The Fed: Lessons learned from the past three years

good morning and welcome I'm David Wessel director of the Hutchins Center on fiscal and monetary policy here at Brookings thank you for joining us for today's event uh the FED what lessons have been learned or should they learn for the past three years the mission of the Hutchins Center is to improve the quality and efficacy of fiscal and monetary policy and public understanding of it and I think what we're doing today fits into all parts of that mission uh the past three years have been very unusual a global pandemic the likes of which we hadn't seen in a century a consumer price index which peaked at nine percent year-over-year uh the Russian invasion of Ukraine a new fed framework and we think that the Federal Reserve needs to hear from Outsiders about what it should know and what it should learn and particularly what it should do in the future so that it can do a better job at managing these difficult situations uh now let me say a word about why we have this particular cast I've gotten some criticism that there's nobody here who hates the fed and that's true there are people who question the fed's Mandate question its governance even question the wisdom and background of its top policy makers and those are conversations worth having but that's not the conversation we're having here today we have an unusually good mix of a economists who embraced the fed's mission stable prices and maximum sustainable employment people who have substantial experience as policy makers and Scholars who are well positioned to offer Reflections and constructive criticisms of the fed's monetary policy and its framework over the past three years so that's what we're doing here today we're honored to have our own Ben Bernanke and Olivier Blanchard from the Peterson Institute across the street who are going to speak about first about their views on why we had so much more inflation than some people although not everybody anticipated and then we have two discussants Rich Clarita who was vice chair of the fed and Jason Furman from Harvard former chair of the Council of economic advisors then my colleague Louis Shane will join them up here and we'll have a discussion of the questions that are raised or the ones that Louise will make sure that she raises the questions that they ignored in their paper and then our second paper is by goiti Edgerton of brown and Don Cohn of Brookings former Vice chair of the FED which looks closely at what the fed's framework changes meant and what its monetary policy tools particularly forward guidance uh contr how they contributed to the inflation problem we have and then after that Ellen Mead who was involved in the framework will give some discussion remarks and then we'll have a panel up here to discuss what questions the FED should have on its agenda when it red when it re-examines the framework as it's promised to do in 2025. so we have a very full day I thank you all for coming all the papers and all the slides are posted on our website and the video will be there as well so with that I'd like to call Olivier to the stage to make the initial presentation of the blushard Bernanke paper foreign thank you so this is indeed a paper with Ben the division of labor is I'll presenter paper and Ben will address most of the questions after that um do I have to direct this to something thank you good so let me start with the theme of a paper go back to the end of 2020 of the beginning of 2021 and there were there was a large number of very large fiscal packages so there was a cares act in March of 20 then the covet package by Trump in December and then under the Biden Administration the American Rescue plan and this added to to more than 5 trillion this looked very big and there were two views at the time uh they they focused uh on the labor market as what the where the action might might be there were the optimists and I think this was the view of the people at the fed and they concluded that the Phillips curve was very flat so even overheating would not lead to much inflation and expectations had become very strongly anchored so that there would not be very large second round effects and so on they were epessimists and I would put myself there I would put like Summers there as well and maybe Jason as well the idea was yeah and this is how things have been over the last 20 years but given the size of a shock the Philips curve may well steepen very much as you get to very low unemployment and expectations May well the anchor if inflation is really taking off the outcome turned out to be neither so there was inflation so the pessimists were right but the channel That for which inflation or the med affected inflation was not so much for labor market which we had very much focused on it was the Goods Market it's where the action really took place commodity prices went up a lot there were shortages price spikes and most of the action came from there so we got the inflation but not for the labor market rather for the Goods Market which I think is a general lesson to be learned so what we've experienced in the last three years is headline inflation has been nearly completely dominated by Price shocks one quarter there's a large change in the energy price in the next quarter it's food a price of of our price spikes and so on but and this is what we see and this is what's discussed every every month when when the CPI comes out but behind the scene you have had what we think is fairly steady overheating after the covid period which have put pressure on wages and that's they are hard to see when the rest moves a lot but as price sharks tend to fade and I think the assumption is that they will then what appears and was not visible before is this higher wage inflation which is due to another heated labor market and some this anchoring of expectations so that looking forward we're going to be dealing with a very different type of inflation in which it's really the labor market again which becomes the central issue and we will probably have a slow down the economy that's very much the theme of of the paper okay the approach that that we have taken has three steps so the first one is we constructed a really simple analytical law to basically think about the mechanisms for which price shocks are overheating a labor market will affect inflation so for those of you who have come to bookings papers meetings for many years this is very familiar and basically you can read an old paper by Tobin and it's nearly the same it has a wage equation which captures the effect of what happens in the labor market on wages it has a price equation which reflects what wages are doing and other costs are are doing and then it has expectations of inflation and we think it's important to separate between short-term expectations what you expect to happen next year and long run expectations which is what you expect say in 10 years so the first thing I'm going to do is basically show you them all quickly and then show you two of the implications which I think are absolutely Central then the second part of the paper is we estimate that more on the pre-covet sample so we say up to from 1990 to 2019 let's estimate this equation and we use we play which I think is a is a good game which is we use the structure of the theoretical model the analytical model we just allow for more lags because it's clear that the Dynamics in the real world are more complex but we don't play around trying different specifications so I'm fairly convinced about the robustness of what I'm going to say which is a relevant Dimension and then what we find is that given the state of a of a labor market so if I take as given the fact that there has been overheating and that there has been price shocks then the pre-covered equations work well it's not as if suddenly the world became completely different the shocks were different but the structure of the analytical structure basically explains very well what has happened one more conclusion which I did not expect is we don't find the anchoring of expectations or very minor the anchoring of expectations I explained what this means and we were worried about catch up which is the notion when then there are price shocks the wheel wage tends to decrease and the question is how much do the workers try to get back the real wage when they have lost the real wage loss and we find very very little effect of this which is clearly good news maybe not for workers but good for inflation now at the end this will be the last part we show the implications of the empirical more and we show the effect of a different shocks what happens if there is a price of energy shock or what happens if the labor market overheats and then we give you a decomposition of a history of inflation over the last three years and then we are very tentatively because this is not the purpose of a paper looking forward suppose the price shocks go away why can't we expect inflation to do and that's that the focus is then again on the state of a labor market and how much more tightening is needed in order to get inflation from for to say two percentages the target okay so this is the mall and uh some of you are probably allergic to algebra but I think I can give you a sense of of the equations and if you look at them they are they're very simple wage inflation depends on expected price inflation as you try to basically maintain your wheel weight looking forward it depends on the state of the labor market it is viable X I shall say more about X you can think of it that this stage has unemployment or a vacancy unemployment ratio and then there's an additional term which is a term in the middle in the first equation which is a catch-up effect which is that if the price level increase much more than you expected your will wage has decreased how much of this are you going to try to get back when there was indexation in the old days this would happen more or less automatically but now there is not and the question is do workers try to basically get the real wage that they had before rather than the lower real wage that's the equation that's the one we're going to estimate the other equations are absolutely straightforward we think of of of the price all these are logs obviously for those of you who look at the equations inflation price inflation depends on wage inflation and on the relative price of a non-labor inputs so if the price of energy goes up relative to the wage then it leads to a burst off of inflation completely traditional we have a variable that I'll talk about which is that we have clearly commodity prices such as energy and food but you know one of the stories of of this episode is the shortages and the price spikes so we have a shortage variable which would not have been there you know before 2019. then we have two two equations for expectations which basically is a short run expectations depend on Long Run expectations but you think it's anchored too and past inflation so if past inflation is higher you adjustable and then the long run expectation is again the same it depends on itself lagged and if you see that inflation has been higher you may adjust your long run expectation a little bit we would expect the effect to be small but not not zero okay so let me give you two slides which show simulations of them all which are going to be very important in thinking about what happens in the data so this is the effect of one-time permanent increase say in the price of energy so it's high energy inflation golf for one quarter right it's a change in the level and therefore in the growth rate it's a one-time increase in the growth rate of the price and initially clearly this increases prices so the increases inflation okay but then what happens over time depends on two characteristics of the economy and of them all the first one is how much do expectations adjust well achieved to this when people see high inflation how does this change the way they think about coming inflation and catch-up which is that if there has been a shock like this how much of it do they want and I give you two loci the first one the blue one is expectations don't react very much and catch up is weak so the effect goes away nearly right away you see it in the quarter in which it happens but after this it's nearly gone not completely gone you can see that you don't quite go to zero because expectations have moved a little bit the red line is kind of a back case ketchup is strong expectations we act strongly so you get strong second round effects and because this affects expectations you end up with higher inflation in the long run so keep this in mind and you'll see the data in a while and compare this is the effect of permanent tightening of labor market so again think of X as low unemployment or high vacancy unemployment ratio and there again you're going to get the direct effect which is if a labor market is very tight you're going to get pressure wages which is going to lead to pressure on prices that's the standard textbook but it's it can be strong or it can be weak as long as X is too high relative to its normal value so as long as unemployment is below you star to use the usual jargon then there's going to be pressure inflation so in that case inflation keeps increasing but the way it increases depends again very much on the Dynamics of expectations if expectations react very much you get inflation to increase faster and faster this is really the acceleration is the hypothesis of the old days and that's the Brown Line but if expectations are quiet you get some increase in inflation but it's less and you can see that the blue line here good so this was part one now we go to the data and let me just say a few things about what we do so we estimate the four equations exactly as we you've seen them so not all the variables are not in all the equations or maybe variables which were implied by them all we allow for us use quarterly data we allow for four lags of all the included variables we don't play with flags at all so it's a bit in the state of a VAR but with zeros where we think that some variables don't belong the identification if you want to think in terms of a VA is that the main assumption is we assume that wage inflation doing one quarter does not respond to anything within the quarter so this allows us to basically get an identified system the sample we didn't want to go back to 1980 or 1970 because things were different we started in 1990 where inflation is relatively stable and so the sample is 1990 to 2019 there is one equation where we cannot do what I said which is stop in 2019 because in the price equation shortages play a big role there was no shortage basically before that so if you only use the pre 2019 sample you don't see anything so for the price equation we use the full sample other variables let me not you know go through them we do a lot of robustness for example we do it with a CPI we do it with a pce for the price on expectations we choose a Cleveland fed of a server of professional forecasters the two things I want to mention is this shortage variable so we know that there were a number of markets where you know you couldn't get the goods and in the paper we have a discussion of the automobile sector where we can really tell the story in detail the question is how to capture this we found that the viable shortage when you go to Google Trends Works marvelously in the sense that there are two quarters in the history of the last three years where without it you get a large forecast error and if you basically if it's over two quarters where people went to the net and said shortage shortage and so we use that variable and it beats actually many other variables which have been proposed that that's a variable we use footnote it actually has come down from the Peaks it is very far from zero and so it indicates that people are still worried about shortages and the other good and and the other uh viable for the labor market and there's a long discussion in the paper which I will not go back to is instead of using unemployment we use a vacancy unemployment ratio and that's something that I've argued for in a long time with Peter Diamond but until now the two variables varied more highly correlated you couldn't tell but in this crisis they have separated this is what's known as the shift in the beverage curve and we think that the over U is the right variable okay so let me now move very quickly so what this shows is basically the results of the regressions and given the time I'm just going to ask you to look at the visuals so what this does for example for the wage equation it uses with estimated equation up to 2019 and then use this to predict what has happened since using the actual values of uh the other you and so on right so as you can see for the wage it kind of works and if we had time I would talk about the coefficients but I don't for the price equation now again that's more in Sample than fixed population but you can see that it works amazingly well uh by the standards of that type of exercise and then okay so let me now take an issue which is very important which is as you as I've argued headline inflation is completely dominated by the price of energy the price of food and shortages now where do these come from is a big issue and there are two stories one is well just happened coincidentally or the other which I tend to believe is that it came largely from aggregate demand just in go through the usual Channel but it basically put pressure on commodity prices and so on so what we did and I think that's an important part of the exercise we said let's look at commodity markets in general so let's take all the community prices that we can put our hands on it's reasonable I think to think that on the demand side there is a common element which is that evays higher demand there is higher demand for all Commodities on the supply side it is more likely that the supply shocks in each market are more idiosyncratic you know there's a mine for lithium which is open always upon with copper so if you assume that then the common element of all this series is something like aggregate demand and so that's what we do we do a principal component and what you get is this the red line is the sorry the blue line is the principal component and the red line is in the top price of energy and in the bottom the price of food and you can see that until the Ukraine episode the blue in the red line are very similar so my sense is much of a price movement comes from uh from from aggregate demand so I can get the man in the end didn't work so much for the labor market but it works for a Goods Market let me keep going these are the regressions for expectations and again very good fit I think what's important here is that yes both short one and longer expectations respond to actual inflation but the coefficients are very small so let me move I'm going to redo the two exercises that I showed you in the theoretical more so this is the impulse responses of inflation to one standard deviation in one of the pie shocks so one time increase in the price of energy or any the point I want to make I've reproduced the theoretical one on the top is basically that they don't last so this idea basically there hasn't been second world effects there are these big shocks every quarter but they more or less disappear in terms of the effect on inflation for next quarter it could have been different and maybe it's different in Europe for example but that's what we thought by contrast if you sustain too high vacancy unemployment ratio then you get you know something which doesn't go away and builds up and so again you have a very high frequency shocks and the thing behind so when we go two more slides so this is a decomposition of price inflation since the first quarter of 2020 look at the colors and basically what seems to dominate as you can see is blue and yellow right and blue and yellow are basically the price shocks it's price of energy price of food its shortages and you can see from quarter to quarter that's most of the action right what you see also is the small red part the small red part is the result of overheating in the labor market and it's not big right this trade effect just for the labor market is more and the question is when the price shocks go away then basically the yellow and the blue will disappear and you'll be stuck with the red which doesn't look very big but may actually be fairly hard to get rid of now this is the same for wages now you can see that for wages what dominates is V over U much more the effect of price shocks is only for their effect on expectations they don't affect wages directly okay slide I hope I'm still more or less on time okay so we did something that with a very reluctant to do because we know of a journalist in the room are going to look at this thing much too closely we decided that we could not stop and not think about okay what happens if so these are conditional projections but there are no a specific forecast remember the more is estimated up to 2019 it hasn't been optimized to have the best forecast price shocks may not be zero so now that all the caveats I can talk about what happens here because I think that's the important part so what this does is it looks at eight three different paths in which we do something to view so the first one the brown one is we keep it at the current value which is 1.8 right which we think is overheating right the second one we get it down over eight quarters to 1.2 which we