President and Chief Executive Officer, Federal Reserve Bank of Chicago
Global Chief Economist, Citigroup, Inc.; Adjunct Senior Fellow, Council on Foreign Relations
Charles L. Evans, president and chief executive officer of the Federal Reserve Bank of Chicago, joins CFR’s Willem H. Buiter to discuss issues facing monetary policy in the United States. Evans discusses U.S. economic performance since the 2008 recession, long-term implications for monetary policy, and Federal Reserve strategies for growth.
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.
BUITER: Good morning, ladies and gentlemen, fellow members. It is my pleasure to introduce Charles Evans to you, president and CEO of the Federal Reserve of Chicago, who will join us in conversation in the C. Peter McColough Series.
Charlie Evans had had a long and distinguished career at the Fed of Chicago before he became CEO and president there. He is also a distinguished scholar on the American economy who has published widely on monetary policy’s impact on the United States economy, inflation, and the other things that tend to keep us awake at night, if it’s not the elections.
So let’s start by giving Charlie a chance to give us an update on his view of the issues facing monetary policy in the U.S.
EVANS: OK. Thank you. Thank you, Willem.
It’s really nice to be here. I know the arrangements were made for this talk many months ago, but when I finally focused in, I was surprised that we could get so many people on Election Day. But I guess this is a quiet time until tonight, when we find out how things are turning out. At any rate, let me just give a thumbnail sketch of how I see the economy, and then we’ll have a conversation.
You know, so in terms the economy, in terms of the outlook, I think that after, you know, the first half of this year got off to a weaker start, growth is picking up and, you know, we’re looking for it to be pretty decent. I would say the big challenge for monetary policy at the moment is that inflation continues to be running a little bit low, a little bit soft relative to our objective, and I’ll talk about that.
In terms of the economy, the third quarter growth was really pretty good, 2.9 percent. And when you understand or appreciate that we think trend growth is a lot closer to 1 ¾ (percent) right now, that’s above trend growth, and that’s really a pretty good number. I think on the soft side the private domestic final product was a little bit weaker than that, in the 1 ¾, 1 ½ (percent) range. And so that is a cautionary note going forward.
But basically labor markets have been very strong. Every, you know, first Friday of the month, we get the Labor and Employment Report, and the numbers have been really quite good for quite a long time over the last few years. The unemployment rate has fallen back down to 4.9 percent. That’s a very good rate. And we’re having a very legitimate conversation among policymakers as to whether or not this is full employment—maybe 5 percent is the natural rate of unemployment—or whether or not there’s still a little bit of slack. But it’s a really quite good labor market, but maybe the natural rate of unemployment is 4 ¾ (percent), maybe even a little bit lower.
But employment growth has been good, the last three months averaging 175,000. We’ve had over 200,000 for the last couple of years on a longer-term basis. And again, when you recognize that for lower trend growth and the labor force slower growth, when we get to sort of sustainable growth, if we achieve that for some period of time, we think that employment growth on the order of perhaps as low as 60,000 per month would be consistent with that. So 175(,000), really quite good in that context.
That’s supporting a stronger consumer right now. I marvel at that. I marvel at the strength of the consumer and how the U.S. consumer is what’s really picking up the pace, not business fixed investment—not the business side, but the consumer. After 10 percent unemployment, slow recovery, dead overhang, working through that, slow wage growth, and it’s the consumer that we’re relying on to continue this growth. That’s a good thing. It’s also a little bit of a risk, I would say.
Wage growth has been relatively modest. We could expect wages to improve from where we are and it would still not necessarily be inflationary.
It’s the business fixed investment side that makes me a little nervous. When I talk to corporate CEOs before FOMC meetings, or just when I’m out and about, you hear, you know, a lot of commentary about how they’re basically right-sized for the demand that they expect to face. They don’t really see the need to expand their existing facilities. Maybe acquisitions, things like that; but in terms of their existing facilities, they feel like they’ve got what they need in order to meet demand, and nobody’s running away with their customers, and so they can afford to be cautious and there’s no penalty for that. So that’s—normally we might have expected stronger investment at this time. Maybe there’s more risk aversion caution, and there’s a good bit of uncertainty.
You know, in terms of potential growth, I think going forward something that I try to get across to every audience that I speak to is that our expectations over the next several to many years is that growth is likely to be more on the order of 1 ¾ to 2 percent. And if you just think about the three prior expansions before this slow recovery, going back to 1982, when the economy has been expanding, we’ve had average growth of 3 ¼ percent—3 ¼ percent. And a lot of that is strong labor force growth.
Only more recently it’s been strong productivity growth. From 1995 to 2005, we really had a productivity acceleration that took two forms.
One, for the first five years, was capital-embodied technology advancing. Technology and durable goods industries was a big part of that, advancing more strongly to the benefit of everyone.
And then, when we got to 2000 and after Y2K, that sort of settled in back to more normal levels. And it was really the residual—it was business improvement, process improvements that had total factor productivity increasing at a stronger pace for the next five years.
So we had a 10-year run of very good productivity growth. And, you know, when you see a 10-year run, it’s very natural to kind of go, is this the future? Is this how we’re going to see it going forward? Or is it one-off? Now it looks more like a one-off. We’ve sort of reverted back to that earlier pre-’95 productivity growth period. Maybe more innovation could change that, but at the moment we’re getting disruptive types of innovation, and that hasn’t yet found its way into widespread business process improvements, I would say. And so that’s part of the underpinnings for a slower growth trajectory.
