View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

A Brief History of the Fed Universe

Greater Vineland Chamber of Commerce
Vineland, NJ
April 17, 2019

Patrick T. Harker
President and Chief Executive Officer
Federal Reserve Bank of Philadelphia

The views expressed today are my own and not necessarily those of the Federal Reserve System
or the Federal Open Market Committee (FOMC).

A Brief History of the Fed Universe
Greater Vineland Chamber of Commerce
Vineland, NJ
April 17, 2019
Patrick T. Harker
President and Chief Executive Officer
Federal Reserve Bank of Philadelphia

Before I begin, I’d like to do two things.
First, I want to congratulate the Chamber on its centennial year — happy anniversary.
Second, I want to address the elephant in the room. It might be better to avoid such a divisive
subject in these polarized times, but I think it’s better to face controversy head-on. So I venture
in, bravely posing the question: Is Vineland the dandelion capital of the country or the egg
capital?
This has been a subject of internal debate at the Philadelphia Fed for weeks now, and Wikipedia
supports both camps.
So please, by a show of hands, help us start the healing: dandelion or egg?
Now that that’s settled, I’ll turn to something almost as important: the economy.
At an event like this, I’d normally give an economic update and discuss what that means for my
policy outlook, and I intend to do that. But I’ve also been asked to give a Fed primer for anyone
who’s not 100 percent familiar with the history and functions of the Federal Reserve. If you
count yourself among them, you’re in very good company. It can be a byzantine and
complicated system, and I remember being surprised, as a newly minted member of the board
of directors, at the scope of the Fed’s work — it’s more than just interest rates.

1

With that in mind, I’ll give a quick intro to how the Federal Reserve came to be and what it is
we do, then give the requisite outlook with some added context.
And I will start with the most important aspect of Fed history and tradition, which is the
standard disclaimer: The views I express today are mine alone and do not necessarily reflect
those of anyone else in the Federal Reserve System.
The Federal Reserve System
With that done, a brief history. It’s probably safe to say that a central bank like the Federal
Reserve could only happen in America. That’s because its structure reflects a deep and longstanding battle of ideological wills that are foundational to our national existence.
The Fed has only existed for a little over a century. Compare that with the Bank of England,
which has been around since 1694, or the Riksbank, Sweden’s national bank, which was
established a few decades before that. Of course, those were sovereign nations much earlier
than we were, but the Federal Reserve Act was passed in 1913 — not exactly the dawn of the
republic. So why is that?
Without going too far down the historical rabbit hole, there were, in fact, attempts — and
successes — at central banking in the United States before the Fed. But their rise and fall
reflected those competing ideological forces: On one side were those who wanted the stability
and economic advantage wrought by a central bank, while the other housed those who
fundamentally distrusted centralized power. This was at the heart of our founding: Federalism
and Republicanism. Hamilton and Jefferson. Dandelion and egg.
Before the 20th century, we had two real central banking successes — both in Philadelphia, by
the way — which we imaginatively refer to as the First and Second Banks of the United States.
Both had 20-year charters when they were established, and both faced political climates that
were hostile to their renewal when the time came — which meant both were left to expire.
That philosophical tension never went away. But in the late 1800s, a series of booms and busts
culminated in the Panic of 1907, and the need for a central bank became clear. The Federal
Reserve was born.
2

Again, I will spare you the extensive details, but the important part is the result: a decentralized
central bank. A compromise between those two underpinning viewpoints.
At its center is the Board of Governors in Washington D.C., which is where the Chair sits and is
what most people think of when they hear “The Fed.” But there are also 12 District Banks
around the country, each an independent entity with its own president and board of directors.
People often ask what it’s like to work for Jay Powell, or Janet Yellen before him. But the thing
is, I don’t. I work for our board and our District.
That unique Fed structure gives us a better view of the realities on the ground — the United
States is a vast and complicated economic machine, but it is fundamentally made up of a
collection of micro-economies across the cities, towns, and communities that blanket the
country.
The regional Banks bring the viewpoints of our Districts when we meet in D.C. to formulate
monetary policy, which we do roughly every six weeks at the Federal Open Market Committee,
or FOMC. Again, that local perspective is crucial, because we’re making policy at a national
level, and the size and scope of the U.S. economy can flatten the peaks and valleys we see in
different areas.
In those meetings, we discuss monetary policy and, at the end, we vote. The governors are
permanently in a voting position, as is the president of the New York Fed. The rest of us rotate
in — I’m up in 2020, and despite the fact that you’d never know who’s in rotation until the last
30 seconds of a two-day meeting, people will be a lot more interested in what I have to say
come January …
Congress outlined a “dual mandate” of price stability and maximum employment for the
Federal Reserve, which is again unusual for central banks, most of which focus solely on
inflation. The Fed also regulates banks, processes payments, and conducts economic research.
And — the part that never gets enough attention, in my opinion — we do research and work to
help strengthen our local economies. As I said, each of the Banks are independent entities,
which means we have the freedom to tailor our work to our own area’s needs. While all Feds
3

