C. Peter McColough Series on International Economics With Charles Evans

Charles Evans discusses the Federal Reserve Bank of Chicago's role in the U.S. economy and policies for economic growth.
 

The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

 

KEENE: I will go by memory of the cards—here they are, I think in the back—of the rules of the McColough Series. We welcome you this morning. Of course, cellphones, please pay attention to your cellphones and modern paraphernalia. We will speak for thirty minutes, and then I will go to your good questions. And hopefully President Evans answers them. And in doing that, let’s try to avoid observations that can go on a long time in our treasured one hour that we have. I think some of you have heard that from me.

This is a wonderful audience today. We have—there are some wonderful people here from academic economics, market economies, and of course all of you as members of the Council on Foreign Relations. This is on the record, and the press attending in the background—in the back, rather, will speak to Mr. Evans after our one hour. These are always important discussions but made more so here from the gentleman from Virginia and Carnegie Mellon, and that he speaks with unusual clarity as many of you know. The Evans rule—is the Evans rule still in effect? Is it?

EVANS: No, Janet got rid of the Evans rule in March 2014.

KEENE: (Laughs.) There was an Evans rule for a while. I guess we’ll discuss that as we can. But far more important, Charles Evans speaks his mind. He’s always been that way with his commitment to Chicago economics, and to Mr. Moskow at the research department there, and now onto his important duties.

So let us dive in right now. And I, in the many speeches you’ve given, have to go to the speech in Frankfurt, Germany, where you speak about midcycle and about the dynamics that they have. Let’s first define this new phrase—I don’t believe I read it in Dornbusch, Fischer, Startz. What is midcycle?

EVANS: Well, you know, what the Federal Open Market Committee sort of identified in early, you know, 2019 is that, you know, the state of the economy, and financial markets, and inflation were behaving somewhat differently than we thought, you know, going into the end of 2018. And so we had been raising the short-term policy rate, the federal funds rate target for, you know, some time. We were never on a preset course for anything, but we were basically increasing the federal funds rate by twenty-five basis points every quarter. And then we got to the point where it’s, like, there seems to be more uncertainty. There were a lot of things in play. The Chinese economy.

And it looked like the path that we had expected, which in my own estimation would have called for probably three more rate increases in 2019. All of a sudden that didn’t look like that was appropriate. So in the middle of this, you know, economic cycle, as we had been taking the funds rate we thought to a more neutral setting and then just a little bit beyond that, we decided: I’m not even sure what neutral is anymore. I think it may have moved down on a short-term basis. And we need to make an adjustment so that policy would be—and I would say, moving from leaning towards a restrictive stance as a path towards leaning towards an accommodative stance. And that’s pretty much what I think we’ve engineered with our third rate cut at our last meeting.

KEENE: Parse the distinctions of, as Vice Chairman Fischer would speak of, ultra-accommodative, where we are now within accommodative—I love the phrase “hawkish rate cut.” Please explain that to me when you get a chance. Hawkish rate cut, is that—

EVANS: I don’t use language like that, so.

KEENE: I know. I know. It’s—

EVANS: So it’s explaining somebody else’s—

KEENE: It’s not appropriate for the Council on Foreign Relations. But within this is this path of accommodation that we’re on right now. We’re at a stasis point now, waiting for more. But how accommodative is accommodative right now?

EVANS: It’s a great question. So—you know, so, you know, at some level monetary policy can be very detailed, very technocratic. You can look at a lot of data. You can try out different models. You can look for a robust response. But at some point you’re always basically searching for: Do I want to be neutral? Do I want to sit in the background and just let the economy go? Let businesses do what they do very well—you know, capitalism, and they employ people, and they deploy capital, and they put it in play when the government is behaving in a nice, responsible, value-added manner then the economy does very well. And you sit in the background. And then sometimes there’s a shortfall of aggregate demand, a weakness, and, you know, providing more incentives for credit intermediation is helpful, or the other way around.

So you know, you’re sort of trying to find out, are we neutral? Are we accommodative? And I would call the midcycle adjustment as one where we were clearly on a path headed towards slightly restrictive, historically not that restrictive at that point in an economic cycle but slightly restrictive. And now in my own mind I was searching for something that was definitively accommodative. Not hugely accommodative, but definitely on the accommodative side of neutral. And I think that neutral rate probably moved down. I mean, on a long-run basis my assessment of neutral is 2 ¾ percent. And so we were still below that when we paused. And now we’re at 1 ½ to 1 ¾. I think we are definitely accommodative, but I’m not entirely sure that the short run neutral funds rate isn’t a lot closer to 2 (percent), or something like that.

KEENE: I want to get to that in a moment, but you mentioned the foreground right now. And there’s times where a central bank can afford the luxury of being not in the foreground. Is the central bank of the United States of America right now too much in the foreground? Are we asking too much of the Eccles Building?

EVANS: No, I think at this point in the cycle, as we made that judgement to move toward something more neutral—and, in the short run, neutral was moving up during that time. In 2014, we still had a lot of work to do, even though we started thinking about raising rates. But, you know, I would say that policy is not that far off neutral. I would say it’s accommodative. That’s a point where—there are other factors, you know, working. There’s—businesses are, you know, working very hard to take advantage of the tax reform that they enjoy now, to focus their business investment. Of course, businesses investment right now has been falling a little bit, so that’s been a weakness. And other factors, the weak foreign growth, trade policy uncertainty, and things like that. So there’s a variety of external factors that have acted to be restrictive. And so it makes sense for us to try upset that a little bit in a risk management setting. But basically, we’re not in the foreground, I would say.

KEENE: In, I believe the Frankfurt speech, you mentioned this one measurement here, 2 percent, adding to the—2 percent inflation added to the real R-star, and it migrates within your text from five, down to four, down to 2 ½ percent. How R-starry are we? Are we slaves to this calculation right?

