Independence, Structure, and Risks Ahead for Central Banks

- Good morning. Let's go ahead and get started. I'd like to begin by welcoming everybody on behalf of my co-organizers, John Cochran and Michael Bordeaux to the annual Hoover Monetary Policy Conference. John Taylor organized the first of these back in 2008 and 2009 in response to the global financial crisis, and they became an annual affair starting around 2013 with only a break due to COVID like the earlier ones. Today's conference is set to be a lively discussion of the most pressing issues facing monetary policy as well as the world economy. We're gonna be talking about topics that range from central bank independence structure and central bank mandates, interactions between fiscal and monetary policy, international issues, risks, challenges and opportunities, and of course our policy panel as the last session of the day. We'll also have remarks from our director, former Secretary of State, Condoleezza Rice, around 11:00 AM and then we'll be treated to a wonderful talk by Tyler Goodspeed based on his book and the talk is called Firefighters and Arsonists Monetary Policy and the History of Recession. I also wanna let you know that we have a sampling of books that you can pick up written by some of the people at the Hoover Institution, including Tyler's book on recessions, which I read recently. It's also a very good book. Before we go to the first panel, let me just say a few things. First of all, we're gonna try to keep the trains running on time, so if you're in a session, please listen to your moderator when, when they say that the time is up during the general discussion, please identify yourself by name so everybody knows who you are if they don't already know you. Okay, well, with that, we will move to the first panel, which is on independence and governance. And the moderator is John Cochran and the presenters will be Edward Nelson, Gary Richardson, and David Wilcox. Thank you.

- Thank you everybody. Just to add to what Valerie said, there are two books in particular that I want to draw attention to. No, not my books. The conference volume resulting from last year's conferences here and the John Taylor celebration volume collecting those essays is also here. So you're, I think those are free. Yes, yes. So free books. What can you ask for? Okay. This session is on Central Bank. Independence, obviously an important issue. It's one of two panels we have on Central Bank Independence. Now that's much in the air, but let's remember, central Banks are not absolutely independent. We do not appoint a Federal Reserve chair. Maybe you can be chair next time, ed and say, Hey, go print money, do whatever you want with it, and nobody can stop you. That's not how it works. In fact, this is the 250th anniversary of a time in our republic when we decided, no, we don't have unaccountable power and just let it do whatever it wants. Independence. The Fed has no rights of its own. Its independence is granted by Congress for Congress' purposes, which are of course pre-commitment. It's part of that wonderful set of institutions that we have in the United States to deliver a government that pre-comm commits against actions that will be damaging in the F future and therefore gives us stability and prosperity today. There's three parts to independence, broadly, operational independence, the mechanisms that let fed leaders once put in place, make decisions without political, immediate political interference. But of course, remember when the other party is in power, what is once political interference becomes democratic accountability. The second is the limited mandate. You can only be independent if you stay within a limited mandate. And so the nature of the mandate and the nature of the limitations on the Fed, which preserve its independence is an important thing to talk about. And history, the Fed's independence comes from a long line of, of a long historical development, which is important for us to remember. And that's something that all three panelists will touch on today. So with that background, let's see, we're gonna go in the order on the program. So Ed Nelson, why don't you start and the slides hopefully will show up. Yes, there. They're,

- Well, thank you John, and thank you also Valerie and Mark and the Hoover Institution for inviting me. I'm very delighted to be here. And the first thing I should say is that the views I'll be expressing of the view, my views and not those of the Federal Reserve system. And when I'm expressing views, most of them today will be on at matters of interpretation and selection because the paper is essentially a factual compendium trying to draw out key aspects of how Federal Reserve independence has operated in practice in the five and a half decades through the Greenspan period. And especially trying to bring out the arguments for independence as viewed by the Federal Reserve chairs. And I'll really just be providing snapshots in this presentation. I, this is really just trying to wet your appetite for the paper rather than try to really go through the paper. But I will talk about, I will try to show you some of the, what seemed to me very striking, self-contained descriptions of, of the situation that per various Federal Reserve chairs had given. And so Martin, in 1955, obviously he was chair for 50, right? Basically right through the fifties and sixties. William Martin said, under the present law, even if the White House should bring all the pressure in the world to bear, the law gives us the authority so that we can act as we believe necessary. And Paul Volcker obviously was there during the disinflation period and administered the disinflation. And his position was that we have a charter basically from the Congress. We of course are independent from the administration, but he, he, as he put it, any encroachment on our independence will be firmly resisted. And the way he summarized the situation was the Federal Reserve Systems reports to us accountable directly to the Congress, which was given the constitutional authority over money by our founding fathers, in part to insulate the authority from the executive less it become too powerful. And the another point he made was to run through this fairly familiar list of ways in which Federal Reserve independence is enshrined, including long terms for the governors and stagger, stagger staggered terms. They cannot be removed because of policy difference. Obviously he was talking mainly from the Federal Reserve Board rather than from C perspective. But could, you could add also the fact that there are bank presidents and he also mentioned that Federal Reserve operations of finance from its own resources. And one thing I really stress in the paper is that there's no connection really between independence and the rest of the government staying silent in a one way of, one extreme way of thinking about this is that one way in which discussion of inflation didn't cover the Federal Reserve sufficiently in, in politicians' discussion in the seventies was that they were talking about non-monetary causes of inflation when they should have talked more about the relationship of inflation to monetary policy. So in that sense, we shouldn't applaud the fact that maybe that politicians didn't necessarily talk about the Federal Reserve when they were talking about inflation. And similarly, there's no gag order or anything like that in, in Implied by Independence in terms of commentary by Congress or the White House on, on monetary policy. So the way that Alan Greenspan put it, obviously, he was able to establish a sort of prestige that made, made, made him very well received in Congress in particular, he said it's wholly appropriate that we should be hearing from you the White House, from everybody with respect to what you they think the problems are. Anybody who can add new insight, new evidence, which would help us do a, a job. I think it's important that we get that. And one of the main things I go through in the paper is the economic rationale for independence. And although can't really claim that these are completely separate rationales, I think it's useful to break it into three, three parts. One is, as expressed by Federal Reserve chairs, they've articulated the case for independence in terms of first longer term costs of using monetary policy to overstimulate the economy, the need to secondly, the need to avoid subordinating monetary policy to treasury financing requirements. And third, the need for her long horizon in monetary policy, policy decision making, I don't discuss this this morning, but in the paper I argue that the third is not really the time inconsistency argument, that it's really a separation of long run and the short run that is really separate from the research emphasis on time inconsistency. And an example of the ways in which Federal Reserve chairs of justified independence on the over simulation side is Paul Voca, for example. He said, obviously the danger always is that an attempt to reduce interest rates artificially you end up with higher interest rates. Obviously that's the Fisher effect. And he also said any with regard to the fiscal side, all of human history economically is the sovereign clipping the coinage to meet his expenses. That is presumably why we have an independent central bank to try to resist that temptation. And Alan Greenspan in 1995 said the same thing. He said, A history is replete with examples of fiscal pressures leading to monetary excesses and then to greater inflation. So those are quotes for you, John, especially. And before that, that was obviously a big part of the Martin tenure as well. And I also talk about the need for a long horizon, but I'll skip that. And in terms of as the practice in independence, one thing I I, I like to stress is that I really think there's one clear cut case of lack of independence in the episodes that tended to to be talked about in the research literature and a couple that are cited, but in my view and not very good examples, the first is pre 1951, that was a case in which the Federalists are willingly, but nevertheless was subordinate to the treasury Fed financing requirements through its pegging of interest rates, long-term interest rates in particular. So there was formal independence, but there was defacto non independence. And so that was a case of lack of Federal reserve independence. There are two other more recent examples, not very recent, but in post 1950s that are often cited in literature with, with regard to examples of the Federal Reserve independence being superseded by the executive. And I don't think either of these stand up. One is Lyndon Johnson. Lyndon Johnson in 1965 made a complaint about public complaint, essentially about the Federal Reserve Board at that, at that time raising the discount rate that was a public well-publicized dispute, but it didn't, it didn't lead to a monetary policy change in the direction that Johnson at the time was advocating. So I would say that was not a case of lack of independence. More recently, or at least in, in the last, in the, in the post post Martin period, there was Arthur Burns and of course the, the, the so-called most famous example of lack of independence, namely the 19 71 72 monetary policy ahead of the 1972 election. I think we, it's very hard to break away from the fact that as a matter of record, the Nixon administration did untoward things to get reelection in 1972. That's Watergate essentially. And so it's a very slippery slope to assume that monetary policy was part of this scheme one way in some, in some way of being too deliberately too easy and, and being engineered to promote Richard Nixon reelection. And I can certainly give you many examples in which Arthur Burns was far too close to the administration in terms of having lot, giving lots of opinions about administration policies and so forth pro and con and during his tenure and far too involved in talking about the executive branch. But I don't think it's a good example of a case of monetary policy being subordinated to the executive. Why? Because 71 to 72, although in retrospect, and it was certainly a misguided period of excessive monetary policy, ease was not a period in which Arthur Burns was doing something he didn't want to do on economic grounds. The policy mix in 71 to 72 of inflation controlled directed by directed to incomes policy, essentially wage price controls plus easing on the fiscal and monetary side was the policy mix that Burns had been advocating. He'd viewed inflation's cost push press, wage price controls on the Nixon administration. So the Nixon administration bent to his interpretation, people like George Schultz of the of Sea, a big name here, were, were were beaten in this internal argument within the overall government and Arthur Burns prevail. And I, I'm a big skeptic about being, thinking the FMC transcripts of some shrine that tell you lots of secrets about what Federal Reserve policy makers were thinking. And by this, by consistency with that, I don't think the internal conversations between Nixon and Burns are very, very devastating or, or decisive evidence. With regard to contradicting this, this story I've just told that is I don't think those, those tapes indicate that Burns Succumbeded or was doing was succumbed to Nixon pressure or was doing something on the economic policy side that he didn't want to do well before his White House conversations with Nixon Burns stated policy makers that these, the controls price controls would usher in lower interest rates. And so we should not be surprised that subsequently interest rates fell after this. What he perceived as a good policy mix was, was introduced. He, he engineered the drug deductions, but it was part of what he perceived as a package. And the Federal Reserve discussing shared objectives with the, with shared executive objectives, with the executive, whether it the ca or the President, is not the lack of independence. There's obviously the, the big distinction between the Be and Fisher distinction between instrument independence and goal independence. And what I'm talking about is instrument independence, which I don't think was, was violated in this episode. I just wanted to conclude by giving maybe one or two presidential quotations. We often in, in, in hearing about Federal Reserve independence over time, we hear a lot about Lyndon Johnson, we hear about a lot about Richard Nixon and because of the Vol disinflation and the, and the change from Miller to Vol, we hear a lot about Jimmy Carter. We hear a lot about Ronald Reagan. But in the course of doing this project, I found some, what I thought were somewhat neglected quotations from given by Gerald Ford when he was president, because I think they really captured these, a lot of the key arguments very, in a very succinct manner and really quite, quite interesting as a subtle understanding of the role of the relationship of the, of a subtle understanding of the relationship between the Federal Reserve and, and the presidency. 49 75 said, when interest rates rise, there's a temptation to call for the Federal Reserve to provide even more money and more credit to satisfy the demands. As we have seen in the past, when this is done, the longer term result is inevitably more inflation and even higher interest rates. And same year, he said, my judgment is that the Federal Reserve Board needs a high degree of autonomy. The minute we turn the central banking setup into a political weapon, then I think our credibility for responsible monetary policy goes down the drain. I don't call up Arthur Burns and tell him to do this or do that, and the Congress can't unless they change the law. Now that doesn't mean Arthur Burn's monetary policy was good, but I'll Good, good monetary policy is distinct from independent monetary policy, but I think that the mistakes in the seventies were not really to be understood in terms of lack of independence in that is what I've argued in this paper and in some of the work I've done in the great inflation. Thank you.

- That was wonderful. Thank you. And what a good model for take taking within the time. Good care. You're next.

- Thanks. I'm gonna talk about Fed independence in a bit of a bigger picture, but if, if there's a takeaway message from what I'm gonna tell you, it's that Fed independence was very well designed to withstand demagogue. And I'm gonna tell you a little about, about how it was designed, and that gives you an idea about why I think Fed Independences appears to be so robust in the face of the current attacks. Okay. And then sort of in the bigger picture, I want to tell you quickly that the Central Bank independence in the United States has very deep roots. This issue was discussed by our founding fathers. It was discussed in the debates when they set up the Federal Reserve. And it's, it's a political idea, not an economic idea. So politicians devised the idea of independence. They use the word independence, and they have the, the legislation that gives us independence has a very specific meaning politically and legally, which is broader and a little bit different than the concept of economic independence. We talk about as economists. Now, the past political debates about central bank dependence have had huge impacts on the structure of the federal and state governments. And I think that's something to keep in mind when you think about what the Supreme Court is thinking, because certainly the clerks and probably most of the justices understand the decisions they might make in cases about, say, cook versus Trump or Powell versus Trump can have implications for the structure of government far beyond the Fed. And I'll remind you of that, and then I'm gonna talk about a little bit about the recent attacks and why I think the Fed has withstood the recent attack, so well, 'cause it was really designed to withstand this type of attack. And then, and just mentioning the, the long run question of what, what the survival of Fed independence could mean for the structure of the federal government. So yeah, our, our founding fathers argued about the benefits and the costs and the independence of a national bank. They, they really wanted to establish, or about half of the founding fathers wanted to establish a national bank and about half didn't. And they really worried if they established a national bank, they wanted it to be, they didn't use the term independence yet, but they wanted it to be at a distance from politicians because their experience was that if politicians ran monetary policy like in the Revolutionary War, we'd get a lot of inflation now because the founding fathers really couldn't agree on whether we should have a bank or not. The Constitution is kind of vague about this. There are some statements in the Constitution that appear to authorize Congress having something to do with regulating the value of money, but it's a little bit ambiguous. And it was intentionally written ambiguously because they couldn't agree in the constitutional convention on this issue. So they just made it ambiguous. And then there was a big debate which happened, I'm sure you've heard repeatedly in the 19th century about whether Congress could authorize a national bank and how Congress could use its enumerated powers to create money and regulate the value thereof. Now, the Supreme Court eventually weighed in on the legality of Congress establishing a national bank and regulating the value of money. This decision in McCullough versus Maryland is really important because it makes two, there's the two foundations of the, the federal government come from this decision. One is there was a decision that the Congress has implied powers that are not enumerated in the Constitution, and those implied powers exist where they're necessary to implement the explicit powers that Constitution gives to Congress. So this sort of settled the vagueness in the Constitution, right? And this was Alexander Hamilton's original argument. Yeah, we didn't explicitly authorize creating a bank or a central bank, but we have given explicit powers to do things which to do Congress needs to create a central bank. So the Supreme Court recognized that constitutionality of implied powers and a lot of the debates now in a lot of areas that, that are before the Supreme Court have to do with the extent of the implied powers of Congress, right? And so that comes back to this debate about the Central Bank. The other thing in this decision is that the states are forbidden from taking actions that infringe upon both the explicit and implied powers of, of Congress. So when you think of now about what the Supreme Court is thinking and maybe why they're delaying any decision in the Cook case, is they're really worried that the decisions they would make here could have very broad, long lasting implications for the structure of government. Now, I wanna tell you a little bit about what Congress means by independence and first tell you about kind of what they were worried about when Congress set up a first bank in the United States, and then a second bank of the United States, and then eventually the third bank of the United States, which we call the, the Federal Reserve System. And in the congressional debates and all these occasions, they, they talked about a bunch of issues, some of which as economists were very familiar with. So the Congress was always worried that the structure of the Central Bank and the structure of its leadership could influence the value of money, it could generate inflation or in the, which they were worried about, but also deflation, which they were worried about a lot in the past. Another concern was the ability of the central bank to redistribute wealth between creditors and debtors, between regions of the nations, between bankers and businessmen. And so the redistribution is something that was a big concern of, of politicians, and they've designed the leadership structure of the Fed and what they call independence to kind of protect the public from the redistributive hours of the central bank. Politicians were also worried that creating a central bank and the central wealth could, could affect the balance of political power in the United States in some of the ways that we think about today, where politicians can manipulate the interest rate and the pulse of the economy around elections. But they're also just worried about the ability of the central bank to affect the economy and then generate flows of money to politicians, right, to, that they would use to in their campaigns. And the last big concern was corruption, that putting people in charge of a central bank gave them a lot of opportunities to enrich themselves or their families and their friends. And so now I'm gonna tell you the, the definition that Congress gives us of independence in the debates about the Federal Reserve Act in 1913. And this, the, what Congress said is that they wanted to create a leadership structure for the Central Bank so that policies would pursue the public interest as defined by Congress. And they wanted the policy makers, they put in charge there to be independent of all other influences. In 1913, they're concerned a little bit about the President and they mentioned that, but they have a whole list of other things that leaders should be independent from. So other politicians, particularly Congress, their own personal interests, other private interests and bankers and businessmen's interests, right? So the idea of independence from the political, from what's written in our political records is that policy makers should pursue the public interest is defined by Congress and be independent of all other interests. So the President is one of them, but not the only one. Okay? Now, the, the leadership structure we have of the Fed today really comes from the ideas of two men. One is Carter Glass, and the other is Robert Owen. They debated a lot about how to create a, in a structure of independent leaders and thinkers. And I'm gonna come and tell you the way Independence works today and tell you the kind of independent contributions of these, these two men. But the, the solutions they came up with in 1913 were to create a very complicated structure, right? They're worried about the leaders of the system being influenced by all sorts of interests, and they want to shield the leadership from this. So they come up with a Fed, which is some of the structure we, you know, we have today. It's quasi-private, it, the corporations are unique. They have some features of private enterprises where they have, part of the structure is owned by the banks who have capital stock, and they vote for the leaders, but it's also kind of partially public. Some of the board directors are appointed by the public and are supposed to rep the, represent the public interest. And then the profits from the enterprise are remitted to the US Treasury, not to the stockholders. The decision makers were insulated from policy makers and from politicians. We had a federal reserve board, which supervised and had political appointees on it, including the Secretary of Treasury and the comptroller of currency. But originally, almost all the operational decisions were made by the, the, the regional banks, particularly their heads who were then called the governors. And then the system was regional. So we had 12 different banks, and the 12 banks could set independent monetary and, and lending policies. And then the, the banks had kinda limited powers. Originally, the Fed had a limited corporate lifespan and had a 20 year charter, which was made perpetual with the McFadden Act in 27. And there was a federal supervision, but not federal control. So that leadership structure, you know, existed for about 20 years. And then it was changed dramatically in 1935 because of the Great Depression. And then we get the, the leadership structure we have today where we have a centralized national monetary policy. And the debates in 35 really revolved around ensuring that the Fed was, that monetary policy set by the Fed was gonna be independent from the president. And they did this by creating this structure, you know, an FOMC that has bank presidents on it, and the FOMC can choose its own chair, and then a board of governors where the members are appointed for long staggered fixed terms, and they have for cause protection. Now, the man, the, the, the independent or structure is, is reformulated in 1977. And there's two key things that are come in, and these are actually, these are the ideas of Robert Owen, which he advocated really strongly, and he couldn't get it into legislation, but it was in practice. So Robert Owen had always advocated that the Fed needed a clear written mandate. The mandate in 46 was to, monetary policies should be focused on the goals of maximum employment, production and purchasing power. In 1977, they rewrote the prepositional phrase to the one we're familiar with today, maximum employment, stable prices, and moderate long-term interest rates. Owen had also argued that Congress should force the leaders of the Fed. And he, his words were to come and talk to us so frequently that they can't forget what their job is, which is to fulfill the goals set by Congress. So in 77, they finally instituted this regular reporting requirement. Every six months, leaders of the Fed show up before Congress to talk about the mandate and what it means and what they're doing to fulfill it. And Owen had he, he had wanted it to be quarterly, but okay, so we got every six months. So why, why do we have this ongoing discussion? Congress has tried to write a central bank mandate for a long time, for a century. They debated at 1913 what to write between 19 and 30, 19 35, they debated again and again and again and again. How do we write the mandate to explain to the leaders of the Fed what we want them to do? And Congress basically got to the point where they said, yeah, we can't do it. Right. There's a lot of reasons why it's really hard to write a mandate. First is we might not know what the right mandate is, right? Because even as economists, we, we have trouble doing it. It's also very difficult to translate the economics and the policy into legal language and to understand how that legal language would be adjudicated in courts. So the, the solution that Congress came up with is we have a prepositional phrase, it's pretty short, it seems reasonably clear. And then on ongoing basis, we're gonna talk with the leaders of the Fed to make sure that they know what we mean and we understand what they say. And that's kind of a, a key element to the idea of independence, is that Congress will give the Fed a admission and they'll have a ongoing interaction with the Fed to make sure that the leaders of the Fed understand what the mission is. And so the, the two key on the other key idea underlying independence, particularly independence from the President, is that first that Congress is gonna teach the leaders of the Fed what the law is, so they follow the law. The other is Congress makes it really hard for the President to intervene into the relationship between Congress and the leaders of the Fed. And basically the, in 1935, the Senate had decided that they should structure the, the leadership structure of the Fed so that a, a president cannot control the, a majority of the leaders of the Fed and cannot really substantially influence them without the consent of first the Senate, probably the Senate of the House. And, and if they want to go around the Senate, they'd have to go through the Supreme Court. So you'll, if you kind of know the nomination process, you know, the Fed is unique of almost all government agencies. There's no acting leaders in, in the, in the, on the board of Governors. If a seat on the Board of Governors is vacant, the President can't appoint an acting person to it. No one can serve on the Federal Reserve Board of Governors unless they've received the consent of the Senate. If your term on the Federal Reserve Board ends and the Senate has not appointed the replacement, you can continue in office, right? So I think Steven Miran right now is right, his term expired, but he's still serving, right? 'cause his replacement, which is gonna be Kevin Walsh, hasn't been confirmed yet. So the Senate really wanted to structure the Fed this way, and I'm just about out of time. So I'm gonna wrap up and just tell you the recent attack. So you'll notice that the, I'd say the, the government has responded to the attacks on the Fed by the President exactly in the way that it's supposed to, and exactly in the way that it was designed in the 1930s. So far, I would say the members of the Board of Governors, particularly Chair Powell and Governor Cook, they're doing their jobs. The Senate did pretty much nothing. The Supreme Court is trying to do as little as possible, right? And this is the system working as designed because if the Senate and the Supreme Court don't do anything, the president can't take control, right? And that that was the system. This was planned by Carter Glass, and it seems to be, have worked really effectively, right? They, no one has to argue with president, the President trying to take control of monetary policy. They just have to sit on their hands. And the Fed independence will be assured.

- Thank you. Sit, sit on your hands is often an interesting and good piece of advice. Last we have David Loka.

- Good morning. I am correctly listed on the program as affiliated with the Peterson Institute for International Economics. I am also affiliated with Bloomberg Economics. And if I don't get that in, I'll hear about it back at the office. I'm gonna give you a darker take on the Federal Reserve independent situation than Gary and Ed just did at the moment. This is still a tail risk, I think for off in the future, perhaps far off in the future. But if one of the leading problems in your life is you don't have enough to worry about, I've got a solution. I've got one more item to add to your list and that's what I'm gonna gonna talk about today. Traditionally, the main pillars of Federal Reserve independence have been thought of conceived as being rooted in Washington DC the long overlapping terms, 14 year term served by governors, the independence of the Federal Reserve from the appropriations process and the for cause protection that is written into the Federal Reserve Act from its founding in 1913. And the Reserve banks have been seen as important components of Fed independence, but if anything, perhaps secondary building blocks of that structure. But more recently, a different threat to the Federal Reserve that is grounded in the Reserve banks has come to the fore. And that has to do with the fact that the Federal Reserve Act gives the Board of Governors the power to remove bank presidents. And so this seems like it raises the possibility of a playbook for a president to gain control, not just of the reserve board based in DC but of the open market committee that controls interest rate decisions. And the playbook isn't particularly complicated. Aun two term president, given the way that terms are structured, is guaranteed of being able to make no fewer than four appointments to the Board of Governors. And so very determined president of the United States could set a litmus test for candidates to the Board of Governors that you will be willing if the situation arises to vote to remove reserve bank presidents. And with over the course of a four year, sorry, a two term presidency, eight years, four, such people could be appointed in practice, probably more given that members of the Board of Governors tend not to serve out the full extent of their appointed terms. Now admittedly, what I am, am talking about here still appears to be a tail risk. I don't think there's a realistic possibility of this happening in the near term, but I'm not, I do want to emphasize I'm not engaging in idle theorizing. The threat is real enough that at his most recent and presumably last press conference as Federal Reserve Chair Chair Powell volunteered without being prompted that the removing bank, federal Reserve Bank presidents from office over different views on monetary policy would be the beginning of the end of the Fed's ability to make monetary policy independently. So this is exactly what I'm concerned about, and I'll use an expression that you'll, you'll perhaps appreciate for me is rather theoretical, this is a hair on fire concern for me. Now, there is a complication, and that complication is that the drafting of Section 11 F is a little more arcane than what I've led on to this point. And to quote it in its entirety, it says, it gives the Board of Governors the power to quote, suspend or remove any officer or director of any Fed Reserve bank. The cause of which the cause of such removal shall be forth, shall be forthwith communicated in writing by the Board of Governors of the Federal Reserve System to the removed officer director, and to the Reserve Bank. Now, I've only begun to scratch the surface of the historical record about what the heck they meant by that. And it's rather difficult to read, even though I've read it 32 times. And why didn't they do copy and paste from the provision protects members of the Board of Governors from the removal power of the President of the United States? They didn't. And I think that's an interesting puzzle. Now, it's clear that the stakes around this issue are quite high. If the Fed Board were ever to attempt this, first of all, it would surely end up guess where in, in the courts. But if they were to succeed, if the court system was definitively to rule that the Board of Governors does have the power to remove reserve bank presidents and reserve bank presidents do not have the effective equivalent of for cause protection, then the whole concept of everything this conference is about today is eviscerated. There would be a clearly hardwired playbook for a determined president who wanted to take control of interest rate policy decision making. The issue might seem familiar, but I'm, I'm going to tell you why you feel like you've heard about this lately, but it's not quite the same thing. The Board of Governors under a different provision of the Federal Reserve Act was required to approve the reappointment of all the Reserve Bank presidents with a deadline of March 1st. And it's very peculiar that March 1st deadline arises in years ending in one and six. And if you go and Google in years one and six, you will never not find that phrase in the Federal Reserve Act. But it arises because of a confluence of a couple of provisions in the Federal Reserve Act. It's not clear to me whether the designers of the Banking Act of 1935, that Gary mentioned, whether they realized the implication that they were putting in place a structure that would require this, the synchronization for all time into eternity, or at least as long as the Federal Reserve system exists, that there's this moment of heightened fragility and fraught. Because at that time, all bank presidents have to come up for re-approval. Now that's a different provision of the Federal Reserve Act. And there the, there the word cause does not exist. There are no conditions that are set on the power of the Federal Reserve to approve the initial appointment of reserve banks. They can simply withhold approval. Now to delve into the history for just a moment, Gary has helpfully introduced the, some of the drama persona, namely Carter Glass and Robert Latham Owen. There's a third person who figures prominently in this story and whose history I really want to delve into. And that's a Senator James, a Reed from the state of Missouri. And I mention it because I think it's possible, although this is the third theory I've heard for an interesting anomaly in the design of the Federal Reserve system. What the heck does Missouri do having two reserve bank cities? I think it's possible the answer could be James Reed, he was a member of the Senate Banking Committee. The Democrats narrowly, Chris is shaking his head, not not so talk to Dave Wheeler. I will do so, I will do so. He was a member of the Senate Banking Committee. The Senate Banking Committee was controlled seven to five by the Democrats. There were three renegades of whom James Reed was one. And so while it's not clear to me what went on in discussions between Owen and the three renegades led by Reed, it strikes me as possible that a certain action that I'm about to describe took place because of the need for Owen to get those three people to change their mind. In the event Owen only got two. And so the committee banking committee was deadlocked six six. I would've thought that meant that the bill would die in committee. In fact, what happened was really interesting. Owen reported the bill out of committee without recommendation so that it could get to the floor of the Senate. I didn't know that was a thing. Now, what was the change? Carter Glass put in place a version of for cause protection for reserve bank presidents. This is on the house. Carter Glass was chair of the House banking Committee. And in his version of the bill, the provision that I'm focusing on said, and I want to get the language right, it listed specific instances that would rationalize the removal power of the Federal Reserve Board. And specifically it listed in Carter Glass's version in competency, dereliction of duty fraud or deceit. That was in the version of the bill that glass introduced in July of 1913. As it moved through the house, that provision got strengthened and it went to, it went from strong to really strong. And in addition to requiring one of those conditions that I just mentioned, it mentions an opportunity of a hearing, presumably for the person being removed to defend themselves from the accusations. And it also required the approval of the United President of the United States. Now, the president of the United States couldn't initiate the removal under glasses version, but the president had to approve it. All of that got removed in the Senate version. And so I think there's a really interesting historical puzzle there that I'm interested to, to try to uncover and peel back. So important questions and uncertainties remain, I hope the need to resolve these uncertainties never comes to, to fruition. It'll be a a, a legal mess. What I do want to emphasize is one point of clarity in the midst of all this ambiguity, and that is that Congress was not unfamiliar with the concept of at will employment. Now this is the, the provision I'm showing here is the one that protects members of the Federal Reserve Board of Governors from a removal by the President. And this is where you see the, the phrase has become quite familiar now unless sooner removed for cause by the president. That's what all the Humphreys executor business is about. A second instance in the Federal Reserve Act is the one that I've been talking about. This is the version that actually passed in the Senate. And in this version, the key phrase is the cause of such removal to be forth with communicated. And the issue is the, is that meant to be equivalent to for cause or is that meant to be something different? Now it's clear that con, while, while Congress didn't do control c control v on this section of the law from the one that protects board members of the Board of Governors, what is clear is that they were completely familiar with the concept of at will and employment. And they use that language a couple of times. Here is one of them. This is a provision of the Federal Reserve Act that empowers the local boards of directors at each reserve bank to remove any employee of their respective reserve bank. And I know there's current and former reserve bank presidents here. And so I suspect this provision is of deep familiarity to all of you. This is at will employment. And so Congress knew this concept and didn't employ it. My bottom line and highly tentative and still speculative conclusion is that where we landed perhaps at the, as a result of a messy political compromise, maybe involving Senator James Reed, is we ended up in some kind of middle, ambiguous, unsatisfactory, unclear mess that I fear will have to be litigated through the courts. Thank you very much.

- Thank, thank you all. We'll, we'll move to questions. And while you think about yours, I I gotta ask a question really for each of you, but take a feel free to respond to the others questions, starting with, with ed. Ed shows you why I love historians. Historians go back to the primary sources, all of them and then blow up stories that you always thought were true, such as the famous Nixon story. Thank you for that. But I'm, from what you said, it has occasionally happened here at Hoover that we criticize Federal Reserve actions as having perhaps not been optimal. It doesn't look like the Fed's policy failures in the past have come from a lack of independence. In fact, if anything, the biggest one, 1930s, the Fed independently went off in a direction where the administration may have arguably been right, that deflation was a bad idea. That I I think that's an optimistic tone. It it means that if the Fed has made mistakes, they've been of its own volition and that independence is working pretty well, at least so far. Yes, David, perhaps not, not in the future. Gary, you point out that part of the independence and when the Fed was set up in 1913 and the argument throughout the 19th century was for the Fed to be independent of banking interests. Now, in 1913, the Fed was not granted a big financial regulatory role, which it has seen since taken on. And certainly though it was lender of last resort, the scale of of bailouts and financial market support was not something I think they contemplated. Perhaps, I wonder if you think that the Fed has become a little less independent of banking system interest than Congress intended. And there's a discussion we've been all having should banking regulation and financial stability things be as independent as monetary. And and finally, for, for David, thank you for pointing out that I think in software we would call this a, a bug, a security flaw. What every, you know, years ending in one in six, do you reappoint them all? I don't think they intended that. Fortunately, it looks like the Fed cleverly got around this one, and so we have to wait till 2 0 3 1 before the potential security flaw shows up again. So, so perhaps things are going okay, and also the reserve banks have become less powerful and power seems to be floating to Washington. So I wonder today, and and my apologies to all the Reserve Bank presidents out here who are smart people running good institutions, but is their power more advisory and just how bad would it be if they, you know, their power now is they get to vote on the FOMC and, and other than their advisory power that perhaps their limitations on their power, which is a problem for other reasons, limits the damage that could do. If you guys wanna comment on that, then we'll go to questions from the audience.

- Sure, thanks John. I guess at the risk of qualifying a compliment he gave me, I guess I should say I'm not a historian, obviously a lot, a lot of us who work on economic issues to do with, to do with the, the record of defense spending or monetary policy get involved in a lot of these archival materials. But we like to call ourselves narrative, narrative economic research or something like that just to, to not to be, not to be look as though we're being too imperialists and saying we're, we've given ourselves a new degree. But related to that, the, the narrative work on monetary policy, I think, I think especially I give a shout out to Christie and David Roma here have made a, a, a big point about understanding monetary policy developments in terms of ideas or doctrine. And I think that is linked to the issue you mentioned, John of independence is not a guarantee of appropriate monetary policy. What tends to guide monetary policy strategy is doctrine. And by that, by that I mean the conceptual framework that policy makers have, and that can be good when the central bank is independent or it could be good when it, the, it's quite possible that it could be bad when the central bank is independent and that the, the executive or the congress actually has, has a better grasp of what the, the economic system is. So for example, in 9 71, it probably was the case that the, some of the things that's coming from the Nixon administration were better economics than what Arthur Burns was giving George Schultz being the premier example there. But there were other, other, other less admirable aspects of the Nixon administration economic team like that, that George was fighting against. So, but it, it does illustrate the fact that those critical of the, of the central bank in the, in the direction of non independence and not, there's no necessary relationship between that and good and good and bad policy. And the 1930s would be an example of Congress actually was pressuring for easier monetary policy in the early thirties. And Prematures make a big deal about the fact that when, when the, when Congress did put pressure on the Federal reserve to ease policy, the Federal Reserve started going that direction. So you might, you can think of it as help contributing to the climate of opinion in a, in a, in a favorable way through having a, a better economic model, if you like. But I would say that it's very important for an independent central bank to have a good economic model, by which I mean in, in the broad sense, good grasp of its relationship between monetary pol monetary of its act of between its actions and the economy. And that hasn't often always been the case, even in periods when it's been very independent.

- Yeah. So you asked about kind of should the bank regulators be independent? And I would say, and I have a couple of a new, a new published paper and a new working paper on this. Yeah. It's really important that the bank regulators be, regulators be independent. The American experience of when, when bank regulators are subordinate to, to politicians is that bank failures get very dramatically shifted over time, particularly during elections. You can imagine like no banks fail in the run up to the election. And then a lot of banks fail the day after the election. The my new pa working paper shows the, the first banking crisis in the, in the Great Depression happens to start the day after the gubernatorial elections in, in the fall of 1930. And I, the paper explains why that hap why it happened on that day. So now this, there's an interaction with monetary policy in independence, which is important to think about. And this comes back to, to David's point, but I'd say it in the United States today, at the state level, most bank regulators are independent. And it's been that way since the 1940s because of the problems that us experienced with politically subordinate regulators in the twenties and thirties, the control over the currency was the first federal employee given employment protections. And so by law today, the contrary of the currency serves a fixed term cannot be removed from office with except for cause and not without the approval of the Senate Banking Committee, whether that that provision has never been tested in court and whether it would be legal under the current Supreme Court rulings, who knows? But so that the independence of the supervisors is really important. How much of that is now legal? We don't know because of recent Supreme Court decisions about, you know, kind of independence of, or independent agencies and employment protections for political appointees. Now there is an interaction between monetary policy independence and kind of the independence from Wall Street. And David showed you a picture of the, the Federal Reserve Act where they explain it's, it's kind of this coded language, class B and C directors aside in the present. So when for most of the history of the Fed class A, B and C directors chose the bank presidents, the Class A directors are appointed by financial institutions to represent the interests of financial institutions. That's three of the nine board members in Dodd-Frank, the class Congress worried that the reserve banks were too subservient to Wall Street, were serving the interest of Wall Street too much. And that could be the, like lack of independence from Wall Street at the Reserve bank level could have contributed to the buildup of financial risk. So the law was changed. So now only Class B and C directors, three of whom are appointed by the Federal Reserve Board, three are appointed by the, by the member banks. But all six represent the public interest but don't represent the interest of banks. So now the CEO is hired and fired just by that subset. And when, when Dodd-Frank was passed, I worried that that could in, in the long run reduce the independence of monetary policy by, by making the decisions about who is the Reserve bank president, much more subject to politics and now can be controlled by the president. 'cause three of the directors of the banks right, are appointed by the Federal Reserve Board, which could become beholden to the president. So I think this is an, in an really interesting design feature, right, where David now is pointing out the risk to monetary policy independence, which has been created by trying to make the, the reserve banks more independent from Wall Street

- Even you're scribbling curiously, so you must have some thoughts,

- Software bug. I don't know whether the, what I, whether I would characterize this as a software bug or not, but here's what I do know for sure. It's like a party game where you're given six pieces of information, some of which may or may not be relevant to solving the puzzle. And there's only one possible solution to the puzzle. I've stared at the language and put the six party pieces, party puzzle pieces together and I'm totally convinced this is the only Mar March 1st of years ending in one in six. It's the only solution to the, the party puzzle. Whether they understood that's what they were doing initially or not, I don't know. You rather provocatively asked, and I think I'm paraphrasing perhaps a little with too much liberty, whether the reserve banks are just afterthoughts in the policymaking conversation. I would strenuously re reject that. I think they're critical to preventing groupthink, which is a common critique of the open market committee that a lot of the banks have had intellectual identities that distinguish them from the sort of conventional Washington consensus. And I think that's been really important in coming. Chair Warsh has said he wants to promote a, what he calls a family fight at FOMC meetings. I, he's, I'm a little surprised he's so vociferous about this because he experienced that for the years that he was a governor. But I, my guess is he's going to find that the conversation is very robust at reserve at FOMC meetings and that an important reason why it's robust is because of the participation of the bank presidents who bring these differing perspectives.

- Yes. That's very important. Okay, I think we're gonna collect a bunch of questions. So guys get your, get your notepads ready. So Sebastian go first and then try to grab the, try to grab the, the mics. Yes. And then Jim Bullard second and Mike Bodo third. And we'll keep going.

- Thank you John, thank you to the panel. Great conversation. I have a couple of questions I think that I forget who said that like, Congress has these recurrent meetings with the leadership of the Fed so that Congress tells the Fed or reminds the Fed what Congress's objectives are. Who is Congress? I think that Gary said the Senate and then the Senate and the House, and then David mentioned the banking committee, the how vague or how precise is the, the stature and how important is the banking committee as opposed to the Senate in general and, and what is the dynamics? What in the, the, the hearings were that Kevin was subject to it appeared that there was a, I mean we saw a great confrontation within the banking committee between one of the senator, the senator from Massachusetts and Kevin. So how important is the committee? That's, that's one question. And the other thing that I'm puzzled, I, I learned a lot from the presentation I am puzzled about, it's not so much the years ending in one and six, but in a statue that was so carefully crafted, the fact that all 12 presidents are appointed simultaneously and not staggered. And so it, it seems to me that that is, at least from a theory point of view, if you're a hacker there, that's a a a, a real weakness of the system. Everything is staggered except the 12, the 12th president. And the question, and another question there David, is, I, I forget who said this. There are no acting members at the, the, the governors are there acting members as presidents of the reserve banks. So what happens is one of the, of the presidents is by the board dismissed who runs that, that reserve bank. Thank

- You. We're gonna keep collecting questions. David, hope you remember all that when time comes. Jim.

