Powell comes in and he provides that, kind of a breath of fresh air. The “aw, shucks, I’m just one of the ordinary people here doing my part.” I think you mentioned in recent piece, it's important because of the Trump attacks and because there's always be congressional pressure. I mean, Ben Bernanke in particular got a lot heat because they were trying all these new things but it seems very radical at the time.

Craig Torres: Hard to explain.

David Beckworth:     It's hard to explain, it is and so I think it is nice to see this happening and you mentioned there's going to be a roadshow coming up that the Fed is going to do and that's part of this increased transparency communication program right?

Craig Torres: Yeah, it's not only to academics. They say it's going to be for stakeholders which I assume labor is a big stakeholder in Fed policy. We'll see how they develop it but my colleagues think and I agree, part of this is to sort of socialize policies that they may have to do again in the next crisis and one of them might be one near and dear to your heart, NGDP targeting.

David Beckworth:     Great.

Craig Torres: Which is really hard to explain, so maybe you could help them be very ... like I think Mercatus and your group should think, well, what's the classroom addition of NGDP targeting?

David Beckworth:     Well, if Jay Powell is listening, here is my advice Chair Powell. First, I would sell it as a regime or a target that stabilizes the growth of your income. It'd be a nominal ...

Craig Torres: My income. My humble family's income.

David Beckworth:     Right.

Craig Torres: Okay.

David Beckworth:     I mean, it could be ... step aside any technical for a minute, nominal GDP targeting is a target that stabilizes total spending but the flip side of that is, it also stabilizes total income growth, nominal or dollar income growth. The easy, accessible way to explain this is look, instead of stabilizing prices per se, we're going to be stabilizing your income growth. We don't want it to collapse, to go too high. Now, of course each person, there's idiosyncratic differences based on productivity, what you do, what industry you're in. But, in general, you want to stabilize the overall average count of ...

Craig Torres: I like that as a humble family man with a house and a mortgage so tell me if the economy is running south and my raise has fallen to zero and my colleagues and hopefully not me are getting fired, how do they guarantee that?

David Beckworth:     Well, they have to adjust monetary policy accordingly and of course, part of this is also building up expectations, part of the panic, the cutback in spending is you believe you are going to have an income cut going forward and so there's a lot of things to work out, a lot of theory to test but the idea is you would see people being less worried about income cuts going forward because again it has to be credible and there's a long conversation that we could have whether it could be credible but compare this to for example, inflation targeting so I mentioned Bernanke had a hard time.

David Beckworth:     Remember 2010, he was being grilled before congress about “you're debasing the dollar, you're going to create hyperinflation” and all he was trying ... he was actually trying to raise the inflation rate back up closer to two percent from where it was. It's actually really low. He had a hard time explaining, “why do you want to increase inflation?”

Craig Torres: That's right. That's a not a populous message, I'd say.

David Beckworth:     It's not and really what he was saying is he wants increase aggregate demand or total spending and inflation is just the symptom we all look at to see whether we've done that and I say cut to the chase and repackage it, as “I'm going to stabilize normal income.” I think there's a way to market it. It would take a concerted effort by the Fed to get it across but I am excited about this review they're having and this roadshow you mentioned. I am just curious if you've heard more details about it. So they’re literally going to go around and stop at places in the country and “come hear Jay Powell speak about what's going on at the Fed,” that kind of ... it was like a fair, is that the spirit of it?

Craig Torres: Yeah. I mean, I think pulling up to the Burger King in Des Moines with a speaker on a truck and say ... I think that's a great idea but I don't think they're going to do that. I don't think they know what they're going to do. In fact, I know they don't. This is still being developed but I think the intention is, to speak to different audiences than academics only.

David Beckworth:     Okay, and I know the vice chair Richard Clarida has a big role to play in this. I know he's overseeing in the conference they're going to have next June but I imagine he's a part of this conversation as well. It would be interesting to see what he does and where he goes with it. I want to go back just briefly to your incidents at the crisis where you and Bloomberg News sued the Fed and opened up ... and just to put that in context with what we've been saying about increased transparency communication, do you think that action was maybe a pivotal catalyst in terms of making the Fed more open long term as well? One of your legacies will be that the Fed will think twice about keeping secrets close to its chest?

