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World Economic Update: After Greenspan

Speakers: Alan S. Blinder, G.S. Rentschler Memorial Professor of Economics, Princeton University; Former vice chairman of the Federal Reserve Board, John P. Lipsky, Vice Chairman, JP Morgan Investment Bank, and Stephen S. Roach, Chief Economist & Managing Director, Morgan Stanley
Presider: Daniel K. Tarullo, Professor of Law, Georgetown University Law Center
January 31, 2006
Council on Foreign Relations New York, NY

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Council on Foreign Relations
New York, NY

Meeting Highlights

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Tax Cuts:

Daniel TARULLO: “Go back to the tax cuts of 2001, where Alan Greenspan possibly was decisive in turning the debate, in getting those tax cuts pushed through the Congress and in creating a key part of the national saving conundrum that is at the heart of these imbalances.  How do you look back on that?”

Alan BLINDER: “One of the questions that frequently comes up is, ‘what’s the worst thing he did in 18-1/2 years?’ And that’s what I answer…I think he stepped way over the line…and made a big mistake. Now, it wasn’t his policy. You really have to blame this on the president and the Congress—they’re the ones that enacted it—but  I think he played a role in enabling it. Ironically, this biggest mistake he has made in 18-1/2 years was not in monetary policy. He’s hardly made any mistakes, a couple of small ones, in monetary policy.”

Eclectic Approach:

Stephen ROACH: “If you were to ask me to identify Greenspan’s greatest strength, the eclectic approach would be it. I worry that if we get locked into a rules-based assault on a specific numeric target with respect to inflation, that we then deny ourselves the flexibility from time to time in dealing with other issues.” 

Alan BLINDER: “Bernanke has described inflation targeting as constrained discretion.  That means some long-run constraint on the pure exercise of moment-by-moment discretion. This is exactly what Greenspan never wanted. Not the slightest constraint on either his strategic or tactical discretion. And that’s the one and only reason why he’s been dead-set against it all this time.”

CHALLENGES FACING BERNANKE:
Inflation:

Stephen ROACH: “Ben Bernanke’s a smart man and probably the most talented academic to ever take this job in our central bank—the world’s greatest inflation targeter with no inflation to target. And the challenge is, what is he going to be facing, near term, if the outlook for inflation is as stable as it appears to be right now?…If there’s a weak link in the global macro chain, that’s possibly where it is, in an environment where inflation is fairly stable. If there is a missing or a weak link in Bernanke’s skill set that he brings in as a central banker, I think that’s also where it is.”

Oil:

Alan BLINDER: “My biggest concern remains what it’s been for a while, which is oil. I don’t know where this thing is going, where I’m starting to get used to $65-, $75-a-barrel oil. If that’s the new equilibrium from which there are ups and downs…we’ve got some fearsome ups ahead. If you look around the world, where oil comes from, it’s a little bit scary what’s going on in a lot of those places, geopolitically. And I’d have the feeling, if I were in [Bernanke’s] shoes, that we had…somehow skated through the first one, two, three, four, however many stages, of the oil shock without any damage to speak of, and can we keep on doing this?”

Globalization:

Stephen ROACH: “I think the point on globalization is absolutely critical…the Fed always viewed the economy through the lens of closed economy models. And now the interplay across borders and—not just in terms of capital flows, but in terms of labor flows, savings flows—really begs central banks to begin dealing with policies much, much more through open economy models. And that’s going to be a big challenge for the Bernanke Fed right off the bat, I think.”

Stephen ROACH: “Folks who warned about inflation, inflation, inflation are starting to realize in a globalized economy manufacturing prices are set globally, not locally, and what we’re also finding out is we don’t have a very good handle on what represents full employment in this economy, and yet those are the cutting-edge kind of decisions that the Fed is going to have to act upon in the next few years.”

Interest Rates:

Daniel TARULLO: “That policy initiative [raising interest rates to normalize monetary policy] is coming to an end either today or maybe the next Fed meeting on March 28th.  But not only does Dr. Bernanke face the normal jitters with the new person coming to the helm, but he also is entering a situation in which there would have been uncertainty about Fed policy whether or not Alan Greenspan was staying.”

John LIPSKY: “The Fed is engaged at the current moment in doing something that has no exact precedent. There is no precedent for a period of rising Fed interest rates in a context in which inflation is already consistent with the Fed’s long-term goal…And to lay out the guideposts of how the Fed is going to conduct policy in an environment of price stability that is something that really hasn’t been discussed, even though it strikes me as the truly novel aspect of the current environment.”

The Dollar:

Alan BLINDER: “In the first term of Ben Bernanke, he’s going to have to confront a significantly declining dollar. That’s always a challenge to a central banker.”

THE BERNANKE CHAIRMANSHIP:
Confidence:

Alan BLINDER:  “A new guy—an academic, yet—is about to take over, and markets register their angst about things in two basic ways: volatility, which, when it gets really bad, can be actual gapping of prices, and in widening of risk premiums. So what are we seeing? Low volatility, incredibly low risk premium, with no evidence that they’re rising as the judgment day, February 1st, approaches… the interesting thing is what are the rates between tremendous vote of confidence in Ben Bernanke, who’s going to step into the shoes of this titan, and confidence in the Federal Reserve as an institution; that is to say, when the big cheese walks out the door, we still have the Fed. It will still do more or less the same thing.You can still trust the Fed.”

Stephen ROACH: “Despite his brief tenure at the Fed and the impacts in terms of shaping some of these transparency issues, he starts with a clean slate on the confidence front.” 

Inflation Rates:

Alan BLINDER: “They will enunciate an inflation target very clearly. They will not play games anymore; there will be a very clear enunciation…There are members of Congress worried that giving this exalted numerical status to the inflation target will somehow denigrate the employment target, and the Fed, after all, does have a dual mandate from Congress. Bernanke has heavily endorsed the dual mandate; he will continue to do that.” 

Transparency:

Daniel TARULLO:  “[Bernanke] has been advocating more transparency in monetary policy-making, not here, but just around the world.”

Daniel TARULLO: “Bernanke has said the way in which we, meaning the Fed, can most efficaciously affect the long-term rates that matter to people—mortgages, medium-term investments and the like—is through a policy that gives assurance or more assurance to borrowers and lenders as to what those short-term interest rates will be out into the future.  And that’s why he has become such a proponent of transparency.” 

Alan BLINDER: “This [transparency] is not stepping off a cliff into the unknown. It’s one more incremental step down the road that the Fed has been traveling since 1994, and I think it should keep on traveling down that road.”

The Dollar:

Alan BLINDER: “No central banker likes to gloat about his currency going down, even though Ben Bernanke will know, as Alan Greenspan did during 2002 to 2004, that it needs to go in that direction.You don’t gloat about it. You don’t cheer it along. We three will be cheering it along. At last the dollar’s going back to equilibrium, where it needs to be. But if you’re sitting in the central bank chair, you don’t do that.”

 

DANIEL TARULLO: Good morning, everyone, and welcome to this special edition of the World Economic Update. We apologize for the changed format this morning in which we’re making you sit classroom style, but the interest in the meeting was such that we couldn’t fit enough of you around tables.