have a community development function, each of us executes it in a different way. At the
Philadelphia Fed, we’ve created the Economic Growth & Mobility Project (EGMP), which
focuses on what we think are the three foundational aspects of economic mobility: job creation
— that is, stable, well-paid jobs that lead to financial security; workforce development — that
is, education and training for people to get those jobs; and infrastructure, which includes
everything from housing to transportation to broadband.
The Fed can’t make grants or finance projects; it’s not in our congressional remit. What we can
do is bring people together and offer sound research. So with the EGMP, we’re forming
partnerships around our District to help address systemic issues in what we call Research in
Action Labs.
The first of those was in northeastern Pennsylvania, where they did have one of those three
pillars — a lot of jobs at fulfillment centers — but were struggling with another: infrastructure.
Those centers are located outside of town, and the region was built like most of America in the
latter half of the 20th century: constructed to bring commuters from the suburbs and outskirts
into the city, not the other way around. So we worked with local partners, and they came up
with a collective set of solutions that worked for them — launching pilot programs, establishing
a council on equitable transit, and making transportation a priority in the area.
That part is crucial: The Fed can offer research, data, and support, but communities are the
ones that understand their own unique needs. Our job is to offer our research and convening
power, and to share projects’ data and results with anyone who might benefit. We’ve already
heard from communities that have issues similar to northeastern Pennsylvania, asking how they
can do something similar. Now that we’ve helped with the program, we can share a blueprint.
Different Banks also sometimes specialize in particular research areas. Obviously, Dallas does a
lot on energy markets. New York has a special focus on international financial markets. In
Philadelphia, our area of expertise is consumer credit: cards, household debt, student loans,
etc.
So that’s the Fed overview. We do a lot of things other than monetary policy.

4

For instance, we use our research to share our economic outlooks.
The Outlook
Turning to the first part of our mandate, “maximum employment” means, more or less, that if
you’re looking for a job, you can find one relatively easily. That comes with some caveats,
including that it doesn’t necessarily mean you’ll find the job you want, and, obviously, this is
nowhere near a technical term. In fact, somewhere, a cold shiver just ran down an economist’s
spine … But by a colloquial measure, that’s what we mean.
The unemployment rate will never be zero. People naturally leave jobs and come in and out of
the labor force, and we expect some level of unemployment to reflect that. We think about a
sort of happy medium, where jobs are available but not so abundant that it starts to put
upward pressure on inflation; we refer to this as the “natural rate” of unemployment. It’s
important to note that the natural rate is elusive – it’s more easily evaluated in the rearview
mirror, and even then it’s not concrete enough for consensus, but we do have estimates. Most
economists currently put that measure somewhere around 4½ percent. So by contrast, the
current unemployment rate of 3.8 percent is relatively low. I actually see that rate moving
further down this year — somewhere around the 3½ percent range — before edging back up a
few tenths of a percentage point.
Job creation is another metric that garners a lot of attention, and the last two months’ data
definitely made a few headlines. February’s initial number made headlines at 20,000 — though
it’s now been revised up to 33,000 — because it was much lower than expected, and much,
much lower than other months. March, on the other hand, was a robust 190,000 — which has
been more or less the average number over the last half-year or so.
These numbers illustrate the persistent Fed mantra of data dependency. First, it’s important to
take a medium-term view, and not let one report or data series derail an outlook. Second, the
dismal science is not exact. If you look at economic predictions from a year or two ago, a lot of
them had job creation slowing significantly by now — my own included. But the labor market
has shown remarkable strength, and its continued tightening has surprised a lot of experts. So

5

it’s important to be patient as the data roll in, and not jump to conclusions on the basis of one
round — or even a generally agreed-upon prediction. We want the data to confirm it.
Turning to price stability, the Fed has a goal of 2 percent inflation. That’s enough for the
economy to grow at a healthy pace without price changes causing discernable friction in the
economy.
After several years of running persistently below our preferred 2 percent target, inflation finally
started running about that rate. In recent months, it’s edged back down somewhat.
I see inflation averaging slightly higher than 2 percent this year and next. Again, my focus is on
the medium-term average, and what I’m watching in particular is inflation’s trajectory — that
is, not just its direction, but the speed at which it travels.
As with all things policy related, I’ll be driven by the data. In particular, I’m giving weight to core
inflation for a better view of the fundamentals, as fluctuations in energy prices are likely to
affect the headline metric.
Turning finally to GDP, I see growth a bit above 2 percent for 2019, and around 2 percent next
year, which I see as trend.
That number is disappointing to a lot of people. But it’s important to remember that we’re on
track for the longest economic expansion on record, and it’s coming in the context of very low
unemployment and low and stable inflation. In that setting, continued steady growth is not
what I’d call “disappointing.”
There are, of course, some risks to watch for, and I’m keeping an eye on global developments,
growth abroad, and trade.
Another risk that’s been discussed is the yield curve, a part of which inverted last month. Again,
a primer for the uninitiated. The yield curve shows the difference between the return on bonds
with various lifespans — in general, shorter-term bonds tend to have lower returns while the
longer terms yield more. Economists refer to the premium on short-maturity Treasuries as “the
money premium,” reflecting the idea that they have many of the features of money. The
6