Craig Torres: I can tell you as someone who's filed many FOIAs subsequently, if anything, they've been ... they have been before Powell, a little bit even more entrenched fighting us even harder. Yes.

David Beckworth:     Okay.

Craig Torres: For example, I FOIA'ed I believe, I've submitted a lot of FOIAs, the financial stability report. Something they had internally. They denied us saying, there was confidential supervisory information in that. Later I learned, guess what, there isn't because the supervisors don't really share that information with the broad FOMC staff because it's very, very confidential. I think it's slow, I think it's transparency on their terms and like I say, they're moving cautiously slowly.

David Beckworth:     Okay. Well maybe also that lawsuit that was filed earlier had the backing of Bloomberg News, the deep pockets of your president Mike Bloomberg and maybe, they would move again, if they had that on the radar screen. That a big player was going to…

Craig Torres: Well, I think in terms of ... if they do something big again ...

David Beckworth:     They'll be mindful of the possibility.

Craig Torres: Yes, yes. I think the propensity would be, to be more transparent to that.

David Beckworth:     Well, that's good so you can take some credit then in nudging that in the right direction. Again, having the Jay Powell personality on board also makes a big difference. I want to also ask about Jay Powell ... Again, tying this into our theme about transparency, putting a good foot forward, a good face on the Fed, one of the stories that was reported over the past year since he's been in office is that he has worked hard to circumvent the barons of the Fed or they get around the cogs and bureaucracy of the feds so there's these powerful positions and I've talked to some people who have worked there in their past and they tell they are very powerful and that it's not easy to get around them.

David Beckworth:     In fact one person told me that even Chair Ben Bernanke and Janet Yellen had these problems where they would ask for something to be done and the barons would resist or wouldn't make it easy and this person compared to show yes minister, where the ... The person, the British would ...

Craig Torres: Was this person on staff?

David Beckworth:     Yes, I don't want to mention their name but they were in a very prominent position and they saw first-hand and they were disillusioned to some extent. Jay Powell ... Anyway, Jay Powell seems to have kind of worked around that a little bit. Do you remember the story about-

Craig Torres: Yes, my colleague Chris Condon wrote it.

David Beckworth:     Yeah.

Craig Torres: I think he broke that story, so I think what he's after is ... according to what we've published, is they want to see debate. It's not only the staff coming to them with ready answers.

David Beckworth:     Yup.

Craig Torres: The conflict around those answers is something increasingly the leadership of the Fed has valued. Debate around those answers. You tell me, I think the economics profession, it has this propensity to arrive at certainties and when they do that, they are all kinds of things you willfully neglect and assume. Those get you into trouble, am I right?

David Beckworth:     Yeah. Well, in fact, this same individual, to answer your question was there during the crisis and he accuses or sees, groupthink occurring because there was an answer that would be funneled up to the FOMC, to the chair and there wasn't this discussion.

Craig Torres: Is that the result of the way economist model things, do you think?

David Beckworth:     In his perspective, I can't answer that question certainly but from his perspective, the issue was more ... there was a system in place, they got channeled through the barons and there was that and they gave the final answer as opposed to let's have some discussion that not everyone on the staff is going to agree with whatever the consensus maybe. I think that was ... the take I got was there needs to be more discussion within the Fed and there was discussion just it couldn't get funneled up to the top very easily but I'm sure, I mean, your point is a little different that maybe economists are overly precise, is that your critique?

Craig Torres: You tell me. I think the profession aims at precision and one of the interesting things about Jay Powell's Jackson Hole speech was the pushing back against precision. The profession comes up and says, well, we have this estimate of this infamous neutral interest rate or which economists call, I'm going to apologize to the public here, r-star. His answer to that was, it's just an estimate.

