June 19, 2020

A Fed for Next Time: Ideas for a Crisis‐​Ready Central Bank: Panel 2 Defining Fiscal Stimulus Duties

David Beckworth

Senior Research Fellow

George Selgin

Senior Affiliated Scholar
 

How Will the Fed Fight the Next Crisis?

In just a dozen years, the Federal Reserve has faced two severe crises. And twice it has responded by leaning heavily on emergency lending powers it seldom used before by improvising temporary lending programs and taking part in fiscal policy.

In the meantime, the Fed’s nonemergency lending facilities have hardly changed, and may well prove insufficient when the Fed faces its next crisis.

The implication of this is both obvious and ominous: while we still count on the Fed to deal with crises, we no longer know how it will deal with them. Instead of being predictable, the Fed’s crisis‐​prevention methods have become unpredictable–and controversial–adding to, instead of allaying, economic scrutiny.

Can we do better? Can we improve the Fed’s systematic response to crises, making that response both more effective and more predictable? Can we thereby limit the Fed’s entanglement in politics? What can the Fed do to promote these ends? What might Congress do?

PANEL 2: DEFINING FISCAL STIMULUS DUTIES

  • Peter Conti‐​Brown, Assistant Professor, The Wharton School of the University of Pennsylvania
  • Elga Bartsch, Head of Macro Research, BlackRock
  • Joseph Mason, Russell B. Long Professor of Finance, Louisiana State University

Moderator: Chris Condon, Federal Reserve Reporter, Bloomberg News

Register for upcoming panels here.

Introductory Remarks

David Beckworth: Greetings, and welcome back to our conference titled, “A Fed for Next Time: Ideas for a Crisis-Ready Central Bank.” In this conference, we are looking at ways to improve the ability of the Fed to better respond to future crises while minimizing its entanglement with politics. This conference is being hosted by the Mercatus Center, as well as the Cato Institute. George Selgin and I are the hosts. Last Tuesday, George kicked off the conference with a panel that looked at the issue of credit policy by the Federal Reserve. It was a great panel. I encourage you to look at it if you haven't already. Today's panel is titled “Defining Fiscal Stimulus Duties” and will help us better understand where to draw the lines between fiscal policy and monetary policy. I will now turn our program over to Chris Condon, who is a Federal Reserve reporter for Bloomberg. He will be moderating our panel. Chris, it is all yours.

Panel Discussion

Chris Condon: Thanks very much, David. I am honored to be shepherding the conversation today. I'd like to welcome our audience. And as David said, we're hoping to examine the boundaries between fiscal and monetary policies, which as we've seen in recent weeks can become quite blurred during a crisis. So perhaps it's a good time to ask why is it that these boundaries should exist in the first place? What are the consequences for our economy and our democratic institutions if they're poorly drawn, or if we don't remain faithful to them? And what might we do to improve those boundaries or better observe them so that when the next crisis occurs, whether that's two or 20 years from now, we'll be better able to respond?

To tackle all this, we have an outstanding panel. Each of our three guests will have a short presentation and we'll follow with the discussion and question and answer period. You can submit your questions via the Cato website or on Facebook, Twitter, or YouTube by using #CatoEcon. That's #CatoEcon, all one word of course.

So let's turn to our panel. I'll introduce them in the order in which they will be speaking to you today. First we have Peter Conti-Brown. Peter is an assistant professor at the Wharton School at the University Of Pennsylvania and a nonresident fellow in economic studies at the Brookings Institution. He has a law degree from Stanford law and a PhD in history from Princeton. He's the author of The Power and Independence of the Federal Reserve. And he's working on a new political history of the Fed to be published next year from Norton Liveright.

After Peter, we're very fortunate to have Elga Bartsch, managing director and head of macro research at the BlackRock Investment Institute. Prior to joining BlackRock, Elga was global head of economics and chief European economist at Morgan Stanley in London. She was a member of the ECB Shadow Council and a trustee of the IFO Institute for economic research. She has a master's and PhD from Kiel University.

And last but certainly not least, Joseph Mason, professor of finance at Louisiana State University and a senior fellow at UPenn's Wharton School. Previously, he was senior financial economist at the US Office of the Comptroller of the Currency and a visiting scholar at the Federal Reserve Bank of Philadelphia and at the Federal Deposit Insurance Corporation. His background on financial crises and various forms of bailouts, including the numerous formed under the Reconstruction Finance Corporation, has been cited by academics and in the media worldwide. He has PhD from the University of Illinois at Champaign.

Peter, could you please take it away?

Peter Conti-Brown: Glad to do it. Thank you so much for that introduction, Chris, and to David Beckworth and George Selgin and all the rest for hosting such a terrific set of panels at a most appropriate time to be considering these questions. And I'll be clear, we're not the only ones considering them. A few weeks ago, I was taking the garbage out and behind a mask was my wonderful neighbor who knows what I do for a living. And he asked me through that mask, "Are we a country with a central bank or a central bank with a country?" Now, to be clear, we are a country with a central bank. Let me answer that question directly. I also want to be clear that I have little patience for the Fed conspiracy theorists who think that the Fed is an acronym and spend most of their lives on Twitter. And to be clear, my neighbor is also not one of those conspiracy theorists.

What his question gets at is the question for our panel, which is about boundaries. How do we make it sure that our central bank serves the needs of our nation? How do we make sure that the institution itself, legally constituted, that evolves by norms and practices that shift over time to answer financial and economic and even political needs that themselves shift over time? How do we make sure that we get the best from that institution? And how do we manage the inevitable unintended consequences by those efforts?

