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Foreign Affairs Media Call: Adam S. Posen and J. Bradford DeLong on Federal Reserve Policy

Speakers: Adam S. Posen, President, Peterson Institute for International Economics, and Bradford DeLong, Professor, University of California, Berkley
Presider: Gideon Rose, Editor, Foreign Affairs Magazine
July 10, 2013
Council on Foreign Relations

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OPERATOR: Excuse me, ladies and gentlemen, we now have the speakers in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of the presentation, we will open the floor for questions. At that time, instructions will be given if you would like to ask a question.

It is now my pleasure to turn the conference over to Gideon Rose.

GIDEON ROSE: Hi, everybody. Gideon Rose here, editor of Foreign Affairs. Welcome to what should be a fascinating call.

We have two spectacular guests today: Brad DeLong, who's professor of economics at UC Berkeley, a research associate at NBER and a visiting fellow at the Kauffman Foundation, and Adam Posen, who is now president of the Peterson Institute for International Economics and was recently a member of the Bank England's Monetary Policy Committee.

Both of them have wonderful pieces in our current issue. Brad's piece is a review of Alan Blinder's book "After the Music Stopped," which is a history of the financial crisis, and Adam's piece is a review of Neil Irwin's "The Alchemists," which is a review of how central bankers dealt with the crisis. And I think that they would both say that you should read not just their reviews, which are excellent, but also the books in question, which are also excellent.

So one of the things --

MR. : Undoubtedly.

ROSE: One of the things that's great is that these are guys who are not only top-notch commentators and economists themselves, but able to speak intelligently about the mystery and magic of what goes on in economic and monetary policy. So we thought we'd have them in for a discussion on what's happening now and where it should go next, and basically help us understand the situation we're in and how to get out of it.

So let me start by throwing it to Adam, since you have direct personal experience in there. What is Bernanke and the rest of the Fed going to be doing today, and why?

ADAM POSEN: Thanks, Gideon, and thank you for this opportunity to publish in Foreign Affairs something a little more than a book review. The -- Bernanke and the Fed are going to be sticking to their guns and thereby shooting the economy in the foot. So essentially, they have committed to tightening, in the next couple of meetings -- there's a lot of jabber out there about, it's tapering, it's not tightening.

But in the market, since everybody was still expecting -- there was some possibility it could go on forever or go on much larger, cutting that off -- in market terms -- cutting off that possibility, in market terms, is a tightening. And that's why we've seen interest rates rise, and now, mortgage applications fall.

The reason they're doing this apparently is because they're scared of a bubble -- a bubble in U.S. credit markets, a bubble in U.S. housing markets. Fed governor Jeremy Stein has been particularly influential in arguing this, and Bernanke seems to have come over to this point of view. And you can tell that not just from they say but the fact that this tightening doesn't make much sense given the economic forecast they have, which is for very low inflation and only slow decrease in unemployment.

So in terms of what they're actually going to be doing -- in the immediate term, Chairman Bernanke is speaking today at a history conference and speaking next week in a report to Congress, and he's going to be just emphasizing the idea that forward guidance -- all this talk is very important, but that they're not going to be deterred from starting to taper or cut back purchases.

And in the medium term -- meaning over the next six months, I think, once they start tapering, they're not going to turn back. They're going to taper quite a bit. And by the time we have a new chairperson in January, they will be almost done purchasing government securities.

ROSE: OK. Brad, you, like Adam, think this course is really, really misguided. So explain to me -- if people like you guys are so strongly opposed to it, why are the people who are following it following it? Is it because they just are irrational or crazy, or is it because there's some other agenda going on that the rest of us don't really understand?

J. BRADFORD DELONG: Well, I hate to say it, but it's not entirely clear to me why the Federal Open Market Committee is following this strategy -- (inaudible) -- that, (has ?), indeed for the past six years. I would have expected Ben Bernanke, student of the Great Depression, kind of person who was on, say, the left -- Japan needs much more monetary stimulus side in the 1990s to react to the financial crisis and the subsequent collapse of risk tolerance on the part of financial markets by saying that it's the job of the Federal Reserve to drive long-term interest rates low enough so that Americans, as a whole, no longer want to deleverage.

(And ?) if the problem is that -- you know, (in ?) the economy as a whole -- there can't be a debt without a credit; there can't be a debtor without a creditor. So when somebody decides they want to become more of a creditor, someone else has to decide that they want to become more of a debtor. The right thing to do right now would be, presumably, for the federal government to be becoming even more of a debtor than it is for it to be accommodating the desired deleveraging by the private sector by running up even larger deficits and issuing even more Treasury debt.

But given that the federal government is not going to do that thanks to the 2010 elections, and also thanks to the kind of fact that Obama went with the Bernanke wing rather than with the -- (inaudible) -- wing of his advisors in 2009, 2010, then the only way to rebalance the economy (at high ?) employment is for the Federal Reserve to get long-term interest rates down so low that people as a whole no longer wish to deleverage, that they're happy with the asset structure that they have.

