The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
EXAMINING FEDERAL RESERVE REFORM
PROPOSALS
HEARING
BEFORE THE
SUBCOMMITTEE ON MONETARY
POLICY AND TRADE
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
NOVEMBER 7, 2017
Printed for the use of the Committee on Financial Services
Serial No. 115–56
(
U.S. GOVERNMENT PUBLISHING OFFICE
WASHINGTON
nshattuck on FSR297 with DISTILLER
30–775 PDF
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00001
Fmt 5011
:
2018
Sfmt 5011
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
PATRICK T. MCHENRY, North Carolina,
Vice Chairman
PETER T. KING, New York
EDWARD R. ROYCE, California
FRANK D. LUCAS, Oklahoma
STEVAN PEARCE, New Mexico
BILL POSEY, Florida
BLAINE LUETKEMEYER, Missouri
BILL HUIZENGA, Michigan
SEAN P. DUFFY, Wisconsin
STEVE STIVERS, Ohio
RANDY HULTGREN, Illinois
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
KEITH J. ROTHFUS, Pennsylvania
LUKE MESSER, Indiana
SCOTT TIPTON, Colorado
ROGER WILLIAMS, Texas
BRUCE POLIQUIN, Maine
MIA LOVE, Utah
FRENCH HILL, Arkansas
TOM EMMER, Minnesota
LEE M. ZELDIN, New York
DAVID A. TROTT, Michigan
BARRY LOUDERMILK, Georgia
ALEXANDER X. MOONEY, West Virginia
THOMAS MacARTHUR, New Jersey
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana
MAXINE WATERS, California, Ranking
Member
CAROLYN B. MALONEY, New York
´ ZQUEZ, New York
NYDIA M. VELA
BRAD SHERMAN, California
GREGORY W. MEEKS, New York
MICHAEL E. CAPUANO, Massachusetts
WM. LACY CLAY, Missouri
STEPHEN F. LYNCH, Massachusetts
DAVID SCOTT, Georgia
AL GREEN, Texas
EMANUEL CLEAVER, Missouri
GWEN MOORE, Wisconsin
KEITH ELLISON, Minnesota
ED PERLMUTTER, Colorado
JAMES A. HIMES, Connecticut
BILL FOSTER, Illinois
DANIEL T. KILDEE, Michigan
JOHN K. DELANEY, Maryland
KYRSTEN SINEMA, Arizona
JOYCE BEATTY, Ohio
DENNY HECK, Washington
JUAN VARGAS, California
JOSH GOTTHEIMER, New Jersey
VICENTE GONZALEZ, Texas
CHARLIE CRIST, Florida
RUBEN KIHUEN, Nevada
KIRSTEN SUTTON MORK, Staff Director
nshattuck on FSR297 with DISTILLER
(II)
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00002
Fmt 5904
Sfmt 5904
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
SUBCOMMITTEE
ON
MONETARY POLICY
AND
TRADE
ANDY BARR, Kentucky, Chairman
ROGER WILLIAMS, Texas, Vice Chairman
FRANK D. LUCAS, Oklahoma
BILL HUIZENGA, Michigan
ROBERT PITTENGER, North Carolina
MIA LOVE, Utah
FRENCH HILL, Arkansas
TOM EMMER, Minnesota
ALEXANDER X. MOONEY, West Virginia
WARREN DAVIDSON, Ohio
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana
GWEN MOORE, Wisconsin, Ranking Member
GREGORY W. MEEKS, New York
BILL FOSTER, Illinois
BRAD SHERMAN, California
AL GREEN, Texas
DENNY HECK, Washington
DANIEL T. KILDEE, Michigan
JUAN VARGAS, California
CHARLIE CRIST, Florida
nshattuck on FSR297 with DISTILLER
(III)
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00003
Fmt 5904
Sfmt 5904
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00004
Fmt 5904
Sfmt 5904
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
CONTENTS
Page
Hearing held on:
November 7, 2017 .............................................................................................
Appendix:
November 7, 2017 .............................................................................................
1
41
WITNESSES
TUESDAY, NOVEMBER 7, 2017
Bernstein, Jared, Senior Fellow, Center on Budget and Policy Priorities ..........
Levin, Andrew T., Professor of Economics, Dartmouth College ..........................
Levy, Mickey, Managing Director and Chief Economist, Berenberg Capital
Markets .................................................................................................................
Plosser, Charles I., Visiting Fellow, Hoover Institution .......................................
8
7
10
5
APPENDIX
Prepared statements:
Bernstein, Jared ...............................................................................................
Levin, Andrew T. ..............................................................................................
Levy, Mickey .....................................................................................................
Plosser, Charles I. ............................................................................................
42
53
112
120
nshattuck on FSR297 with DISTILLER
(V)
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00005
Fmt 5904
Sfmt 5904
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00006
Fmt 5904
Sfmt 5904
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
EXAMINING FEDERAL RESERVE REFORM
PROPOSALS
Tuesday, November 7, 2017
U.S. HOUSE OF REPRESENTATIVES,
SUBCOMMITTEE ON MONETARY POLICY AND TRADE,
COMMITTEE ON FINANCIAL SERVICES,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:19 p.m., in room
2128, Rayburn House Office Building, Hon. Andy Barr [chairman
of the subcommittee] presiding.
Present: Representatives Barr, Williams, Huizenga, Pittenger,
Love, Hill, Emmer, Mooney, Davidson, Tenney, Hollingsworth,
Moore, Foster, Sherman, Green, Kildee, Vargas, and Crist.
Chairman BARR. The chair is authorized to declare a recess of
the committee at any time, and all members will have 5 legislative
days within which to submit extraneous materials to the Chair for
inclusion in the record.
This hearing is entitled ‘‘Examining Federal Reserve Reform Proposals.’’ I now recognize myself for 5 minutes to give an opening
statement.
Some see the last decade of monetary policy as a failure, while
others see it as a success. Wherever we stand on this debate, I
hope we can all agree that stronger economic growth over recent
quarters is promising and American economic opportunities can expand even faster with reforms that build on the best ideas from
both sides of our aisle.
The legislation we will consider today does just that. Monetary
policy can appear complicated, but whether you work in the Fed’s
Eccles Building or in any of our districts, monetary policy supports
a stronger economy when it is communicated simply and clearly.
Recent Fed research finds that uncertainty about monetary policy
slows our economy and reduces credit availability. In other words,
simple and clear policy communications improve American economic opportunities.
Both Democratic and Republican witnesses have testified before
us on the importance of a simple and clear communication of monetary policy. For example, during our last Humphrey-Hawkins hearing, Federal Reserve Board Chair Yellen expressed interest in
working with our committee to codify a simple and effective strategy for a more transparent monetary policy.
In addition, former Vice Chair of the Federal Reserve Board Dr.
Donald Kohn offered the following advice in a recent Brookings Institution report. The Federal Reserve should use the semi-annual
monetary policy report to better explain and focus on its broad
nshattuck on FSR297 with DISTILLER
(1)
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00007
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
2
nshattuck on FSR297 with DISTILLER
strategy. For some time, the Fed’s Open Market Committee has
been shown the results of a number of policy rules, and this material has been accompanied by explanations of why the current and
expected settings of monetary policy might deviate from the rules.
The Monetary Policy Transparency and Accountability Act that
we will consider today provides for exactly this type of framework.
Indeed, this bill reflects the very generous advice of both Chair
Yellen and Dr. Kohn. Our draft legislation also addresses what
Members of Congress and experts from both sides of the aisle see
as an opportunity to better manage our fiscal house and increase
our financial resiliency by protecting households from bailouts and
holding Congress to account for tough decisions that can easily be
punted to the Fed. Our congressional Accountability for Emergency
Lending Act takes an important step in this direction by embracing
this bipartisan Warren-Vitter framework for congressional approval
of emergency lending.
At the same time, our Independence from Credit Policy Act maintains the Fed’s role as an originator of emergency loans while insulting our monetary authority from compromising political pressures to overreach into credit policy. Authoritative economists of
different stripes share a common concern about these pressures.
Testifying as a witness for my Democratic friends, MIT Professor
Simon Johnson emphasized this bipartisan agreement.
I think we are all agreeing that this fiscal policy infrastructure
is the responsibility of the fiscal authority, which is that of the
Congress and the United States acting through the Executive
Branch. It is not the responsibility and should not become the responsibility of the Federal Reserve.
Recently, Brandeis Professor Stephen Cecchetti shared the same
concern as a minority witness for our Joint FI-MPT Subcommittee
hearing. And even the New York Times’ Paul Krugman joined this
chorus, highlighting how the Fed’s unconventional balance sheet
blurs the lines between monetary and fiscal policies.
Acknowledging such concerns during our last Humphrey-Hawkins hearing, Federal Reserve Board Chair Janet Yellen committed
the FOMC (Federal Open Market Committee) to re-establishing a
bright line between monetary and credit policy. She said the FOMC
has clearly indicated that it intends to return over time to a primarily Treasury-only portfolio. And that is in order not to influence
the allocation of credit in the economy.
Coupled with our congressional Accountability for Emergency
Lending Act, the Independence from Credit Policy Act does precisely what Chair Yellen has advocated—a return to a primarily
Treasury-only portfolio while maintaining the Fed’s role as an
originator of emergency loans.
Greater transparency, independence, and accountability for monetary policy coupled with greater fiscal accountability for Congress,
that is a solid bipartisan recipe for what we all want, and that is
greater economic opportunity for all Americans. I look forward to
our witnesses’ testimony and working with my friends on both
sides of the aisle to realize the considerable benefits that this legislative package will deliver to each of our diverse constituents.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00008
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
3
nshattuck on FSR297 with DISTILLER
The Chair now recognizes the ranking member of the subcommittee, the gentlelady from Wisconsin, Gwen Moore, for 3 minutes for an opening statement.
Ms. MOORE. Thank you so much, Mr. Chairman. And I want to
thank our witnesses for coming in today. I look forward to your testimony.
As for the bills we are considering, on one hand, I think that
they are better than the other Audit the Fed bills we have seen,
but overall they seem like problems foisted into a functioning system. I am glad that the majority has abandoned the so-called Taylor rule, but a watered-down Taylor rule is probably as unworkable
if the Taylor rule is flawed.
The 13(3) authority, I have my own questions about it, but I have
spent some time with the Fed understanding the importance of
13(3). Dodd-Frank made the right amount of reforms to the Fed in
this regard, and I sure hope that the new Fed chair would really
sit down with Chair Yellen and really let her explain the benefits
that 13(3) has had.
At this point, I think the one thing that frightens me the most—
and I would appreciate more clarity from this panel on—is the restriction of what the Fed holds, this Treasury-only schemata. It
seems to me that this would be very problematic—this would have
been problematic had it been in place during our crisis. So like I
said, I don’t see the problem that these bills are designed to solve,
but I can see plenty of problems this legislation might cause.
I would like to yield the rest of my time to Mr. Sherman.
Mr. SHERMAN. The Fed should be restructured in part because
it is so highly undemocratic. It is the only governmental institution
where at least some of the leaders are selected by the notion one
bank, one vote. All Fed Governors at all levels should be Presidential appointees.
Second, it is undemocratic because the California bank does not
have a permanent seat on the Fed committee, whereas the New
York bank does, whereas far more people live in the California region. The allocation of seats should reflect population, not political
power.
If there has been a failure of Fed policy, it is because they were
too timid with quantitative easing. And now they are too hawkish
when it comes to raising the interest rate. Our inflation rate is not
only below their target, it is below the target they should have,
which would be closer to 2.5 percent.
We continue to have low wages. What Americans demand is the
kind of labor shortage that will cause much faster growing wages.
That cannot be achieved with the Fed’s current timid policy of caving in to those who just, for historical reasons, believe we should
have higher interest rates and abolish quantitative easing.
Finally, it is only because Fed policy is the domain of people who
live in the Fed world that we ignore the $75 billion to $100 billion
the Fed has been able to transfer to the U.S. Treasury. In my district, that is real money, and yet it doesn’t get the—we pay far
more attention on the cost of building one bridge in Alaska than
we have in $75 billion to $100 billion transferred to the U.S. Treasury for several years in a row because nobody pays attention to the
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00009
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
4
nshattuck on FSR297 with DISTILLER
Fed except the Fed community, and the Fed community is embarrassed by its profit.
I yield back.
Chairman BARR. The gentlelady’s time has expired. Would the
gentlelady yield back?
Ms. MOORE. I yield back.
Chairman BARR. Gentlelady yields back. At this time, we would
like to welcome the testimony of our witnesses. First, Dr. Mickey
Levy, the Chief Economist for the Americas and Asia at Berenberg
Capital Markets. He conducts research on a variety of U.S. and
global economic and macroeconomic topics and is an adviser to several Federal Reserve banks, including the Federal Reserve Bank of
New York. Prior to his current position, Dr. Levy was Chief Economist at Bank of America and Blenheim Capital Management. He
also has been analyst at both the Congressional Budget Office and
the American Enterprise Institute. Since 1983, he has served as a
member of the Shadow Open Market Committee.
Dr. Andrew Levin, a Professor of economics at Dartmouth College. He was an economist at the Federal Reserve Board for 2 decades, including 2 years as a special adviser to Chairman Bernanke
and then Vice Chair Yellen on monetary policy strategy and communications. He subsequently served as an adviser at the International Monetary Fund. Professor Levin is currently an external
adviser to the Bank of Korea and a regular scholar at the Bank of
Canada. He has also served as a consultant to the European Central Bank and as a visiting scholar at the Bank of Japan and the
Dutch National Bank. And he has provided technical assistance to
the National Banks of Albania, Argentina, Ghana, Macedonia, and
Ukraine. He received his PhD in economics from Stanford University in 1989.
Jared Bernstein is the Senior Fellow at the Center on Budget
and Policy Priorities. From 2009 to 2011, Bernstein was the Chief
Economist and Economic Adviser to Vice President Joe Biden; Executive Director of the White House Task Force on the Middle
Class; and a member of President Obama’s economic team. Bernstein’s areas of expertise include Federal and State economic and
fiscal policies, income inequality and mobility, trends in employment and earnings, international comparisons, and the analysis of
financial and housing markets.
Prior to joining the Obama Administration, Bernstein was a Senior Economist and the Director of the Living Standards Program at
the Economic Policy Institute in Washington, D.C. Between 1995
and 1996, he held the post of Deputy Chief Economist at the U.S.
Department of Labor. Bernstein holds a PhD in social welfare from
Columbia University.
Finally, Dr. Charles Plosser is a Visiting Fellow at the Hoover
Institution at Stanford University. Plosser served as the President
and CEO of the Federal Reserve Bank of Philadelphia from 2006
until his retirement in 2015. In his position, he served as a member of the Federal Open Market Committee. Prior to joining the
Federal Reserve, Plosser was the John M. Olin Distinguished Professor of Economics and Public Policy and Director of the Bradley
Policy Research Center at the University of Rochester’s William E.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00010
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
5
Simon Graduate School of Business Administration, where he
served as Dean from 1999 to 2003.
In 2004, he was a visiting scholar at the Bank of England. Since
January 2016, Plosser has served as a Public Governor for FINRA,
where he serves on the Investment Committee and the Financial
Operations and Technology Committee. Plosser earned his PhD
and MBA degrees from the University of Chicago.
Each of you will be recognized for 5 minutes to give an oral presentation of your testimony. Without objection, each of your written
statements will be made part of the record. Dr. Plosser, we will
start with you. You are now recognized for 5 minutes. And if you
could just push the button to turn on your microphone.
STATEMENT OF CHARLES PLOSSER
nshattuck on FSR297 with DISTILLER
Dr. PLOSSER. I am technologically challenged at times.
Chairman BARR. Thank you, sir.
Dr. PLOSSER. Chair Barr, members of the committee, thank you
very much for the opportunity to share some thoughts with you
today on the Federal Reserve. I have been talking about the Federal Reserve for the last 20 years at various times, and so I have
given a lot of thought to many of its issues.
It is simplified but helpful to think of Fed actions in terms of its
balance sheet, liabilities, predominantly currency, and the reserves
of the balance sheet. Increasing the liabilities is typically associated with monetary policy. However, the Fed can also manage the
asset side of its balance sheet. Changes in composition of those assets are typically referenced to as credit policy.
Historically, the Fed has conducted monetary policy through the
purchase or sale of Treasury securities. Indeed, the vast bulk of the
Federal Reserve assets have been U.S. Treasuries since the modern
Fed began in the 1950’s. Credit policy simply did not play a role.
Moreover, for most of the post-World War II era, the Fed’s portfolio of Treasuries was purposefully designed to be neutral vis-a-vis
the private sector. It only held Treasuries, and the distribution
among bills, notes, and bonds was managed to roughly match the
distribution of the Treasury’s issuances. In other words, it was felt
that the Fed’s portfolio should not try to alter the relative prices
determined in the marketplace.
Now, during the financial crisis and subsequent recession, the
Fed altered both the size and composition of its balance sheet. In
early 2008, the Fed sold Treasuries to fund the purchase of approximately $30 billion of mostly private-sector high-risk assets to
support the acquisition of Bear Stearns by JPMorgan. Credit was
also extended through various other lending programs that targeted specific industries, asset classes, and creditors.
Now, whether you can consider these as justified because of the
credit or not, they were, in effect, debt-financed fiscal policy without explicit authorization of Congress. Now, given the distributional effects of such interventions, it is not surprising they became
somewhat controversial.
The major form of—another major form of credit policy was the
result of quantitative easing. QE was unconventional, but it was
also unprecedented in that a significant portion of the assets purchased were in the form of mortgage-backed securities, not U.S.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00011
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
6
nshattuck on FSR297 with DISTILLER
Treasuries. This action was explicitly intended to provide credit
support for the housing sector.
So why should the Fed have the authority to allocate credit within the economy in support of one industry, one company, or one individual? What are the risks and dangers of such a framework?
The major risk is that it invites political interference and undermines the integrity of fiscal policy. History suggests that central
banks that remain independent of the political environment and
the fiscal authorities do better at controlling both inflation and promoting economic stability. Do we really want the Fed being lobbied
by Congress or the public to manage the assets on its balance sheet
to promote various political or fiscal agendas?
The current trends I believe are not encouraging. For example,
some Members of Congress approached the Fed to lend money to
the automobile companies in 2008. In 2010, Congress required the
Fed to fund a Federal agency over which it had no authority. And
in 2015, Congress funded part of a transportation bill off the Fed’s
balance sheet.
I believe these actions are bad policy. They undermine the independence of our central bank monetary policymaking by confusing
the roles and responsibilities of monetary and fiscal policy. Fed
independence is fragile, and it is eroding. The Fed itself is contributing to this erosion of independence by engaging in off-budget fiscal policy through credit allocations.
A policy that restricts the Fed to own only Treasuries would go
a long way toward limiting the Fed’s ability to engage in credit allocation and limit the potential for abuse or political abuse in particular of its balance sheet. It would also help maintain a clear distinction between the role of the Fed and the role of the fiscal authorities, and thus help protect it from political interference.
Some say an all-Treasury portfolio was dangerous and would
limit the Fed’s ability to respond in a fiscal crisis. But since 2009,
I have been arguing that there is a better way. And it is to recognize and clarify who has the decision rights when it comes to fiscal
decisions and who should be held accountable. The idea is to make
clear that such emergencies is—it is the fiscal authorities that have
the power and the authority to conduct fiscal actions, who should
own both the decision rights and the accountability.
The role of the Fed should be limited to helping the government
execute those policies, but the Treasury would then be responsible
for obtaining approval of Congress for the interventions and then
required to swap Treasuries for non-Treasury securities acquired
by the Fed, thus restoring the all-Treasury character of the Fed’s
balance sheet.
This Fed Treasury accord would enable emergencies to be addressed in a timely manner while protecting the integrity, accountability of fiscal policy decisionmaking.
[The prepared statement of Dr. Plosser can be found on page 120
of the Appendix.]
Chairman BARR. The gentleman’s time is expired. And we look
forward to continuing this discussion in the Q&A. So we will now
have to move on to Dr. Levin. You are recognized for 5 minutes for
your opening statement.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00012
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
7
STATEMENT OF ANDREW LEVIN
nshattuck on FSR297 with DISTILLER
Dr. LEVIN. Chairman Barr, Ranking Member Moore, and members of the Subcommittee on Monetary Policy and Trade, thank you
for inviting me to testify at this hearing.
The Federal Reserve is America’s central bank. Its monetary policy decisions affect every American. Given the Fed’s crucial role, it
is important to ask, to whom is the Federal Reserve accountable?
Who is the Fed’s boss?
Of course, the answer is Congress. The Fed reports directly to
Congress, not to the President or anyone else. Now, I have intentionally used the term ‘‘boss’’ because we can draw on basic management principles to shed light on the issues being considered
here today.
Turning to exhibit one, here are three principles that are followed by every well-run business or nonprofit organization. One,
the boss must stay well informed about the employee strategy.
Those consultations take place in annual reviews and occasional
status updates, which are essential for maintaining accountability
and avoiding micromanagement. After all, an employee can’t be
productive if the boss is constantly second-guessing their decisions.
And that is the basic rationale for preserving the Fed’s operational
independence, but requiring the Fed to explain its policy strategy
in terms of simple benchmarks, which I will return to in a moment.
Two, extraordinary budget items require prompt approval. An
employee should have authority to incur routine expenses, but the
boss has to approve extraordinary items. And that principle is the
essential rationale for preserving the Fed’s operational independence, again, but establishing procedures to facilitate prompt congressional approval for its emergency lending facilities.
Three, extraneous tasks should be re-assigned elsewhere. Effective delegation requires a clear delineation of responsibilities. If a
work assignment evolves into a task that doesn’t fit within the employee’s job description, then the boss should re-assign that task to
someone else.
Following the same logic, private assets shouldn’t stay indefinitely on the Fed’s balance sheet. Those assets should be swapped
for U.S. Treasury securities, again, preserving the Fed’s operational independence and its designated scope of responsibility.
Now I would like to focus on the rationale for establishing simple
policy benchmarks. Turning to exhibit two, you can see that as of
last June, investors saw roughly 50/50 odds, just like a coin flip,
that the Fed would hike interest rates in December. Those odds
edged down during the summer, but then skyrocketed into early
autumn, not because of some sterling new economic data, but simply because Fed officials started signaling a rate hike through their
speeches and interviews.
In fact, as you see in the exhibit, investors now see the rate hike
in December as a practical certainty, even though the FOMC won’t
be meeting until mid-December, almost 6 weeks from now. Evidently, the strategy underlying the Fed’s decisions is not very well
understood, even by investors who sift through every tidbit of Fed
communications, and much less so by members of the general public.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00013
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
8
By contrast, simple benchmarks can provide a transparent
means for the Fed to communicate its strategy. It is really important to note here such benchmarks are not intrinsically hawkish or
dovish. For example, Janet Yellen, when she was Vice Chair in
2012, referred to one such benchmark as the balanced approach
rule because of its effectiveness in fostering the Fed’s dual mandate
of maximum employment and price stability.
Turning now to exhibit three, you can see here that a balanced
approach benchmark provides a remarkably good approximation to
the Fed’s actual policy path over the last few years. In fact, this
benchmark is essentially the same as one I presented at a conference on full employment that my colleague, Jared Bernstein, organized back in 2015. This exhibit shows, it confirms that simple
benchmarks can be helpful in clarifying the Fed’s monetary policy
strategy. That will contribute to its overall transparency and accountability to the Congress, its boss, and to its effectiveness in
serving the American public.
Thank you for your consideration. I will be glad to answer any
questions.
[The prepared statement of Dr. Levin can be found on page 53
of the Appendix.]
Chairman BARR. Thank you, Dr. Levin. And, Dr. Bernstein, you
are now recognized for 5 minutes.
STATEMENT OF JARED BERNSTEIN
nshattuck on FSR297 with DISTILLER
Dr. BERNSTEIN. Well, thank you very much. Great to be here.
And my testimony conveys a simple message. The independence of
the central bank is an essential ingredient to its functioning. Of
course, that independence exists within the legal context set forth
by Congress and it is essential for this committee to continuously
revisit this context.
But maintaining the central bank’s independence must always be
an elevated consideration. In this context, some of the ideas and
the proposals under discussions are worthy of consideration, but
some are too restrictive. They threaten the Fed’s independence and
add unnecessary and potentially damaging process requirements
that could do more harm than good to the U.S. and even the global
economy.
Before commenting on the proposals, I would like to suggest that
in an all-too-other dysfunctional and highly partisan environment,
the Federal Reserve is one institution that has been highly effective in carrying out its mission. Though the Fed failed to identify
the housing bubble, it quickly moved into emergency mode when
the bubble burst and the downturn ensued.
The bank deployed its significant weaponry against the downturn, including its first line of defense, reductions of the policy rate
and emergency lending, and later when the policy rate got stuck
at its lower bound of zero, the Fed turned to alternative forms of
monetary stimulus.
While some of these actions are behind the motivations for today’s hearing, my assessment is that they were effective in offsetting the historically large demand contraction that followed the crisis. I cite research that tries to isolate the impact of quantitative
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00014
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
9
nshattuck on FSR297 with DISTILLER
easing, including bond purchases that would not be permissible,
agency MBS (mortgage-backed security), under one of the proposals
considered today. These actions were effective in thawing credit
markets in hard-hit sectors of the market, noticeably housing finance.
Post-recession, the Fed continued to promote the recovery and
the unemployment rate recently fell to what is now the lowest jobless rate in 17 years. In other words, if I were looking around
Washington for an institution that fits the adage ‘‘if it ain’t broke,
don’t fix it,’’ my first thought would be the Federal Reserve.
Among the three proposals under review today, I find the proposal to limit the Fed’s independence regarding its emergency lender of last resort function potentially most problematic. Though I
recognize the motivation for the proposal, I see two major drawbacks.
First, since the crisis, Congress legislated the Dodd-Frank financial reforms, key sections of which were designed specifically to reduce the need for Fed intervention in this space, including a vice
chair position for the Fed, for financial supervision, numerous restrictions to 13(3) lending authorization, and liquidation authority.
Dodd-Frank, along with recent international accords under Basel
III, also increased the first line of defense against illiquidity and
solvency crises, capital requirements that disallow excessive leverage. I see no reason to add new complexities into this system until
we give the Dodd-Frank measures a chance.
Second, and this is a profound concern with this proposal, it
takes the authority for emergency lending outside of the Fed and
requires both chambers of Congress to provide a timely 30-day approval of the Fed’s emergency loans. I believe this adds unnecessary risk to credit markets and the broader economy. It is an imprudent departure from the lending authority established in 13(3)
of the Fed’s charter, one that undermines both the independence of
the institution and its role of, quote, lender of last resort. With this
change, the 535 Members of Congress all become lenders of last resort, a possibility I strongly urge this committee to avoid.
If Congress fails to approve an emergency lending program within 30 days, the borrower, who by definition is facing a balance
sheet crisis, must pay the loan back to the Fed. Moreover, Members of Congress and their staffs must quickly engage in highly
technical analysis of whether lending institutions are illiquid or insolvent, the quality of their collateral. Such analysis is standard
practice at the Fed, but by insisting Congress engage in it as well,
the proposal introduces the possibility of politicizing the analysis—
and if Congress fails to act in a timely manner—triggering significant market disruptions.
I do think the bar should be high for approval of emergency lending, but my bottom line is that clearing that bar should be the purview of the Fed, not Congress. Thus, should the committee consider
raising the internal bar within the Fed, inside the Fed, while this
should be done carefully and with great attention to potential unintended consequences, it is consistent with prudent congressional
regulation.
Conversely, raising the external bar by requiring congressional
approval goes way beyond this benchmark. The best way to avoid
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00015
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
10
emergency lending by the Fed is to avoid credit bubbles, systematically underpriced risk, and the crises that followed these financial
pathologies. And the way to achieve that is through market oversight and regulation.
I would also caution the committee against further restrictions
on the Fed as to the type of debt they can purchase in their open
market regulations. The Banks of England, Japan, Canada, and
Europe all have few restrictions on the type of assets they can purchase, and this creates a flexibility for their central banks to bring
the water to the specific sources of the fire.
I thank you, and I look forward to your questions.
[The prepared statement of Dr. Bernstein can be found on page
42 of the Appendix.]
Chairman BARR. Thank you, Dr. Bernstein. And, Dr. Levy, you
are now recognized for 5 minutes for an opening statement.
STATEMENT OF MICKEY LEVY
nshattuck on FSR297 with DISTILLER
Dr. LEVY. Chairman Barr, Ranking Member Moore, and members of the committee, I sincerely appreciate this opportunity.
The ultimate objective is healthy, sustained economic growth and
rising standards of living. The challenge is identifying the proper
policies and the proper mix of policies—fiscal and tax, regulatory
and monetary—to achieve desired outcomes. The Fed’s emergency
measures during the 2008–2009 crisis certainly helped stabilize financial markets and avert an even deeper recession. But we have
to distinguish between the conduct of policy during a crisis and
during normal times.
The efficacy of the Fed’s sustained artificially low interest rates
and massive asset purchases once the recovery took hold are questionable and have been the source of undesired distortions and pose
very large risks. The Fed’s QE3 asset purchases policy to reinvest
all the maturing assets, artificially low interest rates, all of these
stimulated financial markets. But they failed to stimulate faster
growth. Nominal GDP growth has actually decelerated.
The economy would have grown along its modest pace and job
gains would have occurred even if the Fed had not engaged in QE3
and even if it had normalized rates quicker. History shows conclusively that once an economic recovery takes hold, raising rates back
to neutral does not harm the economy.
But the Fed’s extension of monetary policy through uneven discretionary approaches has given a false sense or a false impression
that the mandate of the Fed is to manage the real economy and
fine-tune it, and that more and more monetary stimulus was needed to prop up the economy. In reality, the frustrating underperformance of the economy reflected the growing web of regulatory
policies, government-mandated expenses, and tax burdens.
The Fed’s extended easy policies has created many distortions
and burdens. Let me mention a few. Tens of millions of primarily
older people face low yields on their savings. Tens of millions of
renters face higher rental costs as real estate prices have moved
up, stimulated by the Fed. Moreover, the Fed’s $4.5 trillion portfolio involves enormous risks. The CBO estimates that a 1 percent-
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00016
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
11
nshattuck on FSR297 with DISTILLER
age point increase in interest rates would increase budget deficits
by $1.6 trillion over 10 years. Take this risk seriously.
My recommendations are, the Fed must continue to normalize interest rates as it has been. With regard to inflation, the factors
that have brought down inflation recently below the Fed’s 2 percent target are good for the economy and increased purchasing
power. The Fed should not express so much public angst about a
non-problem of low inflation.
In fact, economic growth, business investment, and real wages
are picking up momentum and confidence is elevated despite the
Fed hiking rates. The reason for this is largely the government’s
recent changes to ease the burdensome regulations and tax reform
prospects.
Second, the Fed and Congress are really too complacent about
the Fed’s massive balance sheet, particularly amid improving
economies. And I urge the Fed to gradually eliminate its entire
mortgage-backed securities holdings. With the mortgage market
healthy, and housing doing quite well, why is the Fed holding any
MBS? Why is it allocating credit to a sector that doesn’t need it?
The Fed should aim to reduce its balance sheet much more than
it is currently aiming for. Some Fed members are talking about
lowering it from its current level to about $3 trillion, which would
still leave $1 trillion in excess reserves in the banking system. We
need to assess the costs as well as the potential benefits of that.
What might be the costs? Its involvement in fiscal policy, paying
interest on excess reserves, the Fed’s expanded footprint in financial markets.
Third, the Fed and Congress should adopt a rule to establish and
prevent the Fed from ever purchasing equities under any circumstances.
Finally, and most importantly for the future, the Fed really
needs to reset monetary policy. It should have a flexible rulesbased approach. And by flexible, what I mean is, follow a rule as
a guideline that will improve transparency and your committee’s
ability to supervise the Congress while at the same time giving the
Fed substantial or any types of discretion it needs during emergency situations.
Thank you.
[The prepared statement of Dr. Levy can be found on page 112
of the Appendix.]
Chairman BARR. Thank you all for your testimony. And the
Chair now recognized himself for questions for 5 minutes.
So last year, a research team from the University of Chicago,
Northwestern, and Stanford published an article in the highly regarded Quarterly Journal of Economics. And that article found that
uncertainty about economic policy in general reduces American investment, output, and employment.
And just last month, a team at the Federal Reserve, researchers
at the Fed found the same problem with monetary policy. According to their study, quote, ‘‘uncertainty about monetary policy increases credit spreads and reduces output.’’
Dr. Plosser, you have served on the Fed’s Monetary Policy Committee. You are an accomplished economic researcher. Do these
findings from both the Fed and from the various academics—do
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00017
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
12
nshattuck on FSR297 with DISTILLER
these findings seem reasonable to you that uncertainty about
where monetary policy is going can, in fact, slow our economy and
constrain credit availability?
Dr. PLOSSER. Thank you. I think the answer is yes. They certainly make sense. I think there is a challenge in how you quantify
those effects, but you can see the uncertainty showing up in a number of different situations.
Think about the uncertainty of credit policy, about how much
MBS was going to be bought and how much not. Were they going
to rescue Lehman Brothers like they rescued Bear Stearns? Without articulating a policy that—strategy that guided those decisions,
it resulted in uncertainty. The taper tantrum, as they said, that occurred.
All those are examples of effects in the markets that came about
through some uncertainty or through doubt about whether the Fed
was going to follow through on some of its pronouncements. So I
think it is very important that, yes, I think that uncertainty can
matter. How and when it shows up is a bit of a challenge. But that
just says that the Fed needs to be more strategic in articulating a
strategy about how it is going to behave if certain things happen.
Chairman BARR. Thank you. And, Dr. Levin, you, too, are an accomplished economic researcher. You have advised both Fed Chairman Bernanke and then Vice Chair Yellen. And in addition, you
coauthored an article last year with the FED UP! Coalition’s campaign manager calling attention to the importance of transparency
for our monetary policy authority, and acknowledgements for that
article included Dr. Bernstein, who joins our panel today.
The article called for the Fed to include in its Monetary Policy
Report a discussion of any economic models and benchmark rules
that are used in setting the course of monetary policy. Dr. Levin,
does the discussion draft that you have before you today, the Monetary Policy Transparency and Accountability Act, does that bill as
currently drafted as you see it effectively achieve that goal without
mandating the FOMC to follow any particular mechanical rule?
Dr. LEVIN. Well, thank you, Mr. Chairman. So, first of all, I just
want to go back to something that Congressman Sherman mentioned before. The Fed serves the American public, and I think it
is appropriate for Congress to think carefully about how to make
sure the Fed is a fully public institution. That was the key point
of the paper that we wrote last year. It is critical for the Fed to
be diverse, regionally diverse, diverse in respect to the policymakers and the staff who are working at the Fed. Those are all
critical issues that were in that paper.
But on the specific issue, I think that—as I said before—clarity
of a benchmark rule would help serve the public. It is related to
your question to Dr. Plosser. It would help alleviate uncertainty in
financial markets, and more generally businesses and consumers,
the strategy the Fed is following. So I think it is appropriate in
your draft legislation that the Fed have a simple strategy that it
can explain to Congress and the public.
Ideally, it would choose that strategy at the beginning of each
calendar year. And of course, during the year, things might—unexpected things might come up, and then the Fed officials would explain if they need to change the strategy or deviate from the strat-
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00018
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
13
nshattuck on FSR297 with DISTILLER
egy. So in that sense, I agree with you that this is a reasonably
flexible approach that would help improve the Fed’s transparency.
The Fed needs to have discussions among experts like Dr.
Plosser was, with different points of view. Some people think that
the Fed should continue to normalize. The policy rule that I
showed you on the chart, it is not so clear, because if inflation
stays around 1.3 percent where it is today, and output is just growing at a sustainable pace, then that rule would say that there isn’t
necessarily such a strong case for the Fed to raise interest rates
further at this point.
But again, that is the sort of debate that should happen at the
Fed. The Federal Reserve would choose the benchmark under your
legislation. And it would be able to change the benchmark, but it
could use that as a point of reference. And so I think this would
be a very constructive way forward.
Chairman BARR. Thank you. And I would like to ask the same
question to the other two witnesses, but my time has expired, so
we now move to the distinguished gentlelady from Wisconsin, the
ranking member, Ms. Moore, for 5 minutes.
Ms. MOORE. Thank you so much, Mr. Chairman. If I have understood the testimony we have had here today, it seems like there is
not that much disagreement with regard to the Fed having taken
the appropriate emergency lending authority. But then it seems to
differ after that point.
Dr. Bernstein, let me start with you. I am not trying to pick on
you, Dr. Levy, but I just underlined some stuff in your testimony
that I thought was very interesting. You thought that the economy’s lackluster response to the Fed’s stimulus highlights the important influences of other policies and factors, and you talked
again about Dodd-Frank, the government tax and regulatory policies at both the State and local levels, in both the financial and
non-financial sectors, the Fed paying interest on reserves, and saying that the banks just can’t lend, because they are just so burdened by regulations.
Now, the banks are doing great, last time I checked. They are
very profitable. And, Dr. Bernstein, I think we heard you say and
talk about in your written testimony that we saw unemployment
fall to 4.1 percent. What am I not getting here between the two of
you?
Dr. BERNSTEIN. Well, I think you raise some great points, and
these thoughts came to mind listening to Charles Plosser also talk
about the impact of Fed-induced uncertainty. In fact, unemployment is historically low. We are creating something like between
150,000 and 200,000 jobs per month. That is a strong clip of job
creation at this point in the cycle. I suspect all of my colleagues
would agree with that.
The GDP is growing slower than we might like. That is a function of low productivity growth. And I haven’t heard any convincing
arguments that would connect Federal Reserve policy to that. So
I think that if you are looking at economic conditions and you are
trying to make a case that the Fed is somehow doing the wrong
thing, you have a very high bar to cross.
As far as the crisis goes, many of the policies that are taking a
bit of a hit from my colleagues up here have been shown not only
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00019
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
14
nshattuck on FSR297 with DISTILLER
to be effective in pulling the recovery forward, but as I dictate in
my testimony, looking at a wide spate of research, are associated
with much quicker GDP growth, much lower unemployment, and
including some of the bond purchases and emergency spending programs are associated with significantly lower interest rates in
those sectors that clearly were important to growth.
If anything, it is my view that is what has held back faster
growth in terms of a policy setting was austere fiscal policy, not
monetary stimulus.
Ms. MOORE. Right, right, right. OK, so you talked about the—
what if the Fed had been prohibited, as this legislation suggests,
from purchasing Treasuries in response to the 2008 crisis, if we
had the policy that would limit its purchases? What do you think
would have happened?
Dr. BERNSTEIN. Well, John Williams of the San Francisco Fed is
I think a very highly respected empirical macroeconomist. He argued that the MBS purchases were, quote, the most effective part
of the Fed’s asset purchase programs and that they, quote, ended
up having kind of a bigger bang for the buck than the Treasury
purchases.
I quote research by Alan Blinder, former Vice Chair of the Fed,
and Mark Zandi, highly respected economic researcher, that underscores Williams’ finding. Within a short time, they write, the MBS
purchases by the Fed meant that, quote, homebuyers with good
jobs and high credit scores could obtain mortgages at record low
rates which helped end the housing crash.
And in my testimony, I not only underscore those results, but I
urge the committee to look at the potential for other asset classes
that the Fed might be able to purchase, depending on the nature
of the crisis. And I suggest municipal bonds might be one area to
look at.
Ms. MOORE. Well, the heart of the financial crisis was in the
housing sector, so do you agree that that was good for the Fed to
target that sector?
Dr. BERNSTEIN. In a sense, we were, quote—and these are very
big air quotes ‘‘lucky,″ because the Fed, within its charter, was able
to purchase assets from the very sector that took the hit, the housing sector. That might not be the case next time.
Ms. MOORE. OK. Thank you. I think I will yield back the balance
of my time, since we went over last time.
Chairman BARR. The gentlelady yields back. The Chair now recognizes the Vice Chair of the subcommittee, Mr. Williams from
Texas.
Mr. WILLIAMS. Thank you, Mr. Chairman. And thank all of you
for being here today.
This subcommittee is grateful to have the testimony of so many
of you, and we appreciate it, on a very important topic. As Vice
Chairman of this subcommittee, I have been privileged to work
with my colleagues and industry experts to ensure the Federal Reserve does not step beyond its intended purpose and authority and
continues to play an independent role in monetary policy. I consider today’s discussion a pivotal step in the right direction. I look
forward to working with the Chairman and distinguished members
on these issues.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00020
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
15
nshattuck on FSR297 with DISTILLER
So, Mr. Plosser, my question to you is, in March, you stated during an interview that you are concerned about preserving the fragility of independence as Congress considers reforms to the Fed.
Now, based upon your previous role as president and CEO of the
Federal Reserve of Philadelphia, do you feel that the reforms being
considered today would help to maintain that independence?
Dr. PLOSSER. Thank you, sir. I do. I think—as I talked about
Treasuries and about political interference or political involvement
of Fed and its own decisionmaking and pressures, both politically
and by the public, I think it is very important that we separate
clearly the responsibilities of the fiscal authorities from those of the
monetary authorities.
The more those responsibilities are blurred and overlap in some
ways or have dual responsibilities, the harder it is to hold either
party, Congress or the Fed, accountable for the decisions that they
make. So it is really important, I think, to keep a line between
monetary and fiscal policy.
And one of the things I have argued is rather than undermine
independence of Fed’s monetary policymaking, it would be better to
narrow the scope of their responsibilities in a way that helped
them focus on things that they can control and ultimately Congress
wants them to do. So this separation between monetary and fiscal
policy I think is an important aspect, and I think the way the bills
are written and go to a Treasuries-only policy and to provide mechanisms for emergencies should they arise, it holds the right parties
accountable at the right time.