Today we're talking about the line between fiscal and monetary policy, but I want to talk about some limiting principles in general that cabin or seek to cabin the Federal Reserve and other central banks from other democratic and technocratic institutions and why none of these limiting principles is likely to be effective on its own. I want to talk about these limiting principles epistemologically. By epistemology here, I mean the different tools that we use to inquire about knowledge and truth related to, but a little bit different from, disciplines that we have in evaluating the structure and purposes and functions of institutions.

So I want to talk about four epistemologies or disciplines in this approach. First law, then history, then finance, and finally politics. And in each case, I want to highlight why these disciplines are valuable, even vital, for determining how we can limit the functions of the Federal Reserve in a crisis, but how none taken alone is sufficient.

So first let's talk about the law. If you were to ask the question, what can the Fed do and what can it not do, for many citizens and certainly lawyers, the answer is, well, we should refer to the Federal Reserve Act, the central bank's founding charter. It's a statute passed through constitutional means to become the law of the land. And indeed the Federal Reserve Act is filled with many positive and negative limitations, mandates and restrictions. But to illustrate the epistemological problem as law as a limiting principle, so tell Congress you simply need to write a law that limits what the Fed can do. To illustrate why I think that that is not a sufficient answer I want to walk through three different legal problems that I would regard as easy, medium, and hard in the case of the Fed's emergency lending to see what the law, if your understanding of the law is traversed, would actually mean.

Here's an easy one. In section 13(3)(b)(4) of the Federal Reserve Act, this is all online so you can, if you're interested, Google this and you can read along with me, there is a very simple sentence. "The board may not establish any program or facility under this paragraph," meaning its emergency lending authority, "without the prior approval of the Secretary of the Treasury." That's it. That's the whole sentence. So surely from a legal perspective, one limiting principle is that whatever else the Fed may do or whatever else emergency lending may be, it must have the approval of the Secretary of the Treasury.

But what if the Fed just doesn't do that? What if the Secretary of the Treasury seeks approval from the Fed before engaging in its emergency interventions? But what if the Fed ... But I want to be clear that there's no evidence at all that the Fed has done it in the 2020 crisis, but what if some future central banker just said, "We're not going to"? What then? I call that an easy problem because the legal limitation is so clear. But what happens when a central bank chooses to ignore even clear legal restrictions is not at all an easy problem.

Surely from a legal perspective, one limiting principle is that whatever else the Fed may do or whatever else emergency lending may be, it must have the approval of the Secretary of the Treasury. But what if the Fed just doesn't do that? What if the Secretary of the Treasury seeks approval from the Fed before engaging in its emergency interventions? What if some future central banker just said, "We're not going to"? What then? I call that an easy problem because the legal limitation is so clear.

Let me take a question that I would regard as medium difficulty in statutory interpretation. And this is one that my friend and our panelist from Tuesday, Lev Menand, sees as a limiting principle, but I'm not so sure. In 13(3)(b)(1) we read, "As soon as practicable after the passage of Dodd-Frank, the board shall establish by regulation the policies and procedures governing emergency lending under this paragraph." That happened as soon as practicable. Took about three years, but they did it. Now, reading again in the statute, "Such policies and procedures shall be designed to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system and not to aid a failing financial company." I'm going to read that part again, but I'm going to change the way I emphasize the words. "Such policies and procedures shall be designed to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system." I'll just stop there.

Do you see the difference? On one reading it seems that the Dodd-Frank amendments restrict any emergency lending under 13(3) to the financial system. But in the first reading, it seems to be that whatever restrictions might be in place are that emergency lending cannot be to aid a failing financial company and must be toward the system. Now, I regard this as a medium question. I think those who read it as Lev does, and he's not alone, are making a perfectly reasonable textual interpretation of the statute. But I think my version is also pretty reasonable. And I think 13(3) is meant to be systemic interventions, facilities, not individual companies. And that taken in its full context, that would be true. So who's right? Is Peter's version correct? Or is Lev's? We don't have a judge to intervene and settle the score and so we get a question of medium legal interpretation.

Here's one that I would regard as harder but related. It's in the same section, 13(3)(b)(1). And it says that, "These regulations that the Fed must pass around emergency lending are designed to ensure that the security for emergency loans is sufficient to protect taxpayers from losses and that any such program is terminated in a timely and orderly fashion." What does timely and orderly fashion mean? How do taxpayers realize losses from a non-appropriated entity like the Fed? Is that just through the remittance that comes at year's end? What if that remittance was completely non-legal, it wasn't formalized in statute until seven years after the statute was written?

Now I could go on. I love this stuff, reading the Federal Reserve Act. Most of you won't, but even if you do, we must all realize that law's power as a limiting principle, to which all of us may unanimously agree is a mirage. It's very fraught, even for easy cases, but very hard ones can make law extremely clumsy to circumscribe the power of central banks. And if you don't believe me, then I want you to go look at two recent Supreme Court cases, one on DACA and the other on Title VII and see if you agree that textualism is always such a straightforward exercise.

We must all realize that law's power as a limiting principle, to which all of us may unanimously agree is a mirage. It's very fraught, even for easy cases, but very hard ones can make law extremely clumsy to circumscribe the power of central banks.

All right. I want to spend most of the time on the law, because this is one of the most obvious tools that we reach for it when thinking about limiting, but I want to go quickly through history, finance, and finally politics. For history, one of the most enduring traditions of the central bank of the Federal Reserve is the vaunted concept of Fed independence. Now, many people view Fed independence as having its origins in what is now called the Fed Treasury Accord of 1951. And I think that's all incorrect just as a matter of history. What the central negotiating parties thought they were accomplishing in 1951 was disputed even before the ink was dry on the single sentence that constitutes an accord, which by itself simply announces that an accord was struck.

