Finishing the Job and New Challenges

>> Michael Bordo: Welcome, everybody, to the second day of this event. This is our annual Monetary Policy Conference. It's been going, I don't know, for about 15 years. We have a fantastic lineup this year, we have some new topics. We're focusing on geopolitics and lots of stuff that we usually don't focus on.

And I just wanted to just welcome everybody. One thing I just wanted to let you know is that when we have Q&A and you have a question to ask or something, please identify yourself. Otherwise, have a good time. Condi, there she is. And we're gonna start with some welcoming remarks from our director, Condi Rice, thanks.

>> Condoleezza Rice: Thank you.

>> Condoleezza Rice: Well, thanks very much, Michael. And I just wanna start by saying that I thought yesterday and last night was just absolutely terrific to honor our colleague and friend John Taylor. I think we got a full picture of all that John has contributed. I was especially really quite taken away by Edward Nelson's talk.

I had no idea how much influence John had had on Alan Greenspan and on Milton, who, in pure Milton form, may never have been fully convinced but nonetheless was very influenced by John as well. So thanks very much for those of you who participated in that. Over the last few years when I've opened this conference, I've opened it by saying that the international system, the international global commons, as our friend George Shultz called it, led by the United States has been eroding for some time.

Both on the international economic side and on the international security side, if one thinks about expectations that you could put your supply chains pretty much anywhere you wanted to, you could invest where the ROI was greatest. You could think about an integrated international economy with a few outliers, like the North Koreans, but for the most part, it was an integrated international economy.

And then over the last several years, as tensions have emerged between the United States and China not just on the economic front but also on the security front, some of that sense of an integrated international economy had begun to break down. Well, that was a period of uncertainty.

But if we are now to talk about today, we're in an avalanche of uncertainty because everything about this international order seems to be in question. The US role in it, is US Treasury, the dollar, a flight to safety or not? How to think about trade relationships and how to think about the relationship between those trade relationships and those economic relationships and longstanding American security relationships.

I have to say I noted that when the President put up his chart on Liberation Day that the countries were kind of indistinguishable as to whether they were friend or foe. And that would be quite different than the way the United States has conceived of its role in the international system over time.

And so I think we are moving to a new era. We're not quite yet there, which means the uncertainty is greater than ever. A friend of mine actually used the avalanche metaphor to say that when an avalanche is happening, you really can't stop it. You just have to figure out how you're gonna dig out of it.

And so I assume that at this conference, with all of the eminent people that are here, that you're gonna have to figure out how to dig out of the avalanche and how monetary policy relates to the changing international environment that we see. I'm delighted that you're here. I wanna thank the organizers of this conference.

I wanna thank Michael and John Cochrane. I wanna thank Valerie Ramey, who's been very involved as well. It's a wonderful tradition that John Taylor began with this Monetary Policy Conference. He continues to be an animating spirit in this conference, and to do some work too. And so thank you very much for your presence here, thank you for your attendance.

I know it's going to be a wonderful day of discussion, conversation, hopefully controversy. And in the end, I hope you can help us figure out how to dig out of the avalanche, thanks very much.

>> Volkker Wieland: My name is Volkker Wieland. It's a pleasure to be here and thank you very much to the organizers. I actually traveled in from Germany, from Europe, yesterday, actually from Munich. And there are lots of good news in Germany. We have a new Chancellor, the world has a new Pope who hails from America, and we all here have John Taylor.

 

So I'm very grateful to the organizers that I can participate in the celebration in honor of John Taylor. And I feel very honored to moderate this morning's first panel on John Taylor and Taylor rules and policy at the Hoover Multi Policy Conference on finishing the job and new challenges.

 

It's also a great honor to speak right after Condoleezza arise. Thank you. So in a way, this panel is part of both events. I mean, it's a joint event. And yesterday's event to honor John's path breaking and highly influential contributions to economics as a science, into economic policy as a science and as an art.

 

And to today's event that dives into current challenges for central banks around the world. It was an amazing conference yesterday. It gave justice to the wide range of fundamental scientific contributions by John to motor economics, the modeling of the macroeconomy, price and wage rigidities, methodological advances to solve and estimate macro models with rational expectations.

 

And I may add, with learning finance and asset pricing, international monetary and fiscal policy interaction, and prominently for us today, rules for monetary policy, and I may add, fiscal policy. So those of us who are on the annual mailing list of this Swedish committee, let's make sure to get that message across to them also.

 

But there was more yesterday as the many students and friends of John gathered and shared their views on his work and their experience with him as a human being. And in my humble view, no matter how important or unimportant we are in the eyes of society at large, what really matters is how we live our lives and how we deal with all the human beings around us.

 

And right at the first panel, Andrew Levin spoke about these aspects of John Taylor and he spoke about stewardship and the how to be a good steward. And it was moving to hear throughout the day what everyone shared about John in this regard. I was not able to be here due to a delay of my flight, but I was able to follow much of it from the plane via the Zoom link.

 

And so I could also testify to that. So today we start with Taylor rules and their use in policy. We have an amazing list of speakers, six speakers which leave us little room. So where do I hit the button here? Here. So here are six names, just so I don't forget anyone.

 

We start off so we'll have only, I think 10 minutes per person. We start off with John Williams, a student of John and one of the world's most influential central bankers today as FOMC member and head of the New York Fed implementing US monetary policy. Then Augustin Karstens, General Manager of the BIS.

 

Both send videos. And then here with us in person we have Christopher Waller, currently on the Federal Reserve Board of Board of Governors, and Loretta Mester and Charles Plusser, both previously serving as Federal Reserve Bank Presidents and on the fomc. And Kevin Warsh, formerly also board on the Board of Governors from my side.

 

I was also a student and research assistant of John in 1992-1995, actually together with John Williams. And when I moved as a young economist to the Board of governors in DC Taylor rules were a hot issue, a hot item. So I got immediately involved. I was of course pleased that what I learned at Stanford could be put to use right away and was involved in preparing material for the policy meetings of the governors using Taylor Rules.

 

Other people there involved and included John Williams, Andrew Levin, Athanasius Orphanidis, David Small, David Wilcox. There was the early leadership by Donald Cohen, Peter Tinsley, Dale Henderson and Richard Porter, among others, who all worked at the institution and helped put these ideas to practice. And once the Fed started doing communication following its decisions beyond just on which arm Alan Greenspan was wearing his materials, which at one point was chosen as an indicator.

 

So they actually started using words and the framework when that was discussed. How to have a verbal communication after decision also followed the ideas of the Taylor Rule. And I could tell you some anecdotes about Alan Greenspan and staff Fed staff work on policy rules, but there's no time, so maybe some other time.

 

We're moving from the history of economic thought and economic policy to today's challenges. And to set that up, let me just show you one slide with Taylor Rules and the fed and the ECB policy since 2019. You probably have discussed similar things yesterday. And you can see on the left for the US and on the right for the Euro area.

 

Isabel Schnabel will also be speaking later from the ECB Board that a range of Taylor Rules gave clear signals for the need for policy tightening from 2021 onwards. The Fed is actually publishing a version of policy rules and they signaled policy easing from mid 2023 onwards. And recently policies were quite in line with those prescriptions and we hope to find out recently.

 

So not in 2021. And we hope to find out more about the likely steps ahead in the future. And that's exactly what we hope to hear and get insights from this panel. So without further delay, if I can say, let's get started with the videos. There will be no further introductions from my side.

 

I've introduced everyone and we go straight to the videos and then one speaker after the other and then a Q&A and a final round of replies. Thank you.

>> John Williams: Hello everyone. I wish I were back on the Stanford campus with you for this wonderful occasion celebrating my mentor, advisor and dear friend, John Taylor.

 

I'm so glad to have the opportunity to share my experience learning from one of the great economic thinkers and scholars of our time. Now, it's worth noting that John has had not one, not two, but three fundamental concepts in monetary economics named after him. There's the Taylor Principle, the Taylor Curve, and of course, the Taylor Rule.

 

In addition, John has consistently emphasized the need for approaches to monetary policy that are robust to the myriad uncertainties we face. Indeed, this quest for robustness was the frame by which John identified what became known as the Taylor Rule. I arrived at Stanford in 1989 as a budding economist.

 

John became my advisor and hired me to be as a research assistant. And it was an extraordinary privilege to have those two most wanted positions. It was a critical and exciting time to be thinking about economic policy. Of course, that's a line that I've had occasion to repeat many times since.

 

During that period, with the advent of inflation targeting, the practice of monetary policy was on the cusp of a revolution. At the same time, John and others were reexamining the theory and evidence behind the ways that policymakers could consistently deliver low and stable inflation in the post Bretton woods era.

 

My role in all of this was running multi country model simulations for John's book Macroeconomic Policy in a World Economy. Which led the way for John's great work Discretion Versus Policy Rules in Practice. This brilliantly synthesized theory and experience to yield clear prescriptions for good policy, and that experience informed my career in so many ways.

 

What I learned then, and something I've carried with me for over three decades, is the importance of connecting theory and practice. The theories that shape good policy are derived from the experiences of the past and they create the lessons for the future. It's a principle that I return to constantly and it's something I impart to others.

 

The power of great mentorship in our world of economics especially, is an equally important lesson from my time with John. This conference is a testament to how his thinking and teaching has led to pivotal transformations in central bank policymaking and to informing generations of economists. So, John, congratulations on a truly revolutionary career, and thank you.

 

 

>> Agustin Carstens: It is a true pleasure to be part of this special occasion honoring my good friend and esteemed colleague John Taylor. John's academic contributions to central banking and international finance are monumental. But what stands out just as much to me is his valuable career in public service and his dedication to upholding sound principles in policymaking.

 

His impact extends far beyond academia. He has been a guiding force in shaping policy frameworks that have stood the test of time. Today, I want to share some personal stories that highlight just how impactful John has been in all these areas. I have had the privilege of knowing John for many years, and our paths have crossed at some of the most important moments in global economic policy.

 

We first worked closely together when we were both undersecretaries at our respective finance ministries, John in the United States and me in Mexico in the early 2000s. That period was marked by critical challenges in global finance. I was fortunate to witness firsthand John's ability to navigate these challenges with clarity and conviction.

 

One of the first major issues we worked on was sovereign debt restructuring for emerging markets. At this time, emerging markets had faced two decades of recurring debt challenges typically resulting from macroeconomic imbalances. The first was in Mexico in 1992, this was followed by a wave of crisis across Latin America in the late 90s.

 

The East Asian financial crisis underscored the vulnerability of even seemingly high performing emerging markets to sudden capital flow reversals. In 2001, Argentina experienced a dramatic default. The need for a formal framework for sovereign debt restructuring was widely acknowledged, but identifying the right mechanism had proved to be a challenge.

 

The IMF had a proposal known as the Sovereign Debt Restructuring Mechanism, or SDRM. This had merit and could have provided a more orderly and predictable process for managing sovereignty faults than what existed before. But both the United States and Mexico had concerns about its rigidity and its implications for national sovereignty.

 

Rather than simply opposing the idea, John played an instrumental role in pushing for a better alternative, enhancing collective action clauses in sovereign bond contracts. Unlike the SDRM, which centralized decision making under international mechanism, collective action clauses allow bondholders and sovereigns to negotiate restructuring terms directly. As a result, they fostered market-based solutions while preserving discipline.

 

Mexico was one of the first countries to implement the enhanced collective action clauses in our sovereign bonds, setting an important precedent that has since been widely adopted. Beyond his work at the US Treasury, John's academic contributions have also had a profound real-world influence on the conduct of monetary policy, including in emerging markets.

 

His Taylor Rule became a cornerstone of modern monetary economics, giving central banks a clear rule-based framework for responding to inflation and output fluctuations. Although best known for its application to the analysis of US Monetary policy, in my view the Taylor Rule may have been also very influential and valuable in emerging markets.

 

Where it was a powerful tool for central banks seeking to build credibility and enhance the effectiveness of their monetary policies. The Taylor Rule and inflation targeting both emerged in the early 1990s. Before then, many emerging market central banks faced macroeconomic imbalances and often operated under policy frameworks that frequently lacked consistency.

 

The traditional nominal anchor for many of these economies at the time was a fixed or highly managed nominal exchange rate. But this was proving to be increasingly unviable to in a world of globalized trade and finance, inflation targeting held the promise of delivering something better. It sought to establish a firm nominal anchor for the economy, creating the necessary conditions to enable greater exchange rate flexibility and providing a convincing rationale for central bank autonomy.

 

However, central banks that adopted inflation targeting, particularly in countries with a history of high inflation, still face the challenge of establishing their credibility. Why should businesses, households, and financial markets believe their commitment to keep inflation low? In this context, the Taylor Rule was a powerful tool. The Taylor Rule provided a systematic approach to assess the appropriateness of interest rate setting based on inflation and economic activity.

 

This helped central banks enhance transparency, reduce uncertainty, and strengthen market confidence. All this contributed to the successful implementation of inflation targeting regimes and helped reduce inflation from high levels and tanker inflation expectations. Nevertheless, at times, central banks in emerging markets, including Banco de Mexico, had to adapt their monetary policy frameworks to overcome challenges posed by volatile capital flows and currency fluctuations.

 

Most central banks in these jurisdictions adopted flexible exchange rate regimes, but the depth and functioning of foreign exchange markets could not always be assured, particularly during crisis. We therefore established frameworks that allowed the exchange rate to act as a shock absorber and source of market discipline most of the time.

 

However, we still retained the option to intervene when markets were particularly thin, especially when sharp exchange rate depreciation threatened our inflation target and the anchoring of inflation expectations. The great financial crisis, the zero lower bound and unconventional monetary policy in advanced economies were further game changers. The effects of US Monetary policy became even more pronounced.

 

This enhanced the role of exchange rates and capital flows for monetary policymaking in emerging market economies. For many emerging markets, including Mexico, this meant facing a flood of capital inflows when rates were low and capital outflows when tightening cycles began. In this context, these jurisdictions had to balance the need for domestic policy autonomy with the reality of global financial integration.

 

We adapted our Taylor Rule benchmark to account for these global dynamics by introducing the US Shadow rate to better reflect the monetary policy reaction function. John's work gave us a strong foundation and we built upon it in ways that reflect the realities of emerging markets. That's a testament to the strength and flexibility of his ideas.

 

The Taylor Rule was also a valuable addition to the analytical toolkit of international institutions like the bis. It provided us with a convenient metric to assess and summarize the conduct and stance of monetary policy across our members. Even Today, more than 30 years after John first proposed it, the Taylor Rule remains the starting point for much of our analysis of real world monetary policy.

 

For example, in one of our most recent quarterly reviews published just a few months ago, my colleagues Boris Hoffman, Cristina Manea and Benoit Mojon used modified Taylor Rules to show that central banks in advanced economies typically respond much more strongly to inflationary pressures driven by changes in aggregate demand than they do when inflation results from changes in aggregate supply.

 

Needless to say, this topic is particularly relevant in the aftermath of the post Covid inflation surge. The work was innovative and featured some cutting edge econometrics and yet, because it was couched in terms of a Taylor Rule, its conclusions were easily understood and absorbed by policymakers. In a sense, the Taylor Rule provided a common language to make technical vocabulary understandable for for those in the trenches of day to day policy making.

 

John, I want to personally thank you not just for your intellectual contributions, but for your friendship and your unwavering commitment to fostering cooperation. Your impact on monetary policy and international finance is immeasurable and I, along with many others, have benefited greatly from your wisdom. You have made a difference that will endure for generations.

 

It's an honor to celebrate you today, and I look forward to many more conversations and collaborations in the years to come.

>> John Williams: Well, thank you, we actually also gained some time, according to my counting, taking two presentations in the intro. We're next on to Chris Waller and then Loretta and Charles and Kevin Warsh.

 

If we stick to about 10 minutes per speaker, maybe we can get more time for Q&A and for the final round of the four people here on the panel. So, Chris, up to you.

>> Christopher Waller: Well, first of all, anybody watching who thinks I'm going to talk about monetary policy today, you're gonna be sadly disappointed.

 

So thank you, Volkker, and thank you for the opportunity to speak to you today. John Taylor is deservedly well known for his work on monetary policy rules, the best known of which bear his name. But in the early 1980s, John was part of a broader discussion about rules versus discretion in the setting of monetary policy.

 

Now, the traditional argument for discretionary monetary policy was that any policy choice that a rule would recommend could be replicated by discretion, but not vice versa. So discretion allowed more flexibility than a rule, and thus was the dominant strategy for setting monetary policy. I think Ed Nelson talked about this last night.

 

Then in 1977, Finn Kintlin and Ed Prescott published their paper, Rules Rather than Discretion, the Inconsistency of Optimal Plans, which argued that policy promises made today may not be carried out in the future if there are advantages to reneging on those promises. Reneging on promises made by discretionary policymakers, they argued, is much easier than reneging on a policy rule, which is a way to commit to future actions.

 

Now, Kidlin and Prescott provided a simple and appealing model at the end of their paper. The model had an incentive for the central bank to renege on its promise to keep inflation low, since doing so would expand the economy and lower unemployment. But if rational agents knew of this incentive, they would not find the promise of low inflation credible and would therefore raise their expectations for future inflation.

 

The central bank would then have to validate those expectations with higher inflation to avoid a recession. So in the end, the economy ends up a high inflation equilibrium with no gains of higher output or lower unemployment. Now, Kiddle and Prescott then showed that if, on the other hand, the central bank could commit to following a rule to set policy, then it could not renege on its promises.

 

As a result, inflation would stay low while yielding the same outcomes for output and employment. In this case, rules do beat discretion, this was path breaking research and it came to influence both the theory and practice of central banking. It was also part of the basis for Kittlen and Prescott's Nobel Prize in economics in 2004.

 

But commitment to most things in life is easier said than done. Even rules can be abandoned if it is optimal to do so. In the absence of commitment, can the central bank do anything to enhance the credibility of its promise to keep inflation low? In 1983, Robert Barrow and David Gordon used the Kidlam Prescott example to study reputation building by the central bank.

 

The basic idea is to establish a reputation for fulfilling your promises. But what promises can be made in a discretionary world that the public would find credible? Now, what they showed is promising the low inflation outcome wasn't credible. However, the central bank could promise an inflation rate that was between the low and the high inflation equilibrium.

 

If private agents expected this intermediate inflation rate than the gains from reneging would be reduced just enough to dissuade the central bank from breaking its promise. Consequently, promises to deliver this intermediate inflation rate were credible and society was better off than they would be in the high inflation world.

 

Showing that credibility really mattered in a world in which commitment was not feasible. I now introduce John Taylor and his work into this story which coincided with the beginning of my own research career. In 1983, having read the Barrow and Gordon paper, I started working on reputation building strategies as part of my PhD dissertation research.

 

In the process, I was struck by the thought that the building of credibility and reputation hinges on the person setting monetary policy at the time. If that person leaves, does the central bank have to start all over to rebuild its credibility? At the time I had in mind Paul Volcker, whose personal credibility seemed so crucial in the Federal Reserve's campaign to vanquish high inflation.

 

Relying on the credibility of individual policymakers seemed like a weak foundation for sustaining the credibility of policy promises. That is when I went back and I read John Taylor's discussion of the Barrow and Gordon paper in the Journal of Monetary Economics. John applauded the analytical contribution that Barrow and Gordon as well as Killen and Prescott had made.

 

But he was skeptical about the practical applicability of their story. In his critique, John said the following. In other well recognized time inconsistency situations, society seems to have found ways to institute the optimal cooperative policy. As a 24 year old, as I read that sentence, I thought so how does society build credibility into the institution instead of relying on the credibility of an individual?

 

That one sentence that John wrote in 1983 Set me off on a 20 year journey studying Central bank design. So where did it lead me? Around that time Ken Rogoff published his paper on what he referred to as conservative central bankers. In his terminology, a conservative central banker was someone who disliked inflation more than the rest of society.

 

Rogoff showed that a conservative central banker would choose a lower rate of inflation than the average citizen would want, but at the cost of higher instability of output and employment. Nevertheless, this trade off improved social well-being, but there was one catch to this solution. There had to be safeguards to guarantee that the conservative central banker could not be fired for this policy decision ensuring that these promises to control inflation were in fact credible.

 

In short, the central bank had to be independent and protected from the threats to its independence. This type of institutional design issue was one that I was interested in research. So up until Rogoff's work, the underlying assumption had been that the central bank was trying to maximize social welfare and that its preferences were aligned with those of society.

 

Think of it as just a standard representative agent economy. But as I read Rogoff's work, it suggested that society consisted of people who had a variety of views about inflation, meaning they would also have different views on the trade off between inflation and output stability. Consequently, members of society may have different views on how conservative the central banker should be.

 

But where are these views coming from? Where are these preferences coming from? So I tried to endogenize the heterogeneity and preferences. I had the idea that all individuals had the same fundamental preferences for inflation and output stability. But they varied if they worked in different sectors of the economy.

 

In one sector, wages and employment were determined in a standard competitive fashion. In the other sector, wages were determined by wage contracts and employment was demand determined. Thus, when a negative shot hit the economy, the wage contract workers suffered a bigger reduction in employment because wages couldn't adjust.

 

Whereas in the competitive sector wages would adjust to soften the blow of unemployment. Implying that if the wage contract sector got to choose the conservative central banker, they would want a more dovish central banker who would accept slightly higher inflation in return for greater employment stability. The flexible wage workers wanted the opposite.

 

They were more hawkish on inflation because they didn't bear the same employment volatility. So the punchline was that if political parties formed around these workers in different sectors, then they would choose and install central bankers with different policy preferences if they won the election. Now, it was around that time that I read Alberto Alesina's paper on partisan business cycles.

 

In that paper he assumed there were different political parties, each having different preferences about inflation and employment. One party was more concerned with price stability and less concerned with output stability. Just like my other work, monetary policy and inflation outcomes were determined by the party that won the national election.

 

As power changed hands after an election, monetary policy would differ from expected policy depending on who won the election. These election surprises would create volatility in monetary policy and thus inflation and output. In other words, elections would lead to, in Alicena's words, partisan business cycles. Now, in Alicena's model, monetary policy was fully accountable to the electorate, which is desirable.

 

But it came at the cost of greater economic instability. Now this was a brilliant paper, but again it raised a serious question for me. Why would society choose full electoral accountability and maximum volatility in monetary policy? Economists usually think there are trade offs on the margin such that corner solutions like that aren't optimal.

 

It seemed to me that there could be a welfare improving institutional design for the central bank. And I looked at the Federal Reserve Board of Governors structure and I felt that electoral accountability could be achieved through the appointment process, but economic instability could be reduced by having a central a monetary policy board composed of current and past appointees who set policy according to a majority rule.

 

This thinking led me to taking a variant of Alicena's model and studying how a policy board could change his results. I assume the board members were appointed by the winning party of an election to serve for multiple periods. This appointment process provided accountability to the electorate via the nomination confirmation process to ensure that economic stability would be improved.

 

I assumed that these members served staggered and long relative to the election cycle terms in office. Furthermore, as in Rogoff's model, board members could not be removed from office. This feature of the model captured the idea that the central bank board would be independent. Now, my research showed that having an independent policy board set monetary policy, social well being was improved relative to alicena's results.

 

Accountability to the electorate could be achieved through the nomination confirmation process, and economic stability was enhanced by having a group of individuals set policy who could not be removed from office. This structure is the one that we have in place today at the Federal Reserve. I would argue it has stood the test of time and I hope that it continues to be in place for years to come.

 

So to conclude, I have come full circle in my professional life from first reading that sentence that John wrote in 1983 to researching Central bank independence and central bank boards for 20 years. And then becoming a central bank board member, which led me here today so that I can finally thank John for sending me on a wonderful journey that he had no idea he launched me on.

 

Thank you.

>> Loretta Mester: So I never had the opportunity to take a course with John Taylor, but I've learned so much by reading your papers and hearing you discuss other people's papers that I really feel like I'm one of your students. So I wanna thank you for all of those contributions and I'm really honored to be able to participate in today's conference.

 

So every macro model incorporates some type of Taylor rule relating the central bank's policy rate to a set of economic conditions. And the Taylor principle, which holds that the nominal policy rate should be increased more than one for one in response to a sustained rise and inflation, is now accepted as appropriate monetary policy.

 

Now, the economics profession has not determined that there's a single policy rule that's optimal across a variety of economic models and in a variety of economic circumstances. Different rules can imply different paths to the monetary policy interest rate. And I wouldn't wanna argue that a central bank should set policy simply by following the prescriptions from a single rule.

 

And we heard yesterday that really that's a strawman that people have put up. I think a more general, significant idea that I take from John Taylor's body at work is that a consistent, systematic approach to setting monetary policy can make the policy more effective at achieving its economic goals.

 

So while judgment must be brought to bear in policymaking, I believe it should be disciplined judgment informed by rules informed by models rather than discretionary opinion that's not necessarily consistent with the underlying structure of the economy. Now, policy rules are useful in internal policy deliberations as a way to discipline judgment.

 

And rules can also help policymakers explain their Decisions to the public and, you know, doing a better job of explaining and conveying the policy reaction function improves transparency, accountability and credibility, all of which support monetary policy independence. And now, of course, we have limited time today, so I'm going to focus my remarks on first internal deliberations and then on external communications.

 

So policy rules are used at the Fed both internally and externally. The Board of Governors Semiannual Monetary Policy Report began incorporating prescriptions from a set of monetary policy rules in July 2017. And except for the June 2020 and February 2022 reports, rules have appeared in every report since then.

 

The Board SAS Baseline Forecast and TEALBOOK Part A, which helps to coordinate FOMC policy deliberations, incorporates a policy rule. And in the tealbook there's a section on monetary policy strategies that show policy prescriptions from several rules. Of course, various policymakers have used rules to help explain their own policy views.

 

Some of them are in this room. Yet I think rules could be used more consistently in materials provided to the FOMC prior to meetings to help guide the internal deliberations. So when I was a policymaker at the Federal Reserve bank of Cleveland, I found that looking at the prescriptions from a set of simple, robust policy rules across different economic forecasts really helped me formulate my own policy views.

 

And actually in 2016, we started publishing the current readings from a set of policy rules and also a tool that allows any researcher or market economist or any interested party to customize the rules to generate alternative policy paths depending on what your forecast own forecast is. So intuition can actually lead you astray.

 

The economy really encompasses a vast array of interactions and general equilibrium dynamics between various actors and sectors. And I find that economic models and policy rules discipline one's thinking about the relationship between incoming data, forecasts, risk and policy decisions. I can't keep a general equilibrium model in my head.

 

And you need to have the models written down that actually help you think through things. They really help to ensure that judgment which has to be brought to bear in Policymaker is consistent with how the economy actually works. And when the Fed's policy stance was different from what the rule suggested, I really had to carefully consider where, you know, whether there were factors or alternative model assumptions that could support that deviation.

 

And see, that was very helpful to me as I was thinking about policy. In addition, seeing the variation in prescriptions from different rules also helped me assess what the salient risks were to the outlook. So I didn't find the fact that there wasn't a single rule that everyone accepted as being necessarily a negative, it actually helped us actually have other rules that work robustly.

 

I did use simple policy rules to help me construct my submission to the Summary of Economic Projections, and I also found the rules helpful in understanding the SEP results across participants. So if you look at the September 2018 transcript, which is now public, I discussed the type of policy rule that could fit the SEP projections and compared that rule to the policy rule in the staff's Teal Book forecast.

 

And it turned out that the derived FOMC participants rule was a little less inertial than the tealbook baseline rule. But the main difference was that the SEP rule put little weight on the unemployment gap and a high weight on the inflation gap. And given that the Teal book's baseline rule was a very good description of the past behavior of the FOMC.

 

I found this to be a cautionary tale, it meant that the committee was planning to react differently to incoming data than it had in the past, and in particular it was reacting much less to the tightness in the labor market, as summarized by the undershoot of employment from its estimate of the natural rate of employment or U star, than it had in the past.

 

Now, I believe that framing an internal policy discussion like this at the four SEP meetings would help participants have a better understanding of what their SEP submissions imply about the committee's reaction function. And I think the committee could go a step further and actually ask FOMC participants to submit two sets of rejections, one based on their current view of appropriate policy, as is currently done, and one based on a benchmark policy rule.

 

And in this exercise, I think it's less important about what the particular rule is chosen than the fact that it would force some consistency across the forecast. Committee participants will get a better sense of the assumptions each colleague was making about the underlying dynamic economic dynamics in construction their forecast.

 

In addition, if the prescriptions from a set of rules applied to different forecasts were given more emphasis in internal deliberations, I think it would help illuminate for participants the type of variation one could expect in the policy path if the economy were to evolve differently than the modal forecast.

 

I think we learned that putting too much weight on a particular forecast can lead to policy mistakes. And looking at various scenarios and the variation policy prescriptions across those scenarios helps to mitigate that risk. And if you look at the teal book, it includes alternative scenarios. I think it's particularly useful to analyze these alternatives when the level of uncertainty is high.

 

And there are several plausible scenarios that are nearly equally likely. Arguably, during the pandemic, the FOMC put too much weight on the scenario in which inflation driven by supply side shocks would prove to be transitory, rather than the alternative scenario in which demand side accommodation was also an important contributor to persistent high inflation.

 

Had FOMC meeting deliberations routinely included a discussion comparing proposed policy paths with prescriptions from rules, the discussion would have highlighted that policy was increasingly deviating from the Taylor principle. Now, of course, it's not clear that having that insight would have changed Fed policy decisions, but I also think we can't rule out that it might have resulted in the FOMC moving rates up sooner.

 

Policy tightening may have been able to be more gradual than it ended up having to be, which would have proved less risk, you know, pose less risk of financial instability of the kind we saw in March 2023. So let me now turn to external communications. As everyone probably in this room knows, the benefits of clear communication and systematic policymaking derive from the fact that households, businesses and investors make economic and financial decisions based on their expectations of the future, including the future path of monetary policy.

 

Now, when monetary policymakers set policy in a systematic way and clearly communicate this, their actions become more predictable. And that predictability enhances the transmission of monetary policy to longer term interest rates, lower policy uncertainty, reduces term premia and better aligns longer term interest rates to the expected path of short term rates.

 

The public gets a better sense of how monetary policy is likely to change as economic conditions evolve. And with such knowledge, households and firms can plan better. They can make better saving, borrowing, investment and employment decisions. In addition, when the public understands the usual strategy for setting policy, it's gonna understand the policymakers reasons for deviating from that approach in extreme circumstances such as the global financial crisis or the pandemic.

 

And those deviations are gonna be more successful because of that understanding. So really, instead of limiting options, being consistent and communicating the rationale for decisions can expand policy options. Of course, the communications challenge for monetary policymakers is to give the public a good sense of the usual reaction function, how policy is likely to respond conditional on how the economy evolves, without implying that policy is pre committed to a particular policy path, regardless of how the economy evolves.

 

And I don't think it would be that large a leap to start using the prescriptions from the policy rules published in the Fed's Monetary Policy Policy report as a reference point in policy communications. I think they provide a good illustration of conditionality and better link up the changes in economic conditions to changes in policy when actual policy differs from the prescriptions from the rules.

 

The policymakers could explain why, now, in an uncertain environment, more communication is better than less. But it often seems that in uncertain times, policymakers want to explain less because the uncertainty around the outlook and risk make them fear being locked in or being perceived as making promises they may not want to keep.

 

So at the Fed, the trend has been towards shorter communications. My first meeting as Cleveland Fed president was in June 2014 and I looked at the statement. There were 759 words in the FOMC statement. My last meeting on the FOMC as fed president was June 2024 and by then there were only 295 words in the statement.

 

So there's a nice research paper by McMahon and Naylor and they really indicate that shorter does not necessarily mean more easily understood by regular people. Other people like the media, some in this room, Fed commentators, they're gonna fill in the void in communications with their own interpretations. And while they're very good at what they do, sometimes that interpretation will differ from what policymakers intended.

 

So I actually think it's better for policymakers to take control of the narrative. And I think if policy communications routinely included a discussion of a consistent set of data that inform the outlook, the policymaker's outlook and risks around the outlook, some alternative ways the economy might evolve, and how the policymaker plans to balance the risk to the dual mandate goals.

 

At least in the Fed, the public would have a better sense of what data dependent means. And these kind of communications don't have to be technical. In fact, they're better if they're not. Instead, they would strive to convey complex ideas in an accessible manner without jargon. And the recent research by McMahon and Naylor suggests that can be done.

 

Finally, we live in a time of rising public skepticism about experts and declining public trust in institutions. Probably the number one way an institution can build trust is to be excellent at what it does, that is to reach the goals that it's been charged to achieve. And that means having a very well qualified staff making decisions informed by the best information and analysis available.

 

But regardless of how good the policymaking foundation is, we have to recognize that a high degree of uncertainty often clouds the outlook and increases the number of plausible scenarios that could play out, raising the risk that even the best formulated decisions don't produce the intended results. So a central bank needs to be constantly building its credibility with the public.

 

And I think it can do so by explaining its policy goals, taking a consistent approach to policy decisions rather than a discretionary one. Communicating in a transparent way so that the general public understands the rationale for its decisions, and holding itself accountable, taking ownership of any deficiencies and making improvements to its policy strategy.

 

In an uncertain world, economic conditions can evolve in an unexpected way. That requires a change in policy. And if the public understands the reason for the change, it's going to be less likely to interpret the change as evidence that the past policy stance was in error or that the institution is succumbing to outside influences.

 

Instead, the public would understand that if there is a material change in the economy, it's appropriate for monetary policy to evolve, too. So that's a really simple concept, but I do think it's worthwhile, worthwhile one to really explain to the public, because as much as we'd like it to be true, telling the public, trust me, is not good monetary policy communication.

 

Thank you.

>> Volkker Wieland: Thank you.

>> Charles Plosser: Good morning, everyone. It's really a pleasure to be with you. At the end of the day, I'm delighted to have the opportunity to participate in this conference and the celebration of John Taylor's contribution to economics. As we've heard off and on since yesterday, John's academic contributions run deep, and I can't say that I can add to that because so much has been covered.

 

They're even deeper than I may have thought they were just a few weeks ago. So we all owe a great deal of appreciation and respect for John and his thoughtfulness and his willingness to engage both in the theory and in the practice of making policy. And sometimes that's a hard gap to span.

 

So, like many of you, I wanna thank John for your contributions, your wisdom and your friendship. Thank you. So, in my brief remarks today, I'm gonna reflect on what might be described as some internal conflicts in the way monetary policy has been followed and also how it has contributed to confusion and perhaps less desirable outcomes than might have otherwise been achieved.

 

I also think you'll find that my comments and Chris's comments and Loretta's comments, there's some really common threads to what we're thinking about, but perhaps looking at them from a little different perspective. So I hope that will be useful. Now as we all know, since the work of Lucas Kidding and Prescott, and of course, John Taylor most of all, and many others, we have learned the benefits of carrying out policies based on a commitment to a specific goal and the systematic and predictable actions necessary to achieve them.

 

And those outcomes typically are preferable to policies under discretion. Now, to be sure, these issues that we've been talking about, the central bank is aware of them, obviously, and understands these issues, but the credibility or the importance is understanding credibility and commitment. The Fed has worked hard to improve transparency and to signal commitments to various goals.

 

Notably, after almost two decades of discussion, the Fed finally adopted an explicit inflation target in 2012. Now, achievable goal is an important step, but it's only the first step. The important follow up as you've been hearing is making that commitment credible. This is the difficulty that we face, and it's not an easy one and it will never be perfect.

 

But without that credibility, the outcomes suggested by our models and theories may be unachievable and may even be counterproductive. Thus, I think that an important role for the central bankers and their associated governments is to promote ways to make monetary policymakers more credible. Now, there are various ways of approaching that.

 

One is to enhance credibility and monetary policy commitments by delivering by central bank delivering price stability over long periods of time that spans episodes of turmoil, changes in administrations and various shocks. Obviously, the Bundesbach, the Swiss national bank are the classic examples of central banks that earn credibility through such a reputational gaining process.

 

Such reputation building takes time, takes a little luck and perseverance. But it also can be fragile. And policymakers can easily damage their own reputations or their institution's reputation through discretionary actions of various kinds or failures of various kinds. I think the inflation spikes in 21, 22 was a step back for the Fed's reputational building efforts.

 

Other ways to increase credibility can come from institutional factors that constrain or limit the discretionary capabilities of the monetary authorities. Now, such limitations are also important for securing central bank independence. The independence of the monetary authority is incredibly important, but it simply cannot be sustained in a democracy without clearly achievable goals and constraints on its powers and authorities.

 

There must be limitations. Such institutional constraints can make the monetary authority less discretionary as well and more accountable. For example, narrow and achievable mandates can help focus monetary policy and reduce the temptations to venture into other more politically sensitive areas. I've argued for some time now that missing truth and the expanding expectations for monetary policy can drag the Fed in the highly political arenas that undermine its independence and weaken its ability to deliver on its price stability mandate.

 

In addition, other types of things that can help this is restricting the Fed to holding an oil Treasury's portfolio. That restricts the Fed from and limits the Fed's ability to engage in credit policies and allocation to the purchase and sale of private sector securities. Interestingly enough, the Fed Treasury Accord of 1951 was an intent to relieve the pressure on the Fed to expand or contract its balance sheet to accommodate the Treasury's debt management objectives.

 

That was successful and a huge step towards Fed independence at the time. Unfortunately, at least my view that the Fed's new AMPA reserve regime and interest on reserve combined to make an end run around that protection that was built into the 51 Accords.

>> Charles Plosser: It did that by allowing the Fed to expand or contract its balance sheet.

 

 

>> Charles Plosser: Its balance sheet without altering its interest rate policy. What this does from an institutional standpoint is opens the door for fiscal pressures to manipulate the size and composition of the Fed's balance sheet for political objectives. This breakdown in the barriers between monetary and fiscal policy drags the Fed ever more deeply into political issues.

 

And thus a threat to its independence as the Congress or an administration seeks to use the balance sheet for its own political aims. As important as independence is the source of constraints I'm suggesting here will also contribute to the Fed's credibility. And commitment to its stated goals by reducing the range of discretion available to it.

 

Another way to increase the credibility of the central bank is the adoption of a rules like system that we might describe as a Taylor rule of some kind. And it describes how policy will react to specific economic events. Now such systematic rules are generally thought of, as I said, Taylor type rules and are best described as reaction functions that describe settings based on the actual or forecasted values of the data.

 

Now, adoption of such reaction functions help strengthen the commitment and transparency of policy and provides a forum in its own right of forward guidance. Now, FOMC transcripts clearly demonstrate that that many members, if not most or all, understand the importance of credibility and commitment in what they do.

 

But in another sense the Fed and many other central banks still take a very what I would describe as a highly discretionary approach to policy. Policy is often described as being data dependent, a phrase that I like very much and used myself, but without describing how the data affects policy, that is saying more about the reaction function.

 

Such statement as a standalone statement is pretty vacuous, it really doesn't say anything about what the Fed will do. It's just said that it's going to do something, whatever it feels like doing, and so in a sense it's a little misleading to think that is a commitment to anything.

 

And so, I feel like that's more of a sense of discretion really than it is of commitment. From my perspective in my time at the Fed, I think it's noteworthy that despite the policy discussions. Information that's in the tier book sometimes or in the monetary policy report, I'll come back to that in a minute.

 

That despite those discussions, it's hard to find any reference to rules or systematic policy that might bolster credibility in the actual policy statements issued after each meeting. And those statements, I don't think I've ever seen the word rule or systematic or how a rule might influence or did influence that policy decision.

 

Nor do you find such a reference in the quarterly summary of economic projections. It would be wonderful, I think Chris alluded to this and others have as well, that that's an opportunity, I think, for the Fed to integrate its perspective on rules to racially enter the SCP. Now, there is this usual reference for some time in the semiannual monetary policy report on the implications of some basic rule like guideposts.

 

But from my perspective and others may differ. I've always felt that that discussion was more of an afterthought than it was an integral discussion, an integral part of the policy making process. And of course I say that in a generality, but for individuals that may not be true, so I don't want to overplay that.

 

As I mentioned, the Fed seems to acknowledge the benefits of commitment and credible policies conducted in systematic matter. The challenge the Fed confronts is that it retains the desire to be discretionary. And when the Fed says on one page it's committed to doing X and the next time they say, well, if the data change or if the world changes.

 

We'll change our policy, they're actually undoing, in my view, the commitment they were just trying to make and so I think that tension between those two approaches is very difficult. And I think the way to think about it is to think that, particularly in the case of forward guidance that the Fed used to talk about back in the 90s.

 

And Greenspan and other times they talked about forward guidance in terms of sort of the balance of risks. And that wasn't a commitment to anything, but it was sort of telling you a little bit about how the Fed evaluated the risk. And as we all know, during the great financial crisis, the policy rate approaches lower bound.

 

The Fed took the view that forward guidance could be used as a distinct and independent policy to shape expectations. The idea, of course, was that by promising to keep rates lower for longer than otherwise would occur, whatever that was, monetary policy could potentially provide a form of stimulus.

 

This approach clearly depended on the credibility and commitment of the Fed's promise and the understanding of the public's as to what the actual policy entails. Now, this strategy, however, is undermined and can prove counterproductive if the Fed's promise is not credible or well understood. Indeed, the Fed's announcement in August 2011, it kind of, and my review of history, you might say in the radish.

 

And that August meeting of 2011 was widely interpreted by some or widely interpreted by many people. Is that what was this commitment? They were confused, did the keeping rates low for two years was not a signal that the economy was going to be better? It wasn't interpreted positively by a lot of people.

 

In fact, the interpretation of many people was that the economy would be in dire straits for the next two years. That had the opposite effect. That would have the opposite effect of what the Fed was intending. So the credibility and commitment of its statements really hang such promises by a thread, and it's very hard.

 

And just one more paragraph, the strategy that many of us talked about yesterday in terms of the Taylor Rule and Loretta was talking about, and I have talked about it, about making a Taylor Rule or a rule as a prime guidepost where there's the ability to deviate or to be discretionary under certain circumstances.

 

I think that's probably the most viable approach. But here, too, you have to be careful. You have to be careful about assigning under what conditions can the Fed deviate and why. If it becomes common practice for the Fed to choose, let's say, a different approach than the rule says, then what happens?

 

Then you have discretion, and then the Fed has to wonder, all right, when I am following the rule or I do want to do something that's credible, how does the public know they won't? I'm calling a card, it's discretion. We're gonna change, we're not gonna do that. That practice actually undermines the credibility they're trying to build.

 

So, Andy, modern monetary theory tells us that effective policy is enhanced in important ways by the credibility and commitment of policymakers to behave in a transparent and systematic manner. There are a number of ways for the Fed or any central bank to enhance its credibility, including institutional arrangements that imposed limits or constraints on objectives and ranges of discretionary powers, the adoption of operating regimes that incorporate more disciplined and systematic decisions.

 

The Fed has come a long way in some dimensions on the road towards transparency and credibility. But there's still opportunity for improvement and reducing its reliance on discretion can only enhance their position. The lesson might be for the Fed to spend less time and effort seeking or justifying the expansion of their powers and the range of options for intervening in the economy, and more time arguing for limitations on themselves that might support independence and strengthen their ability to make credible commitments.

 

Thank you.

>> Volkker Wieland: Thank you, Charles. So we're right up to our last speaker, Kevin Warsh.

>> Kevin Warsh: Thank you very much. It's an honor to be here. It's an honor to share this panel with public servants, past and present. Strong, committed, dutiful servants, as was the practice many years ago.

 

I used to follow cleanup after Charlie and Loretta, and they would go on and on. So I have to say this very briefly. They would come to the these meetings very well prepared, with their speeches and I would come with a bit of a note card. So we're keeping that tradition on.

 

And it's also an honor to be here moderated, if not by a public servant, someone whose parents named him after a great one. So thank you, Volkker. Let me do a few things just to borrow on what my colleague said. First, I'll do a little bit of trip down memory lane, like Chris did, in honor to John Taylor.

 

I'll then give three learnings from the Taylor Rule that I think has some broad applicability. Then I'll talk for a moment about what's missing from the Taylor Rule, understandably, because the innovations, for better and worse, about policy sense. First, I was first exposed to the Taylor Rule on this ground, if not in this building, more than 30 years ago.

 

And John's leadership really makes us all his intellectual heirs. I see other professors of mine like John Kogan here. So this brings me back to when I was about 19 years old. I looked at the Taylor Rule last night on the way out, and I did have a bit of a trip down memory lane.

 

And when I looked at it with sort of fresh eyes, it had a simplicity, an elegance, almost a clinical quality to it that is in stark contrast to some of the volume of commentary we get from the modern central bank. And that's certainly attractive. When I remember seeing it for the first time 30 years ago, it was a period closer to the great moderation.

 

It was understandable that we would say we can reduce our knowledge to this rule. And it was wonderful to have a simple and robust rule at the time 30 years ago, too. I think the tradition in which John envisioned this came from a period around this institution when Milton was still with us, that they grew.

 

And as a result, I grew somewhat skeptical of big black box models, of complicated multivariate regressions. And so simplicity had a huge appeal. I remember debating or listening to the debate, I was a child, about whether the rule was descriptive of what policymakers do do or whether it should be normative, what policymakers should do.

 

You also remember some 30 years ago, fights that were had on these grounds about what are the right coefficients, what's the shape of the Phillips curve, how flat is it, or should we discard it altogether? So for me, this was a formative time to be here with the great minds in the profession like John and so many others.

 

Second, what are the legacy and learnings that John imparted through the rule that I think broadly has some application to the conduct a policy. But like Chris Waller, I will avoid the current policy conjuncture as best I can. One is we've learned, I think quite assuredly in the last generation or so that there is no cruel choice that the two objectives embedded in John's rule of low inflation and unemployment are not at war with each other.

 

They aren't enemies, they're friends. And so the idea that we can push one up to move the other hopefully has been beaten out of the current practice of policy. Current policymakers can judge that better than I Second, I think we should understand that the rule is aspirational. The rule is we in economics profession want to reduce our knowledge of the economy to a rule.

 

And so John's rule is important cuz that's who we wanna be. Many of us came to economics because we were studying physics or math and we decided it was a little too hard, so we ended up in economics. And so while the rule is powerful, I think even John would acknowledge it's not equals MC squared.

 

The difficulty about economics, unlike physics, is our atoms keep learning and they change their minds in the world. The economy acts fundamentally differently today than it did even a decade before. But the aspiration is an important one, tends to be in economics that most of the results we come up with we have to recognize that they're somewhat over determined.

 

We have to resist this idea of scientism. We have an exaggerated sense of how everything works in the economy and so we can reduce things perfectly to a rule. But John's aspiration is the right one and it's the subject of inquiry that his successors need to say, how can we make the rule, any rule, even better?

 

So it strikes me that it's important to aspire to it. And like my other panelists said, the economy cannot thrive consistent with its full objectives, with a fully discretionary central bank and central bankers acting as overlords. What monetary policy is, if not a pure science, yet is it's a craft.

 

That doesn't mean it's arts and crafts, it's a craft. We need to take the science seriously and ask about what we can do to pursue it more. We central bankers, especially people that are in the arena like Chris, must understand that central bankers are thinkers. They're not profits, that's a second learning.

 

What's a third and final learning? And this one, I think is easily forgotten, inflation is a choice. The world's central bankers get to choose the inflation rate. When you look at John's Rule, there's no victimhood in the rule. The central bank gets to establish the policy rate and drive an inflation objective.

 

Central banks in his rule are not victims. There's no anguish of central banking. Those days are behind us. Inflation isn't caused by pandemics and autocrats around the world. The inflation level is set by the world central bankers. And without going too far afield, in my view, it's principally set by spending and printing.

 

I think the other thing I must say I acknowledged when I looked at the rule last night on the flight out here is what's absent from John's Rule. Understandably so. There's no balance sheet in John's Rule. There's no mention of quantitative easing. Of course, we created that some years after the rule found its way into our textbooks.

 

And in some broad sense, I think we should acknowledge now what we acknowledge at its creation. The Federal Reserve created a second monetary policy instrument, a second instrument that has an effect on inflation. If the central bank were to quiet its printing press, then we could go back to John's Rule and we could say, what does the rule tell us?

 

But with a very active, large and often growing balance sheet, we have two policy instruments, imperfect substitutes for each other, working sometimes at cross purposes, sometimes working together. But if the printing press could be quieted, we could have lower policy rates because a $7 trillion balance sheet is having an effect on these inflation objectives.

 

There are many benefits of a small balance sheet, including lower rates. But better economic outcomes is probably the most important among them. What's the second and final thing that's I won't say, missing from the rule? But is implicit in the rule. And I think every one of my colleagues on the panel referenced it.

