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Bloomberg Audio Studios podcasts, radio

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>> Hello and welcome to another episode of

the Odd Thoughts podcast. I'm Tracy

Aloway [music]

>> and I'm Joe Weisenthal.

>> So Joe, Trump nominated Kevin Worsh to

be Fed Chair last week. We've been

talking about it on the show. Obviously,

this has big market implications, but

I'm starting to think that the

sociological

questions and aspects of this are kind

of more interesting.

>> I'm so intrigued by the constellation of

people who have come out either in

support or opposition of this name. It

is not like any other nominee that I can

recall where you have fairly sort of

mainstream even sort of liberal names

like Jason Ferman or Gita Goponath uh

saying there's a great pick etc and then

you have Paul Krugman and Neil Da saying

this is a terrible pick and so forth. It

is it it cuts in ways that I would not

have necessarily anticipated not like

any other Trump pick that I recall.

>> Yeah, it is very split and it feels like

there's a split within Worsh's own

thinking as well. Right? Because here we

have a guy who has talked about wanting

to overhaul the Fed, right? And even

break some heads, I think was a direct

quote that we've mentioned before. He

has given a speech that is literally

titled an ode to independence at the

central bank. But

>> at the same time, there's a big question

mark about how and why he has suddenly

seemingly gone from an inflation hawk to

someone who's advocating for low rates.

>> Totally. And of course I think I mean

for you know just to be blunt this would

have been something that any nominee

from this administration to some extent

there would have been question marks

around because you know obviously Trump

has been very critical of uh Jerome

Powell despite the fact that he

nominated him himself and it's clear

that he wants a low rates now kind of

guy in there. He said after the

nomination he's like you know he didn't

make many promises but he's going to I

think he's going to be a low rates guy.

And then he joked a couple of days later

that he was going to sue about to bring

that up and that was a you know he was

joking. He said he was going to sue if

war

>> joke

is yeah joke air quotes you don't know

it but this has been the big thing and

so the question is the degree to which

an incoming Fed chair presume if he

passes the Senate which isn't guaranteed

but if he passes the Senate can

establish his commitment to what he's

long talked about which is Fed

independence while also you know not

immediately

angering the guy who nominated him

>> exactly

>> to the extent that that matters. Exactly

right. So, we need to talk about all of

this, get a little bit more color on, I

guess, Fedboard culture,

>> and political minations as well, and

market implications, of course. And we

really do have the perfect guest. We're

going to be speaking with Richard

Clarida. He is of course global economic

adviser at PIMCO, a professor of

economics at Colombia and most

importantly for the purpose of this

particular conversation, he's a former

vice chair of the Federal Reserve Board.

So honestly the perfect guest. Rich,

thanks for coming back on the show.

>> Thank you. Looking forward to our

discussion.

>> So why don't I just start with the very

obvious question and we can dig in from

there. But last week when the news broke

about Worsh being selected by Trump,

what was the first thought that went

through your head?

>> I think it's a very sensible choice. It

it makes sense along important

dimensions. In particular, it's

important because I think based upon

background and and what he's been

writing recently that wars will work

very well with Scott Bessant at at the

Treasury. there is Fed independence that

we'll get into, but it's important as a

practical matter that the Fed work well

with the the Treasury and so it makes

sense along a lot of uh uh dimensions.

Actually, let's just get into that

because I do find that to be very

interesting. Say more about working with

the Treasury. You know, some people

would say that is not the Fed's job. In

fact, I would say, you know, Kevin Worsh

going back to the immediate post great

financial crisis era had talked about

how, for example, it's not the Fed's job

to backs stop fiscal policy. It's not

the Fed's job to enable larger deficits,

which he, I believe, saw QE as enabling.

But from your perspective, talk to us

about what a positive relationship

between uh the Fed chair and the

Treasury Secretary looks like.

>> Yeah, it thank you for letting me add

some color. to that because there there

dimensions and domains where it would

actually be a very bad idea for the the

Fed to be dominated by the Treasury. But

along several dimensions, a

collaborative working relationship is

important and I'll name name several.

First is the Fed going back to its

founding is the fiscal agent of the the

government. it has a responsibility to

make sure that the treasury market has

adequate liquidity that it functions

properly. Um, and so that that's an

important element of of the job and

always has been. It's also important

because the Fed uh has an important role

in bank regulation but not a not a

monopoly role. The the controller of the

currency which is within Treasury also

has a a regulation responsibility as

FDIC. So as a matter of necessity on

bank regulation there there needs to be

a degree of of of coordination and and

so I would really highlight those two

areas.