Mr. WILLIAMS. OK. Do you think there are any areas where you
feel that the Fed is currently acting beyond its jurisdiction?
Dr. PLOSSER. I can’t think of any right at the moment. I mean,
they are beginning to unwind their balance sheet, as was said. I
think—I wish they could do it a little faster, I think, because I
think that is—
Mr. WILLIAMS. Could you talk closer to the mic, please? Thank
you.
Dr. PLOSSER. Sorry. I think they are not doing anything immediately that is not appropriate. They are unwinding their balance
sheet. I wish they would focus more on unwinding from the MBS
and shrinking their balance sheet a little bit faster. In fact, I think
that is actually more important right now than raising interest
rates.
Mr. WILLIAMS. OK. Mr. Levy, thank you for being here today. In
your testimony, you acknowledged—rightfully so—that the actions
of the Fed following the economic crisis have, in your words, extended the role of monetary policy beyond its normal scope. You
say that the Fed’s position that QE3 was responsible for increases
in employment and economic expansion reflect a great deal of hubris.
I would tend to agree with you. Do you agree with the characterization that the purchase of mortgage-backed securities by the Fed
is a dangerous long-term strategy?
Dr. LEVY. Yes, I agree. Particularly we have—once again, the
Fed’s original purchases of MBS, November 2008, was as Chairman Bernanke said, an absolute emergency. The MBS market was
frozen and really threatened the global financial system.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00021
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
16
nshattuck on FSR297 with DISTILLER
We are no longer in an emergency. Financial markets are normal. Mortgage markets are normal. Housing market is doing just
fine. Why is the Fed the largest holder of MBS in the world? It just
absolutely doesn’t make any sense, and it is not a good long-run
strategy.
So once again, I think we need to distinguish between the proper
role of the central bank during an emergency and the proper role
during normal times. And we are certainly in normal times now.
Mr. WILLIAMS. OK, let me ask you another question. Will the
proposals before us help to successfully unwind the excessively
large balance sheet of the Fed, do you think?
Dr. LEVY. Excuse me, sir. I didn’t—maybe I didn’t hear—
Mr. WILLIAMS. Yes, will the proposals before us help to successfully unwind the excessively large balance sheet of the Fed?
Dr. LEVY. It won’t hurt it, but it doesn’t directly address it. I
mean, so right now, the Fed’s strategy for unwinding its balance
sheet ever so gradually and passively effectively involves reinvesting all but about 97 percent of MBS and Treasury holdings,
this very gradual unwind.
And it is a step in the right direction, but I think it should be
more aggressive, because once again, I don’t think the Congress or
the Fed are really considering some of the risks involved, but not
just the Fed stepping over the bounds into fiscal policy, but there
are just massive risks, including the risk that Congress thinks of
this as risk-free money to spend. And that is very dangerous.
Chairman BARR. The gentleman’s time has expired.
Mr. WILLIAMS. Thank you, Mr. Chairman.
Chairman BARR. Thank you. The gentleman’s time has expired.
The Chair now recognizes the gentleman from California, Mr. Sherman.
Mr. SHERMAN. Mr. Chairman, I want to thank you for putting up
a quote from Congressman Brad Sherman when it was your time.
I can think of no more credible analyst. And you quote me to say
that Section 13(3) is still a dangerous code section.
Dr. Bernstein points out that because of the other provisions of
Dodd-Frank, it is less likely to be needed, which means it is less
likely to be abused, but it is also less likely to be necessary. So the
question then is, how can we make it even less likely to be necessary? And first thing we should do is break up the too-big-to-fail.
Too-big-to-fail is too big to exist. And we should never have a circumstance where the Fed is tempted to use 13(3) or to come to us
for emergency legislation, as they did successfully in terms of passing their legislation, by saying, look, if this one entity goes under,
it is taking the entire economy with us.
I would point out that one thing that 13(3) does not have is a
dollar limit. I remember when the chair of the Fed was here and
I proposed either a $4 trillion or an $8 trillion limit, and the Fed
chair would not go along with that, that was at a time when it
wasn’t being used at all. So it is—clearly Congress should be consulted at some stage.
Mr. Plosser, you point out that we should not use 13(3) to help
any one individual or company. There is a constant debate in our
society between democracy and rule of the philosopher-king ex-
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00022
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
17
nshattuck on FSR297 with DISTILLER
perts. You would think that democracy had won that debate. I am
by no means sure.
I think that there is general agreement that the people of the
country can elect politicians, so long as those politicians don’t control anything that is thought to be really important, and that if
politicians do, that process is known as politicization of what actually the philosopher-kings should control.
Mr. Levin, you point out that the Fed shouldn’t suffer from second-guessing. Welcome to Washington, D.C. I don’t think there is
a member of this committee who is not second-guessed on everything they do at all times. And the financial press seems to exist
for the sole purpose of second-guessing the Fed.
Speaking of whether the Fed is predictable or not, they are absolutely and totally predictable within one quarter of 1 percent. That
is pretty good. Reasonable minds on the Fed can differ to the extent of one quarter of 1 percent. They are far more predictable than
anything else I am aware of.
The problem with the Fed balance sheet is that they are shrinking it when they should be growing it. You can say there is no crisis, but wages remain stagnant. That leads to divorce. It leads to
drug abuse and opioid abuse. It leads to broken families. It leads
to a host of problems that we would not have otherwise. And so it
may not be a crisis for the whole country, but it is a crisis for millions of families.
Let’s see. So I want to focus—since I have Dr. Bernstein here,
on the tax provisions. We were talking about those earlier. Oh, and
I do want to thank, as long as the—I mean, the majority has put
my quote up on the board knowing that I should follow their lead.
I have also put my own material up on the board.
And I want to point out that the abandonment of quantitative
easing is going to cost our Treasury between $80 billion and $100
billion a year. And we live in this strange world where almost everyone except our witnesses are unaware—and maybe some of our
members are unaware—that this money is coming into the Treasury. And then our witnesses live in a world where that is shameful,
because it is unintended, because that isn’t the purpose of the entity. I would say that if you were in the private sector and your byproduct starts making you huge amounts of money, that creating
the byproduct becomes one of the purposes of the company.
But, Dr. Bernstein, did the models on the effect of this tax law,
do they deal at all with the increase in the trade deficit due to the
strengthening of the dollar due to the increase in Federal borrowing?
Dr. BERNSTEIN. I know my time is up. I will answer you with one
sentence. The theory of the case on the tax cuts is that the cut in
the corporate rate will draw in capital flows from abroad, and those
will increase the trade deficit.
Chairman BARR. Gentleman’s time is expired. The Chair now
recognizes the gentlelady from Utah, Mrs. Love.
Mrs. LOVE. Thank you. Thank you all for being here. In previous
hearings regarding the Fed and monetary policy, we had discussions about the Fed being just as bad as everyone else at economic
and financial forecasting, despite having an army of PhD economists running complex computer models.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00023
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
18
nshattuck on FSR297 with DISTILLER
Why do you think the Fed is so bad at forecasting? And I was
wondering if I can get your thoughts on that, Dr. Plosser.
Dr. PLOSSER. I think that economists in general are not that
great of forecasters. That is just the reality of it. Many of the
things that go wrong with forecasts are the things that—are events
that occur that weren’t forecastable and therefore cause problems.
I also think that actually raises the importance of the distinction
between what we might call a rules-based strategy and a discretionary strategy. Discretionary strategy says the Fed will do what
it wants to do when it wants to do it for reasons that it feels it
wants to, OK? That is very unpredictable as to how that is going
to respond.
Mrs. LOVE. Right.
Dr. PLOSSER. But the future is uncertain. Always has been uncertain and will continue to be uncertain. The value of many of the
rules-based strategies and the strategies where you articulate, well,
what will the Fed do if this or this happens? Right?
Mrs. LOVE. Right.
Dr. PLOSSER. That reduces uncertainty. You don’t have to guess
what the Fed will do. It won’t make up new reasons for doing the
thing it is doing. It will be a bit more predictable.
Mrs. LOVE. OK.
Dr. PLOSSER. Because the future is predictable.
Mrs. LOVE. Right.
Dr. PLOSSER. So I think that we have to just accept the fact that
the future is unpredictable and think about strategies that allows
the Fed to operate in an unpredictable world in a predictable way.
Mrs. LOVE. OK, I am glad you said that, because I am trying to
figure out a way to do that. So according to former Federal Reserve
Board Governor Kevin Warsh, currency stability is one of growth’s
best friends. He also worried that the Fed’s extraordinary tools encouraging businesses to favor financial engineering over capital investment and consequently weakened growth in business investments is providing to be an opportunity killer for workers.
Do you agree with that assessment or disagree with that assessment? Yes, I am still sticking with you. Yes.
Dr. PLOSSER. I apologize. I am sorry. I thought you were talking
to Dr. Levin.
I agree with most of it. I do think that many of us said during
both very low interest rate period when we reached zero and during quantitative easing that much of the effects of those efforts
were absorbed in financial re-engineering by companies, restructuring corporate debt policies, and one of the big puzzles for the recovery and one of the reasons it was slow was the fact that real
business investment didn’t grow like it had in previous recoveries.
It wasn’t as responsive to the typical tools of monetary policy.
We saw this effect in financial re-engineering, restructuring of
debt, so forth and so on. So I think there is—I share a lot of the
concerns in that statement.
Mrs. LOVE. OK, I want to get to Dr. Levy, because we have had
an opportunity to discuss this before. You and I have talked in previous hearings about the relationship between monetary policy and
employment. And why do you think that the Fed’s policies have
been such a boom for what Kevin Warsh has referred to as finan-
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00024
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
19
nshattuck on FSR297 with DISTILLER
cial engineering, while leaving too many Americans underemployed
and barely able to make ends meet?
Dr. LEVY. This is a great question. So getting back to Dr.
Plosser’s comment, and Kevin Warsh’s comment, it is critically important to point out that while the Fed was very successful in lowering the real cost of capital, businesses didn’t respond. And they
didn’t respond for a host of non-monetary reasons, including tax
and regulatory policies.
Now, to your point on employment, there are so many factors affecting employment and wages that go so far beyond monetary policy. Productivity has been slow. This should be a subcommittee on
education, because let me give you an important statistic. Eightyfive million people, working-age population, have a high school degree or less. Wages tend to be low. Monetary policy can’t do anything about it.
OK, so—and you could go through a host of other government
regulations. So this is why I am emphasizing that we all want
higher standards of living. The issue is, what is the proper role of
monetary policy? So the Fed could add on QE3 and QE4 and up
to a zillion, and it is just not going to create the type of employment gains and wage gains that we all really want.
Chairman BARR. The gentlelady’s time has expired.
Mrs. LOVE. Thank you.
Chairman BARR. Gentlelady’s time has expired. The Chair now
recognizes the gentleman from Arkansas—the Chair recognizes the
gentlelady from Wisconsin?
Ms. MOORE. Yes, thank you so much, Mr. Chairman. Excuse this
interruption. I would like to ask unanimous consent to place a
statement in the record from Better Markets. There was a quote
attributed to them taken from a release issued in 2015 when the
Warren-Vitter bill was introduced. And they just want to clarify
the differences in that bill and what is being offered here today,
just for the record.
Chairman BARR. Without objection. So the statement will be entered into the record. And the Chair now recognizes the gentleman
from Arkansas for 5 minutes.
Mr. HILL. I thank the Chairman. Appreciate you and Ms. Moore
convening this hearing. And thank our excellent panel. Appreciate
all of your participation, as well.
This subject of Federal Reserve independence from credit policy
is not new to this subcommittee, and so I am glad we are continuing this discussion. As Marvin Goodfriend, a professor of economics at Carnegie Mellon, said in 2014, I think it was—he summarized it nicely, said flexibility and decisiveness are essential for
effective central banking. Independence enables the central bank to
react promptly to macroeconomic or financial shocks without the
approval of the Treasury or the legislature. Central bank initiatives must be regarded as legitimate by the legislature and the
public. Otherwise, such initiatives will lack credibility essential for
their effectiveness.
The problem is—which is what we are talking about today—to
identify the limits of independence on monetary policy and credit
policy to preserve a workable, sustainable division of responsibilities between the central bank and between the fiscal authority.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00025
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
20
nshattuck on FSR297 with DISTILLER
And I think that is really at the heart of what we are talking about
today.
And if we have an efficient monetary policy, then it helps our private markets allocate goods and services, most readily—finding
their most promising opportunity. And if we engage in what we
have done over the past 10 years, we really skew the price mechanism and skew investment. So I really appreciate your testimony,
all of your testimony.
We have seen around the world unprecedented accommodation,
not only here in the United States, but in central banks around the
world, where I think Japan now is somewhere approaching 100
percent of GDP with the size of its balance sheet, and we are at
about a quarter of our GDP. And in Europe and in Japan particularly, we have $12 trillion, $13 trillion of sovereign debt at negative
interest rates. And we have some of those central banks buying
corporate debt and equity obligations, something that we have certainly been concerned about here.
So I do think, as the Ranking Member noted, that there are concrete reasons why we are having this testimony and thinking about
why those distorted price signals and the mixing of credit and monetary policy are not a good thing for our country.
Dr. Plosser, in talking about Treasury-only, I want you to emphasize that we have 40 percent of the new issue MBS owned by
the Federal Reserve right now. We have about 15 percent of the
Treasury market, more or less, since the crisis. And I think—last
time I looked at their statement, they own 4 percent of other,
which includes Maiden Lane, which I guess is the residual detritus
of Bear Stearns.
Your concept is that we just simply—whether it is a 13-D action
or any other action, if we the Fed take on a non-Treasury asset
that in some reasonable amount of time we ask the ultimate fiscal
authority of the Treasury to take that and swap Treasuries back
to the Fed, isn’t that what we are talking about?
Dr. PLOSSER. That is the essence of it, yes, Congressman.
Mr. HILL. So that doesn’t—it doesn’t per se that—and I agree
with Dr. Bernstein. We have to be very careful in how that is done
and the timeframes and we don’t want in a crisis to make things
more difficult. But the ultimate issue is that the Treasury, just like
if it hadn’t done a very effective job in getting rid of their final
TARP assets, they would be liquidating Maiden Lane and not leave
that over at the Fed. Isn’t that an example of what you are talking
about?
Dr. PLOSSER. That is essentially what I have been arguing, exactly that.
Mr. HILL. And—
Dr. PLOSSER. And by the way, there was a memo written between the Treasury and the Fed back in—it was in 2009, where
there was an understanding that the Treasury would do everything—because this discussion started way back then—that the
Treasury would do everything it could to relieve the Fed of those
private-sector assets, recognizing that they were really the responsibility of the fiscal authorities.
That never happened, obviously. And so I think this is really
about the process of restoring the Fed so it can continue to conduct
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00026
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
21
nshattuck on FSR297 with DISTILLER
monetary policy in a manner that is appropriate without—with
Treasuries, rather than trying to deal with the Maiden Lanes of
the world.
Mr. HILL. Well, not only be neutral between the private markets
on that credit allocation and monetary policy, but also put the fiscal authority, which is under the purview of the Congress, into
whether we are going to spend money on one thing or another to,
quote, intervene in markets in the time of a crisis. I think you
make a good point. I yield back, Mr. Chairman.
Chairman BARR. Gentleman yields back. The Chair now recognizes the gentleman from Minnesota, Mr. Emmer.
Mr. EMMER. Thanks to the Chair. And thank you to this great
panel for being here today.
I want to followup on Mrs. Love’s questions relating to Kevin
Warsh’s quote about financial engineering. And, Dr. Levy, since
you were on this when the time ran out, can you give me some examples of the types of financial engineering that Mr. Warsh was
referring to?
Dr. LEVY. Quite simply, by keeping rates at zero, so the cost of
capital is zero, that gives companies the flexibility to alter their liability structure, alter their capital structure in any way. And the
problem you run into is when you are running a company, and
your Treasury Department starts making too much money, and
your basic business isn’t, things aren’t good.
I hate to say this in such lay terms, but if it becomes so financially advantageous to take advantage of the current financial system to generate profits, then you take your eye off your basic business ball. And I think a lot of that happened.
So once again, if we go back to what the Fed tried to do and was
very articulate about in—say, its QE3, Chairman Bernanke when
he rolled it out says, OK, QE3, we want to pump a huge amount
of excess liquidity into the economy, keep rates very low, and
through forward guidance convince markets we are going to keep
rates really, really low for a really long time. We want to encourage
risk-taking and push up asset prices, and all of that is going to
stimulate aggregate demand.
It did all of that, but it didn’t stimulate aggregate demand. Once
again, I will emphasize, I understand employment went up, but
nominal spending growth in the economy didn’t accelerate. And so
when economists talk about distortions, you can drill down to what
it means for household decisionmaking and business decisionmaking.
Mr. EMMER. So what do you think the Fed should be doing to encourage capital investment and job creation instead of this financial engineering? Instead of making too much money through the
Treasury? What would a better approach be?
Dr. LEVY. Well, I think the Fed should proceed to normalize interest rates, and that means raising rates right now toward 3 percent. I don’t think it should—which would mean 1 percent real
rate. I don’t think it should be sidetracked from that due to low inflation or any international whatever should come up.
And I think on its balance sheet, the Fed should, once again, proceed with a strategy to unwind all of its mortgage-backed holdings
over, say, a period of 5 years, which is reasonable. You could do
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00027
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
22
nshattuck on FSR297 with DISTILLER
most of it passively. You wouldn’t have to sell any. And to basically
normalize policy and set the record straight about what the proper
scope of monetary policy is, and I think that would reduce uncertainty and build confidence in the private sector.
Mr. EMMER. Well, that is interesting, your last statement, because my next question was, in your opinion, has the Federal Reserve done a sufficient job of announcing to the American people
a clear and consistent strategy on how it plans to spur economic
growth?
Dr. LEVY. The Fed’s tried to be transparent, but because it has
not had a strategy, it is very difficult to be clear. And so while they
talk about transparency, their message oftentimes gets muddled
without a strategy. And so once again, I think the Fed should—
during a healthy economic period, it should stick to its monetary
knitting and not try to get itself involved in fine-tuning the economy and giving mixed signals to markets.
And I do think the Fed’s forward guidance during parts of this
economic expansion, expressing worries that even a 25 basis point
hike in rates could generate the next recession, it is certainly not
a positive for confidence.
Mr. EMMER. It is not helpful. Thank you. I yield back.
Chairman BARR. Gentleman yields back. The Chair recognizes
the gentleman from Indiana, Mr. Hollingsworth.
Mr. HOLLINGSWORTH. Well, good afternoon. I appreciate everybody being here. It is a rare day when you face four doctors sitting
across from you. Consider it a pleasant experience, right?
But I wanted to talk a little bit more about what has been discussed already. And I think that one of the challenges here is—on
both sides of the aisle is confusing the counterfactual a little bit.
We say, oh, growth is non-zero, thus things are going great. Bank
profits are greater than zero, thus things are going great.
But I think the literature looking back on this shows how loan
growth has been severely constrained compared to coming out of
previous recessions. And so one of the things that I wanted to talk
about was interest on excess reserves and how that may be slowing
banks’ willingness to make loans to other creditworthy borrowers
and to mobilize those loans into capital investment loans.
As you well said, Dr. Levy, that investment has certainly been
sub-par compared to previous expansions. And I guess in my view,
and maybe this has gone out of fashion, but in the super long run,
it is productivity that generates economic growth. And monetary
policy has the ability to move things around on a temporary basis
or on a short-term basis, but ensuring that we ultimately create a
more productive work force, so we create more productive uses for
capital is hugely important. I wonder if you could talk a little bit
about how interest on excess reserves may be constraining those
investments.
Dr. LEVY. OK, so the Fed pays interest on excess reserves, and
for—they put this in place in October 2008. And for a large portion
of the period recently, that interest they pay on excess reserves has
been above the effective funds rate, and therefore that is—it is one
factor but not the only factor that has probably constrained bank
lending.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00028
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
23
nshattuck on FSR297 with DISTILLER
I would also note another factor here is that the Fed stress tests,
while they have been successful in leading particularly large banks
to raise their capital adequacy standards, I can tell you when bank
executives deal with stress tests all day long—
Mr. HOLLINGSWORTH. Their stress goes up.
Dr. LEVY. —they are in no mood to make a loan. And the lenders
down the hall say I don’t want to make this loan because the risk
of making a mistake is very, very large. So I think it all adds up
to—
Mr. HOLLINGSWORTH. If you have a regulatory environment that
dampens loan growth, and then you have the ability with no
counterparty risk whatsoever to earn above market rates at the
Fed, why take on risk without any apparent gain? Right? And, Dr.
Levin, I was hoping that you might comment on that, as well.
Dr. LEVIN. Well, I think I agree with you that the interest on reserves was, you know, granted by the Congress to the Federal Reserve at a time when banks were earning zero interest. And that
was viewed as a distortionary cost that was discouraging banks,
and effectively disintermediating funds from the banking system
elsewhere, because banks are required to hold some reserves at the
Federal Reserve.
This is a crucial question. I think that a part of the solution to
this in my view is that Congress should authorize the GAO to do
comprehensive annual reviews of all aspects of the Fed, including
in the monetary policy—including interest on reserves. I think
there is a real question in my mind why the Federal Reserve is
paying a significantly higher rate on interest on excess reserves
compared to, say, the rate in the repo market or the Treasury bill
market.
Mr. HOLLINGSWORTH. It is certainly something on our minds, as
well, as we continue to focus on that. Obviously, what we want is
capital mobilized in the real economy to make investments, privatesector investments such that productivity will grow over the long
run so that we can realize those benefits as Solow predicted.
Anything that you wanted to add to that, Dr. Plosser?
Dr. PLOSSER. So I agree with what is been said, but I would like
to go back to the beginning of your statement and remind everybody that one of the dangers that we slipped into during this period—and oftentimes do—is relying on the Fed to be the solution
to all our economic problems. And it is not, and it can’t be.
The real key to economic growth is productivity. Productivity of
the work force—
Mr. HOLLINGSWORTH. Productivity generated by private capital
making investments, continuing to grow the economy.
Dr. PLOSSER. And the Federal Reserve cannot determine that.
Mr. HOLLINGSWORTH. I think that is well said.
Dr. PLOSSER. And I think—well, you said it. I was just reiterating how important I think it is.
Mr. HOLLINGSWORTH. You know what? I like that even better.
And I think the addiction to Federal Reserve intervention, especially as you well said during positive times of economic growth,
continues to endanger their ability to come to any sort of help during periods of great acute stress.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00029
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
24
nshattuck on FSR297 with DISTILLER
Dr. PLOSSER. This is the most interventionist Fed in private markets, even today, than it has been in the last 50 years, at least.
Mr. HOLLINGSWORTH. Thank you, Dr. Plosser. I yield back.
Chairman BARR. The gentleman’s time has expired. The Chair
now recognizes the gentleman from Ohio, Mr. Davidson.
Mr. DAVIDSON. Thank you, Mr. Chairman. And I want to thank
our guests. I really appreciate your testimony here and in writing.
And I have learned a lot from some of your other writings.
So, Dr. Plosser, could you elaborate on some of the real economic
opportunities for American households and businesses should they
benefit from monetary policy framework that drew a brighter line
between accountability for fiscal and monetary policy?
Dr. PLOSSER. Well, I think there are a couple of ways to think
about that. One, it is separating roles and responsibilities and accountability. I think in many cases, households are worried a lot
about what the Fed’s going to do next and what it is going to do
to interest rates. And frankly, I believe the Fed is not as powerful
over interest rates and the real economy as people seem to believe.
If you remember, when the Fed began tapering and stopped buying assets, it was because it was concerned about interest rates,
long-term interest rates were going to rise. They didn’t. They fell
for about a year. So I think that this fixation on the Fed’s ability
to control productivity growth, real wages, lots of other things is
overblown and that we need to scale back those expectations and
look for things that focus on productivity that can make the economy grow. And that is what is going to make the real lives.
The contribution of the Fed is going to be mainly keeping inflation low and stable. Alan Greenspan used to say that is—when inflation becomes a non-issue for people’s lives, then we are doing
OK.
Mr. DAVIDSON. Terrific. One of the things that have made inflation such a constraint thing hasn’t really been monetary policy, but
it has been the strength of the dollar and the power of trade. Some
of those dynamics that have taken place—of course, some of that
has led to challenges to the U.S. as the de facto reserve currency.
Dr. Levin, I was wondering if you could comment on that, as a
future challenge, and what role the central banks—in this case, the
Fed in particular—could play?
Dr. LEVIN. Well, I think that the Federal Reserve is the most important central bank in the world for sure. And it is not just Americans who want to understand better what the Federal Reserve
does. It is true all over the world. Other central banks are also trying to understand what the Fed’s decision is and what its strategy
is.
So I just—I want to come back to this question about strategy
for a second. I think one way to think about this—the purpose of
the legislation you are adopting today is maybe relatively innocuous during normal times. Some of it is specifically directed toward
emergency credit and toward actions that would happen in an
emergency.
Even the benchmarks—I think during normal times it is true
that the—for example, the Federal Reserve barely changed the
Federal funds rate for a number of years in the 1990’s when the
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00030
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
25
nshattuck on FSR297 with DISTILLER
economy was on a steady course. I think the purpose of this legislation is to have it in place the next time around.
What are the contingency plans the Federal Reserve is going to
follow? Those should be clarified in advance. I remember, I was at
the Fed at the time. People referred to it as throwing spaghetti at
the wall to see what sticks. And that is not an appropriate thing
to do. It is important for Congress to understand ahead of time
what the Federal Reserve is going to do in an emergency.
The strategy for monetary policy I think of as a little bit like a
patient who is a child, and you are the patient’s family in some
sense who needs to consult with a team of doctors that you respect
and trust, but you want to consult with them and understand the
strategy that is being followed. The strategy. It has to be one strategy.
And it is absolutely true, the economy has lots of uncertainty.
Someone asked earlier about forecasting. But a good team of doctors are going to say, look, here are some risks, we have to take
seriously those risks. If this materializes, here is the action plan
we are going to take. And so those are the sort of things I think
you are asking the Federal Reserve to start doing.
Again, it is not hawkish or dovish. It is good governance here
and accountability and transparency. It will help the world economy—
Mr. DAVIDSON. Correct. And so I agree. And I think the challenge, when you talk about the Emergency Lending Act, when you
look back, so this was forward-looking. Now, if you say—well, let’s
say there is this accountability and we have to check. What do you
see the implications of a potential reversal with the congressional
accountability to say, you have done emergency lending, we think
that was a bit of an overreach. What do you see as the implications
for that level of accountability?
Dr. LEVIN. OK, so the critical thing, again, just use this analogy
with the patient and the patient’s family and the doctors. Try to
consult ahead of time so that by the time when the operation—
again, I strongly believe you can’t micromanage the Fed. It has to
be able to make decisions on a day-to-day basis. But what the Federal Reserve should be doing is consulting in advance to say if this
happens, we may need to carry out this emergency procedure. And
the patient’s family gives a directive to say, OK, we can live with
that.
So the up-or-down vote that this legislation is proposing hopefully what would not happen is a panic, but what would hopefully
be happening is, oh, OK, the risks are increasing, we need to
launch this emergency facility, and Congress says, yes, you have
been explaining that to us for a number of months or years, and
we are comfortable with your going ahead.
Mr. DAVIDSON. Thank you. My time has expired. I yield back.
Chairman BARR. The gentleman’s time has expired. The Chair
recognizes the gentleman from West Virginia, Mr. Mooney.
Mr. MOONEY. Thank you. My question is primarily aimed at Dr.
Levin. And first, go big green, Dartmouth class of 1993 here. I will
be heading back for my 25th reunion this summer. Maybe I will
see you up there.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00031
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
26
nshattuck on FSR297 with DISTILLER
But you have touched a theme that has been of concern to me
for a while of Congress delegating, giving up, just receding its authority to Federal administrative branches. I see that in a lot of
places, not just with monetary policy. I see it with environmental
policy in my State of West Virginia. I have seen it with—gosh, even
declaring war on foreign countries, going to war in foreign countries. I mean, we are seeing it a lot of places. And I think Congress
needs to reassert itself.
In the written testimony, I want to reference the written testimony from Mr. Bernstein, where he emphasized the importance for
Congress to maintain central bank—for Congress to maintain central bank independence and, quote, efficient functionality, close
quote. So, Dr. Levin, does the draft legislation that you reviewed
for the hearing—do you believe it compromises monetary policy
independence or compromise efficient functionality, as your colleague has expressed a concern about?
Dr. LEVIN. OK, look, there is the broader picture and then there
are the details. Let’s just start with the broader picture. That is
why I started with the exhibit. Basic management principles. The
Congress has to be the boss. The Federal Reserve is not an independent branch of government. It reports to you. And it is absolutely essential for you who are elected officials by the public—I
agree with what Congressman Sherman said before. You are the
ones who are elected by the public to oversee the Federal Reserve.
It cannot be truly absolutely independent. It has to be conditionally, operationally independent.
Now, I think this draft legislation at a fundamental level is consistent with the operational independence. In fact, I think, as Dr.
Plosser said, I think it would strengthen in some ways the operational independence of the Fed.
There are details of some of these things about how many days,
for example, before the congressional approval has to be given,
which exact types of securities under which conditions can be purchased. I hope that—I understand that your committee is going to
be marking up this legislation next week. It seems to me that there
may be some room for consultations and compromises, as you always do. But, again, this seems to me as a matter of good governance and transparency and accountability, and I hope there is a
way forward to enact this.
Mr. MOONEY. OK, thank you. Mr. Chairman, I will yield back.
Give my time back to the Chair.
Chairman BARR. The gentleman yields back. The Chair recognizes the gentleman from North Carolina, Mr. Pittenger.
Mr. PITTENGER. Thank you, Mr. Chairman. And thank each of
you for being with us today. It is an honor to have you join this
committee.
I would like to follow up, if I could, on some of Mr. Williams’
questioning. Mr. Levy, if you could just expand further on what you
believe to be the economic risks that are created by maintaining a
balance sheet of the current size?
Dr. LEVY. There is economic and interest rate risk, and there is
also political risk. As far as the economic risks go, the Fed at its
peak remitted about $115 billion, I think in Fiscal Year 2015. Now
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00032
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
27
nshattuck on FSR297 with DISTILLER
it is remitting about $85 billion. It is paying IOER, and bond yields
have come down some.
This crosses the monetary boundary of policy into fiscal policy.
If it sounds OK because it reduces the budget deficit, but that is
temporary, and it is very risky, because as I noted, if interest rates
rise by 1 percent, which is very consistent with the Fed’s expectation that rates are going to rise, and inflation is going to go to 2
percent, then that is going to add $1.6 trillion to the deficits. And
so that is a risk.
The other risk is political. And that is it is too easy for Congress
to look at this as risk-free money and to spend it, and to look at
the Fed as a source of risk-free money. And doesn’t this jeopardize
the independence of the Fed? And Dr. Plosser pointed out that in
December 2015, the Fed—in order to pass the FAST Act, the Congress actually borrowed some of the—took some of the Fed’s assets.
And this is just inappropriate. It is an inappropriate use of monetary policy.
And so the Fed by doing what it is doing has these political and
economic risks. And it is kind of egging on the Congress to take
advantage of it in bad ways.
Dr. PLOSSER. Excuse me, can I—
Mr. PITTENGER. Please, Dr. Plosser.
Dr. PLOSSER. —elaborate a little bit as an example? The danger
is—with the last time I testified here last year one time, I got
asked, well, why shouldn’t the Fed fund our infrastructure projects
by blowing up their balance sheet some more? There is a real problem in many central banks around the world with exactly that.
The Bank of Switzerland, for example, has a very large balance
sheet. It is mostly made up of foreign reserves, currency reserves.
They are in a deep political battle because some parties within
Switzerland want to use that balance sheet to invest in green energy, Swiss companies, other types of activities in the name of diversifying the Swiss National Bank’s balance sheet.
If the Fed maintains a large balance sheet that is not tied to
monetary policy, the use of that balance sheet can—the temptation
to use that for other purposes is going to be great. And I think the
idea of shrinking the balance sheet and tying it to monetary policy
will constrain that activity and actually protect the Fed from
abuses and prevent it from undertaking its own abuses of its balance sheet.
Mr. PITTENGER. Yes, as a follow up, would you say, then, that it
is time for the Federal Reserve to get out of the business of engaging in credit policy?
Dr. LEVY. Yes. The Fed should set out a strategy to wind down
its MBS holdings. There is no reason at all for the Fed to hold
MBS, unless in an emergency situation. And it can do so over, say,
a 5-year period through passively unwinding the portfolio in order
to give the mortgage market time to adjust. It need not sell any
to do that.
Dr. BERNSTEIN. Can I make a quick comment, if that is OK?
Mr. PITTENGER. You can.
Dr. BERNSTEIN. Any time the Federal Reserve engages in monetary policy, it is raising or lowering interest rates, and that is credit policy. So I am not sure I understand this distinction at all.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00033
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
28
nshattuck on FSR297 with DISTILLER
Chairman BARR. The time is—I am sorry.
Mr. PITTENGER. Quickly.
Chairman BARR. Quick answer. The time of the gentleman has
expired. So quick answer.
Dr. LEVY. OK. The quick answer is the Fed by holding MBS securities is specifically biasing the mortgage market at the expense
of other credit markets.
Mr. PITTENGER. Thank you. My time is expired.
Chairman BARR. The gentleman yields back. The Chair now recognizes the Chairman of the Capital Markets Subcommittee, the
gentleman from Michigan, Mr. Huizenga.
Mr. HUIZENGA. Thank you so much. Sorry, I was a bit late earlier. I was—actually had a couple of bills on the floor that we were
moving forward with. And those duties kept me there.
Before I launch into it, I thought it was interesting, the Ranking
Member submitting a statement from Better Markets rebutting
themselves, basically a situation where they believe found themselves inadvertently supporting us and what we are doing. And
heaven forbid. We wouldn’t want to actually come to consensus and
move forward on something.
So whether it is Warren-Vitter or Barr-Moore, I don’t care. Whatever the title and label might be, let’s get some of these things done
that have broad, wide consensus, and not be political about it. So
off of my soapbox on that.
Dr. Levy, just want to touch base. Obviously, you watch financial
markets around the world and on a regular basis and see the real
effects, how monetary policy increases those spreads and decreases
economic growth. You have talked about this in the past, and I am
curious if you could just comment how important it is for this legislation to sustain or even improve upon the stronger economic data,
which we have seen over the last couple of quarters.
Dr. LEVY. I think by normalizing monetary policy it would take
away the monetary crutch from the economy and financial markets. It would not harm the economy, and it would lead financial
markets to be much healthier. The other point I would add is by—
and here I just applaud what Dr. Levin has emphasized—if the Fed
actually had a single, understandable, and cogent strategy, it
would certainly make it easier for the Fed to convey that message.
It would build confidence.
And once again, the proper role of the Fed, we have seen it go
far beyond its scope. Its discretionary policy has created uncertainty. And I would really like to see more of a strategic approach
that lays that foundation for the economy to grow at a healthy
rate. And financial markets adjust.
Mr. HUIZENGA. I think many of us are looking forward to just the
strategy as you just laid out. Dr. Plosser, good to see you again.
And I want to talk a little bit about your article you wrote for the
Hoover Institute entitled ‘‘Why the Fed Should Only Own Treasuries.’’ And that article, I want to quote you, if that is all right.
‘‘History teaches us unless governments are constrained constitutionally or by statute, they often resort to the ‘printing press’ to
avoid making tough fiscal decisions. But in a democracy, independence must come with limitations on the central bank’s authorities
and discretionary powers. Otherwise, central bankers can use their
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00034
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
29
nshattuck on FSR297 with DISTILLER
powers to venture into policy realms unrelated to monetary policy,
especially fiscal policy, which more appropriately rests with elected
officials.’’
And as you know, obviously those Fed balance sheets not only increased in size during the financial crisis, they added large quantities of non-Treasury securities, I think as you put it. Your article
highlights that the more troubling loans under Section 13(3) that,
quote, ‘‘amounted to debt-financed fiscal policy without the explicit
authorization of Congress.’’
So, Dr. Plosser, in your opinion, what are the downside risks of
blurring these lines of accountability for monetary policy and fiscal
policies?
Dr. PLOSSER. Well, I think as we have been talking off and on
this afternoon, it is that blurring that is dangerous. Because what
that does is confuses both in the eyes of the fiscal authorities and
the monetary authorities and the public who is responsible for
what. And who do we hold accountable for what?
And when you put taxpayer money at risk and you buy portfolios
of private assets on the banks’ part, you are, in fact, putting taxpayer money at risk. And you are investing in whatever it happens
to be, MBS mortgage portfolios or whatever happened to be on the
balance sheet that the Fed chose to buy, you are taking fiscal actions.
Mr. HUIZENGA. Is your concern sort of a winners versus losers?
And these governments kind of picking it? Or just in general, and
I am a huge fan of the Swiss normally, but I hope that they don’t
head in the direction that you described.
Dr. PLOSSER. Well, they are getting pressure to head in that direction. That is absolutely true.
Mr. HUIZENGA. Yes, and we have had that. And the downside of
that seems—we are allowing a central bank to venture into some
waters that it just has no business going. Is that your opinion?
Dr. PLOSSER. Yes, it is. And it is a bit of a slippery slope, because
it is very tempting on the part of both parties to let that—but then
it is—again, it is hard to hold the Fed to make it transparent and
to hold it accountable for the kind of things that you actually want
them to be focused on. And the same thing for the fiscal authorities, by the way.
Mr. HUIZENGA. Thank you. Thank you, Mr. Chairman.
Chairman BARR. The gentleman’s time has expired. And the
members have requested a brief second round of questions, if the
witnesses will indulge us with their considerable expertise. This
has been a lively discussion. We appreciate your expertise so much
that members would like to ask you a second round of questions.
So I will start that second round by yielding myself an additional
5 minutes. Picking up where Chairman Huizenga was going right
there, on the downside risk of blurring the lines of accountability
for monetary and fiscal policies, Dr. Plosser, let’s talk about the
legislation that is before you right now. And the Independence from
Credit Policy Act, which is one of the three bills there, how well
does that legislation help the Fed avoid that downside risk of blurring the lines of accountability between monetary policy and fiscal
policy?
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00035
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
30
nshattuck on FSR297 with DISTILLER
Dr. PLOSSER. This is a topic I have been talking about actually
since 2009, was when I first raised this question and asked for a
new accord. And the problem is that what I see in the legislation
and what I have advocated in the past has been this idea that,
look, 13(3) had never been used since the Great Depression. It is
not something you are going to rely on very frequently.
But my view is that it shouldn’t be the authority of the Fed to
lend money for the purchase of Bear Stearns and buy assets, private-sector assets. That belongs to the fiscal authorities. And so I
actually think that the treasury secretary needs to instruct the Fed
to carry out such an action. Maybe it was all decided in consultation with the Fed and other regulators about what needed to be
done. But it needs to instruct the Fed so that this is not—the Fed
can’t take this on its own.
Chairman BARR. And, Dr. Plosser, is it an appropriate solution
to require the swap of Treasuries for mortgage-backed securities?
Dr. PLOSSER. The Fed is the fiscal agent in many cases for the
government, in most cases it is, and so it is appropriate for the
Treasury to instruct the Fed to do something on behalf of the government as their fiscal agent, but then to keep the Fed whole, you
would engage in a swap of those private-sector securities for Treasuries, and then the Fed is back to where it was before, and it is
not responsible for that. It is in the Treasury that makes it—
Chairman BARR. So the fiscal responsibilities remain with Treasury.
Dr. PLOSSER. Exactly.
Chairman BARR. The agency responsibilities, the monetary policy
responsibilities remain at the Fed. Let me also allow you to respond to the typical criticism of Fed reform initiatives, and that is
that when Congress intervenes in this way and proposes reform,
that, in fact, Congress is compromising the independence of the
Fed. Could you elaborate on your argument that no, in fact, this
legislation preserves the independence of the Fed?
Dr. PLOSSER. So that is exactly right. I think it helps the Fed,
because what it does is when Congress, for example, comes to the
Fed and say, we want you to pay for part of this transportation bill
or infrastructure bill or what have you, would you buy some municipal bonds or something from—to help bail them out, the Fed has
a basis for saying no, that is not in our purview.
Chairman BARR. OK, so now, Dr. Bernstein and Dr. Levy had an
exchange there. Dr. Bernstein made the point that productivity levels are not the result of unconventional Fed policy or discretionary
Fed policy. Dr. Levy—perhaps productivity—low productivity is a
function of a lot of things other than monetary policy. I think there
is an agreement on the panel that that is the case.
But could you address the issue of what unconventional monetary policy does to impede maximum economic outcomes?
Dr. LEVY. OK, so unconventional monetary policies during emergencies don’t impede. During normal periods, they distort financial
markets by keeping rates too low, having excess liquidity in the
economy, and this leads to a misallocation of resources.
But I would say as long as inflation stays low, it doesn’t have a
significant depressing impact on productivity. Productivity is a
function of a whole host of other issues. I would say there is the
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00036
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
31
nshattuck on FSR297 with DISTILLER
long-run risk of being excessively easy. It catches up with you, and
it could lead to undesired increases in inflation and interest rates.
Chairman BARR. And so what I have heard here today from the
witnesses is that the principal contribution that monetary policy
can make—however limited that contribution can be—is primarily
that it can provide—it transmits price signals, clear price signals
to actors in the private economy, which in turn can provide a level
of certainty for households, investors, and small businesses.
Dr. LEVY. Yes.
Chairman BARR. And I think that is what we are trying to get
at with the strategy-based monetary policy. My time is expired on
my second round. And I would like to now recognize the Ranking
Member for an additional 5 minutes.
Ms. MOORE. Thank you so much. Let me just open up by asking
Dr. Levin a question. You are a former staffer at the Federal Reserve, so I think what you might have to tell us is very instructive.