- Hi, Jim Bullard Purdue. So excellent discussion and totally fascinating. I love the framing of trying to find flaws in the design. The design has actually worked very well. I think the, the act is very intricate and we know why that is, because of the history of the first and second banks of the United States. So this idea of trying to find, you know, could a determined executive branch, you know, wind their way through this and gain control of, of monetary policy. I think that's fascinating. I'm going to suggest the, that the for cause part is the, is the ambiguous part and the probably the flaw in the system in other contexts. I'm thinking of judges in particular. Congress does it differently. You can impeach a judge so you, you don't like what the judge is doing. I think you need two thirds of the Senate or you know, something like that. I think that's more what we have in mind here. And you could do that really across the government. You'd offer some protection for people, but it wouldn't be just words for cause it would be okay. You don't like what this person is doing, even on policy, you don't like what this person is doing, they're just too far out of the mainstream. It can't get two thirds in the Senate, they're out. So, you know, what do you think about that as a way to strengthen and maybe more, more precise the independence ideas around the Federal Reserve. And the government already does this in the judicial side. So anyway, maybe

- We're gonna, next is Mike Bordeaux.

- Okay. My questions is for Ed Nelson and it's about Burns and Nixon. So I, I did a paper a bunch of years ago where I, I read everything. I read the Nixon tapes and Burns' memoirs and all the literature. And it seemed to me that it's pretty clear that, you know, when Burns was appointed, he, you know, Nick Nixon said that, you know, no recession on my on, on your watch. And Burns said yes. And then there were a whole lot of other places where it seemed like, you know, burns was going along with, with Nixon. So what you're saying is yes, he, that could have been the case, but in terms of what they actually did, that he really didn't, in a sense follow his, his implied agreement with Burns's agreement with Nixon to make sure that, you know, there wouldn't be a recession on his watch. So you're saying he never, he didn't really think monetary policy would've worked anyway. I mean, this is a story you've told a lot, lots of times that he believed in cost push so that it really wouldn't have mattered. So is that, is that what you're saying? That really is didn't do that even though they may have been this pressure, he, that he just had no intention of doing anything about it. But this wasn't clear to me and I read your paper, that's why I'm asking this question.

- Next. Volcker, Wheeland in the middle.

- Thank you. Er Vand from Frankfurt. Two questions. One, maybe this is coming from the perspective of our system where the head of government usually has a majority in Parliament. Why, you know, after all this discussion about how the president might influence or take control of the Fed, why not just change the Federal Reserve Act accordingly? The second question, central Bank independence in the nineties became very popular around the world, along with inflation targeting. Now we have these very strong discussions and attacks on Fed independence. In your view and your feeling, how does that now influence Central Bank, what we observe in the us what you discussed in detail, what's the impact of that around the world or what, how, what, how do you see that having an impact around the world at the moment on the popularity of Central Bank Independence?

- I got Jeff Lacker next.

- Thank you David. I wonder if one explanation of what seems puzzling about the one in six is that what was envisioned by way of reserve bank president's selection then is different from our current arrangements back then given communication technology and the like. It would've been a, a local process run, managed, totally selected by the local reserve bank board and then the name sort of sent for up or down to the board of governors. Now it's, the board has leveraged its appointment, its its approval authority to essentially make it a co-run search process with sort of deeply and intimately managed influence from the Board of Governors. So it wouldn't have, it wouldn't have struck them that a wholesale purge for policy predilections was likely to have taken, WW was likely to have succeeded.

- I, I got Austin in in back, is that Austin? I think? Sorry. Can't see that far.

- Thanks. Austin Goolsby from the Chicago Fed Mike bor, I think this is to David. This is 85% to David at 15% to you John Mike Bordo has an important paper with Ned Prescott about the way that the Reserve banks have been a source of alternative policy frameworks for thinking about monetary policy and really shows pretty convincingly over the last 50 years. Many of the things we take for granted now were they, they were rogue ideas that only came into the system from the Reserve banks. And their thesis is that the organizational structure that the Reserve banks are independent entities allowed them not to be subject to the kind of normal law of central government says this is a dissenting view and therefore must be suppressed. Do you think that if we are getting excessively centralized that the Board of Governors is effectively going to take control of the reserve banks organizationally? Is that a threat in the board Ian sense to the ability of the reserve banks to generate dissenting ideas going forward?

- And I've got one last one way in the back and I can't see well enough to know who it is.

- Yeah. Tola from Apollo. So of course the incoming chair has said a number of different things. So I would be curious in the board's and the panel's view here on, when the board normally makes a decision, is normally by a vote with the 12 voting members. So the question is, what can the chair do when he comes in that will lower the credibility of the institution? In other words, not necessarily specific things he's talked about, but what things can be made that in your view will hurt the independence of the fate made by only by the chair?

- Well, I think we've got enough questions, just one or two for you guys to think about. So in seven minutes and 48 seconds left, so go for it.

- I think I only had a, a couple of things I I needed to follow up on. One is about re reporting requirements on part of the Federal Reserve. Basically there were two laws in the late seventies. One was the change to the mandate that Gary mentioned. The other was the Humphrey Hawkins Act of 1978. And Humphrey Hawkins was what introduced the reporting requirements, the monetary policy report. It didn't actually require the chair to give testimony, but that was happened in practice that that law expired in 2000 or end of 1999. And then the Federal Reserve Act was amended to put in the recorded requirements into the Federal Reserve Act. And so it's always the committee on banking what committee Banking, finance, finance and Affairs, but I think it is and is the, is the Banking, housing and Urban Affairs is the committee that gets the monetary policy report. So that's kind of the, the central tends to be the 10 central reporting committee on, on burns. I don't wanna get into too long a ex explanation, but basically what I'd say is 1970, there was a consensus that monetary policy could ease in the context of very high real interest rates inherited from the end of the 1960s. And what was controversial in my, the controversial, the controversial part of the fact that it interest rates fell under burns, I think is the late 71 period when they fell again. And that period I think has to be interpreted in light of the fact that, that those interest rate reductions occurred after a decisive win by burns to get wage and price controls imposed. And it actually said, he actually told members of Congress that if wage can price controls are introduced, they'll remove inflation pressure. And just for fisher effect reasons, you could move to low, low and nominal interest rates just on, on that ground. So I'd say that Burn certainly said wanted to avoid recession, but he said that publicly when he was in his, in his confirmation hearing in 1969. So I don't think that was kind of a, can be construed as sort of something that ConEd connoted pressure or a condition quick pro quo,

- Gary. So I'm gonna respond to first to Sebastian. I would would say, you asked some details I'll give you about acting later, but the, I would say with Congress and the interrelation between Congress and the Fed, the effectiveness of that depends a lot upon who's on the house and particularly the Senate Banking Committee. And you see that who's there has varied a lot over time. Right? In the 1930s you had two members of the Senate who had been chair, secretary and treasury and chairs of the Federal Reserve Board. And they had authored lots of the act themselves. So they knew in great detail and were very effective at, you know, bringing the Feds leaders and the Fed staff in. So they didn't have a regular reporting requirement, but whenever they wanted, they held hearings, which was pretty frequent. And so over time, the effectiveness of the Senate and House banking committees has changed depending on who the members are. And I think that's, that's pretty clear when you look at the records. Jim, you had asked about the, the impeachment standard. So actually in 1935 when they discussed how to protect members of the FMC from the president, there were many people who advocated having an impeachment standard, including Henry Morgenthau, who is Secretary of Treasury, who had said all the members of the FMC should be protected at the same level as the Supreme Court judges. They should only be removable through impeachment in the senate, the, the senators, right, the banking committee, the group that went off and wrote the act, they chose to have a very narrow wording of just four cause. And the best David and I could figure out by looking at Carter Glass's correspondence was that they understood that the, the four cause protections for federal employees and appointees was, was before the Supreme Court when they were debating this. And they wanted to choose a narrow wording, which they, they were sure the Supreme Court would find constitutional. So they, they kind of gave us the strongest protection they could, given what the Supreme Court had just recently debated and decided. But I think it's really worth considering after a few years down the road for for, for kind of thinking about whether we need to strengthen the, the independence of monetary policy and, and regulatory authority because the Supreme Court now has really changed the rules of the game and that that could, could have an impact when the president wants to get more control over the, the supervision and, and also monetary policy. And oh, so it said why not, not, why not just amend the Federal Reserve Act? I would say the, the design of the Fed is this or the, the, the independence of the Fed is structured by Congress so that the president alone, right. Can't do this. If the president wants to take control of monetary policy, he needs the other branches of government to go along. So he needs to mend the Federal Reserve Act. They would, the president would need the House and the Senate and would need 60 senators. Right? A pretty to call or the president would need the Supreme Court to invalidate big portions of the Federal Reserve Act and just rewrite it themselves. So what it in the us right, it's unique, right? Or or different than the parliamentary system. And the parliamentary system. Usually the executive has a legislative majority, but, but here the president often doesn't have a majority in the House and the Senate. And even if they're all from the same party, he can't get them to go along with his changes. So the, the act is the Federal Reserve Act has been structured right to really limit the executive's ability to, to, to intrude on the powers the Constitution gave both explicit and implied to Congress.

- Rewriting large sections of foundational laws in this country

- Is very hard.

- It would be lovely if we could do that, David.

- Okay. I'm gonna pick out three things and if there were a lot of interesting questions. So if you Feel slighted, please find me at the, at the coffee session, Jim Bullard. Why not just use impeachment? We really need a legal scholar like Lev and or Kate Judge or others who've attended law school. I have that many hours of in the law school classroom. But the question at the core of the issue is the president's authority to faithfully execute the laws under that person's responsibility and as described in the Constitution. And if a provision was, I, I'm, I'm now gonna violate my father's dictum, never to practice, practice law without a license, I'm doubtful it would pass Constitutional muster. If a law said the only way to remove a member of the Federal Reserve Board or a bank president is by impeachment, that the president has no authority to do that, given that there's this sort of gray line between what is executive authority and what is not. Secondly, Austin Gouldsby, could the Board of Governors sort of take thought control of the reserve banks? IWII find that hard to see. Maybe I grew up too much in the old tradition with a lot of independent thought across the reserve banks, but I, I find that really difficult to envision. But I do want to give a shout out to Patrick Harper whose post I thought on LinkedIn was absolutely brilliant. And the gist of the post was that independent Federal Reserve independence needs to be achieved by individual actions and by the things people do. And Jay Powell has exercised that leadership. So my challenge to reserve bank presidents is if you find the intellectual freedom afforded to your scholars to be important, then exercise and equivalent amount of leadership, this is of independence that can be lost if it's conceded by reserve bank presidents. But I'm pretty con comfortable that that won't happen because the tradition is so deeply rooted. Lastly, very briefly, Torsten asked, what can the chair do? The answer is very little on the chair's own authority. There are very few responsibilities that are specifically assigned to the Federal Reserve chair in the act. One of those is to deliver the semi-annual monetary policy report. And the other list of responsibilities assigned to the chair by law is really thin gruel. You look at that, you say, wow, this job of being chair is really just not, not what it's made up to be. The board has broad authority to delegate responsibility to the chair. But again, if you look at the delegations and they're posted on the board website, what has the board delegated to the chair? It's very little statutory authority resides with either the board or the open market committee. And so the answer is the chair can do a tiny amount on his or her own authority.

- Yes, independence must be regularly exercised and not just written down.

- Yeah, absolutely.

- Thank you everybody. This was a great session. We're we're going to move straight to the next session on fiscal and monetary policy interactions. Cheered by Oliver Bush. Where are you? Everybody? Come on up if you feel the need for a break, 'cause you, like me, had a little too much coffee before you started, please come back quickly and quietly.

- Welcome to this session on fiscal and monetary policy interactions. My name is Oliver Bush, and I'd just like to start off by giving a huge thank you to the organizers, to Valerie, to Michael and John, to Marie, Christine and everyone else involved in running this wonderful conference. So, by way of introduction to this topic, I recall that Mervin King famously once equipped that despite accusations that central banks were obsessed with inflation, if anything, they were obsessed with fiscal policy. Now, he, he said that in 1995 in a comment on a paper by John Taylor, but if central banks were obsessed with fiscal policy back then, goodness knows what they must be thinking today. So we might get some indication by reading central bankers speeches. And curiously, if you just, you know, count the number of times that they mention fiscal policy, you don't see that trend rising over time, along with the rise in government debt to GDP ratios. But you do see a pickup during the global financial crisis, as you might expect, and then it stays high for a few years afterwards. You also see a pickup in 2020, but that's lasts much, much less longer than, than after the the GFC. Now, of course, it's a tricky issue for central bankers to talk about in public, so it'd be interesting to know what they're saying behind closed doors. And fortunately, with a passage of time, we do learn about this. So I thought I'd just share a quick revealing example with you. So 50 years ago, in 1976 in the uk, monetary targets were under consideration. And so the question naturally arose, well, what instruments should we use to hit these monetary targets? So to that end, bank of England and treasury officials got together to consider the role of monetary policy, and that group included Charles Goodhart, who turns 90 this year. In fact, so interesting. They concluded that interest rates, and I quote in the present conjuncture of a continuing high PSBR, that's high public borrowing, would not be particularly effective in restraining monetary growth because the effect of higher debt sales would be largely offset by continuing higher debt interest payments. So it sounds to me like these officials understood the essence of unpleasant monetary monetarist arithmetic even back then. So I think this is useful illustration of the benefits of taking a long term, long run perspective to analyzing this issue. So I'm delighted that we have three panelists who have spent a very long time doing just that. So we have Michael Bordeaux from Hoover and Rutgers, Barry Chen Green from uc, Berkeley, and Hall Lustig from Stanford Business School. And they each have 15 minutes, which hopefully will leave the best part of half an hour for q and a. Over to you, Mike.

- Okay. So I'll go up there. Okay. Right. Okay. So I'm gonna talk about my work with Ollie here and Ryland Thomas at the Bank of England. And it's on the great inflation in the uk and the fact that it had a very strong fiscal footprint. And that is a contrast between what happened, we think happened in this country. And, and this will back up some of the things that Ali said in his intro. Okay? So you can use history as, as a useful guide to understanding the drivers of, of inflation today. And the UK experience was amongst the worst of the advanced economies during the great inflation. This little picture here shows you that the blue line, that's the uk and you can see that in this sort of middle period in the mid 1970s that it, its inflation was a lot higher than the US than the other countries. The only other country that high had high inflation was Italy. Okay? And, you know, and the story isn't that different for them, okay? And so the UK story is different from the US It, I mean, it may not be if we studied a bit more, but at as we see it now, it's different because the consensus view here when we talk about the great inflation of the seventies, is we talk about Martin mistakes that Martin and his administration made at the Fed in the sixties, and then Arthur Burns, and then all of this is corrected by Volgar. It's a much more complicated story than that, but in the UK it's different. And we think that the UK was different because of a, because it was a largely a fiscal fiscal story, a fiscal regime story, and that there was a big change that occurred in the fiscal regime from what had been the case for, for centuries. There was a big change in the regime in the sixties and seventies, and then a reversal, okay? So they, we talk about how there was a departure from the long starting approach called the re we call the Treasury view. Also, the Bank of England after 1946 was not independent. And when the way inflation ended was a return to the fiscal orthodoxy that had been around for centuries. And so we think this has some resonance for modern theories of fiscal inflation. So what are the foundations of, of the UK's great inflation? Well, for most of British history, there was a strong commitment to using fiscal policy to stabilize the public finances. This is called the Treasury view. And as I said, Ollie Bush and myself and Ryland Thomas sort of show that this view was abandoned in the post-war period in the sixties and seventies. And what we argue is that fiscal shocks were largely financed by unexpected inflation. And theory tells us, and Ali mentioned this in his comments, that under such a regime that if you have tighter monetary policy, it might actually have made the inflation problem worse. So this was, this was Chris Sims argument about stepping on the rake. And, and Chris Sims gave that paper at the Great Inflation Conference that Athanasios and I gave did way back at, you know, in 2008. And at that time I didn't understand it, but now I do understand it, and I think there is some resonance there. So what's the relevance for today? Well, it demonstrates the importance of the fiscal regime for the inflation generating process has resonance for what happened in the pandemic, as Ollie said. And when fiscal policy isn't used to stabilize debt, inflation can be the mechanism why by which the imbalances are resolved. And monetary policy may actually lose control of inflation and government bond and other markets could become stressed, and that could have other effects on the financial system. And in, in this long paper we did, we, we show there's a lot of evidence for that happening. But if you have a nominal anchor that can act to restrain fiscal policy, so there's theory behind here, I can't go through all of that, but okay, we define a fiscal financing regime as a set of arrangements and institutions accompanied by a set of expectations which determine how fiscal shocks are financed. So this is an equation from John Cochrane's work. And basically it says that if you have this expansionary fiscal shock, it can be financed by surpluses, future surpluses, it can be financed by growth. So you grow your way out of it. You can have fiscal, you can have financial repression, which were real interest rates are artificially held down, and you have inflation. So this is the, the equation that is behind the narratives that I'm gonna focus on at these economic historian. So how do you identify these fiscal financing regimes? Well, we use a narrative approach. What did the policymakers say? And what we did was we rely on budget speeches by the chancellor of the jeer, okay? Going all the way back to the, the, to the beginning of the 18th century. And so that was the main vehicle to announce tax and other fiscal changes. And, and then what we did in our, in our, in the accompanying paper, is a lot of empirical work, which in a sense is consistent with that. You know, we did fiscal, we did local projections that looked at the consequences of, of running fiscal deficits on inflation and on surpluses. And the evidence shows that expansionary fiscal shocks were financed by higher inflation in the sixties and seventies, but it was very different from what happened under the classical gold standard. My my favorite period of history when actually the deficits were financed by surpluses. Okay? So here's the history of economic thought. Nobody does that anymore. I'm of a very old generation, and I actually did do this stuff as a graduate student, and I worked in this field. So here we have a picture that's Walpole. He's the first chancellor of the ejector in the beginning of the 18th century. And it developed this fiscal orthodoxy view, which, which became known as the treasury view. And that comes from ery who wrote in the 1920s. So yet you run, if you have a war, and the Brits had a lot of wars in the 18th century, you finance it by borrowings, you run deficits, but you commit, and everybody understands this, that when the war's over, you're gonna, you're gonna run surpluses and you're gonna stabilize the debt. So Barrow Robert Barrow in 1979 called this, this strategy tax smoothing. And here we have Gladstone, who is a chancellor in the 19th century who strongly sort of, you know, discussed this. So, so what happens? Treasury view, you, we look at the narrative evidence. You, you, you run debt in wartime, you stabilize in peace time. And how do you do this? You use sinking funds and you use terminal annuity. So you have these funds building up to pay back the debt that you've borrowed. And here's a quote from from Gladstone, which basically says, this is what you do in the war. You just, you know, you, you just have to, you just have to pay for the war. Okay? And then here he is in 19 50, 18 59, and then says that when peace comes, okay, you have to go, you have to, you have to cut back. Now this, and so this was what happened throughout the 18th century, okay? And there were two cases into the 20th century. There were two cases when the, actually the war was so big that they had to use fiscal finance. That was the Napoleonic Wars. And then in, in World War One, this picture shows you the ratio of the pri primary balance to income. And basically it shows you that you have a war, you run up a deficit, then after the war, you raise the primary surplus and it shows you, and you can see this is going all the way to World War I, but each of these repayments moves you higher, okay? But what happens is in the 20th century, okay, and this is after World War ii, and we, we, we, we, we could talk about the interwar, which is sort of an intermediate period. The, the Bank of England is nationalized in 1946. The treasury has full control of macro policy, and this is the period of the Keynesian Revolution. Keynes and his followers succeed in arguing for new fiscal, new fiscal policy objectives for demand management. And by the 1950s, the traditional view is, is abandoned. And here's a statement from Dalton that says, you know, we just gotta use demand management. And then what happens is the treasury view comes back with, after inflation comes back in the eighties and nineties, this is a different story than the us. So here we've got Keynes and Morgan Fou. This was taken at Bretton Woods. And so the debt stabilization objective kind of gets thrown out the window as well as the sinking funds. But the other thing that's going on is you got Brett Woods. So you got the pig pegged exchange rate, Britain's a medium sized open economy. And so they really have a constraint. So if they expand too much, you're gonna have a balance of payments crisis. So this was the case, okay? But then they leave Bretton Woods and there's no nominal anchor. And here's a statement from Chancellor Barber that says, no, we can just spend whatever we like. We are gonna really boost the economy, okay? Now, and so they shifted gears and Barbara was the, was the, was the, the best example of the new policy. But people notice this. So here's the times. And they say, you know, the balanced budget orthodoxy has been thrown out the window. Here's one that says that. And this is based on what was called the credit counterparts view that the British monitors had in the seventies. Is that a high deficit for means high M three mean high growth in broad money that's inflation. And in fact, based on this credit counterparts equation, over half of the fiscal deficit during the great inflation was funded by the banking system. And so it was the banks, and this is the case in a lot of countries, a lot of emerging countries, it's the banks that actually did it. Okay? And then what happens is inflation goes up and, and then there's a crisis, and we'll talk about that if I have time. And the IMF comes in, there's a, there's a, there's a currency crash, and they, they changed gears. So here's Nigel Lawson in 1988. He says, we have to get back to this, this balanced budget. And here's Gordon Brown. Same story. Okay? So this is crude summary of the narrative evidence. You can see that all the way up until post World War ii. You look at, at, just looking at, at, at quotes, you know, doing sort of a very primitive, large language model. See, they use the words debt rules, et cetera. See, rules is very important. And John's here, and it's great to see you. But then you get this period at the end here, this is a 19 in the fifties and sixties, and they, it falls off the root off, off the map, and then it comes back in the 1980s. So, ma, my last few minutes, I'll just tell you the history, what happened. So there were four episodes of inflation, okay? Four sort of rises and falls of inflation, okay? There was one in the sixties, okay? This is like the stop go period. Then there's a really big runup after Bretton woods is, is abandoned, okay? Then there's another one, and that has the oil price shocks. Then there's another one with the second oil price shocks. And there's one in the 1980s. And so what happened, well, before I tell you what happened, and I won't have much time to do that. So the, the, the story that most of us have always used is it's, it's a combination of bad policy and bad luck. And the bad policy with stop go in the 1960s, okay? Monetary policy neglect, okay? They, they did not follow the Taylor principle. Money growth was rapid and real interest rates were negative. And incomes policy cost push, they believed that, you know, there was a basic belief that Ed talked about where the, in a sense, it's the unions and supply shocks that caused all of this. And it was fiscally, in a sense, it was fiscally financed. Okay? Also, you've got a bad poll, bad luck, falling trend, TFP growth, a rising niru with the growth of unionization and these shocks, the oil price shocks, and they were accommodated by fiscal. So we say that in a sense, the two things are, are working together. Bad luck, bad policy, okay? Plus the fiscal financing regime. So just to go through it, I'm gonna take maybe a minute longer, there are four episodes. First episode, stop, go. Okay? The belief, they had a belief in the sixties that you could use fiscal, okay? To actually raise the growth rate. This goes back to Herod and Herod and, and Kaldor. You run, you run a fiscal deficit cut taxes, investment goes up, and then the trend growth rate goes up. And this is what they did. They had these periods of very expansionary growth in the sixties, but they're open economy. They have a, they have a currency crisis. They get rescued by the IMF and by the Fed, and they have, they, they cut back and then that happens again. So there's four of these, okay? But eventually they throw in the towel, they devalue, okay? And then the second episode is the, the nominal anchor's gone, okay? We leave the gold standard, the Nixon shock, okay? And now there's no constraint. And the barber boom is one of just going for growth, okay? So they raise nominal, nominal income by, by 20% and real income by 10%. The money supply broad money goes up 30%. Then they also deregulated the banking system and they're running these big fists. So that's the really big, big shock. And then what they do is two weeks before the first oil shock, they set up a, you know, a wage policy income policy, which in a sense has automatic, automatic increases to prices. Okay? So you got this wage explosion, okay? And what happens, you get this perfect storm of 25% inflation, okay? Then there's a currency crash, IMF comes in, okay? The, these guys come in the middle of the night and the black cars, the headlines say the IMF is here, okay? People immediately think about Argentina, okay? And this is a huge shock. And that IMF package in a sense is the, is the defining moment where the government says, oh yeah, maybe we gotta think about this. And they start going back to the treasury view. And this is a statement by Callahan, and Friedman actually said, this is one of the best statements he ever heard by a Secretary of the Treasury. Okay, we got, we got, we gotta get back to balance. Okay? Okay. Then the last episode is bad luck. Second oil price shock. Boom. There's tremendous reactions in the labor market. There's garbage strikes, coal strike, et cetera. This picture here shows you just garbage piling up in 1976 that leads to reform, okay? And now that Thatcher government comes in, okay? They do fiscal reform, they follow the medium term strategy, which is low money growth, okay? And in a sense, and not only that, but in 1981, there's a recession and they run surpluses. Okay? So that's, you know, and this last picture here that in a sense shows you the primary surplus against plotted against inflation. So what you see is up till the eighties, okay? You see that inflation is going up and the deficits are getting worse, and now inflation is after this period, okay? The deficits are not correlated with, with, with inflation. So just to conclude, we think that the post World War ii, it gives UK story, gives a nice case of fiscal inflation. It's made possible by a fiscal financing regime combined with some bad luck and bad policy. And inflation was brought under control with the rediscovery of the treasury view and then renewed reliance on monetary policy, okay? And that I think there is some resonance with what happened in 2021. Okay? And I think, and Cochrane here said, you know, it's like World War ii, it was a huge fiscal shock, okay? And the Fed accommodated it so that it's very, there is something to learn from this. Thank you

- Normal. Normally when you give a short talk, you conclude by saying, I seed my remaining time to the next speaker. I seed my remaining time to the previous speaker

- I I owe you, the data is done,

- Even organize It evens out over time. So yeah, I was about to say thank you to the organizers for putting me on the program, albeit at the last minute. I think I arguably fit better on the next panel, which looks at the international aspect. So I'm gonna do a little bit of both, talk about the international aspect and then transition to, to fiscal policy. So my, my concern as, as I write here is really on the impact of monetary and fiscal policy interactions as they bear on, on, on the dollar, on the global role of the dollar in particular. And I would put those fiscal monetary policy interactions at the moment high up on my list of factors weighing on that global role where the complete list includes questions about debt sustainability in the United States where those questions about debt sustainability give rise to worries that the Fed will come under pressure to keep interest rates low to help with the resulting debt service burden, low low rates fuel inflation, and are associated with dollar depreciation. And that dollar depreciation, the resulting losses on US treasury securities will lead foreign, private, and official investors to begin to diversify away from dollar securities. To the extent that there are questions about the independence of the Fed, that diversification may materialize before the inflation and dollar depreciation themselves materialize. And all of this will reinforce a longer term diversification trend that's already underway. And since the different global roles of the dollar are compliments to one another, shifting away from dollar reserves will eventually lead to measures that reduce the role of the dollar in, in, in other domains in trade, invoicing, trade settlements, other financial transactions and so forth. So a couple of pictures just to remind you of what has been happening. This is the dollars share of allocated identified foreign exchange reserves worldwide. You can see it's declined from a bit more than 70% of the global total at the turn of the century to a bit less than 60% of the global total. Today it go, it fluctuates a bit as a function of exchange rate fluctuations. If you adjust for changes in, in the dollar exchange rate against the other major currencies, the line is smoother. But the starting point and the endpoint are the same. This one is foreign central bank holdings of US treasury securities outstanding. And you can see that this has been falling fairly steadily now for a decade and more. So for completeness, my list of factors weighing on the on, on the dollars global role include worries about financial stability, private credit, crypto changes in bank supervision and regulation. Questions about dollar swap lines. Will these continue to be extended by a fed that is less inde independent or that is intent on focusing on its core mandate? When I go to Europe, lots of of people over there ask me about the future of fed swap lines, to which I respond, I don't know any more than you do. But it is on the mind of, of, of the foreign counterparts of Federal, federal Reserve board members insofar as as international currency status rests on a country's commercial, links with the rest of the world tariff tariffs. And the questions about US commitment to free and open trade weigh on the global role of the dollar increasing US recourse to sanctions encourages foreign central banks and governments to look to alternatives to, depending on the dollar and the US correspondent banking system, weakening US alliance's. Questions about US commitment to nato. We know from history that foreign central banks and governments hold and use the currencies of their alliance partners who are regarded as reliable stewards of their reserves to whom they want to hold, hold their currency as a show of good faith. So our European friends are asking questions about should they rely on, on, on, on the US as heavily in the in as in the past for their national defense? Should they rely on the US dollar and correspondent banking system or as heavily as in the past? Or should they try to become more self-reliant financially and monetarily and above all, I think general economic policy uncertainties in the United States uncertainties about tariffs, but uncertainties about many other things as well. So back to fiscal, I do worry a lot about, I, I worry a lot more now about fiscal dominance than I did even a a a a few years ago. I did a paper with a, a co-author CIR ar AAP on this set of issues for Jackson Hole. Now three years, almost three years ago, we looked for successful debt stabilizations and debt consolidations across a long period of time and a wa a large sample of countries. And we found only two robust correlates of successful debt stabilization and consolidation. One was a high rate of economic growth, painless way of stabilizing your debt ratio is to grow the denominator of the ratio in question and low levels of political polarization such that the different political factions can come together on some kind of compromise solution to the problem of, of chronic deficits that give ri rise to uncon uncontrolled uncontrollable debt ratios and such that when party and power changes, the fiscal strategy does not change and the compromise remains in place. Those outcomes are associated according to our analysis with low levels of political polarization. So you will know courtesy of work by a variety of scholars in, in, in including people at here at Stanford that the US displays the highest level of affective polarization. How members of one political party feel about members of the other political par party, how badly they feel in particular highest level of effective polarization of any advanced economy and a level of effective po polarization that has been rising over time and shows no tendency to stop rising. So this is Pew Research Center survey data on of a large number of voters why that level of political polarization is has been rising. I leave you to your, your, your favorite theory. We can hope for faster growth of the denominator of the debt to GDP ratio. I only observe that economists estimates of how large the boost to productivity growth from AI will be are all over the map. When we will begin to see at the aggregate macro level as opposed to the anecdotal level, real evidence of that boost estimates of that are all over the map. And there are plenty of people who get paid more than I do to estimate what this impact will be, who are pessimistic that there will be a, a, a significant impact on, on productivity growth in the United States anytime soon. This report came across my desk a couple of weeks ago. Case in point, I'm pessimistic about fiscal sustainability and, and worried that there will be pressure on the Fed because the time series for the United States show a weakening fiscal response over time. So people in this audience will be familiar with the bone test for debt sustainability. How does the primary surplus respond to an increase in the debt ratio in the preceding period or periods? Does it respond in a stabilizing direction? And how big is that response? I've done some work recently with Maxim Monet that suggests that it's the primary surplus does not respond to the debt ratio. It responds instead to the debt service ratio. Debt services as a percent of GDP. That's what shows up most immediately in the budget. The debt ratio does not show up in, in, in, in the current fiscal account. And the figure on the right is a reminder that as interest rates go up and down, the two variables do not como strongly with one another. And looking at the United States historically, there has been a, a reaction of the primary surplus to increases in the debt service ratio, but it's concentrated in, in periods characterized by two sets of circumstances in the aftermath of major wars. Here's the Gladstone doctrine, Michael or the treasury view, Michael, or the tax smoothing view. It's evident in the data. And when the real interest rate, real growth rate differential is unfavorable, so you can get a snowball effect more debt as a result of already outstanding debt. So this is the corresponding figure that for the United States, corresponding to what Mike showed you before for the United Kingdom de deficits widen significantly during wars and then they're followed by surpluses in the aftermath of those major wars here. I don't know how visible this this is to the audience. This is the primary surplus ratio regressed on the debt ratio, as in prior literature. There's nothing there for the United States, whether you're looking at 1800 through 2023 or 1800 through 1912. But where there is something is in the debt service ratio in the aftermath of major wars. First interaction term, second interaction term. And in periods when the real growth rate, real interest rate differential is unfavorable other interaction term. Final point, these responses are growing weaker. So the regressions I just showed you work for the entire period, 1820, 23. But they're driven by the data for the period prior to World War I and you find much less in terms of a stabilizing reaction for the period after World War I. There wasn't much of a, a surplus reaction in the wake of the Vietnam War or wars in Iraq and Afghanistan warnings. That that and that, that's a reminder. Debt service now exceeds def defense spending. People point to that as a worry, something it hasn't elicited much of a response. So my pessimism about fiscal prospects in the United States remains intact. That does make me worry about the consequences for monetary policy.

- That's great. Hold a rabbit over there.

- Okay, thank you very much To the organizers, thank you for giving me the opportunity to talk about interactions between monetary and fiscal policy. I would like to talk about something that I've recently been thinking about, which is competing models of, of US treasuries. And what I have in mind there is I want to talk about a, a divergence of models of the government debt markets specifically. I think there's been an increasing gap between the model that market participants, bond investors use when they think about treasuries versus the model that is used by, by policy makers in including central banks. I think these two have pulled apart in recent times in the last couple of years, especially since the pandemic. And and I think that potentially sets us up for challenges when it comes to the interaction between monitoring and fiscal policy. So that's, that's sort of the gist of what I wanna talk about and to, to set the stage, I want to go back to the way things were before the pandemic. By and large US treasuries, as you probably know were expensive if you compare them to close substitutes, say AAA corporate bonds or foreign G 10 sovereign bonds. And the way we made sense of that was building on the work by my colleague Garvin Krishnamurthy and Annette St. Jorgenson and others is US strategies earned large convenience fields. That's sort of the return that investors are willing to forego for the safety and liquidity of of treasuries. They're just special. Okay? Also, typically the, the stock bond correlation was negative. So, so bonds were kind of a nice hedge if you had stock market risk in your portfolio and there was flight to safety in stress events. So treasury yields would come down when bad things were happening around the world. So I wanna draw your attention to this comparison between treasuries and, and close substitutes and, and what has changed in the past couple of years. So on the left hand panel, what you are looking at is the spread between the yield on aaa, corporates and treasuries adjusted for credit risk. So we're putting the comparison on an apples to apples basis. And if investors were indifferent between holding a synthetic treasury constructed from a credit risk free corporate bond and the treasury, then this gap would be zero. But by and large, before the pandemic, what you noticed that there were large positive gaps, which in a way means that the yields on actual treasuries were always lower than the yields on these synthetic treasuries you manufactured from AAA corporate. So investors strictly preferred the safety and liquidity of treasuries. But since the pandemic, I think what you'd notice except for that one spike right at the beginning of the pandemic is that pretty much across all of the maturities, but especially at the longer end of the maturity spectrum, the gap is gone. So what this picture tells you is that right now in bond market investors are close to indifferent between AA corporates and treasuries once you adjust for credit risk. What about if we look at sovereign bonds? So that's the picture on the right hand side. What we're doing there is we're taking the yields on G 10 sovereign bonds excluding the us but we're hedging everything back into dollars again to construct a synthetic US treasury. So we can do an apples to apples comparison. And the, the picture is unfortunately quite similar, tells the same story before the pandemic, especially at lower maturities, you saw big gaps that spiked during crisis suggesting that investors strictly preferred US treasuries to say German bos. But what you see even a little bit before the pandemic, but especially now, is that at longer maturities that gap has actually flipped signs. And, and so it's safe to say that investors actually now sort of strictly prefer a German bond to U US treasury at longer maturity. So US treasuries are no longer expensive when you compare them to close substitutes. But that's not the only thing that's changed. If you look at the stock bond correlation, which was reliably negative before 2020, that has flipped signs as well. This is something that's been documented by many bond market observers obviously. So it's no longer the case that treasuries are a hedge against stock market risk and there's no longer the typical flight to safety during stress events that we've come to expect. I plotted here two examples of this one from last year. What you're looking at is the, in the top panel, the s and p 500, right after the liberation day announcement of the tariffs back in April of 2025. And the red line is the start of the conflict with Iran this year. And you see the stock market seeing a negative correction right after these events. But in the bottom panel you see treasury yields going up reliably in both of these cases, which is the exact opposite what we've come to expect. So you no longer see this sort of typical flight to safety phenomenon. So going back to the slide I started with, it seems like market participants have changed their model of US treasuries. They no longer seem to think of US treasuries as safe in the sense they were before, at least they're cheaper. Now if you compare them to foreign sovereign bonds, which is definitely a big change, the stock bond correlation has flipped signs and you don't see that typical flight to safety. So what that leads you to believe is that investors may be using a different model. The other thing that's changed is that there's now sort of more evidence that the valuation of that is starting to respond to fiscal shocks. Here's an example of that. This is my favorite example. If you go back to last year in May of 2025 when the house was considering the one big beautiful bill that was May 22nd, 2025. What I'm plotting here is at very high frequencies, minute by minute returns on the entire portfolio of US treasuries in red. You also see stock market returns there, the s and p 500 in blue. And then the gray line is the probability of passage in the house inferred from prediction markets. And so as the probability of passage of this bill, which was arguably fiscally bad news increased, you see a big correction in in bond returns as well as stock returns. So you see the valuation of debt starting to respond to fiscal shocks as well. So what does, what does that, what does that mean? Well it, it suggests at least to me, that the model that's being used by market participants has shifted from safe that to risky debt in a risky debt regime. It's really the government that is sort of in the driver's seat, the fiscal authority and its bond holders that are bearing the risk of unfunded spending shocks and treasury yields then are gonna be highly responsive to fiscal news and the value of debt is constantly being marked to market. Okay, so it seems like market participants have shifted from a safe debt model to a risky debt model. But I would argue and happy to be challenged on this, that policymakers including central bankers, not just in the US but in other advanced economies as well, still use models in which government debt is safe. For the most part, all government spending in the background is fully funded. There's really no role in these models for the government debt valuation equation. And, and that of course creates some space for an intervention in the bond markets. And I'll come back to that in a second, but it's not just central bankers. Financial regulators also rely on models in which government debt is safe. Think about risk weights for government bonds and advanced economies. Think about money market fund regulations, but that's potentially a problem. I see a tension here because it seems like market participants now at least are using a different model. And so as a result of that, we may end up in a situation where central banks and financial regulators are second guessing what's happening in the bond market. And they may conclude that there are plumbing problems, for example, that need to be fixed when, when they're really, the market is responding to fiscal shocks and is functioning appropriately. That's the tension that I want to highlight. So coming back to this table, this taxonomy of regimes that I started with, it seems like policymakers are still using the safe model of debt. That's the regime in which central banks are firmly in charge and treasury yields don't really respond to fiscal shocks. There are no unfunded fiscal shocks in this environment. If you take that view, you'd still expect flight to safety and stress events and a negative stock bond correlation. And when you don't see that and this is your model of the world, then you obviously would conclude that the market's not functioning. That there's some problem with the market microstructure, there's some plumbing issue that needs to be resolved. A a good example of this I think is one from the uk, just to remind you, most of you are probably familiar with the details. In September of 2022, there was a brand new chancellor of the ex checker by the name of Quasi Tang who went to the House of Commons to deliver a speech where he set out a mini budget that included 45 billion of unfunded tax cuts. He started his announcement at 8:00 AM in the morning. And when you look at the bond market response, you see that nominal yields on Gils immediately started to go up quite dramatically. Now of course the response of the guild markets, at least initially was driven by fiscal news. That's sort of hard to dispute. It was the chancellor going to the House of Commons laying out his plan for big tax cuts. That's what the bond market was responding to. Of course, eventually it became a bigger problem because pension funds had highly levered exposure to gilts. They were facing margin calls and that actually led the Bank of England to pause QT only a week after they had, they had started it. So this is an example of the potential issues that may arise when market participants and policy makers are potentially using models that could be quite different. Now these two are not mutually exclusive, of course, I think it was Darrell who pointed this out to me on a bike ride last year, and I think he's right about that. These two go hand in hand. You see now in the US treasury market, I think increased fragility, US treasury is increasingly relying on the short end for issuance. And that actually makes sense. If you look at that convenience seal picture I showed you at the short end, there may still be some convenience seals, I think Arvin is gonna talk about that later on. But the US treasury now that the Fed has stepped back and primary dealers have limited balance sheet capacity is increasingly relying on hedge funds to absorb issuance in the basis trade. And so this seems like a, a fragile arrangement that could potentially be tested. So the broader point here is that of course fiscal challenges and plumbing problems in treasury markets are, are potentially potentially intertwined. But I think what what we have learned is that what fiscal policy makers need is some market discipline. It's fair to say I think that in the US that's probably the, the only way we are going to be able to bring deficits back down. I'm showing you here are projections, not forecasts from the congressional budget office for the next 30 years. On the left hand side, you see deficits and net interest as a percent of GDP. On the right hand side you see federal debt as a percent of GDP. And so I think it's, it's clear that what is needed is some market discipline. The risk is of course that if every response in the bond market to fiscal news gets relabeled as a plumbing problem, that the fiscal correction is deferred. And I don't think that that's just a theoretical possibility. So let me conclude. I think market participants and policy makers use different models now of government debt and that's potentially a problem. And as a result, central banks could end up with large balance sheets, warehousing bonds, or they policy makers could try and incentivize banks to do the same. That would be a form of financial repression. If you don't think that's a real possibility. I want to end by drawing your attention to this picture. I first saw this picture presented by Olivier Jean, but this is one I i I took from BlackRock and what it does is it just plots the fraction of government debt held by the banks and central banks in a country against the government debt to GDP ratio. And what you can clearly see here is that if your debt to GDP ratios keeps going up, that banks and central banks will end up being forced one way or another to absorb all the issuance. That of course raises a whole bunch of different problems, potentially inflation, financial repression tax and so on. That's it.