Let me remind you that as with all WEUs, this meeting is on the record. And if you haven’t already done so, please silence your BlackBerries, cell phones and any other electronic devices.

As we usually do, we will begin with a discussion among the panelists of several questions, which I’ll identify in a moment, and then somewhere around 10 past 9:00 we’ll turn to questions from the audience.

It’s very difficult in the last several days to pick up a newspaper or turn on the radio and not hear some assessment of the legacy of Alan Greenspan. What we’re going to try to do this morning is to look forward, though, to look forward to the era after Greenspan when—the Senate willing—Ben Bernanke takes over tomorrow as the new chairman of the Federal Reserve Board. And we’re going to try to do this by addressing three kinds of questions. First, the medium-term situation which Dr. Bernanke faces—and I will just arbitrarily say the roughly four years until the next president has to decide whether to reappoint him; second, the immediate challenges that he faces taking over, the challenges that all Fed chairmen face in their first several months when the markets get accustom to them, but also the specific circumstances that face Dr. Bernanke in the next several months in the first couple of Open Market Committee meetings; and third and finally, we’ll really take a bit of an academic turn, talking about Dr. Bernanke’s own academic work, which he’s carried through as a member of the board a couple of years ago on transparency, inflation targeting, and some of his monetary policy-making theories which may have an impact on the way in which the Fed makes monetary policy over the next several years.

We have with us this morning our regulars: Steve Roach, John Lipsky, and then we’re pleased to have back Alan Blinder. Most of you probably know that Alan was not only vice chairman of the Fed himself, but a long-time colleague of Ben Bernanke’s, and I believe sometimes co-author as well.

So first we’ll start with the medium term—trying not to start with the short term, but trying to start with the medium-term perspective because Dr. Bernanke himself frequently emphasizes the need to look beyond the next interest rate move or the next Open Market Committee meeting.

Last week in London, Tim Geithner, the president of the Federal Reserve Bank of New York, was on a panel with Steve, as a matter of fact, and Tim gave an interesting speech, interesting given the soon-to-be transition at the Fed, which was entitled, “Remarks on Global Financial Imbalances: The Policy Implications of Global Imbalances.” The conclusions that he reached were, first, that although there may be some reasons to think that the adjustment of the current account budget imbalances in the United States may be protracted and gradual, the general conclusion is that these imbalances are unsustainable and they will need to unwind at some point. But time does not necessarily help. But the longer these gaps continue to build, the greater the ultimate adjustment required, and the greater the risks that accompany the process.

And he proceeded to spin out some of what he thought were the implications of the imbalances for monetary policy, specifically that they will—the unwinding of these imbalances will have an impact on global capital flows, and thus on the relative dampening of the level of forward nominal and real interest rates, and the level of demand.

This speech comes, of course, at a time when Tim is going to be sitting on the board with a new chair. Interesting to pull attention to the imbalances just at that moment.

Steve, is that the principal problem that—and the principal challenge that Ben faces over the next four years?

STEPHEN ROACH: “Principal” may be a little strong for me. It probably is. But, you know, looking out over four years, there’s just a multitude of things that can happen, Dan. Certainly, if there is an inflation surprise—and I do not anticipate it—that would quickly move to the top of the list.

But I do think this concept of global imbalances—it continues to be actively debated, and to me the big issue here—rather than just sort of have this cosmic concept called imbalances—that is germane to the U.S. monetary policy debate is the linkage between our historic lows and our overall national savings rate and the current account deficit and how we got there and what the role for monetary policy is for that.

And Tim’s speech, as well as the give-and-take afterwards in London last week, just didn’t quite get there. And I and a few others tried to push him there. But Chairman Greenspan last fall, in a number of speeches he gave, finally started to be more, I think, explicit and direct in articulating the link between asset bubbles and the willingness of individuals and businesses—mainly individuals—to draw down traditional measures of income-based saving, and so then lacking in saving, augmented by these massive government budget deficits, America’s had no choice but to import surplus savings from abroad and on these massive current account and trade deficits.

And what is the role of monetary policy in creating and then resolving the problem? What should monetary policy be doing with respect to asset-driven spending behavior of individuals? What should monetary policy be doing to put pressure on the fiscal authority to deal with the public sector savings rate? I do think those are critical challenges for the next chairman in the years ahead, but by no means are they the only challenge.

TARULLO: Alan, as you look at it as both an academic and a former vice chairman, how do these hanging imbalances affect the way you think about monetary policy over the medium term?

ALAN BLINDER: Well, I think the first thing to say is that you wonder—and that’s about all you do—about what the exchange rate’s going to do. I mean, here we went through this—we could have had this conversation a year ago.

ROACH: Well, we did.

BLINDER: It would have—we did. We did. (Laughter.) Two years ago. Three years ago.

TARULLO: We actually have it every two months!

BLINDER: It would have sounded much the same. It did, right? The dollar seemed too high a year ago. It’s higher now. And so when you’re thinking about monetary policy in a relatively short time frame, what are we going to do with this—looking to the next FOMC meeting is looking far, by FOMC standards. So what we’re going to do now or seven weeks from now—you don’t have a clue what the dollar’s going to do. It’s probably not going to be very different than it is, and therefore we’re going to be living in an environment for a while with a highly overvalued dollar, a huge and growing current account deficit.

At some point this turns around, and that’s going to be—your choice of the four-year time frame, I think, was a good one, because I often say I know nothing about what the dollar will do over the next four weeks, but I’m pretty sure over the next four years it’s going down. So I’m pretty sure, in the first term of Ben Bernanke, he’s going to have to confront a significantly declining dollar. That’s always a challenge to a central banker, maybe more for what he or she says than what he or she does. But I think that’s a challenge that Bernanke is extremely likely to face—

TARULLO: And that—Alan, spin out the nature of the challenge.

BLINDER: Yeah. Yeah.

TARULLO: Obviously there’s a potential impact on inflation as imported goods and services become more expensive, but beyond that.

BLINDER: Yeah. Two things that actually are not as bad as you think: you do think that—there’s a natural effect on inflation for that reason, Dan, but the econometric evidence shows very strongly that it’s much smaller than you think. So yes, you get a little inflationary impulse, but not very much. There are some ideas about why.

TARULLO: But Alan, does it show that it—the response is smaller than it used to be? Isn’t that key?

BLINDER: I think that’s right. And it used to be small, and it’s gotten smaller. (Laughter.)

TARULLO: That’s right. (Inaudible.) It’s gotten a lot smaller.

BLINDER: I believe that’s right. No, I think that’s right.

The second thing that’s surprising, relative to what we teach our youth, is that it doesn’t affect interest rates the way it’s supposed to. It ought to be the case that a dollar—the current—let’s talk about the dollar—that’s anticipated to fall drives up U.S. interest rates relative to, say, euro rates or yen rates or whatever you want to do. It doesn’t seem to do that very much.

So the two obvious problems for monetary policy aren’t there as much as you’d think, and that’s why I said it’s more about what you say about it than what you do about it. It’s not actually going to change the macro environment that much. It will, with a lag, boost net exports, and that of course is relevant. And it will do a little on the inflation front, as you say, and it probably will do a little to interest rates.