David Beckworth:     Yeah.

Craig Torres: There's a big range of uncertainty around so ...

David Beckworth:     That is a nice dose of humility from him on that topic. I do give him credit for that. I would say, Fed staffers would reply ... an economist would reply, “well, we've always had confidence bands or a range ... there is a point estimate but there's always been like ... there's uncertainty” but I think you're right, in practice, even though we say at first, there's a range of estimates, we tend to fall on the point estimate to help guide policy and actually, you know one of my critiques has been, the Fed hasn't disclosed what that actually is. You would hear lots of ... you’d hear Janet Yellen for example, talk about, “we're close to the neutral rate, we’re close to the neutral rate.”

David Beckworth:     Now, the FOMC does disclose the long run and in the Summary of Economic Projections, you can look at the long run, what they think is the long run neutral rate and there's the famous, John Williams and Laubach Estimate but that's a medium range, that's like what you'd seen in the intercept of a Taylor Rule. What we never saw from the Fed was what the short run neutral rate, what is it today so the Fed is going to change policy rates so what is it today? Janet Yellen has a speech I believe in 2015 where she had a chart where she actually showed the short run and again, it was the point estimate, a range around that. I always wanted the Fed to release, to make public and admit there's uncertainty surrounding it but show it.

David Beckworth:     Yes, I think you're right there is a tendency to have an estimate of a point estimate of the natural rate of interest, of the natural rate of unemployment and then to find out later well, we were wrong. I mean, that's clearly the case with their natural rate of unemployment, if you go back to when they started tightening in 2015, it's changed dramatically and if what they believe today is true, then the reasons for tightening in the past were way off. Yeah, so you're right, there needs to be maybe a bigger sense of humility that we really don't know these unobserved important variables.

Craig Torres: Nothing wrong with communicating humility and uncertainty.

David Beckworth:     All right, let's switch to the actual current state of monetary policy in the U.S. The Fed has done a number of rate hikes. There's been a talk of yield curve inversion. The market has become a little more volatile, where does monetary policy stand currently and where do you see it going over the next year?

Craig Torres: Well, we're about to find out. Next week, there is a policy meeting and they're going to splash out all their projections, whether markets believe it or not, we'll see. Right now, markets are fairly in disbelief that they're going to raise three times in 2019 and the latest communication we've heard from Fed officials is that they’re "Just below" the range of estimates of where neutral is. Maybe we could talk about some of the complications they face. They've raised, slowing Europe, possible supply chain disruptions from the trade wars and whether that slows investment spending. Another uncertainty they have is about inflation.

Craig Torres: I find it remarkable that the economy is above the range, GDPM talking about, of their estimate of the speed limit and below the range of their estimate of full employment and inflation has pretty much been a dud. I don't know how they're going to deal with this, either they're happy with inflation, they're unhappy. I think Jay Powell has to say something about this. My ear will be tuned to that.

David Beckworth:     Okay, how do they reconcile that tension?

Craig Torres: Yes.

David Beckworth:     Yeah, it is interesting so I mean, the analogy would be they're driving the car at full speed, maybe a little faster than full speed and yet the engine isn't heating up yet.

Craig Torres: No.

David Beckworth:     According to their model, their engine should be getting really, really hot right now but it's not. What do they do, do they slow down or do they keep going? And going back to the conversation we had earlier about Trump putting heat on the Fed, Trump wants to continue to see a recovery, a strong growth and he's blaming the Fed, and it's true the Fed has some role to play but his own policies on trade surely have some variance as well in what's happening. The Fed is faced in a lot of pressure from the outside and how it responds going forward. Now, earlier in the year, it was interesting when the Fed was talking of rate hikes a little more confidently.

David Beckworth:     There was concern about the yield curve inverting and some of the Fed official said, “So what?” John Williams surprisingly, he's like, "Look, if going to neutral involves a little bit of inversion, I'm okay with it." Governor Lael Brainard mentioned that there's a long run neutral rate or short run, maybe the short run have to go ... is above the long run which might imply some kind of inversion. I think now, at least what I'm seeing is there's a little more humility, a little more caution that maybe we don't want to go that far.