>> So I mentioned at the beginning that I'm

kind of interested in the inner

functioning of the Fed board. From your

perspective,

how does communication between the Fed

and the Treasury actually happen? I'm

sort of envisioning like I don't know a

WhatsApp or signal group chat

>> there. There is a tradition, it's not in

statute, there is a tradition that the

Treasury Secretary and the Fed chair

meet on a regular basis, oftentimes over

uh breakfast. And so during my time,

that was the primary uh point of contact

was bilateral between when I was there

Jay Pal and Steven Minutuchin and then

when Janet Yellen became Treasury

Secretary. So that's informal. There are

typically not staff uh in the room uh

for that. There's also the financial

stability oversight council which was a

creation in DoddFrank which by statute

is chaired by the treasury secretary and

then the there fed among other uh

agencies also participates in that

process. And then thirdly as I mentioned

anything involving a bank regulation is

typically going to involve if the senior

or even the vice chair for supervision

level interaction on bank regulation.

You know, let's get into some of the, I

guess, criticisms or perhaps questions

about Kevin Worsh. And there's a few

different dimensions. One is, of course,

there's perception that he's long been

an inflation hawk and suddenly he's

sounded more dovish over the last, you

know, 12, 18 months or whatever. Setting

that aside though, you know, some of the

criticisms start early on, including his

judgment around the great financial

crisis. Concerned more about inflation,

you know, even up into fall 2008 than

employment right on the eve of collapse.

Also seemed to get very anxious about

inflation soon coming out of the worst

of it, etc. But like when you think

about okay like his qualifications and

what we can expect from him, how much

like when you go back to that era, how

much should we hold that against him

perhaps? Either that he was off the mark

or that he was at least very far out of

consensus at the time. Well, I think you

have to look at the entire picture and

and Kevin was also very involved with

Ben and and and and Tim Gner and and

Dudley and the crisis response to the

global financial crisis which really

played out over a period of 12 to 18

months and I think by most accounts in

my judgment that was a you he actually

added a lot of value in in the fog of

war. inflation as I myself learned

especially in periods of crisis and

unusual large shocks inflation

forecasting can be can be challenging.

So I don't think I would hold that

particular episode against him. I think

it does fairly characterize the way that

most of us think about Kevin throughout

during that period and really the last

15 years is he has been a pretty

consistent critic of the Fed under the

second half of Bernani and then Yellen

and Pal and typically the criticism has

come from the hawkish direction and

certainly in that episode his his

criticism of the Fed was that in some

certain quotes would indicate that

hawkish inclination as Well, maybe just

I can follow up because in your earlier

comment, you also mentioned his his

recent advocacy for for lower rates.

Now, it's important this is in the

context of a committee that under Pal's

leadership beginning in September of

2024 already began to cut rates. In

fact, when I did your show earlier and

we were talking about that right after I

think the initial rate cuts under under

PAL, I made reference to what I've been

calling for some time now the Fed is is

running what I call the quote 2 point

something inflation target which was

they don't like it to start with a

three, four, five, six or seven. But if

inflation gets down to 2 point

something, they can start to talk and

think about rate cuts as they did under

under PAL and in importantly at the

December Fed meeting. So just about six

weeks ago, the Fed indicated through

those very imperfect dot plots that a

majority of the committee of of that

existing committee which Kevin will

inherit felt that at least one more rate

cut this year given the circumstances

would be appropriate. So yes, Kevin has

come out in favor of rate cuts in his

public comments. don't know what he said

privately to the president, but I doubt

that they differed what he said

publicly. But that's in the context of a

committee that at least a majority of

whom think that in this year it'll be

appropriate to cut at least once.

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I'm just going to keep pretending to be

an anthropologist and ask a bunch of

cultural questions, but what actually is

the role of Fed chair when you're in a

monetary policy meeting? So, you know,

let's say that Worish has some sort of

outlier opinion. I I don't know, he's

prioritizing employment versus prices or

whatever.

>> Yeah. Can he convince everyone at the

table, all the voting members to

actually change their minds?

>> Tracy, it's a great question because a

point that I like to make, at least in

my professional time, which goes back to

Paul Vulkar, we tend to talk about the

Fed is the Vulkar Fed, the Greenspan

Fed, Pal Yellen, Bernani Fed. and and

that's appropriate because in this era,

Fed shares have been persuasive and they

and they've usually got their their

their way. But importantly, the Fed as

an institution was specifically designed

by the Congress in the 1930s

in such a way that any material monetary

policy decision, do they raise or lower

interest rates or do they buy or sell

treasuries, requires an affirmative vote

of a committee comprised of 12 members.