EVANS: So this is just a technocratic way of describing what I was just discussing, about are you accommodative or are you restrictive. So if you’re completely comfortable in talking about, you know, I think we want to be a little more leaning towards incentivizing helping credit intermediation so people can take one some investments and consumer spending a little bit, then that would be, you know, below this neutral rate. So you can go as technocratic as you want, and say R-star has moved down, the short-run version or R-star has moved down and I’m just trying to catch up to it and be a little below that. But in my mind we’re just trying to be a little bit accommodative. And it’s very artful. I mean, I would pull out all kinds of technical assessments—Laubach-Williams, other measures of that. But there’s a lot of uncertainty around that, so we have to make judgements.

KEENE: What’s so interesting here, and I will speak of Michael Feroli, JPMorgan, Mr. Browder’s with us from Citibank, Ellen Zentner with Morgan Stanley, and others have a glide path down a terminal rate of potential GDP that’s under 2 percent. Let us begin with the idea that’s not politically acceptable as well.

EVANS: GDP growth?

KEENE: GDP growth.

EVANS: What’s politics got to do with that?

KEENE: Well, it has nothing to do with politics, we understand that.

EVANS: OK, well, you raised it.

KEENE: But the distinction here is you people are dealing with demographics, nominal GDP, what you’ve been handed. And that’s unacceptable to so many and, I would suggest, the impatience of the president as well. How do you deal with that politics buttressing off you every day?

EVANS: I don’t feel alone in this. I think businesses have been dealt this environment. Demographics. Households have been dealt this, you know, environment. The ability of the economy to grow at some—at some level, it’s, you know, very simple. It’s a matter of arithmetic. Growth in output is going to be equal to the growth in labor input hours plus what those hours are able to accomplish with the capital that businesses give them. That’s labor productivity. That’s just identity. And then you sort of look at what determines that. Labor hours. Demographics a big part of that. Well, the aging of the population, male attachment to the labor force diminishes as they get older. Female increases in labor force participation have run their course, that led to very strong growth in labor hours in the ’80s, but now are much weaker. And younger people don’t have the same attachment to the workforce as they used to, so they don’t work as much.

Now, if you add on top of that the fact that you have a particular attitude toward immigration, which would add to labor employment and hours, then you’ve got a big hole that you’re looking at. So that labor hours component is not going to be very large. We estimate it to be half a percent each year going forward—half a percent. Now, labor productivity. What are you expecting from that? I’d love to see that technology is going to improve labor productivity a lot.

KEENE: Well, that’s where I want to go. With technology—you didn’t mention technology in any of that discussion, which is fine, but now we are all living with technology. Does that lead to an inequality? Does that lead to a barbell outcome, where technology advantages some more than somebody else?

EVANS: Let me finish—let me finish the low growth, just to complete that thought, right, because the labor productivity. You might kind of go we got a tax reform, we got disruptive technologies, we got new digital technologies. We ought to see really strong growth. When did we see really strong growth? The ’80s. In the ’80s we saw really strong growth. When we were growing, not in a decline, we grew at 3 ¼ percent. Why was that? Labor input. Labor input was really strong during that time period. How about labor productivity? They call that the labor—the productivity slowdown period. We had great growth, low productivity growth. There was a whole bunch of things going in. It wasn’t until ’95 to 2005 that we really saw an acceleration of productivity. It’s very difficult to predict when labor productivity is going to accelerate. It takes a very long time. Computers hit the factory floor in a digital fashion in manufacturing durable goods in the late ’90s. And so you get this.

But it’s very difficult to predict. You could hope for it to be really strong. You could hope a long time. I just don’t know how to predict—we’re predicting 1 ¼ percent. I think that’s a pretty good rate of growth. And that’s how I get to 1 ¾ percent.

KEENE: Where’s your nominal—

EVANS: And that’s what the economy has dealt that hand, we’re looking at it, the politicians are dealt that hand too. If they want 3 percent, if they want 4 or 5 percent, then you got to think about public policies that are going to have an effect on that.

KEENE: They’ll call it fiscal space this year. We’ll have a new name for it next year.

EVANS: Labor, employment practices, all kinds of things.

KEENE: Tell me about nominal GDP. With the lower demographics, with a new lower potential GDP, do we need to have a reset in our belief in the animal spirit. Are we going to be sustained under 4 percent, or could we do OK with current GDP?

EVANS: Yeah, I don’t spend as much of my time thinking about nominal GDP, you know, as a total package, but I think more about how you carve out the real GDP growth out of the inflation. And I would say inflation has been on the light side. It’s been under our 2 percent objective. And we’ve said that we should be pursuing a symmetric 2 percent objective. So that means, you know, it would be good if the FOMC clarified that a little bit more in some of our discussions about our long-run strategy. I think clarifying what we mean by symmetry would be important. To me, it means we should average 2 percent over some reasonable period of time.

We should probably spend half our time above 2 percent, but we’ve spent our entire time below 2 percent since we called this out. So being willing to go above 2 percent is something that I think conservative central bankers have a lot of trouble with. I think the ECB historically has had trouble with that. Bank of Japan has really had a problem with that. And so if you limit yourself—if you say our objective is 2 percent but you really act as if it’s a ceiling, that reduces the monetary policy space that you have when you need to provide more accommodation during the downturn. So that’s why I think it’s important to achieve our 2 percent symmetric objective.

KEENE: And Evan’s speech is responsible until it’s not. And the words come out here. I have mild comfort with 2 ½ percent inflation. Perseverance is crucial. A powerful, full-throated commitment to this asymmetry you speak of. And it all centers on outcome based monetary policy. Let’s dive into this. Olivier Blanchard and others many years ago said, look, we need to really pop inflation. We need an aggressive approach here. You follow on, as a public official, with really a strong statement that we have to jumpstart this search for a higher-level inflation. Explain what a powerful, full-throated Evans commitment is.

EVANS: Ah, so you’ve interwoven two different policy proposals.

KEENE: Oh, I would never do that. (Laughter.)

