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Federal Reserve documents 35 page

 

As the November 2–3 FOMC meeting approached, Bill Dudley and I used our public remarks to prepare markets for a second round of large-scale securities purchases. Bill, in an October 1 speech, said that the current situation—continued very high unemployment and declining inflation—was “wholly unsatisfactory.” And he helped shape market expectations by putting a hypothetical $500 billion figure on the purchases. He estimated that purchases of that amount would have about the same stimulative effect as a cut in the federal funds rate of a half to three-quarters of a percentage point. I wasn’t so specific in my own speech in Boston on October 15 but said, “There would appear—all else equal—to be a case for further action.”

In the meantime, Janet and I worked to shore up support on the Committee, splitting the responsibility of calling each of the Reserve Bank presidents. I knew Tom Hoenig would dissent again. He was waging an increasingly public campaign, using what was, especially in the staid Federal Reserve culture, provocative rhetoric. In a speech the week before the meeting, he called our prospective securities purchases “a bargain with the devil.” He was worried that the purchases would create financial instability and sow the seeds of too-high inflation. The previous month, Businessweek magazine had profiled Tom in a lengthy article—“Thomas Hoenig Is Fed Up”—and he appeared to be enjoying the attention. Over the years, Tom had impressed me as mild-mannered and civil. I respected his right to dissent, to ask tough questions, and to publicly explain his stance. But now I thought he risked undermining public confidence in the Fed and disrupting the Committee’s deliberative process by staking


out inflexible positions before hearing other Committee members’ views.

 

Other presidents—including Richard Fisher of Dallas and Charles Plosser of Philadelphia—shared Hoenig’s skepticism about aggressive policy actions. But neither of them had a vote in 2010. Fisher didn’t think more monetary support would help because he believed uncertainty created by political squabbling over the federal budget was discouraging businesses from investing and hiring. Plosser continued to worry about inflation and had little confidence in our ability to generate jobs by easing policy further.

 

I knew I could count on the support of Eric Rosengren of Boston, who did have a vote. And I thought that the other presidents voting that year, Jim Bullard of St. Louis and Sandra Pianalto of Cleveland, would support further action as well. It was Sarah Raskin’s first regular FOMC meeting and Janet’s first as Board vice chair. Janet favored strong action and I suspected that Sarah would, too, along with Dan Tarullo. Betsy Duke was much less optimistic about the likely benefits of future easing and worried about the risks associated with our growing balance sheet. Janet had dinner with Betsy, and Betsy agreed to support additional purchases, though without enthusiasm.



 

Kevin Warsh had substantial reservations. He was one of my closest advisers and confidants, and his help, especially during the height of the crisis in the fall of 2008, had been invaluable. He had supported the first round of securities purchases, begun in the midst of the crisis. Now that financial markets were functioning more normally, he believed that monetary policy was reaching its limits, that additional purchases could pose risks to inflation and financial stability, and that it was time for others in Washington to take on some of the policy burden. I met with him on October 8 and assured him we could cut the purchases short if we were dissatisfied with the results or if we saw signs of building inflation pressures. I told him that, in my public remarks, I would continue to emphasize that large-scale purchases had costs and risks as well as benefits. It was a good talk, but I wasn’t sure I had convinced him. We met again on October 26 and he told me he would not dissent. But I knew it would be a difficult vote for him.

 

I thought that the case for action at the November meeting was very strong. Payroll employment had fallen during each month from June through September (the latest report available). True, much of the decline could be attributed to a onetime drop in federal employment as the 2010 census wound down. But nongovernment payrolls had averaged monthly gains of only 84,000 over the period, enough to accommodate recent graduates and other new job seekers but not enough to reduce the overall unemployment rate. At 9.6 percent, the rate was virtually unchanged from the start of the year. And, with the incoming data disappointing, it seemed likely that growth in 2011 would be too weak to reduce unemployment meaningfully. I was especially concerned about the corrosive effects of long-term unemployment. In September, more than 40 percent of the unemployed had been without a job for longer than six months. Their skills were getting rusty and they were losing their contacts in the working world. At the same time, on the other side of our mandate, inflation—already too low—looked to be flat or declining. Over the last six months, it had averaged only about 1/2 percent. Very low inflation or deflation would make full recovery even harder to achieve.