In this context, it’s natural—economic theory would predict that we’d have lower real interest rates if the growth environment was going to be lower. So I point this out all the time: it’s not just monetary policy that might be holding back long-term rates; it’s a worldwide phenomena, as well, that would be consistent with the technology growth, aging population story. And lower interest rates are something we’re going to have to wrestle with in terms of monetary policy.
Now, in terms of inflation, I think that inflation’s been a little bit on the low side. During the slow recovery after the Great Recession, inflation was very low, and it took us a while to get it back moving up. And then, more recently, we’ve had headwinds from lower energy prices, commodity prices, and things like that, the strong dollar. We’ve finally gotten core PCE inflation up to 1.7 percent, and many have said, well, we’re within hailing distance of 2 percent. So we’re close. We’re getting there. And if I had even more confidence that we were going to get to 2 percent, I would feel better about monetary policy renormalization. We’ll see how that goes. I do think that, you know, at the moment there are reasons to be nervous about inflation—“nervous” is a bit strong; not have quite as much confidence that we’re going to get to 2 percent, or that we’re going to get there quickly.
You know, any basic inflation analysis is going to put their, you know, finger on a couple of different factors. One is past inflation. Inflation’s inertial, and inflation’s been low. Sometimes staff forecasting inflation, if you kind of say what’s your best forecast of inflation next year, it’s what it is this year. It’s hard to do better than that. And it’s been low, so that’s one reason why it could continue to be low.
Transitory factors have kept it down. We expect those to go away, so that ought to provide a lift.
Resource slack, Phillips curve. As unemployment gets closer to the natural rate, we ought to see more bidding up of the scarce resources, wages. And, in an accommodative monetary policy stance, that would lead to higher inflation.
You know, at best, slack is maybe neutral. I think there might be a little bit of slack. Maybe there’s not very much. But it’s a very flat Phillips curve, so it’s unlikely that that’s going to provide much lift to inflation anytime soon.
And then the final factor is inflation expectations. And it’s sort of the end point, what everybody’s focused on in terms of setting wages, setting prices in a dynamic world. And I am worried that inflation expectations have been moving down in a way that’s not consistent with 2 percent. In many analyses that we put together, this end point inflation expectation is much more like 1 ¾ (percent).
So when these factors work their way out to a more neutral stance, we would end up at 1 ¾ (percent), which is not 2 (percent). And how do you get inflation expectations up? I think it’s providing credibility to the public and businesses that we’re going to meet our inflation objective of 2 percent, that we’re doing what we can in order to do that, we’re not going to pull back too quickly and defeat that. So, basically, I think that’s one of the larger risks that we have.
Looking around the world, I see far too many central banks struggling with the fact that their inflation is low and they had trouble getting it back up. And sometimes you might wonder if they’ve, in the past, had the wherewithal to get it up to 2 percent.
I’m probably—I’m probably the only FOMC participant who uses the word “overshooting” in their speeches for inflation. I don’t think it’s a crime if we were to overshoot our inflation objective. I think our inflation objective we stated clearly is symmetric, and that means you’re going to spend time above 2 percent as well as below 2 percent. So I think overshooting could be a piece of that.
I think I will turn it over to Willem now to start the conversation.
BUITER: Thank you. Quite a bit to keep us going.
Your statements have very much focused on the dual-mandate role of the Fed—price stability, defined as 2 percent inflation; and maximum employment. Like every central bank, the Fed has a financial stability mandate as well. And since the U.S. has no countercyclical macroprudential instruments, right, other than margin requirements for stocks—and they haven’t been changed in 40 years—can there be a case for raising rates for financial stability reasons, even when it is not warranted for dual-mandate reasons, A, in principle, and B, in practice in the current state of play in the U.S.?
EVANS: I think this is a very important issue. I think it’s an important question. It comes up regularly, and it’s a natural question when interest rates are as low as they have been. Real interest rates are quite low. Investors are facing an environment where, you know, the returns are quite low and, you know, long-duration asset managers, anybody with long-duration liabilities—pension funds, insurance companies—are trying to figure out the change in the environment that they’re facing. And so I think that it’s not unusual to expect that some financial institutions—not necessarily the ones that I just mentioned; far from it—might engage in a little more reaching for yield. Savers are frustrated by the fact that rates are low, and so they might reach and try to take on more risk. Are we getting to the point—when would we know that we’re getting to the point that we have more exuberance in financial investing than is consistent with financial stability? When are those risks rising? And so that could, in principle, be due to very low settings of monetary policy.
What I tried to touch on during my earlier comments were the fact that there are a lot of real reasons why interest rates are low. And I think that even if the Fed were to have a short-term policy rate somewhat higher than it is right now—say 50 basis points higher just for, you know, conversation—it would still be the case that long-term rates would probably be low. I think we’ve done an awful lot of asset purchasing, but—and I think that’s been beneficial for portfolio-balance reasons, why long-term interest rates are low. But when, after the taper tantrum, 10-year Treasurys went from 3 percent down to 1.6 percent because of oil prices, commodity prices, things going on around the world—and we were only continuing to do, you know, a taper after that—I think there are other factors that have led to that.
So is it possible for policy to engage in what would be an even more restrictive setting of monetary policy, because of real rates are naturally low, and it’s restrictive, I mean, it’s hard for us to get policy down as low as that to be as accommodative. So then if we’re restricted, what would that do to our dual mandate objectives? I kind of think that we’d have—be challenged to get inflation up. I think we’d almost be abdicating that responsibility. That’s what I fear. So what’s the balancing act to address any financial instability risk.