You attached to your written testimony a paper that you coauthored with several other people stressing the importance of diversity at the Federal Reserve. What was the essence of that, just very
briefly? Why do you think that that is important? And what were
you talking about in terms of diversity?
Dr. LEVIN. OK, well, there are a couple of dimensions of this that
are important. Jordan Haedtler, who is one of the coauthors, is actually sitting here. Valerie Wilson, from Economic Policy Institute,
was the other coauthor. The three of us wrote this together.
But let me just give you a couple of kind of key points. First, as
I said in my statement, the Fed is America’s central bank. It serves
the whole public. Its decisions affect everyone. So there is a kind
of chain of accountability here. The Federal Reserve reports to Congress. But the Federal Reserve serves the public.
And so it is critical for the Congress to ensure that the Federal
Reserve is serving the public as well as possible. A key part of our
report is that the regional Federal Reserve banks are legally private institutions. Now, it was set up that way for good reasons in
1913, but you should understand that as of today, the Federal Reserve is the only major central bank in the entire world, the only
one, that has such a significant private component to it. And so I
think it is important for Congress over time to revisit this issue.
One possibility is to appoint a centennial commission, some people have raised this idea, and that could be, I think, a bipartisan
initiative to say that we need to reconsider this. Some of the rationale for what the Fed did 100 years ago, it was banker to the banks.
That was its primary role.
Ms. MOORE. OK. Thank you. That is very helpful.
Dr. LEVIN. Yes, OK.
Ms. MOORE. Dr. Bernstein, outgoing Fed Chair Yellen has shared
with us many times that she thinks—she believes that inequality
is very dangerous. And so as I have thought about the testimony
here today and an assessment and evaluation of what the Fed did
do or didn’t do, one of the things I know is our dual mandate to
look out for those who are unemployed.
Can you share with us whether or not you think some of these
analyses are the way they are because there is sort of not a def-
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00037
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
32
nshattuck on FSR297 with DISTILLER
erence to that other dual mandate? And what is your view on inequality and the danger to our role?
Dr. BERNSTEIN. Well, I am glad you raised that, because I think
that those kinds of concerns have been really conspicuously absent
from this discussion so far. And it is a glaring absence.
So much of the discussion has focused on credit markets, on how
the financial sector is doing, on messages and signals and certainty
to the financial markets. That is all critically important, no question. But, in fact, if you look at the sector the economy that has
really been doing great in recent years, it is precisely that side. The
share of national income going to profitability, the equity prices of
the financial markets have been extremely strong.
Where we have problems—even at 4.1 percent unemployment—
is pockets of weakness in labor demand, pockets of severe weakness in income growth. And it is that reason that the Federal Reserve has engaged in lots of the initiatives that have taken a hit
here today from my colleagues, because interest rates are stuck at
zero, the Federal funds rate has been stuck at zero, and so they
needed to engage in other techniques in order to try to further
stimulate the economy to reach those who have been left behind.
If you listen to Janet Yellen talking about either this problem,
the employment side of the mandate, or inequality, you will very
clearly hear those concerns. And so we have to acknowledge that
there are a lot of people who are missing in this room today from
this discussion, and they are the people who are helped most by
the employment side of the dual mandate. It has been a critical
omission, I think, for much of our discussion.
Ms. MOORE. Anybody dying to say anything up there?
Dr. LEVIN. Well, I just want to reinforce what you said about diversity. It is critical for the members of the FOMC and the Federal
Reserve Board, but all the regional Fed presidents, to have geographical diversity. That is why it was created as a regional system. That is really important. They need professional diversity,
background, different educational backgrounds. It is great to have
a Congressman—
Ms. MOORE. You need any black people on the—
Dr. LEVIN. Absolutely. Of course.
Ms. MOORE. OK, OK. My time is expired.
Chairman BARR. The gentlelady’s time has expired. The Chair
recognizes the gentleman from Texas, Mr. Williams.
Mr. WILLIAMS. Thank you, Mr. Chairman and Mr. Levin. The
FOMC proposal before this body today seeks to increase transparency and make clear the way that the FOMC makes its decision. In your testimony, you discussed the fact that the Fed’s monetary policy strategy is not well understood.
So in what ways does the current communication policy keep the
boss or Congress, as you say in your testimony, well informed
about the FOMC strategy?
Dr. LEVIN. OK, so, first of all, the draft legislation requires that
the Federal Reserve have a clear strategy. That would already be
a significant step forward. The legislation requires that the strategy should be—identify a specific policy instrument, which could be
the Federal funds rate, it could be the repo offer rate. It might be
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00038
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
33
nshattuck on FSR297 with DISTILLER
something else over time. OK. It identifies a specific policy tool that
it is going to use, identify specific indicators.
Now, as Jared said, and I agree with him on much of this, there
were times in the past 5 years the unemployment rate was not a
very sufficient indicator of the labor market. President Trump has
emphasized that himself, that there are broader measures of unemployment. Jared has emphasized in his writings—we call it U–6—
you know, that includes involuntary participation and people on
the sidelines.
So, again the Federal Reserve needs to have a clear strategy or
explain to the public how it is responding to these indicators. It
should be a small number, simple, clear indication.
Again, I want to come back to the analogy about the patient. A
child, I have a 9-year-old son, so this is—it hits home for me. When
the patient is sick and you go to a team of doctors, it is a difficult
illness. You want a clear strategy, and you want—the doctors have
to consult with the patient’s family. Everyone understands that.
And we are talking here—as Ranking Member Moore said, we
are talking—and Jared said—this affects all Americans, in the
inner city, it affects small businesses, it affects large corporations,
it affects people in other countries, too. And so it is really critical
here that this team of doctors on the FOMC has a clear strategy
that the public, the Congress, financial markets, small-business
people, everyone can understand that strategy and the debate
about it.
I am totally in favor of second-guessing, by the way. I secondguess the Fed myself. But if you don’t have a clear strategy, then
you can’t debate about it. And it needs to be a public debate about
what the Federal Reserve is doing.
Mr. WILLIAMS. OK, well, let me ask you this. If the Fed takes
a data-driven approach to monetary policy, as they have said they
do, does it follow that allowing a clear picture in predicting future
policy direction will be beneficial to investors and the economy as
a whole?
Dr. LEVIN. Yes. And again, during normal times, this may not be
so complex. There may be periods when the Federal Reserve’s policy rate is more or less normal and more or less stays within a narrow range over a period of time. What we are really talking about
here with strategy is times when things are not normal. How is the
Federal Reserve going to respond to that?
I keep coming back here to contingency planning, because, again,
this is a good business principle for a nonprofit organization, too,
to be thinking about, what might go wrong? And how will the Federal Reserve respond to that? I call it stress tests for monetary policy. You are the boss. You should be asking the Federal Reserve,
if we have a recession next year or 2 years from now or 5 years
from now, what are the Fed’s plans? How will it respond? Is it
going to do more QE? Is it going to go to negative interest rates?
These are critical to the whole American public and to the global
economy. You are the boss. You have to get clear answers from the
Federal Reserve on these issues.
Mr. WILLIAMS. OK, Mr. Chairman, I yield my time back. Thank
you.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00039
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
34
nshattuck on FSR297 with DISTILLER
Chairman BARR. The gentleman yields back. The Chair recognizes the gentleman from Arkansas, Mr. Hill, for another 5 minutes.
Mr. HILL. Well, I have enjoyed this discussion. Of course, when
you are with the deliberative body of second-guessers, we can relate to your comment. We are experts at it.
But one of the biggest impacts of the last 10 years of Federal Reserve policy is skewing benefits to the carry trade and to stock
market investors and 401(k) investors and driving down interest
rates on real estate to, I would assume, non-economic type levels.
So there has been a lot of beneficiaries.
And I agree that they really have not reached a lot of the working people, because we have not seen wage growth or productivity
growth, to Dr. Levy’s comment about aggregate demand has not reacted to this 10 years of extraordinary stimulus, unseen in history.
I mean, we are—we have never seen lax monetary accommodation
like we have seen now.
I want to switch bills for a minute, Mr. Chairman, and talk a bit
about the emergency lending proposal that is before us. And of
course, the theme that we had both in the Choice Act and here is
well-collateralized loans not to insolvent entities at a penalty interest rate and at a short-term duration, but this bill limits that to
financial institutions, supervised by the Fed, for example. I would
be curious of the panel’s view. Is that too narrow? Should 13(3) be
limited only to commercial banking institutions or their holding
companies, to be specific?
I would just like a view from all four of you. Dr. Plosser?
Dr. PLOSSER. I think that is a bit of a difficult question. And I
do think that if you accept the notion, as the Fed has argued, that
there are a lot of non-banks, for example, who are involved in financial markets heavily. And so-called shadow banking system,
how far do you extend this safety net?
The problem is, I think, is—if it is a safety—the Bagehot’s rule
for—Walter Bagehot rule for emergency lending was, as you said,
lend freely at a penalty rate to solvent institutions. So now what
we really are talking about is, do you want the Fed lending to insolvent institutions? And if so, what is the reason for that? And
what is the rationale for that?
That is not what lender of last resort means. So I think we have
to be careful about how we do structure this.
Mr. HILL. Well, I would just—the bill before us, though, is—the
borrower is affirming the borrower is not insolvent. So, I mean, the
real question I have is, should 13(3) be extended to a non-banking
entity?
Dr. PLOSSER. I guess, if I had to—given the way it is structured,
I would say no. I don’t think it is necessary.
Mr. HILL. Thank you. Dr. Levin?
Dr. LEVIN. Well, I just want to reiterate something that Dr.
Bernstein said, which is most other central banks around the world
do have broad authority in an emergency of what kinds of actions
they can take. And it is not just about lender of last resort, and
it is not just about too-big-to-fail.
What is the most important thing the central bank does? Is to
keep a stable unit of account. We call it price stability. That is part
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00040
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
35
nshattuck on FSR297 with DISTILLER
of the Fed’s mandate, OK? That is the single critical thing. And in
a really severe short, like we had in the Great Recession, or even
going back to the Great Depression, we didn’t have price stability
in the Great Depression. Prices fell 25–30 percent.
So it is critical for the central bank to have enough tools so that
when there is that kind of shock that it can make sure that the
price level comes back to a stable level. So, again, I think there is
a case for a centennial commission that would think carefully about
what can we learn from history, what can we learn from other central banks, what can we learn from what worked and didn’t work
in the past recession? Frankly, I think the Fed itself needs to do
more lessons learned and come back to you. You are the boss. And
help think through—we want to be prepared for the next crisis.
Mr. HILL. I agree. Let me hear—
Dr. BERNSTEIN. I can be very brief. I can be very brief.
Mr. HILL. —from Dr. Bernstein and Dr. Levy.
Dr. BERNSTEIN. Yes, I think that is too restrictive. And I think
the Fed needs to be able to lend beyond services—may well need
to lend beyond financial services in emergency because we just
don’t know the sector from which the next emergency will hail—
Mr. HILL. Thank you, Dr. Bernstein.
Dr. BERNSTEIN. —much as Andy suggested. One quick thing. I
would encourage you to read what I wrote in my testimony about
the penalty rate. I actually think the penalty rate in this proposal
is less well thought through than the one in the Warren-Vitter proposal.
Mr. HILL. Thank you. Quickly, Dr. Levy?
Dr. LEVY. No further comment.
Mr. HILL. OK, thank you very much. I yield back, Mr. Chairman.
Chairman BARR. Gentleman yields back. Chair recognizes the
gentleman from Ohio, Mr. Davidson.
Mr. DAVIDSON. Thank you, Mr. Chairman. Thank you all for taking additional questions.
As we talk about second-guessing, I guess that is part of the
whole point of this approval process or validation that Congress
agrees with what the Fed has done in this emergency lending authority. And, Dr. Levy, I was just curious if you could comment on
how the market might react to this period. If this becomes law, we
know that it is sort of a conditional action, so it should be extraordinary. There are a lot of safeguards. It is a very high threshold
that the Fed would go through to give approval. But once they do,
how do you feel the market would react in this period before it is
validated? And then what if Congress does say, no, we are not
going to give our consent to that? Because it requires positive action.
The asset would presumably be worth even less. How do you see
the market reacting to that?
Dr. LEVY. I can only have two comments in response to your
question. And one is, what is the source and character of the crisis?
And I would just note the next crisis is likely to be unlike the prior
one.
And the second point I would make is, the markets are going to
move in response to the crisis. They are not going to wait around
for the Fed and the Congress to respond. It will, of course, respond
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00041
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
36
nshattuck on FSR297 with DISTILLER
to whatever the Fed does, but the markets are going to—they sense
things. They are going to front run whatever you—they are going
to be way out in front of you.
Mr. DAVIDSON. Well, there will probably be indicators of what
they expect Congress will react to, the new dynamic.
Dr. LEVY. Well, wait, let me qualify what I just said. The markets would take comfort if they perceived that you had thought
through logical strategies in response to different types of crises.
The markets would certainly take comfort in that. And also, I think
communications about what you are going to do are critically important.
Mr. DAVIDSON. So I thank you for that. And, Dr. Levin, you commented a little bit about the desired goal of something clear in advance. But here it is retroactive. It is second-guessing something
that has been done by the Fed. And so, Dr. Plosser, I am curious
your thoughts, in terms of you are 25 days past, and the country
can sense Congress isn’t going to take action, isn’t going to validate
that. Is the timeframe important? Is it 30 days? Is it 6 months?
Does it have to be paid back within 30 days? How important is this
to the market function?
Dr. PLOSSER. So let me start by pointing out that one of the values of doing this is that you set out a process about, if such and
such happens, this is what we are going to do. These are the steps
that are going to be followed. That is known in advance, all right?
So markets will build in to their own assessments—it is like a
bankruptcy law. A bankruptcy law says if a firm goes insolvent, all
debt is put into a holding pattern until you can sort through the
assets and liabilities and figure out who gets paid. That is the law.
So pricing of those assets in advance understands that step.
Well, this is kind of the same idea. Here is what is going to happen, so you—by laying it out in advance what the rules of the game
are going to be, markets will price that, in effect, well before the
event actually happens. So that is going to make it less stressful
than it might otherwise be if this came as a surprise of some kind.
The second step, as you were getting to, well, how long should
this holding period be on assets, until Congress decides? Well,
again, I think that knowing this process in advance—and there is
a lot in the bill about how Congress is expected to behave and how
quickly they are supposed to make a decision on this, I think all
of that is going to be filtered in, and the markets will make an assessment whether they think this is a good case for a rescue or not.
And it is going to make the hurdle rate for the secretary of treasury to back the Fed in doing this. If he doesn’t think he can—if it
is not a good case and he is not going to be able to make the case
to Congress, then it might not happen.
But these rescues shouldn’t be made easy. They are not—you
don’t want to encourage them and make them so easy that it just
happens. So I think, yes, it is not perfect, but I think as long as
you lay out the process, things will work as we think they should.
That is all.
Mr. DAVIDSON. It is a good principle. Thank you, and my time
is expired.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00042
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
37
nshattuck on FSR297 with DISTILLER
Chairman BARR. Time is expired. The Chair now recognized for
our final 5 minutes of questioning the gentleman from Indiana, Mr.
Hollingsworth.
Mr. HOLLINGSWORTH. Best for last here. You know, one of the
things that fascinates me about economics generally, something
you guys know far more about than I do, is just kind of its reflexive
nature. And one of the things I really worry about, right—it has
been a long time since I took Econ 101, but permanent income hypothesis, right, and the idea that we are working down somebody’s
curve in their preferences for consumption today versus saving for
consumption later. But with the extended period of time with
which we have undertaken these extraordinary measures, whether
instead of working down that curve, we are bending that curve and
permanently distorting their impression and their tradeoffs between present and future, and it will be difficult for us to either
work that curve again or bend that curve back, such that monetary
policy in the future might have meaningful impacts in the short
run, at least.
And I wonder kind of what your, Dr. Levy and Dr. Plosser, view
on that is and whether we are, indeed, beginning to shape, permanently alter or misshape expectations for the future?
Dr. LEVY. I think yours is a very valuable observation. And I
would just bring out something that I am very concerned about,
and that is the Fed’s policies—and it has had the Federal funds
rate below inflation now ever since 2008—and its massive balance
sheet, people who have come to believe that this is normal. And
when I say people: Households, businesses, savers, and financial
markets.
And that potentially raises the costs of exiting and going back to
normal. I would say so far the Fed has been lucky. And I would
argue also that the Fed has been able to be leisurely in its exit because its policies to stimulate aggregate demand haven’t worked.
So I am very concerned about your point that this—we perceive
current policy as normal. It is absolutely not.
Mr. HOLLINGSWORTH. Right. Dr. Plosser?
Dr. PLOSSER. So I agree with what Dr. Levy just said. I think the
other thing is to recognize that during this period there has been
this huge conflict in public policy. There is the Fed trying to cut
interest rates to zero to encourage people to spend, spend, spend
today, don’t save, don’t save, spend. And then there is the pressure
on banks to not lend, not lend, not lend, unless you are really certain.
So we are trying to—we are tugging at each other in ways that
are—it is confusing, I think, to the general public in terms of, how
are they supposed to respond to all this?
Mr. HOLLINGSWORTH. Right, right.
Dr. PLOSSER. And you are telling the banks not to lend and build
capital, and telling the public, no, no, no, borrow all the money you
can. And I think that that tension is reflected in part—what you
are saying is, are changing people’s behavior about their preferences for borrowing—spending today versus spending tomorrow?
And since we wiped out a whole bunch of wealth in the housing
crisis, now what do households typically want to do? They don’t
want to spend. They need to rebuild their wealth.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00043
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
38
nshattuck on FSR297 with DISTILLER
And so there are all these sort of conflicts that are going on that
have, I think, been not very helpful at the bottom line.
Mr. HOLLINGSWORTH. And, Dr. Levy, something you have talked
about a few times and I just wanted to bring back that point—look,
we talk about the philosophy behind whether the Fed should be involved in such activities that add to such huge amounts to the
Treasury, but also how those seemingly large amounts might pale
in comparison to the potential losses, should interest rates begin to
rise and accelerate steadily. And so an old adage someone once told
me was be careful picking up pennies in front of a freight train.
Even if you get it right a dozen times in a row, you don’t want to
be wrong once. And I think that your point about that several
times is ringing true in my mind.
And, Dr. Levin, something I wanted to bring up and just talk a
little bit about. You have pushed hard for transparency and pushed
hard for a cogent strategy. And one of the things that is challenging about this, right, is knowing what success looks like, because everybody has a different vision of what is success. What is
full employment, right? 4.1 percent seems like full employment, but
you look at U–6, you look at wage growth, and maybe we aren’t
really at full employment. All of these things.
So to me, that harkens back to the need for a cogent strategy and
transparency about how we will work these variables into something, right, whether that is a Taylor rule, whether it is some discretion around the Taylor rule, just some understanding of these
are the things we consider important and these things moving in
these directions will give us indications, but not a clearly defined
‘‘end goal,’’ if you will, since we will never be able to measure what
success really looks like.
Is that something that you would endorse theoretically?
Dr. LEVIN. Yes, and I would just underscore something I think
Dr. Plosser said earlier. The Fed’s job is not fine-tuning the last
tenth of a point on the unemployment rate or the inflation rate.
But it has a crucial job. And I think part of the balancing you are
talking about is the risk management.
Again, like a team of doctors, to explain and say we have a
bunch of diagnostic tests, but they are a little bit hard to read here.
This is an unusual case. And so we are going to be keeping a close
eye on the patient. And if this indicator goes up any further, we
are going to have to take some action. Those are the sort of clear
strategies I think your draft legislation is exactly looking for the
Fed to start doing.
Mr. HOLLINGSWORTH. Perfect. Thank you, Mr. Chairman. And I
yield back.
Chairman BARR. Thank you. The Chair yields back. And I would
like to thank all of our witnesses for your illuminating testimony
here today. And, Dr. Levin, appropriate that we leave the hearing
with another reference to the excellent analogy of the patient and
the family. And for laying the foundation for a strategy-based monetary policy that can help lift our economy.
With that, without objection, all members will have 5 legislative
days within which to submit additional written questions for the
witnesses to the Chair, which will be forwarded to the witness for
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00044
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
39
nshattuck on FSR297 with DISTILLER
their response. And I ask our witnesses to please respond as
promptly as you are able.
This hearing is now adjourned.
[Whereupon, at 4:27 p.m., the subcommittee was adjourned.]
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00045
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00046
Fmt 6633
Sfmt 6633
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
APPENDIX
November 7, 2017
nshattuck on FSR297 with DISTILLER
(41)
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00047
Fmt 6601
Sfmt 6601
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
42
Center on
820 First Street NE, Suite 510
Washington, DC 20002
Budget
and Policy
Priorities
Tel: 202-408~1080
Fax: 202-408-1056
center@cbpp.org
www.cbpp.org
November 7, 2017
Testimony of Jared Bernstein, Senior Fellow,
Before the House Committee on Financial Services:
Subcommittee on Monetary Policy and Trade
Chairman Barr, ranking member Moore and members of the Committee, thank you for holding
this hearing on the transparency, bond purchases, and lending policy of the Federal Reserve in
pcrjods of economic stress. As was the case when I testified before this committee a few months
ago, I return with a similar message: the independence of the central bank is an essential ingredient
to its timely, efficient, and effective functioning. Of course, that independence exists within the legal
context set forth by Congress, and, especially as the economy and markets evolv-e, it is not only
appropriate, but essential, for this committee to continuously revisit this context. But in doing so,
maintaining the central bank's independence and efficient functionality n1ust always be an elevated
consideration.
The bills under discussion today seek to alter the context within which the Fed operates by
constraining some aspect of its operations, specifically emergency lending and bond purchases~ and
by adding reporting/ transparency requirements. I find some of tbe ideas to be worthy of
consideration, but some are too rest11ctive, threaten the Fed's independence, and add unnecessary
and potentially damaging process requirements that could potentially do more harm than good to
the US and even the global economy.
Economic policy always invokes tradeoffs, in this case between the central bank's independence
and ability to act quickly in emergencies on the one side, and its accountability and contributions to
potential moral hazards on the other. Getting the balance right is more art than science, but a good
place to start weighing the tradeoffs is to briefly consider recent Fed perfomunce.
What is Congress Trying to Fix with these Proposals?
The American political system exists in a difficult moment. The word Hdysfunction" i5 often heard
in description of our current situation and I suspect members of this committee would at least
partially agree with that characterization. Members would also agree that partisanship is at a very
high level and creates a tall barrier to working together to enact the nation's business.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00048
Fmt 6601
Sfmt 6601
Insert offset folio 1 here 30775.001
nshattuck on FSR297 with DISTILLER
Amidst these challenging times, the Federal Reserve is one institution that has been highly
effective in carrying out its mission. 1bough the Fed failed to identify the housing bubble or forecast
the crisis when the bubble burst, it quickly moved into emergency mode. The bank deployed its
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
43
That said, some of the Fed's actions dudng the recession, particularly its invocation of the rarely
used section 13(3) in its charter (the part that allows the Fed to engage in emergency lending), raised
legitimate concerns about the creation of moral hazard. Also, even if we agree that the Fed
performed well in the last cdsis and recovery, we cannot know how future Feds would respond. I
turn to these concerns next.
Proposal: "Congressional Accountability for Emergency Lending Programs
Act"
The motivation for this proposal appears in large part to be to reduce the moral hazard invoked
when the Fed provides emergency liquidity to illiquid financial institutions ("moral hazard" occurs
when an economic entity-a person or an institution-is protected against a dsk such that it has an
incentive to ignore the consequences of its risky actions). The proposal intends not to eliminate the
Fed's lending authority, but to significantly raise the procedural bar to its implementation. Though I
recognize the motivation for the proposal, I see two major drawbacks. First, since the crisis,
Congress legislated the Dodd-Frank financial reforms, key sections of which were designed
specifically to reduce the need for Fed intervention in this space. Some of these measures remain
untested (others appear to be working and are keeping the financial system safer than it was), but I
sec no reason to add new complexities into this system until we give the Dodd-Frank measures a
chance. Second, and this is a profound concern with the proposal, it takes the authority for
emergency lending outside of the Fed and requires both chambers of Congress to provide a timely
(30-day) approval of the Fed's emergency loans. I believe tlus adds unnecessary risk to credit
markets and the broader economy.
The proposal increases the minimum number of Fed officials who must authorize an emergency
lending intervention from five members of the Board of Governors to eight members of the
FO.I\fC. It introduces numerous new rules regarding the types of secudties the Fed can accept from
loan recipients, how the Fed determines the sutTiciency of collateral, it specifies how the Fed must
construct a penalty rate at which to lend from its emergency facilities, and vadous other technical
requirements.
Some of these ideas warrant consideration, e.g., raising the minimum member requirement, while
others may be ill-advised. The penalty rate is specified as the sum of an average of a disconnt rate
across all Fed banks and the average spread between distressed corporate debt and a yet-to-bedetermined bond index. This is a highly opaque construct that may or may not serve the purpose of
the penalty rate, which is to charge a premium above market rates to (a) avoid crowding out private
lending, and (b) penalize lenders that systemically underpriced risk. The prescribed formula could
return an overly punitive rate that would potentially undennine the Fed's lender of last resort
function. For example, it is not hard to imagine a cdsis that "blew out" corporate spreads, which,
according to the proposal, would have to be embedded in the penalty rate. Thus, here again, the
proposal mistakenly takes decisions outside of the Fed at risk to the nations credit system at a time
of great stress. Moreover, I am not aware of compelling evidence that the Fed underpriced their
penalty rate in the recent cdsis, so tlus is another example of 'don't fix what isn't broken.'
But my main concern about this proposal is the establishment of procedures for Congressional
approval of emergency credit. This is a sharp departure from the lending authodty established in
section 13(3) of the Fed's charter, one that undermines both the independence of the institution and
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00049
Fmt 6601
Sfmt 6601
Insert offset folio 2 here 30775.002
nshattuck on FSR297 with DISTILLER
3
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
44
significant weaponry against the downturn, including its iirst line of defense-reductions of the
policy rate and emergency lending-and later, when the policy rate got stuck at its lower bound of
zero, it turned to alternative forms of monetary stimulus. TI1ese included "forward guidance"communicating its "lower-for-longer" plans to market participants-"quantitative easing," and
"Operation Twist." Respectively, these largely involved the purchasing of longer-term securities,
including Treasuries and GSE mortgage-backed securities, and extending the maturity of the Fed's
bond portfolio.
While some of these actions are behind the motivations for this hearing; my assessment of their
impact, presented in some detail in my July testimony, is that they were effective in offsetting the
historically large demand contraction that followed the crisis. Looking at the full spate of monetary
interventions described above, Blinder and Zandi find that in 2014, real GDP was 5 percent higher
than it otherwise would have been; the level of payroll employment was 4 million jobs above the
alternative; the unemployment rate was more than two percentage points lower against a
counterfactual of no intervention.
l also cited research that tries to isolate the impact of quantitative easing, including bond
purchases that would not be pern1issiblc-agency MBS purchases-under some of the legislation
under discussion today. John Williams argues that "the central tendency of the estimates fof QE]
indicates that $600 billion of [the] Federal Reserve's asset purchases lowers the yield on ten-year
Treasury notes by around 15 to 25 basis points. To put that in perspective, that is roughly the same
size move in longer-term yields one would expect from a cut in the federal funds rate of 3/4 to 1
percentage point." This too led to faster GDP growth and lower unemployment. As I noted in Julv,
"\X'illiams reports on research that finds the Fed's LSAP program lowered the unemployment rate
by one-quarter of a percentage point, which in today's labor market amounts to 400,000 jobs.
Blinder and Zandi, using a macro-model to score QE against a baseline w~th no such intervention,
estimate that from 2009-14, QE lowered the 10-year Treasury rate by 1 percentage point and raised
the level of real GDP by 1.5 percent." Other research T cited found that the Fed's MBS purchases
lowered mortgage rates by roughly 100 to 150 basis points, which the researchers (Hancock and
Passmore) attributed to both the announcement of a "strong and credible government backing for
mortgage markets" and the actual purchases themselves.
Post-recession, the Fed continued to promote the recovery and the unemployment fell to what is
now the lowest jobless rate in 17 years. At least until recently, the central bank has been admirably
data-driven (some analysts, including myself, have questioned recent rate hikes given low and
decelerating core prices and non-accelerating wage growth); Chair Yellen, in particular, has carefully
and extensively articulated the bank's thinking and their plans. TI1e job market is solid, with average
job gains of 190,000 per month over the past two years. Financial markets are particularly strong,
boosted by strong corporate earnings, and perhaps expectations regarding upper-end tax cuts. Of
course, all is far from perfect: the Fed has consistently undershot its 2 percent inflation target, and
wage growth is slower than many analysts would expect at 4.1 percent unemployment. Slow
productivity growth is another serious shortcoming of the current expansion, but economists have
little understanding of that phenomenon, and I'm not aware of a credible argument that links this
result of any central bank policies.
In other words, if I were looking around \Y/ashington for an instimtion that fits the adage "If it
ain't broke, don't fix it," my first stop would be the Federal Reserve, and frankly, I'm not sure
where, if anywhere, I'd go next.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00050
Fmt 6601
Sfmt 6601
Insert offset folio 3 here 30775.003
nshattuck on FSR297 with DISTILLER
2
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
45
its role as "lender of last resort." \V'ith this change, the 535 members of the Congress all become
lenders of last resort, a possibility I strongly urge this committee to avoid.
If Congress fails to approve an emergency lending program within the 30 days, the borrower,
who, by definition, is facing a balance-sheet crisis, must pay the loan back to the Fed. Moreover,
members of Congress and their staffs must quickly engage in highly technical analysis of whether
lencling institutions are illiquid or insolvent, and the quality of their collateral. Such analysis, to be
clear, is standard, ongoing practice at the Fed, but by insisting Congress engage in it as well, the
proposal introduces the possibility of politicizing the analysis and, if Congress fails to act in a timely
manner, triggering significant market disruptions. Regarding this last point, consider also that there
is a strong likelihood these newly required evaluations would be occurring in the midst of a
pervasive economic shock, if not a recession, meaning Congress would have many other difficult
matters requiring their attention.
To be clear, I do think the bar should be high for approval of emergency lending, but my bottom
line is clearing that bar should be the purview of the Fed, not the Congress. Thus, should the
Committee consider raising the intemal bar (i.e., internal to the Fed), while this should be done
carefully with great attention to potential unintended consequences, it is consistent with prudent
Congressional regulation. Conversely, raising the extemalbar by requiring Congressional approval
goes beyond that benchmark.
Turing to my view that provisions of Dodd-Frank potentially obviate the proposal, consider
recent writings on this point by Fed chair during the financial crisis, Ben Bernanke. He notes that
(my bold):
The Fed intervened in the cases of Bear and .AIC; with great reluctance, doing so only
because no legal mechanism existed to safely wind down a systemic firm on the brink of
failure. A key clement of the Dodd-Frank financial refonn bill ... was to provide just such a
mechanism-the so-called orderly liquidation authority, which gives the Federal Deposit
Insurance Corporation and the Fed the necessary powers to put a failing firm into
receivership without creating financial chaos ... With the creation of the liquidation authority,
the ability of the Fed to make loans to individual troubled firms like Bear and AIG was no
longer needed and, appropriately, was eliminated. As Fed chairman, I was delighted to
see my institution taken out of the business of bailing out failing behemoths.
In addition, Dodd-Frank created a vice-chair for financial supervision (currently held by Randal
Quarles). It added restriction to the Fed's 13(3) authority by requiring: (1) the Treasury Secretary to
approve any lending; (2) loans to be open to a broad class of borrowers and not to any one
individual borrower; (3) the names of borrowers to be disclosed to Congress within a week; and (4)
stricter standards for loan collateral. Dodd-Frank required the U.S. Government Accountability
Office (CAO) to do a one-time audit of the Fed's numerous emergency lending facilities that were
established during crisis, leading to seven recommendations to the Fed, "to strengthen policies for
mana(.;ing noncompetitive vendor selections, conflicts of interest, risks rc:latcd to emergency lending,
and documentation of emergency program decisions" which the Fed agreed were worthy of
implementation (the committee would be well advised to follow up on their progress). Dodd-Frank,
along with recent international accords under Basel III, have increased what many financial analysts
consider the first line of defense against illiquidity /insolvency crises: capital requirements that
disallow excessive leverage.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00051
Fmt 6601
Sfmt 6601
Insert offset folio 4 here 30775.004
nshattuck on FSR297 with DISTILLER
4
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
46
The best way to avoid emergency lending by the Fed is to avoid credit avoid bubbles, systemically
underpriced risk, and the crises that follow these financial pathologies. And the way to achieve that
is through market oversight and regulation. Of course, even with robust oversight, crises can occur,
but T'd urge the committee not to involve Congress in the granular analysis and approval of
emergency lending, but to monitor the effectiveness of regulatory measures currently in place, albeit
as yet untested.
In reviewing a proposal much like this one, here's how Bernanke described his concerns, similar
to the ones I just raised: "[1lheir approach is roughly equivalent to shutting down the fire
department to encourage fire safety ... Rather than eliminating the fire department, it's better to
toughen the fire code." President Trump's nominee for Fed chair, Jerome Powell, recently made a
similar point: "Further restricting or eliminating the Fed's emergency lending authority "rill not
prevent future crises, but it 'W-ill hinder the Fed's ability to limit the harm from those crises for
families and businesses."
In this regard, it is of great concern that some members of Congress want to get rid or de fang
Dodd-Frank. While such a complex law certainly requires monitoring and improving, broad
deregulation of financial markets is completely contraindicated in any case. To do so while also
adding the members of Congress to the list of lenders of last resort would be an extremely reckless
act of economic policy.
Proposal: "Independence from Credit Policy Act"
The main purpose of tlus proposal appears to be to restrict the Fed's debt purchases to Treasury
bonds. Thus, had this proposal been in place in the financial crisis, the Fed wonld not have been
able to purchase agency MBS. Tlus would have been a serious mistake that would likely have
prolonged the downturn, which was, of course, triggered by the bursting of honsing bubble that
ultimately shut down the flow of credit to the housing sector, a key secror of the economy.
In fact, John Williams of the San Francisco Fed has argued that the MBS purchases were the
"most effecti\'e" part of the Fed's asset purchase programs and that they "ended up having kind of
the bigger bang for the buck than the Treasury purchases." Blinder and Zandi's research, cited
abr\\'c, underscores these findings: "within a short time," the MBS purchases by the Fed meant that
"homebuycrs "\\~th good jobs and high credit scores conld obtain mortgages at record low rates,
which helped end the housing crash."
Economist Josh Bivens, in recent testimony before the Financial Services Committee,
underscored a broader theme as to why this proposal would be misguided:
The key insight behind recognizing that QE needed to go beyond simple Treasury
purchases to be most effective is simply that there is not just one "interest rate" in the
economy. Instead, there arc multiple interest rates, and even multiple long-term interest
rates. And expansionary monetary policy should aim to reduce those long-term interest rates
most relevant to households' consumption and fitms' in\'estment decisions -and these arc
not the Treasury rates. Putting downward pressure on Treasury rates should resnlt in these
other rates coming down as well, but there are times when the risk premium to assets that
aren't Treasuries rises substantially (say in the aftermath of the Great Recession and the
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00052
Fmt 6601
Sfmt 6601
Insert offset folio 5 here 30775.005
nshattuck on FSR297 with DISTILLER
5
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
47
related financial crisis), and simply pulling down only Treasury rates would not be the most
effective way to conduct monetary policy.
In the spirit of Bivens' insight, I would encourage the committee to consider the following.
Uniguely among central banks, the US Fed is, with minor exceptions, restricted to purchasing bonds
solely from the US Treasury and the GSE's. In this sense, we were ''lucky" that cause of the
recession was the bursting of the housing bubble, as a channel existed by which the Fed could
prevent the excessive tightening of credit in that sector.
As I noted the last time I testified on this topic, the banks of England, Japan, Canada, and Europe
all have few restrictions on the types of assets they can purchase (though in some cases they must
seek permission from regulators to go into, for example, eguity markets). This creates flexibility for
their central banks to bring the water to the specific source of the fire, based on which sector
experiences a credit crisis. Because such flexibility would be a large change in the US case, my
suggestion here is that the committee may want to study the practices of these other banks and
consider their results in the traditionally more constricted US context.
Bivens' comment correctly suggests that in today's interconnected, global capital markets, we do
not know from which sector the next credit crunch will emanate. Thus, tlus may a particularly
imprudent time to narrow the space of the Fed's sectoral interventions. 'lllis observation is also
worth considering in the context of the rule in the emergency lending proposal that loans should
only be made to firms providing financial services. That rule represents a very significant reduction
of the scope envisioned in 13(3) of the Fed's existing charter, and it may also be too restrictive.
i\dditionally, I urge the committee to consider adding one other type of allowable debt to the
Fed's portfolio: municipal debt. Though this would rcguire, I believe (others question this assertion),
a change in the law govertling allowable Fed purchases, this would be a safe way to off.set recessions
at localized levels while stimulating potentially productive building and the creation of good-guality
jobs (the Fed is allowed to purchase muni debt, but only up to maturities of six months; this would
have to be significantly extended for this idea to be operational).
Proposal: "Monetary Policy Transparency and Accountability Act of 2017"
This proposal introduces the following language: "The [FOMCJ shall annually establish exactly 1
monetary policy strategy, which shall serve as a non-technical public communication of the
Committee's consensus expectation for the conduct of monetary policy during that calendar year."
The central theme of my recent testimony to this committee focused on why this was an impractical,
and even unworkable, idea. However, I should note that the current proposal is less burdensome
than the one under discussion last summer (the Fed Oversight Reform and Modernization Act), as it
does not require a specific rule nor outside regulatory approval for changes in bow the Fed employs
rule-based monetary policy. ln this case, the proposal encourages more of the type of transparency
and public communications in which the Bernankc and Yellen Fcds are already well engaged, though
with an emphasis on rule-based strategies. Such communication is, in fact, a clear positive
development for Fed policy and should be further encouraged.
J\s regards rule-based interest-rate setting, there is clearly a role for benchmarking FOMC
decisions against rules like variations on the well-known Taylor Rule. In fact, my recent testimony
argued that "One of the first guestions a monetary economist might ask in assessing the stance of
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00053
Fmt 6601
Sfmt 6601
Insert offset folio 6 here 30775.006
nshattuck on FSR297 with DISTILLER
6
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
48
Fed policy is, "where is the Fed funds rate relative to the Taylor rule?" However, while this might
well be the first question, it should definitely not be the last."
There are many reasons for t1exibility. First, there's no consensus as to which version of the
Taylor Rule, or any other rule, should be the "exactly 1 strategy" noted in the proposal. My
testimony raised actively debated questions of which int1ation gauge should be used, which
coefficients are most appropriate, what should be the Fed's target inflation rate (more on this in my
conclusion), and which output gap or "neutral" interest rate should be used (note that these
variables are "unobservable"; they must be estimated by analysts and there is no consensus on the
best way to do so; also, they clearly change over time). The Fed also must use real-time data, and
they need to have the flexibility to discount data they believe will be significantly revised.
Moreover, when an economist defends rule-based interest rate setting, he or she tends to show
how their preferred formula follows the actual part of the Federal Funds Rate (FFR). But no one
should take solace from such comparisons as they embed the strong assumption that the path of the
FFR was the optimal one for that period and, an even stronger assnmption, that this path should
dictate the parameters for the optimal path in a later period.
The table below, updated from my earlier testimony, shows the broad range of formula-based
interest rates that would have prevailed in the trough of the Great Recession, and those that would
prevail now. Note the ranges in both columns: from -0.6 to -6.6 percent in the recession, and from
1.1 to 4.1 percent now. I would certainly hope no member of this committee would endorse the
high-end of that range in the current expansion, one that would surely slam the brakes on a healthy
expansion with very low--even too low-inflation.
So, to the extent that this proposal leads to the Fed to increase their communication and the
transparency of their operations, it is worth a close look. But any veering into legislating mle-based
policy making, with granular oversight from regulators outside the Fed, should be assiduously
avoided.
Conclusion
The sound and reasonable motivation of these proposals is to limit moral hazard and to clarify the
transparency of the actions of the Fed, one of our most important economic institutions. I've tried
to highlight the tradeoffs invoked by the proposals, as there is, of course, a delicate balance between
greater Fed oversight and limits on the one hand, and its political independence and efficient
function, especially amidst crises, on the other.
There are, however, at least two areas the proposals do not touch on where I believe the Fed
could improve its operations, both of which bear on issues raised by the proposals. First, the fact
that the Fed has undershot their inflation target of 2 percent signals a significant problem, both with
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00054
Fmt 6601
Sfmt 6601
Insert offset folio 7 here 30775.007
nshattuck on FSR297 with DISTILLER
7
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
49
the institution's understanding of the forces driving prices and the effectiveness of their monetary
policy. My testimony reveals that I am a strong snpporter of the Fed and its actions in recent years,
and yet it is frustrating to hear governors consistently, and, at least thus far, incorrectly, aver that any
day now, key variables will start behaving as they predict. Clearly, a rethink is necessary, and many
analysts, including myself, have called for the Fed to consider changes to how they target inflation.
These ideas include a higher inflation t.~rgct or target price levels (or levels of other aggregates, like
nominal GDP or the wage base). Former Fed Chair Ben Bernanke recently introduced an interesting
hybrid: a temporary price level targeting approach that would kick in only when the funds rate was at
or near the zero lower bound.
