Points trade, i guess, well talk about Monetary Policy with part of that discussion that the fed has started to talk about that being the role of its Balance Sheet. Well talk about that. So randy kroszner, you know them. University of chicago former governor at the fed now University School of chicago. Jon foust now at jon hopkins on leave and back with the feds. You cant quit the fed. So were now in the third longest economic expansion that weve had. One of the questions is will policy change which is being discussed in monetary and fiscal policy extend that expansion or not. In light of the discussion about the Mortgage Backed component of the feds Balance Sheet, we have been looking at fannie mae look at that all the time. Ecb Holding Stead in the second half of july and with the boj saying its going to assess negative rates. It accelerated with the president ial election and it peeked at 2. 6. Right now its 2. 48 or Something Like that. The fed hike in december it looks like the market is prepped for a rise in march, well find out about that. Lets start, get each of you to address first, whats your view of current Monetary Policy. How have the fed been doing up to this point. How fast and far would they go or should they go whats your view on up to the present and then what we should think about Going Forward. Well go across the panel here. Great. Im delighted to be back here at mabe where many years ago i have been on the board. I can see that the conference has grown stronger and bigger. I wish the economy has grown stronger and bigger. We have had consistent recovery and exciting recovery. It m cos down to the number of hours worked. Because of the demographic reasons its going to be harder to get labor hours as rehave in the good old days and productivity is slowed in the u. S. And worldwide. Thats why we only get 2 . We are starting move there grad gradually. Central banks cant do everything. They should be able to create jobs, create inflation, be able to create whatever growth rate they want and they cannot do that. I think the feds have been trying make sure that we avoid the deflation outcome, avoid Central Banks can try to provide increase and inflation and Inflation Expectation which the feds have done. We are starting to come closer to our 2 level. I think the feds have made progress on that. Theres no surprise the fed have been clear on unless something radical happens between now and next week that they will raise rates in march that will get them on a path to raising rates further in year rather than having one rate hike, were going to start earlier giving us a opportunity for more rake height ands see how the economy evolves and inflation evolves. Most are pointing to reasonable growth. Continue slight increases in inflation and inflations expectations which means the feds need to continue on the path they said they are going to be on for the two or three rate increases this year to stay ahead of challenge of inflation. Where are they likely to continue to go over the next few years. Thats an important question that people at the fed and jon has been helping them to think through this where is that imaginal star. Where is this neutral Interest Rate of longrun where would Interest Rate about if there were no feds where would they economy go naturally. I did m some work with former federal bankers from charlie dean and as well as former colleague that works in the merchant markets. If you look over the last 30 or 40 years worth of data, you see tra rates have been falling since the 1980s. This is before the financial crisis. The question we ask is what was driving that change. We argue it was the role of china. China being a high savings economy being integrated into the world economy, shifting out the savings curve. So all of the things being equal, shipping out supply driving the Interest Rates. Trying to become integrated with high economy. Thats going to shift down the supply of savings. Whats going to happen Going Forward. They passed through peak age population. So they are going to start age rapidly. They have a onechild policy. In terms of fertility. They have a high savings rate which is 15 to 20 . Their savings rate is now 3 or 4 . I dont think they are going to go that low in terms of their savings. We are going to see Central Banks driving rates back up. Exactly where they will go, this is not precise enough to tell us that, but it suggests we are going to have offsetting forces, but fundamental economic forces driving rates back up. We will see rates move fundamentals mush rates back up from the zero back up to 1 or 2 . Whereas in the past they have been many of the longer rates have been higher than that. Economists putting decimal points to create sense of humor. [ laughter ] you want to share your shouts with us. I agree very much with pretty much everything randy said and he gave a nice background about the role of economy and during the response to the crisis in the short run in the longer run but he wrapped up with. So i would like to i was at the fed a little recently than randy, i would like to focus on the nittygritty whats happening tomorrow to fill out that picture. So i guess its clear to everybody the feds have gone out of its way to signal another rate increase is likely in march. A thing that surprised me is that the people have decided that this is a surprise. Thats its strange they are doing that. As is the case you assume theres been a titanic shift with the feds and everything going to be different Going Forward