- Okay, thank you all very much. Just while you guys collect your thoughts, I'm gonna ask the panelists to say a little bit more about the risks and implications of fiscal stress for central banks. So in particular, does fiscal stress increase or strengthen or weaken the case for central bank independence? And in the face of fiscal stress, what, if anything, can central banks do to limit the risks to their ability to achieve their monetary policy and financial stability objectives? So why don't we take this in reverse or distance. You are already starting to talk about that Hannah, and then take it back Barry and, and Michael. Thank

- You. Okay, that's a, that's a great question. So I've been thinking about this a a a little bit lately actually, and what, what I've come around to is the view that Central bank independence is, is probably not gonna protect central banks completely from the problems in the fiscal arena. If you look at those CBO projections, what you see is that there's a lot of issuance coming down the pipeline. We're clearly not on a fiscally sustainable path. And it is easy to imagine scenarios where there are stress events in the bond market because bond market participants will push yields up in response to particular fiscal shocks that then trigger central bank intervention. We've seen examples of that in the past, especially in other advanced economies. I could give examples from the Eurozone, I could give examples from the uk in fact, I I just gave one. And so I think it'd be very hard for a central bank to commit to not intervening when it sees stress in the bond market. But as a result of that, I think Central Bank independence in and of itself is not gonna get us out of this problem. I think the only thing that will is, is to, is putting us on a different, more sustainable fiscal trajectory ultimately. And so I think it'd be a mistake to a sort of try and sell Central Bank independence as as the fix for this problem. I don't think it is, and based on sort of historical evidence, I think that's, that's probably the right way to look at it, but

- Okay. Alright.

- So I agree with mu, much of that actual existing central bank independence won't protect central banks completely from fiscal policy related pressures. Actual existing central bank independence doesn't protect central banks completely from any number of different pressures brought to bear, but it's the best protection they, they have in in, in terms of, of the underlying fiscal problem. I agree that monetary policy can't solve all problems and that includes a wide range of fiscal problems. The issue is what exactly should central bankers do? How should they proceed in the face of these fiscal imbalances? And, and, and in response to these pressures, it's clear that central bankers cannot ignore fiscal problems and, and ignore the associated pressures. But I think they need to be forceful and transparently clear about their mandates. They should talk about fiscal policy and fiscal imbalances insofar as they bear on the ability of the central bank to achieve their mandate as explicitly defined. What does it imply for inflation and high employment and financial stability and what does does it imply for their own policy settings? And they should leave the, the rest to other agencies and branches of government.

- Okay, I I, I basically agree with all the others, but what history teaches us, and not just the the UK but you know, if you have a big enough fiscal shock, the central bank loses its independence. So it's just a matter of degree small, you know, small deficits, small, small low debt ratios in countries like advanced countries, you don't have this problem. So it's really a question of, you know, what's going on on the ground. So if you have a big fiscal shock and it's really big and the debt ratio's gonna rise, that's it for Central Bank independence.

- Okay, thank you. So I'm gonna take questions in batches. Now, forgive me, I don't know everyone so I'm just gonna point, but please ensure that they are in fact questions. The more succinct the better. And please identify yourself before asking your question. So this gentleman over there with the

- Thank you, I'm Marvin Barth of Thematic Markets and I, I'm actually gonna violate the rule. I'm just going to throw out a comment for the last two, but I would hope that you would res respond to this, which I'm gonna challenge your data. So first of all, professor Eichengreen, if you actually back out various central banks holdings by currency, which you can do given the three year a folding of the Chinese reserves and you know, large holders like the Swiss who published theirs and the Russian Central Bank, which did before 2022, what you find is that that chart looks totally different. That that is actually two countries have been diversifying away from the dollar Russia and China. And that's really for payments issues, not for currency issues. As you can see by the aid data at William and Mary, the incredible number of dollar liabilities that the Chinese are in cont or dollar claims that the Chinese are willing to build up. So I'd say that there's something very different going on there. And stable coins also highlight that, that, you know, stable coins are 99% dollars more than 99% transactions. Professor Listic on your charts where you are highlighting the spread of triple A to treasuries and also foreign bonds. Those, I would submit that those are actually issues going on with the financial market data that you're using. So if you think about CDS, I assume that you're also subtracting CDS from the US treasury, correct? Or no?

- No. - Oh, well then that changes the entire thing. I wonder why you, why you don't, but

- It doesn't matter.

- Okay,

- Just quantitatively it doesn't

- Matter. And then on the, on the foreign foreign sovereign bonds, I wonder how much of a role FX swaps are playing in, in that right now, because effectively since Basel three accords have come through, what you've seen is a widening of dollar basis, which would give you exactly that trend effect that you're talking about. So just those comments for you two.

- And then, alright, my name is Alejandra Edwards. Great discussion. Thank you very much. This is a question for Hannah Lu Istic. I wonder if you have in your fiscal projections the role, the role of social security and Medicare. I understand that it is, it is included,

- Yes. I'll, I'll explain how the CBO includes it. Yes, thank. Okay.

- And then,

- Hi, thank you very much for a great discussion. Samim Gamy from the New York State Insurance Fund. Just a clarifying question. Do you think an inflation targeting central bank that would follow the tailor principle can become dysfunctional when the public debt and deficit is not on a sustainable path? So that's the first question. And second clarifying question is, you mentioned the relabeling of the supply demand imbalances in the treasury market as relabeling the plumbing issue. I mean, from my personal perspective, it's just demand management. Part of the domestic demand management would be, I mean, fixing potential market microstructure issues in the treasury market. Thank you.

- Okay. Who wants to go first?

- I sure I can go first. Okay. So your question about the, the, the CIP basis, without getting too much into the nitty gritty, you're absolutely right that sort of, since I think 2008, the covered interest rate parity violations have grown in size. The way we document that is, is by looking at CIP and comparing them to L-I-B-O-R rates across a bunch of countries. That's not what I was doing. I was actually looking at treasuries and sovereign bond yields. But, but of course in the background, you're, you're using forward contracts and cross currency basis swaps. Now there is no mechanical relation between the increase in the size of the basis and the plot that I showed, I can guarantee you that. So it's not, that's not what is driving it. In fact, these CIP basis, they increase in, in sort of their absolute value. But, but if you actually look at the numbers for some countries, they go up and they become very positive. And for some countries they go down and they widen. The fact of the matter is that even before 2008, there was a big gap between say treasury yields and foreign yields hedge back in $2. And, and that now has gone away. And I think that is a novel development that is not just about banks being constrained and that creating some widening of the basis in, in covered interest rate parity. But that's an interesting point. Thank you. With respect to, to your question, so my understanding is, this was explained to me by somebody who's an expert, that when the CBO does its projections, it typically is su it sort of rolls forward everything based on the laws that are currently in place except for social security. There, it actually assumes, this is my understanding, but I'm happy to be corrected that when this trust fund runs out, that the federal government keeps its promises. So it's baked into the projection and that is a big part of the projected deficit. Yeah. And then with regards to the last question, I'm, I'm, I'm not denying that there are potentially market microstructure and plumbing problems. In fact, there are that need to be addressed and there might be a good case for addressing them. But if we're always relabeling this event as plumbing issues, then that creates the impression amongst people who are in charge of fiscal policy that the only problems there are in the bond market are plumbing problems. And that would be a mistake because in a lot of these cases, the fundamental issue is that we're on a fiscally unsustainable path. And so it'd be helpful if even central banks would, would actually point, point that out and, and, and bring more transparency when they talk about this, because I think that's the only way that we'll ever get back onto a sustainable fiscal trajectory. So that's my concern

- On, on the question of, of whether, when we talk about dollar reserves, it's all a Russia and China story, or a Russia and China and Switzerland story. I was a little bit uncertain about the period you were asking about China in the last three years, or Russia in the period prior to when it stopped publishing data on reserves and having access to reserves at the beginning of 2022. If I look at the 21st century, at the last quarter of a century, the trimming of of the dollar reserve share has been widespread by scores of countries. So the dollar has lost that 15 percentage point of the global total reserve share over those 25 years. A quarter of what it's lost was gained by the Chinese reman b the other three quarters of what it lost was gained by non-traditional reserve currencies. The currencies of small open, well-managed generally inflation targeting countries who, whose currencies are also called the dollar or the Corona, I don't know what that part is about. And you can find 50 plus countries that over that quarter century have moved away from the dollar on the margin. Everything we're talking about so far is on the margin toward alternatives that have become easier to trade and use as a result of, of digital platforms. I think the term stable coins was mentioned in passing. I think stable coins are a complete non-issue from the point of view of everything we've been talking about.

- I, I'll pass.

- Okay, we've got a, a little bit more time, but not a lot. So please limit yourself to one question each set.

- Thank you. Thank you Tom Hanney come formerly with the Federal Reserve. Now with Mercatus, my question has to do with the idea of a new Accord Fed treasury accord and the fact that we are in a situation of fiscal dominance or near it and the need to address that the, the Fed has imply implicitly accepted the responsibility for stable and very liquid treasury markets and the new accord would involve them. And I'd like your reaction to this, to rejecting that and saying, yes, we, we know it's important, but we are running into very serious fiscal problems and therefore we're, we're not going to honor that beyond a certain point. And we need an accord, which allows us to back away from automatically, you know, standing repo facilities automatically being there for the treasury and the, and the congress and the treasury working away to address these fiscal problems. Because if you don't do that, I don't see how you ever solve this problem.

- So I've been following fiscal policy for decades and in the 1970s when we first time had first peace time deficits and people were concerned and William Chow came out with his long run projections, virtually everybody said it's gonna lead to higher inflation or higher interest rates. And that hasn't happened. And I, I totally agree that, that the current budget process is totally dysfunctional, it's appalling and I'm very aware of the long run projections. But all of you and many others use this word unsustainable. And can economists do any better than to, than to use that to point that, that the current budget situation's unsustainable? I loved what Barry said that the, the Fed should be able to talk publicly about fiscal policy as it may affect monetary policy and be much more outspoken and articulate about it. But, well, so what's the probability that 10 years from now we have the same panel and we're all here and, and the, you know, we say, gee, it was sustainable in the last 10. What's for the future? So I'd like a, a better discussion about unsustainable. We know it's having a big impact. The, the deficit spending, which is all due to, you know, the compounding of entitlements. We, we know it's affecting the allocation of national resources. But I really think we should dig into this issue of just kavalier saying, oh, it's unsustainable.

- Okay. Hannah, you wanna kick off?

- Sure. I, I wanna first address your point. I mean, I, I basically agree with, with your statement. I, I actually didn't know much about the Fed treasury accord, but recently I started reading about it and, and, and I learned that actually there were a lot of Fed officials back then, I think it was in, in 51, who firmly believed that the only way they would have real price discovery in the treasury market is if they convinced market participants that they would never intervene again in the way they did during the second World War. And its aftermath and So it's interesting that we seem to have forgotten that, that now we've convinced ourselves that for bond markets to work well, bond bond market participants need to believe that every other year the the fed will intervene. Something seems off about that. And, and so I'm very sympathetic to the view that in order to have real price discovery in treasury markets, we need to have some firm commitments on the part of central banks, not, not just in the US but but in other advanced economies too, that they will not intervene. Absolutely. With respect to your question about sustainability, boy, I I, I fear that here, I mean, sometimes in the US I think there's this sort of American exceptionalism that that's causes us to be overly optimistic. Maybe that's because in the US we've never experienced the fiscal crisis. I'm from Belgium originally, so we have a couple, and basically the arguments that were used in the 2000 tens to argue that we shouldn't worry about deficits, those no longer apply. Right? I hope you agree. It's no longer the case that R is undeniably lower than G. We now know that R seemed to be lower than G for a while, partly because we were benefiting from this insatiable demand on the part of foreigners for treasuries. That seems to have waned a bit. That's unfortunate, but it is what it is. And I think the other component there, there was another large price and sensitive buyer, and that was the Fed, and that applies to other advanced economies as well. Now that both of them have stepped back, I think we've seen a significant yield response. But, and this related to my first point, I think market participants are still pricing in potential interventions. If you price a 10 year yield, even if the Fed is not intervening, now you're thinking about what could happen in different states of the world. There's some very interesting work by Tyler Muir and Valentine Hadda at UCLA that

- I know. Sorry, we're,

- We're

- Almost out of time, so just,

- Oh, sorry.

- Yes, mic to

- Thank you. I can be quick. Tom, honing on a, on a new accord, if I understood you, you were talking about a new anti accord or a new discord. I'm leery. I, I, I fear that if you open that door, you might not like what walks through at the end of the discussion. Mickey is right that unsustainability is a weasel word, or it's convenient shorthand for a wide range of, of problems that we know are out there. What we don't want to do is try to make unsustainability more precise by, by building a, a, a more refined model of the determinants, of the trajectory of the debt over time. You know, the IMF build builds a bigger debt sustainability model every, every three years when it reviews the machine. But I do think we want to think more about the different dimensions, the, the, the different impacts of a rapidly growing debt ratio and how it, how it will affect different variables we care about.

- Yeah, I I just want to make a couple of comments on the accord. Actually. You know, I recently, I reread Milton Friedman's program for monetary stability, and one of his critiques of the fed back then was that they did debt management. Okay. And there was a real problem because here you got, you know, you're supposed to be conducting monetary policy and they're worried about the debt. So it's the same issue. Okay. And it just, it's just the same issue. It's just gone on. So yes, there's room for tightening, at least, you know, laying out what an accord would be. Second comment is about sustainability. So the question arises, and I thought Mickey might get at it, which is, okay, so the debt's rising and we're having a problem. What do we do about it? Okay. And what, it's really hard to really answer that question because you've got these entitlements that keep growing. And so it's very hard to think of how you actually can get out of that.

- Okay. Thank you very much everyone.

- It is my pleasure to introduce Dr. Condoleezza Rice, who is the ta and Diane Taub, director of the Hoover Institution. And she will give us some director's remarks that will pertain to the kinds of issues we talk about today. Please join me in welcoming her.

- Thank you very much. And it's always joy to have a chance to come to this wonderful conference and to welcome you to the Hoover Institution and to Stanford. I just wanna say I see our, a great leader, really the person who started this whole conference along with George Schultz. I see John Taylor down there. John, great to see you. I wanna thank Valerie and her team, John Cochrane and a number of our other economists who every year carry on this tradition of bringing together people who understand at a very deep level what is going on in our economy, how to think about monetary policy in the economy, but more broadly, how should we think about what we are facing as we try to promote prosperity in the United States and across the world? And I wanna just make a few remarks on the international side. You're about to have an international panel, and it's not as an economist, I wanna be very clear about that. But it is someone who has had to both as an academic and as a policymaker, deal with the challenges of thinking about, let me call it the international political economy. And this is a particularly challenging time to think about that. And I want to go back to something that I say almost every year to this group, which is that we are in transition from one international economy to another. And when you're in transition, you don't quite know where you're going to end up, but you know what you have left behind. And effectively, what we have left behind is essentially 80 years of an international system that the United States, along with its allies, after World War II sponsored, it was founded on some very important principles, including that there should be an international economy that did not have to be zero sum and international economy that did not have to have war over resources. You could trade for them an international economy that was by a victorious power on a built so that both foe and friend could benefit from that. Just think about that over the hundreds of years of international history, that the idea that you would rebuild those who had fought against you, in this case, Germany and Japan, so that they could be part of a peaceful system quite in contrast to the way that Germany was thought about after World War I. And so it was an extraordinary system, both in terms of its norms, in terms of its values, and I think in terms of its effects, it was also an international system that was largely protected by American military power. American security arrangements. Everything from an attack upon one is an attack upon all in the NATO treaty to the defense of Japan, the defense of South Korea, the defense of the sea lanes, and it was indeed a system. Now I'm about to use a metaphor now, I wanna be very clear. It is a metaphor, not an analogy in this system. The United States was kind of the sun, okay? Metaphor, not an analogy. And because it was kind of the sun, its gravitational pull of the strength of its economy, the strength of the dollar, the strength of its innovation, and of course its military power, not to mention its rules based economy. There were kind of planets that were able to revolve around it. And whether you wanted to or not, you're kind of pulled into that gravitational pool. And that planetary system expanded, of course, when the Soviet Union collapsed as more countries came into this international economy that was not zero sum, that tried to freight pay to trade in freedom, that tried to believe in free movement of capital and goods. And then of course, in 2001, China was also drawn into that system after his accession to the WTO. And it was quite beneficial, I think, to everyone that this was a system that allowed the private sector to think about putting its supply chains where it was most efficient investing, where the ROI was greatest and manufacturing and assembling where the conditions were most favorable. And that system worked very, very well. And one of the issues that started to arise, but almost imperceptibly, was that there was a kind of, let me call it a CEO narrative about that system. And then there was beginning to develop a national security narrative about that system. Now, in the days of the Soviet Union, when the great adversary was the Soviet Union, the international economy could go on one pathway or on one parallel to the national security side that really they didn't cross over because the Soviet Union was a military giant, but it was a, an economic and technological midget. And so you could isolate it from the international economy. It was partially very much self isolating from the international economy at no time did more than 4% of Soviet GDP account for in international trade. And that was mostly around around resources. And so it was quite easy to think of a national security narrative and an international economic narrative, needless to say, with the entry of China into the international system. And especially over the period since about 2015 when Xi Jinping essentially laid down the gauntlet and said, we will surpass the United States in technological the frontier technologies like AI and quantum. When it became clear that there was a challenge to the system also in the South China Sea and around Taiwan. And when China would emerge as an adversary that was a technological economic and military peer of the United States. Those two parallel tracks came together. And now when we talk about the international economy, it's impossible not to talk about the national security aspects of that economy. And with the technological overlay, and Valerie and John and others can tell you that I've been saying this, we have to have one conversation about technology, national security and the international economy. And that means that we have to talk across disciplines, we have to talk across questions that we ask about how those are merging. If you don't believe me, read the headlines in today's Wall Street Journal about what is happening with anthropic and mythos. This is a technological development that can drive economic development and productivity, but has huge national security implications. And so my call to you here, my hope for conferences like this is that we will understand that we can no longer isolate the kinds of questions that we talk about in in international economy and political economy. From the questions that we ask about national security and about technological developments. Those have to be one conversation. It's also the case, and I'll close with this, remember, it's a metaphor, not an analogy. The sun's kind of going like this. And so nobody's quite sure how to array around that gravitational pull that seems to be shifting with, shall we say, very often a tweet on, on truth social. And as a result, we are feeling uncertainty and some volatility around the international system that for so long seemed pretty certain. One of the things that we're doing here at the Hoover Institution is try to look out beyond where we are now to think about what will be next in what George Schultz called the Global Economic and Security Commons. Meaning there can't be a world in which the United States, which is its size and power and gravitational pull is also the greatest source of uncertainty. So how do we think about that in the future? That's something that we hope to engage all of you at one point or another in our Commons initiative to try to understand that better. And I just wanna thank you for your fieldy to this conference on these days in May, but also to say that I think the challenge has gotten just much and more difficult as we move forward to what's next. Thank you very much.

- All right. Thank you, Dr. Rice. All right, we will go to our next panel also on international themes. The moderator will be Sebastian Edwards from UCLA and the panelists will be Arvin Krishnamurthy from Stanford Business School, Steven Redding from Stanford Econ, and also a senior fellow here at Hoover. And Kenneth Roff from Harvard University. Thank you so much.

- Thank you, Valerie. Very much. I want to add my, my voice to what Con Rice just told us. And thank John Taylor, who is here with us for launching this conference many years ago. I, I've been coming almost every year. I make sure that I clear my calendar and I start bugging people here at Hoover to the, tell me exactly when in early May it will be. And I want to thank John Cochran, Valerie Ramey and Michael Bodo for keeping up this great tradition. So thanks to all of them. We have a great panel. Now we're going to proceed as usual with following alphabetical order. And in the order in which they are in the, in the program. I, I ended up the last session, the one on fiscal with a, a very pessimistic view of what's going on. I don't think that any of the, of the speakers was particularly optimistic. I think that Michael Bordo looked back at history and, and the uk. So I was not that depressed. I I I had a question why 19? The 1967 evaluation was sort of closed over and focused on the 1976 of pound, the pound, but what Hannah, my former colleague at UCLA and and Barry said, I I think paint a very grim picture going forward. So we'll see what the panel here has to say. We already had quite a bit of international discussion in the previous panel. We're going to go further into it and I hope that we touch can the experience of countries a across the geography including, and if the panelists don't do that, I may do it at the end, Argentina, which it's always a very useful country to make fun of and to illustrate what not to do. But maybe now they are millet and, and Minister Caputo and Federico Zenger, whom I understand you had Kiva talk here recently, maybe are showing us the way to move forward in a number of, of areas. So let's go to the panel. Each presenter will have 15 minutes and that will give us time for conversation, for discussion, and for q and a. And we will start with Arvin, Krishna, Krishna Hy from from, from Sanford. Thank you Christian. 15 minutes, huh?

- Okay. Thank you for having me here. This is, I'm gonna take you through a computation. The computation is what's list listed there, which is how much is the dollars reserve currency status worth. There's a paper that does this computation in more detail. It's with Han Leig and my coauthors, j yang Jang at at Northwestern and Rob Richmond at nyu. So if you want, I'm gonna go through this at a high level. If you want the details of the general delivery model underneath it, look at the paper. That's Ben Franklin staring at you ominously. Okay, so let me just put down the way that we're gonna try to answer this question. Safe dollar debt is world money. And you can see this in many, many different ways. And Barry talked about this in the last session. When you look at foreign exchange reserves, there's lots of dollar safe assets that sit in foreign exchange reserves of central banks around the world. It's more than just official sector. If you look at the private sector, if you look at the banking system around the rest of the world, there's an enormous amount of dollar assets and liabilities there, which also lead to the use of the dollar and particularly the dollar safe assets for a variety of activities, collateral, liquidity, transaction services. So there is, it has been the case that for many decades, dollar assets are really, are world money and there's a substantial amount into demands into the trillions and trillions, tens of trillions of dollars of demand for these assets. So just as an analogy, and this is where I'm gonna go towards my computation, you know, Taiwan exports, semiconductors to the us the world that's a source of, of external value to Taiwan. I think one way of thinking about the US is the US exports safe dollar debt, okay? And the question that I'm gonna run through is, suppose that stopped happening, suppose that the dollar was no longer the world's reserve currency so that the, the demand for safe dollar assets disappeared. And so one export that the US has, which is the, which is safe dollar debt, that export disappears. How will the world ree equilibrate? Okay? And I'm not gonna offer too much motivation for this. I think I feel like the, the panel that we just had earlier offered ample motivation for this. When you just look at the world over the last decade, there's cracks in the sort of status of the dollar as the currency. You can see this in some of the quantities that Barry presented. You can see this in some of the asset pricing facts that Hano presented. When you, when you look at it, it, it looks like there's cracks emerging. So the, the question of this analysis is, is just take those cracks to the end point so that we know what we're dealing with in thinking about magnitudes of what it means if the world was to move away from the dollar. Okay? So as I said, this is gonna be a computation I'm gonna take you through. So I'm just gonna put some numbers to help us guide the discussion. I'm gonna go back to 2016. This is flow of funds from 2016. And the reason I'm going back to 2016 is because the cracks that have emerged, and you could see this both in Barry as well as Han's pictures, had really been emerging over the last decade. So I wanna kind of want to take you back to a day in which I'm fairly sure the dollar was still very firmly, the world's reserve currency. So 2016 flow funds, if you look at the total stock of treasury and agency bonds, there are about 94% of GDP. If you look at private safe dollar assets, so corporate debt principally bank debt, but in, in there is also repo 111% of GDP 2016. Foreign owns 39% of the total public share and 14% of the private share. So there's about 45% of GDP of bonds if you want, that have been exported to the rest of the world in 2016. Okay? So that's qu one quantity. Just want you to fix in your mind, the second number that I want to put in front of you is what is the liquidity services that are being exported on the basis of that debt? So just to, again, Hano talked about this, but it has been the case historically that US safe debt has a convenience yield, it has interest rates that are substantially below other benchmark rates. You can look at this within the us. So looking for example, at comparisons of corporate debt to treasury debt, this for example, is the work I've done with Annette Jorgensen, which puts a number around 75 basis points historically. So over sample, going from basically the 1920s into the early two thousands, an average number of around 75 basis points. So safe dollar debt has yields of about, from the, the estimates from an net were about 75 basis points below corporate bonds. If you look at more recent data, it looks like repo, it almost looks like the new safe asset in the us If you look at those types of spreads looks like about 90 basis points. The relevant comparison for the international sphere is to look at safe dollar assets relative to non-dollar assets. There you have to do a little bit more work to extract out what the relevant convenience yield is because you have exchange rate risk floating around. And I've done some work with Hano and Jin Yang, which puts an estimate of the convenience yield on dollars relative to non-dollar assets of around 2%.

- Okay?

- So I'm gonna take you through a computation in which I'm gonna use 2% as the number. If you don't like 2%, if you prefer smaller numbers, like 1%, just have all the numbers I'm gonna show you, I'm, I don't have a problem with that, okay? So I'm gonna take those two numbers. So a way of thinking about the two numbers I've just shown you is that the rest of the world effectively has been holding safe dollar assets and giving up interest on that to the tune of around 2%. Okay? So let's take those numbers and put those into a model. So I'm gonna, this is the, the competition I'm gonna do, you can think of the US trade with the rest of the world as being the usual goods and services trade of exports and imports. And an additional item that's very special to the US because the US has been the world's reserve currency. It effectively has been exporting liquidity services. How much liquidity services to the tune of those two numbers, 45% of safe assets held around the world, 2% convenience yield, which means 2% times 45%. That's the effectively the liquidity services that have been exported out to the us. So I want you to think about the experiment where the US becomes like any other currency around the world. So the dollar is no longer a reserve currency, it's like anything else in that world. That 45% and the 2% will change. The 45% presumably goes to a much smaller number. I'm gonna use zero in the calibration, I'm gonna show you. And if in going from 45% to zero, the liquidity services component of that export will disappear, right? So how will the world re equilibrate the world has to re equilibrate in one of two places. It has to re re equilibrate in the trade market as well as the asset market. So the US has been running exports and imports and exporting an additional good, a liquidity service. Good. If I turn off the liquidity service, good imports and exports have to rebalance. They have to rebalance by the amount of liquidity services goods that the US is no longer exporting. How will that happen? The way that it'll have to happen is the exchange rate has to move. In fact, the exchange rate has to depreciate to rebalance imports and exports. This doesn't mean that the imports and exports have to reba to zero, it just means that imports and exports have to rebalance the amount of the lost liquidity services. So I don't want to say that the US losing the reserve currency will close the trade balance to zero. I'm gonna do a computation, which of simply cutting off liquidity services and asking how much do exchange rates have to adjust to rebalance the lost liquidity services? Okay? The figure on the left sort of gives you an idea of what you need to pay attention to. The, the amount of movement of the exchange rate is closely related to the trade elasticity. How much imports and exports respond, exchange rates, right? If I know the slope of that orange line on the left, I can compute out how much exchange rates have to adjust, right? And that's one competition I'm gonna take you through. The other thing that has to happen, if on the order of 45% of US safe assets are no longer held externally and are sent back, if you want to, the us the US bond market has to clear absorbing a greater supply. That necessarily means that US interest rates will have to rise. How much will they have to rise? It's the slope. And if you want to, of the bond demand curve in the us. So let's put some numbers in this computation. So as I said, US safe bond GDP share in 2 20 16, 150%, 30% of it in total held by foreigners. So that's like 45% of safe bonds exported in 2016. I'm gonna use a convenience yield in dollar safe assets of 2%. I'm gonna compute exchange rates using the slope of the trade balance curve. That what I'm showing you on the left, the trade literature has examined this thing in great detail. I'm using a long run elasticity from the trade literature. Point three is the number I'm gonna use that'll allow me to figure out how much exchange rates have to move in response to the shock. I need a slope of the domestic bond demand curve. I'm gonna use a, a slope from a paper of mine with an addressing jorgensen, which estimates a slope there. So I i, I really just need a few numbers to get this going. Okay, here's the, the results. So there's a baseline which we calibrate to. We're gonna run the exercise of suppose the demand for dollar safe assets as disappears completely. That's the convenience lots column there. And I'm just gonna recompute a bunch of numbers, right? And the, the, the set, the, the couple of numbers I really want you to focus on is the second row. Second row is the senior edge to GDP, right? Basically it is the amount of liquidity services the US had been exporting for. It's really a function of that 45% of GDP times the 2% convenience yield. That's effectively the amount of seniors the US had been exporting in 2016. If world demand for dollar bonds disappears, that thing is gonna go to zero. The red is the exchange rate adjustment shut that off trade has to rebalance. How much a rebalance? It depends upon the slope of the, of the trade balance curve. That number comes out to be at what, 8.81%. I wanna emphasize it's actually a small number and it's a small number because this is a longer run trade elasticity. But a longer run trade elasticity is the right thing to use for this computation because what I'm really doing is comparing across two steady states. I'm not interested in asking what's happening to the dollar on one day when a tariff announcement happens or what's happening to the dollar when there's an announcement of a war. It is where will this, the system re equilibrate after lots of ups and downs if you were to move to a world in which the dollar was not a low, the reserve currency. So I would argue that is the right elasticity you wanna use. And 8.81% is exchange rate. The, the last thing that I want you to point out is the interest rate effect. So that's really coming off of taking quantity, putting it back onto the US bond demand curve. Interest rates move up by about 87 basis points, which is a large number, and you should really think of this as this is the, the, the, the, the R star or the natural rate of the US will have to adjust up by around, you know, 1% or so in this situation. So you can take those, those those numbers and do another computation just to get a sense of, of what the size is. So 45% of GDP of bonds, 2% convenience yield translates to a 1.05% senior age loss. That is a senior loss, which historically was an asset effectively that the US had, right? Another way of thinking about the US is it had this asset that was paying a dividend, the 1% senior age, which was allowing it to afford a part of a, a trade deficit. I can ask you what is that asset worth? And that's just a simple computation. Take that senior age, it's growing with GDP discount it back, it's a risky asset. So you need to do some finance to get the correct discount rate. And the present value is around $33 trillion. So there's sort of a hidden asset that the US has had by being the world's reserve currency. It's a hidden asset in the sense that it's distributed in value in many different places. Like I I, in my mind, banks have had US banks have a sort of a special place in the world because they've been able to issue dollar deposits for which there's ample demand. So part of the capitalization of US banks includes some, some of the senior rich. The housing market, which is financed by mortgage bank securities, is also part of an asset whose interest rates are affected by convenience yields. So it's built into, if you want to housing values. And then of course the, a topic of the last panel, it's built into the value of, of government debt. So it's implicit in the tax burden in the us. So I'm, I'm, I'm outta time here, but I can just summarize this very simply, which is the exorbitant privilege of the us. One way of thinking about it is it's the US' ability to export dollar safe assets. It's been valuable in the us The impact and exchange rates is small. It is, it is the case that if the US was no longer the world's reserve currency, the dollar would depreciate. But 8.81% is a small number. The bigger number sits in asset values, interest rates up by, on the order of 1% and a hidden asset that's sitting in the system that is 33 trillion. Now, as I look at the world today, I feel like I've sort of seen cracks over the last decade, but there's still, you know, complementarities that are sitting and holding this asset in, in place mostly for the dollar. But it is worth just recognizing the size of this asset before we choose to give it away. Thank you.

- Thank you Aaron. Thank you so much. That was, that was great one time. GDP is the, the value of that hidden asset. That's a lot of money. We now have Steven Redding from Stanford, thank you Steven. 15 minutes.

- Thank you very much. And let me also add my thanks to John Taylor, John Cochran, Steve Davis and Valerie Ramey for the invitation to participate in this terrific conference. I'm an international trade economist, so I thought that I would focus on the international trade side of this panel today and connect with some of the opening remarks a moment ago by Director Rice. So namely, as you all know, that throughout much of the period since the second World War tariffs appeared to be a largely settled issue in developed countries. A multilateral and regional trade liberalization under the general agreement on tariffs and trade and the World Trade Organization meant that the average import weighted tariff in the United States had fallen to less than 2% by the mid 2010s. And then as again, as you all know, during 20 18 20 19, and again in 20 25, 20 26, the United States has imposed tariffs in a sequence of waves that at least initially raised protection to levels, you know, close to those last seen during the Smoot-Hawley tariffs of the 1930s. You know, recently some of those tariffs were struck down under the A EPA act by the Supreme Court. And obviously yesterday the International Court of Trade also struck down the section 1 22 tariffs. But the administration is clearly planning to, to introduce new tariffs under additional existing alternative legal justifications. Alongside those changes in in trade policy, we obviously also see broader tensions in international trade in terms of the Russia, Ukraine, war geopolitical confrontation between China and the United States. And then also obviously recently recent conflict in the Middle East. So I wanna spend some time thinking about what have those changes in trade policy looked like, and then what might be their implications for monetary policy and for broader macro macroeconomic aggregates here in the United States. So I thought I'd start by showing some data. So this graph here shows in dark the US average applied tariff. So this is customs duty collected divided by import values. So it's the effective applied tariff going back to 1915, running through to December, 2025. And you can see here this sort of long post-war decline in tariffs. And then at the very end of the graph, this sudden spike upwards in the 20 25, 26 tariffs, which really marked quite a dramatic change in, in US trade policy against the recent path. And then on the top of the same graph, you can also see in gray the US import share as a share of GDP. And you see, as tariffs came down in the second World War period, we see this equal rise in imports as a share of GDP. So the United States economy became more globalized and that aggregate rise in imports may understate that because one of the things that's been very distinctive about those recent decades has been the emergence of global value chains. Sort of a very kind of distinctive feature of the, of the economy today vis-a-vis past episodes of globalization in the historical past. And on the very bottom of the figure, you see tariff revenues as a share of GDP and a small uptick there with the imposition of the 20 25, 26 tariffs, how foreign countries responded to those tariffs. So a lot of sort of standard trade theories might suggest that you might expect to see foreign retaliation that's been relatively muted, perhaps for geopolitical reasons, with the exception of China that's quite aggressively imposed tariffs on US goods. So China shown here in red the rest of the world in in in dark blue. And then finally another feature of these recent tariffs that sort of highlighted both by Pablo Gelbaum and Mick Kawa from which this series in the slide is taken, and then also by Ken Rugoff's colleagues Gita Gana and, and a former colleague of of his Brent Nyman, who's now at Chicago Booth have sort of emphasized is when you compare the applied tariffs and the figure I showed you earlier and reproduced here, so that's the series in dark blue for all tariffs, and then you compare them to the statutory tariffs, there's actually quite a big gap between the applied and the statutory tariff. Why is that? Well, part of that is imperfect in enforcement. Some of it is exemptions as famously in Apple's watch, source source from China. But then also because as the US has imposed these tariffs, there's been an increased share of trade between the United States, Mexico, and Canada, formerly before 2025 to six, only about 45% of the of trade within the USMC area was actually compliant with the, with the requirements, the rules of origin requirements to qualify for duty free. Obviously with the new and tariffs that there's been a spike rise to over 85% of that trade that's compliant and that's duty free. And so part of the reason why applied tariffs are lower is that combination of exemptions, you know, imperfect enforcement and that increase compliance with the US MCA agreement. And this figure here illustrates that this is sort of showing the share of US trade that enters duty free at the bottom and then in gray, what are called general tariffs. So those are the standard most favored nation tariffs that the United States negotiated as part of the GAT and the World Trade Organization. And therein very dark gray, you can sort of see what are called the special tariffs here, which in, in recent years have been the, the tariffs introduced in 20 18, 20 19, 20 25, 20 26, under special legal justification such as national security or such as sort of unfair trade competition on behalf of China. And at the bottom here you can see that rise in special tariffs as an increased share of US trade that's subject to those special tariffs. But then towards the very end of the series, you see that bounce back in the share of trade that's duty free, which is exactly this increased compliance with the regulations of U-S-M-C-A previously it wasn't worth firms while complying when the tariffs were low. Now those tariffs are quite high. It's actually worthwhile firms incurring fixed costs to comply with, with, with, with the requirements for, for GT free. So this, this is sort of a way of reacting to the tariffs escaping from it, but obviously it's not cost that it comes with its own costs. So what are the broader implications of this change in trade policy for the aggregate economy? Well, one of them is that we are living through what some trade economists have called a great reallocation, which is a large scale change in the, the share of China and, and US imports. And something that director Rice also connected with in AUR earlier comments. So this shows you that a trend in the immediate aftermath of the 2018 to 2019 tariffs, you see China's share of US imports in dark gray hair. And then you see what's called other Asia here, which is around 13 other Asian countries, which have been historically a location of outsourcing from the United States. And you see there's this sort of sharp decline in China's share and almost equal and opposite rise in the share of these other Asian countries that reallocation has continued at great pace since then. And so China's share of direct share of US imports peaked at something over 20% around 2015, and it's now down to around 11%. So roughly the same value just before China joined the World Trade Organization. This figure here unpicks that reallocation, so it shows countries shares of US imports sorted by the value of those shares and accumulating the shares. So essentially if you start at the left and you were to go all the way to the very far right off the end of the axis, this would all add up to one, it would add up to a, a share of one in US imports. And then I'm showing you the top 30 trading partners, the top, the top part of that distribution. And what you can see for this graph is as we move over time from 2017 through to 2025, you can obviously see China moving down that distribution of trade partners and Mexico, Vietnam and Taiwan moving up that distribution. And so there's really been this quite large scale reallocation, it's limited among the top 20 US import partners. It's roughly a reshuffling among those top 20 US import partners. And something to keep in mind here is obviously, although China now accounts for a much reduced direct share of US imports, the US is still exposed to China indirectly through the goods we sourced from Vietnam, Taiwan, Cambodia, which often use intermediate inputs from China. So the one part of this macroeconomic consequence is a large scale reshuffling of US sourcing patterns. And again, this is obviously not costless, there was a reason why we weren't importing this material from, from these countries before the new tariffs. And so there's a real resource cost in that reshuffling of, of us sourcing patterns. How about the implications for the trade imbalance? Well, as you can see in this graph here, so this is the US trade imbalance as a, as a share of GDP pretty flat in the face of this large scale change in trade policy. That's not a surprise. We know that the, the trade deficit is driven by expenditure relative to income or savings relative to investment. And tariffs reduce both imports and exports. And so their net effect on the trade deficit is relatively modest and, and quite and quite subtle. How about the impact on the price level? Connecting very closely with thoughts about monetary policy at the focus of of today's conference. Obviously tariffs are a policy that affects the level of prices they don't permanently affect the rate of growth of prices. What a trade economist's best judgment is the effect of these tariffs on, on the the level of prices. This figure here shows some estimates from Alberto Carvalho and colleagues who estimate that the cumulative impact of this new wave of tariffs during 25 to 2026 is around North 0.8 of a percentage point on on the CPI. That's roughly what you'd expect if you took the increase in the applied tariff, which is about 8%. And then you multiply that by the share of US imports in US GDP, which is about 11%. That gives you just under one percentage point impact on the level of of prices. So this is roughly the, quite the sort of benchmark you might expect from a simple aggregate calculation and just sort of highlights that international trade is relatively modest, although there may be some welfare costs of tariffs and foregoing gains from trade trade, economists typically think those welfare costs are relatively modest. And unsurprisingly the effect of these tariffs on, on the price level is, is relatively modest. Nonetheless, most of those price increases have been incurred either by US consumers, US importers, or US retailers. There's relatively little evidence of, of a large scale fall in the prices received by foreign foreign exporters. Obviously something else that's happened alongside as these tariffs were imposed, and this is very clear on on liberation day, is that the sort of conventional wisdom is that tariffs were often followed by an appreciation of the exchange rates, whereas on liberation day we saw a depreciation. And this connects with Hanna's comments in the earlier panel and vin's comments in the panel today on the extent to which we're starting to see a change in the co variance properties of, of the US exchange rate with macro shocks and the extent to which we will continue to see a, a, a flight to US assets in, in uncertain times there's a flight to safety and whether that's sort of breaking down recently with movements in, in the US federal deficit and the, these recent changes in, in the PO policy environment. And obviously one of the reasons for the persistent trade deficit that I mentioned on the previous slide is partly that persistent fiscal deficit that remains a, a substantial contribution towards that current account deficit. In terms of inflation, though, you know, probably those movements in in the US dollar might be equally as important as the changes in in tariffs and their impact on the level of the price level. And then also obviously most, most recently as another example of geopolitical tensions, movements in oil prices are, are perhaps likely to be even more consequential for the, for the, the consumer price index in, in the immediate future. And here you see this large rise in the price of oil following the, the Iran war in terms of how much of that has gone through into the current CPI. Well the data I'm showing you here arrived with a few months lag, so you're not gonna see the full impact of those changes in the price of oil in the series that I'm showing you here in the most recent months in March, there's some estimates that we are starting to see the increase in the price of oil pass through into the CPI most forecasters estimate that if a dollar, if the price of a barrel of oil rises to around 130 to $140 a barrel, that might again be roughly, you know, 0.75 percentage points contribution towards the CPI, that that ultimately might be passed through in into the level, again, the level of prices. And then obviously one concern might be, well, you know, wage set expectations and firms expectations of prices going to be indirectly affected by that price level effect. So I'm getting close to the end of my time, so I'll try to draw up what I try to to review with a sort of trade based perspective on the international environment, we've seen this quite large scale change in the stature of, of status of of us trade policy, a return of protectionist trade policies and, and increased uncertainty about the level of those policies. One of the things that was very distinctive in that second World War period, the decades after it was the certainty of that rule space international order. Today we've seen quite a, a change in the stance of trade policy and also a spike in uncertainty over a trade policy. Obviously a central insight of neoclassical economics is an international trade is like an improvement in technology because you don't have to produce everything yourself. You can trade and you can exchange on markets and get, get goods in return for the, for the goods that you export. Trade generates the, those aggregate gains, but it comes with distributional consequences, winners and losers within countries recent US tariffs are, you know, reduced the ability of the economy to participate in those aggregate gains. So far, most of the evidence is that they've fallen on US firms and consumers. The incidents of the tariffs relatively modest falls in the prices of of foreign exporters. We've seen the large scale reallocation of US import sourcing patterns that's obviously not costly costless, there's a reason we didn't import from those countries before. The impact on the level of US consumer prices has been relatively modest so far in part because of some of the rise in, in prices in the United States has been absorbed by wholesalers, retailers, and, and, and, and in margins. Looking ahead, these tariffs are, are a level effect on the price level. There's obviously some uncertainty about how that's gonna evolve based on what new tariffs the administration brings to replace the section 1 22 tariffs that were ruled on yesterday and the IE per tariffs that were ruled by the Supreme Court earlier this year. Looking ahead though, any effective trade policy on on the price level is likely to remain relatively modest and perhaps movements in the exchange rate and movements in the, in the price of oil and pressure on, on the Federal Reserve in terms of its interest. Interest setting policy are likely to be at least as consequential as trade policy in shaping the, the evolution of the level of of of CPI. And I should stop there to, to stay on time. Thank you very much.