normal shorthand would be to say that they’re more liquid than long-term securities, but that
money-like quality is something that investors are willing to pay for in the form of lower
returns.
So normally, there is an upward tilt to the yield curve. Long-term rates reflect expectations of
future short-term rates; so if long-term rates fall below current short-term rates, it signals a
market expectation that future rates will likely be lower than they are now — which happens
when the economy gets weak and policymakers respond.
Try saying that last sentence five times fast.
With the yield curve discussion laid out, there are some mitigating factors to consider, because
we’re looking at a very different economic playing field than we have in the past. The Fed’s
balance sheet is still historically large, which may be affecting long-term yields. And while
inversions in the yield curve do appear to have a relationship with downturns, correlation does
not equal causation, and that inversion is not an absolute predictor.
Ultimately, my views are shaped by multiple indicators, and there are certainly aspects of the
economy — the strength of the labor market, for instance — that point to a fundamentally
sound U.S. economy.
Accounting for all those factors — a strong labor market, muted inflation, sustained moderate
growth, and the penumbra of uncertainty — I continue to be in wait-and-see mode, and my
outlook for rates remains, at most, one hike for 2019 and one for 2020.
The Fed’s Balance Sheet
I just mentioned the Fed’s balance sheet, which is yet another aspect of Fed policy and action
that has captured attention lately, and the last issue I’ll touch on before we head into Q&A.
I want to start by saying that while the balance sheet is an important part of the policy
discussion, it’s not indicative of our monetary policy stance.
A final primer, this one on the balance sheet: In the wake of the global financial crisis and the
Great Recession, the Fed turned to what we call “unconventional” monetary policy.
7

Our conventional means of conducting monetary policy is the federal funds rate. Lower rates
can encourage economic activity while higher rates can help prevent overheating. But in 2008,
the economy was severely damaged, and when the Fed lowered rates to essentially zero, it still
needed help. We had to go beyond our usual toolkit and turned to large-scale asset purchases,
which was a program better known as quantitative easing, or QE. QE involved buying assets on
a larger scale and venturing into longer-term Treasuries along with mortgage-backed securities,
or MBS. After three rounds of QE, the balance sheet — which was roughly $900 billion before
the crisis — had swelled to $4.5 trillion.
In late 2014, we stopped the purchases, and kept the balance sheet constant by reinvesting the
proceeds as they came to maturity. A year later, the FOMC voted for the first modest rate hike,
signaling the first baby steps toward normalization. After three more increases to the federal
funds rate, the FOMC was ready to start looking at bringing the balance sheet into the
normalization process, voting in September of 2017 to start the unwinding process the
following month.
At that point, the size of the balance sheet was larger than we’d ever seen, and the MBS in
particular rendered its makeup different than it was before the crisis: Assets were made up
primarily of those Treasuries and MBS, while the liability side overwhelmingly consisted of
paper currency and bank reserves and balances.
The means of unwinding the balance sheet were straightforward: We could either stop
reinvesting the securities as they come to maturity or sell them on the open market. We opted
for the former, with gradually increasing caps on the amounts that were not redeemed. This
helped us attain the gradual, predictable, and thoroughly boring process that we’re aiming for.
Which brings us to 2019. At the March FOMC meeting, we said that we intend to end the
balance sheet runoff in September. Once we do so, we’ll reinvest paydowns from MBS —
subject to a cap of $20 billion per month — into Treasuries, which reflects our long-standing
plans to hold primarily Treasuries in our portfolio.

8

That won’t quite be the end of normalization, however. In September, when the runoff ends,
reserves will likely still be slightly higher than what we need to “efficiently and effectively”
implement monetary policy, and our ultimate goal for reserves is “no more than necessary.”
Our plan is to keep the size of our aggregate securities holdings constant for some time after
September. During this period, we will see a very — and I do stress “very” — gradual decrease
in average reserves, as currency and other non-reserve liabilities grow over time.
For me, a key issue is that we only have estimates of the demand for reserves, which means we
should approach the “efficient and effective” level with caution.
This slow and steady approach, which is based on work by the Philadelphia Fed staff, 1 is not
only the safer option, it has the additional advantage of reducing uncertainty about the
evolution of asset redemptions, and proceeds in the FOMC’s preferred “gradual and predictable
manner.”
Finally, I want to note that balance sheet normalization has received a lot of attention both in
our meetings and communications, and will continue to do so. Again, while that does reflect its
importance, it does not reflect our current monetary policy stance. We often refer to the
FOMC’s “toolkit” when discussing policy options. Balance sheet policy certainly remains an
option, but we’ve put it back in the toolbox, and stored it in the basement — within arm’s
reach, but out of sight for now.
Conclusion
That, in the smallest nutshell possible, is the combination overview of the Fed’s purposes and
functions and my economic outlook as it stands today. Instead of going on any further, I’m
going to stop there to turn it over to you for questions, and again, wish the Chamber a happy
100th birthday — you don’t look a day over 85.

1

I would like to thank Roc Armenter for his research and insight.

9