Brainard on monetary policy reform
Lael Brainard gave a very good speech at the UC Booth School of Business in NYC, which begins by considering what went wrong during the recovery phase of the Great Recession:
Looking back at the international experience, the evidence suggests that forward guidance and balance sheet policies were broadly effective in providing accommodation following the financial crisis. But they were less effective when there were long delays in implementation or apparent inconsistencies among policy tools. It is important to distill key lessons from the past use of these tools in order to make them more effective in the future.
First, in some cases around the world, unconventional tools were implemented only after long delays and debate, which sapped confidence, tightened financial conditions, and weakened recovery. The delays often reflected concerns about the putative costs and risks of these policies, such as stoking high inflation and impairing market functioning. These costs and risks did not materialize or proved manageable, and I expect these tools to be deployed more forcefully and readily in the future.
Second, forward guidance proved to be vital during the crisis, but it took some time to recognize the importance of conditioning forward guidance on specific outcomes or dates and to align the full set of policy tools. In several cases, the targeted outcomes set too low a bar, which in turn diminished market expectations regarding monetary accommodation. In some cases, expectations regarding the timing of liftoff and asset purchase tapering worked at cross-purposes.
In addition, in some cases, it proved difficult to calibrate asset purchase programs smoothly over the course of the recovery. To the extent that the public is uncertain about the conditions that might trigger asset purchases, the scale of purchases, and how long the purchases might be sustained, it could undercut the efficacy of the policy. Furthermore, the cessation of asset purchases and subsequent balance sheet normalization can present challenges in communications and implementation.
Finally, in the fog of war, it was difficult for policymakers to distinguish clearly between temporary headwinds associated with the crisis and emerging structural features of the new normal. In part as a result, it took some time to integrate forward guidance and other unconventional policies seamlessly, and it took even longer to recognize that policy settings were unlikely to return to pre-crisis norms.
This misses the mistakes of 2008, when the Fed wasn’t at the zero bound, particularly the Fed’s excessive focus on inflation (rather than NGDP growth) and its putting too much weight on model forecasts of inflation relative to market forecasts. But otherwise it’s a pretty good summary of mistakes made after 2008.
Brainard recommends a much more timely and expansive use of tools in the next recession, including interest rate caps and forward guidance. She also favors “flexible average inflation targeting”. That might sound worse than strict average inflation targeting, but if it’s an implicit nod to the fact that it’s NGDP that really matters, then maybe it would actually be better. In other words, try to get back to the price level trend line when the deviation is caused by demand shocks, but not when caused by supply shocks.
NGDP level targeting would be even better, but that’s off the table right now, so Brainard is right to focus on those improvements that are the most feasible.
Toward the end she suggests that monetary policy might not be enough, and calls on Congress and regulators to do more, using countercyclical fiscal policy and countercyclical macroprudential financial regulations. I think that’s being overly optimistic.
It’s unrealistic to expect Congress to engage is countercyclical fiscal policy; indeed fiscal policy has been highly procyclical in recent years. Basically, the US is now a banana republic, and the Fed needs to understand that fact and behave accordingly. Banking regulation has also been procyclical, becoming more lax as the economy booms. It’s really hard to overcome political pressures that keep pushing policy in a procyclical direction
Instead of relying of fiscal policy, I’d like to see the Fed ask Congress to give it additional tools. Congress should let the Fed declare an emergency when rates fall to the zero bound, and allow the Fed to buy a much wider range of assets during the emergency. If they wish, Congress could add a provision that the Fed must reduce its balance sheet when the emergency is over, and (without a waver from Congress) not allow the Fed to raise rates until “unconventional assets” (like stocks and corporate bonds) were first sold off.
If fiscal policy is to play any role, it should be for Congress to commit to a bailout of the Fed if its QE program leads to such large losses that the Fed’s assets fall to zero. This is something that almost certainly will not happen in the foreseeable future. But this commitment would add credibility to the sort of large-scale QE programs that might be needed in a deep recession.