Craig Torres: I don't understand the yield curve inversion argument. I mean, if these guys like Raphael Bostic were so concerned about it, they should advocate for faster run off of treasury bonds and put more duration out there and steepen the yield curve. I mean, I really don't get it. They seem to take a lot of signal from what could just simply be savings glut demand for long term assets in a period of low inflation. I'm not sure, it's a ... in my view, I'm not an economist. I'm not sure the committee as whole is going to take a powerful monetary policy signal from that risk.

David Beckworth:     Yeah, no. I think it's a great observation and I would love to see them run down their balance sheet faster but I think what they would say is probably, "Well, we want to be mindful of the liquidity needs of the banking system so," and this gets to the whole 'nother discussion of what should the fed's operating system be, a floor system or a corridor system and how small this balance sheet ultimately get. The last FOMC minutes we saw that they had a discussion on this. Do you have any sense of where they're going because they didn't reached any conclusion last meeting? They said they're going to continue to talk about it. Do you have any sense of where the winds are blowing in this area?

Craig Torres: I think if you read them closely, they've concluded that banks have a preference to hold a lot of safe assets and excess reserves. That leads you to the system they have now which is providing an abundant reserve ... amount of reserves to the banking system and keeping the federal funds rate in a range and not creating this system where banks, trade, and buy and sell fed funds in a very tight market that determines the funds rate, which was this system we're in. This is kind of very technical. I'm not sure the public's concern about it. Banks are very concerned about it.

David Beckworth:     Yeah, I've been following it closely and I've written on it myself and it's definitely something that the Fed internally will be talking about it, I think you're right. It's not something you talk about over thanksgiving dinner with your family, when they go home. Dad, how's the operating system? Just the way it's going in your view. No, so yeah, I do think personally, I think this is an important issue but I think it's probably not that consequential to most people and secondly, I think the Fed is saying, it works well enough. The banks seem happy with it, why rock the boat, why break something that's working? Again, I think there's a cost.

David Beckworth:     It's not this benefits and no cost. I think there's tradeoffs and there's an important conversation to be had on this issue. What about the review we talk about earlier, happening next year? Let me ask a similar question, the options available might be price level targeting, higher inflation targets, nominal GDP level targeting. Do you get any sense from your contacts with the Fed, in what you're reading and seeing and hearing that there's any strong preference one way or the other or is it still an open question?

Craig Torres: I don't get a sense that there's a strong preference. I do get a sense that when they ... we go into a next recession, if it is at all deep, that they'll be down cutting rates to zero once again. Then, what they do beyond that point to stimulate the economy will undoubtedly be very confusing to Americans unless they explain it very well. If they buy more bonds, we've seen Congress has a problem with that, even though quite honestly their fiscal policy creates all these debt instruments that make it very convenient for the Fed to buy. NGDP targeting might be hard to explain, negative interest rates, that's going to be tough. I think all those things are probably on the table and this is an opportunity to socialize that.

David Beckworth:     Yeah, that's ... going back to your earlier point, that's what's important now to communicate, what the Fed is, what it does, that the whole Jay Powell ...

Craig Torres: Yeah. I think ... I should say, I think that's part of this and that's a strongly held view of some of my colleagues, but I also think part of it is to get out of the public and talk to the Federal Reserve. Anything they do on that front, talking to labor is important in my view.

David Beckworth:     Yeah. That's a good point. Even aside from the need to communicate any big changes, just becoming better understood, I think is useful because the Fed is probably one of the most misunderstood institutions in government, at least that's my take, people have lots of conspiracy theories. I think if you were to go to YouTube and just type in Federal Reserve, probably the first few things that'll pop up will be some kind of conspiracy theory about the Fed. I think it would be in its interest to continue doing this. All right, Craig. Well, this has been fun talking about Fed policy and your work on it but you've also done work on some other issues.