EVANS: So I believe you were probably referring to Olivier Blanchard—I think he was research director at the IMF. And he sort of said, you know, there’s real—because what we have said is on average the Federal Reserve, when we go into a recession, we cut the short-run policy rate by at least five hundred basis points, 5 percentage points, and more. If we start at 2 ¾ percent, we can’t do 5 percentage points. And so we don’t have a lot of ammunition and capacity. That’s premised on a real rate of three-quarters of a percentage point and 2 percent being at 2 percent inflation. If you don’t get at 2 percent, you start lower than that. If you had a higher inflation objective, and this is where Olivier Blanchard was musing, if we had 4 percent—4, plus a 1 percent real rate—you know, that gives you 5 percentage points and then you’ve got more capacity.

Central banks have sort of settled on 2 percent. People get very nervous when you talk about 2.1 percent or more than that. But at any rate, so I think most people have backed off. In our own long-run framework Chair Jay Powell took off the table resetting the inflation objective before we even got started, that type of thing. So when you are trying to hit 2 percent symmetrically, I think you need to hit it. And so if you say symmetric, we need to say what we mean. That is if it’s averaging that just means that some of the time you’re going to be above it. And since we’ve been down at 1 percent, and 1 ½ percent, and 1 ¼ for a very long period of time, 2 ½ (percent) just doesn’t seem that outrageous, Except, that there are an awful lot of people who kind of say, as soon as you go above 2 (percent) you’re probably headed to 18 (percent). I don’t know, a big number. And it just sort of presumes that it’s not possible to operate in a parallel environment around that 2 percent. We need to discuss that.

We need to communicate what we mean. I’m comfortable with 2 ½ percent inflation and, in fact, trying to get to 2 percent with momentum, full-throated, harder than many would try, to make sure that we actually get there, head for 2 ½ (percent)—half the time we don’t get to 2 (percent). And then maybe the other half we go over a little bit. You know, when I get to 2 ½ (percent), I’m definitely going to be looking, what’s my forecast? Am I expecting to go under 3 (percent)? Are there special circumstances that are going to make us go further? It is very difficult to generate inflation in the current environment. And in fact, we just agreed to tax reform and a fiscal policy and federal spending that increase the national debt by a trillion and a half dollars over ten years. That’s not enough to get inflation going either. So I think, you know, we need to work harder to understand this and be aggressive.

KEENE: I was talking to Michael McKee this morning about the outcome of your Frankfurt speech. How do we affect the, as you say, momentum, the physics to get above 2 (percent), even 2.5 (percent), three months of 2.7 (percent)? How do you affect that process?

EVANS: You know, I’m trained as a monetary economist. And most of the time your training is, you know, inflation is the monetary authority’s concern. If you’re Paul Volcker, you know, if you’re G. William Miller back in the ’70s and you kind of go, or Arthur Burns, and you kind of go, well, you know, inflation’s doubled, I can’t do anything about that. No.

KEENE: Well-said. We did it on the way down.

EVANS: You can do something. You can do something about that. And Paul Volcker did that. It’s the responsibility to deal with that. If inflation is under your objective, it’s your responsibility. If you don’t understand all the factors that are at work to make you think—you think low rates are accommodative when, in fact, they’re actually still restrictive if you’re not hitting your 2 percent inflation objective.

KEENE: Do you need to drive the vector on the interest rate lower? Jan Moyes (ph) with that summer piece out of JPMorgan, not a forecast but a model of how you bring the ten-year yield down. Is that where we could be heading as we effect an Evans-like 2 ½ percent inflation jump? Is that the kindling for the fire?

EVANS: So I think—so I think there are a lot of details. At any point in the process we could have a discussion like that. And I’m willing to have a—but at the moment, I’m thinking more about strategy and how we go about operationalizing to get to your strategic goals. And I think an enormous part of it is communicating. We are—we are headed for symmetry. We are willing to go over. We must go over 2 percent. If we are going to average 2 percent, you’ve got to be below 2 percent when you’ve been below it. When you think about the effects of the zero lower bound, we now call it the effective lower bound—I guess because some people think we might go to negative interest rates. I think the zero lower bound is probably more accurate.

But you know, when interest rates fall a lot and we’re at the zero lower bound, our expectation is inflation is going to be pretty low. Then we get out of this, in the second half of the cycle, we get back to a more—we should be there now. And then, if you’re going to average 2 (percent), you got to be above 2 (percent) for that second half. Well, maybe you need to be targeting something more like 2 ¼, 2 ½ on the second half of an economic cycle, just to get to an average of 2 percent. Talking about that strategy, making sure that everybody is totally comfortable with it, or not and admitting what your operational approach is, but communicating what you’re going to do. After being very clear about that, and not kind of getting nervous and twitching when you get to 2.1 or 1.9 (percent).

Because, I confess, I’m about as outspoken as anybody in terms with I’m OK with inflation above 2 (percent). But then I start talking about inflation at 2.2, and maybe my—maybe my voice breaks a little bit. I think it’s part of the DNA and central bankers. And we really need to break out of that if we’re going to be able to achieve 2 percent symmetric inflation.

KEENE: I mentioned Gerald Ford today on television. I realized nobody on my staff knew who he was.

EVANS: Former president of the United States.

KEENE: What about with disinflation—yeah, with disinflation now. I mean, that’s really the strategy we’re talking about. How big a constraint is trillion-dollar deficits? You mentioned the fiscal response. The vogue this moment is fiscal space, whatever that means. Are you constrained by the fiscal challenges of the nation?

EVANS: I mean, as we look at conducting monetary policy, you do it over a particular horizon that, you know, you can have some effect on—three to five years. You look at that forecast. There seems to be no constraints from cumulation of fiscal debt. I would expect that to emerge from a very high treasury rates, long-term bond yields. That is not what we’re seeing. Even though we’ve seen a little bit of a turnaround, they’re very low right now. So there doesn’t seem to be any pressure there. This is a different world than the ’70s. There’s an intense desire for safe assets.