To look at history then is also a fraught exercise I say humbly as a historian. In central banking, history provides sticky precedents, but not always clear guidance. And when we assume that history speaks with clarity to which all of us must subscribe, we are very likely to make mistakes. Indeed, I view the Fed Treasury Accord as gaining its life after to justify the substantial interventions, sideways and orthogonal from the president by Paul Volcker, a quarter century later.

What about finance? Would a financial principle to limit the Fed's scope be better? For example, we might say the Fed should only lend to firms facing liquidity constraints, not firms that are insolvent. I'd like you to identify small or medium businesses, or even large ones, in the current COVID-19 pandemic economic crisis who are clearly not insolvent, even as they prepare for bankruptcy. The line between solvency and liquidity is famously hard to identify in a crisis. The same would go for assigning lendable value to collateral, or to say that the way that we underwrite these loans can only take this amount of losses versus that, or that underwriting must follow this number of citizens in a county, but not that. These are line drawing problems extraordinaire, and they are quite complicated to assert at the margin especially, but even conceptually, that they will provide these limitations.

Finally politics. And I want to say a word about the CARES Act. The CARES Act creates a structure that, if not brand new under the sun, is extremely unusual in Fed history, which is that it directs the Treasury to invest appropriated taxpayer funds into facilities that the Fed creates and manages. In other words, it creates a structure that turns the usual conception of Fed independence on its ear. We're not so much worried about protecting the Fed from politics as we are saying that politics must follow the Fed's lead. I'll confess that I am troubled by this structure. I don't want to second guess emergency responders who are working furiously in order to provide interventions that I would regard as desperately necessary even if in a world of second or third best. But I will say that if this endures, if this becomes a sticky precedent, and tries to lay claim on future politicians and central bankers, I fear very much a world not just where the Fed should be protected from politics, but where politics should be protected from the Fed.

I think it is probably better if we abandoned the CARES Act structure for future iterations of emergency lending and say, the fiscal policy with appropriated funds should be done by the Treasury with the political oversight that we'd expect for that and that emergency lending facilities in unusual and exigent circumstances should be the exclusive purview of the Fed with initial approval by the Secretary of the Treasury and distinct oversight sufficient for those actions.

The CARES Act creates a structure that, if not brand new under the sun, is extremely unusual in Fed history, which is that it directs the Treasury to invest appropriated taxpayer funds into facilities that the Fed creates and manages.

The last thing I'll say as I'm running out of time is I want to express some humility about these conclusions. I'm not at all certain of them. I wonder sometimes in my scholarly efforts to pull the curtain back on the Wizard of Oz on Constitution Avenue, the Federal Reserve, if the citizens of Emerald City, aren't better off knowing that there's a good wizard out there managing the system or if we're better off exposing the Fed and placing it on a more realistic foundation. That these are people, with expertise, who have worldviews, and are exercising value judgments. I didn't read the second book to find out what happened in Emerald City after the wizard was exposed, maybe they thrived, and maybe they didn't. So hopefully my co-panelists will have some more concrete examples about, if I am right and we should be doing things differently, what then would be better? Thank you so much.

Condon: Thank you very much Peter. Elga I'd like to turn it over to you now for your presentation.

Elga Bartsch: Yes. Thank you very much. Thank you for having me. When David reached out and asked me whether I would like to speak an event entitled, *A Fed for Next Time: Ideas for a Crisis-Ready Central Bank*, I couldn't help thinking, but that next time is now. Because the way that I see it is that what we are seeing right now and to some extent Peter has named some of the examples. We're really going through a macroeconomic policy revolution. That policy revolution is needed to sufficiently cushion against the Coronavirus shock, but it in terms of the speed and the size and in particular the extent to which monetary policy is now going direct, is blurring the boundaries between fiscal and monetary policy. And such a policy shift could indeed open the door to not only unprecedented government intervention in financial markets and private companies, but it could also further down the road create a slippery slope unless we are starting to put some proper guardrails around the coordination between monetary and fiscal policy and start to think about how best to define an exit strategy.

So what I would like to talk about is a proposal that we made in a joint paper with Stan Fischer, Philipp Hildebrand, and Jean Boivin last August where we sort of looked forward to the next downturn and argued that in the next downturn which is clearly now, which we didn't anticipate at the time, that it would be quite so soon, that we would really need to go from unconventional monetary policy that followed the global financial crisis to an unprecedented degree of policy coordination. And so in the paper, we sort of highlighted that the strict separation between monetary and fiscal policy that we have seen for much of the [inaudible] history on both sides of the Atlantic will probably no longer work in the next downturn. And one key reason why we came to this conclusion was indeed the limited leeway central banks around the world even the Federal Reserve had to provide fresh monetary policy stimulus in the event of another cyclical downturn.

We're really going through a macroeconomic policy revolution. That policy revolution is needed to sufficiently cushion against the Coronavirus shock, but it in terms of the speed and the size and in particular the extent to which monetary policy is now going direct, is blurring the boundaries between fiscal and monetary policy.

