Richard Clarida discusses the U.S. economy and the challenges facing the U.S. Federal Reserve.
The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.
IP: Good morning. Welcome to today’s Council on Foreign Relations C. Peter McColough Series on International Economics with Richard Clarida. I’m Greg Ip. I’m the chief economics commentator of the Wall Street Journal, and I’ll be presiding over today’s discussion.
I’d like to welcome to the stage Richard Clarida, vice chairman of the Board of the Governors of the Federal Reserve System. I’ve known Rich for almost twenty years now, and I feel very fortunate having known him all those years. He’s been a public servant, a scholar. He’s been helpful to me personally in helping understand and follow some of the key economic issues. What many of you may not realize, if you’re not steeped in this kind of stuff the way I am, is how much of a pillar of modern macro Rich really is. Anybody who reads a contemporary article about monetary policy, especially with an international dimension, flip to the bibliography and you’ll see at least several entries of Richard Clarida’s name there.
Rich joined Columbia—Columbia’s economic faculty in 1988. Before that he had a short stint on the Council of Economic Advisors. But his next service in public—his next stint in public service was in the George W. Bush administration in the early 2000s, when he was assistant secretary for economic policy. That’s when I first got to know Rich. After that, he went to work for PIMCO as a managing director and as a sort of in-house economic guru from 2006 to 2018, when he became vice chairman of the Federal Reserve. And so you always need to listen carefully to everything Rich says because not only does it carry the weight of being a monetary policymaker but is steeped it really the frontier of what we know about monetary economics.
So, Rich, please come on us and thanks for coming.
CLARIDA: Well, thank you for the opportunity to join you bright and early on this January Thursday morning. As some of you may know, I am a longtime member of the Council on Foreign Relations and have attended and participated in many of these events over the past twenty years. In fact, Les Gelb brought me in, and I’m forever grateful. Although, I will point out that in my previous visits to the podium I was in the somewhat less demanding position of asking the questions rather than answering them. I’m really looking forward to this conversation and the Q&A. But before I sit down with Greg, I would like to first share with you some thoughts about the outlook for the U.S. economy and for monetary policy.
The U.S. economy begins the year 2020 in a good place. The unemployment rate is at a fifty-year low, inflation is close to our 2 percent objective, GDP growth is solid, and the FOMC’s baseline outlook is for a continuation of this performance in 2020. At present, PCE inflation is running somewhat below our 2 percent objective, but we project that under appropriate monetary policy inflation will rise gradually to our symmetric 2 percent objective. Although the unemployment rate is at a 50-year low, wages are rising broadly in line with productivity growth and underlying inflation. And we are not seeing any evidence to date that a strong labor market is putting excessive cost-push pressure on price inflation.
Committee projections for the U.S. economy are similar to our projections at this time one year ago, but over the course of 2019, the committee shifted the stance of U.S. monetary policy to offset some significant global growth headwinds and global disinflationary pressures. In 2019, sluggish growth abroad and global developments weighed on investment, exports, and manufacturing, although there are some indications that headwinds to global growth may be beginning to abate. U.S. inflation remains muted. PCE inflation running at 1.5 percent, and core PCE inflation was running at 1.6 percent through November, the most recent data. Moreover, inflation expectations, measured by both surveys and market prices, have moved lower and reside at the low end of a range that I, myself, consider consistent with our price-stability mandate.
The shift in the stance of monetary policy that we undertook in 2019 was, I believe, well timed and has been providing support to the economy and helping to keep the U.S. outlook on track. I believe that monetary policy is in a good place and should continue to support sustained growth, a strong labor market, and inflation running close to our symmetric 2 percent objective. As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy likely will remain appropriate.
Looking ahead, monetary policy is not on a preset course. The Committee will proceed on a meeting-by-meeting basis and will be monitoring the effects of our recent policy actions along with other information bearing on the outlook as we assess the appropriate path of the target range for the federal funds rate. Of course, if developments emerge that in the future, trigger a material reassessment of our outlook we will respond accordingly.
In January of 2019, my FOMC colleagues and I affirmed that we aim to operate with an ample level of bank reserves in the U.S. financial system. And in October, we announced and began to implement a program to address pressures in repo markets that became evident in September. To that end, we have been purchasing T-bills and conducting both overnight and term repo operations, and these efforts were successful in relieving pressures in the repo markets over the year end.
As we enter 2020, let me emphasize that we stand ready to adjust the details of this program as appropriate and in line with our goal, which is to keep the federal funds rate in the target range desired by the FOMC. As the minutes of the December FOMC meeting suggest, it may be appropriate to gradually transition away from active repo operations this year as treasury bill purchases supply a larger base of reserves, though some repo operations may be needed at least through April, when tax payments will sharply reduce reserve levels.
Finally, before I sit down with Greg, allow me to offer a few words about the committee’s review of our strategy, tools, and communication practices that we commenced in February of 2019. This review—with public engagement unprecedented for the Federal Reserve—is the first of its kind. Through fourteen Fed Listens events, including an academic conference in Chicago, we have been hearing a range of perspectives not only from academics, but also from representatives of consumer, labor, community, business, and other groups. We are drawing on these insights as we assess how best to achieve and maintain maximum employment and price stability. In July of 2019, we began discussing topics associated with the review at our regularly scheduled committee meetings. And we will continue reporting on our discussions in the minutes and will share our conclusions with the public when we conclude the review later this year.
Thank you very much for your time and attention, and I look forward to my conversation with Greg and the Q&A session to follow.
