C. Peter McColough Series on International Economics With Richard Clarida

Vice Chair Richard Clarida discusses U.S. monetary policy and the U.S. economy.

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.

LIESMAN: Thank you very much. I'm pleased to once again be asked to moderate the C. Peter McColough Series on International Economics. And I guess this might be the second time that I've had a chance to interview the vice chairman of the Federal Reserve, Richard Clarida. And I understand, Vice Chairman Clarida wants to begin with some opening remarks. So, to you, Mr. Vice Chairman.

CLARIDA: Thank you, Steve. It's my pleasure to meet virtually with you today at the Council on Foreign Relations. I do regret we're not doing the session in person as we did a year ago. And I do hope the next time I'm back, we will be gathered together in person in New York City. I look forward to my conversation, as always, with Steve Liesman and to your questions. But first, please allow me to offer a few remarks on the economic outlook, Federal Reserve monetary policy, and our new monetary policy framework.

In the second quarter of last year, the COVID pandemic and the efforts put in place to contain it delivered the most severe blow to the U.S. economy since the Great Depression. But economic activity rebounded robustly in the third quarter and appears to continue to recover in the fourth quarter, although at a pace somewhat slower than we saw in the third quarter. Household spending on goods, especially durable goods, has been strong and moved above its pre-pandemic level, supported in part by federal stimulus payments and expanded unemployment benefits. In contrast, spending on services remains well below pre-pandemic levels, particularly in sectors that require people to gather together—contact intensive services, including travel and hospitality. And we saw some evidence of that this morning in the payroll report. In the labor market, more than half of the twenty-two million jobs that were lost in March and April have been regained as many people have been able to return to work. Inflation, following a large decline in the spring, picked up over the summer but has leveled out more recently. For those sectors that have been most affected by the pandemic price increases remain muted.

Now, while GDP growth in the fourth quarter downshifted from the once-in-a-century 33 percent rate in the third quarter, it is clear to me that since the spring of 2020, the economy has turned out to be more resilient in adapting to the virus and more responsive to monetary and fiscal policy support than many predicted at the time. Indeed, it is worth highlighting that in the baseline summary of economic projections that the committee released, most of my colleagues and I revised up our outlook for the economy over the medium term between September and December and project a relatively rapid return to levels of employment and inflation consistent with the Feds statutory mandate, and certainly as compared with what we saw following the global financial crisis. In particular, the median participant projects that by the end of 2023, a little less than three years from now, the unemployment rate will have fallen to around 4 percent, PCE [personal consumption expenditures] inflation will return to 2 percent, and following the GFC [global financial crisis], it took more than eight years for employment and inflation to return to similar levels. And while the recent surge in new COVID cases and hospitalizations is a serious cause for concern, and clearly a source of downside risk to the very near-term outlook, the welcome news on the development of effective vaccines indicates to me that the prospects for the economy in 2021, once the vaccines can be efficiently and widely distributed, have brightened and the downside risks to the outlook have diminished. The two new SEP charts that we released for the first time in our December meeting speak to these issues [inaudible] uncertainty by providing information on how the risks and uncertainties that surround our outlook have evolved over time. While nearly all participants continue to judge that the level of uncertainty about economic activity remains elevated, fewer participants saw the balance of risk is weighted to the downside compared with September. And although a little more than half of participants judged the risk to be broadly balanced for economic activity, a similar number continue to see the risk weighted to the downside for inflation.

Let me talk now about our recent FOMC [Federal Open Market Committee] decisions and our new monetary policy framework. At our most recent meeting, the committee made important changes to our policy statement that upgraded our forward guidance about the future path of the federal funds rate and asset purchases. And that also provided unprecedented information about our policy reaction function. As announced in the September statement and repeated in November/December with inflation running below 2 percent, our policy will aim to achieve inflation outcomes that keep inflation expectations well anchored at our 2 percent longer-run goal. We expect to maintain an accommodative stance of policy until these outcomes, as well as our maximum employment mandate, are achieved. We also expect it will be appropriate to maintain the current target range for the federal funds rate until labor market conditions have reached levels consistent with our assessment of maximum employment until inflation has risen to 2 percent and until inflation is on track to moderately exceed 2 percent for some time.

In addition, in the December statement, we combined our forward guidance to the funds rate with enhanced outcome-based guidance about our asset purchases. We indicated that we will continue to increase our holdings of Treasuries by at least $80 billion per month and our holdings of MBS securities by at least $40 billion per month until substantial further progress has been made towards our maximum employment and price stability goals. The changes to the policy statement that we made over the fall bring our policy guidance in line with our new framework, outlined in a revised statement of longer-run goals that the committee approved last August. In our new framework, we acknowledge that policy decisions going forward will be based on the committee's estimates of shortfalls of employment from its maximum level and not deviations. This language means that going forward a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy, absent any other evidence that inflation is at risk of moving above mandate consensus levels. With regard to our price stability mandate, while the new statement maintains our definition that the longer-run goal for inflation remains 2 percent, it elevates the importance of keeping inflation expectations well anchored at 2 percent in a world in which an effective lower bound constraint is binding on monetary policy.

