GBIF 2021 Keynote: Randall Kroszner, University of Chicago Booth School of Business

[Music] hello everybody and welcome to this keynote interview with randall krosner professor of economics and deputy dean university of chicago booth school of business and between 2006 2009 a governor of the federal reserve system given that during his time with the fed he chaired the committee on supervision and regulation of banking institutions and represented the fed at the basel committee on banking supervision and financial stability you could argue quite convincingly that this is the man responsible for the current shape of u.s banking which is by and large in superb shape right now with its biggest institutions dominating global capital markets before joining the fed from 2001 to 2003 he served in the white house as a member of the us president's council of economic advisers a period when the president and the country were of course dealing with the aftermath of 9 11. as well as running the executive mba program at chicago booth which sees him based in london he also chairs the federal research advisory committee to the u.s treasury's office of financial research and is a member of the federal reserve bank of chicago's academic advisory council randall has more than 100 publications including his book with nobel laureate robert j schiller reforming u.s financial markets before and beyond dodd-frank and his paper on corporate ownership won the brattle prize for best corporate finance paper in the journal of finance so uh randall very warm welcome to you um thank you so much for joining me today um now one of the big topics of conversation at the global borrowers uh conference this year is unsurprisingly inflation especially u.s inflation and given that you served at the federal reserve during those tumultuous crisis years you are i think probably the most qualified person at this event to talk about inflation so randall let's start by asking you is is inflation that we're seeing a moment cyclical or structural uh well thank you very much for that much too generous uh much too generous introduction uh certainly there were a lot of other players uh who are responsible for the uh the safety and soundness of the us uh financial system so uh i really can't take any credit for uh for that but um thank you nonetheless inflation uh obviously uh that is something that looms large and everyone's uh thinking uh we just had the fed meeting and of course the markets are are digesting uh the uh the new so-called dot plots of when the fed might start uh raising rates and that's moved into 2023 rather than pushed out beyond beyond that and then the question is well what's going to drive them to to raise those rates what's going to drive them to to start tapering and reducing the asset purchases and and obviously a key aspect of that will be the prospects for inflation now so far the market seemed to have agreed with the fed's approach that the very high inflation prints that we have been seeing are transitory the 10-year rate has not really gone up very much i mean actually over the last few weeks it's come down and so uh you know it's been in this range of roughly 150 to 170 for quite some time uh that's a range that we saw it in before the global financial crisis even a bit sorry before the pandemic and so uh we're in a range where we can see very strong growth in the us and not have that be be a problem the question is what will happen going forward and we'll be able to maintain its credibility and will inflation expectations remain well anchored so you know we had a high inflation print what was due to used car prices and then another one due to lumber prices and then next month it'll be due to hospitality issues or airline um airline costs and that's one of the challenges is it you know so i think it is so far series that went off since i agree with the uh i agree with the fed but if you have one-offs for six eight or nine months do people start saying are these really one-offs or is this going to be something that is is consistent um consistent over time but it's a trend towards higher inflation and of course given that the fed has this new approach the average inflation targeting approach which which says that the fed is not going to be proactive it is going to wait until inflation gets above two percent before it responds that's very different than before when of course when janet yellen and beginning of powell's term when the u.s had raised interest rates to around two percent or so even though inflation had still been persistently below is two percent target because it was trying to be ahead of the curve now it's explicitly said it doesn't want to be ahead of the curve well that potentially you know a combination of high inflation prints which we haven't seen for for decades plus this different approach which is saying we're comfortable being quote behind the curve that we don't want to be ahead of the curve that could be a possibility for inflation expectation becoming an anchored and that's what the fed is going to be focusing on really really very very keenly they're going to look at inflation expectations both from the treasury inflation protected securities markets the tips markets we're looking like out five years ten years as well as uh surveys of of individuals and i think that's going to be the real key my modal forecast is that i think the fed is likely to be right uh that uh that they that this will be largely transitory but the key question is if that unanchors expectations then it's not transitory anymore and then it's much more of a challenge i mean i think what we're describing here is sort of the economy recovering from the terrible time of last year and maybe seeing higher numbers because of being compared to such low you know low activity last year but we've also got in the background uh by the president biden's spending plans um you know which will be in enforce i guess once the high prints are out the way and we begin to see what's happening a bit more accurately i mean in terms of those spending plans do you think that they will move the needle and so um it is just astonishing how much new government spending has has come online if you go back to the initial crisis response three trillion dollars december a trillion dollars 2 trillion for the rescue plan and sort of another 4 trillion being bandied about that's more than 50 percent of gdp that's just astonishing even during war we spend that uh that much in such a short period of time and so um the economy is already taking off like a rocket in the us uh with the incredible effectiveness of these these vaccines