IP: Thanks very much, Rich. The committee’s last meeting was December 11th. At the time your colleagues had a consensus forecast of growth of about 2 percent for the year 2020. A month later, how does that look to you?
CLARIDA: I don’t think our view has really changed so much. Of course, we’ll have a meeting at the end of this month and get extensive staff updates. But I think we enter 2020 with the economy growing roughly at trend pace, obviously a very strong labor market, as I indicated. As I mentioned in my opening remarks, Greg, I do think that relative to where we were, say, in the summer and the fall the downside risk to the global outlook has maybe diminished a bit. And there are some early signs that maybe the decline in global growth is bottoming out. But, again, our baseline projection is really, for 2020, in terms of GDP growth, unemployment, and inflation to be pretty similar to last year—with the proviso that we certainly are focused, and indeed very focused, on getting the underlying rate of inflation in the economy back up to our 2 percent objective. And we do see that beginning to play out this year.
IP: Let’s talk about inflation for a moment. The fed has symmetric target of 2 percent inflation. Yet, for almost a decade now it has consistently undershot that target. Why is that, and how worrisome is it?
CLARIDA: Well, let’s talk about why it’s been happening and talk about how worrying it is. Through much of that period obviously the U.S. economy was still recovering from the global financial crisis and recession and unemployment was elevated. So I guess it’s not surprising then that at least the first half of that period maybe inflation was running a bit below our objective. But more recently you are correct that even as we’ve approached traditional estimates of full employment and full capacity, inflation on average has been running a bit below our objective. And that surprised us, and that surprised private forecasters. I would remind you that a year ago—indeed, I arrived at the Fed in September of 2018—and at that point, when I arrived, core inflation was actually running at our 2 percent objective. And so we have achieved 2 percent.
But I think what we’ve realized since I arrived at the Fed in the last fifteen months is that the global disinflationary pressures, which I referred to, are very powerful forces. And policy needs to factor that in and setting policy to get inflation up to the objective. Obviously in Europe, and in Japan, and in many other developed economies that’s been a common theme of the last several years. And so recognizing that challenge we definitely want to have the right policies in place.
IP: So when you look ahead to the next year, how do you see the risks around inflation? Do you think that we’re more likely to have inflation moving up close to target, or are you actually more concerned about risks continuing to move away from target, below?
CLARIDA: So I think we want to distinguish between the baseline view and the risks around that view. I think our and the private sector forecasters’ baseline view is for core measures of inflation to begin to move up towards 2 percent. But I would be honest in confessing that if there is a risk to that outlook, it’s skewed to the downside. Indeed, in our summary of economic projects, and we release the details of that with the minutes recently, you’ll see we actually ask participants four times a year relative to their baseline view are the risks to inflation and output and employment to the downside or to the upside. And the skew of that distribution on the committee is to the downside.
IP: How should policy—your policy stance adjust to those risks? Is policy appropriate as it is now given where you see those risks? If those risks materialize, should policy adjust?
CLARIDA: Well, we do think policy is appropriate now. Let’s talk a little bit about the 2019 decisions. Just to remind you, in July, September and October meetings we decided to lower the federal funds rate target range by twenty-five basis points. So for a total of seventy-five basis points. And as we indicated then, and certainly very relevant to me, one of the very important reasons to undertake that adjustment was that we have these metered inflation pressures and we wanted to try to offset them. Monetary policy operations with a lag Milton Freidman taught us, certainly a long and possibly a variable lag. And so we do think right now that policy is in a good place. But as we’ve said, you know, policy is not on a preset course. And if there is a material change in our outlook, we will respond accordingly.
IP: But realistically, if inflation continues to undershoot the target, or even move further away from the target, is there much that the Fed can do about that?
CLARIDA: Yeah. Well, we do. We think we do have the tools that will be able to achieve that objective. We need to be nimble and we need to be alert not only to U.S., but global circumstances. As I said, these policies were just put in place. We’ve actually seen some indications, for example, if you look at the inflation index bond markets, some pickup in break-even inflation and in survey measures. And so we do think that policy is appropriate and, under our baseline outlook, will continue to be appropriate.
IP: Do you think it’s possible that the risks to—you know, the divine coincidence, as they say in economics, was that full employment was consistent with stable inflation at target. But are we seeing a breakdown of that, to the extent that in the coming year you could have no risks to growth, and yet continued downside risks to inflation?
CLARIDA: Again, I think that is a risk case. And we’re certainly alert to that. But that is not our baseline view. I think this gives me an opportunity, Greg, to talk a little bit about really the remarkable developments in the U.S. labor market. You know, unemployment is at a fifty-year low. And yet, as I indicated in my opening remarks, we do not see excessive cost-push pressure coming from the labor market. And we need to be humble in the precision of our understanding of full employment. The committee consistently over the past eight years has revised down its view of what we call U-star, the rate of unemployment consistent with full employment. My personal estimate is 4 percent. And that could easily be lower. And so I think the committee has exhibited an attention to the data. And as the data has shown, that the economy can operate with lower unemployment than we might have thought several years ago, we are factoring that into policy. And that’s a very—that’s a very good thing.
IP: I think the other thing the committee has adjusted is its view on the neutral interest rate. The neutral rate, of course, the one that’s consistent with full employment and stable inflation. When you arrived I think the committee’s consensus view was that it was around 3 percent nominal, 1 percent in real terms. It seems to have come down a lot. Where is neutral now, and what are the unusual forces that are causing neutral to be so much lower than in the past?