think is probably close to the Natural vacancy unemployment rate and then the green one we take it down in eight quarters 2.8 which is slightly depressed labor market in that sense and the conclusion is that it may take quite a bit of a decrease in V over U uh to actually achieve anything close to a two percent Target two years from now and you know we don't want to push this too much but again now the Phillips curve is very flat and therefore what we have to give what we have to remove may require quite a bit of uh of contraction so let me finish with four conclusions the first one is Universe has been a lot of articles in the Press about the fact that the Phillips curve has died we have to rethink macro macro economics know nothing and so on so on uh I don't think so I mean it looks like you know what we showed you is a fairly standard mall and we applied it to the data and it worked now I think it you really have to think in terms of both wages and prices I think the reduced form price approach that many take is not right there is really action in both good okay the the second is the obvious one which is the complexity of the shocks and we didn't predict them we didn't think that commodity prices would increase as much it took us a while to understand the effect of shortages on price spikes and so on I think looking forward to more episodes in the future we have to be much more open to the fact that they more action potentially more action in The Goods Market uh the the third point and here I'm going to repeat things I've said along the way the price shocks in the Goods Market really have dominated The High Frequency discussion but this is that they haven't had dinette strong Dynamic effects and I think there we have to give credit to the FED for credibility which is that expectations react to inflation but they didn't react to inflation more in this episode than they have in the last 20 years so credibility is there and then the last one which I also mentioned but let me repeat it is overheating in the labor market for until basically recently was a minor factor in inflation right but now that the rest is gone this is what dominates and this is where it's going to be hard to adjust one last remark there is a whole other discussion which is okay so we have to decrease V over U what does this imply for you because U is the viable that you know people think about and that's a discussion that has happened between nice Summers and I on one side and Alex domash and on the other side Chris Waller and it's a question about what has happened to the beverage curve whether it has shifted which is a shift in the violation between you and vu if it has shifted and it remain shifted what we say is bad news for unemployment if Chris Waller is white and there was a shift and the shift is going to be completely undone then we need slightly high unemployment but it's not crazy maybe one percent rather than some larger numbers at this stage I will be honest Chris Waller is doing better than the brochure Summers team but we shall see I hope very much he's right for the welfare of the unemployed but we'll see thank you very much [Applause] great um well this is a wonderful paper it's incredibly elegant it shows how much you can do with a model that I can understand it uses models estimation Etc that hearken back to a number of papers I'd read um from Ben and Olivier's back in as early as graduate school I'm largely in agreement um with the conclusion and the path forward if I had 20 minutes from my comments I would continue on for 10 more with my praise but I only have 10 minutes for my comments and want to describe some of the ways in which I think the paper doesn't settle one of the biggest debates and how I would interpret some aspects of it differently than they do and I think the issue is that the exogenous shocks in the model food energy shortages as the authors well understand productivity as well are all endogenous and so you're really looking at changes in endogenous things and that none of them map exactly um to what happened in terms of policy I think the fundamental debate between the optimists and the pessimists wasn't the slope of the Phillips curve and would you get inflation through the labor market but it was a broader debate on the one side was the Series of Unfortunate Events view that basically the model was correct but the inflation happened because who could have forecast a whole set of Unfortunate Events now those unfortunate events started out with the vaccines being effective which in the first half of 2021 was the reason for inflation in the second half of 2021 the unfortunate event was the vaccines were ineffective which also caused higher inflation the microchip shortages the Portage clogged the Russian invasion Etc these were all things no forecaster could have known about their exogenous shocks on the other side is the original sin view that all of this was due to fiscal and monetary policy and fiscal and monetary policy don't just need to operate through the labor market they can operate through a number of these other channels as well like um shortages broadly my own guests coming into this paper and my own view coming out of this paper is that an orange line core pce inflation has been about five percent annual rate that most of that was original sin it was predictable you just couldn't think the whole inflation was going to operate through the labor market there'd be other channels for demand and that most of the excessive headline over core was an unfortunate accident which was the Russian invasion of Ukraine with very little of that bleeding into core so let me take that second part first I'm going to talk about core inflation and The Limited food energy pass through where the shortages due to the Peloton economy and then talk about an alternative way of thinking about things um uh Olivier showed you this decomposition and you see in the dark blue and the light blue you get the food um and energy and this is for overall inflation there's something really striking about this finding that they don't draw out in their paper which is that these contributions from their model the food and energy contributions are exactly the same as the BLS contribution of food and energy to overall inflation almost exactly the same so these are two pairs of bars the left bar is their shock and it's how much food and energy contribute to overall inflation based on the model and then on the right hand side it's just literally mechanically if food went up 10 and it's ten percent of uh overall inflation it adds one percentage point to inflation that's what the BLS publishes every month and the sum of them are those diamonds the dark diamond is what they estimate the hollow one um is what the BLS does the fact that those are basically the same is consistent with their being essentially zero pass through from food and energy to core not just to core not just um with a lag but contemporaneously as well I think that's quite important because there's been a lot of discussion um about the pastor I think that's broadly consistent with a lot of research by the way that says when gasoline prices go up airfares go up but people can't afford to buy as much other things go down in some previous papers have even found small negative pass-through from oil price increases to to core so they don't look at core in their paper this is sort of rough it's not going to be exactly right it has a residual for some of the error but it looks at the excess of inflation inflation CPI above 2.3 which is the fed's target give or take measured in that space and you see shortages play a really big role in 2021 a sizable role in 2022 and some role in 2023 I don't have time to talk about it but initial conditions isn't a productivity I'm quite worried that that's endogenous and not telling us something external but that's a discussion for another time let's look harder at shortages the shortage story generally has two pieces one is a set of supply chain problems made it harder to produce things largely around microchips sometimes around ports I'm not going to talk very much about that I think that's been pretty dramatically overstated for example Port capacity in 2021 was 18 above what it was in 2019 that was a huge increase in what ports were processing it just wasn't as huge as all the stuff Americans wanted to buy from abroad what I want to do though is talk about the consumer side which the paper talks about in interpreting its shorted shock and give you an alternative interpretation the Peloton economy thesis not their term I'm not sure who first came up with it I've heard both Justin wilfers and Paul Krugman use it is that covid caused people to shift spending from services to Goods and that this rotation was inflationary because the supply of goods is more in elastic I'm really deeply unsure about the first part of this argument and I'm somewhat unsure about the second too so let's look at consumption spending on sporting goods and gyms this is recreational Goods vehicle sporting equipment supplies guns and ammunition you can't break it down any finer than that and you do see a big increase in spending on this but note the big increases are when people get their checks and those increases are happening in the first half of 2021 as the economy is reopening covet is coming down people are going back what were people doing on the services side over the same period of time this is spending on membership clubs and participant sports centers those were Rising quite sharply too and so what we saw in 2021 looks a lot less like covet is keeping people home so they have to order pelotons rather than pay gym memberships and looks a lot more like people are flush with cash the economy is reopening they're spending a bunch of that cash on durable goods and a bunch on non-durables and in fact the 2008 stimulus checks Jonathan Parker's research finds the majority of that money was spent on durables you give people a large lump sum what do they do they try to buy a used car you see similar things in um you know personal care services and personal care products and overall uh moreover the idea that the U.S spending on goods and rotation from Goods to Services was exogenously caused by covid is belied by a comparison to other G7 economies this is real durable goods expenditures in the United States they just go up enormously they go up 10 percent in the first half of 2021 everywhere else they were flat or in Germany they even went down quite a lot and what's notable is most of those other economies were much slower to reopen they had higher covid slower vaccination more rules that prevented people from consuming services so if anything the exogenous it's covid that led to the goods as opposed to you give people a lot of money and what do they spend money on they spend it on Goods that should apply even more to the other economies there so I think the shortages at least on the demand side really were a predictable con sequence of the cash not on the coven the second part and frankly I'm less sure about this and it actually doesn't matter to My overall argument is the authors in interpreting the shortage term have a model like this which is durable goods goes up because people are spending more on durables they can't afford to buy as many services and so Services demand shifts back but because you have this non-linearity you get inflation from one Higher prices on the good side you don't get lower prices on the services side I think that's not necessarily where we were I think where we were might have looked more like this where Services demand would have increased a lot but because goods were so expensive because of the shortages and the like Services Demand only increased a little the service sector also had huge numbers of job openings huge amounts of there wasn't a lot of elasticity when I went out to restaurants in terms of how many people they could serve and the like and say you're on the vertical part of the supply curve in the service sector too and so that rotation as people spent more on Goods Less on Services may not have mattered so let me talk about what I think the pessimists thought from the beginning which based on this overly polemical unfair linear policy analysis give every household a million dollars it's 514 percent of GDP in fiscal stimulus the multiplier 0.8 so GDP goes up 412 percent the unemployment rate Falls to zero Phillips curve has a slope of 0.15 inflation Rises to 2.6 to be clear this is not their model their model has a v over U so it has a non-linearity but I think this was the type of model that people were operating with then when we saw real GDP growth only a little above uh Baseline and massive inflation you come along and run your regression and lo and behold what do you find the model was completely right it was the right way to think about it but there was a shortage shock because there's shortages everywhere throughout the economy and so I think in this title of the slide is unfair Olivier convinced me of that so I'm going to change it later that in the labor market they're doing monetary fiscal to real GDP to the labor market the first steps are happening in the background and that to inflation through the Phillips curve I think a better way to capture the concern the pessimists had the original sin view was that if you get a lot of nominal GDP and you can't make a lot of real GDP what are you going to get you're going to get things through the labor market you're going to get shortages you're going to get higher food prices you're going to higher energy prices Etc and broadly when you look at the experience real GDP did quite well you don't see a lot of Supply shocks in Real GDP the fact that it got back to the pre-crisis forecast by the end of 2021 is amazing a million premature deaths people out of the labor force less immigration all the disruption covid's still with us Omicron hitting and you're back um there so in some sense the real economy did incredibly well it's just so much money was pumped into it nominal GDP went up a lot and that showed up in all the different error terms in their model in terms of inflation being well above What was forecast so summary in conclusion I think it's a really elegant paper I think it's a very good way to think about inflation in normal times I think it doesn't answer the Series of Unfortunate Events versus original sin question I think it finds that food and energy do not explain any of core inflation and I agree with that finding the shortages are just as consistent with demand increases I think that's a more compelling interpretation of them than anything caused by covid or caused by Supply I think for large shocks you almost want to ignore the labor market you know the inflation will show up somewhere even if you don't know quite where and how and regardless I do agree with the authors about what I think their conclusion is the improbability of a soft lending at 2.0 percent inflation thank you [Applause] okay get the uh it slides up oh just click it okay let's see if I can figure this out perfect um I'd like to thank the organizers for uh inviting me to participate uh in this conference I'm sure I'll learn a lot in my 12 minutes I'm going to do three things first because I think this is going to be primarily a U.S focused discussion I want to broaden the discussion to include some contact Global context for inflation and the policy response second I will talk briefly about doing what I think of as rigorous counterfactuals to to Fed liftoff and then thirdly we'll actually discuss the paper and part piggybacking off the fact that I knew Jay simply do a good job so the first thing to emphasize which you all know but it oftentimes gifts forgotten in discussions of fed policy is that a persistent sustained surge in core price inflation is a distinctive and distressing reality of the post-pandemic global economy it could be a coincidence I don't think so so as an economist one is encouraged to look for common uh factors well one common factor is clearly a decline in post-pandemic aggregate supply consistent with uh two percent uh inflation Target the left chart is from a recent excellent speech by Catherine Mann the right chart is from a paper that John Williams previewed or premiered last week at a Fed uh conference and so if you go back to econ 101 or act 10 at Harvard there's aggregate supply and aggregate demand and aggregate supply is clearly an issue in terms of thinking about the level of demand consistent with the price inflation Target secondly and this will get to Jason's point there was a substantial fiscal and monetary policy support delivered during the first year of the pandemic in support of aggregate demand and this is true whether or not you look at the fiscal policy response whether or not you look at in the case of the FED cutting rates to 0 offering for guidance or whether or not you look at balance sheet expansion so I think there's actually more variation across countries in fiscal response than a monetary policy every Central Bank at least I'm talking about advanced economies did some version of cutting rates to zero or to the effect of lower bound if they could doing substantial quantitative easing and offering some form of forward guidance so obviously X post this turned out to be two accommodative relative post-pandemic aggregate supply getting back to Jason's comments but according to observers critics were ex-anti too accommodative even relative to a pre-pandemic arrogant Supply assumption what I would point out is that in June of 2021 the fed's SCP projections projected that in 2021 GDP growth would be at seven percent it came in at five seven and this was not due to insufficient demand now correlations are not causation again another thing we learned in 10 but if one wants to look for correlations in the data there's much more of a correlation between cross-country fiscal uh intervention and cross-country inflation than there is between cross-country growth in the monetary base and inflation and so I think that at least to me is worth thinking about as well again expanding the domain of inquiry away from the FED to what can we learn we have an unusual situation where we have a truly exogenous shock which is a pandemic we shut down the global economy or chunks of the global economy we also then had a reopening shock which in itself was a shock given Supply chains and then we had an endogenous policy response to the first and the second and so I think taking advantage of cross-country analysis at some point will be the preferred approach to thinking about this period as opposed to kind country by country analysis another common factor is a large and persistent change in sectoral relative prices Goods versus Services here I'm not taking a stand on Demand versus Supply if you just go to a basic equation for a price index it's going to be some log linear average of services and goods prices if the relative price of goods goes up for whatever reason if the equilibrium price of goods goes up for whatever reason then the overall price level will go up unless the Central Bank wants to engineer a decline in Services prices so in a sort of a standard model if there's some nominal rigidity in the service sector if there's an equilibrium increase in relative prices the central bank has a choice you either allow the relative price to go through and take a one-time increase in the price level or you raise rates and throw people out of work to reduce the price of services and most central banks went for the accommodation at least initially the relative price changes now there's a saying that facts are stubborn things and here are some facts about Advanced economy post-pandemic inflation and Central Bank policy response number one inflation and advanced economies is well above inflation targets now entering the third year of the reopening number two core inflation in advance economies is well above inflation targets now three years into the reopening with the exception of Switzerland I'll get to Switzerland a minute no Advanced economy Central Bank began to hike rates until inflation exceeded Target almost all advanced economy central banks delayed rate hikes until core inflation exceeded targets so here's the list obviously in the U.S in Canada core inflation was 4.4 at the time of the First Rate hike in New Zealand 2.7 in the Eurozone 3.7 in the UK for and in Sweden 4.1 so all these central banks at some level found themselves and clearly given the choice of policy policy chose to fall behind the chose behalt find behind the curve why this happened obviously is a very important and interesting question but it says more about the practice of inflation targeting Central Banking in this period than it does about any particular implementation of a framework there's a nice recent paper by Beaudry and co-authors looking at an analysis of why inflation targeting central banks delayed liftoff until core inflation exceeded a Target so if the documented inflation overshoots and the choice is to fall behind the curve represent framework failure in this episode they represent at least in this episode failures of both I.T and its first constant flexible average inflation targeting I don't think this is the case I believe these ex post errors were errors of tactics not of strategy tackle the judgments in the fog of war and I'll get back to that more in a moment okay now a little bit on the fact ahead I can do this in five minutes thank you we all know that the FED began