of the thats always nonsense. Let me explain. So i think and by the way, i put this analysis along with my colleague on our website as a Public Service and you can google that and try to read these pearls of wisdom if you like. Let my say my perspective on what the feds have been doing for the last three, four, five years. About three i as advising the chair, you can encapsule late it normalize policy as prudently possible. I think its important to think that way that the feds is inclined to normalizing policy. Whats the problem. Why rate increase once a year. The economy has made it clear as fast as prudently possible is slow, thats up to recently. Let me compare the situation now to the situation a year ago. So a year ago december, in december they did the first rate increase. They published a forecast that showed robust growth inflation rising and four rate increasing in the next year. Let me be clear, they would have been happy to deliver four had they gotten robust economy and inflation rising back to 2 . But what happened . Immediately in the new year Financial Markets around the world went crazy with volatile issue as you know, japan, china, all the ecb accelerated purchases and the u. S. Faltered in the beginning of the year as well. So what happened to the four rate increases . Well, the economy said no and the fed listened and couldnt get the rate increases. Lets with compare it to what happened in december. We are getting to the march, the stock market boomed. Inflation moving back to 2. That is true not only in the u. S. But also in europe and in japan. So it looks to me like you could make a pretty good case that if we had seen that in the previous march they would have seriously considered raising rates then too. Theres no shift then. We dont need any intrigue or fundamental leaks about the economy sit a little stronger but it wouldnt have been odd to see a rate increase. It would have been consistent with four rate increases they put in their survey of Economic Projections if the economy grew with inflation rising. If the economy booms like this they would deliver four or more. Thats a good thing. I dont think the economy probably will boom like that. Like randy maybe a baseline of three. Thats not a statement about the fed. Its a statement about an economic forecast. Randy and i know a bit about the economics. Go talk to your best forecaster and youll find out how many rate increases there will be. We may be good but nobody than anybody else at the forecast piece. What is different . The economy moved on. Employment is better than it was a year ago. Those are modest nudges. Inflation is in a better place than a year ago. All of these are good things. Those are pretty modest. The main big thing thats changed, we all know, and thats the situation at the other end of constitution avenue which is whats going to happen with you know, tax and spending and trade and regulatory policy. You know, that kind of stuff, i just want to take this opportunity to say thats all just crazy. Think about it this way. Whether you like it or not most is kind of academic types like randy and me, i guess. We dont think we know anything about politics. We are not good at it. We are good enough to notice is this a political environment you can probably manipulate to your own advantage . We are pretty good we are not good at that. Nobody in their right mind would be trying to adjust an Interest Rate by a few basis points to send some potent political signal that will effect things at the other end of constitution aft avenue. That would be insanity. Both of you made comments to how much of the decline was a function of Global Economic activity and how much will it push up on rates. So there were some of the longer run forces that had been driving rates down. I think it was very important in that. Obviously in Crisis Response we saw potential for deflation. Many countries responded very strongly. I think everyone kind of learned the lesson it can translate into a Great Depression. It is what they blamed for the Great Depression. We have had a lot of negative shocks over the many years before we had the fed but they didnt turn into Great Depression because there were other stabilizing forces that came in here. The feds stood by and didnt act. I think it was a lesson worldwide and certainly slow World Economic growth is something that will weigh on the u. S. Ability to export. It will have an impact on shortrun measures of inflation, headline numbers. We have had whield swings in energy crisis. I think it was when i was at the fed when the crisis was first heating up in fall of 2008 there was a World Bank Meeting and president bush tried to say how are we going respond to this global globally . It is clearly not a sing le country issue. The swap lines were actively used. The ones that existed are no longer being actively used. So they are very much aware of what each other are doing and also aware of local conditions and those are obviously the ones that drive the policy system. Want to add anything to that . Yeah. Let me just comment a little bit on where longer term rates are now when you think about rates you would like to have, everybody would like the ten year to be back in what we think of as normal i think. That is in which the twoyear rate may be minus 75 basis points. Youre paying a good deal of money to hold your money there for you there. With rates so low theres only so much you can expect on that difference between u. S. Rates and foreign rates without the