But the main thing is central—no central banker likes to gloat about his currency going down, even though Ben Bernanke will know, as he sits in that chair, as Alan Greenspan did during 2002 to 2004, that it needs to go in that direction. You don’t gloat about it. You don’t cheer it along. We three will be cheering it along. At last the dollar’s going back to equilibrium, where it needs to be. But if you’re sitting in the central bank chair, you don’t do that.

TARULLO: And one other thing, before I turn to John, as—if you were sitting (sic) in his shoes right now, what would you be most concerned about? And I guess when I ask that question—

BLINDER: Yeah.

TARULLO:—most concerned about relative to your ability to have an impact on it?

BLINDER: Yeah. I think my biggest concern remains what it’s been for a while, which is oil. I don’t know where this thing is going, where I’m starting to get used to $65-, $75-a-barrel oil. If that’s the new equilibrium from which there are ups and downs—and I’m not at all sure it is—we’ve got some fearsome ups ahead.

If you look around the world, about where oil comes from, it’s a little bit scary what’s going on in a lot of those places, geopolitically.

And I’d have the feeling, if I was in his shoes, that we had somehow—the whole industrial world, really—had somehow skated through the first one, two, three, four, however many stages of the oil shock without any damage of to speak of, and can we keep on doing this?

TARULLO: John?

JOHN LIPSKY: Yeah, that’s certainly something to—it would be a potential concern, and—but let’s put this in a bigger context that I’m sure Alan would agree with, which is the primary goal of the Fed is to keep—is to maintain price stability.

And it’s probably worth noting—and I’m sure we’ll come back to it in the context of this discussion, but it’s rarely noted in the public discussion—the Fed is engaged at the current moment in doing something that has no exact precedent. There is no precedent for a period of rising Fed interest rates in a context in which inflation is already consistent with the Fed’s long-term goal. In other words, every time in the past that you’ve seen the Fed raising rates, inflation has been above their long-term goals. And therefore, to judge policy, one of the aspects has been to exert downward pressure on inflation.

This time they’re trying to—let’s use the word “soft”—create the kind of a soft landing that has not been created before. And to lay out the guideposts of how the Fed is going to conduct policy in that—in an environment of price stability is something that really hasn’t been discussed, even though it strikes me as the truly novel aspect of the current environment.

If we want to turn to the longer-term issues of global imbalances—

MR. : But John, could I just ask you one question on that, just that one point?

LIPSKY: Sure.

MR. : Couldn’t you also interpret just the Fed’s moves, these policy moves, as an effort to normalize rates?

LIPSKY: Of course.

MR. : And not necessarily to fight, you know, the ghosts of inflation past, but just to sort of get rates on an even keel and then go on with the agenda that you’re going to lay out?

LIPSKY: That’s exactly right. What’s even keel? We haven’t heard a real clear discussion about how the Fed is going to maneuver in that context, because every other time, rates have been normalized, inflation has been higher than the Fed’s long-term goals.

Now—and I’m sure we’ll come back to that. But think in terms—just to get the remarks on the table regarding global imbalances, which certainly will be of concern to Chairman Bernanke and others, we could start as a benchmark, what has the G-8 authorities, who have addressed this issue over several years, proposed as the policy means to help push global imbalances back toward something that makes folks more comfortable?

The plan has three elements. One, increase U.S. savings. Number two, enhance growth of domestic demand in Japan and in the euro area. And three, induce greater flexibility in Asia (ex-Japan ?), i.e., among other things, but I don’t think exclusively, for China to show more exchange rate flexibility. But I put emphasis on the flexibility and less on the currency.

We can ask, are those things in train? And I would claim, with or without the Fed, I think the U.S. savings rate—the household savings rate—is going to go up in the next few years. I don’t think that that—policy could help that along or could hurt it, but in fact I suspect that even if there were policy errors, we’re likely to see a hastening of that process, not a retarding of that process.

Secondly, we’re seeing domestic demand strengthened in Japan and in the euro area, and that’s to be welcomed, and the question mark remains the degree of flexibility that we’re going to see in Asia. But, first point, things are moving in the right direction, not the wrong direction, in that regard. And a question that I’m sure the chairman will face and we’ll all face is the implicit one that I think Alan Blinder put forth: Even if things move in the right direction, will it be fast enough to obviate the risk of some financial disruptions along the way?

TARULLO: And isn’t—a key problem that he faces is that most of the problems that you identified are way out of his remit?

LIPSKY: Absolutely.

TARULLO: And so he’s sitting there, with a monetary policy instrument, worried about the foreign exchange, budget, current account, domestic demand in Asia and Europe,

LIPSKY: That’s right. None of those primary policy issues really depend on monetary policy. So monetary policy has got to focus on what it can deal with directly, and that is to sustain price stability.

TARULLO: And he has already suggested, or maybe asserted—I’m not sure how strong the suggestion has been—that he is going to be more reticent when it comes to non-monetary policy issues. So we presumably are not going to be seeing Chairman Bernanke going out talking about whether a tax cut should be extended or whether something needs to be done with the budget or the like.

LIPSKY: Alan can probably talk to that.

BLINDER: I think the answer—

LIPSKY: Can you resist the lure.

BLINDER: Yeah. Well, or should you. I think the answer to that is—your question, Dan, is strongly yes, that Bernanke has that inclination, he has that belief. I think he’s correct to have it. He said it at his confirmation hearing in more or less so many words.

One exception. Central bankers throughout history and all over the world have always had a license to rail against large budget deficits. They always have. They always will.

TARULLO: Because of the pressure it puts on them.

BLINDER: Yeah, because of potential monetization—you can make many excuses—it affects interest rates. You know, central bankers are supposed to be models of fiscal probity. So it’s not fiscally probe—(laughter)—to—(inaudible).

TARULLO: Alan, can I ask you, then, in that context—I know this is a looking forward, but just go back to the tax cuts of 2001, where Alan Greenspan possibly was decisive in turning the debate, in getting those tax cuts pushed through the Congress and in creating a key part of the national saving conundrum that is at the heart of these imbalances. How do you look back on that?

BLINDER: Like you, presumably, I’m getting four calls a day from reporters about the Greenspan legacy, et cetera, and one of the questions that frequently comes up is, what’s the worst thing he did in 18-1/2 years? And that’s what I answer. I agree with you that we never know, you can’t run history backwards, but it might have been the decisive

At minimum, I think we could have got this tax cut scaled back or made contingent or a whole bunch of other things without the support from Mr. Greenspan. I think he stepped way over the line that we’ve just been talking about in that and made a big mistake.

Now, it wasn’t his policy. You really have to blame this on the president and the Congress; they’re the ones that enacted it; but I think he played a role in enabling it. Ironically, this biggest mistake, of course, he has made in 18-1/2 years was not in monetary policy. He’s hardly made any mistakes, a couple of small ones, in monetary policy, which I think goes back to the point of stick to your knitting. I mean, he was awfully good at his knitting, really, really good at it.

Let me raise just a cautioning voice on that one. You see, it seems to me that—

TARULLO: John, you think it’s a good idea for him to push for the tax cuts?