And I think that supervision has to be front and center in doing this, regulatory policies. I agree that our macroprudential tools are not nearly as numerous and strong as we would like them to be. That’s about as vague as I can be on that subject. (Laughter.) And, you know, there might be, you know, call for, you know, doing something else in terms of monetary policy. But there’s also other policies that could be pursued. I think that stronger fiscal policy would alter that real interest rate environment. So that could be part of it.
But the part that I like—you know, sometimes people say, oh, 50 basis points on the funds rate. How much can it matter? You know, it’s not really a big deal. And actually, there’s really something to that. I mean, I’ve heard that from central bankers as long as I’ve been in the central bank—25 basis points, how much is that? It’s not so much the 25 basis points, it’s the path after that. It’s if you were 50 points higher would it be 50 points and that’s where you stop? Or are we talking about 50 points on the way to completely renormalizing and perhaps doing more. It’s that full path of policy that matters.
The same is true for any financial stability response. Would it matter if—for financial stability risk—if the policy rate were 50 basis points higher? Is that the only thing holding us back from CRE investing exuberance, if that’s a little bit on the strong side, for curtailing that? Or by topping it out at 50, would that then give, you know, people a lot of confidence that that’s as much as they’ve got? Oh, not even worried about that. Alan Greenspan gave a speech on that back at Jackson Hole around 2002. So I think this is a fascinating topic. I think it’s extremely complicated. And it really takes on board all of the complexities of policy making, which is it’s not just the first move but it’s the entire path.
BUITER: Thanks. You mentioned that the neutral real interest rate, the risk-free real interest rate, is zero or negative at a whole range of maturities, and is likely to remain that way, I think, for quite a while to come. And that’s a global phenomenon and it’s not something that central banks really can do anything about, except possibly make it worse by being prematurely restrictive. But the implication of that is that we are going to revisit the zero lower bound, the effective lower bound for interest rates on a regular basis in every cyclical downturn in the foreseeable future.
In the past, typically, peak to trough in a regular business cycle, the Federal funds target rate moved but 500 basis points. The Fed’s own dots—the median dots sees it—the rate settling at a peak of 3 percent. I’d be surprised this cycle if we’re going to see two, right? This means that almost certainly during the next downturn—whenever it comes and whatever drives it—we’re going to be hitting the zero lower bound again. What will you do at that point? Do you resume quantitative easing, credit easing, qualitative easing? Do you, you know, lower the effective lower bound, the limit—the things like abolishing cash, so you can’t go seriously negative? So, to be nice, leave $10 bills for grandma and grandad who can’t do iPay, right? Or do you simply acknowledge that you’re out of ammunition as a central bank and call on the Congress to do its bit by, you know, the appropriate tools that they have available to them? (Laughter.)
EVANS: Ah, so that’s an easier question than the last one.
EVANS: No, these are all hard questions. This is a real issue, I think. So if you—if you take on board the fact that we are looking at—you know, given the circumstances we’re facing, given the demographics, the aging of the population, our choice of labor force policies and how large—you can’t just immediately birth 25-year-olds next year, right, but you could change labor force policies to allow that to expand.
Given choices that are made, given the state of technology, I think that the trend outlook is lower than it’s been before. That means real interest rates are going to be lower, as Willem’s suggesting, and then our inflation objective has something to say about how high the nominal interest rates are going to get. And we’ve chosen 2 percent, which seemed like a generous inflation objective back when we were thinking that one through, but it does look as if the shocks that we’re face, the configuration of lower productivity than we probably expected and lower interest rates, means that the total cushion for providing policy accommodation when that’s needed—in the past, we’ve lowered rates by 500 or more basis points when we’ve been getting into a period of softening. If we’re at a 3 percent top out for the funds rate, well, that’s only 300 basis points. So we need another 200. We needed much more than that during the great financial crisis.
How do you address that? Well, we used asset purchases. We expanded our balance sheet. And if our balance sheet were—if we were able to get our balance sheet down to a smaller amount before this cycle is over, then you could imagine that we would have more capacity to increase our balance sheet in response, so more asset purchases could help. But if we started from the size of our balance sheet the way it is now, I think that a lot of people would be scratching their heads and wondering even more how large should the central bank balance sheet be. It’s only about 25 percent of GDP in the U.S. That’s a relatively small number compared to other foreign central banks. But the question is, how many of the other foreign central bank tools do you want to engage in vigorously, or do you have to?
Negative interest rates have been employed by many, many central banks. I take that as something that technically could be made more possible, especially if you reduce the amount of cash available in the system, outlaw $100 bills, $50 bills, get it down to something down. Find a way, though—I mean, remember, there’s a large unbanked population out there. And cash if very important to them. So maybe if the level of financial literacy is very high we can convince people that this is a good policy, but I’m skeptical. I really don’t think it would be politically very popular. I worry about the complaints that would come our way.
This is another reason why I think it is so important to get inflation up to our objectives, for us to live up to what we have said we are going to achieve, because if we find ourselves at a point where we haven’t gotten to 2 percent, and we start in on the next down cycle, then people are going to go, oh, huh, 2 percent, I guess that was more of a ceiling. I can see why you would ask that question. You know, this—if you overshoot, if you average 2 percent I think at least you build more credibility for this. And it’s challenging at 2 percent. So you could ask whether or not 2 percent’s the right inflation objective for the central bank. I think it would be very difficult to increase it. But I think it would be very difficult to implement many of the policies that we’re talking about here too.
So that’s OK. That’s our job. We get paid to do that. And other policy makers get paid to make other policies too, like fiscal policy, which—fiscal policy, if it were more stimulative and if it could be directed into more socially productive uses—infrastructure investment strikes me as something we need to do anyway, why not do it when interest rates are cheaper—or lower—you know, that would end up probably increasing real rates too, and that would help all of us out.