Next, as noted in my testimony, despite internal warnings, the Fed missed the housing bubble,
and the ensuing financial crisis and deep recession had severe, lasting consequences for both our
economy and our politics. Tbis should also be an area where the central bank significandy improves
its performance. Dodd-Frank reforms, discussed above, should be helpful in this regard, as they
create greater oversight functions and introduce rules for monitoring leverage, such as "stress tests"
and higher leverage requirements. But more could be done here, as Baker and Bivens argue in a
recent brief. They suggest three functions that would improve the Fed's bubble-watch capacity,
including communicating warnings regarding large asset bubbles in key areas, accompanied by
warnings that the Fed will take steps to deflate the bubble; deleveraging, which could include higher
margin requirements; and stepped-up bank supervision, as per Dodd-Frank sorts of requirements.
But the first step must be for the bank to recognize that they do not have the luxury to maintain a
view that recognizing and deflating systemic bubbles are outside of their purview, and that their job
is solely to mop up the damage.
Allow me to close with a comment not on monetary policy, but on its very important complement
in weak economies: fiscal policy. As I stressed in my last testimony, the policies of the central bank
cannot offset downturns, especially deep ones, on their own. They can boost liquidity and lower the
cost of credit, but fiscal policy is an essential demand-side ingredient if we want households and
businesses to take advantage ofless expensive and more readily available credit. In this regard, the
pivot to austerity-fiscal consolidation in downturns or weak recoveries-was a significant
headwind to the recovery following the Great Recession. Moreover, the debt-increasing tax cuts
currently under consideration by this Congress are extremely ill-advised in this context Even absent
recessions-a highly unrealistic assumption, of course-just based on our aging demographics, we
arc going to need more, not less, revenue in the future. And in the context of the next recession, it
will be much harder to implement essential fiscal policies if deficits and debt levels are rising.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00055
Fmt 6601
Sfmt 6601
Insert offset folio 8 here 30775.008
nshattuck on FSR297 with DISTILLER
8
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00056
Principle
Sfmt 6601
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
Oversight of
Strategic Plans
Maintain Accountability,
Avoid Micromanagement
Prompt Approval
of Extraordinary
Expenses
Maintain Accountability,
Avoid Micromanagement
Designated Scope
of Responsibilities
by R~assigning
50
Fmt 6601
Insert offset folio 9 here 30775.009
Basic Management Principles
Maintain Focus
Extraneous Tasks
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00057
Probability
100~==============================~~======~~
80
Sfmt 6601
51
Fmt 6601
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
Insert offset folio 10 here 30775.010
Is the Fed's Monetary Policy Strategy
Well Understood by Financial Markets?
60
"Coin Toss"
40
20
FOMC
Meeting
04-~~~~r-r-~~-,~~~~-r-r~~~~~~,-~~+-~
Jun
Jul
Aug
Sep
Oct
Nov
Dec
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00058
Percent
2.o rr==================;--------------1
1.5
- - Simple Benchmat·k
--·Actual Federal l<'unds Rate
'
1.0
,.,.
Sfmt 6601
52
Fmt 6601
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
Insert offset folio 11 here 30775.011
Is the Fed's Recent Policy Path
Consistent with a Simple Benc;hmark?
0.5
_ _..._'lll!all!lt ____ ,
..,.,, ........ -- ....
...,.,.
,/"/
0.0 ~-----------------------~-----------------------------------------------------------------0.5
-1.0~~--~~~--,----,--,--,--,-,--,--,--,-,--.--,-,--,--,~
2013
2014
2015
2016
2017
53
Strengthening the Federal Reserve's Effectiveness, Transparency, and Acconntability
Andrew Levin
Professor of Economics, Dartmouth College
Testimony before the Subcommittee on Monetary Policy and Trade
Committee on Financial Services
U.S. House of Representatives
November 7, 2017
Chairman Barr, Ranking Member Moore, and members of the Subcommittee on Monetary Policy and
Trade, thank you for inviting me to testifY at this hearing. I will start with some general remarks about the
Federal Reserve's transparency and accountability, and then I will focus on the rationale for establishing
simple benchmarks to help clarity the Federal Reserve's monetary policy strategy.
Operational Independence and Accountability
The Federal Reserve is America's central bank, and its monetary policy decisions affect every
American--teenagers entering the job market for the first time, and retired people who are concerned
about the interest earned on their savings accounts; consumers taking out auto loans to purchase new cars,
and workers at the factories that manufacture those cars; households making payments on home
mortgages, and construction workers whose firms are deciding how many new homes to build; small
businesses whose profit margins may be tight, and families that are struggling to make ends meet.
Given the Fed's crucial role in affecting our economy, it's essential to ask: To whom is the Federal
Reserve accountable? Or put more simply, who is the Fed's boss? Indeed, this question is fundamental
for the issues being considered at this hearing. Unlike the Supreme Court, the Federal Reserve is not a
separate branch of government. Rather, the Fed is an agency qfthe government. Moreover, while the
Fed's chair and the other members of the Federal Reserve Board are nominated by the President and
confirmed by the Senate, the Federal Reserve is not like the Treasury Department or other cabinet offices:
Federal Reserve officials do not report to the President, nor does the Fed operate under his direction.
So, let me raise the question again: Who is the Fed's boss? And of course, the answer is: Congress. In
fact, that answer comes directly from the U.S. constitution, which states that Congress has responsibility
for regulating the value of money, and from the Federal Reserve Act, whereby Congress has delegated
that responsibility to the Federal Reserve. Thus, the Fed reports directly to Congress, not to the President
or anyone else.
Now, I've intentionally used the term "boss" because I think we can draw on some basic management
principles to shed light on the issues being considered here today. In particular, how should a manager
delegate authority to an employee in order to maximize that employee's effectiveness and aecountahility?
Turning to Exhibit# l, here are three common-sense management principles that are followed by every
well-run business or non-profit organization and that are highly relevant for the draft legislation being
considered by your subcommittee:
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00059
Fmt 6601
Sfmt 6601
Insert offset folio 12 here 30775.012
nshattuck on FSR297 with DISTILLER
(1) The boss stays well iiJformed about the employee "s strategy. In many cases, such consultations take
place in the context of annual reviews, with regular status updates at a quarterly or semiannual frequency.
These consultations are essential for maintaining accountability while avoiding micromanagement; after
all, an employee can't be productive if the boss is constantly second-guessing that employee's decisions.
And as I'll discuss in a moment, this is the basic rationale for requiring the Fed to explain its monetary
policy strategy in terms of simple policy benchmarks.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
54
2
Exhibit #1: Basic Management Principles
Relevance (or Dra{t Legislation
Principle
Oversight of
Strategic Plans
Maintain Accountability,
Avoid Micromanagement
Monetary Policy
Benchmarks
Prompt Approval
of Extraordinary Expenses
Maintain Accountability,
Avoid Micromanagement
Emergency
Lending
Designated Scope
of Responsibilities
Maintain Focus by
Reassigning Extraneous Tasks
Credit
Policy
(2) Extraordinary budget items require prompt approval. In particular, the employee should have
authority to incur routine expenses up to a specific cost threshold, whereas the boss has to approve
extraordinary expenses beyond that threshold. Again, the basic premise is to maintain accountability
while avoiding interference in nonnal day-to-day operations. And this is essentially the logic for
preserving the Fed's operational independence but establishing procedures for obtaining prompt
congressional approval for emergency lending facilities.
(3) Extraneous tasks should be reassigned elsewhere. Eflective delegation requires a clear delineation of
the responsibilities of each employee. Thus, if a specific assignment evolves into a task that doesn't lit
within the employee's job description, then it's generally appropriate for the boss to reassign that task to
someone else. And this is the basic rationale for the draft legislation on credit policy: The Federal Reserve
has a legal mandate to set the course of monetary policy, to supervise and regulate financial institutions,
and to serve as a lender of last resort-the "banker to the banks." In some extraordinary circumstances,
carrying out that mandate may result in the Fed's acquisition of private assets. However, such assets
shouldn't stay indefinitely on the Fed's balance sheet but should instead be swapped for U.S. Treasury
securities, thereby preserving the Fed's operational independence and designated scope of responsibility.
Monetary Policy Benchmarks
The transparency of the Federal Reserve's monetary policy framework has improved substantially over
the past few decades. Some of those improvements were legislated (e.g., semiannual monetary policy
reports and hearings), some occurred following congressional hearings (e.g., release ofFOMC meeting
transcripts), and a number of other enhancements were initiated by the Fed itself (e.g., post-meeting
statements, expedited minutes, and quarterly press conferences). And when the Fed adopted a specific
numerical inflation target in 2012, it did so in close consultation with members of Congress. Thus, it's
natural and appropriate to wonder whether there's still room for improving the clarity of the Fed's
monetary policy strategy? After all, as Fed insiders often note. "{(it ain't broke, don't fix it. "
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00060
Fmt 6601
Sfmt 6601
Insert offset folio 13 here 30775.013
nshattuck on FSR297 with DISTILLER
One way to address that question is to take a look at the Fed's official communications. For example, at
the conclusion of its policy meeting last week, the Fed issued a 500-word statement. But nearly all of that
statement was pure boilerplate, literally repeated word-for-word from the previous statement. There were
a few brief references to the transitory effects of the hurricanes. But the only substantive changes were
conveyed in two adjectives: the description of recent economic growth was upgraded from "moderate"
to "solid", and core inflation was characterized as "sofr."
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
55
Exhibit #2: Is the Fed's Monetary Policy Strategy Clear to Investors?
Probability
A more concrete way of gauging the clarity of the Fed's policy strategy is to look at market participants'
assessments of the likely path of the target federal funds rate, which is the Fed's primary monetary policy
tool. Turning to Exhibit #2, you can see that as of last June, investors saw roughly 50-50 odds-just like
a coin flip--that the Fed would hike interest rates at its December meeting. 1 Those odds bounced
around a bit over the summer and then suddenly jumped upwards in late September and early October,
not because of some startling new economic data but simply because Fed officials began clearly signaling
their intention to hike rates in December. Indeed, investors now sec the prospect of a rate hike as a
practical certainty even though the December FOMC meeting is still six weeks away. Thus. even though
Fed officials regularly reiterate that the path of monetary policy is data-dependent and not on a preset
course, the Fed's policy strategy is not well understood by investors who sift through every tidbit of
Fed communications, and that strategy is even more opaque to most members of the general public.
By contrast, simple benchmarks can provide a highly transparent means for the Federal Reserve to
communicate the key elements of its policy strategy. Of course, the seminal benchmark was created by
Professor John Taylor of Stanford University and hence is generally referred to as the "Taylor Rule."
In fact, macroeconomists often refer to this sort of mathematical formula as a "rule" or "interest rate
reaction function. "However, as Professor Taylor has frequently noted, it would be inadvisable for
policymakers to adhere mechanically to any simple mathematical formula; rather, such equations
should be viewed as benchmarks or guidelines for the setting of monetary policy, while recognizing that
professional expertise and good judgment will always he essential for sound policymaking in practice.
It should be noted that the use of simple policy benchmarks is not intrinsically "hawkish'' or "dovish"
in the sense of being tied to a specific view about how the Federal Reserve should fulfill its statutory
mandate. For example, Taylor ( 1999) analyzed a simple variant of the Taylor Rule that had been used
in earlier Federal Reserve stall analysis, and Yellen (20 12) referred to that benchmark as the "balanced
approach rule" in light of its effectiveness in fostering the Fed's dual objectives of maximum employment
and price stability.
1
This exhibit shows investors' assessments of the probability that the FOMC will raise the target federal funds rate
at its December 2017 meeting. These probabilities are computed by the Chicago Mercantile Exchange (CME) and
posted in real time on its website; see http://"www.cmegroup_comltrading/inlerest-rates/countdown-to-(omc.html.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00061
Fmt 6601
Sfmt 6601
Insert offset folio 14 here 30775.014
nshattuck on FSR297 with DISTILLER
The CME options data indicates that investors saw very low odds that the Fed would hike rates prior to December,
and that expectation proved to be correct.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
56
4
Exhibit #3: Is the Fed's Recent Policy Consistent with a Simple Benchmark?
Percent
2l~===~===================~--------~-----------------~---------,
2013
2014
2015
2016
2017
Indeed, as shown in Exhibit 3, a variant of the "balanced approach rule" provides a remarkably close
approximation to the Fed's actual policy path over the past few years. This simple benchmark can be
expressed as follows:
i, =
O.Si,_ 1
+ O.S[r( + rr, + O.S(rr,- 2) +
l.Oygap,]
where i, is the current lederal funds rate, i,_ 1 is the average funds rate in the previous quarter, rr, is the 4quarter average rate of core PCE inflation, ygap, is CBO's latest estimate of the current output gap, and
r( is the median projection of the longer-run average real federal funds rate as indicated by the Federal
Reserve Bank of Philadelphia's survey of professional forecasters.
This benchmark incorporates two simple adjustments to the formula considered by Taylor ( 1999) and
Yellen (2012). First, that formula assumed that the longer-run normal value of the real federal funds rate
had a constant value of2 percent, whereas this benchmark follows Levin (2014) and Blanch flower and
Levin (2015) in adjusting that value over time based on the evolving views of professional forecasters.
Second, this benchmark incorporates a moderate degree of interest rate smoothing, consistent with the
earlier findings of Levin et al. ( 1999, 2003).
This analysis confirms that simple benchmarks can indeed be helpful in clarifying the Fed's monetary
policy strategy, thereby contributing to its overall transparency and accountability to Congress as well as
its effectiveness in serving the public.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00062
Fmt 6601
Sfmt 6601
Insert offset folio 15 here 30775.015
nshattuck on FSR297 with DISTILLER
Thank you for your consideration; I will be glad to answer any questions.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
57
5
References
Blanchflower, D., Levin, A. (20 15). "Labor Market Slack and Monetary Policy." National
Bureau of Economic Research Working Paper 21094.
Haedtler, J., Levin, A., Wilson, V. (2016). "Making the Federal Reserve Fully Public: Why and
How." Economic Policy Institute, Washington, DC.
Levin, A. (2014). "The Design and Communication of Systematic Monetary Policy Strategies."
Journal of Economic Dynamics and Control, 49:52-69.
Levin, A., Wieland, V., Williams, J. (1999). "The Robustness of Simple Monetary Policy Rules
under Model Uncertainty." In: Taylor, J., cd., Monetary Policy Rules. University of
Chicago Press.
Levin, A., Wieland, V., Williams, J. (2003). "Performance of Forecast-Based Monetary Policy
Rules under Model Uncertainty'' American Economic Review, 93:622-645.
Levin, A., Taylor, J. (2013). "Falling Behind the Curve: A Positive Analysis of Stop-Start
Monetary Policies and the Great Inflation." In: M. Bordo and A. Orphanides, eds., The
Great Inflation: The Rebirth ofModern Central Banking. University of Chicago Press.
Taylor, J. (1993). "Discretion versus Policy Rules in Practice." Carnegie-Rochester Conference
Series on Public Policy 39:195-214.
Taylor, .J. (1999). "A Historical Analysis of Monetary Policy Rules." In: Taylor, J. (Ed.),
Monetary Policy Rules, Chicago, IL: University of Chicago Press.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00063
Fmt 6601
Sfmt 6601
Insert offset folio 16 here 30775.016
nshattuck on FSR297 with DISTILLER
Yellen, J. (2012). "Perspectives on Monetary Policy." Remarks given at the Boston Economic
Club, June 6. Sec http://www.&deralreserve.gov/newseventslspeechlvellen20I 20606a.htrn.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
58
F lJ
'I'd:
II EMPLOYMENT
2()~- .HJ8-i08Cl:
1·-a:-.:
~02-4i18-105(J: pathrofulkmp!tJ~'mt:tlt.nrg
\\"W\\·.cbpp.urg I
offthcchart~bltlg.org
March 24, 2015
Labor Market Slack and Monetary Policy
1
By David G. Blanchflower and Andrew T. Levin
A fundamental cornerstone of modern macroeconomics is that the economy has a balancedgmwth path that is chamct.erized by stable inflation as well &~ st.oacly growth of production
and employment. In effect, if the economy becomes "overheated" and persistently exceeds
its ha.lanced-growt.h path, theu the most notable symptom will he an acceleration of nominal
wages and prices and hence inflation overshooting the central bank's target.. Conversely, a
persistent shortfall in economic activity and employment. not only h&'l substantial adverse
effects on households' well-being but. is also associated with downward pressure on wages
and prices ami hence with inflation falling persistently short. of the central bm1k's target..
Thus, ongoing assessments of the contours of the balanced-growth path~~and of significant
deviations from that path·~ are a crucial element. of the design and communication of monetary
policy, ("Specially for a central bank with a legal mandate to foster maximum employment
and price st.ability2
In gauging movements in labor market. slack over previous business cydes, macroeconomists
have generally focused on the gap between the conventional unemployment. ra.t.e (that is, the
incidence of people who are out of work and actively searching for a job) and the "natural
rate of unemployment" judged to be consistent. with the balanced-growth path. In the wake
of a severe recession and a sluggish recovery, however, the conventional unemployment gap
can be a relatively poor or even misleading indicator of labor market slack. In particular,
a.~sessment.s of the shortfall of employment. from the balanced-growth path should also inDavid G. BlanchAow<~r is the Rruce V. Hauner professor of economics at Dartmouth College) a professor of
economics at the Uuiversity of Stirling, a rese,arch associate of t.he National Burr:au for Economic Re:'*~arch,
and a program director and research fellow at the Institute for the Study of Labor (IZA). Andrew T. Levin
is currently an adviser in the Research Department at the Iuternational I\Jonetary Fund, and he will be
joining the Dartmouth faculty as a professor of ecouomics in .July 2015. We appreciate many invaluable
conversations with Laurence Ball, Jnrcd Bernstein, Christopher Erceg, :lv1clinda Pitts, Adam Posen, Lars
Svensson, and John Taylor. Nonetheless, the views expressed here are solely those of the authors and do
not necessarily reftcd. the views oft he International ~fonetary Fund or of any other person or institution.
2The FOMC's StatcmPnt of Longer-Bml Goals and Policy SJ.rategy (adopted in January 2012 aBd rea.tfirmPrl
1
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00064
Fmt 6601
Sfmt 6601
Insert offset folio 17 here 30775.017
nshattuck on FSR297 with DISTILLER
annually since then) describes its mandated objectives of maximum employment and price stability as
"generally complt>mentaxy." SPe FOJ\1C, "Statement on Longer-Run Goals and Monetary Policy Strategy,
2014, available at http:/jwww.federalrescrve.ga~;jmonela'l'YJWlicy.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
59
FIGURE 1
The Recent Evolution of U.S. Nominal Wage Growth
Percent
5
Production & Nonsupervisory Employees
All Employees
---------------- 3-J\fonth Change
-
2007
2009
2011
2013
2015
2007
2009
2011
l2·Montb Change
2013
2015
Note: The left panel depicts the growth rate of average hourly earnings i(lr all U.S. private nonfarm
employees, n.nd the right panel depicts the corresponding growth rate for production and non-supervisory
employees. Each panel depicts the annualized :l-month change (solid line) and the 12-month change (dashed
liue). Source: BLS and authors' calculations.
corporate the extent of hidden v.ncrnployment (that is, people who are not actively searching
but who would rejoin the labor force if the job market were stronger) and the incidence of
'itndemmployrnent (that is, people working part-time who want a full-time job).
In this paper, we begin by examining the evolution of U.S. labor market slack over recent
years and show that underemployment and hidden unemployment currently account for
the bulk of the employment gap. Our benchmark a.<>sessmcnt of the current magnitude of
the shortfall in U.S. employment--including the incidence of underemployment and hidden
unemployment--is equivalent to about :3.3 million full-time jobs. Moreover, the uncertainty
surrounding that a.ssessrnent is dearly skewed to the upside, so that the actual shortfall in
employment might well be twice as large.
Recent Congressional Budget Office (CBO) analysis indicates that the potential labor force
i:; currently expanding by about 50,000 to 60,000 individuals per month due to demographic
factors. Thus, if nonfarm payrolls continue to rise steadily by around 260,000 jobs per
month (which has been the average pace over the past few quarters), then the employment
gap might be eliminated toward the end of next year. In contrast, if the economic recovery
decelerates and payroll growth slows to around 100,000 jobs per month (roughly similar to
its pace during 2010 and most of 2011), then the employment gap would barely diminish at
all over corning years.
Next, using state--level data, we find strong statistical evidence that conventional unemployment, underemployment, and hidden unemployment each exert significant downward
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00065
Fmt 6601
Sfmt 6601
Insert offset folio 18 here 30775.018
nshattuck on FSR297 with DISTILLER
2
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
60
pressure on nominal wages. 3 Such results should not be surprising, because employers may
fill a job vacancy by hiring (a) someone who had been out of work and actively searching for
a job; (b) someone who had been working part-time, either at the same firm or elsewhere;
or (c) someone who had just rejoined the labor force and hence wasn't being counted as
unemployed.
Recent data on U.S. nominal wage growth is fully consistent with our assessment that labor
market slack remains substantial. As shown in the left panel of Figure 1, the average hourly
earnings of all private nonfarm employees decelerated markedly in the wake of the Great
Recession, and since 2010 nominal wage growth lws remained mired at around 2 percent. 4
Indeed, the latest 12-mont.h change (from February 2011 through February 2015) was 1.975
percent.. The right panel of the figure shows the evolution of nominal wages for production
and nonsupervisory workers, a measure t.hat is less sensitive to movements in the upper tail
of the wage distribution and hence more informative about broader wage trends. Recent
readings on this measure point to a significant decline in nominal wage growth over the
past few quarters: The 12-month chai1ge through February 2015 was just 1.6 percent, down
growth last summer, and the latest
nearly a full percentage point from the pace of
annualized three-month change was only 0.8 percent.
Finally, we consider the monetary policy implications of labor market slack using a variant
of the simple rule that has been extensively studied by Taylor and characterized as the
"balanced approach rule" by Yellen-" This analysis indicates that the initiation of monetary
policy tightening would be premature at the prPseut time. Indeed, such a policy move
would be a serious mistake in light of substantial downside risks to the current economic
outlook? Rather, liftoff from r.he zero lower hound should be deferred until labor market
slack has diminished substantially further cmd inflation has moved up significantly closer to
thP FOI'v!C's 2 percent inflation goal.
3ln a. sjweclt on .January 15, 2015, Dennis Lockhart (I he president of the Federal Reserve Bank of Atlanta)
stated that economist-s at his institution have nlso ''advanced the t.hesis that the elevated number of people
working part-time involuntarily is restraining wage growt.h.n
4
The same pattern is evident for other measure.; of labor compensation such as the employment cost index.
Indeed, ,1. Robertson and E. Terry ("What·s (Not.) Up with Wage Growth? Ma.crvblog, Federnl Reserve Bank
of Atla11ta, t"ebruary 17, 2015) a.nalyz(_~d n. range of indicators of nominal wage growth and conduded that
((none of the charaderistk-specific median growth rates we loob'd at are dose to returning to prereces.sion
leveh:~. Lower-than-uormal wage growth appears to he a very widespread feature of the labor market since
the end of the recession.''
5
Average hourly earnings of production and uonsupcrvisory workers increased from $20.77 in November 2014
to $20.80 in 1-<"elwua.ry 2015·-a mea...<;ly raise of just a cents. La.ck of wage growth is also found in other BLS
wage seriefL Median usual weekly earnings for full-time wage and sala.ry workers grew by 1.9 percent over
the course of lnst. year and by 1.7 percent in 1.1"' fourth quarter. For all civilian workers, the Employment.
Cost Index (ECI) grew by 2.2 percent. in both the third and fourth quarters of 2014.
6
This rule was iuit.ially analyzed by ,J. 'litylor, "A Historical Analysis of Monetary Policy Rules, in J. Taylor.
eel., Monetary Policy Rnlcs (University of Chicago Press, 1999). Its chara.ct.erizalion as a "balanced approach rule was given by J. Yclkn '"'Perspectives on 1v1onetary Policy, remarks glven at the Boston Economic
Club, ,June 6, 2012 (ht.tp://www.fedemb·e,er-ve.gov/ncwsevcnts/speech/yellcn20120606a.hlm.).
1
7
According to the US Census Bureau, retail sales declined in three consecutive months: -0.9 perrent in
December 2014, -0.8 perc:ent. in January 2015, and -0.6 percent in February 2015.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00066
Fmt 6601
Sfmt 6601
Insert offset folio 19 here 30775.019
nshattuck on FSR297 with DISTILLER
3
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
61
Gauging Labor Market Slack
The Employment Gap
Our measure of the employment gap is the sum of three specific. components 8 First, the
unemployment gap is the deviatiou of the conventional unemployment rate~labeled "U3" by
the Bureau of Labor Statistics (BLS)-from professional forecasters' consensus projections
of its longer-run normal rate (as reported in semiannual Blue Chip surveys). Second, the
participation gap is the deviation (in percentage points) of the actual size of the labor force
from CBO assessments of the potential labor force; this shortfall corresponds to the notion
of "hidden unemployment" described above. Third, the nndercrnployrnent gap takes the
BLS measure of people working part-time for economic reasons (expressed as a fraction of
the potential labor force) as a deviation from its 1994-2007 average and then converts this
deviation into fnll-time equivalent (FTE) jobsH
As shown in Figure 2, the U.S. employment gap has narrowed markedly over the past few
years, along with each of its three components. Nonetheless, it is readily apparent that the
conventional unc~mployment. rate has not served as an accurate synopsis of the evolution of
labor market slack. For example, the declining unemployment rate over the course of 2010
and most of 2011 was not induced by a pickup in job growth but instead reflected the extent
to which many Americans gave up searching for work and departed from the labor force. In
effect, the reduction in the unemployment gap was almost fully offset by a.n increase in the
participation gap, and hence the overall employment gap showed very little improvement
during that period.
Even more importantly, it is evident that the U.S. economic recovery remains far from complete in spite of apparently reassuring recent signals from the conventional unemployment
rate. Indeed, while the unemployment gap ha..s become quite small, the incidence of underemployment remains elevated and the size of the labor force remains well below CBO's
assessment of its potential. In particular, the employment gap currently stands at. around
1.9 percent, suggesting that the "true" unemployment ra.tc (including underemployment and
hidden unemployment) should be viewed as around 7~ percent. Gauged in human terms, the
current magnitude of the employment. shortfall is equivalent to about 3.3 million full-time
jobs.
Of course, the characteristics of the economy's balanced-growth path cannot be directly
observed, and hence a.ny particular assessment of the deviations from that. path is necessarily subject to considerable uncertainty. In the context. of a typical business cycle, such
uncertainty might reasonably he judged as symmetric around the benchmark estimate. At.
the present juncture, however, it seems plausible tha.t prof<:$Sional forecasters and a.na.lysts
at policy institutions may have become overly pessimistic in gauging the extent to which
the Great H.ecession caused permammt damage to the U.S. labor market. Consequently,
8
This measure of the employmE-mt gap wa.s introduced by A. Lcvin ((The Design and Communication of
Systematic Monetary Policy Strategies, Journal of Economic Dynamics and Control (2014 ).
1
9The FTE convt~rsiou factor is eornputed using BLS data on the av('Tage weekly hours of iudividuals working
part-time for economic reasons compawd to the average weekl_y hours of individuals who are working fulltime.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00067
Fmt 6601
Sfmt 6601
Insert offset folio 20 here 30775.020
nshattuck on FSR297 with DISTILLER
4
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
62
FIGURE 2
Benchmark Assessment of the Employment Gap
2010
ZOll
2012
2013
2014
2015
2010
20ll
2012
2013
2014
2015
Xote: This figure depicts the recent evolution of the U.S. employment gap in proportion t.o the potential
labor force (t.op panel) and in millions of FTE jobs (bottom panel). In each panel, the dark-shaded area
denotes the unemployment gap, the medium-shaded area denotes the participation gap, the light-shaded
area denotes the underemployment gap) and the solid llne denotes the total employment gap; all of these
series are shown as three-month moving avE'ragcs. Source: BLS 1 CBO, and <:uttllors 1 calcnlatious.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00068
Fmt 6601
Sfmt 6601
Insert offset folio 21 here 30775.021
nshattuck on FSR297 with DISTILLER
5
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
63
FIGURE 3
Evolving Assessments of the Unemployment Gap
Percent
llr------------------r=~~~~w
;----~
Rate
---- CBO Estimate of Natural Rate
10
2008
2009
2010
2011
2012
2013
2014
2015
Note: The solid line denotes the three-mouth moving average of the U.S. unemployment rate (U3) from
January 200H to February 2015. The shorhhshed lirw denotes the evolution of CEO's assessments of the
]oug-run natural n\te. The long-dashed line denotes tlw Blne Chip consensus (that is, the mean projection)
for the uuemploymtmt rate 5 to 10
ahead, while the upper and lower limits of the shaded area
represent the
projections in
t.op and bottom quartiles, respectively. Source: Source: IlLS, Blnc
Chip Economic
and ;;tuthors' calculations.
the confidence band,; around our current assessment of the employment gap may in fact
be skewed to the upside; i.e., this assessment may well be an nnder·estimate of the true
magnitude of labor market slack To examine that possibility, we now consider each of the
individuaJ components of the employment gap in turn.
The Unemployment Gap
CBO regularly produces assessments of the nat mal unemployment rate that would prevail if
the economy were on its balanced-growth pa.th. 10 More specifically, CBO defines the natural
rate as the l!>vel of unemployment "arising from all sources except fiuctuations in aggregate
d<'mand." In the wake of the Great Recession, CBO refined its analysis to gauge the extent
to which the natural rate has been affected by transitory vs. persistent structural factors.
Thus, over the past few years CBO has produced estimates of the long-term natural rate,
which solely reflects the infiucn<:es of lon~er-last.ing structural factors. 11
10
These asseosments are published in CB0 s mmual Budget and Economic Outlook document each :January
or February a_") well a.s in its midyf~ar updates each August.
1
11 Since
2011 CBO has also produced estimates of the short-term natural rate, which ineorporates the effects of
transitory structural factors. In 2014, CBO relabekm the "long-term natural rate)) as the "underlying longterm rate of unemployment" and began referring to the "short-term natural rate" a.s simply "the natural
rate.)' In the immediate aftermath of the Great Recession, the distinction between these two measures was
quit,e substantia] (with a peak differE-nce of around 0.8 percent.age points). As of 2015, however, the two
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00069
Fmt 6601
Sfmt 6601
Insert offset folio 22 here 30775.022
nshattuck on FSR297 with DISTILLER
G
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
64
Surveys of professional forecasters generally do not collect information about their estimates
of the natural rate of nnemployrnenL However, forecasters routinely make longer-run projections regarding the path to which the economy is expected to converge over time, and
such projections essentially reflect their assessments of ducradcristics of the balanced-growth
path, including the growth rate of potential output and the natural rate of unemployment.
In particular, Blue Chip longer-run surveys (which are condueted semi-annually in March
and October) report on the consensus and wnge of forecasters' projections of the average
unemployment rat.e 5 to 10 years ahead. 12
As shown in Figure 3, the Blue Chip's longer-run consensus outlook in early 2008 was 4.8
pernmt-··virtually identical to CBO's a.ssessment of the natural unmnploynwnt rate. In effect,
analysts generally agreed that. the unemployment gap at that juncture was effectively niL
Shortly thereafter, the actual unemployment rate skyro<:keted upwards, reaching 10 percent
by late 2009. CBO then raised its assessment of the natural rate by just a notch, whereas
professional forecasters evidently became much more pessimistic about the prospects for longln.sting damage to the labor market: The Blue Chip longer-run consensus outlook moved up
to around 6 percent, and the top quartile of projections in that survey reached nearly 7
Jl("n:ent. By 2012, CBO had come to share much of that pessimism and henee marked up its
estimate of the long-term natural rate to levels similar to those of the Blue Chip consensus.
Over the past few years, as the unemployment rate has declined steadily and nominal wage
inflation has been subdued, professional forecasters have been gradually marking down their
longer-run unemployment projections. In the Blue Chip longer-run survey published in
March 2015, the consensus outlook for unemployment was 5.1 percent, while the bottom
quartile has declined to 4~ percent and the top quartile of projections now stands at 5~
percent. Interestingly, that consensus outlook is identical to the midpoint of the central
tendency of FOJVIC participants' longer-run unemployment rate projections that were released in conjunction with the March 2015 FOMC meeting.- CBO's latest assessment of the
long-term natural rate (published in late January) was a notch higher at 5.4 percent.
It seems reasonable to infer that the uncertainty surrounding these assessments is skewed
to the downside. lndeed, if unemployment declines further over coming quarters while
wage inflation remains subdued, analysts will presumably make even further downward
revisions to their assessments of the longer-run normal rate of unemployment. Thus, while
our benchmark estimate of the unemployment gap is quite small, its true magnitude might
well be substantially larger-·pcrhaps by as much as thrcc~fourt.hs of a percentage point.
The Participation Gap
ln conjunction with its estimates of potential output and the natural unemployment rate,
CBO produces regular a-ssessments of the historical and projeeted size of the pot.cnl.ial labor
force, that is, the balanced-growth path for the labor force that would prevail in the absence of
measures are uow identical; i.e., CBO ha.s. concluded that transitory structural factors are no longer having
any significant inflnen('e on thf' natural rat<'- of unemployment.
12
Blm-~ Chip longer-run survey results are reported in the I\{a.rch and October editions of Blue Chip E'conomic
Indicators, a publication owned by Aspen Publishers. Copyright (c) Aspen Publishers, Inc. All rights
reserved.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00070
Fmt 6601
Sfmt 6601
Insert offset folio 23 here 30775.023
nshattuck on FSR297 with DISTILLER
7
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
65
FIGURE 4
Evolving CBO Assessments of the Potential Labor Force
Millions
164
162
Tr.=.=.=_=c=B=o=J=ao=2=o=~~~,--------------------------------,
- - - CBO Feb. 2013
160
!58
156
154
151
1~+-----~-----~------r-----~----------~------,-----~
2007
2008
2009
2010
20ll
2012
2013
2014
2015
Note: The solid line denotes the three-month moving average of the U.S. labor force from January 2007 to
February 2015, and the lhl-shed lines denote the CBO's a..:;;sessments of the potentlallabor force as of January
2008 (short-dashed), February 201:1 (medium-dashed), and January 2015 (long-dashed). Each CBO series
ha' been adjusted to incorporate subsequent revisions to BLS population controls. Source: BLS. CBO. 1md
authors' calculations.
aggregate demand Bhocks. In effect, given detailed projections for the size and demographic
composition of the population (mainly drawing on the work of the Census Bureau), CBO's
assessments of the potential labor force convey its analysis of how demographic and structural
faetom :tre likely to influence the evolution of lRhor force participation over time.
Figure 4 depicts the evolution of CBO's asseosments of the potential labor force. As of
January 2008, CBO estimated that the actual !:thor force (specifically, about 154 million
people) was very dose to its potential level; i.e., the participation gap was judged to be
negligible. Moreover, at that juncture CDO projected that the potential labor force would
expand at an annual pace of about three-quarters of a percent through 2012 and would then
decelerate somewhat to an annual pace of about half a percent in subsequent years. 1:1
In the wake of the Great Recession, the U.S. labor force actually decreased in size through
rnid-2011 and then resumed a moderate upward trajectory over the past few years. Nonetheless, from 2009 through 2013, CDO made only modest revisions to its assessments of the
potential labor force. Most notably, CDO analysis indicated that the labor force had exceeded its potential size by about a full pcre~ntfl.gn point during the lead-up to the financial
crisis. However, CRO made roughly offsetting adjustments to the projected growth rate of
the potential labor force, and hence the implications for the magnitude of the participation
I.> As discussed in C. Erceg and A. Levin (''Labor Force Participation and Monetary Policy in the Wake of
the Great Recession, .!oumal of Money. C'i'edit and Banking, 2014), CBO's labor force projections in early
2008 were broadly consistent with the projections that. were published by BLS in November 2007.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00071
Fmt 6601
Sfmt 6601
Insert offset folio 24 here 30775.024
nshattuck on FSR297 with DISTILLER
8
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
66
gap as of 2013 were essentially the same as implied by its January 2008 assessment.
In contrast, CBO has recently made substantial downward revisions to its assessments of the
entire post-2008 trajectory for the potential labor force. In particular, CBO now judges that
dernographie and structural factors account for a larger share of the post-2008 decline in labor
force participation than indicated by its previous analysis. Moreover, CBO has concluded
that much of the cyclical decline in labor force participation has become irreversible; i.e.,
CBO now anticipates that only two-thirds of the individuals who departed from the workforce
in the wake of the Great Recession will rejoin the labor force as the economy continues to
strengthen.
Evidently, such judgments have crucial implications for gauging the current magnitude of
the shortfall in U.S. employment. According to CEO's latest a.o;sessment of the potential
labor force, the participation gap currently stands at around 0.8 percent (which is the value
that we used in constructing our benchmark estimate of the employment gap as shown in
Figure 2). By contrast, CEO's outlook as of february 2013 implies a substantially larger
participation gap of around 2.6 percent and hence that the employment. gap is nearly t11Jice
as lm:qe a..<; our benchmark estimate.
Breaking down the data by gender is also relevant for assessing the extent to which the
post-2007 decline in U.S. labor force participation might be largely structural or irreversible.
As shown in the left panel of Figure 5, the participation rate of males age 15 to 54 years
wa..s drifting downward during the late 1990s, but that trend was arrested and perhaps even
reversed during the mid-2000s. Thus, there is evidently a substantial degree of uncertainty
about the current magnitude of the participation gap for this demographic group. If one
fits a linear trend over the decade ending in 2007, then the actual participation rate is now
within a percentage point of that trend line-roughly similar to CEO's current assessment
of the aggregate participation gap. By contrast, if one fits a. lirwa.r trend over the five-year
period ending in 2007, then the participation gap is around :'1 percentage points, roughly
consistent with the implications of CEO's assessments several years ago.
As shown in the right panel of Figure ,5, the participation rate of females age 45 to 54 years
was essentially flat from 2000 through 2007, a.nd hence there is simply no basis whatsoever
for attributing its post-2007 decline to structural factors. Rather, it seems evident that this
decline resulted from the persistent weakness of the job market in the wake of the Great
Recession. Moreover, the magnitude of that dccline~ahont 2~ percentage points-is virtually
identical to the drop in labor force participation of a.ll prime-age adults (that is, aged 25 to
54 years), who comprise the bulk of the U.S. labor force. In effect, this pattern bolsters the
view that the Great Hecession and its aftermath were largely r<c)sponsible for the post-2007
decline in the U.S. participation rate, consistent with the conclusions of a nnmber of recent.
empirical studics 14
14
See D. Aaronson, ,J. Davis, and L. Hu, "Explaining the Decline in the U.S. Labor Foree Participation
Rate, Chicago l'<>d Letter #296, Federal Reserve Bank of Chicago, 2012; J. Sherk, "Not Looking for
Work Why Labor Force Participation Has Fallen Dnring the Recession, Backgronnder 2722, Heritage
Foundation Center for Data Analysis, 20!2; W. Van Zondweghe, "Interpreting the Recent Decline in Labor
Force Participation, Economic Review, Federal Reserve Bank of Kansa..<:; City, 5-34 1 2012; .J. Hotchkiss and
F. R.ios-Avila, "Identifying Factors Behind the Decline in the Labor Foree Participation Rate, Business
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00072
Fmt 6601
Sfmt 6601
Insert offset folio 25 here 30775.025
nshattuck on FSR297 with DISTILLER
9
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
67
FIGURE 5
Disaggregated Evidence on Participation Trends
Males, 45 to 54 Years
Percent
90
--~---------------------,
88
87
86
85
,....,...,.....,T'~"'T'r'""T'"MT~..,...,=~r-""T'"",..-n,
1997
1999
20{11
2003
2005
2007
2009
2011
2013
2015
Females, 45 to 54 Years
l'tr('ent
78r-------------··-··----------- -------.
77
75
74
Note: The~ left panel depicls the three-month moving average of the labor force partidpation rate of
males aged 45 to 54 years (::~olid line), along with linear trends fitted to observations from 1997 to 2007
(short-dAShed line) and 2003 to 2007 (long-dashed line)_ The right panel depicts the three-month moving
average of the labor force participation ratP of females aged 45 to 54 years (solirlline), along with its mean
value from 1997 to 2007 (da,hed line)- Source: IlLS and authors' calculations.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00073
Fmt 6601
Sfmt 6601
Insert offset folio 26 here 30775.026
nshattuck on FSR297 with DISTILLER
10
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
68
FIGURE 6
The Underemployment Gap
1995
1997
1999
20{11
2003
20{)5
2007
2009
2011
2013
2015
Note: This figure depicts the three-month nwving average of the number of people employed part-time for
economic reasons as a fra.ctlon of total employment (solid liue) and the mean value of that ratio over the
period from 1994:1 to 2007:12. Source: BLS and authors' calculations.
Finally, it should be noted that the participation rate of males age 45 to 54 years has
recently moved up by nearly a full percentage point, rising from 85.3 percent last spring
to 86.2 percent in the latest BLS employment report. That development may reasonably
provide some reassurance that the labor market damage from the Great Recession is not
irreversible and that many other prime-age adults (both male and f~)rnaJe) as well as younger
adults will decide to rejoin the labor force if the job market continues to strengthen going
forward.