I believed the Committee could not stand by and risk letting the recovery stall out. Moreover, I did not think securities purchases had lost their effectiveness. Since I had begun publicly hinting in August that we might do more, financial conditions had improved, apparently in anticipation of additional policy action.

 

The Dow had risen 12 percent and inflation expectations, as measured by the prices of inflation-protected bonds, had increased toward more normal levels. By itself, a new program of asset purchases was unlikely to be a game changer; it certainly would not create the millions of jobs we needed. But it would help, and it might even be the key to preventing the economy from sliding back into recession.

 

The FOMC voted to buy $600 billion of Treasury securities through June 2011, at a pace of about $75 billion per month. This second round of purchases, which the media quickly dubbed QE2, would raise our balance sheet to approximately $2.9 trillion, compared to less than $900 billion in mid-2007, on the eve of the crisis. As St. Louis Fed president Jim Bullard had urged since the previous summer, we had thought about an open-ended program, where we would vary the amount of securities purchases depending on the progress of the recovery and inflation pressures. But I worried that, with no anticipated end date, it would be hard for us to stop buying without shocking the market. We did say that we would regularly review the pace of purchases and adjust if changes in the economic outlook warranted, but in practice the bar would be high.

Surprising no one, Hoenig dissented—and, to boot, gave an interview the day after the meeting to Sudeep Reddy of the Wall Street Journal in which he criticized the Committee’s action. He would also dissent, for the eighth and final time, at the December FOMC, marking the longest string of dissents by a Fed policymaker since 1980.

 

As he had promised, Kevin voted in favor, but the following week he delivered a speech in New York and published an op-ed in the Wall Street Journal that reflected his reservations. He argued that monetary policy alone could not solve the economy’s problems, and he called for tax and regulatory reforms aimed at increasing productivity and longer-term growth. I agreed that other Washington policymakers should take more responsibility for promoting economic growth. Federal spending on infrastructure projects such as road building, for example, could have helped make our economy more productive in the longer term while putting people back to work right away. Yet nobody expected anything to happen on the fiscal front or in the other areas that Kevin highlighted, either. The reality was that the Fed was the only game in town. It was up to us to do what we could, imperfect as our tools might be.

Hoenig’s comments had irked me, but, despite hearing from a few FOMC colleagues who were piqued at Warsh’s op-ed, I was comfortable with it. I never questioned Kevin’s loyalty or sincerity. He had always participated candidly and constructively, as a team player, in our deliberations. And I was grateful that he had voted for the second round of asset purchases despite his unease. I saw his public comments more as an indictment of policymakers outside the Fed than as an attack on Fed policies. Kevin would leave the Board three months later, but not because of any policy disagreement. We had agreed


when he was appointed in 2006 that he would stay for about five years. We remain close to this day.

 

MARKETS SEEMED TO anticipate QE2 and take it in stride. I thought that we had successfully telegraphed our action. Nevertheless, I wanted to ensure that our aims were well understood. I had seriously considered conducting an unscheduled press conference after the November meeting, but decided that it risked disrupting markets. Instead, I spent several hours telephoning key reporters individually, answering questions on background. I also wrote an op-ed that was published November 4 in the Washington Post. Despite these efforts, I was unprepared for the blowback from policymakers abroad and politicians at home.