To this end, our new statement conveys the committee's judgment that in order to anchor expectations at the 2 percent level, we will seek to achieve inflation that averages 2 percent over time, and that, therefore, following periods when inflation has been running below 2 percent, appropriate policy will likely aim to achieve inflation moderately above 2 percent for some time. As Chair Powell indicated in his Jackson Hole remarks, we think of our new framework as an evolution from flexible inflation targeting to flexible average inflation targeting. While this new framework represents a robust evolution in our monetary policy strategy, the strategy is in service to the dual mandate goals of monetary policy assigned to the Federal Reserve by the Congress and these remain unchanged. Our interest rate and balance sheet tools are providing powerful support to the economy and will continue to do so as the recovery progresses. It will take some time for economic activity and employment to return to levels that prevailed at the business cycle peak reached in February. We are committed to using our full range of tools to support the economy and to help ensure that the recovery from this difficult period will be as robust as possible. Thank you very much, and I look forward to my conversation with Steve Liesman. Thank you.

LIESMAN: Thank you very much, Richard. We'll get right into the questions, and just so people know, you and I will chat for about twenty minutes at this point and then we'll open up to questions as Carrie said earlier. Richard, I want to start off with the events in Washington on Wednesday. To what extent does the political instability that was shown to exist on Wednesday and really erupted out into the public, does that change or have an effect on the outlook as far as you're concerned? And to what extent is democratic stability a cornerstone or a very important aspect of the outlook for U.S. growth?

CLARIDA: Well, Steve, thank you. And I think it's fair to say that, like all Americans, I was angered to see the chaotic images of mobs storming the Capitol and occupying halls of Congress determined to disrupt the constitutional process. But I was thrilled and pleased to see that the House and the Senate have ratified the election results, per the calendar and per the law. And I and I'm sure my colleagues, will look forward to working with the Biden economic team when they take office on January 20 or soon thereafter. You're absolutely right, however, that confidence about the economy and our system is an important factor in economic activity. And I'm hopeful that we can get past this episode and look ahead as the new administration comes in and as we work together to put in place the economic policies that can support the recovery.

LIESMAN: Would continued instability cause you do change your outlook on either the potential of growth or actual growth in the United States?

CLARIDA: Well, that's a hypothetical. I think, hypothetically, if that were to continue, then obviously any instability that erodes confidence and capital spending and investment and consumer confidence is something that we'd have to look at. I don't think that will be the case. But obviously if it were, we would have to factor that in. But let me be clear, I don't perceive that as being a challenge.

LIESMAN: I hope you're right about that. Let me ask you about this morning's payroll report, Richard. It came in about 140,000, the first declined since April. Did you expect this? How much more weakness do you expect in the payroll part of the economy right now?

CLARIDA: Steve, you know, the payroll report is forty pages. There's a lot in there. I think the overall picture was a little bit more balanced than the headline number, which was disappointing. You never like to see a contraction in employment in the economy, especially when we have a deep hole to fill. That said, the job losses were really concentrated in leisure and hospitality, not surprisingly. We did see nice pickups in employment in construction and in manufacturing, and so I think it's not surprising given the surge in new cases and hospitalizations and the natural inclination for people to hunker down during the holidays. I also would note that there were some positive revisions to prior months. So if you add all that together, clearly a setback in December with a sluggish decline of the payrolls, but right now not something that I would expect to continue into the new year.

LIESMAN: That's sort of a nice opening to talk about the outlook overall. You talked about the positive developments of the vaccine. When do you expect that to show up in the economy and when do you expect a greater normalization of both the unemployment rate and the overall economy?

CLARIDA: Well, I think as we've learned, vaccines first have to be developed and they have to be approved and they have to be distributed. So the good news is that through some pioneering research, these vaccines are now developed and by all accounts very effective. They have been approved. The distribution of the vaccines thus far has lagged behind projections, that's obviously a concern. It's my expectation that as we move throughout the spring and into the summer, that vaccinations will become widely available and that there will be take up on that. And then I think at that point, roughly in the summer, we'll begin to see the economy move past the COVID pandemic and return to, I think, not only trend but above trend growth. And as I said, with the SEP projections, we see pretty robust declines in the unemployment rate in this year, and I think other forecasters are similar. But we acknowledge the next several months, because of the surge in the virus and hospitalizations, is going to be challenging. And obviously, until we get the details worked out in distributing vaccines, that's also a challenge. But as we move out through into the year, I do expect those challenges to be met and for the economy to turn in a very, very impressive growth performance and decline in unemployment this year.

LIESMAN: Richard, I don't know how deeply you at the Fed delved into this issue, but I thank you for that answer. What are the risks around vaccine distribution? You're not the first forecaster I've spoken to who has said that vaccine distribution is the absolute key to getting to the spring rebound that they forecast? What are the risks in terms of timing? Is it something that could come three months or six months later? Or is it something that you think is a matter of weeks when you look at the risks around what we know about the problems with distribution?

CLARIDA: You know, Steve, I don't really follow it more closely than what I read in the newspapers. I don't get briefed specifically on the epidemiology of this. What I will say is, I think the key thing is that the development of the efficacy is the most important, and I just have faith in the American system and the American government's ability to distribute a life-saving vaccine. It may take a bit longer than we hoped, but I think we're going to get it done.