The Underemployment Gap
Gauging the underemployment gap seems relatively straightforward by comparison with the
challcmges of assessing the unemployment gap and the participation gap. As shown in Figure
6, the underemployment rate-· that is, the incidence of people working part-time for economic
reasons (PTER) as a fraction of total employment.·- did not exhibit any trend over the period
from 1994 through 2007. It seems implausible that the sudden rise in underemployment
during the Great Recession was caused by demographic or structural factors. And individuals
who arc underemployed are clearly not. "unemployable" (as some have suggested about the
long-t.erm unemployed or those who have dropped out of the workforce), since they arc
already working but simply can't find a full-time job. Indeed, BLS data indicate that the
average person classified as PTER is working about 23 hours per week.
and Economic Research 3:257-275, 201:3; and C. Erceg and A. Levin, "Labor Force Participation and
r..1onetary Policy in the Wake of the Great Recession. :F'or a contrary view, sec Aaronson ct al., ''Labor
fOrce Participation: Recent Developments and Future Prospects, Brookings Papers on Economic Activity,
2014.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00074
Fmt 6601
Sfmt 6601
Insert offset folio 27 here 30775.027
nshattuck on FSR297 with DISTILLER
11
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
69
Moreover, it seems unlikely that structural factors are the primary reason why the incidence of underemployment has only declined gradually over the past few years. After all,
if the economy were on its balanced-growth path and some employers preferred to shift
their workforce toward a greater number of part-time positions, then those employers would
need to offer a relatively higher wage to induce workers to take part-time jobs voluntarily··a
phenomenon that is certainly not evident in the current job market.
In light of these considerations, it is striking that the underemployment rate has only moved
about halfway back from its 2009 peak towa:rds its pre-recession level. That pattern might
well suggest that the overall magnitude of labor market slack may have diminished by a
similar proportion. In particular, as shown in Figure 2, the employment gap reached a
peak of about 6 percent in early 2010. Consequently, it may be reasonable to infer that
the employment gap currently stands at around 3 percent-that is, about a percentage point
higher than onr benchmark assessment. In effect, the evolution of the underemployment
gap reinforces the view that the uncertainty surrounding our benchmark assessment of the
employment gap is skewed to the upside.
The Wage Curve
We now move on to examine the extent to which measures of labor market slack over and
above the unemployment rate impact wages. Vve do so following the approach taken by
Blanehflower and Oswald, using data from the Merged Outgoing Rotation Group (MOR.G)
files extracted from the Current Population Survey (CPS) 15 The CPS is collected monthly
and is used to calculate the unemployment rate and other labor market aggregates published
monthly in the I3LS in the Employment Situation jobs release. 16 Data are available from
1990-2012, so with 50 states and the District of Columbia, there are 1,173 observations in
total. 17
Table 1 presents resull,s using the log of hourly earnings as the dependent variable, whereas
Table 2 nses weekly earnings. The results are essentially the same, so our discussion will
focus on the results shown in Table l.
15
D. Blanchftower and A. Oswald, The Wage Cttrve (Cambridge, MA: MIT Press, 1994).
16 Respondents
in the CPS are surveyed for four consecutive months (waves 1-4), and then after a four-month
break~
arc surveyt.'Ci for another four months (wavci:'! 5-8). The wage questions are only asked in waves 4 and
8) which are referred to as the "outgoing rotations." Each of the annual f\JORG files has approximatcly
170,000 wage observations. Data are aggregated to the level of state and year cell including both hourly
and weekly earnings as well a.s variables on age, gender, race and schooling. This is exact aggregation and
solves the Moulton problem. So a gender variable in the rnicro data file becomes a variable identi(ying
the proportion of workers in a state iu a particular year l and so on for the other variables. l\.1apped onto
the file are data from the BLS on the participation rate ns well a.s the proportion of the employed that. is
part-time for economic reasons a..s well as the number of the unemployed who have been unemployed for
less than 26 weeks; 26-52 weeks and more than 52 weeks.
17
Each regression includes the 19 personal control variables described in the previous footnote, a.s wdl as
a lagged dependent variable that helps mitigate biases of uncertain sign and magnitude that could result
from aggregation or missing variables. The start date of 1990 is determined by the availability of the labor
market status variables, whereas the wage data is available for prior years; hence the inclusion of a lagged
dependent variable does not constrain the length of our sa.mplc.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00075
Fmt 6601
Sfmt 6601
Insert offset folio 28 here 30775.028
nshattuck on FSR297 with DISTILLER
12
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
TABLE 1
Jkt 000000
U.S. State-Level Panel on Hourly Wages, 1990-2012
I) Long-Term Unemployment
PO 00000
Wage,. 1
Unemployment Rate,
0.6835
(340.65)
0.7101
(350.92)
-0.0279
-0.0266
(60.98)
(50.51)
Unemployment Rate,. 1
Frm 00076
%Unemployed >26 weeks,
0.6822
0.7060
0.6834
(340.56)
(350.53)
(3-10 60)
-0.0240
(50.32;
-0.0404
-0.0365
(90.47)
-0.0364
(80.04)
(80.50)
-0.0001
(0.45)
0.0002
(10.39)
% Unemployed >52 weeks,
-0.0004
Adjusted R
-0.0000
(0.05)
0.9947
0.9945
0.9947
0.9945
0.9947
0.9945
0.6825
0.6610
0.6534
0.6607
0.6534
0.6225
(320.42)
(320.40;
(290 85)
-0.0210
-0.0178
(40.27)
(30.64)
2) Underemployment
Sfmt 6601
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
Unemployment Rate,. 1
!330.55)
Unemployment Rate,
(320.67)
(320.04)
-0.0256
-0.0064
(60.46}
(10.25)
-0.0339
(80.73)
Non-Participation Rate,
Non-Participation Rate,.,
-0.0956
-0.0830
(40.94}
(40.33;
-0.0351
190.18)
-0.0906
(40.75)
-0.0823
(40.33)
-0.0954
-0.0925
(40.97)
(50.06)
Underemployment Rate,
-0.0213
(50.87)
Underemployment Rate,. 1
70
Fmt 6601
(10.88)
2
Wage,. 1
Insert offset folio 29 here 30775.029
0.7106
(360 00)
-0.0149
(40.22;
-0.0199
(50.59)
0.9947
0.9948
Adjusted R 2
0.9948
0.9947
0.9948
0.9949
Note: All equations include 50 state dummies, 22 year dummies; I 5 schooling variables plus age, gender and two race variables. All variables are in natural
logarithms. Each regression uses I, I73 observations. Each coefficient's !-statistic is shown below in parentheses. Source: BLS and CPS MORG files.
13
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00077
U.S. State-Level Panel on Weekly Wages, 1990-2012
1) Long-Term Unemployment
Wage,. 1
Unemployment Rate,
0.6499
0.6561
0.6840
0.6560
0.6790
(340.36)
(310.75!
(340.21)
(310.73)
(330.68)
-0.0441
-0.0443
(90.17)
Unemployment Rate,. 1
-0.0405
(70. 70)
(70.55)
-0.0449
-0.0460
(90.31)
(70.87)
%Unemployed >26 Weeks,
-0.0000
(0.08)
-0.0364
(70. 7/j
0.0001
(0.34}
%Unemployed >52 Weeks,
-0.0004
(10.53)
Adjusted R
2
0.6840
(340.21)
Sfmt 6601
0.9924
0.9924
0.9924
0.9924
0.9924
0.6499
0.6268
0.6!25
0.6128
0.6032
(330. 74)
(290.-17)
(280.75}
(290.46)
(280.75)
-0.0000
(0.08)
0.9924
2) Underemployment
Wage,. 1
Unemployment Rate,
-0.0424
(20.54)
-0.0423
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
(80.81)
Non-Participation Rate,
-0.1238
(50.37)
Non-Pa1ticipation Rate,.,
-0.0443
-0.0162
(90.35)
-0.1155
(20. 77)
-0.1207
(40.99)
(50.36)
(5004)
(50.19;
-0.1499
-0.1457
(60.54)
-0.03!4
(70.29)
Underemployment Rate,.,
-0.0264
-0.1172
(60.62}
Underemployment Rate,
0.5821
(260.26)
-0.0151
(80.90)
Unemployment Rate,_,
71
Fmt 6601
Insert offset folio 30 here 30775.030
TABLE2
-0.0313
(70.48)
-0.0259
(60.61)
2
0.9926
Adjusted R
0.9926
0.9927
0.9929
0.9929
0.9929
Note: All equations include 50 state dummies, 22 year dummies; 15 schooling variables plus age, gender and two race variables. All variables are in natural
logarithms. Each regression uses 1,173 observations. Each coefficient's !-statistic is shown below in parentheses. Source: BLS and CPS MORG files.
14
72
As shown in column 1 of the panel labeled "Long-term unemployment", the lagged dependent.
variable has a coefficient of 0.7106, consistent with interpreting this regression specification
as a wage curve rather than as a Phillips curve 18 The estimated coefficient of -0.0279 on the
logarithm of the unemployment rate is negative and statistically significant, with at-statistic
of around 7. A simple computation indicates that the long-run unemployment elasticity of
pay is -0.10, implying that a doubling of the unemployment rate is associated with a 10
percent decline in real wages 19 As shown in column 2, these findings are not sensitive to the
precise timing of the unemployment measure (using the rate in period t- 1 instead of period
t). Moreover, the results reported here are essentially the same as what Blanchflower and
Oswald found across many countries and datasets and are also consistent with the conclusions
reached by Nikjamp and .Poot in a meta-analysis of wage curve estimat~<; 20
The remaining columns of this panel confirm the findings of Bla.nchflower and Posen 21 In
particular, these regressions incorporate various measures of long-term unemployment that
are never statistically significant. Evidently, the pace of wage growth is linked to the overall
level of unemployment and does not depend on its composition, i.e., the relative incidence
of long-term vs. short-term unemployment.
The second panel of the table called "Underemployment," provides some new results. As
shown in the first two columns, the nonparticipa.tion rate (that is, 100 minus the participation
rate) has a negative and statistically significant effect on wage growth, consistent with the
findings of Blanchflower and Posen 22 Next, we incorporate the underemployment rate, which
is defined as the number of workers who say they are working part-time for economic reasons
as a percentage of total employment
shown in Figure 6). '.l'his coefficient estimate is also
negative and significant, and its inclusion does not influence the statistical significance of
the other key variables 2 a
Evidently, wage growth is pushed down by the unemployment rate, the nonparticipation
rate, and the underemployment rate. Thus, while the unemployment rate may have been
an adequate indicator of slack prior to the onset of the Great Recession, all of these forms
18
D. Card, "The Wage Curve: A H.eview, Journal of Ec..onornic Literntv. r-e 33:785-99.
19
Speeifically, this elastidty is computed as -0.0279/(1- 0.7106) = -0.0964.
20
Blan('hflower and Oswald 1 The Wage Curve; D. Blanchflowl."r and A. Oswald, ><The wage curve reloaded.
NBER Working Paper #11338, 2005; P. Nijkmnp and J. Poot, "The Last. Word on the Wage Curve?
Jour-nal of Economic Su:nwys 19: 421-50, 2005. Blanchflower and Oswald (The Wage Curve, p. 357)
stated: "Futurf'; work will have to begin to test for statistically signif-icant differences among numbers that
lie in a rough band from -0.05 t.o -0.20. It would probably he unwise to treat the minus-point-one rule as
more than one of thunlbl'.
21
D. Blanchfiower and A. Posen, "Wages and Labor !\Iarke!. Sla<'k: Making the Dual l\landat.c Operat.ional.
Peterson Institute for International Ec:onomics Policy Brief 14-10, 2014.
22
Blanchflower and Posen, "\Vages and Labor !vfarket Sla.ck; A. Paciorek C:Where Arc t.hc Construction
Workers? FEDS Notes, Board of Governors of the Federal Reserve System, February 26, 2015) found that
many individuals who are out of the labor force appear to be relatively good candidates for construction
employment, at least on the basis of their demographic charaeteristics. In partieular, he suggests there
may be '~a large pool of pt"ople who would find construction work attractive but did not enter the industry
during the bust years.''
23
The results are essentially the same in Table 2 using weekly earnings.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00078
Fmt 6601
Sfmt 6601
Insert offset folio 31 here 30775.031
nshattuck on FSR297 with DISTILLER
15
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
73
FIGURE 7
A Stylized Representation of the Wage Curve
Nominal
\V~e
Growth
Unemployment Rare
Note: The shadcrl area depicts the range for nominal wage growth that .Federal Reserve Chair Yellen has
described .as '(normal.'' Source: authors' calculations.
of labor market slack appear to be crueial in interpreting the sluggishness of nominal wage
growth over the past few years, as shown in Figure 1 24
Figure 7 presents our interpretation of the relationship between nominal wage growth and
the "true unemployment rate (including underemployment and nonparticipation). In particular, we suspect that the wage curve is relativdy flat at elevated levels of labor market
slack, i.e., a decline in slack docs not generate any signifieant wage pressures t1s long as the
level of slack remains large. As noted above, our benchmark analysis indicates that the true
unemployment rate is currently around 7! percent-a notable decline from its peak of more
than 10 pen:ent but still well above its longer-run normal level of around 5 percent;. Thus,
the shape of the wage curve can explain why nominal wage growth has remained stagnant
at around 2 percent over the past few years even as the employment gap has diminished
substantially. Moreover, our interpretation suggests that nominal wages will not begin to
accelerate until labor market slack diminishes substantially further and and the true nncm24 SN' D. Bdl and D. Blanchflower C'How to !'\'Ieasure Und('r<'mploymr-nt? P('trrson Institute for Intcrnat.ional
Economics Working Paper 1:3/2, AuguBt 2013; "Underemployment in the CK Revisited, National Institute
FJconomic Revir:w, 224: F8-F22, 2013; "Labour l\1arket Slack in the UK, National Instit'ute Economic Review, 229:F4-F11, 2014) for mon~ on underemploymcl!t. in the United Kingdom ba..qed on preferences over
hours. \Vorkers are asked in t.he Lahour l:'Orce Survey, whkh is the equivalent of the CPS in the United
States, if they want more or less hours. These responses can be aggregated to the economy level. From
2000 to 2008 there wa.s 110 underemployment as the number of hours of those \vho wanted more hours
approximately equaled the number of hours of those who want fewer hours. Since 2008 the numbers who
want more hours dominate to such a degree that undercmploymeut currently is approximately 1.8 percPnt
on top of the unemployment rate itself. It also turns out that one-third of the extra hours currently come
from full-time workers, suggesting the measure we use iu the US is an underestimate of the true amount
of underemploymt?nt by around 50 percent.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00079
Fmt 6601
Sfmt 6601
Insert offset folio 32 here 30775.032
nshattuck on FSR297 with DISTILLER
16
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
74
ployment rate approaches its longer-run normal level of around 5 percent.
Monetary Policy Implications
No macroeconomic model provides a completely satisfactory description of any economy in
the real world. Indeed, the limitations of existing macroeconomic models have been underscored by the incidence of relatively large and persistent forecast errors in many advanced
economies over the past few years 25 Thus, rather than relying on the monetary policy implications of any single macro model, it seems sensible to consider simple reference rules
that provide reasonably robust performance across a range of plausible models. Such rules
can serve as valuable benchmarks in the decision-making process and in explaining those
decisions to the public. 26
Following the seminal analysis of Taylor, a simple rule-of-thumb for adjusting the level of the
federal funds rate can be expressed as a weighted sum of four components: the equilibrium
real interest rate, the actual inflation rate, the inflation gap (that is, the deviation of inflation
from the central banks inflation objective), and the level of resource slack. 27 \Ve discuss each
of these components in turn.
The equilibrium real interest rate (T') is defined as the short-term real interest rate at which
the economy evolves along its balancC'd-growth path and inflation remains stable at the
central banks objective. As with other properties of the balanced-growth path, the value of
r* cannot be directly measured hut must be inferred from observed economic and financial
data. In our analysis, the value of r' is given by the consensus outlook in the Philadelphia
Feds Snrvey of Professional Forecasters (SPF) regarding the 5-to-10-year ahea.d projection
for the average value of the :)-month Treasury hill rate less the PCE inflation rate. Thus.
1.25 percent 2 ~
using the results of the latest SPF (published in }"'ebruary 2015), we set 1"'
Inflation and the inflat-ion gop. The FOMC ha.<; established an inflation objective of 2 percent,
expressed in terms of the price index for persona.! consumption expenditures (PCE). In
measuring a.ctual inflation, we mitigate tlw influence of transitory price shocks by focusing
on the 12-rnont.h percent change in the core PCE price index (that is, excluding food and
energy prices). In the latest reading, this measure of inflation was 1.:n percent, and hence
25 See C. Romer and D. Romer, ·~l")rogTBm Heport: The NI3ER I\1oneta.ry Eeonomics Program, National
Bun'a.u of Ecouomie Research Report 1,17, 2014.
26 Sce J. Taylor, "Discretion Versus Policy Rules in Prklctire, Carnegie-Rochester Conference Series on Public
Policy 3~):195214, 1993; .L Taylor and .J. Williams, "Simple and Robust Rules for ;>.1onetary Policy, Handbook of Monetary Economics, 2010; A. Levin and .J. Taylor, ''Falling Behind the Curve: A Positive Analysis
of Stop-Start Monetary Policies and the Great Inflation, iu The Great Inflation, Bordo, M., Orplumidf's,
A .. eds., Chica~o, IL: University of Chk:ago Press, 201:1; a.nd A. Levin, "The Design and Communication
of Systematic. Monetary Policy Strategies.
27
Spcdfically, such a rule can be expressed <:l..S follows: it
r" + rr 1. + o(r.t - 1r'") + /3gap1 , where it denotes
the target federal funds rate, r* denotes thP equilibrium real interest rate, Trt denotes a smoothed measure
of inflation, n* denotes the inflation objective, gapt is a rneasurE' of resource slack and the coefficients n
and ,3 indicate how mueh the int~~rest ratt~ should be adjusted in response to the inflation gap (nt ~ rr")
and to resource slack, respectively. Sec .J. Taylor, ''Discretion Versns Policy Rules in Practice.
28
This value of the equilibrium real interest rate is about. 25 basis points lower than the median of F'OMC
participants longer-run real interest. rate projections in the latest SEP (published in mid-March).
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00080
Fmt 6601
Sfmt 6601
Insert offset folio 33 here 30775.033
nshattuck on FSR297 with DISTILLER
17
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
75
TABLE 3
Prescriptions of the "Balanced Approach" Rule
under Alternative Assessments of the Employment Gap
Employment
True
Unemp. Rate
Funds Rate
Prescription
Benchmark Estimate
1.9
7.4
0.29
Lower Natural Rate
(4.8 percent)
2.2
7.7
-001
Higher Potential Labor Force
(CEO 2013)
3.6
9.1
-1.44
Higher Potential Labor Force
and Lower Natural Rate
3.9
9.4
-1.74
Assessment
Source: BLS, Blue Chip Econmnic Indicators, CBO. SPF, and authors' C'akulations.
the inflation gap was 0.69 percent.
Re8ource slack. In light of onr foregoing analysis, we measure resource slack in terms of the
total employment gap. In addition to our benchmark estimate, we consider the implications
of several alternative assessments of labor market slack.
For the sake of brevity, our analysis focuses on one specific rule-of-thumb that was analyzed
extensively by Taylor. 29 This rule prescribes the level of the federal funds rate as the weighted
sum of the equilibrium real interest rate, the current inflation rate, the inflation gap, and
the level of resource slack, with weights of 1.0, 1.0, 1.5, and 1.0, respectively. This particular
specification has been shown to provide a reasonably balanced approach to fostering the
stability of inflation and economic activity, and hence Yellen characterized it as the "balanced
approach rule. 30
As shown in 1:qblc :3, this policy rule prescribes a target f(~deral funds rate of about ~
percent using our benchmark estimate of the employment gap. However, the implied funds
rate is notably lower for other reasonable tt,sessments. Indeed, using CBO's February 2013
project.ion for the potential labor force (as depicted in Figure 4) along with a natural rate of
4.8 percent (cousistent with analysts pre-crisis projections), the employment. gap is uearly
twice as high at around '1 percent, and the funds rate prescription is nearly 2 percentage
29
J. Taylor ('~A Historical Analysis of Ivlonetary Policy Rules, in J. Taylor, ed., Monetary
Rules;
University of Chicago Press, 1999) reported on a comprehensive analysis of the performance
policy rules across a wide range of macroeconomic models.
simple
:{0Yellen, '1Perspectiv(>S on tvlonf'tary Polley.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00081
Fmt 6601
Sfmt 6601
Insert offset folio 34 here 30775.034
nshattuck on FSR297 with DISTILLER
18
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
76
points below zero.
This analysis indicates that initiating the process of monetary policy tightening would be
premature at the present time. 1ndeed, such a policy move would be a serious mistake in
light of substantial downside risks to the currC'nt economic outlook. Rather, liftoff from the
zero lower bound should be deferred until labor market slack has diminished further and
iHfhttion has moved up closer to the FOIV1Cs 2 percent inflation goal.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00082
Fmt 6601
Sfmt 6601
Insert offset folio 35 here 30775.035
nshattuck on FSR297 with DISTILLER
19
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
77
Making the Federal Reserve Fully Public:
WhyandHow
Jordan Haedtler, Andrew Levin, and Valerie Wilson*
August 2016
Abstract: The Federal Reserve's governance structure is outdated and inadequate for ensuring that the
Fed serves the public interest. In this paper, we examine the case for making the Fed fully public ("why"),
and then we consider specific proposals for doing so (''how"). Our analysis indicates that pragmatic and
nonpartisan retonns can strengthen the Federal Reserve's governance while enhancing its operational
independence to pursue its statutory mandate without political interference. In particular, the Fed should
be a fully public institution whose decision-makers are selected by open and transparent processes;
indeed, we find that making the Fed fully public also yields significant benefits for American taxpayers.
Moreover, the Fed should be held to the same standards of transparency and accountability as every other
public agency, including comprehensive annual reviews by the Government Accountability Office (GAO)
and applicability of the Freedom of Information Act (FOIA) to all aspects of the Fed's procedures and
operations.
~ Hacdtler is the campaign manager of the Fed Up Coalition, Levin is a professor of economics at Dartmouth College, and
Wilson is director of the Economic Policy Institute's Program on Race, Ethnicity, and the Economy. We appreciate very helpful
comments, suggestions, and background research t}om Maggie Corser, Ady Barkan, Dean Baker, Josh Bivens, Jared Bernstein,
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00083
Fmt 6601
Sfmt 6601
Insert offset folio 36 here 30775.036
nshattuck on FSR297 with DISTILLER
and Bill Spriggs.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
78
I. Introduction
When the Federal Reserve System was founded in 1913, its fundamental purpose was to serve as the
"bank to the bankers "-that is, a secure depository for bank reserves and a source of funds during
liquidity sh01tages. Thus, like nearly every other central bank of that era, the twelve regional Federal
Reserve Banks were established as essentially private institutions, owned and managed by commercial
banks under the broad oversight of the Federal Reserve Board (which is an independent federal agency).
Over the past century, however, the Federal Reserve has evolved into America's central bank, and its
monetary policy decisions now affect the everyday lives of practically every American family. For
example, when the Fed acts to adjust the level of short-term interest rates, that adjustment is reflected in
a wide array of interest rates and asset prices, including auto loan rates, home mortgage rates, savings
deposit rates, business financing costs, and so forth. And those financial effects reverberate on the broader
economy, affecting consumer spending, business hiring and investment, and the determination of wages
and prices.
Unfortunately, the Federal Reserve's governance structure is outdated and inadequate for ensuring that
the Fed serves the public interest. The presidents of the Federal Reserve Banks sit on the Federal Open
Market Committee (FOMC), which determines the course of monetary policy, but the Federal Reserve
Banks are private institutions owned by commercial banks. Indeed, commercial banks select two-thirds
of the directors of each Federal Reserve Bank, including half of the directors responsible for appointing
its president. Moreover, while the demographics of America have grown increasingly diverse over time,
the leadership of the Federal Reserve Banks (that is, the presidents and the directors) has remained
overwhelmingly white, male, and insular-Dominated almost exclusively by long-time Fed insiders
and individuals with a tinancial background.
Moreover, the Fed's private ownership is now out of step with practically every other major central bank
around the world. For example, the Bank of Canada and the Bank of England became public in 1938 and
1946, respectively, while the European Central Bank has been a public institution since its inception in
the 1990s. Nearly all of the 19 national central banks in the eurozone are fully public; the lone exceptions
are Belgium, Greece, and Italy. And the Bank of Japan and the Swiss National Bank each have miniscule
amounts of outstanding shares, the majority of which are held by other public institutions.'
In this paper, we examine the case for making the Fed fully public ("why"), and then we consider specific
proposals for doing so ("how"). Our analysis indicates that pragmatic and nonpartisan reforms can
strengthen the Federal Reserve's governance while enhancing its operational independence to pursue its
statutory mandate without political interference. In particular, the Fed should be a fully public institution
whose decision-makers are selected by open and transparent processes; indeed, we find that making the
Fed fully public also generates significant bene!lts for American taxpayers. Moreover, the Fed should be
held to the same standards of transparency and accountahility as every other public agency, including
comprehensive annual reviews by the Government Accountability Office (GAO) and applicability of the
Freedom of Information Act (FOIA) to all aspects of its procedures and operations.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00084
Fmt 6601
Sfmt 6601
Insert offset folio 37 here 30775.037
nshattuck on FSR297 with DISTILLER
1
The paid-in capital of the Bank of Japan (BOJ) is fixed at a miniscule amount of I00 million yen (roughly $1 million) that
accrues a tiny stream of dividends (about $50,000 per year). Moreover, the Japanese government owns 55 percent of the BOJ's
paid-in capital, and its other shareholders do not have any role in the BOJ's oversight or management. The paid-in capital of the
Sv,riss National Bank is fixed at 25 million CHF (about $25 million), of which roughly two-thirds is held by public institutions.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
79
2
II. The Rationale for Fed Reform
A. Deficient Selection Procedures
As noted above. the FOMC sets the nation's monetary policy. Under the Federal Reserve Act, the FOMC
has a nuanced structure in which the seven members of the Fed's Board of Governors and the president
of the Federal Reserve Bank of New York are all permanent voting members, while four of the other
eleven presidents serve as voting members on a rotating basis. That design was intended to ensure that the
Federal Reserve Bank presidents-as heads of private institutions-would only constitute a minority of
the voting members of the FOMC. In recent years, however, the Fed's Board of Governors has regularly
experienced multiple vacancies, reflecting a more extensive timeframe for vetting potential nominees a~
well as a more protracted duration of the Senate confirmation process. Thus, the members of the Board of
Governors have constituted a voting mi\jority at only half of the FOMC meetings from 2001 to 2008 and
less than one-third of the FOMC meetings since then. 2 ln effect, increased political gridlock ha~ expanded
the intluence of the Federal Reserve Bank presidents in setting the nation's monetary policy 3
Despite the crucial role of Reserve Bank presidents in determining the nation's monetary policy, the
process for selecting them takes place entirely behind closed doors. Recent Reserve Rank presidential
appointments have revealed a process that is opaque, inbred, and largely proforma. The Federal Reserve
Act establishes the procedure for selecting Reserve Rank presidents. The Federal Reserve Board describes
the process as follows: ''To conduct the search, the Reserve Bank's hoard of directors forms a search
committee composed of Class B and C directors. That committee hires a search firm to help identify a
broad, diverse, highly qualified candidate pool. The committee considers a large nationwide pool of
candidates, both within and outside the Federal Reserve System, who meet the position's qualifications. " 4
Beyond these legal guidelines, very little information is publicly available regarding how Reserve Bank
presidents are chosen. The public is kept in the dark about the candidates heing considered, the time line
for their selection, and the criteria used to assess candidates' qualifications. When the Reserve Bank
presidents in Philadelphia, Dallas, and Minneapolis announced their retirements in 20!4, the stage was set
for a preview of the re-appointment process set to take place in 2016. One by one, the presidential
vacancies at all three Reserve Ranks were filled by individuals who had previously been affiliated with
the same large bank, and the Board of Governors unanimously approved each of those appointments:'
At the Dallas and Philadelphia Reserve Banks, the individuals chosen had heen involved in their own
selcction 6
These, however, are not the only examples of Reserve Bank presidents having an inside track to selection.
A 2015 analysis conducted by the Bipartisan Policy Center found that 17 of the 25 Reserve Bank
2
Indeed, there have been three FOMC meetings at which tl1ere were only four members of the Board of Governors, and hence
they comprised a minority of the voting members of the FOMC.
hfm:~.:www. hrookings.edul-;media 1researchl(ifes 'papers 120 15'03/02-(ed-banks-21 stcentun/pcb workinwaoer) 0 june24 final. pdf.
4
hllps:/lwww.kderalreserve. gov/faqs,how-is-a-federal-resen'f-bq!11::J2Lesident-selecte.ci. IUlJl.
3
5
https:.:~'www.thenation.comlarticle/;vhy-do-!Ormer-goldman-sachs-bankers-keep-landing-for-slots-at-the-federa!-reserve'
6
http:/'1tww. bloomberg_r.;_om/neH's/artic/es/20 I5-06-03/not-(ar-to-lf22.!s::[ed-s-newest-president-searched-f0und-himself:
http:l bi::Q_eatblog.rfgjlasnews.com'20J5;0S.'dall@:ie.4::11{1_!.1J.f!J...·:lJ..q~:,·ard-businf~liJ_j_essor-as-nelJ:::J2If!Sident.html 1
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00085
Fmt 6601
Sfmt 6601
Insert offset folio 38 here 30775.038
nshattuck on FSR297 with DISTILLER
1
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
80
3
presidents since 1990 "have been immediate past employees or board members of a regional bank." 7
In response to recent concerns members of Congress raised about the re-appointment process for
Federal Reserve Bank presidents being an "inside game," leaders at the Fed noted that the Board
of Governors conducts ''ongoing monitoring" m1d an annual review of Reserve Bank presidents'
performance, and that when the time came to re-appoint or replace presidents, the Board of Governors
would "act on the recommendations" of the boards of directors. 8 In 2016, all Reserve Bank presidents
were re-appointed to new terms 9
The re-appointment process is proforma and insular. Indeed, Federal Reserve Bank presidents do not
conceive of their own appointments as having five-year terms; rather, they mostly expect to serve until
they retire or are aged out. One example of the process' perfunctory nature is the routine re-appointment
of presidents who can't possibly serve the bulk of their term due to mandatory retirements.
To ensure that a wider breadth of candidates-not just those with backgrounds at the Fed and within the
financial sector-are considered, the Fed must bring this process out from the shadows.
B. Lack of Diversity
In 1977, Congress amended the Federal Reserve Act to include reforms requiring that Federal Reserve
leaders "represent the public, without discrimination on the basis of race, creed, color, sex, or national
origin, and with due but not exclusive consideration to the interests of agriculture, commerce, industry,
services, labor and consumers."
Despite these effmts to fonnally align the institution with current antidiscrimination laws and to expand
diversity on Federal Reserve Bank boards of directors, the Federal Reserve remains wholly
unrepresentative of the public, in terms of racial, gender, and professional diversity:
•
nshattuck on FSR297 with DISTILLER
•
VerDate Sep 11 2014
13:49 Sep 24, 2018
No African American or Latino has ever served as president of any Federal Reserve Bank.
At present, ten of the twelve Federal Reserve Bank presidents are white men; two are women,
and only one is non-white.
The directors of the Federal Reserve Banks are predominantly white men; specifically,
83 percent are white and nearly three-fourths are men.
About five years ago, the GAO reported that consumer groups and labor organizations were
significantly underrepresented on Federal Reserve Banks' boards of directors. 10 Since then,
however, the share of directors from banking and commerce has increased even further.
Less than 5 percent of all Federal Reserve Bank directors represent organizations governed
by community members and employees.
Jkt 000000
PO 00000
Frm 00086
Fmt 6601
Sfmt 6601
Insert offset folio 39 here 30775.039
•
•
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
81
4
C. Consequences for Decision-Making
Diversity is more than just a symbolic gesture of fairness and inclusion. Empirical analysis clearly shows
that diversity, especially within public organizations, enhances the pursuit of policies and practices that
meet a broader range of public needs and expectations and even improves organizational performance.''
This operates through direct as well a~ indirect channels. When included in decision-making roles,
members of underrepresented groups tend to act to ensure that the interests of those who share their group
identities are not overlooked. Additionally, their presence in these roles also influences non-minority
decision-makers by exposing them to information that may be beyond the scope of their personal
experience.
The advice of Federal Reserve Bank directors and the background of Federal Reserve Bank presidents are
undoubtedly key factors that contribute to the FOMC's deliberations. The attitudes, perspectives, and life
experiences that Federal Reserve Bank presidents and board directors take to the FOMC have an
enormous bearing on the Federal Reserve's decisions, which in turn have major implications for public
well-being. The outsized voice of the commercial banks in selecting regional Federal Reserve directors
significantly affects the capacity of the Federal Reserve Banks to fulfill their responsibility for assessing
and characterizing economic conditions in their respective regions. And the resulting lack of diversity of
the Federal Reserve Bank presidents-in terms of race, ethnicity, gender, educational background and
professional experience--haq substantive consequences for comprehensively and accurately assessing the
strength of the economy in advance of making monetary policy decisions.
Of course, the Fed is not charged with alleviating the full range of structural factors that lie at the root of
racial inequality, and its monetary policy tools would be poorly suited to address those factors. However,
monetary policy actions can significantly affect the pace of an economic recovery and hence have effects
on employment and wages by shifting the balance of power between workers and employers. These
effects tend to be disproportionately large for specific demographic groups because tighter labor markets
also make it more costly for employers to discriminate. Thus, it is appropriate for the Fed to consider
those etiects in setting the course of monetary policy, but the transcripts ofFOMC meetings provide
little evidence that Fed officials have actually done so.
In particular, African American workers suffer disproportionately from labor market downturns and
benefit markedly from economic recoveries. The unemployment rate for blacks typically moves twice as
much as the national unemployment rate. 12 And the unemployment rates of black teenagers and young
adults--especially those without a college degree-are even more sensitive to shifts in the stance of
monetary policy . 13 Nonetheless, even as national unemployment hovered at crisis levels in 20 l 0, the
FOMC meeting transcripts reveal that Fed officials never made a single reference to the abysmal labor
market conditions of African Americans."
11
J.J. Hindcra.. Representative bureaucracy: Fmther evidence of active representation in the EEOC district offices, Journal of
Public Administration Research and 7heory 3(4):415-429, 1993. S.E. Page. The difference: How the power ofdiversity creates
better groups, firms, schools and societies, Princeton University Press, 2007. S.C. Selden. l11e promise of representative
democracy: Diversity and responsiveness in a government agency, M.E. Sharpe, 1997.
12
http.-i/www.fJ2L.Qcgj}ublication 1the-impact~o(:full~emplovment~on-akican-american-e..mplQJ}nent-and-'ff&§f
u http:/ 'www. npc.umich. edu/publications/working paperslpaperl 0/03-1 Orev2.pd{
14
bJJQs;_;j)jjes.google.com/site/kocherlakota009/home/policr/thouglus-on~ooli_q/l-18-!6.
In 2010 the unemployment rate
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00087
Fmt 6601
Sfmt 6601
Insert offset folio 40 here 30775.040
nshattuck on FSR297 with DISTILLER
for African Americans exceeded 15 percent-more than 5 percentage points higher than the national unemployment rate.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
82
5
To see the positive side of these dynamics, it is helpful to revisit the experience of the late 1990s. By
2000. the average annual unemployment rate had fallen to 4 percent-its lowest level in generations, and
the deviation between unemployment rates for blacks vs. whites was only 4. I percent-notably smaller
than in the 1980s or the 2000s. In addition to these substantial employment gains, the real wages of
black workers grew by 2 percent per year during the late 1990s-a tad faster than the wage growth of
1.7 percent per year for whites [FigureD from Full Employment tables &figures.xlw]. These
employment and wage gains translated into improved living standards for African American households.
The share of African American households in the middle 60 percent of the income distribution rose
3 percentage points between 1995 and 2000, whereas that share declined during the recoveries of the
1980s and the 2000s.
It is important to note that these desirable outcomes stemmed from a full employment economy without
any acceleration in the rate of inflation, suggesting that policymakers should be willing to experiment
aggressively with low rates of unemployment for the sake of improving conditions in some of America's
hardest-hit communities without undue concem about keeping inflation rates in check. Such
considerations may be more likely to occur among a group of policymakers who are familiar with the
wide range of economic outcomes in an increasingly diverse and unequal society.
The Fed's lack of sectoral diversity is also a problem. When major corporate figures from a variety of
industries are included on the Reserve Banks' boards, the Fed considers its requirement to represent an
array of economic interests fulfilled. But multi-millionaire CEOs have an inherently different
understanding and perspective than small business owners, debtors, students, middle- and low-income
workers, and those seeking credit. 15 In practice, that lack of diversity has frequently skewed concerns
within the Fed toward inflation and down played the importance of achieving full employment. Indeed,
Baker and Bernstein (2013) analyzed the deviation of unemployment from its full-employment level
and found that the cumulative gap from 1980 to 2012 was about 3 I percentage points.
Finally, the Fed's current governance structure contributes to a "group-think" approach that may explain
why policymakers failed to recognize key warning signals prior to the onset of the financial crisis. Indeed,
Greider (2014) notes that " ... reliance on a narrow frame of reference produces institutional blind spots and
gross errors ... The telling evidence lies in what the Fed does not talk about.lfyou scan the public record
over the last generation, you might conclude that the policy-makers were unaware of the grave disorders
that were steadily accumulating. Or that they believed the economic pressures assaulting citizens were
not relevant to monetary policy. Whatever the explanation, the Fed missed the big story-the steady
economic deterioration stalking the middle class-just as it did not see the reckless behavior in banking
that would lead to collapse."
VerDate Sep 11 2014
13:49 Sep 24, 2018
http:i 'l.r-a·w. bi=journals.com/twincities/news/20 15/08ll9/general~milfs~cJz.9-ken-powell-pav-fm•offs. html
Jkt 000000
PO 00000
Frm 00088
Fmt 6601
Sfmt 6601
Insert offset folio 41 here 30775.041
nshattuck on FSR297 with DISTILLER
15
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
83
6
III. Strengthening the Fed's Governance
Legislative action will be required to make the Federal Reserve into a fully public institution. Of course,
amending the Federal Reserve Act is a delicate matter. and it is crucial to ensure that such legislation
strengthens the Fed· s governance and enhances its operational independence to carry out its statutory
mandate. In this section, we provide a detailed analysis of the governance reforms proposed by Levin
(20 J6), and then we compare this approach to the proposals of Conti-Brown (20 15) and Fisher (20 16).
A. Ownership
Current Law. Each regional Federal Reserve Bank is a private institution that is legally owned by
commercial banks-referred to as member banh-whose headquarters are located within its district. 16
Indeed, the Federal Reserve itself refers to the member banks as "stockholders" who purchase shares
of equity and thereby supply the Fed with paid-in capital." Those shares cannot be transferred or sold;
i.e., each Federal Reserve Bank is in essence a privately-held corporation.
The equity issued by each Federal Reserve Bank-and hence the amount of its paid-in capital-is
determined by the equity of its member hanks. Specifically, each member bank is required to provide
paid-in capital to the Fed that is equal to three percent of its own equity (that is, its capital plus surplus). 18
If a memher bank's equity increases, then it must purchase a corresponding amount of additional shares
from its Federal Reserve Bank. Conversely, if a member bank is liquidated or its equity shrinks, then the
Federal Reserve Bank cancels the corresponding an10unt of shares and refunds that amount back to the
member bank.
As with many privately-held corporations, each Federal Reserve Bank pays dividends to its shareholders.
Under current law, the dividend rate for the larger member banks (assets exceed $10 billion) is given by
the yield on 10-year U.S. Treasury notes, while the smaller member banks (assets less than $10 billion)
receive a fixed dividend rate of6 percent. 19 As of year-end 2015, the Fed's paid-in capital totaled $29.5
billion, of which $27.4 billion was provided by the larger member banks, and $2.1 billion was provided
hy the smaller member banks 20
Proposed Reform. All of the regional Federal Reserve Banks should become public corporations that are
fully owned by the American people. This transformation would be remarkably straightforward, because
the Fed can simply follow the procedures that it already uses for making adjustments to the shares of
individual member banks. Each Federal Reserve Bank will cancel all of the shares of its member banks
and refund their paid-in capital along with the prorated amounts of any accrued dividends; those relunds
will be issued by crediting each bank's account at the Federal Reserve Bank.
10
All nationally-chartered banks are required to be members of the federal Reserve System. Such membership is voluntary for
state-chartered banks, but in practice only a fCw small banks decline that option.
17
!JJ.!JlJ..:/www. te..s;lerafr_gg.rt.:s:.:.gov 1newsevenJs/vress/bcrgg::_Qs;n:gl0 160218a ].pdf
18
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00089
Fmt 6601
Sfmt 6601
Insert offset folio 42 here 30775.042
nshattuck on FSR297 with DISTILLER
Under cunent law, the Board of Governors has authority to call on each member bank to provide additional paid-in capital up
to a maximum of6 percent of its own equity; however, that provision has never been used in practice.
19
These dividend rates became effective on January I, 2016; prior to that date, all member banks acc111ed dividends at the fixed
rate of 6 percent.
20
The total amount of paid-in capital is shown in the .. Federal Reserve Banks Combined Financial Statements'' of
the Federal Reserve's annual report (http:/·www.kderalreserve.govlpublicationslannual-renort/2015-contents.!Jlm). The subtotals
corresponding to large member banks and smaller member banks, respectively, were obtained from the fDIC database of
'·Statistics on Depository Institutions" (/lttps:l/www5.fdic.f!ov/sdi).
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
84
7
This approach to making the Federal Reserve fully public does not involve any change at all in the current
value of U.S. government debt. Moreover, this measure will not have any effect on the size of the Fed's
balance sheet but will simply modifY the composition ofthe Fed's liabilities. In effect, the Fed will be
paying off one form of liability-namely, member banks· paid-in capital-by expanding another type
of liability, namely, member banks' reserves held at Federal Reserve Banks.