- Thank you so much Steven. That was, that was great. I'm writing down questions for the q and a session now We have Ken ov Thank you Ken,

- Thank you very much. Thank you to Hoover for having me. I think this is the third time I've spoken at John's conference. I was actually a visiting a fellow here junior fellow 40 years ago or something. It's so refreshing. I know even within Stanford University or an island, but nevertheless, you know, being exposed to diversity of thought and be able to speak freely is, is wonderful. There have been a number of great presentations already and actually I know some of the material that's coming that cover a lot of the issues that I, I would and I highlight Arvin of course and Stevens, I'll touch on in a second. Han knows what Barry said. I didn't use any slides, but you could just replay in your head Barry's slides and it would've done some of what I wanted to do. And actually Conde's talk hit the nail on the head with some points I wanted to make. The first one is that macro economists have just abandoned political economy that just fell out of favor for a long time. That inflation's never gonna come back. Nothing's, you know, debt's never gonna be a problem. So anyway, Arvin gave an explanation of some of the advantages of being the dominant currency. I think 2015 is a good year to pick. I'll come back to that. I want to talk about some, briefly start with talking about some of the other advantages. And these are less easy to model. There's a work on them and requires probably more interdisciplinary work. But one of them's the ability to use sanctions and you can argue about whether they're effective or not effective and when they're effective, but I think it's been a pretty good tool to have. It was used very, very intensely prior to the current presidency. Another related one is information that so many trades touch the dollar. It's actually a very, very good source of information on what everyone's doing. And I know from many conversations the Europeans hate that almost as much as the Chinese. I probably advantages American banks in some ways. And then there are other issues, I forget who it was who mentioned it, I apologize. But swap lines are another version of sanctions and potential weaponization. There are some costs to being the currency. I think that's important to mention. The one that's in the most economic models is what Elaine Ray and Pierre Olivia Garches call exorbitant duty, which is if the dollar were a safe asset, if it were, it drives me crazy when people say treasury bills are safe assets for the reasons Hano said, and I talk about that in my book, but if the dollar were a safe asset, the exchange rate goes up when there's a a, something risky and bad happens and that actually imposes a loss on US foreign holdings of other countries and a gain to other countries. And so in a way the US is providing insurance to the rest of the world and that's a cost, you can quantify what it is. And actually very, very early people writing about this like Walter Salon at a 64 QJE paper where you tried to quantify that. And I think the more clear bigger cost is you have to have a military, you can't be even in the game of having a major currency, much less being a dominant currency without having a military. It's expensive and they're interlocking and it, it's not just about, you know, protecting everybody's assets. It's not that, it's not just that. I think the fact the US has been such a dominant military power gives the US a lot of leverage in making the rules of the game and how everything works, how swift works, how the IMF works. And when you see President Trump, someone who is sort of unfiltered and wears these thoughts on his sleeve, believe me, Nixon, Ronald Reagan, Lyndon Johnson, many others also use this leverage. I I do think 2015 is a good year to pick as Arvin did. As I highlight that in my book from a year ago, based on many years of research, our dollar year problem, if you look at another measure of dollar dominance, which is one Carmen Reinhardt and I with Ethan Alki developed 2015 looks like the peak of where the dollar was really dominating the global exchange rate system. You can compare it, that's a 2019 QJE paper. You can compare it to a 2003 QJE paper we had and my book updates it and it has sunk some. And so there's no question in my mind that there was some erosion of dollar dominance proceeding the Trump presidency. But you know, there's no question that conversation about that's become more acute. I have to mention, I actually finished my book before I knew who would win the election, but I did it with the university press. It has, I don't know, almost 500 end notes in it and the university press 'cause they just don't care about money sat on the book for four or five months. They could have released it certainly much earlier than they did, but then they released it in April after liberation day and everybody said, how could you know, how could you know, you know, and I benefited a lot from that editorial decision. There's no question that the, what's going on today is aggravating this situation. So Steven, I think, you know, explained some of the frictions, Mor Feld and I had a paper in the macro NBR macro annual in 2001 pointing out that if you have frictions in trade that I can use this word in this audience in general equilibrium, it filters out into everything in finance. And if you're a big winner in international finance as Arvin gave one illustration of you don't think that doesn't hurt when you do something to put in restrictions to trade. I mean that point, if it's not obvious, just think if you put up absolute barriers to trade, obviously you're not gonna get anything out of international relations. And I don't think that, by the way, this is, I think there are many things that are going on today that are not just a Trump thing. I think the progressives love, you know, don't like trade and you can listen to what Bernie Sanders says and, and, and, and such. I think another thing which potentially undermines where the US is today, and if this is gonna slip into fiscal policy is the fact that maybe interest rates won't stay low. And I I I went around the world debating Larry Summers, Paul Krugman, Olivier Blanchard, who said, with absolute conviction in the 2010s, nobody needs to think about debt anymore. I'm, this is only a slight caricature of what they said. And you know, interest rates are low, they're going lower there. You know, there's some arguments about that and there's some very smart young professors here and at Harvard who have papers about demographics. There are people who I think wrongly believe AI will bring interest rates down. But certainly I think there are a lot of factors that will make real interest rates higher populism, high debt levels, military, but understand if you're the world's biggest debtor and the US government has approximately more debt than all the other advanced countries put together, is a little bit sensitive to the high value of the dollar today. But, and with corporate debt it's even more so that's, it's not good for you when you're a big debtor, when other factors are making global interest rates go up, it makes you more vulnerable, it makes your decisions more, more difficult. I mean, look, there are other countries and more trouble the uk, France. But certainly I think this idea that, you know, nothing's ever gonna happen in the US is, you know, an overstatement. And I, you know, by the way, going back to the 2010s, I think that was a very widespread view in academics when Olivier gave his presidential address in 2019. One prominent Stanford economist who knows who he is, said he thought this would be as important as Milton Friedman's address about the neutrality of money. And I, I think that proved to be right, but maybe not in the way that he meant. So you know, that's, if you think of the vulnerabilities of the United States, some of the problems come from outside that China of course is developing its own transaction networks, expanding the use of the r and b. These things take a long time, but not forever. Europe's working hard on that. But I think a lot of the really concerning problems come from within. So it some level fiscal problems are at the heart of it. And if there aren't any, there aren't any, there's an optimistic way to tell things. Interest rates will go down, AI will save the day. I'm very dubious about that. I think it creates a lot of problems along the way to saving the day that, you know, will take years to sort out. But I don't have time to get into it here. I'm very skeptical about the argument which has been used prominently in recent debates about monetary policy that it will push down the neutral interest rate because disinflationary, that's very confused. The Federal Reserve can set inflation at whatever it wants over the long run. The question is what does AI do to the real interest rate? And I think like most positive productivity shocks, if it is one, it's gonna push up the real interest rate for the usual reasons. You can come up with a creative model where that's not true. But I think, I think it, it, it likely is. So what kind of pressures might this create on the central bank? This has been talked about and in the questions, but I think it is fundamentally a political economy problem. And there were many good answers earlier about it depends on the shock, but you know, certainly a war like shock, cyber war, a more major war, the critical thing being something that pushes up the interest rate holding other policies equal if it's a pandemic or what happened in the global financial crisis, it doesn't create the same pressures on the central bank because fiscal policy can be more expansionary. Although that doesn't necessarily mean infinite monetary policy can be trying to cut interest rates more and more. But I think a shock, an example of which at a mini level is the war in Iran, which is just a, you know, small expenditure, you know, a trillion dollars if it costs that as just a rounding error in the US federal budget. But something that's more severe would be import would be important. I want to just touch on a couple other topics which my, my book also talks about, which are stable coins and ai. I agree with what Barry said about stable coins are almost a non sequitur and this idea that they're somehow gonna make the dollar really popular. Let me just say that the Genius Act help might help the dollar in the way printing $10,000 bills might have helped the dollar. It would, but the cost to the treasury might be much greater than the gains that you get in terms of saving an interest and on, on, on ai. I just think, you know, the potential is tremendous, but the also the loss in jobs, the costs and military is very, very hard to know how this will play out. So I'm gonna break tradition and end a little early. I still have a minute and a half. Some people ask what's my next book about? The last one was our dollar your Problem? My next one that I'm working on is our Donald, your Problem.

- Thank you Ken. Indeed you ended up a minute and a half ahead of time. So that gives us more time for q and a. So I will follow the tradition and as you collect your thoughts and prepare your questions, I'm going to ask some questions of the panel. And I'm gonna start by remembering that quite some years ago I couldn't figure out how many, but you'll more or less know at a conference here in Stanford. And, and I think that the whole store, or at least he was here, was Ron McKinnon. And I heard at the time, this is many Barry was here, maybe Ken was here, the dollar has come to an end as a reserve currency and at the time what we were doing we're talking that it was going to be replaced by the yen. So that's tells you how many years ago it was and, and people were saying, well the Japanese are going to take over and they haven't taken over yet because we imposed voluntary export restraints. You guys don't remember that. But we didn't allow the, the Japanese to export enough Toyotas to the us. That's the way we dealt with the trade deficit. And if I close my eyes and I'm a little distracted, the conversation is almost the same and 30 or 35 years have gone by and here we are, the dollar is the reserve currency and I'm wondering what that tells us about what's going on. So one of the questions that I want to ask, and mostly it has to do with vin's presentation, but also the other members of the panel. So let's assume that your scenario Arvin does happen. What's going to replace the dollar? I mean I think that one way to start that conversation is start with, with the, the alternative scenario and you go through the Swiss Franc, nah, the euro, well the Europeans wish that that was the case. I don't think so. The un it will take a long time. They have the military, so Ken said you need the military to, to have a dominant currency. The, the Chinese certainly have the military, but I don't think that that will happen. And so I think that we have to incorporate into this discussion what currency, who will replace the dollar because if you don't have a candidate then we're stuck with a dollar for a long time. And I think that it would be great if we could move in that direction. So I have other questions that I may ask at the end. Oh, one question to Steven. Let me,

- Let me take this one. Though.

- Yeah. So, but let me one first, Steven, what about AI exports? So, or, or, or, or for the, for, for the panel. So we exported, Arvin said we export convenience and we export the, this safe currency. Everyone I know and I travel around the emerging world, everyone in the, in, in, in the emerging world that I know subscribes for payment to anthropic and chat GPT, we, I, I don't, I don't know what the magnitude is, but the export of the LLMs, I, I think it's going to be absolutely astonishing. What will that do to the USD? What will that do to interest rates? What will that do to macro and indirectly to central banks? So, let me go, let me, let me go from Ken because he's eager to answer one of the questions through the panel and then we'll open up for questions.

- Yeah. So I mean, when we're talking about replacing the dollar, you're not asking the right question. You're asking if the right question is, if we become destabilized as from fiscal dominance from dominance over the Federal Reserve, you're looking more at the seventies when there is nothing, you know, that's what really the issue is. Over any short period, nothing can happen. You can lose market share even within that. And the Chinese are going to take market share because they have to, because eventually they're going to want Taiwan, the South China Sea, we're gonna put on financial sanctions and the Europeans are looking at Greenland, by the way, and you lose market share. But if we don't have any problems, I mean, that's gonna be a very smooth, mild thing. But if we have problems, then I think, you know, everyone will lose bonds will lose share and I think, you know, it leaves room for others to come in.

- Okay. Steven, we're gonna go through though, yeah, Steven,

- Yeah, no, a great question. I related to what Ken just said. I mean, one of the things maybe, maybe nothing replaces the dollar and we just end up in a more fragmented, less costly world and we raise transactions costs. That's also another possibility. There are huge network benefits to having a single dominant currency, but if instability in the US reduces the extent to which the dollar plays that role and the whole world becomes more fragmented, maybe that's actually an outcome that we end up with. Nothing replacing it.

- Anything about AI exports?

- I think that's a great question as well. And more generally, trade and services I think has the potential to become increasingly important both as a source of gains for, for countries and also potentially it raises important trade policy issues because with the recent US tariffs on the European Union, for example, that started to raise the debate as to whether Europeans would actually start to tax the, that trade in those digital goods. So I think both from a trade policy side and a trade side, it raises a lot of very interesting questions. And, and you know, ultimately in the background, would the combination of digital printing trade-in services, could that actually replace some of the trading goods? Are they compliments versus substitutes? There are a lot of fascinating research.

- Thank you Arvin. And then we'll move to, to the general questions.

- Yeah, I mean just, I, I completely agree with what Ken said, which is seems like a, the possible answer is erosion and muddling around. I do want to say though, that there's a $33 trillion prize for a replacement and maybe it's not a prize that gets claimed in the next five years, the next 10 years, but there's a prize,

- There is a,

- And economies find ways to

- A $33 trillion prize.

- Yeah. To get, get a prize. So,

- Okay, thank you. So let's open the back there in the middle please. I give, give me your names because I cannot quite see all of you. Yes, they're in the middle please. We're gonna collect three or four questions and then ask the panel to, to reply.

- Thank you very much. Krishna Guha with Evercore Partners, a question I guess is mostly addressed to Arvin, but others may want to comment to two parts. First of all, to the extent that we see the loss of or erosion of convenience yield, can we distinguish as to whether that's a deterioration in the underlying asset or merely that we've satiated demand for the asset by supplying so much of it? And does that matter? Second question, how tightly should we think about the role of the dollar? Is the reserve currency and the treasury securities, the world's safe assets as being stapled together? They're obviously closely related, but how tightly are they stapled together? And I raise this particularly in the context of what appears to be a portfolio reallocation of foreign investors in the US over time to increase their share of equity holdings relative to treasury holdings. Is that potentially the kind of equilibrium we could be in, in some kind of gray zone where treasuries have lost a little bit of their attractiveness, but there's still no real competitor globally? Thank you.

- Thank you John Cochran.

- Thank you John Cochran Hoover, I have two questions. One, sort of following up on the last one, and you can fill us in on the basic economics. Just because I have to pay something in dollars doesn't mean I have to hold a lot of dollars. I can make the exchange conversion, pay, make the conversion back. And similarly, if I want to hold dollar assets, it's not obvious those have to be issued by US entities, especially federal government. A German company could issue dollar denominated bonds and provide those safe assets. So it's not obvious to me we have to go to a world where there is a large holding of us issued securities. And then I'd like you to comment, I I I'd like you to comment on a view which I do not hold but others do, which is that that great that that the dollar is a burden to the US that by, by importing goods which we consume and sending people pieces of paper, this has been a terrible thing for wiping out US manufacturing and the day it's all over is a day to be cherished when us people can go back to working 12 hours a day and putting things on boats and sending it to Vaers and they do cite the, the Spanish and Portuguese who in the 16th century provided the world's currency gold from the, from the Americas, used it to finance a consumption binge and, and then kind of fell apart productively. Now some of the issues, we used it on a consumption binge, but that, that view is out there. I don't hold it, but you probably don't hold it morely than I do.

- That's a Mar Lago view. Right. Okay, any questions here? Yes, Jim here.

- Jim Buller Perdue, the, this is a question for Steven Redding. I love the summary of where we're at on trade and, but I think one thing has changed that maybe you didn't cover as intensively, which is that there seems to be general agreement about the revenue that you might get from taxing trade. And both parties seem to agree on this. And so I'm wondering why the literature doesn't talk more about this. You know, you have a, a range of distortionary taxation, including very distortionary capital taxes. Maybe you should substitute away from the capital taxes and do some of the taxation on the international trade side and that would cause a distortion too. But then you would balance out all the distortions. So it seems to me like the political consensus maybe isn't quite as crazy as my free trade upbringing makes it out to be.

- Okay, I'm gonna have one more question then. Well, we have two questions here so David, and then I cannot see you in the back. So, and then we'll go back to the panel.

- David Beckworth with the Mercatus Center. I wanna go back to, maybe to Ken and, and maybe Arvin can answer this too, but some observers would challenge the notion that the dollar share is declining in terms of being a dominant currency. So I follow Brad Sesser and he makes this argument that some of the decline in the share of China's holdings of dollars is simply a, a switch between its custodial banks as well as the state banks are actually growing in the amount of dollars they're holding. So it's kind of, they're hiding their masking and moreover, he would appeal to this, this kind of popular argument right now, China Shock 2.0, they're gonna have to be acquiring more dollars as they run these large surpluses. And so the world, even though it's a volatile world and there's, there's challenges, the world is still, you know, buying up dollar assets given the big trade surpluses that are being run.

- Okay, the back there, we keep getting more questions. We have, we have enough time at 1230 we have to finish to go to lunch.

- Yeah, thank you. Matt Klein, I write the overshoot, this is for Arvin, but also for Ken based sort of for Hanna, there's some disagreement about whether the convenience seal is still positive or negative, I guess because you know, Hanna's implying that the convenience sale is now negative. So in fact there's no senior age benefit. You know, Ken was saying if treasuries were a safe asset, Arvin is saying there is a safe asset, it's worth, you know, 1% of GDPA year. I'm just curious how, how we reconcile this to what extent if 2016 is a starting point, we've already kinda moved in that direction. Obviously foreign holdings of US access are so high. So maybe it's not that the 45% went to zero, but that the, you know, plus 2% went to negative 1%, something like that. How we think about that. And also in the context of this $33 trillion prize, I just checked the Z one says household wealth is a bit over 200 trillion. So it's about the same magnitude as the decline in the currency. I don't know if that means it's big or small, but just wanna put that out there. Thank you.

- Okay. I think John is, I think that's John, I cannot see very I in the very back. And that's gonna be the last question and we'll go back to the panel.

- John Harley, policy fellow here at Hoover. A question for Ken or I guess anyone else on the panel, just me echoing some of the other questions. What in your mind is the best evidence of de Dollarization that we have so far? And I just, for me, having looked at this data a lot has really struggled to find any sort of evidence. I mean the global, you know, FX reserve holdings of the US dollar were lower in the nineties, you know, 50% it's around 60% Now. If there's any currencies that are gaining in this area, it seems to be like Australian dollar, Canadian dollar, New Zealand dollar, you know, still very small. The, you know, one shares declined in recent years. But I'm, I'm just for such a narrative that it's become in recent years, I'm just curious if there's any sort of data that you look to or point to that might suggest that there's even the beginning of something like that happening. Thank you.

- Thank you John. So we're gonna go back to the panel, start with Arvin. I have one clarifying question extra for Arvin. In your calculations, did you include the currency holdings of USDS under the mattress of Russian oligarchs and Argentinian businessmen protecting themselves for the next bout of hyperinflation? I I, I understand it's about a trillion dollars of actually a hundred dollar notes around that. Did you include those? And then, so take your time answering all the questions that you want to answer and then we'll go to Steven and then to Ken. And we have five minutes for each of you.

- Okay. Many questions. I'm not sure I'm gonna answer all of them, so I'm happy to take them also afterwards at lunch. First of all, I think this, this question about what measures to look at and what tells you that there's erosion. My way of looking at the world is there's many data points. Some of them are in quantities, some of them are in asset prices, some of them are in co variances. All of them collectively point in one direction that I won't put weight only one thing, I'm fairly short. We're mis measuring many different aspects of it. But just take, take the core variance point, the dollar after the tariff shock last year depreciated and in almost every previous incident we, we had a flight to the dollar. So there's core variances that have changed. Convenience yields have definitely fallen quantities are hard to pin down fully because I don't think we see them as much as we'd like to. So, but collectively that that does lead me to, in, to indicate that there's erosion. It's hard to know how much the erosion has happened because I just don't think we have clear enough data to, to nail that down. Just a, a couple of other points. So this is, Christian asked this question about satiation and so you just step back and you look, gosh, the US government has issued tons and tons of treasuries, surely that satiated all po possible convenience demand. But it, the answer to that is more complicated because as Hano emphasized, what has really happened in the world is the long-term treasuries no longer look like a convenience asset. And it looks like T-bills are still a convenience asset, still look like repo is a convenience asset. So one shouldn't understand it as the total quantity. That's the thing that's driving it. What's happened is the market is bifurcated and said this, it's only part of it which I'm really gonna view as safe dollar assets and it's the part that I'm fairly sure you're gonna pay back in the next three months. So it, I think that provides a, I think a better understanding of what's happening. Now that's also related I think to your second question, which is this point came up in in Ken's discussion. When we think about what matters for driving dollar dominance, there's many, many factors various written about this extensively. I think Ken's written about this extensively the mill. So there are many elements of it, but I think one theme that enters consistently across the history and across the writings is the provision of a safe and liquid asset is important in centering the currency. So in that sense, treasuries do staple to the dollar. And so the fact that the world is looking at the US treasury market saying it's less liquid parts of it are less safe is a factor that might unstaple the dollar as we go forward. I I, I feel that the data does tell us something like that. John, I think in your your point, I did a computation based upon the US and I in a way, what you're telling me is there's some other parts of the world that are also in the game of producing dollar assets. It is the case though that that other part of the world that's in the game of producing dollar assets are doing it against non-dollar revenues. The rest of the world that runs currency mismatch is doing this at a cost. We sort of get it for free, right? And that's what's built into the analysis. Matt asked this question about convenience deals going negative. So I wanna be clear for the, for the competition I did, what really matters is the convenience yield on safe dollar assets on an absolute basis, not on a relative basis. When you do a comparison of what's happening to the bun relative to the treasury, you're doing a relative comparison. But if you're interested in asking how much liquidity services are being exported, you just wanna know how much liquidity services are being exported on an absolute basis on dollar safe assets. And that's, that's the number that enters into the computation I'll hand over.

- Thanks Evan. So I mean so many great questions. I'll focus on the two more trade related ones, but I mean both, both great questions. So on the why not have tariffs, it's just one form of taxation. It's a great question. The, I guess there's sort of three reasons why trade economists would argue that terrorists tend to be a particularly costly form of taxation. So the first is although the tariff is actually levied on imports, so the statutory incidences on imports, obviously domestic firms that produce the same type of good also raise their prices as well. Because if the price of my competitor's goods goes up, I'm gonna raise my price too. And so the tariff actually acts like a combination of a tax on consumption and a production subsidy. And so trade economists often refer to that as a byproduct distortion because the tariff does two things, it taxes consumers but it also subsidizes production, which is a sort of an extra distortion. And, and then the other reason, you know, I think you can make the case for a tariff to be part of the optimal tax system, but, but the one reason why trade economists don't think the tariff would end up being very big on that margin is that the base on which the taxes is deployed is quite small. So imports are about 11% of US GDP. Whereas if you say you tax consumption, you can potentially tax the whole of GDP and the distortions of attacks are increasing with the square of the tax, the sort of hoberg triangles idea. And so it turns out that if you wanna raise the same amount of revenue with a tariff that you, you know, versus a consumption tax, it's just less distortionary to use a consumption tax just because the tax base is much bigger. So you can make the case to have, have some, you know, some tariff as part of your optimal tax system. But, but typically, you know, most trade economists would think it's relatively costly relative to some of the other taxes we have at our disposal. Obviously a consumption tax is regressive. That's sort of one side of it, but, but you can make the case for it and particularly in a world of AI where a lot of returns are gonna go to capital rather than labor. Taxing sales has, has some attractions from that point of view. And as a way of avoiding the, the, the, the downside as you pointed out to tot taxing capital. John's question was really great on, you know, exorbitant privilege and it's sort of kind of interesting that we have these two narratives. On the one hand, you know, the US benefits massively from that exorbitant privilege is one side of the literature. And then there's John pointed out, there's the other side of the literature which is this is a disaster, this is a sort of cost of the US and so clearly these sort of two things can't both be, be simultaneously true. I mean my personal take on that would be just that when we think about engagement with the international economy, there are not any gains to trading goods, but there are gains to trade and assets and trade in financial flows. And so actually, you know, if the US is able to provide safe assets and secure property rights be a great place for investment, that's just another source of gains from participating in international economy. If people invest their money in the US we run a, we run a trade deficit while benefiting from issuing IOUs and return. If that's all driven by solid fundamentals in the US that's just another source of gains. But it's a trade in assets rather than just solely trading goods. And I mean my personal take though, that would be whichever position one takes on that view, whether the dollar's a burden or a benefit. I think it's relatively modest in terms of explaining the decline in US manufacturing employment. Just with that sort of insight that I think John actually pointed out to me himself in the past is that if we go back far enough in time, 60% of us worked in agriculture, you know, most of us don't. Now some of that's related to trade, but most of that is just driven by technology and that would again be my view of the decline in manufacturing. You see that secular decline around the developed world. Maybe the China shock at the aggregate level obviously hurt particular communities, particular regions very intensely. But if you look at the economy wide level, it's impact on the aggregate share of manufacturing employment was probably relatively modest compared with these bigger, longer run secular technological changes. But, but these are really, really important debates and great questions and I should maybe stop there to, to stay on time.

- Oh, well lemme start with the, the Mar-a-Lago. Steven gave a great answer that it probably has very little to do. Arvin gave a calculation that's plausible to me in magnitude and probably has very little to do with why our manufacturing hollowed out. It was automation, you know, I haven't, we reevaluated the whole China shock paper and decided that actually very little of it was the China shock and it was mostly everything else and that turned out to be very politically attractive. And so everyone keeps coming back to it, but it's actually not that big quantitatively on clearly the dollars being held. And so there's lots of US based dollar assets. It's overwhelmingly in the global financial system, but at a higher interest rate. I mean that's the question of coming back to the fragility. Is it this time different? You know, is there just not gonna be a problem? And you can tell the story both ways, but I think, you know, certainly from a technocratic point of view, it seems kind of nuts to base policy entirely on the positive spin that there's not any problem. And I remember I, I mentioned, discuss this episode in my book sitting at a conference and I wanna say 2006 or 2007 and a, one of the top European political economists gave a talk at a conference saying, today is a very important day, there is more Euro debt than dollar debt. Well how did that work out? You know, I mean it's not, you know, up to the, that's the whole question. I mean of, you know, what the sustainability, I wanted to mention crypto 'cause I didn't really talk about it. It actually is taking away from the a hundred dollars bills. I have a paper on this. There are a number of other papers about this where, you know, I'm talking it, it's stable coins today. It depends on how they're regulated. It had been Bitcoin, but the whole point of crypto is it's government resistant and so has a lot of attractive properties that physical dollars. I'm not saying it's an exact substitute that's, but you know, it's definitely in the mix and I, I think it's a que you know, question going forward of how far that will go. Leave it at that.

- Thank you council. Thanks to the panel. I understand we, maybe Valerie wants to give us directions, but thank you to the panel and to everyone who has.

- There's been a last minute substitution. Andy Levin was supposed to be the moderator. He is here, but he's still recovering from a respiratory bug, and so he felt better not moderating. So I'm, I'm filling in for him. So for this session, we have Thomas d Dressel, Luis Ano, and Carolyn Wilkins. So come on up and then I'll join you here. Okay. All right. So, so the topic of this session is mandates, tools, and regulation. And one of the themes that came up this morning when we were talking about the importance of independence was that we saw that even when central banks don't necessarily have pressure from politicians on them, you know, basically have some independence, they could still make mistakes on monetary policy. And one example was the Great Depression and, and other poss possibilities that Ed Nelson just brought up, which I hadn't realized was even the Burns Nixon sort of thing. So that's why mandate tools and regulation is very important, because an independent central bank that's allowed to do anything, you know, can be a problem. And it also shows the importance of having good economic ideas governing monetary policy, rather than some of the issues that they had before. Another theme that came up this morning, I think it was Hano that talked about it, which is when you have these changing environments, if you don't change your model to meet them, you can end up misinterpreting the data. So all of those things sort of fit into the, the whole idea of this panel. So we're, we have Thomas d Dressel from University of Maryland, Luis Ano from London School of Economics, and Carolyn Wilkins from Princeton University. And so Thomas d Dressel will be first.

- Great. Thanks a lot for the invitation. The session is titled Mandate Tools and Regulation. In my remarks, I would like to think about those themes through the lens of some new research. And in this research I study quite literally what fetches do all day, therefore, the, the title of my presentation. So what is this research about exactly? As many of you will know, the Federal Reserve releases the daily calendars of the Fed chair. This happens with some, some delay, typically of around two months. But the calendar provides us with an itemized lock of all the appointments that a given Fed chair has or had on a, on a given day. So in a new paper together with Dali Cher, who is a graduate student at Maryland, we basically digitized all the calendars for Bernanke, Yellen and Powell and turned them into data. And that involved, essentially, you know, the data comes as text that involved classifying appointments of the Fed chair into staff meetings, meetings with private sector representatives, meetings with the media, international counterparts, et cetera. So why am I showing this? The, the session is about m tools and regulation, seeing how FET chairs allocate their time in, in different periods revealed something about how the fetcher interprets and, and exercises the mandate where, where the mandate begins, where, where it ends. So I'm gonna show you that for, for three Fed chairs, I briefly wanna mention some, some other work that, that I know some of you have seen before. In that work, I look at presidents and feds and, and officials from the Fed, how often they meet. I do that over a long time period to study threats to fed independence. This year is different. I look at more recent, the more recent experience, but a wider area of, of activities. So let me show you some examples. These are two days in the tenure of Jerome Powell. This is, I picked April, 2020. That's a pretty interesting month during the pandemic. And you see here the appointments that Jerome Powell had on those days. He has a phone call with the general manager of the BIS talks with senators, has a conference call with Steven Mnuchin, again, talks with members of Congress. Another example is here from January, 2009, also a very interesting month. Those are the appointments of, of Ben Bernanke. You see, there's a farewell dinner for Tim Ner, the swearing in ceremony of Dan Rule a meeting with the CEO of of Ford. So there are all those calendars for every day. What we do is we read them into a computer, label those meetings, put them into different categories, and then just plot that time allocation through time. So what I'm gonna do now is just show you a bunch of charts, five or six charts that, that tell us how, how these three fetches allocated their time. So what these charts are gonna look like is on the x axis is time. And I'm always going to plot that at quarterly frequency. And, and in principle we have that every day. I can aggregate that to pre to different frequencies. I'm showing the quarterly series. And then on the y axis, I'm gonna have either the share or the number of activities that fall into a given category. So I'm gonna start with staff meetings. And here I'm going to plot the share. And I, I just wanna point out the very beginning of Bernanke's schedules. The format is a little bit different. So there's this that share is very low, but that, that's due to the way these, these calendars in the beginning are a little bit incomplete. So I want to draw your attention more to what happens after the first three or so observations. So what you see here is there's not a really big difference between those three Fed shares. About 30% of their activities are meetings with the staff. And that highlights the importance of, of staff economists in the, in the federal reserve system for the, for the chair's decision decision making. So there's nothing, nothing controversial here, just shows us that staff have a key role at, at the Fed. Next, I'm showing you meetings with the media, and I am plotting here the, the number of meetings per quarter. Again, the, the first two, three observation in the bernanki schedule. I, I, I don't trust them that much, but even thereafter, there are very few meetings. And then kind of midway through Bernanke's tenure, we really see many more interactions with the media. This is partly driven by the introduction of the official FOMC press conference, which was introduced a midway through Bernanke's tenure that's shown here as this purple bars. And you also see that the purple bars go up under Powell because under Bernanke press conferences were after every other meeting, and then Powell made them after every meeting. But what we also see is that outside of the official press conferences, there are many interactions with the media. There are individual interviews, TV interviews, sit downs with groups of journalists, et cetera. And it shows you that if you draw sort of an average that's around, you know, 12 to 15 meetings per quarter. A quarter has roughly 12 weeks. So the Fed chair meets about once a week with representatives from the media. You can be the judge of whether that's a high or a lower number. I know that in previous conferences here, there, there were discussions around how much the Fed should or should not engage with the media. So that's something that happened under Bernanke and it's, it's something that, you know, has a big footprint in the time allocation of, of the chair. Next interactions with the private sector, this includes representatives from the financial sector, so asset management companies, banks, insurers, et cetera. It also includes representatives from non-financial corporations, interestingly, and you see here. So, so all of these categories are shown as the, as the stacked bars. And you see here that both Bernanke and Powell had a quite a large number of interactions with the private sector and sort of flattens out in the middle. So this is to some degree driven by different crises. So the global financial crisis, which falls into the middle of, of Bernanke's tenure, has a, has a big footprint here. And it really starts also going up under Powell, which is the SVB crisis. And what I found interesting is if you look at these blue bars, these are non-financial corporations. So there are meetings, you saw it in the example for Bernanke, the, the CEO of Ford is in there. They also met with the CEO of Coca-Cola target and, and other companies. So this is, this also is something that the Fed chair does, and it seems to be centered around crises. Next, I'm applauding meetings with international entities, international counterparts. This includes bilateral meetings, for example, when the Fed chair meets with say, the, the governor of the Bank of Japan, but it also includes multilateral meetings, for example, meetings with the World Bank, the IMF or G 20 meetings. What we see here is that there's again, a big number of meetings. So you see in certain quarters as much as 70 meetings and, and phone calls, and there's perhaps a general upward trend. We talked earlier about swap lines and other ways the, the Federal Reserve system connects with other central banks and the world economy. It's important and it has sort of in a secular way trended upwards. The next category is meetings with regulatory agencies. We include here F-D-I-C-O-C-C-S-E-C-C-F-D-C, et cetera. And that that's pretty rare, you know, in many quarters there, there are very few interactions, less than less than five. It starts growing under Bernanke, probably due to the, the global financial crisis. And then there's this huge spike, which is the, the SVB failure. And which was a time when Jerome Powell met a lot in particular with FDIC leadership. So that, that, that really stands out. This is the last figure I'm gonna show and is my favorite one. These are meetings with members of Congress, so with members of the House of Representatives and, and senators, and I'm breaking this down by party affiliations. So we have Republicans and Democrats and also independents are here. And there were some meetings when multiple, multiple politicians were in the meeting. So what we see here is there is really a structural shift under Jerome Powell. Jerome Powell, much more than his two predecessors met with members of Congress. We have another figure in the, in the paper where we, we break that down by Senate and House. And a lot of those meetings are with the Senate typically. Also, this came up a little bit earlier on when, when there was a discussion around congressional interactions, it's often with the leader of the Senate Banking Committee or the House Financial Services Committee. But it's much more that this was the case under, under Jerome Powell. And this has been pointed out by, by other commentators that Powell is a pretty political player and he has proactively sought a connection with Congress and perhaps lobbied, you know, for Fed independence with Congress. So this, this really shows up very clearly here in the data which I found, which I found notable and also the split between the two parties is relatively even. There's a little bit more under power with, with Republicans, but a a pretty even split in those interactions between the two parties. Okay, so let, let me summarize the Fed according to this data, which, you know, it's very indirect data, how a FET share spends their time is a function of what happens during the time. But it is to some degree also a function of what priorities a, a FET share has. So when, when we look at the data, we see interactions with the media have, have certainly grown, starting with Bernanke, interactions with regulatory agencies, have grown again with Bernanke throughout, there's an increase in interactions with international counterparts and starting with Powell, much, many more interactions with members of Congress and then meetings with the private sector and also meetings with regulatory agencies appear to be kind of cyclical and, and have a large footprint in, in crisis times. So I thought this data is interesting to show to this audience because some of these developments have been hotly debated here at Hoover. You know, how much should the Fed en engage with the media? Where do we draw the lines on, on regulation, the political interactions matter, et cetera. So we're in a moment where New Fetcher comes in and Kevin Wash has already made some remarks around, for example, how often the fetch should give speeches, et cetera. So I think this data also nicely tees up a discussion around what should happen going forward and how where should the lion of the mandate be drawn and how that will impact the, the priorities and the time allocation of, of the Fed chair. That's it. Thank you.

- Thank you, Thomas. Alright, next speakers. Luis Carano.