And so as I as I've liked to say and

I'll say it again, really the power of

the Fed chair is the power of persuasion

because at the end of the day he or she

only has one vote. Now it's often argued

that well Rich that's silly because

rarely do Fed chairs get outvoted and

that that's true. It happened once or

twice under Vulkar. It it happened way

back in the 1940s. And so yes,

empirically it may appear as though

chairs always get their way, but but

remember Fed chairs know where the

committee is leaning and often times or

certain circumstances they may

themselves decide not to be on the

losing end of a particular vote but to

try to persuade the committee over time

to move in their direction. Now one

thing I can't really speak to the

Greenspan Fed but beginning under

Bernani and continuing under Yelen and

certainly with Jay Pal there is a lot of

premeating FOMC meeting communication

and indeed Pal during my time there

would have individual bilateral

discussions with the other 18 people not

just the voters but if you know there

are 12 voters and another seven Reserve

Bank presidents who don't vote in a

particular year so Pal would have 18

individual phone calls or face-toface

meetings before every uh meeting. I

don't think that was the practice under

Greenspan, for example. Um, and so part

of really what a Fed chair does is to

get a sense of where individuals on the

committee are, but really an important

power that the chair does have is the

chair sets the agenda for the meeting

and the staff briefings for the most

part are prepared by the board uh staff,

sometimes with input from the reserve

bank presidents and the board staff

reports to the chair. And so the agenda

for the meeting and often times details

about the sort of analysis that would be

useful for the discussion will be

something that the chair will have a

view on. Now now during you you asked

for anecdotes you know during during my

time because of my background in in

monetary economics chair pal J pal did

ask me to take a pretty hands-on role in

interfacing between himself and the

staff in particular the forecasting and

the monetary affairs groups but

ultimately my role was really you know

in service to what he wanted to do to

produce a successful meeting. The final

thing I'll say, you got you got me sort

of wound up.

>> It's all great.

>> The final thing I'll say is, and I think

this has been publicly uh reported, but

it's it the at a typical Fed meeting,

there is a policy announcement that

comes out at 2 p.m. That's a decision,

and the committee, of course, is

discussing that decision, but it's

discussing other options. And at a

typical meeting, in addition to the the

Fed's statement and the policy action

that was the outcome of the meeting, the

committee is also discussing

alternatives, actually tangible

alternatives, alternative A, alternative

B, alternative C. And there can be quite

extensive back and forth in the meetings

about those alternatives. And so even at

the end of the day what the public sees

is the Fed decided to keep rates on hold

and there were two dissents which were

governors and uh Waller a lot more was

being discussed at the meeting as

potential alternatives to that statement

and that decision and a lot of

discussion in meetings can be about what

the committee thinks might be

appropriate for the next meeting or the

meeting down the road. Indeed, one of

the the many things I learned I made a

promise to myself when I was in the job

to to try to learn something new every

day and and and I usually did and and

one of the things I didn't appreciate

before I got into the to the Fed is

especially the the chair and and the

palett you you really need to have a

sense of the arc of both the year in

terms of the data flow you're likely to

get and the arc of where decisions need

to be made and how they're they're made.

And and so there's a lot sort of like an

imperfect but not completely a bad

analogy is we've heard of legendary

football coaches who like script the

first 50 plays of the game. Now

sometimes they move away but they want

to have a plan about how they'll react

if the defense does a certain thing or

the other. And it's not dissimilar to

the way at least when I was at the pal

Fed that that we would be thinking not

only about the January meeting and then

start thinking about March but really

the arc of the of of the year you know

based upon your view of the data and and

a number of other considerations. So th

those are some tangible examples of the

way chairs I think put their imprint on

the on the process. So, thinking of

calling several plays in a row, we've

seen uh Kevin Wars very skeptical of

forward guidance and some of the

monetary policy innovations that

occurred in 2008, 2009, and so forth. I

think it's easy maybe for people to

forget that things like the dots, the

press conference, and so forth, these

are all very modern. For most of the

Fed's history, there was none of this

stuff. Do you think

>> I remember the invention of the dot

plot? Remember that? We were trying I

still don't get it but yeah.

>> Well, we were trying to figure out

internally at Bloomberg like the best

way to translate that information. Do

you think I mean setting aside Worsh's

view, do you think there's an argument

to be made that some of these

communication innovations that maybe

made a lot of sense during a period of

ZER where the Fed was trying to convince

the market that it would be on hold for

a very long time that maybe they can be

revisited and we don't need so much of

this stuff in normal times.

>> Yeah. So I think let's focus now on

communication since that was your

specific question but perhaps later also

talk about Kevin's other critiques which

are broadly the balance sheet sort of

mission creep in the size and the

composition of the balance sheet

>> and then third critique is is grounding

Fed policy both actions and

communication

>> more towards a policy rules framework

and a less moving away from what he

calls meeting by meeting discretion.

Let's talk about communication and and

having observed and and taught this and

and actually done it for four years. I

want to begin with a historically

factual statement that's important to

provide some context. It is perfectly

possible to conduct a very successful

monetary policy without any forward

guidance.

