First lady, she never wanted her husband to be president. Shes frightened, frightened for him. Meanwhile, he has to get up there and inspire confidence in his administration and the whole world. The whole world has to be has to understand that america will. That the war will continue. Q a sunday night at 8 00 eastern on cspan. More from the Brookings Institution forum on inflation. Experts, including former Federal Reserve chair ben bernanke, and former treasury secretary Larry Summers, talked about the current inflation target of 2 and whether changes are needed. Its 2 15. Good afternoon and welcome. Im david wessell, director of the brookings. Thank you for coming and people joining us online. I bring greetings from glen hutchens, the benefactor of the hutchens center, whose chartered plane was canceled so he cant be here today. Hes probably watchology his phone and will undoubtedly be weighing in on everything i did wrong in the first opening segment. When we think that question of rethinking the 2 inflation target is one of the most important questions facing Monetary Policymakers at the moment, you might say that the backwardslooking question we need to think about, which we at hutch. Scenter are thinking about, is how did unconventional policy really work . And should unconventional policy really be considered conventional policy . But we look forward, i think one of the youd have to argue one of the biggest questions now is whether, given everything we know, whether a 2 inflation target framework is the right one for Monetary Policy. After all, when it was conceived, nobody anticipated wed have so many years of trying to get inflation up to 2 . Nor did we think that the longrun equilibrium Interest Rate would be so low that in the last federal and Market Committee survey of Economic Projections, the members said that they expect the longrun rate to be a nominal 2. 8 to 3 . Which means that theres not a lot of room to lower rates, real rates below zero, as we usually do in a recession. When we first conceived this event, one of the reasons we did it is we felt that this was a discussion that was really important but hard for the members of the f1c to have. If you Start Talking about this you frighten the markets and bad things would happen, so you dont talk about it in public. I think we were right that this is an important issue, we were wrong that f1c members are afraid to talk about it. The minutes from the meeting suggest that its been discussed and a number of Regional Fed Bank president s and chairman yellen herself have raised it. But i think that this is not a dilgs decision that can be left to Federal Reserve policymakers or the economists who spend time thinking about Monetary Policy. This is too important a decision to be left to the fed and the economics profession itself. It has to involve a broader array of people, a broader discussion in our society. So this is our attempt to try and explain what the issues are, what the choices are, what the pros and cons are for that broader audience. And im hoping that we can do that. Well try and synthesize this at the end. We have a very crowded schedule, which were extremely pleased about. Its hard to imagine you could have assembled a better group of people to discuss these issues than the ones we have. So im just making a public plea to our speakers that i made in private, which is try and stick to our time schedule so we can get everybody can get a fair shot. Well start with a conversation with Larry Summers, the former treasury secretary, who has raised this issue in public, is going to set the scene for us. Then my colleague Louise Shaner will come and introduce a upon nel to discuss the alternatives. Larry summers. My job at a conference like this, a the a moment when i am not in government, is to surely be provocative and hopefully be sound. My propositions are at root two. One, first proposition, our current framework is likely to involve unnecessary costs in lost output on the order of 1 trillion a decade, or 100 billion a year, relative to what otherwise would be possible. And two, a proper, better framework, which we shouldnt necessarily move to immediately, but we should ultimately aspire to, would involve normal, nominal Interest Rates in the 4 to 5 range. Let me develop this, these arguments, in several stages. First proposition, within the current policy framework, were likely to have by historical standards very low rates for a very large fraction of the time Going Forward, even if in good economic times. David just shared the feds view, which is that the neutral real rate is in the neighborhood of 1 . Were at more risk, at least currently, of falling short of the 2 inflation target than we are of exceeding the 2 inflation target. Its a good rule with official projections. Think about the weather bureau, that when they keep being revised in one direction, theres positive serial correlation in the revisions. So it would be my judgment that further reductions in the real predictions of the neutral real rate are more likely than further increases. The market essentially shares this view. The long run libor forecast is 2. 3 . 2. 3 is less than 2. 8 , but the market is projecting the expected value, the fed is projecting the mode. That is a reason for some discrepancy. On the other hand, the markets forecast builds in a term premium, whereas the feds forecast doesnt build in a term premium. Reasonable judgment, then, if we continue to operate in our current framework, its a reasonable expectation that in good times, rates will be in the 2 to 3 range, typically. And it seems to me obviously thats a projection made with substantial error, but i cannot see good reasons for thinking that the fed and the markets estimates are massive underestimates. Second proposition. Recessions will come. What is the likelihood of a recession . My reading suggests that the best thinking is that recoveries, unlike people, do not die of old age. That the probability of recession once one is significantly advanced into a recovery is essentially independent of the length of the recovery. And that that probability, depending upon just how far back one looks, is something in the neighborhood of 15 to 20 on an annual basis. Thats a historical reading looking back through 50odd years of u. S. Business cycle history. Is it the right view Going Forward . You can make a case that its an understatement of the risks Going Forward. That case would emphasize that normal growth is now 2 rather than 3. 