And Bernanke has taken a good many steps toward doing that over the past six years, but he and his committee haven't done it, and now it appears that they've decided to pull in their horns to say, we've gone way out as far as unconventional monetary policy, as far as we can possibly go, and the fact that the economy is still depressed is the fault of the Congress and the president; it's the fault of the fiscal authorities, and we need now to worry about long-run financial stability issues which are, in some way, compromised by having the Federal Reserve's balance sheet too large.

Now it's not entirely clear to me exactly how and why long-run financial stability is compromised by the Fed having a very large balance sheet and why it's necessarily bad for the Fed to drive long-term interest rates down to where the market really wants them to be, but they've made that decision.

ROSE: Adam, you were on the -- you were a proponent of a looser policy in England during the crisis. Brad points out in his review that he thinks England might end up becoming to this crisis what France was in the '30s, as sort of the natural experiment example of how screwed-up your economy can be if you take things in the opposite direction. What were the people who were you opposed to you thinking? I mean, why were your arguments not accepted, in other words?

POSEN: Well, they were accepted for a while, and then reluctantly -- and then they reached what people perceived the limit. In other words, we voted for quantitative easing for a while, but we never went as far as Brad did.

And the issue is, Gideon, that it's both. And what makes the U.K. such a symbolic case, such a great example or bad example, is, as in Spain, you've got insufficient monetary policy but you've also got fiscal tightening. So we're demonstrating -- and right now Japan is demonstrating the exact opposite. It is finally doing all the aggressive things we've been pushing for, and it's recovering.

So why did people pursue the opposite, just to come quickly to the point? There were essentially three reasons. The first was there were people who saw inflation around every corner; that the moment the Bank of England or any central bank started buying assets, inflation would come back, strongly. That was demonstrably false and then demonstrated to be false, and very few serious people continue with that belief. But at the time, there were a couple voters who thought that.

The two main reasons that were said and which are still very current in the debate in the U.S. and Europe and in the U.K. -- in the euro area and the U.K. is, one, that it was OK to do quantitative easing in response to the immediate crisis in 2008, '9, but doing it now is of diminishing effectiveness and it's higher costs. It's OK to stop a panic, but it's not OK to try to prop up the economy. That's one argument.

And the second argument is, well, hell, things aren't going well, and we've done all this huge quantitative easing. Therefore, it must be ineffective or the economy must have some fundamental problem with it that monetary policy can't solve.

And it's this last point, the idea that because things haven't done wonderfully as a result of quantitative easing, is the point that in a sense is most dangerous, because this becomes self-fulfilling pessimism. You don't do enough, or you don't take account of the other factors -- as in the case of the U.K., the fact that the government was busy raising taxes and cutting spending -- and you say, well, it didn't work; must be there's something wrong with the economy, so there's no point in trying to pump up the economy. And you just assume the result and then cut back on policy. And I warned about this starting at the Bank of England in 2010, but unfortunately, that seems to have taken hold in a lot of places.

ROSE: So is this kind of a game of chicken between the central banks and the governments, and sort of who will -- since the central -- are the central banks to trying to basically kick the ball to the governments and say, look, the real answer has to be your guy's fiscal policy reforms and so forth?

POSEN: It's an astute question. I think it's -- it varies from place to place. In the euro area, the European Central Bank, that is very clearly where the game is. And the German government and the European Central Bank leadership are actually collaborating in saying we're not going to do anything, so you -- meaning Greece, Ireland, Spain, Italy -- have to do the lifting.

In the Federal Reserve context, it's a little more mixed. Chairman Bernanke, I think to his credit, has tried to stay out of or above the detailed fiscal back-and-forth, except to say, wouldn't you guys please make a -- or guys and gals -- please make a decision? Which I think was actually the right course for the central bank to do.

In the U.K., part of the thing that I got involved in fighting against was the leadership of the bank, including the then-governor, Mervyn King, pushed the government very hard to try to do more austerity, cut back spending, increase taxes very quickly. And I don't think central banks should be in that business. Both -- I think it's bad economics and bad politics, but there are places where that's been the case.

ROSE: And Adam -- sorry. Brad, do you want that?

DELONG: I just want Adam to talk some more, because I want some more insight into Mervyn King's thinking, because I have even less insight into Mervyn King's than into Ben Bernanke. And Mervyn is an extremely smart guy and would be the last person who I would have thought would have told the government in the Spring of 2010 that what Britain really needs right now is a lot more fiscal drag on the economy.

POSEN: Well, Brad, we can get into that if people genuinely are interested. All I'll say is, there is absolutely no question that that's what he did, and he -- I think, when the histories of this period are written -- and the Neil Irwin book gives some of this and David Wessel's book and other books have talked about this -- when the histories of this period are written, there's going to be the fact that in the Spring of 2010, all the Western governments, including Japan for this purpose and the IMF all went on this, oh my God, we're going to turn into Greece tomorrow panic and were all together at this crazy summit up in Northwest Canada; they didn't want to be photographed clubbing seals, so instead they decided to club budgets instead. And they just fed on each other, and they all came back from this summit meeting of central bank governors and finance ministers and announced -- including in the Obama administration announced they were not going to do stimulus; they were going to cut back. And so there was this bizarre panic that took place.