You know, people used to kind of go, geez, have you noticed that the German Bund is negative? Who in the heck would want to own the German Bund? And I say, a lot of people because most people who see the negative yield don’t see the point that the price is very high because people want that. So our low long-term interest rates indicate that people are holding that, there’s a demand for that. You could argue that there’s, you know, a need for more supply, and this would be one way for it. But it doesn’t, in any way, as I can tell, constrain our forecast.

KEENE: Carnegie Mellon, with the heritage of Allen Meltzer, Marvin Goodfriend there as well, he wrote at Jackson Hole about negative interest rates. There was a modest uproar about that paper. Your thoughts on the experiment of negative interest rates and, with that, the idea of Japan, to Europe, to a U.S. slowdown. Do we have—should we have a fear of a trajectory towards negative interest rates in America?

EVANS: I think central banks that have used negative interest rates have found them to be helpful for them. I think that if you—let me just take the ECB. The ECB—well, and the Bank of Japan, they came later to the broad asset purchasing programs that the Fed had embarked upon with our open-ended QE3 in September 2012. We did quantitative easing before that, but we did the open-ended in 2012. And that sort of changed things, I think. Forward guidance was helpful, but the combination was useful.

The Bank of Japan did that. The ECB did that. But they also added negative interest rates. So I think that helped them a little bit. If you look at the level of negative interest rates, they sort of pale in comparison to the actual need for accommodation. Back in 2009, according to many interest rate rules, the Federal Reserve should have been seeking to set the nominal federal funds rate at about minus-four percentage point. That’s what the Taylor rule straight reading would have indicated. We can’t do that because, you know, got zero minus seventy basis points is probably a very low down payment on something like that.

Other policies would have been—you know, at some point also fiscal policy and other policies—you know, I think that the central bank has to address inflation and has to help the economy as much as we can, but as, you know, long-term treasury rates go very low, if you’re concerned about that, that seems to indicate that it’s not very expensive to run expansionary fiscal policies, and maybe the tradeoff there is better.

 

So negative interest rates. I don’t think that we can achieve enough with that tool. I worry that financial institutions and savvy investors who would find themselves at risk would organize their resources in a way to make their exposure more limited. That would be a natural thing for them to do. And so I would expect it would be even less effective in the future. I would much prefer to get our communications strategy more in line with achieving our objectives.

KEENE: Financial institutions and savvy investors have gone after you guys over, as you mentioned, the balance sheet and the critics would say quantitative easing, and the new quantitative easing that’s under process now. Bill Dudley, of course, with a firestorm, wrote about this with Bloomberg. Vice Chairman Clarida spoke to me the other day and made clear: This is not a new QE bout. Just lightly touch, given the time, on the repo uproar and the efficacy of your solution away from being quantitative easing forever.

EVANS: Sure. So we spent a long time at the zero lower bound. We got a very large balance sheet. We went up to $4 ½ trillion at some point. And so it was clear that we needed to bring the size of the balance sheet down. There were a lot people who kept telling us, yelling at us, that we should have a lower balance sheet. At the end of the day, we’re going to do what we think is best. But reducing the size of the balance sheet was always part of our plan. And so as we embarked upon a plan to reduce the size of the balance sheet, at some point—you know, and you realize this very early on—how big is the balance sheet going to be when you settle down and then start growing it again? Because cash starts to grow, and the size of the economy, the balance sheet is going to grow.

And so we had discussions about that. And this is going to have an implication for when short-term policy rates all of a sudden might start to tighten, and all of that. And so, you know, we made a judgement that we could reduce the balance sheet to a certain point. And then in early September we kind of learned that it looks like the markets need, on a short-term basis, because of tax policies where checks are written, funds are put off to the side and aren’t used for repo and things like that, and other things, there wasn’t as much liquidity there. You’ve also got a change in regulatory policies so that some of the banks and dealer-brokers that previously were in the business of arbitraging these rates between, you know, repo rates and, you know, other depository rates, they might provide that. And then it’s kind of, like, well, you know, the regulatory incentives now aren’t as attractive for that.

So we kind of decided ultimately that the balance sheet probably needed to be larger than where we were at that time. And so we embarked on, you know, buying $60 billion a month at the moment short-term T-bills. So this doesn’t add duration, to speak of, to our balance sheet. It’s not like the QE, where were buying long-term assets. So in that sense this is not QE. This is just trying to provide liquidity. And we’re going to be searching for the right level of liquidity, so that we can hit our funds rate target—keep the funds rate within the target range and not have it, you know, go above that because of a lack of arbitrage with other treasury rates.

KEENE: One more question, and then I’m going to go to questions from the floor. We have a wonderful audience here today. Just as a warning, the first question will go to the gentleman from Cedar Rapids, who I haven’t talk to before this. But we’ll figure out who the gentleman from Cedar Rapids is here in a moment.

One final question: This is all great. And it’s great for the elites. And it’s great for the suits and ties. But the bottom line is America’s savers have been crushed by this collapse of the real interest rate, and for even that matter the nominal interest rate. Speak to the savers out there. Speak to the have-nots of investment, who haven’t participated through all of this economics.

EVANS: Yeah, I talked to somebody, you know, every morning before I go to an FOMC meeting about this exact problem. My wife is always telling me, make sure that you don’t cut that interest rate. I need a higher savings rate. (Laughter.) You can see what effect that’s had. (Laughter.)

KEENE: Riley (sp), could you—Riley (sp), could you get her on radio? We’ll want her FOMC, Mrs. Evans.

EVANS: You know, so that’s definitely the case. One thing about monetary policy, when you’re raising interest rates there’s some people who benefit from getting higher interest rates. There’s some people who don’t benefit because they’ve got higher borrowing costs, and things like that. So it’s extremely natural for us to, you know, be paying attention to that. But at the end of the day, it comes down to how the economy’s going to do. I think that everybody’s going to be better off when we pursue monetary policies, even when that means low interest rates. So they’re market determined. I mean, we set this short-term policy rate, and then the market determines all the other rates. And if it’s not in line with that—like, if there’s fiscal policy problems, the yield curve will steepen and things like that. So we can’t do everything that’s golden.