LIESMAN: A little bit more faith in your forecast this morning, Richard, than usual, but I hope you're right. Let me move on and ask you in some more detail about the issues of asset purchases. As you pointed out, you guys made a pretty big change in bringing the guidance about asset purchases more in line with the guidance about interest rates, but not exactly. Could you talk about the differences there? You've told us that interest rates will remain low while you're looking for 2 percent inflation and, indeed, actually trying to exceed 2 percent inflation, but we have this kind of thing until further substantial progress when it comes to asset purchases. And several of your colleagues have suggested that maybe asset purchases might end this year. What can you tell us about both of those questions?

CLARIDA: Okay, well, thank you, Steve. First of all, you're right. We view our outcome-based guidance on rates on balance sheets as very complimentary. We also believe that the guidance on our balance sheet, which indicates substantial further progress, means that we are committed to providing a very ample amount of recovery this year. It is outcome-based guidance. And so the duration of the program will depend on some extent on how rapidly the economy recovers. In terms of the difference in the guidance, it merely reflects the fact that as we observed in the last cycle when the Fed was using both large-scale purchases and rates guidance, that it initially cut rates to zero. It then put in place LSAP programs. It then eventually brought the LSAP programs to an end before it hiked rates for the first time. So we've essentially said that we would expect this process to be broadly similar. The recovery is to zero. We're doing both now—large-scale asset purchases and rates. At some point it will be appropriate, but I think that's well down the road. It'll be appropriate to begin to, you know, slow the pace of the increase in our balance sheet, and then finally, once the economy has met the conditions that we laid out in September, we will begin to hike rates. So it's basically a sequential process. But let me emphasize that I think that time is some ways off. And certainly, I certainly think that it could be quite some time before we would think about tapering the pace of our purchases the way I look at the data, and I'm a relative optimist on the economic outlook. But we're in a deep hole, substantial further progress means not only patting ourselves on the back because of the improvement in the labor market, but we want further progress in the labor market and move it towards our 2 percent inflation objective. So I think that's some ways away before we declare victory on that in terms of the balance sheet.

LIESMAN: I will give you one more opportunity, Mr. Vice Chairman, to join your colleagues in suggesting that perhaps that guidance or the reduction could come this year.

CLARIDA: Well, I guess speaking for myself, there's eighteen folks on the committee, my economic outlook is consistent with us keeping the current pace of purchases throughout the rest of this year. Obviously, if the outlook changes, we have outcome-based guidance that will change, but right now, I think maintaining the current pace of purchases throughout the remainder of this year is my expectation.

LIESMAN: Okay, interesting. Can you tell me one of the risks that many people talk about out there when they look at the forecast, and this is obviously an upbeat forecast and you know what they say, I'd be happy for these kinds of problems, is the issue of inflation, that demand could come back stronger especially with a recent stimulus bill that's out there, the possibility of a vaccine. How much concern do you have about inflation this year and is policy right now at the current levels of zero interest rates, the current level of asset purchases? Is it well attuned—you are in a good place as you guys like to say—when it comes to the possibility of inflation later this year?

CLARIDA: Well, thank you, Steve. And I do believe that because of some year-over-year base effects, we will see a move up in inflation, perhaps above 2 percent in the spring and the summer. Essentially as you compare a price in 2021 to a price in 2020 because prices were falling, you will get arithmetically an upper boost to inflation, and I think Chair Powell discussed this at his press conference in December. But I would expect that to be transitory, and indeed, our view is by the end of the year, inflation will be higher than it is today but somewhat below our 2 percent objective. We made a fundamental change in our framework and in our guidance, and so what we've said is that we are not going to lift off until a three-part test is met: inflation's at 2 percent, that the labor market is consistent with our view of maximum employment, and that inflation is sustainably at 2 percent, it actually may move above. And so I think that guidance is important for your viewers and for folks on this symposium to remember. I also pay a lot of attention, Steve, to inflation expectations. Not just market-based measures, but also survey-based measures. And I think we went into the COVID pandemic with inflation expectations at the low end of a range that I consider consistent with our price stability mandate. So I think we have policy positioned exactly where we want it right now. We do expect some move up in inflation this year. But we think it will, to some extent, be transitory. And then as we move into next year, we'll still be running somewhat below our 2 percent inflation objective.

LIESMAN: I'm guessing you know where I'm going after that, which is part of the rise in inflation has shown up in higher bond yields. The ten-year being over 1 percent, does that cause you concern that interest rates are working, at least in the bond market there, are working against what the Federal Reserve hopes to happen or hopes to accomplish with low rates in the broader economy?

CLARIDA: Well, Steve, of course, it is true that rates moved above 1 percent. But, of course, you've been covering markets for decades, you know. The 1 percent yield on a ten-year Treasury was until February of this year never achieved. So rates are still incredibly low. Financial conditions are supportive of the flow of credit. I myself am not concerned with a ten-year Treasury yield just to touch above 1 percent. And I think it's important, Steve, for your viewers to understand that at least the way that I look at the bond market and yields, is you have to try to understand why yields are moving up. And if yields are moving up because people are more optimistic about growth, about a vaccine, are more confident that we'll be able to achieve our 2 percent inflation objective, then that is not something that troubles me in the context of the overall picture. So where I think we need to be focused is not so much our rates moving up and down but trying to get a sense of why they're doing so. And I'll still note that the real cost of borrowing is negative. Ten-year Treasury yields are well below the rate of inflation, and so rates at these levels are not a concern for me.