November 2, the first day of our meeting, was Election Day, and voters had dealt Democrats what President Obama called a “shellacking.” After four years in the minority, Republicans took control of the House. As a result, Barney Frank would lose the chairmanship of the House Financial Services Committee to Alabama congressman Spencer Bachus. Republicans picked up seats in the Senate but remained in the minority there. Perhaps emboldened by the election results, Republican politicians and conservative commentators, including radio host Glenn Beck, hit our decision hard. Sarah Palin, who had never before demonstrated an interest in monetary policy, called on us to “cease and desist.”

 

More troubling, to me, was a November 17 letter from the four top Republicans in Congress—John Boehner and Eric Cantor in the House and Mitch McConnell and Jon Kyl in the Senate. They expressed deep concerns about our action. Our asset purchases, they wrote, could “result in . . . hard-to-control, long-term inflation and potentially generate artificial asset bubbles.” They offered no evidence to support their assertions. The letter came a day after Senator Bob Corker and Republican Representative Mike Pence of Indiana proposed legislation to remove the full employment part of the Fed’s dual mandate, leaving price stability as the only objective of monetary policy. (The change in mandate, if it had been approved, would not have changed policy much, if at all; very low inflation alone justified highly stimulative policy.)

 

A few economists weighed in against our decision as well. The Wall Street Journal published an open letter on November 15 from twenty-three (mostly conservative) economists, commentators, and asset managers who argued that our securities purchases “should be reconsidered and discontinued.” According to the letter, the policy was not necessary, would not work, and risked “currency debasement and inflation.” Among the signatories were Michael Boskin of Stanford, who had chaired the Council of Economic Advisers under the first President Bush; historian Niall Ferguson of Harvard; Douglas Holtz-Eakin, a former director of the Congressional Budget Office; and John Taylor of Stanford. The media and politicians rarely pay attention to statements by economists, but unfortunately they do if the statements are sufficiently controversial (in the case of the media) or support preconceived views (in the case of politicians).

 

Foreign officials joined in the criticism. German finance minister Wolfgang Schäuble was translated


as calling our decision “clueless.” Others, particularly from emerging markets like Brazil and China, complained that our actions, if they succeeded in lowering longer-term interest rates in the United States, would create damaging spillover effects for their economies. Lower rates in the United States could spark volatile investment flows into emerging markets as investors looked for better returns. A week after our announcement, President Obama heard a torrent of criticism of QE2 while attending a G-20 summit in Seoul, South Korea. When I next met with him, two months later, I jokingly apologized for causing him so much trouble. He laughed and said that he wished we could have waited a week.

 

I had had an opportunity to explain our possible November action in advance at a meeting of G-20 finance ministers and central bankers in Gyeongju, South Korea, on October 23. I argued that, because we are an important trading partner for many countries, the rest of the world would benefit from a stronger U.S. recovery. I said that countries with sound monetary, budget, and trade policies could better withstand any short-term disruptions from our easing. Foreign central bankers, who well understood our aims, generally were more sympathetic to our actions than their more political peers in the finance ministries.

 

I was more worried by the domestic criticism than the foreign. The letter from the Republican leaders signaled a willingness to politicize monetary policy. I understood that this grew out of voters’ understandable dissatisfaction with the economy, but it was also the product of confused or deliberately misleading statements about our policies, their objectives, and how they worked. Our difficulties were evident in an animated YouTube video featuring two creatures of indeterminate species hilariously but wholly inaccurately explaining “the quantitative easing.” The video went viral, and by mid-December it had logged 3.5 million views.

The economic logic underlying all three—the cartoon, the letter from the congressional Republicans, and the economists’ missive—was misguided and inaccurate. In particular, there was virtually zero risk that our policies would lead to significant inflation or “currency debasement” (a loaded term for a sharp decline in the value of the dollar). That idea was linked to a perception that the Fed paid for securities by printing wheelbarrows of money. But contrary to what is sometimes said (and I said it once or twice myself, unfortunately, in oversimplified explanations), our policies did not involve printing money— neither literally, when referring to cash, nor even metaphorically, when referring to other forms of money such as checking accounts. The amount of currency in circulation is determined by how much cash people want to hold (the demand goes up around Christmas shopping time, for example) and is not affected by the Fed’s securities purchases. Instead, the Fed pays for securities by creating reserves in the banking system. In a weak economy, like the one we were experiencing, those reserves simply lie fallow and they don’t serve as “money” in the common sense of the word.