>> Paul Vulkar did it for eight years and

Alan Greenspan did it for 17. You know,

there would be little hints and winks

and nods, but forward guidance as we

know it today is really something that

was not really in the toolkit of of Paul

Vulkar or for the first 17 years, Alan

Greenspan. Now, Greenspan's endlessly

fascinating. And one of the fascinating

things about Greenspan is that in his

last two years, and I would say not

coincidentally at the time that Ben

Bernani was a a Fed governor, right at

the very end in 2004 to six, Greenspan

began to dip his his toe into forward

guidance. But for the most part, that

was not really uh part of of the

toolkit. So why did forward guide first

of all then what is forward guidance and

why it become part of the toolkit? Well,

at its most basic level, forward

guidance is providing information to

observers and importantly to financial

markets about the committee's

expectation of the path for interest

rates. Now, there's a huge academic

literature. I've contributed to it

myself. And one of the interesting

things that you might find that's might

be surprising about that literature is

it spent a lot of time 20 years ago

arguing that forward guidance was

irrelevant because the Fed's looking at

inflation data. The market's looking at

inflation data. If inflation's too damn

high, the Fed will raise rates. If it's

low, they'll cut [laughter] rates. So

you don't really get any you don't

really get any incremental benefit by

telling people what you're going to do

if they know you're going to do it

anyway. And so the the case for forward

guidance then has to then rest on

something other than it's okay to talk

about what you're going to do. And and

where forward guidance really became a

focus of the Fed was out of desperation

at the zero bath. So rates got cut to

zero after Lehman Brothers. The economy

was in freef fall. The financial system

was on the verge of collapse

>> and the Bernani Fed could not use

conventional policy to lower rates

because they had hit, you know, a zero

bound. And so they began to provide

guidance to the markets to essentially

reassure markets that they were not on a

hair trigger to hike rates because they

kept noticing that even though the

economy was weak, inflation was low,

unemployment was high, the bond market

kept pricing in rate hikes that they had

no intention of delivering. And so

forward guidance really took on an

important role when the Fed was trapped

at at at the zero bound. Now an

interesting correlary then is what do

you do when you raise rates above zero

and of course the pal Fed did that

beginning well yellen and then pal did

that and I was actually there for the

rate hikes in that in that cycle and the

fed by the time I had arrived

importantly because of the dots the Fed

had begun to had continued to use

forward guidance even after rates got

above zero and oftentimes the dot plot

was an input uh into that since it

provides imperfect but potentially

useful information about the committee's

intention to adjust rates. Let let me

say, however, that I think it's entirely

appropriate that Kevin Worsh or anyone

who becomes a Fed chair now think about

the cost and benefits of forward

guidance. Indeed, I've said for at least

a decade, including before when I joined

the Fed, that forward guidance and

quantitative easing are not exempt from

the laws of economics. they they have

benefits but also costs. There are

probably diminishing returns. And so I

don't think it's at all inappropriate

for the Fed under the leadership of the

chair to think about benefits and cost

of forward guidance in circumstances

when it may be useful and circumstances

when it may not be. Let me just add a

little kota here. Another dimension of

Fed communication that's changed is

really been the result of a change in

technology and access. So, you know, if

you go back to the 1980s, yes, when

Vulkar gave a speech, people would read

it and the Times and Wall Street Journal

would report on it, but other than that,

Fed communication was was pretty uh

limited. Uh and of course now of course

we all have access to the internet and

financial news and each Fed president

and and Fed governor uh give uh speeches

and so there's a lot more individual

discussion of what individuals on the

committee think would be appropriate

policy as well as formal guidance as

well. So I think that's that's sort of

where we are on on forward guidance as

of today.

>> Just one followup to that. The way I

think about it from a market perspective

is that forward guidance you know since

2008 2009 has had the effect of

dampening volatility especially in the

bond market and now if you have less

forward guidance it would seem perhaps

there's a risk that volatility makes a

return. Putting on your your PIMCO hat

from the perspective of the bond market

what would less forward guidance

actually mean? I think you hit the nail

on the head. I think the most robust

prediction I would make is it would it

would in increase to some extent market

volatility in particular interest rate

volatility and importantly and I'll just

be very direct and and and and blunt in

the decade remember rates were at zero

for seven years after the global

financial crisis. Uh Janet Yellen did

not hike rates until December of 2015.

Uh and they've been on hold for seven

years. And so not only was realized rate

volatility low at the front end of the

curve, but the Fed was using a lot of

forward guidance and a lot of

quantitative easing. And that was

suppressing interest rate volatility for

a very long period of time. And then

even once the Fed began to lift off

because it was deploying forward

guidance that also served at the margin

to suppress rate volatility. And you see

this for example the move index which is

a basically a bond market index. So

volatility got down to very low levels.

So, so part of what has been happening

really in the last several years under

the PAL Fed is bond market implied

volatility has gone up relative to the

suppressed levels of the decade before

the pandemic, but not really up to

levels that were at all unusual back in

the 1990s.