dollar really rising in value. The dollar is going to go up and trade deficit we just talked about will get worse almost independent of policy. It is very difficult to overwhelm the fundamental forces when the dollar changes a lot in value just by economic sprint. So we would like good trade policy. If the u. S. Economy keeps growing and Interest Rates go up the trade deficit is getting worse. It is almost it would be very difficult to not have that happen. I want to pause and remind you if you have questions the last 10 or 15 minutes well field some questions. Both of you mentioned some of the policy tools. Theres a lot more policy tools today than there were precrisis. So are there any guide posts or anything for folks to think about when different policy tools should be applied, how they should expect that . John, you start. During the crisis the fed was doing unprecedented things in unprecedented situations. There was no sense you would get by with, well, well do what we usually do at times like these. There werent any what we usually do. It will look more like it did in 1995 to 2005 where even if you cared deeply you didnt need to listen that carefully because it was they were going to do what they usually did at times like these and hopefully we get back to that kind of situation. Now, the Balance Sheet and large scale asset purchases and how that will go, that is a much trickier issue. Some people would say that having stuck their toes in these water and gotten in hip deep that Central Banks maybe have gotten good at it. I dont think theres a lot of taste for that. I think they just assumed even if there was some value to that they just as soon get back to something much more standard in operating procedures, which would involve the Balance Sheet shrinking back to something much smaller, exactly wlats the right number right now is not a matter you even have to think about for another year or two. So how will they adjust the Balance Sheet . I think the preferred approach is to do something really system dp systematic, not disrupt markets and have that not be the way policy is suggested. That is when they change how the Balance Sheet is being used, thats a Technical Choice to get them back to normal. Its not a Monetary Policy situation to signal they want more or less accommodative financial conditions. Whatever pace they choose they would like the Interest Rate to be the main signal of policy and to have the Balance Sheet be a side show. If folks wanted to reduce the Balance Sheet i think it just means the Interest Rate, the feds main policy Interest Rate wi would rise a little more slowly. Its just a balancing rate. Thats my view of how that might go. And i very much agree the fed doesnt want to be using in normal times. They saw it as an emergency measure and one done boldly but reluctantly. It is not something that the fed wanted to do and Central Banks had been reluctant about this. Should they go back to having clean Balance Sheets, that is basically short term treasury securities. Certainly if we are the crisis. It had different approaches the u. S. There was a paper presented by someone, a german. You can imagine the german approach, the precrisis was seen as optimal. If liabilities were basically just cash. It was just cash on the liability side. Nothing exotic there. It gets you to lean and clean. We are pretty far from that in the u. S. If you go to japan and europe youre seeing things a little less clean and certainly lean is no longer a term you could associate with these Balance Sheets. It relates to mortgages, something our moderator might be interested in. You can see back in 2010 when it seemed like the economy was coming back as they imagined it to run off rather than sell it into the marks. They were concerned about disruption. They said well, as people are repaying their mortgages when they didnt want it to shrink further and wanted it to grow. My guess is once they try to normalize the Balance Sheet youll be focusing on that sheet first. It is something that is lean and clean and that gets you there. I think the concern is lack of cleanliness. So what is the optimal size of Central BanksBalance Sheet . We dont really have a good theory for that. One can argue it was a good bench mark. It would be very hard to turn to a model or turn to evidence that said the Balance Sheet is the optimal one. I think there are reasons for having a clean and clean Balance Sheet. It leads to what are you doing . Why are you doing that . If you can buy that why cant you buy this . Think about the political challenges of trying to allocate the debt purchases. If you thought there was a taper tantrum when bernanke said in six to nine months they might reduce the rate imagine what will happen when they say well stop buying equities. Whats this right amount . Basically it relates to how much should the Financial System be running with excess reserves . We went in the u. S. With no exesz e excess reserves to 2 to 3 trillion in the system. I think most Central Banks after the kind of scarring of what happened in the Global Financial crisis in the midto late 2000s feel that vlghaving a little mo curb thshion is probably worthw. My guess is well continue to y use that to set Interest Rates. I think they will be doing that probably with a much bigger cushi cushion. 