 

I call it trust. Chris called it from the literature, reputation building. Loretta called it credibility, so did Charlie. The rule works if the central bank is credible. The rule works if the central bank has demonstrated its ability to achieve its outcomes. To the extent the central bank has made errors in the conduct of policy, the rule doesn't really work because then they have to compensate.

 

I know it would be nice if we could say bygones are bygones, but households and businesses don't believe that past errors have an effect on deadweight losses the economy and can restrict what a modern central bank has to do. The pre-condition for stable prices is confidence by households and businesses that central banks will deliver stable prices.

 

And the best way to give them that confidence is to have achieved it. It is up to the central bank to ensure that whatever shocks happen outside are one off effects. Because as I mentioned before, the inflation rate, not the change in price level, but the second and third order consequence, that's up to the world's central banks.

 

If central banks assert that outside changes in the price level affect inflation, drive a set of inflation outcomes, then they're in some ways admitting something against their own interest. They're saying in some sense that their credibility has been impaired. They're saying that inflation will happen because they don't have the credibility or trust to stop it.

 

This is why the implicit term, but I would say the most important term in John's rule is credibility. When John wrote that down, the central bank was somewhere near the height of its credibility. In order to achieve that credibility, again, the rule can be more operational, more effective and in so doing, the central bank can respond to shocks of all sorts.

 

Bygones aren't bygones, but they should be lessons learned. And as we turn to questions and answers, this is as an appropriate moment as I can think of, both to thank John for his contributions, but at least as much call on what John had always called on us 30 years ago to say.

 

This is a time of inquiry, this is a time of choosing and hopefully that's what we'll accomplish over the course of this day. Thank you.

>> Volkker Wieland: So thank you, Kevin, for being so disciplined with regard to the time also and linking back to the previous speaker in your remarks.

 

And so, we take a round of questions, we collect questions, right? So I see Harold Ulugh right there. I see two questions there. Maybe you can bring the microphone, okay? I was first looking there and then I see Bob Barrow and one person behind and state your name.

 

 

>> Harold Ulugh: Yeah. So Harold Ulugh, University of Chicago. So, I heard Kevin say that large quantity of reserves, the regime of ample reserves that we have right now, I mean, you don't like it. I mean, you advocate for much lower reserves because you said something to the extent that the reserves that we have out there are inflationary, that economic outcomes would be better with much lower reserves.

 

And I just wondered about the mechanism that you're thinking of. I mean, if you think back of the zero lower bound phase where the central bank had a lot of reserves on my balance sheet, I guess they would have wished for a little bit more inflation. It didn't come, there's also the perspective that having ample reserves is getting us closer to the Friedman rule where banks need reserves, but they're getting interest on reserves.

 

So why shouldn't the central bank issue reserves if interest is paid on that? This is an ongoing debate and I rarely hear somebody speaking up for having much lower reserves. So I'm wondering whether you could explain the position.

>> Volkker Wieland: Another question here, Bob Barrow.

>> Robert Barrow: Yeah, I wanted to react to some of Chris's remarks.

 

I think a principal contribution of my papers with David Gordon was really to explain to the profession what was in the brilliantly innovative Kidland and Prescott paper. We worked out a simple example with the cost of inflation and unemployment. And it was completely transparent in that model why there was a benefit from commitment and credibility.

 

And I think until we did that, people basically didn't understand what was in Kidland and Prescott, and that in fact included us. And having worked that out, I think that made the Kidland and Prescott paper much more important. And of course, since that time, as is justified by its innovative nature, that has become a major paper in economics.

 

 

>> Volkker Wieland: If you can just pass the mic behind you.

>> Christopher Waller: Thank you, Jason Furman. This is more for Loretta, but anyone is welcome. The FOMC statements have gotten shorter, but there' research that suggests that volatility around the press conference, including reversals from the way the market moved on, the statement to the press conference has gone up.

 

Is that a problem? And if so, does maybe the statement need to go back to being longer, the press conference shorter or some other solution?

>> Volkker Wieland: And then I had a question back there by Bob King and maybe this is gonna be right. You can bring him over there.

 

And one last question, I think, sorry, Pablo, and I think we have to wrap it up there and maybe you can also keep your hand up so they can bring you the mic already and we don't lose time there.

>> John Williams: So part of the remarks that I didn't deliver yesterday about John's research program is that he's been fascinated with issues of transition, beginning with really his first major publication in the JPE on monetary policy during transition episodes.

 

A recent phenomenon for central banks around the world is the idea of these periodic policy reviews. And what I think is that the periodic policy review process kind of sets up a environment in which we're going to have to think about transitions every five years and that people in the society are going to have to think about transitions every five years.

 

And I think that that has some bearing for monetary policy choice.

>> Volkker Wieland: So, Pablo brief us.

>> Pablo: BWS Management, so we've been talking a lot about monetary policy rules, also the word, but it's in bold in the world. It's uncertainty in this period of very high uncertainty, should we put more or less weight on these monetary policy rules?

 

And given this, what are the policy implications for the next few quarters? Thank you.

>> Volkker Wieland: In terms of the replies, maybe let me start with Kevin and Chris, who've been more disciplined with their time, and then Loretta and Charles. But we have to all four keep it very short.

 

 

>> Kevin Warsh: Thank you very much Volkker, let me respond to the question over here on the size of the Fed balance sheet and QE and reserves. Try to do that briefly so I get a gold star at the end of this. First, the surge in the size of the balance sheet is understandable in periods of great shocks.

 

The Fed was created after a panic early in the 20th century to respond to Those. So nothing I should say should be taken as any criticism of what happens in 2008, what happens in the darkest days of 2020. You have to give the benefit of the doubt, I think, to central bankers in harm's way like that.

 

Point one, point two. I think it's strange to say in periods of 2008 and 2020 that the balance sheet expansion is monetary policy by other means. And not to have any rhetorical or real symmetry on the other end, it can't be monetary policy when the central bank balance sheet is getting bigger, but it's just about bank regulation and reserves in any other circumstance.

 

That kind of asymmetry goes against the very spirit of John Taylor's rules that say maybe you really move to a full policy of discretion. And then finally, I'll just say this. When I joined the Central bank in 2006, we had about an $800 billion balance sheet. If you were to try to scale that to the growth of the economy, the growth of some other things, you'd end up with a 2 and a half or $3 trillion balance.

 

She my guest today as we sit here, the balance sheet's about 7 trillion. The right question was raised over here about transitions. The transition from a more scarce reserve system where the banks were relying on each other most nights, the central bank would just come in periods of extreme illiquidity.

 

That period morphed then into this excess reserves regime. Going back or adopting a third model will take time. It is not something that could or should be done overnight. But I'll only say this. The banks will get used to the liquidity regime around it. And if the central bank has a permanently larger role, not just in crises but in normal times, and are in some sense providing liquidity to the banks, not only all seasons and all reasons, but many nights you fundamentally change the role and responsibility of the central bank.

 

And the transition to what I think is a more prudent system will take time, deliberation and excess of communication with the public and the banking system.

>> Volkker Wieland: Chris.

>> Christopher Waller: I'm gonna just make a point that there's the ample reserves and QE kind of get mixed together. Ample reserves is about finding the right level of reserves and trying to keep it there.

 

QE is about changing the growth rate. So, let me just take a simple rule, a money growth rule. Save money growth is 3% a year. Okay, great, what's the initial money stock? What's the size of the initial money stock? We don't say anything. So that's kind of the difference between thinking about the growth rate and the level.

 

You wanna think about getting the level of reserves, right? And that's about making sure there's sufficient liquidity in the system. From there, making it go up or down for policy is a separate statement. And we can argue about whether we should or shouldn't do that. But getting an ample reserves so that we don't have to have banks scrambling around every night trying to find reserves, or the New York Fed stepping in every day and manipulating how much is in there.

 

That's just as inefficient and wasteful as far as I'm concerned. I just wanna respond to Robert. Your paper's the one that got me started on this whole stuff. And it was, I remember going back when you read the Kiddle into Prescott, it's impenetrable. And in fact, what Finn told me was that when they submitted it, the referees were like, we don't understand this.

 

Can you give us an example of what you're talking about? And that was the example at the end of the paper. So what you did brought a very brilliant insight and made it accessible to the public. And I'm one of those people. So, thank you.

>> Volkker Wieland: Loretta.

>> Loretta Mester: So Jason, my own personal belief is that the statement suffers kind of a Hotel California problem because it's so short.

 

Each word in the statement gets a lot of attention and if there's a change in the word, it gets even more attention. And I think that isn't really healthy. The statement is a communication about the committee's views. The press conference is the chair's views. Now, Jay does a very good job of trying to represent the committee discussion, but you can imagine that another chair might not do that.

 

And so I think it is important for the actual statement to actually say more about what the outlook is, what the risks around the outlook. I think that would be more productive and I've argued that for a long time and we'll see. But I personally would find it better if the statement, which is the communication from the committee, was a little more transparent.

 

 

>> Volkker Wieland: And Charles.

>> Charles Plosser: I'll be brief. I think that I'm gonna go back to the question about the balance sheet. My concern about the balance sheet is partly about monetary policy, partly about the fact that the Fed has never been able to articulate an integrated approach to how QE and the growth assuring of its balance sheet relates to monetary policy.

 

But my problem is really more of a political economy problem is that the Amber Reserve regime exposes the Fed to abuse of its balance sheet by the fiscal authorities. I would prefer an operating regime. I would prefer going back to a Cardiff system for example, but I would prefer an operating regime where the balance sheet is limited or constrained in some way in its use and not a frict parameter to be used for all sorts of other purposes.

 

Loretta gave me an example. Just was it last fall, she mentioned there was some movement in some circles for the Fed to establish an emergency hurricane fund and act as FEMA's funding source and use the Fed's balance sheet to do that. Just terrible idea cuz you invite the political process into determining the size and composition of the balance sheet.

 

That in my view is the real danger and that's what I worry about.

>> Volkker Wieland: Thank you. So without further delay we're moving right on to the next panel and a round of applause for the great contributions.

>> Arvind Krishnamurthy: The topic of this panel is digital assets, payment systems and financial regulation. And in the context of this conference, I think this very much fits into the new challenges portion of this conference. We've gone through a world in the last decade of quite a lot of flux around these topics.

 

The landscape around financial technology and particularly technology around money and payments and settlements have changed quite a lot over the last 10 years and I think has accelerated over the last few years. The landscape around financial remediation with the movement of activities outside the banking sector has also been and something that's very marked over the last decade, something that we will hear about in this panel and then another topic, and maybe it's a very particularly new challenge which I would love to hear the panelists talk about is, you know, since post war we've lived in a world in which the dollars and the safety of Treasuries has undergirded the US dollar as the reserve currency of the world.

 

And I think in the last month there have been cracks in that. It would be another particularly new challenge that it would be nice to hear something about. So with that I'm going to stop and turn it over to the panelists. We have four panelists, Darrell Duffie, Luis Garcano, Charles Calomiris and Lawrence (Larry) Summers.

 

Each of you has 12 minutes. I will be strict with time. Darrell, the floor is yours.

>> Darrell Duffie: Thanks very much, Arvind. Before we start, I want to add to the respect for John Taylor. I've known John for decades as a close colleague. Something that he and I worked on together, that he led, which hasn't been emphasized, is his work on making it possible for large financial institutions to fail without bringing down the financial system.

 

And his leadership on that project, which was called Chapter 14, I believe had a big influence on the sections of the Dodd Frank act that we have today. So thank you John and thank you for the opportunity to work with you. Well, our charge in this panel includes new forms of digital assets and payment systems.

 

So I want to talk about some big changes that are coming into the core of the financial system and the way that money moves through the system. And to do that I want to set the stage for you all. Back in history. June 26, 1974. Let's see who can remember what happened that day.

 

A medium sized bank in Cologne, Germany named Bank Herstadt failed. Von Kirstadt had been doing massive speculation in the foreign exchange market. And when it failed, it had received very large settlement payments on foreign exchange transactions. But it had yet to pay its counterparties that day for example, banks in London and in New York were settling FX trades with bank Hershtad to the extent of hundreds of millions of dollars.

 

Chase Manhattan alone did not get $620 million of payments that day, which in those days was a lot of money. What happened? Well, as a consequence there was a massive disruption in the foreign exchange market. Medium and smaller banks were pretty much shut out of the market. Only large banks were able to conduct transactions.

 

Even Eurodollar interest rates were disrupted. And in that year, spurred by Peter Cook of the bank of England, this Herrstadt event caused the formation of the Basel Commission on Bank Supervision, famous now for Basel I, Basel II and Most recently Basel III. The famous 8% ratio was at that point, some of you may remember, called the Koch ratio, named after Peter Cook who set that up.

 

In addition to establishing proper capital requirements for banks at the time, this triggered a multi decade construction of what is now called CLS bank, which is a way of mitigating this form of foreign exchange risk that can bring down the financial system or banks. And the idea of the CLS bank, which is the next gen way to do foreign exchange payments, is that you can think of CLS bank as a virtual island sitting in the middle of the Atlantic Ocean, so that when a bank in Germany wants to pay a bank in the US for foreign exchange, the German bank kind of flies the money over to this island in the middle of the Atlantic called CLS Bank.

 

And the money waits there until the flight from New York carrying the dollars lands in the middle of the Atlantic. And then there's a handshake at CLS bank in the middle and the dollars continue on their way over to Europe and the euros continue on their way over to the us so that neither will have made a payment at risk of not receiving the payment from the other.

 

Because there's this handshake called payment versus payment in the middle of the ocean that's virtual. CLS bank is a very complex, difficult to supervise and organize organization. It now handles about $5 trillion a day, but still only covers about 60% of the major currencies. And there's a lot of opportunities to go from that second generation approach to the new generation approach for doing large scale financial settlements based on tokenized payments.

 

So I'm going to illustrate how that works. In this chart you can see this payment. In this case it's $500 million in exchange for 460 million, sorry, 400 million euros. And the idea is that the US bank will cryptographically assign those dollars to the European bank conditional on the European bank cryptographically assigning the euros to the US bank so that neither is at risk of a failure of the other to deliver, because those cryptographic signatures are contingent on the other guy signing across the Atlantic.

 

This has already been tested by the Federal Reserve bank of New York in Project Cedar and in Project Jura by the Swiss national bank and the Banque de France. So this is now feasible. It's not being heavily used, but I predict it will. Let me show you in my last slide roughly how this happens.

 

So there's a ledger which can take instructions from any of the participating banks, and this ledger can be recorded, for example, on a blockchain. But it doesn't need to be. The US bank can send a message, an irrevocable message, onto this Ledger saying, these 500. Hundred million dollars belong to the European Bank.

 

If the European Bank sends analogous message saying these 400 million euros belong to the US bank. And now the ledger, which you can think of as a state system, Xt, which records all of the commitments and all of the balances of the participating banks, is able to process these payments.

 

One bank to the other without requiring that intermediary island in the middle of the Atlantic by the miracle of cryptography. And by virtue of this, you can cut out a lot of the expensive furniture that's difficult to govern and difficult to manage furniture in the middle of the system.

 

Let me now turn in the last few minutes to the case of US treasuries. Suppose the European bank is not selling Euros, it's selling US Treasuries to the New York bank. Well, it's the same process, and it might seem futuristic, but it's happening today. There are already billions of dollars of US Treasuries that have been put into tokenized form and exchanged between major counterparties.

 

It's being tested and used by major firms like bank of New York Mellon, using a system called Canton Networks. The market, while it's currently in the billions of Treasuries, is much, potentially much larger, an addressable market of, let's say, in the trillions. There's already $5 trillion a day of transfers of treasury securities that could be mobilized using this form of tokenized exchange.

 

And that, as you might note, we're in the middle of a big movement towards central counterparties. It need not require a central counterparty. So it's the next gen. How long it will take, we'll see, but it's already in motion. So let me complete this idea with some of the key challenges which I think will engage some of the central bankers here.

 

So first, there are going to be some legal issues. What is it exactly that perfects your property interest in the transfer of these Treasuries and cash? And those are being surmounted now internationally. In the United States, there's a movement to update the Uniform Commercial Code so that court precedents will lock down that you actually own the Treasuries when they're assigned to you on the blockchain.

 

It may seem obvious, but when there's billions of dollars of Treasuries involved, you want to be sure that you actually own them. That could be circumvented by legislation that's going through, perhaps through Congress on digital assets. Who's going to tokenize the Treasuries and who's going to tokenize the Cash.

 

We have some precedents in the treasury market. In the early 1980s, private sector firms decided that it would be nice to have zero coupon long term treasury securities. So what they did is they purchased normal coupon treasury securities, put them in a legal lockbox and then issued from that legal lockbox zero coupon securities.

 

And so the private sector could do this. They could tokenize the Treasuries on their own. And that's actually what's happening today. On the other hand, in 1985 the Treasury Department said, well wait a minute, these tokenized, pardon me, these stripped treasury securities are actually trading in the market, sometimes at prices that are richer than the ones that we're issuing.

 

We could do that. And the Treasury Department started to issue its own zero coupon treasury securities. I think the same thing could happen in this case. Once the superior liquidity and mobility of collateral of tokenized Treasuries from the private sector starts to become apparent and they have a convenience yield, the Treasury Department will eventually get around to issuing their own tokenized treasury securities.

 

What about the cash side of the transaction? Who's going to tokenize the cash dollars? Well, I don't think that hundreds of billions or trillions of dollars a day are going to go on a private sector stablecoin in a decentralized finance setting. I don't think if you're familiar with usdc, I don't think the biggest actors in the core of the financial system will be happy with that.

 

Will they use tokenized commercial bank deposits? Perhaps, but they're more likely because of the risks involved in the multi trillion dollar a day market. If they use commercial bank deposits to back those one for one with reserves. And now we could get into the same situation. If those reserves are backing commercial bank deposits, perhaps the central bank itself, the Fed or foreign central banks in their cases will issue their own tokenized forms of reserves.

 

Would that be a central bank digital currency? I would not use that term no more. It's no more a CBDC than currently. Reserves are a cbdc. Both are central bank issued digitally recorded cash money from the central bank. Instead of calling them CBDCs, I would call them just tokenized reserves.

 

It's just another ledger for holding the same instrument. President Trump recently banned CBDCs. There's no reason to think of that ban as applying to anything like tokenized reserves. There are still, however, other challenges. You'll notice in this diagram that the US bank had to put up the money before the transaction was completed.

 

In the legacy financial system that we're dealing with today, the US bank wouldn't need to actually commit the cash until the settlement. In this case, it needs to have the cash before it enters the trade and that's going to place an extra demand. Going back to the previous panel on the need for reserves, the definition of ample reserves may change if the private sector decides that it wants to have a lot of tokenized reserves for this purpose.

 

And that's true whether they're issued by the Fed directly or whether they're placed in a lock lockbox. Legacy reserves are placed in a lockbox and then private sector tokenized cash is issued out of that lockbox. So I think the Fed needs to be flexible in terms of what the definition of ample reserves is.

 

Structural changes in the economy may end up causing the Fed's balance sheet to get bigger simply because the way that finance is conducted changes. There are, however, some approaches that researchers are doing are working on today that would economize on the amount of reserves necessary to run this.

 

In summary, I think we should be looking ahead to a world in which tokenized Treasuries and tokenized central bank deposits are going to be a norm that will change the financial system. And I think that's going to work out rather well. It's going to be important to the United States, which currently has about $29 trillion of U.S. treasury securities in the world.

 

And sometimes we'll be struggling to find owners for those 29 trillion. That number is going to 52 trillion by 2000 and 35. According to the Congressional Budget Office. And that's even without considering the legislation that may be coming through Congress that would further increase U.S. deficits. The quantity of U.S. treasuries owned globally has gone down from 52% in 2009, I.e.

 

owned by foreign investors has gone down from 52 percent in 2009 to to around 35% today. And unless treasury securities can be mobilized rapidly and used as collateral 24, 7, 365 around the world, it's going to get harder and harder for foreign investors to find useful ways to use treasury securities not only to own them, but for collateral mobility and for financing.

 

So, Arvind, that's about what I wanted to say. Thank you very much.

>> Arvind Krishnamurthy: Thanks, Carol.

>> Arvind Krishnamurthy: Our next panelist is Luis Garicano.

>> Luis Garicano: Thanks. Thanks, Arvind, I join everybody on thanking John for his extraordinary inspiration. Also, for all those who do, who work on the two sides of the policy and academic divide, thank you.

 

So I'm going to give you a sense of how all this looks from a European perspective from the other side of the Atlantic and what Europe is trying to do about all of this and what is potentially scaring Europeans. So yesterday there was a statement by Scott Bessant today talking about the law that didn't pass and it was more or less to the same, same tenor as the statement by Donald Trump, the stable coins are going to unleash or the new utilization on stable coins should unleash a whole dominance of the US dollar for years to come, etc.

 

Etc. The essential landscape in US and the US and Europe looks very, very different. Essentially, the US is having this legislation on private digital money on stable coins which is going through the US And Congress, the genius and stable Act. As you know, yesterday, you may know yesterday, part of the legislation failed to pass.

 

Europe has passed legislation stable coins within the general markets in crypto assets. Assets legislation, which is a little part of that broad legislation concerns the stable coins on digital, on public digital money. The U.S has basically, as Daryl just told you, forbid the U.S. Trump administration has issued President Trump has issued an order forbidding it.

 

But Europe is actually moving ahead with the cbdc. The European Central bank pushed the project. The European Commission has picked it up, is making its way to Parliament. The truth of the matter is, it's still not clear at all that these legislation will be passing that will be making it the person, the legislature who was in charge was accused of being kind of in the arms captured by the German banking industry and was was removed so we'll see in the new legislatures who how, how they move how they move this.

 

The approaches are pretty different. Let me just talk about the private side. The approaches are pretty different. So the the main issue I want there are lots of things that that are that are different but let me just mention the the two or three that are that are most important.

 

The U.S. legislation has a potentially and as as I told you it's still all in progress a big hole for non US issuers of stable coins. In particular as you know tether is El Salvador based. The European legislation is very broad as you expect from Europe. It affects everybody who is issuing Euro denominated or any stable coin that circulates in the Euro area.

 

In terms of registration there is an authorization both are going to ask for for, for for a pre authorization for the issues of stablecoins. But the US is going to be more well potentially going to be more flexible to non bank issuers of stable coins. The interest payment is a crucial issue.

 

Mica doesn't allow stablecoin issues to pay interest in the US There's a lot of debate. There was some lobbying from the bank even just two days ago the the American Banking Institute just issued some communique asking legislators not to allow interest payments because that was going to put in at risk the banking system etc.

 

As you would expect banks banks, some banks smaller banks are concerned and consumer protection of course rules are are much much more taken much for much for further forward in in Europe. So it's a more, it's a more restrictive legislation. I didn't really need a chart to make this point but the chart really makes the point right?

 

This is, this is the US dollar. This is the US dollar share in stable coins and the and the rest, I actually you could actually think that the rest of the coins are actually included as well the non-US non Euro the they are so small that they wouldn't really show up in this graph.

 

So Europe is 0.25% of total issuance. So from the European perspective it looks like okay, this is going to happen. U.S. is going to move ahead. There's going to be these loopholes for all legislation, that's more or less how Europe is seeing this. Is this something that really is a risk?

 

Would Europeans really adopt the is it really a risk that US dollar stablecoins will actually become a common way of payment in Europe, well you could say. Well look because the market dominance because the US has a much larger size there's liquidity advantages Et cetera. You could say, well, their regulatory environment is going to be more flexible, more innovative, Europe is always going to be more rigid.

 

And there are network effects, evidently, like always with currencies. And we already seen some users of stablecoins, for example, if you want to get a Starlink satellite in Nigeria, you're going to pay on a USD US dollar denominated stablecoin, potentially. And there are some other B2B transactions that are already taking place, priori, you would think, as I say here, that taking currency risk for European holders of money and of any other assets and the hurdles of Mica would discourage this.

 

On the other hand, network effects are large. Europeans panicked when Libra was put on the table and they thought suddenly, like, okay, everybody who has a Facebook account is going to be able to make these payments without the European Central bank knowing. And kind of the risks that are seen, you can imagine them and, and you know them well, what is going to happen if all these coins are circulating and, and we don't, and we don't have control?

 

There's going to be a weekend control of monetary policy. The ECB worries. We, we, we lose control of what interest gets paid in our, in our own economy. There is financial stability risks. There are people who have currency mismatches. There is the erasion or potential erosion of monetized.

 

So what is the reaction? The, the European reaction is okay, so let's try this cbdc. Let's issue a central bank digital currency which, a digital euro which will allow for some of these advantages and will reduce or limit the risk of these stable coins. Kind of quote taking over if you want.

 

The ambition is obvious. We're going to have this, this digital euro which is going to provide a public a safe, efficient digital payment method. There's going to be a central ledger. So it's not quite the crypto dream. There is a central ledger that is controlled by the ECB but it's going to kind of give certain privacy at least to certain level of transactions and is going to reduce the risk of these other coins.

 

The reality however is that the way the CBDC is being actually legislated and as I told you here, like with a U.S stable, ingenious, everything is in flux. So by the way, the reality of how it's been legislated is either because of financial stability concerns which are, okay, bank sphere or bank deposits flow to.

 

If you can hold an account in the Federal Reserve, if you can hold an account in ecb, why would you hold an account in a bank? So banks are concerned, they do lobbying, so whether you think it's stability, legitimate stability concerns or more like monopoly profit protection from the banks, the truth is the way to get this project forward for the moment has been to handicap it.

 

It's very interesting when I was involved in legislation, when I was in Parliament, in the European Parliament, all the times. Panetta, who was the board member who came to tell us about the project, his biggest emphasis on explaining the project was not so much how great the project was going to be, but how terrible.

 

Okay, the big feature from the ECB of this coin was how much they were going to handicap it. It was going to be like, we will not allow interest payments. There will be strongholding caps. You will have a cascade that goes from your currency immediately to your bank account.

 

So you cannot have it without a bank account. And the moment it raises over this, the moment this wallet, if you want, allow me to call it, the one this wallet raises over a certain limit, it cascades into your bank account. So a lot of what they were doing was, or a lot of what the project does was reassuring the banking sector that this won't be that great, don't worry.

 

Okay? Which is an unusual, which is an unusual legislative aim. Usually when you try to do a project, you Try to do as good a project as you, you can here you're trying to do a project that is kind of so, so of course the risk is, are these limitations proportionate?

 

Is this the right way to operate or, or, or do they render digitally Euro kind of, you know, in the same way that you could say Mika is kind of rendering the European stable coins kind of a bit handicapped. Are you going to render the digital euro handicapped by doing these things and not really allowing it to, in order to, to shield incumbents?

 

So the question to me really is do we really want to handicap the project in order to save the banks and in some sense are the banks worth saving? If you allow me to put it very bluntly. So to a large extent, the functions of the banking system, as most people in this room know, are increasingly being unbundled.

 

Non banks are doing in the US a huge amount of mortgages. That's not happening in Europe. Private credit is enormous. The Fintech firms like Stripe are leading in payments and there is a lot of funds already doing corporate lending. Now on the one hand, banking functions are increasing and we're seeing banks doing more and more.

 

On the other hand, we keep being terrified to death of our banking system. Right, it happens again and again and again. Last time I was in Stanford, I made a morning visit to see an actual bank run in person. I was on Monday, I was there, one of the people in the SVB queue, just seeing what a queue looked like in a bank run.

 

So there's a high leverage, there's receptibility to runs, we are getting ever larger state guarantees. There is another run, there is another. New things that get protected, new liabilities get protected. And there are the commercial real estate exposures, the links between the bank and the non bank system through all of these lines of credit that potentially are going to kind of go back into, into the, into the banking system if there is any crisis.

 

All of that tells you like, I mean we are protecting a system that is very, very fragile. And is this an opportunity like on the one hand the stable coin, on the other hand the CBDC an opportunity to move beyond this fragile system and should we be so, so concerned about protecting it?

 

Obviously everybody's thinking, hey, transition dynamics and transitions matter and I am not going to reduce this, I'm not going to reduce this or underplay this concern. So that's where Europe stands right now on a basic dilemma between making the digital Euro kind of restricted enough that it protects the whole banking system, but making the digital euro to some extent attractive enough that people adopt it and that stablecoins don't become or US dollar denominated or other variants of this are not the ones that are winning the battle.

 

That's all I wanted to say, thanks very much.

>> Arvind Krishnamurthy: Okay, thank you, Luis, Charlie.

>> Charles Calomiris: It's a great pleasure to be here. I want to congratulate John and Mike for organizing what has been a remarkably substantive conference. You know, when you go to conferences of this type, you always can rely on reminiscing.

 

And this was very worthwhile, reminiscent, but it was also incredibly substantive and I appreciate that. Also, I hope I'll be able to surprise you by telling you that the things I'm going to talk about today actually were influenced by John Taylor. And I think I'm surprising John Taylor when I say that too, because some of the core theory that I'm going to talk about today comes from an article that Charlie can and I wrote that was published in the AER in 1991 and John was the editor and in fact had a very big effect on some of the content of that article.

 

So you didn't know that John was a banking theory person, but in fact he was and is. This is a line of research that I began. Now we're going in reverse order. I began as a public servant, not as a researcher, and then got so interested in it as chief economist of the OCC when I was there that I decided it was really worth doing more research on.

 

And what you'll see is that, interestingly, although Luis and Daryl and I haven't talked at all prior to this, that we all have a lot of common ground in our thinking about this. And I realize that a lot of you have not really spent much time thinking about crypto or you think it's some sort of teenage nonsense.

 

And I think that there's a lot of validity to that point of view. However, I want to tell you that stablecoin is different. Stablecoin is big, it's already having some significant. Significant effects. It's going to, I would say, transform the medium of exchange in our financial system soon and that long term.

 

I'll come back to this at the end. We can even think about it as a way to transform the unit of account and actually displace the dollar. And I'll talk about this as a theme that goes back to ideas that Irving Fisher, Milton Friedman, Bob hall and others have had about what is an optimal unit of account and how you can get there.

 

So there's a lot to stable coins that's worth your investing some time learning about them. If I had to as a financial historian, give you an example of what stablecoin is going to do. The example I would come up with as an analogy would not be the founding of the Fed.

 

It would be the chartering of the Visselbank. Because the Vissel bank, as an institution, fundamentally transformed and enhanced international trade throughout the world creating medium of exchange. Changed the network of exchange among intermediaries to be accounts at the Visselbank and got rid of a flawed unit of account to.

 

To create an artificial synthetic paper unit of account that no one had ever imagined before. That kind of transformation. I can't think of any other time it happened and I think that's what we're looking at right now. Okay, so let me tell you some stuff that you already know.

 

Next slide, please. I'm supposed to be able to do that. I can. Great. So, you know, the core businesses that banks are engaged in, they're losing market share. I'm not showing you graphs because I don't have time. They're losing market share both on lending and on payment system functions dramatically.

 

There are some of that on the payment side has to do with things that really are still mainly going through the bank plumbing. Still, you know, PayPal is not a fundamental innovation of payment systems. Stablecoins are because they will operate with a completely new network and a whole new way of executing.

 

So now we're talking about gross time to get to what Darrell's talking about. Now we're talking about gross time. I'm sorry, gross real time settlement at the speed of light in retail transactions. That's a big change. Stablecoin is the interesting thing to talk about, not Bitcoin. Now, all transactions balances that anybody wants to hold over some unit interval of time have to be stable in value or you wouldn't put your transactions balance into that.

 

Stablecoins are the only version of that worth talking about. So forget Bitcoin. Bitcoin's a good thing to do if you want to take, send money to your Venezuelan relatives. You buy it, send it, then 5 minutes later they sell it. Nobody's holding a balance of Bitcoin as a transaction device.

 

Now the interesting thing of course is that I spent most talking about banking in the 1980s and 1990s. I spent most of my time talking about all the great advantages of bundling. Well, guess what? In fact my, my article on that was the one that John was the editor of and Loretta Mester who's here.

 

So amazing combination. The two articles that really explain the bundling of transactions functions through of deposits, let's say in Banks Today and Lending are my article with Charlie can and Loretta's article with Nakamura. Those two articles are different but they have something in common. They rely on fundamental information asymmetries to motivate why you need to combine lending and the payment function of deposit taking.

 

You learn from deposit flows in Loretta's model. In my model it's the deposit that creates credibility of the management of the asymmetric information risk that the banks do. Both models are heavily dependent on information. I would say they are really great historical models. I would say they're not very relevant right now, sorry, to you and me.

 

Why do I say that? Because technology has basically made it possible to separate these functions. Because technology allows us to solve those information problems and in a transparent way that's actually verifiable to a third party. I'm not going to present a theory paper explaining that, but just, you know, my self interest.

 

I'd love to say my model will be relevant forever, but it's not. So there are plenty of technologies. Open banking is very important here because Rishabh, in a great paper that I would recommend to all of you shows that open banking allows competitive lenders to use the deposit information of the bank that you have your deposits in, just as Loretta's model would have it.

 

But you don't have to combine them. So the point is bundling of lending and payments functions no longer is really needed because technology has made that bundling requirement obsolete. Okay, what are some of the advantages of this new technology of fintech and then stablecoins in particular And I'll combine them into a single presentation.

 

So the main thing, when we were at the, when I was at the occ, we had a whole task force on financial inclusion and they were extremely excited about the way fintech was creating financial inclusion opportunities that didn't exist before. The reason is if you're doing small dollar transactions, it's very hard to do them through a brick and mortar bank because the physical costs of banking have an overhead cost that has to be attributed to these accounts.

 

So if you want to do a $5 loan, it's very hard to do that. It costs $100 just to do the loan application at a bank, but you can do that online. And we have new products that are very customized that can displace payday lending and other things to really make through fintech, especially poor people, especially people who don't speak English, be able to do banking transactions both on the lending side and the payment side in ways they couldn't do before.

 

Again, a much longer presentation. Underlying this blockchain has some additional advantages as a network, and there are several of them. One is its security. There’s a New York Fed paper called Pre-Mortem on the Hacking of the Fedwire, right? So a centralized payment system is very vulnerable. Blockchain isn't.

 

It's almost unhackable. And even if you manage to hack it, you'd only get a bilateral piece of the network, you wouldn't get the whole thing. So from a security standpoint, it's great. From a systemic risk standpoint, this division of allowing payment systems, payments and lending to happen in different intermediaries, of course reduces systemic risk.

 

So if you're worried, many people talk about, the payment system is vulnerable to loan losses. Well, that's not true if they're happening in different intermediaries, right? There's also messaging making these smart transfers so that suppose I wanted to gamble by undertaking futures transactions in the South Korean Futures Exchange.

 

I have to be able to transmit my age credibly. I can do that at the speed of light with a message alongside my transaction order in blockchain. So I'm just trying to give you a sense of how big these. These advantages can be. Now what about interest? Well, again, banks have brick and mortar, they charge a very big interest rate.

 

If you're doing this all in space, what's the competitive equilibrium? It's going to be a pass through of almost all the interest on the treasury bills. How is that going to be paid? Now this is a point that Luis raised. So the current bill that's I hope, going to pass eventually.

 

The Senate and House says that the chartered stable coin issuers are not going to be able to pay interest. Don't be confused by that. You don't pay interest on the stablecoin but the security that gives you the ownership interest in the stablecoin will bear interest. And I'll talk about those securities very quickly.

 

But one version of that could be perpetual preferred stock. So stablecoin security could be within an institution that's owned by some common stock interest. The stablecoin could be a preferred stock with a coupon that varies with the treasury bill, minus alpha, which is the spread cost, right? Very easy to do.

 

And that's basically what the intermediaries that are talking about this are already, I would say if not that exact model, they're kind of leaning in that direction. Okay, there are a lot of advantages from chartering stablecoins. I'm sorry, yeah. Gosh. Okay, so I'll give 30 seconds to that and then move to the other.

 

A lot of advantages from chartering them, they have to do with auditing to make sure they actually have the reserves, to make sure that the algorithms do what they say. My view of this is these, these don't require redemption, by the way, because they do require some kind of credible algorithm that buys and sells on a secondary market platform to make sure that you and you maintain the stability of the value, okay?

 

And I'm going to skip to the incumbent. Losers have been the big problem. Note that the Fed, I would say for transparent political reasons that are good in this case, withdrew its guidance that was crippling the development of stablecoins just a week or two ago. And that we have legislation that's likely to go through.

 

Why? Because the banks, I guess, have decided if you can't beat them, join them. And so they want to be able to have a chartered subsidiary that's doing stablecoins. But our legislation is going to allow either non banks or banks to have these charters. Charters are a good idea, especially if optional.

 

Finally. So I think the biggest issue is how will competition happen? Tether has a 90% market share. It's a horrible version of stablecoin. There's nothing good about Tether in terms of governance, in terms of accounting, in terms of anything. But they have a first mover advantage. Why do they preserve that?

 

Because of network issues. They are blockchain embedded in both Ethereum and Bitcoin. So there's this kind of scale network effect that Luis was talking about is very important. Where are the big competitors coming from? Well, there's the US based Circle which has just done an IPO or announced it's going to do an ipo.

 

And there's something even more interesting called the Global Dollar Network. I know I don't have time to explain it to you, but it's a consortium of different firms that are coming together. They've already formed their network, and they're gonna allow others to piggyback onto the network to create a big scale of a stablecoin that can challenge Tether.

 

I'm putting my money on them. One thing I think the regulators could do that would be really helpful is to clarify the common use regulations before we build the rails. So think about railroads or utilities. So people at the global Global Dollar Network might want to build a rail to create more competitive advantage and scale.

 

It would be nice if they knew what the rules were going to be of who was going to have to be allowed to use that before they do it. So this is some of the stuff I think we should be thinking about. I know I'm 30 seconds over.

 

I just want to point out the amazing thing as an economist, to me that comes from stablecoins and from blockchain is that once we have all these transactions they're recorded forever. That means we can actually observe the consumption bundle for tradables and non tradables. That means that we could create through kind of beta optimization a finite number of things that would span that consumption bundle very well.

 

We can tokenize those things like the steak that you have at Ruth's Chris in Washington D.C. and we can have about a thousand of those and use them to create a synthetic unit of account that would have lots of advantages from a consumption standpoint. I think it's going to happen, I'll guess decades from now, but I think it's going to happen.

 

There'll have to be lots of interesting questions answered. How many of these would you need? That's a mundell optimal currency area question. Maybe there'd be six or seven in the US along with the one national one. And that's where I think some really interesting research is heading that is how we're going to abolish this horrible bad innovation called the Federal Reserve.

 

Okay, thanks, Charlie.

>> Arvind Krishnamurthy: And our last speaker is Larry Summers.

>> Larry Summers: This is a kind of Admiral Stockdale moment for me. Admiral Stockdale was the guy who was Ross Perot's vice president got into the debate and said he had no idea why the hell he was here. And I've got about that feeling on stable coins and all the stuff that the three previous guys talked about.

 

I called John about two weeks in advance and tried to get this rearranged, and he said, no dice. Just be provocative and interesting and say stuff that'll make people mad. And that wasn't an entirely alien idea, given my personality. So I decided that I would go through with it.

 

I've got four things to say here today. First, John Taylor's a great man. He's done really important work that has had huge influence. I haven't agreed with large parts of it, but that makes it much more important. The best line any physicist ever said criticizing another physicist was Wolfgang Pauli saying of somebody's theory that it wasn't even wrong, by which they meant there wasn't something clear enough and vivid enough that you could even discuss.

 

It is the great attraction of John's work that that's never true. The Taylor rule is something you can test. The policy propositions that you should use a rule to guide monetary policy are clear and are something you can argue about. And whether you agree or whether you disagree, you are wiser at the end of the process.

 

And so I think John has made an immense contribution to the discussion of monetary policy for which we should all be grateful. And I'm glad to be have my small role in celebrating him, John.

>> Larry Summers: Second observation. I think we've got to do some pretty. Fundamental thinking about the process by which and the way we approach financial regulation.

 

I asked the CEO of a major New York bank to learn the answer to me, for me to a pretty simple question. I said how many people are there on the average Tuesday who work for the federal government who come to your offices at 9 in the morning and who leave at 5 in the afternoon and who are trying to patrol you and regulate you on the average Tuesday?

 

That's a good question. I don't know exactly. And he wrote me back two days later saying 250, that's a kind of stunning thing. And what prompted me to ask the question was I had occasion to talk to one of them, a fairly senior career employee, and I noticed that he used the wrong pronoun, not pronouns in the sense of woke and unwoke, but he used the pronoun we to refer to him and the bank that he was regulating.

 

That can't be the right way for us to have a system. I think we need to just think about a lot less process and procedure regulation and a lot more substance regulation as we think about financial regulation. And I'll just repeat my favorite hobby horse here, market values aren't right.

 

They're always wrong, they always change, but they're very, very often better guesses than the estimates of unmotivated actors. The most important thing that people who've studied finance understand and that people with law degrees do not understand is that it is much safer to loan somebody 96% against Microsoft stock with daily settling up than it is to loan somebody 50% against a shopping center with settling up every six years.

 

And that basic idea does not yet heavily influence our systems of financial regulation. And until it does, I think there's going to be very substantial risk. I think there is a major cultural problem that comes from people's tendency to blame all that is wrong on innovation when the vast majority of financial accident has to do with long term loans against real estate just like it did in 1910.

 

My second broad observation. I am confused about the issues around what should the government do and what should the government make sure that the private sector does not by the standards of the Hoover Institution, but by the standards of Harvard. I give a pretty good anti socialism speech about how the government doesn't understand the government's inefficient and the government screws things up and how it's good to have decentralization and different information entrepreneurial incentives.

 

Really, I promise I get it and I, I believe all of that. And when first exposed to the idea that the government should be the one who created the stablecoin or the government should create a system of deposits for every American at the Fed and all that stuff, I had all those reactions and I was good at saying, you know, Stalin had a really great theory of automobile production.

 

If they were all the same and they were all colored black, it would be really efficient and you'd get economies of scale. And that didn't work out that well. So really, I promise I get it. On the other hand, there are two other things that I'm aware of that I think are kind of important.

 

One is that for every dollar somebody pays into Social Security with a contribution, 98 and a half cents get paid back to somebody else for retirement. If you do the same calculation for IRAs and 401ks and stuff like that, the number's about 81 cents. Now, you know, you get more choices.

 

You can have an S P500 fund, or you can have a Bitcoin fund, or you get more choices. You get statements that have much prettier pictures. You get called a lot by people trying to churn you. So there's something there. Is it worth $0.19 cents on the $1?

 

Not always 100% certain. There are people in this room who know much more about Medicare Advantage than I do. But it may be driving some phenomenal efficiencies. But the amount of money that's being paid by taxpayers or patients, that's not going to anybody who knows which end of a stethoscope goes where is a lot greater in Medicare Advantage than it is in the VA hospital.

 

And so I just think that as we think about this, we have got to be careful on these questions of efficiency. Somebody told me earlier today that Bob hall remarked, apropos of the Hayek information problem, that as best he could tell, the most sophisticated coordination mechanism that existed on earth was headquartered in Bentonville, Arkansas, around the Walmart supply chain.

 

And so I just want to impart a notion of caution as we become hugely enthusiastic about decentralizing everything. My last point is my most fundamental. I'm sorry. I wish I didn't have to be. Didn't feel an urge to be talking about this. We're at a moment when the proposition that the government of the United States is a benign, thoughtful law, respecting force, is in question in a way that has not historically been true.

 

In my experience. I had significant disagreements with John Taylor or Mike. Boskin, during times when they are in office, never occurred to me that those were differences about objectives rather than differences about means to achieve objectives. It never occurred to me that there was a question as to whether they or any from whom they took instructions took seriously the obligations under the Constitution.

 

And the fact that those are questions today that I think can be reasonably asked. And because they can be reasonably asked today, that means that they can be reasonably asked in the future should influence our thinking about the kind of questions that are under discussion today. And so let me just share views on two John asked or somebody asked about reserve currency status of the dollar.

 

I have come to a view that I wouldn't have, certainly wouldn't have thought to articulate this way anytime before the last few months, which is this. The dollar is not guaranteed forever to be the world's reserve currency. There's nothing that says that that is written or that in history that will always be the case.

 

But my reading of history, and I'm nervous to be reading history in Barry Eichengreen's presence, is that in all likelihood, if the dollar loses its status as the reserve currency, it will be the least of our problems. That if the dollar loses its status as a reserve currency, it will be because we are no longer a place that provides rule of law.

 

It will be because we're no longer a superpower. It will be because we are no longer trusted. And if those things happen, the fact that we can't save 20 basis points and can't have the extra security that comes, and there's some limits on the scale of our borrowing, those will be the least of our problems the day the world is united against us.

 

And so I think the right way to think about our reserve currency status is to think about it in a broad context where it's not that we really need to worry that bad things will happen because we've lost reserve currency status, it's that it will be yet another symptom of bad things that today are a serious threat in our country.

 

Last thing I want to say something about is a consensus that seems to have emerged over the last 15 or 20 years that I used to kind of buy into and now I think might be misguided. And that is that monetary policy and the printing of money or the setting of interest rates because of the dynamic consistency problem is a sacred thing from which independence needs to absolutely be there for the reasons that are commonly talked about.

 

But financial regulation, that's like a political thing that needs to be accountable because it's Just another kind of policy like everything else. So it's unthinkable that the chairman of the Fed resigns when we have a new president, but becoming quasi obligatory that the Vice chairman for regulation and supervision turns over, it's essential that the chairman of the Fed delegate heavily to the vice chairman for regulation and supervision.

 

Because if the chairman started taking strong opinions and making his or her weight felt on regulatory questions, then they'd be enmeshing themselves in politics and then they couldn't be relied on to be completely independent and reappointed by presidents of either party. Maybe that's right because there are all kinds of judgments involved in regulation.

 

Maybe that's right because the dynamic consistency problem that is the core of the case for monetary independence is much more present in that area than it is with respect to regulation, that's possible. But when we've got a government that extorts institutions, extorts law firms, extorts universities, on occasion, extorts companies entirely lawlessly, and bank regulators have basically legally have the power to say I'm not comfortable with risk controls at your bank and I think your bank is a threat to fail in a dangerous way.

 

So your bank is closed with far less safeguard than surrounds what the President of the United States is doing to law firms and to universities. When that power exists and when leverage brought on financial institutions is basically the power to transfer resources, the power to lend is the power to give.

 

Anybody who doubted that just needs to considered the PPP program a few years ago. Are we sure that it's such a great idea to say that it's really important to ensure that financial regulation is politically responsive? Are we sure that that's really more important than the monetary dynamic consistency stuff?

 

I'm not at all sure. There's been this huge set of repeated demonstrations all over the world that the people hate inflation. And so doing inflationary things isn't such brilliant short run politics. There are enormously sensitive markets. I'm for monetary policy independence, but gosh, when I think about where the excessive intrusion of politics could do damage, I'm not at all sure that this idea that financial regulation should be politically responsive, but the other stuff should be entirely insulated because they're of entirely different magnitude.

 

I'm not sure that I'm completely convinced of that argument. And so I think all of you, as you reflect on central bank regulation and the structures of central banking and the political institutions surrounding central banking, need to think about kind of a new thing, tyrant risk as an aspect of the analysis and I suspect in some contexts, it will drive towards somewhat different conclusions.

 

Thank you very much.

>> Arvind Krishnamurthy: Okay. Thank you, Larry. I have done a poor job on time management, which is to say we are out of time. So my suggestion is we close right now. And I know there's good discussion we can have. Let's have it over the break rather than take more time.

 

So thank you again to all the panelists.

 

 

>> Arvind Krishnamurthy: The topic of this panel is digital assets, payment systems and financial regulation. And in the context of this conference, I think this very much fits into the new challenges portion of this conference. We've gone through a world in the last decade of quite a lot of flux around these topics.

 

The landscape around financial technology and particularly technology around money and payments and settlements have changed quite a lot over the last 10 years and I think has accelerated over the last few years. The landscape around financial remediation with the movement of activities outside the banking sector has also been and something that's very marked over the last decade, something that we will hear about in this panel and then another topic, and maybe it's a very particularly new challenge which I would love to hear the panelists talk about is, you know, since post war we've lived in a world in which the dollars and the safety of Treasuries has undergirded the US dollar as the reserve currency of the world.

 

And I think in the last month there have been cracks in that. It would be another particularly new challenge that it would be nice to hear something about. So with that I'm going to stop and turn it over to the panelists. We have four panelists, Darrell Duffie, Luis Garcano, Charles Calomiris and Lawrence (Larry) Summers.

 

Each of you has 12 minutes. I will be strict with time. Darrell, the floor is yours.