And Governor King, for whatever set of reasons, was one of the people feeding that panic in the Spring of 2010.

ROSE: In Adam's review, you say that one of the virtues of the Irwin book is that it sort of diminishes or dispels sort of conspiracy thinking and shows the real way that policies are created and implemented and so forth. But Brad, I'm curious; I have lefty friends who feel that the real story is not just ideological disagreement about the future course of monetary policy in the economy here and what we'll do better to help the economy grow, but who feel that behind these policies -- whether it's austerity or the restrictive monetary policies -- is a kind of hidden agenda or a secondary agenda to essentially restructure the economy in certain ways and shift the balance of political economy inside national economies, shifting the burden on to certain kinds of groups, and that that's really what's going on here -- that the choice of policies is driven by a vision of political economy that has less to do with growing the overall economy than shifting the balance of power between groups within it. Do you think that's going on here?

DELONG: Well, you know, I know that -- (inaudible) -- very well, that right now I'm only five blocks way from Berkeley's pre-eminent Marxist bookstore. And let me say that 10 years ago, my lefty friends would have been saying this, and they'd have been saying that there are, kind of, two key institutions that are driving for, you know, austerity and wage cuts and a further shift of income in the direction of finance and union destruction and so forth, and that those two key institutions are the investment banks -- Midtown Manhattan and Canary Wharf, led by Goldman Sachs and are the International Monetary Fund.

And yet, at least since late 2010, the International Monetary Fund has been saying, hey, wait a minute -- and by the end of 2011, the International Monetary Fund was smack on the far left of the policy mix, saying we've made horrible mistakes and we've given very bad advice. The world economy needs more reflation in the short run; it needs bigger budget deficits by credit-worthy sovereigns, less austerity in the periphery and easier monetary policies.

And it was Jan Hatzius, the chief economist of Goldman Sachs, who was out there a year and a half ago, saying the Federal Reserve should take its balance sheet up to $6 trillion immediately, and the firm (himself ?) was letting him do that as Goldman Sachs' economic analysis tradition, in part because they trust Jan Hatzius, to do a good job, and in part because Goldman Sachs is a creditor, and creditors are no better-served by universal bankruptcy than anybody else -- that Goldman Sachs has a lot of nominal assets that it wishes would retain its value; it wants low inflation, but it also has lots of real assets which benefit from higher production and profits, and even a whole bunch of assets that -- (inaudible) -- risky and (thus ?) really turned into equity. So if it were a conspiracy, why are the two big institutions that have for the past two generations been named as the kind of meters of this conspiracy on the other side? And I think that's a question my lefty friends haven't managed to wrap their minds around. And because they haven't managed to mark their beliefs to market, they're still chasing down rabbits that don't exist.

POSEN: Could I -- could I just add something to what Brad said quickly?

ROSE: Sure.

POSEN: You know, in Brad's review of Alan Blinder's very good book, and in Blinder's book itself, I think there's mention made, but I would actually emphasize more, how we got here was an intellectual failure combined with opportunism. So there was a vast range of people, including people ostensibly on the moderate left through the extreme right and through the moderates in the Clinton administration as well as in the Bush and Obama administrations, who totally bought into the idea of financial deregulation.

DELONG: Guilty.

POSEN: Yeah, no, and I did to a small degree also. I mean, so you -- and this was cognitive capture, as they say in the biz. I mean, this wasn't because people were literally being bribed. There was, however, some incentives that you didn't want to be seen as some crazy curmudgeon like Paul Volcker or some lefty lunatic like Joe Stiglitz. Of course, it turned out that Paul Volcker and Joe Stiglitz had a point.

But at the time, there was an awful lot of peer pressure as well just the nice fact that all the people with money tended to agree with you. And there were a few of those people with money who opportunistically took advantage of the fact that, be it Alan Greenspan, Robert Rubin, Larry Summers, Glenn Hubbard -- you know, pick whoever -- sincerely believed that this was the right thing to do.

ROSE: This is a fascinating discussion. And I would love to have -- continue it all day. But we have a -- you know, an incredible audience as well that I want to bring into this. So I am going to take myself out of this now for a second and turn it over so that you guys can continue this wonderful discussion with input from our readers and callers.

So, Operator, let's start the Q-and-A now so that we can get all of our people on the line in.

OPERATOR: At this time we will open the floor for questions. (Gives queuing instructions.) We are currently holding for questions. (Pause.) Our first question comes from Alister Bull with Reuters.

QUESTIONER: Adam, Brad, thanks very much for doing this call. So both of you have voiced some concerns about the communications strategy of the Federal Reserve after the June 19th statement with the chairman's subsequent remarks at the press conference. Since then, you know, markets were very violent, the volatility was extreme. But things have kind of calmed down.