Indeed, this measure will augment the Fed's net income, because the stream of dividend payments is
much more costly than paying for the equivalent amount of bank reserves held at the Fed. For example,
the dividend rate that the Fed pays to the larger member banks (i.e .. the 10-year Treasury yield} is now
close to 1.5 percent-roughly a percentage point higher than the rate of interest that the Fed currently
pays on bank reserves. Of course, the precise magnitude of this spread varies somewhat over time, but the
consensus of professional forecasters is that tl1c spread will remain roughly unchanged over the coming
decade 21 As for the smaller memher banks, the interest rate on reserves is currently far below the fixed
dividend rate of 6 percent, but that spread is expected to narrow over time as the level of short-term
interest rates moves gradually upwards.
Thus, making the Federal Reserve fully public will generate significant ben4itsfor American taxpayers,
because the Fed generally transfers all of its net income to the U.S. Treasury .22 For example, at the current
level of interest rates, the annualized amount of the Fed's dividend payments is about $540 million. 21
By transfonning its paid-in capital into bank reserves, the Fed would instead pay about $150 million in
interest. In effect, this transformation would increase the Fed's annual net income by nearly $400 million
per year. Even with the level of interest rates rising gradually over time, the benefit to taxpayers will
continue to exceed $300 million per year.
Indeed, if we cumulate the annual amounts over the coming decade, the savings to taxpayers from making
the Fedfitlly public is likely to be well over $3 billion. As we have already emphasized. the fundamental
rationale for making the Fed public is to enhance its governance, accountability, and transparency.
Nonetheless, the magnitude of these fiscal benefits is substantial and thereby makes the case tor enacting
this refonn even more compelling 24
The Federal Reserve Bank of Philadelphia regularly collects professional fOrecasters' projections of the longer~n.m average
level of interest rates (!mps:/l1fww.philadelphiakd. oro/re.rg_qn:;lJ-qntfrJ.qJa/real-!i!!..!JL:fJ;lJ.!£.r~<>urvev-o(-pJ:Q[gt!l.Qnal-forecas{t;J.:2.
fn the most recent projections (published la<>t February), the median projection was 2.5 percent for the 3-month Treasury bill rate
and 3.4 percent for the 10-year Trea.<:ury yield~ i.e., the spread between those rates is expected to average 0.9 percent over the
next decade-just a notch lower than the current spread.
22 Under current law, the Federal Reserve maintains a surplus capital account that is capped at $10 billion, and any net income
exceeding that amount must be remitted to the U.S. Treasury. The Fed's net inwme has remained positive throughout its history,
but if its net income ever tumed negative the Fed would draw down its surplus capital and suspend the transfer of funds to the
2l
U.S. Trea.:;ury.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00090
Fmt 6601
Sfmt 6601
Insert offset folio 43 here 30775.043
nshattuck on FSR297 with DISTILLER
23
As noted above. the Fed is currently paying a dividend rate of about 1.5 percent on the $27.2 billion of paid-in capital provided
by the larger member hanks and a fixed dividend rate of 6 percent on the $2.3 billion in paid-in capital provided by the smaller
member banks~ consequently, those annual dividends are about $410 million and $140 million. respectively. By transfom1ing all
of its paid-in capital into bank reserves, a fully public Fed would instead pay its current interest rate of 0.5 percent on those bank
reserves.
14
Making the Fed fully public may also he viewed positively by commercial banks, because the Fed would refund all of their
paid-in capital, which the banks could then invest in the broader economy. Indeed, that is precisely the rationale for 1-LR. 5027,
a bill recently proposed by Rep. Neugebauer that would return most (but not quite all) of the Fed's paid-in capital to the banks.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
85
8
B. Appointment of Federal Reserve Bank Officials
A key element of making the Fed fully public is that the appointment of Federal Reserve Bank officialsthat is, directors and presidents-should occur through an open and transparent process that provides
extensive opportunities for public input.
Directors. Each Federal Reserve Bank should continue to be overseen by a board of nine directors who
serve staggered three-year terms. Under current law, the member banks select six of those directorsnamely, three employees of member banks, and three individuals not employed by any member bankwhile the remaining three directors are appointed by the Fed's Board of Governors. In contrast, once the
Fed becomes fully public, it would no longer be appropriate for the commercial banks to have any special
role in selecting any of the directors. Instead, all of the directors should be selected through a process
overseen by the Board of Governors and involving elected officials of each Fed district.
A fundamental reason for the Fed's regional structure is to ensure that the nation's geographical diversity
is reflected in the Fed's monetary policy decisions. Thus, every candidate for director should be
nominated by at lea<>t one senior elected official--either a governor or member of Congress-from the
geographical area covered by that particular Federal Reserve Bank. The Board of Governors would
appoint a search committee to narrow down the list of candidates a'> needed, and then the Board of
Governors would make the final decision through a recorded vote.
The appointment process should ensure that directors are broadly representative of the public in terms of
racial/ethnic and gender diversity, educational background, and professional experience. The majority of
directors on each board should be affiliated with small businesses and non-profit organizations, including
community and consumer groups, labor unions, and academic institutions. To avoid conflicts of interest
and protect the integrity of the Federal Reserve's role in regulating the banking industry, individuals
affiliated with financial institutions overseen by the Fed should be prohibited from serving as directors.
To ensure a sufficiently high degree of transparency, the appointment process would include the
following elements: (i) publication of the selection criteria and time line; (ii) public forums at which
members of the public can meet with the search committee; (iii) publication of the names of all candidates
under consideration; and (iv) opportunities for members of the public to submit questions to the
candidates, either electronically or at a public forum.
Presidents. The board of directors of each Federal Reserve Bank should maintain responsibility for
appointing and overseeing its president. Under current law, that appointment is made by only six of the
directors, namely, the three non-bankers chosen by the member hanks and the three individuals appointed
by the Board of Governors. In contrast, once the Fed becomes fully public, all nine directors would he
responsible for making that decision.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00091
Fmt 6601
Sfmt 6601
Insert offset folio 44 here 30775.044
nshattuck on FSR297 with DISTILLER
To ensure a high degree of transparency, the process of appointing Federal Reserve Bank presidents
should be reformed so that each board of directors takes nominations from the public, publishes a list of
all eligible nominees, and engages in a selection process involving genuine public participation through
public forums and other forms of input and feedback.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
86
9
C. Terms of Office
Terms of office play a crucial role in ensuring that a central bank has an appropriate degree of operational
independence and accountability. If the term of office is fairly short and subject to renewal, then
policymakers may be susceptible to political interference that could impair the central bank's ability to
carry out its statutory mandate. Conversely, it would not be appropriate for central bankers to have
permanent lifetime appointments, because the central bank is an agency with delegated authority,
not an autonomous branch of government like the judiciary.
In their comprehensive study of central bank independence and transparency, Eichengreen and Dincer
(2014) have noted tlJat the international best practice is for monetary policymakers to be appointed to a
single nonrenewable term that exceeds the length qfthe political cycle. 25 Indeed, that standard is already
followed by several other major central banks. For example, the president of the European Central Bank
and the governor of the Bank of England each serve a single nonrenewable term of 8 years, while the
governor of the Bank of Canada has a 7-year term 26
By contrast, the current terms of office of Federal Reserve policymakers are not consistent with that
standard. The Federal Reserve's Chair is appointed to a renewable term of 4 years, and hence the question
of whether a current Fed chair will be reappointed has occasionally arisen as an issue in U.S. presidential
campaigns. 27 The members of the Fed's Board of Governors are appointed to staggered 14-year tenns, but
in practice tl1eir tenure has averaged only about 4 years. 28 Finally, as previously noted, the Federal
Reserve Bank presidents have renewable 5-year terms, but in practice their reappointments have been pro
forma and hence they typically hold office for two decades or more.
Thus, making the Fed fully public provides a crucial opportunity to strengthen the Fed's operational
independence and accountability. Every Fed policy maker-including the Chair, the Vice Chairs, the other
members of the Board of Governors, and the presidents of the Federal Reserve Banks-should have a
single non-renewable term of 7 years, and those tenus should be evenly staggered over time. Of course,
some appointees may not end up serving a full 7-ycar term due to circumstances that could not be
anticipated at the time of their appointment to office. Nonetheless, the vetting process should aim to
ensure that every appointee intends to serve the full length of their term 29 That constraint might be
binding for some potential nominees who would otherwise be highly qualified. But fostering the Fed's
25
See criteria 1a, 1d, Sa.., and Se in Table 18 ofN. Dinccr and B. Eichengreen. '"Central Bank Transparency and fndepcndence:
Updates and New Measures", International Journal of Central Banking, March 2014, pp.l89-253 {http:l'l'I'}±'W.iicb_grg}.
6
Since 1987 each governor of the Bank of Canada has served a single term of office; that practice has been a matter of
convention rather than a statutory requirement.
27
For example, Chairman Arthur Rurns was appointed by President Nixon in 1970 and reappointed by President Ford four years
later, but the Fcd"s policies were questioned in the 1976 presidential campaign, and in 1977 Chainnan Bums tried unsuccessfully
to persuade the Cmter administration to support his reappointment to a third tenn. [insert reference here/ Indeed, the issue of the
Fed Chair's reappointment has arisen in the current campaign; sec [lttp:/iwwlJ!.JY..§.icom/a..r.ticlesldonald-tG~avs-he-would:
replace-janet-vellep-sumwrts-low-;nterest-rates- 1462465158.
23
Under current law~ a member of the Board of Govemors may initially be appointed to fill out the remainder of someone else's
14~year term and then reappointed to a full 14-year term; moreover, as noted above, the appointment of the Fed Chair is subject
to renewal every kmr years. subject to the constraint that the Chair must be a memher of the Board of Governors. Consequently,
a Fed Chair's tenure may also be very long, as in the cases of William Martin (1950- 1970) and Alan Greenspan (1987-2006).
29
For example, academic institutions typically a!lmv tenured faculty to take a leave of absence for up to two years; thus, a
number of such individuals have been appointed to the Board of Governors and then resigned within 18 to 24 months in order to
return to their academic positions.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00092
Fmt 6601
Sfmt 6601
Insert offset folio 45 here 30775.045
nshattuck on FSR297 with DISTILLER
:::
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
87
10
operational independence is crucial to its effectiveness, and hence it is essential to ensure that the tenure
of red policymakers extends beyond the length of the political cycle.
D. Comparison with Alternative Approaches
Proposals to make the Fed fully public have been debated since the 1930s. Generally speaking, such
proposals have involved one of two approaches: (I) the r ederal Reserve Banks would be converted into
branch offices of the Fed's Board of Governors. and their presidents would become employees of the
Board of Governors; or (2) the Federal Reserve Banks would become part of the federal government, and
their presidents would become federal officials appointed by the President and confirmed by the Senate.
For example, Conti-Brown (2015) has advocated the first approach, while Fisher (2016) has proposed a
comprehensive reform package that would incorporate the second approach. 30 Under either approach, the
board of directors of each Federal Reserve Bank would no longer have any role in il<; governance and
could be transformed into an advisory council or simply disbanded.
Alternative#/: Making the Federal Reserve Bank presidents into employees of the Board of Governors
would risk undermining the decentralized structure of the Fed and consolidating too much power in
Washington, DC. As employees hired and fired by the Board of Governors, the chiefs of the Federal
Reserve Banks could no longer be independent voices representing diverse perspectives and distinctive
geographic regions. Indeed, the entire Fed might become even more susceptible to the "group think"
problem noted above.
Thus, rather than curtailing or abolishing the Federal Reserve Banks, it would be preferable to strengthen
their effectiveness by making them fully public institutions. Involving the senior elected officials of each
region in nominating the directors of its Federal Reserve Bank would help ensure that those directors are
broadly representative of their entire region-not just its financial and corporate interests. Moreover,
opening up the process of appointing the Federal Reserve Bank presidents would dramatically expand the
public's ability to engage in that process at a grassroots level, rather than shifting all of those decisions to
officials at the Fed's DC headquarters.
Examining the experiences of other central banks around the world, the advantages of public central
banks that encourage regional collaboration become clear. In countries where the population is mainly
concentrated in a fairly small geographical area (such as Canada, Japan, Sweden, and the United
Kingdom), the central bank's policymakers are appointed by the national government while its regional
branch offices carry out purely administrative functions. By contrast, the Eurozone encompasses much
greater regional diversity, and hence the European Central Bank (ECB) was intentionally designed to
have a governance structure similar to that of the Federal Reserve. Thus, monetary policy for the
Eurozone is determined by the ECB Governing Council, comprised of its executive board (whose
members are appointed by a joint decision of the heads of all Eurozone countries) and the presidents
of the 19 national central banks (who are appointed by their respective national governments). Indeed,
that regional governance structure has proven crucial in enabling the ECB to face a number of daunting
pol icy challenges over recent years.
30
See http;/ii>alejre,&S'_Qm 1nc/do-the-banks~own~!he-fi:deral-resen:.f!::l.fi-S-finall;'-make-thf.:fl.!J/D:j!er-a-resounding-no-bv-peter
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00093
Fmt 6601
Sfmt 6601
Insert offset folio 46 here 30775.046
nshattuck on FSR297 with DISTILLER
conti-hr/ and lmv://shadow&d orv/wp-contem/uploads/20 16/0.J/FisherSOlv!C-Apri/20 J6.pd(
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
88
II
Altemative #2. The presidents of the Federal Reserve Bank could become federal officials appointed by
the President and confirmed by the Senate, thereby preserving their independent role in relation to the
Fed's Board of Governors. However, shifting the appointment process to the federal level could lead to
a greater number of Federal Reserve Bank presidents with political connections in Washington rather than
deep and longstanding ties to their own Federal Reserve district. Indeed, the Board of Governors itself is
already supposed to be comprised of individuals from diverse regions, but that legal requirement has
rarely been considered in practice. 31
Moreover, expanding the number of Fed officials to be nominated by the President and confirmed by
the Senate could be a recipe for a much greater incidence of vacancies among the Federal Reserve Bank
presidents, similar to the problem faced by the Fed's Board of Governors in recent years. One way to
avoid that particular pitfall would be to slash the number of Federal Reserve Banks, perhaps following a
process similar to the approach used in determining military base closures at the end of the Cold War.
Alternatively, as in the comprehensive reform package proposed by Fisher (2016), the Fed's Board of
Governors could be scaled down to a single Chair while the number of Federal Reserve Banks would
shrink !rom 12 to 8, so that the Fed would have a single decision-making body comprised of nine voting
members-all of whom would be federal officials. Such an approach has substantial implications for
how the Fed carries out its responsibilities for financial supervision and regulation, and hence a detailed
analysis of that proposal would necessarily go well beyond the scope of our paper.
IV. Strengthening the Fed's Transparency and Accountability
Transparency and accountability are fundamental characteristics of every well-governed public agency."
Moreover, the international experience clearly demonstrated that enhancing a central bank's transparency
and accountability raises the public's confidence in the integrity of the monetary policy process and
thereby strengthens public support for its operational independence in carrying out its legal mandate.
In this section, we consider tbree key clements that would significantly improve the Fed's transparency
and accountability, aligning its practices with those of other U.S. public agencies and with many other
central banks around the globe.
A. Public Access to Information
Over the past half-century, the Freedom of Information Act (FOIA) has required that every federal agency
must make its records "promptly available to any person," subject to a Jew specific exemptions that are
intended to protect national security, individual privacy, proprietary business information, and predecisional agency deliberations. As a federal agency, the Fed's Board of Governors is subject to FOIA.
By contrast, the twelve Federal Reserve Banks are private institutions that are not covered by FOIA.
In fact, the Board of Governors has successfully argued in tederal court that it is obliged to protect
31
The law states: "In selecting the members of the Board, not more than one of whom shaH be selected from any one Federal
Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and
commercial interests, and geographical divisions of the country.'' (/71tp:/'w·ww.federa!resene.gov/aboutthefed1section%20JO.hun)
32
for further discussion, see h(tp:/i"regulationbodvofknmrledge.org/regulatorv-process'instillllional-d~' and
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00094
Fmt 6601
Sfmt 6601
Insert offset folio 47 here 30775.047
nshattuck on FSR297 with DISTILLER
!JJ.tp:/"www.Jr.orldbankorg/er'L/topic/oovemance/overview.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
89
12
the secrecy of all Federal Reserve Bank records and guard against their disclosure 33 The legal premise
is that the Board of Governors is the federal agency that oversees the Federal Reserve Banks, and hence
its responsibilities are the same as any federal agency that must protect the confidential information of a
private institution. The federal court strongly endorsed that argument in its final ruling:
" ... as the Board points out, the fact that it can require examination of the Federal Resen1e
Banks is no different than any other financial institution subject to mandatory supervision
by a federal regulator. If a financial institution cannot expect confidentiality, it may be less
cooperative and forthright in its disclosures, even ifan examination is mandatory. There is
no reason to believe the Federal Reserve Banks would not react the same way. "
U.S. District Court for the District of Columbia, Case 13-cv-603-tsc
(Laurence M Ball vs. Board <?(Governors of the Federal Resen•e System)
It is deeply troubling that a federal court has accepted the premise that the public release of their records
could lead the Federal Reserve Banks to become "less cooperative and forthright" in their interactions
with the Board of Governors. Unfortunately, that prospect is a direct consequence of the fact that the
Federal Reserve Banks are currently structured as private institutions owned by commercial banks.
That lack of transparency is inappropriate and unacceptable, because the Federal Reserve's fundamental
purpose must be to serve the interests of the public. By converting the Federal Reserve Banks into public
institutions, the entire Federal Reserve System will be covered by FOIA. Consequently, all of its records
will become subject to prompt disclosure (apart from the standard exemptions), regardless of whether
those records originated at a Federal Reserve Bank or at the Board of Governors.
B. External Reviews
Regular external reviews are a key element of good management for any institution, public or private.
Indeed, such reviews have become standard practice at many central banks as well as global organizations
like the International Monetary Fund:" For example, the Bank of England has a Court of Directors that
has authority to examine all aspects of its activities, and those reviews are conducted by an Independent
Evaluation Office that reports directly to the Com1 of Directors. 35 As noted above, such reviews
strengthen the public's confidence in the effectiveness of the central bank and therehy enhance its
operational independence from political interference.
U.S. federal agencies are generally subject to two forms of extcmal review. First, each agency has an
independent Office of the Inspector General that examines all aspects of the agency's procedures and
operations, with the aim of identifying and investigating fraud, wa-;te, and mismanagement. Second, each
agency is subject to evaluations by the Government Accountability Office, an independent nonpartisan
agency whose fundamental purpose is to help improve the performance and accountability of the federal
government. 36
nshattuck on FSR297 with DISTILLER
VerDate Sep 11 2014
/ptp: 1 :www.cow:!}JQYJenews&2...ltJ.:.2.[J !5/0-1.'02/jmnorgan-gjg-bailvut-record'i-remain-secret. htm.
http://blogs. 1'>-'Sj.com/economics,]O 15;0]l](), how-some-centra!-bank..'i-are-revie-..ved-arozmd-the-wor/&'.
15
f1J1Q;_//www.bankofengland.co,.,yk'about/pages 1peovle 1court.@JJ;s.
36
f111Jr.ij.J::.!Vw.gao.gov/al]put/index.html
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00095
Fmt 6601
Sfmt 6601
Insert offset folio 48 here 30775.048
33
34
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
90
13
Office of the Inspector General (0/G). The Fed's Board of Governors has an O!G that reviews its
procedures and operations, whereas the Federal Reserve Banks are private institutions that do not have
any O!G. Moreover, the Board's OJG cannot conduct any investigation at a Federal Reserve Bank unless
it obtains explicit prior permission from the president of that Federal Reserve Bank. Similarly, the
Board's OIG cannot investigate any FOMC incident involving a specific Federal Reserve Bank without
the specific prior consent of that Federal Reserve Bank's president.
Such constraints on the authority of the Board's OTG authority arc inconsistent with the overarching goal
of ensuring that the Federal Reserve functions as effectively as possible in serving the American people.
By making the Fed fully public, the Board's OIG can assume responsibility for conducting independent
reviews of all aspects of the entire Federal Reserve System--not just the Board of Governors. Moreover,
as with all other major federal agencies, the Fed's Inspector General should be appointed by the President
and confirmed by the Senate. 37
Government Accountability Office (GAO). As noted above, the GAO is an independent nonpartisan
agency that has a proven track record in improving the efficiency and effectiveness of federal goverrm1ent
programs." In fact, over the past five years, the GAO has saved the taxpayers over $330 billion-a return
of about $174 for every dollar spent running the GAO itself.
Nevertheless, the GAO has only limited authority to examine the Fed's procedures and operations:'"
For example, the GAO is cmTently prohibited from reviewing any Fed operations involving foreign
central banks.'0 That prohibition seems particularly unfortunate in light of a recent instance in which the
Federal Reserve Bank of New York inadvertently transmitted $&1 million to hackers who had broken into
the computer system of the central bank of Bangladesh. A subsequent Reuters investigation found that the
New York Fed was ''slow to react to waming signs" and "lacked a system for spotting potential fraud in
real time, even though such systems were already in use elsewhere." 41 Indeed, Congresswoman Caroline
Maloney stated that the incident posed '·a threat to the confidence people could have in the central
banking system."
More generally, the GAO is currently prohibited from investigating any aspect of the Fed's monetary
policy process, including the financial transactions conducted by the New York Fed on behalf of the
FOMC. One purported rationale for that constraint is that the Fed's financial accounts are already
subjected to annual audits by private-sector firms. However, those financial audits are solely focused on
detecting specific evidence of fraudulent activity-a far narrower scope than the GAO's mission of
identifying inefficiencies, operational risks, and potential improvements in policies or procedures that
could be beneficial to the general public or save money for American taxpayers. Moreover, the private
firms tasked with conducting Fed audits are by no means impeccable and certainly do not have a public
track record like that of the GAO. For example, the accounting firm that conducted the most recent audit
17
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00096
Fmt 6601
Sfmt 6601
Insert offset folio 49 here 30775.049
nshattuck on FSR297 with DISTILLER
The GAO has studied this issue and concluded as follo\vs: "We believe that the differences in the appointment and removal
processes between presidentia!fy appointed TGs and those appointed by their agency heads result in a clear difference in the
level of independence of the IGs." {hllp:l/w·ww.gao.gov/ncw.ilems'd0952-lt.pdj)
38 http://www.gao. oov/products/GA0·/6-272T
39
GAO reports on specific Fed activities are posted at http://vv'\vwJCdcralrcservc.gov/newscvents/rcform audit g_ao.htm.
40 Under current law, GAO investigations of the Board of Governors and the Federal Reserve Banks '·may not include
transactions for or with a foreign central bank, government of a foreign country, or non private international financing
organi2:aticon.""(3l USC 7l4.b.!)
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
91
14
of the Fed's books has been sued by Fannie Mae for alleged gross negligence, while the finn
that previously audited the Fed has been ruled to have been negligent in a separate case. 42
Despite some common misperceptions, comprehensive GAO reviews of the Fed need not be a partisan
issue. Indeed, over the past couple of decades proposals to "audit the Fed" have been advocated by
members of Congress from both sides of the aisle 43 However, a significant pitfall of those proposals
has been the prospect that such audits could become a means of political interference. Thus, in initiating
full GAO reviews of the Fed. several specific provisions will be crucial: (I) Such reviews should be
conducted on an annual basis, not be triggered by any congressional committee or member of Congress.
(2) The GAO should freely determine the topics and focal points of each review. (3) The GAO should be
prohibited from commenting on any specific monetary policy decision. With those provisions in place,
comprehensive GAO reviews will significantly strengthen the Fed's effectiveness and its public
accountability without impairing its operational independence to carry out its statutory mandate.
C. Monetary Policy Reports
In accordance with the Humphrey-Hawkins Act of 1978, the Federal Reserve provides semiannual
monetary policy reports to Congress. That statute originally contained specific reporting requirements,
but in 2000 those requirements were streamlined into a single broad requirement to provide "a discussion
of the conduct £>lmonetmy policy and economic developments and prospects for the future, taking into
account past and prospective developments in employment, unemployment, production, investment,
real income, productivity, exchange rates. international trade and payments, and prices. " Indeed,
many analysts have characterized the Fed's semiannual monetary policy reports as largely vacuous.
Thus, in line with the practice of many other central banks, the Fed should begin producing quarterly
monetary policy reports that explain the rationale for its monetary policy decisions and characterize
the diversity of views among Fed oftlcials. 44 In particular, each report should:
Present quantitative assessments of the deviation of employment from its maximum level
and the deviation of inflation from its mandate-consistent rate, and characterize the degree
of uncertainty surrounding those assessments.
Provide a baseline projection for the economy, including information about the factors that
arc particularly relevant for specific sectors, regions, and demographic groups.
IdentifY material risks to the current economic outlook and explain the Fed's plans for
mitigating or responding to those risks.
Discuss any economic models and benchmark rules that are used in setting the course of
monetary policy.
4
~ h1rv:/1www.washingtonpost.com/wp-dln'content/artic/e,2006/!2/f2/AR200612 J20 1386.html:
http.>Jwww.theglobeandmail.com!report-on-businessiindusrly-new.s,the-lmt·-pagelcourt-uphofds-ruling-on-deloittes-negligenceorer-!iv_ef}!/article 28078 784/
43
GA()-;~dits w;~ a key plank of the Fed reform bill proposed in 1993 by Democratic Rep. Bent)' Gonzalez.
44
For example, quarterly monetary policy reports are produced by the Bank of Canada, the Bank of England, the Bank of
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00097
Fmt 6601
Sfmt 6601
Insert offset folio 50 here 30775.050
nshattuck on FSR297 with DISTILLER
Notway, and the Swiss National Bank.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
92
15
V. Conclusion
In this paper, we have presented the case for a set of pragmatic and non patti san reforms that would
strengthen the Federal Reserve's governance and enhance its operational independence to carry out its
statutory mandate of fostering maximum employment and price stability. Moreover, these reforms would
ensure that the Fed is a publicly accountable institution that takes a wide array of economic perspectives
into account, thereby enriching the Fed's decision-making process while affirming the norm that those
decisions should not be subject to political interference.
At the heatt of the proposed reforms is a call to make the Fed a fully public institution whose decisionmakers are public officials selected through open and transparent processes. This begins with transferring
ownership of the twelve regional Federal Reserve Banks away from commercial banks to the American
people. By following procedures already in place for adjusting the shares of individual member banks,
the process for carrying out this transition would be incredibly straightforward, and have no effect on the
current value of U.S. government debt or the size of the Fed's balance sheet.
Another key element in making the Fed fully public involves changing the process by which Federal
Reserve Bank directors and presidents are appointed. In sharp contrast to the current process that is
opaque, inbred and largely proforma, we propose a process requiring a higher degree of transparency in
selection criteria, timeline, selection of candidates for president and board nominees, and extensive
oppottunities for public input. To avoid potential conflicts of interest. we fm1her recommend that
individuals affiliated with financial institutions overseen by the Fed should he prohibited from serving
as directors. Additionally, establishing a single non-renewable 7-year term of office for every Fed
policymaker-including the Chair, the Vice Chairs, the other members of the Board of Governors,
and the presidents of the Federal Reserve Banks-would strengthen the Fed's operational independence
and accountability.
There are clear and measurable bcnetits to these proposed reforms. Making the Fed fully public would
generate a fiscal benefit for American taxpayers of at least $300 million per year. These additional
savings would come from larger transfers of net income from the Fed to the U.S. Treasury as a result of
the Fed no longer having to pay dividends to commercial hanks. In addition to this fiscal benefit, the
reforms we've outlined also provide greater capacity for the Fed to more fully represent and serve the best
interests of the American people when making monetary policy decisions. As America's central bank, the
Fed's monetary policy decisions affect the everyday lives of practically every American family, and have
even greater consequences for specific demographic groups. Bringing the appointment process out of the
shadows and expanding opportunities for public input in the appointment of Fed officials responsible for
making monetary policy greatly increases the potential for assembling a more diverse and inclusive body
of decision makers. More diversity, in terms of race, ethnicity, gender, educational background and
professional experience, would enhance the Fed's ability to comprehensively and accurately assess the
strength of the economy in advance of making monetary policy decisions.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00098
Fmt 6601
Sfmt 6601
Insert offset folio 51 here 30775.051
nshattuck on FSR297 with DISTILLER
Proposals to make the Fed fully public have been debated since the 1930s. Failure to make that transition
has resulted in a Federal Reserve governance structure that is outdated and inadequate for ensuring that
the Fed serves the public interest. Moreover, the Fed's private ownership by commercial banks is now out
of step with practically every other major central bank around the world. Incremental amendments to the
Federal Reserve Act at various points in time have routinely failed to overcome the hindrances of private
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
93
16
ownership, or to transform the leadership of the Federal Reserve Banks beyond the status quo, which is
overwhelmingly white, male and insular- dominated almost exclusively by long-time Fed insiders and
individuals with a financial background.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00099
Fmt 6601
Sfmt 6601
Insert offset folio 52 here 30775.052
nshattuck on FSR297 with DISTILLER
Overcoming these deficiencies and bringing about lasting change within the Federal Reserve requires
Congressional action to make the Fed a fully public institution. Pragmatic reforms that appeal to the
nonpartisan principles of good governance, transparency and accountability are the best way to ensure
that the necessary Congressional action is taken. While the reforms outlined in this paper are by no means
the only options on the table, they undoubtedly meet fhose standards.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
94
journal of Economic Dynamics & Control
journal homepage:
www.elsevier.com/!ocat~!jedc
The design and communication of systematic monetary
policy strategies"'"
Andrew T. Levin
Research Department at the lntemational Monetary Fund, Uniled States
ARTICLE INFO
ABSTRACT
Artide
The efficacy of central bank communications is inextricably linked to the characteristics of
hi.~toty:
Received 13 August 2014
Received in n.•vised form
5 September 2014
the monetary policy framework. Therefore, this paper presents a set of fundamental
principles regarding the joint design of monetaty policy strategy and communications.
The practical implications of these principles are illustrated by considering a number of
significant policy challenges faced by central banks in the advanced economies.
Published by Elsevier B.V.
E.32:
E52
E58
J21
Keywords:
Centra! Bank independ"nce
Inflation targeting
Simple monetary policy rules
1. Introduction
Over the past two decades, central banks around the world have made tremendous strides in clarifying their monetary
policy communications. Indeed, while many other aspects of monetary policymaking remain controversial, economists have
reached a broad consensus regarding the strong rationale for clarity about the central bank's policy framework, that is. its
longer-run goals and strategy, its assessments of the economic outlook, and its judgments about the appropriate path of
policy. 1 In large part, the breadth of this consensus is a reflection of two distinct benefits:
• Clarity about the monetary policy framework bolsters the effectiveness of the monetary transmission mechanism by
enhancing the private sector's understanding of how the stance of policy is likely to evolve in response to changes in
economic and financial conditions.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00100
Fmt 6601
Sfmt 6601
Insert offset folio 53 here 30775.053
nshattuck on FSR297 with DISTILLER
'~This paper was prepared for the Hoover Institution conference on ''Frameworks for Central Banking in the Next CenturyH to be held at Stanford
Uniwrsiry on M.Jy 29-30, 2014. The author appreciates many invaluable conversations with George Akerlof, Ali Alichi, Ravi Balakrishnan. Andrew Berg.
Olivier Blanchard, Danny B!anchflower, Dennis Botman, Charles Calomiris, Nigel Chalk, Luisa Charry, Stephan Danninger, jorg Decressin, Christopher ErC('£",
josh Felman, Emilio Fernandez, Thomas Helbling, Dougl,ls Laxton, Lusine Lusinyan, Tommaso Mancini, jean-Marc Natal, Andrea PescaLori, Adam Posen,
Markus Rodlauer, juan Sole, Lars Svens.'ion, and john Taylor. Nonetheless, the views expressed here are solely those of the author and do not necessarily
reflect the views of the International Monetary Fund or of any other person or inStitution.
1 See Bllndfr <::t ,1i :2009; and YeliPn :"J.Ol .3).
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
95
A. I Levin I journal of Economic Dynamics & Contro/49 (2014) 52-69
53
• Transparency about monetary policy is essential for maintaining the central bank's operational independence in a context
of public accountability, thereby enabling its policy decisions to remain insulated from short-term political pressures.
Economic and financial developments in recent years have broadly confirmed the importance of clear central bank
communications and in many instances have also underscored the scope for significant further improvements.
In contemplating these issues, it is essential to recognize that the efficacy of central bank communications is inextricably
linked to the characteristics of the monetary policy framework. Therefore, this paper presents a set of fundamental
principles regarding the joint design of monetary policy strategy and communications. These principles are framed in terms
that are likely to be relevant for a wide array of central banks, including those of emerging markets and low-income
countries. For the sake of brevity, however, the practicJI implications of these principles are generaHy illustrated using
current policy challenges facing central banks in advanced economies. It should also be emphasized that such examples are
solely for illustrative purposes and not intended to provide any definitive policy recommendations.
ln particular, simple monetary policy rules can serve as valuable benchmarks for central banks in the decision-making
process and in explaining those policy decisions to the public.z Of course, it would be inadvisable for policymakers to
mechanically follow the prescriptions of a rule whose specification has been permanently fixed. However, in circumstances
where policymakers judge that the stance of policy should deviate temporarily from the path prescribed by the policy rule.
the rationale for doing so should be clearly explained to the public. Moreover, the central bank should maintain a systematic
procedure for considering potential adjustments to the specification of its policy rule, recognizing that minor technical
adjustments might occasionally be warranted whereas the fundamental characteristics would not be modified unless there
were compelling reasons for doing so.
The remainder of the paper is organized as follows: Section 2 lays out several broad principles regarding monetary policy
strategy and communications. Section 3 considers the framing of the central bank's inflation objective. Section 4 discusses
the central bank's assessments of resource slack. Section 5 analyzes the use of simple policy rules as benchmarks. Section 6
considers the merits and limitations of specific communication tools. Section 7 concludes.
2. Some general principles
Central bank communications contribute to economic prosperity by facilitating well-informed decisions of households
and businesses and by reducing economic and financial uncertainties. Clear communications also enhance the effectiveness
of the moneta1y transmission mechanism by helping financial market participants and the general public understands how
the stance of policy is likely to evolve in response to changes in economic and financial conditions. In recent decades,
economists have also arrived at a broad consensus regarding the importance of insulating monetary policy decisions from
short-term political pressures. However, the central bank's operational independence is only sustainable if the government
provides a clear legal mandate regarding its policy objectives and instruments and then holds the central bank accountable
over time for fulfilling that mandate. Consequently, enhancing the transparency of the central bank's policy framework and
communicating clearly about the rationale for its specific policy decisions facilitate accountability to the general public and
thereby reinforce the central bank's operational independence.1
"'* Provide regular communications regarding the central bank's assessments of the balance of risks to the economic
outlook and contingency plan..-;; for mitigating and addressing such risks.
Forecasters at many central banks and in the private sector have tended to focus on providing precise assessments of the
modal outlook rather than on gauging the evolution of the balance of risks. Scenario analysis is a valuable tool for examining
key risks and formulating contingency plans aimed at mitigating such risks. In effect, it may be beneficial for central banks
to conduct and publish stress tests for monetary policy, analogous to the stress testing that is becoming standard practice for
private financial institutions.
*
Communicate clearly about the central bank's plans for adjusting the specific instruments that will be used in
implementing its policy strategy over time.
The central bank may be able to deploy a number of distinct monetary policy instruments. depending on its legal mandate
and on the characteristics of the domestic financial system. For example, such tools may include direct lending to financial
institutions, payment of interest on reseiVes. and transactions in publicly traded securities or foreign exchange. Thus, clarity
about the central bank's monetary policy framework necessarily involves transparency about its choice of instruments, including
its assessments of their efficacy, costs, and risks. TI1ere are also substantial benefits of clarifying the central bank's judgments
reg.:m1ing the appropriate path of policy as well as the conditions that could warrant significant adjustments to that path.4
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00101
Fmt 6601
Sfmt 6601
Insert offset folio 54 here 30775.054
nshattuck on FSR297 with DISTILLER
St-e faylnr ,md William~ ;_2{)10) for further analysis and dismssion.
3
Indeed. in his remarks at last December's official commemoration of the Federal Reserve's centennial, then-Chairman Brm;mkf.' \2011) stated:
"Ultimately, however, the most important reason for transp.1rency and dear communication is to
ensure the accountability of our independent
institution to the American people .md their elected representatives." See also Bern<lnke (20071 and
~2014).
4
See Gwkdynal' et ,1L t2005), Swan~on and WJ!lJams 12014\ Slem \2014i, and Yellen z2011. 2014;.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
96
A.T. Levin j journal of Economic Dynamics & Control 49 (2014) 52-69
54
: : : :} Foster and encourage a diversity of viewpoints in the process of fonnulating the central bank's policy decisions and
communications.
Historically, the institutional culture of central banks has tended to be quite conservative, with a strong inclination towards presenting a unified front in all public communications. However, effective risk management and
contingency planning require "outside-the-box" thinking and creative problem-solving. These considerations underscore
the institutional benefits of ensuring that both policymakers and staff represent a diverse set of backgrounds and
perspectives.
3. The inflation objective
::::::} Establish a numerical inflation objective that will serve as a fundamental benchmark for monetmy policy strategy and
communications.
In the absence of an explicit inflation objective. the central bank may be particularly susceptible to short-term political
pressures that lead to gradual upward drift in inflation expectations. 5 Conversely, empirical analysis has demonstrated that
a transparent and credible inflation objective has significant effects in keeping inflation expectations firmly anchored, which
in turn contributes to the stability of actual inflation.'1 Moreover. specifying a numerical inflation objective provides the
central bank with greater flexibility to promote macroeconomic and financial stability.7
The process of initiating or revising the inflation objective depends on the central bank's institutional setting. 1n
particular. the specification of this objective may be legislated in the central bank's charter or determined by periodic
consultations with government authorities. Alternatively, the central bank itself may determine the inflation objective that
is judged to be most consistent with its legal mandate. For example, in 2003 the Governing Council of the European Central
Bank (ECB) established a quantitative definition of price stability-its mandate under the Maastricht Treaty-as keeping
consumer price inflation "below but close to 2 percent over the medium term." More recently, the Federal Open Market
Committee (FOMC) and the Bank of Japan (BOJ) have each established an inflation goal of 2 percent
3.1. Specification
,_,. The inflation objective should be defined in terms of a broad measure of consumer prices: that definition should only be
adjusted for technical reasons.
In the advanced economies. the inflation goal has generally been defined in terms of a broad measure of consumer prices.
such ~s the consumer price index (CPT) or the price index for personal consumption expenditures (PCE). Such measures of
inflation may also fluctuate in response to fiscal policy adjustments. such as a revision in government-administered prices or
indirect tax rates. However. the central bank can readily make note of those factors in its monetary policy communications;
indeed, the Bank of Japan (BOJ) has regularly done so in explaining the implications of recent and prospective value-added
tax (VAT) rate hikes.
It should be noted that significant communication challenges may arise if the inflation goal is defined in terms of a price
index that responds directly to movements in the level of short-term interest rates. For example. a monetary policy
tightening aimed at restraining inflation pressures may nonetheless induce an near-te1m upward shift in such an inflation
measure. In light of such concerns, the Bank of England's inflation target was initially defined in terms of the retail price
index excluding mortgage payments (RPIX) rather than the overall retail price index (RPI). A few years later, tl1e Bank of
England's inflation target was redefined in terms of the CPJ, but that redefinition was clearly explained as a technical
adjustment and hence did not undermine the credibility of the monetaty policy framework. 8
:;:;:} The nume1ical value for the inflation objective should be re-examined periodically but should only be modified for
compelling economic reasons.
To serve as an effective nominaJ anchor, the inflation objective must be transparent and credible~ that is, the private
sector must have a reasonable degree of confidence that this objective will be sustained over time and that the central bank
will take actions as warranted to fulfill that objective. Indeed. in analyzing the early experiences of several inflationtargeting central banks, Bernankc et aL {l999) found that the private sectors inflation expectations tended to move only
gradually in the wake of the initial announcement of the inflation objective. Moreover. such patterns do not necessarily
reflect sluggish information flows or irrationality; rather, the evidence indicates that even professional forecasters tend to
5
See Levin
(2010), and
,,L (2011 ).
The Federal Open Market Committee's statement on longer-run go.als and policy strategy (W\K, 2014) indicates: "Communicating this inflation goal
clearly to the public helps keep longer-term inflation expe<:tations firmly anchored, thereby fostering price stability and moderate long-term interest rates
and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances."
8
See Kinp; (2004) and Curkaynak eta!. (2010).
6 See lcvm N al,
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00102
Fmt 6601
Sfmt 6601
Insert offset folio 55 here 30775.055
nshattuck on FSR297 with DISTILLER
7
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
97
A.T. Levin I journal of Economic Dynamics b' Conrrol 49 (2014) 52,59
199<1
1994
2{102
2006
2010
55
2014
Fig. 1. The Evolution of Longer-Run Inflation Expectations in Three Adv.lnced Economies. Source; Consensus Forecast longer-run surveys of CP! in!lalion
projections 6 to 10 years ahead, published semiannually in Apnl dnd October. Covyrig.ht (c) Consemus Economics Inc.
take a wait-and-see approach in assessing the extent to which a significant institutional change is likely to be durable over
time.·"
The numerical value of the inflation objective is appropriately determined in light of assessments of the relative costs of
inflation, the extent of downward nominal wage rigidity, and the costs and risks associated with the zero lower bound on
nominal interest rates. Such assessments might well evolve over time as a result of new data and empirical analysis, and
hence the specific value of the inflation objective should not be viewed as having been set permanently in stone. On the
other hand, frequent tinkering with the specification of this objective incurs the risk of undermining its clarity as well as its
credibility. Hi Consequently, the specification of the inflation objective should be revisited on a periodic but relatively
infrequent basis~perhaps once eveiy five or 10 years~ in the context of a comprehensive review of the central bank's policy
framework. Moreover, such reviews must be systematic and transparent to ensure that any modification of the inflation goal
would only occur as a consequence of compelling economic reasons rather than short-term political pressures.