>> Darrell Duffie: Thanks very much, Arvind. Before we start, I want to add to the respect for John Taylor. I've known John for decades as a close colleague. Something that he and I worked on together, that he led, which hasn't been emphasized, is his work on making it possible for large financial institutions to fail without bringing down the financial system.

 

And his leadership on that project, which was called Chapter 14, I believe had a big influence on the sections of the Dodd Frank act that we have today. So thank you John and thank you for the opportunity to work with you. Well, our charge in this panel includes new forms of digital assets and payment systems.

 

So I want to talk about some big changes that are coming into the core of the financial system and the way that money moves through the system. And to do that I want to set the stage for you all. Back in history. June 26, 1974. Let's see who can remember what happened that day.

 

A medium sized bank in Cologne, Germany named Bank Herstadt failed. Von Kirstadt had been doing massive speculation in the foreign exchange market. And when it failed, it had received very large settlement payments on foreign exchange transactions. But it had yet to pay its counterparties that day for example, banks in London and in New York were settling FX trades with bank Hershtad to the extent of hundreds of millions of dollars.

 

Chase Manhattan alone did not get $620 million of payments that day, which in those days was a lot of money. What happened? Well, as a consequence there was a massive disruption in the foreign exchange market. Medium and smaller banks were pretty much shut out of the market. Only large banks were able to conduct transactions.

 

Even Eurodollar interest rates were disrupted. And in that year, spurred by Peter Cook of the bank of England, this Herrstadt event caused the formation of the Basel Commission on Bank Supervision, famous now for Basel I, Basel II and Most recently Basel III. The famous 8% ratio was at that point, some of you may remember, called the Koch ratio, named after Peter Cook who set that up.

 

In addition to establishing proper capital requirements for banks at the time, this triggered a multi decade construction of what is now called CLS bank, which is a way of mitigating this form of foreign exchange risk that can bring down the financial system or banks. And the idea of the CLS bank, which is the next gen way to do foreign exchange payments, is that you can think of CLS bank as a virtual island sitting in the middle of the Atlantic Ocean, so that when a bank in Germany wants to pay a bank in the US for foreign exchange, the German bank kind of flies the money over to this island in the middle of the Atlantic called CLS Bank.

 

And the money waits there until the flight from New York carrying the dollars lands in the middle of the Atlantic. And then there's a handshake at CLS bank in the middle and the dollars continue on their way over to Europe and the euros continue on their way over to the us so that neither will have made a payment at risk of not receiving the payment from the other.

 

Because there's this handshake called payment versus payment in the middle of the ocean that's virtual. CLS bank is a very complex, difficult to supervise and organize organization. It now handles about $5 trillion a day, but still only covers about 60% of the major currencies. And there's a lot of opportunities to go from that second generation approach to the new generation approach for doing large scale financial settlements based on tokenized payments.

 

So I'm going to illustrate how that works. In this chart you can see this payment. In this case it's $500 million in exchange for 460 million, sorry, 400 million euros. And the idea is that the US bank will cryptographically assign those dollars to the European bank conditional on the European bank cryptographically assigning the euros to the US bank so that neither is at risk of a failure of the other to deliver, because those cryptographic signatures are contingent on the other guy signing across the Atlantic.

 

This has already been tested by the Federal Reserve bank of New York in Project Cedar and in Project Jura by the Swiss national bank and the Banque de France. So this is now feasible. It's not being heavily used, but I predict it will. Let me show you in my last slide roughly how this happens.

 

So there's a ledger which can take instructions from any of the participating banks, and this ledger can be recorded, for example, on a blockchain. But it doesn't need to be. The US bank can send a message, an irrevocable message, onto this Ledger saying, these 500. Hundred million dollars belong to the European Bank.

 

If the European Bank sends analogous message saying these 400 million euros belong to the US bank. And now the ledger, which you can think of as a state system, Xt, which records all of the commitments and all of the balances of the participating banks, is able to process these payments.

 

One bank to the other without requiring that intermediary island in the middle of the Atlantic by the miracle of cryptography. And by virtue of this, you can cut out a lot of the expensive furniture that's difficult to govern and difficult to manage furniture in the middle of the system.

 

Let me now turn in the last few minutes to the case of US treasuries. Suppose the European bank is not selling Euros, it's selling US Treasuries to the New York bank. Well, it's the same process, and it might seem futuristic, but it's happening today. There are already billions of dollars of US Treasuries that have been put into tokenized form and exchanged between major counterparties.

 

It's being tested and used by major firms like bank of New York Mellon, using a system called Canton Networks. The market, while it's currently in the billions of Treasuries, is much, potentially much larger, an addressable market of, let's say, in the trillions. There's already $5 trillion a day of transfers of treasury securities that could be mobilized using this form of tokenized exchange.

 

And that, as you might note, we're in the middle of a big movement towards central counterparties. It need not require a central counterparty. So it's the next gen. How long it will take, we'll see, but it's already in motion. So let me complete this idea with some of the key challenges which I think will engage some of the central bankers here.

 

So first, there are going to be some legal issues. What is it exactly that perfects your property interest in the transfer of these Treasuries and cash? And those are being surmounted now internationally. In the United States, there's a movement to update the Uniform Commercial Code so that court precedents will lock down that you actually own the Treasuries when they're assigned to you on the blockchain.

 

It may seem obvious, but when there's billions of dollars of Treasuries involved, you want to be sure that you actually own them. That could be circumvented by legislation that's going through, perhaps through Congress on digital assets. Who's going to tokenize the Treasuries and who's going to tokenize the Cash.

 

We have some precedents in the treasury market. In the early 1980s, private sector firms decided that it would be nice to have zero coupon long term treasury securities. So what they did is they purchased normal coupon treasury securities, put them in a legal lockbox and then issued from that legal lockbox zero coupon securities.

 

And so the private sector could do this. They could tokenize the Treasuries on their own. And that's actually what's happening today. On the other hand, in 1985 the Treasury Department said, well wait a minute, these tokenized, pardon me, these stripped treasury securities are actually trading in the market, sometimes at prices that are richer than the ones that we're issuing.

 

We could do that. And the Treasury Department started to issue its own zero coupon treasury securities. I think the same thing could happen in this case. Once the superior liquidity and mobility of collateral of tokenized Treasuries from the private sector starts to become apparent and they have a convenience yield, the Treasury Department will eventually get around to issuing their own tokenized treasury securities.

 

What about the cash side of the transaction? Who's going to tokenize the cash dollars? Well, I don't think that hundreds of billions or trillions of dollars a day are going to go on a private sector stablecoin in a decentralized finance setting. I don't think if you're familiar with usdc, I don't think the biggest actors in the core of the financial system will be happy with that.

 

Will they use tokenized commercial bank deposits? Perhaps, but they're more likely because of the risks involved in the multi trillion dollar a day market. If they use commercial bank deposits to back those one for one with reserves. And now we could get into the same situation. If those reserves are backing commercial bank deposits, perhaps the central bank itself, the Fed or foreign central banks in their cases will issue their own tokenized forms of reserves.

 

Would that be a central bank digital currency? I would not use that term no more. It's no more a CBDC than currently. Reserves are a cbdc. Both are central bank issued digitally recorded cash money from the central bank. Instead of calling them CBDCs, I would call them just tokenized reserves.

 

It's just another ledger for holding the same instrument. President Trump recently banned CBDCs. There's no reason to think of that ban as applying to anything like tokenized reserves. There are still, however, other challenges. You'll notice in this diagram that the US bank had to put up the money before the transaction was completed.

 

In the legacy financial system that we're dealing with today, the US bank wouldn't need to actually commit the cash until the settlement. In this case, it needs to have the cash before it enters the trade and that's going to place an extra demand. Going back to the previous panel on the need for reserves, the definition of ample reserves may change if the private sector decides that it wants to have a lot of tokenized reserves for this purpose.

 

And that's true whether they're issued by the Fed directly or whether they're placed in a lock lockbox. Legacy reserves are placed in a lockbox and then private sector tokenized cash is issued out of that lockbox. So I think the Fed needs to be flexible in terms of what the definition of ample reserves is.

 

Structural changes in the economy may end up causing the Fed's balance sheet to get bigger simply because the way that finance is conducted changes. There are, however, some approaches that researchers are doing are working on today that would economize on the amount of reserves necessary to run this.

 

In summary, I think we should be looking ahead to a world in which tokenized Treasuries and tokenized central bank deposits are going to be a norm that will change the financial system. And I think that's going to work out rather well. It's going to be important to the United States, which currently has about $29 trillion of U.S. treasury securities in the world.

 

And sometimes we'll be struggling to find owners for those 29 trillion. That number is going to 52 trillion by 2000 and 35. According to the Congressional Budget Office. And that's even without considering the legislation that may be coming through Congress that would further increase U.S. deficits. The quantity of U.S. treasuries owned globally has gone down from 52% in 2009, I.e.

 

owned by foreign investors has gone down from 52 percent in 2009 to to around 35% today. And unless treasury securities can be mobilized rapidly and used as collateral 24, 7, 365 around the world, it's going to get harder and harder for foreign investors to find useful ways to use treasury securities not only to own them, but for collateral mobility and for financing.

 

So, Arvind, that's about what I wanted to say. Thank you very much.

>> Arvind Krishnamurthy: Thanks, Carol.

>> Arvind Krishnamurthy: Our next panelist is Luis Garicano.

>> Luis Garicano: Thanks. Thanks, Arvind, I join everybody on thanking John for his extraordinary inspiration. Also, for all those who do, who work on the two sides of the policy and academic divide, thank you.

 

So I'm going to give you a sense of how all this looks from a European perspective from the other side of the Atlantic and what Europe is trying to do about all of this and what is potentially scaring Europeans. So yesterday there was a statement by Scott Bessant today talking about the law that didn't pass and it was more or less to the same, same tenor as the statement by Donald Trump, the stable coins are going to unleash or the new utilization on stable coins should unleash a whole dominance of the US dollar for years to come, etc.

 

Etc. The essential landscape in US and the US and Europe looks very, very different. Essentially, the US is having this legislation on private digital money on stable coins which is going through the US And Congress, the genius and stable Act. As you know, yesterday, you may know yesterday, part of the legislation failed to pass.

 

Europe has passed legislation stable coins within the general markets in crypto assets. Assets legislation, which is a little part of that broad legislation concerns the stable coins on digital, on public digital money. The U.S has basically, as Daryl just told you, forbid the U.S. Trump administration has issued President Trump has issued an order forbidding it.

 

But Europe is actually moving ahead with the cbdc. The European Central bank pushed the project. The European Commission has picked it up, is making its way to Parliament. The truth of the matter is, it's still not clear at all that these legislation will be passing that will be making it the person, the legislature who was in charge was accused of being kind of in the arms captured by the German banking industry and was was removed so we'll see in the new legislatures who how, how they move how they move this.

 

The approaches are pretty different. Let me just talk about the private side. The approaches are pretty different. So the the main issue I want there are lots of things that that are that are different but let me just mention the the two or three that are that are most important.

 

The U.S. legislation has a potentially and as as I told you it's still all in progress a big hole for non US issuers of stable coins. In particular as you know tether is El Salvador based. The European legislation is very broad as you expect from Europe. It affects everybody who is issuing Euro denominated or any stable coin that circulates in the Euro area.

 

In terms of registration there is an authorization both are going to ask for for, for for a pre authorization for the issues of stablecoins. But the US is going to be more well potentially going to be more flexible to non bank issuers of stable coins. The interest payment is a crucial issue.

 

Mica doesn't allow stablecoin issues to pay interest in the US There's a lot of debate. There was some lobbying from the bank even just two days ago the the American Banking Institute just issued some communique asking legislators not to allow interest payments because that was going to put in at risk the banking system etc.

 

As you would expect banks banks, some banks smaller banks are concerned and consumer protection of course rules are are much much more taken much for much for further forward in in Europe. So it's a more, it's a more restrictive legislation. I didn't really need a chart to make this point but the chart really makes the point right?

 

This is, this is the US dollar. This is the US dollar share in stable coins and the and the rest, I actually you could actually think that the rest of the coins are actually included as well the non-US non Euro the they are so small that they wouldn't really show up in this graph.

 

So Europe is 0.25% of total issuance. So from the European perspective it looks like okay, this is going to happen. U.S. is going to move ahead. There's going to be these loopholes for all legislation, that's more or less how Europe is seeing this. Is this something that really is a risk?

 

Would Europeans really adopt the is it really a risk that US dollar stablecoins will actually become a common way of payment in Europe, well you could say. Well look because the market dominance because the US has a much larger size there's liquidity advantages Et cetera. You could say, well, their regulatory environment is going to be more flexible, more innovative, Europe is always going to be more rigid.

 

And there are network effects, evidently, like always with currencies. And we already seen some users of stablecoins, for example, if you want to get a Starlink satellite in Nigeria, you're going to pay on a USD US dollar denominated stablecoin, potentially. And there are some other B2B transactions that are already taking place, priori, you would think, as I say here, that taking currency risk for European holders of money and of any other assets and the hurdles of Mica would discourage this.

 

On the other hand, network effects are large. Europeans panicked when Libra was put on the table and they thought suddenly, like, okay, everybody who has a Facebook account is going to be able to make these payments without the European Central bank knowing. And kind of the risks that are seen, you can imagine them and, and you know them well, what is going to happen if all these coins are circulating and, and we don't, and we don't have control?

 

There's going to be a weekend control of monetary policy. The ECB worries. We, we, we lose control of what interest gets paid in our, in our own economy. There is financial stability risks. There are people who have currency mismatches. There is the erasion or potential erosion of monetized.

 

So what is the reaction? The, the European reaction is okay, so let's try this cbdc. Let's issue a central bank digital currency which, a digital euro which will allow for some of these advantages and will reduce or limit the risk of these stable coins. Kind of quote taking over if you want.

 

The ambition is obvious. We're going to have this, this digital euro which is going to provide a public a safe, efficient digital payment method. There's going to be a central ledger. So it's not quite the crypto dream. There is a central ledger that is controlled by the ECB but it's going to kind of give certain privacy at least to certain level of transactions and is going to reduce the risk of these other coins.

 

The reality however is that the way the CBDC is being actually legislated and as I told you here, like with a U.S stable, ingenious, everything is in flux. So by the way, the reality of how it's been legislated is either because of financial stability concerns which are, okay, bank sphere or bank deposits flow to.

 

If you can hold an account in the Federal Reserve, if you can hold an account in ecb, why would you hold an account in a bank? So banks are concerned, they do lobbying, so whether you think it's stability, legitimate stability concerns or more like monopoly profit protection from the banks, the truth is the way to get this project forward for the moment has been to handicap it.

 

It's very interesting when I was involved in legislation, when I was in Parliament, in the European Parliament, all the times. Panetta, who was the board member who came to tell us about the project, his biggest emphasis on explaining the project was not so much how great the project was going to be, but how terrible.

 

Okay, the big feature from the ECB of this coin was how much they were going to handicap it. It was going to be like, we will not allow interest payments. There will be strongholding caps. You will have a cascade that goes from your currency immediately to your bank account.

 

So you cannot have it without a bank account. And the moment it raises over this, the moment this wallet, if you want, allow me to call it, the one this wallet raises over a certain limit, it cascades into your bank account. So a lot of what they were doing was, or a lot of what the project does was reassuring the banking sector that this won't be that great, don't worry.

 

Okay? Which is an unusual, which is an unusual legislative aim. Usually when you try to do a project, you Try to do as good a project as you, you can here you're trying to do a project that is kind of so, so of course the risk is, are these limitations proportionate?

 

Is this the right way to operate or, or, or do they render digitally Euro kind of, you know, in the same way that you could say Mika is kind of rendering the European stable coins kind of a bit handicapped. Are you going to render the digital euro handicapped by doing these things and not really allowing it to, in order to, to shield incumbents?

 

So the question to me really is do we really want to handicap the project in order to save the banks and in some sense are the banks worth saving? If you allow me to put it very bluntly. So to a large extent, the functions of the banking system, as most people in this room know, are increasingly being unbundled.

 

Non banks are doing in the US a huge amount of mortgages. That's not happening in Europe. Private credit is enormous. The Fintech firms like Stripe are leading in payments and there is a lot of funds already doing corporate lending. Now on the one hand, banking functions are increasing and we're seeing banks doing more and more.

 

On the other hand, we keep being terrified to death of our banking system. Right, it happens again and again and again. Last time I was in Stanford, I made a morning visit to see an actual bank run in person. I was on Monday, I was there, one of the people in the SVB queue, just seeing what a queue looked like in a bank run.

 

So there's a high leverage, there's receptibility to runs, we are getting ever larger state guarantees. There is another run, there is another. New things that get protected, new liabilities get protected. And there are the commercial real estate exposures, the links between the bank and the non bank system through all of these lines of credit that potentially are going to kind of go back into, into the, into the banking system if there is any crisis.

 

All of that tells you like, I mean we are protecting a system that is very, very fragile. And is this an opportunity like on the one hand the stable coin, on the other hand the CBDC an opportunity to move beyond this fragile system and should we be so, so concerned about protecting it?

 

Obviously everybody's thinking, hey, transition dynamics and transitions matter and I am not going to reduce this, I'm not going to reduce this or underplay this concern. So that's where Europe stands right now on a basic dilemma between making the digital Euro kind of restricted enough that it protects the whole banking system, but making the digital euro to some extent attractive enough that people adopt it and that stablecoins don't become or US dollar denominated or other variants of this are not the ones that are winning the battle.

 

That's all I wanted to say, thanks very much.

>> Arvind Krishnamurthy: Okay, thank you, Luis, Charlie.

>> Charles Calomiris: It's a great pleasure to be here. I want to congratulate John and Mike for organizing what has been a remarkably substantive conference. You know, when you go to conferences of this type, you always can rely on reminiscing.

 

And this was very worthwhile, reminiscent, but it was also incredibly substantive and I appreciate that. Also, I hope I'll be able to surprise you by telling you that the things I'm going to talk about today actually were influenced by John Taylor. And I think I'm surprising John Taylor when I say that too, because some of the core theory that I'm going to talk about today comes from an article that Charlie can and I wrote that was published in the AER in 1991 and John was the editor and in fact had a very big effect on some of the content of that article.

 

So you didn't know that John was a banking theory person, but in fact he was and is. This is a line of research that I began. Now we're going in reverse order. I began as a public servant, not as a researcher, and then got so interested in it as chief economist of the OCC when I was there that I decided it was really worth doing more research on.

 

And what you'll see is that, interestingly, although Luis and Daryl and I haven't talked at all prior to this, that we all have a lot of common ground in our thinking about this. And I realize that a lot of you have not really spent much time thinking about crypto or you think it's some sort of teenage nonsense.

 

And I think that there's a lot of validity to that point of view. However, I want to tell you that stablecoin is different. Stablecoin is big, it's already having some significant. Significant effects. It's going to, I would say, transform the medium of exchange in our financial system soon and that long term.

 

I'll come back to this at the end. We can even think about it as a way to transform the unit of account and actually displace the dollar. And I'll talk about this as a theme that goes back to ideas that Irving Fisher, Milton Friedman, Bob hall and others have had about what is an optimal unit of account and how you can get there.

 

So there's a lot to stable coins that's worth your investing some time learning about them. If I had to as a financial historian, give you an example of what stablecoin is going to do. The example I would come up with as an analogy would not be the founding of the Fed.

 

It would be the chartering of the Visselbank. Because the Vissel bank, as an institution, fundamentally transformed and enhanced international trade throughout the world creating medium of exchange. Changed the network of exchange among intermediaries to be accounts at the Visselbank and got rid of a flawed unit of account to.

 

To create an artificial synthetic paper unit of account that no one had ever imagined before. That kind of transformation. I can't think of any other time it happened and I think that's what we're looking at right now. Okay, so let me tell you some stuff that you already know.

 

Next slide, please. I'm supposed to be able to do that. I can. Great. So, you know, the core businesses that banks are engaged in, they're losing market share. I'm not showing you graphs because I don't have time. They're losing market share both on lending and on payment system functions dramatically.

 

There are some of that on the payment side has to do with things that really are still mainly going through the bank plumbing. Still, you know, PayPal is not a fundamental innovation of payment systems. Stablecoins are because they will operate with a completely new network and a whole new way of executing.

 

So now we're talking about gross time to get to what Darrell's talking about. Now we're talking about gross time. I'm sorry, gross real time settlement at the speed of light in retail transactions. That's a big change. Stablecoin is the interesting thing to talk about, not Bitcoin. Now, all transactions balances that anybody wants to hold over some unit interval of time have to be stable in value or you wouldn't put your transactions balance into that.

 

Stablecoins are the only version of that worth talking about. So forget Bitcoin. Bitcoin's a good thing to do if you want to take, send money to your Venezuelan relatives. You buy it, send it, then 5 minutes later they sell it. Nobody's holding a balance of Bitcoin as a transaction device.

 

Now the interesting thing of course is that I spent most talking about banking in the 1980s and 1990s. I spent most of my time talking about all the great advantages of bundling. Well, guess what? In fact my, my article on that was the one that John was the editor of and Loretta Mester who's here.

 

So amazing combination. The two articles that really explain the bundling of transactions functions through of deposits, let's say in Banks Today and Lending are my article with Charlie can and Loretta's article with Nakamura. Those two articles are different but they have something in common. They rely on fundamental information asymmetries to motivate why you need to combine lending and the payment function of deposit taking.

 

You learn from deposit flows in Loretta's model. In my model it's the deposit that creates credibility of the management of the asymmetric information risk that the banks do. Both models are heavily dependent on information. I would say they are really great historical models. I would say they're not very relevant right now, sorry, to you and me.

 

Why do I say that? Because technology has basically made it possible to separate these functions. Because technology allows us to solve those information problems and in a transparent way that's actually verifiable to a third party. I'm not going to present a theory paper explaining that, but just, you know, my self interest.

 

I'd love to say my model will be relevant forever, but it's not. So there are plenty of technologies. Open banking is very important here because Rishabh, in a great paper that I would recommend to all of you shows that open banking allows competitive lenders to use the deposit information of the bank that you have your deposits in, just as Loretta's model would have it.

 

But you don't have to combine them. So the point is bundling of lending and payments functions no longer is really needed because technology has made that bundling requirement obsolete. Okay, what are some of the advantages of this new technology of fintech and then stablecoins in particular And I'll combine them into a single presentation.

 

So the main thing, when we were at the, when I was at the occ, we had a whole task force on financial inclusion and they were extremely excited about the way fintech was creating financial inclusion opportunities that didn't exist before. The reason is if you're doing small dollar transactions, it's very hard to do them through a brick and mortar bank because the physical costs of banking have an overhead cost that has to be attributed to these accounts.

 

So if you want to do a $5 loan, it's very hard to do that. It costs $100 just to do the loan application at a bank, but you can do that online. And we have new products that are very customized that can displace payday lending and other things to really make through fintech, especially poor people, especially people who don't speak English, be able to do banking transactions both on the lending side and the payment side in ways they couldn't do before.

 

Again, a much longer presentation. Underlying this blockchain has some additional advantages as a network, and there are several of them. One is its security. There’s a New York Fed paper called Pre-Mortem on the Hacking of the Fedwire, right? So a centralized payment system is very vulnerable. Blockchain isn't.

 

It's almost unhackable. And even if you manage to hack it, you'd only get a bilateral piece of the network, you wouldn't get the whole thing. So from a security standpoint, it's great. From a systemic risk standpoint, this division of allowing payment systems, payments and lending to happen in different intermediaries, of course reduces systemic risk.

 

So if you're worried, many people talk about, the payment system is vulnerable to loan losses. Well, that's not true if they're happening in different intermediaries, right? There's also messaging making these smart transfers so that suppose I wanted to gamble by undertaking futures transactions in the South Korean Futures Exchange.

 

I have to be able to transmit my age credibly. I can do that at the speed of light with a message alongside my transaction order in blockchain. So I'm just trying to give you a sense of how big these. These advantages can be. Now what about interest? Well, again, banks have brick and mortar, they charge a very big interest rate.

 

If you're doing this all in space, what's the competitive equilibrium? It's going to be a pass through of almost all the interest on the treasury bills. How is that going to be paid? Now this is a point that Luis raised. So the current bill that's I hope, going to pass eventually.

 

The Senate and House says that the chartered stable coin issuers are not going to be able to pay interest. Don't be confused by that. You don't pay interest on the stablecoin but the security that gives you the ownership interest in the stablecoin will bear interest. And I'll talk about those securities very quickly.

 

But one version of that could be perpetual preferred stock. So stablecoin security could be within an institution that's owned by some common stock interest. The stablecoin could be a preferred stock with a coupon that varies with the treasury bill, minus alpha, which is the spread cost, right? Very easy to do.

 

And that's basically what the intermediaries that are talking about this are already, I would say if not that exact model, they're kind of leaning in that direction. Okay, there are a lot of advantages from chartering stablecoins. I'm sorry, yeah. Gosh. Okay, so I'll give 30 seconds to that and then move to the other.

 

A lot of advantages from chartering them, they have to do with auditing to make sure they actually have the reserves, to make sure that the algorithms do what they say. My view of this is these, these don't require redemption, by the way, because they do require some kind of credible algorithm that buys and sells on a secondary market platform to make sure that you and you maintain the stability of the value, okay?

 

And I'm going to skip to the incumbent. Losers have been the big problem. Note that the Fed, I would say for transparent political reasons that are good in this case, withdrew its guidance that was crippling the development of stablecoins just a week or two ago. And that we have legislation that's likely to go through.

 

Why? Because the banks, I guess, have decided if you can't beat them, join them. And so they want to be able to have a chartered subsidiary that's doing stablecoins. But our legislation is going to allow either non banks or banks to have these charters. Charters are a good idea, especially if optional.

 

Finally. So I think the biggest issue is how will competition happen? Tether has a 90% market share. It's a horrible version of stablecoin. There's nothing good about Tether in terms of governance, in terms of accounting, in terms of anything. But they have a first mover advantage. Why do they preserve that?

 

Because of network issues. They are blockchain embedded in both Ethereum and Bitcoin. So there's this kind of scale network effect that Luis was talking about is very important. Where are the big competitors coming from? Well, there's the US based Circle which has just done an IPO or announced it's going to do an ipo.

 

And there's something even more interesting called the Global Dollar Network. I know I don't have time to explain it to you, but it's a consortium of different firms that are coming together. They've already formed their network, and they're gonna allow others to piggyback onto the network to create a big scale of a stablecoin that can challenge Tether.

 

I'm putting my money on them. One thing I think the regulators could do that would be really helpful is to clarify the common use regulations before we build the rails. So think about railroads or utilities. So people at the global Global Dollar Network might want to build a rail to create more competitive advantage and scale.

 

It would be nice if they knew what the rules were going to be of who was going to have to be allowed to use that before they do it. So this is some of the stuff I think we should be thinking about. I know I'm 30 seconds over.

 

I just want to point out the amazing thing as an economist, to me that comes from stablecoins and from blockchain is that once we have all these transactions they're recorded forever. That means we can actually observe the consumption bundle for tradables and non tradables. That means that we could create through kind of beta optimization a finite number of things that would span that consumption bundle very well.

 

We can tokenize those things like the steak that you have at Ruth's Chris in Washington D.C. and we can have about a thousand of those and use them to create a synthetic unit of account that would have lots of advantages from a consumption standpoint. I think it's going to happen, I'll guess decades from now, but I think it's going to happen.

 

There'll have to be lots of interesting questions answered. How many of these would you need? That's a mundell optimal currency area question. Maybe there'd be six or seven in the US along with the one national one. And that's where I think some really interesting research is heading that is how we're going to abolish this horrible bad innovation called the Federal Reserve.

 

Okay, thanks, Charlie.

>> Arvind Krishnamurthy: And our last speaker is Larry Summers.

>> Larry Summers: This is a kind of Admiral Stockdale moment for me. Admiral Stockdale was the guy who was Ross Perot's vice president got into the debate and said he had no idea why the hell he was here. And I've got about that feeling on stable coins and all the stuff that the three previous guys talked about.

 

I called John about two weeks in advance and tried to get this rearranged, and he said, no dice. Just be provocative and interesting and say stuff that'll make people mad. And that wasn't an entirely alien idea, given my personality. So I decided that I would go through with it.

 

I've got four things to say here today. First, John Taylor's a great man. He's done really important work that has had huge influence. I haven't agreed with large parts of it, but that makes it much more important. The best line any physicist ever said criticizing another physicist was Wolfgang Pauli saying of somebody's theory that it wasn't even wrong, by which they meant there wasn't something clear enough and vivid enough that you could even discuss.

 

It is the great attraction of John's work that that's never true. The Taylor rule is something you can test. The policy propositions that you should use a rule to guide monetary policy are clear and are something you can argue about. And whether you agree or whether you disagree, you are wiser at the end of the process.

 

And so I think John has made an immense contribution to the discussion of monetary policy for which we should all be grateful. And I'm glad to be have my small role in celebrating him, John.

>> Larry Summers: Second observation. I think we've got to do some pretty. Fundamental thinking about the process by which and the way we approach financial regulation.

 

I asked the CEO of a major New York bank to learn the answer to me, for me to a pretty simple question. I said how many people are there on the average Tuesday who work for the federal government who come to your offices at 9 in the morning and who leave at 5 in the afternoon and who are trying to patrol you and regulate you on the average Tuesday?

 

That's a good question. I don't know exactly. And he wrote me back two days later saying 250, that's a kind of stunning thing. And what prompted me to ask the question was I had occasion to talk to one of them, a fairly senior career employee, and I noticed that he used the wrong pronoun, not pronouns in the sense of woke and unwoke, but he used the pronoun we to refer to him and the bank that he was regulating.

 

That can't be the right way for us to have a system. I think we need to just think about a lot less process and procedure regulation and a lot more substance regulation as we think about financial regulation. And I'll just repeat my favorite hobby horse here, market values aren't right.

 

They're always wrong, they always change, but they're very, very often better guesses than the estimates of unmotivated actors. The most important thing that people who've studied finance understand and that people with law degrees do not understand is that it is much safer to loan somebody 96% against Microsoft stock with daily settling up than it is to loan somebody 50% against a shopping center with settling up every six years.

 

And that basic idea does not yet heavily influence our systems of financial regulation. And until it does, I think there's going to be very substantial risk. I think there is a major cultural problem that comes from people's tendency to blame all that is wrong on innovation when the vast majority of financial accident has to do with long term loans against real estate just like it did in 1910.

 

My second broad observation. I am confused about the issues around what should the government do and what should the government make sure that the private sector does not by the standards of the Hoover Institution, but by the standards of Harvard. I give a pretty good anti socialism speech about how the government doesn't understand the government's inefficient and the government screws things up and how it's good to have decentralization and different information entrepreneurial incentives.

 

Really, I promise I get it and I, I believe all of that. And when first exposed to the idea that the government should be the one who created the stablecoin or the government should create a system of deposits for every American at the Fed and all that stuff, I had all those reactions and I was good at saying, you know, Stalin had a really great theory of automobile production.

 

If they were all the same and they were all colored black, it would be really efficient and you'd get economies of scale. And that didn't work out that well. So really, I promise I get it. On the other hand, there are two other things that I'm aware of that I think are kind of important.

 

One is that for every dollar somebody pays into Social Security with a contribution, 98 and a half cents get paid back to somebody else for retirement. If you do the same calculation for IRAs and 401ks and stuff like that, the number's about 81 cents. Now, you know, you get more choices.

 

You can have an S P500 fund, or you can have a Bitcoin fund, or you get more choices. You get statements that have much prettier pictures. You get called a lot by people trying to churn you. So there's something there. Is it worth $0.19 cents on the $1?

 

Not always 100% certain. There are people in this room who know much more about Medicare Advantage than I do. But it may be driving some phenomenal efficiencies. But the amount of money that's being paid by taxpayers or patients, that's not going to anybody who knows which end of a stethoscope goes where is a lot greater in Medicare Advantage than it is in the VA hospital.

 

And so I just think that as we think about this, we have got to be careful on these questions of efficiency. Somebody told me earlier today that Bob hall remarked, apropos of the Hayek information problem, that as best he could tell, the most sophisticated coordination mechanism that existed on earth was headquartered in Bentonville, Arkansas, around the Walmart supply chain.

 

And so I just want to impart a notion of caution as we become hugely enthusiastic about decentralizing everything. My last point is my most fundamental. I'm sorry. I wish I didn't have to be. Didn't feel an urge to be talking about this. We're at a moment when the proposition that the government of the United States is a benign, thoughtful law, respecting force, is in question in a way that has not historically been true.

 

In my experience. I had significant disagreements with John Taylor or Mike. Boskin, during times when they are in office, never occurred to me that those were differences about objectives rather than differences about means to achieve objectives. It never occurred to me that there was a question as to whether they or any from whom they took instructions took seriously the obligations under the Constitution.

 

And the fact that those are questions today that I think can be reasonably asked. And because they can be reasonably asked today, that means that they can be reasonably asked in the future should influence our thinking about the kind of questions that are under discussion today. And so let me just share views on two John asked or somebody asked about reserve currency status of the dollar.

 

I have come to a view that I wouldn't have, certainly wouldn't have thought to articulate this way anytime before the last few months, which is this. The dollar is not guaranteed forever to be the world's reserve currency. There's nothing that says that that is written or that in history that will always be the case.

 

But my reading of history, and I'm nervous to be reading history in Barry Eichengreen's presence, is that in all likelihood, if the dollar loses its status as the reserve currency, it will be the least of our problems. That if the dollar loses its status as a reserve currency, it will be because we are no longer a place that provides rule of law.

 

It will be because we're no longer a superpower. It will be because we are no longer trusted. And if those things happen, the fact that we can't save 20 basis points and can't have the extra security that comes, and there's some limits on the scale of our borrowing, those will be the least of our problems the day the world is united against us.

 

And so I think the right way to think about our reserve currency status is to think about it in a broad context where it's not that we really need to worry that bad things will happen because we've lost reserve currency status, it's that it will be yet another symptom of bad things that today are a serious threat in our country.

 

Last thing I want to say something about is a consensus that seems to have emerged over the last 15 or 20 years that I used to kind of buy into and now I think might be misguided. And that is that monetary policy and the printing of money or the setting of interest rates because of the dynamic consistency problem is a sacred thing from which independence needs to absolutely be there for the reasons that are commonly talked about.

 

But financial regulation, that's like a political thing that needs to be accountable because it's Just another kind of policy like everything else. So it's unthinkable that the chairman of the Fed resigns when we have a new president, but becoming quasi obligatory that the Vice chairman for regulation and supervision turns over, it's essential that the chairman of the Fed delegate heavily to the vice chairman for regulation and supervision.

 

Because if the chairman started taking strong opinions and making his or her weight felt on regulatory questions, then they'd be enmeshing themselves in politics and then they couldn't be relied on to be completely independent and reappointed by presidents of either party. Maybe that's right because there are all kinds of judgments involved in regulation.

 

Maybe that's right because the dynamic consistency problem that is the core of the case for monetary independence is much more present in that area than it is with respect to regulation, that's possible. But when we've got a government that extorts institutions, extorts law firms, extorts universities, on occasion, extorts companies entirely lawlessly, and bank regulators have basically legally have the power to say I'm not comfortable with risk controls at your bank and I think your bank is a threat to fail in a dangerous way.

 

So your bank is closed with far less safeguard than surrounds what the President of the United States is doing to law firms and to universities. When that power exists and when leverage brought on financial institutions is basically the power to transfer resources, the power to lend is the power to give.

 

Anybody who doubted that just needs to considered the PPP program a few years ago. Are we sure that it's such a great idea to say that it's really important to ensure that financial regulation is politically responsive? Are we sure that that's really more important than the monetary dynamic consistency stuff?

 

I'm not at all sure. There's been this huge set of repeated demonstrations all over the world that the people hate inflation. And so doing inflationary things isn't such brilliant short run politics. There are enormously sensitive markets. I'm for monetary policy independence, but gosh, when I think about where the excessive intrusion of politics could do damage, I'm not at all sure that this idea that financial regulation should be politically responsive, but the other stuff should be entirely insulated because they're of entirely different magnitude.

 

I'm not sure that I'm completely convinced of that argument. And so I think all of you, as you reflect on central bank regulation and the structures of central banking and the political institutions surrounding central banking, need to think about kind of a new thing, tyrant risk as an aspect of the analysis and I suspect in some contexts, it will drive towards somewhat different conclusions.

 

Thank you very much.

>> Arvind Krishnamurthy: Okay. Thank you, Larry. I have done a poor job on time management, which is to say we are out of time. So my suggestion is we close right now. And I know there's good discussion we can have. Let's have it over the break rather than take more time.

 

So thank you again to all the panelists.

>> Mickey Levy: This next session is entitled Finishing the Job Risks Ahead. And before I begin, John Cochrane, Mike Bordeaux, thanks so much for organizing this and John, congratulations. So when we think about finishing the job, two observations come to mind. First, the Fed has not achieved its dual mandate.

 

Inflation remains well above 2% and the general price level, of course, is nearly 25% higher than it was pre pandemic, which does have adverse impacts on American citizens. Second, to finish the job, the Fed needs to have a robust strategic frame framework that guides it toward the right monetary policy.

 

The Fed's current strategic review provides a timely opportunity to correct some of the flaws in the 2020 plan, including, you know, it's real clarity and it's an objectives and, and restoring some much needed cemeteries. And I would add that while the Fed covets its discretion to help avoid future policy mistakes, I would love to see the Fed consider how to better make use of systematic rules like the Taylor rule as an input to its discretionary conduct of monetary policy.

 

So we truly have an outstanding group of panelists who have a lot to say and we'll get right into them due to a request for changing the order. So we'll start with Peter Ireland, he's a professor of economics at Boston College with a focus on monetary policy and he's my colleague on the Shadow Open Market Committee.

 

Kristen Forbes is basically the all everything professor of management economics at MIT Sloan School and a significant earlier contributor with critical roles as a policymaker. And Jim Bullard, the dean of Daniels Business School at Purdue University and former president of the Federal Reserve Bank of St. Louis. And I note that Jim is also the newest member of the Shadow Market Committee.

 

And then Jason Furman, Economics professor at Harvard and was chair of the Council of Economic Advisors under President Obama and I would say continues to play a critical role in the policy debate about economic policies. So we'll start with Peter.

>> Peter Ireland: Okay, thanks a lot, Mickey. And especially with three of us from Boston on the panel, thanks for not saying anything about the Knicks.

 

I really can't explain what's going on there at all. Anyway, the Federal Reserve's unique decentralized structure with the 12 reserve banks scattered across the country counterbalancing the Board of Governors in Washington. Has historically endowed the system with a fair degree of intellectual diversity, which has worked in turn to lead to significant innovations in both monetary and bank regulatory policymaking.

 

All of that is very nicely documented in a series of papers written by one of our hosts today, Mike Bordeaux. Together with Ned Prescott from the Cleveland Fed, who's also here today. Recently, it seems, though, the Fed seems to have lost some of that intellectual diversity. And one of the ways that loss in diversity has manifest itself is in a kind of narrowing in the range of analytic approaches being used by FOMC members to evaluate their monetary policy options and to explain the rationale for their monetary policy decisions to the public.

 

So let me back up a bit and explain. The dominant approach to monetary policy evaluation at the Fed is, was, and probably always will be the Keynesian one. According to Keynesian analysis, the Fed Reserve conducts monetary policy by managing interest rates. By managing rates, the Fed can induce consumers and businesses to rearrange their spending patterns over time.

 

And those shifting spending patterns then impact on today's rates of aggregate resource utilization, the output gap, the unemployment rate, and so on. And then finally, working through a Phillips Curve, changes in unemployment affect inflation. So within the Keynesian model, the Phillips Curve plays a key role in helping us understand and explain how and why monetary policy actions that start by affecting interest rates ultimately impact on inflation and the economy as a whole.

 

It's not that surprising then to observe that application of Keynesian analysis becomes more difficult during periods of instability in the Phillips Curve. So let me just mention two very recent examples of that. First, during the extended recovery and expansion from the 2008, '09 recession, the unemployment rate in the United States gradually declined and eventually reached levels that by historical standards were really quite low.

 

According to the Phillips Curve, those very low rates of unemployment should have worked to push inflation all the way back to the Fed's 2% long run target, below which it had fallen during the recession, but inflation never quite got there. And then second, and most recently, the FOMC has been working hard to bring inflation back down after the unwanted surge in 2021.

 

According to the Phillips Curve, that kind of disinflationary program should require us to suffer through a period of elevated unemployment. So far, though, inflation has come down by a lot. Unemployment has gone up by just a little. Now, as that last episode indicates, Phillips Curve instability does not have to be an insurmountable obstacle to effective monetary policymaking.

 

But that brings us back to the issue of intellectual diversity, because without an alternative framework to fall back on, it does seem like FOMC members have been left somewhat adrift by Phillips Curve instability, with difficulty explaining to the public what they're doing and why. Fortunately, though, there is an alternative analytic framework that any individual FOMC member could take and use right off the shelf to help restore some much needed diversity to Federal Reserve discussions, decisions and policy statements.

 

According to this alternative analytic framework, the Fed should set aside talk of the Phillips Curve and the inflation, unemployment, trade off that talk of the Phillips Curve ultimately leads to. And focus instead on the central bank's ability to influence the growth rate of nominal income and spending, that is nominal GDP.

 

And as I'll explain this alternative analytic approach, it comes from a different intellectual tradition. It comes from the monetarist as opposed to the Keynesian tradition. But first, just a few quick arguments to support the idea of nominal GDP targeting. First, nominal GDP, it's a nominal variable. It can't be directly controlled by the Fed, of course.

 

But as a nominal variable, there can be no question that through the appropriate choice of policy actions, the Fed reserve can set and hit with a tolerable degree of accuracy any target for nominal GDP growth it chooses over periods extending out, let's say, two to three years. Second, that first point notwithstanding, nominal GDP growth decomposes naturally into an equally weighted sum of real GDP growth on the one hand, and inflation on the other.

 

So by stabilizing nominal GDP growth, the FOMC would continue to pursue modest stabilization objectives for the real economy in the short run, yet even as it preserves longer run price stability. That's to say, the framework is entirely consistent with the dual mandate. Third, and especially important, in the unusual times we find ourselves in today, shocks to aggregate supply move those two components, real growth and inflation, in opposite directions, with muted effects on nominal GDP growth as a whole.

 

So by focusing on staying focused on nominal GDP growth, FOMC members could help themselves see through the effects of aggregate supply shocks and avoid the kind of over accommodation that seems to have plagued us in 2021. That's a point that's been made quite nicely by David Beckwourth and Pat Horan in some of their recent work.

 

And then fourth, and finally, this is what gives nominal GDP targeting its monetarist flavor. The equation of exchange links py, which is nominal GDP to mv, which can be interpreted as a velocity shift adjusted monetary aggregate. So Phillips curve instability is, if you will, the Achilles heel of Keynesian analysis.

 

Similarly, as we all know, shocks to velocity or the Achilles heel of monitor is. But by staying focused on nominal GDP growth instead, the Fed would automatically adapt to shifts in velocity by taking policy actions that generate offsetting movements in money growth, insulating the economy from the effects of those shocks.

 

Okay, so last question. How could any individual FOMC member make good use practical use of these ideas? Okay, well it might be as simple as making consistent repeated reference to a graph like the one I'm showing you here, where the blue line traces out year over year growth in nominal GDP.

 

And the red line traces out a 4% reference value corresponding to 2% growth and 2% inflation. I say reference value instead of target just to highlight. And this is another point David's made in his recent work, nominal GDP targeting does not have to supplant flexible inflation targeting. The analytic framework can be used to support the policy of flexible inflation targeting.

 

Okay, but this is my point, really, the picture, it speaks a thousand words. Put yourself in the shoes of an FOMC member or a college professor trying to explain to an audience of non specialists what the Fed has been doing and why over the last 15 years, using a narrative built around the Phillips Curve.

 

It's not gonna work. On the other hand, the graph allows us to easily identify three distinct episodes in recent US monetary history, each of which has its own lessons to teach us today. So first, from 2010 through 2019, the blue line stays remarkably close to the red. Nominal GDP growth was remarkably low and stable.

 

So for me at least, the lesson looking back on that time is be careful what you wish for. Back in those days, a lot of economists, myself included, spent a lot of time and energy agonizing about the so called problem of one and a half percent inflation. Like if only that were our biggest problem now, okay?

 

Second, all hell broke loose in 2020 at first, for reasons completely beyond the Fed's control. And yet the surge in nominal GDP that followed is a clear indication that the Fed overdid it over accommodating supply shocks. That's an important lesson we should keep in mind for today and for the future.

 

But third, and finally, and on a more optimistic note, recently the blue line has been converging back to the red. We're still a little bit too high. Nominal GDP growth year over year, 4.75%. So little less than one full percentage point above the guideline or the target. But we're getting there.

 

So any individual FOMC member could use this graph to reassure the public that the policy actions taken since 2022 are working and have worked as intended to bring inflation back down to more tolerable levels while still allowing for stable, steady real economic growth. In conclusion, intellectual diversity. It does not have to devolve into the warring tribes of macroeconomics, especially at times like we face today where uncertainty looms so large.

 

It can really help to look at the economic picture from a couple different angles and to use the results from one line of analysis as a cross check against those from another. It so happens, with reference to my graph, I think Federal Reserve policy is pretty much on track right now.

 

If I were a committee member, I wouldn't be pounding the table for big changes in either direction. On the other hand, I think FOMC members would have a much easier time explaining to the public, and maybe even explaining to themselves what they're doing and why, if they would just set aside the Phillips Curve and focus on nominal GDP instead.

 

Thanks.

>> Kristin Forbes: Thank you very much. It is a pleasure to be here, and especially here to honor John Taylor. I first met John Taylor about 25 years ago when I came back from a run and there was a message on my old fashioned answering machine. It said, this is John Taylor from the Treasury Department.

 

Call me back with a number. And I was this close to deleting it. And those were those old machines. Once you delete it, it's gone. Cuz I remember thinking, why would John Taylor call me? The new professor at MIT, and it's sort of interesting looking back. It was, why would John Taylor of the Taylor Rule call me not Under Secretary of the Treasury?

 

It was the Taylor Rule that made you so famous at the time. But then I did call you back thinking that if this was a joke, it was really a bad joke, even by the standards of economics grad students. So maybe it was legit, and it was, and you tried to persuade me to come work for you at US Treasury.

 

And I remember I said no to you multiple times. And that's when I learned how persuasive you could be and how you do not take no for an answer. Something that served you well in government. You did keep improving the offer. And finally I accepted and came to work for you.

 

And it completely changed my career path. After that I still went back to academics, wrote papers, but really focused then on what matters for policy. You showed us how you can be an academic and affect the policy world in a good way. So thank you, John, for setting me on that path years ago.

 

Thank you.

>> Kristin Forbes: So without a doubt, if you hadn't set me on that path to care more about the real world, I probably would not be here today thinking about fighting inflation after the pandemic and what lessons we've learned. So for my comments today, I'm going to draw on a big research project joint with John Grimha and Ayhan Kohs at the World Bank, and in particular a paper we just wrote for the NBER Macro Annual.

 

Thanks to Valerie Ramey. So lots of technical details there, but I'm just gonna go through some of the highlights here. So let's start with what we all know, inflation spiked in 2021, 2022, 2023 hit 7.7% on average for advanced economies, highest since the 1980s. And when it hit these high levels, many prominent economists predicted inflation would not come back to 2% targets without a sharp and painful recession.

 

Some of those people are in this room. Don't worry, I will not name names, but just let's say that was sort of the common belief at the time. But then what happened? Inflation came down very quickly. Still some room to go in some countries like the US, but the IMF is predicting inflation will average 2.0% in 2027 in advanced economies, so pretty impressive disinflation.

 

But what's really remarkable is this happened without sharp output losses, without major recessions and sharp increases in unemployment. Some countries even avoided recessions at all and that's captured in the sacrifice ratio. Nice summary measuring looks at total or aggregated output losses relative to the unit of inflation reduction.

 

This is during tightening phases for advanced economies. And you just see how remarkable the post pandemic disinflation was. Inflation came down very sharply with minimal output losses. We haven't seen an episode like that since 1970, at least when our data begins. So you look at charts like this and you might say this was an unqualified success.

 

You see, my central bankers at events like Sintra, Jackson Hole were sort of congratulating each other. You did it without the pain that was widely predicted. But for my comments today, I wanna raise some cautions. This was successful disinflation by some measures, but there were also some pretty big costs and risks.

 

Some didn't play out, but following the strategy for the next increase in inflation would be risky and I would not recommend it. So in particular, I'm gonna draw three lessons from this disinflation period for the next fight against inflation, which may be starting sooner rather than later in the US.