BUITER: I agree that it may be useful to remind people of how seriously the Fed takes the inflation target, or even try to educate people that if, on average, you are to hit 2 percent you’re likely to overshoot it from time to time as well to undershoot it. But it still doesn’t mean you can achieve your target, right? You have to have the tools. And there are two reasons, as we know from textbook economics, why monetary policy can fail to be effective. One is that monetary policy doesn’t affect financial markets—the sort of horizontal element, if you want, right? Sort of change in monetary policy, conventional, unconventional, does not affect financial market prices, asset prices and yields, financial conditions. And I don’t think we’re there yet. I think the transmission is getting murkier and less reliable, but it still moves asset markets.
But then there’s the second thing: even if you move asset markets, yields price and all that, it fails to stimulate the real economy. And I think that we are actually probably pretty close to that, in the sense that in this still crazily highly leveraged economy we’re still above—we’re still at the level for financial—corporates that we were in 2007, again. Households are deleveraged relative to the crazy levels of 2007, but I think that level is still by any objective standard dangerously high if rates are to ever normalize. So we have a really—I think extremely highly leveraged system in which rate cuts or rate increases may simply affect the speed of deleveraging, rather than real activity.
And so if we are out of oomph, right, and the Japanese central bank have said that more or less, right? I interpret Kuroda’s latest statement as saying: OK, boys and girls, I give up, right? Please, you know, Ministry of Finance, give us fiscal stimulus. And no matter how much you borrow, we’ll make sure that a 10-year yield doesn’t rise above zero, right? This is—isn’t it time that if you don’t have the ammunition of your own that you do start ringing more actively the doorbell of those who do?
EVANS: So I think that’s a reasonable set of concerns. I do take very seriously that the debt levels that we are looking at—you know, federal government debt levels are quite high relative to what we’ve enjoyed in the more recent past. You know, it’s not on the basis of wartime financing where it would have been more reasonable to have debt like that. And so I understand completely the desire to sort of bring something back down to a more normal setting.
I do think that policy tools—you know, in the U.S., we’re kind of lucky in the sense that we are looking at an upward-sloping policy path. That means that at least we can think about the influence of—if we end up reducing that path. That at least has some expansionary policy relative to what—you know, the Bank of Japan, when you’re at zero and everybody expects you to be zero for a long time, there’s no additional tool there. So at least—and Willem said that. At least we’ve got a little bit there.
I think—but I think there’s a real risk. If we focus a lot on the debt and trying to improve that, if we start focusing on entitlements—and Social Security is probably one of the more manageable ones when you get into it—but one of the challenges I think we’re facing is that there are an awful lot of assets that people have accumulated that they’re trying to put into play in order to get some kind of a return. And you know, the scale of assets relative to the demand for using those sources of funds, that’s really been a big issue in a global environment where capital is flowing into the U.S.
I mean, Bernanke and Greenspan talked about this in the mid-2000s, and how that was holding down longer-term interest rates. And I think we’ve seen more of that, just the general improvement in global economic activity and incomes and wealth creation and the dearth of high-quality assets around the world. And then you layer on top of that for consumers, households in the U.S., maybe you need to be a little more nervous that you won’t be getting as much Social Security or something like that, that’s going to lead people to need to smooth their consumption and save more and add to that additional desire for savings to be remunerated.
Unless there’s a demand, and who’s the demand coming from, is it the consumers or the business side, that’s why I’ve mentioned, you know, business-fixed investment, everybody being comfortable with exactly their capacity now is very limiting in terms of who is going to be driving demand in the future. So I think we need to think about the implications of these longer-term adjustments, and try to right-size them on a medium-term basis so that it doesn’t get in the way of the expansion that we’re hoping to continue with, but perhaps make some corrective action in a longer-term basis.
Very difficult to do that. And in fact, I’m not sure I would even believe that as an individual if you started, you know, trying to tell me things like that. I’d start thinking you were going to try to, you know, take a whack at things that would affect me now. So I think that’s another credibility issue. And it’s very hard. That’s why, if you can—if you can identify productive investments that improve the infrastructure that, you know, in the past they’ve had a very high social rate of return, you know, that might be a very good use.
BUITER: I have one final question before we open to the floor. The Fed tends to ignore the external consequence of its policies, except as far as the feedback onto the U.S. economy through external trade, cross-border capital flows, confluence, contagion, and all that. And the reason that’s given for that is that you have a domestic mandate. Actually, the Federal Reserve Act says maximum employment, stable prices, and (monitor ?) long-term interest rates. It doesn’t say in the U.S., but never mind. (Laughter.) I take it that there’s a reasonable interpretation. But I’ve actually read it, so I just wanted to get at it.
But even if that’s correct, is there not I think a sort of fundamental moral principle, especially if you are the provider of the only serious global reserve currency, that you are responsible for the totality of the foreseeable consequence of your actions, even if some of these consequences don’t impact on your objectives? So concretely, why during the taper tantrum of May/June 2013 did the Fed not make available swap lines to the emerging markets, like India, Brazil, Indonesia, and Turkey? And should they not consider doing so if the next round of rate increases—assuming they take place—were to have similar disruptive impacts on key emerging markets?
EVANS: Well, I think—you know, I think it’s—I think it’s very useful for policymakers in the U.S. to get together with other policy—international policymakers, share their viewpoints on how markets, you know, can best, you know, compete across borders, what, you know, supervisory responsibilities we have on a global basis, and help make things work as effectively as they can. I think that sharing information about our economies, the way that the central banks do in Basel and other forums, is quite useful. But it’s sharing information. It’s not coordinating policy. It’s not coordinating a single monetary policy. I suppose there have been periodically a couple of announcements during the financial crisis where central banks have collectively taken a very small action and hoped that that would provide confidence and things like that.