CLARIDA: Yeah. A great—a great question. And one certainly, as you know, I spent a lot of time thinking about both before and since I arrived at the—at the Fed. So I do think there’s a new neutral globally. Before the crisis, if you look at empirical estimates, the U.S., Europe, U.K. were operating with interest rates that were about 2 percent plus inflation—so, say, in the range of 4-5 (percent) neutral nominal rates. And I believe for some time, going back to 2014, that neutral for the U.S. is in the range of 2-3 not 4-5 (percent). So why is that? You are correct that the committee—the median—so we’re all into distributions at the Fed. So the median participant believes that the longer-run neutral rate is 2 ½ percent. When that question was first asked of the committee in 2012, every participant thought the neutral rate was above 4 percent. So over the last eight years there’s a dramatic decline.
And again, that just reflects the fact that what we would expect to see in the economy with a higher neutral rate just does not materialize. So we revised that down. So the question is, why is neutral lower? And I think the important thing for folks here to understand is there’s a substantial common global component to neutral rates, both as a matter of economic theory and what we observe in the data. So it’s not a coincidence that the ECB’s estimate of neutral and the Bank of England’s estimate of neutral, and the BOJ’s have all declined. They’ve declined because we have an integrated global capital market. What has happened? We have a global slowdown in productivity growth. We have aging demographics that create a demand for safe riskless assets. We have changes in the financial system that create a demand for safe, riskless assets.
When you add all that together in an integrated global capital market, all those forces together are pushing down neutral rates. Now, our estimates are imprecise. There are standard error bands around them. But I think it’s really indisputable that neutral rates globally are lower. And that’s an important fact of life for central banks.
IP: Does this mean that even if U.S. economic data and fundamentals seem to be improving that what the Fed can do is somewhat constrained by events abroad, and that the U.S. neutral rate might have to remain low even if the fundamentals that typically determine that, like growth in unemployment and inflation, would otherwise call for a higher rate?
CLARIDA: Yeah. I guess I would phrase it a bit differently. I would say we need to respect that there’s a global component to this, and we need to factor that into our calculation. I’ll state right now, I don’t think we are constrained now. We have the policy that we want in place. But that policy reflects obviously—the fact that the funds rate range is 1 ½ to 1 ¾ (percent) is reflecting that downshift in neutral. But I do think, Greg, that relative to where, for example, the situation confronted by the ECB or Japan, it’s important to note that under, you know, Ben and Chair Yellen, and continuing under Chair Powell, the U.S. has been able to move away from the zero bound, to get interest rates up. And we certainly have the capacity to use the policy instrument, whereas perhaps other central banks don’t. And it’s also important to remember that.
IP: So in late 2018, as the committee was moving to normalize interest rates—this was around the time you came on board—we also saw a fairly substantial tightening in global financial conditions and a strengthening of the dollar. And as you know, the committee changed course, altered its bias, and then you’ve talked about the reduction in rates that happened last year. Well, were those events in 2018 perhaps evidence that the U.S. had started to move a bit further than the global neutral rate would have recommended?
CLARIDA: Well, certainly about that I would—I would point out a couple things. The first is, we ended up in December of 2018 moving up the target range for the federal funds rate to 2 ½ percent, which at the time, and to this day, was the committee—the lower end of the committee’s estimate of neutral. So I think the way to look at that cycle, and Chair Yellen said this at the time. And as a Fed watcher I complimented her for it. You know, most of the period of 2015 through 2018, the Fed was really not running a tight policy. It was removing accommodation. And really, only in September of 2018 did the funds rate move above the underlying rate of inflation. I see Mickey here. You know, we certainly think a funds rate below inflation is typically—
IP: September 2015 or September of 2018?
CLARIDA: Well, in September 2018, I misspoke, we moved the funds rate above inflation. So I think a fair reading of that—of that period was really a period of policy normalization, not to be running necessarily a tight policy but to get policy up to neutral with 3 percent growth and a fifty-year low of unemployment.
So what changed in 2019? Well, I think several factors changed. The first is that the global economy slowed a lot more than we and others projected. Underlying trends in inflation indicated that we were not staying at our 2 percent rate of inflation. And as I mentioned, we kept getting good news in the labor market that indicated that we needed to respect the real possibility that the labor market could operate with a lower rate of unemployment than we might have previously thought. And so those factors together, along with these muted global inflation pressures, persuaded a majority of the committee, and certainly myself and the others who voted for it, that was appropriate to provide some adjustment at this point in the business cycle.
And of course as you know, Greg, because you were covering it at the time, you know, this is something that’s not—this is basically textbook monetary policy. Chair Greenspan in ’95, for example, after hiking rates went through a period in which rates were adjusted by seventy-five basis points. And the expansion continued for another five years. And so I think, in sum, we felt that in 2018 we were getting policy up into the neighborhood of neutral, and then as the global economy slowed and inflation proved to be more muted than we forecasted, we adjusted.
IP: One of your—well, a staff economist at the Fed, Michael Kiley, recently put out a staff paper which, as we all know, does not necessarily represent the views of the Federal Open Market Committee. But he addressed this question of what has been a global factor in the U.S. neutral rate. And the bottom line was that using a variety of models he suggested that using U.S. factors alone, the real neutral funds rate was around zero, which is to say around 2 percent nominal. But when you actually add these global factors, it was negative 1, or 1 percent nominal. What do you think of those estimates? Does that sound, you know, directionally about right?