 

I'll go through them quickly and then I'll expand on them in more detail. My first point will be that we need to think about success yet using a broader measure than just if inflation eventually gets to 2% with minimal output losses, we need to look at the path and what happens in the price level in between.

 

A nice compliment to Peter's comments. Second, we need to be wary of the strategy of starting to tighten policy late and then raising rates aggressively. That has some pretty substantial risks and costs. And my third point will be we need to put more weight on inflation anchoring and reinforcing central bank credibility worked last time, may not be as strong this time around.

 

Before I go into those three points in more detail, two really big caveats. Some of my criticisms, I realize are with the benefit of hindsight, it was a lot harder to make these decisions in real time. Fully appreciate that. And also that many aspects of the pandemic were different.

 

We don't wanna draw too many lessons from that. Hopefully we will not go through another experience like that again in any of our lifetimes or longer. But the lessons I'll focus on, I think are lessons that persist across other inflation episodes, especially if there's an important supply side component.

 

So, bottom line, while the strategy to fight inflation largely worked last time, it did have its important costs and downsides. And we want to be careful following that strategy when inflation picks up again again, maybe starting very soon. Okay, so let me go through the lessons in more detail.

 

First, let's think about how we measure success during a disinflation strategy, if the strategy worked. And for this I'm gonna drill in more just on the US so we can really be specific, not look across a broader set of economies. This shows sacrifice ratios for the US during each of the historical tightening phases in the US since 1970.

 

For core and headline PCE inflation, you see sacrifice ratio during the most recent disinflation was very low. I didn't forget to draw it on the graph. Even, if you can't see it in this giant screen, it is there. The sacrifice ratio is 0.04 this time around based on headline PCE inflation.

 

So why was this ratio so low? It's a ratio, there's two components, let's look at the components. Start with the headline or the numerator, which is the total output losses. They were tiny during this recovery. And when you look at the denominator, the reduction in inflation that was very large.

 

So both of these parts of the ratio were actually at historic records relative to any tightening phase since 1970. So not surprisingly, you put a tiny, tiny number in a numerator, a big number in a denominator, the ratio is close to zero. So this really shows how remarkable this recovery was and why it's not surprising.

 

A lot of central bankers thought this was a very successful disinflation. Minimal output losses per large inflation reduction. But if you leave the halls of central bankers and conference rooms like this, as the people sort of making the food driving you around, was this a successful disinflation? Most will say no.

 

And we've seen that in the votes in a number of different countries where governments in office have lost power. And we've seen it in a lot of polls of consumer satisfaction. So people are not happy despite what looks like successful disinflation by these measures. Why not? What explains the disconnect?

 

It is largely, not entirely, but largely because of what happened to prices in the adjustment. So this graph shows what happened to the PCE price level starting from one year before the first rate hike of different tightening phases in the US since 1980. The yellow line shows what would happen to prices if inflation was at 2% over this four year window one year before the race.

 

First rate hike to three years after. The red line shows what happened to prices this time around. Price level increased by about 17% over this fairly short window. That was very painful for people who were not expecting it and had become accustomed to inflation around 2% or lower over previous decades.

 

Of course central banks are not in the popularity business. Just cuz people didn't like this doesn't mean it wasn't the right policy. But there are reasons why central banks should care about such a large increase in the price level. It was so large it has changed the price and wage price and wage setting process in ways that will persist even as inflation falls to 2%.

 

We've seen it where consumers are now much more sensitive to prices, even short term changes in inflation. Now we're going to affect inflation expectations more, even medium term inflation expectations more companies now are much faster to adjust prices when input prices change. So there have been changes in the monetary policy transmission mechanism and inflation expectations are probably not as well anchored.

 

So even if inflation comes back to 2%, the big increase in the price level will likely persist. Second lesson, so a lesson from that is next time around when inflation hits, we probably should pay more attention to how you get inflation inflation back to 2%. How much does inflation overshoot and for how long that can affect the transmission mechanism going forward.

 

Second lesson is we've already heard quite a bit about the response to the post pandemic inflation by central banks was a slow start to raising interest rates. I hit a couple of different metrics of that which I will go skip because we already saw a lot of this yesterday with Taylor rules where the Taylor rules clearly showed the central banks were slow to start tightening as economies recovered and inflation picked up.

 

But then they raised rates very aggressively. So I know better than to show any other way of showing this than the Taylor rule. So since we saw that yesterday, so let me just jump to what the lessons were of the strategy. Start late, start raising rates rate, but then sprint raise rates aggressively.

 

Some might argue that worked pretty well. Did get inflation down with minimal output loss. So in this research paper we try to quantify the pros and cons of this strategy and really put some numbers on it so we can learn for next time if this strategy made sense.

 

So let's look at pros and cons of each component or a of couple components of the strategy. Start to raise rates late. That does have a couple big important benefits. It does mean you have more time to assess what the outlook is, especially in a period of high uncertainty.

 

Assess if the recovery is ingrained before you start hiking. Also gives you time to avoid breaking past policy commitments. If you committed to guidance, committed to asset purchase programs, you can exit gradually before raising so really important benefits which undoubtedly contributed to the slow start. But there are some pretty big costs.

 

If you delay raising rates, prices go up more, inflation goes up more, price level goes up more and you're going to get a bigger price level overshoot. And we quantify that and that isn't the most important driver of high inflation, but it does add meaningfully to the increase in the price level.

 

Also then since the price level goes up more, you need more aggressive rate hikes to bring it back down. So pros and cons. What about the trade offs of more aggressive rate hikes? Another key part of the strategy, aggressive rate hikes did have some important benefits. It did bring inflation down faster.

 

It also reinforced central bank commitments and credibility, especially the supersized rate hikes some central banks did. But we also quantify some pretty important loss costs. More aggressive rate hikes do mean larger output losses. And also when you raise rates faster than people expect, you're more likely to break some something.

 

We saw warning of that with SVB and the regional banks took another government stepping in to stabilize things. But that's an important warning going forward. If you raise rates very aggressively, you do increase risk that something breaks in the system. Also when we try to quantify this, what comes through very clearly is, well, these strategies sort of largely work to bring inflation down with minimal output losses.

 

A key tenant that made it all tie together without larger output losses was the strong anchoring of inflation expectations combined with strong central bank credibility going into this inflation period. And that is so important. I'm gonna make that my third and final point, which is the importance of inflation anchoring in central bank credibility.

 

Well, just about every strategy we look at for monetary policy has pros and cons, costs and benefits. There's trade-offs, you weigh the trade-offs when deciding how to use them. The one policy that doesn't seem to have trade offs, at least in terms of macro variables, is inflation anchoring and central bank credibility.

 

Those have very strong significant benefits in terms of reducing sacrifice ratios leading to smaller output losses and smaller increases in the price level. So that is a reminder these are key priorities, key parts of any central bank strategy. You need to prioritize inflation anchoring. But what worries me is we cannot take that for granted today.

 

Some measures of inflation expectations, like here's one. U Michigan five year inflation expectations, have recently spiked to levels that we haven't seen since the early 1990s. This is just one measure, others have not gone up as much. But we're seeing them go up in a number of measures and not just in the US even in the UK for example, we're seeing some of the long term measures of inflation expectations go up in ways that should be a red flag.

 

We came into the pandemic with inflation expectations very well anchored at two, if not below. In some countries after the surge of inflation, they're not as well anchored. So counting on them staying there for the next inflation surge is risky. So let me just conclude, so what happens when inflation picks up again, something we might be facing sooner rather than later in the US.

 

What are the lessons we've learned? I think big picture, post pandemic disinflation was successful by a number of metrics. There is a lot we can learn, but there's also some aspects of that strategy we do not want to repeat. We should pay more attention to the extent and duration of deviations in inflation.

 

It's not just getting inflation to 2% at some distant point in time. Let's look at what happens to the price level and the path there fits nicely with Peter's work. Second, central banks should try, if possible, to act pre-emptively. Don't wait and start late and then sprint and raise rates aggressively.

 

Got away with it once, it's a risky strategy to count on in the future. Third, protect the anchoring of inflation expectations. We can't count on them the way we did before. So overall, next time inflation rears its ugly head, I think we should think about a more balanced adjustment path.

 

Here's a rough ratio we put together. It looks at the accumulated change in prices during tightening phases relative to the accumulated output losses. So it's basically a measure of when you have to make an adjustment, how much is through prices versus how much through output or activity. Sometimes it's pretty balanced, but what you see is how unusual it was during the most recent period.

 

Basically all of the adjustment happened through prices, nothing through activity. That's probably not a strategy you want to replicate again. So lots of interesting implications for the next increase in inflation and particularly in the US in response to tariffs. But I will leave that for the panel discussion.

 

Thank you.

>> James Bullard: Great, thanks. Thanks very much to John Cochrane and Mike Bordeaux for organizing this fantastic conference to honor the career of John Taylor. Fantastic career. He's been a great mentor and supporter of mine. I just wanna align my comments with everything that's been said here about the intellectual rigor, but combined with the kindness and the willingness to debate everybody, I think that's just a fantastic legacy.

 

So congratulations to John. My comments are gonna dovetail, especially with Peter Ireland's comments. This conference is a bit of a victory lap about all the great things that have been accomplished in the last 50 years by many people in this room in thinking about how to conduct monetary policy better and identifying the critical aspects.

 

But all is not well in Macroland. And I have three suggestions for what I think is gonna have to happen going forward if we're gonna continue to maintain the same kind of cohesion and relevance for policy that we've had in the last 25 years or so. So I'm gonna make three suggestions.

 

To possibly improve monetary policy, one has to do with tweaking slightly the sticky price assumption that has dominated thinking. Another is to deal more explicitly with heterogeneity. There's a big Hank literature out there, and I'll talk about that a little bit. And finally we'll talk a little bit about net assets out there, especially federal debt, which is a big concern in this room.

 

But I wanna think about that problem a little bit differently. So all of this has to do, in my mind, with taking the precepts of monetarism, but blurring the distinction between what, what the Chicago school would have called money and versus debt. But we blur that distinction a little bit in these papers that are cited at the bottom here.

 

One is published with Ardi Singh and Yasek Sudha, if you wanna look at that one. The other one is a manuscript that I'm working on with my graduate student at Purdue. So sticky prices, the profession became aware and internalized the idea that you had to have a friction if you're going to rationalize monetary policy.

 

That for a lot of reasons, that came to be sticky prices. That was often thought of as a shortcut and, we'll revisit that later, but it's never really been revisited. I've never thought it was a great assumption. It was heavily criticized at the beginning, but you needed a friction, so let's, let's go ahead and do that.

 

So what you're saying with that when you're trying to communicate to the outside world is that the reason you need this elaborate monetary policy apparatus is because firms can't be trusted to maintain to change their prices at the appropriate time. It's not a great rationale. And when you look at times of high volatility, firms are perfectly willing to change their prices in those times, and we certainly saw that in the last couple of years.

 

So, could the profession do better? You are gonna need a friction to rationalize monetary policy. If you don't have a friction, you're gonna get the real business cycle right back in your face. So you gotta have a friction somewhere. But I think we could do a little bit better with a different friction.

 

And I think that different friction and different people have commented on it here in different ways, but it would be nominal contracting. Doc P Schneider in particular talked extensively about reams of nominal assets that are out there and how a surprise inflation or unexpected inflation would revalue all those nominal assets.

 

So if you build a model with that friction, nominal contracting friction, you'll come to a conclusion similar to the sticky price models in that what you want to do as a monetary policymaker is get back to the wixelian natural real way of interest that Mike Woodford talked about.

 

So it's exactly the same in that respect, but it would be a better friction and we can build on it more easily. As in the next two points you'd be saying that the reason you have elaborate monetary policy processes in all these oecd, well, really all countries around the world is because there's all this nominal contracting going on.

 

So what you really need to do is promise the right level of nominal GDP or the right price level out in the future so that people are sure that when they contract in nominal terms, they're going to have enough nominal dollars to pay off all their debts. If that works well, then you're gonna have a great outcome.

 

And optimal monetary policy would get the nominal contracts to behave as if they were real state contingent contracts, which are the optimal ones. That would come from economic theory. So I think this is a great story about what monetary policy is actually doing. We're all contracting, let's say five years in the future or 10 years in the future.

 

We wanna know what that price level is gonna be out there. The central bank can't control the real growth rate of the economy, but they can control the price level in a way that'll make sure that the right amount of nominal dollars is there in the future in order to pay off all the debts.

 

So you get a high in the model. This works perfectly actually and you get really great outcomes. So the second step then is to deal with household heterogeneity more seriously. So Gini coefficients are notoriously high in the US and really around the world, but post war macro has not wanted to deal with this or has not been able to.

 

I think the idea was let's walk before we can run. Let's write down models that don't try to take on heterogeneity. But now if you don't take on heterogeneity, then you don't have anything to say when that issue becomes the most salient issue. And I think that happened to macroeconomics in last decade.

 

You do have a burgeoning Hank literature which is fantastic work, a lot of great things happening. But if you look at the Bandari et al paper in econometrica, that's about optimal policy in the Hank model. That paper says that the traditional distinctions I believe everyone in this room has about what's what proper fiscal policy is versus monetary policy, all gets blurred.

 

The Ramsey planner in their paper wants to provide insurance to all these households that are experiencing idiosyncratic risk. And so the monetary policy looks totally different from a Taylor rule, totally different from what we're used to talking about and we have been talking about over the last couple of days.

 

But if you're gonna do this, well, either that literature is just gonna go off the rails, it's possible, or we gotta find a way to connect that literature to all the great lessons that were learned over the last 50 years and then work from there. And so you need a benchmark model that can handle that.

 

And that's what we're talking about here. So what you can do is in the heterogeneous agent literature, they're always talking about uninsurable idiosyncratic risk, which is a great thing to talk about, but they should have more aspects of life cycle in there because life cycle is a big part of inequality in the data.

 

Certainly people that are closer to retirement hold more assets and people are in the middle of life cycle, earn a lot more income. So you're gonna get some of the Gini coefficients just from life cycle alone. And so you should put that more squarely in the middle of this analysis.

 

Huggett Ventura in your own found that 63% of lifetime earnings can be explained at the beginning of the life cycle. Heckman is another one that has talked about this kind of thing. So you should have a model where when they're coming into your model to analyze, they're 20 years old, you should be able to predict a lot of their lifetime income.

 

On top of that, there's shocks that happen during your life, all kinds of different things. That should be about 37% by extension. So that's why the most recent paper is called the 37% Luck Paper. So if you do this, put this together in a model, you'll get high levels of inequality, but you'll maintain conventional monetary fiscal boundaries.

 

So the central bank wants to have a smoothly functioning credit market. They can do that according to the model. And then the fiscal authority can tax as they wish to reduce the consumption Gini coefficient if they want to do that. And you can talk coherently in a way about a heterogeneous agent model that connects to everything that's gone on that's been talked about in this room.

 

And then from there you can do perturbations on that kind of model. So it's a benchmark model, you can do perturbations on that make it more complicated, do more complicated types of calculations. So the third point would be to think differently about nominal assets that are out there.

 

So, in this kind of model, you're gonna have a natural demand for nominal assets. Well, where's this natural demand coming from? It's because there's uneven income across the life cycle. And because of that, you wanna use those types of agents want to use asset markets in order to smooth consumption over their life cycle.

 

So they're gonna have a certain amount of demand for nominal assets. And we're forcing all this to be in nominal terms cuz we have the Dobke Schneider idea. And that should be fine. And then there'll be some luck experienced over the life cycle and that will matter too, for how many assets each individual asset, each individual agent wants to hold.

 

So in the US data, now these are net assets. So you've got a net out. So these are assets in positive net supply. You would think of that as being corporate debt that's referring, that is a nominal claim to physical capital. You might also think of federal debt and positive net supply.

 

But it's a little fuzzy exactly how to get this, but we should be working that. That's 4.52 GDPs in the data. So I just wanna impress upon you that that's a lot of dough, over 100 trillion. And so if you're moving the price level around erratically, yeah, well, that's gonna have a huge effect on the economy.

 

That's why this is a good model of what monetary policy is trying to do. But if you have notions of excessive or unsustainable levels of nominal assets, you have to ask yourself, well, how many nominal assets does this society want to hold? And what would be the normal amount of nominal assets that they're holding?

 

And then is there too much out there and is it net excess supply or not? And that would help us address issues about federal debt, I think, which have been hard to answer. And we've all been saying the sky is falling for 30 years. It's no wonder no one believes us after a while.

 

So I think this might give a little bit different angle on how we should think about debt. So if you had a multi country model, then just by extension, which I don't have, but I would like to build. So if there are enterprising graduate students here, let me know that there could be demand for nominal assets coming from the other country based on its life cycle characteristics and its luck characteristics.

 

And then one country or the other could be issuing, trading those assets around globally. So you'd have to assess whether there's too much debt globally and not just whether there's too much debt in one country or not. And so this I think lends a little light on why it's been hard to assess whether particular debt to GDP ratios, as has been done in the literature, 90% was at 1 point thought to be a sort of limit.

 

Is that really meaningful when you think, start thinking about things from this angle. So three suggestions then about what to do just so you don't forget what they are. You should switch off the sticky price assumption, which is not terrible, but just move it a little bit over to the credit market and think about the Dobke Schneider friction.

 

So it's just that everyone has to contract in nominal terms. That's gonna be okay in the end if you have a good monetary policymaker because those nominal contracts will act just like real estate contingent contracts. You should develop a more extensive model of a household inequality so you can talk more specifically, answer questions more specifically about how what monetary policy is doing versus what fiscal policy can or should be doing.

 

And then finally, this will give us a little bit different angle on assessing total nominal assets, net nominal assets in the economy, and whether there are too many of them or too few of them. What we think would happen if there was too many. Okay, I'm gonna stop there, thanks for your attention.

 

Thank you.

>> Jason Furman: Thanks, I'm glad to go last because I have as many slides as Kevin Warsh and Larry Summers combined. I had heard for years about this legendary conference and wanted to get myself an invitation. And I thought maybe I could just write John and ask for an invitation.

 

But I thought that was really undignified. So instead I wrote a Wall Street Journal op ed in December saying that after years of resisting, I'd finally come around to the Taylor rule and right after that, my invitation showed up in my inbox. I'll come back to that because it'll fit in with some of the themes of my remarks.

 

But I very much relate to what Peter said about intellectual diversity. And my perception, as someone who's been sort of near monetary policy for a long time but never in it, is that the world's central banks are roughly operating at about the 80th percentile of goodness. And by the way, everything else in economic policy is at the 1 percentile.

 

So 80 is pretty good in terms of the way they operate, the way they communicate, the outcomes we get, etc., that that is better than it was decades ago. Moreover, the variance between different central banks is smaller than it was decades ago because the amount of communication conferences that people are at together, ways in which they're trained, ways in which they speak, has really, really converged.

 

That's a pretty good thing. And one wouldn't wanna give that up lightly. But there are things that are better than the 80th percentile, and trying to find them would be something that's worthwhile. But of course you don't want to end up at the 10th or maybe even worse first percentile in the pursuit of it.

 

So how can you continue to experiment, continue to improve in a world where there's just less variation and less lessons to draw? One of them is people outside central banks having ideas, ideas that are sometimes radical, sometimes quite different. John certainly has his share of those. When you're in government, you probably shouldn't do something unless you're quite sure and have kicked the tires hundreds of times.

 

When you're out of government, you don't wanna totally make stuff up at random, but the bar should be lower because you're generating variance generating ideas and other people can sort through it. So whether that's nominal GDP targeting, fiscal theory of the price level, alternative theories of inflation, more of those existing outside the central bank.

 

Second, there's then within the central bank the fact that every six weeks the FOMC gets together and almost every time there are 12 people who vote, all of whom claim to agree with the decision. Sometimes it's 11, but always it's 12. But then you look outside and there are thousands and thousands of people commenting and the one thing they all agree on is that they would have done something different and better than what the people in that room did.

 

To me feels like an unhealthy degree of agreement within the central bank. And so more different perspectives, more willingness to share those perspectives, more willingness to debate those perspectives would create possibly a healthier ecosystem in that regard. Now why did I come around to John's view? I started graduate school in 1994.

 

The first paper I was actually really excited about wasn't any of the Taylor rule, but was the staggered price setting and wage setting that to me showed that there wasn't this tribal distinction between the fresh water and the salt water. But one could reconcile them and not have to be tribal about that particular debate.

 

But if you were paying attention to the macro economy from say 1995 to 2019, the idea that Alan Greenspan, Ben Bernanke and Janet Yellen were all collectively much, much smarter than any incredibly simple formula. That every time they used their judgment, they used it to the better, whether it was in the context of global financial crises in the late 1990s, the financial crisis here, or COVID, and that you should trust discretion.

 

Well, within microeconomic research there's been a number of big revolutions, but one of the most important ones is a shift towards pre registration. And what pre-registration says is before you go out and collect any of your data, you say exactly what you're gonna do and exactly how you're going to examine that data, exactly what regressions you're gonna do.

 

And then you report them. With preregistration, you lose some creativity and flexibility that when you open up your data set you can sort of run some things you weren't planning on. Some quirk or anomaly comes up, you realize it needs to clean in some way, but you gain quite a lot in terms of not using all that creativity for the purpose of p hacking and data mining yourself to whatever conclusion it was that you had wanted.

 

And it's a tricky thing, it's not obvious the ratio between how much you want to tie your hands to avoid data mining versus tie your hands and restrict your ability to be creative and interesting about what you find. I would say over the last couple of years, the wisdom of that tying your hands and the benefits of that versus the cost of giving up on the creativity have really been impressed on me.

 

So just to give one very simple example of that is what do you use to understand what underlying inflation is? You don't want to use headline inflation, it's noisy. You wanna use some concept. Well, there's lots of concepts out there. You can use median, you can use market based core, you can use trim mean, you can use whatever sort of vivisected dissected subset of the inflation measure that you want.

 

I went and tried to look at the predictive power of these different ones and ran it through some different tests. And it turned out all these different ways of slicing and dicing the data were actually relatively similar in terms of their predictive power. You could make an argument for one versus the other, but almost they were all much better than underlying inflation.

 

And so you could decide each month you're gonna go through and figure out, based on that month's peculiarity, which things you want to add and subtract from the inflation index. And one theorem in economics is if you take out everything that grows faster than average and leave everything in that grows slower than average, you're gonna get a core measure that's lower than you otherwise would have.

 

And you can do that every month, or you can just decide, you know what, I'm gonna pick one of these and it may not even be the perfect one. But if I just stick to it and repeat it and use it month after month, I'm at least not gonna let myself fall into that trap of being the person that at first was saying that cars needed to be excluded from the inflation measure and housing included, and then the next year reversed it and took housing out of the measures and put cars in.

 

I'm not naming names here. I don't see the person in this room that did that. So that type of tying your hands. And what I do now is every month I do something called the ecumenical inflation measure. I take 21 different measures and report the median of them.

 

And I don't get to choose what that answer should be. The Taylor rule is a similar form of pre-registration. And by the way, I would say the Fed has done some of that too. As it shifted between different inflation measures. So I would much rather in addition to an inflation target, have an operational.

 

It's core, I would suggest core market based PCE excluding the imputed stuff. That's what we're gonna look at, that's what we're gonna talk about, that's what we're gonna focus on every month. Obviously our long run goal is still price stability but if it was something else that would be fine too.

 

It's the changing from month to month what sub indicator you're looking at that I think creates more problems than good things. Next place where pre-registration obviously shows up is that you pre-register the formula you're gonna use to combine those different data once you've decided on what those data are.

 

And I know this is the same thing that John thinks. I wouldn't still turn things over to a computer, at least not until ChatGPT6 comes out. Until then though, having a very, very strong default because people should have a very, very good argument for going away from that.

 

When you see a Taylor rule that said in early 2021 that the interest rate should have been 8 and instead it was 0, that sort of dwarfs any other error and it came out of the types of discretion and slicing and dicing the numbers and making predictions that introduced error and bias rather than wisdom into the process.

 

The last thing I'll say in the spirit of something that has some chance of being true but is not true enough that were I in charge of the central bank tomorrow that I would go out and do it. Is the amount of communication and noise around that communication by a number of different measures has gotten higher over time.

 

No one really likes forward guidance because constantly the bank is departing from the forward guidance that it had. There's a logic for it. When interest rates are at the zero lower bound and you want to lower the real interest rate by tying your hands in the future as inflation rises.

 

But with interest rates where they are now, there's almost no logic for it. So my suggestion would be to move interest rate setting closer to a random walk. For this to catch on, I'll need a better way to describe it than random walk. So what would that mean?

 

When the committee gets together, it decides what it thinks the best interest rate is based on the information available on that date. It sets that interest rate the minute after that meeting ends. The market expectation for interest rates at the next meeting are now a 50% chance that they'll go up and a 50% chance that they'll go down.

 

The chair's statement won't have any meaning at all anymore because the interest rate itself was the sufficient statistic. You don't even need a statement to go along with the meeting. It tells you everything that you know about where the state of policy is. And then you're as likely to go up and down in the future.

 

Now relative to where we are right now, what are you giving up on? You're giving up on gradualism. One of the issues with benefits of gradualism is you worry about instability in the financial system. But we had some very, very rapid rate movements in 2022 and 2023 that made me think that gradualism is less important than I had previously thought.

 

The second thing is maybe people think you're a bunch of sort of drunken idiots who are doing a random walk. And so you cut rates and then, wait, then you raise them again, then you cut them again, then you raise them again. So that would take a little bit of getting used to and more communication.

 

The flip side, the advantages are not just the communication and the noise around the communication and reducing the value of those open market operations, but also would mean that you're no longer basically guaranteed to constantly be behind the curve. If you're committed to gradualism and committed to forward guidance, you basically can't move the first time you think you should move.

 

You have to wait until you're really, really sure. So in some sense you think the Fed funds rate should be cut by 200 basis points. When you do your first cut and then you say, we're gonna cut at the next six meetings, that means you're always gonna wait too late to cut too late to raise rates.

 

And either be accused of being behind the curve or, or in reality be behind the curve. There's no central bank in the world that does this right now. So I'm not totally convinced that it's correct. There's some chance that it used to be closer to the way things were done.

 

So my modest suggestion would be that New Zealand try it out and we can all come back and discuss it at a future meeting here. And thanks for having me, John.

>> Mickey Levy: When I introduced this panel, I was remiss in not bringing up the issue of risks ahead.

 

So before we take questions from the audience, you've all articulated your strategy for how to improve the future. What are the risks ahead? I mean, does anything jump out of you now? And then we'll take quickly, questions from the audience.

>> Kristin Forbes: I can jump in is what I said in my comments is I worry that inflation expectations are not as well anchored as we have all come to believe and trust and count on when inflation.

 

The fact inflation went up to double digits in some advanced economies the last couple of years in medium and long term inflation expectations stayed pretty well anchored is really, really remarkable. Now inflation has come back down, but people are much more sensitive. I mean, open up the newspaper in the US, we know what's happening with egg prices on a day by day basis.

 

People are just paying a lot more attention. So I am worried if in the US prices go up, say around tariffs, even if all our models suggest it's temporary and it's something you could look through in some circumstances. That only works if inflation expectations stay well anchored. And I don't think we can count on it today the way we could a few years ago.

 

 

>> James Bullard: Yeah, I mean, what I was trying to get across in my comments was that the intellectual underpinnings of success in monetary policy are being undermined in the way the directions that the literature is going in right now. And if you take the Hank models very seriously, you might get, and I think the lead research does tend to be very influential over time.

 

You might get a very different room full of people and a different, very different type of monetary policy in the future. I'm not sure it would be good, but that's the direction things are going.

>> Jason Furman: I just think the uncertainty is just the biggest problem we face and there's three levels of it.

 

One is, what will happen to tariffs in July, for example, when reciprocal tariffs are supposed to come back and took a whole month to negotiate a free trade agreement. A free trade agreement, a sort of minor deal with the United Kingdom. What's it gonna be for the rest of the world?

 

Second is uncertainty about the consequences of that uncertainty we don't have notwithstanding research done including by people in this room I think a completely reliable way to plug uncertainty into a model and tell us what's going to happen to unemployment and inflation. And then finally there's this uncertainty about the outlook for uncertainty itself will in July we have a complete resolution to the tariff thing.

 

The whole issue will be behind us and we'll be focusing on tax cuts and deregulation or will this just pop back again constantly and that just three levels of uncertainty is the likes of which at least you know caused by policy we haven't seen before.

>> Mickey Levy: Questions from the audience Mike?

 

 

>> Mike: Comments and a question. First I applaud especially Jason, I interpret what you're saying is we need a little humility and in policy making and I think that's really really desirable. My second point is I view by far the greatest uncertainty and risk facing the economy is over long run productivity growth and what happens if there's any measurable difference in 1% or 2% over long periods of time.

 

What that does in populations that are not seeing their standard living grow any faster and the demands they place on systems and so on. So it's in the background we talk about short run stabilization policy but just FYI, let's not forget that it gets me to my third point in a question for Jim which is you emphasize Hank models.

 

And yes they give us some insight and you emphasize Bandari, Golosov and Sargent but that and fiscal monetary interactions and the Taylor rule doesn't work so well for a Ramsey planner infinitely live Ramsey planner incident program. But in that model you only have lump sum taxation and a linear labor tax and so you're ensuring against states of the world with monetary policy.

 

But we have very different fiscal instruments and they do a lot both to stabilize the macro economy to some extent with automatic stabilizer, do a lot to redistribute the way we have transfer payments. The way we have contingent transfer payments, depending on the state of the economy, and a variety of things of that sort.

 

Plus we have a progressive income tax, as many countries do. You could argue it's too progressive, not progressive enough, doesn't raise enough revenue, raises too much, whatever you want to do. But I would just be very careful about concluding monetary fiscal interactions based on a model with such primitive understanding, primitive modeling of the fiscal system.

 

We know from decades of public finance, second best public finance literature, results can vary a lot depending on what you assume the instruments are and how they're fixed and how much they can vary. So I just urge a little bit more humility in jumping to having the Fed be paying a lot of attention to inequality issues.

 

We have an old theorem in economic planning that you need as many instruments as you have targets. And so we better be pretty careful about trying to muck things up with having the Fed take even more things into account and try to compensate for inadequate redistribution or insurance in the fiscal system, when actually a lot more exists in the real world than in the model.

 

 

>> Mickey Levy: Steve.

>> Steven Davis: Thanks, super interesting panel. I wanted to pick up on one thing Jason Furman said. I share his concern about the extent of uncertainty, much of it induced, most of it induced by policy in the environment. He rightly pointed out that our capacity to quantify that uncertainty is limited and our understanding of how uncertainty actually works through the macroeconomies also limited.

 

There's many ways we can improve along those dimensions, but one that I've been involved in with folks at the Atlanta Fed and various other projects is to ask individual agents, influential ones, what they perceive about the environment they operate in and how it will affect their decision making and their plans over the next six months.

 

So there's the survey of business uncertainty fielded by the Atlanta Fed as one systematic effort in this direction. The questions we fielded, the special questions we fielded in the April 2025 survey and the results will be reported on a blog post next month, explicitly asked business executives. There's about a thousand of them who responded in the survey across industries and states, weather policy uncertainty.

 

We didn't describe it as policy uncertainty. We described in the question uncertainty about tariffs, taxes, etc., etc., five or six categories, whether that is influencing their plans over the next six months for investment and hiring. Okay, so about 40% of them said the uncertainty that they face in the Policy environment has caused them to scale back their hiring plans in the next six months and about half of them said it.

 

It's causing them to scale back their investment plans. They're a small percentage on the other side by the way that are increasing investment or hiring, but it's less than 5%. Those are big numbers. So then if they gave an answer yes, it's causing us to scale back or increase.

 

We followed up with a quantitative question so that we could get, and we're asking them to assess their own business outlook, not the macroeconomy. So that's a different object but just the bottom line. Numbers are businesses themselves. Business executives tell us that the uncertainty that's arisen in the past couple months is leading them to cut their capital investment spending plans by about 16% over the next six months and to reduce their gross hiring by about 13% over the next six months.

 

So those are non trivial numbers. They're probably not enough by themselves to drive the economy into recession. One last point on this. We also asked them what are the most important sources of policy related uncertainty in their own for their own businesses? And you won't be surprised to find out that tariff policy is the overwhelming winner.

 

 

>> Mickey Levy: Evan, did you, and then Sebastian.

>> Evan Koenig: So Evan Koenig retired from the Dallas Fed. This is motivated mostly by Peter Ireland's comments, but I think it's related to things that Jim said and that Kristen said. You were looking at nominal GDP growth over a four quarter period, I believe.

 

Is that the appropriate horizon? One reason we saw the increase in a huge increase in the price level was because initially though nominal GDP growth fell in response to the pandemic, it then overshot and way overshot for an extended period of time. Even though the growth rate has gotten back close to 4%, the level of nominal GDP is a heck of a lot larger than it would otherwise have been.

 

What's the appropriate horizon for looking at nominal GDP growth? We need to look at the level instead.

>> Mickey Levy: Sebastian.

>> Sebastian Edwards: Thank you. Sebastian Edwards, great panel. I have a question. Maybe two questions. Larry Christiano yesterday brought me all the way back to my undergraduate years when he drew the ISLM curves.

 

I learned macro, my first textbook was Martin Bailey. If you remember Martin, great economist for Chicago and in Maryland. Now the LM curve, which Larry Cristiano was shifting around is the synthesis of the supply for money and the demand for money. The one thing that we haven't heard in this conference is anything about the demand for money in an explicit way.

 

This brings me back to Argentina. Maybe the demand for money is not that important anywhere in the world, but I can assure you that in Argentina it is very important. And with CBDCs, there's no reason, if Argentina relapses and it's doing well right now, but relapses back into inflation, that there will be no demand for Argentine pesos, and the Central bank of Argentina will have a very difficult time.

 

My question is, is the demand for money still something that the people in the panel and generally in this conference worries about? The second issue, we've talked a lot about history of thought here. I really liked what Jim Bullard did, but I think that his nominal contracting one can find back Don Patinkin, who is another name who has disappeared from our discussion, and he was at Chicago, my first professor in monetary theory.

 

And if one goes back to his thick book, there's a lot of nominal contracting and real balance effects and so on and so forth, and they play a very important role in the transmission mechanism. So I wonder whether Jim's very interesting work, from what I could gather, would take into account some of that, those contributions.

 

Thank you.

>> Mickey Levy: Okay, I'd like the three. I'd like all the panelists to very quickly respond to the question most appropriately directed to them.

>> Peter Ireland: Sure, let me respond to you, Sebastian. So actually, in the paper I prepared for today's session, I dig one step deeper behind the trends in nominal GDP growth and look separately at M2 and velocity.

 

I think one of the ways in which nominal GDP targeting can add intellectual diversity is just to sort of gently push some economists in that direction. Along those lines, let me just mention M2 growth as it happens has stabilized at about 4% per year. Velocity is more or less back to where it was in 2019.

 

So again, using this as a cross check, what that tells me is that monetary conditions are normalized and consistent with a return in inflation back to 2%.

>> Kristin Forbes: I'll just jump in on the comments on uncertainty and productivity growth based on my experience when I was at the Bank of England during Brexit.

 

So this was a period we spent a lot of time thinking about what's the effect of uncertainty after the surprise Brexit vote. And initially we saw all the survey data collapse. We all knew uncertainty was bad, but it was very hard to know. Back to Steve's comment of what is the impact, how big will it be?

 

And the initial reaction by many people was this will freeze business and freeze activity and all the surveys suggested it would. So that caused the Bank of England to do a very aggressive easing in response to what we thought would be a collapse in output. But what we saw was actually how resilient firms were and consumers were.

 

Maybe half the country wanted Brexit, but companies adjusted pretty quickly in the short run. So the impact of uncertainty actually wasn't big short run. Where it hit was longer term in terms of investment. Activity continued, companies figured out how to work around things but they hesitated investment. And then that meant over time productivity growth fell quite a bit and now UK productivity growth is quite a bit lower.

 

So I see that as really the biggest risk in a lot of ways. We've seen how resilient companies are over the last few years, handling the pandemic, handling sanctions. We've seen trade reroute around the world. Companies are resilient, but there will be less investment. And that is in some ways the biggest cost is then lower productivity growth longer term.

 

 

>> James Bullard: Yeah, thanks. So thanks for the question. So I'm Michael Boskin, Public Finance has dealt with all this. I totally agree. But it does make sense that a Ramsey planner, if you had all this idiosyncratic risk out there, the planner probably is going to want to insure people against that risk if they can.

 

And they might use monetary policy to do that. That's the message of the Bendari et al paper. It was very powerful in that paper. Surely it's not a very realistic setting. I agree with that. But my point is write down a benchmark model that has the same heterogeneity that they have and then get the separation that we all think is there about from monetary policy and fiscal policy.

 

And why does that come about is because your monetary policy is influencing the real economy or the real interest rate for the whole economy. You got all kinds of people, rich and poor, young and old, that are using credit markets. So you don't wanna distort that because that's affecting everybody in the economy.

 

And then you wanna use fiscal policy if you want to redistribute to the lower end of the income distribution, use fiscal policy to do that. You wanna have a model that says that starts from that, that's your benchmark model. Then you go and do all kinds of things with heterogeneity from there.

 

So that's a little bit of a twist on what the Hank literature I think is doing. What's the horizon? Evan Koenig, what's the horizon for nominal GDP and the model I'm talking about, it'd be one period ahead, but by extension it's at all horizons, all the way up to 30 years or farther if you want.

 

So there'd be this whole path of nominal income that the central bank felt like they could realistically deliver on. And in the model they deliver perfectly. But you say, well, given circumstances in the economy and what I think I can do with the price level, I think the nominal income will be 5% higher two years from now, okay?

 

If you say something like that, then everyone goes and contracts based on that. And then you make sure you deliver on that. That's perfect credibility. And then you get this really nice outcome of optimal monetary policy. So horizons would, the answer is all the horizons, I guess. And on money demand, Sebastian Edwards, so there is money demand.

 

Like I said, you're blurring the distinctions that would be very popular in this room about there's something called money and then there's something called debt. But I would challenge you between 2010 and 2019, you seem to have a lot of pieces of paper out there that had an interest rate on them, but the interest rate was zero.

 

So what was the difference between that stuff and the currency that you were carrying in your wallet? Not only that, you had negative nominal interest rates during this period. So if you think more in those terms, maybe it's not so bad to think about the money as being interest bearing money.

 

How much demand is there for that? And then you do your monetarist type calculations. That's been unpopular, but I think that's the direction things should go in. And the model I'm talking about goes in that direction.

>> Jason Furman: And on productivity first of all for our long run well being obviously it's more important than anything else we've been talking about.

 

In some ways it does make me more worried about nominal GDP targeting when the variance of possible productivity outcomes over the next decade or two are much more different. Maybe there's some mechanism for adjusting what the reference target and the like is and in the shorter run it does raise some interesting questions.

 

First of all we're getting I think now more demand associated with the hope for future productivity than we are getting productivity. And even if we get the productivity will it be like Alan Greenspan? Was it great that he figured it out sooner than anyone else or did he just get lucky should the next central banker try to do that?

 

And I think the greater emphasis on rules over discretion would say don't try to be Alan Greenspan and readjust monetary policy based on a bet around productivity.

>> Mickey Levy: I wanna thank the panelists very much and the audience, and it's lunchtime.

>> Michael Bordo: Now we have some entertainment. Torsten Slok is going to give a talk. Okay? And I just want to say a couple of words. I've known Torsten a really long time. In fact, I knew him since he was a graduate student. He was my research assistant in a big project I did with Barry Eichengreen.

 

And I spent that year at Princeton University. I had a fellowship from Peter Kennan, and he did a fantastic job, and it was great knowing Torsten. And then from there he went to the imf, he went into the private sector, and now he has. Over the last few years, he's become probably the most prescient commentator.

 

Okay. On what's going on in the real world. So I think we're extremely lucky to have him here. I've been thinking about bringing him here a long time, so I'm going to turn the floor over to Torsten.

>> Torsten Slok: Thanks so much, Mike. I remember trying to simulate a model.

 

What had happened if we had not had the gold standard was quite a challenge with you and Barry, but thanks so much for having me. So what I'm going to talk about are issues around what is the outlook for corporate finance? And specifically focusing on what is the role of private credit?

 

And I'll make three conclusions in three different areas. First of all, we will have a look at what is the source of credit in corporate finance. Today, when we open our textbook, we normally think about it as, there's a bank, I need some money. I walk into the bank and I get a loan, and that has an interest rate, and that's what matters.

 

But as we all know, today the financial system has changed and evolved quite significantly. So therefore, the banking sector plays a very different role relative to what it used to do. So the first few slides will focus on what are the sources of credit, what are the types of corporate finance that are happening today.

 

Secondly, I'll turn to the role of private markets, and I'll focus on one very important issue, namely, why is it that financial markets are spending so much time on the s and P500 when there are 6 million businesses in the US with employment? So we'll look at a few slides of what is the size of private markets and what is the size of public markets.

 

And finally, we'll turn to a topic that we also just have discussed in several of the panels. Namely, what is the impact of tariffs on corporate finance? What is the impact of all this uncertainty in terms of how companies are financing themselves, and what does that mean for how we should think about borrowing and credit so with that little agenda, let's first turn to the first topic, namely the issue of what is the role of the banking sector in corporate finance?

 

And what you see in this chart here is simply I took the data from the flow of funds or the financial accounts at the Federal Reserve, as it's called, and simply divided what is bank lending divided by total lending to the corporate non financial sector. And as you can see in this chart here, the banking sector is playing a smaller and smaller role.

 

So this raises of course, a lot of questions around, well, what are then the other sources of financing? And if the banking sector is playing a smaller role, how should I, when I write down a model of the financial system, how should I think about what is the role of interest rates, credit spreads, different types of collateral, different types of lending, when you think about whether they are risky or non risky.

 

And the bottom line is as a starting point, that the banking sector just is not what it used to be when it comes to thinking about credit to corporates. And why is that the case? Well, that's the case because corporates borrow in many different ways today. Here are for example, some of the obvious normal examples and ways of looking at how do companies borrow.

 

Number one, of course, is bank loans. And again, in the textbook, we normally think about bank loans as something that goes back on the bank's balance sheet and that is also the traditional term loan. It is also the traditional revolving credit facility. But nowadays, as we also know, bank loans are also bundled and sold off as loans in markets.

 

So yes, some lending by banks ends up on bank balance sheets, but there's also some lending by banks that does not end up on bank balance sheets. That's of course the traditional way that we've thought about corporate credit and the traditional way we thought about borrowing. The second way, if I'm a company and I need to borrow, is of course I can go to bond markets.

 

The investment grade corporate bond market today is about $9 trillion in size. And of course I can do also high yield. I could also do convertibles, I could do various forms of financing that are other places to find money if I need money for a project as a company, other than going to a bank and borrowing other types of borrowing for companies now moves into the space where private credit is playing a very important role.

 

One area of course, that gets a lot of attention is direct lending. So direct lending is that Apollo gives a loan to a company and that has some terms and they have some covenants associated with it and that loan then plays out on its own as a private loan that basically is not on a bank balance sheet.

 

It's not part of corporate bond markets, but it's simply just a private loan between us and the borrower. Other types of corporate finance, of course, is asset backed lending, trade credit. You can have lease and equipment financing, hybrid instruments and securitization. So just to say, as we all know, it is just no longer the case that companies go into the bank branch and say, I would like to borrow and if they get a yes, it's great.

 

If they get a no, it's too bad. There are many other ways, of course, that corporates can borrow at the moment. And the conclusion is again that the banking sector is just playing a much, much smaller role than what it used to do. So why is this important?

 

Well, this is very important because if we begin to think about the structure of the US economy, most of their attention, if not all their attention in financial markets goes towards thinking about the S&P 500 companies. There is endless news on Bloomberg, CNBC, Financial Times, all newspapers around.

 

What are the S&P 500 companies thinking about and what are they saying and what are their earnings telling us? And that is of course all very interesting on its own, but that completely ignores that there are 6 million businesses in the US with employment. So why do we only spend time on 500 of those?

 

And one way of trying to assess what is the importance of all the other businesses that are not the S&P 500 companies is to try to look at employment in S&P 500 companies, which is what you see to the left, and compare that with total non farm payrolls.

 

So if you go in to your Bloomberg Terminal or FactSet or elsewhere and ask the question how many people work in S&P 500 companies? And the answer is it's around 29 million. That is the global number. So remember, Coca Cola also has workers in Canada, in Australia, in Japan, in Europe.

 

So if you add up all workers In S&P 500 companies, you get to roughly around 30 million. But now compare that with total employment in the US which is in round numbers around 160 million. So that immediately tells you that yes, The S&P 500 companies are important, but it is actually only about 20% of total employment in the US.

 

And if you begin to adjust for how many of the S&P 500 employees actually work in the U.S. you get that it's an even smaller number. So that's another way of saying yes, it's correct. If I'm Apple, if I'm Coca Cola, I can go to the market, I can issue bonds, I can also get a bank loan.

 

But if I'm one of the 80% of the companies that are not in The S&P 500, of course I need to finance myself differently. And that's in particular where private credit is playing a more important role. Another way of looking at that is to try to look at companies by revenue size.

 

And this chart may come as a surprise, but the data tells you, as I written in the title, that 87% of firms with revenues of more than $100 million are private. So this is also telling you that we have this idea of private companies. This is like small mom and pop companies, but that's actually not the case.

 

The vast majority of companies with, again, more than 100 million in revenue are actually private. So why is this important from a macro perspective? Because private credit and private equity is beginning to play a bigger, bigger role, but we are still relatively small compared to financial markets overall.

 

One way of looking at that is to look at this chart here that shows you at the global level all the way to the left. This is the size of global fixed income markets. They are at the moment, as you can see, about 141 trillion. According to the BIS, the global equity market is about 115 trillion.

 

And the total size of the entire banking sector in the world is about 100 trillion. If I now go in and add up what is the total amount of money in private credit and in private equity, the number that you get is about 15 trillion. So often it's mentioned, for example, in private credit, that has been growing and today it's about one and a half trillion.

 

And that is a big number on its own. But the bottom line still is that financial markets more broadly, if you want to finance yourself, you could go to bund markets, you go to equity markets, you could go many different places. But overall, private markets are still a relatively small part of the overall picture when it comes to to finance.

 

And if I now take the difference in the chart I just looked at and compare that relative to where were we in 2013 compared to where we are today. So these bars now tell you what has been the growth rate of different parts of the financial system. You will see to the left that global fixed income markets are about $50 trillion higher, global equity markets about $50 trillion higher, and the banking sector is about $40 trillion higher.

 

And global private markets are about $10 trillion higher. So, yes, it gets a lot of attention, all the growth that you're seeing in private markets, but private markets have actually grown in dollar terms much, much less relative to other sources. Of financing. So the conclusion is, well, of course private credit and private equity is indeed growing and it's growing quickly in percentage terms, but it's actually growing relatively slowly when you compare it to in dollar terms where what's going on in other parts of finance.

 

So if you are a company and you to get financed in some way or another, yes, private credit is one option and it is growing quickly in again in percentage terms relative to where we were 10 years ago. But the biggest growth in dollar terms continues to have been in other types of financing.

 

And let me now finally turn to the last point, namely discuss what have tariffs meant for corporate finance. And here of course, we have some different ways where we can try to figure out what what is uncertainty at the moment. And we have the important measure done by Baker, Bloom and Davis, which of course we also just talked about in the previous panel.

 

And that is what you see here in the blue line. And remember, the measure of policy uncertainty includes literally a number of different policy areas. And as an attempt to try to ask the question how much uncertainty is there at the moment about policy and what is the discussion around politics, policy topics at the moment relative to where we have been before?

 

And the chart here, of course speaks very clearly that the level of uncertainty in the Blue line is of course extremely elevated. And this is not only trade policy. This is of course also a lot of other policy areas. So one way of trying to think about what is the impact of uncertainty on corporate finance is and admittedly this is an embarrassingly simple chart.

 

But just to compare that with what we have in the green line, namely the corporate bond spread. And I do appreciate that it doesn't work in correlation all the time, always going back in history, but it has opened up a gap here where you begin to think about, well, given the uncertainty that we're facing, why are credit spreads not wider?

 

Why are people not more worried about the downside risk to equities? Why are people not more worried about credit spreads potentially have to widen out a lot more. So one way of looking at this in the language of what's going on at the moment is that the blue line could be viewed as the soft data.