But beyond that, I think our responsibilities are to our own economies first and foremost. To the extent that there’s some ability to take into account the spillover effect, that doesn’t defeat the policy that we’re trying to achieve in our own country, then that certainly makes sense. But, you know, I think the question as to how essential this comes down to what types of promises have been made in the past as to the level of collaboration. And if there have been promises that have been made that we want to work together and, oh, you can count on us and our capital flows and all of that, that would be wrong in order to get in the way. But I think we’re all better off at some level if we all understand we’ve got to get our own house in order. When capital comes into our own countries it ought to be for, you know, a longer-term investment. If it’s extremely short, hot money, we ought to treat it in that way and have type of regulatory policy.
But I’m sort of at a loss to know exactly what we should do when every time I’ve sort of been involved in a conversation like this, where I was—at the IMF, World Bank meetings one time I had the high honor of being invited to be on one of these panels with other emerging market central bankers, right at a moment when this was an issue. And then after saying we should all, you know, have these conversations, but, you know, everybody’s got to take account of their own house. There’s general nodding of heads at that, so.
BUITER: OK. Thank you.
Well, it’s now time to invite members to join this conversation with their questions. Remember, this is on the record. If you have a question wait for a mic to come your way and please speak directly into it. I mean, this is good instructions.
EVANS: I’ve attended this forum before. My memory is it doesn’t get easier at this point. (Laughter.)
BUITER: Please stand, state your name, affiliation, and one question only, please, and keep it concise to allow other members to speak.
The gentleman over here.
Q: Kim Davis with Charlesbank Capital.
To what extent is your long-term forecast of 1 ¾ percent an economic forecast or a political forecast? (Laughter.)
EVANS: Oh, one and three—well, I mean, it’s an economic forecast informed by some assessment of what different policies are likely to entertain. So, I mean, just—I mean, let’s just think about how do you get to 1 ¾ (percent)? Well, you know, growth at some level is going to be the growth in the labor input plus what the labor can actually achieve with all the factors available to it, namely productivity—you know, the capital that firms allow them to use in that. So it really comes into—comes down to growth in the labor input and growth in technology and productivity.
Well, I mean, you know, if all of a sudden productivity is going to increase if, you know, new machinery is going to be put in place and workers are going to be able to get a lot more done with that then, you know, that would be strong and improving for trend real GDP growth. Now, that’s assuming that with more investment you don’t get less labor input. If they work to offset each other, then the challenge continues to be there, and what it would be for real interest rates. It’s probably a little more complicated than that simplistic analysis.
So, you know, fiscal policies might incent certain types of investments or innovations but, you know, innovations are—sort of come from good thinking and not government policy per se but a good policy environment, that type of thing. It doesn’t come overnight. If you’re restricting labor input so that we’re not going to get growth, and of course it’s efficiency of the labor input so it’s going to be still weighted to some extent. That matters as well. But if you have policies in place that restrict that, it’s just simple arithmetic that’s going to be limiting for what our possibilities are—economics or politics. I’ll leave it at that.
BUITER: Gentleman over there please. In the—yeah.
Q: Byron Wein, Blackstone.
I wonder if you could shed a little more light on the productivity issue. If productivity is the stuff that our standard of living is based on, and also corporate profitability is related to, the fact that it’s been so disappointing is one of the serious problems the economy has faced. Do you have any special insight into why we’re here and what we can do to improve productivity?
EVANS: Well, you’re an economist. (Laughter.)
Q: I used to be. (Laughs.)
EVANS: I should hope you’d be—yes. It’s amazing to me how often economists could use the following phrase: You know, even though I work in this area, I really don’t understand X as well as I ought to—productivity, inflation, financial market—you know, the list could go on and on. But productivity has been a really big one. I mean, you go back to Nobel Laureate Bob Solow, who invented growth theory and TFP, the residual of innovation, and others who have worked on it, they described it as, you know, our level of ignorance about technology.
It’s the residual. It’s after labor and capital do their thing and then, boom, all of a sudden there’s more of it. And how do we get more of it? And then Solow would say, you know, computers. They invented computers and they’re everywhere—everywhere except in in the productivity statistics. People buy them, but we’re not getting more out of them. Not until about the mid-1990s. And then it was a surprise. And so I think we’ve been surprised in many ways how capital embodied technology really made a big effect in ’95 to 2000.
Is it just that it takes 15 years or more from introducing integrated circuitry to finally having an effect? I don’t understand that length. Disruptive technologies. There are a lot of gee whiz, that’s a neat gadget out there, but at the moment it’s disruptive and it’s, you know, challenging other viable technologies and rendering them not as useful. And there’s a struggle—I think competition’s a huge part of all of this. Why is productivity so important for our—well, standard of living? In part, it’s because it drives competition, allowing more people to complete and compete away vested interests, which aren’t as productive as they’ve been in the past, and keeping us going and all those kinds of things.
And so, you know, to some extent I think it’s government policies. You know, to some extent regulatory constraints could be putting, you know, some constraints on that. But then on the other hand, competition somehow sometimes goes in directions that you can’t figure out. So, you know, productivity is—that’s a big one. If we could—you know, usually the story I tell about when I try to explain to people I think trend growth is more like 2 percent—1 ¾ to 2 percent. The reaction I get from people after that is usually: You know, what you said made sense. I just wish you could have said 4 percent. (Laughter.) I’d like 4 (percent) too, but you have to get the productivity, you have to get the labor input, you have to get everything that allows demand to take advantage of all of that and continue to grow. That’s really first order policy priority, I think, going forward. But it’s a big, big ask.