CLARIDA: That seems low to me. I have enormous response for Mike. He’s one our top researchers. Again, as you mentioned, those are not the views of the committee or the board of governors. But this is very solid research. And I think it indicates there are a range of estimates, and we need to be attuned to that. But, no, those particular numbers do seem low to me.
IP: But even if the levels are, perhaps, you know, not where you are, but as a contribution—which is basically, global factors have reduced the neutral rate by about a full percentage point in the United States. Does that sound about—would you be—does that sound about right to you?
CLARIDA: Let me—let me get a little bit academic here. I think there are different concepts of neutral floating around. I like to focus on the longer-run concept, where do you think the neutral rate will end up after cycle plays out? And I’ve not changed my view on that. My dot has not moved since I got to the Fed. I’m not—as vice chair, I’m not allowed to reveal which one it is, but it has not—(laughs)—but it has not moved. And but certainly there’s a related concept, which is the short-run neutral. And that can move around for a variety of reasons, including global developments and policy.
I think that to me—frankly, Greg, that’s a less useful concept, because in the academic literature, to which I contributed, you can attribute almost any movement of policy rate to neutral. And that’s a little bit of a—a little bit of a stretch. So let’s just say my long-run estimate of neutral remains unchanged. But I would say, in that context, that policy is now providing some accommodation. We are running a rate that’s below our estimate of neutral and my estimate of neutral.
IP: OK. Let’s talk a little bit about what you’re going to do going forward. I know that you mentioned you have this framework review, which is all about seeing whether you have the tools and the framework necessary for dealing with macroeconomic challenges. You know, the former Federal Reserve Chairman Ben Bernanke gave a talk this past weekend in San Diego, where he talked about the extent to which new tools like quantitative easing and forward guidance can supplement the interest rate going forward. And he estimated that quantitative easing and forward guidance can contribute 3 percentage points equivalent to three percentage points of ease. So if the neutral rate is, say, 2 ½ (percent), then that’s like having 5 ½ (percentage) points of monetary ammunition. What do you think of those estimates? I mean, that would suggest that there is—that the Fed doesn’t really have to worry about running out of ammunition and hitting the zero lower bound.
CLARIDA: OK, well a couple of things. I certainly have read Ben’s paper. I read everything that he does. And I’d like to say, first, I think an important benefit of not only Ben’s paper, but similar analysis that we’re doing, is to focus attention on the fact that tools such as forward guidance and quantitative easing should not be viewed as exotic. They—we have said they will be part of our toolkit in the next downturn. And I think one of the contributions of Ben’s paper was to provide some quantification of perhaps the value that those tools can play. I think there are a range of estimates there, so I wouldn’t necessarily endorse the particular number in Ben’s paper, but certainly we’ve said we can adjust the policy rate. I, myself, believe that forward guidance under appropriate circumstances can be a very powerful tool in the—in the toolkit. And there are different flavors and different ways to implement forward guidance.
What I would say on quantitative easing, and I gave a speech at the Swiss national bank in November where I elaborated on this point, I’m in the camp that think that the quantitative easing programs put in place during the crisis were effective and did have an effect on easing financial conditions. But the estimates are imprecise. And moreover, I think on a going-forward basis what I need to think about is whether or not an application of these—of this quantitative easing tool could be expected to deliver, you know, the same bang for basis point. And it may well be the case, that was Ben’s argument in his paper. But the law of diminishing returns is a very powerful force in economics. And so we also have to be concerned that it may also apply to quantitative easing as well. So I think Ben’s paper is a very valuable contribution, but I wouldn’t necessarily endorse the particular numerical estimate.
The other important point, since you mentioned it, is Ben emphasizes that his outlook, based on that paper, is predicated on assumption that going into the next recession that the underlying neutral rate will be, say, in the 2-3 percent range. And he argues that if going into the next recession it’s not, then you actually don’t have as much space. So that’s an important factor as well.
IP: And are there reasons to think that in fact it will actually be dropping going into the next recessions for either U.S. or global reasons?
CLARIDA: Well, that would—again, we don’t have a crystal ball and we don’t think a recession’s imminent. But if history is any guide, you know, typical estimates of neutral do tend to begin to shift down going into a severe downturn. So that’s certainly a risk.
IP: And is the next downturn likely to be global, and therefore all those global factors will be playing a part?
CLARIDA: Well, again, no crystal ball, but the reality is there is a global cycle. You know, it’s a little bit—it looks a little bit different than it did thirty years ago because of the huge role of China, both in size and growth rate. But there is a global cycle. And certainly I think—you know, up at Columbia when I teach my course, I talk about the small economy in recession, and everybody else. But in reality, there is a global component. And the risk—you see Benn Steil here—the risk globally is when you have all the major economies going down together, it makes it difficult for any one economy to use any given set of tools. That doesn’t mean you don’t use them and you can’t be effective, but it does impact the appropriate policy.
IP: So you and your foreign colleagues will certainly have your work cut out for you if and when the next cycle turns.
All right, I think we have some time now to turn to questions and answers. So if you—we have people with microphones in the audience. If you raise your hand, we’ll get you a microphone. Please, a reminder that this is on the record. Please state your name. I would ask the member to state your name before you ask a question.
And I think, Fred, I saw your hand up there.
Q: Fred Hochberg.
A question. Around the world, certainly in this country but elsewhere, legislatures have very little leverage or flexibility on fiscal policy, whether it’s raising bus fares in place—or gas prices in Chile, and so forth, which puts more and more on central banks. So it seems that globally we’re going to be relying on central banks to really steer the economy. And do you really have the tools to do that without a fiscal or legislative partner?