LIPSKY: Well, let me put it in a slightly—

TARULLO: Okay.

LIPSKY:—let me put it in slightly more—it’s going to be a little bit more nuanced—(laughter)—

TARULLO: I can’t let you get away with nuances. (Laughter.)

LIPSKY: Oh, come on. See, look, see, what is—looking back, what’s the lesson that we learned from the Great Depression, and that is, among others, it was from the studies of people like Ben Bernanke and Alan Blinder—was that we took a period of financial disorder and converted it into an economic disaster which inappropriately restricted policy.

What has happened? We’re in a period of globalization that really began in a certain sense in 1990 with the collapse of communism, the creation for the first time of a true global economy with universal institutions, but a world that contrary to the Bretton Woods’ vision was a world of floating exchange rates and open securitized capital markets, as opposed to the Bretton Woods’ vision of a fixed exchange rate, closed capital market world.

So it hasn’t been around that long, and it went through a severe testing period in `97, `98, `99, 2000—Asian crisis, Russian default, LTCM, Brazil, Argentina, what have you. It could have been a pretty ugly period, and policymakers learned the lesson of the Great Depression. They learned a lesson taught by Professors Bernanke and Blinder and others and reacted with expansionary policies. Now, you can claim that the tax cuts were really envisioned in a different way, and it was only by accident that they came at the right time, et cetera, et cetera.

But it strikes me—given what the serious problem or potential problem at the time for Alan Greenspan to have stood up and said this is a terrible mistake on long-term issues, on long-term basis, on fiscal policy and create the image that policymakers were divided about what policy ought to be doing, I hate to say it—regardless of what you think those tax cuts were going to do in the long-run or not, I just can’t see how that would have been helpful.

TARULLO: But wait a second. Why shouldn’t—there’s a difference between him imposing the tax cuts and just not opining them.

LIPSKY: Well, to be—I think we’re—you know, now, we’re being a little nuanced here.

TARULLO: No, but that’s—(laughter)—I don’t think that’s—I don’t think it’s nuanced at all because this discussion is raising the issue of what the role of the Fed chairman is. Should the Fed chairman confine himself more or less to monetary policy with perhaps some—where he references the budget, or should he become the principal guardian of the economy?

LIPSKY: Well, I think we all think that—the Fed chairman’s goal—role is not to be the principal arbitrator of tax policy or fiscal policy in general. I think we can all agree on that. So I think to focus on that as a major issue in determining the course of the subsequent economy, I think is—

TARULLO: But it goes to the question—

LIPSKY: Their priorities are wrong.

TARULLO: I think it goes to the question of his credibility, which is the reason why we worry—why some worry about, well, the chairman speaking on these issues, right?

LIPSKY: Yeah, but I—again, I think there’s a general consensus under normal times it’s not the role of the Fed.

BLINDER: What I think it goes to potentially is the independence of the Fed. I mean, that the—it happens in this particular instance. But the notion is that if I poach into your backyard, you can poach into mine, and that’s what you really want to stay away from.

TARULLO: But incidentally, Alan, Alan Greenspan also spoke out in favor of the budget cuts—the budget balancing program that we put forth in 1993. Do you think that was a mistake as well?

BLINDER: No, because that comes under the rubric I said: rail against budget deficits. He did not, for example, enter probably at all, maybe the slightest bit—I’m trying to remember now—the huge fight we had, as you’ll remember, over what percentage of the deficit reduction should be taxes and what should be spending, not to mention which spending. I don’t remember Greenspan getting involved in that at all. He was there cheerleading for large deficit reduction which was quite appropriate, and he did some good.

TARULLO: Okay. So now, let’s shift focus back into more immediate time frame, which is to say the situation that Dr. Bernanke faces tomorrow and in the next few months.

Now, you’ve all been reading the papers, so you all know that there’s this lore that new Fed chairs are likely to face challenges from the market, either because markets are just very uncertain—this is a new person; they’ve gotten used to the old person for better or worse—but also in this particular instance because the Fed has been in an unusual posture since the middle of 2004. It has said, essentially, “We’re going to raise interest rates, and we’re going to keep raising them for awhile because we’re trying to normalize monetary policy and get into a roughly neutral situation.” That policy initiative is coming to an end either today or maybe the next Fed meeting on March 28th. But not only does Dr. Bernanke face the normal jitters with the new person coming to the helm, but he also is entering a situation in which there would have been uncertainty about Fed policy whether or not Alan Greenspan was staying.

What is he likely to face? What kinds of responses is he going to have to make, John, in order to project a little bit of assurances out to the market?

LIPSKY: Well, the people have asked, among those calls that we all get, what impact is Ben Bernanke going to have on the conduct of monetary policy? And I—my answer is, well, in a sense he already has. There have been two major changes in Fed policy—the way the Fed conducts policy over the past year that have largely gone unnoticed at this level, and I think Ben Bernanke had something to do with them.

First, a year ago February—we’ve talked about here before—February 2005 in the Monetary Policy Report to Congress, which is the kick-off for the big congressional testimony, the semi-annual congressional testimony of the chairman, that policy report contains something called the central tendency forecast for the economy. And that forecast is an FOMC forecast, it’s not a staff forecast. And in the past, that forecast would have gone through the end of 2005, the one in February. As I describe it, for a central banker, a nine-month forecast describes an environment, but you wouldn’t imagine that your short-term interest rates could have an impact on the economy. In February of 2005, that forecast was extended through the end of 2006; in other words, a year and nine months. Well, that changes the character completely. You absolutely have an impact on the outcome in that time frame. As I said at the time, that’s as close as a Greenspan Fed is going to get to formal targeting.

TARULLO: Yeah, we’ll talk about that in a minute.

LIPSKY: And Ben Bernanke was one of the proponents of that change. And it was so hidden—in the policy report itself there’s a footnote to the table, is the only mention of the fact that they had completely changed the character and had moved to a quasi-targeting environment. The—well, let me finish. The FOMC now releases their minutes after three weeks, changing the character of that document—much more transparency, much more immediacy—another proposal supported by Ben Bernanke. So already he’s had some impact.

It will be fascinating to see how he conducts himself in presenting the Monetary Policy Report to Congress in the next few weeks in which, number one, all it’s going to take is a slight change in rhetoric and that medium-term—that central tendency forecast becomes something more like a real target. And what the Fed has—as I said earlier, what the Fed has not been particularly forthcoming—they said they’re aiming for neutrality, but to say how do you know when you get there, the chairman, so far, has—

TARULLO: Well, he says you know it when you see it.

MR. :—you know it when you see it.

But I had hoped that somebody would ask, okay, give us a little bit of help here; what are you going to be looking at when you know it when you see it? Right? (Laughter.) And I’m hoping that Ben Bernanke, who’s inclined to be quite a bit more explicit, is going to tell us in an era of price stability, where the Fed’s goal is to sustain the current inflation rate and sustain the current rate, not to lower them, how do you know when you’re doing the right thing? And I’d say that’s a bigger challenge than people seem to understand.