BUITER: I think the gentleman over there was next, and then back there, and here.
Q: Thomas Costerg with StanChart.
Can I re-ask you the question about the swap lines? I’m not sure if you answered. So the question being, why not why not authorizing some swap lines with, say, the Central Bank of China since you do one with, I guess, the European Central Bank, and you seem quite worried about the Chinese economy?
But my second, my key question was actually about the bond buying program. It is done out of New York here, the New York Fed. Do you think one day it could shift to the Chicago Fed? And if you do the bond buying program in Chicago, would you have the capacity and the willingness to assume the bond buying program?
EVANS: Well, I think the issue with the swap lines is, you know, we have a number of standing swap lines. They’re usually not employed very often. They are for, you know, certain types of events. But I think, you know, when you’re focusing on markets and how they’re supposed to be working well and the incentives that they induce, I think it’s just tended to be—you know, are added to that—(audio break)—a little of that—as little as, you know, is necessary. And I think with emerging market economies, they could have other accesses to—access to liquidity from other private financial sources or other central banks and things like that. So, you know, I think we’re probably open-minded to talking about things like that, but it hasn’t been a tremendous priority—for right or wrong.
On the bond purchases, I’ll simply say that the New York Fed has been designated by the Federal Open Market Committee to be its agent, to carry on financial transactions relates to our open market balance sheet assets. And they have—you know, this is, you know, public information—they have a secondary site in Chicago is—I don’t know if you knew that when you asked the question. But they have a secondary site in Chicago. It’s a New York Fed operation operating in Chicago. And they do split operations across a wide variety of everything that they do. So, you know, that’s a contingency capability but, you know, it’s just prudent planning, I would say.
BUITER: Very good. Gentleman in the back there.
Q: Thank you. Good morning. Earl Carr, representing Momentum Advisors.
You talked about the importance of the Fed sharing information with emerging markets, such as China. Could you comment on how do you assess the Fed’s ability to share information with China? Do you think we’re sharing enough information? What are we not sharing? And essentially, what should we be doing that we’re not currently? Thank you.
EVANS: Well, I think we have fairly standard relationships with all major foreign central banks. China’s one of them. And, you know, we get together at, you know, different places. I’m sure that we send, you know, groups of economists and, you know, financial people over there and, you know, talk about issues that are relevant to all of us. So I just view it as the way we talk with other foreign central banks. I don’t think there’s anything special or limited in that regard.
BUITER: Gentleman over here.
Q: Yeah, you haven’t addressed currency at all in your comments today. Can you just talk a bit about the dollar and how impactful it is in your thinking as you think about reactions to monetary policy and how concerned you may be about diverging from global central bank policy with rate policy and the impact on the dollar and how that factors into your calculus.
EVANS: So I’ve been with the Federal Reserve now for 25 years. And back in ’91 I joined. And when we first, you know, got there and I was a lowly economist, they would give us two-week training on topics never to talk about. One of them was the future path of interest rates, but that’s now become a tool of policy. But the other one is currency movements. And they would also say, well, the answer is that the U.S. Treasury is in charge of the dollar. (Laughter.) I never found that to be particularly satisfying. (Laughter.) It’s sort of the answer. We don’t want them talking about monetary policy, so we don’t talk about the dollar.
What we do talk about is the effect of changes in relative currency prices. And so, you know, I would say that the dollar, obviously, has been particularly strong, you know, relatively recently, certainly since 2014 when there was a very big change in the market environment, energy prices, commodity prices, and ECB’s focus on more accommodation to get inflation up, and that type of thing. I would say that during that time period, a strong dollar has led to lower import prices in the U.S., and that’s been a headwind for us getting headline inflation back up to 2 percent.
Now, I tend to like to focus on core inflation, and so I take out the more volatile pieces. But you know, import prices kind of work their way throughout that. So that’s been a bit of a headwind. I think the thing we always point to is you don’t have to have the currency turned around and go back to where it was in order for that to work its way out of inflation. It’s the change in relative prices. So if just stabilizes and we continue with underlying inflationary pressures in the U.S., that would work its way out. If it does, you know, retrace some of that, then it would be even quicker.
I think that—you know, normally it’s not that big of an issue when one central bank, you know, makes a move that’s different than other central banks. But I think that the current environment is a very different one. So I would say that the U.S.’s position of, you know, relatively strong economy, closer to increasing policy rates, more regularly perhaps, inflation getting closer inflation—our inflation objective—you know, that’s going to be a very different trajectory of policy than other central banks are pursuing. So it would be natural, from a theoretical standpoint, to expect, you know, currency rates to have some differential impact.
I think what that means is that we would see more headwinds to getting inflation up as we do that, and so that would impart more restraint. If we’re raising rates in the hope that we’re not going to overshoot or we have more inflationary pressures, and if the dollar were strengthening throughout that—scratch your head—you know, that would also help us keep our inflation objective closer. I think those are some of the things that come to mind.
BUITER: OK, but when I teach behavioral economics, and I get to cognitive dissonance, I always cite the example of the Fed does monetary policy and the Treasury does the exchange rate. Interest is completely—is a complete nonsense. (Laughter.)
Back there—yes, that one back there.
EVANS: It’s nonsense to think these are unrelated in their influences on prices, yes, well.
Q: Dick Ravitch.
Do you think that the—how are you?
Q: Do you think that the growing unfunded liabilities of states and cities pose a threat to the stability of the financial system in this country?