And there is sort of a narrative building in the markets that Bernanke might have kind of got away with things, that what he did wasn't particular elegant or clean cut, but they've reintroduced some term premium into the -- (inaudible) -- that might not be inappropriate. And kind of he might have got markets over a difficult hump. I mean, how would you view that, that he sort of got away with it or maybe normalcy is being restored? Thanks.

POSEN: Alister, this is Adam. And I'll try to be brief so Brad can come in as well.

You know, I think that's casting it in the wrong -- the wrong terms, because what's happened is, yes, the Fed did something which even lefties like me would long want to -- I'm not that left -- would long want to happen, which is have two-way risk, that it's not a one-way bet for all these private money makers from the Fed, that there's two-way risk in the Treasury market and in other markets.

But that was a side effect. And that wasn't the main intent of the policy. And instead what we've gotten is a commitment to tightening that is totally at odds with the same forecast that Bernanke enunciated. So then you have to ask yourself, why are they doing this? And as I indicated earlier, I think it's because they're convinced they're chasing bubbles.

That relates to a whole different set of issues, but what it certainly means is that there's a lot more uncertainty about Fed policy going forward, which is different from simply the idea that Fed policy could go either way, which is constructive, but the idea that we don't know what's driving Fed policy and they're not being very clear about it, which is not very helpful.

DELONG: I mean, certainly the Federal Reserve did not want long-term real interest rates to jump up by a full percentage point last month, in June. Certainly wasn't what they wanted the impact of their communication strategy to be. So in that sense, it's clear their communication strategy has gone substantially wrong and wrong in, I think, a quite destructive direction, you know. That is, the world doesn't need higher long-term interest rates on safe assets by that much right now.

It means that, you know, say the unemployment rate come the middle of 2015 will probably be three- or four-tenths of 1 percent higher in the United States than it would otherwise have been, and that's a bad thing.

And I do think it greatly added to confusion about what the Fed is doing, simply because it seemed that Bernanke was creating a good deal of certainty or at least state-dependent certainty by adopting various versions of Charles Evans' rule that we're not going to seriously think about raising federal funds rates until interest rates -- or no -- until inflation rate gets above X or until the unemployment rate gets below Y. And yet now all of a sudden, by saying that we are sufficiently worried about long-run financial stability that we are anxious to begin a taper, and once the taper is completed, we will then be anxious to start raising the federal funds rates -- a great deal of that understanding of what Federal Reserve policy would be now seems to have vanished from the markets and put the markets back at (stasis ?).

POSEN: Let me -- let me, Alister, just quickly, one more thing. This is Adam again. The other piece which you and I have discussed is they're talking and all -- I mean, as Brad says, they don't want long rates to go up, but they're talking -- both the chairman and everyone else has spoken in a sort of whiny fashion, like why can't we control everything?

And one of the huge lessons of monetary history, let alone over the few years, that you can't fine-tune monetary policy; you don't control the economy, you know, that precisely. And so for them to be sort of complaining, well, we did this and we had a side effect we weren't expecting is, at a minimum, disingenuous and frankly is bizarre when they're using an instrument just talking that they have no reason to think should have predictable effects.

So I think another piece of the problem is that Bernanke and the committee suddenly are acting as though they have a control over the economy that no one should rightly expect they do.

DELONG: (They're saying ?) -- not to complicate the Evans rule, that they want to say that we are going to look not just at inflation rates and unemployment rates but also at employment-to-population ratios and at housing, and here's how all these things are entering into our thinking. I think that would be fine and wonderful and would add to predictability, but the June communications effort did not do that. And I think in part because the June communication effort confused people, people are now starting to get more confused as they wonder who is going to succeed Ben Bernanke and what their policies will be.

QUESTIONER: So If I could just come back -- one thing -- Brad, you said they mentioned financial instability as an explanation for talking more specifically about tapering, but in fact they have not mentioned financial instability. So I mean, are they sort of saying one thing but actually you believe that that's what's driving them? Because they are not identifying financial instability as a clear and present danger.

DELONG: Well, they're worrying about levels of asset prices. Jeremy Stein especially has been incredibly vocal on what incentives are you providing banks to reach for yields when their cost of funds is -- well, when their cost of funds can't drop below zero and yet what can they loan out that makes any money, and banks face costs of 3 cents per year on every dollar of liabilities. Doesn't that create a situation in which they have to take risks they and we don't understand?

And indeed there has been a lot of talk about perhaps -- if not bubbles, about froth in markets and about how the Federal Reserve, well, should not be in the business of owning every single risky asset issued by or guaranteed by the government. And when I listen to that, I translate that into long-run worries about financial instability. And I don't know know what you hear to summarize that, but that's what I hear, at least.

OPERATOR: Thank you. Our next question comes from Byron Wien with Blackstone.

QUESTIONER: Hi. It's my belief that a substantial amount of the bond-buying money -- the $85 billion a month that the Fed is putting into the system flows into financial assets -- doesn't flow into the real economy. And so therefore, the Fed easing is really pushing stocks up and bond yields down, and not really helping the real economy all that much. Do you agree with that or disagree with it?