TARULLO: You sometimes wonder whether it was not purely coincidental that the Soviet Union dissipated just around the time that the Fed started issuing statements, because all those Kremlinologists who used to have to pore over whatever was coming out of Moscow needed something else to do, and now they pore over the FOMC statements when they come out every couple of weeks—

MR. : The Fed came later. The Kremlin became transparent first! (Laughter.)

TARULLO: Right! Well, there’s a lag there till ’94, that’s right!

So, Steve, John has described the sort of structural process of transparency, which we’re going to talk more about in a moment. But what I’ve been thinking of as Bernanke’s problem is exactly what I said a minute ago, that people are going to pore over everything that he says, and they’re going to read into everything he says perhaps more than is to be deserved. That makes me wonder on this issue of whether markets challenge—markets create challenges or whether they just are particularly sensitive to Fed responses, makes me wonder whether the uncertainty itself makes it more likely that there is going to be some sort of dislocation in the market because people are reading too much in, or they’re unsure of how the Fed’s going to respond.

ROACH: Well again, why is there uncertainty that usually accompanies the transition to a new Fed chairman? It’s pretty simple. There’s no, you know, deep science to this. Today after the FOMC meeting I guess there’s a lunch and, you know, there’ll be a lot of tears at the table. (Laughter.) And then Greenspan will go back to this office—it’s about twice the size of this room—and he’ll take the pictures off the wall, he’ll take the books off the shelf, he’ll take the papers out of the desk, and he’ll leave. But the most important thing he takes with him today is about 18-1/2 years of confidence that the markets have placed in him, the man, the maestro who through thick and thin has done an extraordinary job at the helm of the world’s most powerful central bank.

Ben comes in tomorrow or the next day, whenever he’s finally approved and sworn in, and despite his brief tenure at the Fed and the impacts that John stated in terms of shaping some of these transparency issues, he starts with a clean slate on the confidence front. And markets—they’re not mean-spirited, but in not really having a deep sense of history with Bernanke the chairman, there will be more of a natural inclination to wonder out loud, and in various sort of trading-type moves, whether Bernanke is going to lean one way or another.

I think we get too caught up in this transparency itself. Transparency is terrific. But what markets and investors in general are going to do here is to peer through this increasingly transparent lens and try to look inside the heart and soul of the Bernanke Fed.

Ben Bernanke’s a smart man and probably the most talented academic to ever take this job in our central bank—the world’s greatest inflation targeter with no inflation to target. And the challenge is, what is he going to be facing, near term, if inflation is—the outlook for inflation is as stable as it appears to be right now? And I think that ties back to your first question on the nature of these global imbalances, their implications for capital flows and currencies. If there’s a weak link in the global macro chain, I think, you know, that’s possibly where it is, in an environment where inflation’s fairly stable.

If there is a missing or a weak link in Bernanke’s skill set that he brings in as a central banker, I think that’s also where it is. And I think—and I knew if I did these things long enough with John, I’d finally start to find something I would agree with him on—(laughter)—but I think the point on globalization is absolutely critical. The Fed, when I worked there back in the Jurassic era, but up until now—and I’d be interested in Alan’s—on this—the Fed always viewed the economy through the lens of closed economy models. And now the interplay across borders and—not just in terms of capital flows, but in terms of labor flows, savings flows—really begs central banks to begin dealing policies much, much more through open economy models. And that’s going to be a big challenge for the Bernanke Fed right off the bat, I think.

TARULLO: But hold that for just a second because I want to ask you one question on his set of issues, and then I wanted—obviously, Bernanke is following a huge figure in monetary policy, probably the best central banker we’ve ever had. That’s decidedly a dual-edged sword, right? On the one hand, it makes it very easy for him to articulate an intention to have continuity in his policy, so it’s something for everybody to glom on to. On the other hand, the 18 1/2 years of credibility that Steve just mentioned is impossible for him to generate in any short-term period. Which of those factors do you think is going to weigh more heavily in the near term?

BLINDER (?): Well, the term “eclectic continuity.” I think we’re—here we are on the 31st of January, living through what I consider an incredible financial surprise in that the financial markets’ security blanket, the man who’s been there for 18 1/2 years, the unquestioned “capo”—what’s the rest of it?—anyway, the chief is about to walk out the door, as Steve said. A new guy—an academic, yet—is about to take over, and markets register their angst about things in two basic ways: volatility, which, when it gets really bad, can be actual gapping of prices, and in widening of risk premiums. So what are we seeing? Low volatility, incredibly low risk premium, with no evidence that they’re rising as the judgment day, February 1st, approaches.

Note that this is a known date. It’s not like they’re facing some defused uncertainty that someday Greenspan won’t be around anymore. But we know February 1st he won’t be around anymore. This is some combination, and the interesting thing is what are the rates between tremendous vote of confidence in Ben Bernanke, who’s going to step into the shoes of this titan, and confidence in the Federal Reserve as an institution; that is to say, when the big cheese walks out the door, we still have the Fed. It will still do more or less the same thing. You can still trust the Fed.

I don’t know which the weights are, but however the weighting actually goes, it’s very good. It’s a good augury for the near-term transition. Now we all know that something’s going to happen. And when that something happens—I don’t know what it’ll be—the market’s going turn its eyes to the new chairman of the Fed knowing that it’s not Alan Greenspan anymore. So just as Alan Greenspan got his baptism under fire in October of 1987, at some point—I hope Ben Bernanke will get more than three months to settle into the desk and learn how to use the phones before he gets hit with something like that. But at some point he’s going to be tested. I think he’ll pull through very, very well, and then the markets will say, “Aha,” you know, “We’ve got this new guy on the block. He’s awfully good.”

LIPSKY: Let me just add a couple notes on that. It seems to me that you can overly personalize these things. And that makes a good story, but when we take a look at financial markets, as Alan says, they’ve been extremely tranquil. And you take a step back and say, Well, look, core inflation has been roughly stable for the last three years, and 10-year Treasury bond yields have been in a range for the last three years, and corporate profits have grown—they’re at record highs that have grown as a share of GDP virtually in ever quarter over the last three years, and they’re now—profit margins and profit share of GDP at record highs. The stock market, in broad terms, has reflected that. And so in a way, you’d say: Well, maybe—maybe—the markets are actually focused on the fundamentals more than anything else.

MR. : Well, what about risky assets, John, that normally are normal—

LIPSKY: It’s not as if nothing has changed and people have just gotten crazy.

Now—

ROACH (?): But the point I just wanted to reiterate—what I started—is you have—all of that is true, both what Steve said and what John said, but we have this big event, the changing of the guard at the Federal Reserve—

LIPSKY (?): Right.

ROACH (?):—and there’s not an iota of evidence that this is upsetting, for example, these credit spreads, which are so narrow.

LIPSKY: And I would say why. Number one, in his confirmation, you had to wonder—to most folks, to most folks, I think, when the Fed revealed their long-term preferences last February on inflation, there were folks around Wall Street telling me the Fed wanted inflation higher; that inflation—core inflation, above 2 percent, was perfectly fine with the Fed. And the Fed told us, “Sorry, you’re wrong. That’s not our definition of price stability.”

Ben Bernanke got up in Congress and said, “My definition of price goals is 1 to 2 percent.” Okay. Completely consistent with Alan Greenspan.