To illustrate the foregoing principles, it is helpful to consider the evolution of longer-run inflation expectations in three
advanced economies. as depicted in Fig. 1.
Canada: In early 1991, the Canadian government and the Bank of Canada agreed on a policy framework with a mediumterm inflation target of 2 percent for the total consumer price index (CPI). Initially, that target does not appear to have been
fully credible: as of spring 1992, professional forecasters still anticipated that CPI inflation would settle at around 3 percent
over the longer run. Over time, however, inflation expectations moved into line with the target, facilitated by the Bank of
Canada's actions and communications and underpinned by the breadth of public support for its policy framework. Indeed,
smvey evidence and financial market data indicate that inflation expectations in Canada have remained firmly anchored
since the late 1990s. 11 Moreover, the monetary policy framework has been reviewed regularly at five-year intervals, but each
of those reviews has concluded that the existing policy framework continued to be workable and appropriate; cf. Carney
(2011).
United States: Longer-term U.S. inflation expectations drifted steadily downward during the 1990s~a period in which the
Federal Reserve did not have an explicit inflation objective but pursued a course of policy that has been characterized as
"opportunistic disintlation. 11 That course of policy effectively ended in mid-2003, when the Federal Open Market Committee
(FOMC) indicated that a substantial further decline in inflation would be unwelcome. Consequently, professional forecasters
longer-term outlook for U.S. consumer inflation levelled off at around 2 percent, although empirical analysis subsequently
indicated that inflation expectations were still not as firmly anchored as in a number of other economies that had
established an explicit numerical inflation objective. In january 2012, the FOMC established a longer-term inflation goal of
2 percent, as measured by the price index for total personal consumption expenditures (PCE), and has reaffirmed that
inflation goal at each of its annual organization meetings since then. 15
japan: During the 1990s, the Bank of japan (BOJ) indicated that it was aiming at modestly positive levels for published
measures of inflation. thereby keeping the true underlying rate of inflation close to zero. The Consensus Economics longer-run
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00103
Fmt 6601
Sfmt 6601
Insert offset folio 56 here 30775.056
nshattuck on FSR297 with DISTILLER
10
J).:!'nutc-r ct 111.
analyzed data
three emerging-market economics and found that inflation expectations were somewhat less firmly
anchored in Brazil (where
inflation target is speofied on a year-to-year basb) compared with Chile and Mexico (e.Kh of which has a fixed target for
inflation).
11
The Consensus Economics survey results indicate that professional forecasters longer-run outlook for Canadian inflation has stayed very close to the
2 percent target throughout the past 15 years. Moreover, Gmkdyt;dk n <1!. (2006 1 analyzed Canadi<m daily data on forward inflation compensation that is.
the difference between forward rates on nomina! and inflation-linked bonds and found that tar~forward inflation compensation did not respond
significantly to either Canadian or U.S. macroeconomiC news.
12 See !l:kyn (1~J%l.md Orph,:;wdc; .1nd
13 !t should be noted that rlg-. 1
longer-run outlook for U.S. CPI inflation-the measure used in Consensus Forecast surveys.
The Federal Reserve Bank of Philade!phias quarterly Survey of Professional Forecasters (SPF) elicits projenions for both the CPI and the r'CE price index. In
the May 2014 survey, the SPF's median projection for the 10-year average U.S. PCE inflation rate was exactlY 2 percent, while the conesponding projection
for U.S. CPI inflation was a notch higher at 2 1/4 percent. virtually identical to the outlook in the April 2014 Consensus survey.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
98
A. I
56
levin 1journal of Economic Dynamics
[J'
Contro/49 (2014)
52~69
outlook for japanese CPI inflation declined gradually during the 1990s. it remained at around 1 percent through the
4
subsequent decade even as heddline inflation was generally running below zero.l Jn March 2013, the BOJ announced a strong
commitment to taking the requisite quantitative and qualitative policy measures in order to achieve its 2 percent inflation
goal. The BOj's actions and communications evidently succeeded in bolstering the credibility of its infl.ation goal: as of April
2014, the longer-run Consensus outlook for Japanese CPI inflation stood at 1.7 percent. up from 1.1 percent a year earlier and
higher than any previous reading since the mid-1990s.
3.2. Time frame
"'* The central bank must clearly convey its assessments of the time frame over which inflation is projected to converge to
its objective and the policy actions that are likely to be warranted in fostering that conve1gence process.
Generally speaking, the framing of any goal may be practically meaningless without some sort of concrete plan for
achieving that goal within a reasonable time frame. Thus. to ensure that its inflation objective serves as an effective nominal
anchor, the central bank must dearly communicate its strategy for bringing inflation back to the objective, including the
anticipated time frame tOr the convergence process as well as the policy actions that are likely to be warranted.
The appropriate time frame for closing the inflation gap-that is, the deviation of actual inflation from its objectiveevidently depends on conjunctural conditions. For example, if a transitory commodity price shock induces a spike in
consumer price inflation, policymakers may reasonably anticipate that inflation is likely to revert to its objective fairly
quickly even in the absence of any policy actions. Conversely, an ongoing acceleration in commodity prices may exert
persistent upward pressure on inflation. and a significant monetary policy tightening might indeed be warranted to offset
such pressures and bring the inflation rate back to its objective. Indeed, in the absence of clear communications about the
central bank's policy strategy, longer-run inflation expectations could become dislodged and exacerbate the upward
pressure on actual inflation.
Inflation gaps can also arise from shifts in aggregate demand that may result from changes in fiscal policy, external
demand, or credit market frictions. During "normal" times. the central bank can take prompt action to offset such shifts,
thereby stabilizing resource utilization and keeping the inflation rate close to its objective. In contrast, when faced with a
large and protracted decline in aggregate demand, monetary policy can become constrained by the zero lower bound on
nominal interest rates, and hence the shortfall in aggregate demand may exert persistent downward pressure on the
inflation rate.L~ Under such circumstances, the rationale for clear monetary policy communications becomes even more
compelling:
To illustrate some practical implications of this principle, we briefly consider recent developments and prospects for
inflation in the United States and the euro area.
United States: U.S. inflation plummeted during the Great Recession and remained subdued during the early stages of the
economic recovery. Indeed, Federal Reserve officials flagged the risk of further disinflation or deflation as a key rationale for
launching a second round of large-scale asset purchases (commonly known as QE2) in late 2010. 16 In the first half of 2011,
headline inflation moved sharply upwards in the wake of surging global prices of energy and other commodities, and
measures of core inflation also headed upward. reflecting pass-through of higher input prices as well as the effects of
supply-chain disruptions in the aftermath of a tragic earthquake and tsunami in japan. At that juncture, the FOMC clearly
indicated its judgment that those developments were largely transitory and hence that consumer inflation would "subside
to levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity
price increases dissipate." (FOMC. 2011)
As shown in FiR. 2, that expectation proved to be well-founded. The four-quarter average rate of PCE inflation peaked at
around 2 3}4 percent in 201"1 :Q3 and then headed steadily downward toward a level of about 1 percent. As of early spring
2014, FOMC participants and professional forecasters generally expected that PCE inflation would head gradually upward
toward the FOMC's 2 percent inflation goal. Indeed. at that juncture the FOMC made note of the risk that inflation could
remain flat or decline further over coming quarters. 17
Euro Area: As noted above, the ECB's policy strategy since 2003 has been explicitly intended to maintain euro area CPI
inflation "below but close to 2 percent over the medium run." The ECB President subsequently defined this time frame very
specifically: "The medium term for a central bank is a period of 18 months to two years." (Trki"H~t, 2008). Actual inflation has
exhibited substantial fluctuations in recent years. dropping close to zero in the wake of the global financial crisis and then
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00104
Fmt 6601
Sfmt 6601
Insert offset folio 57 here 30775.057
nshattuck on FSR297 with DISTILLER
14
In 2006 the nornirtal anchor was framed more specifically in terms ofyNHo-ye<tr changes in the CPJ, and policy board ml"rnbers' assessmems of rhe
appropriate value for the inflation goal had a midpoint of 1 percent. ln early 2012, lhe BOJ specified a numerical inflation goal of 1 perc<.>nt for the time
being" and a year later the BOJ rev1sed its inflation goal upward to 2 percent.
15
inflation developments in the advanced economies in the wake- of rhe global finandal crisis.
1\·l.lllw.,.on N <ll.
16
(2011 }.
See !krnankc ·:2010; and
17
During the first half of2014. each FOMC meeting .<.tatement indicated that 'The Committee recognizes that inflation persistently below its 2 percent
objective could pose risks to economic performance. and lt is monitoring inflation developments carefully for evidence that inflation will move back toward
its objective over the medtum term. n
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
99
A. I Levin I )oumal of EconOmiC Dynamics & (ontTo149 {2014) 52-69
Z1HO
lOll
ZOlZ
ZOI3
2014
2015
57
Z016
Fig.. 2. The U.S. inflation outlook. Note: In this figure, actual U.S. inflation (solid line) is measured by the four-quarter average fhange in the PCE price index.
The FOMC's inflation outlook (long-dashed line) is represented by taking the midpoint of the centra! tendency of the PCE inflation projections of individual
Committee participants. as published in the March 2014 Summaty of Economic ProjectiOns (SEP). The private sector's inflation outlook (short-dashed line)
is represented by the projenions for PCE inflation published in the May 2014 edition of the Federal Reserve Bank of Philadelphia's Smvey of Professional
Forecasters (SPF). The post-2007 trend (dot-dashed line) is estimated by ordinary least squares regression using quarterly data for the period 2007:Q1 to
2014:Q1.
2010
2012
2014
;l(ll6
2018
2020
Fig. 3. The inflation outlook for the Euro area. Source: Consensus forecast longer-run St!rveys of CPl infl.ltion projections 6-10 years ahea.d. published
semi<mnually in April and October. Copyright (c) Consensus F.cmmmics Inc.
rising above 2 1/2 percent following the global surge in commodity prices. In the face of those developments, however. the
ECB succeeded in keeping longer-run inflation expectations anchored at around 2 percent. 13
As shown in Fig. 3. the inflation outlook for the euro area deteriorated markedly over the course of 2013 and early 2014. 1:·)
According to the Consensus Economics longer-run survey published in April 2014, forecasters expected that euro areJ
inflation would rise only gradually over coming years before eventually converging to the ECB's inflation objective towards
the end of the decade-a far longer convergence horizon than would be implied by a "medium run" time frame. Moreover,
the-re were notable downside risks to that outlook: In the ECB's May 2014 survey of professional forecasters. respondents
assigned a 30 percent probability to outcomes in which the inflation rate in 2015 would remain below one percent. In light
of those risks. ECB officials indicated that they were prepared to take further policy actions to foster a more satisfactory
inflation outlook and to ensure that inflation expectations would remain firmly anchored.
3.3. Financial stability considerations
=> The central bank should ensure that financial stability considerations do not undermine the public's confidence in its
nominal anchor.
The global financial crisis spurred the recognition that price stability and macroeconomic stability are inextricably linked
to the stability of the financial system. Moreover. while macroprudential supervision and regulation should serve as the first
line of defense in averting financial crises, there is a growing consensus that monetary policy adjustments may also be
warranted under some circumstances. While a full discussion of the implications for the design of monetary policy strategy
and communications would go well beyond the scope of this paper. one key aspect bears emphasis at this juncture.? 0
18 See BH·dl(·y d ,1!. [20!1~ and G.1l;m ct ,1J. :2011:.
19
The contours of the inflation outlook in the ECB's quarterly survey of professional forecasters (available at http: ;ww'<v.ecb.turopa.eu;\rats;'prlce;,
mdiciforcc.a\t) a!'e very similar to the Consensus survey results shown in Fig. 3.
2
For further analysis and discussion. see Sven~\D,1 : 20nl and Alicbi <'1 al. (2014 ~.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00105
Fmt 6601
Sfmt 6601
Insert offset folio 58 here 30775.058
nshattuck on FSR297 with DISTILLER
°
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
100
A. I tevin 1journal of Economic Dynamics & Conirol 49 (2014) 52-69
58
Nonvay
-,----r,
Sweden
Percent
Percent
3.00,----r,--=======n
2.6
==========n
- - - Inflation Target
- - - Inflation T argct
2.75
2.4
2.50
2.2
2.25
2.0
2.00
1.8
1.75
1.6
1.4 -h--rrrrrrl-r-r-r-rTTrn'TT-rrrrrn-,-,-,..,-..,.,J
2014
2002
2006
2010
1998
Fig. 4. The evolution of longer-run inflation expectations in two Scandinavian economies. Note: Each panel depicts the centra! bank's iofl<~tion target
(dashed line) and the evolution of longer-run inflation expectations (solid line), as measured by a moving average of the l,ltest two semiannual Consensus
forecast surveys ofCP! inflation projections 6-10 years ahead. Copyright (c) Consens.us Economics Joe.
In particular, it seems to be essential to ensure that financial stability concerns do not undermine the public's confidence
in the central bank's nomina! anchor. Indeed. keeping longer-term inflation expectations firmly anchored is almost surely a
crucial element in fostering the safety and soundness of the financial system. Conversely, a policy strategy that allows
inflation expectations to drift over time seems likely to be counterproductive for financial stability as well as price stability.
Fig. 4 points to the potential relevance of this issue for two Scandinavian economies. The Sveriges Riksbank's inflation
target of 2 percent was established in 1993, and by the late 1990s longer-run inflation expectations were welt-anchored at
that target. Norges Bank's inflation target of 2.5 percent was established in 2001. and over the subsequent decade it
succeeded in keeping longer-run inflation expectations close to that target. More re-cently. however, both of these centra!
banks maintained a relatively tight stance of monetary policy aimed at mitigating emerging financial imbalances, even as
inflation dropped persistently below target in each economy. Consequently, longer-run inflation expectations--at least as
measured by Consensus Economics surveys-began drifting downward noticeably.
The inciden-ce of disagreement among forecasters tends to be highly correlated with the degree of uncertainty about the
economic outlook: cf. D'Amico d!Hl Orpha11ides {2008). Consequently, measures of cross-sectional dispersion can also serve
as useful indicators of the extent to which longer-run inflation expectations are firmly anchored. 21 for example, the TNS Sifo
Prospera survey (which is conducted on behalf of the Sveriges Riksbank) indicates that the degree of dispersion regarding
the Swedish inflation outlook widened notably over the past several years. ln particular, the cross-sectional standard
deviation of 5-year-ahead inOation projections increased from 0.30 percent in january 2011 to 052 percent in july 2014.
Over the same period, the mean forecast in the TNS Sifo Prospera survey declined about 0.3 percentage points to a level of
about 1.8 percent?.:; Moreover. since the extent of dispersion is directly linked to the degree of sampling uncertainty
associated with any specific survey, these results do not appear to be significantly different from those obtained from the
Consensus Economics longer-run surveys.
4. Assessments of resource slack
"'*
The central bank should regularly communicate its assessments of resource slack and the degree of uncertainty
sun·ounding those assessments.
One of the cornerstones of modern macroeconomics is that every economy has a balanced-growth path that is consistent
with keeping intlation stable at its desired rate. With that conceptual framework in mind, there are two compelling reasons
for assessing the magnitude of resource slack-that is, the level of economic activity relative to the balanced-growth pathand incorporating such assessments into the central bank's monetary polit-y strategy and communications. First, shortfalls in
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
et <!I. ':2011.1.
results are available at
Frm 00106
http://WlNW.prosperasejrepart.sjinflation~expeaations.
Fmt 6601
Sfmt 6601
Insert offset folio 59 here 30775.059
nshattuck on FSR297 with DISTILLER
21 See Curkaynah N di. (?:010: and
22 The survey methodology and
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
101
A. I Levin j journal of Economic Dynamics & Control 49 (2014) 52·-69
59
aggregate income and employment have direct human costs. because households experience a lower level of economic
wellbeing. Second, rates of resource utilization influence the setting of wages and prices. and hence persistent resource slack
tends to exert downward pressure on inflation; conversely, persistently elevated rates of utilization tends to induce upward
pressure on inflation. Consequently, the monetary policy goals of macroeconomic stability and price stability are generallythough not always-complementary.
Of course, the contours of the balanced-growth path cannot be directly measured, so its characteristics must be inferred
using statistical analysis of observable data. Moreover, such estimates are necessarily uncertain and subject to revision, and
the extent of that uncertainty may be highly relevant in determining the course of monetary policy. These considerations
underscore the benefits of regular communication of the central bank's assessments of resource slack as well as the degree
of uncertainty surrounding those assessments.
To illustrate these issues. the remainder of this section focuses on challenges in gauging the magnitude of labor market
slack-an issue that is of particular relevance for U.S. and U.K. policymakers at the current juncture.
4.1. Deviations from
Okun~
law
In his classic work, Okun (1962) documented a set of empirical comovements between real output and the
unemployment rate-often referred to as Okun's Law-that have proven to be remarkably robust over time and across a
wide array of countries. 23 For example, the following version of Okun's Law is estimated using annual U.S. data from 1980 to
2007:
{1)
Ll.u, ,~ 1.26- 0.431\.y,
(0 16)
(0.04)
where Ll.u, denotes the change in the unemployment rate (Q4/Q4), Ll.y, denotes the growth rate of real GDP (Q4/Q4), and
the standard error of each regression coefficient is shown in parentheses. This equation has a remarkably good fit
(R2 =0.79), and the residuals exhibit no serial correlation at all (DW=1.89).
In effect, Okun's Law indicates that the unemployment rate will tend to dedine when the growth of actual GOP exceeds
its potential growth rate, and conversely, that unemployment will tend to show little or no improvement when real GOP
growth is roughly in line with its longer-run normal rate. As shown in fig. 5, however, the recent evolution of the
U.S. economic outlook does not seem to have been consistent with that pattern.
As shown in the upper panel of the figure, real GDP growth from 2010 through early 2014 consistently underperformed
relative to the FOMC's economic outlook;l4 For example. in November 2010 the FOMC indicated that the economic recovery
had been "disappointingly slow" and launched its second round of large-scale asset purchases (QE2); at that time FOMC
participants generally expected that by 2012 the pace of real GDP growth (Q4/Q4) would pick up to about 4 percent.ln fact,
however. output growth during 2011-2012 only averaged about 2 percent-not even reaching most participants'
assessments of its longer-run normal rate. Consequently, in September 2012 the FOMC initiated a third round of asset
purchases (QE3), with the expectation that output growth would subsequently pick up to around 3 1/2 percent."
Unfortunately, the economy underperformed yet again during 2013, with GOP growing notably slower than Committee
participants' assessments of its potential growth rate (which had been revised downward about a half percentage point
relative to their assessments three years earlier).
In light of Okun's Law, one might have expected that the persistent underperformance in economic growth would have
been associated with relatively little improvement in the unemployment rate. In fact, however, as shown in the lower panel,
the decline in unemployment over that
timefr.:~me
was much steeper than the FOMC anticipated.:u; For example, the FOMC's
june 2011 meeting statement conveyed the expectation that unemployment would "resume its gradual decline," and the
statement issued in November 2011 indicated that the Committee expected that unemployment would "decline only
gradually towards levels judged to be consistent with its mandate." At that FOMC meeting, participants generally projected
that the unemployment rate would be close to 8 percent as of 2013:Q4. In fact, however. the unemployment rate
plummeted to around 6 3/4 percent by the end of2013 and to around 6 percent by mid-2014-only slightly higher than the
upper end of the central tendency of FOMC participants' assessments of its longer-run normal rate.
21
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00107
Fmt 6601
Sfmt 6601
Insert offset folio 60 here 30775.060
nshattuck on FSR297 with DISTILLER
See recent studies by f{a!Je-t ,JJ. (20Hl .and Llaly ('t <1!.
24
!n 2007 the FOMC initiated the quarterly publication of its Summary of Economic Projections (SEP). which reports the central tendency and range of
Committee participants' projections for GOP growth. unemployment, and inflation. (The phrase "Committee pi!rticipants" refers to all of the members of
the Board of Governors and presidents of the Federal ReseJVe Banks.) ln 2009 the FOMC further enhanced its communications by reporting on participants'
estimates of the longer-run norma! rates to which those variables would converge over time in the absence of further shocks. In effect, the SEP's longer-run
projections convey p.:trticip.ants' assessments of the characteristics of the balanced-growth path, that is, the potential GDP growth rate and the natural raie of
unemployment(often referred to as the NAIRU).
~:s At that meeting, the FOMC also announced its expectation that a highly accommodative stance of policy would likely remain warranted ··for a
considerable penod as the economic recovery strengthens" and that Hfroff from the ZLB was not likely to be warranted ·•ar least until mid-2015."
26
From November 2010 to April 2011. FOMC meeting st.:~tements projected "a gradual rE;>tum to higher levels of resource utilization." The june 2012
FOMC statement projected that the unemployment rate would "resume its gradual decline'", while subsequent FOMC statements projected that the
unemployment rate would ··decline only gradually" (August 2011 to january 2012), wdedine gradually·• (March and April 2012), ··decline only slowly'· (June
and August 2012). and ~gradually decline" (January 2013 to january 2014).
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
102
AI Levm j journal of Economic Dynamics & Control 49 (2014) 52-69
60
Real GDP Grvwtb
r~rceot
I
·'"••IGrow<h
- - ~""· 211Hl Outlook
- - - &p. 21112 Outlook
I
- - - Mar. 21114 Outlook
C=:J Lunger-Run Normal Rat;:c
2010
2012
2011
201-4
2013
2016
2015
Vnemph.oyment Rate
Percent
10
Actual Unemployment
- - Nt>v. 21Hl Outll)(lk
9
~---===-~:~:i:!!6:::::~
---- - - Recent Trend
..........._
c::ll-'.lU(:I'r-Run
N!>nnai!Ute
--- -----
-~-::.::.:_
::..._-. . ._::--
'
2011
2012
2013
2014
2015
2016
Fig. 5. The evolution of the U.S. economic outlook. Note: The upper panel depicts the actual path of U.S. real GOP growth (solid line) from 2010:Ql through
2014:Qt along With the midpoint of the central tendency ofFOMC partlnpants' projections for the trajectory ofGDP growth (Q4/Q4) as of November 2010
(dashed), September 2012 (dot-dashed), and March 2014 (dot-dot--dashed). The !ower panel depict<> th<> actual path of the U.S. unemployment rate {solid
line) from january 2011 through April 2014; the midpoint of the central tendency ofFOMC participants' projections for the path of the unt'mp!oyment rate
(Q4 average) as of November 2011 (long-dashed), March 2013 (dot--dashed), and March 2014 (dot-dot-dashed); and the linear trend based on the latest
12 months of unemployment readings. !n each panel, the shaded area denotes the evolution of tht' ('entral tenden'y of FOMC participants' <~.ssessme-nts of
the longer-run normal rate; those cerHral tendencies are Slmply extended from March 2014 through the end of 2016 for illustrative purposes.
These departures from Okun's Law can be gauged in terms of the out-of-sample forecast errors from Eq. (1) over the
period from 2008 to 2013. As shown in the left panel of Fig. 6, the deviations from Okun's Law have been remarkably large
and persistent. The historical residuals {1980-2007) have a standard error of 0.44 percent, so that a deviation of around
- 1 percent would be expected to occur no more than once in a 20-year period. And given that the historical residuals are
serially uncorrelated, a sequence of three consecutive deviations of that magnitude would be exceedingly rare, say, once in
10,000 years.
In interpreting these deviations from Okun's Law. one key element is that potential GOP growth appears to have shifted
downward substantially in recent years. 27 Indeed, CBO (2014) estimated that potential GDP growth had an average rate of
.about 1.5 percent during 2011-2013, compared with an average rate of about 3 percent over the period 1980-2007. Using
the estimated slope coefficient of 0.43 in Eq. ( 1 ), that decline in potential GOP growth would induce a downward shift in the
residuals of about 0.65 percent-roughly half the magnitude of the forecast errors shown in the left panel of Fig. 6.
However, it is also important to consider the possibility that the recent trajectory for unemployment may have at least
partly reflected a decline in labor force participation that was induced by the sluggish pace of the economic recovery:c:{
Indeed. Okun himself flagged this issue in his classic paper:
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00108
Fmt 6601
Sfmt 6601
Insert offset folio 61 here 30775.061
nshattuck on FSR297 with DISTILLER
In a slack labor market, people without a job may give up when they are convinced that job-hunting is a hopeless
pursuit. They then may be viewed as having left the labor force though they stand ready and eager to work.
The response of participation rates is likely to be a complicated lagged phenomenon which will not be closely tied to
the current unemployment rate. While this aspect of the difference between potentia! and actual output is hard to
quantify, zero is certainly not a satisfactory estimate. (Okun 1962. pp. 5-6)
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
103
A. I L('vin I journal of Economic Dynamics & Contm/49 (2014) 52-69
61
Employment Growth
llncmployment Rate
2.0
!.5
1.0
0.5
0.0
-0.5
-1.0
-4
2008
2009
2010
2011
20!2
2013
----,-----,---,----·-,----,---~
2008
2009
20!0
2011
2012
2013
Fig. G. US. Deviations from Okun's Law. Note: This figure depicts out~of-sample forecast errors for 2008 to 2013 as implied by two versions of Okun's law
estimated using U.S. annual data from 1980 to 2007. The left p.1ne! shows the forf'cast errors associated with equation (J ;. which is specified in terms of
changes in the unemployment rate. The right pani'l shows the corresponding implications of equation
which is specified in tenns of employment
growth. In each panel, the shaded region denotes the 95 percent confidence interval based on the standard error of each regression.
Thus, we now turn to the following variant of Okun's Law involving employment growth rather than changes in the
unemployment rate:
(2)
where .6.et.denotes the growth rate of total employment (Q4/Q4). As above, this specification has a good fit over the sample
period 1980-2007 (II'~ 0.69), and the residuals exhibit no serial correlation at all (DW = 1.74).
The out-of-sample forecast errors from Eq. (2) are shown in the right panel of Fig. G. Notably, the forecast errors for the
period 2010-2013 vary in sign from year to year and fall well within the 95 percent confidence interval-a much better
out-of-sample fit than Eq. ( 1}. These results bolster the view that the unexpectedly steep decline in unemployment over that
timeframe was indeed related to the concomitant drop in labor force participation.
4.2. The composition of labor market slack
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00109
Fmt 6601
Sfmt 6601
Insert offset folio 62 here 30775.062
nshattuck on FSR297 with DISTILLER
As discussed in the Bank of England's May 2014 Inflation Report, the employment gap can be represented as a sum of
three components: the unemployment gap, the participation gap, and the underemployment gap. In particular, the
unemployment gap is the deviation of actual unemployment from the NAIRU, and the participation gap is the deviation of the
actual labor force from its equilibrium level. The underemployment gap refers to the incidence of involuntary part-time work
relative to its normal level, that is, the incidence of individuals who are currently working part-time (less than 30 h/week)
who would prefer to have a full-time job but are unable to tind one.
The upper panel of Fig. 7 shows the Bank of England's assessments, as of May 2014, regarding the magnitudes of the
specific components of the U.K. employment gap. Each component is scaled by its standard deviation over the period 19922007 in order to retlect the extent to which the current magnitude of that gap exceeds its normal variability. Evidently, all
three components became quite large in the wake of the global financial crisis and remained sizeable through 2011. As the
U.K. labor market subsequently improved notably, the participation gap essentially disappeared and the unemployment rate
reverted close to its normal level, whereas the underemployment gap remained about two standard deviations away from
Bank staffs current assessment of its medium-term equilibrium.
The lower panel depicts an assessment of the evolution of the total U.S. employment gap in terms of these three
components. The unemployment gap refers to the deviation of actual unemployment from the CBO (2014} estimate of the
NAIRU, and the participation gap refers to the difference between the actual size of the labor force and the CBO' (2014 J
estimate of the potential labor force. The estimate of the underemployment gap shown here is obtained using a trend-cycle
decomposition of the incidence of involunta1y part-time work; detailed information is provided in the appendix. Evidently,
while U.S. labor market conditions improved substantially since 2010, this estimate suggests that the U.S. employment gap
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
104
AJ Levin j journal of Economic DynamiCs t?t Conlrol 49 (2014) 52-69
62
United Kingdom
2008
2009
2010
:wn
2012
lOB
2014
21H2
2013
l0l4
United States
2008
2009
2010
2011
Fig. 7. The magnitude and composition of labor market slack. Note: In the upper panel (which borrows directly from Ch.m 3.7 of the Bank of England's May
2014 !ntlation Report), the unemployment gap is the difference between the actual unemployment rate and the Bank staffs estimate of its medium-term
equilibrium rate; the paJtidpation gap is the difference between the actual labor force participation rate and the Bank stafrs estimate of its medium-tenn
equilibrium rate; the- under<'mployment gap is the difference between average weekly hours worked and Bank staffs estimate of its medium-term
equilibrium level: and each of these gaps is scaled by its own standard deviation (computed for the period 1992-2007}. The lower panel depicts the level of
the US employment gap (expressed in millions of full-time equivalent (FTE) jobs) and its components, where the unemployment gap is the deviation of
actual unemployment from the CBO's estimate of its longer-run natura! rate, the p.11ticipation gap is the deviation of the labor force from the CBO's
estimate of its potemiallevel, and the derivation of the underemployment gap is shown in the app<>nclix.
remained quite large as of spring 2014 and that the participation gap and the underemployment gap accounted for the bulk
of that gap. 1 u
5. Using simple policy rules as benchmarks
"* Simple monetary policy rules can serve as valuable benchmarks in determining the course of monetary policy and
explaining tfwse judgments to tile public.
No macroeconomic model provides a completely satisfactory description of any economy in the real world. Indet.'d, the
limitations of existing mJcroeconomic models have been underscored by the incidence of relatively large and persistent
forecast errors in many advanced economies over the past few years. ' 0 Thus, rather than relying on the monetary policy
implications of any single macro model, it seems to be sensible to develop simple rules that provide reasonably robust
performance across a range of plausible models. Such rules can serve as valuable benchmarks in the decision-making
process and in explaining those decisions to the public. For example, following the seminal work of Taylor ( !~l93), a vast
literature has investigated the specification and performance of simple monet.:uy policy rules of the following form:
(3)
where it denotes a me.1sure of the short-term nominal interest rate, r* denotes the equilibrium real interest rate, pir is a
smoothed measure of inflation, pi* is the central bank's inflation objective, Xt -x;' is a measure of resource stack, and the
coefficients a and fJ are chosen appropriately in order to foster the stability of economic activity and inflation. For example,
the Taylor ( 1993~ rule was specified in terms of GOP price inflation and the output gap. with r = 2, Jt* = 2, and a=fJ = O.S.JJ
panel data and found highly significant effects of rhe participation gap and the underemployment gap (Jll
States and the United Kingdom, respectively.
(2014).
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00110
Fmt 6601
Sfmt 6601
Insert offset folio 63 here 30775.063
nshattuck on FSR297 with DISTILLER
the seminal analysis of the "monetary policy frontier" in cenns of the relative variability of economic activity and inflation.
reported on a comprehensive analysis of the performance of simple policy rules across a wide range of macroeconomic models.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
105
A.T. Levin/ journal ofFcorwmic DynamlCS fT Contro/49 (2014) 52-69
63
Nonetheless, there are two distinct reasons why it would be inadvisable for policymakers to mechanically follow the
prescriptions of a rule whose specification has been permanently fixed:
• Economic conditions may occasionally arise that are not well-captured by any of the models that were used in
formulating the policy rule. Thus, in certain circumstances policymakers might judge that the stance of policy should
deviate temporarily from the path prescribed by the policy rule, and the rationale for doing so would need to be clearly
explained to the public.
• The salient characteristics of the set of plausible models will inevitably evolve over time, reflecting new economic and
financial data and ongoing improvements in analytical and empirical methods as well as changes in the structure of the
economy itsel[ Consequently, the central bank should have a systematic procedure for considering potential adjustments
to the specification of its policy rule. Minor technical adjustments may occasionally be warranted, but the basic
specification of the policy rule would not be modified unless there were compelling reasons for doing so.
To illustrate these considerations, the remainder of this section focuses on two practical issues that are currently facing
monetary policymakers in a number of advanced economies. It should be noted that a number of other important issuessuch as the appropriate degree of policy inertia or implications of uncertainty about natural rates-cannot be addressed
within the scope of this paper. 32
5.1. The equilibrium real interest rate
Conceptually, the equilibrium real interest rate is the level of shmt-term real interest rates at which the economy evolves
along its balanced-growth path and inflation remains at its objective.'n Of course. as with other properties of the balancedgrowth path, the level of the equilibrium real interest rate cannot be directly measured but must be inferred from observed
economic and financial data. For example, Taylor (1993} specified the value r* = 2 based on the historical average value of
the real federal funds rate.
However. there are strong conceptual and empirical reasons to expect that the equilibrium real interest rate may move
significantly in response to a shift in total factor productivity growth that changes the pace of output growth along the
balanced-growth path. Moreover, econometric analysis suggests that the level of r* may also vary over time in response to
other domestic and global economic developments. Such shifts in the value of r* can be consequential for the performance
of a simple policy rule. For example, if the economy were on its balanced-growth path (x 1 ""' x:') but the true value of the
equilibrium real interest rate were a percentage point lower than the value specified in the monetary policy rule, then
inflation would persistently fall short of its objective: e.g., with a= 05, the prevailing inflation rate would be zero instead of
2 percent.
As shown in Fi,g. 8, professional forecasters' assessments of equilibrium real interest rates shifted downward substantially
over the past few years. Prior to the onset of the global financial crisis, the consensus outlook for the far-ahead fotward real
federal funds rate (left panel) was roughly in line with the value of 2 percent embedded in the Taylor (1993) rule. The
consensus outlook subsequently declined to around 11/4 percent-a decrease that is roughly comparable to the reduction of
about 0.6 percentage points in forecasters' longer-run projections for U.S. GDP growth (not shown). The dispersion in
forecasters' views is evident from the interquartile range, which effectively covers the entire interval from 0 to 2 percent
Substantial downward revisions in r* have also occurred for a number of other advanced economies (right panel).>1
5.2. Measures of Inflation and Resource Slack
For a policy rule like Eq. (3) to serve as a practical benchmark for monetary policy, the central bank needs to clarify which
measures of inflation and resource slack will be used in computing its prescriptions. During normal times, the particular
specification of those measures may be fairly innocuous. For example, a quarter-point difference between two measures of
inflation would only imply a difference of about 40 basis points in the prescriptions of the Taylor ( 1993; rule, and a half
percentage point difference between two measures of resource slack would only affect the Taylor rule's prescriptions by
25 basis points.
In contrast, when a large shock has pushed the economy relatively far away from its balanced-growth path, the
specification of the measures of inflation and resource slack may become highly consequential. For example, ·!ay!or's ( 1993-)
rule was specified in terms of the output gap, which CBO (20!4} estimated at -4.3 percent as of 2014:Q1. Thus, with the
coefficient fJ = 0.5, the Taylor rule would imply a funds rate reduction of about 2 percentage points (assuming a constant
value of r* and with inflation at its target rate).
32 OrplMnii\(''> ,1nd William~ (20-01; analyzed the implications of uncertainty about potential output and the natural rate of interest in the formulation
\Voodford (2003 J analyzed the benefits of history dt>pendence when the policy instrument is constrained by thP
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00111
Fmt 6601
Sfmt 6601
Insert offset folio 64 here 30775.064
nshattuck on FSR297 with DISTILLER
it is evident that the real interest rate i1 - pi1 is equal to r* when Jt- W and x1 = x7.
34
furcen
Pe~tat{);i (?.014; provide comprehensive analysis of the evolution of global real mterest rates over the past several decades and in the
wake of th(' financial crisis.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
106
A.T. I.evm Jjournal of Economic Dynamics & Contm/49 (2014) 52-69
64
United States
Other Advanced Economies
Percent
3.5
4.5
- - Blue Chip cons('nsus
lntcrquartilc Range
3.0
---- Canada
4.0
2.5
3.5
2.0
3.0
1.5
2.5
1.0
2.0
0.5
1.5
0.0
2006
1.0
2008
2010
2012
2014
2006
2008
2010
2012
2014
Fig. 8. The t>volution of professional forecasters' assessments of equilibrium real interest rates. Nor(': The left panel shows the wnsrnsus outlook (solid
line) and intcrquartile range (shad<•d area) of professional forecasters' projections for the avNage level of the U.S. 3~month treasury bill rate 6-10 years
ahead.less the consensus of their projections for the average level of U.S. CPI inflation 6 to 10 years ahead, computed <IS a moving aver.:~ge of the latest two
semiannual Blue Chip Economic Indicators longer-run surveys. Copyright (c) Aspen Publishers, Inc. The right p<lnel shows corresponding results t<1ken from
Consensus Economics' semiannuallonger~run surveys regarding the expe<:'ted average level of 10-year Treasury bond yields 6 lo 10 ye,lfs ahead less the
expected average level of CPI inflation 6 to 10 years ahead; these results .lre shown for Canada (short-dashed), Gem1any (dot~dashed), jdpan {dot-dotdashed), Switzer!.and (solid), and the United Kingdom (long-dashed). Copyright (c) Con.~ensus Economics Inc
One plausible alternative would be to use the unemployment gap as the measure of resource slack. Indeed. Orphanides
and Williams (2002) suggested that the prescriptions from the following rule would be roughly equivalent to those of the
Taylor rule:
(4)
where u, denotes the actual unemployment rate, uf denotes the NAIRU. and the coefficient of - 1.0 on the unemployment
gap was based on the usual application ofOkun's L,1w._\ 3 CBO (2.014) estimated that the NAIRU would remain steady at 5.5
percent through the remainder of this decade, implying that the unemployment gap was about 0.75 percentage points as of
mid-2014. Consequently, according to this specitication, the prevailing degree of resource slack would only call for a modest
funds rate reduction of less than a percentage point, all else equal.
Conversely. the preceding analysis in Se(tion 4 may provide a compelling rationale for specifying the benchmark rule in
terms of the employment gap rather than the unemployment gap. especially when there are large and persistent deviations
from the unemployment rate version of Okun's law. As shown in the lower panel of
7, the total U.S. employment gap
was close to 3.5 percent as of 2014:Q1-that is, about three times as large as the unemployment gap. Consequently, using the
same coefficient of --1.0 as in the preceding specification, this measure of resource slack would call for a funds rate
reduction of about 350 basis points, all else equal.
6. Communication tools
6.1. Post-meeting statements and press conferences
=l>
The head of the moneta1y policy committee should hold a press conference following every regular~scheduled meeting.
In recent years, there have been numerous inst.mces in which an abrupt shift in the economic outlook has warranted a
prompt and decisive monetary policy response. That experience has underscored the importance of having regular
monetary policy meetings at which policymakers can carefully consider the incoming economic and financial information
and determine whether any action would be appropriate at that particular juncture. Moreover, policymakers need to be
prepared to provide a prompt explanation to the public regarding the rationale for each policy decision, regardless of
whether the decision involves action or inaction.
In all of the advanced economies, the monetary policy committee has a regularly scheduled meeting every few weeks.
For example, the Bank of England's MPC and the Bank of japan's policy board each convene on a monthly basis, while the
VerDate Sep 11 2014
13:49 Sep 24, 2018
See the discussion of Eq. (1) in Orphantdes
Jkt 000000
PO 00000
-tlld Williatn~
Frm 00112
(2002).
Fmt 6601
Sfmt 6601
Insert offset folio 65 here 30775.065
nshattuck on FSR297 with DISTILLER
35
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
107
A.T. f.evin j joumal of Economic DynamiCS [7' Connol 49 (2014) 52-69
2006
2007
2008
2009
20H}
20ll
2012
2013
65
lfll4
Fig. 9. The evolution of FOMC meeting statements. Note: This figure shows the number of words in each of the FOMC statements that were issued in
conjunction with reguLarly scheduled meetings from M.uch 2006 through April 2014. This word count does not include voting tallies, dissenting views
(if any). or S<'parate decisions of the Federal Reserve Board (as distinct from the FOMC). The content of each FOMC st.nement is categorized as follows:
(i) the Committee's policy decision, that is, the actions taken at the meeting as well as any forw.ud guidance about the likely future path of policy; and
(ii) the Committee's economic rationale, including its synopsis of recent developments and its description of the economic outlook and the ha!,mcl.' of risks.
FOMC and the Bank of Canada's governing council each hold meetings eight times per year.·{;; Of course, a monetary policy
committee can also convene unscheduled meetings as needed-either in person or via conference call-but such meetings are
quite rare apart from crisis situations.
The standard practice for every monetary policy committee is to issue a written statement following the conclusion of each
regularly scheduled meeting. but the purpose and structure of such statements varies significantly across central banks.
In some cases, the post-meeting statement is very brief and simply conveys the substance of the current policy decision. For
example, following its meeting on 8 May 2014, the ECB issued the following statement: "At today's meeting, which was held in
Brussels, the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest
rates on the marginal lending facility and the deposit facility will remain unchanged at 0.25 percent, 0.75 percent, and 0.00
percent, respectively." On the same day, the Bank of England released the following statement: "The Bank of England's
Monetal}' Policy Committee at its meeting today voted to maintain Bank Rate at 0.5 percent The Committee also voted to
maintain the stock of purchased assets financed by the issuance of centr.:tl bank reserves at 375 billion."
In contrast, some central banks-including the Bank of Canada, the BOJ, and the FOMC-generally issue much longer postmeeting statements that provide a specific description of the policy decision and explain the economic rationale for that
decision. As shown in Fig, 9, FOMC statements typically comprised about 150-200 words during the first two years of
Chairman Bernanke's tenure in 2006-2007. The total length of FOMC statements surged during the financial crisis and
continued rising over subsequent years to around 800 words by spring 2014. That upward trend mainly reflected the increased
complexity of policy decisions involving large-scale asset purch<Ises and forward guidance about the pace of purchases as well
as the timing and pace of liftoff of the federal funds rate from the zero lower bound. In addition, the economic rationale in each
FOMC statement was also expanded from about 100 words prior to the crisis to around 200 words more recently.