DELONG (?): Well, the real economy is linked to the financial economy. Stock yields up -- (inaudible) -- stock prices up, makes people more willing to kind of take risks and undertake operations and investments that they hope will produce equity value that the market will recognize in the future -- bond yields down does make it easier to borrow.

I think the big problem is -- and here I probably would wish we had Joe Gagnon from Adam Posen's shop on this call -- the problem is that the part of investment that is not happening in America today is housing investment. And to the extent that what quantitative easing was doing was lowering mortgage rates, the fact that housing investment does not seem to be terribly responsive to mortgage rates right now for a lot of reasons is something that would make monetary easing a lot more ineffective now than it would be in normal times.

And so, to that extent, I think it's a good point, and that is a reason why expansionary fiscal policy right now is probably the stabilization policy tool of choice, but our chances of even having that are put out the window in the United States -- (inaudible) -- 2010 and 2012 -- (inaudible) -- Congress -- (inaudible) -- produced by those elections.

POSEN (?): I don't have anything to add, so go ahead, please.

OPERATOR: Thank you. The next question comes from Simon Kennedy with Bloomberg News.

QUESTIONER: Hey, Adam. This is a question for you. The Fed and the other central banks have been -- you know, we've talked about this before -- have been particularly bad at forecasting these last five years if you look at their growth forecasts -- made in December; the next year, they've been off by quite a way. What confidence do you think they would have that that problem has been fixed, and is the risk -- there's an optimism by us still going forward which could be revealed when they pull back?

POSEN: I think -- I think, Simon, it's a very fair question, and you're being gracious, because of course, the Bank of England, while I was there, was one of the worst in terms of having -- the MPC having bad forecasts. I think that there is -- there are three things going on that are going to diminish the errors and somewhat increase the confidence.

One is that a large chunk of the errors were due to fiscal surprises, that the fiscal policies were more austere than people expected and that the governments -- the -- even the central banks built into their forecast, and their impact of these austerity measures was higher -- as the saying goes, a larger multiplier than expected. Some of us, myself included, and then later, Olivier Blanchard and Daniel Leigh at the IMF had warned about this, but the bulk of central bank forecasts assumed very little impact for fiscal policies.

And then, the other piece of it is just that we do a bad job in central banks of feeding in international feedbacks, that when there's a synchronized downturn, we tend to underestimate how much -- even in the U.S. effects in other countries affect each individual country. Now, is that fixed going forward? Well, on the first point about fiscal policy, I'd like to think they've improved it, both the fiscal path going forward are more predictable, and more importantly, that the central banks are using more realistic multipliers and assumptions. On the second point, there's been less progress.

But the -- I think the big thing, to return to something I said earlier, Simon, is that we're going to start having more and more pessimism because there's this self-fulfilling prophecy aspect that, oh, my God, we did overestimate growth; it can't be because we made a mistake; it has to be because the fundamentals of the economy are bad; there's a structural problem, and so therefore we revise down our growth forecasts going forward. So they may become more accurate not because they're getting the economy right but because they're driving the economy more towards the forecasts.

DELONG: Although whenever -- I thought that structural problems meant that if you took steps to boost spending, to boost nominal GDP, it would show up as an increase in inflation rather than as an increase in real growth. And to say that there's a structural problem when both real growth and inflation are coming in well below your forecast -- that's not a definition of structural problem that I had heard before 2010.

POSEN: I mean, Brad, I think your point is right intellectually and on the facts, but I think if you go to the discussions that are taking place at the Bank of England or at the Fed or at the ECB now, they sort of wave their hands about inflation and say, well, it's temporary factors; it's noise, which is what the chairman and others just did about the recent low inflation in the U.S., but they insist that the recent run of data on GDP must somehow be more real. I don't think this -- for the reasons you said and other reasons, I don't think this is intellectually justified, but I do think that is very much the spirit of the discussions.

DELONG: And a great deal of keying off of the employment rate rather than the employment-to-population ratio at a time when those two are saying very different things about how much slack remains in the economy.

POSEN: Yes, although that -- we should be fair that that is a particularly U.S. problem. In Europe --

DELONG: (Inaudible) -- yes.

OPERATOR: Thank you. Our next question comes from John Calverley with Standard Chartered Bank.

QUESTIONER: Hi. Adam, I have question for you. I mean, you -- the two of you have put quite a lot of emphasis on the financial stability side, for the reasons of the Fed's shift in policy. But the also seem to have become much more confident about the economic outlook, about the resilience of the economy to the fiscal tightening, about the growth of payrolls. We're looking at 200,000 payrolls, on average, over the last six months. And also, the tail risks have perhaps gone away a little bit. People are thinking now in terms of Europe and in terms of the fiscal confrontation.

So my question is do you agree with the outlook that things actually will improve once we get past the big fiscal tightening this year? And do you think that the 1 percent rise in 10-year yields is enough to derail that?

POSEN: John, it's good to hear you on this call.