But in this case, I think getting the economy going so that the job market is very strong, labor markets are very strong, I think the consumer right now is supporting the economy in an enormous way, in a way that the business side at the moment is not—even though the architects of tax corporate reform indicated it should be stronger than that. And so I think that our—

KEENE: Did that work out?

EVANS: We’re still waiting to—well, there are so many other things going on with—

KEENE: Brad Setser had a great thing on Twitter today really questioning the efficacy of tax reform.

EVANS: Ah, well, you know. But at any rate—

KEENE: I don’t want to get you in that much trouble right now.

EVANS: You know, but I think that getting the economy going is going to help everybody, including savers.

KEENE: Yeah. Yeah. In this room a number of years ago, he was with the IMF at the time, John Lipsky talked about macroprudential risk. We’ll let him have the first question today. Dr. Lipsky.

Q: Thanks. Good morning, Tom. Good morning, Charlie.

EVANS: Good morning. Good to see you.

Q: Quick question. Obviously the Fed in recent—the FOMC in its recent pronouncements has paid a lot of attention to international economic development and financial developments. Does that represent a heightened awareness of the influence of international forces on domestic—on the domestic economy and, hence, on domestic—on Fed policy? Or is this in line with the—with previous practice? And secondly, it was—many had suggested that with central banks, all key central banks focusing on the same inflation target of 2 percent, that that would bring about an implicit coordination of international—of monetary policy among key central banks. Yet, today we see substantial differences in actual short-term rates, and uncertainty about its influence on the value of—the global value of the dollar. Has that agreement on a common inflation target actually brought about coordination of international monetary policy?

EVANS: Yeah, no, that’s really interesting, and quite complicated because, as you point out, it sort of gets at the foreign exchange values. You know, we could all agree on different inflation objectives and that, in principle, would have a path for how foreign exchange rates would evolve smoothly over time if everything went on a steady-state fashion. So it gets complicated pretty quickly. But I believe that on that basis more clarity for all the central banks as to what their objectives are, the weights that they give to inflation versus other objectives—which in most of those cases are secondary to the inflation rate. But they also care about the economy and also probably financial stability to some extent.

And so the more we all understand and are in line the sense that it’s normal, we do this too, so it’s more likely we’ll understand that, you know, I think there’s better understanding of the policies that everyone would pursue to achieve that. I wouldn’t call it coordination. As you know better than I do, there’s lots of conversations. People get together in Basel six times a year at last and other places around the world. And so there’s a sharing of information about what’s going on that I think is helpful for everybody to achieve their objectives. And you know, if it’s not cooperative, at least it’s non-rivalrous, as best it can be.

I think in terms of the international situation I don’t think things are different in terms of a different policy reaction. I think it’s a different moment in time than many other times, where you know, Europe is definitely slowing, Brexit is a huge uncertainty even though it looks like now things could play out in a more careful fashion. But it’s really hard to guess that. And China’s a big uncertainty, and then international tariff trade discussions, uncertainty around that certainly changes things. So, I mean, in terms of the mid-cycle adjustment, I would say this is very much a risk management approach to ensuring that the U.S. economy is positioned as well as it can be for a little more noise from wherever it could come from to the economy to help support it.

Our adjustments have not been anywhere, you know, large enough to change the dynamic substantially. If there was a big negative shock we’d have to respond. And I would expect other countries would have to. So I think this is sort of the normal response, but the moment in time is really, you know, quite different and large events.

KEENE: You’re channeling there Frank Knight, Chicago, I’m going to say 1921 or maybe 1923. But parse right now: Chair Powell’s out there at the press conference and he has to parse the risks you measure versus the tangible uncertainties that are out there right now. Expand a little bit here on how uncertain those uncertainties are. I sound like Mohamed El-Erian. I’m sorry. How uncertain are those uncertainties right now? Those unknowns?

EVANS: They’re uncertain. They’re big. (Laughter.) You know, before breakfast we were talking about a few things. And we mentioned Rudi Dornbusch. And you know, while I never met him myself, I have seen a number of scholars who studied with him, and he’s much beloved. And Paul Krugman attributed, but others too, to Rudi Dornbusch this idea from international crisis that you can see something really bad happening, and it unfolds in a very slow fashion, and you just think that it has to change the world, and it doesn’t, and it takes longer than you can imagine. Then when things really hit the fan, it happens much more quickly than you ever, you know, expect. And so there’s this non-linearity. You can call it uncertainty in the sense that it may never have happened. You can’t predict the timing of it. But there are these factors out there. And unless something offsets them or somebody else gets their act together, you know, it doesn’t look like it would be helpful. But it might not occur. That’s really hard to address.

KEENE: Ellen Zentner, please, the chief economist at Morgan Stanley.

Q: So I thought the Evans rule original was brilliant because unemployment—or, rates remained low, at least until unemployment was below 6 ½ percent. But you had to guard against financial stability, and that was important, right? So as long as inflation doesn’t move—isn’t projected to move above 2 ½ percent. So if you think about, you know, you all have been discussing inflation framework. What would an Evans rule look like today, that would aim at getting inflation higher but have some sort of knock-out clause for financial stability?

EVANS: Yeah. So—you know, so when I was arguing for forward guidance, it was a little bit simpler in the following sense: We were stuck at zero on the funds rate. We had a lot of discussions about, you know, the committee was divided. Some people wanted to raise rates, you know, sooner than certainly I thought. And the unemployment rate was high. And you had a discussion about, well, what’s the natural rate of unemployment? What if it’s 7 percent? If it’s 7 percent, maybe we need to start to raise the funds rate. Now we think it’s more like 4.3 percent, so you talk about uncertainty. There’s a whole lot of that. And it was a little easier. I thought we were trying to stifle premature expectations of a Fed tightening. Now, if you’re going to do it, I mean, we’ve got the funds rate target at 1 ½ to 1 ¼ percent.