CLARIDA: It’s an excellent question. And I do believe that obviously in a downturn textbooks would indicate, and I think experience would confirm, that it’s desirable to have both fiscal and monetary policy working together, and in the same direction. Again, not forecasting a downturn, but certainly generically in a downturn you would want both policies to be operating together. Obviously, you know, we don’t—we don’t weigh in on fiscal policy in the details, but certainly your general point is one that we would—that we would agree with.
IP: Over here.
Q: Paul Sheard, Harvard Kennedy School.
CLARIDA: Hi, Paul.
Q: Hi, Rich. Thanks very much for your talk this morning.
Maybe an extension, push that first question a little bit further, pivoting back to the review that you’re undertaking of the tools, strategy, communication which has been going on for quite a long time. It sounds like it’ll be a little bit longer before it comes out. But in the context of that review you’ve done this listening tour, fourteen events, taking a lot of inputs, a lot of outreach. Have you had any dialogue or taken any input formally or informally from the relevant parties in the administration or the Congress, particularly apropos of the point that perhaps in a downturn in the future there will need to be better coordination between monetary and fiscal policy?
CLARIDA: Well, just state that the current Fed, like all Feds, has had regular conversations with other policymakers. I won’t go into any of those—any of those details, but speaking specifically about the review, the review is about monetary policy. The review is not about making recommendations for fiscal policy. We have a mandate assigned to us by Congress, which is to run a monetary policy to sustain maximum employment and price stability. Obviously appropriate policy will need to factor in, realized in projections of fiscal policy. But let me be very clear and on the record, our review is not looking at fiscal policy options. That’s not what this is about.
IP: Question here.
Q: Thank you. Juan Ocampo.
Richard, you mentioned there is a number of observations that have kind of gone from—deviated from prior trend, like unemployment and so forth. One that also seems to be kind of behaving differently is the business cycle itself. The one that we’re in right now is very long in the tooth, but it seems to, you know, be pretty frisky. Is that something you guys are looking into, and kind of thinking maybe that’s changed in a major way?
CLARIDA: Excellent point. So in July of 2019 the current economic expansion, as dated by the National Bureau of Economic Research, because the longest in the—in the U.S. data, which I think goes back to the 1850s. So there may have been a longer expansion in 1821, but we don’t know about it. But—and you are correct. You know, there’s an old saying, expansions don’t die of old age. And certainly this expansion appears to be—to be very robust.
I pointed out on several occasions, you know, consumption’s 70 percent of the economy. In my professional career, the U.S. consumer in the aggregate has never been in better shape. You’ve got solid income growth. Households, unlike other parts of the economy, the household sector deleveraged substantially. Obviously strong labor market, wage growth. The savings rate is at a twenty-year high, which I view as a positive because that means households in the aggregate are not over-extended. So I think that’s a very positive development. The financial system is much better capitalized. Obviously large banks are subjected to significant stress analyses. And so, you know, broadly speaking, I would reject any suggestion that just because the expansion’s in year eleven, you know, it’s about to end. Again, you know, we get paid to think about downside risk and put in place appropriate policies, but there is no reason whatsoever to think that this expansion cannot continue.
IP: OK. Back there by the pillar.
Q: Hi, Rich. Joyce Chang from JPMorgan.
CLARIDA: Hi, Joyce.
Q: Good to see you. And thanks for your comments.
As part of the policy review, are you considering more flexibility with the average inflation target, given the downside risks that you’ve highlighted? Thank you.
CLARIDA: Well, the short answer is, yes, we are considering it. Our current framework would be referred to generically as flexible inflation targeting, which we share with most of the central banks in the world. And under flexible inflation targeting, what you try to do at every point in time is to get inflation to your—to your target, regardless of how you got there. So a close cousin by a different approach to monetary policy is some version of average inflation targeting, where you set policy based upon the path that it takes to get there. So, for example, under average inflation targeting if you spent a number of years below your target you would try to run a policy that would seek to spend some time above the target.
And let me explain why that’s potentially important. It’s important because in a world in which neutral rates are low, that Greg and I discussed, for any given set of shocks you’re more likely to hit the zero lower bound. And at the zero lower bound, you’re more likely to have a period where inflation’s below target. And so the reason why thinking about average inflation targeting or different variants is relevant as part of this review is it’s very important—price stability really requires that expected inflation in labor markets and in financial markets be accurate at the 2 percent objective. And average inflation targeting is one way to help anchor inflation expectations at 2—in our case at 2 percent.
What Chair Powell has indicated and what I’ve said is 2 percent is not a ceiling, as far as active policy is concerned. And yet, for a combination of shocks and other factors, we’ve been operating below 2 percent. And I do think it’s important, and the review is thinking about different approaches that would include an element of average inflation targeting. But again, we’re continuing this discussion at the committee. It will certainly proceed throughout the first half of this year. So nothing definitive to say for you. But it’s clearly something that we’re looking at.
IP: Yes, there, sir, with your hand up there. Thank you.
Q: Thank you. I’m David Braunschvig.
What do you think can be done to fine-tune and improve your measurement and metrics of service productivity? For example, the bifurcation between the technology-rich and technology-poor services, in as much as services represent such an important part of the economy and technology plays a role that is often misunderstood?