 

This is the conversation in financial markets about, well, what will happen with trade policy, Is it going to remain at these levels, is it going to go down, for which countries will it go down? And that soft data is very different from what you see in the Green line, which could be interpreted as the hot data because everyone would tell you that the last earnings season was actually okay, so if the last earnings season was okay, well, maybe credit spread should not be widened that much.

 

And if credit spreads shouldn't widen that much, well, maybe then, okay, we can justify where credit spreads are at the moment. But the risk, of course, is that this could begin to spread if uncertainty stays at these levels. So what people try to do is to do impulse response functions literally between these variables and various combinations, trying to figure out, if I give a shock to uncertainty, and in particular, if that shock persists, what is the consequence then for credit spreads?

 

Likewise, you could also try on real economic variables, what are the consequences for unemployment, for GDP growth, for inflation? And the conclusion, of course, is that no matter how you design your model, you come to the conclusion that if uncertainty persists at these levels, it will of course begin to have significant consequences.

 

And one way that this has shown up in the more recent forecast from the consensus is that people are beginning to basically pencil in stagflation. And you see that in this chart here. This is going into your Bloomberg terminal and looking at the survey of forecasters every single month and asking the question, what is the consensus predicting that inflation will be in 2025?

 

And what's the consensus predicting that GDP will be in 2025? And for a long time, starting in 2023, this was a relatively boring outlook. The consensus was saying, yeah, GDP will be moving basically sideways, as you can see, at around 2%, and inflation will also be moving sideways at around 2%.

 

But then, of course, in the last few weeks, and in particular, of course, starting in March, if we take our textbook out, this is exactly what we should expect. A trade war is exactly stagflation, namely higher inflation, and of course, lower growth. So that's of course also implying that now from a corporate finance perspective, we need to think about how is the Fed going to respond to this.

 

Higher inflation says the Fed should be hiking, but we got growth says the Fed should be cutting. So which one is it? And will the Fed put more weight on the slowing growth, or would the Fed put more weight on inflation going up? Thankfully, the dot plot is revealing what the Fed will do.

 

Namely, the dot plot is saying that the next move from the Fed will be rates are going lower. So this, of course, opens up a lot of quantifications in terms of, well, but are we sure that inflation will be under control? So, as we all know in this room, there are various quantifications from the Yale Budget Lab, from the Pen Warden budget model, from the Tax foundation, from the Pearson Institute.

 

They try in different forms to quantify how much will inflation go up as a result of the current level of tariffs? And on average, the estimates bring you to roughly 1 percentage point lift in inflation over the next 12 months. So if that's the case and you look at this picture, you begin to worry that maybe inflation will now be roughly four, maybe four and a half percent by the end of this year.

 

Can the Fed cut rates if inflation is 4%? That remains to be seen. But this, of course, is also a very important backdrop for for whether corporate finance and corporate borrowing will continue to still be as benignly priced as it is at the moment. So the bottom line from this, of course, is that the macro backdrop for the trade war is indeed bringing a lot of questions to the marketplace, especially when it comes to what policies we're doing and how policies should be responding to a stack inflation shock as we're seeing here at the moment.

 

And the last point, when it comes to what are the implications of the trade policy shock, something that of course is also very important is to think about the liquidity in financial markets. And this chart here shows you. In the green line is the broker dealer inventory of corporate bonds.

 

And in the blue line you see the total size of the corporate bond market. And as you quickly can see, partly because of Dodd Frank and other reasons, the dealer inventory is very, very low at only $30 billion. And the total stock of corporate bonds outstanding is about $10 trillion.

 

9 trillion in investment grade credit and in very round numbers, about 1 trillion in high yield. So if you divide these two numbers with each other, you can see that there is basically less than 1% in liquidity available. Why is that important? Because when we went through the first few weeks here of April, when we got a shock because of the trade war, we began to see the bid ask spread in credit widen out and in particular began to widen out on off the run bonds.

 

Remember the corporate bond market, in this case for ig, the investment grade corporate bond market, have some bonds that are traded every day, all the time. You can easily do that if you would like to sell something. But there's also on 50% of the market that are off the run bonds, there is just very little liquidity.

 

And this chart here shows you the bid ask spread where when it comes to liquid securities, which is the green line and of the run bonds, which is the blue line. And as you can see, immediately when the shock hit, we began to see the bid ask spread widen.

 

And why is that important? Because when you think about this from a shock perspective, well, if someone suddenly would like to change their positioning in corporate bonds and there is no liquidity in public corporate bond markets, of course you begin to see badass spreads widen. And that's when you begin to see real challenges in the financial system because there basically is very little liquidity in credit markets at the moment.

 

And this brings me to a very important conclusion that there is often a debate about. Well, public markets are safe and they are always liquid. Well, as we have seen literally over the last month, that's just not the case. Liquidity began to blow out in a very significant way.

 

And you of course have safe investments in public markets, but you also have risky investments in public markets. Likewise in private markets we also have safe investments and we also have risky investments. So the conclusion is that the trade warm. And what has been less discussed is that what the Shock that we are living through at the moment is really a test of how liquid are markets for anyone who would like to turn their portfolios around.

 

And the answer is, as you can see, that the dealer inventory is very low. Meaning that if I would like to buy, let's say I'm a pension fund in Boston, I would like to sell some corporate bonds, or I'd like to buy some corporate bonds, there's just very little inventory left.

 

And likewise, the spread that I have to pay has unfortunately widened out quite substantially. It has improved a little bit since we put this chart together. And on a daily basis it may also on some days be better than others. But on average it takes about five days to trade a specific corporate bond at the moment.

 

And that's of course not an environment that we think about from the textbook where you have a market that's functioning very well. So with that, let me just end up by saying, summarizing what the complications have been for corporate finance, especially also when it comes to capital markets.

 

So yes, the macroeconomic shock of stagflation creates problems for the Fed. But what really is the most significant problem is also how we have seen significant issues with capital markets being very different today relative to before uncertainty went up because of the trade war shock. So this chart here shows you loan issuance.

 

So think of this as loan issuance in the marketplace, where banks bundle together loans and go and issue them combined, either as you can see, as repricings, refinancings, extensions and non-refinancings. And as you can see, after Trump won the election in November, you began to see loan issuance go up.

 

So the bars for December and January were very high. There were a lot of people who had been sitting on the fence who came to the marketplace and wanted to issue debt. And that's of course what you can see in this picture here. But unfortunately, after the trade war began, you can see debt issuance came down quite substantially.

 

And this has unfortunately also been the case when you think about IPO activity, this has also been declining. And finally, you've also seen M and A activity declining. And why is it capital markets activity is so weak? Well, think about it. If you are in corporate finance, you try to build a model for the next three years where you think about what is the revenue for my company, what are the costs for my company.

 

And of course, a very important part of this calculation is, is to try to figure out who will be buying my product. And if you don't know what the risks are, can I sell to Canada, can I import from Mexico, can I get imports from China? Then those risks create a much bigger standard deviation of what is actually the outcomes that we are expecting.

 

And if I not only have a bigger standard deviation, but I also, because of stagflation, have a higher discount rate, that means that corporate finance is hit by the double whammy of first of all having a lot of uncertainty about what's happening with my earnings. And the second problem is I also now have uncertainty about what's happening to my discount rate.

 

So if I go to the market, I'm a private equity fund, I would like to do an exit and I try to have a company that would like to sell. The challenge is that there's just so much uncertainty about not only the discount rate, which was the problem before the trade war came along, but also because of the issues around what is the profile for how much money will this company make.

 

And that's why capital markets, effectually they are open for very high quality companies, but for the rest of the market they are effectively shut down at the moment. And that is obviously also something that has very important implications for the business cycle. So the conclusion, of course from this is that as long as uncertainty is high, this continues to be something that has very important implications for corporate finance.

 

So the bottom line is we have a very unique situation where there are some very important impacts on, on corporate finance, both from the structural reasons I mentioned and also from the cyclical reasons I mentioned. And finally, just the last point, let's not forget, as we also talked about in several panels, there are also other things going on that potentially could have implications for corporate finance.

 

And one thing that of course could also be happening is issues around the levels of debt for the federal government. Of course, if we have a trade deficit, then of course the rest of the world accumulates a lot of U.S. assets. And this chart is just here, an important reminder about what is the amount of assets that the rest of the world holds.

 

So to the left you see total amount of US equities held by foreigners is about $18.5 trillion. So that's about 20% of the S&P 500 is owned by foreigners. You can see in the middle bar US treasury $7 trillion is held by foreigners. That's about 30% of U.S. treasuries outstanding.

 

And finally to the right, $5 trillion in corporate credit held by foreigners. That's about 30% of of the credit market that foreigners own. So the conclusion now is if we begin to talk about Mar a Lago or swapping treasuries with 100 year government bond with no interest rate.

 

It opens up a lot of conversations around, well, what a foreigner is going to do and if foreigners own as much as 20, 30% of financial markets. This of course also begins to have important implications in particular when we begin to talk about what it means for Treasuries and what it means for the level of rates and term premium.

 

So the bottom line, to summarize what I've said, first of all, there are some very important developments that we should not forget are happening where the banking sector plays a much smaller role and private credit and markets are playing a bigger role. That's a structural change. This has been going on, as the first chart showed, literally for decades.

 

And it just continues to point in direction that banks are less and less in the business of holding loans on their books. The second thing is of course cyclical changes. I spoke about tariffs and stagflation. This is also,of course, something that has increase implications for corporate finance. It is more something of course that's a cyclical development, but nevertheless something that continues to be very critical for how we think about what companies pay when they borrow at the moment.

 

And finally, the risk to the outlook is the much broader issue of what's going on with debt and what's going on with things such as the Mar A Lago Accord and the administration's policies towards how we're going to deal with these challenges if we do want to build a bigger manufacturing sector.

 

That's not something that directly impacts on a day to day basis, of course, what's happening from a corporate finance perspective, but it's enough to potentially be a risk that we worry about in terms of what companies have to pay when they borrow. So with that, let me stop there and turn it back to Mike, see if we have time for questions.

 

 

>> Michael Bordo: I think we have time for some questions.

>> Speaker 3: Can you talk for a minute about the distribution of private debt? Private credit number one, US versus global. How much is this a phenomenon where it's concentrated?

>> Torsten Slok: Yep.

>> Speaker 3: And secondly, increasingly you see sophisticated asset managers, wealth managers, advising their clients to include private equity and private debt in their portfolio allocation.

 

Do you have a view on that?

>> Torsten Slok: Yeah, so if you look at the total amount of private credit outstanding is about one and a half trillion, and roughly a trillion of that is in the US, so it is mainly a US phenomenon. And that has a number of reasons for that.

 

But one very important reason is that US financial markets partly of course are a lot bigger, but also because there are various other rules in other countries where it's in some cases can be much more difficult to do private credit. But the answer to your question is it is to a large degree mainly a US phenomenon.

 

And the second part of your question is very important. Financial advisors are a very important client of Apollo. There, we have registered investment advisors. We have ubs, Morgan Stanley and others. And absolutely a lot of our funds can be found on the shelves of financial advisors. And the idea is exactly that this gives access, democratization in terms of access to private equity and private credit.

 

Of course, as an investor you need to spend some time thinking about what do these different funds do, what are the differences in strategies. And a lot of the things that I talked about here become very, very important discussions, namely around are you investing in growth companies? Are you investing in value companies?

 

If you invest in growth companies and interest rates are higher, then of course that will have some implications. So the growth profile and the profile of what the assets are and the funds are very important aspects of this. So there is that important education part in terms of making sure that investors understand what are the different products that are on the shelf anymore.

 

 

>> Samim Ghamami: Thank you. Samim Ghamami from the SEC. How do you measure vulnerabilities in private credit market, and what are the current impacts of uncertainties on private credit other than the business development companies that are relatively transparent?

>> Torsten Slok: Yeah, so as you know, there are BDCs that are publicly traded where you of course can see everything that they are doing.

 

So that can gives you at least an idea on that front. I would say at the highest level, from a macroeconomic perspective, one very important dimension is this dimension about, well, if interest rates are now going to stay higher for longer, because inflation is higher for longer, that then brings, of course, a lot of discussion around which types of strategies are more sensitive.

 

If interest rates are higher for longer, and the strategies that are more sensitive are obviously businesses that have no earnings, companies with low coverage ratios. That means companies that have very little earnings relative to their interest payments. So there's a different way of saying business models in areas such as software, enterprise software, life sciences, venture capital.

 

By definition, venture capital is investing in companies with no earnings. So of course, if you have no earnings and the profile is that earnings only come after five, ten years, of course those companies are going to be more vulnerable to a higher discount rate. So this one answer to your question is that one dimension that is important for assessing who is impacted by what is to try to look at what is the sensitivity.

 

Are these companies actually some companies that have earnings or not? Another dimension is also the trade war. There are various sectors in the economy that are differently impacted by the trade war. The sectors that are significantly impacted by the trade war is consumer retail. It's energy, it's industrials, because those are businesses that generally have imports from the rest of the world.

 

Other parts that are less impacted is, for example, health care, tech media, telecom, because those are generally service sectors. So I go to the doctor, I go home. Again, that has nothing to do with tariffs. But in that sense, it also becomes another dimension of thinking about what are the risks in terms of who is it that's most impacted by tariffs.

 

But I think the main answer to your question is that there really is very little difference between public and private. In the private market, something is safe, something is risky. In public markets, something is safe, something is risky. So from that perspective, it is the same thing. It's just a matter of whether you almost with the BDCs, can see any difference between what is public and what is private.

 

 

>> Speaker 5: The stability of the IG spreads kind of makes sense in terms of perhaps those companies are most able to sustain the uncertainty. At the same time, what's happening as those spreads are stable, what's happening with borrowing costs of private companies that might be more susceptible to the Risks.

 

 

>> Torsten Slok: Absolutely, so the credit spectrum here, of course. So at Apollo, we are also Athene is our insurance company. So Apollo has $800 billion AUM and Athene is the vast majority of our assets and 95% of the assets we have in our insurance company are investment grade credit.

 

There are also other strategies to your point, and other managers, of course, who are further down in the credit spectrum. And certainly it's the case that there's been less liquidity than there has been in even in the IG market here. So you're right, there are certainly liquidity issues and issues to think about in terms of what are the various parts of the credit spectrum and in terms of what are the vulnerability to bid ask spreads widening.

 

When you do experience a shock, the good news again is that remember, investment grade in the public market is $9 trillion and high yield is $1 trillion. So the investment grade market is nine times bigger than high yield. So that means that IG is still by far the biggest part of credit markets.

 

 

>> Michael Bordo: There's a question there.

>> Torsten Slok: Yep, Mark.

>> Axel Merk: Thank you, Torsten. This is Axel Merck Investments. Fascinating as always. This audience might be interested in systemic risk. And when I heard you talk about spreads, what came to mind was economic slowdown, but not systemic risk. Is in any of the work that you presented the potential for more systemic risk to the system.

 

 

>> Torsten Slok: So if you just compare the charts I had with the size of private markets compared to the size of bond markets, equity markets and the banking sector, I mean, private markets are still very, very, very small. The total size of private markets, as that chart show, was roughly around 15 trillion.

 

And the total size of all the other markets combined is more like 400 trillion. So from that perspective, private markets still play a very, very small role. And another way of answering your question, if you go in and look at the employment report and ask the question, how many people work in commercial banks?

 

The answer is there is one and a half million people who work in commercial banks. How many people work combined at Apollo, Blackstone, KKR, Carlyle? It's about 15,000 people. We simply do not have the reach and the touch compared to what the corporate banking sector is doing. So that means that the total commercial banking sector has branches of all across the country.

 

That of course are much more out there and of course are much, much bigger in scale than what we are in private markets. So in that sense, private markets are a much, much smaller entity relative to what you have in the rest of the financial system.

>> Krishna Guha: Thank you.

 

Krishna Guhar, with Evercore. To what extent do you think it's realistic to look to private credit as potentially a substitute source of finance in the period ahead? If elevated uncertainty makes it hard to raise capital in public markets, should we think of this as a source of capital that can step up?

 

Or in reality, will it also be cautious and constrained for exactly the same reasons as public markets?

>> Torsten Slok: So it is absolutely clear, including for the last few weeks, and I'm not saying anything confidential here, Apollo put $25 billion to work simply because there were a lot of opportunities to step in.

 

So we view ourselves as stabilizers of the financial system. There was an opportunity, otherwise market would have adjusted much more to the downside. Another way of looking at that is the LGI crisis in the UK. We also were very active buyers at the time. We also helped stabilize the financial system.

 

So, to your question, it is absolutely the case that you want to have someone who's willing to take risk when there's distress. And that is one role that we have played among others. But that being said, the size of what private credit and private equity is doing is still relatively small compared to the size of the other markets, as the chart was showing.

 

So in aggregate, we are still quite small relative to, again, the hundreds of trillions of dollars of other types of financing that are available for companies.

>> Michael Bordo: Okay, so listen, this is fantastic. We have a lot to worry about, that's what my takeaway was. Thank you. It was really.

>> Ross Levine: Welcome to the first session after lunch and the title is Global and Strategic Issues. I got to commend the organizers for putting together the idea for this panel, which must have taken place a few months ago and given recent events, it's quite apt. So around 400 BC, Greek historian Thucydides argued that war is not so much a matter of arms as it is a matter of money.

 

And a few years later, Dwight Eisenhower had a similar quotation arguing that the foundation of military strength is economic strength. And other leaders have further asserted that that international economic integration is essential for forming the alliances underpinning national security. For example, Prime Minister Winston Churchill argued that through trade we find the means to preserve peace and project power.

 

And following World War II, the US followed Churchill's strategy. It created a vast web of of international institutions that fostered freer trade and the goals were very clear and very clearly articulated to that this freer, more competitive markets would generate long run economic benefits for the US and those countries.

 

Joining the network and those economic allies would become a strategic alliance against communism. The success of this strategy and further lessons from history led former US secretary of defense and our Hoover fellow Jim Mattis to argue, throughout history we see nations with allies thrive and nations without allies with her.

 

These observations raise important questions about the future of US economic power, national security, and in light of recent US policy initiatives, and I look forward to learning more from the panelists on this issue. Furthermore, many may make the mistake of viewing each economic policy in isolation. For example, extraordinary attention has been given to international trade and potentially the international trade war with China.

 

And obviously this is a central concern and one again I'm sure our panelists will talk about. However, US trade policy has ramifications beyond trade in the winners and losers of tariffs in the domestic economy. For example, we know that international capital surpluses mirror trade deficits. The connection between international trade and international finance therefore raises a whole slew of questions about the repercussions of attacking the trade deficit.

 

To say this attack may increase the cost of US Federal debt, increase the costs to US firms of raising capital financing for investments, and increase the costs to US households of borrowing to buy homes or other items. Furthermore, trade policy reforms that increase the costs to the government and firms of raising capital can slow economic growth, boost deficits, and accelerate the day of reckoning with our fiscal debt burden, which will be covered in the next session.

 

So examining trade policy in isolation is a potentially grave mistake given that trade is linked to growth and finance and fiscal and monetary policies more generally and Again, I hope to learn much more about this from our panelists. With that, each speaker will have 12 minutes to make opening remarks.

 

Then we'll throw it open to the floor and questions. And I'm going to first turn it over to H.R. McMaster, the former National Security Advisor and wonderful colleague, and H.R. it's all yours.

>> HR McMaster: Thanks for the privilege of being here for this great conference and to honor just an amazing colleague, John Taylor, one of the many people from whom I've learned so much here at the Hoover Institution.

 

I'm applying for college credit and economics. Since I've been here, since 2018, I think I've earned it, and hopefully a little bit of his rubbing off on this washed up general. But I'm here to set up the panel to talk really about how economics and financial dimensions of economic power, you know, play into, I think, what is the most significant competition of this century.

 

And that's the competition with the Chinese Communist Party. I believe it's going to be the defining competition of this century because free and open societies, I think, appear at the moment at a position of disadvantage. And I think at a position of disadvantage really having to do with China, the Chinese Communist Party and its axis of aggressors that include China and another revanchist power in the Eurasian landmass of Russia, as well as Iran and North Korea.

 

Largely because we had disengaged from critical aspects of the competition with authoritarian regimes in the post Cold War period because of really three interlocking and what turned out to be fundamentally flawed assumptions about the nature of the post Cold War world. First, that an arc of history had guaranteed the primacy of our free and open societies over closed authoritarian systems.

 

Secondly, the great power competition was, was a relic of the past. And then finally, that our prowess, our technological prowess, our technological military prowess would guarantee our security well into the future. And those assumptions, I think, really betrayed what I would call strategic narcissism, the tendency to define the world only in relation to us and assume that what we do or choose not to do is decisive toward achieving a favorable outcome.

 

And of course, there are others who enjoy authorship over the future, and that includes this axis of aggressors. So what I recommend, first as a first step is we have to overcome that narcissistic view and apply what a visiting fellow here, Zach Schor, a fantastic historian, calls strategic empathy.

 

And that's really a concerted effort to view the complex challenges we face from the perspective of the other and try to understand better the emotions and the ideology and the aspirations that drive and constrain others, especially our enemies, adversaries and rivals. So you know these assumptions about the post Cold War world turned out to be false.

 

In this century a new great power competition has emerged. The actions of the Chinese Communist Party actions driven by Party's leaders, fears and ambitions I would argue. Have revealed to the world that that its Leninist system will prevent the Chinese people from realizing Milton Friedman's and John Taylor's vision of a free market that empowers individuals and drives prosperity by allowing people to make their own choices.

 

As Milton Friedman observed, underlying most arguments against the free market is a lack of belief in freedom itself. The Party is intensifying efforts to extend and tighten its exclusive grip on power internally and gain preponderant power in pursuit of this vision of national rejuvenation externally through a campaign of what I would describe as the three Cs of CO option coercion and concealment.

 

China co ops countries, international corporations and elites with false promises of impending liberalization, insincere pledges to work on global issues and especially. Especially, the lure of short term profits, access to the Chinese market and access to Chinese investments and loans. CO option includes debt traps set for corrupt or weak governments.

 

CO option makes companies and corporations dependent and vulnerable to coercion. The Party coerces others to ignore its efforts to extinguish human freedom internally, as it did with the case of the National Basketball association quite famously, but many others and many US and international companies as well. It applies coercive power to reshape the international order to favor its authoritarian form of governance and its status mercantilist economic model.

 

Examples of CCP's subversion of international institutions includes, you know, the World Health Organization, the Human Rights Council, UNESCO, even icao, the International Civil Aviation Organization. That's just to name, just to name a few. So to compete effectively, we must correct fundamental misunderstandings concerning the nature of the threat from the Chinese Communist Party and then discuss how the free world might prevail in that competition and secure a better future for generations to come.

 

Because the stakes are high. I mean, if the Chinese Communist Party wins, the world is less free, less prosperous and less safe. So a common understanding of the nature of that threat is what I'd like to talk with you about. And then talk about how we can generate the resolve and take actions to turn what authoritarian regimes regard as our free societies and free market economy's weaknesses into our greatest competitive advantages.

 

The Chinese Communist Party uses two fundamental misunderstandings to get away with various forms of aggression. Internally as it perfects its technologically enabled Orwellian police state, and externally as it pursues primacy through programs such as military civil fusion, made in China 2025 and One Belt One Road. If you want a quick primer on these, not that any of you need it, our colleague Liz Economy just did a fantastic policy ed video where she lays out all of these mechanisms of coercion and these programs and strategies that, that the CCP employs.

 

And these include the Global Development Initiative, the Global Security Initiative, and most ambitious and maybe scariest of all, I would argue, the Global Civilization Initiative, which aimed to extend CCP influence over economic, security and cultural governance worldwide. So what are these misunderstandings? The first misunderstanding is that Chinese aggression is the result of US China tensions or as a reaction to just Donald Trump being so mean, right?

 

And it derives, I think, from this narcissistic assumption that the Party has again, no aspirations of its own and has no volition except in reaction to the United States. However, I think we should consider the Party's deliberate suppression of the COVID 19 outbreak, the persecution of doctors, journalists and others who tried to warn the world about COVID 19 and the subversion of the World Health Organization.

 

Adding insult to injury, in the post Covid period, the CCP employed Wolf warrior diplomacy to obscure China's responsibility for foisting the pandemic on the world and portrayed China's response as superior to the responses in the rest of the world. Also, I think consider the massive global cyber attacks on medical research facilities in the midst of the pandemic and the punitive cyber attacks and economic coercion of Australia.

 

And the most recent cyber attacks, the Volt attacks that we've experienced are identified to place a latent offensive cyber capability in America's critical infrastructure. In 2024, the US department of justice revealed that the China linked cyber group Volt Typhoon had infiltrated our critical infrastructure. And of course, it just doesn't end there in cyberspace.

 

There's lots of physical aggression happening in the South China Sea vis a vis Taiwan. Bludgeoning Indian soldiers to death on the Himalayan frontier. And then I think what we should really consider is Xi Jinping's boasts of his intention not to be constrained in any way, but to extend his efforts to coerce his own people and extinguish human freedom there.

 

The recent actions in Hong Kong, Jimmy Lai and others, incarceration, but his bragging that he's going to expand the concentration camps in Xinjiang. So I think it should be clear to us that it's not the United States or even how mean Donald Trump is that is causing this problem and this behavior.

 

So I think what we should acknowledge is that CCP aggression is not a US problem. It's a whole world and especially a free world problem. The second misunderstanding is the competition with China is dangerous or even irresponsible because of a Thucydides trap that presents us with a binary choice between passivity and destructive war.

 

That's a false dilemma. I would argue that passivity in connection with CCP aggression in the South China Sea and elsewhere had put us on a path to conflict with, with China because China was emboldened by that passivity. And so I think that what we have to recognize is that the Party promotes this false dilemma.

 

It loves kind of the slight misinterpretation of the book the Thucydides Trap, to portray efforts to defend against its aggression as simply the status quo power, you know, the United States trying to keep the rising power, China and its people down. So it's important to reject the Thucydides Trap and this idea that it's a choice between Beijing and Washington, I think it's very important to communicate to our friends and partners around the world that this is not a choice between Washington and Beijing.

 

It's a choice between sovereignty and servitude. And this is why, as Ross alluded to in the beginning, to confront China's aggression. It's really important, I think, to have a concerted multinational response. And years ago, 2017, 2018, I would often say to President Trump, hey, Mr. President, if we shoot all of our allies to get to China, China wins.

 

And so, I'm hoping that President Trump will recognize that for us to prevail in this competition, we have to work with at least the other of the world's largest free market economies and work together. So I think that connecting these misunderstandings and improve cooperation with allies is important if we're to compete.

 

And again, what we should be thinking about is how do we turn what the Party views as our weaknesses into our greatest competitive advantages? And so we have competitive advantages in our free market economies and in what we regard as unalienable universal rights. The Party views freedom of expression as a weakness to be suppressed at home and exploited abroad.

 

But it's the free exchange of information ideas that may be our greatest competitive advantage. I'll go through these quickly, so we can get to discussion. Freedom of expression and freedom of the press also play a key role in promoting good governance to inoculate countries from these bad deals under one belt, one road, these predatory loans, and so forth.

 

As with freedom of expression, the CCP views tolerance of diversity as a threat. Although some might see expanded immigration from an authoritarian state is a danger, the United States and other free and open societies should consider issuing more visas. Providing more paths to citizenships, especially for those who have the knowledge, skills, abilities that can help us maintain our competitive advantages.

 

What President Trump has said in the past staple that H1B visa to any graduate who has earned an advanced degree in math, science and engineering. The CCP views its centralized statist economic model as bestowing advantages, especially the ability to successfully coordinate efforts across government, business, academia and the military.

 

And it views our decentralized free market economic systems as unable to compete with China's centrally directed strategies. And I think that's why our free market economies need to demonstrate the competitive advantage of, of decentralization and unconstrained entrepreneurship. So competition between the free world and authoritarian regimes will determine, I believe, whether democracy and free market economies prevail over authoritarian and statist economic models.

 

China and Russia have expanded, of course, the self described partnership for New Limits of no Limits. There is kind of unprecedented degree of cooperation going on among this axis of aggressors. And I think it's really important for us to no longer undervalue the degree to which strategic application of economic power and Matteo will have some tremendous ideas on this is essential for advancing U.S. vital interests.

 

I believe President Trump has an historic opportunity to correct this chronic shortcoming in US grand strategy with an integrated strategy for economic statecraft oriented on securing the nation, reinforcing our technology, technological innovation systems and shaping fair reciprocal trade and commercial relationships. But action is necessary to counter Chinese economic aggression.

 

The Trump administration, I think, must recognize that more interventionist and economic statecraft policies will inevitably result in trade offs. An overarching framework for principles and objectives of strategy, which is what we argued in a paper, so I won't go into detail on this, is essential to help policymakers decide among competing trade offs and to determine the best way to integrate the tools of economic statecraft to advance our interests.

 

So finally, I'll just say that strengthening free market economies and democratic governance could be the best means of countering CCP's campaign of co option coercion and concealment. Strengthening democratic institutions and processes and in our own nation and in nations that are targeted by the CCP should be a matter of urgent importance to us.

 

And so I'm confident, I'm confident because of all of you here, the wisdom that's in this room, and I'm confident that support for free markets and democratic institutions, as well as the unalienable rights that should be afforded to all peoples is not just an exercise in altruism. But protection of those rights and promotion of democratic governance is a practical means of competing effectively with the CCP while building a better world for future generations.

 

Thank you.

>> Ross Levine: Thank you, HR Matteo, it's all yours.

>> Matteo Maggiori: So first, let me join in congratulating John on the conference yesterday and everything that you've done for economics, both in the profession and at large in policy is really remarkable career. And I think we're all very lucky to have learned from you.

 

Now for the specifics of what I'm talking about. I knew that HR was going to talk about the military and he knows infinitely more about that than I do simply because I know zero about it. He's also very knowledgeable, but me knowing zero helps. The second thing, I knew he was going to talk about China and so I thought I would talk more about the US side.

 

So HR has an incredibly good report online on a proposal for more systematic economic statecraft. Just thinking about what do we want to do, what are the objectives and coordinating the policies so that we don't come at it from an app hazard perspective. And so I'm going to review what we've done so far instead of doing that.

 

So if you could advance the slides for me, let me start from the fiscal situation, okay? Because this is rather important. These are all familiar to all of you. These are some of my data. This is the CBOE and it's plotting federal debt held by the public in the United States.

 

So it's no secret that the debt has been going up, has been going up rapidly since before the global financial crisis, as we spend for the fiscal response to the financial crisis, then again for the fiscal response to the pandemic. And the last part of the line is not an expectation as what the CBOE expects would happen if we did nothing, if we went on with the current legislation.

 

So you can see that we're at the highest debt to GDP levels, certainly in the post war period. The last time we were there, the debt that financed the war, if you advance the slides, the way we would think of them as economists, is the following simple graph.

 

If you have very little debt over gdp, there is a safe equilibrium. Everybody knows that debt is safe because you're going to repay it because you want to borrow in the future. If you push it a little farther, things get more interesting, not in a good sense. Now you're in an intermediate region, which is called the instability zone, where there are two possibilities.

 

If the foreigners or the domestics get scared about what you're going to do to the debt, for example, because you're mentioning forceful extensions or not paying interest, interest rates spike at those high interest rates. Since the debt is high, repayment is too expensive and you actually decide not to repay, fulfilling the expectation that they should be scared about you.

 

Now, the other equilibrium, the good one, is still present. If they don't get scared and they give you low interest rates. Given those low interest rates, even with a high debt, you repay fulfilling those expectations. So now you have two possibilities. And when you have two possibilities, it becomes a game of confidence which equilibrium is going to show up tomorrow.

 

And these things can be stable for a very, very long time and then go down in flame very quickly. And then, of course, there is a region where you borrow so much that it's pretty obvious you're going to default and interest rates are high. And that's the only possibility.

 

If you flip one more slide for me. Now, if you go back to the previous graph, the big question that we all have right now is have we entered that instability zone? I mean, clearly a 60% debt to GDP ratios, we all thought it was only going to be safe at 100%.

 

We don't really know where the lines are, it's difficult to estimate them. But we started having this conversation. So when Emmanuel Farr and I wrote that paper 10 years ago, people thought we were absolutely insane for even mentioning the possibility that US debt will not be safe. And today this possibility is routinely mentioned in the past.

 

Now you might still think it's insane and very low, but we're having the discussion fast forward when we're 150% debt to GDP ratios and we'll have that conversation a lot more, and you'll start thinking it's a lot less crazy. And you don't want to get there now with this in mind, you want to think about what is happening right now with US Policy and both with the holders of our debt and our partners.

 

So if you can forward, if you think of the Latin motto of once safe and always safe, that's a recipe for disaster. Once investors start thinking that since the US has been safe for a while, it will always be safe, that's generally how you get into trouble. It's exactly how we thought about the banks going in 2008.

 

And when you look through the arc of history and some of my colleagues will do substantially better than me at this, there is nothing that should make you confident that because you've been a reserve country for long enough, you'll always be. England had a stellar reputation in the classical standard and during the interwar period and ended up going off the gold standard, which is largely a form of default on a promise.

 

At the beginning of the depression, it depreciated 30% unexpectedly and never really recover its reputation. You look at other reserve currencies in history that suffer the same fate. So it doesn't have to happen, but it's also not guaranteed. You cannot do whatever you want because this is a birthright.

 

This is something that you get because investors are confident in your future fiscal and. Monetary policy, and that that combination is going to keep the value of the debt stable. So if you forward for me again now, if you think about this, with this sort of risky background on our fiscal situation, there has been a big surgeons in geoeconomic activity.

 

You've all seen the headlines between tariffs, export controls, deals with China, the mile might not happen. Certainly a rethink of even our basic relationship with the European Union or Canada or Mexico. The world order is clearly going through a moment of unprecedented change, certainly during my lifetime and for most of your lifetimes, particularly with our closest allies.

 

And that's worrisome because if you're already in a position where you don't want bad outcomes, you don't want further uncertainty, provoking those kind of rethinking is not usually the most advisable strategy. And I wanted to give you a sense of what's happening in real time. Could you forward on me?

 

So what I've been doing in my research in the last few months is essentially using artificial intelligence to read hundreds of thousands of documents in almost real time to try to figure out how are firms responding to sanctions, export controls and tariffs. So the blue line that you can see here, and this is all online, you can download it.

 

You can see that there are three big spikes. One big spike is the earlier Trump administration, those are the tariffs with China. The firms are massively reporting being worried about this, they're being affected. Then there is a spike in 2022, those are the sanctions on Russia. There are sanctions on export controls.

 

And then you can see that the line goes vertical. So this data is updated to April 24th. So every firm is reporting being very worried about tariffs or being affected. Now if you forward one, you can ask, how are they talking about this? They might be talking about tariffs but saying they're a great idea, or they might be talking about tariffs and saying, we think these are going to be bad for us.

 

And here the line is decomposed into the positive and negatives. And largely you only see the negatives. The firms are all reporting the tariffs being negative for their economic outcomes. And this happens even when you restrict to only American firms. There is a spike to the positive. You can see it at the very bottom corner.

 

What is the positive? Those are American firms that report their competitors being more affected than them from the tariffs in particular, for example, like steel. And therefore they're thinking that they're going to get a bigger market share. So that's a domestic subsidy of production component of a tariff.

 

But overall, if you look at A list what the firms and the professional analysts are reporting. There is no shred of a doubt that the reaction is negative. They're perceiving them as being negative. If you go one further, you can then ask deeper how exactly are they reacting to this environment?

 

What are they doing? And you can see three interesting things. The first one is they are trying to go around this. They're trying to read out the supply chains to make sure that they get low effectiveness. The second thing is that you see a big difference between sanctions and export controls and tariffs.

 

When you look at the reactions to tariffs, they all mention moving prices. And I'll show you in a second that the prices are going up. They're reporting increasing prices. It's an ad valorem tax, we're not telling you that you can do the activity. We're telling you that we're going to charge you for doing the activity.

 

And they're passing through some of these tax to the buyer. When you look, instead of export controls, those are quantity restrictions or sanctions. We're telling you you cannot do this activity or you can do it up to a maximum. And there you can see that the major reaction is market exit.

 

We're telling you you cannot export to China, you cannot export to Russia, you cannot buy from Russia. And so this is a little bit of the difference between the jacks are living high fan, small yard versus generalized studies. They're very much talked about in some components as both being for national security, but they're vastly different how they're affecting the firms.

 

One thing is a restriction on a few technologies that people like HR might have the deep expertise to say these are affecting our military or they might be posing a competition. And one thing is a generalized, potentially very high tariff on all inputs that we buy anywhere in the world, including those that might make us stronger.

 

If you go to the next slide. So this is the major worry right now, it's prices. When you ask, okay, you told me that you're adjusting prices, but are they going up or down? They're going up and they're going up more by American firms than they are by the rest of the world.

 

And that's a major worry that, for example, Jay Powell articulated earlier this week of we're going to face a weak demand and at the same time a shock to inflation. And if you're trying, you know, if you're a sitting central banker, that's not a great combination to have to fight.

 

It's a tightrope to be handled. So you these we're going to keep doing. One of the great things of being at Stanford and let me publicize it is the university has made very large investments in artificial intelligence. So we can do these things in real time and at scale.

 

And we're going to keep tracking this. And so if you're interested in this type of data and economic policy, you can find it online. But the policy message is when you look at the data for April or the data for March for the lead up is massive uncertainty.

 

A lot of it is in our traditional allies is across the board. The firms are largely reporting negative outcomes. The positive outcomes are coming from the few firms that think they're going to get a bigger market share or higher profit margins because their competitors are more affected by the tariffs of themselves.

 

And the biggest response seems to be we're increasing prices, we're moving our supply chains. I'm not sure that that's what we wanted. If that was the plan, this did it. If the plan was something else, then we have to confront these are the outcomes so far and see if we can improve, change the policies to get to the outcomes that we would have liked.

 

Last one, so if you're interested, this one is online. I know that a lot of you are interested in real time data, so you can grab it, thank you.

>> Christopher Meissner: Okay, well, I'm grateful to have the opportunity to be on this very esteemed panel and to be here on this great occasion.

 

So thank you to the organizers for a job well done. I want to talk about the second wave of globalization and the first wave of globalization and make some kind of long run comparisons. Second wave of globalization this period of intensified international trade, cross border movement of capital and migration prevailed between 1950 and 2008.

 

And this recent period of globalization was founded on a strong belief that economic integration was a handmaiden of economic growth and development and geopolitical stability at that. Hegemonic leadership by the United States and its allies provided the cornerstone of globalization. But since January 2025, I think the US has abruptly changed the terms of the agreement.

 

The United States has basically started a global trade war. Clamped down on immigration. Mood of the possibility of meddling in foreign investment, emphasized the burden of operating the world's dominant currency. These strategic changes have implications for economic growth and stability as well as economic policy. So how do we reach this crossroads?

 

Well, I think the global financial crisis of 2008 probably played a role. Lots of things have been happening since then. I think the second factor, as was mentioned before, was the rise of a new global superpower China. Since reforms in the 1980s, that economy has grown at double digit rates.

 

Exports have been booming, GDP is rising, and it's turned an impoverished nation. And populous nation into a manufacturing powerhouse. I think some economists and policymakers and others attribute China's rise to unfair trade practices over generous subsidies, expropriation of Western technologies. And even an undervalued exchange rate. And many advocated sanctions on China because of these forces.

 

So the first significant action has really come as of late in the first Trump administration with tariffs of 10% against China. And most recently tariffs, which are basically prohibitive of up to 125% on China with some exceptions. Not only that, but President Trump has decided to raise tariffs on other close trading partners like Canada and Mexico.

 

And there's a threat that by July 2025, significant tariffs could be higher on all trade partners in proportion to bilateral trade imbalances. So with that introduction, I want to talk a little bit about tariffs and trade costs in the United States case over the long run. I wanna talk about the trade wars of the past, with special emphasis on the Great Depression, and then come around to likely scenarios for the near term in the United States economy.

 

One justification for tariffs recently was, and I want to quote this, President McKinley made our country very rich through tariffs, and we were at our richest from 1870 to 1913. That's when we were a tariff nation close quotes. Historical record is obviously at odds with this assertion. Back in the 19th century when tariffs were quite high, GDP per capita was about $6,000 in $2017.

 

And the economy hasn't stopped growing. It's much higher than it used to be as tariffs have come down. Not only that, recent research that I've undertaken with Alex Klein. Looking at disaggregated data from the US Economy in the Gilded Age shows that industries with higher tariffs were actually less productive.

 

Their labor productivity was lower when tariffs were higher. So there doesn't seem to be much truth in the idea that tariffs promoted growth, what did? Well, I think it's fair to say that America grew rich despite tariffs, not because of them. What mattered were things like natural resources, innovation, agglomeration, building out the railroad network, and all sorts of forces like that.

 

Recent research by Rick Hornbeck and Martin Rotenberg, it showed that counties that got connected to the railroad network were dramatically more productive. They opened their market access, and it did them well. In fact, looking at the opposite, this business historian, James Foreman Peck looked at the automobile industry near the beginning of the 20th century.

 

And argued that US engineers were a little bit behind, quite behind European engineers solving problems that they had already solved in Europe. And he attributed that backwardness to 45% tariffs in that Industry and a lack of competition regarding the first wave of globalization and all these ups and downs.

 

Sure, if you want to get more information on this, there's a great book on it. It's at your disposal on Amazon and from Oxford. What I've learned in writing that book and in the course of years of research on this is that more open economies tend to be richer.

 

This is true in 1900 when countries lowered their trade barriers with the rest of the world and were more proximate to other rich countries. They were better off, they were richer. Not only that, but in the late 19th century, integration was not a barrier to cooperation. Research with Michael Huberman shows that greater integration with leading countries led to leverage over their trade partners to persuade trade partners to to improve their labor standards to match their own.

 

The carrot of continued market access and implicit trade sanctions was virtually always enough to bring trade partners in line and to improve their labor standards. Like the advanced countries, globalization kind of collapsed in the Great Depression. It was a bad scene. The trade war kind of kicked off in 1930 when the United States, with the Smoot Hawley tariff, raised tariffs by over 50%.

 

This led to retaliation and protest with our trade partners. Against protesters, exports fell about 18% and against retaliators by about 31%. According to research by Chris Michener, the trade war of the 1930s raised tariffs from an average of 6% to about 25% amongst the largest economies. And it wasn't good for economic growth.

 

To the extent that you can see these numbers, it's not a great scene for these 28 countries. Export to GDP ratios in the trade war of the early 1930s fell by about 17%. The average decline in output was about 23%. And in ongoing research with Thilo Albers, building on his dissertation at the LSE, we're finding that about 63% of the decline in GDP was attributable to the trade war.

 

So small open economies are harmed significantly by higher tariffs and some of the damage done was on the order of 100% for some of the small open economies. Further, the period of the 1930s wasn't great for freedom and liberty. The demise of globalization was associated with the rise of fascism.

 

And previous research has shown a figure like this the second wave of globalization, globalization 2.0. I think it's fair to say that the countries that have more and better market access are still richer. They're doing better. Contrary to some things you may hear, globalization has been good for jobs, even in the United States.

 

My colleague Rob Feenster estimated that several million jobs were created in this later period of globalization. In recent decades, Globalization 2.0 created a sort of Pax Americana, or liberal peace, where territorial integrity was largely maintained. There's actually a bonus here too. In the last period of globalization, globalization 2.0, rising trade integration was associated with a rise in democracy.

 

Things have kind of changed in the last hundred days. Tariffs have gone up to an average of 23% in this country, that is remarkably high. That's a tenfold increase off our average tariff of 2.4% which prevailed at the end of 2024. There's been a clampdown on immigration, which is having a chilling effect on visits to the United States for work, leisure and study.

 

And people are actually discussing the role of the dollar on the international scene. So what's going to happen? Well, I don't know, there's a lot of uncertainty. Lots of things could happen. Here are some possibilities based off of history. It's pretty clear that in the immediate short run prices are going to be higher, we're going to face shortages, producers are going to find it difficult to source important inputs.

 

It's going to be a lot of self harm. In the medium term, I think over the next few months we could see quite a lot of retaliation, even more than we've already seen. And this is only going to lead to continued deterioration in the US economy. This would lead to worse terms of trade, falling employment and things we're already about to see.

 

But even worse, think of the Great Depression and you don't have to be convinced given that data uncertainty remains high. This is having a stifling effect on consumption and investment and henceforth employment. And I would like to think that the Fed would probably prioritize employment. Then think about the inflation cost of all these actions.

 

Time is getting close to ending, let me just end with a hopefully a little bit more rosy scenario. We could call it Globalization 2.1. I don't know if it's the most plausible, but it's good to dream in this world. We could imagine a world where the threat of higher tariffs from the US lead to reductions of tariffs and non tariff barriers with our trade partners.

 

This could happen with our main trade partners, Canada, Mexico, EU, Korea, Japan, which covers about 85% of U.S. exports, which would already be a big boost to GDP, adding probably several percentage points to economic growth. That would be a good scenario. Now China's kind of adopting a posture of retaliation and it seems to be a little angered by recent moves.

 

But if China were to come into the fold and lower some of its non tariff barriers and make some adjustments in its economy towards boosting domestic consumption, things could improve even more. The US could improve its exports in leading sectors like AI, Cloud, other it, finance, insurance and even the primary sector.

 

And that could be a big boom. We could see greater integration, lower prices and easing Fed, annd would be kind of like a positive supply shock. Again, I don't know if this is the world that's the most plausible. This world would definitely be richer, it'd be safer, and I think that's a case.

 

It's a scenario worth hoping for at the very least, thank you.

>> Harold James: Well, thanks so much, it's wonderful being here, wonderful being on this panel and especially listening and thinking about John Taylor's work. It's been fantastically, fantastically useful. And I think also for historians who go back and look at monetary history and episodes even of catastrophic monetary mistakes in the past, having your framework really, really helps us in doing that analysis.

 

You won't be surprised if I have some of the points that we've already heard in this wonderful, wonderful panel. I mean, in some ways the story that I think Chris is telling and I'm telling is that it's a kind of back to the future scenario that we've had terrible moments in the past and it looks to many of us as if we're reliving some of those episodes.

 

So I think one of the great analysts of this is Joseph Schumpeter, the Austrian economist writing just at the end of the First World War, in the moment of a big catastrophe, nationalism and militarism and not the creatures of capitalism are capitalized and end by sucking the best strength out of capitalism.

 

And that's the danger of that we're running into. And in particular, I Think it's fascinating that the figure that Schumpeter focused on and the work was originally written in German. But Schumpeter quotes this figure, Joseph Chamberlain, writing, speaking in English, Joseph Chamberlain, the great, great master orator, the transformative politician of the late 19th century, the early 20th century, who was the tariff man in late 19th century Britain and pushed for tariffs and pushed for imperialism.

 

Those are the two linked motives that Chamberlain pushed again and again. And it was also very explicitly linked to a narrative that Chamberlain was very fond of, beginning his presentations by his big orations in Birmingham City Hall. Elsewhere, he started off by saying that Britain was in the decline.

 

And the story that he had was very much, really, absolutely the same kind of story as we have in terms of the relationship of the discussion, US versus China. For Chamberlain, that was Britain confronted by a rising imperial Germany, an autocratic Germany that was distorting the rules and doing many, many unfair things.

 

From the point of view of Chamberlain's narrative, some of the unfair things they were doing don't seem to us to be so unfair. They were having good universities, they were having a lot of research in basic industries. And so there really was a problem. But one of the points that I think you have to make, and Chris has already made, that is that Chamberlain's recipes that were then implemented by his son Neville Chamberlain, as Chancellor of the Exchequer and then as prime minister in the 1930s.

 

Did more to precipitate British decline, and in the end also led, and particularly spectacularly, as I think people know with Neville Chamberlain, led to colossal geopolitical mistakes in terms of what Neville Chamberlain was doing in 1938 and 1939. So this is an example of somebody who gets it wrong.

 

So let me turn to the same kind of material that Chris has gone through thinking about the long waves of globalization, and you've heard it already, that there's globalization one in the middle of the 19th century, and globalization, too, from the 1970s onwards, and that these are transformative.

 

I've also been thinking about this for a long time, and what I think of as increasingly important is trying to identify what occurs at the switching points, when globalization turns in one direction or another. When it surges in the middle of the 19th century, when it surges after the 1970s, or when it goes, when it's broken in the interwar period by the First World War and then particularly by the Great Depression, by tariff conflicts.

 

And the story that you heard already, what are they? Well, it seems to me that it's important here to distinguish between supply shocks and demand shocks. And that in particular there's a remarkable pattern that we get out of this study of the long waves of globalization that it's negative supply shocks, really severe negative supply shocks that make people realize that their existing models are broken and that they need a better, more open approach to policy.