Alan Greenspan has told us that he doesn’t think it’s the Fed’s job to be fooling around reacting to asset price movements, because it doesn’t know more about what’s right than does anybody else, and that following a paper by Ben Bernanke and—Bernanke presented at Jackson Hole—said if the Fed tried to react to asset prices, they’re just as likely to screw it up as to make things better. And he reiterated that in his confirmation hearings. If anything, he said he’s going to be less likely to enter into the political debate in terms of policy.

And finally, something that hasn’t been mentioned—this is a—Ben Bernanke has been a Fed governor, and he’s also been a little bit through the crucible. I think it was very useful that he gave a speech in May 2003 in which he talked about the risks of deflation and the power of nonconventional monetary policy that got folks on Wall Street jumping up and down, said, “The Fed’s going to do this,” got excited. And so I think Mr. Bernanke’s already had a real practical lesson that when you’re in the Fed, you got to be real careful about what you say.

TARULLO: Actually, that’s an excellent point. I think everybody who has been in the government in any sort of relatively senior position has seared on their memory the first time they said something and made news—(laughter)—because most of the time, they didn’t intend to make news with what they said.

MR. : Dan, it sounds like you’re speaking from personal experience.

TARULLO: Absolutely. (Laughter.)

MR. : Never happened to me. (Laughter.)

MR. : Yeah, right!

MR. : Watch it!

TARULLO: And the only good thing, Steve, was that the news I made was in Tokyo, when everybody here was asleep.

MR. : I got woken up! (Laughter.)

TARULLO: They—John’s mention of transparency and also of the relative personalization or depersonalization of monetary policy are good segues into the final topic we wanted to address, which is Ben Bernanke’s ideas about monetary policy-making. As John mentioned, for decades, I think it’s fair to say, he has been advocating more transparency in monetary policy-making, not here, but just around the world. He has authored or co-authored a number of academic papers; had a book five or six, seven years ago, called “Inflation Targeting,” which was a comparative study of experience in other advanced industrial countries and an advocacy for the U.S. moving in the direction of targeting.

So we want to ask what practical chance is there that there will be a palpable shift in the policies of the Fed along these lines, and if there are, how much difference it’s likely to make.

Before I pose those questions to Alan, let me just say a couple of things by way of common background. Bernanke has consistently made the point that the only thing the Fed can directly affect is the federal funds rate, which is not an interest rate that matters to very many people. It basically just matters to banks that have to get money overnight because of their reserve needs or clearing needs.

And so Bernanke has said the way in which we, meaning the Fed, can most efficaciously affect the long-term rates that matter to people—mortgages, medium-term investments and the like—is through a policy that gives assurance or more assurance to borrowers and lenders as to what those short-term interest rates will be out into the future. And that’s why he has become—and that’s why he’s says he’s become—such a proponent of transparency. Yes, he thinks in law professorial terms that it’s a good idea for democratic accountability to say what it is that you’re doing. But he really looks at this, I think, as an extension of Fed policy. It’s really a policy instrument itself, in addition to being just a good government measure.

Alan, I did notice, as we all did, that he explicitly embraced the idea of numerical inflation rate or range of inflation rate statements in his confirmation statement to the Banking Committee on November 15th, said that one possible step toward greater transparency would be for the FOMC to state explicitly the numerical inflation rate or range of inflation rates it considers to be consistent with the goal of long-term price stability, although he then went on to assure the committee that he would take no precipitate steps in the direction of quantifying the definition of long-run price stability but would instead commit it to further study.

BLINDER: Right.

TARULLO: What do you think his thinking about this is now—that is, his academic learning, leavened through the three years of experience on the Fed—and what would he have to do to change things?

BLINDER: Yeah. I think that, like Judaism, inflation targeting comes in reform, conservative and orthodox variants. (Laughter.) And while in that book that you referred to, and some of Ben’s other academic writing, he was something between conservative orthodox—he was never orthodox—something between conservative and orthodox, it’s very clear that while on the FOMC for three years, he migrated to reform inflation targeting. So what’s reform inflation targeting? Well, it’s about 16 millimeters away from what John described before, which is that instead of making people go to the footnote on page 39 of the semi-annual report to try to figure out what’s the Fed’s inflation target—because after all, if it says that’s where we think inflation will be two years from now, that’s probably where it wants it to be—the Fed will stop playing games and come out and say that, that either this is our target number, although we don’t expect to hit it to the decimal, or this is our target range. Bernanke, for example, has spoken of this comfort zone that’s a hundred basis points wide. And will simply say so, and that’s about it, that’s about all you need to be a reform inflation-targeter. Now, that does not make you Don Brash in New Zealand, or anything like that, or even Mervin King in England. But it’s—I think it is the step that he will take. I think he’ll take it relatively quickly, though not precipitately. As he said, what does that mean? The Fed staff will insist on studying this to death. They will produce a telephone-book-size study about whether the number should be 1.7 or 1.6, and whether it should be defined by the PCE deflator or the CPI or seven other choices and six other variants, none of which are very important. When that is done and a consensus is reached—and he’s a good consensus-builder on the FOMC, they will enunciate an inflation target very clearly. They will not play games anymore; there will be a very clear enunciation.

Now, what I left out, in that process there will also be some consultation with the Congress. There are members of Congress worried that—and it’s not a completely irrational worry, but I think Bernanke will be able to put the fear to rest easily—worried that giving this exalted numerical status to the inflation target will somehow denigrate the employment target, and the Fed, after all, does have a dual mandate from Congress. Bernanke has heavily endorsed the dual mandate; he will continue to do that. I believe the cost of the switch to inflation targeting—and by the way, I think they’d be wise not to use the name “inflation targeting”—

TARULLO: Can we call it now forecast-based monetary policy?

MR. : That’s always been the case.

BLINDER: No, we can simply call it greater transparency about what the Fed is doing. (Laughter.)

TARULLO: There’s a catchy title!

BLINDER: Less catchy titles are better sometimes!

He will have to constantly reaffirm the commitment of the Fed to high employment, which Greenspan has been loath to talk about. He has talked about it, but you see it much more in Greenspan’s actions than in his words. In the case of Bernanke, I think you’re going to see it more in the words as part of the process of eliding any political difficulty of making numerical the Fed’s price stability target.

ROACH: Dan, can I take the other side of the inflation targeting debate? I mean—

TARULLO: Yes. But I just want to ask Alan one brief question, and then you can take it.

ROACH: All right.

TARULLO: And the brief question, Alan, is, as you describe it that way, a sort of diluted form of inflation targeting, will, if implemented, it make that much difference either to the expectations, to market access?

BLINDER: No, I think a small difference. It’s another step down the road. If I took John’s little history back a little further, if you went back into 2003, when Bernanke also created all this stir about deflation and Greenspan said something about it then, it was a legitimate—I think markets were genuinely confused about a first-order question, which is does the Fed want inflation to go up or down relative to where we are today? Markets should never be confused about that. And that will take that confusion away.

TARULLO: Okay, Steve.