Until recently, until the recent run-up in yields, I was more bullish on my U.S. outlook for 2013-2014 than consensus. So I was already saying real growth in 2013 in excess of 2 1/2 (percent), close to 3 (percent); real growth -- (audio interference) -- more than 3 year-over-year percent. And so -- and in contrast with some of my colleagues like Dave Stockton and Joe Gagnon at the Peterson Institute, who are very smart -- but in contrast to them, I always felt that the sequester's impact was likely exaggerated.

So I mean, I think you can tell that story. But as you indicate -- you indicate one question, and I want to raise a different concern. So one question is now that the markets have priced in this jump in rates, for whatever variety of reasons, how much impact does that have?

Since this was looking to be, on my analysis and, I think, probably yours and most people's, a housing-led recovery, and the new types of mortgage products we have tend to reflect interest rates faster than they used to, this is potentially a very significant drag. How significant? A hundred basis points, a few tenths of GDP probably. So it's meaningful. It's not going to turn us into a recession, I'm pretty confident, but it's meaningful.

I think the fundamental issue -- sorry. I think the fundamental issue that you're raising, John, that's implicit in this is, like you say, you know, it could be the Fed's doing this because they've gotten a lot more bullish. And certainly some of the statements that various FOMC members have made since the chairman's press conference seem to read that way.

But then they've got a contradiction, and this was sort of said by Brad earlier, that if they're really bullish about unemployment coming down quickly, that implies -- and they're pretty explicit about this -- that they don't expect participation, meaning the number of people seeking jobs, to go up very much. As you understand that if -- you know, if rising employment start pulling people back into the workforce, the unemployment number may not move very much, even though more people are employed.

Where the Fed seems to be making a very gloomy view that very few people are going to leave nonparticipation for participation. If that's the case, it's then harder to be optimistic about recovery in the U.S. because that says there's something fundamentally wrong with the labor market, or that there's a lot of what we call hysteresis, a lot of lingering damage.

So to me, and to a lot of people, the Fed's -- that's why I emphasize these other factors, because the Fed's forecast doesn't really hold together a coherent whole. You can't quite get to what they're talking about in terms of de facto tightening based on the macro outlook, especially given that they're assuming very little pickup in participation. And therefore, I think it's because they're chasing bubbles.

DELONG: Well, there is also the striking change in what a bullish macro outlook means with employment, the population ratios as far below recent values and unemployment rates as far above as we have now. Back in 1975 or 1983 or, indeed, at the end of 2009, a bullish macro outlook would be for 5 percent-plus real growth.

And now we're talking a bullish macro outlook at something that gets real growth within shouting distance of 3 percent for the next two years, on the low side. And that's a huge change in what we think the American economy is kind of capable of in a recovery. And we should not forget that our ideas of bullishness as far as the macro outlook is concerned now suffer from the soft bigotry of low expectations.

OPERATOR: Thank you. Our next question comes from Rich Miller with Bloomberg.

QUESTIONER: Thank you all for hosting this. It's very, very educational. I don't know if either of you saw the paper by San Francisco Fed John Williams the other -- the other day, but I'd be interested in getting your thoughts on what he talked about and especially the sort of theme of that -- what's optimal policy under certainty is not necessarily optimal policy under uncertainty.

But sort of in line with that, I think, Adam, you mentioned this whole benefits versus costs of QE. Do you -- do you -- the argument seems to be that the more QE you do, the fewer the benefits and the greater the costs. Do you believe that? And you know, is -- just how big can the balance sheet get before, you know, you start to worry?

POSEN: Right. Rich, why don't -- since I've downloaded President Williams' paper, but I haven't yet read it, why don't I let Brad respond to that part and I'll respond on the costs.

QUESTIONER: Sure, sure, sure. I'm just surprised anyone's even had a chance to read it yet because it just came out.

DELONG: OK. Hello.

POSEN: Brad reads incredibly fast, watch his blog.

QUESTIONER: This is true. (Chuckles.) This is true.

DELONG: OK. See, the problem I have in understanding the Fed's thinking is that I was brought up very much in the, kind of, stabilize inflation as unemployment -- (inaudible). And you want to keep inflation expectations well-anchored. And as long as inflation expectations are well-anchored, you want high employment. And what that means is that you want to react very aggressively on the upside when it looks like expectations of inflation have become unanchored and are rising.

But also, that as long as inflation expectations are well-anchored, there's essentially no downside to doing more stimulative monetary policy, that those make people thinking about undertaking long-term investments confident, that the downside -- (inaudible) -- risk of a large, prolonged depression of high unemployment isn't really there.

Those stabilized people's expectations of what nominal GDP rates will be, you know, that it's not just that it won't exceed a certain level, but also that it won't fall below. And yet, the Federal Open Market Committee seems to be, in some sense, worried that too big a balance sheet on its part will be a source of risk.

Now, one of the risks that Jeremy Stein and Esther George -- (inaudible) -- is that if the Federal Reserve buying up all these safe, long-term paper -- (inaudible) -- then banks that need to report profits so their CEOs can keep their jobs will have a hard time making the three cents per dollar of liabilities they need to report nominal profits and won't do things we won't understand until it's too late, and then they'll get into big trouble. And this time, the political -- (inaudible) -- the political climate will not be such that we can bail out the banks again, and then we really will be in Great Depression -- (inaudible).