 

And that's what happened in the middle of the 19th century. That's when the great free traders prevailed intellectually, when John Bright, Richard Cobden were thrust into positions of authority. That's the story of the 1970s when we think of Milton Friedman becoming enormously influential and people of different political backgrounds pick this up and think that openness is the key.

 

Why? Because there are supply constraints and in the middle of the 19th century it was food in the 1970s it was oil, energy, petroleum and in these cases the prices that are the result of the negative supply shocks send signals that more investment is needed and more linkages are needed.

 

And so the technologies that are already available for instance, the steam engine that powers. The railways and the transoceanic shipping in the middle of the 19th century, instead of using them just for little local expeditions, local routes, you can use them to create big networks. And you can feed Europe as a consequence of developing big networks of railroads and transoceanic shipping.

 

Or in the 1970s, container. The container had already existed as a concept. There were containers in the 1930s, I believe. From 1950s, there were regular container shipments between New York and Florida, but just that one route. And then in the 1970s, when everything becomes expensive, the prices send a signal.

 

It's a case, it's a wonderful case of markets working and sending signals. Demand shocks, the Great Depression or 2008, demand shocks, in both cases emanating from financial crises. Financial shocks have a tendency to turn globalization in the other direction. And so I tried in this book to make a typology of these crises.

 

And you can see that sometimes it's a little bit mixed, and you get supply and demand crises simultaneously. So they're not as easily separable as they are in the. My basic story of the mid 19th century. Negative, negative supply shock, 1970s, negative supply shock, 1920s and 30s, negative demand shock.

 

The First World War in particular, is a mixture of a supply shock and a demand shock. And it explains, I think, the craziness and the contradictoriness of policy over the next decades. And it seems to me that we're in some ways reliving that moment of a mixture of supply and demand shocks.

 

So let me just focus in a little bit on why and how the negative supply shocks have generated a lot of the uncertainty that we're in after 2020. The basic supply shock is from COVID but what Covid does is then to make sure that everybody who controls some kind of resource thinks that they can use it.

 

And so I think it's an explanation, for instance, of the radicalization of President Putin's policy and why he makes the decision, terrible decision, in February 22, to invade Ukraine. So he thinks that because Russia controls a lot of energy supply, it can use that as a weapon against the rest of the world, and it can constrain it.

 

So there's a lot of work about it, and it's very, very interesting because the point of these supply shocks is that they are often very, very specifically focused. And so I think one of the best and earliest studies of this was the EBRD transition Report a couple of years ago.

 

And they have a chapter on this, and I highlight this table. I obviously can't discuss it in Detail. But here is a list of all the critical commodities that are crucial to the green transition. And you can think about them. And anybody who controls anything on this list, and a lot of these are controlled by China.

 

Anybody who controls anything on this list is in a very powerful, powerful position, but we don't know which ones are the most crucial. And one of the things that we find is that the focus on choke points varies from time to time. So one of the things, for instance, that we suddenly learned in February 22, that I don't think anybody had paid any attention before, was that semiconductor manufacture depends on neon gas.

 

Where do you get neon gas from? Again, something that Nobody knew before February 22, but a lot of people worried about it after that, is that it's a byproduct of a particular steel manufacture process that was basically only done in the former Soviet Union and so only practically done in Russia and Ukraine.

 

And the war interrupted that. And so we got a constraint on the supply of semiconductors in the immediate aftermath of 22. The EBRD report in 2023 focused on gallium and germanium, on these rare earths and critical minerals that were important for electric vehicle production and solar panels on that big table.

 

There's also a brief mention of dysprosium, but there's no discussion of dysprosium at all in the text. And I think it's only recently that we've begun to absolutely be centrally aware that dysprosium is at the key of a lot of the contemporary issues. Because this is something controlled by China, which we need for the production of magnetic shields, high resistance magnetic shields that are important, for instance, in developing nuclear fusion, but also in many, many computer and advanced data processing techniques.

 

And so the limitation on dysprosium is a critical story. And getting substitutes for these, well, of course you can do that over some time, but you can't do it quickly. And the consequences that not just do you get increased prices. And the increased prices will send the signal, of course, and you will get a correction in the end.

 

But in the moment, you get an absolutely strategic incapacity to do anything. And it's that that I think is the core reason why the April 2 move and why the movement to tariff wars has been so disruptive. But let me just put it in terms of the classification of different reactions.

 

For The United States, April 2nd Liberation Day is a big negative supply shock. For the rest of the world, it's primarily interpreted as a demand shock. So we're exactly in the kind of First World War situation where there are simultaneous supply and demand shocks and you will expect different reactions.

 

So the reaction that I think you may get, and you know that is part of Chris's optimistic scenario, is that this will tell us that we simply need to develop more supply everywhere, more supply all over the world in this country, but in many other countries. And that's a route out.

 

And so it is, I think, quite possible to see that more globalization rather than less globalization could be an outcome of all this uncertainty. But that looks rather distant. And in the meantime, we have the kind of uncertainty that Torsten reminded us of at lunch. And so I thought, this story is absolutely crucial.

 

You saw this slide already at lunch. But this is the story of stagflation, the likelihood of stagflation, increasing likelihood of stagflation. And that, of course, really takes us back straight to the world in the 1970s. And you remember again that the 1970s, in the end, has a good outcome and it makes for better policy making and a more openness to.

 

In policymaking, but it's a tumultuous political process before you get there. In the interim, you know, let me just put this together by thinking of some lessons from these moments from the 1840s or the 1970s. In both cases, you had surges of inflation, and they weren't really strictly transitory in the sense of, as it was debated in the immediate aftermath of COVID but they needn't be long term either, but they're somewhere in between.

 

And in particular, there are also moments in which relative prices change. And so it's actually very difficult in this kind of setting to think of the standard guidelines that we use when we want to think about monetary policy, because we rely a lot on that, on aggregates, on baskets, on measurements of inflation.

 

But this is a moment when relative prices move very quickly. Secondly, these moments are moments in which there's an intensified pace of technical innovation. And thirdly, they produce more great power political conflict. So one of the ironies of this moment in the middle of the 19th century was that people like the great Victorian free traders like Cobden and Bright said, this is going to make peace.

 

And then, very, very quickly, there was the Crimean War, it was the worst episode in interstate conflict since the Napoleonic Wars. And then, the critics said, aha, this shows that peace doesn't necessarily result from commerce. So we're in that moment of a very, very conflictual moment. And let me go back to one of Schumpeter's observations.

 

He's very much thinking about in these moments of doubt and where we don't know where we're going, we go back to atavistic ideas, and we think we need big gold hoards. And so one of the things that we haven't had all that much in the discussion so far is the discussion of gold in the international monetary system.

 

But it's striking that that's part of the story of the movement away from the dollar. And if you think about the last 10 years, Russia, China, India, Turkey, Kazakhstan, and then more recently, European allies of the United States, Hungary, Czech Republic, Poland, have been building up massive, massive gold reserves.

 

So this is a reflection of doubt about the international financial system. And it leads us to a very, very kind of atavistic view in which seizing gold is important. And that also, I think, is part of the obsession that we're going through just at the moment in the United States, thank you so much.

 

 

>> Ross Levine: So we have about 14, 15 minutes for questions. Please, we'll take, like, two or three and please give your name and I'm going to start with my former professor, Sebastian, and then we'll go to Steve Davis.

>> Sebastian Edwards: Thank you so much, is this on? Yeah, great panel, I want to talk a little bit about gold.

 

Harold ended with gold and its current situation. $3,300 an ounce, that's a lot of money. But I want to go back to Matteo's timeline, which I thought was very interesting. He talked about reputation and credibility and pointed out that in 31, the United Kingdom devalued sterling up by 30% or so and never recovered.

 

What is missing in that line is that in 1933, the US not only abandoned the gold standard, but it abrogated the gold clauses and it basically or literally defaulted on private and public debt. It devalued the dollar in January of 34 by 41%. In 35, the Supreme Court said that it was okay to abrogate gold contracts retroactively and nothing happened, credibility was maintained.

 

It actually increased and we had a new equilibrium where, as Barry Eichengreen and Chris and others have documented, gold came back to the US and we got out of the Great Depression. So the question is there is an alternative to the doom scenario. I am personally pessimistic, but I think that if we look back at history, there is an outcome already in history where the Hemega defaults and maintains its privileges.

 

The question to the panel is what are the privileges probabilities of that outcome being the final outcome? And Chris had an optimistic outcome, but he didn't give us probabilities. And I think that looking back at history, the abrogation of the gold clause is a very, very important episode.

 

 

>> Ross Levine: I'm going to take one more and then we'll merge them together, so Steve.

>> Steve Davis: Thanks, Steve Davis, great panel. There's an important aspect of the present moment that I thought was missed in the discussion. And I want to draw the contrast between the current tariff hikes and Smoot Hawley.

 

Smoot Hawley was a piece of legislation that passed Congress. The tariff hikes and gyrations in the last three months are entirely the whim of one man. And most of these tariff hikes are being the alleged lawful authority is either to legislation that never mentions tariffs or or legislation that appeals to emergencies.

 

Whereas the kinds of things that President Trump is concerned about are long run trends. And I think this reveals something important about the present moment that affects the outlook for uncertainty and for further globalization. In particular, we are seeing a moment with tariffs and maybe in some other respects as well where there's unrestrained exercise of executive authority without clear grounding in the law or even the Constitution.

 

These matters are being litigated now. They will eventually reach the Supreme Court and perhaps that will reimpose some constraints. Perhaps under some circumstances one can imagine that Congress might take back explicitly its power to set tariffs. But until there's some kind of reimposition of constraints on the executive's authority to raise or lower tariffs at the President's whim, I don't see how we get back to the situation.

 

We can have trade deals, but they just, they don't mean much because they're not credible. And so in that respect, I see this current moment as quite different from say, the Smoot Hawley tariffs and so on. And it speaks to me to the need for internal US reforms to get us back to where we were before, both domestically but also with respect to the possibilities that the United States might again become a linchpin for a global economic commons.

 

So on that pessimistic note, I will stop.

>> Ross Levine: Let me turn it over, I'm not sure who's going to want to take these on. Sebastian's question is, is there room now for the US to abandon some obligations? What would the ramifications be? Would it be catastrophic or might it be different?

 

And then Steve Davis's point about that now is now is different, that some of the historical analogs don't hold because partially what's going on is an assertion of executive authority. So please.

>> Matteo Maggiori: So to Sebastian question. Sebastian has a wonderful book on exactly that episode. I would say that that has happened again in 73.

 

Nixon went off Bretton woods and money flowed to Switzerland. Switzerland went to negative interest rates and capital controls. Eventually we came to our senses that Switzerland is too small and there was no alternative. And the US has survived as being central. The question is, do you want to take a chance?

 

The UK was forced into that and the existence of an alternative, the US being ready to take on the monetary Germany might have facilitated the permanent exclusion of the UK from the role. So there is certainly a big sense that, as Margaret Thatcher put it, there is no alternative plays at all into this.

 

It's a very informal notion, particular at least in economic analysis. But as China develops, as the European Union might get its act together in terms of capital markets integration, any signal that you're not going to fulfill your obligations in the presence of alternative can be very expensive. And so I don't know that anybody.

 

I certainly don't have a good guess of whether you could get away with it or not, but I certainly have a very good guess. And why on earth would you even try, rather than play the good equilibrium to Steve's question? I mean, again, Steve has done amazing work with Nick Bloom on uncertainty in text.

 

And I piggyback on top of that in my remarks. I think you're totally right. A lot of what is happening is uncertain. It's uncertain not just because it changes very quickly. But also because even if it were to stick, it would have to go through a lot of litigation and presumably through Congress that may assert more of his authority in the tariff space.

 

That's where I think the text and the high frequency data makes a huge difference. The firms have to react to this in real time. They don't have the benefit of waiting three years and figuring out whether Congress woke up and we didn't have the tariffs. And so a lot of the effects that we're seeing are coming from pure uncertainty and volatility rather than anything that is currently on the books.

 

There are some on the books. I mean, there's the steel tariffs, the tariffs from the earlier part of administration. The Biden administration didn't take down so there are certainly some already there and there is evidence that they're stuck around through two administrations, in fact. And so I don't know that if I were doing this as a firm.

 

I would have a expectation that these things are not gonna happen or they're gonna be quickly reverted, given what we've seen in the last two administrations. But it's a big part. That's also why I think looking at the actual tariffs that get implemented would miss most of the economic action.

 

And the uncertainty index and things like that play a very big role in thinking about what are people actually reacting to.

>> Ross Levine: Harold, I know you wanted to jump in.

>> Harold James: Sure, I mean, in a way, interestingly, the two questions I think have a kind of link together.

 

So first of all, with the Steve Davis question about the tariffs and the difference between Hawley, Smoot, Hawley and the present. Yes, that's absolutely right. But I think in both cases you kind of get a learning effect in that. One of the things that people quickly realized about Smoot, Hawley was that it was the result of congressional action.

 

And that it was going through Congress that increased what Herbert Hoover had originally had as a very, very modest agricultural tariff into this massive tariff book. And so the reaction to that is in the Roosevelt administration with the Reciprocal Trade agreement act in 1934, to take the power back to the President.

 

Because the President has an overall view of the United States rather than thinking about each little bit of it where some congressman will benefit from some particular bit of tariff. So I think we're going and we are having that. I mean, in terms of constitutional challenges and many people are making exactly the point that you're making that these tariffs are actually unconstitutional and they demand to be challenged.

 

And so you can expect a shift back to Congress. But the link to Sebastian's question is the rather odd fact that Roosevelt really enjoyed after he played with the. He abrogated the gold clause, he enjoyed fixing the exchange rate of the dollar in an arbitrary way. And so famously he liked to joke with Treasury Secretary Morgenthau that he was fixing the rate of the dollar for the day by looking at the tea leaves that he poured out of his teapot.

 

So in the same way as this was a kind of arbitrary exercise, we, we came back then to the conclusion that we actually need a rules based framework. And that, you know, brings us really, really back to the world of 1944 and the Bretton Woods Conference and the world of rule based monetary policy.

 

 

>> Ross Levine: Christopher, did you want to a little.

>> Christopher Meissner: Bit on what Steve said, I agree with what Harold said. You know tariffs have seemingly become a tool of foreign policy as much as economic policy, which leads to new complications that we haven't seen before. And it's not totally clear whether Congress wants to take back the powers that it originally had and has given in various trade acts.

 

So we'll have to monitor that situation and see how the courts decide. And I think our best chance is public opinion. We'll get immediate feedback in the months to come on the effects of tariffs. And my guess is that many, as per Matteo's charge, will be hurt from these tariffs and that will swing public opinion.

 

But again, there's the foreign policy imperative, which ties back into the first talk on this panel, which is getting more interesting by the day.

>> Ross Levine: Please, yes, right behind you. Man with the white shirt, no tie, I like no tie.

>> Krishna Guha: Thank you, Krishna Guha with Evercore. I wanted to return to this question of this instability zone that Matteo referenced in his presentation.

 

It strikes me that while there are lots of contradictions within the administration's trade agenda at the moment. The dangerous contradiction is between the trade policy and its implications for capital flows and the fiscal situation and the risks that are attendant to that. Of course, as the panelists have rightly said, it's not just attempting to compress trade deficits themselves.

 

It's the wider retreat from international economic integration that this represents and potentially security integration as well. So even in the baseline case, that's likely to reduce the convenience yield on holding risk free dollar denominated securities. That's going to increase the monetary interest that you need to pay on your government debt.

 

And it seems to also increase the likelihood that at some conjuncture you could reach a global buyer strike, for instance, if the deficit were to explode in a cyclical downturn with a lot of discretionary fiscal stimulus to try to buy your way out. So beyond observing the that we're in this terrain where you could have multiple equilibria.

 

Is there anything that we can say beyond that to bring some sort of discipline to thinking about how we might switch from one equilibrium to another? Is it pure sunspot stuff or can we think about this in a more operational perspective, if you like?

>> Ross Levine: Please, yes.

>> Kana Norimoto: Thank you, Kana Norimoto from Fidelity Investments.

 

Just to build on Krishna's question with regards to capital flows, I'd like to invite the panelists to tell us what they think is the right policy solution for the potentially hyper mobilized financial flows that we may see on the back of this. I think it's quite interesting that we've already had an appreciation of the Taiwan dollar last week.

 

It seems some of our Asian allies are, are thinking that perhaps they need to appreciate their currencies to placate our current administration and this could mobilize through the FX channels a significant unwind of the investments that they have made into our markets. So I'm curious in particular if there are any lessons to be learned from the sterling area and how we are able to how can we solidify some of the capital that is actually held by our allies abroad?

 

Thank you.

>> Ross Levine: And Michael, yes.

>> Michael: One quick comment, if somebody else raised this, I apologize. I had to step out for a few minutes. But Chris, you had these beautiful graphs of the history of tariffs and how they had not high tariffs did not say, lead to increased prosperity.

 

But much of the discussion of tariffs that's going on now has a flip side that is kind of nutty in a sense because for much of the history of tariffs, they were the major revenue source for the federal government. They were there to raise money to fund the government, not just to protect industries.

 

Of course there was protection and so on, differentiated, et cetera, but that was one of the two main purposes in any event. And obviously, we didn't have an income tax, that you couldn't have an income tax in 1820. Okay, but nowadays, obviously we have many more tax devices.

 

We have, for better or for worse, we have debt and tariffs that even the ones we're talking about, if you make any reasonable calculations, would be a tiny fraction of revenue. So I just think that people who kind of relate to the 19th century are kind of missing half the story, that's all.

 

 

>> Ross Levine: So I've done a bad job as moderator. So I wanna give everyone a chance to have a closing remarks and then give you also means you can just choose whichever question you wanna answer. I'm gonna add in another question, more for HR, because I'm very interested in the strategic elements.

 

And that is, given the things that you're saying, how has the US Been doing over the last five years? I wanna give a broader perspective, not just focus on one administration, and where are we really going wrong, really going right? So let's go in reverse order and please keep it short.

 

 

>> Harold James: Okay, very briefly, revenue and tariffs. I think that's, that's enormously important. But it also makes me think about what might be the reaction of other countries to the chaos. And so one of the possible measures that you might think about is that other countries might say, well, you know, you, the United States are terribly worried, or at least Mr. Mehran seems to be terribly worried about the way in which the inflows of capital into the United States have created this extraordinary exorbitant liability rather than an exorbitant privilege.

 

So we're going to help you. We're going to put a tax on revenue that comes from investments in the United States. And it seems to me that this would be a plausible and attractive for the revenue issue from the revenue point of view. An attractive countermeasure that many countries would be absolutely justified in thinking about.

 

 

>> Ross Levine: Aggressive, yes.

>> Christopher Meissner: Yeah, thank you, yeah. I don't think we should extrapolate 100% from the past, but I would say that in the 19th century, tariffs were as much about restriction as revenue. When revenue got too high or too low, they adjusted the tariffs by fractions of the prevailing tariffs, percentage points of GDP and tariffs were about 30% on average and didn't climb down too much from that in the course of those years.

 

So there was a lot of restriction, a lot of lobbying and some revenue issues. I think the parallel between the sterling area and what's going on now, from what I've heard, I guess there's a paper by Stephen Mirand about renegotiating long term debt and reminds me, yes, of putting sterling balances on lockdown.

 

But there are other experts like Catherine Schenk on that that should be here and be talking about that. So I'll just say that's interesting and thank you.

>> Matteo Maggiori: So, two remarks on what you asked me. The first is you get lucky in these situations if the market starts signaling a problem and you have time to get to your senses.

 

But there is no guarantee of that. In fact, we normally model these as runs on a country because they look like a bank run. Everything is fine until it isn't. And what lures you into the Big problem is precisely the absence of market signals. Now you can argue that in the last few weeks we started seeing market signals with treasuries and the dollar trading off the usual pattern with equities that we should come to our senses-

>> Matteo Maggiori: Really, you should have no confidence that the markets are gonna give you a long leeway to see coming.

 

This might happen very quickly in some sense. You know the monetary system is really built on fiscal capacity and confidence and confidence evaporates very, very quickly. So we used to say the US is the world banker and mean it as a positive thing of you have assets and liabilities.

 

After 2008, we say the US is a world banker. Hence you might blow up pretty quickly. You might get a run on the country and that's a scary scenario and you want to stay far away from it. And if you're a large debtor and you start mentioning not repayment, that's the quickest way to perceive a crisis.

 

It kind of becomes self fulfilling as people worry about you. So I'm very surprised to see officials talking about we might do something about this that just normally would be the one advice that we would confidently give. Please don't. Similarly, accounting identities. I teach a class in international macro.

 

There's some stuff that is pretty boring like you know, the capital account and the trade balance. You can't have capital flows but run a big trade balance. That stuff seems to become fascinating again because people get it wrong. I used to teach you and people were really bored.

 

Now I used to teach and it's in the New York Times every day. It's the same thing as like no, inputs do not substrate from gdp. Yes, we do write them as a minus in the accounting identity. No, it doesn't mean a negative. Getting those things right seems easy and a very nice thing to do in policy compared to the usual space where we've done those things right and what's left is the things what reasonable people might disagree.

 

So I think a lot of the advice is on the really basics. Let's just get those rights and there will be a better world to be in.

>> HR McMaster: Hey, just quickly to address Ross's question and then also Steve's earlier question, I think that we're, we're not, you know, we're not doing enough to counter Chinese economic aggression.

 

I think where a lot of the historical analogies break down that we've been talking about is that in the 19th and 20th century, we didn't have a Chinese Communist Party that was really, really was a Leninist system. We assumed maybe in the 1990s, early 2000s, that, you know, to quote Dr. Evil that the Chinese Communist Party was the Diet Coke of communism.

 

But they're not, I mean, they're the real Coke of communism. And they want to tear down the existing rules of international discourse and replace them with a new set of rules that is sympathetic to their system. And I think you have to pay attention to a few things.

 

What Xi Jinping says, what he does in terms of, with the economy and with the buildup of the military. And I think that all indicates that Xi Jinping is preparing China for war and is trying to use, I think, a lot of our lack of attention to how we're underwriting our own demise in his favor.

 

So I think what we've done in the last several years, last five years and going back to 2017 is we've recognized the nature of the challenge. A lot of the international investment flows into China that were in many ways the scaffolding that was holding up their system has dried up.

 

I think that's a positive, that's a positive indication. And I think there is a recognition that we have to put into place a strategy that integrates all the tools of economic statecraft and efforts of like minded partners to counter various forms of Chinese economic aggression. To get to Steve's question on the tariffs and everything, and the kind of jumbled nature of this policy, I think it would be really critical to kind of clarify objectives, right?

 

And is it to generate revenue? Is it for national security? Is it to counter unfair trade and economic practices? I would say it's the latter two and I would recommend a few clear objectives that we should orient on cognizant, as I mentioned in the introductory remarks, of not compromising the strength of our free market economic system.

 

And our sort of unbridled entrepreneurship and, and our ability to mobilize private capital and not have the state being the allocator of resources. The first of these would be to reduce China's coercive power over the US Economy mentioned that Vladimir Putin had assumed that he had created a high degree of dependence on, on Russian natural gas and oil to a degree that he could do whatever the hell he wanted.

 

So we know from that case that that's a bad practice to give a hostile authoritarian regime coercive power over your economy. The second would be to bolster the resiliency of supply chains that are critical to national security. Scott Atlas and I worked on a piece, gosh, in 2017 on the degree to which we have allowed the pharmaceutical supply chain to be controlled by China.

 

This was of course, at the height of. No, this was, sorry, 2020, the height of COVID And of course this applies to a lot of critical materials, some of which I think Christopher, you mentioned them. Christopher mentioned these at the end of his, at the end of his brief.

 

The third would be to expand our defense industrial base to strengthen national security and ensure our ability to mobilize in wartime. We have seen our industrial base atrophy to an alarming degree and we have to do something about that. I mean, I think it's an urgent matter. Are tariffs part of that?

 

Probably, but there are a range of other policies that I think would be even more important than tariffs themselves. The fourth would be to counter Chinese economic aggression and to protect, you know, the US critical economic and defense related competitive advantages. And this would be, of course, you know, IP theft, subsidization, you know, the vast overcapacity in dumping activities to ensure that we can't regain our footing in some of the critical supply chains or industrial bases.

 

And then finally to set policies that foster economic growth and innovation kind of an offensive minded policy to take advantage of our free market economic system. So I think that's what's missing. There isn't a discussion of what the heck we're trying to achieve with tariffs, but also with the broad range of tools of economic statecraft.

 

I do think there's a good team coming in. It's really important to understand that. I don't know how many people have the Senate confirmed, I mean, 60 or something, I think. So there are good people who are going to be coming into government in Commerce and Treasury and Defense who I think have very good ideas and strong knowledge base on how to apply the tools of economic statecraft to accomplish clearly defined objectives.

 

So what I would expect to see is a much better explained and more rational approach in the months ahead.

>> Ross Levine: And please join me in giving all the panelists a hand.

>> John Cogan: Please be seated. We could begin. So I'm John Kogan, Senior Fellow here at Hoover and let me introduce our topic today with a few remarks. I'll focus on the United States, but my comments apply in varying degrees to the fiscal circumstances faced by most advanced countries. US fiscal policy is on a dangerous path.

 

For more than a half a century the United States government has continually run annual budget deficits. The only exception to this unprecedented 50 year plus string is a brief four year period of surpluses during the dot com boom. Recent Congresses and Presidents have worked particularly hard to make sure that we continue down this perilous path.

 

When the United States treasury closes its books at the end of the current fiscal year, it will report that federal spending, excluding interest on the public Debt is about $6 trillion. This amount is 50% higher than it was just six years ago. In 2019, right before the pandemic.

 

Add in interest payments and the increase rises to 60%. That temporary surge in government spending during the pandemic is now in the process of of becoming a permanent fixture in the US budget. The US now faces primary deficits of $1 trillion that in the absence of any fiscal restraint or any tax increase will soon become $2 trillion and then $3 trillion.

 

Now it'd be one thing if these deficits were used to finance investments in the future. But in the US only 5% of federal spending goes for non defense infrastructure projects, R and D education programs. Most expenditures consist of transfer payments. Both history and economics teach us that the path that we are on will ultimately have serious adverse economic consequences.

 

So what are these consequences? How will they manifest themselves? Can they be avoided? Is there way a way off the current fiscal path? What role can monetary policy play in alleviating any adverse effects that are likely to come from continuing down this path or from trying to get off it?

 

What market signals should the Fed pay attention to to identify emerging debt related economic problems? What signals should it not pay attention to? Definitive answers to these questions and I'm sure the ones you have will be provided by our expert panel. Here we have Alan Auerbach from UC Berkeley, Michael Boskin from the Hoover Institution, Hanno Lustig from the Stanford Business School and John Cochran from Hoover.

 

Alan, you want to kick it off?

>> Alan Auerbach: Well, I'm particularly glad that this conference includes this session on fiscal policy. That's usually the only time I get invited to conferences on monetary policy. And it's particularly nice this year because I get to help celebrate John's contribution, John Taylor's contributions.

 

I've been concerned about US deficits for about 35 years and warning about the dangers of continuing to run them. So I may have lost credibility at this point, but I'm here to argue that this time is different. And I've got several reasons for saying so. First of all, the debt to GDP ratio we have right now of about one is substantially higher.

 

It's about three times what it was before the financial crisis. And while we talked about deficits and our concerns about deficit spending in years before that, if you look at the patterns of the debt to GDP ratio leading up to the financial crisis, it tended to ebb and flow, but there was no obvious pattern.

 

Since then we've had basically two big jumps in the debt to GDP ratio, One associated with the financial crisis and the other associated with COVID And notably Those jumps, unlike for example the jump during World War II, those jumps were not succeeded by any reversal. The US had an all time high debt to GDP ratio, publicly held debt of a bit over 100% at the end of World War II, and of course it fell quite rapidly after that.

 

But the big jump that we had in the aftermath debt during and after the financial crisis and then again during the COVID induced recession were not reversed. We basically in each case reached a new plateau of the debt to GDP ratio. And so we really have less room to maneuver than we did in past periods when we at least for, for a period of years, ran large deficits.

 

The second thing that's different now is that we have larger primary deficits built into our forecast than in the past the last three years. Last three fiscal years, last three completed fiscal years, we've had primary deficits of over 3% of GDP. That is unprecedented in the post war period, except for periods during and immediately after recessions.

 

So for example, that we had several years, four years immediately after the financial crisis, two years, the two fiscal years when Covid hit, and then 1983, which was just in the aftermath of a very deep recession. Except for those years, we haven't had primary deficits of more than 3%.

 

We've had them for the last three fiscal years during a period of pretty good economic performance. Now, if one looks at the Congressional Budget Office projections going forward, the primary deficits fall below 3%. But there's a big asterisk next to that, which is that those are based on current law, which includes the expiration of virtually all of the 2017 tax cuts.

 

If one incorporates those tax cuts in the forecast, the primary deficits jump way above 3% again and they continue throughout the next several years, leading, by my calculations, with Bill Gates. Gale in a recent paper to a projected debt to GDP ratio again publicly held, not gross debt to GDP ratio at the end of the next of the basically the current decade through 2035 of 134%.

 

Now remember, the all-time high debt to GDP ratio was 106% in 1946. And of course the difference between 1946 and 2035 is that there's no prospect without major changes in policy of a decline. There's no peace dividend this time. That already happened. There's not another peace dividend on the way.

 

The third thing that makes this time different is that Congress has stopped responding to budget conditions. In a paper that Danny Yagan and I did for the Brookings panel in the fall, we analyzed fiscal feedback rules following the same procedures that I used in a Brookings paper little over 20 years ago.

 

And in my original paper I found that legislative that there were strong legislative reactions to larger projected budget deficits. In particular, larger budget deficits led to legislation that adopted fiscal consolidation on both the tax side and the spending side and that that was pretty constant throughout the 1980s and 90s and into the early part of this century.

 

But sometime within the last couple of decades that responsiveness entirely evaporated to the point that Congress no longer responds at all to fiscal conditions no matter how large the projected deficits are. It doesn't lead to any kind of difference in policy. And one only has to look as an example at the difference between the tax policy process in 2017 now.

 

So under the same president, so political conditions not obviously different. In 2017 there was concern about the size of the deficit, additions to the deficit that would be caused by the tax cuts. There was a target of one and a half trillion dollars over 10 years. And in the reconciliation process there were attempts to find certain sources of revenue to lessen the problem.

 

In 2025, Congress has adopted a current, so called current policy baseline which says the tax cuts that extend existing previous tax cuts have no effect and therefore don't have to be any cause for concern. And we don't really have any, can't really have any confidence that the very large tax cuts that will be coming as a result of extension of the 2017 legislation as well as additional measures that have been added to that will be offset in any significant way by reductions in, in federal spending.

 

And so we're going to have a very large, probably bigger than the 134% debt to GDP ratio that I mentioned. And I should say also that that projection doesn't incorporate any responsiveness of the debt service costs to that is it incorporates additional debt service costs but not any increase in interest rates with respect to the debt to GDP ratio.

 

Incorporating that would exacerbate the increase in the debt to GDP ratio. And the final thing I would say that is different is that we are rather than sort of relying on our exorbitant privilege to lessen the cost of debt service, we have an administration that is, as has already been discussed here today, that is pushing against that and viewing the very strong demand for US assets as a curse rather than a blessing which presumably is going to increase the cost of debt service to the extent that it spooks foreign investors.

 

Of course we add to all this the which all of which is going to put a lot of pressure on the Federal Reserve. It's just going to, it's also going to lead to demands and already has for monetary accommodation. And whether this time is different in terms of Fed independence is for others to say who are more expert on the politics of monetary policy than I.

 

But I think that certainly contributes to the challenge we face now that really makes it different than in other cases where we've worried about deficits. So to the extent that this plays out in an increase in either in monetary accommodation or through some other mechanism, higher inflation. I just wanna add one final point, which is that inflation.

 

There's very little of a silver lining here in terms of inflation's effect on our fiscal problems. We tend to think that because of most of the national debt is is not indexed, that sudden burst of inflation will help our fiscal picture. And indeed the debt to GDP ratio did go down during the run up inflation associated with COVID it actually improved even though we were running large deficits during that period.

 

That may happen again. But it's worth pointing out that even with a substantial reduction in the debt to GDP ratio because of rapid unexpected inflation, we will still face a daunting fiscal challenge because of the very, very high primary deficits that extend out as far as the eye can see under any realistic projections.

 

And one should keep in mind that these primary deficits are real. They're basically determined in real terms because we have an indexed tax system, because our major expenditures such as old age entitlement programs and national defense, which occupy the lion's share of the federal budget, are all marked in real terms rather than nominal terms.

 

Social security, because Social security benefits are indexed to the price level. Health care, because health care is based. The cost of health care is based on the delivery of services. Not on nominal budgets and defense for the same reason, because we determine what it costs to provide national defense based on.

 

Based on what it costs to pay soldiers and procure weapons. And those things don't, you know, are not, are not determined, not in nominal terms, but in real terms. So we may have, because of the unusual circumstances that we face, we may have excessive pressure on monetary policy and we may see additional inflation in part because of that.

 

But even if we do see that inflation, we are still going to have massive fiscal challenges that we are currently nowhere near addressing. Thanks.

>> John Cogan: Thank you, Alan, for that uplifting message. Michael.

>> Michael Boskin: I may not be much more uplifting than Alan, however, I want to provide some additional context.

 

I think I'm going to dispense with virtually all of my slides so I can get through material a little more quickly. I want to emphasize several points. First, looking at the historical data, there are some very important things to appreciate. Number one, that what governments actually do in the real world, in the advanced democracies has changed markedly over time.

 

They're primarily redistributors of income through transfer payments and social insurance, not purchases of goods and services, including defense. So it's important. And building roads, et cetera. That still goes on. But those were in the Eisenhower administration that was 80% of non interest spending. Now it's a minority of non interest spending.

 

Second, that something Alan mentioned. But a large fraction of our budget is on autopilot. We with an anodyne phrase call them entitlements, but they're not just that they continue, but they actually schedule to grow. And we need, we badly need to have a debate about whether we want them to guarantee a real level of income or that, for example, Social Security payments should rise by 25% every generation.

 

And we don't do that. We have really haven't engaged on that kind of a conversation in many, many years. So that in addition, that makes things more difficult. I do want to say that when we look at post World War II history, Alan Kind of alluded to this, I'll be more explicit that if we look at every presidency Since World War II, President Obama ran the largest cyclically adjusted deficits until President Trump 1.0, until President Biden, and now President Trump 2.0 may wind up taking the crown.

 

We're facing a fiscal trifecta that I think is really important to emphasize about how difficult this will be. And this is really my sense of urgency, more than what some other people have said about the impending financial crisis, et cetera, that some foresee. That is, we have an urgent need for substantially increased defense spending.

 

Real defense spending this year is $100 billion less than it was 12 years ago when we weren't worried about Russia and China. Yes, we still were somewhat in Iraq and Afghanistan, but not much. And we also obviously seen a much bigger bang for the buck from the Defense Department.

 

That's an additional story. Secondly, in a few years we have what you might call the cliffs of the unfunded liabilities and Social Security and Medicare becoming politically salient when current law would mean that we'd have over a 20% reduction in Social Security benefits according to the to the schedule.

 

So there will be immense pressure and the longer we wait, the more likely it is we'll be raising taxes rather than having a more sensible mix of responses, including the possibility of eliminating the cap or raising a tremendously high level on Social Security income, that is income that is taxable under Social Security, which would add a very large discrete increase in marginal tax rates on a very productive part of the population and small businesses.

 

So those things just to get a sense of it, Social Security, Medicare, we've got what, seven, eight, ten years depending on whose projections you want to look at. And the longer we wait, the more difficult it will be. So the better we can do in getting our fiscal house in order, the better we'll be able to do now to deal with defense and our non defense spending, the better we'll be able to deal with that.

 

And the more time we have to make those reforms in Social Security and Medicare, the less disruptive they'll be and probably the better. The ultimate combination of ways we deal with those shortfalls will be. The next point I was making is Alan kind of essentially alluded to this by his saying that he had been warning about this for some time and not much has happened.

 

But many economists and policymakers have been surprised we haven't had an overt fiscal crisis. Secretary Rubin warned of it all the time, for example, and many others. Yeah, we did have a surge in big increase in the price level of surge in temporary inflation. Whether that's John Cochran's fiscal theory, the price level will debate.

 

But in any event, we haven't had what some have thought was fairly likely from the large run up in debt. I think the main reason we haven't had that was Jason's Back to the old debate between Al Harberger and Marty Feldstein how open our capital markets were and whether we needed domestic saving to finance our investment or whether we could have foreign capital at least for a considerable length of time.

 

And basically the supply of capital to the United States has proven far more elastic over a far longer period of time than people were thinking about back then when they thought in closed economy terms. Whether that will continue, whether we'll remain innovative enough and have high enough returns and be safe enough and the like.

 

So that will continue remains to be seen. We are 40% of the global bond market and 40% of the global equity market now, so all that remains to be seen. But what we have are. I will put up one quick thing here to bore you with equations. We have the government's intertemporal borrowing constraint, the present discounted value of the future primary surpluses has to cover the debt and I would say net of assets, something that is starting to gain attention in Washington, but it doesn't say anything about where along that path they will show up, what happens if we don't, if we wait, et cetera.

 

So it's become very convenient to have the anodyne phrase. And then we have the debt dynamics, different equations, how the debt GDP ratio evolves based on the relationship of the. Of the after of the interest payments by the treasury to the growth rate and the primary surplus. In any event, we've had this anodyne discussion of it being unsustainable, which I view as the basically the political equivalent of, what do I want to say?

 

Of less than a rallying cry. Okay? Unsustainable sort of anodyne phrase. Then again, economists and policymakers have been crying wolf, and policymakers have found it convenient to kick the can down the road and to shift the burden to future voters, future taxpayers, or to future elected officials to make the tough decisions.

 

I won't go over my discussion. You'll have to read it when the conference final comes out, or get the slides of what real effects the debt may have and the intellectual history of that in economics and the last several decades, tracing back to Bob Mundell and Franco Meanni saying that there was debt illusion.

 

Jim Buchanan saying that it made people vote for bigger spending because they only perceived the tax cost. Jim Tobin saying that there were many different features of government debt as an. An asset that made it have real effects relative to other assets available and so on. And the counter revolution, Robert Barrow, you still here, Robert.

 

In any event, reinstating Ricardian equivalence in the people's thinking, the debates about whether to what extent it holds and how that. And then Olivier Blanchard's presidential address, basically claiming that we could roll over the debt forever and that there was big welfare improvement by a Sri Mourdet. I've deconstructed that in the next year in the papers and proceedings, if you're interested.

 

I think both of those are not fully descriptive, I think Robert's just a more fundamental question. Ricardian equivalence is incorporated in a lot of macro models now. I don't view it as compelling completely, but I do believe that we'd have to shave the traditional estimates of deficits of finance spending crowding out investment dollar for dollar to something like 50 to 60 cents on the dollar and there's 40 cents, perhaps in round numbers coming from imported capital and private saving.

 

So with that in mind, I do want to turn to a few additional points. Okay, and that is number one, that we shouldn't just look at the deficit and the debt. We have to look at what it's composed of. It makes a difference how what we're spending on, whether we're spending on consumption or productive government investment.

 

Let me emphasize productive. We don't have a market test for much government investment and you can call lots of things investment that have very poor returns. But we do have a large government capital stock and we have a need for building it up further, especially in the military when we have sharp swings and the need for that.

 

We did debt finance World War II after all, and much of Reagan's military buildup. And that probably was very wise on standard public finance principles. The next thing I'd say is it's not just the level of taxation but the structure that makes a big difference whether you're taxing, saving an investment and whether that's heavily ineffective marginal rates or whether you're doing things that are infra marginal if you're raising revenue and or if you're taxing consumption.

 

So I think that's important, that leads me to my next point. There's a lot of data that suggests a lot of many studies suggested that increases at least over a sizable range after some minimum increase in the debt GDP ratio will slow long term growth. The IMF has studies, there are many others.

 

We can go on and on with standard production functions plus the usual analysis of the extent to which Debt substitutes for tangible capitals and portfolios and come up with a conclusion. But the basic story is it probably is deleterious, but the last thing you'd want to do is deal with it by a bunch of anti growth measures that basically delete the purpose or defeat the purpose of slowing the debt.

 

One of the main purposes of slowing the debt GDP ratio to keep growth going. So I think that really have to pay attention to what the tax structure is and the like. And that gets me to my final point before I get to monetary policy and say a word or two about that.

 

And it's simply this the best way out of a debt dilemma or I don't think we'll be able to totally grow out of it. The best thing we can do is to maintain a strong growing economy on average over the longer term there's much that has to be done to deal with that.

 

With the tax structure, yes, with spending and the debt, yes, with entitlement reform, but labor market reform, regulatory reform, all those sorts of things can help. How much they'll be able to help makes a very big difference. The standard estimates of our long term productivity growth and our long term GDP growth potential are very low now compared to our history.

 

Partly that's due to slower demographics. If we don't continue to have a lot of immigration into the United States. CBO has been below 2% for some time in their forecast of long term real GDP potential compared to 3% or so for much of the post World War II period.

 

Well, if our fiscal policies and other policies are generous, entitlements, our regulation, etc wind up making that prophecy come true or it becomes even slower. At a very slow rate of productivity growth, you're not going to have much of an improvement in living standards for our population and it's going to be even harder, harder still to deal with our more existential needs that HR was pointing out earlier.

 

Our need to increase our defense spending, our need to do some of the other things we need to do both publicly and privately. Privately. Thank you.

>> Hanno Lustig: Okay, well, thank you very much for inviting me. It's a real honor to be here. I'm going to talk about the interaction between monetary and fiscal policy.

 

And so to do that I want to set the stage by taking you back to. Let me start my stopwatch here by taking you back to March 2022. That's sort of when the Federal Reserve said, well, we're done expanding our balance sheet to absorb issuance of Treasuries and other securities and central banks and other advanced Economies followed suit.

 

And then as sort of the price discovery process resumed in bond markets in advanced economies, what we saw was that there were some hip hop hiccups along the way. I'll give you a couple of examples. For example, In July of 2022, the Eurozone saw large increases in spreads between core and periphery bond yields.

 

But the example that's been referred to earlier that you probably all know about was the announcement of the trust budget in September of 2022, which was followed by large bond yield increases. France experienced some volatility in the bond market in December of 2024 when the fiscal consolidation plan of Barnier ran into trouble.

 

And then More recently in March 2025, Germany released its constitutional debt break in order to increase defense spending. And that gave rise to really large increases in bond yields in the next 24 hours. And then of course, just a few weeks ago here in the US in early April 2025, what we saw was that in response to these tariff announcements, the new tariff plan, US long term interest rates rose significantly.

 

So between April 4 and April 14, the spread between 10 year US treasuries and German bonds increased by about 50 basis points. So that was a big increase. And in most of these cases, and that's what I want to talk about today, market observers, policymakers sort of instinctively reasoned, well, there must be a problem with the functioning of the bond market that may call for intervention.

 

And in fact, In July of 2022, the ECB rolled out preemptively something it called the transmission protection instrument that was designed to suppress spreads that are not driven by fiscal fundamentals. The footprint of market segmentation. In September of 2022, the bank of England in fact briefly resumed its bond purchases just a week after it said it was done purchasing bonds in response to the.

 

The hiccup in the gilt market after the announcement of the trust budget. So you do see sort of a pattern here. I think that pattern reflects the fact that policymakers and market observers have sort of over the years now adopted this view that government debt and advanced economies is safe.

 

And by safe here I mean broadly speaking, has sort of zero beta, I'm not just talking about the possibility of default. And then these large yield spikes are just not supposed to happen even in response to bad fiscal news. Just not supposed to happen. If you adopt a safe view of government debt, then in fact what you expect to see is sort of flight to safety, right?

 

That's what we've gotten used to in the U.S. that's what we saw during the great financial crisis. In December of 08, investors fled to the safety of Treasuries, bidding up the price of Treasuries. But that is in fact not what happened in March of 2020. In fact, treasury yields, as I'm sure you remember, increased significantly in early March 2020.

 

It didn't happen in April of 2025. So the last two tests of this sort of flight to safety mechanism, I'd say we didn't pass. Now, if you sort of adhere to the safe debt view, as I said, then these yield spikes are the signature of sort of market dysfunction.

 

And you conclude, well, there's a plumbing problem. And in fact, and Thorsten talked about this earlier in the UK, in September 2022, the liquidation of highly levered guild positions by pension funds was blamed. And I'll come back to that in a second. And that was a problem. Similarly, in April of 2025, market observers here blamed the unwinding of the treasury basis trade.

 

This is a trade where hedge funds go long, take cash positions in Treasuries, short futures on Treasuries to earn a small basis, and when that basis widens, all of a sudden they're forced to unwind and that could create upward pressure on yields. But I would argue there's a different view.

 

This is a view that is more common in emerging markets, which is, well, you shouldn't take it for granted that government then is safe because it's backed by something that's quite risky, which is future surpluses. And when governments implement large tax cuts or spending increases that are not funded by future tax increases or spending decreases, well then the market value of outstanding debt should be marked down and yields in order to do that will have to increase.

 

This can happen a variety of ways. It can happen by increases in expected inflation, increases in term premia, decreases in the convenience yields. We talked about convenience yields earlier on government bonds, or even increases in default risk premium or a combination thereof. And so what I want to do now, I'm a business school professor, is give you a little case study of this and to convince you that this really does happen and it's not always just the plumbing.

 

So let me take you back to the UK. September 2022. On September 22, the BoE, excuse me, announced that they were done purchasing gilts. And then the next day, Friday, September 23rd, the brand new Chancellor of the Exchequer went to the House of Commons to deliver a speech where he announced sweeping tax cuts that were supposed to stimulate economic activity.

 

And what you see here, the dark area, is where the Chancellor starts to address the House of Commons and explains what's in the budget plan. And what you can tell right here is that right away both the 10 year and the 30 year gilt yields start to go up really significantly.

 

The 10 year nominal yield increases from around 3.5% to 3.7% in a matter of an hour, an hour and a half. The 30 year rose significantly about adding 27 basis points to the yield on the day. And this happened well before there was any problem with the plumbing.

 

Now, subsequently, and this is what Thorsten was referring to, there was a real plumbing problem in the days after that. What happened was that a lot of these liability driven investment strategies that pension funds had implemented while they were losing money, and so these pension funds were getting margin calls, and then what they did in order to meet these margin calls is in a lot of cases, liquidate these positions, thus further putting upward pressure on yields.

 

But again, the original shock here clearly was fiscal in nature, and it wasn't just all about the plumbing. Then what finally happened in this case is that on September 28, the bank of England said, well, we're going to resume purchasing gilts, even though just a week before that they said that they were done.

 

And then finally, the way this story ends is that in early October, the tax plan was abandoned and the Prime Minister, as I'm sure you recall, was actually forced to resign. And after that, gilt yields, of course, came permanently down. But it sort of does beg the question, well, what would the bank of England have done if this tax plan had not been abandoned?

 

Which brings me to COVID 19, which I think is kind of illustrative and provides a cautionary tale. Between March 9th and March 18th, 2020, here in the U.S. 10 year U.S. treasury yields increased by 68 basis points as bond markets were slowly starting to digest the largest post war fiscal shock that was about to occur.

 

And some economists pointed out correctly that primary dealers in the US had trouble absorbing all of the Treasuries that were being sold by market participants. They were running out of balance sheet capacity. And then these events triggered massive intervention by the Fed and central banks around the world.

 

On March 15, the Fed Open Market Committee announced that they were going to start purchasing Treasuries to support the smooth functioning of treasury markets. And if I can direct your attention to that slide, what you see there in the right hand side panel is the purchases of notes and bonds.

 

So excluding T bills, the red area, that's the rest of the world. The rest of the world didn't really help us in Covid, as you probably know. In fact, they were selling early on. And so the Fed actually ended up absorbing more than issuance for four quarters at the start of COVID between March 2020 and March 2021.

 

And of course that begs the question, well, we sort of started all this to address a plumbing problem, but if we were concerned about market functioning, then how did absorbing all of the issuance for 4/4 improve market function? Maybe it actually potentially impaired price discovery and sent the wrong signal to fiscal policymakers.

 

And this brings me to fiscal policy about how much fiscal capacity they really had. Because ultimately fiscal policymakers rely on the bond market to tell them, and that requires a price discovery process that works. So ultimately central banks and governments can coordinate on a safe debt regime in which bondholders are protected from fiscal shocks, but then taxpayers have to bear the burden and that rules out unfunded spending and tax cuts.