David Beckworth:     You've done work on automation and work and to segue into that, I'm just going to ring up an interesting story that happened recently. You probably saw this robot that malfunctioned in the New Jersey Amazon warehouse to open a can of bear spray and sprayed 24 humans put them in the hospitals and of course, the headline was it accidentally sprayed them and everyone coats were accidentally, and if you're old enough to remember Terminator and Skynet, there were jokes about Skynet has finally emerged and a robot overlord are here again, this is maybe the first feudal attempt but more seriously, we have these discussions about the rise of automation, artificial intelligence and will blue collared jobs survive this advent of change?

David Beckworth:     You've written some interesting work on this and learned some things so tell us what you found, I mean, if you look at Rolls Royce Factory for example, tell us some of the insights you've gleaned from this?

Craig Torres: Well, I think my profession, journalism and the Silicon Valley which tends to hype because hype equals money for those people, the more attention they can get, the more money they'll get, mostly, have overstated how automation is going to affect labor. The big challenge based on what I've seen is to figure out how labor works with this automation and sort of reimagine labor and that's what I saw at Rolls Royce. I visited a lot of plants in my time. Usually, when you go into a manufacturing facility, there are men and women standing in front of something, watching it do something. That machine has become the hands and partially the decision making apparatus for humans and what they would normally do.

Craig Torres: At Rolls Royce, it was amazing to see a $35,000 piece of titanium, going through all this cutting and no humans observing it at all. That machine was storing data on what it was doing. It was comparing it to what it had done before. It was measuring heat, all other kinds of metrics. I had to ask, well, what exactly are humans doing in this place? They seem to be walking around and observing and the manager there, Lauren, said that's pretty much right but I need those people to be facilitators around this process and keep a very close eye out for what he called non-standard events. A machine only knows what it knows.

Craig Torres: If something begins to go awry, you can't always detect how to fix it or what's going wrong. It's like a GPS in your car, suddenly, you come upon a detour. Well now, you're going to have to make a decision. You can't rely on that GPS. In high precision, parts like this having humans around the system, optimizing it, figuring out how to make these machines work better was a real enlightening thing for me.

David Beckworth:     All right, so one of the points you raised in your piece in the Rolls Royce factory ... by the way where is this Rolls Royce Factory located?

Craig Torres: It's sort of southeast of ... east of Richmond let's say.

David Beckworth:     Okay, and you made this point that it's AI and automation isn't necessarily reducing the amount of labor. It's just reorganizing labor so people are still working. People on balance have lost absolute number of jobs, just they're doing different jobs, they’re using ] their time differently around the factory, is that fair?

Craig Torres: Yeah, I did a story many years ago about the advent of automated cashiers, so you go to CVS, there are no people cashing you out. You check yourself out. You go to Giant supermarkets here in Virginia, you check yourself out. If you ask those companies, what are people doing? Well, they think this is productivity enhancing because our people can do other things. They can help customers, they can restock shelves. They can make sure there's more order in the system. It just to simply change what people are doing. By the way, I'll add this. This mythology, that this is going to reduce the number of jobs, it takes a lot of jobs, higher paying jobs, more technical jobs to devise these systems and maintain them and do things with the data.

Craig Torres: Every time you go to Giant and you swipe your Giant card which it asks you to do, to get that discount, what they're doing is gathering data on your purchases. Your very personal purchases. They have to anonymize that data. Look at it from an inventory standpoint. You may think that's all automated but it takes a lot of labor to get your hands around that. I think it's very interesting, we all believe like we'd be sitting on our couches, listening to Steely Dan and robots would be doing the job. Guess what, it takes a lot of humans to work with a digital economy.

David Beckworth:     Yeah, they need us because we complement what they can do.

Craig Torres: Yes.