CLARIDA: It’s a great question. Obviously measurement issues are relevant to the central bank, and particularly in this issue because, you know, the simple version of this is that if we’re—if we’re understating productivity we’re probably overstating underlying inflation. The Boskin Commission back in the ’90s did the landmark study using 1980s data. And at the time, estimated that traditional measures of inflation, certainly the CPI, were upward biased by about half a percentage point. And most of that was due to the fact that we’re mis-measuring productivity. So certainly the Fed has a large and very capable staff that are looking into those issues. It’s certainly relevant to the way that we think about longer-run trends. Frankly, it’s not necessarily relevant to the meeting-by-meeting policy decisions. But certainly it is an important part of understanding the—understanding the economy.
And very—just one example of that, sir, is a very well-known issue in price indexes, is the bias in price indexes when new products are introduced. You know, after all, you know, there was—you know, there was no internet thirty years ago. So what is the price of internet services, or was? There are different ways to get at that through so-called hedonic indexes and the like, but I think the one thing we can say for sure is that the cumulative effect of technology means that we are understating that level of productivity and probably overstating inflation. The real challenge is now much. And more importantly, and I’m not an expert on this, is there have always been measurement issues. And so to have an inflation effect, the measurement issues have to be getting worse. And there’s some reason to think that may be true. But I think it’s too soon—too soon to tell.
IP: Yes, right here, please.
Q: Thank you. Tara Hariharan, NWI.
So can I ask you to expound a bit further on your brief comments about the repo facility? I know that Chair Powell made it very clear it is not, not, not QE, but—
CLARIDA: It’s not. And it’s not.
Q: And it isn’t. (Laughs.)
CLARIDA: Not, not, not QE.
Q: But is there any concern within the Fed that in any kind of tapering off the facility has to be careful because of the concern that this might be, like, a mini-taper tantrum?
CLARIDA: OK. All right. So, yeah, that’s a very good question. So let’s just give a brief recap of where we are, and how we got here. So in January of 2019, the committee formally affirmed its desire to have an operating framework in which we seek to operate with an ample level of reserves. And within that framework, the interest that we pay on reserves, the so-called IOER rate, really becomes the policy instrument. And as a consequence of that, we know that we’re going to be operating with a level of reserves in the financial system much larger than we did before the crisis, because we had a different operating framework. We announced and then implemented in July of 2019 that we were going to stop shrinking the balance sheet. So we stopped shrinking the balance sheet in 2019. And at the time we indicated that at some point we would need to start growing the balance sheet again in line with the organic demand for our liabilities.
Important thing to remember is that there are nearly $2 trillion of currency outstanding globally, half of which is actually outside the U.S. And currency is a zero-interest loan to the—to the government. And so there are factors that tend to reduce reserves, including currency demand. So fast-forward to September of 2019. In September of 2019 there was obviously a very, very notable disruption in the repo market. Not directly in the federal funds market, but in the repo market. And obviously they’re tightly linked. And for one day, the market clearing federal funds rate actually briefly moved the top of our target range. So as a result of that, the committee decided in October to resume organic growth in the balance sheet, so we’re purchasing treasury bills at a pace of 60 billion (dollars) a month. And we’ve also had in place repo operations, both overnight and especially at year end some term repo operations.
And as I mentioned in my remarks, they were successful in avoiding any excessive year-end volatility in the repo market. But let me—let me be very clear. I said it in my speech, but I want to say it again. The focus of the Federal Reserve is to have an operating framework that helps us to keep the federal funds rate in the target range. We’re not targeting the repo rate. Obviously the rates are interconnected, and if there’s difficult in liquidity flowing in the system then we want to be attentive and attuned to that. But the plant that we announced in October is to continue the pace of T-bill purchases through the second quarter of this year. As the minutes of our December meeting indicated, we were briefed by the staff of the New York Fed at the December meeting that it could well make sense for us to continue the repo operations after January, but to gradually begin to reduce their size. And so that’s obviously something that we will be discussing at our upcoming meeting.
But ultimately we do think that the plan that the plan we announced in October and that we are implementing will get reserves up to the ample level, and that—and once we get to that point certainly we would not be expecting to have ongoing large repo operations as necessary.
IP: Thanks. Yes, right there, please, in the middle table.
Q: Hi. Bob Hormats. Thanks, Rich, for a great presentation.
CLARIDA: Hi, Bob.
Q: I wonder if you could comment on sort of a medium-term question. That is, what’s tending to happen now as a result of relatively low interest rates is a lot of leveraging—federal, state, and BBB corporates, and others. And that’s all quite comfortable in this current interest rate environment. But in an environment in which rates go up, or the economy weakens, what looks like comfortable debt servicing obligations can become very uncomfortable. My concern, I wonder if you share this concern, is that a given point if rates start going up, there is going to be an inordinate amount of pressure coming from the federal government, or states, or corporates on the Fed to do something about it. in other words, if that in effect starts imposing a burden on the economy, then are you under a greater degree of pressure than you otherwise would be to take monetary policy action to offset the excessive borrowing, or the enthusiastic borrowing that’s taken place in this more comfortable environment?
CLARIDA: It’s an excellent question. And one of the—one of the innovations that Chair Powell has brought to the Fed is that now we publish twice a year financial stability report. We did two of them last year, and we’ll continue to do two a year. And the most recent financial stability report appeared in November. And we dedicated a lot of space in that report precisely to developments in the corporate—in corporate leverage. And so leverage levels are high. You know, not a surprise, with rates low, that companies will take advantage of that. I do think it’s also important to note that corporate leverage is definitely elevated relative to where it was a decade ago, but it’s also the case that in the aggregate corporations have used this period of low rates to extend the term of their debt. And so you also have to factor in not only the absolute amount of leverage, but also, you know, in essence the rollover risk in the market. So we’re looking at that as well.