It has also become standard practice for central banks to hold regular press conferences at which the head of the monetary
policy committee presents some opening remarks and then engages in Q&A37 The media participants typic..11ly represent a wide
spectrum of news outlets, including mainstream and social media as well as the finandal press. Consequently, central banks have
generally found press conferences to be an effective platform for explaining the central bank's policies to the general public as
well as for addressing more specific points that are relevant for analysts and other specialists. The frequency of press conferences
varies noticeably across central banks. TI1e Feder.:ll Reserve Chair holds a press conference following each quarterly FOMC
meeting at which committee participant<; update their assessments of the economic outlook. At the Bank of Canada and the Bank
of England, press conferences are held once per quarter in conjunction with the release of monetary policy reports. In contrast, at
the BOJ and the ECB, press conferences take place every month at the conclusion of each monetary policy meeting.
Recent experience points to the merits of relatively frequent press conferences and the limitations of post-meeting
statements. For example, as shown in the left panel of Fig. 10, all of the significant revisions to the FOMC's policy decisions
from early 2012 through spring 2014 occurred in conjunction with quarterly press conferences. In principle, of course, the
FOMC could make substantive adjustments to its policy stance at any meeting, even if there were not any press conference
afterwards. But the reality is that 30-60 min of Q&A can provide a much more comprehensive explanation than a few
hundred words in a written statement. Indeed, as shown in the right panel of the figure. revisions to the economic rationale
in FOMC statements over the past few years rarely involved changing more than about 50 words. Consequently. there seems
to be a strong case for arranging press conferences to be held in conjunction with every regularly scheduled meeting, so that
the monetary policy committee has the flexibility to take action whenever warranted while ensuring that such actions are
clearly and promptly communicated to the public.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00113
Fmt 6601
Sfmt 6601
Insert offset folio 66 here 30775.066
nshattuck on FSR297 with DISTILLER
36
The ECB's governing council has traditiona!Jy held monthly policy meetJngs but recently announced that it Wlll be shifting to a schedule of eight
monetary policy meetings per year starting in 2015.
:n At some central banks. one or more cleputies also participate in the press conference and assist with the Q&A
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
108
A. I Levin jjoumal of Economic Dynamics & Control 49 (2014) 52-69
66
Policy Decision
200~------·---·-·-----C~-----------------
Economic Rationale
100~------------------------~-----
90
160
80
120
I!
2012
Ill
20B
IV
11
II
2014
Ill
2012
IV
II
Ul
2013
IV
!I
2014
Fig.. 10. Revisions in FOMC statement language (number of word changes from previous FOMC statement). Note: Thts figure depicts the incidence of
revisions to the FOMC sta!ement issued after each regularly scheduled meeting since january 2012 compared with the FOMC statement from its previous
regu!Mly scheduled meeting. The number of revisions is obtained by counting how many words have been inserted or modified (not incl\lding
rC'a!T,mgements in word ordt>r). The decomposition of the content into the policy decision (left panel) and economk r,nionale (right pane!) is described in
the notes to the preceding figure. In each panel, the shaded bars denote instances in which the Federal Reserve Chair h&!d a press conference following the
conclusion of the FOMC meeting, and the dashed line indicates the mean number of revisions which were made at FOMC meetings that did not include <1
~ness conference.
62. Monetary policy reports
o;- The central bank should publish quarterly monetary policY reports that provide a detailed rationale for its policy
decisions.
Press conferences and post-meeting statements are valuable tools for communicating broadly to the general public.
However, it is also essential for the monetary policy committee to publish more detailed information about the rationale for
its policy decisions. Such reports can be particularly helpful in ensuring that professional forecasters and financial market
an~1lysts have a clear understanding of the central bank's policy strategy, thereby reducing economic and tinanciai
uncertainty and facilitating the effectiveness of the moneta1y transmission mechanism. Such reports are also highly relevant
for academic economists, who often play a key role in evaluating the central bank's policy framework and in contributing to
its public accountability over time.
fn particular. regular monetary policy reports can provide crucial information about the central bank's assessments of the
economic outlook and the balance of risks. Such reports provide a means of discussing the specific details of economic and
financial developments-and the methods used in analyzing those developments-that go well beyond the intrinsic limits of
what can be communicated in a post-meeting statement or a press conference. Moreover, as noted above, monetary policy
reports can present the implications of alternative scenarios thal illuminate key risk-management issues.
From a practical standpoint, monetary policy reports are largely prepared by the central bank's staff. Consequently, such
reports are typically viewed as effectively representing (either implicitly or explicitly) the views of the head of the monetary
policy committee. However. such reports can also seJve a valuable role in presenting the diversity of views of the entire
committee. For example, the Bank of England's May 2014 Inflation Report frequently utilized phrases like "the central view of
most MPC members" and "a range of views on the Committee."
7. Conclusions
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00114
Fmt 6601
Sfmt 6601
Insert offset folio 67 here 30775.067
nshattuck on FSR297 with DISTILLER
Clarity and transparency of communications play a key role in enhancing the effectiveness of monetary policy and in
sustaining the central bank's operational independence over time. In recent years. many central banks around the world
have made significant improvements to the clarity of their communications. However. such communication will inevitably
be a work-in-progress that requires continual effort and engagement with the public. Moreover, there are numerous
dimensions of policy strategy and communication for which further research is warranted by economists at central banks
and international organizations as well as at academic institutions.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
109
AJ: Levin/ Journal of EconomiC Dynamics&' (antral 49 (2014) 52-69
67
fig. A1. Trend-t_-yde derompositlon of U.S. mvohmtary parHime
Fig. A2. The nMp;nilude and composition of the US C'mployment gap since
Appendix A
This appendix describes the methodology used to construct each of the three components of the US employment gap
that are depicted in the lower panel of fig. 7. The unemployment gap is the deviation of the civilian unemployment rate from
the CBO (2014 l assessment of the longer-run NAIRU. and the participation gap is the percent deviation of the actual labor
force from the CBO (2014) assessment of the potential labor force." The rmderemployment gap is defined as the number of
full-time equivalent (FfE) jobs (expressed in proportion to the potential labor force) that would be required to eliminate the
cyclical component of involuntary part-time work.
To construct the underemployment gap, the following three monthly time series were downloaded from the BLS
website: (a) number of individuals working part-time for economic reasons (seasonally adjusted, BLS Identifier
LN$12032194); (b) average hours per week of individuals working part-time for economic reasons (not seasonally adjusted,
BLS Identifier LNU02033232); and (c) average hours per week of individuals who usually work full-time (se<1sonally
ddjusted, BLS Identifier LN$12505054). Henceforth these three series are denoted as NJNV, HJNV, and HFULCn The relative
shortfall in hours per week is given by HRATJO =HINV jHFULl..<Jn
Next, the incidence of involuntary part-time employment was normalized by the potential labor force. i.e.,
INVRT = 100*NINV jLFPDT. The trend-cycle decomposition of INVRT was obt•ined by applying Eviews HP filtering algorithm
over the sample period 1960:1 to 2007:12. where the smoothing parameter of 129,600 was determined by the Uhlig-Ravn
formula. To project the trend beyond 2007, its monthly average change was computed for the period 2005:1 to 2007:12, and
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00115
Fmt 6601
Sfmt 6601
Insert offset folio 68 here 30775.068
nshattuck on FSR297 with DISTILLER
the (BO (2014) series were published at an annual frequency, Eviews was used
average method.
39
The Eviews X13 procedure was applied to HJNVOL, since the BlS does not publish a seasonally adjusted version of that series.
4ll The Bl5 series on full-time hours is only available starting in 1994:1, and hence the mean valueof0.535 for HRADOover the post~1994 sample was
used in constructing the underemployment gap for al! penods prior to 1994.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
110
AT. Levin/ )ouma! of Econonnc Dynamics & Contro/49 (2014)
68
52~69
that slope (namely -0.0015) was used to extend the trend linearly from 2008:1 to 2014:4. The cyclical component
JNVCYCLE...,.. JNVRT- JNVTREND; the resulting trend-L-ycle decomposition is shown in Fig. A l. Finally, the underemployment
gap is obtained as (1-HRATJO)*JNVOLCYCLE.
Using these methods, fig. /\2 depicts the evolution of the magnitude and composition of the U.S. employment gap over
the past five decades.
References
Aaronson, D., Davis, J-, Hu. L, 2012. Expl.:tining the Decline in the U.S. Labor Force Participation Rate. Chicago Fed ~tter #296, Federal Rese1ve Bank of
Chicago.
Alichi, A.. Fe!man,J., Fernandez Corugedo, E.. Laxton, D., Natai,J., April 2014. Anchoring inflation expectations
World Economic Outlook. International Monetary Fund. Washington DC, pp. 41~43.
L,
2013. Okun's Law: Fit at Fifty? National Bureau of Economic
:~n11. 1\!c intlarit.n t:'Xpd:t,,:\(!11~
Hrmlv
wh~n
inflation is undershooting (Box 1.3), In:
(Jrney, M., 2011. Renewing Canada's Monetary Policy Framework. Remarks given at the Board DfTrade of Metropolitan MontreJI, November 23. Available
.Jt (!\tlp:if1NW'N.b<lnkok:UMd<i.C.!/20J! ·JJ lf<~!l\"Whl~~-C,\1\<KJ,H\}(Hld,liY·pniKy-fl,))lWW!lrk).
Congressional Budget Office, 2014, The Budget and Economic Outlook: Fiscdl Ye.us 2014-2023, February.
DJ!y, M., Fernald, j., jorda, 0 .. Nechio, f., 2014. Labor Markets in the CioN! Financial Crisis: The Good, the Bad and the Ugly. Ff'deral Reserve B.Jnk of S<ln
Frandsco Working Paper 2014-11.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00116
Fmt 6601
Sfmt 6601
Insert offset folio 69 here 30775.069
nshattuck on FSR297 with DISTILLER
D'Amico, S.. Orphanides, A., 2008. Uncertainty and Disagreement in Eronomic Forec.asting. Finance:' and Economic Discussion Senes 2008-56, Board of
Governors of the Federal
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
111
A.T. LI?Vin I journal of Economic Dynamics & Control 49 (2014) 52-69
69
'Ed ). :vton<'tdry l'r,licy Ru!e~. Unive•·siry of Chicago Prc~or.
Bandbook of Monet.1ry Economics.
Central Bank. june 5. AvaJ!able at <hltps:/,\rvww.,;:rJ).enropu.eu·press;
Economic Review, Federal Reserve Bank of Kansas City, pp. 5-34.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00117
Fmt 6601
Sfmt 6601
Insert offset folio 70 here 30775.070
nshattuck on FSR297 with DISTILLER
of New York, April 16. Available at {http:rJw;.vw.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
112
Monetary Policy for Healthy Economic Performance
Mickey D. Levy*
Testimony before the Subcommittee on Monetary Policy and Trade
Committee on Financial Services
U.S. House of Representatives
November 7, 2017
Chairman Barr, ranking member Moore and members of the Committee, I appreciate this opportunity to
present my views on the Federal Reserve's monetary policy. I begin with the ultimate goal of sustained
healthy economic growth and higher standards of living. This of course is a laudable objective, but it
requires the correct set and mix of policies. Policymakers must identify which policy tools are
appropriate to achieve desired economic performance and the proper mix of policies. While fiscal, tax
and regulatory policies heavily influence economic outcomes, today's hearing focuses on the Fed's
conduct of monetary policy.
Two things have become obvious during the 2002-2007 economic expansion that was marked by the
debt-financed housing bubble, the financial crisis and deep recession of 2008-2009 and the current
lengthy but slow-growth expansion. First, monetary policy plays a critical role-and serves best by being
even-keeled and pursuing a low inflation target during expansions and actively countercyclical in
response to downturns and financial crises. Second, there are limitations to what monetary policy can
achieve, as some of the sources of under-performance in the economic and labor market are beyond the
control of monetary policy and best addressed through other economic, fiscal and regulatory policiesand pushing monetary policy beyond its limits does not improve performance but instead generates
risks and uncertainties that undercut desired economic objectives.
The Fed's creative emergency measures during the 2008-2009 crisis helped stabilize financial markets
and avert an even deeper and more damaging recession, but the efficacy of its sustained artificial low
interest rates and massive asset purchases, well after the start ofthe economic recovery is
questionable. It has not stimulated faster growth and has distorted economic and financial
performance, and poses sizeable risks.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00118
Fmt 6601
Sfmt 6601
Insert offset folio 71 here 30775.071
nshattuck on FSR297 with DISTILLER
*Chief Economist of Berenberg Capital Markets, LLC for the Americas and Asia, and member, Shadow
Open Market Committee. The views expressed in this paper are the author's own and do not reflect
those of Berenberg Capital Markets, LLC.
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
113
The Fed's efforts to stimulate economic growth and employment, lift wages and improve other labor
market conditions has extended the role of monetary policy beyond its normal scope. The Fed's
massive asset purchase programs and maintenance of an excessively large balance sheet have crossed
the border into fiscal policy and credit allocation. Confusion about the proper role of monetary policy
and what it is capable of achieving relative to tax, fiscal and regulatory policies has made Congressional
oversight of the Fed much more difficult.
The economy is now growing on a self-sustaining basis and is far beyond the point of needing the Fed's
excessive monetary ease as a crutch. Now it is time to institute changes that set monetary policy on a
course consistent with sustained healthy economic performance and establish a framework for dealing
with emergency situations. The Fed should continue to normalize interest rates and modify its balance
sheet unwind strategy. A framework needs to be established that clarifies the proper scope and
operational conduct of monetary policy during emergency situations, along with the roles of the
Treasury and Congress.
The Expanded Scope of Monetary Policy
Even after the economic recovery gained traction and was self-sustaining, the Fed dramatically
expanded its balance sheet through massive purchases of treasury and mortgage-backed securities
{MBS) while maintaining zero interest rates, all in an effort to stimulate economic growth and job
creation. The Fed's macroeconomic models predicted that through the "real balance effect",
maintaining low rates and providing more excess liquidity would encourage risk-taking and push up
asset prices, all of which would stimulate faster growth in aggregate demand.
In reality, the Fed's QEIII and forward guidance stimulated financial markets and home values as
predicted, but the response of aggregate demand was tepid at best-in fact, nominal GDP, the broadest
measure of current dollar spending in the economy, actually decelerated. In the four years following the
implementation of QEIII {through 2016Q4), nominal GDP growth averaged 3.7%. Most striking, business
investment growth remained disappointing even though the Fed was successful in reducing the real
costs of capital and business profits and cash flows were rising to record levels. Employment rose and
the unemployment rate receded, but wage gains fell far shy of expectations.
The economy would have grown along its modest pace and jobs gains would have occurred even if the
Fed had not engaged in its asset purchases and would have gradually normalized interest rates. Not
surprisingly, the Fed's interpretation of the slow growth has been different. It takes full credit for the
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00119
Fmt 6601
Sfmt 6601
Insert offset folio 72 here 30775.072
nshattuck on FSR297 with DISTILLER
2
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
114
increase in employment. Until recently, the Fed argued that any monetary policy normalization would
have sidetracked the economic expansion. These positions seem to reflect a good deal of hubris, but
nevertheless led the Fed to delay unwinding its balance sheet out of fear of any negative repercussions
on the economy or financial markets.
History has shown clearly that following countercyclical monetary accommodation, once an economic
recovery from recession has taken hold, Fed rate increases back to neutral do not harm economic
growth. Granted, there is no experience of unwinding an excessively large balance sheet, but it is highly
unlikely that a gradual unwind that still leaves an ample amount of excess bank reserves would harm
performance.
The economy's lackluster response to the Fed's stimulus highlights the important influences of other
factors and policies, and the Fed's limitations in achieving certain economic objectives. The Fed's efforts
to stimulate the economy through monetary policy have been countered to a large degree by
counterproductive government tax and regulatory policies. In general, a growing web of regulatory
burdens and uncertainties about future tax and regulatory policies-at the Federal and state and local
levels in both the financial and nonfinancial sectors-have constrained economic activity.
Banks have been deterred from lending by the burdensome regulations imposed by Dodd-Frank and the
Fed's stress tests, as well as the Fed's policy of paying interest on excess reserves (IOER), which may
have led banks to park excess reserves at the Fed.
These factors have clogged the monetary policy
channels. In the nonfinancial sector, the increasingly burdensome tax and regulatory environment has
constrained business and household spending. Of note, uncertainties about these government-imposed
burdens have led businesses to raise their required hurdle rates for investment projects, offsetting the
attractiveness of low costs of capital. This has led businesses to scuttle investment expansion plans.
The Fed's overly-cautious forward guidance ("if we raise rates at all it may throw the economy back into
recession") may have added to business and household caution. In addition, low interest rates have
increased demand for holding money. As a result of these factors, despite the dramatic surge in the
Fed's monetary base resulting from the Fed's asset purchases, in recent years M2 has grown at a
modest 6% rate and nominal GOP has grown even more slowly, reflecting the persistent decline in
money velocity.
Along with weak productivity gains, the tepid response of nominal GOP to the Fed's
unprecedented efforts to stimulate activity has been a key reason why inflation has remained below the
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00120
Fmt 6601
Sfmt 6601
Insert offset folio 73 here 30775.073
nshattuck on FSR297 with DISTILLER
3
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
115
Fed's 2 percent target. Along with soft productivity gains, it has also served to constrain wage increases.
Inflation results from excess aggregate demand relative to real productive capacity. With nominal
spending growth during this expansion through 2016Q4 hovering around 3.5% and estimates of real
potential growth centering close to 2%, inflation has settled around 1.5%. To put this into historic
context, nominal GOP grew 5.3 percent annualized during the 2001-07 expansion and at a 5.6 percent
pace during the 1990s.
In addition to the slow productivity, soft growth of aggregate product demand has influenced wage and
price setting behavior. Businesses know that the soft aggregate product demand environment
constrains their flexibility to raise product prices, which reduces their willingness to grant higher wages.
In the last two quarters (2017Q3-Q4), nominal GOP has accelerated to a 4.6% growth pace and
productivity has picked up. If these trends are sustained, wage gains will rise.
The Fed's Balance Sheet
The Fed's asset purchases ballooned its balance sheet to $4.45 trillion by mid-2014. The Fed's policy of
reinvesting maturing assets has maintained that level of assets. The Fed's portfolio includes $2.5 trillion
of U.S. Treasury securities of various maturities and $1.8 trillion of MBS, primarily with long maturities.
The Fed is now the largest holder of each, with 17 percent of outstanding federal publicly held debt and
12 percent of MBS outstanding. (The Fed's holdings ofTreasuries are counted as publicly-held debt
because the Federal Reserve Banks are legally capitalized by the private-sector banks in their districts).
Prior to the financial crisis, the Fed's balance sheet was roughly $850 billion, comprised nearly entirely
of short-term Treasuries and other liquid securities.
The Fed's out-sized balance sheet and its MBS holdings directly infuses monetary policy into fiscal and
credit policies, and involves significant risks, including risks to the Fed's independence. The Fed's
significant earnings-it effectively funds its long-dated portfolio with short-term borrowing-are
remitted to the US Treasury. These remittances peaked at $117 billion in Fiscal Year 2015 and have
receded to roughly $81 billion as average bond yields have fallen and the Fed has raised its Federal
funds rate, which triggers higher IOER to commercial banks. These remittances have reduced budget
deficits, but they entangle the Fed's monetary policy in the government's budget and fiscal policy in
unhealthy ways and involve sizeable risks to current and future taxpayers.
Congress has a tendency to view the Fed's remittances as risk-free and permanent (it has already taken
advantage of the Fed's balance sheet and profits to fund some spending legislation) and maintaining the
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00121
Fmt 6601
Sfmt 6601
Insert offset folio 74 here 30775.074
nshattuck on FSR297 with DISTILLER
4
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
116
Fed's balance sheet involves sizeable interest-rate risks. Such risks may undercut the Fed's credibility
and threaten its independence. The interest rate risks should be taken seriously. The Congressional
Budget Office has estimated that a 1 percentage point increase in interest rates would raise budget
deficits by $1.6 trillion over its 10-year projection period. Such a rise from current low levels would not
be a surprise: the Fed's official forecasts call for a rising Fed funds rate, sustained economic growth and
2% inflation, and economic momentum is building.
The Fed's efforts to be more transparent about monetary policy should include a clear and honest
assessment of the government's budgetary risks of its sustained outsized balance sheet. Congress must
be more aware of the interest rate risks, and understand that taking advantage of the Fed's
contributions to temporarily reducing deficits to finance spending programs is inappropriate and
imprudent.
The Fed's sustained holdings of MBS directly involve the Fed in credit allocation and are inappropriate.
The Fed's first MBS purchases at the height of the financial crisis in November 2008 had a distinct
purpose-to stabilize a completely dysfunctional and illiquid market that posed a threat to global
markets. Soon after these first purchases, then Fed Chair Bernanke stated that the MBS purchases were
in response to an emergency situation, and that the Fed would unwind them on a timely basis. Instead,
the Fed added dramatically to its MBS holdings through QEII, QEIII, and has maintained them through its
reinvestment policy.
The Fed's MBS holdings effectively favor mortgage credit over other types of credit. Mortgage markets
are functioning normally with sufficient liquidity, and even a casual observation of the housing market
suggests that the Fed's ongoing explicit subsidies of the housing sector are irrational.
The Fed's LSAPs have not involved purchases of equities. Some financial market participants and fiscal
policymakers have argued that it may occasionally be appropriate for the Fed to buy equities. It is not,
under any circumstances. In emergency situations-so-called "unusual and exigent circumstances"the Fed's efforts to stabilize financial markets would be much better served through temporary loans of
other specified liquid financial securities, without the excess economic and political baggage of
absorbing equities into its portfolio. Purchases of equities would be very risky on many dimensions, and
should be deleted from the Fed's potential monetary policy "tool kit".
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00122
Fmt 6601
Sfmt 6601
Insert offset folio 75 here 30775.075
nshattuck on FSR297 with DISTILLER
5
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
117
Recommendations for the Conduct of Monetary Policy
The Fed should continue to normalize monetary policy: it should continue to raise rates, but it should
modify its balance sheet unwind strategy to gradually eliminate its entire holdings of MBS and aim to
reduce its total asset holdings more than it is currently suggesting. These steps would not harm the
economic expansion but would reduce distortions and improve the health of financial markets while
reducing the risks involved in the Fed's current balance sheet policies.
In addition, the Fed needs to adopt a flexible rules-based approach of conducting monetary policy and
establish clearer rules for when and how it executes emergency monetary operations. The roles of the
Treasury and Congress must also be clarified. A flexible rules-based approach would be a favorable
change from its current discretionary approach, increasing its transparency and enhancing the ability of
Congress to supervise the Fed.
Interest rate and balance sheet normalization. Currently, the Fed funds rate is below inflation even as
the real economy is growing above standard estimates of potential and gaining momentum. The Fed
should continue to raise its target rate toward the natural rate of interest plus the Fed's 2 percent
longer-run inflation target, consistent with its official forecast of the appropriate path of the Fed funds
rate.
With the economy operating near estimates of potential and the unemployment rate below estimates
of its natural rate, an acceleration of economic growth would naturally require quicker rate increases,
while a material economic slowdown should slow the pace of normalizing rates. Tax or fiscal legislation
that raises economic growth and expected returns on investment would be associated with a rise in the
natural rate of interest. This should lead the Fed to adjust up its trajectory and end-point of the
appropriate Fed funds rate.
The Fed should maintain its longer-run inflation target of 2 percent, but tolerate a lower range of
inflation if inflationary expectations remain well-anchored and are not a factor that influences
household or business spending and investing decisions. This is more in keeping with the VolckerGreenspan consensus during the successful economic period known as The Great Moderation. The Fed
should express less worries that inflation is too low; rather, the low inflation is favorable for economic
performance. The Fed must tone back its tendency to fine-tune the economy and acknowledge that its
best contribution to sustained healthy economic growth is to maintain an even-keeled monetary policy
consistent with stable, low inflation.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00123
Fmt 6601
Sfmt 6601
Insert offset folio 76 here 30775.076
nshattuck on FSR297 with DISTILLER
6
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
118
The Fed has embarked on its current strategy of very gradually and passively unwinding its large
portfolio of treasuries and MBS that involves reinvesting all but a small fraction of maturing assets ($6
billion per month in treasuries and $4 billion per month in MBS). It will gradually increase those
amounts of unwind as deemed appropriate. The Fed has not set an official strategy for the size of
balance sheet it ultimately aims to maintain, but several Fed members have stated that the goal should
be to keep the balance sheet sufficiently large in order to maintain a large amount of excess bank
reserves. Governor Jerome Powell, the nominee to be Fed Chair, has stated the aim of reducing the
Fed's portfolio to $2.5-$3.5 trillion. Based on the current $1.5 trillion in currency in the economy, this
implies the Fed would maintain over $1 trillion of excess bank reserves. Other Fed members have
mentioned $3 trillion.
This strategy should be modified in two ways. First, the Fed should reset its strategy to fully unwind its
MBS portfolio, but make it sufficiently gradual such that the mortgage market is allowed to absorb the
Fed's reduced role in the MBS market. Although the bulk of the Fed's MBS holdings are of long
maturity, their duration is significantly shorter, reflecting the natural amortization of mortgages and
principle pay downs. Accordingly, this MBS unwind likely could be nearly fully achieved over a five year
time period. The key point is the Fed should establish a reasonable unwind strategy and stick to it.
The Fed's intention of maintaining a large balance sheet and buffer of excess reserves implies a shift
from pre-financial crisis operating procedures. The Fed would continue to remit substantial profits to
the Treasury. Under this procedure, the Fed would continue its post-crisis policy to pay IOER and
manage the effective Federal funds rate through a "floor system". This contrasts to its historic reliance
on a market-based "corridor system". The Fed's argument for this new strategy is that it would benefit
the Fed's conduct of monetary policy and enhance its ability to stabilize financial markets. I am not
convinced of the benefits of this new procedure relative to its costs in terms of the Fed's expanded
financial footprint and its ongoing exposure to fiscal policy and associated economic and political risks.
However, this preference is less important than the higher priorities of fully winding down the Fed's
MBS holdings and reining in the scope of monetary policy. More thorough cost-benefit analysis of this
issue is required rather than agreeing to the Fed's arguments.
Resetting monetary policy. Resetting monetary policy to a flexible rules-based approach would steer
the Fed away from a fully discretionary approach and its short-term oriented tendency to fine-tune the
economy toward a flexible rule that operates as a guideline that focuses the Fed on a longer-term
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00124
Fmt 6601
Sfmt 6601
Insert offset folio 77 here 30775.077
nshattuck on FSR297 with DISTILLER
7
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
119
strategy of achieving its dual mandate. One benefit of this approach would lead the Fed toward
conducting monetary policy within its natural scope and avoid discretionary polices that historically have
been the source of mistakes and undesired economic outcomes.
The debate about implementing a rules-based policy has been influenced by the notion that it would
unduly constrain the Fed and prevent it from responding to an economic downturn or financial crisis.
That is not its intention or the intention of pending legislation. Rather, a rules-based approach would be
used as a guideline, and would allow the Fed to deviate from the rule, but require that the
Fed explain those deviations to Congress and the public. This would improve transparency and facilitate
improved Congressional supervision of the Fed. It would also be an important tool for reaching an
understanding about the limitations of monetary policy and its proper role among other economic
policies in achieving desired economic objectives.
Analysis shows that more rules-based policy over time would have generated smoother fluctuations in
aggregate demand and improved economic performance compared to actual policy; but once again,
such a framework must provide sufficient flexibility to quickly and aggressively maneuver monetary
policy amid financial crisis or economic downturn. My observation is such a rules-based guideline would
result in even-keeled monetary policy during normal times, and the efficacy of monetary policy during
extraordinary times would depend on the discretion, judgment and leadership of the Fed, as is currently
the case under fully discretionary policy.
Establishing the ground rules for emergency monetary policy. Ground rules need to be established for
the conduct of monetary policy under extraordinary circumstances, including approval processes and
responsibilities of the Fed, Treasury and Congress. Many of these governance issues are complex, but
several things seem clear. While precisely defining emergency situations-unusual and exigent
circumstances-that require extraordinary Fed intervention is difficult, responsibilities and approval
processes within and across institutions must be established, and Congressional oversight of Fed
operations must be open. I view several items as important. The Fed's governance rules should be
modified such that Fed decisions to engage in extraordinary monetary policy should be determined by
the FOMC, rather than just the Board of Governors. The Treasury should be mandated to approve the
Fed's extraordinary interventions and capital exposure. The Congress should be involved in approving
the budgetary impacts of the Fed's emergency policies, and its supervisory role should be spelled out.
The Fed, Treasury and Congress have learned a lot from the financial crisis, and they should coordinate
to be prepared for future economic, financial or idiosyncratic shocks.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00125
Fmt 6601
Sfmt 6601
Insert offset folio 78 here 30775.078
nshattuck on FSR297 with DISTILLER
8
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
120
Testimony before the Subcommittee on Monetary Policy and Trade
Committee on Financial Services
U.S. House of Representatives
November 7, 2017
Why the Fed Should Only Own Treasuries
By
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00126
Fmt 6601
Sfmt 6601
Insert offset folio 79 here 30775.079
nshattuck on FSR297 with DISTILLER
Charles I. Plosser
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
121
Why The Fed Should Only Own Treasuries'
By
Charles I. Plosser
Visiting Fellow
Hoover Institution, Stanford University
One of the most important guiding principles of sound central banking is the independence of monetary
policy decision-making. History teaches us that unless governments are constrained constitutionally or
by statute, they often resort to the "printing press" to avoid making tough fiscal decisions. But in a
democracy, independence must come with limitations on the central bank's authorities and
discretionary powers. Otherwise, central bankers can use their powers to venture into policy realms
unrelated to monetary policy, especially fiscal policy, which more appropriately rests with elected
officials. If a central bank has the power and willingness to conduct fiscal policy, it undermines the
integrity of fiscal choices by Congress and the checks and balances on the distributional effects of fiscal
actions. Engaging in such actions also undermines the central bank's legitimacy and the case for
independence.
It is useful to think of a central bank in terms of its balance sheet. For the Federal Reserve, the liabilities
are predominately currency and the reserves ofthe banking system. Increasing the liabilities is often
thought of as monetary policy. However, central banks also manage the asset side of the balance sheet
and governments often put constraints on what the central bank can acquire or hold. Changes in the
composition of the assets are often referred to as credit policy.
Historically, the Fed has conducted monetary policy through the purchase or sale of Treasury or
Treasury-related securities (such as repurchase agreements). Thus, the vast bulk of Federal Reserve
assets has been Treasury securities. Credit policy did not play a significant role as assets outside of
Treasuries were relatively small.
During the financial crisis and ensuing recession, this picture changed dramatically. The Federal Reserve
made a number of decisions that significantly altered both the size and the composition of its balance
sheet. For example, the Fed pursued a program of large-scale asset purchases in an effort to increase
monetary accommodation after it reduced its conventional policy tool, the federal funds rate, to near
zero. The balance sheet grew from less than $1 trillion to $4.5 trillion. This expansion was achieved, in
part, through the purchase of large quantities of Treasury securities.
But in a more unusual step, the Fed also purchased large quantities of non-Treasury securities, altering
the composition as well as the size of the Fed's balance sheet. In particular, a significant share of the
purchases was in the form of mortgage-backed securities (MBS), which targeted the housing sector for
special attention and thus was a form of credit policy in support of a specific sector of the economy. So
VerDate Sep 11 2014
This piece was published by the Hoover Institution as part of its Defining Ideas Online Journal, June 10,2017
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00127
Fmt 6601
Sfmt 6601
Insert offset folio 80 here 30775.080
nshattuck on FSR297 with DISTILLER
1
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
122
quantitative easing (QE) was a mixture of monetary policy, adding liabilities in the form of bank reserves,
and credit policy that altered the composition of the assets away from Treasuries toward housing
securities and MBS in particular. This was an unprecedented market intervention by the Fed.
More troubling was the lending under Section 13(3) of the Federal Reserve Act (FRA), which included
support of the creditors of Bear Stearns and AI G. The Fed also funded other lending programs designed
to support the purchase of commercial paper and other types of asset-backed securities. These credit
policies were market interventions intended to benefit or subsidize specific parties during the crisis. The
broader goal was to help stabilize the financial system. Regardless of the rationale, the Fed sold Treasury
securities from its portfolio and used the proceeds to purchase risky private sector securities. These
actions amounted to debt-financed fiscal policy but without the explicit authorization of Congress. Given
the distributional effects of such interventions, it is not surprising they proved controversial.
A Fed with the power to engage in fiscal policy through such credit allocations faces risks that its
authority can be abused by political leaders or the Fed itself. The discretion to engage in credit
allocation represents an open invitation to politicians and interest groups to pressure the central bank
to use its authority to manage its assets to further some other agenda. Maybe the Fed should invest in
green energy companies, in domestic manufacturers who pledge not to ship jobs overseas, or
infrastructure bonds issued by state or municipal authorities. This may seem far-fetched, but Congress
asked the Fed to invest in the automobile companies in 2008. After all, it had already supported Bear
Stearns and AIG, and weren't the big four auto companies as important to the economy and
employment as these financial firms? Fortunately, the Fed said no, but the discretionary authority to
engage in credit allocation could prove to be a threat to Fed independence. This danger is further
aggravated by the calls for the Fed to rely on an operating regime that untethers the balance from
monetary policy. In such a regime, the size of the balance is free to vary while monetary policy is
determined by the rate of interest on reserves. What a temptation for mischief with the balance sheet
that could prove to be.
In response to such criticisms of the scope of Fed authorities, the Dodd-Frank legislation in 2010
modified lending under Section 13(3) to programs with "broad-based eligibility." Dodd-Frank also
attempted to devise a resolution regime for large financial institutions so that such rescues by the Fed
need not arise in the first place. The actions by the Fed that pushed the envelope and scope of Fed
authorities also have spawned other proposals such as the "audit the Fed" movement and calls for
changes in Fed governance. These latter proposals, if passed, would strike at the heart of monetary
policy independence.
One way to limit the Fed's ability to engage in credit allocation and reduce the incentive for political
interference is to restrict the central bank to an all-Treasuries portfolio. This would not constrain the
conduct of monetary policy. There are ample Treasury securities for conducting monetary policy for the
foreseeable future. The large purchases of MBS were a significant departure from past practice and, as I
mentioned, were a mixture of both monetary policy (increasing the size of the balance sheet) and credit
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00128
Fmt 6601
Sfmt 6601
Insert offset folio 81 here 30775.081
nshattuck on FSR297 with DISTILLER
policy (changing the composition of the assets on the balance sheet). The justification of the MBS
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
123
purchases was not based on the scarcity of Treasuries available for purchase in the open market, but on
the desire to support housing, which was viewed as important to economic recovery.
A Treasuries-only policy would prevent the Fed from purchasing private sector assets that would offer
some firms, sectors, or asset classes preferential treatment and expose the taxpayer to credit risk. It
would also prevent the Fed from rescues or bailouts of creditors on its own discretionary authority as it
did during the crisis under Section 13(3). Moreover, it would rule out the discretion of the Fed to acquire
agency securities and municipal bonds, as well as private securities such as equities and corporate
bonds. These limitations would strengthen Fed independence by reducing the incentives for political
interference and lobbying by interested parties.
Some argue that an all-Treasuries portfolio would limit the ability ofthe Fed to respond to a financial
crisis. As a lender of last resort, the Fed should focus on the integrity of the payment system. As
articulated by Walter Bagehot in 1873, the central bank should lend to solvent institutions at a penalty
rate against good collateral. The Fed's lending to Bear Stearns and AIG were not examples of such
lending. Instead the Fed lent to failing institutions against questionable collateral. Moreover, the Fed has
never articulated a strategy for determining who and when such emergency lending was appropriate, or
defined the collateral requirements.
It should not be a goal to make bailouts and rescues easy for the Fed, or any other agency for that
matter. To reduce moral hazard, such options should be eliminated or made very difficult to pursue.
Section 13(3), even as revised, permits the government to use the Fed's off-budget financial position to
engage in fiscal actions so the fiscal authorities do not have to step up to the plate. This encourages
moral hazard, increases risk taking, misplaces decision rights, and undermines accountability.
A Treasuries-only constraint on the Fed would dramatically curtail its credit policy actions, reduce moral
hazard, and protect its independence. Yet some argue that the Fed must have the authority to intervene
in an emergency much as it did in 2008. But this is not necessary. Fiscal policy that puts taxpayer funds
at risk should be the responsibility of Congress and the U.S. Treasury. It's unnecessary to grant the Fed
discretionary authority to execute such rescues. If a situation such as Bear Stearns were to arise, the first
line of defense should be orderly liquidation or bankruptcy. Neither would necessitate a financial role
for the Fed.
Nevertheless, it is understandable that many believe that there should be some backstop mechanism for
the government to act on relative short notice. Emergencies can and do arise. What is needed is a
mechanism that aligns decision rights and accountability for the fiscal actions being contemplated.
On several occasions', I have suggested a new accord between the Fed and the Treasury. The idea is to
specify ex ante the decision rights and accountability for such fiscal decisions during a financial crisis.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00129
Fmt 6601
Sfmt 6601
Insert offset folio 82 here 30775.082
nshattuck on FSR297 with DISTILLER
2
https:l/www.philadelphiafed.org/-/media/publications/speeches/plosser/2009/02-27-09 us-monetarv-policyforum.pdf?la=en
https:l/www. phi ladelphiafed. org/-/media/pu blications/speeches/plosser /2012/02-24-12 us-monetary-policyforum.pdf?la=en
https://www. philadelphiafed .org/-1 media/publications/speeches/plosser/2013/11-13-13 _ cato-i nstitute.pdf?la =en
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
124
The decision to put taxpayer funds at risk in order to allocate credit differentially across parties or
sectors lies with the fiscal authorities. The accountability then should also rest with those authorities.
The role of the Federal Reserve should be limited to helping the Treasury implement the decision.
Recognizing the appropriate accountability, the Treasury would be required to remove the private
securities from the Fed's balance sheet in exchange for Treasury securities, thus restoring the allTreasury character of the Fed's balance sheet and ensuring that the fiscal authorities are accountable for
the risks.
The framework is easily described:
1. The Federal Reserve should be required to maintain a Treasuries-only policy as it pertains to the
conduct of monetary policy.
2. The Federal Reserve should be prohibited from purchasing non-Treasury securities, private sector
securities or lending against private collateral except through traditional discount window operations
with depository institutions.
3. Emergency lending under Section 13(3) of the FRA should be eliminated and replaced with a new FedTreasury accord, under which the Fed may facilitate, at the Treasury's request, the purchase of private
sector securities in an emergency. The Treasury would be required to seek Congressional approval for
such expenditures within 30 days of the action. Upon approval, the Treasury would promptly arrange to
exchange (at book value) Treasury securities for the private sector securities temporarily acquired by the
Fed. Should the Congress not approve the action, the Treasury would require the Fed to liquidate such
securities within 60 days. Any losses or gains incurred by the Fed under such an action would be the
responsibility of the Treasury. Through these provisions credit policies would cease to be a tool of the
Federal Reserve and would no longer be a threat to the independence of the Federal Reserve.
To illustrate how this might work, consider the case of Bear Stearns.
The decision to support the rescue of Bear Stearns should have been made by the U.S. Treasury. Bear
Stearns was not a depository institution, nor was it regulated by the Fed. Rather, it was an investment
bank which had as its primary regulator the SEC. Surely, consultation with the Fed, the SEC, the FDIC,
and other agencies would be appropriate, but the decision should be that of the fiscal authorities. The
Fed could help facilitate that decision and be instructed by the Treasury to acquire whatever securities
required to implement the decision. But it is important that the decision rights rest with the Treasury,
with the Fed as the facilitator operating under the instructions of the Treasury.
In this case, the transaction could have proceeded as it did. The Fed facilitated the purchase of Bear
Stearns by JP Morgan by, in effect, purchasing (raising cash by selling Treasuries from its portfolio)
approximately $29 billion of high risk private assets. These risky assets were placed in an LLC wholly
owned by the New York Fed, named Maiden Lane.
Then comes the important part. The Treasury would then be required, within 30 days, to get an approval
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00130
Fmt 6601
Sfmt 6601
Insert offset folio 83 here 30775.083
nshattuck on FSR297 with DISTILLER
or appropriation by Congress. Following approval, the Treasury would arrange an exchange of those
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
125
private assets purchased by the Fed for Treasury securities. For example, the Treasury could simply issue
debt in the amount of the book value of the Maiden Lane assets and deposit the proceeds at the Fed in
exchange for the ownership of Maiden Lane assets. The Fed would then use the proceeds to purchase
Treasuries in the secondary market. At the conclusion of such an exchange, the Fed's portfolio would be
returned to where it was before the transaction, the U.S. Treasury would be the owners of the Maiden
Lane assets, and accountability for the decision would rest with the appropriate decision-making
authority. Any gains or losses on the ultimate disposition of the securities would then accrue to the
Treasury and the taxpayer.
Requiring the Federal Reserve to maintain an all-Treasuries portfolio would address several issues. It
would protect its independence; reduce its discretionary authorities; and return fiscal authority and
credit allocation to Congress and the U.S. Treasury.
VerDate Sep 11 2014
13:49 Sep 24, 2018
Jkt 000000
PO 00000
Frm 00131
Fmt 6601
Sfmt 6601
Insert offset folio 84 here 30775.084
nshattuck on FSR297 with DISTILLER
0
G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-07 MPT LEG P
@FedFRASER