- Yeah, you say it perfect. You doubt, but you say it perfect. Hello. Thank you very much. Thank you Valerie. And thank you John. And, and thanks for, thanks for, thanks for setting this up. I put my blog in the title so that people could, could, could register the marketing announcement. So I'm going to, I'm going to try to, I'm going to try to use Europe. I'm going to assume that most of the crowd doesn't care about Europe, but they do care about mandates and tools and accountability. And I'm going to try to draw some lessons from what we learned in Europe. And the lessons are kind of in relation to, to a, to a piece that John published. And, and you know, John's, John's thoughts on this. So, which I was like, okay, if you want, if you want a mandate, if you want independence, you, you need at least these three things to work to together. And it's a package with the three parts. It has to have a limited mandate, limited tools, and you have to be accountable. And I'm going to show you that these things are necessary, but they're endogenous. And that even though the ECB has the narrow mandate, it has the strong legal independence and the, in the treaty level prohibition, it's not gonna actually, as you will see, be able to have defacto independence. Although it looks very, very independence. The idea is gonna be that as long as the toolkit kit is unconstrained, the mandate is really kind of, it's very easy for the mandate to drift in the case of the European Central Bank, the drift, as we document in our, in our joint book on the Europe, which you have outside to, to pick up for free, the drift in the mandate enables the drift in the mandate happens through two, two expansions of the mandate, which are protecting the monetary transmission on the monetary policy and ensuring financial stability through those two little holes or big holes. Basically, you can stick anything in as you will, as you will see in a second. So, and, and then the facto, the, the, the, the rest of the architecture, that's the rest of the job. So I'm going to show you that there is a leak in, in, in fiscal that we start with QE and with TPI down the road at least to deal management. And by using these tools and the fiscal situation we're confronting, we end up with fiscal dominance. We see that the toolkit also expands in finance and we end up with financial dominance. I'm going to do something that we asked John to not do in the book and we didn't do in the book, which is talk about climate. I'm going to talk a little bit about climate and tell you, show you I, I'm, I'm saying climate dominance bit tongue in cheek. Okay? Don't take me, don't take me to say like there is climate dominance in the ECB, but, but I'm, I'm going to coin this term for whatever is is useful. So the fiscal dominance comes because the bank tools allowed this leak into fiscal policy. I'm not going to tell you something that you don't know. You, you saw this in the, in the Fed, a huge fiscal expansion, big, big balance sheet expansion that converted all these, all these liabilities into overnight debt. And now the taxpayers pay the policy rate on every, if you think of the balance sheet as a consolidated balance sheet, the taxpayers are paying the policy rate. And so you accumulated, as in the case of the fed very large losses, 90 billion combined by those four entities. The, the bundes bank, the foreign bank, the France, the MB and the and the A CB. Interestingly, and Han Lu has been writing about this in Europe. There is something that doesn't happen in the US when you get this, this fiscal interventions, which is they also have an element of cross-country distribution. I've listed some of the main ones, the PPP flexibility, the TPII will not go through all these acronyms because you will get bored to tears, but you all know about target two and otherwise Vulcan no is gonna explain you for sure. But the basic idea is that you are gonna have a very large transfer that has been calculated by, by, by hano and co-authors. This is the upper, the higher spread counterfactual at very, very significant transfers of GDP over 10% from Germany to Italy in Spain. By the way, these are no transfers in their calculation to the Italian Spanish taxpayers. Some of it three points or so, four points of GDP are transfers to the banks, to the Spanish and Italian banks. I can explain you the mechanics if people want them in the, in the break, but i in the, in the q and a, but I think people, people know them. The surplus that you need to compensate for the structural deficit that we are seeing are unlikely to appear. This is a graph from a bruel report from the end of last year based on the, on the whale, on the, on the world economic outlook that gives you the consolidation that you need in order to stabilize the debt at the levels of today. And almost everywhere in Europe, you will see that the US numbers in the stochastic sustainability analysis that Zeel Meyer et al in Bruel do doesn't come out too well too badly. The US is in the middle there at 1.3 points of GDP of consolidation. Several countries in Europe are, are, well all of the rest of the list, as you see is there. So you're not going to have that surplus coming. And what that means is that with the pension me that the political economy, I mean I think everything you need to know is, is, is in these graphs, right? That's this, this, the left one is from the ft I have a similar one for Spain. They didn't put the graph for Spain. You see that the French pensioners are on average earning more than the average working age adult. That's the average pension in in France. My calculation in Spain is the exact same. It's, it's bigger, the Spanish pension and the, and the Spanish salary. And you see that most of the increase in real GDP per capita has been the blue line for Spain is, is the salaries. And the orange line is for pensioners has all gone to pensioners. So pension arithmetic is very bad. Why do I say this? Well, because given this drift in the mandate, what is happening is that the pension reform in France has been reversed as you know, November 25, the assembly blocked the reform. The retirement age moved down from 64 to 62. I mean, just let that sink in, right? McCone had managed to push their retirement age up to 64 and it, he had to rectify and go back to 62. The markets, I mean, there was a little reaction, okay? I'm not going to tell you they didn't react, but there's many people from the markets here that can tell you the reaction was minimal and the reaction was minimal because the ECB there is there to close the spreads. And it's not something that the politicians haven't noticed. Okay? So when you do pri when many, many people not inside this room do macro as in the old times of 40 years ago with GS and Ts and all these aggregate quantities as if humans didn't exist, they forget that humans do exist and they're still human. So Desmond and Sean saying that today, actually, he said this is not from today, but I read what he said today, this debt is not real. I mean, of course the ECP already has it. Why doesn't he write it down? What difference does it make? That is his view. He wants to cancel the COVID debt to pay for the social transition. And from the right has said, you know, maybe the French economy breaks the whole Europe breaks. Okay? So we are gonna have, if I get elected, a very serious conversation with a CB. So both wings are treating the A, CB as a, as a, as a tool that is there not as a taboo. And the a CB doesn't really have a good option. Okay? I mean, how much of this is because of the mandate drift and expanding the toolkit into QE and all that? I I, it's unclear whether this will happen. Otherwise, what is clear is that once it has happened, politicians have recognized and now it has two options. It can hold the line on inflation and then the sovereigns are going to be in trouble or it can keep the yield management and the prices stability is going to go away. Okay? So that's the first mandate drift, the toolkit expansion. The second of course is financial dominance. And, and here, I mean the excuse of the ECB is, is a pretty good excuse. It's not very good in the, in the first case, although we do explain in the book that there were no crisis fighting tools, but that was endogenous. Of course the drift here in the financial dominance case is more in some sense necessary. But you'll see how endogenous they CB starts buying this, this bank doing emergency loans, subsidized emergency loans, banks, the TLTs lasted for 10 years. Resolution in Europe hasn't really been used. Those are the resolutions that were done by the European organ that was created this European resolution, the some resolution board, this, no, it's not sovereign. Ah, the resolution board and the single resolution board, SRB and 23 of the rest of the, all the bank rescues have still been done at a national level. Why? Because the national, there is the toolkit of the A CB and they're expecting the a CB to come and, and do merger lending when necessary. So there is no deposit deposit insurance and the German spark has, are chaired by German politicians. There's a very nice piece by Nicola Varone, co-author Macal showing that 82% of the board chairs of these saving banks in Germany are elected officials. So again, you get an institution that is very politicized and the fact that the mandate is price stability, is that going to prevent the leakage? Well, not because the ECB is there to pick up the pieces when the banks go past and the SRB is not big enough or powerful enough. So again, tool drift and endogenous expansion of the mandate. Third, climate dominance. So again, I tongue in cheek. So here we have a clear mandate that says price stability. And we have the European central bank that is doing corporate beholden surrounding climate, better rated climate issues, climate factors in theological frameworks, climate related disclosure, climate re stress test. You'll say, how on earth are they doing this? If they have a limited bank, there are two doors that they use. One is the secondary objective, which are prejudice to price stability. They have to support the, the union's man, but economic policies, but they don't really use that. What they do is they pay economists, like people in this room writing huge DGSE models to show that inflation will go crazy with climate, et cetera. And that transmission will be affected. Now what is interesting about this is that it's not inflation, it's not inflation, it's price levels, right? So there is a, a blog, an FT article in a blog by Frank Elon that says like the inflation surge was a fossil, fossil fossil inflation. The imported fossil fuels went up. And then there was an energy, huge energy increase, which shows that we needed the energy transition, which hopes that shows that this is a monetary policy problem. The problem is the inflation went down. Did you see any policy, any mix in the climate, in, in the energy mix between 22 and 23? I don't think so, right? Inflation went up and it went down and the energy mix didn't really change. So it is not the energy mix which explained the increase and is not the energy mix. What increase explains the down, but also and more important for me, yes, climate shock do produce price shock, but I mean it's really a huge endowment of the profession that we haven't managed to explain to the world the difference between price level and inflation. I, I, I can't understand why, why this is not an obvious point. So the acbs on projections show that the energy driven race gives place to a energy driven decrease, but also don't expect that those models are going to take into account that clean energy investment. And the carbonization and a TS design are actually increasing price levels as well. Okay? And I am in favor of many of those measures as somebody who does defense, for example, the a TS, but it's not like they don't also have an increase in the price levels if that's what you're worried about. So the single mandate that the Jones peace defense is really not enough also in the climate case because the institution is going to interpret the, the, the mandate and is going to find the door to expand that mandate. So I'm basically going to to, to wrap up with talking, talking very briefly about the Fed. So what we're wrong. So fiscal dominance comes from a, with a narrow mandate, oh, impossible, you're not gonna have fiscal dominance. Yes you are, because the tools expand with qe, QE and with the TPI and all of that. And the ECB expands the mandate to say, well, we can do this debt management because it's not debt management, it's not deal management, it's actually preserving the transmission of monetary policy, financial dominance. Again, the mandate is narrow, but the toolkit expands how, because with all these land of last resort operations, we end up in a world where basically the banks understand that they are going to be bailed out and financial dominance is inevitable. And with the climate there was a narrow mandate, but the red definition of climate risk as a risk to transmission has expanded the scope. So my lessons are that yes, the independence deserves, thenar requires the narrow, the narrow interpretation of, of the mandate. The A CB has legal independence. So that's not going to, that's not gonna cut it. The weakness is you're gonna have the ability to expand on this marrow mandate as long as you have all this tool kit as your disposal. So things that I think you need to do is to make sure that all emergency facilities that are put in emergencies go away when emergency is gone, require authorization for asset purchases and beyond treasury, between treasuries and try to not allow this, this drift. And finally, that the threat to independence is not just the unlimited mandate, but it's really they, it is endogenous, the mandate and the tools are endogenous to the world where this institutions are living. And as long as they can interpret the mandate in those ways, the drift is inevitable and the loss of independence probably also. Thank you.

- Thank you Louise. And our next speaker is Carolyn Welcomes.

- Well, thank you very much for the invitation. It's always an amazing conference that lives beyond the day because a lot of people follow what was said, and I, I know that from a a point of view outside of the, of the US and so, and so I wanted really just to start right at the beginning, I mean, obviously the mo modern case for Central Bank independence is, was built around monetary policy and price stability. We heard a lot about that just now. And so, you know, clearly we wanted to delegate these decisions, the operational decisions in a way to achieve price stability and avoid short term political pressure that really matters. It's, it matters a lot more now than maybe before because of the US fiscal position that we've talked about quite a bit today. But the fact that we've had COVID, we've had the GFC, we've had the expansion of balance sheets and the tools not only, not only on the monetary policy side, but but on the financial stability side, I think we need to review what independence actually really means. And so, and so, you know, I wanna do that by, by making the case that the, that the central bank independence is being tested across several margins all at once. Okay? It's about really about what's the, is the independence to do what with what instruments and under what accountability framework. And so if we talk about it, we can organize around three, three themes that I think are a bit different, but, but complimentary to what we just heard, which is why is monetary policy and, and financial stability policy, why are they different and why do they require different forms of accountability? What is the balance sheet debate and how the Fed uses its balance sheet really about what's it asking us to choose between and what governance is needed so that we can have some flexibility that I think central banks need, but avoid the mandate creep. And so before I start, I'll just say these are my views, not the views of the Bank of England. So, so if you look at, if you look at monetary policy and fin and, and financial stability, they clearly don't fit into the same independence framework. Clearly from monetary policy, the mandate's pretty clear even with the US having their, their dual mandate, you can still measure inflation, you can have some estimates of full employment and so, and so you can assess how well the fed's doing Congress and markets can, you know, can see whether the Fed is actually delivering on its promise. But on the financial stability side, it's completely different. Success is actually when a crisis doesn't happen, nothing happening is not really a, a key performance indicator and more importantly, the tools are very different. The measure, the measures that we put in place to mitigate the, the probability of a crisis happening or to respond to a crisis when it, when it does happen, affect particular firms and markets, even what business models are viable, were not in ways that monetary policy really doesn't. And those costs that are, that are imposed by any of these actions are really visible. But the benefits need to be counterfactual and how you can agree on a counterfactual situation to assess the net benefits of any of these tools is, is subject to a lot of debate. And I think the point I'm trying to make is really close to the one that Andy Andrew Bailey made last month that Columbia and others have made many times before the case seems better developed for monetary policy even though we have lots of discussions about it and much less complete for financial stability. And, and so the problem is, is you can't cleanly separate them because obviously successful monetary policy depends on financial stability. If you don't have well functioning credit markets or accredited intermediation, even trust in money claims, while monetary policies aren't gonna be very effective and in a stress episode, actions to stabilize markets may be necessary, otherwise monetary policy won't work at all. So still those two separate functions cannot be allowed to blur into one kind of open-ended authority like I would argue we've, we've sort of seen over the past decade or so. So where these one set of decisions, there's a ton of things I could talk about, but one set of decisions where these issues are especially visible are with respect to the balance sheet and how the balance sheet is managed. And I think the debate that we hear, the political economy around it or just the politics around it, tend to conflate two different questions. One is what balance sheet authorities does the fed need in normal times to implement monetary policy to do its job? And the second is, what should it be able to do when interest rates are at the lower bound or when markets are under severe stress? And if I start with normal times, I'm instinctively very sympathetic to a smaller central bank balance sheet In Canada, the pre-crisis corridor system worked really well. Their, their lien system seems to be working well so far, keeps the central bank put footprint a lot smaller and preserves that monetary fiscal boundary. But I realize you just can't adopt that in the US we've got a different banking system, more con, more concentrated and we've got a a payment system. This is getting maybe a little technical like going to the dentist as Chris Waller said once, but, but we've got more liquidity saving mechanisms in our, in our, in our LVTS. And so we've got less need or demand for, for reserves. I also think we can't, I agree we can't turn the clock back to 2007 for for many, for many reasons the currency outstanding is higher, more volatility in the TGA. We've got new regulations, all kinds of things that mean probably gonna end up with a bigger balance sheet. But I think Chris Waller in his speech last year at the Dallas Fed made a really important distinction and that was that there are two reasons that the balance sheet grew and one of them was the move from the scarce reserve system to amp ample reserves and the other one was qe. And they're quite different. And I think when we assess what happened and what we need to going forward, we need to keep that in mind reserve remuneration no matter what is not a side issue. But again, it's not about the optics of visit right? To to pay banks for, for reserves. It's really about what kind of operating system do you want, right? So there are trade offs there and I think that it's a choice what kind of operating, operating system you, you want not about, not about the payments to banks. And you know, bill English and Don Cone made this point really clear in their bookings note, the banks actually have to fund their reserves, the reserve holdings. And over time the effect on treasury remittances depends on the fed's net interest income. So not just on the gross interest paid on reserves asset composition's. Another, another issue I think in, in normal times there's a reasonable case for holding shorter term assets because, and that's if your system like in the US permits, that reduces the interest rate risk and limits the fiscal optics and it also helps distinguish between normal time operations and when some extraordinary operations are required. There's other models out there. The Bank of England has a repo led demand driven framework that so far seems to be good. It's a smaller steady state balance sheet, more active routine liquidity provision. The real test's gonna come when there's some stress. I think really the choice is how actively do you want to manage liquidity and how leads do you want to encourage demand for reserves to decline? But I don't think the normal times is the hardest case. I think the hardest case is when you're at the zero lower bound or when, when just purchases of t-bills is is not enough. So, and you know, the Fed has a mandate to execute on and so if they, the interest rate tool is not the one that's gonna work to do the job, then something needs to happen. Of course, the obvious thing is fiscal policy because fiscal policy could be better placed to support demand, but we just can't assume in the US or in any country for that matter matter that fiscal policies is gonna be timely or targeted or well coordinated with monetary policy. And so, and so I think if you're gonna commit to your dual mandate, it's a bit like man marriage. You have to be able to to, to commit in good times and in bad. And so the bad times could be, could be periods of market stress, right? You could have something like March, 2020 when the Fed didn't, did not start doing QE in the usual macro sense that did it to, because the treasury market was under strain and they thought, well if core markets aren't functioning, monetary policy, transmission won't work. That made total sense to me, you know, later that morphed into stimulating the economy. And so maybe, maybe QE was appropriate at the lower bound, but it needed to be justified differently. And I think this is where the framework matters. So I think that asset purchases for, for market functioning are targeted, they're temporary and they're tied to market conditions and you get out fast, you know, for qe, the no one's gonna disagree that they're, they're tied to the outlook for inflation and employment and that, you know, you need to take into account all the risks, including the fiscal risks. But I think where we could do better is really on the assessment of the net benefits of the qe. And I think, and I think, and I'll talk about this a little bit later, but I think EXI explanation and ex post accountability are really difficult to do without that full framework. I did a paper with Bill Dudley for the G 30 last year and there were two issues that we saw. The first was that, that the fed just shifted gradually between market functioning language and macro stimulus language. And then there wasn't any kind of full framework that that really tried to have a comprehensive set of costs and benefits. As conditions changed, they would've benefited from that. I think Andy Levin, who is in the back trying to deal with his respiratory issues, put the numbers, tried to put the numbers on this and others have tried it too. And I think those are very, very important initiatives. You don't have to agree with every assumption that they make behind their estimates to accept the governance point that I wanna make, which is large scale asset purchases, lead and need and explicit framework for assessing the benefits the fiscal costs. And, and this needs to be done before you start and as conditions change and you double down. Okay, so, so I guess I guess that that, you know, another point that I'd like to make is really about the, the governance. I think that the tools need to be limited, but the devil's in the details. Where do you put those limits? And you still need some flexibility. And so I don't think we can settle the question by saying, okay, there's one operating framework we need, there's one set of tools that we have because we just don't know what the future's gonna be like. So, but I think that we can manage that, we can limit it and we can limit the mission creep and then deal with the flexibility through governance. And so the first is mandate consistency. Can the central bank deliver on its monetary policy mandate both in normal times and when you've hit the lower bound or when you have financial stress? Second is operational capacity. Can it control short term rates and normal times? That sounds like an obvious one. The third is market functioning capacity. If core markets break and the central bank can't intervene quickly with purchases for example, there's gonna be an issue. And I think that people will change their mind about what set of policies they wish they had or tools they, they, they, they wish they had. But again, this accountability framework should be there to keep those kinds of interventions temporary and not drifting into permanent balance sheet policy. We need some fiscal boundary discipline. It was talked about, I think very well by the previous speaker, Luis, but, but maybe not approval per se, but in some other jurisdictions like Canada or the uk there are indemnities that are either required or were requested before these kinds of purchases and financial risks were incurred. The last one and the one that I really want to emphasize is accountability and review are the net non-standard tools subject to an Xtandi framework, net benefit assessment, exit principles and independent external evaluation. You know, there's not one student I have that doesn't want to set and grade their own exam for sure, but one of the lessons I took from the bank, the central bank reviews that I did for the Reserve Bank of Australia and and the Ricks Bank, was that they can actually increase central bank independence and increase the credibility because they allow the assessment of the frameworks and tools with, with hopefully sensible people and not turning the day-to-day decisions into political bargaining. So the last thing I'm, I'm gonna say when I when I look at this is that maybe we could look in terms of governance to other frameworks. The Bank of England, we could talk about it more afterwards, I think has a very interesting framework to separate financial stability, prudential regulation and monetary policy. One of the most important things is that the, the CEO of the PRA is not on the monetary policy committee, but there are other advantages to that framework. So final thing, this almost looks like the, the last slide of Luis all I wanna say it's not all about the legal restrictions and, and things that allows you to do durable independence has to satisfy democratic accountability. And I think I went through a couple of ideas that I think would help that.

- Thank you Carolyn. Let me just start with a couple questions and then, and then we'll go to general questions. So first of all, I wanted to ask Thomas, you, you presented such interesting new data, you know, we all kind of have impressions and it's so great to, to actually have data on it and I was just wondering how you think that data might be used as a next step. So that's for you, for both Luis and Carolyn, you, you've talked about some of these other structures that they have in, in say the UK or the ECB and I wondered your views on thinking about perhaps changing some structures in the us. So for example, you showed us that mandates having narrow mandates is certainly not a panacea, but would it make sense for the US to have the ECB structure mandate where a primary is price stability and secondary is the employment? And the reason I ask is there is very interesting paper by David and Christie Roamer at Brookings a couple years ago trying to figure out if the fed's new framework WA had led to the rise in inflation 2122 and they going through FOM minutes of the FOMC. They actually concluded that no, it was because they suddenly started putting a higher weight on the employment term in the objective function. And not only that, they, the way they were talking, it sounded like they were substituting the employment of the most margin employment rate of the most marginal worker rather than the average employment rate. So I have a question of, you know, whether that would, whether that would be recommended and whether it might make a difference.

- Yeah, I'm glad you found the data interesting. I've been looking at it a lot and and was wondering if people find it interesting and then I thought if anyone does, then it's the, the fed nerds that come to this conference in, in some previous research. It's the paper that I mentioned in the beginning. I I looked at the calendars of US presidents, those are available for a very long time period. And then I, I built an indicator from those calendars that I then use in a more formal eco econometric analysis combined with some, some narrative identification strategy. Here it is a little bit more difficult because the data doesn't go back very far and it's a little bit hard to benchmark it. There are, there are calendars for, for fetches going further back in time, but they're very patchy. There's a little bit for Greenspan, there's for example nothing for, for Arthur Burns, which would be particularly interesting. So at the moment I'm presenting this rather descriptively and, and, and think that's interesting in, in its own respect. Doing something more formally is a, is a bit difficult due to the short time period and, and lack of, lack of benchmark. But I'm, I'm actively thinking whether whether I can do more. It's, it's kind of interesting that in the, in the managerial economics literature, there's some work on CEO time allocation and how that affects performance. I I think there's nothing in the monetary policy literature. So maybe in that direction there's something there. If anyone has ideas, let let me know. But for now it's just some descriptive, hopefully interesting figures that come out of this.

- Yes, on the You want to start on the mandate? No, I mean on the mandate. I mean I-I-I-I-I go back a bit to, to what I said. I mean, if, if you have the, the, the ECB has has the right mandate. I think it's, it was, we, we went in the book over over the reasons and the, and the way that the, the, the, the, the people who set up the, the Europe thought about monetary policy and they thought with very sharp clarity about the risks and the ways that monetary financing could happen in a monetary union and so on and so, and so they, I mean, it's as good as it gets. I don't think the mandate has any problem. I don't know if John would, would disagree with that, but I think the mandate is, is, is exactly right. And, and I mean I think that gives you what the limits are and the limits are at the end of the day, an institution, a place like the us which is, which is probably going to be at 140, I don't know, I know can tell us some crazy number about what, what what debt debt ratio. Ratio. I mean that 140 is going to be in, in, in, in a few, in a couple of years, but it's going to have very, very large debt. I would imagine that the pressure to, they won't default. So the pressure to monetize will be similar. And I don't know that employment objective will make a difference either way. That's my sense. I mean, my sense from the European case is that at the end of the day, financial stability and, and, and not rocking the boat too much is going to prevail. And if the alternative is provoking a huge fiscal crisis, then whatever the letter of the mandate says is not going to be strong enough either way. So I I would, I would, I would be in favor of doing what you're suggesting, right? There's no question about it. I would be in favor, as I said, in the last light of limiting the, the two kit and, and, and, and doing the emergency operation and undoing them because it's very easy to do qe, but it's very un difficult to undo it. But I am not sure it would be a a, a sharp change in, in that moment, which we are all thinking about, which is when, when, when, when, when it will come to a, to a fiscal crisis. And, and I guess the reaction is the one that we, that we can anticipate. By the way I said V villain, I'm so sorry, I I was

- So, so I'm just gonna, so QE is difficult to get into. I think it's more easy, it is easier to get out of than it's har it's hard to get out of, but easier than people think it. I think that, I think that part of the barrier was having a clear set of exit strategies that allowed credibility, that allowed sort of flexibility when conditions changed in terms of sequencing, but also maybe a bigger stomach for some volatility in the transition that may be uncomfortable but doesn't have real effects. Easy to say when you're not in the seat on, on the, on the catch. So, so I'm gonna just say that, and of course with hindsight, in terms of the mandate, when I was at the Bank of Canada, I never advocated going to a dual mandate because I thought the a flexible inflation targeting regime was just simple, easier to explain and, and, and be accountable for without any clear, you know, from the research, any clear compromises with respect to welfare outcomes as they're measured in these studies. So we could discuss that. But I would just say that it's not a get outta jail card for some of the issues for th three things. One, we just observe that many central banks with single mandates made the same inflation error. You know, you could argue that the US issue with more the issue the Fed was more related to the asymmetry of their inflation target. Like we worry more when, when we're below and we're gonna make up strategy than it was with the employment mandate. But I think the second thing is that when there's the divine coincidence, it doesn't really matter. You get the same outcome. And even in the face of trade-offs, even with a single mandate, you're still compelled through political economy to explain what your trade-offs are and why you're making them. So it doesn't get you outta that. And then I think at the end of the day, the employment mandate, the full employment is also a question of horizon because if you put too much weight on that, all you end up is more inflation and, and in, in the face of a supply shock, and then even less employment down the road because you have to react more quickly and more than you would've otherwise.

- Thank you. All right, John Cochran and then Sebastian afterwards.

- Hi John Cochran Hoover, you knew I wanted to jump in on this one. Thank you, Valerie.

- Yes. We know

- This was a great session and I think you're highlighting what's in the mandate. What's important about the mandate is not what's in it, it's what's not in it, the mandate means and nothing else. Thank you very much. That's the important part. Mandate drift. Luis, thank you. What a wonderful, what a wonderful new word. Everyone in America is a Supreme Court scholar and we're all originalists. So we like, we look at these words, but in fact, the mandate is what it evolves into, what it gets interpreted into and, and the way it happens, the Central bank does something, you know, the fed supports corporate bond prices. The ECB starts bailing out countries, and if no one objects and they do it a couple more times, then that has become part of the mandate. And that's actually, you know, how things are supposed to work. But here, there's the, this really highlights a big weakness. We have, we talked about congress and, and quarterly and, and reporting and so forth, but I don't remember anyone in Congress saying, fed, you've exceeded your mandate. It's mostly you need to send more money to my constituents in the European Union who is there to complain if the ECB exceeds its mandate. What, what committee in Brussels is out there saying, you've exceeded your mandate. The, the ECB is way more independent than the Fed in that there is no one to complain when, when they've done. Which brings me to the, the, the big question. It is 1951, it's not 1972. The issue facing us for going forward is not some Phillips curve goofing of the economy. It's the fiscal question part of Central Bank's independence is to pre-commit. We're not gonna bail ba bail governments outta their fiscal problems. And that is a design, a good design so that countries can pre-commit to repay their debts and, and not inflate them away. Historically, that was way more important than Philips grip. Some central banks were not allowed to buy their own treasury bills precisely to stop that. But do we really want that? Do we want that prohibition on financing deficits? Well, it's, we're all kind of anti deficits, I can tell here. Oh yeah, we want the fed to not, not bail out of deficits and so forth. But really, how about we're gonna replay COVID. Do you really want the Fed to say, Nope, we're on on, we're not monetizing, we're not lowering interest rates. Our job is inflation. Tough luck. How about World War ii? Do we really wanna lose World War II on the altar of no inflation? We're not monetizing debt, we're not holding down interest rates. We're not forcing people to hold government bonds. Think about what you're saying. What you're saying is the Central Bank should have the power to force a fiscal adjustment when the pre-commitment failed. You government must raise taxes, you must cut spending, you must default rather than inflate. That is our job. Even if that means losing a war, I don't think any of us want to go that far. I don't think the Fed's mandate is to go that far. But I think we need to all understand where is in this fiscal monetary thing, where's the limit? Because we all say the Fed shouldn't do fiscal policy. That's fiscal policy. You must raise taxes. It it, you know, that's deep into fiscal policy. I would like the Fed to have a strong and official mandate. And then it's Congress's job to say, this is an emergency, sorry, mandate suspended. You, you guys do it. Where we are now, I, I think is not, we are not prepared for what happens when, say China invades Taiwan. And, and this exact question comes up again, your thoughts, I had to turn that into question somehow.

- Sebastian Edwards. And then, and then the next one will be Han Lustig. And I can't see that far back, but you're, you are the next one after Hanno.

- Thank you, Valerie. I have two very simple questions and after John Cochran's very passionate presentation on, on, on mandates, I, I feel a little silly. But anyway, Thomas, I loved what you did. What I found missing you, maybe you have it in the paper, is how often the chairs meet with the precedent. And it turns out that the White House log is available all the way back, at least to FDR. When I did my, my, my book on the ion of the Gold Clause, I saw every day the, the, the, the appointment book. So if I remember correctly, and Mike Bordea would know better or many others here, Arthur Burns Secret Diaries, because the, the book is called Secret Diaries. He met with Nixon very, very often and often called by Nixon to come in and he would lecture him. Now, we were told in the morning that they didn't disagree on, on, on things. So it was not that Nixon was telling him what to do, but I think it would be very interesting to go and look and maybe you do it. I didn't, I didn't, I didn't see that. But you didn't present it. Yeah, and the other,

- He has a fabulous paper on

- It. I haven't seen

- It. It's been published and, and so this thing is a follow up, but,

- Okay, so I should, I should, I should, but maybe you should give us a little summary of that. Let me, I ask another question I had in the, of, since the morning, if you go to Latin America, which I do all the time, people talk there about central bank autonomy. They don't use the word independent. And I've tried to use AI to see what the difference is. And, and it's too legally in granular for me, but I'm, I would be interested on, on, on, since we're looking at, at the language and so on, what are the, whether there is a difference or whether there are totally equivalent words, an au autonomous central bank from an independent central bank.

- Alright, next is Han Lu. Stick here in the front.

- Okay, I have a question about, about accountability. So Luis, you gave the, the example of the ECB as a central banquet, a very narrow mandate that is at least sort of nominally quite independent as well. But, but obviously they've drifted, arguably from, from their mandate. And, and so they have not been held accountable. And John then asks, well, well, who, who's supposed to hold them accountable? May, maybe you can you can speak to that, but, but I'm, I'm gonna guess that part of the challenge there is if you're sort of a member of European Parliament, is you need quite a bit of expertise in order to be able to, to do that because these things are pretty complex and you're sort of up against a central bank with a staff of hundreds of PhD economists. So you're a little bit outgunned, I think, in a way. Is that part of the problem? And then, and then a related question about accountability is one that Amit and I just talked about, which is part of accountability probably is that, that central bankers have to admit they made a mistake. And that doesn't happen quite often, maybe because they're worried about loss and credibility, but, but it's, it seems like that also ought to be part of the process.

- Alright. And the next, as I said, I, I can't see that far back. He, he has his hand up. So please state your name. I don't have my glasses on. Sorry.

- So, Torsten Slack from Apollo. So the current situation in Europe and the US when it comes to the mandate is really, really interesting because we are facing the same shock. Namely oil prices have gone up. And what are markets pricing? Well, the ECB has a mandate that when they only look at inflation, oil prices go up. Of course, then we'll have a lot of hikes. The Fed with a dual mandate. Of course it's not seeing any hikes. There's a little discussion around how long time rates will stay constant. But the first conclusion is the US is a net oil exporter. Europe is a net oil importer. The euro wide model has an effect on the economy at three times bigger than in. So, and maybe this question is mainly to lose, I mean the CCB mandate by mandate, by hanging it so hard on only inflation. Are we not shooting ourselves a little bit in the foot in Europe by hiking rates in a situation where Europe is much harder hit by higher energy prices. So in that sense, the very, very strong dogmatic approach to what is our mandate in this situation is actually hurting if Europe does go out on high rates several times.

- Andy Levin down here near the front.

- Yeah. Thanks. So appreciate your, your stepping in, Valerie. So first of all, the, the, the work that Bill Nelson and Brian Lou and I did was based on data through September, 2022. So it's now about four years old. Bill's been keeping people up to date through LinkedIn, right? So it can read it, but I, the, the projection we made at that time was $1.5 trillion. And the latest update we made after the New York Fed released its productions, you know, within a hundred billion, more or less. Now some, I think John Cochran says, oh, 1.5 trillion, that's just a drop in the bucket. But you know, I think for a central bank that's, that's a lot of money and it's held up. But the reason I mention it related to what Carolyn said is that the Fed still has not done the public learned. Okay? Even though we're four years afterwards, there's still no report. Now the other thing I wanna say is about the mandate. This was mentioned this morning in 1978. Congress said, we're the boss, we want you to come to us twice a year. Semi, semi-annual hearings. The laws, it's section two B of the Federal Reserve Act on or about February 20th and on or about July 20th. And the on or about was always taken to being a few weeks earlier or later. So we're talking about since February, 1979. What is that? About 30, 39 years or something? You do the math. Okay. Quite a long time. Every single year there's been a semi-annual report to Congress, monetary Policy Report to Congress, and a hearing where the chair appears before the Senate Banking Committee and the House Financial Services Committee. The last time we had that hearing was last June, do the math. June 24th, if I remember right. Okay. Today is what May 8th. There we're already past the latest ever. I'm like, just check this with Cha Chi B the latest ever in these last, you know, since 1970. And the latest ever for the first semiannual report was the first week of March. Something's going on here. Now I asked Cha Chi Bt, and by the way, Chachi beauty's not perfect, but I thought it was an interesting question. I said, please do a careful search for media coverage of the lapse and semial report and hearing during the first half of 2026. I said, careful search. 'cause if you don't say careful sometimes it's like, oh, I couldn't find anything. It says, A careful search does not show meaningful media coverage of the apparent lapse or delay in the Fed's semi annual monetary policy report. And Humphrey Hawkins testimony during January through May, 2026. What the search does show is striking silence. The silence is because there's been no federal, is there a board press release to say, we got an exemption. Congress is our boss. They told us how that that law, you know, don't worry about it too much. Now look, in criminal law, you have a penalty. There's a fine, or, you know, whatever can be more serious. These mandates here, there was just an assumption of good faith that, and that assumption of good faith has been carried out since 1979. I'm totally mystified about this and I, I really, I know there are media people in the room here. It's not too late. Sometime in the next few days, maybe the banking committee says, oh, we, we canceled it. I, I'd be surprised if the Senate and the House both said it. Now, another thing that's important that related to this morning, the Federal Reserve Act is very clear. The chair of the Federal Reserve Board is the active executive officer, the CEO. And Ellen's nodding her head bill's head Volcker can nod his head, too many of us have worked there. Everyone knows the staff reports to the, to the chair. The chair is the boss. And could be a female chair like Yellen or a male chair, okay? That's why they call it chair. But the staff reports to the chair. The Federal Reserve Board approves the monetary policy reports to Congress. So all the regional Federal Reserve bank presidents are off the hook here. But I would also say that all the, all the members of the Federal Reserve Board who may be in the room, are outside the room, are also off the hook. Why? Because the chair directs the staff and the chair controls the agendas of the meetings. And if there's no press release and there's silence, then there's only one person who has to be asked the question. We know who it is. So I'm curious, when we're talking here about legal mandates, what do we do in a case like this?

- Thanks, Andy. All right. We only have two and a half more minutes and we don't have a break between the next one. You've gotten many, many nice questions, but, but if you could just respond very briefly,

- I'll just take 15 seconds. Great question. I have a whole other paper about meetings between presidents and federal reserve officials. I can tell you Nixon and Burns met 160 times. Clinton, for example, met with Fed officials only six times. So there's a huge variation. I have a whole paper about that. More recently, Trump won. There were nine meetings, Biden three meetings, and Trump two, three meetings. I can send you the paper.

- So on the accountability, I won't talk about independence in autonomy because I'm not an English speaker. So I get, I get hope free from that. On the autonomy on the accountability, Hano asks with intention, because I was the ranking member on the econ committee of the European Parliament. So my job was the president of the European Central Bank had to go there four times a year and testify in front of us. How much accountability was that? And then we had a little, the, the ranking members kind of had the time to talk to her and to Mario, to, to, to Mr. Drag at the start as well. And, and just in private a little bit, how much accountability was there? I think, I think very little. And I, I think back of that, and I wonder why, I mean, I did ask the questions like, okay, why are you not doing this? Why are you not doing that? But if go too far, what do you say? You like say, oh, you're going too far. I mean, it doesn't really matter. You know what I mean? Like, it's not clear that that it is an effective mechanism in Europe. It's not, it's not. I I don't think it, it, it actually limits and provides that account. I mean, I, I, I'm not sure. I mean, we, my staff was really good and we were very well prepared, but I don't know that we were really holding them accountable.

- Two things on the accountability, I'm just gonna say that, that the Rick Stag has in the, the government has in the legislation that external reviews are legislated as being required. And one of those stats, the external ones are every five years. Can't get around it. Second, second, I think your question was very provocative and it's a long conversation. I just say that democratically elected government that has goes through the right process can do what it wants and should be able to. That's kind of number one. Number two though, is that they need to do it for the front door, not the back door. And they need to be honest and ready to deal with the consequences. And if we think about the US as having exorbitant privileged and in, in, in global financial markets, a change like that would have consequences globally, probably, depending on what everybody else did. Fine, maybe worth it. And the other thing, when you unwind it, there are winners and losers. And we saw that in the, in the wake of World War ii. And you need to be ready for that too.

- Can I do one phrase on ton's question on the oil? I mean, I, I mean I would say like if, if the European Central Bank on the oil shock, if, if we agree that it's a price shock and not an inflation shock, they should look through this and, and, and they should not necessarily act differently. And I was there in vol conference at the A CB Watchers and I got the sense that they, that's how they saw it. But let's see.

- Alright, thank you very much to our panelists.

- Our moderator is Ross Levine, who's a senior fellow at the Hoover Institution, and the presenters are Marvin Barth from Thematic Markets, Darryl Duffy from the Stanford Graduate School of Business, and Christina Skinner from the US Department of the Treasury.