2 trillion, probably not. Ten of billions, probably not either. I think it will be the big debate, whats the optimal level of the Balance Sheet for running the committee and how much cushion should we have in terms of excess reserves . And i think i want to maybe i dont know if its clarify or disagree. You or randy can be the judge. Very diplomatic. It is just a clarification. We could never disagree. It is actually sincere. Randy said would like to get back to normal as quickly as possible. It would be selling it off and thats not going happen. If you heard as quickly as possible, no. Its going to be allowing more than likely sure. So if i can continue, the the second point is that just to make sure Everybody Knows this, the fed can only buy treasury securities and agency securities. So its not like the fed could have ever been as for good or for ill ever been as messy or as not clean as so not obl cant, they havent. Now, is there a desire to exit the Mortgage Backed securities more rapidly than the treasuries . I think there was at one time. Im not so sure thats still there. As randy said, it is true that as the Interest Rates rise you get less mortgage and those Mortgage Backed securitying live longer. They will be living longer as rates increase. There will be a question to whether the fed wants to sell some or let them run off in a way that could have a bit of a long tail. So far the fed has more recently said it is unlikely to sell because they dont want to disrupt the market except maybe residu residual, you know, once it gets to be so small it couldnt disrupt the market. Five of the first ten questions were about the portfolio. Are they able to change the portfolio, in other words, if you shorten the duration is that actually a tighttightening . Yes. In the feds way of thinking that is a tightening, that the main effect of quantitative easing was taking long durations out at the market. As the duration of the portfolio moves down it is a bit of a tight tightening. If it moves down more quickly the fed is likely to believe it is appropriate to raise rates in order to keep the financial conditions about where they like it. Now, the question might partly have been some people including former governor stein have argued that that manipulation of the duration of the portfolio might be an active policy tool every day. It could be, but randy and i have both said that i think theres no taste for that really, not much praktly no taste at most Central Banks but certainly at the fed for using that. It will naturally happen if they let the portfolio run off. Its not for policy purposes. Theres little taste for actively and normal times using that tool. One thing is to make sure it was rapidly transfer into longterm rates and then buying back to make sure they were transferred into low boar reing costs. It will be interesting to see if its what they want when they exit. It will be one of the key issues Going Forward. We have a very different shape as we did. One last question, my understanding is there was an experiment in the late 1990s when we ran what some of you may not recognize as a federal budget surplus. The question was if that were to continue what kinds of securities could be traded to conduct Monetary Policy and there was an experiment related to assets terminated because of the concern, something you pointed out which was youre indicating some preference. The temper tantrum effected the housing market. It dropped sales by 10 . Are they comfortable now that the housing sector is in good shape . When they make a decision to let it they will simply start the structural shift to treasuries away from mortgage security . I think you put it quite well. I think they will do it when Economic Conditions permit that. I think this discussion will be a discussion later this year into 18 and my hunch is it will probably not be implemented until late 18 or 19. I think they have been able to roughly move into the range they feel comfortable and say the economy continues to recover. We can start to pull back from other areas. What they want is something thats very rapid. If you want to search for the word gradual and synonyms from feds speakers, i dont think there is any word they used more frequently than that. They want to do something that is less of a tanantrum. They dont understand how which could lead to increases in both short and long rates. Thats a discussion or thats its a discussion that will occur over the next year but i think it will be far off. Just to add a couple of things, i this i the fed does not now see, you know a pressing need to act immediately in this regard. They believe they can sort of try to implement it. That means not only do they need to make the decision, they will communicate it very clearly in advance because there isnt. I think youll know a good deal about this before well before it happens. Now, the other thing that we havent really mentioned is that if those happen a year from now as we are talking about it could be a very different fomc. You should take everything randy and i have said about what the fed is likely to do more than a year or so in the future with a bit of a grain of salt. It will really depend on you know, we have two governors right now. Governor is leaving in april. The position is up in february of next year. Vice chair is up in june of next year. So thats a whole new ball game. All of these things are things that, you know, in many areas Monetary Policy in normal times, most folks agree on that. It doesnt matter that much who is running the fed. These things are well i would thats a little strong. Relative to these questions, those are more settled. How will somebody feel about lean and clean and it could change