plus a successful rollout um that by the way that's something interesting that's happening here in the uk a very successful rollout and although there's been a bit of a delay here i think um the uk economy is also going to be taking off quite quite strongly so you've got an enormous amount of fiscal stimulus plus the pent-up demand that comes from people having really significantly increased their savings over the the last year and so you're seeing very strong increases in demand in different different sectors and because of the either furlough schemes in the uk or unemployment benefits in the us you see plus still some wariness of people coming back into the labor market because health concerns you're seeing labor shortages you're seeing um high pressure on on wages and and so that again is a recipe for inflation taking off in a more persistent way and uh and potentially unanchoring expectations um i think it's very difficult to spend this much money responsibly in such a short period of time so totally on board with the spending in response to the crisis year ago that was extraordinarily important and with the fed providing the support that it did through asset purchases and bringing interest rates down to zero that's what you've got to do in the midst of a crisis to make sure that the pandemic didn't turn into a financial crisis and i think the fed gets a lot of credit and central banks around the world get a lot of credit for for doing that but then when you layer on top of that an enormous amount of continued fiscal uh fiscal spending that raises questions will people start to worry can the debt be repaid um i don't think there's any issue about that right now but maybe a little bit more down the line the big challenge is what if interest rates start to go up so what's been amazing is that despite this explosion of debt issuance at the governmental level not only us but other countries around the world most countries actually have lower death service costs now than they did before the pandemic that's because interest rates have come down so much what if those rates start to go up what if inflation expectations start to move up what if there's some concern about fed credibility there's a double whammy that's there because you have a big crunch on the on the fiscal side because the uh you get a very big increase in the uh in the servicing costs and you're getting much higher costs for for finance which many firms also issued a lot of debt much of that some of that debt is floating but but some of it is is fixed a lot of it was relatively short term and so they may have to refinance at a higher rate and so um that's that's really it makes things very fragile do i see disaster on the horizon no um do i see a possibility of it yes and so i think investors need to be thinking about risk management around that possibility because i think uh the possibility of inflation inflation expectations and interest rates spiking up are much higher now than they've been over the last decade you mentioned the efforts that central banks have gone to um in response to the crisis um um you know is is central bank um you know the concept of central bank independence though what is what do you think is now realistic so it's very very interesting because when in the us we passed the reforms uh so-called dodd-frank reforms that had both regulatory aspects to them but also affected the the fed so the actions that were undertaken by the fed when i was there we decided those it was just uh it was the five of us at the board of governors if we all voted for an extraordinary uh program that was that was the way the law was set up the law was amended to say no the fed can't do that on its own anymore it has to make sure it gets signed off from the treasury department before it does those sorts of things the concern had been that well that will mean that the fed can't be nimble it can't respond boldly and quickly to a crisis obviously that's not true we had a you know a really bold you know even more bold response to the crisis um a little bit more than a year ago than we did when i was at the fed they set up all the programs that we had pioneered from uh from a decade ago plus a whole lot more but the interesting part is the plus a whole lot more what happened was that congress appropriated money for the treasury to use to work with the fed to set up facilities for main street lending programs and other programs that the fed hadn't done before so that was really the first time that the uh the congress was effectively directing the fed to do certain things now it wasn't traditional monetary policy but it was something that you know was an important aspect of uh you know uh had an important impact on that the fed's balance sheet so what i worry is that the congress may have thought well you know now we can kind of you know through the treasury tell the fed what to do on certain things and particularly let's say if interest rates are or there's a concern about um debt financing costs congress may not be so sanguine about having jay powell start to raise interest rates might slow economic recovery might lead to slower growth of employment or maybe even an increase in unemployment it'll increase debt servicing costs and so i think you may get a lot of political pressure on the fed much more than in the past because of these uh this now experience that the the congress has had kind of telling the fed what to do in certain aspects not traditional monetary policy aspects but things that are on on the edge of that and with so much debt outstanding both the public and private sector that there's gonna be a lot of pressure on the fed not to to move and and so is its uh independence under threat right now i wouldn't wouldn't say that but i could see in a in a more challenging economic situation where the economy is not taking off like a rocket where interest rates are going up that it might be more difficult and unfortunately what happens is that if the fed loses credibility um it has exactly the opposite consequence of what congress might want interest rates are only going to go up further because inflation expectations will be unanchored they'll become very worried yeah you mentioned um some of those you know covered responses um and i'm just wondering um is it the case that every time there's a crisis now the efforts that went into that crisis become the benchmark for the efforts for the next crisis i.e let's say another crisis is the u.s and five times in five years time will we automatically reach for the efforts we went for this time round which which were extraordinary some of them um or will we