David Beckworth:     They can take repetitive task and automate them but there's some things that create ... require creativity and problem solving and back to Rolls Royce example, you mentioned then the story that there was some part of the factory, was having the problem, they weren't cutting correctly and the machines ... No, machines couldn't tell why. No one can figure out until someone ... one of the employees figured out, well there's these ...

Craig Torres: Sky lights.

David Beckworth:     Sky lights that are causing the machines to warm up at a certain time of the day and causing this variance in what they do.

Craig Torres: Yeah, exactly, that is a true story and I'll add this. I was also at BMW Spartanburg. Largest BMW plant in the world. As you walk through this plant, you see robots, welding away and they're in cages so they don't hurt anybody, mashing these metal together and welding these bodies. As you walk down the line and get closer to what you and I would experience in a car more and more humans are around this. In other words, quality control and the things that you and I are going to touch leather seats. Perhaps we wanted a particular navigation system or sound system in this, a lot of humans around that.

Craig Torres: Finally, this was cool, an X5 rolls off the assembly line, a human gets in it, drives to what looks like a big garage door and inside that is like a mini race track that has railroad tracks, cobblestones and all these sort of rough surfaces, and he drives it around and around and it's a human ear that listens and says, does this sound like a BMW? So try doing that with a machine.

David Beckworth:     That sounds like a fun job. You mentioned in your piece that in this new work environment with Robots and AI but there's demand for a new type of factory worker and some school, some technical colleges are responding and you give this example, you mentioned this, a technician starts off making $48,000 a year and can earn as much as $70,000 depending on the achievement and skill level, mostly at least two years of experience or precision machine certification from the community college. It seems that could open up the door for technical schools, more community college, maybe less traditional college degrees.

Craig Torres: Yeah. Another myth David is that ... I mean, it's partly true but it's also kind of untrue is this worker shortage thing, okay? Take trucking. There's a shortage of workers. You're an economist, you know what that means. There's a shortage of workers at this price.

David Beckworth:     Right, prices can change.

Craig Torres: Yeah, and also someone was telling me yesterday, if you look at the BLS data, actually we've hired a lot of truckers so how could there possibly be a shortage? What I find is companies like BMW and Rolls, if they're not finding the workers they need, they'll go out and create the supply. They'll work with community colleges and they'll put money and invest in training and get that labor supply they need. They'll find it, they'll create it. I think that's a wonderful thing. That's just great. It's great to see the private sector doing that and it kind of breaks this economist myth like there's this market and there's this pool of labor out there and then sometimes we run up against shortages.

Craig Torres: Companies knew how to deal with labor supply. They're really good at it. BMW is as good at that as it is, steel supply chain or anything else. I'd put it that way.

David Beckworth:     Well, you've been breaking my heart here, Craig. Tearing down the economist but you're right, I think an economist would say another day well, prices will clear the market so prices will adjust but it's interesting you mentioned that because we have talked about in the show before some disturbing trends and fertility rates in the US, fertility rates are going down. It seems to be a new tone against immigration, even legal immigration, lowering the levels of that and we think long term we need people in this country to pay ... to make things, to pay for things and what's interesting though is I think what we're touching on here is robots can replace humans to some extent.

David Beckworth:     I was reading an article, preparing for the show in the Wall Street Journal that mentioned that the US is number seven in the advanced economies in terms in the number of robots per person. It's not the first ... some of the Asian countries are higher and they argued the reason for that is there's stronger demographic pressures, for example in Japan. They've been kind of forced so the producers, the firms are turning to these machines because they can't get enough people. Maybe there's training of people but there's also a greater alliance on machines and I just wondered to what extent we can solve our demographic problems with robots. Any thoughts on that?

Craig Torres: It's kind of a ... Again, I'm not an economist but I will give you a hint about something I'm working on. When we're hiring a lot of people to get GDP out the door and we're doing some investment in the economy but that tells you the relative price of labor compared to capital even with these big tax cuts, companies still think that's pretty cheap and flexible, more flexible than a long term capital investment or R and D or whatever. We seem to be finding the labor. I mean, it's incredible the job numbers we're printing.