a lot depending on the particular folks that get chosen to actually make those decisions. Yeah. You touched on the second five questions that came in the first ten which all had to do with who is going to be on the board Going Forward. You dont have to if its uncomfortable but you might. [ laughter ] i think the administration has not made their intentions very clear with respect to the feds. They publicly said that its very important for them to pick a vice chair for super visivisid regulation. Names get floated. I have no incite of where they will go from there, but my guess is they will focus on that first and the other pieces will fall into place. Yeah. I think many of the regulatory questions which hasnt been our focus today are likely to be the most important and that choice will when she leaves and if a new vice chair comes in those will be big issues. But as far as the sorts of folks that are likely to be appointed, i dont have any special information or incites. As i said, i think its really important that they have been successful. You know, there has been talks about not so many academics. I dont think thats a major shift if somebody has a conventional understanding. It will be able to understand the needs of Monetary Policy and handle it in largely similar ways. The regulatory side is much more contentious and would be a whole different session than london. Im not particularly qualified to speak on. There are a couple of questions tieing back to the former panel on trade. A question with regard to how u. S. Monetary policy might impact immerging markets if there are structural changes taking place within trade usually mandates are to focus primarily on domestic economic activity. To the fact that it effects the domestic activity thats usually the focus through Central Banks. It causedd turmoil. It is on the Financial Stability side and real activity side. I think exactly as john has said, fed is very well telegraphed the direction it is going in. It seems to be getting credibility that it will move more than once at the end of each year and that is playing out. Unlike a few years ago the markets seem to be doing okay. It is having impacts on the Foreign Exchange values, but if we looked around the globe its not just the u. S. Equity markets its in many countries around the world including americaning marke merging markets. They might have feedback effects on the u. S. I dont think it will be the prime focus for should it really should it be. Okay. Maybe this is the rapid round here. All right. Are some 50 oil prices good or bad for the committee . Are sub 50 oil prices good or bad for the economy . You know i think long or short . Yeah. I would say like with the strong dollar, weak dollar and other, they help some and hurt others. If you said in the long run would you rather have cheap resources or any resource or expensive resources, cheap resources is the answer if that means that it can be supplied plentifully at low cost. Yes. And the question is so overtime you adjusted that. It would be the first answer. You know, thats a positive. You have to look at the broader impacts. I certainly think about regulatory barriers to, you know, effective operation of markets or something thats very important. It takes us back to the first discussion. Right. If, you know, issues and whatever the issues in the environment you pick those that have very different views on it. In general if you can make the market work better setting aside those issues and the price of energy goes down thats a winner overall for the economy. And speaking to the stimlative nature of raising policy rates and maybe interest on excess reserves, thoughts on whether that would be thats where the real challenge is you could lead to some Financial Disruptions if these contracts cant make good on as we gradually exit it should be less of a challenge. In this aud yoens raising rates would be stimlative. I think its a question about Something Like that and i guess like the question about low oil prices, theres always it would have certain stimlative ifects in helping out fixed incomes and the Life Insurance pension funds. Those are really important and well be in a lot better place if it allows the companies to be in a healthier position. It will be stimlative. It is despite the fact that we are at that turning point and hopefully Interest Rates rise and the economy warrants letting them rise at a at more than the glacial pace we happen to see over the last couple of years. It would be nice at the short end and if the economy warrants it. It looks like it is going to. It was not exactly going to be around zero but we would say for some time. We eventually did. We got an agreement to say that but i dont think anyone was sitting around that and thought it was going to be eight or nine years where we were debating are we going to start the process. Lets wrap this up. Prediction is especially with respect to the future. Join me in thanking our panelists. [ applause ] thank you very much to doug and sean and randy. Thank you for supporting us. Thank you. I would like to ask our next panelist to come up to the stage and take their seats please. Cspans washington journal live with news and policy issues that impact you. Coming up Iowa Republican congressman on the revised travel plan. Then Washington State democratic congresswoman on Trump Administration policy and border security. Sure to watch cspan live at 7 00 eastern. Join the discussion. 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