And so I think my first order assessment

is we may be going back to what I would

call more normal or preGFC levels of

rate volatility. Now the Fed is not the

only only game in town when it comes to

rate volatility. There's reasons for

rate volatility to be elevated because

of uncertainty about fiscal policy for

example uh as uh as well. You know first

of all I want to say you know I remember

the concern that the Fed had in 2009

about does the market see the Fed as a

hair trigger on inflation? I don't think

a lot of people remember this, but in

early 2009, the market was pricing in

rate hikes by the end of 2009, which

seems almost unbelievable in retrospect

when you remind us that the Fed went

seven years without a hike. So, there

really was a very intense challenge on

the Fed's hands to convince the market

that it was going to stay on hold for a

very long time. And I think forward

guidance clearly played a sort of

specific tech role there. Let's talk now

about balance sheet. Yeah,

>> Bill Dudley wrote a column for Bloomberg

Opinion uh after the Worsh nomination

and he was sort of critical. He said he

didn't think that Worsh was going to be

able to shrink the balance sheet much

further unless there were some other

changes perhaps relating to banks

capital requirements etc. Worsh's own

criticisms of the balance sheet seem a

little bit of a moving target at some

point. How well do you I mean maybe I

would ask how well does any economist

have a handle on the effects of balance

sheet policy but what's your read on

sort of the reality of wars coming

intersection perhaps with the balance

sheet

>> yeah so I think there are two related

but distinct elements to this first is

that Kevin has been publicly and

consistently critical of every expansion

in the Fed's balance sheet since the

first QE1 program so he very famously

said he was opposed to the QE2 program

in 2010. Uh although I think he did vote

for it, but then he left soon uh after.

And so there's the issue of

backwardlooking, oh, the Fed should not

have been buying treasuries and

mortgages as it did. And I think there's

no reason to think he's changed his

mind. Indeed, Secretary Bessant wrote a

piece with a very provocative title, the

Fed's, you know, gain of function uh

monetary policy. and he was also

critical in retrospect of the expansion

in the Fed's balance sheet. The

important question of course for for

OddLot's listeners and for markets is

okay that's the past looking ahead and

one of the many interesting things that

Kevin Walsh said during his I guess

campaign to become Fed chair was to call

for a new accord between the Treasury

and the Fed with regards to the balance

sheet. Now he hasn't provided a lot of

details. What we do know is what the

first accord between the Fed and the

Treasury looked like, which was back in

1951. And what was interesting about

that, it was essentially the Fed's

declaration of independence to raise

rates without getting approval from the

Treasury, which is why Fed historians

think of it as really a signal event in

Fed history. So, I don't think that's

really an issue. Now, presumably what

Kevin means when he talks about an

accord is a mutual understanding between

the Fed and the Treasury about the size

and composition of its balance sheet.

And so, for example, you could agree

that the Fed needs to have the current

size balance sheet, but it should not

own mortgage back securities or 30-year

Treasuries. It should own T bills. So,

that's a conversation you can have. You

can also also have a conversation about

the Fed having a a smaller balance

sheet. admire of Bill and I I read that

column and agreed with almost all of it.

The the point being is is to get from

here to there is is not straightforward

and in particular it involves the

banking system in terms of the level of

reserves in the banking uh system. The

Fed has been very reticent uh although

it's been tempted and it's discussed

selling mortgage back securities. You

can find it in the transcripts going

back a dozen years and two years. And so

right now there is no appetite in the

existing Fed to think about shrinking

the balance sheet through any sort of a

any sort of a sale. And then finally and

I and I do want to get this on the table

because I think it's a very important

point that is often imperfectly

appreciated is the following. In 2008,

coincident with the global financial

crisis, the Fed also achieved from

Congress the statutory authority to pay

interest on bank reserves. Until that

point, the Fed created reserves by

buying securities, but they earned a

zero uh interest rates. And that not

just the Fed, but most other central

banks now pay a market rate of interest

on bank reserves. And the reason why

that's important is the following. What

it means is that when the Fed does do a

QE program, when it buys a mortgage

security or a Treasury, it's not really

printing money in the sort of money and

banking sense that you're buying a

coupon and paying for it with a $100

bill and thus extinguishing the coupon

payment. What you're really what the Fed

really does now with modern QE and

interest on reserves is it's not

extinguishing government debt. It's just

changing the maturity composition of

government debt from fixed to floating.

Because at the end of the day, the Fed's

balance sheet and the Treasury's balance

sheet are consolidated. When the Fed's

profitable, the the the Treasury gets

that interest income. In recent years,

the Fed has not been profitable and it's

been withholding those remittances. And

so once once you think of it that way,

then you start to think about a scenario

where a Treasury Secretary could, if he

chose to say, you know what, I want to

be the big sheriff in town when it comes

to maturity composition. So if I think

there are too many 30-year treasuries,

I'll buy them and sell T bills and the

Fed can buy the T bills. And so there

are scenarios over time where we could

rethink what QE is in addition to what

the size of the balance sheet is. But

this is not, you know, a 30 minute or

you know a oneweek exercise. This will

be a pretty complicated intricate

process. But I don't want to rule out of

hand that it's something that uh is you

know beyond considering or discussing.

>> [music]

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>> So other than his distaste for the size

and potentially composition of the Fed

balance sheet, there's something else

that Worsh doesn't seem to like, and

that's I guess traditional economic

models. So he's been critical of the

Phillips curve for instance. Uh he's

been critical of data dependency at the

Fed which kind of leaves the question if

you're not going to focus on data and

you're not going to focus on models what

are you actually using to formulate

monetary policy? Do you have any any

read on what that could be?