And so now you would be trying to craft something where you’d indicate, we’re going to continue to maintain an accommodative stance of policy. Maybe that would be keeping the funds rate target where it is now, until—and then some objective is stated. So my colleague Neel Kashkari, I believe, is not been shy about sort of saying, you know, we should have inflation at 2 percent. And maybe one thing to do would be keep accommodative policy until inflation gets to 2 percent. That could be one example of that.

It gets to be—well, it was—it was kind of easy then, because unemployment was so high, and 6 ½ percent was such an achievable objective, you just kind of new that we should blow through that. You know, you get to 2 percent and you kind of go, is it sustainable at 2 (percent)? Did we just kind of touch 2 (percent)? You know, should we have six months at 2 (percent)? You’d have to craft something like that. And then I suppose I know I have a number of colleagues on the committee, judging by my colleagues’ speeches and our summary of economic projections—the committee’s fairly well divided. You know, a number of people have mentioned financial instability risks, that if there was more leverage taken, more frothiness in markets, then maybe the low funds rate target would be inconsistent with that.

I don’t subscribe to that argument myself, because I think that’s trying to do too much with a single tool. I think our supervisory and regulatory policies ought to be ensuring that any damage that comes from leverage—first off, it’s we don’t get to an overleveraged position, and then also that we’re ready with capital and macroprudential tools.

KEENE: Can you reflate without re-leveraging? Can you relate without re-leveraging?

EVANS: Well, I mean, you would have to talk about the circumstances. I mean, are we talking about a 2009 period? And so I think a lot of it comes down to capital in the banking system. And at the moment, it looks like we have, you know, quite a lot of capital. We’ve added more and better capital, and the regulatory environment has shifted just a little bit to allow, you know, more dividends and things like that, a little bit. You know, it comes down ultimately during a financial downturn, when banks are rebuilding their capital when do they think they’ve got as much as they need to lend freely and intermediate credit in all the right places? And that’s one of those things that I think always takes longer than most people appreciate.

And I think that was a big part of coming out of the financial crisis this time. And also, you know, financial institutions thinking about how their business model might change over the next five and ten years. And so it gets complicated pretty quickly. But we’ve only got one tool. There’s an awful lot of objectives out there. And if you want to put a little political spin on some of these things, it just—

KEENE: Oh, please.

EVANS: No, no, you—I only say that because you did. But if you did about, you know, you’d like more growth and things like that, you have to think about sustainability and all of that. And so it gets complicated very quickly.

KEENE: Well, the path—let’s go to Willem Buiter here. The path from Yellen, James Tobin. With Citigroup, Willem Buiter.

Q: Thank you very much.

You mentioned that the standard Taylor rule in 2009 called for a roughly minus-4 percent policy rate.

EVANS: I think so.

Q: Something—

EVANS: Yeah.

Q: Admittedly, wherever the effective lower bound is, it’s bound to be higher than that. But it doesn’t explain why the margin that is there, technically, wasn’t used by the authorities. My question is, is this political? Or is there a belief that there is a reversal rate which behaves—(off mic)?

EVANS: You mean why we didn’t take it into negative territory?

Q: Yes. And at the next time of asking, the next cyclical slowdown, you will be back at effective—at the zero lower bound. And why not plod further? Is there any particular reason for that?

EVANS: That’s a good question. Certainly the Fed was ahead of the other central banks in 2008-2009. It started in the U.S., and our problems were worse initially. I think there—you know, I really can’t recall any substantial discussions of negative interest rates during that time. I would give, you know, professor, governor, Chairman Ben Bernanke huge credit for thinking up new liquidity programs that were inspired by things he had studied in the 1930s and problems there, and all of that. Negative interest rates just weren’t something that seemed to appeal to many people.

Now we have experience in these other central banks, and so you could imagine trying that. You know, like I say, I think maybe you could get seventy basis points. And whether or not that would be help? Maybe. I frankly think that a lot—I mean, you know, if we had a longer discussion about asset purchases and open-ended QE3, and you can probably—every side can find studies that indicate powerful, not really so powerful, and event studies being what they are that’s a very difficult thing to measure. I continue to come down on the side of it really came down to communicating the signaling channel. We were going to do whatever it takes. If you look at what Mario Draghi achieved in 2012 by saying: We’ll do whatever it takes, and it will be enough. What did he do? He developed the OMT. How many OMT bonds did they ever issue? None.

Q: (Off mic.)

EVANS: I mean, you know, showing your willingness to do something that previous versions of the head of the central bank weren’t willing to contemplate goes a-ways. Following through and delivering them is really important. So constantly working on that. If negative interest rates were a helpful signal—and I think that’s part of what it is, because they keep backtracking on what reserve levels are actually being hit. You know, if anything you’d kind of want to hit more of it. And if you lend out more, then you get more credit, and whatnot. So the design is challenging.

KEENE: This gets to courage and, as you mentioned, the perseverance needed to reflate above 2 or 2 ½ percentage. I want to circle back to this single idea: What is the mechanism of that perseverance, that courage, that we need?

EVANS: Well, I think it’s very important that the central bank have sufficient level of independence and be perceived as independent. So I think whenever you start worrying about the actions that I take through increasing my balance sheet might not be perceived well by a variety of authorities, that tends to make you wonder about that. Being able to undertake these very strong actions and be accountable—so go and testify to Congress and explain it to the public and everybody. I’m not saying it’s not without risk, because we tried things which had not been tried before, to my knowledge. And they were unpopular for a lot of people.

And then you got the saber question. I have taken the saber question many, many times. It’s still there. It will always be there. You know, some people benefit from some policies and other people are disadvantaged. You know, when Paul Volcker had to bring double-digit inflation down, the unemployment rolls increased hugely. And that was part of the cost. And so monetary policy affects people differently at different points in time.

KEENE: Sir.

Q: Thank you. David Braunschvig.

You alluded to the conundrum of lack of productivity growth in the ’80s. How comfortable are you with your metrics and your ability to appropriately measure productivity in services, which is—constitutes the lion’s share of our economy?