say that that's put to bed now we can't use those those were those were you know one-off things that we can't reinstate what's going to be the appetite in the next crisis for reinstating these things so i think the markets are clearly assuming that there is a floor uh that if something really big goes wrong that you're going to get a very strong monetary policy response and what's interesting now is i think the markets are coming to expect a strong fiscal response because a decade ago there was an enormous debate over spending a trillion dollars now of course in you know in a much more partisan environment uh last last march u.s spent three trillion dollars so three fifteen percent of gdp uh just like uh just like that so i think now the markets are expecting both the fiscal and monetary response and um and i think in extreme circumstances like a pandemic that's totally appropriate to have that kind of response from the government the government's providing that kind of insurance function the challenge is what is a a shock that is so big that would um elicit that kind of response and so the concern is that if the markets are assuming that any major shock the fed and the physical authorities will take care of it that means we're going to be in a more fragile situation people aren't going to be taking as much caution as they otherwise would a phrase that i i use ever since the global financial crisis is if other people are not worried i'm worried because in the run-up to the global financial crisis we had record low levels of volatility everyone thought that you know housing prices can't go down all these these kinds of things and when people are not cautious that means the shock that comes in can ramify through the system quickly and we're in a much more fragile situation and i worry about that down the line that there are too many assumptions that oh well just you know trillion dollars here from uh the fiscal authorities and seven trillion dollars of asset purchases by the fed take care of all ills if people start thinking like that you're going to find ills that they can't take care of and that kind of moral hazard problem is something that i do worry about over time now that said i don't think there's a mistake that was made to respond to a crisis so i think you do have a crisis response but if people start thinking that things that really aren't crises but are just downturns or not so nice outcomes that you're going to get this kind of response then you get into that moral hazard territory um related to that question but also the central bank independent question is you know you look at government borrowing levels right now um but you know should we expect them to be permanently elevated given the support that's now expected to be provided so i i think and this gets back to our discussion before of you know are we able to spend all that money responsibly so you know initial crisis response i think that's extremely important but many of the proposals now for either short-term or longer-term spending is is going to increase the productive capacity of the economy is this going to solve some of the the key issues that we we face whether it's climate change or inequality if it's just spending for spending sake we're just putting a big burden on future generations and we're also risking the possibility that markets will say can they really pay that back you know they really have the wherewithal to do it in some sense it's a little bit like a company if the company has a lot of good prospects it makes a lot of sense to borrow so you can invest and take advantage of those those possibilities going forward and that'll have a productive payoff that makes total sense if a company is issuing debt just because debt is cheap and they can issue it and then they don't uh you know they sort of spend money willy-nilly and it's not for very good investment projects that means that that's not going to be repaid and the company's going to be in bankruptcy and and so now our comp our country is exactly like companies know but that idea is still there are you spending the money wisely and if it is for productive purposes and certainly there are a lot of infrastructure projects in the u.s that are worthwhile to do but if you're just suddenly trying to get you know two to four trillion dollars out the door and just do projects it's going to be hard to make sure that you've you've chosen good ones to make sure that they're going to have a good payoff so that's the the key concern that i have of is the money going to be spent wisely i think it's difficult to spend so much money wisely um that's not to say that there can't be some value in spending but i think that's also how the markets will look at it if they see this is useful spending that is actually resolving supply chain issues resolving bottlenecks and in the economy that's fine if it's just being spent for spending sake and not going to have a payoff that's a problem um both i think it's unfair to put the burden on our future generations markets at some point gonna say they're not gonna pay it back don't worry and then interest rates spike you mentioned climate change just then um i'm wondering what you think uh is the role of central banks in fighting climate change so uh that's a very interesting issue because there's been a lot of expansion of central bank responsibilities over time so it used to be primarily inflation then inflation and certainly in europe in the us inflation and unemployment and then financial stability that mandate has become more explicit in many many places and now potentially something related to not just financial stability but sort of broader issues like uh like climate change and so i think it is very important for central banks to be aware of the risks that are associated with climate change and make sure that the financial institutions that are doing lending uh and that are involved in the markets are aware of that and so that they do proper proper risk management but i get worried if um if people are looking to central banks as the expertise on climate they don't have the expertise on climate uh there are a lot of others who have that so i think it has to be realistic to see that central bankers will be uh using the information that comes in from climate experts in helping the uh to do their their due diligence on supervision and regulation and making sure that that's taken into account when banks are doing their lending but if you're looking at them to be sort of an independent um an independent voice and an independent uh monitor i think that's asking too much they don't have that that expertise and