>> I think u you know and I've known Kevin

I think for a dozen years. I didn't our

our terms as fed officials did not

coincide, but I've gotten to know him

since and we've met many times and had

many conversations and the like and I

read most if not all that he writes. You

know, my my sense is really that his his

critique is that a lot of economic

models in macro tend to to put a lot of

emphasis on on the demand side of the

economy. Now I can point you to my first

speech as Fed vice chair in October 2018

where I also put on the table that

policy need to think about the supply

side of the economy and the Fed doesn't

want to be in the business of raising

rates because too many people have a job

if that's not inflationary and the the

way you sort of square that circle is

your outlook on on on productivity. And

so it is correct that if you get more

growth because you've got a more

productive economy either through

innovation or deregulation

then the Fed should not get in in the

way of that. And indeed during my time

the pal Fed didn't you know the models

uh both in the Fed and outside in 2019

were saying and indeed if you look at

Fed communication in 2017 it was saying

if the unemployment rate falls below 5%

we'll have to hike rates because that's

going to be inflationary and by the time

I got there the unemployment rate was in

the fours and we didn't have inflation

and it got down to the low threes. And

so it is correct that there is a supply

as well as a demand side to the economy.

And if the supply side can grow faster

with higher employment without

inflation, the Fed should not get in the

way with that. So I I 100% agree with

with with that. Now the the challenge is

the economy, as Jay Palace said, the

economy is constantly uh changing. And

maybe just a little a little bit of a

wonkish uh comment for the the wonks in

your audience. And and let me set the

record straight. Uh you know, the old

saying, facts are stubborn uh things.

And we all live, you know, we're all

three of us were around in the 1990s.

And Greenspan is justly uh complimented

as he should be indeed what I teach this

material. I always emphasize this period

for recognizing that because of the

internet and connectivity and personal

computing that there would potentially

was an eminent increase in pickup in

productivity. And the staff and other

governors were saying we should hike

rates and green spend. And I said, "No,

let's see. we may get this may be a

productivity-led boom and that's indeed

the story between 1995 and 1999

but if you look at the greenspan Fed in

1999 it was hiking rates even though we

had very strong productivity growth and

we had strong economic growth in the

face of a very buoyant stock market and

what people forget [laughter] is that by

2000 the federal funds rate was at 6 and

a half% so it is true that Greenspan did

hold off for several years, but by the

end of that of that uh tech internet uh

boom and dare I say irrational

exuberance, his famous phraseology,

Greenspan was hiking rates very

aggressively in the face of very strong

productivity growth. So when people

refer to that period approvingly as a

reason uh for the Fed to hold off from

from you know hiking or certainly

continuing to cut rates because of

productivity you have to look at the

entire decade. You just can't cherrypick

three or four uh years. This is

interesting. You know, just while we're

here, talk about Green Greenspan. I

mean, why did he raise rates so

aggressively? And did Greenspan's own

rate hikes in the late '9s not really

gel with his own comments about the

capacity for the economy to grow during

a time of expanding productivity?

>> The explanation, I would argue, was

really was really twofold. I I do think

by that time although I haven't

memorized the memoir but but I think by

that time the the irrational exuberance

piece was a factor there is a there is a

wealth effect so if stocks are going up

people are wealthy they spend more and

so central banks don't like to be in the

business of of pricking uh bubbles but

there is a connectivity between a very

very fully valued stock market and your

macro outlook you know we all remember

some of us remember Pets.com you know

the sock puppet Super Bowl commercials

and also I just think by that point

although inflation had not moved above I

should also mention the other

fascinating thing about that period is

it's clear now from the transcripts that

the Greenspan Fed by the mid to late 90s

was in essence running what we would now

call an inflation targeting regime and

that the target was two but Greenspan

was always resistant to the idea the Fed

should ever publicly say that they were

targeting 2% inflation but by the late

90s you have inflation moving up close

to 2% and you could really I view this

as a period where Greenspan's basically

saying I don't want to go back to the

bad old days of 8 7 5% you know

inflation and so it was probably

preemptive as well not resisting the

productivity but merely uh trying to to

keep the economy in in balance and then

the final thing I'll say sorry to be

wonky is that as a matter of economic

modeling other things being equal if

you've got faster productivity growth,

you'd expect that to move up what

economists call the neutral rate of

interest anyway. And I think actually

Bill Dudley made that point in his

column as um as well.

>> Never apologize for being wonky on this

show.

>> Good.

>> I want to go back to the question of

central bank independence. So if if we

assume that Worsh truly wants to do his

own thing outside of presidential

influence and again there are there are

some people who doubt that is the case

but if we take that premise how does he

actually display or demonstrate the

central bank's independence when you

have a president who likes to talk about

interest rates and likes to joke as we

were saying earlier about you know I'm

going to sue War if he doesn't lower

rates.