But I think more broadly what your questions suggests is certainly something that we think about, and that all central banks think about, which is the appropriate balance and availability of tools to deal with potential issues in the financial system. And what the Fed has traditionally said, as do most central banks, is that your first choice is to deal with any potential issue using macroprudential tools, and to save monetary policy for maximum employment and price stability. That all sounds good, you know, in theory. In practice I think the reality is that the toolkit of macroprudential tools is perhaps not as well-stocked as we liked. And so these are always judgements that we’re having to make. It’s certainly a very relevant factor. Both Vice Chair Quarles and Governor Brainard spent a lot of time—and of course our staff as well. And so we’re certainly not ignoring it. We think it is an issue in the financial system. But you know, we’re just—you know, I think the short answer is we’re alert to it and keeping our eye on it.
IP: Rich, if I may, I think another element to Bob’s question, because of the very large federal debts we have, mean that any action you take on interest rates will have major implications for federal financing. To what extent would any sort of financial or political pressure coming from that end affect any decision that the committee makes on the appropriate stance of monetary policy?
CLARIDA: Well, certainly political pressure would have no factor. Again, we have to take monetary policy based on the outlook for the economy. And obviously fiscal developments are an input into that, but we take the fiscal policy as exogenous and as determined by the Congress and the—and the White House.
IP: Thank you.
IP: Yes, right here.
Q: Hi. Robyn Meredith from Bank of New York Mellon.
CLARIDA: Hi, Robyn.
Q: You talked earlier about the global disinflationary pressure that you were seeing. I think by that you meant negative interest rates in Europe, et cetera. But could you talk a bit about—go into some depth on trade? The trade war, it seems to me, has meant that we are increasingly at least having tar on the tracks of globalization, which held prices down before. And if we are indeed moving into a world in which the giant economy centered on China and the giant economy centered on—or a giant trade centered on the U.S. are bifurcating into two separate worlds, what will that mean? Is that something you guys are thinking about?
CLARIDA: OK. So there are, I think two elements to your question. Let me address them in turn. So the global disinflationary forces that I was referring to, I think low rates are sort of an implication—sort of reflecting that. But I’m really referring to the fact that at least for traded goods, obviously big chunks of the consumption basket is non-traded. But at least for those parts of the economy exposed to tradeable goods, what you observe in the official data—so, in a year when inflation’s 2 percent, what’s going on is that services inflation is three and goods inflation is minus one. And this has been evident in the data now for fifteen years. And I won’t even get into sort of the ancillary aspects of digitization and all of that. But just physical goods trade is—prices are falling in absolute terms. And so you have these important relative price changes.
Now, you actually I think are suggesting what I would call, you know, a hypothetical scenario, where there may be a scenario where there’s such a U-turn in global relationships that those global disinflationary forces abate. Obviously that is a scenario. That’s not the scenario that we think that we’re observing. I would point out, in the official U.S. data for last year, even though there were some—obviously some tariffs put in place on imported goods, import prices actually fell last year. So the overall disinflationary forces, we think, are still—are still very relevant. But longer term, you know, you are correct. If you really were to have a sea change in the way that global trade evolves then obviously that would have an effect on inflation, and we would have to think about it. But that—we don’t think that’s where we are right now.
IP: Yes, right here.
Q: Thank you. Lew Kaden. I’m identified the Council as the chairman of the Markel Foundation, but before I retired for ten years I was responsible at Citigroup for all the control functions and had a lot of interaction with your predecessors and your colleagues from essentially all of the central banks in the major financial centers around the world, because of Citi’s international footprint.
And I wanted to ask you if you could comment on what we see as the current challenges on the supervisory and regulatory side. And I can say that when I retired, after a period of time I felt somewhat free to comment about the experience I had around the world during the crisis and afterward. And in a series of speeches and some writings, I said I thought while the U.S. banking system was more resilient than its counterparts in Europe, the Asia story is more complicated, but the U.S. overall was quite resilient. And that’s reflected in the economic performance of the major financial institutions in the recent period as well. But my own view is that the underlying challenges coming out of the crisis are still there.
And I summarized it in some of the writing and lectures that I gave as categorized in culture, ethics, and talent. And I don’t think that those have been entirely addressed, even in the successful large institutions in the U.S. And when you move elsewhere around the world, the underlying issues are even more severe, because the institutions are less resilient, with some exceptions, like some of the best of the Japanese and some special cases. There’s a lot of talent and potential in China, for example, including in the national banks. But the system needs so much work. And the best of the policymakers understand that, but that doesn’t mean that they’re any more speedy in the reform program than other parts of their system. So wonder if you could comment a bit on the supervisory part of your responsibilities.
CLARIDA: Yeah, absolutely. So a couple things on that. First of all, the Dodd-Frank Act created a new position, which is a vice chairman for supervision and regulation. And the first person to fill that is my colleague and good friend Randall Quarles, who’s just doing a remarkable job. I get a briefing every week, either from Randy for staff, just to keep up with the flurry of ideas coming out of his shop.