EVANS: I do think they’re a big challenge for, you know, many, many states and municipal entities. Illinois is certainly one of them. I think most recently the city of Chicago has made a little bit of progress in funding their pensions, but it’s probably through some very aggressive attitudes towards how long you can stretch out the funding for things like that. So I think there’s still a lot to be—a lot to be achieved, I think. And they’ve increased taxes there. And that’s very challenging.
I think Chicago is—you know, unless you come to Chicago you probably don’t understand it very well. They do have all of these unfunded liabilities. The state of Illinois and Chicago, it’s really a big concern. They’ve increased property taxes most recently, but it’s really a vibrant city. The Cubs won, you saw that, right?
BUITER: Yeah. (Laughter.)
EVANS: But it’s also the case that corporations are moving their headquarters downtown. And so if you think that the city is really struggling and not going to do so well going forward, corporations are moving downtown. McDonalds, Motorola Solutions, and others. And that’s in part because that’s where the workforce is. That’s where the younger workforce wants to be. And I’ve talked to a number of people who have done this and they’ve said that they’ve seen applications for jobs just skyrocket since they’ve moved into Chicago, as opposed to being in the suburbs.
So getting this all right is very important. Solving these issues is—you know, is critical. I don’t really have all the answers because, you know, the promises that it made are extremely large. Some of the—some of the contracts have automatic inflation adjustment of 3 percent each year. We haven’t been able to achieve 3 percent. (Laughter.)
BUITER: But they have. (Laughs.)
EVANS: (Inaudible)—or whatnot. So these are real benefit increases at a time where they’re very difficult to fund, and something that needs constant attention.
BUITER: I’m sorry, the gentleman over there and then you.
EVANS: Does anybody ever answer that question and say it’s as simple as that? I mean, because—I mean, so many of these questions are sort of like—I don’t have full—
BUITER: It’s very simple: raise taxes, cut benefits. Done.
EVANS: And get reelected, yeah. (Laughter.)
Q: Ed Guineade (ph) from Morgan Stanley.
So you’ve talked about inflation expectations having gone—long-term inflation expectations having gone a little lower than the Fed’s target of 2 percent. Typically I’ve heard Janet Yellen talk about that it’s taken the Fed many years to get to this point where 2 percent has become a credible target. Do you see a further step the Fed could take in the immediate term to sort of pick those expectations up back to 2 percent, besides just simply the overshooting point that you mentioned? But also, would you advocate increasing the target to more than 2 percent?
EVANS: Well, Willem covered, you know, so many of the issues involved in our weak policy instruments if we’re at the zero lower bound going forward. And if that takes place when our balance sheet is already very high, that’s going to be very challenging. And so I think it’s worth discussing anything that could improve our ability to response more aggressively. A higher inflation objective would be on the list to discuss. Other people have mentioned price level targeting. I think that’s kind of difficult, but it’s on the list to discuss. Nominal income targeting. People probably don’t understand that any—they probably understand negative interest rates better than they do nominal income targeting. So that’s a hard one. But, you know, on a topics to be discussed, I would include all of those things.
I think the concern with inflation expectations now is we’ve said 2 percent, we said it in January 2012 explicitly for the first time. I think most people probably were under the assumption that 2 percent is what we were aiming for for quite some time. It took us a long time to get to that environment. I would date that as May 2003 when the FOMC first said there’s a small chance that inflation could become uncomfortably low. Before that, the answer was always inflation is too high, it needs to be lower. I don’t have to tell you 2 (percent). It’s too high. But we got there. And now once you say it could be uncomfortably low you have to ask, well, what’s uncomfortably—you know, where is that sweet spot.
So if it’s 2 percent, is it an average of 2 percent or is it a ceiling of 2 percent? And that’s what worries me because if we failed to get up to 2 (percent) in a sustainable fashion, it could be thought of as a ceiling. I think that’s the first step towards becoming the ECB or the Bank of Japan, if you’re in a world where you have a challenge with all of that.
BUITER: God forbid, yeah.
EVANS: And so you need to live up to what you promise. I also think that, you know, there was an academic debate. Kydland and Prescott won the Nobel Prize in part for their contribution to this debate—rules versus discretion, time and consistency, where Barro-Gordon put together a model and you kind of go, you know, compassionate central bankers trying to get unemployment a bit lower than is sustainable is at the root of so many of our inflationary problems. And so we’re just going to get more inflation and not better unemployment. I think Ken Rogoff, who advocates the cashless society, probably got this right when he said another way to solve that is not rules. Put conservative central bankers in place who don’t have this—they still care about not having unemployment be high, but not quite the same way. So they don’t shoot for something unsustainable and they bias-correct that.
Now we’re many, many years later. So you put conservative central bankers in place. I think we’ve got conservative central bankers, but I think we’ve also learned that that wedge can’t be attained. I think that’s imparted more of a disinflation bias because of this. I think it’s why we have to work harder to tell people this is what we’re really trying to achieve, because otherwise a ceiling kind of seems natural from that Barro-Gordon/Rogoff world—in my mind.
BUITER: Mmm hmm. The gentleman in front of the pillar and then his neighbor.
Q: John Biggs, retired from TIAA-CREF and been studying insurance regulation at Stern for the last 15 years.
We’re very pleased that the Chicago Fed now has a very fine research group working on the issues on insurance regulation. We published Anna Paulson’s first paper, but her second one, on AIG, was extremely interesting because it studied what would have happened if the Fed has not intervened in AIG. She took the balance sheet at the end of 2008 without the 185 billion (dollar) infusion, and found that they had started the year, 2008, with 95 billion (dollars) in capital and they lost 100 billion (dollars) in that one year. Now, originally, everybody blamed this on the credit default swap. Well, they lost only 40 billion (dollars). The rest of it lost 60 (billion dollars). And the people who—not seeing the problems with the life insurance regulation.