to lift off in March of 2022 and given the inflation oversuit and persistence one is encouraged to think about a counterfactual liftoffs for the fed you know counterfactuals are both too easy and too hard so to put some discipline on this process I'll look at two plausible counterfactuals one is that the FED had just lifted off according to a standard tailor type rule remember in a Taylor rule if inflation's above Target you want to raise rates but if unemployment's above your estimate of Full Employment you want to depress rates and in the case of the fed you really don't get a lift off under the balanced approach rule until the September 2021 fed meeting now this is a static rule uh you know Central Bank that had a good crystal ball and who saw the inflation obviously could have hiked but just on a static tailor rule you would have gotten liftoff in September at the earlier table I showed you the Ave average gap between when core inflation moved above two and when the Central Bank began to hike it was about six months and so that would also put it in roughly September of 2021. interestingly enough the threshold forward guidance that the fed put forward in September of 2020 to lift off namely that inflation's at Target and and the labor market is in the committee's Judgment at full employment those conditions were met by December of 2021 so three months after the conditions for a standard Taylor rule uh and this just documents that those conditions were met by December 2021. so a couple of things before I actually get to discussing uh the paper first is what's striking in these charts for for dallas-fed trim means so underlying inflation uh and the labor market is they both go hockey stick at exactly the same time which is the third quarter of 2021. so up to that point if you came into the year with a prior that there was slack in the economy both through the labor market and an aggregate supply there is nothing to really change you of that view until obviously things went hockey stick and in particular at the point that broadbridge price inflation picked up in the U.S the level of GDP was still two percentage points below then estimates of potential and of course in the labor market the unemployment rate was north of five and participation was below the one indicator and again we saw this in Olivier's a paper in his work the one indicator that was back to pre-pandemic levels was the vacancy unemployment ratio by by the fall of 2021. so finally some thoughts on the paper itself as as Jason pointed out most of the inflation overshoot in 21 and early 22 was it is attributed to food energy shortages and the residual maybe picky backing a little bit off Jason's comments is the residual picking up excess demand not captured by Vu and some other variables in particular Vu and theoretical models can reflect both supply and demand so fast forward to today the residual is now small and if you squint at the last bar and in q1 2023 it looks like in this model what I would call underlying inflation is around four percent and that actually comports with other models that I look at statistical models of underlying inflation are all somewhere in the mid to high threes right now in terms of specification I was reassured by the finding that during this period inflation expectations remained well anchored that certainly is a policy success compared to the 1970s one thing that's interesting about looking at long-run inflation expectations data is in the last 10 years or so it's pretty mean reverting whether or not you look at Michigan surveys or or other indicators it's pretty mean reverting around a particular level so given that they don't find a lot of pass-through into long-run inflation expectations a version of the model that essentially essentially reflects that could be an interesting alternative calculation so thank you very much and I look forward to the discussion [Applause] foreign before you speak everybody just as a reminder to hit the the little button here that looks like a microphone so um first of all thank you very much for an incredibly clear um presentation and clear really wonderful discussion remarks I thought those were fantastic I'm going to basically give you a chance to respond Ben um to the discussions but let's just let's just start with the big question which is you know what how do you view this question about what your papers does or doesn't say about the effect of fiscal policy on inflation so let me first thing to discuss and it's uh Jason is my go-to guy for inflation information both at Peterson and on Twitter um and Rich of course was in the room you know when it was decisions were made as Hamilton tells us so I really value their views I think that I'll respond mostly to Jason since he spent the most time on our paper um uh he sets up the the um debate as being sort of fiscal monetary aggregate demand versus you know Supply constraints and that's not at all what we were trying to do we think that accurate demand was an important part of the story what we did say is that the aggregate demand working through the labor market because of the Phillips curve is flat and because the output gaps were not that big did not have a large effect on wages in the short term that's that's that's the uh contrarian thing that we say but we also talks explicitly about the effects of aggregate demand on commodity prices we do this exercise with with the principal component and also the effects on the demand for uh Goods like cars that were in short supply so I just reject that and we do look at aggregate demand uh albeit we don't develop all of the linkages by the way to ignore the supply constraints I um we actually did research by calling GM and talking to the economists there if you look at our figure six you'll see that at the same time that prices were Rising sharply in the Auto industry and inventories were collapsing production was going down I mean if it was it was a demand side thing you think production would at least stay the same or it'll go up a little bit so I do believe that there was a supply side constraint what we were trying to do I should say was not to play A.D against as what we were trying to do is show that um these different sources of inflation and there were multiple sources of inflation interact with each other for example higher uh gas prices coming from higher oil prices in turn might affect uh people's inflation expectations which in turn might affect the wages that they ask their employers for which in turn might affect the prices that the employers charge and despite the comment about core inflation I think if you look at it I think you know we do find that energy and food prices did have a bigger effect in their share of uh of the basket both because they have some longer term effects on other goods and services but because of these indirect effects going on Jason gave a political polemical example of a million dollars a person just for his future research and this is a neutral comment he ought to try a real example World War II uh where both the supply and the demand of consumer goods went up tremendously I mean I'm sorry the demand for consumer goods went up tremendously Supply went down because uh the government was converting uh factories to to war production uh rationing and so on kept prices under control but I think there's some there's some good case studies to look at that aren't quite so hypothetical um the last thing I want to say and this has puzzled me and I've been following Jason's work for a long time is this argument that the fact that nominal GDP went up while real output stayed the same it somehow proof that fiscal policy was important I I just don't see it I'd like to see the model I'd like to see the estimates there's nothing think about your econ 101 book and I know that Jason teaches that at Harvard uh if the ad curve and the as curve are both moving up at the same Pace you get constant output and Rising prices there's no there's no reason why that can't be true in fact there's a paper a nice paper by the Darkly only and gertlers came out that argues that the main sources of the inflation were on the supply side but the Fed was accommodating that so as to avoid a recession and therefore you were getting big inflation without you know a recession so I guess my argument is just that you know while it is a tautology that if output growth is constant and inflation is high that nominal GDP will be high uh I don't see I just don't see why that uh says anything about the source of the inflation thank you thanks you want to respond um so um yeah let me just respond to three of those points first of all if I said that your paper implied it was Supply and I was disagreeing with your paper and saying it was demand that's my fault for speaking unclearly I think the paper is agnostic on whether shortages food and energy are Supply or demand I think unfortunately the big question a lot of people had was were those changes completely predictable so if you did this fiscal and monetary policy you were inevitably going to get shortages so you should have been able to predict the inflation or was it like the Russian invasion of Ukraine which I certainly would not for fault any forecaster at the FED for not having Incorporated um in their 2021 models so my claim is that your paper just doesn't answer that question I was then supplying the interpretation that I think of the shortage term as probably telling us more about demand than Supply and also the shortage term not being like a random unpredictable shock like the Russian invasion of Ukraine but something that should have been fully expected especially in a world where you would expect people to buy a lot of durables with one-time checks I agree with your discussion of cars I think that is the one example where there and it's a quite big and important one because it's a big part of durable goods where there was a supply problem almost every other durable sector though does not look like cars even for Cars part of the supply problem was that microchips were being diverted and produced for other consumer electronics rather than from Cars so it's self um the lower production was a function of demand elsewhere and moreover this the general equilibrium point that if you have to spend more on a car you can't spend as much on a restaurant and then it matters a lot whether that doesn't affect inflation because you're on the elastic part of the curve or it does because you're on the inelastic so the first one just to sort of summarize that I'm not disagreeing with your paper I am interpreting your paper differently than I think some of the initial interpretations I have seen on the a second point of World War II I think World War II was the reason why I thought there might not be um in the sort of best argument for there not being inflation would be that the World War II experience was continued what was interesting about World War II was output when I can't remember the numbers four or five percent real GDP above its previous uh Trend just a dramatic increase a lot of things went into that like wage price controls directed production um and the like if you looked at the summary of economic projections that rich showed us with what seven percent GDP growth or whatever it was in 2021 those projections were remarkable they had GDP growth at the end of 2021 being higher than the pre-pandemic forecast that the FED made even though their forecast for the unemployment rate was lower than their pre-pandemic forecast so how are they predicting higher output with lower unemployment they had a huge burst of productivity that is what you saw in World War II I think some of that productivity is endogenous and I think if we had had that huge burst in productivity it would have absorbed the demand and we wouldn't have gotten the inflation the fact that we got normal productivity not actually not normal it was above normal in 2021 but not way above normal I think was at the root of the forecasting errors if you go into the models and finally on the nominal and real GDP in some ways I said it already but you do 10 and a half percent of GD you do 10 of GDP and fiscal stimulus for two straight years that money has to go somewhere and if it can't you know if real output is going up sort of as much as it can prices are the things that can adjust in an unlimited way real output faces a set of real constraints and the fact that those real constraints didn't look like World War II um I think was you know maybe a little bit surprising x-post but probably a reasonable thing to have expected X empty Olivia I think there's an interesting question about whether we should have predicted the increase in commodity prices in 2021 and I think it's fair to say that nobody did and respectively clearly it was due to aggregate the math it seems to me a good part of it and we should probably have anticipated it but I think somebody should look more closely because after all us is not the world commodity prices are traded on a world basis was the U.S fiscal expansion sufficient to explain the increase in commodity prices sorry was the U.S suppose we want to to to to to to blame the U.S fiscal expansion for the increase in commodity prices when we have to convince ourselves that the US is big enough that it explains the increase because the other countries did not have the same kind of fiscal expansion the other is just a side remark we basically have swept the issue of productivity growth under the rug and we have not focused on it and productivity growth has moved enormously During the period going up and then down and then still down at this point and I think that's probably more part of a story than than we have emphasized and there should be more work on it Olivia can I ask you a question you said maybe you should have been able to predict the commodity prices do you think the shortages if somebody did this type of policy again would you predict shortages outside of a covet setting so yes with us so I you know I've learned my lessons right so next time it happens I'm ready uh it seems to me that I'll think hard about the effect on commodity prices and we have a increase in demand is sufficient and I will think out about How likely we are to get to the point where the supply curve in particular sectors becomes vertical I think most of the previous cyclical situations where search fed firms were operating on the horizontal part so even if output was a big higher than they would have liked they could still do it I think what happened here is that the vertical part in some segments just shifted back and the shocking demand was so loud that this time we actually got a lot of outcomes on the vertical part so I think if we get again a big demand push and indications that the supply side may not be very elastic in some sectors I will worry example as opposed to exposed can I ask a question about this catch-up this lack of catch-up and so there's a little bit sort of looking for it I think there's a debate among people who say we you know the feds has to look at wages because that's what's going to be determining inflation and other two people say look the real wage is still lower there has to be ketchup at some point and therefore it's so you can imagine that markets will come down as wages go up so maybe the wages will react later has this changed your view of that or how do you think about that and is it surprising that there's no catch-up does that mean that the real wages sort of forever lower because of this episode well not necessarily forever but is it there's a distinction between catch up which is making up uh unexpected inflation in the past and which if there was if there were strong catch up I think of that as a price wage spiral in a sense you know inflation goes up unexpectedly and so workers want to get compensated for that and that feeds into prices et cetera et cetera but we don't get that we don't find your catch-up effect so um at least in the short run real wages do go down as they have empirically um over time as labor markets tighten for example the you know the um they still can eventually uh uh catch up um what was the other part well so if you think that what happened was there was a high demand prices went up pushing up markups then is it possible that wages can go up without it then being reflected further into and the response is a decline in markups that's I think one view of of what could happen right so wages can go up but you don't necessarily get inflation because basically it's just coming out of sort of high profits well it's certainly possible we always in in the fed the fomc we would talk about where markups were and how much space there was for wages to adjust you're nodding you know you were at those meetings um I think it depends what we're we're saying is that supply and demand conditions uh in product markets are important and uh the the markups not all of them perhaps but at least some of them depend on you know demand and Supply in a particular uh product Market I was very surprised I mean as you feel the only equation which is not absolutely standard in this small as opposed to what you would teach on the glass is the possibility that workers may want to catch up uh and that's an old discussion in the labor literature between the Phillips curve and the and the Phillips and the wage curve I was surprised that the coefficient we got in one of the specification is basically zero in another specification is point two but it's it's very small and you always have to worry that yeah maybe not yet and maybe it's coming and I you know we clear we cannot pull this out I'm sufficiently surprised that we put some weight on on a probability that it actually happens the thing we did not discuss in the paper it didn't come up in the discussion is markups and this as you know a group of people who believe that inflation is due to Greed and it's very difficult we agreed I mean we don't exactly know how to measure it I think we capture part of that through the price spikes for shortage but I think people have in mind that's wider than that happens in distribution the only thing I can say is I'm agnostic on that one as well but we were able to explain price inflation without without invoking greed doesn't mean it's not there but you know as you saw the price equation fits amazingly well without having to resort to it doesn't mean the issue is closed uh or settled but I was surprised as well great we're going to take oh do you want to get a question yeah just super briefly first of all if you look at the pictures Olivia showed of the model and the wage prediction the price prediction the price was almost exactly spot on insofar as the wages weren't spot on wages were higher than what was expected not lower than what was expected so that goes a little bit the opposite direction in terms of the paper's finding on the greed flation I'm agreeing with Olivia on the gridflation thesis and the like um the other thing I just would observe is in terms of can we hope for margin compression to bring inflation down without wage growth slowing without labor market softening unit labor costs since prior to the pandemic have increased by more than prices and so if anything it's possible that firms haven't fully passed through on the increased wage costs and that again is consistent with the model the findings of the model in which if anything wage inflation has been a bit higher than you would have expected great okay now we're going to take a couple of questions from the audience we don't have a lot of time but there'll be a mic coming around um here yeah tell us who you are where you're from please uh Brian sack formerly diesel in New York fed um so I'm going to direct this question to Jason but I'm certainly interested in everyone's view um you lump fiscal monetary policy together as the original Sinners and I want to ask you know which is the bigger sinner in some sense and I know it's you know I know it's they're not perfectly separable and obviously monetary policy is reacting to the economy which is affected by fiscal policy so it's not really clear how to do the counterfactual but for example if we had a normal size fiscal response during covid and monetary policy followed the type of approach that rich sort of described which was a delayed lift off and then revert to a Taylor Rule and we had done QE uh what's your guess at where inflation would be today thank you yeah let's take one more musical right next door all right thank you Krishna guha with ever core partners and also formerly of the New York fed uh so I wanted to ask Olivia and Ben um if I understood the presentation correctly you anticipate that it'll be difficult to and hard going slow going to bring down the underlying inflation rate from here the component that's sort of Phillips curve related if you like um that I think must imply that you think we're operating along the verticals the along the horizontal segment of the Phillips curve at this point in time if we were in a sort of when I noticed that gout is here if we were in sort of gouty's inverse L new Canadian Phillips curve type World in which that labor supply curve itself has moved a bit during the pandemic is it possible that we're still on the easy down segment of that Phillips curve as opposed so in other words still on the vertical part of that Phillips curve rather than the horizontal part so it might actually be easier than in your model to get that that underlying piece of inflation down thank you great okay