In the past when I discuss this provision, commenters sometimes want to talk about a fiscal bailout of the Fed as something that might actually happen. That’s not a productive discussion. It’s not going to be needed in the foreseeable future. (The currency stock alone is $1.8 trillion.) The point is to remove any anxiety that Fed officials might have regarding a “whatever it takes” approach to stimulus.
Indeed I don’t think it’s even useful to talk about the Fed buying stocks, as that also seems unlikely to be necessary. What is necessary is to convince that markets that the Fed would buy stocks if needed to hit their average inflation target.
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22. February 2020 at 17:12
Fiscal policy is limited by the fact we have an ongoing generous welfare system directed at the elderly and disabled and parents of young children. So the next welfare dollar spent ends up in the pocket of an able bodied adult without young children that should be in the labor force. So it is not a coincidence that the job market/economy only picked up after the Republicans stopped the Obama “stimulus” in December 2013. So Q1 2014 featured that awful winter and then boom in Q2 and we are still in the expansion.
22. February 2020 at 17:32
Sumner: “Basically, the US is now a banana republic, and the Fed needs to understand that fact and behave accordingly..” – really? The USA = The Philippines? That’s news to me, and I live part of the year in the PH.
Sumner: “If fiscal policy is to play any role, it should be for Congress to commit to a bailout of the Fed if its QE program leads to such large losses that the Fed’s assets fall to zero. This is something that almost certainly will not happen in the foreseeable future. ” – uh, those two sentences don’t match. I mean, if it’s “almost certain” that Fed assets don’t go to zero (Sumner in the past has said the Fed assets are rock solid; I maintain they are full of toxic junk bonds, but anyway), why do we need a credible commitment from Congress? Rational expectations will ensure that there’s no danger of uncertainty. Besides, the 2008 crisis showed Congress can be quick to make up new rules, to protect banks, if need be (bank bailouts). I doubt the market is worried.
Sumner: “Indeed I don’t think it’s even useful to talk about the Fed buying stocks, as that also seems unlikely to be necessary. What is necessary is to convince that markets that the Fed would buy stocks if needed to hit their average inflation target.” – What? Again the two sentences contradict each other. But it is useful to discuss Fed buying stocks, and indeed already has been done, indeed, was done in 1987, with the creation of the Plunge Protection Team by Reagan. I guess Sumner is saying that the US needs an explicit stock buying program like they have in Japan, rather than a covert program? Something like that. Far from me to criticize, what do I know except logic and uncommon sense?
22. February 2020 at 21:24
Basically, the US is now a banana republic, and the Fed needs to understand that fact and behave accordingly—Scott Sumner
We have Detroitified the Heartland, and Hong-Kongified the coasts. Now we can banana-ify the entire country!
Stanley Fischer suggests that an independent Federal Reserve decides when it goes to helicopter drops, in future economic recessions. I say we go full Bananarama on this.
Leave the ability to implement helicopter drops in the White House. Then we can vote the President out, if we don’t like the results.
Transparent, with accountability. Such are the foundations of democracy, but I guess in a Bananaramaland, no one cares about that.
22. February 2020 at 23:03
Side note:
Speaking rationally (out of character, but hold on), I do not think the coronavirus, aka COVID-19, is all that serious.
But I watched a segment of ABC News yesterday, and if that is how the mainstream media is treating the topic, then yes, the Fed should start printing money until the plates melt, and then start issuing scrip.
I have rarely, perhaps ever, seen such an egregious case of fear-mongering as that projected by ABC “News,” what with videos of people in hazmat suits, stories of airplanes denied landing, films of Ukrainian protestors setting fires to prevent coronavirus patients from entering the country, and images of red blotches overing the globe, indicative of fresh and lethal coronavirus outbreaks. I was appalled, but also thought ABC had engaged in the most-adroit, spectacular and irresponsible video sensationalism I had ever seen.
Maybe ABC will win a Pulitzer.
Certainly, the travel and hospitality sectors are going to take a hit, on fear alone.
Authorities seem unable to inform the public that most victims are elderly or have underlying issues, and the vast majority of cases are mild. Some people are even asymptomatic—that is, they simply shake the virus off. In fact, no one knows if this is actually the usual result, since people who do not feel sick are not usually tested.