ROACH: Yeah, you know, this is a great debate that has a long history in economics, the debate between discretionary and rules-based policy. And it was the summer of 1978—I was on the staff of the Federal Reserve Board in Washington; new Fed Chairman G. William Miller came in to take over the Fed. He didn’t have a clue as to what to do. And he sat through—the Fed had sort of a biannual meeting of academic consultants where they bring consultants in from the outside to advice the Fed on policy. Milton Friedman was there and extremely aggressive and said that the Fed should basically get rid of the staff, get rid of most of the regional support staff and go purely to a mechanistic, rules-based monetary targeting regime. Period. End of story. And the other giants in the profession in that room, such as Paul Samuelson, Bob Solow, and others, took tremendous exception to Professor Friedman’s recommendation, and it was an extraordinary debate to be witness to. Today on the op ed piece of The Wall Street Journal, Milton Friedman threw in the towel on rules-based monetary policy, all these years later, and said that he never thought he’d say it, but, you know, discretionary policy is okay. Maybe it was the man, Greenspan, but I’m going to grant that, you know, that the history of the last 18 years said that he did a darn good job.

The U.S. right now is alone in major central banks in having this more eclectic approach. If I were to go back, if you were to ask me to identify Greenspan’s greatest strength, the eclectic approach would be it. I worry that if we get locked into a rules-based assault on a specific numeric target with respect to inflation, that we then deny ourselves the flexibility from time to time in dealing with other issues. An example of that right now, the ECB. They are caught between a rock and a hard place because all they know under their mandate is price targeting, and the European economy could be getting, and I think could be doing a much better job if they had a more eclectic approach to monetary policy—

TARULLO: But, Steve—Steve—the Friedman—the Friedman rationale for monetary policy roles was dominated by government failure, right; that he thought that any time the government had discretion they were going—

ROACH: That was a small part—

TARULLO:—they were going to screw up.

ROACH:—that was a small part of it, Dan. No, he really truly believed in stable velocity, in a constant relationship between the money supply and nominal GDP—

TARULLO: But regardless of what Friedman believed—regardless of what Friedman believed, the more recent—and by recent I think I mean 15 or 20 years worth of writing in this area—I think has been about what I introduced this question by saying, which is, how to increase transparency and let the markets get a better sense of what you’re doing. In that 1999 book, Bernanke said that he didn’t want a straitjacket. He kind of wanted a loose-fitting garment, I think, was the metaphor that he used, and he also said he thought that if you had that kind of approach, you could actually deviate from it when necessary because of an—

ROACH: Okay. But the counterfactual—the counterfactual response to that is, Dan, what’s wrong with what we’ve got now?

TARULLO: Well, I think—well, Alan—I should let Alan explain because Alan was the one who characterized this as an incremental rather than a watershed kind of—

BLINDER: I think what’s wrong—

ROACH: Didn’t you hire Ben Bernanke at Princeton?

BLINDER: I did. Yeah. (Laughter.) I was very proud of that—(laughter)—and still am.

What’s wrong is not so much wrong anymore as it used to be. If you went back to the dark ages—the `90s, which in Federal Reserve transparency is the dark ages—the Fed wasn’t saying boo to anybody. Let me give you an example which I think you will remember. I recall being on board in `94-`95 when we were tightening interest rates—raising interest rates from 3, it turned out, to 6. There was a period of time when market expectations, where we were headed to 7.5 to 8, and bonds were priced accordingly. And I can tell you that inside the FOMC, even the most hawkish member thought that was way out of line with where we were going. That was—I was not the most hawkish member, but even the most hawkish never thought we were going to 8 percent, but this was in the market’s head.

These kind of things don’t happen anymore because the Fed is much more transparent. But I think the way you want to think about this is not at all stepping into a straitjacket, it’s as Dan said. The notion is to try to anchor long-term—long-term—inflation expectations around the target, and one professed benefit of that is it gives you greater short-term flexibility to react to crises, such as the Fed did in 1998 when there was no reason for domestic purposes to lower interest rates. In fact, if you remember, people were afraid we were overheating at that time, but the Fed did it, I believe, for extraneous reasons.

So I want to go back to what John and I sort of jointly said. This is not stepping off a cliff into the unknown. It’s one more incremental step down the road that the Fed has been traveling since 1994, and I think it should keep on traveling down that road.

ROACH: If I could just add a couple of—

TARULLO: Just do it quickly, and then—

ROACH: First of all, it strikes me that the—this debate rules versus discretion can get way overdone in the current context, and if you want to look at the state of the debate with regard to monetary policy and the legacy of Alan Greenspan and Ben Bernanke’s likely position, there’s no better source: go to the website of the Kansas City Federal Reserve, go to the Jackson Hall Symposium, look at a wonderful paper by Alan Blinder about the Greenspan legacy, and look at the commentary by John Taylor of Stanford University. Alan said that the secret of Alan Greenspan’s success remains a secret, and—(laughter)—and John Taylor said, “Excuse me. Actually, it’s quite straightforward and structured. And you can elaborate the principles that Greenspan operates, and you would find that that discussion is a very genteel one and that it does not describe apocalyptic difference of opinion.” And it strikes me—

TARULLO: Okay.

ROACH:—let me just add one thing, because I think we’ve missed a little bit—this is sounding that—this discussion has been a little bloodless and a little too sanguine, because—and I think—

TARULLO: I don’t know what’s wrong with Roach today.

ROACH: (Laughs, laughter)—because—

MR. : I can’t get a word in edgewise. (Laughter.)

MR. : Now, Steve—

ROACH: If I can get to the point, just very quickly. Look, let’s assume that there is macro success in the sense that the Federal Reserve is successful in—in hitting its targets, if you will.

Inflation 1 to 2 percent, growth 3.5 to 4 percent sound awfully good. We would celebrate the continuation of that success. I tell you that even if that happens, it is going to be accompanied by a much slower growth in household net worth than in the past decade, much slower rise in asset prices than in the past decade, much slower growth in consumption spending than in the last decade. And if the economy is going to reach potential, it will have to be because of stronger growth in business spending and an increase in net exports.

In other words, this is not going to be just steady as she goes even if the macro variables are. Furthermore, the test for the Fed is going to be how to know the maneuvers in a situation in which there are a lot of sectoral pressures in the economy and a lot of folks who said, “Gee, I was doing better before and I’m not doing as well now because my asset prices aren’t going up like they were.”

And finally, the Fed itself is going to be confronted by—look what’s happened. Folks who warned about inflation, inflation, inflation are starting to realize in a globalized economy manufacturing prices are set globally, not locally, and what we’re also finding out is we don’t have a very good handle on what represents full employment in this economy, and yet those are the cutting-edge kind of decisions that the Fed is going to have to act upon in the next few years.

So I think there’s going to be plenty of challenge in being transparent and understanding what the right thing to do is going to be.

TARULLO: Okay. We do have time for a few questions. This discussion was so good that we went a little longer than normal. When I recognize you, please, A, stand up; B, wait for the microphone; and C, say who you are before you ask your question.

Yes, right here.

QUESTIONER: I’m Scott Pardee. I’m a professor of economics at Middlebury College. I also worked at the Fed, like many of you here. When I do retire, I expect to be getting a check every month from the Fed. And I think several of you will feel the same way. What about Don Cowan (sp)? What about Jerry Corrigan (sp)? What about Bill McDonough (sp)? What about Jack Guinn (sp), who had to handle the question of getting cash to people after Katrina?