5 . So you have to slip less far to fall into recession. It would emphasize a higher degree of geopolitical risk now than in the past. It would emphasize that we have a more financialized, more levered economy with higher ratios of wealth to income thats therefore more at risk of financial disturbance. A case for more optimism, would be the past probability is an overestimate would emphasize lower inflation and less risk of inflation getting out of control, forcing the fed to hit the brakes hard. It would emphasize smaller inventory cycles in a lesstangible and physical economy. Im not compelled that one of those sets of considerations is far more important than the other. So i think 15 annually is a reasonable estimate of the probability of a downturn. Third observation, Monetary Policy of the standard form will lack room to do what it usually does. On average, rates are reduced nominally by 5 Percentage Points in order to combat recessions. The low numbers are at the beginning of the period when there were very substantial credit rationing effects that were important in understanding how the economy functioned. So that 5 strikes me as, if anything, slightly on the low side. If you look at nominal rates, you conclude a 5 reduction is necessary. If you look at real rates, you similarly conclude about a 5 reduction in rate is necessary. You can see where this is going. 5 is substantially more than 2 to 3. The likelihood, i would argue the overwhelming likelihood, is that when recession comes, policy will not have sufficient room to cut rates as much as it would like to within the current framework. If one believes that neutral real rates will decline further, or that theres a risk that they will decline further, this effect is, of course, magnified. These conclusions are not very far from those reached in a much more elaborate way by kylie and roberts. Kylie and roberts conclude theres a 30 to 40 chance, 30 to 40 of the time well be at the zero lower bound. If you assume that once every seven years well be in recession, and you assume that once we get into recession we rates will be constrained by the zero lower bound for three years, one gets that well be at the zero lower bound about 30 of the time, given our current framework. Observation four. If within this framework the expected output losses are large, kylie and roberts estimate an output loss above 1 of gdp on average. That would be at current magnitudes over the next decade about 200 billion a year. I think its plausible to suppose that their estimates are too high. I have a much more back of the envelope approach. I said, suppose when we get into one of these episodes and were constrained for three years, about 40 as long as we were constrained after the 2008 crisis, that well lose 1 of gdp the first year relative to where we would have been, 2 of gdp the next year, and 1 of gdp in the last year. If you take that number, you get a loss of about 4 of gdp once a decade. That works out to about 1 trillion over the next decade, or 100 billion a year. The calculation could obviously be wrong if recessions were more frequent or they were longlasting or a negative spiral developed or there were historesis effects. You can imagine reasons why the calculation would be an overstatement. But it seems to me hard to argue that what i have said is way off as an estimate of the cost of the insufficient ability to adjust Monetary Policy. How can this calculation be way off . I might ive addressed the question of whether im way off on the frequency of recessions or way off on the amount of Interest Rate cut that is necessarily when you have recession. Ed the main challenge to this type of calculation, it seems to me, is the suggestion that alternative forms of stimulus can be provided, and so the zero lower bound is not an important constraint because monetary stimulus can be provided nonetheless. Thats what janet yellen tried to argue in her jackson hole speech in 2016. I am far from convinced, and i would make these points. First, starting at 2. 5 10year its, if you simply imagine that the economy goes into recession, and then you imagine that the fed cuts rates four or five times to a 25 basis point Feds Fund Rate and nobody does anything else, the 10 high year rate will findist way down to 1. 5 or in that range. It seems to me quite questionable how much extra stimulus would be developed by any further reduction below 1. 5 Percentage Points. Thats possible. And that applies with respect to any monetary that argument applies with respect to any monetary device that might be developed. With respect to quantitative easing, i would note that theres less room now than there was previously. That it is far from clear in retrospect that it is as effective once periods of major liquidity are removed, as is often supposed. As ben acknowledged, it doesnt really work in theory. I think the evidence now is much less clear than it once appeared that it works in practice. Especially in light of the awkward fact which most discussions of qe pass over, that the quantity of u. S. Public debt that markets have to absorb has increased rather than decreased during the qe period. Given the activities of the treasury. And given the further observation that the swap spread is negative. Somewhat inconsistent with the suggestion that theres an induced short supply of treasury debt. So i am completely unconvinced that qe can be our salvation next time round. What about Forward Guidance . The