 

As the economy strengthened, banks would begin to loan out their reserves, which would ultimately lead to the expansion of money and credit. Up to a point, that was exactly what we wanted to see. If growth in money and credit became excessive, it would eventually result in inflation, but we could avoid that by unwinding our easy-money policies at the appropriate time. And, as I had explained on many


occasions, we had the tools we needed to raise rates and tighten monetary policy when needed. The fears of hyperinflation or a collapse of the dollar were consequently quite exaggerated. Market indicators of inflation expectations—including the fact that the U.S. government was able to borrow long-term at very low interest rates—showed that investors had great confidence in the Fed’s ability to keep inflation low. Our concern, if anything, was to get inflation a little higher, which was proving difficult to accomplish.

 

A second common misconception was that our hundreds of billions of dollars of securities purchases were a form of government spending, comparable to the Bush and Obama administrations’ fiscal stimulus packages. This confusion led to some scary, though entirely misleading, claims about the cost of our policies to taxpayers. Our purchases were analogous to a financial investment made by a family—such as buying a stock or bond—rather than to a family’s paying rent or buying gas. Indeed, since the interest paid by the securities we acquired exceeded the interest we paid on the additional reserves that banks deposited with us, our purchases would prove highly profitable for taxpayers.

 

The only useful response to the post-QE2 confusion, I believed, was more communication and explanation. I met with and called legislators, including critics such as Senators Shelby and Corker, Paul Ryan (the senior Republican on the House Budget Committee), and Dave Camp (the senior Republican on the House Ways and Means Committee). In September I had held a town hall meeting for high school teachers. I made public appearances, including a second 60 Minutes interview on December 5. But I knew that we would need to do more to get our message across.

 

 

* The initially reported rates were revised in 2012 by the Labor Department to 10 percent in October 2009 and 9.9 percent in December 2009.


 

CHAPTER 22

 

Headwinds

 

The clock in my dining room in the Martin Building was ticking down to 2:15 p.m. It was April 27, 2011. Michelle Smith and her Public Affairs colleague Rose Pianalto—the sister of Cleveland Fed president Sandy Pianalto—waited with me. I sipped from a bottle of water and kept my eye on the clock. In a few minutes I would take the unprecedented step, for a Fed chairman, of beginning a series of regularly scheduled press conferences.

 

With no auditorium or television studio at the Board large enough for a press conference, we had decided to use our largest dining room, on the same floor as the cafeteria. (My small dining room had been pressed into service as a green room.) The logistical challenges of holding such a high-profile and market-sensitive event on live television were daunting, and Michelle and Rose, along with many other staff members, had been working for weeks trying to anticipate every contingency.

 

We had also carefully considered the staging of the event, aware that every detail could send a subliminal message. We wanted the feel of an economic seminar rather than a news conference in a more political venue. Consequently, I would not stand behind a podium but would sit at a desk (placed atop a platform to give the TV cameras at the back of the room a clear shot), with the assembled reporters seated at long tables. In a nod to Washington convention, though, I would be flanked by an American flag on my right and the Federal Reserve flag to my left.

 

I had rehearsed answers to possible questions with the staff, more than I normally would before congressional testimony. We expected reporters’ questions to be more pointed and more technical than those usually asked by members of Congress. I was certainly not a novice in dealing with the press. I had taken questions from reporters after speeches at the National Press Club as well as in many off-the-record


meetings with editorial boards and other groups of journalists. Nonetheless, I was nervous. It seemed as though the cable TV business stations had talked about nothing else for a week—and we had been swamped by requests to attend. Michelle invited about sixty reporters—one per news organization, including newspapers, magazines, wire services, network and cable TV, and radio. Foreign outlets also attended, including Der Spiegel, Agence France-Presse, TV Asahi of Japan, and Korea Economic Daily.