The Fed is a clunky instrument to boost aggregate domestic demand, but it should do all it can, probably preemptively.
23. February 2020 at 00:02
Benjamin, a death rate of 2-3% might not sound like a lot to a primate brain adapted for dangerous life on the savanna, but it is fact a big deal with the asymptomatic aerosol transmission that’s being reported. Being of a fast mutating family, the perhaps seemingly excessively urgent concern with containing it is the worry that we could have a super flu on our hands if we don’t. i.e. something that rolls through on a yearly basis in many different forms, but with 10x (or more) the death rate of flu.
23. February 2020 at 01:51
Romeo—- let’s see how the death rate shakes out, in nations outside China. Also, remember, that is the death rate of reported cases. There may be lots of people who are only lightly symptomatic or asymptomatic, who don’t bother to go to the doctors.
I wonder if residents of Hubei avoid going to the doctor, for fear they will be quarantined and unable to go to work and make money. This would explain why the death rate appears to be higher in Hubei than other regions or nations. That is, many thousands of people in Hubei have coronavirus but avoid going to the doctor as they have a mild case and also fear quarantine.
The CDC reports that 14,000 people in the US have died from flu this flu season, including hundreds of children.
23. February 2020 at 04:19
Adding stocks to the assets the Fed can purchase is Roger Farmer’s version of QE and NGDP targeting. Farmer calls it Prosperity for All (that’s the title of his book). My concern is that we already rely too much on rising asset prices for prosperity. If investors believe that the Fed will rescue falling stock prices by making large purchases in the open market, investors will be even more likely to invest in financial assets rather than productive capital. But Sumner is correct that as long as there are Republicans, fiscal policy will be pro-cyclical: expansionary when the president is a Republican and contractionary when the president is a Democrat. In other words, monetary policy is all we have, so we might as well make it as effective as possible. That’s the implication, an implication I believe can lead us down the path of ever greater reliance on rising asset prices for prosperity.
23. February 2020 at 04:37
@Benjamin Cole – please don’t post off-topic stuff. You lost the debate to Romeo. As for your R-naught varies by geography argument, it’s rebutted by this thread: https://moneymaven.io/mishtalk/economics/emergency-coronavirus-lockdowns-in-10-italian-cities-mEPJ29tK30ubuCGuqL0bbw
Note the scientists talking, not some random clueless dude on the internet (that would be you my friend). Italy, a winter country favored by the virus, is rapidly getting infected, if anything R0 is even greater than Wuhan.
@rayward – thanks for sharing what your boy Farmer is saying about PPT. NGDP targeting is also the subject matter of a paper by James Dorn at Cato this month (“James Dorn … suggests replacing the present dual mandate with a single directive to keep NGDP on a stable path.”) Sumner / Selgin’s ideas are gaining traction! I don’t mind since I feel money is neutral short term and long, pace hyperinflation, so it won’t hurt to try, though I think Sumners will eventually go too far and advocate ruinous Weimar hyperinflation, which will ruin his legacy. The revolution always devours its own young.
23. February 2020 at 06:13
Ray Woepez—
The list you link to, from Mishtalk, has nations like Japan, with 134 cases and one death.
Given current trends, China, a nation with 1.2 billion people, will have far fewer deaths from coronavirus then the US, with 330 million people, has from garden-variety flu.
There was one report of a fellow near Athens who was wearing a hazmat suit and adult diapers. Perhaps you are taking sensible precautions but I think you are overreacting.
23. February 2020 at 06:23
Add on for Ray Woepez: Besides, I expect you to say something along the lines that coronavirus will eliminate older, unproductive people from the population, and thus is actually a macroeconomic positive.
You know, certain people rhapsodize about the “cleansing effectc that economic recessions have on the economy, by eliminating weakling businesses and employees from the economy. Think of the coronavirus in that way.
23. February 2020 at 07:25
I think we should rename the Fed to “the Banana Stand”. Because there is always money in the banana stand.