But I don't know whether that's the tail risk that is driving Federal Reserve's decisions right now or not, and they aren't being terribly communicative about whether that fits, and otherwise, I don't really see a significant tail risks on the downside from the Federal Reserve having a larger balance sheet; that is, if people get sick of holding cash, it could always raise the interest rate on the reserves by a little bit; if the prices of the bond it holds fall, it can always -- (inaudible) -- that -- it's the ultimate, (patient ?), long-term investment, and thus not something that really has to worry about what having a very large balance sheet does to the economy in the sense of creating any substantial risks.

So I have a big problem understanding where these fears of the larger Federal Reserve balance sheet are coming from and what's supposed to happen.

Now, I understood back in 2008 and 2009 about people who said the federal budget will get out of control and once you start -- (inaudible) -- you can't stop it, and once foreign markets take a look at the debt trajectory, they'll demand a high term premium, and then the federal debt will explode. And then we'll be, if not Greece, at least we'll be Greece-like.

But once it became clear in 2009 and early 2010 that U.S. Treasury bond was in fact the safest asset around and that increases in risk in other countries pushed Treasury prices up rather than down, the kind of fear of a debt explosion of the U.S. becoming Greece ought to have gone away.

And I don't understand what's replaced it, (kind of ?) why the Federal Reserve thinks it has to talk about papering and when it will begin to paper, rather than simply saying, at the moment, our estimates for real GDP growth and for inflation have both undershot what we thought they would be a year ago; therefore, if anything, the policies we adopted a year ago were insufficiently expansionary, we should be thinking about increasing the pace of quantitative easing, rather than paper.

There has to be some big risk they see coming from some set of macrofinancial events that they're scared of, and yet, to my knowledge, nothing's been identified, other than this worry about -- (inaudible) -- banks reaching for new.

POSEN: I fear we're coming up on our time, so just let me add a couple of things, Rich.

As I tried to convey in my review of "The Alchemist" in Foreign Affairs, you know, you have to understand, part of this is a committee, and no matter how smart and dedicated the people are on any given committee, if you meet month after month talking about the same things over and over and you're always disappointed, people just start coming up with crazy ideas. And they don't tend to just stand by their position -- some of us do, and then we're seen as erpers (sp) or derpers (sp) or whatever -- (scattered laughter) -- the term of art of the moment is. But you know, most people, they start to get frustrated.

And so there's been, even among very smart people at various central banks, the sense that, well, you know, we're doing all this and it's messy and people don't like it and I've got friends on Wall Street -- or, not even friends -- people on Wall Street and people in Washington telling me this is wrong, you know, and I keep hearing this and nothing seems to be fixed and nobody's praising what we're doing and, gee, something must be wrong.

And so there's this search, this eternal search, for what the costs are. And so to restate some of what Brad said, you know, leaving aside what Jeffrey -- Jeremy Stein said awhile ago. I mean, there's essentially three sets of costs that are -- have been considered by more than one person.

One is the idea that this somehow messes up the money markets because the Fed -- or certain other specific markets because the Fed takes such a big share of the markets. That's a technical issue in a world of financial innovation where private sector firms leapt in wherever there was deregulation. It's not clear to me why they can't just adapt back later. And there's very little evidence for this. But, anyway, sometimes people mad are about that. Even if it exists, this is a very small problem.

The second set of problems, which Brad emphasized and which I agree with, is this (big ?) fear of bubbles. And as you well know, Rich, the Bank for International Settlements and people associated with that have been talking all about this, and there is this religious faith that we get bubbles because central banks are loose, not because there was irrational exuberance, not because there's deregulation, not because there are political factors involved, but because of central banks.

Now, this turns out to be wrong, but it remains a very convenient thing for people to say because then they can say, well, it wasn't because we actually have to reform the banking system and it wasn't because large numbers of Americans got suckered. It's because Greenspan and Bernanke left interest rates too low for too long and we don't want to repeat that.

And so what's happened is everybody, myself included, agrees now that having credit booms and busts are terrible things and you want to avoid them, but that wishing doesn't make it so. You know, just because that's something you want to do, that doesn't mean that the tool you happen to have is the right thing for doing it; that if you do less monetary policy, you pre-empt a bubble. If anything, what we're seeing around the world in China, in Hong Kong, in Australia, in Turkey, in the U.K., everywhere, is it takes a lot more than just raising interest rates or stopping easing interest rates -- stopping easing policy to pop a bubble.

So, you know, as I argued a few years ago, you've got a problem with your shower -- banging the shower head with a hammer isn't going to help; you need a wrench. And so all these people can get themselves all caught up worrying about bubbles and they're using the wrong tool, which is the general interest rate, to deal with it.