David Beckworth:     Yeah, consistently.

Craig Torres: Yeah. Yeah, so long term can we find the labor? I'm as concerned as you that we have this tone against immigration. We're sitting at George Mason University. I'm sure there's a ton of highly qualified foreign students here, who would want to get their degree and work in America. If we're selling, exporting, this fantastic educational system that people come all over the world for, you would think we'd want some of them to stay here.

David Beckworth:     Right, but we make it tough for them to do that.

Craig Torres: Right.

David Beckworth:     Yeah. Another point to bring out about automation and work and change in society, I saw an article by Holman Jenkins from the Wall Street Journal.

Craig Torres: Yup. I know him.

David Beckworth:     Okay, fascinating piece. I really liked it. The title was “Self-Driving Cars Returned to Earth” and he goes through all the hype around ...

Craig Torres: I'm glad he did that.

David Beckworth:     The cars. I mean, everyone is worked up and to be hip, you had to jump on board the self-driving car fad. Everyone from car makers to academics to pundits we're talking about it and now they're finally coming down to earth in the sense they realized it's actually quite a bit away. We are seeing robots, we are seeing automation coming but there's still a long ways to go in this dire future and what you're showing is even now, we're doing a good job finding new jobs for people you might be, otherwise, out of work.

Craig Torres: Yeah, we're doing a good job, I agree with them that there was a lot of hype in my professions to blame around driverless cars. What caught my attention is states, municipalities don't seem to have laws on the books regarding this yet, insurance companies. I haven't really seen the industry talking about insurance policies and simply, we had someone in from Cisco a few years back. He said the communications infrastructure is nowhere near ready for this. I am concerned. I think inequality is a big, big issue in America. Our educational system is okay but I have kids in high school and I am worried that in the rush to teach the basics, writing an essay, mathematics, my kids aren't getting enough exposure to what's happening in industry.

Craig Torres: I'm not saying like you should have a chief executive of a corporation in there every week but something to get them more exposed and excited about, workplace of the future would be good. I don't know how you fit that in. My wife's got a master’s in education. I don't but I feel our educational system is a little bit abstracted from the whole dialogue about what skills kids are going to need.

David Beckworth:     That's a good point. I got children as well but younger than yours but my oldest has gone to for example a summer camp. They do 3D printing and engineering but you do think incorporating that kind of stuff into the curriculum. Yeah, some schools do but yeah, I do think about the same things moving forward. Well, let's move on in the time we have left to a related area that you've written on but slightly different and that is the role government plays in innovation. The role government ... and funding new ideas and a big part of that is DARPA and some of the research funded by the defense department but tell us about your work in that area.

Craig Torres: There's this whole sense of ... and there's a book written about it. I think I mentioned in my story about the entrepreneurial state. I find it interesting and here we are talking about it at Mercatus which in my opinion, based on what I've heard from people at Mercatus, there would be a lot of cynicism about this. However, I don't think you could say that, I'd like to see Mercatus answer the success of DARPA and the success of the Human Genome Project at the National Institutes of Health and things like the internet that have come out of DARPA. Laser gyroscopes, all this work would seem to me, is extremely valuable. Here's the thing, David. There are investments and research that the private sector simply won't do. It's too big, it's too speculative. I'm going to give you an example which I love this story. I really do. I did a piece on how Greenville became kind of a regional startup capital.

David Beckworth:     South Carolina?

Craig Torres: In South Carolina, of all places. Yeah and I ask why? How did this city attract so much startup activity and this fervor about that which I think is what many, many, regional cities need to do. As I was doing that, I ran into this guy who had this technology, right in the cancer ward of a hospital where ... and he is now taking cancer cells out of patients. The doctors are giving it to him. He's growing them in a human body like 3D environment, not on a Petri dish. Before these people are ... get chemo, he actually test the chemo against these cells and ask, is this going to work? When someone has a cancer and they say, you have a 60 percent survival rate.