EVANS: Yeah. No, those are good points. Productivity is one of the most difficult things to measure, services in particular is very difficult. Yeah, I take those points. I think that no matter how poorly they may be measured, at the moment I believe them to be measured on a basis that is consistent with the way the national income and product accounts are measured. I say that only because if we pick a benchmark—we can pick a benchmark, GDP growth, real GDP growth. I’m trying to explain to people why I think 1 ¾ percent is the rest growth rate for the economy. I do not think it’s 3 percent.

Now inflation has not been growing very strongly. Part of this is going to come down to if inflation were growing very strongly, golly, you know, and we’re at 2 ¼ percent growth, and inflation is growing very strongly, we’d have to have more restrictive policies. I would guess that would reduce economic activity. And so that would make you wonder about what productivity is. Now, if productivity was really strong, that presumably would reduce unit labor costs, and that could be consistent with the lower inflation. So, you know, I look at inflation and I kind of go: If we can hit our inflation objective and get that right, we look at real GDP, we look at all the indicators of productivity. And if they’re aligned and seem like they’re doing well, then I call it a day and I’m done. The research staff looks at productivity and tries to find out if there’s new insights from the services.

It’s very important. There’s no doubt about it. But it’s the—you know, the big inflation and how’s the economy doing that capture most of my attention. I’m sure that some sectors of the economy have very strong and thriving productivity growth. But when you put it all together—and we’ve also got the age of disruption too. And so you see spectacular productivity gains in other areas that completely decimate, you know, the legacy producers. And that gets averaged across that. So you kind of want to—people usually want to pick out the winners and look at the strong productivity growth. And we’ve also got the laggards that need to be dealt with.

KEENE: To this wonderful question—

EVANS: It’s a hard question. I can’t do justice to it.

KEENE: It’s a hard question. There’s no answer there. I was speaking with Alan Meltzer in Pittsburgh—I had lunch with Alan Meltzer in Pittsburgh. And we got in this raging argument about should we—

EVANS: Alan Meltzer? No, Alan Meltzer? You upset Alan Meltzer?

KEENE: I upset Alan Meltzer at lunch. It’s hard to do. (Laughter.) But we had this ranging debate about John Edwards and two Americas versus the desire to aggregate or, as you say, put all the data together. Do we need to be more respectful of not putting all the data together and worrying about two or three Americas? The haves benefitting from the new productivity and the have-nots left behind?

EVANS: I had a lot of respect for Alan Meltzer. He was an esteemed professor at Carnegie Mellon when I was there. I didn’t always agree with everything, but that’s the nature of economics.

Yeah, I don’t know. I think it’s—you know, the state of the economy is really hard. You know, I was falling back on my meager economics training and macroeconomics. One of the first things you assume is that the distribution of activity just isn’t that important—income distribution, high income, low income. It’s just a simplifying assumption, but it seems like the level of income inequality is really very large at the moment. And the nature of productivity enhances returns to education and certain skills, lead to outcomes like that. And I think if you’re, you know, wondering about appropriate levels for economic growth that benefit a large swath of the population, you have to be thinking about how you can address some challenges that aren’t in my economic models to help more people benefit from that.

So, I mean, is that two Americas, three? The data—you know, you can kind of try to do the uniform macroeconomist viewpoint that it’s GDP and that’s all I care about. But there’s way more, you know, going on. And this comes up in the economics profession now, in the lack of diversity and women in the profession, and do we find ourselves looking at certain questions more and deciding that it’s perfectly fine because of that? I really don’t know, but I know that when I have more people in the room giving me new perspectives on how things should be playing out, I usually end up in a better place. So this might be an example of that, it might not. I don’t know.

KEENE: Benn Steil, please.

Q: You emphasized that the 2 percent inflation target should be seen as a 2 percent average over time. What is the difference between that and shifting entirely to price level targeting?

EVANS: Oh, well, ah, yeah, I see. Yeah, average. Average could be viewed as a weak form of price level targeting. You know, price level targeting, in all its glory, could set up a price line. You know, and you kind of go we should be averaging 2 percent on the price line. And if we under-achieve, then we’re going to make up for it and get back on the price line. So on average—you know, in averaging, depending on how hard the average is, you know, outside of the window you might give up on some of the losses. It would be similar—it could be similar.

At the moment, the FOMC has employed the term symmetric for 2 percent. We have not strongly defended our definition of symmetric. There is a sentence in our long-run strategy which, when it was pointed out to me the other day I had kind of forgotten that we had put in, in all honesty. I was far more interested in getting symmetric in there than worrying about the sentence. The sentence is: The committee would be—could become concerned if inflation was persistently below or above 2 percent. And if you kind of look at—listen to that, it sounds more like, well, the committee would kind of like a tight error band around 2 percent. It doesn’t really speak to averaging or symmetry. And as I think about it, it’s kind of like, well, if I was at 1 percent and I wanted to be closer, I should take strong action to make sure that I get there so it’s not persistent. But I think we need more—to put more work there.

Average is one way of dealing with that. How strong that would be, though, and how we would answer the question, well, is that sort of a soft price level targeting or are you going to let bygones be bygones? And there’s a lot to explain. And so it gets hard really quickly. Now, the technocrat in me might be happy to, you know, go fifteen rounds on that, explaining what we mean by that. But talking with the public and actually living with it I think is much more difficult than that.

KEENE: So much of this seems, and I—

EVANS: That doesn’t sound like a satisfactory answer, does it? (Laughter.) I mean—

KEENE: That’s OK. It wasn’t the best one you’ve given but it was OK.

EVANS: Oh, I didn’t say it wasn’t a good answer. (Laughter.) I mean, sometimes all you can do is deliver an unsatisfactory answer. (Laughter.)

KEENE: Robert Samuelson, a wonderful book on inflation. And so much of what you’re talking about is the ghosts of our childhood. He would mention Walter Heller in the 1960s. Let’s circle back to that. Are we just afraid of our past? I mean, is it just that simple? Can you imagine 2.6 percent inflation? What will the next press conference be like? There would be an outrage. I mean, how do we get beyond our youth?