LIESMAN: I'm assuming we have a fairly sophisticated audience here at the Council on Foreign Relations, but I'll just explain my next question a little bit more in detail, which is that one of the tools you have while keeping asset purchases the same is to buy more on the long end and sell some on the short end. And that could depress the long end of the curve. Richard, I don't know the extent to which you can give us some detail about what kinds of levels—first of all, do you support that at this time, and if not, what kind of levels might trigger your concern about high-bond yields and be something that would motivate you to support that kind of operation where you would try to specifically depress interest rates on the long end?

CLARIDA: Well, Steve, of course, that is certainly an option that is available to us. It's in our toolkit, Chair Powell referred to that in his December press conference. But let me say right now, now, right now is, you know, the first week of January 2021, we like the current setting of policy. I myself would have no inclination or think there's any need to think in the near term about adjusting the duration and the maturity of our purchases. In terms of a particular level, you know, I think as a Fed policy maker, that's something I'm not going to get into. But what I did say is right now rates are still very accommodative. They're reflecting, I think, improved growth prospects and some sense that we've avoided a deflation outcome. And so I think those are all developments consistent with where we would like to see the economy go. But I'm not going to give you a particular level. I don't think that'll surprise you.

LIESMAN: We have six minutes of this one-on-one here, Richard. I've got sixty minutes additional questions, so I'm going to try to move on. Let me talk about another risk that's out there and how much concern you have about levels of the stock market. Jobless claims come out at eight hundred and something thousand and the stock market goes up. Turmoil in the streets in Washington, DC, siege of the Capitol, the stock market goes up. You know, I guess we have a small decline today, but in general pretty flat market on a decline in the number of jobs that are out in the market. Are you concerned that this loose monetary policy has led to bubble-like conditions in the stock market?

CLARIDA: It's something we monitor as part of our financial stability surveillance. It's not something that sitting here today is of particular concern to me because you also need to note that with regards to the stock market, that analysts and forecasters as economic prospects have improved, have revised up their earnings estimates quite a bit. And obviously, stocks are going to be a function of earnings as well as the, you know, the discount rate. And obviously we understand that with rates low that's supporting stocks and bonds. But I think one thing it's important for the participants to appreciate, Steve, is that, you know, the U.S. is part of a global economy, and there are very powerful global forces that are driving down riskless rates. You know, our federal funds rates at ten basis points, rates are negative in Europe and Japan. And so there is a global decline in riskless interest rates, and that's going to be reflected in asset valuations. And what that says is that although there are things individual central banks can do that influence that, there's also a substantial global element to that as well. But no, to answer your question, specifically, I'm not concerned because I think market valuations are reflecting a quicker rebound of profitability than folks thought was possible in the spring. And obviously the vaccine has been very good news and probably also additional fiscal support given the election outcome.

LIESMAN: Is it fair to say that if those earnings don't appear and yet stock markets remain high, that would be a level that would cause you concern for development?

CLARIDA: Well, that's truly a hypothetical. So the next time we get together, we can discuss that if, indeed, that materializes. I'll leave it at that.

LIESMAN: Okay. Okay. Fair enough. One criticism, a persistent criticism of the Federal Reserve is how low interest rates, which have helped the stock market, end up exacerbating inequality. I'm wondering if there's a reason, I'm never quite sure what the answer to or the responses would be from the Federal Reserve, which is hard to imagine that higher rates would increase equality, but that being the case I wonder if you might respond to the impact of equality of low rates on inequality in the way that policy does, in fact, exacerbate that?

CLARIDA: Sure. Well, obviously, the Fed has a very powerful set of tools, but it's a pretty limited toolkit. We basically can either adjust rates or the size of our balance sheet or our guidance. And when we do that it has, we hope, and indeed the record shows, it can have positive impacts on supporting employment, business formation, the ability for people to refinance or to buy a home. So those are all positives for both employment and the income distribution. But lower rates also tend to boost equity valuations and other valuations, and so I think the picture is a complex one. We acknowledge that the setting of our tools impacts the economy in a complex set of ways, but our mandate from the Congress is really maximum employment and price stability. And if we thought we could increase employment by raising interest rates, we would, but we don't. And so the reason why in 2019 is the economy slowed, we made a downward adjustment in rates was to support the labor market. We had the lowest unemployment rate in fifty years. We had good wage gains, especially at the lower end of the distribution. So it is true that low rates do tend to support equity valuations, but it's true more broadly they also support employment and other important things in the economy.

LIESMAN: Yes, I think it is worth mentioning, Richard, that the change to be looking at needing to see, for better or worse, the whites of the eyes of inflation before raising rates to let the unemployment rate sink to [inaudible], certainly a measure that works against inequality. I did hear one of your colleagues talk about actually looking at the Black-White unemployment rate gap as one measure of how close to full employment you are. Do you endorse that idea?