23. February 2020 at 07:28
What’s an example of a demand shock not caused by a monetary or tax authority?
23. February 2020 at 08:58
Gene Frenkle claims that more fiscal stimulus ends up in the pocket of “able bodied adults without children” by which I assume he means adults living on state hand-outs. Actually government can spend fiscal stimulus on what wants: infrastructure, education, handouts for pensioners, you name it.
Scott says “Congress should let the Fed declare an emergency when rates fall to the zero bound, and allow the Fed to buy a much wider range of assets during the emergency.” Problem with that is that it results in the Fed owning assets which it is not normally regarded as being the Fed’s job to own: stocks or whatever. I.e. economic distortion ensues.
23. February 2020 at 08:59
Lael Brainard said:
It’s taken years to get Fed officials to absorb the importance of associating Fed actions with specific points of time in the future to ensure the market ‘buys’ into their policies (actually it’s the reverse, where they’re following market expectations), but they appear to have finally learned from the Bernanke Noise Event (concluded and followed up here). Since we were the only ones banging on about timing in our real time analysis when these events were happening, can we claim credit for shaping the direction of the Fed’s policies today?
23. February 2020 at 09:09
Ray, It’s not to reassure the markets that there will be a bailout (the market knows that), it’s to reassure the markets that the Fed understands there will be a bailout, and that it’s “OK”, and hence won’t hold back on doing enough QE.
Rayward, I believe that Roger wants the Fed to actually buy stocks. I don’t. I want the Fed to say it’s willing to buy stocks if necessary, in which case it would not be necessary.
Ralph, Under my plan the Fed would not actually buy stocks. It would not be necessary.
Ironman, Everyone’s been asking the Fed to make guidance conditional on outcomes.
23. February 2020 at 09:20
Scott concludes, “What is necessary is to convince that markets that the Fed would buy stocks if needed to hit their average inflation target.” So every other household will run out and buy a new fridge or similar just because it thinks inflation will be 2% rather than 1% in a year’s time? I doubt it.
23. February 2020 at 09:24
I disagree very much that the Fed would not need to buy stocks. Given its past behavior, you would predict the Fed to be too slow to react and try newish things and to do those things in inadequate amounts. The Fed still needs to earn credibility in a downturn by wiping out some market participants betting against decisive action.
23. February 2020 at 09:25
Scott— putting aside the really wise guy statement that US is a banana republic (which made it harder to understand your overall point), this essay kind of blew me away. You have introduced ideas which seem scattered and off the cuff. I am not suggesting they are not consistent with NGDP—and the limitations of a blog can confuse matters when you try to squeeze so many ideas in a short space
One of the attractions of your approach is that “it is as simple as possible but not more simple”. We have not even seen the Fed work properly with the powers it had and you are now adding more powers it should have. In this essay you introduce ideas outside of the Fed’s current scope thus creating much complexity. 1) introduce flexible targeting to only respond to demand shocks 2) Buy a wider range of assets 3) new laws requiring Fed to sell assets at certain times 3) new laws prohibiting raising rates until unconventional assets are sold 4) have the “threat of Fed buying stocks to meet inflation targets
Maybe you are thinking out loud. Blogs are good for that.
. We need to persuade Fed on NGDP. That requires organization and action. These other issues you raise really confuse matters and break the “as simple as possible” paradigm.
23. February 2020 at 10:16
Ralph Musgrave, the government can and did give money to able bodied adults without young children…and it produced suboptimal GDP growth. So we had what amounts to as an experiment with UBI from 2009-2013 and it did undermine economic growth. Contrast that with our “experiment” with universal health care in which states like Texas and Florida didn’t expand Medicaid and still were the most popular states for Americans to move to. So people under 65 years of age still aspire to a job with benefits and don’t just want free Medicaid. So there is no reason for red states to continue to oppose the ACA Medicaid expansion.
24. February 2020 at 05:52
What are the “interest rate caps” Brainard favors? It sounds kind of like usury prevention, which I assume is incorrect – surely it would be bad for banks to be prevented from making the higher interest (ie higher risk, more dynamic) loans they would otherwise make.