 

Alternatively, they can coordinate on a risky debt regime that protects. Taxpayers, but then that exposes bondholders to fiscal risk. But you can't really do both. There's a choice there. And ultimately, I guess, and that's the point I want to emphasize. It's important that policymakers, central bankers, particularly use the right model of government debt when they're judging whether the bond market is functioning and whether sustained intervention is called for.

 

And this brings me to my final point. As was pointed out by Alan earlier, the US Federal government is not on a sustainable fiscal trajectory. In the baseline case, the CBO projects federal government will be running primary deficits until 2053. Federal debt held by the public in the baseline scenario is projected to hit 153% in 2053.

 

But that doesn't include an extension, as Alan pointed out of the Tax Cuts and Jobs Act. If that is extended than the debt GDP ratio according to the CBO in 2053 would exceed 200%, 47 percentage points higher than in the baseline scenario. So price discovery process in treasury markets ensures that fiscal fundamentals are priced in.

 

That imposes discipline on fiscal policy. If government debt really is risky, then occasionally large yield increases may be appropriate in response to adverse fiscal news. That's part of the price discovery process. The risk is if central banks use the wrong model of government debt, then they may end up using their balance sheet to continue to absorb a lot of the issuance to fix a sequence of plumbing problems.

 

And then as in the case of Japan, ultimately you may fundamentally impair the price discovery process in the bond market altogether, potentially at a great cost to taxpayers and to savers. Thank you.

>> John Cochrane: Thank you. I also want to talk about fiscal monetary interaction. We've got the world is ending signs which I don't need to repeat because been done so beautifully.

 

But how does that affect a monetary policy? So we need to remember inflation is always and everywhere a joint monetary and fiscal policy interaction. And what are the channels? The most obvious that we know all is that in a time of big deficits, there's pressure on the central bank to finance those deficits or to hold down interest costs on the debt.

 

And not necessarily pressure. During the pandemic, the Fed monetized about 3 trillion of debt and totally voluntarily. There wasn't an independence issue because they diagnosed the problem the same way the treasury did, but there was monetization. For that's something that's a fiscal and monetary thing that happened together.

 

Getting out of it. Higher interest rates to fight inflation create additional deficits because of the interest cost on the debt. And at 100% debt to GDP. That's big. 1% real interest rate is 1% more GDP to interest cost. That's 1% of GDP more deficit and that's deficit fuel on the inflation fire.

 

If you don't do something about it, there's a windfall to bondholders. If you do bring down inflation, you're paying back long term bondholders in more valuable money. That too is significant with a large amount of debt. And of course, if the Fed raises real interest rates, the whole point is to go through softening the economy, Phillips curve, blah blah blah.

 

And that is going to induce bailouts, stimulus, automatic stabilizers, additional deficits. Every single model we have describes disinflation as a joint monetary fiscal contraction. Because fiscal policy has to tighten to pay all of those costs. Even if you're New Keynesian, you say passive fiscal policy. Footnote 4 Lump sum taxes take care of it.

 

All those lump sum taxes must happen. And if they don't happen and they're big, you cannot lower inflation. And I want to show you that. Here's some graphs to make that point. So let's. I claimed that every single model is joint monetary fiscal and without the fiscal contraction you don't.

 

The Fed cannot lower inflation. Here's the new Keynesian model, Taylor rule, Taylor principle selecting equilibria. The top left one. The standard New Keynesian is Phillips curve and Taylor rule. No fiscal theory. Funny business here. Even I know how to compute these models too. I haven't forgotten. Perfectly standard.

 

There's an AR1 shock. That's the U on the top. Interest rate goes up, inflation goes down. Yaha, that's a. That's a disinflation. But notice the interest rate is higher than the inflation. There's a long period of high real interest rates here. Those are real interest costs on the debt.

 

Someone's got to pay them. Let's look at footnote 4. Aha. Passive fiscal policy raises lump sum taxes, in this case by 5.9% of the value of the debt to pay those interest costs on the right, a totally standard New Keynesian model. I ask of the model. Okay, I want to find a U.

 

A monetary policy disturbance that produces exactly the same interest rate path. Notice the interest rate, the different vertical scales. The interest rate comes down as an AR1. Those interest rate paths are the same, but choose a different. There are many different shocks that produce the same interest rate.

 

Of those, pick a shock series that involves no fiscal policy contraction. So Fed, do what you can, but there's. You call Congress and say I want 5.9% of GDP, more surpluses. And they say, ha ha ha. Well, here's what happens. Totally standard new Keynesian models. Different shock process, same interest rate.

 

Look, inflation goes up without the fiscal tightening to pay the interest costs on the debt. Inflation goes up when the central bank raises interest rates. And this is the totally standard New Keynesian model. And you can eyeball it, you can see that the pie and the eyelines are about this.

 

So the present value of the real interest rates are zero. Here's the fiscal theory of the price level model with new Keynesian model. Notice the graphs look exactly the same. They are exactly the same. You can interpret the same calculations in multiple ways. Here the Fed picks the interest rate path.

 

That's the thing we observe. There are many FIs, there are many possible inflation equilibria with that fiscal path, that interest rate path. Fiscal policy picks which one of the equilibria we get by how much surpluses they're willing to give. On the left, fiscal policy tightens 5.9%. On the right, fiscal policy says we're not doing it.

 

And then we pick a different inflation equilibrium without the fiscal tightening. Inflation goes up the fiscal and sort of an embarrassment. Here it is the tightening, the equilibrium selection, the fiscal policy that does all the disinflation. Higher interest rates in the New Keynesian model, without that equilibrium selection business raise inflation.

 

You need the fiscal policy. Here's adaptive expectations. Good old islm. The model's on the left. Notice I've got PI t minus 1s where there should be et PI t plus ones. That's how the old fashioned model works. Higher interest rates raise the real interest rate. That pushes output down.

 

Output down pushes inflation down. Going forwards. The standard story told to undergraduates. And this is a. I've got a Taylor rule in here as well. So what happens? Raise the interest rate as you raise the interest rate and inflation starts to go down. Looking forward, real interest rates are high.

 

That pushes inflation down. But following the Taylor rule, the interest rate then, then, then follows the inflation down and we restabilize at a lower level the standard story of what happened in 1980. But wait a minute. Look at the interest rate relative to the inflation. There are positive interest costs on the debt here.

 

In fact, this graph here, the, the, the magenta line graphs what happened to the discounted value of the debt which has to go to zero. It's not going to zero if nobody pays those interest costs costs on the debt. In this model too, if there is no change in fiscal policy to pay those interest costs on the debt, higher interest rates cannot lower inflation.

 

The reason is higher real interest rates push inflation down. Okay, that, that works. But then we've racked up interest costs on the debt. The only way to not pay those interest costs on the debt is to have negative real interest rates for a while to run down the bring the debt value back down.

 

But that brings the inflation back up again. You cannot lower inflation. And unless fiscal policy pays the interest costs on the debt, this is the best I can do. This is a unpleasant interest rate arithmetic. It's no change in fiscal policy, but the Fed can do some good here.

 

Raise the interest rate. What that has is the unpleasant interest rate arithmetic. You can inflate in the future, raise lower long term bond prices, make short term bonds more valuable and, and disinflate. Now notice what the Fed can do is move inflation through time without fiscal help. We're not lowering inflation durably, but you can move around through time.

 

And that's a great and good thing to do that, that can help smooth inflation. But without fiscal help you can't bring inflation down forever. The 1980s were a joint monetary and fiscal disinflation. 1980s like the poster case for monetary policy came in. And by the way, are we here?

 

Is a very interesting question. 1979 was. There was a big inflation that came and went in 1976. Then a big supply shock came in 1979 and our central bankers were facing the same supply shock. Now I think we were a little embarrassed about how much accommodation we did back then.

 

I'm worried about are we running right into 1979? But let's move on to 1982. Yes, interest rates went up, inflation came down just like that graph I showed you. But look, interest rates above inflation, high interest costs on the debt. Great deal. If you bought bonds in graduate school and I was in 1982 in graduate school.

 

I wish I had bought bonds at 15% yields and get paid off. When the CPI had gone down to 5%, who paid those? Taxpayers paid those. The 1980s were had a fiscal and monetary reform during the night. There was a Social Security reform. Heavens. A Social Security reform where we saw the looming crisis and put that present value of long term future surpluses back on a sustainable path for another 40 years.

 

There was a tax reform, there was deregulation, there was growth. So the present value of surpluses did pay for the disinflation. And there's the surpluses down below. There were deficits, small, small primary deficits in the 1980s. But then look at the late late 80s, the 90s, early 90s and late 90s, the surpluses came in.

 

The present value of surpluses did it. It was a joint fiscal, monetary and microeconomic reform. And many times, especially in Latin America, they've tried to raise interest rates without solving the fiscal problem. You get a little bit of inflation going down for a while and then boom, 1976 turns into 1979.

 

So what about the shadow of debt? What is the real problem? As I see it, the big problem is the fiscal space. Not so much just the trundling along, but the fiscal space of what do we do to react to a shock? What happens when there are crisis?

 

When the Fed wants to raise interest rates, do we have the fiscal space to pay higher interest costs on the debt? If there's a geopolitical crisis, which we've been talking about, is there the fiscal space for the treasury to borrow all the money it needs? Now there's good and bad news here.

 

What counts is the present value of surpluses. You do not need a couple years of austerity. You do not need gimmicks. In fact, everything that matters is outside of the budget window. It's okay to borrow if there is credible future surpluses. What you need is the credibility that you're going to go back to some sort of normal policy and decades of small primary surpluses or even slightly negative primary surpluses.

 

If you've got some exorbitant privileges, that 1% liquidity, you can even have a little bit negative. But they got to get smaller. On the other hand, long term surpluses, they have to come from growth spending and marginal form, high marginal tax rates. You can grab some money now.

 

But if you kill growth just a little bit, you've killed your tax revenue going out 20 to 30 years years. So you don't need short run austerity, you don't need capital taxes. The long run Laffer curve is not about labor, leisure. It's about investments that pay off in growth 20 or 30, 30 years from now.

 

There's a fiscal monetary coordination going on over in Europe as well. And I want to advertise a book that Luis, who's here, and Klaus Mazik and I have coming out in June on the euro. There's fiscal monetary coordination in a written for you. The Euro is a wonderful invention.

 

There's a problem if you have a currency union, a temptation for countries to borrow and then say, no, we can't pay back. Ecb, hello, bail us out, print some money. The architects of the euro understand this beautifully and especially given 1990s, they really admirably, they structured it with some really good rules against this problem.

 

Central bank is independent, it has an inflation mandate, a tradition nearly legal, of we don't buy government debt, a no bailout clause among the member states, debt and deficit limits. They really thought about it. But a couple little items were left a little bit unstated because on your wedding night you really don't want to write the 15th clause of the prenup.

 

We'll figure it out later, honey. Which is what they did. And the biggest one is if, if a member state does get in trouble, did they default like a company or do they not default? And we didn't. And there was no mechanism for default because we don't really want to talk about default.

 

We treated, they treated government debt as risk free for banks. But on the other hand, there wasn't clear that there was any way for them to never ever default. Well, we'll figure that out. Unfortunately, a sequence of crises came that no one imagined at the time. The financial crisis, the sovereign debt crisis, QE Covid and so forth.

 

And each time the ECB was kind of stuck. They're the only game in town and we got a bailout by government debts and so forth. But now we're kind of stuck. There's a big balance sheet, there's a lot of moral hazard. Everyone expects the ECB to step in and tamp down problems in the future.

 

Italy borrows and goes on a super bonus binge. That's a good joke for another time or over beer. So it's time to bottle up the moral hazard. And that's the point of our book. And I won't give you now, especially as John is looking nervous, a long list of reforms.

 

So my closing comment is, when we put this together, we thought about fiscal, monetary, of course, tariff monetary policy is the big issue now. And there are two issues I think worth talking about first, Tariffs are a supply shock. So the tariff monetary thing is, what are you going to, you know, you get to go back central bankers and relive 1979 or 2022 and get a chance to say, boy, here's how.

 

I might have done it differently in unpleasant times, but the deeper problem is the tariff. International financial. Monetary shock. If foreigners cannot get dollars via trade, they cannot buy our Treasuries. If they cannot buy our Treasuries, then the US must boom today. Set savings equal investment, balance the budget.

 

That means massive cuts in consumption. And the way you have massive cuts in the consumption is the government stops sending people checks in order to finance their consumption. Interest rates spike in order to get that savings equal investment. Be careful what you wish for. You might just get it.

 

 

>> John Cogan: Thank you, John. Will we have time for questions or comments? Maybe. I'll gather a batch here first. Right there. Then if we could have another one here. Sebastian, down here. State your name first, please.

>> Lawrence Ball: Larry Ball, Johns Hopkins University. So I think there's a pretty persuasive case that we're on this unsustainable path.

 

So the debt gdp ratio is 100%. It'll be 134% in 10 years, then 168%, then 200%. And there's a political deadlock that means we'll never get off it that path and assume actually there isn't any special mistake like a Mar a Lago accord or we hit the debt ceiling in default.

 

Suppose we just plot along with 3% primary deficits a year. So we all, we know that, you know, at some point before the debt GDP ratio reaches infinity, you know, there will be a sudden flight from Treasuries and unimaginable financial crisis and the world economy will collapse. So in between 100% and infinity, is there any way to have informed speculation about is the 134% going to do it or does it have to be 500% or is there just any way to think about at what point do we fall off the edge of the earth if we keep going?

 

 

>> John Cogan: So let's hold on that question. Gather a few. We have Sebastian here.

>> Sebastian Edwards: Yeah, I'm tempted to answer Larry Ball's question and say the number is 260% which comes from Japan, but the panel knows more than I. I have a question based on Hanno's presentation, but everyone or anyone Hanno said there is a plumbing problem and we hear this all the time.

 

The equity market crashed and bond yields went up. Hanno added, the dollar went down, but then there was nothing on the dollar in your presentation after just mentioning it. Now if I look at the dollar, it lost 3.3% which is nothing and it's still 11% higher than before the pandemic.

 

I think that you are badmouthing the dollar for no reason. So that's the question.

>> John Cogan: Vicki.

>> Mickey Levy: So this whole discussion about is debt sustainable? The notion is eventually something really bad is going to happen. Higher inflation, higher interest rates. But for all of the reasons that Michael Boskin described to us, it's having the effect now.

 

It's not we have to wait in the future where somehow we're going to fall off a cliff. But the impact is now and the impact is all about how we're allocating national resources. If we did have a much lower debt to GDP like pre financial crisis, we would have already allocated more for defense and you would have been happier.

 

So it's not just the allocation of national resources, but the way we're allocating resources now through providing significant income support is very likely reducing labor supply and economic growth right now. So let me just toss out two statistics. We've tremendously broadened the eligibility for Medicaid and right now there are 73 million people receiving Medicaid costs 880 billion a year right now.

 

The SNAP program, 42 million people are on it. That costs 113 billion last year. To what extent is this affecting labor supply now, particularly at a time when, you know, some of us are concerned about future immigration? And so it's having this effect right now. And I would just add one other thing.

 

Of course it's been the compounding of the indexed entitlement programs. But even if we go back to the 1990s when we talked about Gram Runman one and two and three and all the ways to reduce deficits. It. Was all about non defense discretionary and everything else was off the table.

 

And so the word entitlements in budget process has evolved into mandatory spending. And so the whole process needs to be changed. But I just want to emphasize this point that if feeling it's having a big impact right now, so we don't even have to posit the idea that is debt sustainable because it's having a big impact on economic performance as we speak.

 

 

>> John Cogan: Thank you, Mickey. We have probably time to gather two more questions, then we'll go back to the panel.

>> Patrick Kehoe: Hi, Patrick Kehoe. So I guess it's for Mike and Alan. Some states like Utah have done a particularly good job of following close to a balanced budget rule by separating their budgets into operating expenses and general investment funds.

 

And you can bond it if you can make the case that it's seriously a useful investment. Otherwise it's closer to pay. Go on that, obviously you couldn't get the US government to go for that right away, but could you at least redo the accounting principles for how government budgets are broken down and explained and with the idea of shooting towards that kind of principles namely if it's normal government expenditure it's supposed to be close to pay go.

 

And if it's infrastructure et cetera investment and you don't play games with what's an investment and what's not and you gotta be very careful about that could even presenting it that way as a desired goal and then moving towards it some of the Latin American countries who got out of their problems worked their way into reforms by explaining to the people and then later did a hard transition is that too hopeful or or is there any chance.

 

Thank you.

>> John Cogan: One more right down here Michelle.

>> Isabel Schnabel: Thank you very much for a fascinating panel. ISABEL schnabel, European Central bank so I have one comment on Hanno's presentation and one on John's so Hanno you had this slide on the different market dysfunctions and it includes. Booted the episode of March of this year when Germany announced its fiscal package.

 

But I would actually argue that that is a very different type of episode because what you saw there, there was no market dysfunction. And actually everybody was happy that Germany was taking up more debt and it was even seen as fostering German growth prospects. So I think that's a very different type of episode.

 

I wouldn't include it in that type of list. And then on John, I mean, of course you've written this fascinating book, certainly a bit controversial at times, but very important for the debate. I mean, I think we have to acknowledge that, I mean, the euro area is a very complex structure because we have a single monetary policy, but we have 20 sovereign states with separate fiscal policies.

 

And that makes it quite complicated. And when there are shocks, I mean, what has happened many times is that we've seen that sovereign spreads have moved in a destabilizing fashion. And that for us as a central bank is a very complicated situation because it immediately has implications for the monetary policy transmission, because you immediately get very different interest rates in the different parts of the euro area.

 

And this is why we have, over time, designed different tools in order to deal with this. And these tools are not perfect, but they also shouldn't be kind of portrayed as tools that are there simply to compress the spreads. Actually, they have quite a few safeguards. So you have the OMT with exposed conditionality, you have the TPI with anti conditionality.

 

And there are many things that we try to do in order to deal with the issues that you also raise. And then of course, we also shouldn't forget that there is a fiscal framework. Again, it's not perfect perfect and it's not always working. But in any case, and if you look, actually Hanno also mentioned the French episode.

 

And there you see when there are fundamental issues in particular countries, you do see movements in spreads. It's not correct that we've kind of ironed out all the spread movements. So there is market discipline. Maybe not as much as there would have been otherwise, but market discipline is actually there.

 

 

>> John Cogan: So we've had a good set of questions, some direct to Hanno and. But why don't we go from the end, John? It's a smorgasbord. Take your pick.

>> John Cochrane: Okay, quickly to Larry's question, because I think it's like one of the most important, not to say Isabel's is most important for Europe, Larry's is most important for the US what's unsustainable will not happen.

 

And so this is not that projection is going to happen. The only question is how is it not going to happen and is it going to to be easy or hard? And if we see these forecasts, why is the bond market still holding US debt? Why don't we face Argentinian or Greek levels of interest rates?

 

Well, I think the bond market figures, the US is a great country. Sooner or later, after we've tried everything else, we'll do the right thing again, because this is not hard. A commission made up of, you know, five randomly chosen people in this room could come up with a program to solve this thing in about 10 minutes flat.

 

Especially if you cross out politically feasible in today's political environment. Because the minute there's a crisis, the political environment changes completely. And I think our government will do this. We have to close a little optimistic. I think Alan pointed out we don't respond to the debt, but our government responds to interest costs.

 

Just like Joe and Jane. Joe and Jane, you know, the credit card company says you can borrow 2% or for governments, negative 2%. They say, yeah, let's, let's, you know, buy the new car, buy the new house. Interest costs are 5%. We got to cut back. So I am hopeful that once again there will be a time of reform before that our government will not shoot itself in the foot and go down a completely needless debt crisis.

 

Because this is, there's no external shock. This is all internally done. Of course, Isabelle, you're exactly right about the euro. But sometimes spreads are fundamental and default spreads and those market signals need to go back to governments to say, hey, you know, you got to watch yourself a little bit.

 

Corporate spreads are sometimes default spreads. Country spreads could be default spreads. And there isn't really a mechanism. The banks are still completely loaded up with, with sovereign debt so that it's very hard to have a sovereign default. So there's still a problem there. You're doing your best, but let's get together and fix the structural problem.

 

So it's easier to be the ecb. I mean, that's our basic job, make your life easier.

>> Hanno Lustig: Thank you. Okay, let me start by taking a stab at Sebastian's point, which I think is an interesting one. You were sort of saying, well, you know, at the end of the day, between March, April 4 and April 14, the dollar only depreciated by say 3 or 4%.

 

That's not a big deal. But it happened when at the same time US long term interest rates were rising a lot relative to say, German interest rates. I think the increase in debt spread was about 50 basis points. And so based on standard economics and just recent history, what you would have expected was a strong appreciation of the dollar just on the basis of what was happening to the interest rate difference.

 

I've done some work recently with Arvind Krishnamurthy and a bunch of other co authors where we attribute this to the decline in convenience yields. So we've talked about this. The US is the world's safe asset supplier. The doll is the reserve currency. One measure of this is if you take a German Bund 10 year German Bund and you hedge it into dollars.

 

Historically that synthetic US treasury was always more expensive than the real thing or vice versa. The yield on the synthetic treasury was higher. That's not true any longer. And I think, and this perhaps is a beginning of an answer to Larry's question, I think that's concerning. So you can do this at the 1 year, 5 year, 10 year horizon.

 

You take German yields hegemon to dollars compared to U.S. treasury yields. The U.S. treasury yields and the actual Treasuries are now higher at all tenors. That's a completely new development even at the one year horizon. I think that's concerning because it suggests that it's no longer true that say European investors are willing to pay a little bit extra for the safety of dollar denominated US Treasuries.

 

And that has big implications for fiscal policy as well. I think that's an important fact. And then let me just say that I agree with Isabel that the German episode, I was actually showing that to show that there are lots of examples recently where bond markets respond to fiscal shocks.

 

And I think that that in a lot of cases is exactly what should happen. And I think that's so I think we're in agreement on what was happening there. To your broader point, I'm more skeptical than you are about whether in the Eurozone we're really letting markets dictate what happens to spreads.

 

When you see that in equilibrium a large price inelastic investor is absorbing a lot of the issuance. And this is not just true in the Eurozone, it's true here as well to some extent that I'm skeptical about those market prices. The example that I always revert back to is Japan.

 

Japan in Japan, the Bank of Japan for the last decade has absorbed almost all of the issuance. Do I think that until recently, do I think that. Long end of the yield curve was particularly informative there about fiscal capacity. True fiscal capacity? No, not really. I think it was a giant exercise of financial repression which is very costly for Japanese depositors who are saving at the short term interest rate.

 

So, that's my-

>> John Cogan: Great, thank you. Michael.

>> Michael Boskin: Yeah, a few comments. First of all, while we've all worried about what the deficit and debt may do and how, how it evolves and the pressure it might put to inflate, et cetera, we haven't ever mentioned that the Fed has adopted a lot of fiscal policies that are to say to be generous, stretch that Section 13 authority, et cetera, that now it's been assigned that it's been asked to do that, et cetera.

 

But there's a question of what makes sense for the Fed to be doing as an institution, whether that's jointly in cranium concert with the fiscal authorities. But just FYI, we should not let that go unmentioned. On the question of where we're going to hit the fan, the most famous forecast, the most famous person who went out on the limb and said there was a big Cliff, was it 90% of GDP?

 

That was Ken Rogoff at Harvard. And that came and went and it turned out there was a mathematical mistake in the calculations. But in any event, nobody knows for sure. However, however we do know. I mean simple analysis tells you there's got to be an upper limit on the fraction of wealth people will be willing to hold and say in dollar securities, for example, okay, they're not going to hold all of it for diversification reasons.

 

All right, and there are many other things that would be way under 100% what's going on in their economy with the need to transact. So but the key is before we get there, you know, the supply of capital to the US is going to become more inelastic. So interest rates are going to rise more rapid.

 

Real interest rates are going to rise more rapidly. So we have to pay close attention to that. I think, I think anybody tells you exactly they think they know where that is or that it's independent of every other country having analogous problems in various, a greater or lesser degree I think has probably been inhaling.

 

So I think we just can't say for sure. But we do know that we're getting, we know there are icebergs out there and the wise path isn't to keep going, let alone to what we're doing now speed up, but to alter somewhat of a different course. We're having obviously trouble doing that.

 

And on Pat's point, I developed capital accounts for the federal government when I was a young scholar and OMB took them over. You can argue what kind of a job they're doing, et cetera. And as I said, we don't have market transactions to discipline those investments. But I think there's an opportunity there if we can hold the rigor about what really is tangible capital.

 

That I think is the big risk that you get some, let's say a government that wants to have a very expansive definition of human capital and all transfer payments are helping people and that's improving their human capital, whether they just consume it rather than they get educated or do job training or anything.

 

So I think it has some possibilities. I actually proposed this in the 1980s to President Reagan in a meeting and he loved the idea because he quickly figured out that that would make it a little more palatable to finance a big defense buildup. But it got scuttled when Cap Weinberger, then the defense secretary, went haywire when he realized we'd have to take depreciation into the operating budget.

 

And his answer was we'd be giving the Russians all these secrets. So that's how we didn't get Cap. That's how we didn't get President Reagan deciding he'd like to see us start at least present the stuff that way, whether actually gonna budget that way, at least present the material that way.

 

 

>> John Cogan: Alan.

>> Alan Auerbach: Yeah, I just wanna pick up on that last point. I think as much as I think reforming budget measures and concepts is useful, I think the main thing that distinguishes state behavior from the federal government is that states are much more subject to the discipline of capital markets than the federal government.

 

States have adopted on their own, without any constraints imposed balanced budget rules. The capital budget's really part of the balanced budget rules because that's really the only way that you can borrow except for very short term fluctuations. And that wasn't just because they were good government types. It's because they wanted to retain access to capital markets.

 

And they also have a much bigger problem of potential labor mobility. If they're a failed state, they'll lose people. And so I think, however well we measure concepts at the federal level, if the market doesn't impose discipline on the federal government and if there's nothing else built into the politicians to be fiscal conservatives, I don't think it's really going to help very much.

 

 

>> John Cogan: Well, great. Well, thank you.

>> Michael Boskin: Just one quick quip.

>> John Cochrane: Come on.

>> Michael Boskin: Since we've been so pessimistic, I want to just say, the optimist says things can't get much worse. The pessimist says, yes, they can.

>> John Cochrane: Since we're overtime, let's start at 5. On the policy panel.

 

 

>> Michael Boskin: It's great.

>> John Cogan: Okay, please join me in thanking the panel.

>> Peter Henry: So welcome to our last session of the day. In 1984, output per worker in the United States was roughly on par with that of Japan and the group of countries that now comprise the European Union. At the end of 2024, productivity stood at $170,000 per worker for the US $120,000 for the EU and $100,000 for Japan.

 

Against this backdrop, in April of 2025, there was a radical change to the economic policies first enumerated in James A. Baker III's 1985 speech at the World Bank IMF meetings that drove the relative rise in U.S. prosperity, the absolute rise in global prosperity, and the decline in poverty across what was once called the Third World.

 

Whether the move from free trade and the invisible hand to record tariffs and the state hand is a permanent or temporary change, the uncertainty it has unleashed and its attendant consequences for asset prices, investment growth, inflation and unemployment are real, if not yet fully manifest. In short, the US and global economy have been hit by a multifaceted supply shock that continues to unfold and has consequences for leaders charged with formulating monetary policy strategies.

 

We are very fortunate to have with us today four of those leaders, Isabel Schnabel of the European Central Bank, Alberto Musalm from the Federal Reserve bank of St. Louis, Beth Hammock of the Federal Reserve bank of Cleveland, and Lisa Cook from the Federal Reserve Board of Governors, will share their big picture perspectives on monetary policy frameworks at this moment in history.

 

Accordingly, I encourage the audience to focus their questions on the strategic intellectual challenges facing these leaders and to resist the tactical temptation, however veiled it may be, to ask them what's next for rates. Turning briefly to logistics, each speaker will have 12 minutes. We will then turn to the floor for questions from the audience.

 

I will gather three to four questions at a time before turning to our panelists to respond. When the microphone comes to you, please identify yourself clearly before asking your question. We will continue with rounds of questions in this fashion as time permits, ending promptly at 6:10pm and Governor Cook has to leave at 6:05pm so she's excused in advance.

 

Isabel, the floor is yours.

>> Isabel Schnabel: Thank you so much for inviting me to this excellent conference. It's an honor to participate in such a distinguished panel at a time when central banks around the world are examining how to respond to the new shocks that we are facing. In my remarks, I will take a European perspective, and my main conclusion will be simple.

 

In today's unsteady world, monetary policy should keep a steady hand. A key determinant of optimal Monetary policy is the slope of the Phillips curve. As you can see on my first slide, the Phillips curve became noticeably steeper in the aftermath of the pandemic. Before that it had been essentially flat.

 

So these are the blue dots. If the curve is steep, central banks face a smaller sacrifice ratio as also discussed this morning by Kristen, meaning they should react more forcefully to deviations of inflation from target even when the economy is hit by a supply shock. Instead, if the curve is flat, a large policy impulse is required to move output to generate aggregate price effects.

 

Then it can be optimal to tolerate moderate deviations of inflation from target in both directions, provided inflation expectations are well anchor. However, as you can see on this slide, identifying in real time if expectations are anchored is far from easy as different measures may even point in different directions.

 

So what explained the steeper Phillips curve and the post pandemic inflation surge? One explanation is firms price setting behavior which you can see on this slide. Standard New Keynesian models assume that the probability of firms resetting their prices is constant over time. This is a fair description when aggregate shocks are small, such as during the 2015-19 period.

 

The Blue dots. However the past few years have demonstrated that in the face of large shocks, firms tend to raise their prices more frequently, as shown by the yellow line and the Phillips curve steepens. My next slide shows that pricing behavior is asymmetric. It acts as an inflation accelerator when firms face positive demand shocks, but it does little to prices in the face of negative shocks due to downward price rigidities.

 

The second explanation relates to the labor market. Downward nominal wage rigidity has been a key factor explaining the missing deflation in the aftermath of the global financial crisis. But when the labor market is tight, as it was in recent years, wages are more flex. My next slide shows that this seems to have led to a nonlinear Phillips curve both in the United States and in the Euro area.

 

However, new research shows that nonlinearity holds only when controlling for expectations of professional forecasters, but it disappears once inflation expectations of households and firms are considered. Hence, it is conceivable that the Phillips curve did not become steeper in recent years, but rather shifted upwards as inflation expectations rose.

 

The expectations that are relevant for such an upward shift are not necessarily longer term expectations that central banks typically pay most attention to. This slide shows that the longer term inflation expectations have remained remarkably stable over the past few years. Rather one year ahead. Inflation expectations have been shown to explain a significant share of the recent rise in nominal wages and hence inflation in the United States and elsewhere.

 

Drawing the right conclusions from the recent inflation surge matters for our monetary policy today. The relevant time horizon for monetary policy is the medium term. The past few years, however, demonstrated that inflation forecasting at times of large shocks is inherently difficult. For this reason, the ECB has increasingly turned to a data dependent approach while remaining forward.

 

Looking at present high uncertainty, lower energy prices and a stronger euro exchange rate will likely dampen headline inflation in the short run, potentially pushing it below our 2% target. The question is however, whether these developments provide meaningful signals about the medium term. In the euro area, there are two forces that could pull underlying inflation sustainably away from our target.

 

One is fiscal policy, which is set to expand on a scale unseen outside deep recessions, especially in Germany. This is likely to put upward pressure on underlying inflation over the medium term. The other is global fragmentation. While the scale and scope of tariffs remain highly uncertain, ongoing negotiations still give hope that agreements may be reached.

 

But should these negotiations fail, the euro area will simultaneously face adverse supply and demand shocks as the EU will retaliate. On balance, these shocks are likely to put upward pressure on underlying inflation. The severity of the negative demand shock will depend on two factors. One is the hit to US economic activity and to global demand, which will dampen euro area foreign demand.

 

The second factor is the degree of demand reallocation, I.e, the elasticity of substitution between foreign and domestic products. A robust finding in the literature is that products that are more differentiated tend to be relatively priced inelastic as they are more difficult to substitute. The left hand side chart of this slide shows the relevance of this for the euro area as the bulk of exports to the US is in pharmaceuticals, machinery, vehicles and chemicals which are typically highly differentiated.

 

Let me give you an example. Banknotes in the United States are overwhelmingly printed using machinery from a single German manufacturer which cannot easily be replaced. In the short run, this may limit the hit to foreign demand. In addition, trade diversion may benefit euro area exports. Should prohibitive tariffs on Chinese imports remain in place, they will measurably raise the euro area's price competitiveness in in the US Market.

 

This is relevant as the right hand side chart illustrates that the number of industries in which both Chinese and euro area firms have comparative advantages has increased measurably over the past decades. In other words, euro area foreign demand may prove relatively resilient. The recent appreciation of the euro does not refute this view.

 

Looking through the ups and downs in effective terms, the euro is trading just 2.6% above last year's average. In addition, invoicing of exports to the US and US sollars limits the exchange rate possible. This slide shows that the price inelasticity is also reflected. In recent surveys, manufacturing firms are reporting an expansion in output for the first time in more than two years and fewer firms are reporting falling export orders.

 

Even if developments partly reflect front loading by firms, it is still remarkable how resilient sentiment has remained in the face of high uncertainty. Downward effects from lower demand on inflation are likely to be counteracted by the supply shock from retaliatory tariffs. The strength of the supply shock again depends on two factors.

 

One is the path through of higher tariffs to consumers. The recent appreciation of the euro provides some margin for euro area firms to buffer cost increases from retaliatory tariffs. But profit margins have already been squeezed by high wage growth and the sluggish economy. Recent surveys suggest, and Matteo just showed additional evidence that firms plan to gradually pass higher tariffs on to consumers.

 

The second factor relates to global value chains. Today 70% of international trade is conducted by multinational firms distributing production across countries countries. Tariffs can cause shortages of critical intermediate goods and raise firms marginal costs which would be propagated through the production network. The left hand side of this slide shows ECB staff analysis suggesting that even if the EU does not retaliate the blue bars higher production costs through global value chains could more than offset the disinflationary pressure coming from lower foreign demand, making tariffs inflationary.

 

Overall, these effects become stronger with full retaliation. The yellow bars, the right hand side chart shows that as the trade conflict intensifies, retaliation will increasingly include intermediate goods as these account for nearly 70% of euro area imports from the United States, which would constitute a much broader cost push shock for euro area firms.

 

Excess capacity in China may mitigate these effects only to a limited extent as the European Commission clarified that it intends to protect euro area firms against dumping prices. How then should the ECB respond to current shocks? The lessons from the pandemic suggest that from today's perspective, the appropriate course of action is to keep rates close to where they are today.

 

That is firmly in neutral territory. What I saw from Volker's slide today is that that is fully in line with the Taylor rule he presented. So thank you very much John, also from my side for providing us these useful tools for our monetary policy analysis. Such a steady hand policy provides the best insurance against a wide range of potential outcomes.

 

Specifically, it avoids reacting excessively to volatility and headline inflation at a time when domestic inflation remains sticky and new forces are putting upward pressure on underlying inflation over the medium term. It also avoids overreacting to concerns that tariffs may destabilize inflation expectations once again. This slide shows that households short term inflation expectations have recently started rising again also in the euro area.

 

However. There are currently no indications that expectations are at risk of unanchoring. My next slide shows that the steady hand policy also addresses risks of a more substantial decline in aggregate demand. If tight labor markets were the main culprit for the recent steepening of the Phillips curve, risks of a sharp inflation decline are are moderate.

 

Today, both in the United States and the euro area, the vacancy to unemployment ratio has fallen markedly. We are thus likely to operate close to or at the flat part of the Phillips curve, in stark contrast to the high inflation period. We would only need to react more forcefully to the tariff shock if we observed a sharp deterioration in labor market conditions or an unanchoring of inflation expectations to the downside.

 

Both seem unlikely at the current juncture. Despite the number of vacancies, declining unemployment in the euro area remains at a record low. And as shown on my final slide, most measures of medium term inflation expectations remain tilted to the upside. So my main message today is that the ECB should keep a steady hand.

 

In the current environment of elevated volatility. We need to remain focused on the medium term. Given long and variable transmission lags reacting to short term developments could result in the peak impact of our policy only unfolding when the current disinflationary forces have passed over. The medium term risks to euro area inflation are likely tilted to the upside, reflecting both the increase in fiscal spending and the risks of renewed cost push shocks from tariffs propagating through global value chains.

 

Therefore, from today's perspective, an accommodative policy stance would be inappropriate also because recent inflation data suggests that past shocks may be unwinding more slowly than previously anticipated. By keeping interest rates near their current levels, monetary policy is neither excessively holding back growth and employment nor stimulating it. We are thus in a good place to evaluate the likely future evolution of the economy and to take action if risks materialize that threaten price stability.

 

Thank you very much.

>> Alberto Musalem: Good afternoon everyone, I'd like to thank the conference organizers Michael Bordo and John Cochran for the opportunity to participate in this panel. With distinguished colleagues and policymakers, conferences at the intersection of research and policymaking provide an invaluable opportunity to enrich both worlds. I'll share my personal views, which do not necessarily reflect those of my FOMC colleagues.

 

Let me begin by reviewing my perspectives on the current state of the US economy activity has moderated. Business and consumer sentiment has declined. Financial conditions have tightened some but remain broadly supportive of the real economy. The labor market has been cooling but remains resilient and near full employment.

 

Inflation has declined towards our 2% target since 2022, but remains above target and progress has been slow. Since mid 2024, inflation expectations have been mixed. Near term expectations have risen, while most measures of long term inflation expectations have remained stable. Monetary policy is currently modestly restrictive and I believe appropriately so for an economy at full employment.

 

With inflation above target and some measures of inflation expectations moving higher, consequential trade, immigration, fiscal and regulatory policies are being implemented. They are intended and have the potential to substantially change the flow of goods, services, capital and people across and within countries, including the United States. They also are likely to change the taxation of and the incentives for consumption, savings and production.

 

Without judging or evaluating the merits, I am focused on the net total effect of these policies on the US Economy through the short and long run and through demand and supply channels. In this context, I believe an effective monetary policy can successfully navigate toward our congressionally mandated goals of maximum employment and price stability.

 

Trade policy changes from the beginning of April are likely to move employment and inflation in opposite directions. Monetary policy can manage the resulting trade off by weighing the size and persistence of inflation's deviation from target and that of employment of the employment shortfall. An implication of this balanced approach is some short term tolerance of higher inflation to lessen the cost of an employment shortfall, provided that medium to long term inflation expectations remain anchored.

 

In fact, a balanced approach requires anchored inflation expectations because price stability is necessary for maximum employment. I believe policy must prioritize inflation expectations if expectations threaten to become unanchored. The experience of the 1970s showed that sustaining maximum employment and a durable economic expansion is difficult when inflation expectations is elevated and volatile and when the public expects it to remain so.

 

If inflation expectations are not well anchored, history tells us that restoring price stability is more costly in terms of foregone employment and economic activity. To date, announced tariffs are higher, are broader and have prompted stronger retaliation than many had expected. If a cycle of high tariffs and retaliation is sustained, economic activity and employment are likely to be meaningfully dampened.

 

The impact on prices and the persistence of inflation will be determined by the relative size and persistence of opposing demand and supply factors. I expect direct one off effects on the prices of imported final goods, indirect effects on the prices of domestically produced goods and services, and possibly second round effects on inflation.

 

In the other direction, reduced economic activity will likely have some dampening effect on inflation. After an initial uptick in inflation, I perceive 2 equally likely inflation scenarios ahead. It is possible that higher inflation will be short lived and mostly concentrated in the second half of 2025. As businesses run down inventories and pass tariffs on new goods purchased onto consumers as one off price increases, it is equally likely that inflation could prove to be more persistent.

 

The risks of higher and more persistent inflation are currently elevated. Because the pre tariff starting point for inflation is above target. The recent period of elevated inflation likely has raised the public's sensitivity to it. Some measures of inflation expectations have risen and tariffs apply broadly to intermediate inputs, prompting supply chains rearrangement.

 

Thus far, I have focused on a scenario of high and broad based tariffs being sustained along with retaliation. It is also possible that fruitful trade negotiations and de escalation will lead to a resumption of global trade flows and a modest reconfiguration of supply chains. If this scenario were to happen soon.

 

The US economy could remain close to the path that it was on. One with a resilient labor market and ongoing convergence of inflation to target. Appropriate monetary policy will differ according to which scenario will come to pass. It could be appropriate to look through inflation and potentially ease policy if tariffs are sustained but inflation is short lived, inflation expectations remain well anchored and economic activity is meaningfully slower.

 

Otherwise, I will be focused on a policy path to ensure that a tariff related adjustment in prices does not turn into persistently higher inflation and that inflation expectations remain well anchored. If instead there's a de escalation of trade tensions soon, the current policy stance will remain appropriate. That stance is focused on further progress of inflation towards 2% in the context of a full employment labor market.

 

Committing now to looking through the inflation impact of tariffs or to an easing of policy runs the risk of underestimating the level and persistence of inflation. Implementing a corrective policy switch to lean against inflation is a classic issue in central banking. Real time parsing of direct price level effects from indirect and second round inflation effects is difficult.

 

Mistiming the policy switch can be costly for the public in terms of inflation and employment outcomes. Especially if inflation expectations were to rise further. The difficulty would be further compounded because trade policy does not happen in a vacuum. Beyond tariffs, I'm also focused on the net total impact of evolving fiscal, immigration and regulatory policies on the outlook.

 

To conclude, I consider it prudent to navigate according to two key principles. First, I continuously update my outlook for the US economy and my assessment of the balance of risks with incoming information to discern the most likely scenario and appropriate monetary policy. Second, prioritizing well anchored inflation expectations is crucial to ensure that a policy approach that responds both to inflation deviation from target and to employment shortfalls remains feasible.

 

I believe the FOMC's current policy stance aligns with these principles and is best positioned to deliver stable prices and maximum employment for the people we serve. Thank you and I look forward to engaging in the discussion. But before leaving and finally, I would like to also take a moment to thank John Taylor for all of his contributions as celebrated yesterday.

 

Especially for arming central bankers like me with a framework, a benchmark and a principle against which to stress test their policy thinking on a daily basis. And on a personal note, I, like many others was exposed to John Taylor's work in the early 90s when I was a graduate student and I was immediately fell in love with the simplicity of the Taylor rule and the applications of it.

 

Ten years later I got to meet John Taylor and Kristen Forbes by the way, when John was in government at the U.S. treasury, of course I was dying to talk about the Taylor Rule, but at that time he was interested in sovereign debt restructuring and I was involved in emerging market debts at the time.

 

And so they were the Treasury, I was not the Treasury. So we ended up talking about sovereign debt restructuring. So thank you, John.

>> Beth Hammack: My thanks to the Hoover Institution for inviting me to speak on this esteemed panel and for scheduling this during the Cavs Game three, providing a much needed distraction from what could likely be another heartbreaking loss.

 

It's great to be back at my alma mater. I'm especially grateful that I was able to join yesterday in the celebration of John Taylor when we experience uncertain economic times with a wide range of possible paths for the economy, simple policy rules provide a good starting point for assessing how monetary policy may wish to respond in different scenarios.

 

As Loretta noted this morning, the Cleveland Fed's website has a section that looks at federal funds, rate projections based on 7 simple policy rules and multiple forecasts, including the rule that John Taylor published in the year that I graduated from Stanford. I combine this information with a variety of economic and financial data, forecasts and anecdotes from businesses and community contacts as I think about the appropriate path for monetary policy.

 

Recently, the signals about the economy have been decidedly mixed. By many measures, the backward looking data have been encouraging, but heightened uncertainty surrounding government policies is clouding the outlook and raising the risks of higher inflation, slower growth and softening in the labor market. So let me briefly share my current views on finishing the job amid current challenges in the economy.

 

And as always, the views I present today are my own and not necessarily those of the Federal Reserve System or my colleagues on the Federal Open Market Committee. The economy entered this year with solid momentum as real gross domestic product increased at a 2 and 3 quarter percent annualized rate during the second half of last year.

 

Based on the first estimate, GDP declined in the first quarter behind this week, headline number Consumer Spending and Business Fixed Income Business Fixed Investment both grew at solid rates. A key question is whether this will continue as national survey measures of consumer and business sentiment have declined, with many respondents citing policy uncertainty.

 

At the Cleveland Fed, we compile feedback from regional business and community leaders into our source indices, which capture recent and expected trends in the 4th District's economy. In general, our contacts report subdued economic activity in their comments to us. Many contacts indicate that they have paused some spending in light of increased uncertainty surrounding government policies including tariffs, immigration, federal spending and employment.

 

A growing share of contacts expect that their non labor costs are going to rise in the coming months, with many noting higher tariffs as a key factor. Looking at our maximum employment goal, the US labor market has been healthy. The unemployment rate was 4.2% in April, a relatively low level and similar to readings over the last 12 months, with solid job gains on average through the first four months of this year.

 

On our inflation objective, we've made good progress, but there is still more work to do to return the economy to price stability. Headline PCE inflation was 2.3% through March. Core PCE inflation, which excludes the volatile food and energy sectors, was somewhat higher. The Cleveland Fed calculates several alternative inflation measures that focus on price changes in the center of the distribution in order to limit the influence of outliers and capture the inflation trend, including the median cpi, trimmed mean CPI and median PCE inflation.

 

These measures have also come down from their highs but are running above headline inflation and above our objective. While the recent inflation data have been encouraging, they are backward looking and do not capture very recent developments on net. The tariffs that have been put in place constitute a substantive change in trade policy.

 

It will take some time for the overall economic effects of these recently enacted and other proposed changes to government policies to become clearer in the hard data. In this dynamic environment, I am considering a variety of data to inform my view on progress towards our dual mandate goals of maximum employment and price stability.

 

Beyond the usual monthly and quarterly indicators on growth, inflation and the labor market, I'm looking at higher frequency data evolving conditions in these times. I find that anecdotal reports from business, community and financial market contacts are especially helpful because they provide timely information and additional context to the hard data.

 

Staff at the Cleveland Fed produce and update novel data series to help shed light on current conditions. One recent project uses natural language processing to quantify the sentiment of the Federal Reserve's Beige book entries. As a predictor of recessions. In a second project, Cleveland Fed researchers compile data from advanced layoff notices filed under the Worker Adjustment and Retraining Notification, or WARN act that serve as a leading indicator for layoffs.

 

I also monitor financial conditions to assess their impact on households and businesses. In recent weeks, financial conditions have been volatile as markets have incorporated new information into asset prices in response to tariff announcements. In early April, financial conditions tightened on NET as major equity indices declined, credit spreads widened, and long term interest rates increased.

 

At the same time, the dollar weakened against a basket of foreign currencies. This pattern was different from recent risk off episodes in which equity prices declined, credit spreads widened, the dollar appreciated, and U.S. treasury yields fell as domestic and international investors sought the safety of US Government bonds.

 

More recently, as tariff policy has shifted, some of these measures have largely retraced their initial moves. Markets respond to data and announcements at a high frequency. My job as a policymaker is to separate the signal from the noise in financial market fluctuations. Doing so allows me to incorporate into my outlook market trends that are likely to affect the real economy, recognizing that volatility on its own can have a dampening effect on spending and investment.

 

A common theme from talking with business community and financial market contacts is that uncertainty is elevated. I see risks around both legs of our dual mandate that could lead to higher inflation outcomes and to lower growth and employment outcomes in the near to medium term. This is a difficult set of risks for monetary policy to navigate given the economy's starting point.

 

With inflation still elevated and with both sides of our mandate expected to be under pressure, there is a strong case to hold monetary policy steady at its current modestly restrictive setting. I am usually inclined to take action, but in this case, taking no action may be the best choice to balance the risks coming from further elevated inflation and a slowing labor market.

 

If this scenario comes to pass, then it will be important to ensure inflation expectations remain well anchored while assessing the likely magnitude and persistence of the misses to each side of our dual mandate goals. In terms of inflation, it is certainly possible that increases in tariffs could have only a short lived effect.

 

But coming after an extended period of elevated inflation, consumers and businesses may respond differently to this event than might have otherwise been the case. When clarity is hard to come by, waiting for additional data will help inform the path ahead. But other scenarios are also possible, and instead of focusing on a modal outlook, I'm considering a range of possible outcomes.

 

If the economy should falter in inflation decline, then it may be appropriate to ease policy by lowering the federal funds rate from its current level, perhaps even quickly. If the labor market remains healthy and inflation moves up persistently, then monetary policy may need to follow a more restrictive trajectory.