Technologies guarantee if I misrepresented anything all right let's take the first one a fiscal monetary policy yeah great and by the way that inverse L is actually what we teach in our intro class and sort of the way I see the world um For Better or For Worse um so in answer to your question Brian I think the quantitatively larger sin was fiscal policy especially for the year 2021 the less forgivable sin though was monetary policy and there are a few reasons for that the fiscal Choice was basically made in January 2021 although it didn't pass for another two months the world was somewhat unclear at the time how much this was going to be a complete bounce back versus an economy that was still dragging so I think there was considerably more fog at that moment I have lower expectations for fiscal policy when they got the sign right unpleasantly surprised um and uh and nothing happened really after that monetary policy made the error again and again at meeting after meeting after March it didn't really respond to or react or change anything when fiscal policy was quite different from what they'd originally built in and I do have higher expectations for the FED than just getting the sign right and I think the fed by the way caught up much faster than I was recommending and sort of got it back together but you know six months after it should have and what do I think caused that I think fed policy became quite asymmetric it became about shortfalls not deviations on unemployment fate was you had to offset and undershoot but not offset and overshoot you couldn't lift off until you're at maximum employment no matter where you were on inflation you could use a fork you couldn't use a forecast to raise rates in expectation of inflation but cute is the forecast to not raise rates because you're forecasting inflation would go away and then initially there was an asymmetry of the speed of movement rates could go down quickly they couldn't go up quickly they dropped that last asymmetry they dropped it much more firmly than even I could have thought they would have so I think they caught up I don't think anything they could have done could have stopped the inflation in 2021 but I think we'd probably have less today if they hadn't made that less forgivable error oh sure is Rich one you want to come in I'm respectful time I've said what I wanted to say yeah press the button thanks I said most what I wanted to say in the 12 minutes I I do think that eventually there will be Scholars who will look at this entire period and take advantage of the cross country analysis to refine and sharpen their inferences and I will just leave it at that great into krishna's question so I think there are two different objects and I think you may have mixed them face with wage Phillips curve and that we're talking about the slope of a curve the effect of Labor Market State on inflation and then there is of this other object which is the output Supply which is this inverted l I think that to the extent that we still have a number of firms which are on the vertical part of the inverted L then we were places where there are still shortages and again when you go to Google Trends you seem to think you seem to find that people believe that there is to the extent that these goes away we'll get downward pressure on prices as firms go back to the horizontal segment but what the last figure of our paper suggests is that if you go to the wage Phillips curve the coefficient on the labor market variable which is the vacancy unemployment ratio is significant but not very large and so if you actually want to decrease inflation you really have to decrease the vacancy on employment ratio by a lot which most likely translates into a fairly substantial increase in unemployment but these are two separate issues we are out of time please join me in thanking our panelists for a great discussion [Applause] [Music] foreign for the Lively conversation we're now going to move to the second paper which is by goiti Edgerton of brown and Don Cohn of Brookings where in the first part of the conversation we talked about how did inflation evolve and why and now we're going to talk about essentially what we ended the last panel on how did the FED use the tools that it has and what should we learn from the new framework that they put in place in August 2020 and the forward guidance that they issued goity is going to speak first and then Don and then Ellen Mead is going to respond and then going to eat on and Ellen will join me on stage for a conversation similar to the one that Louise just said so koiti thank you okay um I'm uh eckerton uh thanks a lot for um to the organizer to uh invite me uh to speak here to this uh and being in this distinguished panel with uh you know three uh Grand Old twice man that are legendary in the profession and me so I decided to wear a tie to make up for my lack of Gravitas and that's uh uh you know uh the other authors here uh so uh and I especially want to thank them to uh hook me up with Don Cohn who of course is a legend at the fan and Rose from being a staff member to being a governor I never went beyond the staff level I sort of escaped to Academia and I had the brilliant idea when we started writing this darling I think it's less brilliant in retrospect that we would talk every week over soon uh for an hour or so and for the first two months we were talking and Don asked me so have you actually done anything and and I sort of not really in terms of writing anything up that's not what I said but and actually I think learned what I had actually happened and really learned more more there in those three months than I'm Laura who learned sort of uh the last three years I have to admit uh so this is one of the more challenging papers uh that I have uh written I have to say uh and you know when important people uh speak on topics like this they give disclaimers doesn't represent the view of this institution or another my disclaimer would be different uh this does not represent my view a year ago and may not represent my view one year from now I may even change my mind over lunch I mean so the uh the truth is that the last couple of years have changed my priors and model and that's in that respect is very different from Olivia which he sort of you know it didn't seem to have changed his prior very much mine have radically changed and that's in contrast to you know in response to the financial crisis and so on I mean I had worked on that under Ben's tutelis at Princeton and I felt that we had sort of you know I felt roughly that we had written a road map in the script and everything sort of confirmed when I thought but this here really hasn't uh so I was sort of an enthusiastic supporter of Team temporary and an enthusiastic supporter of the new framework and uh and I even so enthusiastic that uh I did for the first time and only time in my life I wrote an op-ed and enthusiastic support of Team temporary so what did they say basically inflation there's nothing to see here not a problem as good fortune would have it it was written in Japanese so okay now uh I don't think anybody will hold it against me in the future but uh I have a lot of things to say here so and a lot of slides so I think I better get on with it here so what this paper is about is that uh what we're trying to do is to try to understand is the change in the policy framework that then and Company and Don put together in 2012 to the new framework in 2020 whether that may have played a role in the inflation run up okay and and this is a very succinct document that's what these pictures are supposed to tell you was attempted to give it names like article one because there's seven paragraphs and they're all very well thought out uh so that's sort of our uh assignment so we're not really asking here how much of the inflation was caused by the federal reserves uh to any policy framework which is going to be my aggravation or straight up mistake instead it's sort of and there's a sense in which my account is going to be a little bit biased for this reason we're sort of trying to ask could it have right so it's sort of like a stress test so it's going to be biased and since we're going to be looking for reasons for how we could have interplayed with uh what we saw and if so uh through what mechanism and in a way it's an ultimate stress test to the framework because you know you have once in a century shot and nobody anticipated and you know was very strange a lot of a lot of dimensions so uh I think a key conclusion and you know when I see the 10 minute sign I'm going to rush to main lessons and probably skip a bunch of slides but sort of a key conclusion is that the framework was very well designed to deal with what people were really concerned with leading up to the pandemic which was sort of a world in which you have low R star and inflation below Target and but exposed it looks a little bit less well designed for sort of once in a century Shop with a lot of unknowns right and known unknowns like rumfels would say uh now of course the question going forward is after covid will we get back to that environment where it was really designed for and that's an open question I mean I've written uh uh record for me probably not for Larry Summers paper five papers with him about tactical stagnation uh now he seems to have taken 180 degrees and thinks it's all gone I mean it's a sun cost for me but a little disappointing uh but but so I haven't made up my mind quite up about that but I'm I'm more actually an Olivia's Camp there that I think we're going to get back there so the question is then how uh well uh uh framework suited us for that okay so this is going to be the structure and I'm going to start by um talking about the leader and of of the policy framework what we call the mistake of uh 2015 to 2019 I like the more Punchy title of the mistake of 2015 because of Friedman's famous paper the mistake of 1873 this mistake is not of course of that order but I think it frames I think the mindset of people when they were writing uh the policy framework so let me just tell you first what that is and why I think it played an important role in how the framework gets put together and how the framework dealt with it so if you take a look at when you know the interest rate has stayed at zero throughout uh since 2000 December 2008 uh when uh the fat Lord went down to the zero bound so what happens then in 2015 unemployment is five percent fed is expecting uh a tight labor market because their estimate was 4.9 uh and uh you know start typing tightening rates what happens well they start tightening rate but unemployment goes all the way down to you know 3.7 in July uh 2019 and as you can see basically no inflation pressures right you see leading up to 2019 there's even deflation impressive so in fact the FED starts cutting rates uh in 2019 mid into 2019 leading up to the pandemic because they want to try to reach the uh reach the inflation Target okay so uh if you think and look at both their phones he was thinking when they were making that decision so here what you see is in this blue uh in this blue uh shaded area it's the central tendency of the forecast of the fomc at the time they made that decision start to tighten so what you can see that they're expecting pce inflation to gradually go back to Target unemployment to gently go below uh full and full employment and then go back to full employment as time moves along and uh having to tighten along the way to get there right and then in the solid line you see the thing went quite differently unemployment kept falling without any inflationary pressures so you know in fact they reversed uh course and started cutting rates now what was their estimate of uh the you know U star or the natural rate of unemployment in 2019 I mean it was a sense in which they were asking themselves who knows right after having you know seen this dramatic reduction without any inflation pressures so okay so the lesson people took from this was that uh inflation persistently below Targets in 2008 and people were becoming very worried that this would start feeding into expectations and bring down uh inflation expectation which is a concern if you think that you're going to be hitting the zero bound a lot right because that leaves you less room because inflation expectation is going to drag down the normal rate so and if you then bought into the kind of story uh many were telling including me and and Summers that there's a permanently lower uh natural rate of interest possibly even negative this you know could be a big issue so the lesson learned then was uh you as an imperfect unemployment is imperfect proxy for Max employment changes in you has very limited effects on on Pi you know in inflation the the in the Philips River Flat and there has been a Precision fall in R and I think that sort of uh formed the basis of the framework and this is just one example of a Fed policy maker that gave a talk here's Brookings that's why I sort of put it up here you know that sort of summarizes this nicely saying you know sensitive to price to labor market tightness is very low flat Phillips curve has the important Advantage we can let the labor market run hot with very little risk to inflation which has big benefit because you include expand employment uh and and in particular uh she suggested that with a new framework that you would not repeat the kind of mistake made in 2015 had this new framework in place they would not not uh have withdrawn our accommodation until uh until the uh until they will see clear evidence of uh you know unemployment falling wouldn't have let in the trigger they would have to see clear evidence on the inflation side so let's see then what they did with uh the 2020 uh framework and how that and led them to a forceful implementation in 2020 which uh I think turned out to be very consequential so major changes we go to details in the paper but I saw the textile analysis is that first they Define declining R and potential International elb as the central problem going forward and this is very important change that I underappreciated at the time as an enthusiastic supporter of this uh framework they really really replace from the old framework any deviation that penalized any deviation deviation of employment for maximum with shortfall from Maximum employment so in other words it became a one-sided uh objective function we only care if an unemployment Falls below our estimate because above fine okay so this was a very important uh uh change they introduced a new tool of average inflation targeting implying an overshooting if inflation was below Target but they were not specific about time Horizon and it was also asymmetric in that they were only going to compensate for uh undersfielding and then they sort of and that's clear when you look at the statement they literally in article two as I would like to call it you know they were listed their objective inflation employment then and stability of long rates they literally just moved unemployment first you know and it's kind of hard to interpret that in any other way that that was going to become a bigger uh focus and then they eliminate all examples in previous framework of how you starts actually that that is actually estimated and part of the policy decision making process okay so why would it have prevented the mistake well I just told you well you wouldn't be uh too concerned if unemployment was falling below your estimate uh you would wait for inflation to uh reach uh its uh reach its Target okay so what did this then mean the pandemic when they just introduced the framework so what it meant was a forceful as power put it a forceful implementation of our framework and what I think is key here and I under and underestimated its significance until I was dedicated by Don about it so there's a key statement in September 2020 where the committee says it's going to keep the target range at zero to one quarter uh until maximum unemployment is reads and inflation has risen to two percent right and projected to do go over it for some time so it's the and feature that is very interesting there right so uh it seems like a very good solution but to a wrong problem is an excellent solution to the problem faced in 2015 and you can kind of see if you take a look at what people were expecting when they put this forward guidance in place again the this is the central tendency in blue they were expecting sort of a repeat of 2015 that inflation gently going back to Target unemployment falling and actually falling faster than inflation would converge to Target and you know they wouldn't have to race rate for a very long time well that was an excellent solution to the problem of 2015 but we're faced with a very different one when inflation started picking up before Unemployment uh went down okay so in reality then what happens is that when they finally tighten in March unemployment is down to 3.5 basically pre-pandemic levels influence inflation 7.7 as measured by pce and 8.5 as measured by CPI so very different from the scenario they were anticipating when putting in this forward guidance so in a sense a brilliant solution but it wasn't uh was an intervalent solution to the wrong problem because it seemed like there was insufficient attention given to well what if inflation were to rise before employment the ant uh stipulation seems to suggest that there was basically no bound on how much you would let inflation rise before you tighten as long as she didn't think you were at maximum unemployment so and I think there's some evidence of this and one we talked about the fiscal uh uh expansion if you look at the Menace of fomc he wants it that become clear that there is going to be a big uh physical expansion to basically say the benefit of our outcome-based guidance is we don't need to do anything until these two conditions are satisfied right and one thing that I found surprising was that in December 2021 when you have seen pretty substantial rise in inflation so the statement from 2020 isn't changed until in December 21 and at that point uh you know they kind of just doubled down we're not going to raise rates until employment reaches maximum and it is not there yet in 2021 uh so uh but they predicted it will be satisfied uh next year so this is sort of them doubling down in December with inflation having exceeded two percent which is an understatement perhaps uh the committee expected be appropriate to make to the Stark mental labor market if reached uh levels consistent with the community's assessment of Maximum employment so this is the numbers that we're looking at pce 4.8 unemployment 4.25 primates uh 70.6 and and if you take a look at uh where they were in uh Mars from the race rates unemployment in primates population ratio is just basically it's exactly the same levels as pre-pandemic so it seems almost like they literally waited to lift until these Max employment were exactly hit and that seems to me a little bit uh problematic now so I'd have little time so I'm not going to bore you very much with these equations uh because I have a little time except just to say that I think there was an the way people were thinking about this was mostly looking at reaction function and simulation in them in the model I think it would have been useful and I think it is useful for the next framework and Analysis to think about this in terms of objectives of the fat and the implication of changing that objective and here what they were really doing rather than having a symmetric objective which is if the the lambdas were the same on the labor employment they were really saying okay we don't care if there's an overshoot in unemployment we're going to put all our emphasis on uh shortfalls so as long as if you have a lack in the way in which policy is set so you set interest rate which is IP before you realize the other variables is just the most reduced form simple model you can imagine what you're going to get is that this is going to be an expression for inflation what you're going to get there is going to be a bias in inflation the FED is going to be less willing to make a policy that risks a shortfall than an overshoot in equilibrium that's going to mean that more often than not you're going to get an overshoot and here the formula for inflation over cgc sort of different uh possible explanations for uh why there was an overshoot the most important one that I'm going to emphasize is that the FED overestimated maximum deployment and here maybe I'll uh disagree a little bit with my old advisor and and Olivier so the inflation biasis is essentially here what I just said uh and you know I don't want to say that's necessarily a bad thing I think in fact the the framework was explicitly designed to over correct uh deflation revised it was trying to you know offset it because they were concern with uh fall and so I'm not necessarily saying this was a bad or unintended unintended consequence but you know trying to uh tease out where they whether it went too far or not I think is something we need to study uh I have another we have an appendix an example where this can also potentially lead to a perception bias but I feel that the empirical evidence on that is not very encouraging Don was very skeptical of this having any relevance whatsoever so I just put it we just put in an appendix where it's there to die but you know I encourage you to read appendix B uh okay so how did it play out and I'm just going to go very quickly five minutes has not come