>> You also use the word campaign in you

Kevin Wars's campaign, which I thought

was an interesting choice of words to

describe the last several months.

>> That's okay. Uh that's he he's he's a

very he's a good choice. And there there

were three other candidates and um and

and it worked. I think I think there'll

be a couple things uh Tracy that that

we'll we'll see pretty soon. In fact,

I'll let I'll let you and your listeners

decide if it's a it's a joke. But one

thing I find humorous, I'll share with

you is that, you know, if if if JPL

really wanted to complicate the

situation for his successor, you know,

he cut rates at the March and the and

the April uh meeting to get the funds

rate down to the level where at least

[laughter] the committee seems to think

is the destination so that there's

nothing for the next person to do. I

don't think Powell's going to to do that

because I don't think it's

>> monetary policy by trolling. I don't

know if that's a that doesn't sound like

a Powell thing, but that would be funny.

Yeah, but you know, but but but but

there is a kernel of of truth to it,

which is as we said earlier in the in

the podcast, the power of the chair is

the power of persuasion. Wars will only

have one vote. You've got some very very

highprofile and confident people.

There's a voting rotation as your

listeners know. So right now you've got

folks like Beth Hammock and you've got

Lori Logan, Neil Qashqari in Minnesota

are are voting now and and Anna Pollson

in in Philadelphia. I I believe and you

know and Lori Logan and and and and

Hammock and and Kosh Curry will not will

not be shy publicly or I'm sure in the

meetings if they disagree with what they

would perceive and I'm not saying wars

would do this as you know we're going to

keep cutting rates below a level where

the committee seems to have a broad

sense that the neutral rate the

destination rate is going to be

somewhere in the low threes you know

three and a quarter three whatever and

so I do think that we'll under the sort

of baseline scenario for the economy uh

we we may get to that level of rates uh

sometime this year and then at that

point the issue would be depending on if

there's political pressure on on how the

worst Fed would navigate that and my

sense is notwithstanding all the

discussion of the supply side benefits

of of AI and and deregulation

you know if if the hint or the

discussion of a future rate cut would

would trigger nervousness in the

financial markets, break even inflations

go up, expected inflation measures go

up. You know, I think Worsh would and I

think War and the Fed would take that

seriously. So my my read is that he will

he will navigate the data as it comes.

uh he'll he'll want to focus on the

supply side, but but at the end of the

day, look, no no no no no Fed chair

wants to go down in the history books as

the Fed chair that squandered 40 years

of price of stability. And uh and so at

the end of the day, and this is I think

perhaps what the president was referring

to on more than one occasion when he was

thinking about who he was going to

choose. I'm paraphrasing, but he said

something like, you know, people will

say one thing and then they get in the

job and they disappoint you. And so I

think that that's an element of the of

the institution and of the committee

structure that will continue to be

relevant.

>> It's so interesting. I mean something

that's interesting is when we you

mentioned the 40 years of general price

stability. It's interesting that like

Arthur Burns that is a name that has a

lot of it's been tarnished right because

of the inflation. And yet Bernani, who

you know went through the the great

financial crisis, the worst downturn

ever, by and large is remembered as

having been a very good central bank

chief. And so it's striking that, yeah,

you have a few years of inflation,

everything, oh, you're a disaster. But

if you have a great recession underneath

your uh term, by and large, you could

still have a pretty good reputation. I

want to ask though, you know, the thing

is right now we still have above target

inflation and maybe AI will drive a

productivity boom and allow the economy

to grow very fast with low rates etc. In

the here and now though we we haven't

even gotten back to 2% yet and so and a

lot of these benefits of AI still very

theoretical.

>> Yeah. Well, I I I'll I'll be even more

blunt. I I think you can make a case

that although longer term AI uh will be

disinflationary as the productivity

benefits arrive, you can I think you

make a very plausible case that between

between now and then

the capex buildout

>> to train the models is going to be

increasing demand in a fully employed

economy before the productivity benefits

arise. And so if I were still teaching

intermediate macro, this would actually

be a pretty interesting uh case study to

go on on the chalkboard that in 5 years

you've got more GDP per worker. That's

great. That's disinflationary. But

between now and year five, you're going

to be double doubling your tech capital

spending investment, which is adding

demand before the productivity benefits

show up. So it's not a slam dunk to me

at all about what about what AI means

for for monetary policy near-term even

though maybe in five years the

productivity benefits are so large it it

will it will have a different you know

tend to be disinflationary. So I think

it's AI is complicated along every

dimension you can think. It's a

complicated technology. It has

complicated economics and social

potential ramifications and I think it's

it's not a slam dunk easy situation for

the for the central bank either. I have

one last question about central bank

independence. Setting aside Wars's

comments, something we haven't talked

about at all is the subpoena to Jerome

Powell over the um over the offices over

the renovation. Powell was very specific

in that he thought the subpoena was

motivated by punishing him or trying to

get back at him for doing rate policy

that the president didn't like. Two

things related to that. A, does the

subpoena in your view sort of add to

your worry either medium or long term

about how long the central bank truly

will be an independent institution in

the United States. And a correlary to

that, you mentioned Powell control the

uh wars by cut doing all the rate cuts.