EVANS: My own take on this is that most central bankers in the United States remain scarred by the experience in the ’70 and double-digit inflation. And I think that it’s not that difficult to sort of say inflation ought to be 2 percent, inflation ought to be close to 2 percent, symmetric. But I think going above that just so many people with a long history in the Federal Reserve—I think Paul Volcker would sort of say, oh, geez, once you get to 2 ½, where are you headed—3, 4, 6 (percent)?

KEENE: Well, that’s the answer to that? So we print 2.8 (percent) three quarters in a row, does that establish behavioral patterns?

EVANS: Three quarters in a row?

KEENE: Two-point-eight percent three quarters in a row—

EVANS: Oh, three quarters, oh come on, Three years—three years—

KEENE: OK, three years in a row, let’s go even further. What are the patterns then of society? That’s the fear, that it begins to build, isn’t it?

EVANS: Yeah. We don’t—you know, so—you know, I’m on the older—you know, the people who still remember the ’70s are, you know, the older generation, right? So the younger generation, if you ask them about inflation, you know, they probably think that it’s low and they would have a hard time imagining that it would be much stronger. If you ask people, you know, would you like to have 4 percent inflation? No. Would you like to have 6 percent nominal wage growth? Yeah. You know, money illusion and, you know, who gets to share sometimes in nominal wage growth maybe don’t get hit the same way from inflation. We just sort of assume that it’s the real magnitudes that matter most. And I do subscribe to that. But, you know, you can get people to answer surveys in different ways depending on which question you want. Nominal wage growth is one way to get different answers.

KEENE: One more question, over here. Sir.

Q: Christian Rekna (ph), Bank of America.

I want to take your question on what you think the Fed will do in the case of negative interest rates. And there might be a lawsuit, like in Germany, they’ll be taking the central bank to court there over negative rates being bad policy. You said policy of negative interest rates may be helpful. What will the Fed do here? Are rates negatively—are they legal or illegal, from the Fed’s point of view?

EVANS: We haven’t really contemplated. I haven’t seen any, you know, legal arguments. It’s a fee. You know, I imagine that you could charge a fee for putting reserves with the central bank. Oh, you know, I don’t know anything about this, right? I just don’t have an answer for that.

KEENE: One more question. Sir, right here.

Q: Niso Abauf of Pace University.

What is your best predictor of inflation? Obviously it doesn’t seem to be the quantity theory of money. Is it the real productivity growth versus wage growth? Or is it some other model?

EVANS: That’s a shocking question, because the answer for so long has always been the best forecast of inflation next year is whatever inflation was last year. It’s really hard to come up with a forecasting indicator that improves upon just the inertia of kind of where you’ve been. There’s a lot of discussion about the Phillips curve, resource slack. Golly, it was just earlier this year at a University of Chicago conference here in New York that the paper—I think the title was: The Phillips Curve is Alive and Well. I didn’t see it that way myself. Phillips curve seems to be pretty flat. So the unemployment rate’s at 3.6 percent. And I’m pretty sure a lot of people would have been aghast and would have thought that inflation has to be about 3 or 4 percent if you had told them three years ago that the unemployment rate would be 3.6 percent. There’s not a great indicator. It’s pretty artful.

I do think that—you know, so I end up falling back on inflation expectations as being very important. I mean, the Fed inflation forecasting model is the way Janet Yellen described it back in 2014 at Amherst, I believe. You know, inflation is going to depend on inertia. Lags of inflation. It’s going to depend on resource slack, to some extent. It’s going to depend on external factors, the dollar, and things like that. But the resource slack, to some extent, but the question is what’s the coefficient on that? And it seems like it’s incredibly small compared to the ’70s. It was much bigger. As you win the battle on inflation, and inflation expectations go down, we seem to have seen a shrinkage in that response path. But you’ve still got inflation expectations because firms are constantly thinking about setting prices and keeping them in place for some period of time.

So I think getting inflation expectations up is very important. And so that’s why my communications bang the drum. Let’s full throat it. We are going to get inflation to 2 percent. We’re going to keep going. Symmetry at 2 ½ is OK. And the pursuit of 2 percent symmetric. If we get inflation expectations up, then I think that helps reinforce the 2 percent objective. But forecasting, really hard. If anybody’s got a better indicator, happy to always hear it.

KEENE: Come by after this discussion. One final question, and then off this wonderful idea. I think of David Blanchflower at Dartmouth railing about this idea of a fully employed America. Are we fully employed? How close are we to fully employed?

EVANS: So I think one of—you know, so the Fed has embarked upon our Fed Listens listening tour conferences for the last eighteen months, about. Chair Jay Powell came up with this idea. Rich Clarida has sort of followed through and implemented. All twelve banks have had a conference at our banks. We had, in Chicago, the academic style conference where people came and gave papers on different policy tools. But I think some of the panels at the individual bank Fed Listens have been very interesting. And we’ve heard from, you know, people who are in the community, people who are, you know, labor union, just, you know, regular people, and asking: What about the labor market? What is maximum employment? Because Federal Reserve Act says that we’re supposed to pursue monetary financial conditions to support maximum employment and price stability. What is maximum employment?

It’s easier to sort of look at the unemployment rate and say: I think the natural rate of unemployment is whatever it is, and it moves around over time. But there’s a lot of uncertainty. I don’t know what it is. And so I think we ought to probe and continue to support the economy with a strong labor market, at least until we see inflation being inconsistent with our objective. At the moment, it’s not. And it’s inconsistent as too low. And so, you know, allowing accommodation to continue to allow the labor market to be strong and grow further, is really good. So I think that’s one of the things that’s come out of the Fed Listens. And we need to also find a way to put that in our long-run strategy in a more concrete fashion, I think.

KEENE: Well, this has been wonderful. Charles Evans, thank you so much, the C. Peter McColough Series on International Economics. Thank you for the wonderful questions. (Applause.)

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