up yet has it okay so I'm going to go quickly to this so I can get to Lessons Learned okay so how did it play out impossible interaction with the framework so here you see uh the super core and what I want to point out to you is that so I wrote my team temporary uh uh article right around when the super core was low and I was convinced okay this was all temporary what I find a little bit surprising isn't in the fall when you have super report that excludes all of these controversial uh components is that the Fed was still uh you know not really giving any caveats for inflation overshoot until you reach maximum employment and not really doing anything until in March uh there so I think an important feature so it seemed to became a become a binding constraint having reached maximum employment so I think it was an important feature in which they overestimate the degree of uh what was the maximum unemployment employment and part of it was that unemployment was still below pandemic levels that you can see there this is basically the decision period right after the physical stimulus they could have tightened in between then March 2001 to 2022 right so unemployment was still back to pandemic level it reached it 20 March 22. uh prime age employment to population had not reached pandemic level until March 22. however if you looked at things like uh labor tightness that was the overview that we discussed that was at its Titus level since World War II they're basically and it reads over one in May 21 and there are five periods essential peers when it is like this tight World War One World War II the Korean War the run-up of the Vietnam War covet so I think in all five episodes were associated with inflation searches so to me that suggests that a this was an important indicator that the labor market was tight B and that's where I disagree with my esteemed advisor and and his esteemed co-author uh that I think it may have been uh playing a bigger role than they uh then they made it out to be so why was descending conflicting signal there I think we agree that there was just change in spending patterns uh how do I Nest why do I disagree with her conclusion because if you look at empirical evidence that never actually looks at how Theda or or U over V interacts with inflation you see that once it crosses one there seems to be some change and this is just the raw data we have more sophisticated empirical analysis including using another empirical framework of plan chart uh to suggest that there was something going on there as data goes above one and this here is just the raw potato from metropolitan areas in the U.S and you have the bread here denoting post covered and it seems awfully consistent with uh non-linear Phillips curve okay so summary uh asymmetric loss function overestimating of Max employment non-linearities inflation let's go to the lessons learned so the first thing I want to point out is that okay things may have gone wrong on some Dimensions but let's recognize employment is now back to where it was pre-pandemic and amazingly you know we may argue that some mistakes are made but you know that has retains its credibility and that's took great credit of the leadership in its communication and and you know whatever fault the the new framework may have you know this is I think a really strong measure of success uh but if to summarize big themes that we have in the concluding session is that I do think we do think that one-sided employment objective give rise to hosts of complications that we still not fully understand and the AIT was pretty one-sided and they can I think people didn't really know how much inflation would be permitted the second big theme was that forward guidance issued under the new framework really Amplified the inflationary price already implicit uh and I think that was an engine resolution to the 2015 but a lot more problematic when inflation overshoots Target before you were sure about the employment situation which is very difficult to assess especially in this period it was less suitable for inflation undershoot overshoot than the other way around required reading employment when it was very hard to um judge for the framework uh the next frame which I think should be tested against considerably in more in different stress scenarios hours that have and I will emphasize tentative conclusion is that on balance the complication created by the asymmetries probably creates more problem than it solves uh so you know the penalty would be small if the philosopher is flat but if there's non-linearity there may be some significant uh problems associated with it uh and the cost uh non-trivial uh the uh having a better understanding of uh uh how the forward guidance discipline the policy framework uh should be part of the discussion and the asymmetry put extra pressure on judging Mexican maximum unemployment which is inherently a pretty difficult task lessons for forward guidance and then I'm going to end so it is a very valuable tool and conditional based for guidance is certainly a lot better than candle division in that respect I think it was a good element of the forward guidance but I think it was not well designed if inflation moved ahead of unemployment then I think that was a problem and lack of clear and transparent definition of Max employment I think in the next review it would be useful to have an exact definition of that and you know we need to recognize that conditions are never going to conform to those envisioned when we set the forward guidance sometimes even some flexibility guidance won't be enough to allow you know the committee to to address to very situation and what was expected uh and you know uh in unusual situation I think it should be adjusted with meetings and I saw it is a little bit peculiar the September 2020 was set up for a very different scenario than was realized yet it was only changed in December 2021 and then in a way just to double down on reaching the employment Target okay so uh I think I'm out of time so let me then leave it this and the rest of the paper and the slides are online so I hope you have time to take a look at those thank you thank you so I just click forward and okay there we go well thanks to the Hutchings Center Hutchin Center for inviting me to join you today in this important uh discussion I think it's great that Brookings is kicking off the fed's next framework season with these two important papers and Edgerton and Cohen I'm going to call it the EK paper assesses the contribution of the 2020 framework to the search and inflation um we've gotten a good summary a quite complete summary and my comments aren't going to focus on everything in the paper but on a few uh topics that that I thought were important to raise but the overall paper is well worth reading and um and I hope we'll discuss more uh in the later discussions about the recommendations um that were just reviewed because they really make a valuable contribution so start taking exercises or postmortems are important that's what really this is all about there was a research conference that we held at the Chicago fed in 2019 as part of the framework review that included a postmortem stock taking exercise by Everly stock and right and that exercise was not about understanding the causes of the global financial crisis but about the effectiveness of the fed's policy and promoting the economic expansion that began in 2009. I think there's a higher hurdle this time in the stock taking exercise because we need to assess both cause and effect um how much did the new framework contribute what about that forward guidance um which was really the implementing language for the framework what about the view on the evolution of the pandemic and the extent to which factors boosting inflation were transitory Supply related would resolve over 2021 or the underestimation of the strength of the labor market and you throw all of these in the pot together and it's a little bit hard to sort out I personally think the authors weigh a little too heavily on the actual 2020 framework document itself rather than a lot of these other factors although they do bring them in over the course of the paper um so um the 2019 stock taking applied to the fed's actions from 2009. and the authors at that time use the fed's 2012 framework to go back and evaluate actions taken as of 2009 and this was appropriate because the 2012 framework was an articulation and clarification of the strategy the FED had been following for some time and similarly the 2020 framework articulated approach to policy that was evolving but which began to play an important role in decision making in the 20 teens with respect to the thinking about both dual mandate goals and I'll come back to this a bit more later so mindset is important um EK tell us that and [Music] um the Everly second right analysis affected the fed's thinking uh on the eve of the pandemic we can see that that stock taking concluded that the forward guidance and lsap tools had played an important role in speeding the economic recovery but could have been even more helpful if they've been rolled out sooner and more forcefully and that's something the FED did uh took very much on board in its pandemic response in March 2020. um the Everly stock and write analysis is consistent with Edgerton and cohn's view about regret about the decision to lift off uh in 2015. the unemployment rate could have been reduced further with negligible effect on inflation um If the Fed had waited and eggerson and Cohen see that as an informative as a formative uh experience for the Fed so Eckerson and Cohn um described the mindset that surrounded the 2020 framework review the lower neutral rate implying a greater likelihood that policy rates would hit the effective lower bound and attendant risks associated with Associated trips to the elb for achievement of the Dual mandate goals a potential downward spiral is under achievement of the inflation goal uh lowers inflation expectation and further reduces the fed's policy space and there were significant important research contributions from inside and outside the fed the authors give us a nice review of the issue and Associated findings and I agree with them that this mindset about the most important problem facing policy makers dominated thinking coming into the framework review in 2019 and indeed the new in the new framework statement uh the framework statement retained the original first paragraph but highlighted this issue in a new second paragraph but what that meant was that the new framework was very specific to a particular problem it wasn't a broad articulation of goals and principles as the 2012 framework statement had been but it narrowed the focus to a particular very significant pressing issue and um uh eggerson and Cohn uh criticized the narrowness of the framework because it left undefined how the FED would behave in the event of inflation surge which as likely as it seemed at the time is what actually occurred so I agree with their recommendation that the next policy framework should should be robust to a broad range of possibilities but they use the term scenarios and stress tests and I wasn't sure exactly what they were advocating it sounded more like a framework manual maybe than a broad statement of principles um uh as the two prior framework statements have been um but in any event a framework statement of goals and principles whether broad or narrow needs other Communications that spell out the tactics and this brings us to forward guidance um and and forward guidance in 2012 for guidance in 2020 um uh uh were part of implementing uh a framework uh the December 2012 conditional forward guidance around um the policy rate and around asset purchases included full-throated Escape Clauses in the event of afflation inflation surge but the forward guidance in September and and December 2020 was very muscular and didn't possess similar Escape hatches um I I won't repeat here because um Gowdy did such a nice job of of laying it out on his slides but the key question was um uh that the FED expected to remain at the effective lower bound until it had achieved both maximum employment and two percent inflation uh with an expected overshoot and I think they're right uh to criticize this aspect of the forward guidance but I don't think it's correct to say as they do that the September 2020 statement quote implied that the FED would not tolerate any level of inflation without acting if employment had not reached maximum to be fair um there was a final new paragraph introduced in the statement in 2020 that provided an out um that paragraph said the committee could quote adjust the stance of monetary policy as appropriate if risk emerged that could impede the attainment of the committee's goals and in assessing that appropriate stance um the committee would consider labor marketing conditions inflation pressures and inflation expectations and I've added that language there so should the Escape Clause have been in the conditional forward guidance um as it was back in 2020 I think that would have been clearer and and more explicit um but it's not correct to say that the fomc had completely tied its hands so um uh exercise Cohen also point out that the committee could simply have adjusted the forward guidance at any of its meetings and I agree it's not clear why the fomc waited so long to make meaningful language adjustments um uh you know you have the the language not really being adjusted uh still in November 2021 the committee's saying that inflation having persistently run below its longer run goal um the committee will aim to achieve inflationally moderately above two percent for some time and at that point you know inflation had been averaging two percent since early 2021. so the language adjustment didn't really occur until the December 2021 meeting I'm I'm in complete agreement with them on this point and now let me turn to some other changes in the 2020 20 framework on the maximum employment side of the Mandate and here's where I have a a good bit of disagreement with their interpretation so they point to three important changes on the maximum employment side of the Mandate first The Ordering of the goals was changed throughout the statement to be consistent with the ordering of the goals in the Federal Reserve Act um they say quote it seems difficult to find an alternative interpretation to this change than that the Federal Reserve wanted to communicate its increased attention to this part of the Dual mandate how can I change that simply winds up ordering in the framework statement with the Federal Reserve Act um reflect an increased attention Beyond what's in the act itself second um there are these new words a more expansive definition of Maximum employment which characterized maximum employment as a quote broad-based and inclusive goal um and they see this characterization these new words together with the dropping of the median longer run normal unemployment rate from the SCP is opening the door this is a quote for considering the status of subsections of the nation based on income or other defining characteristic so let me look first at this SCP uh item that was dropped this figure that was cited and it was cited by way of example the original statement said it was an example and I've always thought that was because the sap is not a committee forecast it's a collection of individual forecasts premised on individual assumptions of appropriate monetary policy so dropping the reference to a number that's not endorsed by or reflective of the committee or agreed to in a consensus fashion from a document that is a consensus document doesn't seem inappropriate to me uh the framework statement retained language saying that maximum employment is quote not directly measurable changes over time owing largely to non-monetary factors that affect the structure and dynamic of the labor market and that it wouldn't make sense uh would not be appropriate to specify a fixed goal for employment and that in making its assessment the consider the committee would consult a wide range of indicators so many aspects of the earlier statement were preserved um since the mid-20 teens the fomc has been communicating its attention to a broad range of labor market indicators both internally and externally staff presentations to the fomc have routinely included metrics such as unemployment rates by race and ethnicity in June 2016 the MPR included a box examining whether gains from the post-gfc expansion have been widely shared and subsequent mpr's included boxes analyzing labor market outcomes housing returns to education other topics for different demographic groups so to me the addition of the words broad-based and inclusive merely acknowledged that the fomc did not take a summary statistic approach to evaluing maximum employment and the committee continued to say as it had in 2012 that it saw maximum employment is largely determined by non-monetary factors um further um they note that um some policy makers had highlighted the potential gains for some groups due to the new framework um and and I think I agree with that um statements about potential gains um uh uh were related to demographics of the labor market in the late stages of the expansion which connects to the Third change that they highlight which is the introduction of asymmetry with respect to the employment like the Mandate that the committee would seek to mitigate shortfalls of employment from assessments of its maximum level rather than deviations as in the prior framework so that's the FED would ignore overshoots of employment which as far as having little implication for inflation given the flatness of the Phillips curve and they use a simple model to illustrate that this asymmetry leads to an expansionary bias in policy and generates an inflation bias and as they note if the Phillips curves flat the size of the inflation bias could be quantitatively trivial but the gains in employment could be large in June 2016 the teal book document circulated to policy makers ahead of each fomc meeting began including a new loss function in its optimal control simulations and that loss function assigned a zero weight to unemployment outcomes below the natural rate so that loss function place an asymmetric weight on the unemployment Gap and these simulations are available on the fed's website until book materials from June 2016 onward and available through the end of 2017. the teal book said quote policymakers choose this relatively low path for the policy rate because the desire to raise inflation to two percent is not tempered by any aversion to the undershooting of the natural rate that helps achieve this outcome tighter labor market causes inflation to reach two percent more quickly than in the case of equal weights thus this cement asymmetric loss function was recognized as having an inflation bias in the teal book one helpful for meeting the two percent inflation goal and was not motivated by a singular desire to boost employment or help disadvantaged groups um I'm close in time right so I need to kind of I'm out of time okay so let me give one final comment because I have to skip um uh yeah um and that's on whether the 2020 framework provided the Death Note for preemptive policy action um I saw the framework very much as downgrading estimates of U star in the policy making process but I didn't see it as throwing preemptive policy away the way uh eggerton and Cohn do the statement continues to say um the framework statement that the committee's policy decisions reflect its medium-term Outlook in addition to its longer run goals and assessments of the balance of risk and I'd point you to comments in um Loretta Master's remarks earlier this year at the monetary policy Forum where she said um that the fomc should have acted sooner to address inflation but didn't see the delay as having been generated by an app since of preemption so much as overly optimistic forecast for inflation um she sees the framework changes as reflecting uncertainty around assessments of maximum unemployment quote given that we don't know where you start is policy makers should not base policy solely on what could be an overstated estimate of this construct so to conclude because I know I'm out of time and and we've left the discussion of tapering of asset purchases for later I really enjoyed reading this paper and thanks for giving me the opportunity to discuss it thank you I'm going to make a slight change Kristen Forbes is going to Oh no you're up sorry I'm ahead of myself come up come on uh well thank you both I think you're on the end oh that's what it's following directions not very well obviously but uh so um I'm kind of struck by listening to this conversation of observation I've made about the FED in the past that everybody at the FED is fighting the last war but everybody's fighting a different last war and the case you've made here is that the uh in the statement the Fed was fighting the 2015-29 carrying period and it turned out to be inappropriate um Don I want to ask you about a couple things uh that have come up in the conversation and and pick up also on something that uh that Ellen said at the end um uh it seems to me that I worry a little bit that gouty discovered the framework read it with the care of a talmudic scholar and has now determined that everything that happened to monetary policy in the last few years can be found in the parsing of the wording of the framework but it seems to me that there's quite a difference