The final thing, and this was what we'd talked about at the Jackson Hole conference last summer -- I don't mean you and I; I mean me and debating Mike Woodford and others -- is that you -- there's this political sense -- and this is what Glenn Hubbard and John Taylor on the -- among the various -- and Larry Lindsey -- among the various distinguished people from that end of the spectrum were arguing -- that, well, the Fed is getting itself into political trouble because it's making decisions about individual assets, and therefore it's getting into so-called fiscal policy and it's favoring one group or another group, and this is going to constrain independence and this is going to lead to a backlash to the Fed and that's the real cost, and so you have to not do this because it's going to delegitimize the Fed or ruin Fed independence.

And I view this as a very pernicious point of view because it essentially says, don't do the right thing because you're scared people will misinterpret it, and I view it as an incredibly -- to use the word again -- "disingenuous" point of view because, as Brad mentioned earlier, all monetary policy is distributive implications whether you're unemployed or not, whether you're a creditor or debtor.

So, this pretense of now suddenly monetary policy's doing something which affects groups differently than they did in the past is just a misconception. But there are a lot of people, as you well know, Rich, in a lot of central banks who are very nervous, including especially at the Fed, where they've been under attack politically from the populist right, which they're completely unprepared for; they're used to being under attack from the left. And they're freaking out, and so therefore they want to say, well, you know, I worry about bubbles, too; oh, I worry about instability.

Now, what is disappointing and disturbing is instead of it being a just sort of empty "I feel your pain, now go away and leave me alone so I can do real business," they seem to have shifted from "I feel your pain and, yeah, OK, I'm going to try something screwy to make up for it."

And even if you believe that they should be popping bubbles and even if you believe there is a bubble in U.S. credit markets now, which you can argue both of them, although I think the second is doubtful, you then still have to believe that this tapering will have some meaningful effect on that, which I think is a very open question, and that this tapering, the costs of getting the economy wrong in the short term outweigh -- are outweighed by the benefits; that remains to be seen. So I think that's why -- sorry to give such a long answer, but I think there's a bunch of reasons, very human reasons and political reasons why this idea just is grabbing such a hold, but none of them are good justification.

DELONG: Christie Romer found an interesting passage from the 1960s from then-Fed chair William McChesney Martin, about how if the FOMC were to start making decisions out of fear of losing its political independence, it had then already lost its political independence. (Inaudible) -- want to go there.

ROSE: One last -- one last question I think we have time for.

OPERATOR: Our final question comes from Paul Handley with AFP News Agency.

QUESTIONER: Hi. Professor DeLong mentioned the preparation for succession. Is it -- could it be that the FOMC is quietly trying to put itself in a position to prepare for succession risks, any kind of thing that would greet a newcomer, even putting itself in a better place for what -- Mr. Posen talked about keeping two-way risk into the market for Treasury buyers and such. Or -- and if it isn't doing it right, what should it do to prepare for succession?

DELONG: Well, I think Obama should already have named a successor, that this is -- if you look over the past five years, Obama has been singularly bad, has been two standard deviations below average in the making timely appointments part of the job go over -- go throughout the administration. And it's not just that the Republican Congress has failed to confirm and failed to vote, it's that Obama has failed to nominate. And I think in a good world, we would have a successor-designate already in place, and people would be relatively happy, and uncertainty would be minimized.

As to what the FOMC can do, was it Larry (Meyer ?) who said that the first rule of the FOMC is that the appointed governors vote with the chair, that the FOMC largely does what the chair wants, subject to the chairs not wanting to have too many explicit dissents from too many bank presidents. And so they really I don't think play a -- the (governors ?) don't really play a significant role, except inasmuch as they want to dig in their heels and warn about -- (inaudible) -- how publicly they'll dissent from the chair.

ROSE: Adam is one those types who digs in his heels and talks about it. Do you have anything to say in your final comments?

POSEN: In my final comment, I think -- I think too much is being made of succession. It's inherent that we do this. (Inaudible) -- published a paper saying that doesn't matter as much as people think, even in the Fed. And when you look at the list of candidates since Christie Romer, unfortunately, does not seem to be on the short list, the amount of space between what they're likely to do any of the leading candidates and where we are now is not that great. So yeah, they're probably going to start -- try to start tapering or tightening before the next person gets there, but that doesn't solve the problem because then the next person is going to be watched carefully for when they raise rates. So, you know, that may be motivating them, but I think it's foolish for them to worry about that.

QUESTIONER: Now, do you understand why Christie Romer doesn't seem to be on the short list?

POSEN: Because people -- no, I -- I'm not going to speculate on the record for that. I just -- my understanding is she's not, and I would have put her on the short list, but my understanding --

MR. : (Inaudible) -- the Obama administration senior policymakers, she was the closest to having a correct view of the situation early.

ROSE: On that note, we'll have to cut this one short. We could be here all day talking to these guys, but everyone has jobs to do, and they have to go back to their careers. We hope you enjoyed it as much as we did, and we hope we will see you or hear you soon on a future call. Thanks, Brad, thanks, Adam, and thanks, all of you, for taking part. Talk to you later.

MR. : Thank you, Gideon.

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