- Welcome. We've had a very busy day so far and we have an outstanding panel that to start out at today or to start out now. So what's distinctive about this panel is that it's quite broad and yet uniform. There's a lot of overlap. So we're gonna have Marvin Barth who has worked at the Treasury and at the Fed and is in the in the markets and also worked at the BIS and I think he's gonna shake things up a little bit in telling us what's wrong with the Fed. We're going to have Darryl Duffy, my Stanford colleague, one of the most influential scholars in finance and, and a leading voice on what I find fascinating how, what I would call the machinations and market micro structure of the Fed in markets, how that influences what goes on at the big scale in terms of payment systems and the operation of monetary policy. Christina Skinner, whose work from a legal perspective, I've learned quite a a bit from in terms of the governance and the independence of the Federal Reserve and she is now at the US Treasury. So we'll, we're gonna start with Marvin, who like I say, is gonna push us on the analytical framework of the Fed. Christina will then, and then Darl will follow and who's gonna push us on the fed's operatings mechanics, I think focus on liquidity. And Christina who will, I hope give us the inside scoop on Secretary Besson's leadership of the Financial Security Financial Stability Oversight Council. So Marvin, please take it away. Okay,

- Thank you very much. I'm pleased to be here and thank you Ross. Thanks you to our organizers, to Valerie and and John and and Michael and John, I have an apology, I'm sorry I didn't get the catcher signal that it's supposed to be a softball, so I'm throwing it tight and on the inside and hopefully that's okay And also I generally speak extemporaneously, but I'm very concerned because I have a a few slides to get through then I'm not going to get through them in time unless I read from them. So I'm gonna be a little bit more boring than usual today. So at thematic markets, I am in the forecasting business. My clients hedge funds, asset managers, global banks and multinationals pay me to see the major trends in the global political economy and markets before other people. Something that I've done with reasonable consistency over the last 25 years. Today I'd like to share with you my outlook and in the process illustrates some of the risks, challenges, and opportunities that we face. But my main message is going to be about fed independence given the topic here, and I see that as largely a risk that has been self-created. I say this is a friend of the institution where I spent my formative years and where I have many friends still, maybe not after today. While I do not condone the methods employed against Fed officials, I sympathize with many Americans, frustration at the lack of accountability for an institution that has failed badly in its mission and is desperately in need of reform. The challenge that I issue to the great minds in this room is how do we ensure that a central bank is both independent as we all agree is necessary and accountable. A running subtext of my talk, which Secretary Rice and Ken Roff also alluded to earlier is the illustrate is illustrated by an anecdote from my early days at the Fed Fresh from UCSD when Michael Bordeaux was a visiting scholar there and he came into my office and he's seeming embarrassed he shouldn't be this, he's, he's the hero in this story. And he said, that's a lot of math books that you got there and econometrics you think maybe economic theory and history play any role in your analysis. And I'm pleased to tell Michael 30 years later that my forecasting method follows from his advice and of course the excellent tutelage of my mentor Valerie, in between my frequent econometrics beatings. These all play a critical role in my analyses and I rely heavily on them in identifying what I see are the major themes driving global markets. And so today I am gonna talk about those themes that I see driving global markets. The first is localization being is believing global entropy and what I've called the politics of rage. Their collective effects have raised US potential growth, the marginal product of capital in inflation pressures and are leading to greater decentralization of finance and shrinking globalized supply chains for manufacturing. Let's start with localization. 2012 was an unheralded but important breakpoint in the global economy, cross-border investment that had trended steadily from rich economies to poor economies for decades reversed particularly in the US coinciding with the largest investment boom in post-war US history when you accumulate it at the same time, the import share of US GDP peaked after five decades of trending higher and has fallen steadily since. As I show here, this is true of both imports as a share of CapEx and consumption. The less steadily both my analyses and anecdotal evidence gleaned from companies I speak with and private equity firms suggest that the culprit is technology. When automation becomes cheaper than outsource labor, integrating production closer to your highest value customers makes more sense than globalization. One could say that globalization is the first casualty of AI being is believing is my layman speak for self-fulfilling expectations. It's long accepted economic theory that if consumers believe inflation is rising, they are more willing to accept higher prices. But quantifying this, especially when inflation expectations are stable, has been a challenge. As a result, most econometric models neglect or deemphasize them and for many years that worked. If you take a look, econometricians did a much better job than any type of expectations analysis. So take that Michael Bordo, but then COD happened, oh dear, what happened here? That doesn't look good for the econometricians or the model builders does it? The fed's flexible average inflation targeting, in my view, successfully unhinged inflation expectations. That was actually the intent. And people closest to price prices didn't forecast it. This is a really important point. They created it with their expectations, hence their contemporaneous re reactions. Those are led by 12 months, right? In a perfect reverse order of education that I will likely show corresponds to institutional trust. Inflation expectations were far better predictors than professional economists, bond traders or the Fed who couldn't seem to even acknowledge what their lying eyes were telling them. There is an important secondary message here in my business. I know a lot of bond traders and I doubt that one of them can tell you what the price of a gallon of milk is to suggest that their pricing of future inflation is representative of consumer price in expectations given their repeated failures To predict de anchoring of expectations from the 1970s through COVID reflects a profound ignorance of finance, economic history and theory. Consumers that form prices in our economy struggle to balance their budgets and by the way they vote. Failures of accountability like this and the attitude that bond markets and experts seem to know better than voters have been one of the key drivers of what of populist anger in the politics of rage. A report I wrote a decade ago, I found that the primary driver of populism is average citizens' perceptions that they've been disenfranchised by elites, pursuits of their own interests at the expense of the masses. Contrary to popular opinion, this is not about education, but about trust. David Shore, chief data scientist for President Obama's 2012 campaign has shown that trust far more than education predicted votes for President Trump anthropologist Heidi Larson has amply demonstrated that perceived loss of control rather than education or lack of knowledge are the primary drivers of both vaccine he hesitancy and conspiracy theories. If you take one thing from my presentation today, let this be it. You are not going to educate populism away nor will you convince voters or that you or populists that you are acting in their best interests. They don't trust you. And after long sequence of failures by experts and policymakers who have, whose costs have largely fallen on average citizens who can blame them, American populism has a long tradition and its own peculiarities in temperament, governing philosophy and policies right down to legitimized graft, president Trump is merely the second coming of the first populist Andrew Jackson. It only feels unfamiliar because we're ending a centrally long period of federalist descendancy. There are two facets of Jacksonian popul populism that are particularly relevant to our topic here. First is hostility towards centralized finance or government control of it. And second, a strong national defense free of foreign entanglements and focused on offshore balancing in American interests. The first is of obvious interest to the fed or obvious relevance. Don't forget that it was Andrew Jackson who successfully killed the second bank of the United States. The second is a predictable response to global entropy. The post-war liberal orders collapsed that began about three decades ago through arrogance, idealism and shortsightedness. The West forgot that power and the ability to police the world order comes from the capacity to manufacture guns. 155 millimeter artillery shells and now drones not from GDP, but China didn't. In fact, both Chinese policy makers genius in raising a billion people out of poverty and their supposed failures of over capacity reflect an intentional policy to shape the future battle space through tipping technological leadership and military industrial capacity in their favor through a massive scheme of industrial subsidies. The contours of this strategy were outlined in a 1997 book by two people's liberation Army senior colonels called unrestricted warfare. In my research, I've shown that three digit level Chinese Chinese import penetration directly reduces total factor productivity in US manufacturing firms By undermining learning, by doing, as those firms are forced out of business and into runoff mode, this isn't because Chinese factories are more economically efficient. Chinese total factor productivity growth has been negative for more than a decade. Belatedly the US is awakened to that threat and this is what was behind the Biden administration's industrial subsidies and the Trump administration's tariff walls. But tariffs are only part of the Trump administration's response, realizing that rebuilding industrial capacity will take a decade or more and that the PLA navy will outclass the US Navy by tonnage, technological sophistication and weaponry. Within a few years, the US military has shifted to a hybrid war warfare strategy of sea denial. China may control the seas soon, but by seizing the world or China may prevent the US from controlling the seas. But by seizing the world's major choke points, the US will also prevent China from controlling those seas. Every single one of these boxed choke points is one that the Trump administration has moved on in just the last year. Rising resource nationalism and transportation costs are a clear result. What does this all mean? Well, first localization is driving potential growth. The marginal product of capital and neutral interest rates higher while compressing imports. This is clear in both the economic data and in financial market prices over the last decade being as believing is driving inflation persistence despite the Fed's denials. Global entropy is simultaneously reinforcing localization, shifting out the aggregate demand curve by increasing redundancy and defense expenditures and shifting the aggregate demand, or excuse me, aggregate supply curve inwards by raising costs. Finally, the politics of rage is well raging as seen from the genius and clarity acts. It is advancing decentralized finance, which my co-panelists might touch upon, and it is also pushing for greater accountability from bureaucracies. So let me illustrate this method with two current examples of how I forecast using themes or the narrative method. Had you relied on standard models and generic studies of tariffs, which notably are of small developing economies largely rather than a large, mostly closed economy on the technological frontier, you would've predicted as most economists did, that the broad large increase in US tariffs last year would reduce US CapEx and impair productivity growth. I forecast the opposite that tariff walls would accelerate localization driven CapEx and shield US manufacturing from productivity killing Chinese subsidies investment. The investment numbers are undeniable. The US attracted 80% of announced global CapEx last year, two thirds of which occurred after liberation day and more than half of which was in manufacturing. In contrast to the consensus narrative that this is all AI data centers hard data on CapEx and durable goods orders validate the announcements that you see there. It's too early for me to claim victory on productivity, but it is notable that US manufacturing productivity flipped from negative to positive on the first round of Chinese tariffs and accelerated last year. But enough about me, let's consider how the Fed looked at the same economy and as my youngest teenage daughter would say, embarrassing, despite having almost 500 economists working for them, I don't even have a research assistant. By the way, actual GDP growth has outpaced the most optimistic FOMC members' estimate of trend growth for over a decade. Let me repeat that for over a decade. That is despite the fact that realized real interest rates have made a mockery of their estimates of neutral policy rates. To paraphrase the Princess Bride, I don't think restrictive means what they think it means. FOMC likes to blame their failures on CID as though no other committee faced the cough shocks or uncertainty tell that to Warren Harding who had to face World War I, the Russian revolution's, unprecedented distri disruptions of both grain and oil prices, the largest US steel workers strike and the Spanish flu all while handcuffed by the gold standard or even the much maligned Arthur Burns who had to manage a float of the dollar. Nixon's price controls the Arab oil embargo and the great grain robbery all without the benefit of inflation expectations. Data or well accepted understanding of the Phillips curve can shift by any objective measure of inflation. The Powell Fed is the seventh worst ever and the fourth of the Fiat era, but that's unfair to Paul Volcker, who handed 12% inflation as his welcoming was handed 12% inflation as his welcoming gift. By contrast, Jerome Powell inherited sub 2% inflation and is bequeathing Kevin Walsh, 4.4% PC inflation that's accelerating. Importantly, this poor record was a team effort. I'm pleased to see that a few FOMC members have finally found their independence in the last couple of meetings. But the record is clear. The Powell Fed has the lowest race of of dissents since the Fed Treasury Accord secured their independence. In closing, I'd like to relay one more message from ancient Greece, Athens's greatest hero, the Stockley saved Greece from conquest by the world's first true empire. Despite this miraculous success, Thema Stockley was ostracized by that is publicly exiled by public vote for fraud and treason. Historians agree that the charges were questionable and factionalism played a role, but almost all agree that Thermo Stockley also lack the humility before his fellow CI citizens and that sealed his fate. The current political assault on the Fed faces similar factionalism, but it also results from objective policy failures. The Fed continues to deny in a democracy. Everyone right or wrong must be held accountable by the people. The Fed would be well to do. Remember that if a democracy could turn on a hero like the Stockley, it can turn on them.

- Thank you, Marvin. So you know how Valerie was sort of mad at you in terms of econometrics. Valerie gave me one job, it's just to keep everybody on time

- And I did a too

- And now she's gonna be mad at me. Please, Daryl.

- Thanks Ross. And thanks to Mike, John and Valerie for having me speak about this. Today I'm gonna address issues related to the size of the Fed's balance sheet. Now, before I get into the details, I might surprise you by not focusing on the asset purchases that the Fed has made. They've the discussions of the Fed's independence often get into questions about why the Fed has purchased so much assets and concerns over whether that could eventually cause concerns about the fed's. Let's say over exuberant purchasing Kevin Walsh, for example, last spring at the G 30, at his G 30 speech around the IMF meetings. Express that view. I'm instead not gonna focus on the assets because it's not, that's not where we are right now. We're at a situation in which the Fed's liabilities are really what's constraining the size of the Fed's balance sheet. Keeping it at a minimum right now of in excess of $6 trillion. I want to get into why it has to be so big and what measures might be taken if the Fed really did want to reduce the size of the balance sheet. What it might need to do, and I'm, I'm sure Arvin might remember this conference maybe six or seven years ago where I objected from the audience to a claim from the panel that Arvin was was in by another speaker who suggested that the Fed should reduce the size of its balance sheet and continue to do that until reserves are scarce like they were before the financial crisis. And I objected saying you, you can't really do that because that would cause a crater on money markets. The money markets need a lot of reserves to actually run. Now I'm going to backtrack a bit on that claim after some further study, but first I want to give you a little bit of background. So these are the liabilities as of last week from the H four one of the Federal Reserve system to scale and currency 2.5 trillion. I don't think the Fed is gonna try to hoover up all the currency out there. So that that's pretty, you're pretty much stuck at two and a half trillion of paper currency. The TGA is the Treasury general account. This is a deposit account that the US Treasury Department has at the Fed. It's not the largest liability, but it has gotten quite large. And in fact, just in the last week, the Treasury Boring Advisory Committee has discussed ways to reduce that possibly by up to a half depending on whether or not their ideas are adopted. But the really big one you can see on the left-hand side of this diagram is reserve balances. These are deposits of commercial banks at the Fed that they use to run their business operations and they also use to meet requirements. And if there were were to be a reduction in the size of the Fed's balance sheet, the only significant reductions really could be and the amount of reserve balances needed to run the system. And some would claim, well yeah, let's just sell assets until we get back to let's say 2007. When at at that time $10 billion, about 1 21, 250th of this amount was sufficient to run the system. So how could it be that if 10 billion was enough then that the economy requires 2.9 trillion today? And the answer is largely through the effects of liquidity regulations and their interaction effects with the payment system. So we're gonna take a little deeper dive into that. After the financial crisis, Congress and regulators got religion about telling the largest banks you need to be self-sufficient for liquidity. You can't expect the Fed to come and provide the additional liquidity that you need. You have to have your own resources. Now how that regulation has been implemented or there's a family of regulations have been implemented, has led the largest banks to a practice of not coming to the Fed when they need more reserves to run their businesses, which means they need to start each day with enough reserves to do all the payments that they need to make during that day. I'm going to talk about how this situation could be mitigated if the Fed really did choose to reduce the size of the balance sheet. Now I'm not taking a stand on whether that's a good idea and I'm certainly not suggesting we should make reserves scarce. Again, as governor Chris Waller who's sitting in the audience today, was quoted at a recent, at a recent conference, having banks scrounge under the couch cushions for additional money is massively inefficient and stupid. And I agree with him, why would you do that? Having enough reserves to run your business is is not a shame. You should allow banks to have what they need, but the trick might be to reduce the demand for reserve balances so that banks can do what they need to do with a lot less reserves. So here are four ideas for doing that that I wrote about in a recent Brookings paper. So again, not taking a stand on whether the Fed is or is going to do this or should do this, but if it were to do this, how could it achieve a smaller balance sheet? And I ordered these in increasing order of difficulty and effect. So as you go down the list, you're getting into bigger and bigger potential reductions in the size of the balance sheet and harder and harder things to do and that and then it becomes a policy decision if you want to do any of these or some of them. The first item on the list is to take out the bumps in the quantity of reserve balances that happen during the year by temporary open market operations. So if there's a shortfall in reserves on a given day, for example, because the Treasury general account jumped up with tax payments and a bunch of reserves came out of the system and into the Treasury general account, the Fed could re could fill in that pothole by creating additional reserves with temporary open market operations. This is one of the ideas that Bill Nelson has suggested and Annette vs. Jorgenson at the Federal Reserve Board has also suggested this idea. And there are additional kinds of bumps and potholes that show up that could be smoothed out and that would allow the Fed on average to lower the path of the quantity of reserve balances a bit, but not a large fraction of 2.9 trillion, maybe a hundred billion or two. So that wouldn't be all that hard to do, but it's not gonna buy you a lot of reduction in balance sheet. The next one is going to these liquidity regulations that I mentioned a moment ago. If banks have gotten the largest, banks have gotten the impression that they shouldn't go to the Fed in, let's say in the middle of the day to get additional reserves to make their payments or go to the discount window or go to the standing repo operations that the Fed with which the Fed provides liquidity. If they're reluctant to draw on those sources of additional reserves when they need them, then perhaps it's possible to encourage them to get over that. That could make quite a difference. And I'll give you some quanti quantification at least for an illustrative model in a minute. A third option is actually to improve the efficiency of the payment system. So almost all developed markets, central banks other than the Fed have what is known as a liquidity savings mechanism, which is basically a way that banks can make their payments without stacking up reserves at the beginning of the day and then paying out of their reserve balances. Instead, they can make payments, outbound payments out of their inbound payments. That's what a liquidity savings mechanism can do and it can save a significant fraction of that 2.9 trillion. I'm not suggesting that's easy, that would be a huge amount of operational work. Retooling the payment system is not a simple matter. And then finally, possibly the biggest effect would be to tier the interest rate that the Fed pays on reserve balances. What does that mean? A number of central, not including the Fed pay, the their administered interest rates, the interest rate on reserve balances in the US, but not on the full quantity of reserves held by a bank, but rather only on the quantity of reserves that are necessary for the bank to run its operations. You could call those required reserves and then the Fed could drop the interest rate on the remainder of the reserves. Banks faced with that situation would say, I am not gonna invest in reserves beyond what I need to run my business operations. I'm gonna try to get rid of the rest analogously to what happened in before the financial crisis when the Fed paid no interest on anything and banks hated to have reserves sitting around on their balance sheets. And that's why the system was able to run on 10 billion. I'm not saying it was pretty and I think the Fed made the right decision to pay interest on reserve balances, but if it really wanted to reduce its balance sheet, it doesn't need to pay the whole full freight interest on every dollar that a bank has at the Fed. It could pay the full freight interest on the first portion and then a lower interest rate on the rest, and then banks would try to eject those additional balances as quickly as they could. So in the remaining few minutes, I'm sure Ross is gonna tell me when I'm out of time, I'm gonna run through some of these ideas in slightly more detail. So instead of going through all of the liquidity regulations that I described, I'm gonna go through one that's not even on on most people's radar, which is intraday. Overdrafts. There's no regulation today that says banks cannot overdraft their federal reserve accounts and smaller banks do. The largest banks once did that in size to the extent of a hundred to $150 billion inside each day. That's the largest 10 banks. But since the financial crisis, they've hardly overdrafted at all. That's for two reasons. One, most of the time reserves have been abundant. There's been no need to overdraft. However, when reserves have not been abundant, for example, in September, 2019, the largest banks did not overdraft and interest rates went skyrocketing because there were not enough reserves in the system. Why wouldn't they overdraft in order to make their needed payments in the middle of the day? Because at least in the spirit of these regulations, it would look like the largest banks that do it are not self-sufficient. They're contrary to the regulations that say banks must demonstrate that they're meeting all of the liquidity re requirements that they have from their own resources, not from the fed. Similar concerns arise with the discount window and standing repo operations, but I won't get into that. Here's an example. This is only an illustrative model. An equilibrium model in which banks can meet their, get out half of their payments early in the day by one of two methods. One is to rely heavily on overdrafts and the other is to rely heavily on reserve balances that they start the day with. Blue is reserve balances that you start the day, red is relying on overdrafts. All of the scenarios in this diagram of blue and red bars paired together have the same effective throughput in the payment system. And you can see that a little bit of overdrafting on the left hand side in red and a very small amount of reserve balances is satisfactory. Or you can do it with almost no overdrafting and a whole lot of reserves. That suggests that if banks were willing to overdraft that the size of the Fed's balance sheet could be much smaller. The other, another mechanism I mentioned is liquidity savings mechanisms. And as I mentioned, a bank doesn't need to pay all of its outgoing payments from its own stack of reserve balances. It could make its outgoing payments from its incoming payments. That's what a liquidity savings mechanism does. And this illustration is from the Bank of Japan, which has one of these. Bank of Canada has it, the Bank of England has it, the European Central Bank has it. They're all quite effective. They aren't easy to implement. The Fed doesn't have one. If it were really on a mission to reduce the size of its balance sheet, this is a way to do quite a lot of that. And I'm gonna skip this and then finally go again to tiering interest rates on reserves. Here's two examples. The Reserve Bank of New Zealand and the Norwegian Central Bank, the Reserve Bank of New Zealand has found that this is quite effective in reducing the demand for reserve balances that banks had been investing in in order to get the interest. And now they're just using by and large, just using the reserve balances to make payments. The other example is from the Norwegian Central Bank, which was very disappointed that its interbank market had become more hardly any interbank trading. When they tiered the interest rate paid on reserve balances, the banks with excess balances were anxious to get rid of them and they loaned them to the banks with less balances. That means the Fed could reduce the total amount of reserve balances in the system. You might say, well this is really complicated. The Fed would never do this and banks would complain. I only found out recently that in fact the Fed did do this. It was the initial design for paying interest on reserve balances that was introduced in the financial crisis in 2008 had two tiers. It only lasted for about five or six weeks and the Fed that it needed to go to the zero lower bound in order to support the economy. And when it did that, both tiers got crushed to zero. And ever since then, there's only been one tier. So it's not impossible for the Fed to do this, but I'm sure that it's not easy either. And I can, I could go into that in more length, but I think Ross is gonna tell me I'm out of time. Is that correct?

- If you need to wrap up, go

- For it. That's it. I've given you the list of things that I think could be used effectively to reduce the size of the Fed's balance sheet if it really wanted to, if the Fed were to go out today and just sell assets and hope for the best, it would be quite a mess. It would be worse than September, 2019. The size of the balance sheet is growing 2019 when we had this problem, reserve balances were at 1.4 trillion, now they're at 2.9 trillion and we are constrained in the same way. So if the Fed does wanna reduce its reserve balances, it's gonna have to be get somewhat creative and roll up its sleeves. Thanks very much,

- Christina.

- Okay, good afternoon everyone. Thank you so much to the organizers for inviting me here today and for indulging me and doing something a little bit different. So I am not going to be talking about central banks, I'm not gonna be talking about monetary policy. Instead I'm talking about financial stability policy and in particular from the vantage point of the Treasury Department, which is where I am now. And really, it's such a pleasure to be able to speak to this group at an institution that has long insisted that sound policy begins with clear thinking about first principles. And that's really the theme of my talk today. And in particular because the panel is focused on risks and opportunities. I wanna speak to you about how the Financial Stability Oversight Council, which is the group within treasury that I lead, how FS o under Secretary Bessons leadership has been focused on reorienting its approach to financial stability At its core, this has been an effort to mitigate risk and also return policy again to those first principles to ensure that the FS O is working to support rather than constrain a dynamic and resilient market economy. So I'm going to spend the next 13 and a half minutes telling you how we are embarking on that journey. So before I do that, I wanna speak a little bit to this audience who may not be familiar about the origins and the evolution of the Financial Stability Oversight Council or FS OC. So the FS O was established by the Dodd-Frank Act in 2010, and it was a response to the 2008 financial crisis. Its mandate, broadly speaking, is to identify risks to US financial stability, respond to emerging threats and promote market discipline. The structure of FS OC is not incidental. By placing the treasury secretary at the head of the council Congress very much recognized that financial stability policy necessarily involves trade-offs. It involves judgment about uncertainty and about the appropriate balance between public intervention and private risk taking. At the same time, also importantly, the Dodd-Frank Act left the term financial stability largely undefined. And that ambiguity created flexibility. But it also meant that the council's direction would depend on the intellectual framework that was brought to bear on the problem. And over time, that framework has evolved in its early years. The SO emphasized the designation of non-bank financial firms for enhanced supervision, reflecting a view that systemic risk could be mitigated by extending bank-like regulation beyond the traditional banking sector that blew that view turned out to be flawed, and we can talk about that in Q and a if you want, in later years. The scope of that inquiry expanded to encompass a broader set of more speculative concerns that even indicated policy would track a longer even undefined time horizon, such as, for example, climate related financial risk. Meanwhile, across the regulatory landscape reforms accumulated, many were well motivated and could have been individually justified, but they were rarely assessed in their ag in terms of their aggregate effect on market functioning, capital formation, or on the economy's capacity to grow. And so after 15 years of the fsoc, it became necessary to take a step back, not to revisit the goals of financial stability policy, but rather for us to consider the framework through which those goals were being pursued. And so again, as I mentioned, we've been focused on recentering financial stability policy to its core purpose and its core mission. And the starting point for that reassessment was a simple but often overlooked question, which is, what is financial stability policy for? From our perspective at treasury in a market economy, the objective can't be to eliminate all risk. Risk is inseparable from innovation, from investment and from growth. Rather, the purpose of macro prudential policy is to ensure that financial disruptions don't propagate in ways that materially impair the real economy, business formation, employment and household wellbeing. Over time, however, that policy had drifted toward a different objective and it spawned very different policy goals. And that objective was focused on minimizing the incidents of financial distress often without sufficient regard to the cost of doing so. Now again, that shift might have been understandable in the aftermath of 2008, but over time it contributed to a one directional policy, what might have been described as a ratchet toward ever greater precaution coming from the Financial Stability Oversight Council. And the consequence is a familiar one in economic policy, when risk mitigation is pursued without discipline, it becomes self-defeating. A system that's designed or aimed at eliminating volatility can end up suppressing the very dynamism that makes the system resilient in the first place. It risks reducing what can aptly be described and what has been described by others as the financial stability of the graveyard. This is a condition that is one of apparent calm, but it's sustained by constraint rather than strength. Such a system is not well suited to an economy that depends on entrepreneurship, capital formation and adaptation to change. So Secretary Besson's contribution has to been to re-anchor financial stability policy in its proper objective, supporting a financial system that supports the real economy rather than one that attempts to insulate from itself. And that reorientation rests on two very specific propositions. The fro. The first is that growth is a foundation for financial stability. Economic growth is not intention with financial stability. It's one of its primary foundations Growing. Economies are more resilient. Growth improves balance sheets. It raises incomes relative to liabilities. It enhances the capacity of firms and households to service debt and to absorb shocks. A substantial empirical literature supports this relationship. Credit expansions that aren't grounded in real economic growth are among the strongest predictors of financial crises, while sustained growth improves the capacity of this system's ability to absorb shocks. Conversely, we know that periods of weak growth or contraction tend to expose and amplify financial vulnerabilities. Financial crises become economically damaging when they spill over into the real economy. We know this when disruptions to credit and confidence in para production, investment employment, the historical record is unambiguous on this point. Financial crises are deeper and more persistent when they coincide with declines in output and income. And this has direct implications for our policy design. The financial regulation, the way that we think about financial stability and its interaction with financial regulation, can't be evaluated solely in terms of its effect on measured risk within the financial sector. It ha it also has to be assessed in terms of its impact on the broader economy, on credit availability, market liquidity, and productive investment. And so policies that constrain these channels may appear stabilizing in the short term, but at sufficient scale, they erode the underlying conditions that make stability possible. So the relevant question is not whether financial stability policy reduces risk in isolation, but whether it contributes to a system capable of sustaining growth, absorbing shocks over time. The second proposition that I referenced is that financial stability is inseparable from economic security in the current environment. The potential sources of systemic risk increasingly lie at the intersection of economics and geopolitics. A growing body of work and geoeconomics of which many of you are no doubt familiar has also underscored this point that economic and financial systems are increasingly shaped by strategic competition among states, not just by market forces. A dynamic that blurs the boundary between economic policy and national security. A financial system ultimately rests on the productive capacity of the economy that it serves. That capacity in turn depends on secure supply chains, reliable access to energy and critical inputs and continued leadership and technologies that shape productivity and competitiveness when those conditions hold. The financial system benefits from stable cash flows, predictable investment horizons and resilient balance sheets. When they weaken, the effects are transmitted rapidly into financial markets through price, volatility, liquidity, stress, and heightened uncertainty about future returns. It follows that many financial disturbances are not endogenous to the financial system. They're the downstream expression of structural vulnerabilities in the real economy, which are often intensified by these geopolitical pressures. Recognizing this changes how financial stability analysis should be conducted. First, it requires greater discipline in prioritization. Not all risks are equal. And attempting to enumerate every conceivable vulnerability can dilute focus and encourage a regulatory and financial stability posture that is expansive but not necessarily effective. Second, it requires attention to the cumulative effects of policy. Financial stability policy is often thought about incrementally, but its impact can be experienced in the aggregate. And so understanding as an interagency body, how different rules interact and how they shape incentives, market structure and economic activity is essential. Third, this vantage point requires a strategic outward looking perspective. The United States, as we've been discussing all day, occupies a central position in the global financial system, the role of the dollar, the functioning of treasury markets, and the depth of US capital markets are not merely domestic concerns, they're pillars of the international economic order. Those pillars in turn are shaped by these geopolitical dynamics, including competition among major powers and the possibility of coordinated or cascading shocks. Finally, integrating economic security into financial stability. Policy underscores a broader point. Stability is not a fixed state. It it's an outcome that depends on the strength, the resilience and strategic positioning of the underlying economy. And these principles are very much at the heart of how the council is going about its work. Currently we're focused on treasury market resilience, recognizing the treasury market's central role in global finance. And its important both to liquidity and price discovery. We're prioritizing cyber risk and crisis preparedness, particularly in light of increasingly sophisticated threats that have the potential to disrupt critical market infrastructure. We're supporting bank regulatory and supervisory modernization that's ongoing at the various council member agencies, which has its emphasis on material risks, transparency and minimizing unintended distortions. We're also engaging actively on artificial intelligence. We're seeking to support innovation in the private sector while ensuring that emerging technologies strengthen rather than undermine financial resilience overall and replacing renewed emphasis on household financial resilience because the stability of the financial system ultimately depends on the condition of household balance sheets. So let me close with a simple observation. Financial stability is not an end in of itself. It's a means, one that supports a broader objective. A growing dynamic economy capable of generating opportunity and absorbing shocks. A system that attempts to eliminate risk altogether will not achieve that objective. It will tend instead toward rigidity and ultimately that will lead to fragility. The task of policy in our opinion is therefore not to suppress all risk, but to government to ensure that the financial system remains capable of supporting growth while withstanding inevitable disruptions that requires judgment, prioritization, and a willingness to revisit established frameworks in light of new realities. And at the Fs OC under Secretary Besson's leadership, that is the approach that we've been pursuing. We believe that it offers a more coherent and a more durable foundation for financial stability. One that's grounded in recognition that growth, security and stability are mutually enforcing not trade-offs or a zero sum game. So thank you and I will seed my minute and a half to the panel for questions.

- So I'll continue the tradition of, of posing a few questions, one to each, so to to to to to Marvin. Let me ask the following. I'll ask it about how you predict. So you talked about populism and you talked about financial regulation. And so when I hear what you're saying about populism, people are, are angry. They're angry being, there's no better institution to be angry at the Fed. It's centralized, it's a, it's elite, it's obscure, all of those things. And so that might push toward or make a population sympathetic towards deregulation of a variety of forms or a weakening of regulations that may or may not be good, but at least maybe some of them were restricting excessive risk. And at the same time, it's hard to believe if we were to suffer another major financial crisis that the Fed wouldn't do what it is shown that it will always do, which is to bail everybody out. And so that the investors, regardless of what is stated, are going to expect that bailout. So given that sort of, what do you predict in terms of how things would evolve? So that's, that's one question for Darryl. I really wanted to hear what your assessments are. So again, and you were extremely clear if, and you're not necessarily arguing that it should be, but if the goal is to reduce the balance sheet, which which of the options that you gave us do you favor or more accurately, you know, what are, what are some of the pros and, and and the cons? And Christine, I have a, I'm, I'm very sympathetic to the view that growth and stability can be mutually reinforcing. And I'm very sympathetic to the view that the goal of financial sector policies is not stability per se, but to foster in innovation and entrepreneurship and economic growth. I'm also very sympathetic to the view that regulations of all sorts can build up that at some point are probably not very effective at creating stability and probably do quite a bit to restrict growth. The question I have is, and maybe you can't answer this, is how do you go about the sequencing that from a market oriented perspective, you would want to do something to get markets incentivized to reduce excessive risk taking. That comes from too big fail expectations. And so an attempt to reduce the reg and an attempt to reduce regulations in the name of fostering growth, which I'm sympathetic to once you get into the details, is that going to simply be going to become reducing restrictions on excessive risk taking. Okay, so you were where, and that would lead, forgetting about the stability issues, you could get less growth and more instability because you would be incentivizing excessive risk taking, which is means a misallocation of resources relative to what it would be without those interventions. Okay, so I've spoken way too much. So please, Marvin,

- You didn't speak o overspeak as much as I did, and thank you for the time, Christina. So if I hear you correctly, you are expecting consistency from voters.

- Actually I'm, I I'm I'm expecting them.

- No, I I - I'm expecting you go with it however you want.

- IIII was being facetious, but look, I do see a political economy here that is developing for decentralized finance. I would disagree quite strongly with Professor e Eichengreen and Professor Roff on this one. I, I mean, I definitely think stable coins are and narrow banking are taking off here and it's a political economy argument. On one side, you have a populous base that wants to have this, they want this to be decentralized. They, you know, are not in favor of banks. So, you know, they want deregulation simply because they don't trust regulators, they don't trust anybody in the bureaucracy. And we've had movements like that in the past. What's been different is now we have a technology and it's a technology that's already been proven out there. So one of the things that I think is perhaps, you know, missed by a lot of people, and by the way, I'm not a, I'm not a crypto head, I've never advocated crypto or anything like that, so I'm not one of those people. But you now have that global remittances in dollars on stable coins are approaching FDI in the United States in magnitude. So these are not small numbers anymore and they're growing very rapidly at about 50% a year. So you can see where this this is going to go. So one, you have the technology that's joining it. Now the second thing that you have that, that's coming along or that's there is they have money. It used to be that only the banks had the money, right? They had the capital base, which is important in a political economy argument. Well now the crypto people have a lot of money. I went to lunch with one of my clients who's made all his money in crypto. He talked all about owning half of Hokkaido Island in Japan to go skiing. He was wearing, you know, I wear suits still obviously apparently to David. We, that makes me the, what was it, the Dark Knight. But he, he came to to lunch in custom made Savile Row silk sweatsuit that costs 5,000. And that's all he wears now. Okay? They have money and they're using it to get this stuff done. So this is where I see things going. I actually do think that we're going to down a path of narrow banking, but you are going to see deregulation of the banking s system alongside it.

- Thank you there, Ross. You always ask the hardest questions. So at first, I don't expect the Fed should do any of these without a careful study. There's cost benefit involved in all of them. The two of the more difficult choices, liquidity regs and payment system revisions are actually to some extent substitutes. Because if banks can be convinced that liquidity regulations should not discourage them from using the fed's liquidity facilities or overdrafting, then they don't need to be hoarding a lot of reserves in order to make their payments every day. And they could, they could use overdrafting or they could draw reserves from the Fed. So I would pick one of those two. If you had to pick from those two today rather than both the temporary open market operations. I don't think they're gonna get you a lot of distance. They're not as difficult to implement as the others. I don't see any reason not to do some work on that. Although there are some in the federal reserve system that go by the principle that they should put the quantity of reserves that they supply kind of on autopilot and not make adjustments when the market is running short by that method. They should wait and hope that the banks are gonna come to them for liquidity when they need it. That's called a demand base system. And that goes back to the same liquidity regs issue. So liquidity regs are pretty central in this whole thing. As for tiering the reserve balances, tiering the remuneration of reserve balances, that would be extremely effective and also extremely difficult to convince the banking lobby that, that it's a good idea. So there'd be quite a lot of concerns about profitability associated with interest earned on reserve balances. And that would, that would be challenging. I don't know if that's a satisfactory answer, but I want to come back to the fact that I don't think the Fed should do anything quickly or without careful study. And I, you know, I wouldn't expect the Fed to do anything else than that.

- Thank you.

- Okay. Thank you for the question, which is very hard and thoughtful and I, so I have a couple of different ways to answer it. I think, you know, big picture, your question is, well, you know, when you're advocating for policies that support growth, how do you know you're not inadvertently encouraging a level of risk in the system that could ultimately undermine that objective? So the first thing that I'll answer is, you know, it's important to understand what the FS o is and what tools we have, right? We are, you know, the macro prudential authority in the United States. And so, you know, the council can speak, you know, collectively or through the leadership of the secretary and sort of articulate its view on what it thinks financial stability risk is and articulating that view publicly in our meetings or in our annual report, you know, sets the, sets the tone overall for the marketplace, right? And so what we can do is say, you know, failure to innovate, failure to con compete, failure to take risk, right itself is a financial stability risk. We can be more discerning in the risks that we lay out, right? So for example, in most, you know, annual reports to date, it had sort of become this catalog of risks that was a bit of a hotel California, you know, once something was a financial stability risk, it never came out. So we've tried to adapt a new structure where we're prioritizing, right? A couple of key actionable risks, right? And the rest is sort of our statutory duty to monitor. So for example, in our last annual report, we were focused on treasury market resilience, cyber AI adoption, and supporting the agencies in their regulatory modernization. We can support our objectives around growth and security by doing things like creating new data sets that support the councils and being more disciplined in how we articulate financial stability, right? So creating measurable and track trackable benchmarks, creating some indicia financial stability, we can engage in creative ways of scenario planning and tabletop exercises to enhance our coordinating capacity. So these are ways that we can use the council's resources both to sort of set the tone and the culture around risk taking in the financial marketplace and in the banking sector. And also use the count, use the FS o as a real sort of coordinating body and use, use that power that way. What we, what we don't do is we, we don't do micro prudential regulation. So in terms of that balance between, you know, risk and the governance of risk, right? The council doesn't do that, right? That's for the prudential federal banking regulators, that's for the market reg regulators. And you know, they've been hard at work doing that. And so the treasury secretary can sort of use the council to support them in that effort, but we aren't engaging in that kind of analysis, right? Those, the primary prudential regulators and market regulators. But what I will say, just, you know, as an observer of how well that that effort has been going is that, you know, regulation can't be a one-way ratchet, right? So the, the the premise, you know, we often, you know, even in the context of our annual report, because one of the recommendations or one of our priority areas was supporting the work that was going on in regulatory modernization, we would get questions from the public, questions from the media along these lines. You know, how do you, how do you, how can you be sure that you're not going to, you know, generate or, or support too much risk? And, you know, taking a step back, it's like there, there needs to be some kind of laffer curve for macroprudential policy, right? If regulation is constantly added on after a financial crisis, right? But there's, but, but we can't concede that there has to be an effort to right size it or to modernize it or to, or to, you know, tailor it to current conditions. Then it's just this sort of accumulation in one way ratchet that is inevitably going to deter growth. So again, not our job to do, but that's the vantage point in why we support the agencies in engaging in this regulatory modernization effort.

- Thank you. Okay. We have some chance for questions, please? Oh, no, no. Oh, we're waiting. Please give your name and affiliation. Oh,

- Hi, Steve Davis Hoover institution for Christina. I, I would welcome some additional insider perspective on whether the financial architecture in particular, the payment systems, custody arrangements for securities under are under particular threat from advances in ai. I'm guessing you have some insight into that, that most of us don't. And whatever you can share, I would appreciate hearing,

- I'm gonna take a few questions. My former Berkeley colleague please and Michael, yes and yes,

- Thank you. A question for Christina uc, Berkeley u Chenko, if we had undue do frank act, how much extra growth we're going to have, how much more risk we're going to have in the system? What's the trade off here? I was wondering if, if Zach had any studies to that end? Thanks.

- Okay. Do Michael and the and then the, the, yes. Okay. Michael,

- Thank you Bill Nelson, bank Policy Institute. I have a question for Darrell and a question for Christina. So Darrell, the defining characteristic of a scarce reserve system is that excess reserves are paid quite a bit less than the market rate. That's what gives banks an incentive to economize on reserves and at what it's, what gives them an incentive to go to each other to get their liquidity needs initially. And it's what allows for a thriving interbank market. I'm a big fan of markets as opposed to the government being the first line of defense in April, 2008 when the Fed was first thinking about how should we use our new authorities, they said, well we should pay a market rate on required reserves and a substantially below market rate on excess reserves. Now of course, to make that happen, you have reserves have to be scarce, otherwise the market rates go down to the rate on excess reserves. So that was exactly the approach that was adopted that you praised mightily at the end of your presentation. So you began by saying scarce reserves were stupid and you ended by saying, these are the best thing, this is the best arrangement one could possibly imagine. So I'm not a hundred percent saying we should go back. I'm not saying we should go back to the, to the past, but I am encouraging you to rethink the proposition that this is obviously stupid when you also viewed it as obviously wonderful. So, and for Christina, a question in your capacity is heading the FS o. So the Genius Act allows stablecoin issuers to back their stable coins with uninsured deposits at banks. In my experience, spending a lot of time working on financial stability, people love to present their liabilities as moneylike and then turn around and invest in risky, illiquid things. And among the things that the stable coin issuers can invest in investing in uninsured deposits at some bank that maybe they have set up, it seems like the most attractive option that would be available to them. So my question for you is, if we had a world where there, I don't think there's gonna be a lot of stable coins, but some people do. If there was a world where there's gonna be a lot of stable coins and they were backed by uninsured deposits in the banking system with the potential that when they were run on that we then yank those deposits out of the banking system. Is that a financial stability risk that concerns you?

- Okay, Michael? Oh yeah, Mike.

- Yeah, I guess what I'm gonna say is echoing, a lot of people have said, I went sort of paper a long, long time ago with Anna Schwartz. It was called, it was called Real versus Pseudo Systemic Risk. Okay? This is long anyway, and this, I guess, pertains to both Christina and Marvin. So I mean, how, how do you determine if financial innovation is gonna lead to systemic risk? There's a, it's a big question. I mean, how do you do this?

- Because talk, talking to the, the

- Mic. Okay. How, how do you determine if, if financial innovation's gonna lead to systemic risk? This pertains to a lot of things. You've got private equity, stable coins. Okay. I'm also working on stable coins with Carolyn Wilkins and getting at these issues. But how do you do this? Because you, you know, the people that do this stuff, they're very well paid and very smart, okay? And they're a lot, probably a lot better paid and smarter than anybody in, in any government. So I don't, you know, how do you, how do you, how do you deal with this issue without either doing what you're afraid of doing, which is stifling it, or in a sense saying, oh, this is gonna be fine, these guys are gonna work it out and then end up with a financial crisis.

- Okay, we're gonna do one more question by Professor Levy right back there. I'm sorry. And then we'll, so, so we'll give you a short period of time to answer all those questions.