So faced with the monetary policy tank that wasn't even half full and then some parts of the world, Europe would be one, almost running on empty already, we argued that in order to overcome the limitations of the effective lower bound for interest rates, we'll need to see much closer coordination. And that is exactly what we're seeing at the moment. And some of it is down not just to the size and the speed of the COVID-19 shock, but also its nature. Clearly there was a need to move at high speed and boldly and it was also obvious that fiscal policy on this occasion really needed to take the lead. And I think the reason why it was necessary and is necessary is that policymakers really need to put money directly into people's hands through fiscal policy measures and through government guaranteed lending programs.

So this is not a situation where traditional unconventional monetary policy would have worked, because even that unconventional monetary policy typically works first and foremost through the interest rate channel, reinforcing forward guidance, all that kind of stuff. But with policy rates and bond yields already being so close to zero and in some cases, even below zero, there wasn't much juice in that interest rate channel anymore. And so what we are seeing right now is that I think fiscal policy is taking the lead and monetary policy is providing a very important assist in terms of ensuring that financial markets keep functioning in order to prevent an unwarranted tightening in financial conditions and also in providing some direct financing to private sector entities, or even in some cases, public sector entities to support spending. And they do so by essentially bypassing the traditional transmission mechanisms through the financial system.

But for me it's quite important to understand that going direct is not the same as helicopter money. Going direct could converge towards helicopter money in very extreme cases but first and foremost, it's the monetary policy stimulus that coincides with an expansion in the central bank balance sheet. And that also does not necessarily mean the direct financing of public deficits because the debt could also be purchased in the secondary market. What it means is that a fiscal expansion is accompanied by an expansion in money supply and that's very important. So we currently have this policy revolution and what I would call an ad hoc coordination between monetary and fiscal policy. And as I already said, that's certainly welcome to overcome the COVID crisis at hand at the moment. But over the medium term, it will require to think quite carefully about institutional guardrails around this coordination, to really ensure that stabilization policies stay on track.

And I think the reason why it was necessary and is necessary is that policymakers really need to put money directly into people's hands through fiscal policy measures and through government guaranteed lending programs.

So I want to talk a little bit about what these guardrails could look like. You probably need something that is a monetary finance fiscal facility because fiscal policy especially in the sizes of the fiscal stimulus that is needed right now could run the risk with no monetary policy support of being counter contracted by a marked increase in interest rates. And that would really defy the purpose of the fiscal policy stimulus. But so in order to provide some guardrails around the policy coordination between monetary and fiscal policy, what we outlined last August in the paper was really at a relatively abstract level, to suggest sort of a stylized idea of a standing emergency financing facility which would be set up and sized by the central bank. It would activate when the central bank realizes that it doesn't have sufficient monitoring policy ammunition to deliver on its policy targets, notably, the inflation target, but also where applicable like in the US, full employment.

And so it would be in the task of the central bank to really determine how much of a joint program was needed to get the economy back onto its equilibrium track and to then provide such funding either directly or indirectly to the fiscal authorities. And in this context, we thought it might be very helpful if the central bank also at this stage when activating the standing emergency financing facility also considered making up for past inflation undershoots. So potentially moving towards temporary price level targeting. And sort of the central bank continues to sort of monitor the situation, produce forecasts as per normal, and when it considers the economy being back on the equilibrium track, it would sort of decide to deactivate the standing emergency facility, and any additional government spending, deficit spending, would then need to be financed in the markets as normal.

And so here the task for fiscal policy would really be twofold. First of all, to accept that macroeconomic stabilization in the low growth, low inflation and therefore a low equilibrium interest rate environment is only something that can be achieved jointly by monetary and fiscal policy. And secondly, really sort of subscribed to the framework of the standing emergency financing facility within the umbrella of which obviously, it would be the fiscal authorities who would decide how the fiscal stimulus is best spent in order to foster political priority, social preferences and the like. So we see really the fiscal policy duty would be to deploy the funds but it's the task of the central bank to size the joint initiative. And it would also, in some cases, I don't think we have that problem now, but historically in Europe, we had some reluctance to engage in deficit spending for instance, in my home country, Germany.

In order to provide some guardrails around the policy coordination between monetary and fiscal policy, what we outlined last August in the paper was really at a relatively abstract level, to suggest sort of a stylized idea of a standing emergency financing facility which would be set up and sized by the central bank.

And so by a central bank sort of formally announcing how much funding would be needed, how much deficit spending would be needed, at least you could also put some pressure on governments that are potentially too austerity-minded and thus sort of undermine the central bank's ability to deliver on the policy targets, whether it's price stability, or price stability and full employment.

So let's just before concluding just quickly assess the revolution that we have seen literally happening in macroeconomic policy making in just three months’ time. So not only is the policy response that we're seeing both on the fiscal side and the monetary side at a completely different scale compared to the global financial crisis, but the response, the policy response has also been faster than we have seen ever before since the Second World War, but maybe the most important part is really that some of the sort of core pillars of what is effectively I think a global policy framework of separation to a considerable degree between monetary and fiscal policy has been pretty fundamentally transformed. And the key aspect of this transformation is first the attempt to go direct. So bypassing traditional transmission through the financial sector and instead finding more direct pipes to deliver liquidity to households directly or to companies.

The second aspect of the transformation is the blurring of fiscal and monetary policy that I already mentioned and for which I sort of suggested as a potential sort of policy solution, at least at the framework level. And then thirdly that some of the government support that we see going to companies directly comes with pretty stringent conditions, and that could also become problematic in the functioning of financial markets and also in corporate governance. But we, so I think in the space of literally just a couple of weeks, seem to have now crossed the Rubicon in terms of the separation between fiscal and monetary policy and sort of moved, without sort of much of an in-depth discussion about frameworks, into this ad hoc coordination. But I do think that now that we have a little bit more breathing space, it is really worthwhile discussing some of the longer term consequences. Because as central banks increasingly are sort of implementing what de facto policies that have a clear fiscal aspect to it, they could become more vulnerable to political pressure as Peter also mentioned, and we know from history.