 

At 2:15 precisely I walked into the improvised studio to the clicking of cameras and took my seat. I looked over the rows of reporters and began a short statement.

 

We had been discussing the possibility of regular press conferences for some time, and the FOMC had endorsed the idea at the March 15 meeting. Many other central banks hold press conferences, some as frequently as monthly, and adopting the practice seemed the natural next step for increasing transparency at the Fed. As I had often remarked, monetary policy is 98 percent talk and 2 percent action. That’s especially true when short-term interest rates hover close to zero and influencing expectations about future interest rates becomes critically important. Still, the backfire potential during a live, unscripted televised exchange with reporters was significant. Any wrong or unintended policy signal could roil markets. And we knew that once we began holding press conferences it would be difficult, if not impossible, to stop.

After the blowback that greeted our introduction of QE2 in November 2010, however, we needed more than ever to explain our policies clearly and effectively. We had announced on March 24 that I would hold four postmeeting press conferences a year, coinciding with FOMC participants’ quarterly submissions of projections for economic growth, unemployment, and inflation.

 

In my opening statement, I said that we would complete, as promised, $600 billion of Treasury securities purchases under QE2 by the end of June, and that we continued to expect the funds rate to remain low “for an extended period.”

 

It was premature to make a definitive judgment about the effects of QE2, but the early signs seemed promising. Financial conditions had eased considerably since I had first hinted at a second round of securities purchases at Jackson Hole eight months before. Stock prices had risen 27 percent, and spreads between the yields on corporate bonds and Treasury securities had narrowed (suggesting more willingness by investors to take on risk). Longer-term interest rates had fallen with the announcement of the program, as expected, but subsequently rose as investors became more confident about future growth and less worried about deflation. The pattern was similar to what we had seen after the expansion of QE1 in March 2009.

Improved financial conditions in turn seemed to be helping the economy. Payroll increases averaged close to 200,000 per month in February and March, and the unemployment rate, which had been a discouraging 9.8 percent in November, had dipped below 9 percent. I said that the FOMC expected the recovery to proceed at a moderate pace, with unemployment continuing to fall slowly, though some unforeseen developments—most importantly, the disastrous earthquake and tsunami that hit Japan on


March 11—could temporarily weigh on growth. Besides inflicting tragic loss of life—some twenty thousand people died—the earthquake and tsunami disrupted global supply chains. The sudden shortages of critical parts limited the production of automobiles and other manufactured goods around the world. In a gesture of solidarity, the Fed and the Treasury had coordinated with the Japanese in a rare intervention in the foreign exchange market. The week after the quake, along with other G-7 countries, we bought dollars and sold yen to bring down the value of the yen and help make Japanese exports more competitive. It was our only foreign exchange intervention during my time at the Fed.

 

Inflation prospects posed some tricky issues. QE2 had been undertaken in large part because of our concerns about deflation risks, and now, less than six months later, those risks seemed to have dissipated —another apparent success for the program. But had we overshot? Gasoline prices had risen by almost a dollar per gallon, to $4, since the QE2 announcement. Food prices were also rising, propelled by global increases in the prices of major crops (wheat, rice, corn, and soybeans) and some weakening of the dollar.

 

After Neil Irwin of the Washington Post asked the first question at the press conference, about an apparent slowing of growth in the first quarter, Jon Hilsenrath of the Wall Street Journal asked if the Fed could or should do anything about the increasing costs of gas and food. Everyone was aware of our critics’ repeated warnings that our securities purchases might cause out-of-control inflation. Should the Fed consider reversing its easy-money policies?