between the framework and the forward guidance and that there's a tension here between forward guidance which obviously has its place particularly at times when we're at the zero lower bound but it in this case seems to have prevented the fed from doing what it has been asked to do so often in the past which is be nimble so I wonder if you could distinguish for us how much of the problem is the framework and the mindset and how much was the specifics of the forward guidance and the inertia that it induced in in the FED reaction when fiscal policy turned out to be so big and inflation worse than anticipated sure so I think the frame the forward guidance in at least importantly grew out of the framework and uh and Gowdy put up the quote from J cap J Powell who's which said the forward guidance was a forceful implementation of the framework now it is true that the forward guidance went Way Beyond the framework so in the framework there there's the asymmetry the labor market asymmetry but it doesn't imply that policy should be that the nominal rate should be zero up until the time you get to Full Employment it just says that you shouldn't be reacting I think it does Ellen's imply about preemption I mean it says you shouldn't be reacting to what you think are overly tight uh labor markets because they're going to cause inflation with a lag and that lack of preemption was contained in the forward guidance in in the in the fed's announcement so the announcements before September 2020 talked about expected and anticipated conditions the announcements from September 2020 on did not they only talked about actual getting to Full Employment so I do think that that that that piece the framework influence the forward guidance but the forward guidance was much more I think to blame than the framework but I don't think you can really separate them the more I thought about the forward guidance as Gowdy and I were working on this the less sense it made so in in what in what in what model what world should you be at a negative at the highest real interest rate at full employment would be minus two that's if inflation expectations were anchored at two so they said we are going to get all the way to full employment at a minus at a minus real interest rate I don't mean to be looking at Rich I shouldn't be looking but and and it seems to me that guarantees a rather substantial overshoot certainly a full employment and likely even with a flat Phillips curve to some extent uh with inflation so it was kind of a very extreme version of the don't preempt and be very very easy as you get to Full Employment and don't worry about and don't worry about overages so I really and then the other part of the forward guidance was the guidance that came later on the um on the taper and then the stuff that said we're going to warn you before we even announce as we're even thinking about taper we're going to tell you that we're thinking about it then we'll announce the taper and we won't lift off rates until the taper Assurance to we're no longer buying Securities and I thought that uh that just added another bunch of inertia to the policy process that really wasn't wasn't necessary rich I agree that if the FED had lifted off a couple months earlier which was even I I think I I think it's hard to imagine it would be much before September October or November of of the Fall it wouldn't have made that much of a difference in inflation but it would have started the process and it would have taken a little something off and I think it would have helped The credibility of the Federal Reserve to recognize the problem first earlier and not get to December 2021 when inflation was several percentage points above the goal seemed very persistent and say we're still not at full employment so we can't raise interest rates those Escape Clauses were there or I guess that escape Clause was there but it was never discussed it would never came up in any conversation and so I think maybe you're right we should be careful that we don't say that there was an inescapable uh commitment here but the fact that no one really ever discussed the Escape Clauses strikes me that the FED itself was thinking it had a pretty strong commitment to wait to full employment almost whatever the inflationary was you know down in all my years of covering the fed you were never that emphatic about anything when we were interviewing you I kind of I wish we could roll back the clock um it does seem just to add one thing before I turned down I thought I think you raised the question I was going to ask like would it really made any difference if they tightened policy six months earlier and I think you suggest that we might have had slightly less inflation it doesn't seem to mean that another element is we wouldn't have had to have such rapid rate increases and we are now learning that those have some unintended consequences there we go um I just wanted to respond on to a couple of things that you said um one of the reasons I think of the forward guidance is being implementing language for the framework but quite separate from it is you know it can be revised every six weeks it has a smaller group of people that vote on it and um the hurdle is not consensus indeed as you guys point out there were two dissents at the September 2020 meeting so um I think the forward guide just because of the governance issues makes it a more Nimble um sort of thing and and um but yet I do agree with you that it was um uh very muscular now the question is would it have been you know if if those uh the vacancy to Unemployment uh data had been paid better attention to over the summer of 2021 the FED might have reached the conclusion that maximum employment had been achieved without getting the unemployment rate and the labor force participation rate back to pre-pandemic levels that would have made all the difference right so that's not about the forward guidance per se but about a judgment of the economy yeah Kathy could you talk a little bit about the um tapering so j-pal's view was that it doesn't make sense to be buying bonds while you're raising interest rates because it's like stepping on the brake and the gas at the same time although I believe the bank of England actually did that um and you argue that they needn't have waited for uh to end the asset purchases before raising rates could you walk us through the argument there and why you think they had the wrong sequencing or they thought they had to have a sequencing yeah so um one of the things that I didn't have time to talk about was the additional let me talk about in the paper was the additional inertia that was created by the quantitative easing measures and then the FED sort of said that Aid would give very long warning for when they would start and B they wouldn't start raising rates until that was completed the argument being that you know the asset purchases were stimulative while the interest rate were restrictive I suppose I don't see any uh inconsistency in you know slow and orderly uh you know the resolution of the asset purchases whose impact is mostly at the time they're announced and to to my view has a lot to do with smoothing Market functioning uh and then at the same time start raising rate like indeed the bank of England uh did so I don't see I think they created an unnecessary barrier there that may have played some role in the delay although I don't know how much just want to respond very quickly to a couple of other uh issues right so like you correctly say what we are doing in this paper is like a talmud scholar looking at the in the could the you know new framework had played a role it's really not a sober assessment of how much will it play I view it more as I thought my home assignment was sort of being the devil's advocate here and asking the question could it have and then through what mechanism and that's sort of what we're trying to spell out here if I would have been asked the question which was more Blanchard than uh bernanke's you know trying to explain this Earth through different mechanisms I think it would have written a very different paper instead this was focusing on that element could it right and then how uh you know I think I will have to uh you know I haven't come to full determination of you know parsing out how much it's contributed and then a little bit about the uh issue of so what we were not saying in the paper was that the forward guide in September of 2020 uh uh in September 2020 we're not saying that that actually bound the hands of the FED what was surprising to me because there is an escape Clause what was very surprising to me is how much the views seemed to believe that it did and that comes out pretty clearly in the discussions even at the time they changed the language of December 20 21 where you know I think it would have been reasonable to say that you had reached Max employment but they sort of in a way double down and say actually we're not there quite yet so to me the surprise was that it didn't sort of uh when there was a surge tried to use the Escape plus home a little bit the forward guidance and instead of leaving it unchanged for more than a year and that is sort of more uh our criticism as opposed to claiming that it was a strict binding constraint I don't think it was but I think to a surprising degree it was treated as such um Don you make a point at the end of the very last recommendation that there's too much essentially too much group think of the fed and that there wasn't enough diversity of view this is a comment that's often made about the FED uh I think sometimes with justification and sometimes not given the famous stories about the Federal open mouth committee but I was intrigued by you suggested whether there's something about the decision-making process at the fomc that is discouraging a more fulsome discussion of alternative views and dissents and I wonder if you could elaborate a little about that and then I'm going to turn to the audience well I think um this is another irony David relative to where I was because I spent at least four years helping Ben get a consensus on the committee and reduce the number of dissents that we might have um but I think as in as an outsider it did strike me as I thought about this period with all these very difficult questions that were being discussed in the public right it's not as if this is totally exposed I mean is Jason and others pointed out there were potential inflationary implications of fiscal policy Etc how few dissents there were essentially no dissents between the time the forward guidance was put in and June I guess of 2022 and I and so I you know I haven't read the transcripts I wasn't inside the meetings but you wonder how vigorously alternative perspectives were being reflected in the in the meetings you can look to a certain extent to this the projections because they have a central tendency and a broad a range of projections and at least until I think until the early part of 2022 that was a pretty narrow set of set of views um I don't know I mean it's it's hard I also wonder I don't so I think really the point I was trying to make or we were trying to make in that last in that last recommendation was should the Federal Reserve itself just do a self-examination of how it's it's making these decisions an awful lot of stuff happens in the week before the fomc where the consensus is formed decisions essentially get made announcements are written Etc and whether that leads to enough challenge of the of the existing uh consensus I think is is the question I'm thinking as you speak I can't my chronology is not right but I suspect in some parts of this time they're meeting remotely because of coven yeah so that we know that that eliminates the coffee break conversation um I'm going to turn to the audience now uh Jason and Steve lisman and Mike Kelly and David Wilcox so that should bring some some let me take two questions at a time and then we'll do it my question is what do you think of this comment um I understand fiscal policy trying to learn from the mistakes of the past 2009 through 12 was way too small and fiscal policy was compensating for that in the other direction I think they overcompensated for it I never understood at the time and I don't understand in retrospect why people thought monetary policy made much of a mistake at all from 2005 through 2019. I think there was too much self-flagellation around that the inflation rate was sort of 1.7 1.8 it's 20 to 30 basis points off I'm willing to stipulate that if the FED gets inflation to 2.2 there won't be a person in the country saying that that's above on their target they'll say 2.2 is 2. so looking back on it you know why should we think the FED got anything lower than maybe an A minus an A minus before all the inflation of recent decades um in grades for its performance from 25 to 2019 and there was sort of no mistake to really learn from there Steve leisman Steve can you stand up so the mic can find you thanks and thanks uh for putting that together this conference um well things are I don't remember reporting on the fed and thinking they are or are not following the the statement the long-run policy statement so I just wonder if you guys have thought about how influential it really was in making a policy and then just one other one other thing um how do you factor in sort of I guess the best way to put it is facts on the ground rather than the kind of theoretical framework which is if you remember in September 21 the chair was waiting for the benefits to run out thinking that would result in an influx of workers to the workforce how does that factor and then again in December 2021 there was the the Omicron wave which I don't know maybe helps explain the failure of the FED to Pivot I don't know how much maybe it's confounded as you are about that but there were those two things that seemed to be kind of outside the framework that you're looking at thanks right I mean your point Ray Steve is it and I think Loretta Master made it maybe it's just a bad forecaster we're over emphasizing does someone want to take uh Jason's question about was there a mistake in 2015-19 that needed to be fixed I mean I I thought it was very reasonable at the time to be concerned about continuous decline in our star and uh you know and that was starting to show up possibly in fall and inflation expectation that would leave even less room for interest rate Cuts in the future so yeah I mean you know missing a Target by small amounts in itself is not a big deal but I think they were looking forward to a more serious problem down the pike if that they were getting gradually less and less room and I think that was a perfectly legitimate thing to be concerned about at the time but I actually I disagree a bit with my co-author here in the sense that I I look at the framework as having two important pieces one is the average inflation targeting which is really meant to deal with the zero lower bound the effective lower bound is very similar to as Rich Clarita pointed out in a speech on this stage is very similar to Ben bernanke's temporary price level targeting that's to deal with that but I think the asymmetry in the labor market approach is to deal with a different a really a different problem which was we overestimated how high or underestimated how high employment could go before inflation picked up we thought the Phillips curve was too flat Etc and uh it's not really the same as the elb problem and there I I think I think um and and our conclusion was we really need to go back and rethink that piece of the asymmetry is that necessary to address the issues we might be facing or the costs of that asymmetry that more than the benefits uh might have been I think the flat Phillips curve and Jason has pointed this out and writing is a two-edged sword because if you go past an inflation if the filter is very flat you go past Full Employment and inflation only begins to pick up a little bit you've got a long way to go back in order to get inflation back to your two percent Target so inflation doesn't pick up much when you overshoot but it doesn't go down much when you come back so uh I think I hope that the framework and maybe this will be part of the next panel discussion that the framework focuses a bit on that piece of the asymmetry is it really if we even if we return to a lower star low inflation world is that piece of the asymmetry still necessary to get the benefits I agree there are benefits from running a hot labor market but there may be other ways of getting those benefits so I just think it needs a and I think that Ellen correctly if I'm wrong when I went to some of those federalism events and I had the feeling that policy makers really did think Jason that they could have had a better employment picture if they hadn't been so tight-fisted and that maybe it wasn't big in tenths of a percentage point but confronting people over and over again influence them to think where we want to take the risks yeah yeah right and and actually the page of comments that I deleted from my uh presentation was on the FED lessons and the role that I think it played psychologically in people's thinking going into because of course we couldn't engage um businesses a bit but you couldn't engage Community groups and and community colleges and labor market groups and so on on inflation because there was no inflation there was nothing to talk about they didn't understand the questions right but if you ask them about the labor market you heard all about problems that were being solved that ultimately were bringing people on the margins back in you know okay Chris can you bring the mic down to Rich and meanwhile can someone give the right Mike Kiley wave your hand look at Mike Kiley David Wilcox then we'll let Rich extra we kind of didn't answer Steve's question oh yeah I'm sorry go ahead please yeah so I I think I think there is an issue to be interested in Ellen's perspective on this that this statement is issued in January and rarely referred to afterwards now I think it did inform the forward guidance and everybody you Mr leesman and everyone else is are totally focused on the forward guidance because that tells you something about what might happen at the next meeting and the meeting after that in the meeting after that but it would be helpful for the Federal Reserve I think in their communication every once in a while to take a deep breath look back and say how this fits into the framework and in that regard I think I hope that when they re-examine the framework this issue of what happens when the goals aren't totally aligned when you're above one below another needs a little more attention and a little more care and because that's the situation they at least they thought they were in although I think the U over V suggests they weren't the situation wasn't quite as contradictory as they as they thought okay could I just have one more sure of course um you know I too thought that the framework didn't play much of a role except there were a few conf press conferences where I recall chair Pals saying something about the paragraph It's really about Supply shocks when the goals are not complementary right and then he mentioned balanced approach which of course was the language that was deleted from from the new framework statement but he would go to that paragraph because that's the issue you know that they were most thinking about was these Supply shocks and in terms of the question about you know I remember there being a focal point around September 2021 when the extended UI ended kids are going back to school so on and so forth maybe that that's when labor force participation picks up you know I think you can tell a lot of this story around a forecast that just makes a number of mistakes and I'm not saying it would have been easy to make a forecast but yeah all right Kylie finally um so maybe uh two observations and one then one question in the form of a comment um observation number one when I look back at the so it certainly resonated with me goiti's you know uh description of the framework as creating asymmetry which has an inflation bias and that of course was meant I think to offset the downward inflation bias in work that you know associated with little r star in that model it's low R star driven primarily by aggregate demand shocks and it's desirable to have an overshooting type policy when I think of that literature though that overshooting is described in terms of inflation not in terms of the unemployment rate now it is the case that if aggregate demand is driving everything those are the same but when I think about the work I did with John Roberts or with Ben or others it was always expressed in terms of inflation because actually supply and demand factors are both important and inflation will better capture those and so I think it was a perhaps an over optimization to a world in which demand is the primary driver and our star is low and that thinking more flexibly would have sort of leaned against the asymmetry in uh output or unemployment I think secondarily related to that our models suggest that lower unemployment is desirable that does not mean that lower unemployment should be ignored in setting monetary policies so in our standard new Keynesian model the equilibrium level of unemployment is inefficient and it's desirable to have lower unemployment that doesn't lead to a loss function of the type that Ellen described that's used in in some optimal control simulations at the FED in 2016 