In the space of literally just a couple of weeks, seem to have now crossed the Rubicon in terms of the separation between fiscal and monetary policy and sort of moved, without sort of much of an in-depth discussion about frameworks, into this ad hoc coordination.

Peter referenced already the Treasury Accord that it's sometimes not that easy to extract yourself from these kinds of heated political situations. And I do think that there are examples in history that show that without the proper guardrails around how monetary and fiscal policy work together, and without defining a clear exit strategy, it's not obvious how policymakers are going to put that genie back into the bottle, the genie of coordination, the genie of monetary financed fiscal measures, and given the steep increase in government debt that we're likely to see on the other side of the COVID-19 crisis, there will be most likely quite a bit of pressure on central banks to absorb a considerable part of that debt and to avoid an uncontrolled rise in long-term interest rates. This could be in the form of yield curve control, but it could also be more informally. But I think that that is really where something like a standing emergency financing facility would provide exactly a framework that helps us to define when to exit from the joint monetary fiscal policy effort, and that should really be driven first and foremost by the inflation outlook and not, for instance, be dictated by a financial or indeed fiscal sustainability concerns.

There's still time I think, to work on such a framework, agree on such a framework. Because if we don't, the orderly exit from this policy revolution could become indeed more difficult and it might require another run-up in inflation as we, for instance, saw in the 1950s before it becomes obvious that really, we need an exit strategy in order to anchor inflation expectations firmly and the benefits of this.

So let me just sum up by again, sort of stressing that the next time is now. We have seen macroeconomic policy, monetary and fiscal policy going through a very rapid revolution in the effort to cushion the Coronavirus shock. And it is essential, and the right measure, to go direct. But this has been a blurring the boundaries between monetary and fiscal policy very materially. And this could potentially put us on a slippery slope unless we use the time well to put some proper guardrails around this ad hoc coordination and start to think about how best to define a clear exit strategy. And we think that the framework we provided in our paper last August would be such a framework. Thank you very much.

Condon: Thank you, Elga. Just a quick reminder to our audience at this point that you can submit questions. Just include the hashtag #CatoEcon. We've got several good ones in the queue already, but please submit a few more, we would be happy to ask them. Joe, you are next. Please take it away.

I think that that is really where something like a standing emergency financing facility would provide exactly a framework that helps us to define when to exit from the joint monetary fiscal policy effort, and that should really be driven first and foremost by the inflation outlook and not, for instance, be dictated by a financial or indeed fiscal sustainability concerns.

Joseph Mason: Thanks, Chris. Elga brings up some good points there with regard to exit. I want to highlight those as I began before I even get into entrance and what it is we're entering. But when you conceive of something as an emergency financing facility, then one thinks about the world once the emergency has ended. But as Peter noted, tangentially anyway to what Peter noted, once you build interest groups through the structure that you've put in place, those interest groups are going to defend their allocation of finance and really not advocate any such exit in order to continue the status quo. This is a very complicated machine we're talking about. As complicated as monetary policy is.

And I want to go back to the foundations of monetary policy. Really, what do we expect the Fed to do and get to the question of how does a credit facility fit into what the Fed does? Monetary policy really is built around the nexus of money, prices and growth. There was a great piece in The Economist more than a decade ago, that raised the questions of what are money, prices and growth. For a long time, monetary policy along with macroeconomics focused on what is growth. We'd like to say, oh, it's just GDP. But once you start digging down into GDP, which GDP components? What does GDP contain? Does it contain services? Does it contain the tech sector? Many other aspects of GDP are still being innovated in terms of how to measure GDP, how to measure growth and how to measure economic activity.

Of course, growth has to be weighed against prices. Prices are typically gauged by inflation, but what is inflation? We really don't know that. We take some CPI figures, some PPI figures where we know that there are problems with chain linking, with the quality of goods over time and measuring those inflation measures. This is a very technical enterprise. There are people that devote their entire lives to the study of what is inflation and how do you gather price data.

This has been a blurring the boundaries between monetary and fiscal policy very materially. And this could potentially put us on a slippery slope unless we use the time well to put some proper guardrails around this ad hoc coordination and start to think about how best to define a clear exit strategy.

But even more than a decade ago, The Economist raised the question of what is money? The idea of money is changing over time, and we don't even need to go to cyber currency to think about that. Just the idea of what is money to a firm? What is a near money? what are cash instruments to a firm? And how does the Fed support markets in these cash instruments in near money instruments raises a question of what should the Fed be doing. And I think you're seeing a response to that fundamental question by the Fed's very broad intervention in a variety of markets to help firms maintain funding. In other words, to help money markets work out their own supply and demand issues before directly injecting money. But even in saying this, it's important to remember that there's a long history to Federal Reserve monetary policy or just monetary policy, even outside of the Federal Reserve.

The Federal Reserve started up really with very little idea of what monetary policy was. The main objective was to be an investment bank, if you will, for U.S. Treasury debt. The Treasury needs an investment bank, because a Treasury that also controls inflation could inflate away the value of the debt that they're due to repay over time. And therefore, has no credibility. That lack of credibility was shown throughout the history of the United States under the first and second banks of the United States, where, to be quite honest, foreign investors really didn't have a lot of confidence that the U.S. could really maintain their position on a gold standard and wouldn't otherwise devalue, which led ultimately to the founding of the Fed in order to stabilize treasury issuance.