CLARIDA: Well, I think, what the idea I do endorse and clearly that's one that I and my colleagues look at, is the labor market is a very complex market, and I think it's fair to say in the past communication from the Fed has focused excessively on one indicator of the labor market, which is the unemployment rate. And I do think that a feature of the Fed that I've observed now as an insider for two and a half years is that even though we sometimes speak in shorthand about the unemployment rate, we're looking at a broad range of measures, including differential unemployment rates in different racial groups. And I think it's clearly the case, Steve, that our Fed listens to events as part of our framework review. It really reinforced to us something we probably understood anyway. But it reinforced the point that we talked about economic recoveries as though they're sort of all alike, but the reality in most economic recoveries, most of the gains at the lower end of the income and education distribution that accrue actually accrue towards the end. This idea of running a hot labor market, and of course, the word hot labor market connotes that there's some sort of inflation pressure and as Chair Powell and I and others have indicated before the pandemic, what we found out in 2019 and up through February of 2020 is that the U.S. economy can operate at a much lower rate of unemployment without concerning pressures on inflation. And if we're able to do so then that's going to actually be able to benefit groups as you mentioned, not only by racial but other educational opportunities.

LIESMAN: Well, it's one of the single biggest changes I've seen in a couple decades of covering the Federal Reserve. Richard, I have one more question I'm going to save for maybe a little bit later, maybe one of the members of the audience will pick up on it. But right now I'm going to turn it back to Carrie Bueche, who is going to bring in our audience questions.

STAFF: [Gives queuing information.] We will take our first question from Larry Meyer. Mr. Meyer, please accept the "unmute now" button.

Q: Okay. Hi, Rich. Thank you for your remarks. And as you know, I hang on every word you say. And the word that's hung me up is flexible. Now, you know, flexible average inflation targeting is the name, but there's some mischaracterization there. We've never seen such an inflexible monetary policy when starting from the effective lower bound. The policy rule is r equals zero, not to respond to any changes in economic development except for escape clauses. So that's number one. And number two, it's temporary, right? And it doesn't apply, I think, you have to clarify it when you get to a situation where there's a decline in the—it doesn't get things to the effective lower bound. There is no average inflation targeting in place. So clarify that for me. I mean, you're the author. Clarify.

CLARIDA: A couple of points on this. First, Larry, we are at the effective lower bound and unfortunately have been there for most of the past twelve years and are likely to be there for more years. And so one of the important advancements in this framework is to take on the effective lower bound head on and to say, what do we think we need to do to offset that constraint on policy so as we can achieve our dual mandate objectives. And we've come up with several changes to our policy to do that. One, as you correctly say, is essentially we are implementing what has been called in the academic literature, a "lower-for-longer” policy. That goes all the way back to work at the Fed, I think, when you were there in the '90s, you know, Williams and [inaudible] and many others. And basically what we've said is we're doing a version of "lower-for-longer," the rates are going to be at zero until these conditions for liftoff have been met. We also have a related condition that we are not going to preemptively raise rates simply because a particularly estimated Phillips curve model says that the labor market is too tight. We're actually going to be looking at the inflation and inflation expectations data itself.

It's also important, as I pointed out in a speech at the Brookings Institution a couple of months ago, to understand what this regime looks like once we lift off. And once we lift off, the goal is to bring inflation back to 2 percent. Because 2 percent is our long-run goal. And what we've said is that the pace at which will bring inflation to 2 percent is going to depend on things like measures of expected inflation and also by how far inflation has fallen short of our 2 percent average goal since we hit the effective lower bound. The third point I would say, Larry, is that our framework, we believe, is certainly a framework that can serve us well if, knock on wood, in a future downturn we're not at the ELB. And then at that case, I think it would look very similar to, you know, to what we've described and that if we have a downturn with an elevated unemployment and a fallen inflation, we're going to run a policy that brings unemployment down and inflation up. And similarly, once we achieve those objectives, we'll want to make sure that in the long run inflation returns to 2 percent. And so I would argue, and indeed you've picked up on this in some of your writings, I would argue that in terms of our reaction function, it's actually somewhat simpler than under the prior inflation targeting regime. But that would be the way I would describe it to you.

LIESMAN: Carrie, do you want to go to the next question?

STAFF: We'll take our next question from Ed Cox.

Q: Ed Cox with the Committee for Economic Development. Much appreciated, Richard, if you would comment on the level of reserves held at the Fed and what conditions might cause an adjustment of the interest rates they're on.

CLARIDA: Thank you, Ed, and good to hear you virtually. Yes, obviously, the level of reserves in the banking system has surged this year. And that reflects the fact that we have been purchasing a lot of Treasury and mortgage-backed securities. Now initially, those purchases in the spring were for market functioning. And we had to buy a lot in order for the Treasury market to continue to function and, of course, that added to reserves in the system. Before the pandemic we were talking about an ample reserves regime. Obviously, reserves are well above ample at these levels. In terms of renumerations, since 2008, the Fed has paid a market rate of interest on reserves, and we continue to do that. And the important point is that by paying interest on reserves, it enables us to maintain control over interest rates even with a system that is awash in Washington reserves. And obviously, over time, we would expect reserves to decline as the economy recovers. But they certainly did increase in response to the crisis actions that we took in the spring.

STAFF: Our next question—

LIESMAN: Excuse me, Carrie, one second. I think I just want to follow up real quick. Richard, can you foresee a time when you'll have to increase that level of interest on reserves in order to sterilize what's going on out there?