fact that the fed is moving with some vigor towards tightening, while inflation is at this moment well short of 2 . The fact that the fed is not willing to predict inflation above 2 at any moment, even a hypothetical moment of the tenth year of recovery with an Unemployment Rate of 4 , must be undercutting whatever credibility might previously have attached to the idea that a Federal Reserve would be willing tom with substantial ly super 2 inflation rates. Finally there is the possibility of fiscal policy. I would only note that growing levels of the debt to gdp ratio coupled with readings of a political process and the way the political process responded to the aftermath of the recovery act suggest little basis for serenity that substantial fiscal policy will be quickly entered into the next time the economy goes into recession. My conclusion therefore is that we are living in our current framework in a singularly brittle context in which we do not have a basis for assuming that Monetary Policy will be able as rapidly as possible to lift us out of the next recession. And, therefore, that a criterion for choosing a monetary framework when we next choose a framework should be that it is a framework that contemplates enough room to respond to a recession, meaning nominal Interest Rates in the range of 5 in normal times. Whether that is achieved through changing conventions on how one permits a bothtarget inflation, providing for adjustment to changes in based on the price level rather than the rate of inflation, or whether that is done in the context of relying on nominal gdp, seems to me to be a question of second order importance. What is of primary importance is that we establish a framework in which our best guess is that we will have room, rather than that we wont have room to respond to the next recession. So i would suggest as a design criterion that an appropriate framework allows for a 5 nominal Interest Rate in normal times. I would just conclude by observing that if i am wrong and we assume i am right, we will live with marginally, perhaps more than marginally, higher inflation. But if we if i am right or if the trend towards a declining neutral real rate continues and we ignore it, we will put ourselves at risk of very substanti substantially exacerbating the next recession. And that the consequences for welfare, not to mention political economy, i would suggest dwarf those of marginally higher inflation. So i would hope that all consideration of monetary frameworks emphasize centrally the need to provide for adequate response to the next recession. Thank you very much. Thank you, larry. One question, then well take a few questions from the audience, then we might be able to respond in the next session as well. If you had to decide today what the new framework should be without regard to the difficulties of changing it, do you have a horse in this fight . A horse in this race . Which one would you choose . I really wanted to emphasize that something that would have a normal Interest Rate of 5 is much more important to me than the tactical choices. If i had to choose one, i would choose a nominal gdp target of 5 to 6 . And i would make that choice because it would attenuate the issues around explicitly announcing a higher inflation target, which i think are a little bit problematic on political economy grounds, and because it would build in the property which i think is desirable that the slower the underlying growth rate, and therefore the less likely to mean lower neutral real rate and is likely to mean less normal productivity growth which is relevant for the zero floor on wages. And so a nominal gdp target has that as an advantage. That would be my bold, big step. My smaller, i think more practical step, would be an explicit acknowledgement by the central bank of an object iive super 2 inflation in the late stage of an action pansion. Based on the confidence that a recession would come at some point and would provide for some further disinflation. And by doing that, one could preserve the 2 inflation target, justify a more expansionary policy today, and it seems to me, be entirely responsible. I dont think it is possible to reconcile the forecasts of 2 inflation with not a single dot above 2 inflation on forecasts assuming continued expansion with the claim of being symmetric about the 2 inflation mandate. Thank you. I should have noted, people are welcome to stand in the back if you like, but if the room, just out across the hallway, we have a big screen and you can sit down if you like. So anybody who wants a seat should do it. Ill take a couple of questions, let larry respond, then well move on, if anybody has one. Roberto . Theres a mike coming. If you would tell us who you are and please make it a question, which has a question mark at the end. Ill try to. Roberto macron. All this discussion assumes the neutral rating gone to stay low. Anything in your view, any realistic policy that can be implemented that changes that . Thank you. Take another one . Steve . Larry, do you envision any fiscal response to this next recession . As in, would you then i know the horse has left the barn with this particular year, but envision creating fiscal capacity right now in order to let fiscal play a part and not put all of the recession response on the monetary side . One more. Yes . Gentleman here. Wait for the mike. Please tell us who you are. That was roberto perli, steve leaseman, and you are . Patrick lawler. Our experience with inflation, im guessing 3 to 4 range, which might be consistent with your target nominal rates, our history doesnt show any ability to keep a rate in any kind of narrow band at that point. Are you at all concerned that raising inflation that much might engender much wilder sw g swings in what kinds of things Monetary Policy is expected to respond to . Three good questions. Answer them in the order you like. All questions to the form, am i at all concerned . The answer is, yes. I do not share your