Very quickly, the Fed was wound into funding World War I and World War II, essentially supporting the treasury in their issuance, which finally led to the accords. Peter's right, the question of the accords historically contains a lot of issues within it that don't necessarily bear relevance today. But the issue of independence is something even deeper that goes to separating inflation or control over inflation from the entity that's issuing the debt denominators in that currency.

But the idea of open market operations, as we know them, got a slow start. There were some experiments with open market operations just prior to the Great Depression, though those petered out for a number of reasons. It really took hold then in the 1950s after World War II and the Fed got around to doing something other than funding Treasury operations.

Very quickly, the issues of open market operations got into issues of what are appropriate targets, because you can't see growth directly and you can't see growth but for a lag in prices that occurs after you intervene in the money markets. So what do you use as a target in between your intervention and the price effect and the growth effect? The Fed played with reserves for a long time, free reserves, Fed funds. Now the Fed has been going through a period of change with regard to their targets, Fed funds hasn't quite worked as well. Actually, hasn't worked for a while.

The question of the accords historically contains a lot of issues within it that don't necessarily bear relevance today. But the issue of independence is something even deeper that goes to separating inflation or control over inflation from the entity that's issuing the debt denominators in that currency.

And so it's kind of not surprising to see the Fed intervene a bit in direct credit policy. If you don't have a target and you're not sure where things are going, why not intervene directly in markets? Credit policy has been with us for a long time. Since the Jeffersonian ideals. The idea was we need to support farmers. Agriculture is where the United States future is. And so we've always supported farmers. We just do it that way. One of the first special pieces of bankruptcy codes was written for railroads because they're socially valuable. We thought these transportation links needed support. But these are our examples of what you might think of as targeted industrial policy. They flow through to home ownership. It's another targeted area. But what the Fed has really gotten involved in is a more general credit policy, offering credit to the economy without thought to a particular industry, but the tradeoff between target and general policy can be a little bit tricky.

The general idea of what the Fed is doing was built out of the historical experience with the Reconstruction Finance Corporation in the 1930s. Though, the Reconstruction Finance Corporation itself began really with the War Finance Corporation enacted to help funding efforts to fight World War I, which was itself an emergency, if you will. The Reconstruction Finance Corporation is often held up as an example of a general credit policy that was very successful, but I offer the assertion that the features that made the Reconstruction Finance Corporation successful are largely features that we are reluctant to advocate today. Those features can really lie around three main elements, funding, scope, and the ending or the unwind that Elga was talking about.

In terms of funding, the Reconstruction Finance Corporation was funded independent of Congress. It sold its own bonds. Some of those bonds were bought by the U.S Treasury, but others were bought by the public. With this kitty of funding, the RFC did not have to rely upon congressional appropriations, did not have to rely upon the congressional funding process, and could be very, very independent of Congress. That independence became a problem just like recent funding under the CARES Act with regard to who the RFC was giving funding to. Within a few months, there was a crisis developing with regard to disclosing the names of banks who had borrowed from the RFC with papers putting those out, there being leaks in Washington, et cetera, et cetera.

What the Fed has really gotten involved in is a more general credit policy, offering credit to the economy without thought to a particular industry, but the tradeoff between target and general policy can be a little bit tricky.

So the reactions you're seeing today are very, very typical of these types of programs, but there's something that should very much be taken into account and just adopted. Let's disclose. Scope is very important. As Peter noted out, there's a tradeoff between liquidity and solvency. The RFC was supposed to provide liquidity. They were very clear that they did not support insolvent institutions, and there are many institutions that they turned down. The RFC gave out loans initially. Loans really didn't help. If you really want to help firms, you need to invest in capital. So within a little over a year, the RFC turned to giving capital to banks and later on to non-banks. So the scope even evolved to all commercial enterprises.

It's important to note that then the RFC turned into an entity that helped finance World War II as well. But even without going that far, the RFC spawned many agencies that are still around, including Fannie Mae, the Small Business Administration, the Export Import Bank, entities that were left even after they're unwound. And I want to make the point, the unwind wasn't easy. The RFC was supposed to be an entity that existed for one year and then was done away with. Of course, when we came up to that one year, Congress said, "No, no, we want you around for a while. Give them a couple more years." It was supposed to go away in 1935. Congress again said, "No, no, extend." It eventually extended until 1957.

Part of the problem of the unwind came because it's hard to define an emergency and when you're done with an emergency. Were we done with the Great Depression in 1935, or did we think we were done in 1935? We know now we went through the '37 recession, but we didn't know then. But still many were not willing to put this entity out of business. Sure it lasted through '57, but that was through World War II. But even after World War II, authorities said, "Well wait, we can't get rid of this yet. We need that credit funding." So, when do you decide this is done? In fact, Congress decided with regard to the Small Business Administration and the GSEs and the ExIm Bank, but will never be done. We need these around.

So why not build a general entity that will be around and manage it along those lines? Well, when you start intervening generally in the economy, you don't have a say in what industries you're going to support. And in the hearings around the dissolution of the Reconstruction Finance Corporation, one of the main objections from members of Congress was that the RFC had invested in, and I quote from the hearings, "Whorehouses and distilleries." And it was felt that maybe the United States didn't really have a role in supporting such industries.

So this idea of the ending and the unwinding is important, but it even goes beyond those considerations. The end of the RFC really didn't come until the 1970s because it was only in 1957 that they began unwinding these investments. So you have a firm, say, who has support from RFC, either equity, capital or a loan. Who's going to take that over? Can the RFC sell it? Will a bank take it? Some banks would take, others they would not. You need to replace this funding structure with something.