CLARIDA: I don't think that's on the near-term horizon. I think that at the point that we've achieved our liftoff goals, which is 2 percent inflation, full employment, we will of course need to start thinking about raising rates and at that point would raise the rate on reserves. But I don't foresee a need to do that before that time.

LIESMAN: Go ahead, Carrie, sorry about that.

STAFF: We'll take the next question from William Perlstein.

Q: Good morning. Thank you, Vice Chair Clarida. Both the Dodd Frank Act and the Budget Act have put limitations on the Fed's potential actions in a financial crisis. Do you see a need to ask Congress to change any of the limitations that had been put on the Fed?

CLARIDA: Well, thank you for that. And the short answer is no. We do believe that our Section 13(3) authority in order to, you know, lend against good collateral and unusual and exigent circumstances is very important. We think it was absolutely essential to have that authority. We deployed it, I think responsibly, and if I might say, creatively and boldly in the spring. But we've also said that these facilities really are for unusual and exigent times. And as we move past the COVID pandemic, we would expect to put them away. Obviously, right now the recent legislation that passed the Congress dictated that any equity investments in our 13(3) facilities and the corporate and the Muni and the main street programs, that those programs cease lending at the end of this year. And we respect that and, indeed, we've already returned most if not all of the Treasury equity for those programs. But importantly, this legislation did not change our 13(3) authority one iota. Now, I would note, I think it's implicit in your question, sir, that one important change in Dodd Frank was to require going forward the Treasury secretary to affirmatively approve and endorse any 13(3) facility. And we accept that and we understand that and we don't think that is in any way going to be a challenge if they need to be deployed in the future.

LIESMAN: Would you like to see, Richard, those programs started up again under the new administration?

CLARIDA: That will have to be—that's certainly not something that is relevant right now. I think whether or not the programs restart is going to be really a function of where the economy is. We were very gratified that we did get the fiscal support and again, it's sometimes called stimulus, Steve. But this is really a relief package. It's a package to provide income support through unemployment benefits and also paycheck protection is very important. And that program, I think, being put in place and beginning to support the economy now is very, very positive. So we may not need to even think about or to have conversations about relaunching facilities. But obviously, I'm sure that's something that the Treasury Secretary-designate Yellen and Chair Powell, will be, you know, will be attuned to if that is needed. But right now, I don't foresee that. But that's certainly something that is possible under the existing statute.

LIESMAN: Carrie?

STAFF: We'll take our next question from Eric Pelofsky.

Q: Thank you, Vice Chairman. I wondered if you might comment on how you see Chinese behavior in the coming year with regard to our Treasuries and what kind of risks that you think that the range of risks that are available to the U.S. in that regard?

CLARIDA: Thank you, Eric. I think I would broaden the answer beyond China. There's a global market for Treasuries. U.S. Treasuries are really the gold standard for collateral and risk-free assets. You know, more than half of all Treasuries are held outside the U.S. and not just in China. And so obviously that, you know, there's an old saying going back to the '60s, the U.S. enjoys an "exorbitant privilege." And one element of that as the provider of a reserve currency is that people want to hold Treasuries for liquidity and collateral reasons, and so that does tend to lower our borrowing costs. But that's really been a fact of life for fifty years. And I don't see that shifting or changing broadly in 2021. I won't have any comment on particular countries.

STAFF: We'll take our next question from Jeff Rosensweig.

Q: Vice Chairman, I'm at Emory University's Goizueta Business School. I had an honor in the late 1980s, you were demanded in Washington, so I subbed for you at Yale and I taught international finance and money and banking. And at the time I don't think the Federal Reserve looked at exchange rates very much. And I wonder now if it's on your dashboard? I think, for instance, they could affect inflation expectations. I wonder what is the role of exchange rates?

CLARIDA: Yes. Well, hi, Jeff. Long time no see. One of the evolutions at the Fed that I think was very positive that began somewhat under Ben Bernanke but certainly continued under Janet Yellen, is for the Federal Reserve in its communications to acknowledge the exchange rate, you know, as an important factor in thinking about the economy. And this is not just because exchange rates go up and down because of trade or whatever, but because of the role of the dollar in global reserve currency. I talked about the exorbitant privilege a moment ago, but one of the costs of providing the global reserve currency is that it tends to be a safe haven currency in times of distress, which tends to mean that when the world economy is going south, people buy dollars and that tends, obviously, to appreciate the dollar and that hurts trade sensitive sectors. And that also tends to lower inflation because it lowers import prices. And so we certainly do understand and try to assess how movements in the dollar impact our inflation and our aggregate demand and our aggregate demand forecast. You know, that being said, we don't target the dollar. We're not pegging the dollar and any decisions on dollar diplomacy are squarely the purview of the Treasury secretary. As a former Treasury official, I can remind you of that. But yes, certainly we don't have our head in the sand. We are not oblivious to the important effect that movements in the dollar can have on aggregate demand and on inflation, and we do try to understand that in the context of our forecasts and projections.

LIESMAN: Jeff did me the favor, Richard, of asking the question that I had left over there. But I do want to just follow up with the recent movement of the dollar, which has been weaker. How does that change, in effect, your outlook right now?