Craig Torres: It usually means, the chemo works 60 percent at the time. Before they go through all that pain of chemotherapy, he's able to give the doctor an early answer. The state of South Carolina is an equity investor in this very small company. I called them and I said, why? You don't get a big employment bang. These are a few people working in a cancer ward in a hospital. They said, we know if this is successful other companies will cluster around it and they'll be spin offs and we want ... we're investing in the ideas. That is an amazing thing and I think it's really valuable, really valuable.

David Beckworth:     Yeah, you also have another interesting story and this goes back to DARPA. Maybe spell, what does DARPA stand for?

Craig Torres: Defense Advanced Research Projects Agency.

David Beckworth:     This is the defense department giving out dollars to investors who might have a product that could serve them in a long run.

Craig Torres: Or to innovators.

David Beckworth:     Innovators.

Craig Torres: Yeah.

David Beckworth:     You gave the example of the swarm drones. Tell that story, it's an interesting one too.

Craig Torres: There was this guy named Brandon. He was working in a WeWork building in Alexandria when I caught up to him. He developed this hive for drones and the military was interested in it because they could press a button and all these bees would zoom out over the battlefield and in fact, he did simulations. Mock battles with the marines using this system and provide situational awareness, through all these cameras that were perched over the battlefield. No venture capitalist would invest in this because the laws right now are very restrictive regarding who can fly drones where. They didn't see ... if you're an investor and it involves like municipal state even federal law, that's complicated.

Craig Torres: It's conflictive, you're probably not going to do it because you can't see an exit or clear return. Nevertheless, DARPA invested in this, in this guy. He sees like a commercial application. If I call in and my house is on fire, why went a fire department, hit a button, my address gets plugged into their drone system on their roof, off it goes, before the firetruck even arrives, they get to look at how bad is this fire. Is it spreading to the neighborhood and I have visibility on it, long before they show up. That seem to me like something ... it's proof-

David Beckworth:     It's amazing, yes.

Craig Torres: Yeah, yeah, yeah.

David Beckworth:     Yeah.

Craig Torres: The private sector wouldn't fund it.

David Beckworth:     Yeah, and your point is in that they can fund projects that wouldn't otherwise be funded. Now, some of them maybe bad but ... or example of the ones that have worked are the genome project and others. Along those lines, you point out though that funding, federal funding for R&D for this type of research has declined over time so it's at its peak in the 60s and one of the reasons of its decline is because if you have a limited amount of federal dollars to spend, politically it's easier to spend it on projects that directly the common person, like an infrastructure, spending bills, put someone towork, it makes everyone happy or R&D, is kind of a long term horizon ...

Craig Torres: Yeah, with failures by the way.

David Beckworth:     Yeah, lots of failures so it's a struggle I guess to ... DARPA is not going to be getting lots and lots of money from congress to do this kind of activity.

Craig Torres: I think we have a problem as Americans culturally with, watch Solyndra and watching ... with failure really.

David Beckworth:     Spectacular.

Craig Torres: Yeah, yeah. We do and I think it's a hard political sell to say well, I just flushed a bunch of taxpayer dollars down on something that didn't pan out but on the other hand the things that have panned out ...

David Beckworth:     The internet.

Craig Torres: The internet have been tremendously valuable.

David Beckworth:     I got to ask one last question.

Craig Torres: Sure.

David Beckworth:     The time is almost up and looking at the chart that you showed, these federal outlays for R&D, research and development, they peak in the 60s, they come down, looked at another graph, that went up a little bit in the 80s but they're still ... the trend is downward. Was the peak in the 60s surrounding like the space program, the Cold War, arms race, is that where they were going?

Craig Torres: I don't know but that would ...

David Beckworth:     That seems plausible, I think.

Craig Torres: That seems plausible.

David Beckworth:     Yeah, okay. Well, I believe our time is up our guest today has been Craig Torres. Craig thank you so much for coming on the show.

Craig Torres: Thank you.

David Beckworth:     Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app and while you're there, please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening.

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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.