So really this is quite an involved enterprise once you get into credit policy and really go down this road of supporting a general credit policy. Certainly sometimes you need it. Wouldn't you want to invest in developing a COVID vaccine right now? Sure. That would make a lot of sense. On the other hand, if you start picking what you think are winners and those turn out not to be the winners, then you may disadvantage the ultimate winners in the competitive fight. That is one of the strengths of the United States. In fact, one of the early problems of the United States was pandemics. There were routine pandemics of disease around the United States and the world.

And in those days, the European approach was to shut down the economy like we did recently. The US didn't do that. Now, I don't want to make light of the issue that lives were lost, but the vaccines for many of those diseases were developed in the US. So there's something to be said for a free and even playing field, though there's something to be said for support. Do I have an answer to this question? No, I don't. I just have a lot of questions and the warning that whatever we get into, be prepared to have something big that we could possibly unwind. Thank you.

Wouldn't you want to invest in developing a COVID vaccine right now? Sure. That would make a lot of sense. On the other hand, if you start picking what you think are winners and those turn out not to be the winners, then you may disadvantage the ultimate winners in the competitive fight. That is one of the strengths of the United States.

Condon: Thanks so much, Joe, a quick reminder again, to our viewers, whatever platform you're on, submit your questions with the hashtag #CatoEcon. We have a number of questions. We had a flurry of questions, Elga, for you, and they're somewhat specific. 

Let's throw one or two of those at you, Elga. One question says, "Is it correct to say, your proposal amounts to a helicopter drop tied to a price level, but with oversight from the Treasury Department?" And a second viewer asks, "Would you be open to tying the standing emergency fiscal facility to a nominal GDP-level target?"

Bartsch: Yes, thank you very much. So, the idea is not really helicopter money. You could argue that in a very extreme case where you commit to have this facility running for an infinite amount of time, it amounts to helicopter money. But really that is in a very extreme case and that's not the basic idea. The basic idea is really a monetary finance fiscal facility of a limited and temporary nature, where the limits are defined and set by the central bank under the policy objectives that the central bank has been assigned, by either the constitution or the legislative branches of the respective country, and to put a framework around it.

The idea really brings together on the one hand, the monetary financing part, which again, doesn't necessarily mean direct financing. It can also be indirect financing, but it means that the money supply needs to increase to be able to absorb the debt and to prevent interest rates from rising.

And then secondly, the combination to basically expedite the process of converging back to the macroeconomic targets, notably the inflation target to also switch to temporary price level targeting. So I would prefer that over nominal GDP targeting, even though the differences there are mostly nuances. But given that a number of countries really specify the objectives on the inflation side, and sometimes not even on a GDP or a PCE deflator, but rather on a consumer price index. I think to keep it clean and focus on the price level would be my preferred option.

The basic idea is really a monetary finance fiscal facility of a limited and temporary nature, where the limits are defined and set by the central bank under the policy objectives that the central bank has been assigned, by either the constitution or the legislative branches of the respective country, and to put a framework around it.

Condon: Thank you, Elga. A bit of a broader question for all of you. Each of you, of course, have some very important reservations about how things have unfolded during this crisis. But let's consider what happens if the actions taken by these emergency credit facilities and the extraordinary coordination that's happening between the Fed and the Treasury. What if it turns out to be extraordinarily effective in dealing with this crisis that we have and is quite good at helping the economy bounce back? Does that change the criticisms that you have of it? Or might it simply make it more difficult to address and have us stick to the principles that you wish to adhere to? Peter? Maybe you could start with that.

Conti-Brown: I think that one of the most effective ways that we create knowledge about central banking is to be very sensitive to what works and what doesn't. I think it was very hard to watch so many people who had buttered their bread during the 1970s and '80s in central banking, see 2009 or 2016 as virtually identical. Those who did that missed an awful lot about how the world can change.

So in my critique of the CARES Act and some of the lines that have been transgressed between fiscal and monetary policy now. I hope to update my priors and see what works and what doesn't. I also want to tell you that I'll be putting a timeframe around these aftershocks. Not just to measure the rapidity of a bounce back, which I think should be the primary focus for what we do, but also the interactions that follow from here. And that will be something that we should be measuring for many years after the fact. How Treasury, and Fed, and Congress interact with each other.

And I think that's one of the most important aspects here. We are missing so much congressional oversight right now that should have very little partisan content in it. It should instead be about institutional prerogatives of keeping Congress, and the Fed, and Treasury in relatively separate lanes.

I think that one of the most effective ways that we create knowledge about central banking is to be very sensitive to what works and what doesn't.

And so I think I would separate those two. I'd look at the economic consequences for which all of us should be updating our priors. And I'd look at the institutional consequences, which should take some time to really digest and understand.

Condon: Joe I'd invite you also to take a crack at that as well, if you wish. But I'll also pose to you a couple of questions that viewers have asked about your thoughts on the RFC. The first reads, "So is something like an improved version of RFC a fiscal facility that would exist only in times of crisis? Or would it stand through normal times?"

And the second question is, "Can you talk a little bit about why the RFC was created in the first place? Was it intended as the division of labor between it and the Fed?"

Mason: Thanks, Chris. So, first of all, to your original question about the crisis. I do not consider what we're going through currently a crisis. It is an engineered slow down within the economy. It is not even an ordinary recession. It is engineered recession. So if you take that context, the question of what to do next, does not necessarily follow your crisis blueprint.