 

We will simply have to see how events unfold. I would rather be slow and move in the right direction than move quickly in the wrong direction. Fortunately, we with policy at its current modestly restrictive level, I think we are in position to assess the incoming data, the risks to the outlook, and the appropriate policy response to achieve our longer term objectives.

 

Let me conclude with three sets of big picture topics that I've noted in other venues and are worth repeating here. The first topic is R. There is considerable uncertainty over a fundamental concept for policymakers. How restrictive or accommodative is monetary policy? My view is that monetary policy My view that monetary policy is only modestly restrictive is based on my assessment that the economy has been resilient, the labor market has been healthy, and inflation has come down only slowly.

 

Under the current setting, figuring out the neutral rate is always complicated. There's evidence that the neutral rate changes over time, with some models and estimates pointing to long running structural factors and others capturing a role for shorter term forces. Fiscal deficits, productivity growth and the structure of the Fed's balance sheet are just a few such factors.

 

Recent and prospective changes in government policies could also affect our star. This is a topic that bears watching. My second topic is the Federal Reserve's plan for the balance sheet. Tools, trade offs and assessments of the level for ample reserves will all be relevant in the near to medium term, but we also need to think over a longer term horizon.

 

What does a neutral balance sheet look like, especially on the asset side? Should we align assets and liabilities and if so, how? How much volatility should we be willing to accept in overnight markets? Ultimately, there might be trade offs between the variability in short rates and the size of the balance sheet.

 

Could there be benefits from separating market functioning balance sheet actions from all other actions? I see these questions about the steady state for the balance sheet as worthy of discussion by the fomc. My takeaway is that rapidly expanding the balance sheet is easy, but shrinking it with minimal market impact is harder and takes more time, especially after purchasing a lot of long dated assets.

 

My final topic is the growth of the private credit market. This market fills the financing gap for relatively higher risk middle market borrowers. There are some financial stability benefits of the growth in this market, but there are also some risks. Some of these risks include the market's relative opacity, the growing exposure of pension funds and life insurers and interconnections between private credit and the banking system.

 

As the rapid growth in private credit investments compresses returns, these funds may employ more leverage. In fact, while the level of private credit fund leverage appears moderate, it has been notably increasing over the past several years, particularly at business development corporations. As a Federal Reserve policymaker, I am attuned to the potential financial stability risks from this fast growing market and with that I thank you for your attention and I look forward to the upcoming discussion.

 

 

>> Lisa Cook: Good afternoon. Thanks to John again for his multi dimensional and long standing contributions to the economics profession and to policy formulation and practice, including during our time at the Treasury Department when he was Secretary Undersecretary and when I was a postdoc at the Treasury Department. You can see my comments on loop in a video tribute out in the atrium.

 

Thanks also to Michael and John for the opportunity to participate on this panel and to Peter for moderator. It is an honor to be with you here today and it is always good to be back at Stanford and at the Hoover Institution. I spent several formative years of my career here, including as a National Fellow, and always enjoy returning and it is a privilege to share the panel with Dr. Schnabel and President Mus Solomon Hammack.

 

I look forward to our discussion. Before that, I would like to briefly discuss a topic I see as critical to the path of the economy, productivity growth. Productivity growth has been surprisingly strong in recent years and this has influenced my view of the appropriate stance of monetary policy.

 

I will also explore two ongoing developments that are likely to influence productivity growth moving forward. Changes to trade policy and wider adoption of AI productivity dynamics are something I have studied closely and will continue to pay careful attention to as I consider the appropriate stance of monetary policy.

 

It is helpful to start by looking back about three years to the middle of 2022. At that point the global economy had largely reopened after pandemic closures, an historic amount of federal support had been deployed and unemployment was falling toward a half century low. But supply disruptions persisted and the 12 month inflation rate reached its.

 

Peak at over 7%. The challenge for Federal Reserve policymakers was clear move inflation back towards its 2% target while maintaining the health of the labor market. The fomc, which I joined that year, began to raise the fed funds rate from near zero, ultimately reaching just above 5% in mid 2023.

 

Many forecasters predicted that a recession in 2023 was more likely than not, and yet one did not materialize. Instead, inflation came down considerably while unemployment remained low. How did this unusual and welcome outcome happen? Two important factors were the unwinding of pandemic era conditions that previously constrained the supply of both goods and labor in conjunction with labor restrictive monetary policy that contributed to a moderation in aggregate demand.

 

Today I would like to call attention to a third factor, a greater than usual increase in productivity during the pandemic recovery during the Excuse me. Prior to the pandemic, from 2007 to 2019, productivity growth in the business sector accelerated averaged 1.5% annually. In the past five years, productivity growth accelerated to 2%.

 

While some of the productivity gains may reflect situations unique to the reopening of the economy, it is notable that the level of productivity as measured by output per hour remained above trend throughout 2023 and 2024. This increase in productivity was partially driven by pandemic labor shortages themselves. When it was difficult to find employees as many Americans retired or stepped out of the labor force, many businesses innovated.

 

For example, restaurants adopted online ordering apps and retailers accelerated the implementation of self checkout systems. These changes improved efficiency and contributed to an expansion and potential gdp. As a result, price pressures eased from their peak while demand remained strong. Improved productivity is widely beneficial to the economy. It allows workers to receive pay raises without companies needing to further increase prices and helps ensure consumers have access to the products and services they demand.

 

Furthermore, and particularly relevant to me as a monetary policymaker, a rise in potential output lessens the need to use monetary policy to slow demand. This effect is good for the obvious reason that it allows economic growth to increase without higher inflation. But importantly, it also lowers the risk of a policy overshoot that could cause the unemployment rate to rise.

 

Now that I have reviewed the role that productivity growth played in the post pandemic recovery, I would like to focus on two countervailing forces on productivity that I am currently studying. These are changes to trade policy and the growth of AI. I expect to see a drag on productivity in the near term stemming from the recent changes to trade policy and the related uncertainty for several reasons.

 

First, uncertainty related to trade policy is likely to reduce business investment going forward. At this time, firms do not know the ultimate level and incidence of tariffs, nor their duration. Firms contemplating large investments might observe the conditions that could hold under the paradox of thrift, wondering whether they could get a better deal if they just wait.

 

Higher costs of imported materials and components could cause firms to delay or scale back their investment plans. This reduction in capital formation can lead to slower technological innovation and adoption and decreased overall efficiency and production processes. Second, protectionist trade policies, while intended to support domestic industries, may inadvertently lead to a less competitive environment if they prop up less efficient firms.

 

And third, any supply chain disruptions resulting from the policy changes would make production slower and less efficient. These disruptions can lead to inventory mismatches, production delays, and increased costs as firms scramble to find alternative suppliers or redesign their products to accommodate new input constraints. This set of disruptions could pose a particular challenge for monetary policymakers.

 

A reduction in potential GDP means less slack in the economy, which in turn means greater inflationary pressure. According to the Taylor Principle, for which no explanation is needed for this conference, taming higher inflation requires a higher policy rate. I believe that keeping inflation expectations credibly anchored is essential.

 

Therefore, all else equal, lower productivity could cause me to keep supporting rates at a higher level for longer. The second ongoing economic development I see altering productivity is the rapidly expanding use of AI. I view this emerging technology as likely to have a significant positive effect on productivity growth.

 

In fact, I see AI is poised to be at least as transformative as other general purpose technologies such as the printing press, the steam engine, and the Internet. With wider adoption of AI, we could have a surge in potential output. As I have discussed in several recent speeches, AI has the potential to revolutionize several sectors of our economy.

 

We already see AI assistance boosting productivity and customer service, software development, and medical diagnosis. AI's ability to process and analyze vast amounts of data could lead to breakthroughs in scientific research and innovation, resulting in an increased arrival rate of ideas, further amplifying its effect on productivity. Of course, an AI productivity boom would come with its own set of challenges.

 

If potential output expands too rapidly, it could leave slack in the economy and the labor market. Moreover, the productivity gains from AI may not be uniform across sectors, job types, or tasks, leading to a transitional period as the labor market adjusts. Despite these challenges, I am optimistic about AI and its potential to drive significant productivity growth in the coming years.

 

To summarize, I see an important role for productivity growth to play in assisting FOMC policymakers to achieve our dual mandate goals. This dynamic played out alongside other factors in recent years when inflation eased from historic highs while the labor market remains solid. Two currently unfolding economic events are likely to influence productivity growth in the coming years, specifically changes to trade policy and the expansion of AI.

 

Those two developments may prove to run counter to each other, but it is too soon to predict precisely. I will be closely monitoring developments in this space. I look forward to engaging with those studying this topic, including, I am sure, many in this room and on this campus.

 

Thank you. I look forward to our discussion.

>> Peter Henry: Okay, the floor is open to the audience for questions. I will collect three or four questions and please identify yourself clearly. We'll start with the gentleman here in the middle and then we'll work our way forward.

>> Speaker 6: University of Houston.

 

This is for Lisa Cook. You identified two factors for productivity, tariffs and AI. I was surprised that you didn't mention immigration because it seems to me immigration could have a negative effect on productivity that could easily be more serious than tariffs.

>> Peter Henry: Daryl Duffy was next and then Jason Furman and then John Cochran.

 

 

>> Darrell Duffie: Thank you, Daryl Duffy. Isabel, last November at your money markets conference, you spoke about liquidity on demand as a way for for the ECB to reduce its balance sheet and have banks come to the ECB when they needed more reserves. At the Federal Reserve, it's been a challenge to get banks to come to the Fed when they need reserves.

 

During svb, there was the bank term facility. On very generous terms, the banks took that. But your facilities for liquidity on demand, like the discount window or the standing repo facility, have not been all that effective at generating liquidity on demand when reserves are needed. Could I get some comments on how it's going in Europe and what can be done in the United States to reduce balance sheets while maintaining liquidity in the banking system?

 

 

>> Peter Henry: Jason Furman in the back is next and John Cochran and then we'll have some responses. Jason, all the way back.

>> Jason Furnman: While I generally agree with the approach that the Fed has outlined in dealing with the tariffs, I do wonder, and I'm going to ask a contrary question, which is partly to Isabel.

 

Europe has had experience with raising vats and then temporarily changing vats, and I'm wondering how the ECB has looked at that and whether they look through the inflationary changes from changes in vats or looked at the headline number. And then for anyone from the Fed who wants to answer, why should we think of tariffs differently than a vat or with a vat would we be if the United States established one, would would we think that's causing a lot of inflation and we need to worry about the inflation it's causing.

 

 

>> Peter Henry: John Cochran's next in the front. All the way in the front here.

>> John Cochrane: Hi, I'm John Cochran Hoover. Both the Fed and the ECB are soon heading into conclaves to do a strategy review and that's entirely a good thing. The last strategies were well constructed to worry about deflation at the zero bound, and that's not our problem anymore.

 

I'd like to ask where you want to think it's going with particular with three issues. First, both the Fed and ECB define their targets as inflation on a forward looking basis with I know in the Fed's case we'll make up shortfalls but not we won't make up past overshoots.

 

Really that implies if you knew the price level was going to go up 20% and then no more inflation, say well, inflation's on the forward looking basis. The peasants with pitchforks are really mad about the last price level increase. I wonder if this isn't time to promise to reverse overshoots in part for the same reason that might help you a lot on fighting inflation going in and to anchor expectations.

 

Do you think it's important to distinguish supply and demand shocks? After all, supply shock that lowers potential output and lowering interest rates isn't going to do much at that point. You would think a different response would be appropriate. And last, the last strategy review promised slow responses which both ECB and Fed did to the last interest rate.

 

But maybe 1979 and 2021 weren't, weren't so great on slow responses. Should we not think about swifter responses and promising responses? Because if you need to raise rates, politicians, budgets too big to fail bank, everyone's going to be screaming about it. And so having a promise in place that says and a strategy we're going to respond quickly if we had to would seem to be a very useful thing.

 

 

>> Peter Henry: Okay, I think of the order right. Lisa Cook first and then Isabel Chenabo and then others jump into the other questions.

>> Lisa Cook: Certainly respond to the AI question. So my there are five generations of Baptist ministers in my family and my dad used to say that God only talks to you for 30 minutes.

 

So I just keep things really tight. So I didn't include immigration because of our time limits. But if I had more time to talk I certainly would have talked about immigration, but for a slightly different reason. What you probably know is that more than half of the PhDs in stem are, are awarded to those who have a first degree from another country besides the U.S. so if I'm thinking about incremental additions to the stock of knowledge through patents, through educating the next generation of researchers, I'm really worried about immigration and not necessarily the individuals who might be engaged directly in that, but that of their families and so on.

 

Certainly we've seen our colleagues, some of our colleagues migrating to places like Canada and Europe. This is definitely, this is our comparative advantage and I think it could have long term effect. So I didn't forget about it. I just thought I didn't have time to cover it, but that's a big concern.

 

Thank you for raising it.

>> Peter Henry: Dr. Holmes.

>> Isabel Schnabel: So maybe first on Darrell's question. So as you said, we have, we introduced an operational framework that you could describe as a demand driven system, which means that in kind of in the once we are in a kind of steady state, it's the banks that actually demand the liquidity and are responsible for then raising our balance sheet.

 

And it's no longer the ECB that's, you know, actively buying bonds, for example. So in our case, we have already significantly reduced the balance sheet, especially because our longer term refinancing operations have matured and we've also embarked on qt, but that is a smaller part of the reduction.

 

But nevertheless, we are still in a situation of abundant excess liquidity and therefore we still don't have much demand at our operation. But there is nothing to worry about. It's simply a reflection of the fact that liquidity is still abundant. Of course, there is a question whether there could be stigma in accessing our weekly operation.

 

I should probably say. I mean, we've never had any stigma on those operations. So my hope would be that also the transition will work. But of course we have to see, and we are monitoring that very carefully because maybe it is still the case that no bank wants to be seen to, no larger bank wants to be seen to be the first one to access these operations.

 

And this is, for example, why, I mean I've published a blog together with the head of our single supervisory mechanism where we made very clear that also from the supervisory side. It's seen as normal business to get liquidity from the central bank in the weekly operations because that's a very important part of the stigma.

 

So for now there's not much to see. But I'm quite optimistic that eventually when we get closer to less ample liquidity, that banks are going to start to access our operations maybe then quickly on the review. Of course, we are also in the middle of a strategy review, I mean we discarded the makeup strategy last time already very early in the process.

 

Remember, we had an academic roundtable, I'm not going to give any names, but basically the first person who spoke said, forget about makeup strategies. You will never, I mean they may, you may do it in one direction, but you will never push the economy into a recession just in order to, you know, to get, to get back to this 2% pattern.

 

I still find that quite, quite plausible. So we never had a makeup strategy and I think I'm not saying too much that we are not going to have it anytime, anytime soon. So I still believe that this forward looking approach is the right one. Even though of course, as clear as Christian said, I mean people cannot ignore what happened in the past, and so we have to think about how to deal with that.

 

And then, I mean on your point on the swiftness of responses, I think we have learned that we have to be able to change the course of monetary policy relatively quickly when we are facing large shocks. And that is, I think most central banks didn't, didn't do that in the previous episode.

 

So it took a long time to reverse course. There was of course, partly due to forward guidance, I mean, I would say that, asset purchases in general, as we also discussed before, are relatively hard to reverse. And so I think we have to think about how we can be more, more agile and that is in both, in both directions.

 

Of course the previous strategy reviews were very much under the impression of the 0 lower bound and was our reaction function. All our reaction functions were very asymmetric. I think there is a clear argument for becoming more symmetric there.

>> Peter Henry: Beth Alberto comments on the strategy and then maybe we'll come back to Isabel to talk about the vat.

 

 

>> Beth Hammack: Yeah, I'm happy to comment, Darrell, on your comment about some of the tools that we have. I mean we are also, we are operating in a different regime than the ecb. From a liquidity perspective, we're in an ample reserves regime and we are continuing to reduce the balance sheet.

 

There is a concern at times about whether or not banks would be willing to use the ceiling tools that we have in place. So whether that's the discount window or the standing repo facility, which help to provide that cap on rates and to keep things well maintained. You know, we've seen a couple of episodes whether it was the third quarter of last year when rates traded meaningfully above, you know, in the most recent episode in April, things were very well contained.

 

The desk in the New York desk that manages the balance sheet has been spending some time thinking about ways that they could help to improve it. And I think Roberto Perli had a speech yesterday where he referenced that they're going to begin doing morning operations, which would be one way to help.

 

Another tool that could be useful is central clearing. So if the standing repo facility was, was a cleared facility rather than a bilateral facility, that would likely reduce the balance sheet cost for dealers and make it more attractive for them. It could also have the benefit of reducing stigma for them.

 

The discount window again is another ceiling tool, but that has different challenges from that perspective because you couldn't really clear those pieces.

>> Alberto Musalem: Thank you. Let me just pick up where Beth left it. On the discount window. There's a modernization effort going on and it has to do with, you know, the stigma side, but also making collateral management for the depository institutions more effective and efficient, particularly with respect to collateral posted at the fhlbs versus at the Fed's discount window.

 

So that works ongoing. Also on Jason's question on the VAT experience. Yes, the VAT experience is the classic textbook of a one time price increase. In Japan, they've changed the sales tax many times, and we see is inflation goes up for that month, and then stops after that.

 

I think the initial conditions are important. Today we have inflation is above target, has been for four years. We have inflation expectations in some horizons, the short end rising. We have a public and businesses that may be more sensitive to inflation than they have been in the past.

 

And we have tariffs very broadly across all of the input output structure of the economy, including intermediate inputs. Of course the sales tax would also do that, although maybe the cascading of the sales tax may not be as depending how it's implemented, may not be as complete as it is with intermediate inputs.

 

So the initial conditions are different and that has to open the door at least to the possibility or the risk that the impact will not Be just like a sales tax increase. On the framework questions, John, there were four or five questions in there. So what I will say is we're continuing to work on the framework.

 

All banks are contributing, the Board of Governors is contributing. It's really a system wide effort. We're reaching out to communities we serve. We're having the Fed Listens events, we're listening to how policy has affected people's lives and livelihoods in our districts to pick up on what Isabel said.

 

You know, I don't want to prejudge what the framework will say because we're still working on it. Some way through it, my own personal view is that, you know, the prior framework, the framework we have today that is being revised. I had as a central case effective lower bound, which causes some asymmetries, and therefore the framework has some built in asymmetries in it.

 

The catch-up strategy being one of them, the definition of the shortfalls being another, and there are other asymmetries. And what I learned is that going forward you have to build consider a framework that is more robust to different states of the world, still considers the zero lower bound asymmetry and state, but is focused on other states also.

 

And absolutely you have to consider supply and demand shocks and trying to distinguish between them.

>> Peter Henry: So we have time for one more round of questions. I know. Go ahead, Lisa Cook, and she needs to leave. So please go ahead.

>> Lisa Cook: John, for bringing this up. And I think that one of the things that's happened is that we are looking at the data that were available.

 

Do we need to use different types of data, data that might be more informative at different points in the business cycle, during business cycle transitions versus other parts of the business cycle, different types of research. So the research on sectoral analysis and macro models has changed since the beginning of our strategy review last time.

 

And I think that this was a shortcoming, we weren't doing as much of that. And I think that we are learning from the research that's being presented and we're learning. From the data and how we should interpret the data at different points. So I think it's comprehensive, it's large questions, it's smaller questions, more defined questions, more amorphous questions.

 

But stay tuned. We're still working on it.

>> Peter Henry: All right, so second round of questions. I want to warn you that John Cochrane had special privileges organizer to ask a five part question that will not be tolerated with others. So let's go 1, 2, 3. And then for the lady in the back row over there.

 

 

>> Torsten Slok: Okay, I'm Torsten Slack from Apollo. So given that the term premium has gone up quite a lot more recently, how should we think about this in a Fed decision framework? If the term premium goes up for fiscal reasons and the fiscal outlook just continues to get worse and worse, does that mean the central bank should be cutting because we get tighter conditions in the long end?

 

Does it mean the Fed should not do anything in the front end? Should we just wait and see? Or does anyone on the panel have any view on, first of all, if you disagree with why the term premium is going up, but what does it mean for monetary policy when we have this fiscal push on the term premium higher in the background?

 

 

>> Peter Henry: Okay, I think the next was President Bullard and then I think Tycho and then lady in the back row. If I've had it correct.

>> James Willard: Thank you, Jim Willard, Purdue. So this conference has historically asked a lot of questions about balance sheet policy and wanted more clarity around balance sheet policy.

 

So would it be possible in the framework review to say something about balance sheet policy? I think in the past, the committee has not been able to come to complete consensus on that, but maybe there's more consensus these days than there would have been. And also, also in Europe, it's not as clear to me what the statement is on the purpose and nature of balance sheet policy for the ecb.

 

 

>> Peter Henry: Two rows back to Professor Kehoe.

>> Patrick Keheo: Hi, Patrick Kehoe at Stanford. So I was talking to the grads the other day about how tariffs will pass through and how much wind up in final consumer prices as they trickle in overtime. And we're just chatting about how different it is if you're taxing final, final goods.

 

So if you're taxing this particular shirt or types of shirts, it's not in the middle of a value change. But if you tax something at the center of production that goes into many, many goods, like steel, it could have massively more effects. And we're trying to look at papers, we couldn't find that much work on that and if you're trying to figure out if you had huge tariffs and a lot of them run things right at the center of production as intermediate inputs would be passed on in many industries, you could get a much more, a bigger multiplier on final goods changes.

 

Have you, have your teams been thinking about issues like that at your feds and the board of governors?

>> Peter Henry: Last question. Back row on the right.

>> Elena Pastorino: Thank you. Elena Pastorino, Stanford University and our institution. This is an end of the day question for Isabel and the panel.

 

Overall. I'm a European economist, so my eyes are often trained on Europe too. We used to be talking about political uncertainty at times instability in terms of the US but the same issue can be talked about in race for Europe too, and the war in Ukraine. In the Ukraine is not just in the background but for men in the foreground.

 

So the question is what is the actual size of the monetary space in which the ECB can operate in light of all these challenges? Thank you, Dr.

>> Peter Henry: Schnabel, we'll start with you. And we thank Lisa Cook. She has to catch a flight.

>> Isabel Schnabel: Should I start? So maybe I say a few words about balance sheet policies which of course have to be also be part of a strategy discussion.

 

I mean I've, I've given already many speeches on, on asset purchases and so on, so I'm not telling any secrets is my, my personal view here, of course. But I mean, I think what is, what is clear is that when it comes to balance sheet policies one has to distinguish different purposes.

 

And I mean so far asset purchases, we mainly have the QE type as a stance instrument and then we have market stabilization and the general, I think there's a general consensus that asset purchases for market stabilization have been very effective and they can be relatively short lived, they have relatively small side effects and therefore they are, they're very well accepted.

 

I mean the discussion is really much more around QE for stance reasons. And there, I mean it seems to me that kind of the ratio of benefits and costs is worse than we may have thought. So they were probably less effective than we had thought and they were more costly than we had thought, which would lead me personally to the conclusion that the bar for QE in the future should be higher than it was.

 

But that also that needs to be discussed. And of course, but that's not to be, I mean, let me be clear. I do think there is a case for this tool in the toolbox and especially when we are getting close to the effective lower bound, there is clearly a case but maybe we have to be a bit more cautious on that, on the question on final versus intermediate goods.

 

I mean, I. So who asked the question? Yes, sorry. I showed one chart in my presentation where we actually, I mean, we. We looked, of course, from our perspective and there we. We look precisely at this question whether it makes a difference, whether in that case the retaliation is on the final or the intermediate goods.

 

And it makes a big difference. And so maybe you can have a look at that paper because I think it's interesting. I'm not sure I fully understood the final question. I mean, of course, there are huge challenges in Europe, in the world. What does it mean whether we have the space in order to deal with that?

 

So we have a clear mandate. It's price stability. So can you clarify a bit what you meant? If we have the time, maybe not.

>> Peter Henry: Maybe we'll hold it

>> Isabel Schnabel: otherwise.

>> Peter Henry: Yes, yes. Bilaterally, afterwards. Alberto, Beth, anything you'd like to add?

>> Beth Hammack: I mean, I'll comment on term premium.

 

I don't know that I have a strong view on what is driving it. We have a number of models that work on decomposing it. For me, the important part is. As I think about financial conditions generally, term premium is a component of that in terms of level of term rates.

 

And that has an impact on households and businesses and affects their willingness to borrow or lend at any point in time. And so to me, it's really thinking about that channel and how that's going to change their viewpoints. And so I think the role for monetary policy is not to combat term premium per se.

 

That's not our role. Our role is to think about the overall impact. On the economy and on the real economy and to take it in from that perspective on the balance sheet. I appreciate the question. I don't believe that a broad balance sheet policy is within scope for us to put in this framework review.

 

But I do think monetary policy is at its best when it's clear and transparent and when the public has a good sense of what our reaction function is. And so I think it's a great suggestion that we should engage on putting out more transparency around what our policy for the balance sheet is.

 

 

>> Peter Henry: St. Louis, you have the final word.

>> Alberto Musalem: Thank you. So. So on balance sheet policy, again, I don't want to prejudge the outcome of the review. I'll state my personal views. My personal views are that I would, I would think it productive to communicate to the public the conditions under which the balance sheet policy should be used at the effective lower bound or used for market function reasons or used for monetary policy reasons.

 

I believe the public would and the markets would benefit from that kind of information and structure. On Pet Keyhoe, absolutely, if you have intermediate goods, the pass through is higher. That's why the analogy to the sales tax or the VAT may not be direct because the VAT you get reimbursed, it's not, it doesn't cascade down the entire input output structure, whereas tariffs would on intermediate goods.

 

So it could be a little higher. I've seen private estimates, including intermediate goods, private sector estimates, that is, we do our own, the private sector estimates with the effective tariff rates of about a week or two ago, they're changing every day, right? But we're suggesting including intermediate effects, something like 1.5 to 2% impact on the price level with no information on how that would be distributed over time, right?

 

Because we don't know. And I agree with Beth on the term premium. The way I think about it is we look at a lot of models and they tell slightly different stories. Sometimes in agreement, sometimes not. Ths way I interpret it is the exposure. The expected real rate without the term premium has been coming down.

 

So has the risk free nominal rate coming down. The expected inflation long term has been rising modestly, very modestly. And the term premia on inflation has been rising some. And the term premium, if you decompose the term premia into inflation and the real return premium, it's about 50/50 in terms of drivers of what's rising, what's increasing the term premium.

 

So it's hard to say this is fiscal policy or monetary policy. It's just very impossible to say that.

>> Peter Henry: Please thank me in joining the panelists, the organizers, and thank you, John Taylor.

>> Francois Velde: Going to illustrate a few outcomes and a few thinkers as kind of signposts in this history of which I'm going to try to show that there are some patterns, as an economic historian, that's what I do. I look for patterns, and then I'll just quickly summarize the facts at the end.

 

The timer isn't working, so that's dangerous, I might be going over, anyway, at least you have booze, you'll just have to wait for the food. So I'm gonna start with this text, which was written by a Roman jurist in the second century A.D, he was a high official in the Roman Empire.

 

And this is a commentary on some law, and he was trying to talk about the legal aspects of purchase and sale. And there's a buyer, there's a seller, and whether you're one or the other makes a difference from the legal point of view. And he says, but it wasn't always that way, and we didn't always have money.

 

Rather, every man bartered what was useless to him for that which was useful according to the exigencies of his current needs, for it often happens that what one man has in plenty, another lacks. But since it does not always and easily happen that when you had something which I wanted, I, for my part, had something that you were willing to accept.

 

Lack of double coincidence of wealth. This is where it gets interesting. A material was selected, a passive voice, which, being given again, passive voice, a public and stable value, avoided the problems of barter by providing a constancy of quantity. This material, struck with a public imprint, provides use and ownership less from its substance than from its quantity, right?

 

So by quantity, you probably have to think of the coins, number of coins that there are, nor are both things called merchandise, but one is the price. So why is this text interesting? Because it ended up being part of the legal tradition of Western Europe in the 6th century A.D Justinian compiled lots of legal text, and this one was one of the texts that was preserved.

 

And it's a text that many people thought about over time, and it framed the understanding of money. So as I said, initially, Paulus was just trying to distinguish between the symmetric borrower situation from the asymmetric buyer and seller. But it's a foundational text, first of all, it's the first statement of the double coincidence of wants.

 

And as you saw very clearly and crisply presented, and it highlights the dual nature of money, there's both something profoundly natural about it. There's this problem, and that's an obvious solution, but there's also something artificial or constructed about it, that's where the passive voice was coming in. It was selected, a form was given, the word public appears twice.

 

So it's both a natural thing and a social thing. And money in the early middle ages and early modern period actually reflected this dual nature. On the one hand, money consisted of coins. So, gold, silver, material objects, and the size, the specifications of those were determined by the sovereign.

 

There are no numbers attached to these coins, by the way, nothing was written on it. The value was in terms of some reference coin, but it was not inscribed on the coin. So that's the physical side. But then the social construct appears in the fact that the accounts were kept in units and liabilities were denominated in these units of account.

 

And what was a unit of account? It was a reference to one of the specific coins that was or maybe used to be in circulation, but it wasn't anymore. So the unit of account was the penny, say, the penny originally was a coin that circulated. Maybe it's still circulated, but it was an abstract reference to that coin.

 

So when I'm talking about monetary policy in such ancient times, what am I thinking of? Well, there was some monetary policy, you could change the contents of a coin that was called a debasement. If you're reducing the contents of the coin, you could change the price that the mint paid for metal.

 

So you would be changing the seigniorage rate, or basically the monopoly tax that the government levied to make coins. Or you could modify the face value, the value assigned in reference to some coin. So this is not quarterly fine tuning of deciding we're gonna do this, we're gonna do that.

 

But there were decisions that needed to be made at various times to make up for depreciation of coinage, I'll talk about that. To prevent outflows or sometimes raised revenues, use the inflation tax. So the doctrine that was elaborated in time, in the background, they're civil lawyers, they're really only focused about debt repayment.

 

And their view is, you shouldn't harm the creditors, so they have a very hard money view of things. They look through the unit of account, the social construct aspect, they look through to the substance. And they say, if you lent X amount of gold, you should get back that same X amount of gold.

 

The church lawyers for a historical accident actually think about public policy. And the reason is, it's kind of an incident, but there's a king who had come to the throne, he swore to uphold the currency. And then after his accession, he realized that the currency had been debased shortly before by his father.

 

But now he's sworn enough to uphold his bad coinage, so what do you do in those days? You write to the Pope, you say, dear Pope, here's my pickle, can you get me out of it? And the Pope says, yes, well, it's an oath, so we have to take this seriously, but since the coin was bad, you're allowed not uphold it and go back to the original coinage.

 

And then the Church lawyers, so that became part of the law of the Church and said, well, what was wrong about that coin? What's wrong about debasing a coin? And so, over the course of a few decades, very rapidly, they elaborated the doctrine. They admitted that the right to make coins belong to the sovereign, that was a tradition inherited from the Roman law, from the Roman Empire.

 

But money serves a common purpose, and so, the sovereign can't just do anything he wants with it, because as Aristotle said, it measures all things. And as Proverbs says, diverse weights, diverse measures are not a good idea. So it measures all and should not change without consent. And here it's an interesting aspect of Church law.

 

They reused an element of Roman law to manage trusteeships or tutorships, that which affects everyone requires the consent of everyone. So there was this idea that, well, maybe under some circumstances you can muck around with the currency, but you should do that with the consent of everyone. There were exceptions that were allowed, and these exceptions accumulated over time.

 

Little moderate Seage that was okay to cover the production costs of making the coins. Legitimate emergencies were okay, but in principle, you're supposed to require consent. And in the 15th century, they added this interesting notion that, if you do that, you can issue bad coinage or really crappy coinage, but afterwards, you have to buy it back, basically.

 

You have to make whole the people to whom you gave the coins, or the people who hold the coins at the time the emergency ends, actually. So a few examples of thinkers along this path. The guy is on the left, the context is on the right. The context is a graph showing the number of, Of units of account per fixed amount of silver over time.

 

So if it goes up, it means there's less silver in the corn. It means the coin is depreciating or it's commensurate to the price level, so if it goes up, it's like the price level. There's two countries here, England and France, England is red, France is blue. So two things, both of them have a, if you really squint at it, you filter the heck out of it.

 

There's a long run trend for these two and roughly the same for the two countries. And you see these little jumps occasionally, I'll get back to those. And also make a mental note of the dot, the red dot somewhere around 1695. The other thing you notice is apart from that trend, there's these crazy swings.

 

Now, as you probably know, for a good chunk of this graph, the two countries are at war with each other because England is convinced that it owns France and France begs to differ. So that goes on for a hundred years. And these really crazy swings with the French, those coincide with periods of wartime, so these are debasements.

 

It's a log scale, by the way, so we're talking serious manipulations. Nicole Reim, who's on the left, was a cleric, he was trained in church law. He was steeped in these ideas that he talked about. But he was also an advisor to the King of France, who was very enlightened right in that period or right after the big first burst of debasements.

 

And he talked about, in very subtle ways, about essentially the effect of inflation on nominal contracts, why it was bad. He explained that the prince's gain was the community's loss, but it was grounded in this notion that money is a tool that belongs to everyone and you can't muck around with it even when you're being invaded by the English.

 

So this is pretty strong hard money, there's another fellow in that tradition, a Spaniard, a Jesuit. Now, his context is a little different. The Spaniards had just discovered fiat money printed on copper instead of paper, but it's basically fiat money, and they started printing a lot of it, and he's writing in 1609.

 

So the graph shows you the nominal and the real balances of this stuff that are going up over time, and then crazy things happen afterwards. But he's writing when the two lines, nominal and real, coincide. So there's not much depreciation or not much inflation yet. But he's saying, guys, it's coming and it's gonna be bad.

 

And he really has very, very harsh words for creating this fiat money. It's display silver, it's like a tax. You're taking away the properties of your subjects. You're not allowed to do that, not without their consent. And he did say there are some benefits from having this kind of inflation.

 

And there's a very interesting analysis of foreign trade and so forth. But he says, on balance, as a good economists, the costs outweigh the benefits. And he also notes very pointedly, when bad things happen, people in power get blamed. And he's talking to the King of Spain. He did run into trouble with the Spanish Inquisition, I have to admit.

 

Now, before I get to the third character here, I have to explain what his context was. It has to do about recoinages. One problem with physical coins of gold and silver is that, well, that depreciates over time by where the coins where. And I have some obscure work on this estimating.

 

It can, year by year, it's not huge, but over decades or centuries it can accumulate to pretty significant amounts. So you end up with a population of coins, some are new, some are old, some are worn, some are not worn. You don't have a single clean standard anymore.

 

And if there's a deficit, a trade deficit that you have to settle by shipping metal out, of course the heavy coins are gonna go out. So the average weight decreases over time, the exchanger depreciates, people get upset. Some point you have to do something. Natural thing to do is either you debase, that is the new coins that henceforth you will add to the stock are of the average level of the ones out there, or you recall all the coins and, you make them new again.

 

But then there's a question on what standard do you do that? So either you go back to the old standard, but then, the coins are worn, they're missing 10%. So you're the 10%, you're gonna have to find it from somewhere. Or else you say, well, bygones are bygones, the coins have depreciated the new standard.

 

The new coins are gonna be at the, the 90% of what it used to be. So in one case the cost is on the bondholders. In the other case it's either on the money holders who will have to come up with a difference, or else the government comes up with a difference, which means the taxpayers.

 

So these conflicts, you know, bondholders or taxpayers, that's a very old story. In fact, in 1622, Naples was in one of those situations, really, really bad. And the the local government had decided, well, we're gonna debase, and then the King of Spain heard about it. He says, that's out of the question, I'm a hard money kind of person.

 

Curiously, at the same time is doing this comfort stuff. But anyway, he says, no, you have to recoin at the old standard. Initially he thought, he said, the cost is gonna be borne by the money holders. That didn't work out, especially because some of the money holders were banks and they were gonna go bankrupt and they're gonna be a systemic crisis.

 

So they ended up with a complicated formula where the depositors were bailed in. There was also local taxes raised and a tax on foreigners because after all their debt had been revalued, so it was only fair that they should contribute to the cost. Similar situation shows up seven years later in England.

 

So that's the picture on the left, sorry, on the right, which shows the price of a guinea, a constant amount of gold in terms of local silver currency. And you can see that by the 1690s it suddenly starts going up very sharply. So it's a similar situation, the coins are clipped or worn, it's terrible, recoilage is needed.

 

We're gonna do it with a new technology, so the new coins are gonna be much better. And John Locke is advising the Parliament because there are some people in Parliament saying, let bygones be bygones, let's devalue by 20% so the cost won't be borne by anyone, well, except the bondholders.

 

And that's what the people in Parliament were advocating. And Locke was really against that, furiously against that. Contracts are sacred and we just had a glorious revolution. We can't start fooling around with property rights at this point. I'm putting words in his mouth, but the words that follow are from him.

 

Men and their bargains contract not for denomination or sounds, but for the intrinsic value, which is the quantity of silver that the public authority has said should be in the coins. So in the name of that social contract, we cannot modify that social construct because that would be violating contracts.

 

So that's what the recoinage was done at government expense, that is a taxpayer's expense, which ended up being 65% of annual revenues in the year 1695, in the middle of a European war. So extremely costly. I'll just briefly mention, things change, so we get out of the Middle Ages, there are some innovations that are going to change somewhat the terms of what does it mean to have price stability, paper money?

 

Jurors discover that, paper money is okay. Marco Polo tells us, people over there on the other side of the world do it. And the Neapolitan backs actually start having circulating pieces of paper, and the law also changes. The the big case in England is the so called mixed monies case.

 

There's a French jurist, the doctor. Doctrine changes fairly abruptly, saying basically, the government can decide what, what does a dollar mean? And they can do it overnight if they want, that's their right. And now we have the prototypes of central banks that start appearing. Some of them have ledger money, some of them have circulating notes.

 

The basic point is now it becomes possible to disconnect the substance and the unit of account much more easily. You just stop converting or suspend convertibility. Does it change the prescriptions? Not very much, you still have this notion and John Locke, I think, was very influential in creating this culture of sound money that persisted into the 19th century.

 

He still has this notion of emergency suspensions. You have some crazy people like John Law that Mike mentioned who say, hey, with this new invention we can actually do very fancy stuff. But that didn't turn out terribly well for him. So that's what happened with him, that's the value of his pieces of paper.

 

Over the course of a few months, they fell from 100% to just a few percent. So that kind of gave a bad name to fooling around with paper money. So here's a kind of a summary of European experience in the 18th and 19th century. What was the experience?

 

This is plotting basically the exchange rate relative to. For England, it's the value of the currency in terms of gold. And then for all the others, I use the exchange rate from those countries to England and then convert it to gold. So basically, how does your currency compare to gold?

 

And there's a variety of experiences. But what's interesting is even the best of the class, the top left, the flat line, means price stability. But you have these deviations and again, the scale is the same. If it goes up, it means that you have a depreciation, of course.

 

And they have been mentioned over the course of the conferences. Great Britain, suspension during the Napoleonic wars, US, the greenbacks during the Civil War, France. It's a very nice flat line with an unfortunate episode there in the 1790s during the French Revolution where I've had to move to a log scale.

 

And then you look at the others, it varies, but a lot of them, they try to stick to relatively flat lines, so price stability. Italy is in the middle right panel before unification, it's pretty flat, after unification, doesn't hold very well. And then the bottom of the classes is at the bottom, which is various, what do I have?

 

Yeah, Spain, Portugal and the worst are Austria, Russia and Sweden, who started experimenting with print with banknotes very early on, from the mid 18th century. As you can see, their experiences are somewhat painful, but they're striving, everybody's striving to get back to a stable standard. Austria is the more pitiful story.

 

They spent the whole 19th century trying to get back onto the gold standard. And every now and then they get, there's a revolution in 1848, there's a war with Italy in 1859, there's a war with Prussia in 1866. So it takes them forever to get, but eventually, by the end of 19th century, they get on the gold standard.

 

So, the gold standard, which is sound money, it's kind of the norm for the good countries, the periphery, they have a harder time, although their experience shows that it's possible to shadow the gold standard. And so there's this notion that it's okay to deviate from the gold standard under exceptional circumstances.

 

And that's something that Mike Bordo a long time ago with Finn Kinlan called the state contingent gold standard. But kind of my point is this has a very long history as a principle, that's 1914 again an index of the value of the currency for a whole collection of countries after World War I, so it started in 1919.

 

That was a really, really big event. So very few countries were able to make up and get back to the earlier standard, although famously Great Britain did in the 1920s. The two interesting facts here are, one, there's a huge diversity of experiences, again, log scale. So that's in order to fit Germany and Russia and so forth.

 

Although whether you were a winner or loser, which is indicated by the colors, is not a perfect predictor of whether you had a bad experience or not. In fact, some of the interesting cases are the Baltic States or Czechoslovakia. But the second point is after a few years, everybody tries to get back on a flat line.

 

So in the 1920s, there's still the objective of price stability. Of course, as we know, after 1929 things are very different. I'm gonna skip over the 20th century in the interest of time and because that's where micro imperative advantage diminishes. That is, I can't fool you as easily.

 

I'll just throw that picture that everyone's familiar with, but cast in kind of the same framework as the previous pictures. So this is price levels in various advanced countries normalized to December 2019, with the odd exception of Japan, it kinda looks the same. The slope goes up, steepens for a while and then it flattens again and of impact on the Price level is between 15 and and 25%.

 

I did just for fun, this is a scatter plot of, for a whole bunch of countries. On the vertical axis is the, how, the increase in the price level over the course of four years from 2019 to 2023. On the horizontal axis is an index of central bank independence that clearly doesn't tell you very much.

 

This is a picture I stole from the paper that Robert talked about, but was too shy to present to us. But if you look at government spending on the horizontal axis and inflation on the vertical axis, it lines much more. That's it, what do I take out of this?

 

The price stability objective has a very long history going back hundreds and hundreds of years. Practice, it meant monetary dominance, but not absolutely strict adherence at all times. And of course, as John Cochran reminded us yet again, monetary dominance has very strong fiscal underpinnings. Somebody has to come up with a dough.

 

It usually included these escape clauses, the state contingent gold standard. But the key question is, okay, you're allowed to deviate, do you go back to the original standard or do you go back to stability but necessarily, makeup. Do you have a makeup strategy or not? When the deviations are huge, like Germany, there's no point in trying to do a makeup strategy, but from these large deviations, there can be serious distributional consequences.

 

So, in that perspective, the shock that we just had, it's looks big by great moderation standards, but by the standards of history, it's not really that big. And some of the questions that were raised during the conference were, was this allowed under the escape? Escape clause, or was this a serious deviation?

 

There was no makeup, and we've just discussed that in the last panel. But as John mentioned with the pitchforks, there can be political consequences. That's it, thank you very much.

>> Speaker 2: We take one or two questions. Okay, Andy and Jim. Jim, okay.

>> Jim Bullard: Jim Bullard, Purdue. So as I understood, the Pope played a key role in this, would it have mattered if the Pope was American do you think?

 

 

>> Francois Velde: If he had been a Cubs fan, probably it would have been PR and would have been much better, but-

>> Speaker 4: So coincidentally, my question's related. So I had the honor of writing a paper with Michael Bordo about 10 years ago, more or less when we started it, and we actually had the quote that you have from Julius Paulus.

 

It was the opening quote of our paper on digital currencies. I mean, the only reason I mention it is because Julius Paulus was given the honorific prudentissimus, which roughly would be translated as most prudent, remorsewise, most sage. Cuz he actually ended up providing a lot of the legal advice of the Roman Empire at the time.

 

And so I was thinking maybe the Pope could give that award to John Taylor it's the honorific of prudentissimus, so.

>> Speaker 2: All right.

>> Speaker 4: Yeah, that was fascinating. Could you say something about the assignats? You have the diagram there on the French Revolution. What I find very interesting is that, if I understand correctly, Robespierre ended up being kaput because of the combination of hyperinflation and price controls.

 

So could you clarify what-

>> Francois Velde: No, he died before the hyperinflation.

>> Speaker 4: Okay, so- Could you tell us a little bit about the assignats, which is- So the very short story is three periods, period one, this paper money is launched, is backed by land instead of being backed by gold, but it's solely backed, works nicely, doesn't depreciate.

 

 

>> Francois Velde: Scene two, France stupidly goes to war with the rest of Europe, and tax revenues are collapsing. The only resource they have is printing money, but it soon depreciate. So they say it's what Tom and I call the guillotine-backed regime, where you're gonna have to accept that piece of paper otherwise.

 

And so that's under Robespierre. And that works for a while, but Robespierre is overthrown for a host of reasons, not so much that aspect, I think. And then the day after he dies, there's a police report saying two things are happening, the currency is starting to depreciate, and prostitutes have come back on the streets and-

 

 

>> Francois Velde: And then we get the hyperinflation after that, but it's afterwards, yeah. So once the restrictions are removed.

>> Francois Velde: Well, once the, once the threat of legal action, cuz he was a very stern man.

>> Speaker 2: I will.

>> Speaker 2: Okay, we gotta get to dinner, you know, Jon Hartley there, yeah.

 

 

>> Jon Hartley: Thank you. I think a chronicle of deflation, probably one of my favorite papers of all time, it's a paper by Francois. I'm curious, that paper is largely about monetary non-neutrality. I'm curious, sort of in this whole span of history that you cover, what do you think or what have you learned about monetary non-neutrality in these instances?

 

And at what point does monetary policy take on, I guess, a more benevolent nature, but there is some sort of a perceived, maybe dual mandate or another triage going on? I'm curious where that fits in.

>> Francois Velde: So the episode in question relied on the fact that in France you didn't have denominations written on the coins.

 

And it fits in this story because there had been deviations from price stability in the previous years and John Law in particular. And after that, the government felt a need to the earlier level in line with this tradition that you have to make up for things. And they named explicitly the fact that the bondholders had seen their debt devalued, and they wanted to make it up to them.

 

So they wanted to change the price level, and they thought that this is gonna be a piece of cake. The coins that are worth six, we just announced that now they're worth three, and we're done. And they thought, yeah, it might take a week, two weeks maybe at most.

 

And yeah, to them, they discovered monetary non-neutrality. And so that was eventually, Hume read about this story and talked about it. I don't see it feeding back to discussions of what's the right standard. Although, I mean, after the suspension of convertibility by the Bank of England in the 1810s, there were debates about whether do we have to make up or not.

 

Do we have to return to the old standard? And there were some cranks who said, no, no, you shouldn't, it's gonna be deflationary, and they weren't taken seriously. There's also debate after the Civil War over the terms of the resumption, whether you should go back completely or not.

 

So you see these questions of the effects of the redistributional effects starting to play into the political debate. And then in terms of when do people start thinking in terms of a dual mandate or to, I'd say that's more of a 20th-century thing. Now, why that changed, that's political economy stories.

 

 

>> Speaker 2: Let's get Hoyt, an economic historian, back there.

>> Francois Velde: Yeah, I don't want to keep people from the free with that-

>> Speaker 2: Yeah, that was-

>> Hoyt Bleakley: Thanks, so the phrase coin of the realm, I suppose, is something I'd never thought of until you said this, that you gave this presentation.

 

Now, often this is backed with the state being somewhat aggressive and making sure that there is a coin of the realm. But how often was there a relaxation of that, that there was tolerance of other monetary instruments, maybe even an endorsement of competition amongst different regions?

>> Francois Velde: Yeah, that varies a lot, it depends on how big you are.

 

If you're a small little city-state, it's kind of hard to keep the foreign coins outside. But say, very roughly, medieval tends to be fairly tolerant. And then about 6th, 17th, 18th century is when you see countries usually starting to prohibit foreign coins. Before then, 15th, 16th century, sometimes you actually have official values for the foreign coins.

 

You had long lists of foreign coins and what they're to be taken at. But it's a nation state kind of thing, I would say.

>> Speaker 2: Barrel, slate barrel, yeah.

>> Speaker 8: So after the Napoleonic wars, there was the question about going back on the gold standard in the UK.

 

And it was David Ricardo who took the lead in parliament, particularly arguing to go back and to go back at the previous parody. But was that kind of the first example of that when that occurred in 1821 or whatever it was?

>> Francois Velde: Of what? Of returning or of debating the question?

 

 

>> Speaker 8: Of returning.

>> Francois Velde: No, no, I mean, there were other examples, this wasn't the first time, by a long shot. This may be the one of the times, no, actually, I mean, the Neapolitan example, 1622, there's public debates about what should we do?