But more broadly, the U.S. financial system is in a much more robust place than it was a dozen years ago. Obviously our focus are on the big banks, and the banks that we oversees and regulate. But whether or not you’re looking at levels of capital, or liquidity, resiliency, the stress testing, resolution. And so during my confirmation hearing I was asked about this. And I said, these are very, very important improvements. And certainly anything that I vote on or I think about would want to respect and maintain all of those benefits.
That being said, one of the themes and one of the motivations in our approach to financial regulation has been, where appropriate and without any cost or inefficiency, to tailor regulations as appropriate. In particular less by size of institution and more by lines of business and systemic risk. And the Crapo bill, which passed the Congress in the spring of 2018, actually laid down some very specific markers about how to do that. And so much of my time with the Fed in the last fifteen months has been implementing—has been putting in place the regulations to implement that.
But all of us are very attuned to the need to be alert. It’s a very complex financial system. You point out to the complexities. And globally different countries and different continents have different approaches to this. Now, one of the things that I’ve observed in my—in my time at the board, and one of the big—oftentimes you get asked, what’s your biggest surprise. And one of my biggest surprises is that as a—that as an academic and a Fed watcher for decades, I had the luxury of just focusing my attention on one important, but very specific, thing the Fed does, which is eight times a year it either raises interest rates or lowers rates or does nothing.
But once you get inside the building, you realize the complexity, and I would argue, the interplay between the monetary policy decisions and the supervision and regulation. And what I found, when I’m thinking about monetary policy is I really want to also understand the supervision and regulation piece, and vice versa. So I think it is important to think of them together, as a package. But broadly speaking, at least with regard to the U.S. financial system, you know, I think it’s in a very, very good shape. And the post-crisis changes in supervision and regulation have been very positive.
IP: Very quickly on that, Rich, obviously monetary policy cannot directly do much about inequality and the gaps between rich and poor. But perhaps on the payments and supervisory side there is some role here. And under the chairmanship of Jerome Powell, for example. We have seen the Fed move forward on its own real-time payment system. And we’ve—there’s an interesting discussion going on right now on changes to the Community Reinvestment Act. Does the Federal Reserve, in those roles, in your view, does it have some responsibility to sort of narrow some of the inequities we’ve seen in our economy?
CLARIDA: Well, let’s talk about CRA first, and then—and then talk about the other element of your question. So the Community Reinvestment Act is a statute, 1977, I believe. And so both Chair Powell and Governor Brainard, who are taking the lead—taking the lead on this—for us. But we all believe that our job is to effectively interpret the CRA in a way that’s consistently and fully in line with both the letter and the spirit of the CRA. Now, the world is a lot different than it was forty years ago. So it would naïve to think that the CRA doesn’t deserve occasionally to be refined. And we’ve certainly indicated that we’re open to doing that. But I think in terms of our motivation, our motivation is just the law of the land, and we want to faithfully put in place regulations that reflect that law, and that also are attentive to the world and the financial system in which we live.
We have spent time during our Fed Listens events and did have a staff briefing in our December meeting, as the minute revealed, on the interplay between monetary policy and income distribution. So let me talk a little bit about why we’re doing that. And the main reason we’re doing that, it’s very practical, to understand the right monetary policy to put in place we have to understand the transmission mechanism between policy and the economy. And in fact, we can get a better sense of the transmission mechanism if we move away from a representative agent to a world where you’ve got different consumers, with different access to credit, different exposures to different risks. And I think the reason why we’re only focusing on this now is economists have known for decades that that would make sense. The challenge is those models tend to be more complex. And we really now just have the modeling capability to have a more nuanced and granular view of the financial system.
So the primary motivation for looking at distribution is really to give us a better sense of how we can put in place policies. You know, that being said, I think what we—broadly speaking, what we really focused on is maximum employment and price stability. And if we can consistently achieve that, that’s going to have a very favorable impact. You know, certainly for a person who’s unemployed, getting a job does a lot for his income distribution, so—or, her income distribution, so.
IP: Thank you. I think we have time for actually one more. Yes, there.
Q: So to totally change the subject and come down to Earth, you probably know there’s a network of central banks—Christine Lagarde, Mark Carney leading it—with regard to how monetary policy may or may not be able to respond to the climate change question. And I would be curious to know—the U.S. is nowhere in that leadership. And I just wondered if it reaches your level of discussion. Thank you.
CLARIDA: Well, certainly what Chair Powell and us have indicated, hat we are certainly very, very—we’re following those efforts closely. And in particular in our international discussions in the G-20, and at the BIS, and others. We’re certainly engaged in those—in those conversations. Just recently Governor Brainard gave a speech on climate change and monetary policy. And since we have limited time I won’t synthesize your speech for you, but it will give you a good snapshot of where—of where we are on that right now.
IP: Your colleague, Robert Kaplan, was in San Diego. He said that their research has found that extreme weather events—leaving aside whether monetary policy can do anything about climate change—extreme weather events have become more frequent, and more regular, and more extreme. And that alone seems to be changing economic outcomes. Do you agree? Do you see that happening?
CLARIDA: Well, I certainly agree that traditionally the Fed, especially in our regulation and supervision capacity, at the individual bank level, has always been focused on exposure of banks to extreme weather events. You can think of parts of the world where—countries where that’s very relevant. And as we’ve indicated, probably, you know, to the extent that extreme weather events are a more frequent or more extreme, that that does need to be factored into the way that we assess whether or not banks have adequate capital and risk exposure. So I think Rob is exactly right.
IP: All right. Rich, thank you very much.
CLARIDA: Thank you, Greg.
IP: It’s been a very good discussion. Appreciate it. (Applause.)