and then it's diluting uh their core core competency on regulation inflation etc um so um just on that subject uh would would you for example agree that central banks should have favorable risk weights for example companies that are deemed sustainable or indeed encourage or at least say that they're going to buy more debt in qe programs of companies that are deemed sustainable do you think that's the right way to go about it so two different aspects they're both very interesting and so so i think the key thing is is focusing on the um the the the risks and both the combination climate risks and the risks for the lending for the financial institutions and so obviously those are closely related and making sure that banks are systematically analyzing that trying to get data on that trying to encourage systematic disclosures about that so that banks as well as other investors can benchmark and understand what are the impacts of uh of firms on climate as well as the impacts of climate on these firms operations i think that's that's super important i think that's a that kind of getting good systematic data out to make better uh better decisions is important and that's a broad public policy issue that banks can do whether they should be just purchasing green bonds or not it comes back to a definition of what is a green bond and so this is a very big challenge to come up with what the right answer is for something like that so you have um like you know large hydrocarbon companies that are also very large investors in green energy and so should they be included and then you encourage them to to go even faster to to get to to zero carbon or should be excluded um and it's not clear that excluding them has that much of an impact on their cost of capital actually one of my uh colleagues uh at university of chicago um has written a very interesting paper um on this issue of maybe it actually would be better for people who very concerned about climate rather than boycott or divest to take an ownership share and then try to get um get initiatives on the on the proxy statement to say that they should be should be moving more quickly and he argues and has some empirical evidence behind that that those are much more effective at trying to move towards these goals of dealing with climate change than traditional traditional sort of boycott or divestment so i think it's an open question and that's why i'd be weary of uh of just saying ah we should just buy green bonds because i'm not sure that's the most effective way to get to the objective that we all uh i think many of us many of us share sure just moving uh slightly on if you don't mind to um uh the banking system um that you of course helped rewrite after the global financial crisis has it passed a test in your view um in the last 13 or 14 years so i think we've had the real test over the last uh the last 13 or 14 months and i think it's come through pretty well uh clearly we needed more capital than we had before and significantly higher levels of capital more liquidity than we needed before significantly higher levels of liquidity now that didn't obviate the need for the fed and other central banks to do as it purchases and bring interest rates down so i don't want to say that everything is perfect and that if the central banks hadn't responded the system would have been resilient enough to make sure that the um uh the real shock of the pandemic didn't turn into a financial crisis but i think it has made the the system much more much more stable is it perfect for sure not there's still there's still a lot of work that we can do on improving risk management but i do think we've seen a lot more resiliency in really a pretty astonishing shock than we would have 15 years ago okay um you mentioned all that you know i get this i get the sense that you're you are perhaps slightly concerned maybe you're ready to bid it but you're slightly concerned by all the money going into the economy you know the guidance stimulus programs and i'm just wondering um if i were to ask the question to you about can we see the sources of future economic crises um would would the stimulus plans that we're talking about right now are they you know the genesis of future crisis well it certainly is one possibility because we can you know as we're discussing before this could lead to an overheating this could lead to expectations of inflation's inflation we've gotten clearly inflation has moved up but that's likely to be temporary but it could be persistent inflation expectations could become unanchored that would lead to the fed having to significantly raise rates or if it doesn't raise rates then people being even more worried about the potential for inflation sharp rise in interest rates could lead to a very significant tightening of financial conditions a significant revaluation of many asset prices and for example for uh growth growth firms growth is firms are based on you know future growth and future prospects even if they're not producing very uh producing many profits now well when you're discounting at effectively zero interest rates the future looks just like today if interest rates go up a lot the future doesn't look so good relative to today and if they're producing those profits the values come down very significantly so this could have a very big impact on growth from valuations for example and so if you have interest rates spiking up um because of concerns about being able to repay the debt concerns about inflation that i think would have the seeds for uh for a crisis because it would be uh it would be crunching um uh crushing on the fiscal burden it'd be crushing for firms that have a lot of debt outstanding and uh and so you could have uh you could have a problem there do i think that's a likely outcome no is it something that we should be doing risk management around for sure because i think this is a more likely outcome than we've seen over the last uh less decade but that doesn't mean that it's a likely outcome but it is something that is i think of a significant enough concern that investors as well as policy makers should be thinking about risk management around that yeah okay well um randall thank you so much that's been fascinating you've been fantastic incredibly interesting thank you so much thank you as well to our audience for tuning in thank you uh for joining us um and actually stay with us for the next section next uh session which we'll follow shortly and that is going to be on sovereign borrowing thank you very much

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Length: 28min 1sec (1681 seconds)

Published: Tue Jun 29 2021