- So this is, this is addressed to, to Darrell about, about the Fed's balance sheet. So we've moved from a scarce reserve system to abundant reserves, and now it's, the Fed calls it ample without really defining what ample is. So, along comes Kevin War, and he's already said that he wants to reduce the bloated balance sheet because to him, the balance sheet kind of reflects the Fed's mission creep. Okay? So you're gonna have this internal debate within the Fed. And Darryl, I know you're contributing and your research is contributing to it about how to define ample. And then the risks involved in reducing the balance sheet without unnecessary risks. And I presume that those risks are measured as, quote unquote undesired volatility in the short-term funding markets. Okay? So in that regard, when we think about the short-term funding market and undue risk, I would toss out a general observation that the Fed historically on many fronts tends toward fine tuning. So does the Fed have this innate view that any volatility in short term funding markets is negative? Or have they really thought through what an appropriate amount of risk is without over fine tuning the concept of volatility?

- Okay. So we're gonna go in reverse order. So we go, Christina, and, and it's also the order in which most of the intensity of the questions came. So we'll go Christina, Darrell, and then Marvin.

- Well, thank you for all of those thoughtful questions. I will try and address all of them as much as I can, and many of them I can't really address. So the first question was about cyber risk in general. I'm sure you can imagine, I can't speak to the specifics of your question, but the overarching posture is, you know, cyber risk is nothing new. Cyber risks have existed for a very long time, and while the pace of those cyber threats may increase major financial institutions, pieces of financial market infrastructure are considering this an opportunity to revisit and double down on their cyber hygiene as any prudent risk manager would do. On the second question about, I believe you used the term undoing, Dodd-Frank, so vice chair for supervision is, is here in the room and on the next panel. And she's much better placed to answer that question than I am. But what I would say is, you know, I don't, and I, again, I don't wanna put words in her mouth, it's never been a question of undoing Dodd-Frank. It's always been an issue of modernizing the rules for the current environment. You know, it can't possibly be the case that a regulatory framework that we put in place after a major financial crisis 15 years ago is necessarily appropriate to the current financial system. And, you know, why wouldn't we wanna take a step back and evaluate the costs and unintended consequences of that framework for one, and whether way, whether there are ways in which that framework has impeded productive credit and financial intermediation. And try and fine tune that and bring it into the, into the current era. And, you know, we, we support the vice chair as she undergoes that effort, as well as the other prudential regulators. So I think it's healthy with any sort of regulatory framework, especially those that are put in place in a post-crisis era to be w willing to reconsider them after a certain period of time. Bill, you asked a question about stable coins and the reserve assets that are backing stable coins. So look, I think it would be premature for me to give you an opinion on what the potential financial stability risks in the stablecoin market are. I will say that section 15 of the Genius Act does require the fsoc to report out on the potential financial stability risks in the stablecoin market, as well as, you know, a range of other issues in coordination with the other regulators. And so we're thinking through what financial stability issues look like in as applied to, you know, stable coins because, you know, we don't wanna shoehorn stable coins into some other, you know, box that they're not. I will say that there is an expectation that a large proportion of the reserve assets will be treasuries, and we do expect that that will in turn, support the resilience of the treasury market. And then Mike Bordeaux, you asked a question about how do you know when, if particular financial innovation is a systemic risk? Well, you know, you can't really, there's no magic crystal ball for predicting whether financial innovation is going to be a systemic risk. So you have to, you know, you have to decide, are you going to take an approach that's very prophylactic and speculative and therefore tries to cabin things as a financial stability risk and to some extent suppress them before they get out of the gate? Or are you going to take a view that, you know, prophylactics is an impediment to growth and that failure to innovate and compete is itself a financial stability risk and therefore look for clear evidence of a financial stability risk before moving. And so I think that prior approach has been tried in the past. And the posture of this, this Fs OC under Secretary Besant, is more focused on having objective evidence of a, of a, of a systemic risk before moving to prohibit it. And, you know, especially in light of those geostrategic issues that I mentioned before, you know, AI is a perfect example of that, right? We have to responsibly adopt AI and work with the private sector to responsibly adopt AI or, or the failure to do that will become a greater risk. So you can't predict it with certainty and you just have to decide with meth methodology you're going to pursue, you know, prophylaxis or wait for the wait for the evidence.

- Thank you, Christina. Darryl,

- I'll, I'll go quickly by consolidating the questions from Bill Nelson and, and Mickey Levy 'cause they're quite related. And I'm gonna do that by going back to route 2006 or oh seven when Don Cohn asked me into the Fed to do some research with Adam Ashcraft on why it was so difficult for the Fed to manage at that time with scarce reserves. The problem at that time is, suppose the Fed wanted to set market interest rates at 4%. That was its targeted rate, but it wasn't paying interest on reserves. So if a bank missed, it was missing 400 basis points and talk about scrounging under the couch cushions for money, the panic that sets in that Adam and I quantified as you barely can make your payments, and at the end of the day, you're scrounging so hard to find enough reserves to make those payments meant that a mere $10 billion of reserve balances circulated around and around the financial system exceptionally fast. And if the Fed missed, the volatility in financial markets was tough and the cost of scrounging for money was tough. This is a lot different than tiering between 4% interest rate and 3.5% interest rate with let's say a couple of trillion or a trillion of reserve balances in the system. The shadow cost or LaGrange multiplier is not 400 basis points for having that additional dollar that you barely made it with. It, it, the system is a lot more forgiving, so you don't get this kind of extreme volatility. And the, the fine tuning that the Fed can do can be somewhat more forgiving. There's gonna be, the market rate is gonna settle between the upper tier and the lower tier. And if the Fed misses by a bit, it's not a catastrophe and rates are not gonna go skyrocketing by 300 basis points. And, and payments are not gonna be missed with desperation towards the end of the day because there's gonna be a lot of balances in the system that full amount of required balances for business operations and meeting liquidity needs will be there. So it's a much different, not as stark as the situation that you described. Bill, we can discuss this later if you, if you don't agree. And Vicki, I hope that that also got into the issues that, that you asked. Thank you.

- Thank you. We're a little bit over time. So Marvin, you have the last quick word.

- It's just a, I think the answer is your question to me 30 years ago, right? I mean, this is the point of innovation is that we won't have a model of it. And so we need to use all our faculties of analysis to handle those things. And look at this conference, we're still discussing how to shape a central bank appropriately. How many years after the Ricks bank was founded? It, it takes time. Okay.

- Thank you. Please join me in thanking the panelists.

- I am Paola Sapienza. I'm a senior fellow here at Hoover and I'm really delighted to moderate the final panel of this conference. This is the panel that is with people that everyone has been talking about for the rest of the conference. So I want to first thank the organizer, Michael, John, and Valerie also command them for doing a policy panel with the real policy makers, which is not always happening at conference. So we have a great lineup. We're gonna go in alphabetical order. I'm gonna, you know, there's very famous people, so I'm gonna briefly introduce them. Michelle Bowman, vice chair for supervision of the Federal Reserve Board, brings a combination of community banking experience, regulatory expertise, and is leading, I hope she's gonna talk a little bit about that, A more significant transformation in supervisory. Mary Daley, president of the Federal Reserve Bank of San Francisco, one of the clearest thinkers on how structural shifting labor market are reshaping some of the policy landscape. Austin Gouldsby, president of the Federal Reserve Board, the, the Federal Reserve of Chicago, leading expert in innovation, public finance taxes. And finally, Christopher Waller, he's a governor of the Federal Reserve Board, one of the most rigorous monetary economist. He's also doing lots of heavy lifting. I learned recently he lifted 365 pounds for his birthday. So that's impressive. So we're gonna, I know lots of people have approached me saying that they have a lot of question for you guys, so, so we're gonna go, I'm not gonna do a lot of introduction. I'm gonna ask some question after. So we're gonna start with Michelle 15 minutes each, and then we're gonna go to general discussion.

- Great. Well thank you Paula. It's wonderful to be here with so many esteemed economists and people we've read about and have had the opportunity to work with some of you. But it's great to be here. I am pleased to visit Stanford. I think that this might be my fourth or fifth time, but I've only ever been able to introduce one person as a speaker. So this is my first time on the stage. Very exciting. So thank you for the invitation, John to do that. But good afternoon and thank you for the invitation to join you at the Hoover in Hoover's annual Monetary Policy Conference. As the Fed's vice chair for supervision, I oversee the safety and soundness of the banking institutions that we oversee with responsibilities that are closely linked to another of the fed's important roles, which is to safeguard financial stability. So instead of talking about monetary policy, my remarks will focus on this topic, and today I'll address a challenge that emerges at the intersection of these two responsibilities. That is when regulatory requirements become disproportionately burdensome relative to risk, and banks simply curtail the targeted activities, this leaves a deficit between demand for banking services and banks that are willing to provide them. When banks are no longer willing to provide specific services, non-banks step in to meet those needs, an activity is essentially pushed out of the regulated banking system. So this includes the migration of corporate lending from banks to non-banks. Therefore, my remarks will focus on private credit funds and business development companies and will consider the circumstances that lead to this out migration, the implications of banks exiting these services and the Federal Reserve's policy response. Over the past 10 years, we have seen a shift in how credit reaches businesses in the real economy. Since 2015, the bank share of corporate lending decreased from 48% to 29% in 2025. The private credit market is a significant driver of this shift. In the United States, the private credit market has grown significantly and currently accounts for about $1.4 trillion, similar in size to both the leveraged loan market and the high yield bond market. But despite its recent rapid growth, private credit is still a small fraction of overall corporate borrowing in the United States, making up only about 10%. There is no mystery about what drove the shift in corporate lending away from banks. While the post 2008 financial crisis reforms strengthened bank capital and liquidity, which were necessary to promote the safety and soundness of banks and US financial stability. They did so with unintended consequences. Attempts to address the legitimate gaps resulted in some requirements becoming excessive relative to underlying risk, forcing banks to pair back on some corporate lending activities or to raise the cost of credit to borrowers. The effects of the current framework become clear when we examine the incentive structure that it creates. Current capital rules create a perverse incentive. Ironically, banks a more favorable treatment for lending to private credit funds than for lending directly to creditworthy corporations. This treatment encourages banks to finance intermediaries rather than directly serve and borrowers. The broad definition of NDFI includes an array of diverse entities like private credit funds, business development companies, insurance companies, private equity firms, and broker dealers. These entities differ in terms of the types of lending that they offer, the effectiveness of their underwriting and risk management, their ability or inability to work with borrowers under stress, the stability of their funding sources and their connections to the banking system. NFIs also rely on diverse funding structures with private credit funds and some BDCs, primarily attracting capital from institutional investors, including pension funds and insurance companies, and with other BDCs providing access to retail investors and DFI are also interconnected with the regulated banking sector through bank loans that typically involve revolving credit lines and term loans. But over the past decade, growth in bank lending to NDS has outpaced the growth in all other bank loan categories. Recent bankruptcies that impose losses on banks and nds have raised concerns about the quality of loans made by private credit providers. More recently, worries about exposures to industries vulnerable to the implementation of ai. Like the software sector have compounded these concerns. We have already seen one potential channel for the transmission of risk within the financial system, the withdrawal of private credit funding sources as a result of private credit losses and the failure to achieve targeted investment returns. Some private credit funds have experienced a wave of redemptions concentrated among BDCs that are, that offer investors limited redemption rights. Despite these redemptions, banks have continued to extend credit to BDCs and other private credit vehicles with loan commitments and outstanding amounts growing significantly over the past year. These loans generally appear to be well collateralized, which should help protect against bank losses in the event of borrower distress or default. Even though ND i's generally lend to riskier borrowers, default and loss rates would need to be abnormally high for banks to be at risk. Recognizing these challenges. Let's turn now to the federal reserves approach. Our current approach relies on three complimentary pillars. First, recently proposed changes to the Basel three framework address the punitive capital treatment imposed on traditional bank lending activity. Unfortunately, the banking, regulatory and supervisory framework has created an environment in which traditional bank lending activity has migrated outside of the banking system to non-banks. In the case of mortgage lending, our priority is to ensure that our capital regulations better align bank capital requirements with risk across multiple asset classes. For bank lending to corporations and businesses, the proposal would generally reduce the risk weight from 100% to 65% for corporates that are considered to be investment grade by the lending bank. These changes in the capital proposals will reduce the gap in risk weights between loans to non-financial businesses and loans to non-bank financial companies. This will increase competition in ways that benefit borrowers and reduce risks to financial stability. The proposal enables banks to compete more effectively with ND i's in serving credit worthy businesses. When banks receive a more favorable treatment for lending to private credit funds than for lending directly to credit worthy corporations. That can result in an undersupply of credit to TRA to traditional bank business borrowers. By properly calibrating capital requirements, we can allow banks to more effectively compete in providing credit to private business. Banks have deep experience underwriting loans to these borrowers and they should not be excluded from serving their customers to meet this market demand. But to be clear, the capital proposal maintains the tro, the strong banking sector capital, while ensuring that regulatory requirements do not lead to activities leaving the regulated banking sector. Second, our approach recognizes that addressing the inappropriate risk weighting of certain activities doesn't mean eliminating private credit from the market. There is a role for both banks and N DFI in providing credit to private companies. N DFI serve legitimate functions through their specialization in narrow market segments, speed of origination and the flexibility in their credit terms. They are well suited to provide long-term loans to borrowers that may be unsuitable for banks, typically smaller and riskier borrowers that are financed with locked in capital from institutional investors. BDCs, for instance, make most of their loans at spreads of 400 basis points or more, whereas large banks make most of their loans at 200 basis points or less. The optimal outcome preserves the division of credit provision private credit funds and banks can effectively serve different parts of the market. The long-term relationships that banks have established with corporate clients gives them an an advantage in underwriting and monitoring loans for their traditional customers. Banks are funded primarily by depositors and providers of short-term wholesale funding and DFI have different expertise and may have a greater tolerance for risk. Their model relies on funding from investors who accept relative illiquidity in exchange for higher expected returns. The question is not whether N DFI should exist. Instead, we should ensure that the regulatory framework does not tilt the playing field to push activity outside of the regulated perimeter perimeter for reasons unrelated to risk or efficiency. Some lending to non by non-banks is riskier and is better kept outside of regulated financial institutions because it can be funded by investment structures that rely on more stable funding and less leverage. But when credit worthy businesses that could be served by banks instead turn to private credit, primarily because of excessive regulatory burden, we should consider whether our rules are appropriately calibrated. And the third pillar, finally, even as the Fed seeks to level the playing field and to preserve complimentary roles for different segments of finance, we should improve our ability to understand the connections between these segments. One approach is to provide more transparency through regulatory reporting. Measuring and monitoring risks in bank lending to nds requires effective supervision and data that can be collected through regulatory reporting. Our current data reporting relies on industry classification codes that are too broadly, too broad to effectively measure these specific exposures. The current industry code for other financial vehicles includes hedge funds, private equity funds, BDCs, special purpose entities, and asset backed security insurers. Without further distinction, this lack of granularity makes it difficult to assess concentration risks, measure in interconnectedness, or calibrate capital requirements to actual risk. Therefore, the board will update our regulatory reporting to ensure that supervisors have transparency into bank lending. To N dfi. The update requires the largest banks to report financial information about ND fis to which they extend credit, including total assets, net income and leverage that enables an analysis of credit underwriting and ongoing risk assessments. This enhanced transparency also supports other policy objectives. It will provide a better understanding of the risks associated with bank lending to ND fis relative to other types of bank lending. It will ensure that supervisory stress test models are appropriately calibrated for these exposures, which will also benefit activities and processes related to capital planning. It will allow supervisors to independently evaluate risks and assess the condition of these borrowers on an ongoing basis. This can increase consistency and eliminate the need for ad hoc data collections and other onsite supervisory efforts. These three elements, recalibrated capital requirements, preserved complementary roles for different segments of finance, and a new targeted data collection are part of an integrated approach to supervision that serves multiple objection objectives. An approach that supports economic growth by enabling banks to deploy capital efficiently supports financial stability by improving risk monitoring of bank investments in N dfi and it maintains safety and soundness by ensuring that banks remain well-capitalized, providing supervisors with necessary information to comprehensively assess those risks. Together, these create a more efficient, stable financial system where banks return to providing traditional banking activities and credit and other risks migrate to entities and investors better suited to bear them. As we consider these issues, we should remember that regulation always involves choices and trade-offs. The federal reserve's rep approach represents an evolution in supervision and regulation. We recognize the changing landscape of credit intermediation, but preserve our commitment to safety and soundness by calibrating capital requirements more closely to actual risk. We enable banks to compete on a more level playing field with non-bank lenders and serving credit worthy borrowers Through targeted data collection, we can better understand and effectively supervise these relationships and their inherent risks. So I'll conclude by saying that I look forward to working together with my us, my colleagues in the other regulatory agencies as we continue to refine our approach to modernizing supervision of this evolving landscape. Thank you.

- Thank you, Micki. Perfect.

- Go ahead. Excellent. So the first time I was on the policy panel at Hoover, I came and I had I think one slide and a long text. And the person who was on the policy panel with me like this one was Jim Bullard. And he had no texts in all slides, and I thought, there's a revelation. This is a place where I can do that. So I'm gonna follow suit. So I'm gonna talk about something that is on our minds. When I called Valerie or email Valerie and I said, what do you want us to talk about? She said, something that's not narrowly focused on policy. Something that's big in thinking about how we do macro and monetary policy strategically. So I'm gonna talk about shocks and monetary policy, and importantly how to assess the conventional wisdom. So let me fix ideas by telling you what I mean by conventional wisdom. A where do I point? Okay, I'm gonna knee out. Oh, there it is. No, that's, now I gotta go backwards. Okay, now I gotta go forwards. I did it. Hallelujah. Okay, so the conventional wisdom I'm talking about is when you get a shock to the economy, then you want to understand as policymaker, whether it's a supplier demand driven shock, because you want to understand what to look for and then you wanna understand if it's persistent or if it's temporary. And if it's temporary, the standard conventional wisdom as you look through it. And if it's persistent, well then you react, you respond in some way or at least you consider responding. So that all works until it doesn't. And so I'm gonna do what Marvin did in, in, you know, many slides. I'm gonna show this one slide where you can see that we had the pandemic inflation and in the pandemic inflation we continue to say that it was transitory and thought it was transitory. It wasn't just we're saying it and hoping there was a forecast, it was transitory, but it wasn't correct. And so then the subsequent runup in inflation, which doesn't look very much, it's another shock, it's two shocks actually. We had the tariff shock and then now the oil price shock. And so inflation's picked up a bit and it doesn't look very different than some of the run-ups you saw in the great moderation or in the, that decade after the financial crisis. But in point of fact, it's got a lot more attention because the concern is, is this going to turn into another post pandemic surge or is it going to be the normal, hey look through an oil shock look through a tariff shock. So how do we know, how do we assess that? That's the question. And early on in my career, I was told by Alan Greenspan and then followed along by Janet Yellen, that you can't really use models to beat models when you're trying to forecast because you can use their history, but you don't know how they're gonna forecast in the go forward period. And you only know X post if they're, if they're wrong. So then what do you do? Well, we had a chance to challenge that, that logic when we went to the GFC. So this is a picture from after the global financial crisis and the debate at the time, if you'd like to read transcripts at the Fed, that, and many of the policy makers who had to grapple with that are, are here or usually come here. You know, the labor market question was, did the enormous shock to the labor market that pushed unemployment considerably higher than we had seen in a long time. Did that result in through hysteresis or just displacement, a persistent shock that meant it was secular and the fed couldn't offset it? Or was it simply a long lasting cyclical shock that we could offset? And there was, there were estimates at the time, Ana Kota estimated that the natural rate of unemployment had actually risen to 8.9%. And John Williams, who was the research director at the time, and I was on his team, we, we, someone argued about this a lot, but he said it was as high as 7% from his models. And the problem was that these were models that were predicting this. Arianna was saying, you can't make construction workers into nurses. And John was saying, but Loach Williams tells you that you know, this is it. And the, and the problem is you can't settle that debate without more information. So we started producing more information. Now you're not gonna be able to read a word of this, I don't think reading is the point. The point is we started making what ultimately was called labor market dashboards, labor market heat maps. I've only got one part of the heat map. There's actually two, three pages of this. But the point was then you take lots of data, you take as much information about the labor market as you can possibly take, you figure out whether it's below or above its historic norms. And if you're really thinking about this hard, which we did, you're, you're putting, this is a, from a briefing I gave, but you can do this, many banks did this many reserve banks, the board staff and many academics. You're actually trying to understand which indicators lead, which indicators lag. When would I know we're on a cyclical upswing? How would I know? But even that's dissatisfying because then you just have more data. And what would happen is the debates would come to, you know, well I like this indicator better than that one, but we're still just guessing about which indicators are gonna tell us the truth. Not guessing, but, but anticipating or expecting estimating and arguing about that. So the, the next thing we did is we talked about, and many of them did this, I'm just gonna focus on this since I know it well. So I wrote a paper with Bart Hobe, Isha Shaheen and Rob Valletta where, and for the JEP where we tackled this idea of we got a lot of data. How do we discipline into models? So the question we wanted to know is what would move the job creation curve and what would move the beverage curve? And when they intersect, what would we learn about where the natural rate of unemployment is? And you, we were able to separate it with theory into cyclical factors, structural factors, and then score them as whether they would be normally in conventional wisdom transitory or more persistent. And then we can take that to the data. And if you're interested, you can read the paper on that and it'll tell you all the different ones, but I didn't have time to show. But the point isn't really about this paper. The point is about you take the analysis, you take the theory, you take the conventional wisdom, and then it points you to what to look for in the other sources of information you had. And ultimately we, our estimate was something closer to 5.6 for the natural rate of unemployment. The we, the policymakers used this and other analysis and all the different things that that academic research and policy research at the Federal Reserve was bringing to bear to change their views. And this is a picture of how, you know, the unemployment rate evolved, but also how the CBOs interest, natural rate of unemployment evolved and how the summary of economic projections measure of ustar evolved. And it, they were lower than they had originally thought. And in part they, we learned that from just seeing how the economy could go. But mostly we learned it from understanding that there was not a lot of evidence to suggest that it was going to be as high as it was. And there was more evidence suggesting that people can change industries. You might not make construction workers into nurses, but construction workers can definitely do other things. And it was a lot more mobility. So those were the pieces of, of information. And the point of this exercise is to say that when you don't know the answer between models or you don't know if it's persistent or transitory, you start digging for more information. So then the question is, can we do the same thing for inflation? So let me remind you of the problem we had on inflation, which again, Marvin kind of showed, but I'm gonna show you in more detail using the summary of economic projections. So the same debate came up, is it temporary or persistent? I'm trying not to use the word transitory. So you know that temporary means that, but I'm not using it anymore. So we, so this is the, basically what we were grappling with was inflation's coming in. If you use conventional wisdom, it's a supply shock. And this is before it was really clear that people were gonna come outta their homes right after the COVID and then they were gonna stay outta their homes and buy a lot of things and they were gonna be supported by accommodative monetary policy and supportive fiscal policy. But for a minute put that to the side and say a standard supply shock you look through, unless you think it's going to be persistent. And I don't think anyone knew at the time. Most people didn't that this was going to be, you know, one supply chain disruption after another. But that said, here's the picture, headline inflation, PCE inflation is the blue, the the March 20, 21 year end projections for inflation. These are the year end projections that, and this is the median of the SEP. And just out of respect for other policy makers, there were other people who had different dots, but this is the median of the SEP and then it, so what you can see is that the FOMC put in March a marker on where inflation was when we had to make the projection. And then we also, and I was on the committee at the time, so I, I own this too, but we, and we had a little bit of an increase, but then by September we moved it up, but we still thought it's going to come down rapidly. And so obviously reality often is a forcing function for trying to figure out where you didn't see something. And so we dug in to what we didn't see and how much longer would it last. And again, many people in the federal reserve system did this work. I'm just going to show you things that I know very well because I was, we were doing them in San Francisco. So we, we recognized that these traditional inflation gauges, they weren't giving us anything. And if you look at inflation, you're getting backward answers. And so you're still in the forecasting of how long this will last. It's very unsatisfying to try to extrapolate from what's happened. You also have inflation expectations. But again, those were moving around and it was not as reassuring to say that medium run isn't really moving in long run, staying stable. You wanna make sure you're really sure of that. So we started making a dashboard really looking with the material that we had learned in the GFC. Many of us still had that experience of the, of the unemployment rate and trying to grapple with that. And so we started building an inflation dashboard or a heat map. Now I've put the whole thing up there, but what I want to start with is the, the columns. So the columns you'll notice don't look like traditional measures of inflation. They've got different pieces of analysis in them. These are ones that the San Francisco Fed did like trying to decompose inflation and demand driven versus supply driven cyclical versus a cyclical responses sector responses. We have a momentum, a shock momentum index which just asked historically what, how persistent or shocks to hit one sector versus another. And so what should we extrapolate from that? And then things like the vacancy to unemployment rate ratio, you know, that's not common, wasn't commonly used if you remember before the pandemic to forecast or think about labor market tightness. But it was very material in this period. So we didn't have this dashboard when we were doing the march SEP or the the September SEP, but we had it afterwards. And so I put it here just to ask the question, would it have helped us And from this red that was very present in 2021 and certainly by September of 2021 it indicates that a lot of the elements of inflation that would be persistent were flashing red or showing red. And it just gives you an idea that this dashboard might, would likely have been helpful in just understanding there was more there than what was obvious from the conventional wisdom or was obvious from, you know, taking the categories of inflation and trying to figure out if you used cars were gonna stay high or and keep rising or, or go back down. So those are the kinds of things that I think are relevant for assessing conventional wisdom and checking our work. So then the final thing I'll say in terms of the slide is let's apply this to the current moment. And it turned out to be helpful, at least in my own thinking in how I thought about the inflation shock of, I'll start with tariffs. So the conventional wisdom is tariffs are a one-off you, you raise them and then you go out, you then they go, they raise inflation, but they don't keep raising inflation. So it goes back down as they roll through. So we were looking at all these different measures and many others, I'm just giving you the stylized dashboard here so that it can fit on a page. But looking at this measure, this dashboard and many others, and only a small fraction of that dashboard was showing red or even showing pink. And it was just checking the work of is it really going to be a look through? And you do that and you know, we go out and talk to businesses too and ask them about how much they're passing through, et cetera. But this was the part that made it easier to have more confidence, not complete confidence, but more confidence that looking through was a reasonable strategy to have while you're being watchful that something else might change. So now we have the oil shock on top of that, and this is, you know, we only have data through April, so there's still more data to watch, but it's, you're starting to see red in the areas that you'd expect. And one of the things I'm really keeping an eye on myself is not only the momentum index but the New York Fed's global supply chain index, which they also developed during the pandemic. And if an oil price shock turns out to limit the supply chains and then it takes, you know, we've learned about supply chains is once they get clogged up, it takes a long time to bring them back. And so that's the things that could lead to more persistent pressure on inflation. And this doesn't say you're gonna have more persistent inflation, it says you're gonna have more infl persistent inflation pressure. So I, I offer this here and I'll conclude by saying that, you know, the, the message from all of this isn't that you can do perfectly by looking at more data. The message of this in my judgment is that the Federal Reserve and any policymaker really needs to think about how do you resolve the, the models are our benchmarks. They give us a a starting point. Conventional wisdom is critical I think in terms of what has history taught us, but then history has to be disciplined and what we understand from history with the incoming information. And if we do that well and keep looking, you know, under every rock for things and use analysis and models to discipline that, then we have a much better chance of seeing things before they get there. We won't see everything. I mean that's the unfortunate part of being central banking. You don't know everything until you know it, but you can know more than we would. And I think we've had a history of this that history for me started in the GFC when we really dug in, but it's extended now to the, to the inflation shocks that we face. So thank you very much. Thank you.

- This is really a job everyone on time. Austin, your turn.

- Okay, thank you. It seems like every time I come out to Stanford I've gotta talk about productivity and that's the, that's that's natural I guess. Thank you so much for having me. And what a, what a fabulous conference it is been so far. Last time I was here was about a year and a half ago for SIE ppr and it was in this very room and it was at this very podium. And I argued about the productivity data that although productivity data are always noisy, I thought that there, there had been a persistent increase in the productivity growth rate and some people were attributing that to a onetime level shift coming out of COVID, maybe work from home and things like that. But I argue that based on some of the research done at the Chicago Fed, more of the productivity growth increase looked to be at least related to tech industries and, and AI usage. And if so, might end up being sustained for multiple years rather than being a one-off. As the technology adoption worked its way through the economy though, I said then two things. One, if this happens and it is sustained, it will make us richer, it will be wonderful. And I said there could be a tension when it comes to setting interest rates if that were to happen. 'cause there are forces going both ways. So in summary, the productivity growth has been sustained ever since then, higher than the, the trend was before COVID and the AI hype has grown even more than, than the productivity growth rate has. So I'm back out here at Stanford with some more specific follow-up thoughts on how should we think of the increase in productivity growth, like what we saw in the 1990s or what we've seen the last few years, or what might be coming down the pipe if AI is as great as, as they say, how might that affect monetary policy decisions? I think it's fair to say that a lot of the current discussion on that topic is, has referred back to the 1990s, it and the internet caused a surge in productivity growth. As we know, the annual productivity growth, the, the growth rate rose more than a full percentage point per year above the prior trend. Alan Greenspan was the fed chair. He decided that the higher productivity growth meant lower inflation, therefore rates could be lower without overheating the economy. So I wanna think, I want to think that through in some more detail, what are the conditions in which that argument holds? And I hope to convince you that it makes a big difference whether we're talking about unexpected increases in the productivity growth rate, which arrive without warning or expected increases in the productivity growth rate that are going to come in the future. And everyone believes that they're going to come in the future because those two different cases can have totally opposite implications for the interest rate Before just walking through some simple scenarios. I wanna drill down a little bit more about the 1990s episode in a way that is relevant for this discussion. The productivity growth acceleration in the mid 1990s was not clear in real time it had not shown up in the data. Alan Greenspan argued that there were strong corporate profits plus declining unemployment with rising wages and falling inflation. And he imputed that that must mean that there is faster productivity growth that is not yet measured. And on that basis, he argued against raising rates. But by the late 1990s, the productivity growth rate had clearly confirmed. Chairman Greenspan's hunch and Greenspan himself began arguing that if everyone expects a rise in structural productivity, even if it's proven valid, that that could pull forward a bunch of aggregate demand before the productivity gains have actually arrived. And that at some point that would need to be met by tighter policy to prevent inflation. By 1999 going into 2000, as you saw on Mary's chart, inflation was rising pretty, pretty significantly. And the Fed raised rates six times in less than a year in 99 and 2000. So now let us move back into the land of theory at the Chicago Fed. We wanted to think about whether a productivity boom today that looked like the one in the 1990s, would it mean the same thing for monetary policy? So we, we weren't trying to reinvent the wheel, we just started with a standard basic new Keynesian representative agent model with sticky wages and sticky prices that we calibrated it to match the empirical slope of the Phillips curve and to match an average duration of one year between wage changes. We don't have any capital, there's constant returns to scale. Monetary policy follows a standard Taylor rule that tracks the natural rate of interest and responds to inflation and to an output gap. We're not, we're not trying to do anything sophisticated, we're just trying to understand the stylized impact in a normal model. And to it we added a productivity growth increase of one percentage point per year for 10 years. The length is arbitrary, we just add it. We say what happens to inflation, what happens to output, what happens to the natural rate? Now importantly, the entire productivity surge is a surprise. Okay, so in this graph on the top left, the blue, I have black, but that's not black is it? That's blue. The blue line is actual productivity growth for 40 quarters. It's gonna be plus one percentage point and then it's gonna go away. The yellow line is what the expected, so nobody knows it. Every year it drops in their lap and they're like, wow, I didn't expect this to be here. And when that happens, as you would expect, the productivity surges, inflation falls, there's stickiness. So the wages are slow to catch up with the higher productivity. So the marginal cost fall production ramps up, the productivity surge raises output higher than potential. So it's generating a positive output gap. But here in the lower right you can see the low inflation more than offsets the increase in the output gap. And the standard tailor rule says you should lower the nominal rate in response to that shock. And to me that feels very much like a mid 1990 scenario. The productivity growth lands on us, we, the proper fed response is to lower the rates. Okay, but now consider the identical situation. The productivity's gonna go up for 10 years, exactly the same magnitude, but everybody knows it. Okay, so the yellow line of expected, everybody says AI is amazing, we're gonna get one percentage point a year for 10 years. And now a weird thing happens. So the inflation drops pretty much like before and the output gap goes up pretty much like before, but something totally different happens in the interest rate. It rises instead of falling. So what the heck is happening? Inflation's going down, why? Why is inflation going up? And the answer is, since everyone now knows that the productivity growth is coming in the future and that it's going to make them rich, they want to pull their activity forward to today. It's just a wealth effect. The consumer's lifetime income is going up, so they want to raise their consumption now, but most of the productivity miracle is still yet to arrive. We just, we know it's coming, but it's not here yet. So capacity hasn't expanded and that shifting from the future threatens to overheat the current economy. So the central bank has to raise the return on savings to get that pulled forward, consumption shoved back out to where it needs to be. And if it didn't do that, then the economy would overheat today and inflation would blow up the natural rate rises. The standard Taylor rule says that for the expected productivity, the central bank has to raise the nominal rate. And there's a bit of a caution. Let's say you're old school and you're the central bank says, I don't even wanna have an opinion, I'm just gonna wait until there's actual inflation or actual overheating before we do anything. Now the problem is that can backfire and it illustrates the dynamic. Here's the same model with the same predicted, but the orange line, the blue line is exactly what it was before the orange line is what happens if the central bank doesn't pay attention to the way the productivity is changing? The natural rate doesn't incorporate it into the tail rule, doesn't try to offset the wealth effect of higher expected productivity and only responds once you get inflation and an output gap opening up. And what you see is that the wait for it strategy has much higher inflation and much high, much more overheated economy than when you take the natural rate into account. Of course, once you see inflation and a big positive output gap, the Taylor rule says you gotta go raise the rates, but in the end you have to raise the rates substantially more than if you were paying attention as it was going along because this is the thing, if you don't react and you just let it overheat, it overheats and you and, and on average you have more, you have more inflation. Now as a, as a sad aside, I would like to say that one of the first pieces that that I knew of that emphasized the point that news about future productivity growth might force a higher nominal rate, even if inflation was lower, was this Simon Gilchrist and John Lahey paper in the JME back in 2002. As many of you know, John passed away suddenly from complications in a, in a household accident. He was 10 days before starting as the research director at the Chicago Fed. And it's really heartbreaking to think how much we we could have benefited from from his insight these days. As we walk through these three, the thing that I like about these, they're just finger exercises, but they make clear what the mechanism is. And I think to me they made clear it doesn't really depend on the model. Yes, we don't have capital. Yes, it's a very simple setting, but the fundamental thing is if output exceeding potential you think leads to inflation, and if the agents are forward looking, then the amount of inflation pressure is gonna depend on how people are reacting to these announcements about future income and future productivity growth. And I feel like back in the real world, it suggests what the policy makers should be on the lookout for. When, when, when we're thinking about this, we should be on the lookout for anything that looks like pulling activity from the future into the present. So wealth effects on consumer spending, some of it right out the window here in Palo Alto, that would be a bad sign. High investment in data centers driven by stock market valuations, driving up the cost of land and electricians and computer chips for non-AI industries. The bigger are these kind of effects, the more they suggest that productivity growth might be pushing up the ideal interest rate rather than down. And more importantly, just go measure how much productivity people expect to be coming down the pipe versus how much we've already experienced. The bigger the share of the total productivity boom that is still on the way, the more likely it is that rates are gonna need to rise. Now Ezra Car who's at the Chicago Fed has led a survey of three groups, economists, tech people, and the general public about the future implications of ai. And he asked them, how much do you think productivity is gonna go up? And interestingly, the median person in each of the three groups pretty much agreed that they thought it would be about one percentage point for the next 10 years, one each year for the next 10 years. The OECD and McKinsey have studies that project similar. All of those would mean that the lion's share of the productivity boom from AI is still to come. And that would likely mean there are gonna be a lot of incentives to pull it forward and and borrow off of the future. So there's a mixed message here. Productivity growth is still a massive boon for the economy. We want it. What it means for interest rates though is a little more subtle. I think it depends a lot on whether productivity's expected to come in the future. If it happens unexpectedly, rates should probably fall. The more it's predicted to be coming soon, the more it's gonna motivate shifting behavior by forward looking agents and the more likely it is to drive up the natural rate to prevent overheating. If the central bank reacts too slowly, it probably gets worse. The bigger the hype, the bigger the concern. And note I didn't say one word about bubbles. This whole thing was about the fundamentals. Thank you,

- Thank you.

- I hate following him, but I'm gonna take one second to be to discuss it. This wealth effect thing has been around for a long time in a lot of models. So like the forward guidance puzzle where we say we're gonna keep rates low into the future, you should get these huge consumption booms. We didn't see 'em when that happened. So what tends to happen if you take this model and make half of the consumer's hand to mouth to bring that wealth forward, you have to have no borrowing constraints. But if you can't borrow and bring it forward, it chokes all this off. Or you take habit persistence models, which say people wanna adjust their consumption slowly. So there's a whole literature that tones down what's in there. So it'd be interesting to see what happens if you ran the models that way. All right, after that excitement, thank you for the opportunity to speak today, since I'm not gonna talk about monetary policy. So if anybody's watching this and they're waiting for me to talk about it, you know, you can go off to the pub. What I want to talk about is something related to the first two words on this slide, independence and structure. So what I want to talk about is Central bank independence, but applied to reserve bank operations. I know right now they're gonna say, here he goes again. The decentralized and regional design of the Federal Reserve helps reinforce our independence by ensuring that the full range of interest and views are represented in policy discussions and that is something that should be preserved. But much of the day-to-day operations of the reserve banks are not connected to monetary policymaking. And I recently gave a speech at the Brookings Institution where I suggested some improvements to the efficiency of reserve bank operations. I believe that these improvements would keep the Fed's commitment to wisely use public resources in serving the American people, and thus help support our independence in conducting monetary policy in the public's interest. Now, in that speech I asked two simple questions. First, what are the functions and activities that are unique to a reserve bank district and need to be done by a reserve bank in a manner tailored to the local economy and local needs? Second, what functions and activities can be done anywhere and in fact can be done better and more efficiently if standardized and exploit economies of scales across the entire Federal Reserve system? So that first question addresses functions where geography matters, and the second focus on functions for which geography just doesn't matter. Now it's clear that there are responsibilities that belong in a district and to be true to the genus of the federal reserve design, it should be locally run. The president's vote on monetary policy, having a research function to aid the president's community outreach, community development, supervision, and discount window operations. But I noted in my speech that most system employees are engaged in operations providing critical services to the banking system, the US Treasury, and ultimately the American Public Information Technology, human resources, financial management, enterprise risk management, and payments are essential to achieving those operational outcomes. But there is no obvious rationale to do these things in 12 different ways or done individually 12 different ways. These are certainly services needed by each reserve bank, but they do not need to be provided by each reserve bank. These are functions that can be done in a standardized and centralized way and provided uniformly at scale across the system, the system, and ultimately the taxpayer benefits from lower operating costs and better operating overall risk management with services delivered consistently across the reserve banks. So I propose centralizing and standardizing back office functions and having the reserve banks focus on the things they uniquely provide to their districts. Now toward that end, the presidents have developed a framework that shows how to reap the risk and efficiency benefits of standardization and centralization. And I wanna apply their efforts. It is this tremendous step forward for the Federal Reserve System. Now, after I gave that speech, I have heard several comments that my proposal was somehow at odds with the fundamental and time-tested design of the Federal Reserve Act with its emphasis on regional perspective and reserve bank independence. So let me address that concern. The Federal Reserve system was designed as a federated system expressly to meet the needs of a large inverse country. And while avoiding the concentration of too much power of influence in places like Washington and Wall Street, the 12 reserve banks were designed to carry out most of the non-monetary policy functions and services with oversight by the Board of Governors. In this sense, the Reserve banks are able to make largely independent decisions on operations while being accountable to the board and the American public. Day-to-day control is not exercised in Washington, but by the Reserve banks. This is how they have operated since the beginning of the Fed. But as I said, in that speech, technology and leg legislative changes are driving us to rethink how we provide those services in a cost efficient manner. So the question that the presidents and I have been facing is how is how do we exploit those efficiencies while maintaining the spirit of regionalism and reserve bank independence? That is at the heart of the Federal Reserve Act. Now the presidents have answered that question by developing a framework that have the Reserve banks make independent decisions as a collective group as opposed to making decisions on a one by one bank by bank basis. Now there is still oversight of these decisions by the Board of Governors, but it's just that oversight, not decision making. Regionalism is preserved via the activities I listed above that are unique to each district and ensures that the spirit of the Federal Reserve Act is maintained. But functions such as human resources will now be centrally led by a single reserve bank who will then act like, for a lack of better word, a contractor for the rest of the reserve banks to provide services with appropriate service level agreements. Accountability is strengthened in the process, but the Reserve Bank responsible for a particular function will have the authority to allocate resources to operate in a cost efficient way that achieves operational excellence for the system as a whole. Now, individual banks must give up day-to-day decision rights over how the contractor bank provides those services. The board will maintain its oversight role to ensure that performance meets service expectations and costs are appropriate. But the key element of this design is that the Reserve banks still have control over all operations. Their operational independence is not diluted in this framework. Furthermore, the President's plan distributes key responsibilities across the system so that each bank contributes in a manner consistent with its local expertise and Ts and capacity to benefit the system as a whole. But to make this new framework effective as a collective group task with improving operations and at a lower cost, there has to be a change in mindset and a change in governance. Bank presidents and first vice presidents need to adopt a system, first Bank. Second mindset. This is a change in mindset that I have been pushing since I was given my oversight role in 2022. Now, historically, there tended to be a bank first system, second philosophy, which was fine when everything was done locally, but times have changed and so must our mindset. What also needs to change is the governance model. While striving for consensus is a great model for making difficult policy decisions, it is not obviously successful when running a complex and critical when running complex and critical operations. Otherwise, one bank can halt actions that are needed to move the system forward. Again, in the past this was not uncommon, but moving to a model where consensus is not the modus opera operandi will require, will require rethinking how decisions get made for the system. Banks will need to give up day-to-day control of many parts of their operations and delegate decision makings to a single bank that requires collective trust in the contractor bank and a commitment by that bank to deliver the services needed by all other banks. So to conclude, over the last six months, the board and the reserve banks have moved rapidly toward developing an approach that I am confident will modernize our operations to be more efficient while enhancing service delivery. There are still details to be worked out and all of us who play a role in system leadership understand the complexities of change management and execution. That is especially true given the criticality of the services that are provided by the reserve banks, including moving trillions of dollars in us in payments every day for commercial banks and the US Treasury. But the foundation is now in place for driving important transformation and I look forward to working with all the reserve bank presidents and first vice presidents to move this framework forward. Thank you very much. Thank you.