CLARIDA: I thought you would ask that, Steve. So I went back looked at a chart of a broad dollar index going back five years. What I often find, and I did this in my prior work spending more time in markets, is that headlines about the dollar tend to show up after there's been a noteworthy move, but what they oftentimes neglect is what preceded that move in the prior three or four years. And so what you basically see with broad measures of the dollar is that its level now is just a bit below its average level over the last five years. What happened, of course, is that we had a big move up in the dollar with the flight to safety in the spring, and that has retraced now as risk appetite has returned. And so, broadly speaking, the dollar is more or less, you know, in a range that it's been in for the last five years. And it's not something that causes me any concern right now.

LIESMAN: Thank you, Richard. Carrie?

STAFF: We'll take our next question from Joseph Bower.

Q: Thank you very much. I'm been at Harvard Business School for about fifty years. And most of my time I've been doing what used to be called institutional economics. One of the things that's fascinated me in the discussion of inflation has to do with this old idea that inflation was too much money chasing not enough goods. Since the '80s, in my research what I've seen is, except in a few areas where there are new products, brand new products, there's over capacity across the world in almost all goods. So what I've been wondering is the monetary discussion really focuses on and looks at inflation solely in those terms. It seems to me that reason we're not getting inflation is there's a surfeit of goods in most areas. Could you comment on that? And that will be for a long time. We won't see that ending.

CLARIDA: Yes. Well, I think that's an excellent point. It's one that I've thought about and studied and spoken about it at the Fed. And I'm agreeing with it, I'll put the answer this way that a fundamental shift in the U.S. economy began to emerge in the mid-1990s. And it's received, only recently it's begun to receive the attention it deserves. And it's the basic idea that in the '60s and '70s and early '80s, when we had inflation and, you know, Volcker inherited 14 percent, that it was more or less dispersed pretty evenly across different categories of goods and services. So goods inflation was fourteen and services inflation was fourteen. And, of course, Milton Friedman taught us that inflation is really a general upward movement in prices. There will always be relative price changes. Well, the big change in the U.S. economy, at least beginning in the mid-'90s, is that, once under the leadership of Volcker and Greenspan, inflation fell from 14 to 2 percent, then essentially since the mid-'90s you've had two economies. You've got the goods producing part of the U.S. economy in which there's basically—not only is there not any inflation, on average, prices are falling because it's exposed to international competition and also tends to reflect technological improvements more quickly in price declines, and then that's about a quarter of the economy. And about three quarters of the economy is the service economy where inflation has been running about 2.7 to 3 percent. So, in essence, in a year when we exactly hit our inflation target of 2 percent, what happens is that goods prices are falling by 1 percent and services prices are going up by around 3 percent. And that's a manifestation of one I and others have called these very powerful global disinflationary forces that were not so evident back when inflation itself was so high. It tended to obscure those. But now that inflation is low, you really do see the role of trade and technology having a major input and impact on U.S. inflation.

LIESMAN: Not to mention I would say the expectation that people have to pick up on what Jeff was saying that high prices won't stand because of the competition.

CLARIDA: Yes.

LIESMAN: It does raise the question, though, which we talked about earlier, you could have this demand resurgence based on the relief that's out there, based on a resurge in the vaccine. Is it possible there could be a mismatch this year where the supply side has a little more trouble coming back in that global supply chain that Jeff was talking about, lags behind the terms of the ability to fulfill the demand for goods?

CLARIDA: Steve, I think that could happen. I think to some extent it will happen—we just don't know how long it will last. If that does play out this year, speaking for myself, I would tend to look through that as essentially a one-time relative price adjustment that's needed to get people back in and employed in the service sector. As it's happening, it might show up as inflation above 2 percent. But I wouldn't expect it to persist for several years. I think it'll be pretty compressed in terms of the length of time but as it's occurring, obviously, if it does happen, we'll have to study it closely. But my inclination now is if we see that is that not to view that as something that we should try to lean against or to tighten policy because it's a bad development, it's just the price system working to reallocate resources back towards services, and as you said correctly, Steve, to get supply in line with demand. You know, we've got more than a trillion of excess savings in the economy, we've got more checks coming into the mailbox with this recent package. And so there's going to be enough demand in the economy this year, and supply and demand will come into balance. But to me that's not something that I would anticipate would cause for any adjustment in the policy that we've communicated.

STAFF: We'll take our next question from Melissa Saphier.

Q: Hello and thank you for this talk today. It's been really interesting and informative. I'm Melissa Saphier, I work at Bridgewater Associates. One question I had for you in regard to the labor market as we emerge from this crisis is it's striking that this is the first recession in a long time where job losses have been concentrated in the services sector. That's a very different pattern from past recessions where we saw the job losses primarily concentrated in manufacturing, and then those jobs just mostly didn't come back as businesses got more efficient and automated the jobs away. I wonder, of course, as we emerge from the virus and restaurants reopen some of those service jobs come right back. But what do you see is the potential, how concerned are you that some of those services jobs just won't come back the same way we saw manufacturing businesses figure out how to operate without those jobs in the past recessions?