The appropriate monetary policy response to swings in energy and other commodity prices has long challenged central banks. Over the years, the FOMC has generally chosen to look through them and focus on more stable measures of inflation trends—such as so-called core inflation, which excludes energy and food prices. This approach has often been derided. As the question is usually put, “Don’t you people at the Fed eat or drive?” Yes, we do, and the Fed has always equated price stability with low overall inflation, including inflation in energy and food prices.

 

We paid attention to core inflation because there is a lag between changes in monetary policy and their effect on the economy. We must take into account not only the current inflation rate but also the prospects for inflation a few quarters ahead, when the effects of policy decisions will actually be felt— much as a quarterback throws the football to where he expects his receiver to be, not where the receiver is at the moment the pass is released. Research shows that setting aside the most volatile prices leads to better predictions of overall inflation. We had faced a similar dilemma in the summer of 2008. Energy prices were rising sharply, though the economy was weak. We—correctly, in hindsight—had resisted raising interest rates.

 

I told Hilsenrath that we saw the recent increases in gasoline prices in particular as likely to be temporary, the result of factors mostly outside of monetary policy, including political unrest such as the Arab Spring (which had raised concerns about reduced oil supply). As best we could tell, neither the rise in oil prices nor the increases in crop prices seemed likely to translate into persistently higher overall


inflation. Consequently, I said, no monetary policy response was warranted.

 

After about an hour, the press conference ended. It looked to have been a critical, and logistical, success.

 

 

SPEAKING OF CRITICAL SUCCESSES, in May 2011 the HBO movie Too Big to Fail, based on Andrew Ross Sorkin’s book of the same title, told the story of the crisis. Paul Giamatti’s version of me earned him an award from the Screen Actors Guild. To gather material for his characterization, Giamatti had visited me at the Fed. His father, Bart Giamatti, had been the commissioner of Major League Baseball. Our lunch conversation turned quickly to the game and we never talked about the Fed or the financial crisis. I guess he got what he needed, judging by the critical reception of his performance. While I have read Sorkin’s book, I have never seen the movie. I avoided it, perhaps unfairly expecting an oversimplified treatment of complicated issues—not to mention the fact that it would feel strange to see myself portrayed on screen. When asked my opinion of the film, I would respond that I didn’t need to see it; I had seen the original.

 

Around the time the movie came out, Bill Clinton invited me to meet with him. I had met Hillary Clinton during her time as senator and then secretary of state. Once, to lunch with her, I walked the block from the Fed to the State Department, accompanied by my security detail. She welcomed me warmly and we ate at a table for two that had been wheeled into a small private dining room. She conveyed her support for the Fed’s actions during the crisis but listened more than she spoke, pumping me for my insights into the world’s economies.

 

At my meeting with Bill, we spent more than an hour in the living room of the Clintons’ home in Washington, near the Naval Observatory. He looked thin—after several heart surgeries, the most recent in 2010, he had reportedly become a vegan—but he conversed with great energy about politics, foreign affairs, and the economy. He too greeted me warmly and praised the Fed’s response to the crisis. He urged me to continue my efforts to speak to the country, such as the 60 Minutes interview and the news conferences. He said people were uncertain and afraid and needed to hear from someone who could explain what was happening. Americans would become more confident, he told me, if they understood better what was going on.

 

 

AS IT TURNED OUT, the FOMC correctly diagnosed the inflation situation in the spring of 2011. Gas prices would peak in early May and then fall the rest of the year. Overall inflation, including food and energy prices, would rise until September and then move steadily downward. However, once again we (along with private-sector forecasters) were too optimistic about economic growth. As in 2010, promising growth in the spring would give way to a summer swoon. Job gains would slow sharply—on average, only about 50,000 jobs were created each month in May, June, and July. The initial August report showed a complete stall in job growth. The unemployment rate, after its encouraging drop early in the year, would stagnate near 9 percent into the fall—a net improvement of only about 1 percentage point since the


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