where you ignore it right it just says well it's desirable to have it somewhat lower but you should still be responding to lower inflation right there are still costs I mean to lower unemployment there are still costs I mean so in Broad terms the framework seemed to over optimize to this demand world and you know I think we have a long history in monetary policy research where optimizing your framework to a specific model will lead to a bad outcome right that you should attenuate your your responses in any individual model or framework because the framework's very uncertain nonetheless I wonder how different outcomes would have been and in particular I wonder your views on if the framework had been perfectly symmetric whether or not the real challenge was associated with having a forecast targeting framework and the forecast always be that next year we'll have Goldilocks next year inflation will be two percent and next year unemployment will be near its natural rate even if we don't do anything and that really has nothing to do with asymmetries right that is a view of where the economy is going thanks Rich and then David and then we're going to move uh I'll be quick I what I would say is to Jason's point about that period one reason why in retrospect Jason we're given an A minus is that the FED in real time including when I was there essentially had to ignore backward looking models that said inflation would surge on the unemployment rate got above five indeed the committee lifted off in December of 2015 when the unemployment rate was at five because the FED models were saying it would take off and the pal fed certainly at that point became very very skeptical that we should base policy on on that model simply because you kept falling with no cost push pressure so I think there's an opportunity cost clearly but there's also an opportunity cost to running a policy that's that's very very tight because the model keeps looking at inflation to go up and I think that's also relevant yeah David can you wave your hand so they can find you it's coming from behind you in the interest of brevity I'll suppress most of what I had planned to bless you to um listening to the discussion it seems to me that one factor that has been uh greatly understated is the profound uncertainty that policy makers and frankly staff forecasters face in the moment and I think there's a tremendous risk of overlearning the lessons of the last uh three years because the last time we had a shock of this nature was uh as best as I can tell approximately the influenza 1919 18-19 the next time we have a experience like that I hope we'll look back I think there are important lessons to learn but my guess is that the primary danger we face today is over learning the lesson of the highly atypical shock and forgetting that at least or under appreciating that in my view I think we're headed back to the environment of the 2010s where the primary challenges indeed below our star and the risk of sinking into a morass of inflation expectations that are eroding and monetary policy becoming increasingly incapable of combating that I agree and I think the other thing I should have mentioned earlier is that this is an interim assessment and if we get through this period the next two years with a soft or softish Landing we may decide that we took a risk and it was worth taking and it wasn't such a bad outcome and we won't know that for a few years and then history will judge this a lot more on things that have yet to happen so that please join me in thanking the panel yeah and then we're going to make a slight change in the program uh before we move to the full panel on what should be in the next framework review uh Kristen Forbes from MIT former member of the bank of England monetary policy committee and an all-around good person uh has some slides and she's going to share them and then I'm going to bring up the whole panel so Chris okay thank you congratulations to Dave and the the team for putting together this event and having people start to think about the framework review in advance there's clearly some room for improvement this time around um so Dave has asked me to talk about what should be on the agenda for the framework of you what should we think about but to do that I think I need to first take a step back and say what has changed why should we be thinking about changes to the framework review and I want to highlight three sets of changes uh the role of global shocks High inflation in the Phillips curve and the where policy rates are now many of these are obvious but I think it's just where and many of them have been talked about already this morning but it's worth just running through quickly because the world today does look quite different than it did in 2019 2020 when the framework review was happening and it's these changes which are the main reason we are talking about changing and rethinking some of the uh framework um and then I'll end with what's next for the framework review okay so first what's changing the global environment let me start with all the global shocks um as usual at a Fed conference we don't talk much about what's going on the rest of the global economy Richard thank you for bringing that in uh but uh the the key point I want to make is that Global shocks are increasingly important in driving headline inflation CPA inflation this is an update of a graph I actually presented here gosh before covid and when I did a Brookings paper on the role of globalization and infecting inflation and the main takeaway from a typical Brookings paper you know about 80 pages but it can be quickly summarized in this is that Global shocks are increasingly driving CPI inflation this is the prince first principle component of CPI inflation in red it shows that CPR inflation around the world is increasingly driven by shocks like oil shocks commodity shocks Global Supply Chain issues Global slack so that is um but also important is core inflation wage inflation is affected a bit more by global shocks but not much more core inflation wage inflation is still largely a domestic process um and that agrees with the results in the paper by Ben and Olivier and here's just the the graphs that they showed us if you look at what drives CPI inflation over the past couple of years Global shocks food and energy shocks were a key driver but when you look at wage inflation the global shocks have been a much played a much more minor role um so I think that's important for a couple of reasons as we think about a framework the first key takeaway from this is that in any point in time in any year it's going to be really hard to hit a CPI inflation Target and even core can bounce around some because of these Global shocks so trying to set a mandate where you're supposed to hit a Target in a specific Target in any given month is just asking too much you don't want monetary policy to go up and down to try to hit that specific Target in any given period when these Global forces are going to drive inflation away from a Target and by large amounts at least the US has a big advantage over most other countries where the target is core inflation so you get away from some of this but I think there's should still be some more flexibility because these Global shocks do matter so much also one reason why you might say we don't need to worry so much about the global shocks if they do largely fade and pass away is because inflation expectations have remained anchored as again we saw in the first paper so there hasn't been much pass-through of this period of sustained High inflation on wage setting but I'm not sure we can claim Victor on that quite yet the verdict is still out we may we'd love to see this updated in a couple of years for the U.S and also important in other countries it's not clear inflation expectations have been as well anchored the UK is a prime example where we've seen High inflation largely driven initially by external shocks it has passed through into the wage and price setting process to a larger degree it does seem to have unanchored inflation expectations during a period when the bank of England was raising rates at a slower pace so I don't think we can claim victory here even if the global shocks are usually more transitory effects on Headline inflation they still can pass through okay second change in the global environment other than or in the macro environment other than an increased role of global shocks is that inflation is back this just shows the share of countries that have inflation too hot just about right or too cold this is a set of advanced economies independent central banks inflation targeting Etc um I mean we all know inflation has been too high in most countries around the world but it's important to note that the period when this framework was done was that period where there was a lot of green and blue when inflation was too low I don't think anyone working on the framework then foresaw how quickly inflation could come back in Bee high so it just was not dealing with a world where inflation is very high was was not Central and that's why it was easier to write an asymmetric framework because High inflation just was not seen as a major risk it's back um related to that we heard a lot of talk today about the Phillips curve is the Phillips curve alive is it flat is it steep um I I will skip some of that discussion but I just want to make a couple important points about the Phillips curve uh the Phillips the on the left is the original Phillips curve is Philip Stewart for the U.S what's important from this is it is not a straight line it is non-linear it is a curve somehow we seem to have forgotten that in much of the discussion that especially preceded uh 2020 when unemployment is higher and unemployment Falls and when unemployment is above neighbor when unemployment Falls there's not much effect on wage wages when unemployment Falls quite low and is below nehru then when unemployment Falls further there's going to be a bigger effect on wages this is just on the right an estimate of this CR when you but it's very hard to estimate that in real time for any country if you do it cross-country shown on the right you do get the sort of curved effect there's now a series of papers that are starting to be in and how the Phillips curve is back and how it's non-linear and I think we just need to remember this lesson there will be periods the relationship between unemployment and wage inflation seems weak but if you push the labor market hard enough that unemployment is very low and well below any sort of equilibrium rate you're going to eventually have some effect on wages estimating exactly what that that point where the break happens though is very hard in real time the curve shifts it tilts it flattens the break point can move based on structural changes on where your nehru is so you know very hard to use in real time but I think that concept is important to remember if you push the labor market too hard and unemployment Falls too low again you will get wage pressures and inflationary pressures so you have to have that involved in the framework it's not free to push the labor market too low too hard final point on how things have changed is interest rates a lot of the concern which drove some of the changes in the framework of you was that interest rates would remain very low so there was not space to lower them further when the next shot hit to stimulate the economy so here's a graph of some interest rates in some of the big advanced economies people are talking to you for a while so now I want to have you think for a second just look at that for a minute apologies to a few of you who saw me present this last week in Florida so look at interest rates policy interest rates and major economies a couple things might jump out at you one for the U.S we set a ban now not a rate so five in five and a quarter let's say that's the top of the band five to five and a quarter where the U.S rate is today anything else jump out at you is odd I'm tempted to call you David David but you might have seen my slides so you know it's coming for those of you who follow markets minutely you might notice the UK looks off a little UK bank rate is now at four and a half percent but Market expectations are that it'll go to about five so so maybe this actually shows where policy rates are expected to settle during this hiking cycle but a couple you might notice something else off it's not that MIT Ras have gotten uh unreliable instead what it is is this is actually not policy interest rates today it's rates in 20 at the end of 2006. the right is where policy interest rates are today the average is basically the same and I think this is just a I've picked the year on purpose obviously but look at how similar these rates are U.S basically the same you know UK is expected to go where it was in 2006. many of the others basically the same I think this is just a reminder we've we spent a lot of the framework review was on the period that was from the 2010s we thought the world was different rates would be lower inflation lower less concerned about a Phillips curve um but the world today might actually be just more of a return to a more normal world of the 1990s 2000s we don't know we don't know what world we're going back to we could be going back to World of the 2010s where these interest rates get low again inflation is low again or we might just be back to a world as pre-2010 and that requires a different framework so that's the key sort of takeaways I thought about this in aligns with the the second paper by Gautier and Don is we need a framework that will fit these different environments we don't know where the world is going we don't know if inflation will be a big problem in the future we don't know where policy interest rates will settle we need a framework that is Nimble enough for all of those so what's that mean concretely um first uh and I'll Focus the changes on how these relate to some of these changes in the in the macro environment Global shocks are going to continue to be important in driving headline inflation potentially core inflation and potentially risks of feeding through into the wage and price setting process so it's it's just going to be hard to meet any two percent goal in any month these Global shocks matter they're big they're not going away so I would I think on the table should be the consideration of a more flexible numeric Target not having to hit two percent it was Jason had just said maybe we shouldn't have done so much handwringing about being at 1.8 percent that shouldn't be a failure that doesn't sound so bad given the role of these big Global shocks so maybe we should have a band one and a half to two and a half percent and not again have to feel like you have to go to Extraordinary Measures because you're off by a bit given the role of global shocks maybe we should shift to a model something like the bank of England does where you aren't aiming to hit a Target in any given month but you are adjusting policy interest rates to have inflation go to a two percent in two years time so you let the global shocks fade and your goal is to hit that Target in a certain window and not in any given month um and and the same vein I think it's very important to now that we are in a world of higher inflation uh rely Less on forward guidance maintain more flexibility I think this was a mistake as we emerge from covid of the the uh fed tying its hands with its Guidance with its commitment about what it would take before it started to tighten monetary policy and also tying its hands through its QE program by being so hesitant to talk about talking about tapering and then talk about tapering and find friendly tapering that made it harder for them to adjust rates in a more timely fashion so beware of any of these sorts of policies that make you lose your guidance you need or lose your flexibility you need to be nimble to use Dave's Words in terms of the changes where we are now in a world of higher inflation where the Phillips curve is alive or it released on the steeper part of it I think we do need to bring back a focus on the risks around inflation to the framework of you back to a more symmetric framework you know echoing the comments we just hidden last last paper allowing the FED to be able to adjust rates preemptively to labor market deviations in both directions the asymmetry made sense if you thought we would always be in a world of the 2010s of low inflation flat part of the Phillips curve but we're not we need to bring the Symmetry back um and then the final so key consideration is with policy rates now well above their effective lower bounds I think there's less concern about limited policy space again I don't know where rates will settle I think they'll probably come down but probably not as low as they were uh before cobit hit um and this is where I think it would be this would be a good opportunity to clarify the framework for other monetary policy tools we've actually talked quite little about this whole new set of tools which are now a standard part of the toolkit um and in particular talking about when you use asset purchases talk about limiting asset purchases so they're easier to get out of when it's time to end an asset purchase program so it won't then take longer to adjust policy rates and also something which I can't believe we've avoided most of the day some discussion of how you use asset purchases for financial stability concerns if you may be adjusting interest rates in a different direction for example The Dilemma the bank of England was in in October with the ldi crisis when they wanted to tighten monetary policy because inflation was still too high but yet they had to buy assets for financial stability issues I think it would be useful to clarify in advance ways that can be done a separate a separate facility a separate name so it's clear you're not doing QE while you're raising interest rates you're doing asset purchases for financial stability reasons shorter term limited duration you unwind them quickly like the bank of England Doug clarifying that in advance would be helpful it's part of the framework review so finally I think those are some of my suggestions at least to get the conversation going on what should be looked at in the framework review I think what's also important though is what is not up there one thing that is not up there is going back to more formal rules that was at a Fed conference in Atlanta in Florida last week and there was a push for sort of more tailor rules more formal rules um I I don't think that makes sense especially given all these structural changes also what I did not put up there was shifting to a higher inflation Target I'm also surprised we have not had that discussion yet probably we will on the next panel but I'll leave that discussion for the next panel thank you [Applause] thanks so if I can call uh abandoned Olivier Ellen and Rich up here and because we only have five seats I'm going to stand and I'm sure that if Jason or County or Don has anything to say I'll find a way to close it hold behind schedule we're going to go like 15 minutes over I think that Kristen gave a good start to what I was hoping we can do in this session which is try and put a few things on the table for the FED when they revisit the framework which their scheduled to do in 2025 I think somebody suggested someone I know suggested to Jay Powell that they do it sooner and he winced so I don't think that's going to happen and maybe some of these issues will be clear by then uh maybe some of it maybe uh Kristen's chart of interest rates will look less like 2006 and more like 2019 we just don't know yet but um Dan I wonder if I could start with you um before the fed put out its framework you had articulated I think it was a speech at Peterson where you talked about temporary price level targeting and the idea was that we'd have an inflation Target normal times but when we ran into this awkward situation of the zero lower bound then we'd have a period where they would Target the price level and I wonder in light of that and there was a lot of similarity to that in the new fed framework do you think that that's a good idea do you think that the framework should be different in 2025 given what we've just gone through or do you think we landed in a good place and we just had a bad run I I don't I don't think the temporary price level Target is anything to do with what Donna gelty were talking about which was the lack of preemption and coding to zero the temporary price little Target doesn't talk about employment it's about and we had a paper with John I had a paper with John Roberts and Michael Kiley where we did simulations to try to figure out what was optimal and what we found was it really once inflation had been established it targeted for around a year then you could begin a process of of increasing um as some as I think Chris is important as others pointed out um when you have a downward bias on inflation because of the effective lower bound if your Target and maybe this is maybe this should be formal if your target is say inflation or inflation expectations in two years then there's got to be periods of overshoot and that's just part that's the logic of this um I I think the the revision is going to have to take into account the fact that you know that we won't be necessarily at the zero lower bound you know all the time like we thought might be the case before but this that should still be in it because that