CLARIDA: Well, Melissa, it's a great question. And I've not made up my mind on how, if you will, I think what you're really getting at is how much scarring will there be from this recession? And you can define scarring in different ways. One way, I think, relevant to your question is the mismatch in the labor market between people that had great jobs in service-intensive sectors, and some of those jobs may not come back and then at what point do you transition. And we've known in labor economics for decades that when you've got sectoral shocks, that there is some time of adjustment. And it's certainly something that the Fed staff is following very, very closely because this is an unprecedented situation in so many ways with the pandemic. We don't have a lot of historical episodes to look at. So we're very alert to that risk, and we're very focused on trying to come up with measures of how significant that can be, but I'll just have to leave it at that.

Q: Thank you.

LIESMAN: Richard. It does beg the question, if you don't mind, when does the U.S. economy get back to the levels that it left in February? And part of the calculation of that is, even if we get back to a hundred, we will have lost the growth that we would have had [inaudible]. So what's your forecast on when we return to the first level of a hundred and the second level of getting back to what we lost in terms of growth?

CLARIDA: Yes. My projection in the December SEP is that we would close that first gap that you mentioned, i.e., we'll get the level of GDP back to the February level sometime in the second half of this year, maybe the third quarter, maybe the fourth quarter. Depending on the flow of debt it could be the second quarter. We ended the year, oh, we think, we don't have the data yet, but it looks like we ended the year about 2, a little more than 2 percent below the prior peak. And so obviously, you know, we'll have to have some more growth, but I think growth in a plausible range to get that. The second part of your question is the more interesting and the harder one, which is, because the economy is always growing in good times away from recessions, then the real metric for achieving potential is not just you've got back to the prior peak, but that you've recouped the loss growth that you lost. And I think on this, Steve, it's a little bit murkier this time for the following reason: that if you look at the collapse in the economy in the second quarter, yes, it was 30 percent annualized, but there was also roughly a 30 percent annualized decrease in effective supply because people weren't going to the pizza parlors and they weren't going to the baseball games, and so on. And so there is going to be a tricky issue for growth. People who do growth analysis on how you view the lost output in 2020 given the pandemic. One simple thing we'd say, well, in 2019 we grew at 2 percent, so in 2020 we'll grow at 2 percent. But conditional on the pandemic that might not have been a good outcome. But I do think now going forward the relevant consideration is going to be getting back to the previous path. And as you know, Steve, because we talked about this years ago, the U.S. economy took a big hit in the global financial crisis and by some measures never recoup that lost gap. You know, it grew but the shortfall in growth from '09 to 2013 was essentially never recouped.

LIESMAN: All right, Carrie, I think we have time for a couple more, maybe.

STAFF: We'll take our next question from Peter Hooper.

Q: Hi, Richard, calling you from Deutsche Bank.

CLARIDA: Hi, Peter.

Q: Thanks very much for very thoughtful remarks here. Sort of a two-part question, kind of following up a little bit on Steve's latest but a lot has happened this week. Almost lost in the shuffle is the Georgia election, which does have significant implications for the macro outlook. A lot of forecasters are revising up their forecasts with a massive new fiscal stimulus likely. Has that shifted your view at all? Has that been worked into the baseline you've been discussing and, in particular, does it influence your thought about the timing of starting to taper on the balance sheet? And then a second part of this question is, as we look out further and we do eventually get to inflation rising, which could happen sooner now, but what level of inflation do you begin to come uncomfortable with? Is it two and a half or above, particularly in light of the extent to which we've been below for so long?

CLARIDA: Yes, so there are two parts to that question. So on the first, in my December SEP projections, I had made an assumption that there would be some sort of a fiscal package, as you know, that that bill passed after our December meeting. So in some sense, the fact that we got that $900 billion bill right at the end of the year, I had already, more or less, thought that was my baseline case. It is true, however, that with the election outcomes in Georgia, that that does increase the likelihood of an additional package or for those who thought that would be an additional package potentially increases the potential size of that. I've not really begun to analyze that, you know, we'll be having our briefings going into the next meeting and I'm sure that'll be something that we'll be discussing. But I haven't formed a view on that right now but in terms of the magnitude, we clearly know the sign.

In terms of inflation, and here I'll have to be a little bit pedantic but I do think it's important, we very likely will get some pretty big relative price moves this year with year-over-year base effects. And I think a lot of private forecasters have PCE inflation moving above 2 percent on a year-over-year basis. And, you know, Chair Powell indicated, I've indicated today, that's not something that would cause me to concern because I don't view that as an underlying, persistent factor. You know, we've laid out a very specific set of conditions to lift off. We want inflation to be 2 percent. And we want to be in the vicinity of what we agree is maximum employment and we want to have some competence that it's not a fleeting engagement at 2 percent but that inflation is at that level sustainably. So to some extent, as always, those are judgment calls. I don't think it's productive now to get into what level is, you know, too high or too low. It depends, as you know, upon shock. So I'll be looking at compensation, productivity, market expectations, survey-based measures of inflation, expectations in trying to navigate among all of those to form a view.

LIESMAN: Carrie, it's your call if you want to go over or if you want to bid the vice chairman to have a good weekend.

STAFF: Since we're past 12, I think we're all set for now.

LIESMAN: Okay, I want to thank the people who are watching. I thank the Council on Foreign Relations for having me as moderator once again. And thank you, Vice Chairman Richard Clarida, for a really excellent and really interesting conversation and terrific answers to all the questions that were out there.

CLARIDA: Thank you. Next time in person.

LIESMAN: Yes.

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