The life insurance companies were all bankrupt at the end if it hadn’t been for the Fed’s intervention. Chairman Bernanke said, sort of naively at first: I don’t know insurance. And he didn’t, because the Badgett’s rule would have said they should not have lent the money on assets that weren’t any good. But he now—I think he sort of softly said, I think we made an error on that. But thank God they did intervene, because that bankruptcy would have involved all their life insurance companies, all of which were regulated by Texas. And they did the securities lending disaster for the company. They lost $20 billion in something like 3 weeks from their securities lending business. So it was a—but now we’re faced with an insurance industry with a very weak protection from the states. And there’s absolutely no cash available if there’s a problem in the insurance industry.
I think probably the work you’re—finally, we have a very good research group looking at that in the Chicago Fed, but I’m sort of interested in your observations on how big that risk is. And people don’t seem to be aware of it or talking about it at all.
EVANS: Well, I appreciate those very nice comments. I’ve been very pleased that we have been able to contribute more resources to build a staff that’s part of the financial monitoring teams that the Fed has in order to keep track of financial stability risks around the economy. So Anna’s group regularly contributes to our four times a year discussion of financial instability risk that the FOMC has, you know, in the hopes that we could see something that we didn’t quite see so well during that time period. I think that so many of these markets are extremely complicated and insurance, I think, is definitely one of those, where so many—you know, so many funds are directed towards those institutions that have to invest them.
And they invest, you know, in ways that can be very beneficial for the economy and a long duration since. But then they also get caught up in some liquidity things, which I think increase the risk during that time period, some of the securities lending, and things like that perhaps. So we’re—you know, we’re trying to keep track of that. Now, I mean, in terms of the total risk that, you know, everybody’s facing, I take greater comfort from the fact that most of what they’re focused on is real-money investing at longer horizons. And as long as they’re not too much in the liquidity side that risk should be smaller. I think these are old issues, though, in the industry about mutual companies and the states and how they’re regulated and whatnot. But the—anyway.
BUITER: The gentleman over there? Yes.
Q: Ed Cox, NY GOP.
You mentioned the importance of changes to the labor inputs into the economy. Could you talk about the constraints on those inputs, and particularly high minimum wages, which there’s presently a very big political push for these days?
EVANS: Yeah, I think—you know, I think wages are an issue in many cases. Yeah, I don’t know, I mean, there are proposals to—and I guess in some places they have increased minimum wage by quite a lot. So that’s obviously a big shock, I think, in some locations. You know, $15 in New York is not quite the same as $15 in West Virginia, if you had something like that, obviously—some regional perspective on this. You know, those are big, big numbers and whatnot.
I think that, you know, part of the challenge here is the fact that the minimum wage is not indexed or—you know, it just sort of—you know, it goes up and then its real value depreciates with inflation. If we have inflation then the burden, if that’s a burden for some firms, kind of goes away until somebody else is able to increase it or whatnot. In the current environment that doesn’t have as an effect. But I think in many cases the effect of minimum wage laws is not—I mean, it’s probably negative, but it’s not always very large in many cases. But some of these proposals are quite high. And so those are challenges, certainly for small firms, that type of thing.
BUITER: The gentleman over here.
Q: Jacque Molande (sp) with DMB Bank.
Is there any discussion at the Fed that kind of the big fines we see against banks or the increased regulation is having any sort of chilling effect on underlying economic growth? Or if that’s the case, is it kind of worth the tradeoff to avoid, you know, the risk of another financial crisis?
EVANS: I think some of the fines that have been announced, obviously, have been extremely large and they have large implications for the capital remaining at those institutions. You know, those are decisions made by the Department of Justice, but as we pay attention to their, you know, influence, they obviously affect the business models and they affect, you know, how the financial institutions are going to carry out their operations going forward. So some things that I’ve read recently in the newspapers, you know, are anti-money laundering and things like that, which I think are—you know, they’re going to be with us. I mean, in a world where terrorism continues to be a risk and where it’s funded through nefarious activities, you know, we need everybody to play their role to make sure that we don’t facilitate that in ways that were never intended.
I think that that provides, you know, quite a disincentive for financial institutions to go into certain areas completely, as opposed to being discerning and trying to fund, you know, good-quality investors. If you’re in those emerging market economies, obviously, and you need those funds, this is really devastating for them. So I think we need to understand the incentives that are put in place and the business models that come from that. But I also, you know, kind of understand the risks that we’re all, you know, facing globally. And it’s a big challenge.
BUITER: There’s room for one more question, if anybody has—yes, the gentleman with the beard.
Q: Hi. Jonathan Spicer with Reuters.
Circling back to the comments on productivity and labor inputs, what role does trade play in that? And since it is Tuesday, do you have any concerns about some of the campaign rhetoric around open borders, closed borders, for reaching that 2 percent goal? Thanks.
EVANS: Well, I think in terms of productivity, you know, what’s very important is, you know, competition at some level. So, you know, I think that however it comes about, the more competitive, you know, all of our markets, you know, in individual areas are, the more we’re challenged and the more that the folks that are putting together the best products and with the best means are providing the best value, that that’s going to continue challenging everybody to look forward and do their best. And so sometimes trade plays that role. And so that’s obviously very important. But I tend to think the competition at some very general level is extremely important for that.
BUITER: All right. Well, ladies and gentlemen, all that remains is for me to thank Charlie Evans for a very interesting hour. And I wish him success in overshooting inflation. (Laughter.) Thank you. (Applause.)