There are a lot of good people at the Fed. Why do we have to sit through, over and over and over again, conversations, even among people who know better, that it’s just the chairman?

TARULLO: (Inaudible). (Laughter.) Alan, you were not the chairman—

BLINDER: I was not. I was “the other Alan” when I was there. (Laughter.)

MR. : The answer, Scott, is, yes, there are a lot of good people at the Fed doing lots of things. You mentioned, for example, disbursing the cash in areas in instances of emergency. That’s not what we were talking about. We were talking about sort of the strategy of monetary policy. And the fact is that the Fed has always—I guess with the exception of the William Miller interlude, which didn’t last very long—always been a chairman-dominated organization. Arthur Burns was dominant, Paul Volcker was dominant, McChesney Martin was dominant. And I think no one’s ever been as dominant as Alan Greenspan, and I think that’s the basic reason that we’re focused on the change in chairmen.

TARULLO: And there’s a corollary to that, which is that it’s conceivable that Bernanke will try to adopt a lower profile and will try to involve the rest of the board more than Greenspan.

MR. : I believe he will. I believe he will.

TARULLO: Next question. Yes, ma’am, right there. Wait for the mike, please.

QUESTIONER: Ricki Tigert Helfer, Financial Regulation and Reform International. Alan, I want to test your thesis about the importance of a specific target by pointing to a few factors. One, can you imagine the sorry spectacle of U.S. senators trying to debate whether 1.6 is the right number, 1.7 or 1.8? As somebody who had to testify before them almost 30 times, I think it’s going to trivialize—potentially trivialize the target.

Secondly, haven’t you forgotten the importance of group dynamics? Alan Greenspan of all people will say that he valued enormously the kind of information he got constantly from Fed staff, from others as well, and in the discussions of the FOMC and other discussions. And I think he would say, as I’ve heard him say, that it’s important to have those as a way of testing the theses that one has.

And finally, since Alan also has said and does say that the Fed can affect policy through monetary policy only at the margins, and therefore I think he thinks he has a somewhat wider margin for affecting it if he has a little bit of wiggle room; that maybe he’s right and you’re wrong?

TARULLO: Yeah. Another way of translating that question, why is Greenspan not for what Bernanke is probably for.

BLINDER (?): The inflation target.

TARULLO: Yeah.

BLINDER (?): All right. Let me try to work backwards through your questions there. You’ll have to remind me what the first one was.

TARULLO: The senators.

BLINDER (?): Greenspan is against this for a very simple reason. He—Bernanke has described inflation targeting as constrained discretion. That means some long-run constraint on the pure exercise of moment-by-moment discretion. This is exactly what Greenspan never wanted. Not the slightest constraint on either his strategic or tactical discretion. And that’s the one and only reason why he’s been dead-set against it all this time.

The first question was—first of all, I don’t imagine there being congressional hearings on this. It’s not a change in the law. Maybe I’ll be wrong and there will be. What I imagine is consultations with the Congress, with the relevant committees, especially, in the House and the Senate. Those conversations, as you say, Ricki, are not going to be over whether the number is 1.6 or 1.7. And they don’t know what the PCE deflator is anyway. (Laughter.).

And it’s not important that they do. We got a lot worse shortcomings than the Congress than that they don’t know what the PCE deflator is. (Laughter.)

What they’re going to be over is, is the move to inflation targeting or whatever the Fed decides to call it, an abnegation of the Fed’s dual mandate of a downgrading of the importance of unemployment, which nowadays is a bipartisan concern. Way back when, when I was a child in this profession, it used to be Democrats that were worried about that, and Republicans that didn’t. Now it’s completely bipartisan. They both do. And you had a middle class which is now forgotten. What was the middle one?

MR. : I think it was variant and why Greenspan is—

MR. : By the way, if you want to get a succinct vision of Chairman Greenspan’s view on this, at his introductory remarks at the Jackson Hall symposium three years ago, if I could summarize it, his position is, “Inflation targeting is for sissies. (Laughter.) And if you don’t have credibility, I can see why you might want to use this to get it, but if you’ve already got it, why would you want to bother?” And comment by Professor Ben Bernanke in the audience stepped up and said, “But of course we’re talking about the post-Greenspan era.” (Laughter.)

TARULLO: Okay. Yes, ma’am, right there. Yep. No, no, a little further back. There you go.

QUESTIONER: I’m Moshibe Connor (sp). I’m an attorney.

I just had a question to Mr. John Lipsky. You speak about globalization, and then I’m wondering what effects increasing disparity in income, particularly in emerging markets, will have on the world economic situation. And as well as what do you know that we don’t know that makes you think the U.S. savings rate will go up? (Laughter.)

MR. : All right! Well, resources of JPMorgan Chase. (Laughter.)

LIPSKY: No, this is easy. I’ll contest the premise of your first remark. If globalization—the hallmark of globalization has been the emergence of emerging Asia, which then the rapid growth in emerging Asia has been the greatest, most effective anti-poverty program ever devised in the history of the world, and let’s keep it going. And globalization is not inherently worsening distribution of income and wealth; to the contrary.

Second, why is the savings rate going up? Ask yourself why the savings rate went down in the U.S. Somehow there’s a premise that everybody was stupid. But normally you think of people who save too little as becoming poor. But in the United States, household net worth is at record highs. So why—it seems pretty straightforward. The reason why the savings rate went down is because net worth went up faster than people thought. Why did it go up faster? Because inflation fell unexpectedly, and with it came a decline in real and nominal long-term interest rates that raised the value of long, live assets. At the same time, there was an unexpected surge of productivity that made us recognize that we’re living in an economy that has the potential to grow 3 1/2 to 4 percent a year, not 2 to 2 1/4 percent a year. That was the conventional wisdom only a few years ago. So folks feeling richer unexpectedly lowered their savings rate.

Look forward, now run the tape forward. Is inflation going to continue to fall? And the answer is no. So are interest rates going to continue to fall? The answer is no. Is productivity going to continue to accelerate? Well, it’d be wonderful if it is, but I think that would be pretty amazing. So let’s assume at best that it’ll stay stable. So as a result, you’re not going to see the rise in household net worth at the same pace and you’re going to see a renormalization of the savings rate, and I don’t think it even takes—as I said at the outset, if policymakers do something to screw it up, i.e., run high inflation, they’re only likely to accelerate that process. So I think this one’s baked in the cake, and I don’t think that policy has that much to do with it.

But—and parenthetically—there’s a conventional wisdom that the rise in household net worth is a result of the housing bubble—first of all, forget whether there’s a bubble or not a bubble. The facts are that the 80 percent of the rise in household net worth over the past few decades has come from sources other than home ownership. It has come from ownership of financial assets, of private proprietorships, of private equity. It’s because homes are basically levered, and so even though they provide good rates or return to individuals, to households, they don’t explain most of the growth in net worth.

Too easy.

TARULLO: Okay. We’re out of time. Thanks to the panel. Thanks to you. See you next time. (Applause.)

 

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