- Thank you everyone. This was great. We have half an hour before the, so I'm maybe I'm gonna intersperse some of the question later, but I'm gonna go to the public right away because I know that Yeah, I knew there are lots of people that have questions. I have. Can I have Mike over here? Amit? Oh, over there. Okay, that's fine. Yep.

- Thanks

- Steve. Yeah,

- Thanks. Great. That's on the great discussions. Comment on Austin's remarks and I wanna draw attention to another federal reserve survey that looks at expectations of productivity growth. That's one I'm involved in at the Atlanta Fed. We take a different approach than the one Ostin describes. What we do is we survey CEOs, ask them about what they expect AI's impact to be on productivity growth in their own firms over the next three years. And then aggregate that yields a somewhat lower number than the one Austin described 75 basis points per year of extra productivity growth rather than a hundred. But it's a very different approach and it's broadly in line with what Austin described. So I find that reassuring. But something else, and this this relates to Chris Waller's comment on Austin, he, Chris briefly describes some mitigating factors, some complexifying factors in that it's also the case that if you look at the investment data, and I suspect this is true in the spending data as well, that the response to AI thus far is extreme, extremely skewed. So in the Atlanta Fed, we just released a blog post earlier this week that looks at AI spending, investment spending at the firm level. So just to give you an idea of how skewed this is, it's about the mean is 14, the mean employment weighted across firms is 14 times as large as the median. Okay. So to Chris's points about when you can bring wealth forward and how that might affect demand today here we have the added complexity that at least on the investment side, and I suspect, and this goes back to Austin's remark about what he sees driving around Palo Alto, that the, the wealth effects that are brought forward in today's spending on the consumption side and the investment side, I think are highly uneven in the economy. One last observation on this point. We have everybody from Silicon and valley enthusiasts who tell us AI is so great that no one will need to work in five years. That's how rich will be to i the, the most recent Michigan consumer sentiment survey, which I not sure if you wanna take that with a grain of salt perhaps, but it, it, it's been running at the lowest levels on record. So there's this enormous heterogeneity and perceptions about whether things are good or times are good or bad. And I kind of invite Austin to comment on how that might affect his, his analytical approach to this issue.

- We're gonna take questions because, so there is a mi rule here.

- Thanks sir. Amit Hoover institution, this is a question for Michelle. So thanks for laying out how you're thinking about the financial intermediation architecture with both banks and non-banks, and I appreciate how you're thinking about reducing regulatory costs on banks so that they could be competitive, especially in segments where they have a comparative vantage maybe relative to non-banks. I was wondering if you would be willing to comment on something that's also happening in Palo that, that you've sort of alluded to earlier, not here, which is the architecture of supervision, like streamlining supervision, changing the models like camels and so on, that also gets to compliance costs. And I wonder when you've thought about reducing regulatory costs, if you've, if you've also taken into account the fact that the compliance costs are also going to go down in supervision and if one is overcorrecting, maybe by doing all of these things at the same time or how you're thinking about it,

- Pablo, you know, a VW asset management related question to Steven. So AI among the, among the general population, it's very unpopular. And if you look at service like the New York Fed, it says that people think they're gonna be losing their jobs. I mean, the probability, the perceived probability of losing a job is very high. My understanding is in, in Austin's model, this heavily relies the implication of the second model is that the, the, the, a key assumption is that people are gonna be borrowing, but if people think they're gonna be losing their jobs, you could get actually the opposite effect in which the saving rate increases in preparation for AI taking over. How, how, how are you thinking about this in kind of in, in, in the context of your model, is this something we should really be concerned about, even if, and the consumers could be wrong and not lose their jobs, but it's a fact that they currently think they're gonna be losing their jobs. So how would that affect the, the, the implication from a policy perspective?

- Joan?

- Hello. I got a short one for each of you, Mickey. I don't understand why you'd wanna lower the capital requirements on anything. Private credit is not doing well because it has a lower capital requirement. They have a lot more capital and more long-term debt. They, why aren't you cheering that here? We have a, a way of funneling money to corporate lending that is, that is not funding itself from run prone liabilities in the end instead of of having deposits which are prone to runs going into corporate lending. Mary, that was great. I wonder what you think of Bob Hall and Marianna EK's observation that because inflation was completely flat, that means we were at the natural rate all along. Austin is absolutely wonderful. I think your model, you left out capital, which you kept it simple, which, but it seems that capital adds to the need. If you have to invest it to get this productivity, you're gonna have a higher marginal product, higher a rate. You need to look, find the Elon Musk video where he says nobody should save for retirement. 'cause we're all gonna be rich in the future. And, and finally, Chris.

- Oh damn. I was hoping I wouldn't get any

- Questions. Oh, no, no, no. The minute you say centralized for efficiency, kind of, you know, the Hoover instincts go off, you know, we should get rid of these stupid state governments and just have the federal government do it. You know, let's have a big conglomerate. The Soviets were, you know, oh, we only need one steel mill. Hoover has its own H hr, thank God we're not under Stanford hr. And thank God Stanford and Harvard and Yale and Princeton don't have one. Centralized hr. We'd never hire anyone. In closing, by the way, I wanna thank all of you. The previous policy panels were fantastic. You guys have hit it out of the park. This is the best one in the 16 years of this conference, so thank you.

- Hi, my name is Alejandra Edwards and I had a question, but for Austin, but I, I think it's gonna be a repetition. And the question had to do with what happens if there is a lot of unemployment coming up from that productivity growth. And one for Mary, it's my own, but I don't understand how those little squares go from green to red in those tables. Could you please explain?

- Oh yeah, sure.

- Okay. So I have one there and then one very patient person at the back.

- Yeah, I have a question for Chris Waller on the proposal. I'm just trying to understand the governance of such a change. So you are the governor in charge of reserve bank operations. You make this proposal, but the board doesn't need to vote on this proposal. That's a question. And then, so it's put out to the reserve banks and it sounds like they are jointly and cooperatively trying to come to a solution to implement the proposal. Are there any sort of required votes or governance structure?

- No.

- Yep. Jim Ballard again, so this is for Austin at Purdue, we're always talking about AI all day, every day. So I thought you did a great job of framing up this issue, which is going to be very hot in monetary policy going forward as to whether, but you know, I guess I would just like to know, did you do any analysis about, you expect the productivity boom in the future, but it actually doesn't materialize versus you expect the productivity boom in the future and it does materialize or it even exceeds what you thought. So you could get the risk of getting it wrong. The policymaker getting it wrong on either side, and maybe you have just have intuition about that, but there's an awful lot of expectation out there and it's not clear there's gonna be enough profits out there to pay for all these data centers and so on. So it could go a lot of different directions.

- I think I'm, I'm gonna stop here and start giving you some time. Christopher, do you want to start? We're gonna and respond to the questions.

- Oh, wow. No,

- That's it

- On centralization. I mean, we're just, we're arguing about exploiting economies of scale and lowering costs to provide the same level of service. That's straightforward. Econ, I don't see that. Plus we try to be good stewards of taxpayer dollars. So, you know, whatever your psychological scars are from the word centralization, John, those are your demons, not mine.

- Does he, can I, can I ask a follow up on that? I mean is like, as you were, is a follow up on John, but on a more positive side. So one of the, one of the, one of the concern that we often have with central banks, we think about the independence from government, but there is also independence from banks. Your, from, from the, from, from the banking system. So your story to me seems positive on that dimension because to some extent, you know, a more structural way of organizing the regional banks should insulate them more from banking pressure. Are you thinking in that or are you just thinking about efficiency?

- No, I'm just talking about back office operations and how to do 'em in the best efficient way without reducing service.

- Okay, Austin.

- Okay, well there were a couple of, of different themes. What for the, for the ones that are, what if there's a lot of unemployment or what if people are afraid that AI is going to going to take away their jobs in the future or in the space of if consumer sentiment is really bad, isn't the implication of this that things should be overheating now that's the danger. Yes, I think it is. So if any things that we have people's fear that they're going to lose their jobs in the future leads them to precautionary save, that would be going the other way. And then, then we'd be less nervous. Don't convince yourself though, that Well, if 50% of consumers are hand to mouth and they can't borrow from the future, then we can't overheat that. Steve, I think the, my intuition was if you think there's a khap economy and equity values are going through the, the ceiling and the top of the K are spending like crazy on houses in Palo Alto out of their equity wealth, nobody has to borrow anything. And it could still look very much like what, what I'm, what what I'm describing now with Steve Davis. Let me just observe what a coal family, my friend and colleague for 25 years and he calls the Atlanta Fed to do his survey. Yeah, thanks Steve. Then. Oh good. Hit a blow. What a blow. What a blow. You've been talking to Chris too long. He's like, oh, efficiency. Atlanta knows how to do the surveys.

- Damn right. Yeah.

- I John, I thought you were gonna ask, and it is kind of related to this discussion about, I thought you were gonna say, Hey, if everybody thinks like Elon Musk and in the future we're gonna be risk, not only don't save for retirement, don't work now. And I I was thinking you were about to say that. I was saying in a weird way that is a form of consumption. So the shifting of consumption to the present of the form of leisure. I'm gonna take leisure because I know I'm gonna be so rich in the future. If you started to see labor, labor supply, labor force participation unexpectedly dropping among the same group of people, that would also be a thing that should start making you nervous. The last thing I'll say we have can, can we pull the slides back up to Jim to your question of what if they get it wrong? I did have a slide where I did that. The only reason, well,

- Is there - Anything, if it comes up, we'll we'll have it, but if not, the only reason I didn't present it in addition to you couldn't see it, but I finished with two seconds left in my time is it's a little less robust. So the thing about the, what I showed you is a very simplified model, but it's pretty robust. We tried different models and, and different production structure. This thing, it makes a big difference.

- Here it

- Is.

- Okay, here it is. Let's see.

- You have to switch

- What maybe you want.

- I have no idea where to point.

- Keep, keep going. Keep, where is it?

- Oh,

- Oh,

- Dang it.

- It just had a leg. It went, it went many times not

- Having a leg.

- I - Hit too many. This is why the survey's in Atlanta,

- Okay, here's continually disappoints here. The, the, the only complication is, so here it falls off halfway through. So we are, we, but everybody keeps thinking it's about to come back. And now that makes a huge difference. Do does when it falls off, does everybody realize it's done or are they still waiting? Wait a minute, it's gonna come back. Just wait one year. So I I said let's just have them keep thinking it's coming back. It's, they think it's gonna be 10 years. Interestingly, you can get it if you think through the intuition, the more you think is coming in the future, the more you're pulling it forward to today. So the bigger the disappointment's gonna be, the recession's gonna be bigger because there's stickiness and inflation is kind of persistent. All this shows you is you can easily get stagflation when that happens where you overheated the economy and you got inflation going, and then you get the recession because you, you you overspent compared to what you were. And this is all fundamentals. This again, this is not a bubble, this is just, they made a mistake. I should have done it. But you should, I should have done it the other way too. What if we get a blessing? I think that goes back to the original one. What if you just got 10 years of productivity that you didn't expect? The rate goes down every everybody's happy because, 'cause it, 'cause it goes great. But thank, thank you for these comments. That was, that was really helpful,

- Mary.

- Okay, so I'm gonna take the prerogative of having the microphone to say something about Austin's piece that relates to what I was trying to say in, in my work is that my presentation is, you know, I like where you ended Austin. And I think that's really important. We can sit here and it's fun to do 'cause we're at Hoover and deliberate the models and should we have capital in them or is is everybody's or there's too many hand to mouth people that we can't possibly get the result. But the thing that you said at the end is really the discipline, which is what would we look for that would prove to us whether we were there. We're not gonna to look to R star because that's up, hard to estimate. And you know, vaguely, vaguely understood in real time. So the the things you talked about was data center investment and consumer spending at the higher end. And do they keep going through that? And there's a whole list of other things. So I think that's the discipline for the model and trying to figure out whether the, the good scenario or the bad scenario would merge. Now on the questions, I'll start with the green and red since that's easy and I should have said it, it was just illustrative, but the green and red was really standard deviations away from your historical norms. So if you're two standard deviations away, you're red. If you're one, you're, you, you, you move up radiations of color, the real elements that got us to move forward with those measures. And many people do it. I mean, the Kansas City Fed has a labor market index. Now the Atlanta Fed publishes regularly a spider chart that shows how far away or how close we are to conditions that would be recessionary or, or dynamic. And the the whole point of this is you learn early by doing this, which ones lead and which ones lag and which ones help and which ones don't. But it goes back to something that I learned in microeconomics. I'm trained as a labor economist and when the professor said, you'll never know anything for sure in micro. So you're going to have to have a preponderance of evidence. And so I'd see these, these questions that, that the models produce as a preponderance of evidence mentality. Okay, so are you talking about Bob Hall and Mariana's work where they're, they're, so Mariana Klik is on the San Francisco Fed staff and we have vigorous debates about whether because inflation was pretty constant for a long time that we had reached the natural rate of unemployment. And there's something to think about there. But what we kept finding, and I had the same, you can have the same debates with many people. What you keep finding is the labor market is more flexible than what the natural rate estimates are. And that you can't always use inflation, especially when it's surprising that it's not moving. So we put, we put all these shocks onto the inflation and the great moderation and the GFC at the post GFC and nothing happened with inflation. It was stuck basically at 1.8. And so no matter what we did, and then it becomes an uninteresting measure or calibrating measure for where the natural rate of unemployment is. And so that's why in many of the, the discussions we had, we were learning about the natural rate of unemployment or how far the economy can go down without spurring inflation, you know, experientially and we could run hotter because we didn't have an inflation problem. That's, you know, ultimately, I'll tell you how I, and I always conclude with Bob Hall and Arianna is that it's really hard to tell Americans that you're taking, you're gonna constrain their job growth when we have price stability. And so the natural rate is a concept that's useful for benchmarking, but actually the data teaches us where the labor market can go and how fast it can run. I think that was the end of my question. Yeah, thank you.

- Thank you Micki.

- So I'll start with John's question about what, why do we care about private credit and monitoring it? I think from the perspective of financial stability, we need to understand how all of these different activities work together and what the investments of the banking system are into those areas that are much less opaque. So in, in the, the unintended consequences, I think of Dodd-Frank, when it was implemented, it risk weighted a, a lot of activities that were really commonplace in the banking system in ways that made it banks really not interested in continuing to do that. And it pushed it into the non-regulated space. And then we couldn't understand how those investments were being, were being utilized because we weren't collecting any data that could help us understand that until we don't oversee the non non-data, non-bank financial sector. So it was difficult for us to understand what the spillovers could be, how we could think about what kind of a financial stability it, it could be, and at what point should we be really concerned about it. So I do think that we took the opportunity with the new Basel capital rules to bring a lot of that back activity back into the banking system because we far over calibrated on regular banking activities in that rule itself. So, and I think everyone knows that that many before me had tried to implement a response to the Basel three process that, that we agreed to in 2017. And this was the, the right way, the right opportunity. And I think there is a shift to a mindset around the world on bank supervision and regulation that says, it's time for us to stop thinking about what happened before we've overcorrected or corrected appropriately. And in some ways for those activities, what are, how should we be thinking about what's gonna happen in the next 10 years or the next 20 years? And how should we be positioning the banking system for that? So in our work to modernize the, the regulatory and the supervisory systems, what we're trying to better understand is how can, how can we bring some of that activity back in, but also allow for innovation in the banking system and recognize that, that those activities are going to change and we need to be positioned to be able to oversee those, whether through regulation or for or through supervision. So your question was about supervision and we're making a lot of changes and a lot of those changes are related to, I serve also as the chair of the F-F-I-E-C right now. So when I, when I became chair, I had a big agenda and people that also were serving with me said, this is a very sleepy organization. And I said, it's not now

- Wake up.

- Exactly. So we've been doing a number of different things through the F-F-I-E-C and in the coming weeks we're going to be introducing a new update to camels among many other things that we've been working on that won't be quite as public, but, but these are things that have not been looked at or reviewed or updated in 50 years. And so when you're thinking about frameworks that worked for banks back in, you know, pre-farm crisis, maybe we're not looking at things or things or thinking about their inter interactions and how we should proportionately understand what activities or what, what, what supervisory constructs should comprise each one of the components of the camel's rating framework. And what we found was that oftentimes the m part, the the management rating had been abused in ways that was not transparent, that it integrated a lot of things that weren't related to necessarily management that then led to a, an opportunity to downgrade the financial institution from its composite perspective. So through that and recognizing having been a banker and implementing a lot of these rules and regulations and, and being subject to supervision, what I recognized was that in addition to watching some of the bank failures that we, that occurred over the last few years was that we were not really looking at things in a way that would allow us to effectively and promptly understand what was happening in the banking system. And what I would point to in particular is that for some reason we stopped looking at reports like the report in the spring of 2022 that showed us that there were problems with Silicon Valley Bank and then later in the fall when those were exacerbated and other reports that we were not responding to as well. So one thing that I've done as the vice chair is to implement a, an independent review of the failure of Silicon Valley Bank. We're in the process of learning some of the shortcomings of the previous reports that have been done. One of those shortcomings is that people from outside of the Federal Reserve were not interviewed. Kind of head scratcher, isn't it? So I think that there were a lot of opportunities for us to think about did we learn the right lessons? How can we learn the lessons that keep us from, from, from repeating the failures that led us to the, one of the most costly bank failures in the country's history. So by focusing on material financial risk and recognizing that there were more than 30 Mr. Mrs that existed on Silicon Valley Bank, only a handful of those had anything to do with material financial risk, which is actually what brought the bank down. So when the bank doesn't understand how to prioritize what those findings are and how to mitigate those findings and make them and remedy them, is it any wonder why we weren't focusing on the right things to keep Silicon Valley Bank from, from failing? So in our review of MRA, so we've published this statement of supervisory operating principles. It's the first time the Federal Reserve has ever done anything like that to provide transparency to how we approach supervision and what we're focusing on and how we're thinking about things in very plain language. So we, we, we use mrs, which are matters requiring attention to identify areas of either violations or areas where we want a bank to, to fix things that we found to be problematic. We had MRIs on the books from 2001. Does that tell you that if we thought it was that important in 2001 decided as an MRA we weren't following up to make sure that that condition was mitigated? I think we had a problem with the way that we were implementing these tools and now what we're doing is taking a look back to try to make sure that one, that they were appropriate when they were issued. Two, if they've been mitigated, we need to make sure that they are lifted and that we understand and, and the bank understands when we have a problem and we've identified it, what is it, what's the condition that says you fixed it? And then how do we make sure that if you do the same thing again, you get another MRA instead of leaving one on the books for 26 years. So,

- So you're making, hopefully that answers your question a way more practical. It's not that you're

- Underweight No, no, no, we're not, we're not doing anything less. What I would tell you is that we're focusing more on financial risks. We're, we're still doing all of the other components of our supervisory process that includes cyber risks. Obviously we know that there are a lot of cyber risks that exist in the financial system. We're still doing BSA and a ML, everything else that is, is a regular component of our supervision programs we're continuing to do. But what we wanna make sure that we're not missing is those things that actually lead to big failures like material financial risk.

- Okay. I think we are at the end of the time, I, Valerie will.

- Hello everybody. Hi. We're we're supposed to start. Okay, so I'm gonna introduce our, our speaker, but before I do that, I wanted to tell you that we had this great conference last year. Many of you were there. It was a conference in honor of John Taylor, the book's out, and this is the book. Okay. It's a fantastic book. Yeah, it's your book, John. So I, I thought everybody should get a copy of this. Okay. This is, this is, they did a spectacular job and now I'm going to just, you got the, you got a copy of the book A John? You did. Okay. He did. Okay. So I, I'm gonna introduce Tyler Goodspeed and I, I've known Tyler quite a while. I guess I, since I've been coming to, to Hoover and he's gonna be our, our dinner speaker. Tyler, Tyler has, has worn several hats in his young career. He is a, he was a Hoover Junior fellow, that's how I met him. He was a professor in England, he's a policymaker. He was chair of the US Council of Economic Advisors in the last Trump administration and now he's a chief economist in the corporate world now as an eco. And he's an economic historian. That's the most important thing. And as an economic historian, he authored excellent book on free banking. This is like maybe 10 years ago and I think we had him come to my university and talk about it. But now he's gonna tell us about his new book. Very superb new book on recession. This book, which everyone interested in, you know, insent Economic Issues Should read, is really, it's really unique. It combines historical narrative and data for several centuries covering every business cycle in in the UK and the United States. And the purpose of the book is to answer the question what causes recessions. And I'm not gonna go through, it's his book, he'll tell you about it. But one thing I'll say, his analysis shoots down just about every well-known explanation, including something I once did with Joe Halbrick who's here and ends with this, these fascinating insights of the zone. So I'll let you let him tell you about his story. So thank you very much.

- Thank you, Mike. I must say it is a real pleasure and privilege to be back at the Hoover Institution. Looking around, I see many friends and former colleagues, and I should note I see many friends who are also former colleagues. I see no former colleagues who are not also friends. I must underscore upfront that my remarks this evening represent my own views and should not in any way be interpreted as representing the views of any other individual or entity. If asked when the price of a barrel of oil reached its all time high one might reasonably offer 1973 during the Arab oil embargo. 1979 following the Iranian revolution would be another good guess as would 1990 during the Iraqi invasion of Kuwait. But the correct answer would be June, 2008. In fact, since 1945, the inflation adjusted cost of energy was never higher than it was in summer 2008, as a result of a confluence of unanticipated shocks to both energy supply and energy demand. By the summer of 2008, the average American household in 2020 $6 was paying $8,500 per year on energy goods and services. That was $2,000 more than they'd been paying just a few years prior. In 2020 $6, the price of a gallon of gasoline reached $6 and 17 cents the highest ever to date. As high energy costs drove up the cost of fertilizer and farmers shifted production toward the production of ethanol from corn in part, in response to new policies, food inflation spiked to above 6%. For many American households, remember half of whom typically have no savings after tax, it was unsustainable. Driving to work, dropping your kids off at school, heating and cooling your home, putting food on the table. These are not exactly expenditures on which it is easy to economize under financial pressure. By summer 2008, about 5% of American homeowners had thus fallen seriously behind on their mortgage interest payments. And the rest, as they say, is history. Like tropical storms, we tend to name recessions. But unlike the naming convention for hurricanes, for storms of the economic variety, we have this persistent habit of naming them after some expost perceived excess during the preceding economic expansion. Hence, the 2008 recession was not the 2008 energy crisis, it was the housing bubble. The relatively mild and short recession that inaugurated the 21st century was not the nine 11 recession, it was the.com recession, the.com bubble. Earlier this year, many economic commentators were all writing, writing the obituary of the current economic expansion at the hands of an anticipated AI bubble. But is it true that to understand episodes of economic contraction, it is first and foremost to the contours of the preceding economic expansions, to which we must turn, do expansions die of their own cumulative excesses imbalances, fragilities their advanced age, their infirmity, or in the words of Ben Bernanke, are they murdered the notion that expansions are ultimately culpable for their own recessionary? Death is certainly 1st of August Providence, the MIT economist, Charles Pit Berger's classic manias panics and crashes is currently in its eighth edition. And though you may protest otherwise, most of you still believe it. That's why we call the 2000 recession, the.com recession, the 2008 recession, the subprime crisis. There's British economists among us, many British economists still assigned blame for the 1973 UK recession on the so-called barber boom. Now, fortunately, the boom bust view of economic fluctuations, the mania, panics and crashes view is scientific in one crucial sense. It yields empirically testable falsifiable hypotheses. Unfortunately, inferences fraught in so far as one relies exclusively on the 12 US recessions since 1945, because though one may think that with quarterly or monthly data available since 19 45, 1 has all these degrees of freedom, the reality is you have 12 with a slope and an intercept, you've just chewed through two. So in the book I extend recession chronologies and multiple macroeconomic time series all the way back to 1700 on a consistent basis in the United Kingdom and the United States to examine no fewer than six key hypotheses generated by the boom bust view of economic fluctuations using a sample of 132 recessions. First hypothesis. If recessions are fundamentally a function of human psychology or processes that in here in economic expansion, then we should exem expect to observe that the frequency of recessions is roughly constant across time and space. But over the past 200 years, the United States was vastly more recession prone than the United Kingdom by a factor of two in just the past century. The United Kingdom avoided recession in 19 37, 19 48, 53, 57, 60, 70, 81, 2001 US recessions each and recessions on both sides of the Atlantic had become much less frequent over the past three and a half centuries. And that is a long run structural trend dating back to 1700 and a chow test cannot find a statistically significant breakpoint at any specific points in time with the possible ex possible exception of 1785 in the United States. And you can just think about some recent institutional changes then second variation in the height to speed or duration of economic expansions should explain something of the variation in the depth, the speed, the duration of the succeeding economic recessions, deeper, faster, longer recessions should succeed higher, faster, longer expansions. They do not, not for GDP, not for consumption, not for investment, not for bank credit. Estimated coefficients are zero third expansions should die of old age. If recessions are the consequence of cumulative excesses imbalances or fragilities that build up during the perceiving expansion, then we should expect that the probability of expansion death should increase with age. But it does not. And contrary to the seminal work of D Bold and Ru Bush, I find that expansions on both sides of the Atlantic have never died of old age. They have always been Peter Pan rather than the picture of Dorian Gray. Fourth, more broadly, there should be some information in an economic expansion that can inform the probability of the subsequent recession. But the yield curve, the sum indicator credit spreads cyclically adjusted price to earnings ratio leading economic indicators, dynamic factor models with markoff switching skyscraper embassies, all of them abound in false positives and false negatives over the past four centuries. Recessions are fundamentally un forecastable. I mentioned the 2001 recession conventionally attributed to a peak in subsequent decline in US equity valuations. Incidentally, tech stocks had already started to recover by the start of that recession, but that was just one of at least four shocks impacting the US economy in 2001, not the UK economy incidentally, but the US economy. And I demonstrated in the book that quantitatively it was the least important of those four shocks. And we have estimates of the responsiveness of consumer spending to changes in financial wealth and they cannot explain the magnitude of the decline in consumer spending in the third quarter of 2001, especially if one considers that tech stock ownership was skewed heavily toward high net worth and high end income. Individuals who tend to be less responsive to changes in financial wealth. The most important of the four shocks in 2001 were the terrorist attacks of September 11th. And in fact, all, all of the output decline during that relatively short recession occurred during the three months that included those attacks, the consequent closure of US airspace, widespread fear among consumers, households and businesses and economic activity grinding to a halt in the economic center of what was then the second largest economy in the United States. And that was un forecastable. Fifth, the rise of a more interventionist countercyclical state should have attenuated the depth and duration of recessions over time, yet on both sides of the Atlantic, statistically recession depth and duration have been constant over time. Going back to 1700, if anything, UK expansions have been longer since 1945 rather than shorter. And recessions have always died of old age. The strong age dependence of recessions is not a modern phenomenon within cycle. Macroeconomic volatility has declined since 1945, but it's actually only declined to levels that prevailed before the incredibly marshal period between 1914 and 1945. Finally, sixth, if recessions are performing some cleansing reallocated corrective function, then several years on from a recession, we should expect economies to look fundamentally different from how they would've looked had they continued uninterrupted along long run trends. But several years on from a recession using a HP filter or Hamilton filter. The allocation of people capital and output typically looks remarkably similar to how it would've looked had the economy continued uninterrupted along long run trends and far from enhancing the reallocation of people and capital from less to more efficient firms and enterprises. Recessions are rampant age discriminators. They discriminate against younger workers, they discriminate against younger, more dynamic firms. They discriminate against research and development they impair rather than enhance the process of creative destruction. In his classic novel, Leo Tolstoy opened with the line that all happy families are alike. Each unhappy family is unlike, is unhappy in its own way. Recessions, I contend, are apt illustrations of what I describe as the Reina principle. While ongoing economic expansions are broadly similar, there was mention of Mariana and Bob Hall's work earlier today. They're gradual yet inexorable recoveries from earlier contractions that lead to positive trend. Economic growth of the over the long term. Every recession instead represents an economic expansion that failed or was terminated in its own way, indeed, as early as 1927. It was actually ironically a Soviet economist in Moscow, OGEN Slutsky that are known for the slutsky equation, but Ogen Slutsky who demonstrated that the summation of random or chance causes could generate what looks like cyclical behavior, cyclical fluctuations, even though the underlying data generating process is random. And if we could move to the the next slide, Slutsky Suki used old Russian lottery ticket numbers to construct a moving sum and the resulting series mapped perfectly or almost perfectly onto an index of British business conditions over nearly half a century. The problem is that this idiosyncratic nature of recessions, it rebels against our evolved human logic. We are pattern seeking mammals. Patterns are how we relate, observe stimuli to subsequent negative experiences, the ingestion of colorful mushrooms followed by illness, the excess exposure to sunlight followed by sunburn. So too with the negative experience even trauma of recessions, do we thus seek to relate that trauma causally to some precipitate action or actions that we might endeavor to correct in the future, lest we incur that trauma and guilt again. Yet our search for patterns such as predictions of recessions or predictive models, can often lead us to connect data and events that appear related but are in fact random or unrelated. It's actually a common effect of our cognitive wiring, the technical term for which is ania, the opposite of an epiphany. And the stories we tell ourselves about recessions abound in epiphanies as we seek patterns in the height, the speed, the duration, the constitution of an economic expansion that can hopefully explain the likelihood depth, speed, duration, and composition of subsequent recessions. And crucially, in part, a moral lesson, there's a reason parables are among the most enduring stories for humans. But a key lesson of the long history of recessions is that statistically there is no information whatsoever in the contours of an economic expansion that can explain variation in the likelihood or contours of the recession that follows. And so our aous thinking about recessions isn't innocuous because it can lead us to attempt to sedate or otherwise medicate economic expansions that fundamentally die healthy in the mistaken belief that doing so can prevent recessionary death. Great historical events like deep recessions do not require structural causes, inevitable, deep historical forces. The reality is typically more prosaic. Consider again what began as the 2008 energy recession. There is a counterfactual state of the world and not an improbable one in which that was your typical garden variety post 1945 energy related recession. But what turned that into a much deeper contraction was ironically a British commission of a very American error. The classic even textbook British response in moments of financial stress going all the way back to 1826 as the economic historians in the room will know often fueled by ham sandwiches and whiskey over late nights and exhausting weekends, was to adhere to some form of badges rule in concert with the Bank of England, coordinating and facilitating the acquisition of weaker banks by stronger banks. Indeed, this was precisely what allowed the United Kingdom to avoid recession in 1866 and 1873 and 1890 and to avoid a what could have been a much deeper recession during the oil embargo recession of 1973. But in September, 2008 over the pivotal weekend, the Chancellor of the Ex Checker blinked and instead adopted a classic American approach, which was to permit institutional barriers to block the timely acquisition of a weaker bank Leman by a stronger bank, stronger healthier bank. The very well run, well-capitalized Barclays before then immediately proceeding to publicly bail out other financial institutions in the disorderly aftermath. And we know the consequence reserve primary fund broke the buck because of its nearly billion dollar investment in Lehman commercial paper. As Lehman US conducted a global cash sweep at the end of every trading day. When the US parent filed for chapter 11 bankruptcy protection, Lehman International in London immediately had to file for protection under an administration order in London. This effectively froze all of Lehman International's assets and liabilities, including the collateral of institutional clients whose funds they have ated triggering a run on UK financial institutions by institutional investors. So while recessions are inevitable, there has never been an immortal economic expansion. Any given recession in any given year is not, they are conditional, they are historically contingent. But though we may be unable to predict recession, the evidence is unambiguous. That expansions have been living longer as we households, businesses learn how to better absorb the kinds of shocks and the magnitudes of those shocks that historically would have generat generated recession. Moreover, while we worry a lot about recessions and rightly so because recessions hurt a lot of people, we ought to be at least as concerned about economic expansions. The United Kingdom, as I noted, was historically much less recession prone than the United States. The United Kingdom is also and has long been at least 30% poorer than the United States. Ultimately, the majority of years in which economies expand matter much more for long-term economic prosperity and indeed human flourishing than do the minority of years in which they contract. And though it may be odd for remarks about recessions to so conclude, so it does, thank you.

- We, I think we have time for a couple of questions. Right?

- I, very nice. Really thrilling presentation. So why should the baseline be that these things would be predictable if you thought they were predictable? You could make money on them. And so the theorem would be they're not gonna be predictable. So especially as expectations have come to revolutionize macroeconomic thinking and kindleberger might have been a little too early for that, but you know, I think Samuelson wrote in the sixties, you wouldn't expect predictability here because of the role of expectations. So what do you think about that? So really you're saying that that that confirmation of the theorem, I guess,

- So this was posed to me by a, a very eminent macro economist recently who referenced the queen posing the question in 2009, why did no one see this come coming? And the after the fact answer of the macro economist was, well, because these things are unpredictable. If we knew that there was gonna be a a bank run tomorrow, we would pull our funds today. If we knew that there was gonna be a recession tomorrow, then we would save more today, invest less today, hire less today, and we'd have the recession today rather than tomorrow. So we can simulate these shocks, we can estimate the impulse response functions, but we can't predict them to which I then asked him, well what do you call the 2001 recession? What do you call the 2008 recession? And he said that's, it was the housing crisis, it was the.com, it was the.com bubble, it was the housing crisis. I what implicit in that is that there is some information that cyclically adjusted price, earnings ratio, housing prices, that there's some information in that expansion that should or could have predicted the subsequent recession and Yep. But, but that's, that's sort of 'cause we, I would say the main message is that we probably ought to be, be taking our models and that prior more seriously because we, after the fact, we always fall into storytelling mode. And I think that is a key inside of Schillers.

- Yeah. Anybody else?

- Steve?

- Well Steve, - So a comment in our way in thinking about what you're describing, you can think of recessions as falling process and each instance of the poissant arrival process might be unpredictable. Nonetheless, we might undertake some reforms over time that reduce the poissant arrival rate. And it seems to me there's one clear example of that not so apparent in the history of the United States and the United Kingdom, but if you look at a broader set of countries around the world, there's a pretty clear pattern that civil wars or large scale civil wars are pretty much almost guaranteed to trigger a recession, if not a depression in that country. So whatever we can do over time, and at least if you believe Stephen Pinker, and perhaps until quite recently, there has been a long term secular decline in various indicators of violence, including interstate conflict. So I I do think that, and it's not inconsistent with anything you've said, it rather shifts the focus towards, yes, there are many potential culprits of the murder that is a recession, but we can take some of the worst culprits off the table or make them less likely to occur and thereby reduce the frequency of what is still essentially an unpredictable event.

- So one of the things Steve, I like about your question is that you, you largely answered it. So I have, I have two key thoughts 'cause I think this is, this is essential and it speaks to unconditional probabilities in any given year. So for example, over the past century, the unconditional probability of a pandemic related recession is about one in a hundred. The probability of a war related recession has gone down. And in fact one of the most prolific murders of economic expansions in the 18th and 19th centuries, particularly the 18th century on both sides of the Atlantic, was not just war, but war that really visited your soil or world war. All of the longest recessions on both sides of the Atlantic have been war related with the one exception of the Great Depression. But there is a lot ELs going on with that. But all of them, the longest for the United Kingdom, it was the 1760s or the seven years war, it was af during and in the immediate aftermath of World War I during, in the during and in the immediate aftermath of World War II in the United States, there were colonial related war related recessions. I also think it's so that has been declining over time. I also think the contrast in recessionary experience between the United Kingdom and the United States reveals two additional. So there are two main reasons that the United Kingdom was historically less recession prone than the United States. One was that from 1826 on it had a nationwide system of branch banking. So you had a broadly diversified portfolio as your national banking system. The second was that from 1926 to 1972, the United Kingdom went without an official coal strike. And during that time the UK economy was overwhelmingly reliant on coal rather than oil. When the United States went through from 19 48, 53, 57, 70, all of which were oil related recessions. So that diversification that has been going on over time in our banking systems and our energy systems speak, I think to those str those processes you're talking about.

- Take another question, Torsten. Yeah,

- Great. So thanks so much. Yeah, this was indeed very fascinating. Thank you very much. I look much forward to reading your book. So taking the peril is 2008 today we have a data center built out. A lot of people are worried about exactly the same. We had a housing build out. And that will of course ultimately by definition result in a slowdown in data center buildup. And therefore some slowdown, at least in construction growth of data centers. We might not be quite there yet, but at lead the parallels to the kindleberger view of building something up and then slowing it down, it clearly there. And now by coincidence, we also have an energy shock exactly on top of that, just like we had in 2008. So are we saying that the confluence of factors of some buildup, even if we think in your view that this might not be the source of a recession, but the combination of that with an energy shock, is that saying that there might be a recession coming later this year or are we still saying that it's just completely unpredictable?

- Well do the, do the second question. Having just written a book, a conclusion of which is that recessions are fundamentally un forecastable. I shouldn't be getting into the business this evening to the first question. One of the things that really surprised me in the book is that when you look back on past transformational technologies, be it canals, be it railroads, be it fiber optic cables in the nineties and two thousands, the real physical infrastructure is remarkably faithful to long run trends. And those trends resemble a beautifully smooth S-curve, adoption curve. And so heading into 2026, as everyone was worried about an AI bubble causing recession, my baseline on the basis of three and a half centuries of economic history was that AI investments were more likely in the near term to be a casualty of a recessionary shock elsewhere than a cause thereof. And speaking of unconditional probabilities, I mentioned pandemics. If you look over the past century, in any given year, the unconditional probability of an energy related recession in the United States, not the United Kingdom, but in the United States, it was one in 10 that has been declining over time. But that's the sort of century unconditional probability. But before, before the oil shocks of the post-war period that we're most familiar with coal industrial action in coal was a perennial contributor to recessions in the late 19th and early 20th centuries. And before that it was Pete and Provender Pete being combusted for residential heating and industrial power generation, provender being the primary fuel for the primary source of ground transportation, namely animal draft power.

- Thank you. Well that was fantastic. Thank you very much.