One could think for instance, of how we can most effectively utilize the opportunities presented by the slowdown. We have people at home, people who can't work. Should we target those people for training opportunities that are subsidized by the federal government to retool?

If we think through some targeted approaches this way, this might help us emerge stronger, but it's not a crisis. We're not worried about where the losses are, we know where there are. It's not like things got stirred up the way they did in the global financial crisis.

I do not consider what we're going through currently a crisis. It is an engineered slow down within the economy. It is not even an ordinary recession. It is engineered recession. So if you take that context, the question of what to do next, does not necessarily follow your crisis blueprint.

So that leads into your other issues. Should we have a standing facility? I think that we do, I think we should acknowledge that we already do. The federal government now is in direct control of student lending for college students. Obviously we have the Fannie Mae, Freddie Mac, where those institutions are heavily influenced by the US government, the Small Business Administration, others. Why don't we take what we have and centralize it and direct it. Because we have these leftover influences from the RFC that we wanted to think went away because we don't really do things like that, that reeks a little bit of socialism in the 1950s. Why don't we put it back together and admit that we do have some social goals and some needs to drive economic growth and retool economic growth following this engineered slow down during the pandemic and shoot us out the other side.

In response to the origin of the RFC. It wasn't even really supposed to be a federally sponsored enterprise. Originally, it was going to be a cooperative enterprise among the banks with the government coordinating bank developments. When you think of it that way, isn't that really what we're trying to do? That failed, that failed objectively and had to be replaced within about eight months with a more centralized mechanism that was independently funded.

We know congressional funding doesn't work. It stymied the efforts of the Resolution Trust Corporation after the '80s thrift crisis. Which was stopped for 18 months while congress debated who should get the contracts thrown off by the RTC. No, we need independent funding, continuous attention to economic growth and a solution that can last us for a while going forward without necessarily getting to some of the perceived excesses that the RFC did. But something that can benefit us, not only for this slowdown, which by the way, isn't going away. We're going to be affected by this new disease for a while. We don't have a vaccine for SARS and MERS yet. Okay? So this is our reality. How can we utilize, find opportunities within this and build a structure that can utilize those opportunities to move us forward?

We need independent funding, continuous attention to economic growth and a solution that can last us for a while going forward without necessarily getting to some of the perceived excesses that the RFC did. But something that can benefit us, not only for this slowdown, which by the way, isn't going away.

Condon: Thanks, Joe. I have another broad question to address to all of you. I'm wondering if [inaudible] in monetary policy lines as an important problem? Is this ultimately because of overreach by one institution or another? I think in many years past we feared the Federal Reserve would overreach its authority. But in this case, is it more so a case of filling a vacuum where the Congress is not acting? And how much does that relate to bipartisan dysfunction in Congress? Joe, I saw you nodding rigorously there. If you could jump on that and then maybe we could go to Elga for some wrap up comments as we're nearly up against our limits.

Mason: Yeah. Looking at the problem historically, monetary policy was too successful. And in the 1990s. It led Congress to be sanguine and say, "Oh, the Fed will do it all for us. We don't need to do anything." Well, sorry Alan Greenspan retired and their monetary policy doesn't solve everything. We need fiscal policy, but fiscal policy involves tough decisions out of Congress. And I would like them to step up. I don't even need to go to partisan politics to get to that because in my opinion, both sides have dropped the ball. They need to step up and they need to play their role in the overall goal of maintaining steady economic growth.

We need fiscal policy, but fiscal policy involves tough decisions out of Congress. And I would like them to step up. I don't even need to go to partisan politics to get to that because in my opinion, both sides have dropped the ball. They need to step up and they need to play their role in the overall goal of maintaining steady economic growth.

Condon: Elga do you have some thoughts on that theme? Or another one that you'd like to hit before we close?

Bartsch: Yes I have. So I wouldn't necessarily say that monetary policy has overreached on its own volition but if anything, I would argue it has been overburdened. We see this, there are examples in the US as well, but for instance just looking at Europe in what is still a very incomplete monetary union. Because we don't have a fiscal union, we don't have a political union.

It's pretty clear that much of the aftermath of the global financial crisis and the Euro crisis that followed, was really left for the European Central Bank to mop up and to straighten out. And I think I wouldn't want to see it characterized as overreaching. I would more characterize it as being overburdened and that's, I think, problematic. It was a secular trend that was made possible by disinflation which started in the 1980s. But obviously as inflation started to undershoot and equilibrium interest rates kept for a variety of reasons, grinding lower. It was clear that that phase would need to come to an end and that fiscal policy would now need to step up. And that also means taking ownership in political processes and at the electoral ballots.

I wouldn't necessarily say that monetary policy has overreached on its own volition but if anything, I would argue it has been overburdened.

Condon: Great. Thank you very much Elga. I'm afraid now we're running out of time. I want to thank our outstanding panelists for a great discussion. I want to thank our audience for tuning in, for submitting many great questions. I apologize that I could not get to all of them, we had only limited time. And I would remind you that a video recording of the event will be available later today on Cato's webpage. And with that, I'm going to turn it back to David Beckworth for some closing remarks.

Closing Remarks

David Beckworth: Thank you panel for a great discussion. That was really thought provoking. Thank you, Chris, for a great job moderating that panel. And thank you Elga, Joe, and Peter for great comments. Thank you listeners as well for joining us today. And we invite you back next week on Tuesday, June 23rd for our next panel. You won't want to miss it. It's titled *Modernizing Liquidity Provision*. Until next week, take care.