you know when you're at the lower bound you've got to compensate for the fact that you know you're not able to keep inflation up to the Target all the time you need to have some overshoot so I don't think anything what would you do different if you were rewriting the framework yeah the 2020 framework well um again I think I think there's a depends how much you think of the September December 2020 um guidance as part of the framework if it's not part of the framework then I think I would be a little more fuzzy about the Full Employment concept recognize that there are multiple indicators for example that should be taken into account I would talk about uh having a period of time to reach the Target that you know it doesn't have to be at the Target all the time on forward guidance I think um so I don't want to go into odysseun versus delphic Ford guys I think there are times at lower bound we're we're very tough for very clear explicit four guidance is quite helpful um and so that should be part of the toolkit when you're away from the zero lower bound transparency demands that you give some idea where you think the economy and policy are going but it could be very general and in those cases um I think that we we the FED not we anymore the FED needs to have a better way of communicating that these are very provisional these are subject to change and and so on so an indicator of the certainty of the guidance as well as the guidance itself would probably be a useful Edition rich okay we give you full credit for all the good parts and the bad parts of the framework but you're no longer at the board so uh and I I want to complement both County and and uh Olivier have been quite uh humble and say where they made mistakes so I want to invite you to follow that Spirit what not what would you have done differently in 2020 because you've talked a lot about that but if we're revisiting the framework in light of recent experience what would you recommend what issues be on the table well this has been a great session I do appreciate as well the idea that this will become a lot clearer when we actually see how this episode uh ends up but I appreciate getting a head start on it I'd say a couple of things I think you know within within the building and when we did the framework review it was pre uh pandemic so we were still in the Eccles uh building um we always thought of the framework statement itself is and I think Jim Bullard has used this term quasi-constitutional the the framework statement has no nothing in it about forward guidance uh QE as did the 2012 statement had no reference to that either so in our own mind and in my mind I always thought about the framework statement as defining goals and and priorities and then the implementation obviously myself I think I gave six speeches as Vice chair including two at Brookings on how I read the framework statement and implementation and to me the most straightforward way to do it was essentially for the committee to decide based upon having been at the zero bound when it would make sense to lift off using the totality of data labor market data inflation expectations and then at that point to essentially revert to traditional inflation targeting I still think that makes a lot of sense I think it's entirely consistent with the existing uh language but certainly uh I I think in something in that direction makes sense I I will say that you know with forward guidance like with with any you know the law of diminishing returns is relevant there are there are costs and benefits and certainly if you look at the forward Guidance the the committee offered in September of 2020 and December of 2020 um you know the cost benefit of the guidance on the balance sheet I think was a close call then and in retrospect uh I think and I made this point in in some talks I gave here in papers I've given I think I think the guidance very specific guidance on tapering and talking about tapering did put in a lag of any of several months six months some number of time amount of time between when a liftoff would have been called for when the commit committee did so I think you know critically thinking about cost benefit of guidance uh is is uh is relevant because obviously one option is if the world changes you just abandon the guidance but what was interesting about being on the committee at that time was that there was a perceived cost of abandoning the guidance given the prior commitment so I think I'd make those two points um Alan you look like you had wisdom to share no I just wanted to follow up with a comment on the the tapering and the guidance around that you know this is another place where I think mindset and what you bring from past experience um were formative you know back in 2012 there was this little episode called the taper tantrum and uh and it really did um ruffle uh the fed and and Communications had to be worked out and uh you know I remember uh then chair Bernanke saying tapering is not tightening uh I don't know how many times he used that phrase to um to convince markets that you know a discussion of tapering did not mean that the Fed was going to lift the policy rate from zero uh eminently and so the whole procedure that was laid out which really made sense at the time because the recovery was so slow allowed the FED to proceed very very slowly and even then once tape bring ended there was still more than 12 months before the policy rate was lifted you know picking that apparatus up and plopping it down into the current environment really was just not the right approach this time and so I I really agree that you know that whole thing needs to be looked at including uh the idea that you might begin to lift off before your taper is completed as suggested okay so just to make sure I understand rich I think you're saying not much needs to be changed in the framework but we need to give more thought to how we use forward guidance and Ellen is saying a good research question before the we get into this again is how do we think about tapering and stock versus flow I just have a quick coming in that one partial solution is to when you do QE programs do a fixed amount for a fixed time uh I I I think there's downsize as well right but should be credited for being sensitive to the verse around tapering when the FED adjusts its program there could be Global implications and it's very hard to assess what those are so big credit to the FED for being more sensitive um but a good counter example is the Bank of England when they did their QE programs they announced a fixed quantity which so the default was it ended and then you didn't have to worry about messaging how do you end getting ready to talk about it there's the default built into markets is an end date and that end date is often wrong I think the bank of England probably ended a little but at least there's an end date on the books that's the default um and if it's not enough which often happens then you can always do more but that then you get if anything the announcement effect of doing more but again it's the end is marked priced in marked in less risk of ending it and if the date's off by a couple months that's still a lot easier than I'm struck by how hard it is to focus the conversation on strategy because we keep going to tactics um Olivier uh well I you saw you making some notes so I don't want to preempt anything you'd say but I am interested in your current views on If the Fed is revisiting the inflation Target in 2025 what would be the smart thing to do then given what you've said in the past so I think in the abstract the argument for having a higher Target inflation remains very strong and Christian may be right that the r star will be sufficiently high that we don't have to worry but I worry and I remember what the excess probability was when we decided on two percent which was zero and it turned out to be a hundred so it seems to me that it would be good to increase the inflation Target I used to be of a four percent uh opinion I've concluded based on the number of papers that at four percent the salience about inflation and that starts changing behavior in ways which complicate the task of a of a central bank so I've downgraded to free from two to three what I hear is well one percent who cares one percent is what we got by doing QE so one way of thinking about it is if we had had a target of one percent more maybe we would not have had to do QE and I think on that would probably be better off I think QE is a very complicated uh set of measures to use with many many many adverse effects so this is in the abstract I realized that at this stage the central banks don't want to talk about it because they want this inflation and they don't want to change the Target and it would be counterproductive for them to talk about it but almost surely there is going to be a point where the issue is going to be there where the rubber is going to hit the road if I remember the U.S expression for that which is you know in the next six months it's like he will be around free and given that the wage Phillips curve is very flat getting to 2 is not going to be trivial and it may be very hard for the FED to say well we have to go to two and we're going to keep interest rates very high I suspect what's going to happen is that the FED is going to be more relaxed it's not going to change the target but it may not be in a hurry to get to two and maybe along the way there's a discussion but I think the argument is still very much there and you agree well I agree in theory but I think the actual reality doesn't doesn't really support it um one thing nobody talks about is politics the Congress let us put in an inflation Target without being part of the process and I had to consult widely with that I remember we were here and Janet Yellen put up a a video of the head of the house Financial Services committee saying under no circumstances will you raise the inflation Dart I think if you did it you would have to consult with Congress and you might find out at the end that your inflation Target is one so I think it's a very big issue the second thing is that you know whatever would have been the theoretical right thing in the beginning and I think it's debatable right now there's some very heavy barriers to making a change obviously with inflation High you don't want to you know give up The credibility that you're serious about inflation don't want to change where the target is so that you can put it around the the arrow um but the other part is um we've had and a de facto two percent inflation Target in the US since the 90s and uh that's built up a lot of credibility and expectation I think the change would I mean again you know I'm just trying to bring out all the issues I think of reality uh the change would be difficult to maneuver and get people to find it credible um it would have disruptive effects on bond markets for example so I understand completely the argument in favor um and I've seen papers that you know say would make a big difference I think we got more than one percent out of QE by the way but but uh there are there are some real pra given where we are today as opposed to starting from from you know the original position of you know it's it's quite a challenge to make that change uh Corolla I should have asked people to identify themselves before so I'll ask it now sure hi I'm Carol binder from Haverford College um my question is about the the role of possible fed lessons events in the next framework review um I think the FED lessons events that were in like 20 19 2020 those are at the same time as there were a lot of um a lot of papers op-eds conferences about the possible threat of populism to Central Bank and in some ways I saw them as like maybe a response to that to kind of like let's respond to what the public wants so that they will let us be independent um so I wonder like to what extent any of you think that the FED listens events um led to some led to some of the problems with the new framework and whether they're necessary or a good idea for the next framework review maybe I'll jump in on that um I think for the FED to seek input in that format was was not only important but I think will be durable you know what the FED does with that input is up to the The committee's Professional a judgment I I think that there are a lot of elements of the framework that uh are worth revisiting but I think one that has a lot of support certainly when I left and I haven't heard any comments to the contrary was um uh what was fed listened uh but um but again that's that's one of many inputs the committee will have I think they will keep it in place uh to make the German well I've got the microphone I want a second something Kristen uh said in our framework review in the we released we then when I was there released extensive we had seven rounds of briefings at the fomc from from system staff it wasn't just a board effort and actually one of those briefings was a dedicated briefing on thinking about defining the inflation objective explicitly in terms of a band or a range we chose we they the committee chose not to go down that road given the initial conditions because the concern was if the committee were to find a range of you know one and a half to two and a half that could reinforce the view that inflation would never get to do and then and then reinforce the challenge of inflation expectations sagging this so wanting to get away from the two percent as a ceiling perception which other central banks have had to confront but but the initial conditions will be much different in 2024 and 2025 and I think I would hope that the merits of seriously considering a range could be uh entertained because I think Kristen is right when you're a central banker there are always shocks uh maybe fewer in the U.S than in the UK but there are always shocks and success is really keeping inflation expectations anchored and I think you can achieve that with with a well thought through and communicated range so I would hope that the committee does consider that next time wait a minute let's go Sac first Brian sack the idea that there would be a silence and no one asking a question is just too much for leasement to take I want to ask a question it's actually similar to a question I asked rich in Hoover I think in 2019 which is um I mean if you could measure intermediate term inflation expectations accurately right I mean wouldn't the robust the most robust framework approach be just put that in your your reaction function and and react to it I mean all these things about the lower bound causing this chronic bias I mean you could see that in five year five year break evens I'm not saying that's the measure the perfect measure but you know they were below two from 2014 through 2019 they reflected this bias but it seems like something like that like I think everyone almost any framework is going to agree that you want to make sure your long-term inflation expectations are anchored so to me that seems like the most you know robust idea is just to react to that to make sure that those are at a level consistent with your target I was wondering if you had in common I I have a paper with Michael Woodford he did all the hard math um which shows that you get circularity in that kind of situation that that the FED says we're going to Target two percent the market says oh okay we'll expect two percent and there's really you sort of can get to multiple equilibria and there are actually some problems with that but but I I on the other hand I have advocated what Doris fencing calls inflation forecast targeting and you know in principle when you have lags you don't want it to be a two percent you know on every Tuesday you want you want to have a a path that takes you to two percent over a period of time and I think one of the dimensions I think several people already said this one of the ways in which you can uh improve the trade-off against employment is to be flexible in how long you take to to get to the official Target Steve oh please yeah wait for the mic so people on the great beyond can hear your thoughts okay the circularity is a very good point but I mean the whole experience from 2014 to 2019 I mean we did see inflation expectations at least measured in some measures like looking too low so it's not like it's a meaningless you know idea that you know hey policy should react to that and and be looser to address that so I'm safe then I'm gonna after Steve's question I'm going to ask he's reviewers put even if you've said it before one thing you think should be on the agenda when the fed revisits the review When Alan Mead comes back to run it in 2025. uh David sorry this park is back to maybe the last panel I wonder if Olivier and Ben would talk about the possibilities or probabilities of the Immaculate disinflationary outcome from your paper to the extent that it seemed reliant on going back to the prior efficiency of Labor allocation before the pandemic it doesn't seem like a incredibly improbable outcome so I just want to address that thanks well again there's a extended debate between Chris Waller and Andrew figuera and uh Blanchard domination Summers about the likelihood of this apparently historically that doesn't happen very often but of course this is a very unusual situation um the issue is we don't fully understand why the beverage curve moved out it has to do to some extent perhaps with more reallocation taking place in the economy it could be that people are more reluctant to come back to work and therefore they don't search US intensively so it could be I raise the possibility without having any sense of probability that um over time we move in some direct you know to some you know back towards the original beverage curve which would make the unemployment cost much less um it's not yeah so but we don't know uh Olivier pointed out that the most recent readings unemployment is stayed about the same or actually dropped a little bit while the number of vacancies has come down so so far so good for the you know for the immaculate this inflation folks okay one one thing that should definitely be on the feds agenda when it revisits review do you want to start Ellen so I I'd like to follow up on this uh comment that Don made about um a little bit more discussion in the committee um while there were I think it was five meetings at which uh framework review topics were discussed there was never a go round on the draft consensus statement that took place in a meeting and um you know I went back to the December 2011 meeting as I Was preparing for this and that's really quite a discussion and quite an interesting thing about what is a framework statement what should be in a framework statement how do I as a policy maker see a framework statement so I think I would encourage the committee to have a discussion that five years or six years later we could uh read and get a sense of their views rich well I already weighed in on the idea of taking the the range of the band uh seriously but the other I would mention and I want to second I think what was mentioned in some earlier panels I I think putting some meat on the bones of what is what is a you know broad-based definition of Full Employment there are ways to make that operational including using you know labor market condition indexes for example the Kansas City fed or even tying the tight labor market to some notion of the level of you know wage gains consistent with productivity I think would be quite uh useful no one's happy with putting all the eggs in the used star basket since it moves around and so putting some time if not in the framework statement then into operationalizing it I think would be quite helpful because as my as my chart showed both the Kansas City 18 indicator index and the Vu index were essentially saying mission accomplished by the fall of 2021 well I would say a band but since uh rich just said it I'll say back to a more symmetric framework so the FED can preemptively address risks that when inflation is picking up too quickly not just when inflation is too low okay so I was very much taken by Christine's first point about the role of global talks I mean and they maybe the recommendation is even more for Europe which is more or less only affected by global sharks at this stage and it clearly limits the ambition of any Central Bank when you take this very large shocks and that has to be taken into account more explicitly Ben well I guess I would say that there should be something about given the lags a monetary policy that the Outlook has to be considered in making policy decisions with do do attention to the uncertainty necessarily associated with the Outlook so I guess that's just the back door way of bringing back a little bit of preemption great so I want to thank everybody including our panelists and Ben and and goiti and Jason Furman and I want to thank my team Stephanie sensula and Helen Shan who managed to pull off an event with the res events manager on vacation and thank all of you for your attention in coming and you can re-watch this whole thing at your leisure at faster slower speeds depending on your taste [Applause]

Channel: Brookings Institution

Views: 9,171

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Id: wyaoEC5O7JY

Length: 201min 30sec (12090 seconds)

Published: Tue May 23 2023

Reddit Comments

[u/Peak_Flaky]

Does it really take three hours to say greed increased and now its thankfully decreasing?

[u/InvictusShmictus]

Thx gonna use this to fall asleep tonight