Now, what do you see as the odds that he

stays on the board until his term as

governor ends even if he's no longer

chair?

>> First of all, there is there is

precedent and the Fed's a very very

president focused institution. Legendary

Fed chair indeed had a building named

after him. Mariner Eckles was an FDR

appointee and then when Harry Truman

became president, Harry Truman named

another Fed chair and Eckles stayed on

and and actually became a real thorn in

Truman's side. I would be surprised if

J. Pal stays on for the remainder of his

term as governor, which which runs

through uh January of 2020.

Would I be shocked if he stayed for a

meeting or or two? No. Only Powell

knows. He's been asked that question two

dozen times and he always gives the same

answer. But but I sense he's probably

not going to be staying on, you know, in

terms of this case, you know, I pal's uh

comments can can um you know, stand for

themselves. I won't weigh in. What I

will say though is we have not only this

the current thing that you just

mentioned about investigation on the on

the building, you know, we also have the

Lisa Cook case.

is going to weigh in on on on that. And

this is all sort of tied up into this

idea of can Congress establish a central

bank with a degree of independence to

raise or lower uh rates. And an

important element of this is this idea

of four cause removal. You know, beyond

that, it's just going to play out and I

don't have any particular expertise

about where it will end. But I will say

is at the end of the day I do expect

that the Fed is an institution and it's

will have sufficient independence to

raise or lower rates because of its

institutional structure and I think

ultimately the courts are going to back

that up.

>> All right, Richard Clara truly the

perfect guest. Thank you so much for

coming back on All Thoughts.

>> Thank you. Thanks, Rich. That was great.

>> [music]

>> So, that was a really fun conversation.

I like the idea or I'm not sure I like I

am intrigued by the idea of uh monetary

policy by trolling. [laughter]

>> That'd be so funny if there was like no

room left to cut by the time Kevin got

there and then he couldn't um fulfill

any inclination to cut. But I think it

actually raises an important point and

I'm thinking back to the conversation we

did with Emmy Nakamura where she talks

about central banks building up a sort

of store of credibility and then having

to spend it at various points. If you

have a president who is so opinionated

when it comes to interest rates and

certainly not shy about tweeting or

talking about them, I feel like it

inherently starts to spend down some of

that credibility because it just becomes

very very difficult I think to

demonstrate your own independence.

>> Yeah, I think it's going to be really

tricky. You know, it's obviously

something we talked about with Scand

last week, which is that there's

multiple potential nominees who would

have come in with a willingness to cut

rates further at this point. Christopher

Waller being an obvious one. He's been

voting for rate cuts, but he also has a

lot of credibility because he was voting

for rate hikes and, you know, 2022,

2023, and so forth. I think it's going

to be uh, you know, it'll be tricky for

War and But on the other hand, look, I

would say also, you know, it's easy to

say, oh, he's got to come in, he's got

to build credibility. A lot of people

really like him. A lot of people who

have worked with him at various times,

who have known him think he's a serious

thinker, that he knows what he's talking

about, that even if he doesn't always

agree with them, particularly on things

related to the balance sheet

communication, that he's a honest

broker. So maybe, you know, maybe we are

overstating the risks or maybe it's easy

to overstate the risk that he comes in

and has a real fight on his hands to get

the uh policy agenda that he wants.

>> Oh, to be a fly on the wall of the first

meeting with War, right?

>> Yeah, that'll it'll be uh it'll be super

interesting. I also really like I wonder

if he's going to get rid of the press

conference. That's my prediction.

>> I would not be surprised. And you know

what I'll say like [snorts]

>> these are new things. It's not a it's

it's not like he'd be overturning 80

years of president here. This is a very

modern thing. And a lot of the

communications innovations were as rich

said a very specific purpose when the

Fed was at Zerp to convince the market

that it would stay low because and they

needed to make that case. So if there's

a sort of honest look at all of these

postGFC monetary policy changes, I don't

I I [clears throat] certainly think

that's totally fine.

>> I think Jackson Hole might be in danger,

too.

>> You think so?

>> Yeah, maybe. [sighs and gasps] just out

of pure self-interest. I hope not. I

hope not, too. I like enjoy going to one

of the most beautiful places on Earth

every year. But we'll see.

>> Yeah. Uh I hope I hope it doesn't go

away.

>> All right. Shall we leave it there?

>> Let's leave it there.

>> This has been another episode of the Odd

Thoughts podcast. I'm Tracy Aloway. You

can follow me at Tracy.

>> And I'm Joe Weisenthal. You can follow

me at the stalwart. Follow our producers

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Bennett at Dashbot and Kalebrooks at

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