Earlier this week, the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution hosted \”A Fed duet: Janet Yellen in conversation with Ben Bernanke\” (February 27, 2018). Video, audio and a transcript are all available here. I\’ll focus here on a few of Yellen\’s comments that caught my eye.
Building Consensus as the chair of the Fed. The Federal Open Market Committee, the policy-making part of the Federal Reserve, doesn\’t literally operate by consensus. But there has traditionally been an effort to try to build at least a rough consensus, and members have often been willing to coalesce behind a policy option that they found acceptable, even if it wasn\’t necessarily their first choice. Yellen describes her process of managing these meetings in this way:
\”And initially, at meetings we would have a lot of options on the table and there would be go-arounds and people would express their views. The options–there were people who would favor options that didn’t get a lot of support and they would tend to see that. You know, I love Option Number 9, but I was pretty much alone in doing that. And what I found was it was great. Over time people who favored options for which there wasn’t a lot of support tended to shift their support to options where there was greater support. And gradually, we narrowed things down to one and got complete agreement.
\”So I guess what I do is I often compare the job of managing the committee to the issue a designer would have to face who is trying to decide what’s the right color to paint a room. You have 19 people around the table, and you want to come up with a decision we can all live with on what color to paint the room. And we’d go around the table. Ben, what would you like? You think baby blue is just absolutely ideal. David, what do you think? Chartreuse you think is a lovely color. (Laughter) And we go around the room like that. And the question is, are we ever going to converge?
\”I would feel my job is get everybody to see that off-white is not a bad alternative. (Laughter) As brilliant as your choice was, maybe you could live with off-white, and it’s not so bad. And we can converge on that and it’s going to function just fine and maybe we can agree. So I felt I was often trying to get the committee to coalesce and decide. We’d come up with a good option that we could all agree on.\”
The zero lower bound is likely to be a repeated problem in the future. The current policy of the Fed is to aim at an inflation rate of 2%. The current projections for the federal funds interest rate in the future is that it will be 2.75%. Thus, the next time the Fed wants to cut interest rates, it is going to have negative real rates very quickly, and run into the zero lower bound quite soon.
\”[T]here is a problem and it’s a problem that I think I didn’t recognize when we chose 2 percent as a target [for inflation], how serious it would be. There had been only one country at that time, Japan, that hit the zero lower bound. That seemed like a rare circumstance. And since then, many advanced countries have faced the zero lower bound. There’s now growing agreement that somehow the new normal going forward is a world where productivity growth has been low. Perhaps we’ll be lucky and it’ll rise, but it has been low. We have aging populations and a strong demand for safe assets. It looks like interest rates, long and short, had generally been trending down among advanced countries even before the financial crisis. And I think there is now reason to believe that the new normal for the U.S. and many advanced economies will be on a lower average level of short-term rates.
\”The FOMC in their December projections projected the longer than normal level of the fund’s rate at 2.75, which is just three-quarters of a percent in real terms. And if that’s right and there are estimates of the equilibrium real rate that are even lower than that, zero bound episodes can be much more frequent. This means that for monetary policy, at least short-term rates have much less scope to be used to stabilize the economy. And I think the first thing is to recognize is that this really is a problem. It behooves policymakers and researchers more generally to think about are there changes we can make to the monetary policy framework that would be helpful in dealing with that?\”
When Angelo Mozilo Switched Regulators. Angelo Mozilo started the mortgage lender Countrywide, which was heavily involved in subprime lending. In 2010, after being booted from the company, he signed an agreement with the Securities and Exchange Commission where he did not need to admit wrongdoing, but did pay fines of $67.5 million while agreeing to a lifetime ban \”from ever again serving as an officer or director of a publicly traded company.\” Yellen tells the story of dealing with Mozilo when she was at the San Francisco Fed–and learning that Mozilo had decided to switch regulators.
\”Our supervisory folks that I met with were alerting me to underwriting practices that were a huge concern. They were telling me about low-doc and no-doc loans, about the rising prevalence of ninja loans, no income/no jobs/no asset-type loans. We supervised Countrywide for a while and looked at their mortgage business which was growing enormously. I met pretty regularly with Angelo Mozilo. And the San Francisco Fed was quite concerned about what was going on. We tried to insist on tighter risk controls.
\”And one day Angelo came up and we had our regular quarterly meeting and he said to me, Janet, I have to tell you, it’s been terrific to be supervised by you. You guys are really on top of your game and we really appreciate all of the valuable advice that you’ve given us. But, you know, we’ve realized that we don’t actually need to be a bank holding company. We realized it would be okay to be a thrift holding company. And so we’re changing our charter. And indeed they did so and decided it would be nice to be supervised by the Office of Thrift Supervision that is no more. So that kind of gave me a sense of what was happening. ….
\”I think what I failed to appreciate was, what if housing prices began to fall? I just really did not understand how vulnerable the financial system and particularly the shadow banking system was, how leveraged it was, how much maturity transformation there was, how much of this risk that we thought was being disbursed through the economy was really remaining on the books of these institutions. So I wrongly thought if housing prices fell a medium amount it would do damage to the economy and the outlook, but it would not destroy the core of the financial system. And I think that was a failure to appreciate the weaknesses.\”
\”One is that Clinton’s first steps, first economic policies, put in place a plan that would lower budget deficits. There had been great concern about out-of-control budget deficits, and it was reflected in high long-term interest rates. But the Clinton administration was, rightly I think, very concerned that tightening fiscal policy when we had an economy that was just recovering. Unemployment remained high, and they were worried about the negative impacts of fiscal tightening on the economy.
\”So let me just say at the outset: in general, the view that tight fiscal policy tends to depress employment and economic activity—I believe to be correct, and I’m not questioning that. But the Clinton policy was one that phased in very slowly over time a tightening of fiscal policy, so it wasn’t a tightening in day one or year one that was dramatic. I believe it was a very credible multiyear commitment, which served to quickly bring down long-term interest rates dramatically. So in point of fact, I think for at least some several years this was a fiscal tightening that actually was expansionary because the decline in spending or increase in taxes didn’t occur immediately and long-term rates came down very quickly. The economy continued to recover. So the notion that a very well-designed fiscal tightening policy need not have adverse impact on economic activity was one lesson we took away.\”