Federal Reserve documents 38 page

I talked and emailed with voters and nonvoters alike. All had a voice at the FOMC table and could influence their colleagues. I had a particularly intensive ongoing email correspondence with Narayana Kocherlakota, a former University of Minnesota professor who succeeded Gary Stern at the Minneapolis Fed in October 2009. A nonvoter in 2012, Narayana had opposed additional monetary stimulus as a voter the year before. He had attributed much of the labor market’s troubles to businesses’ difficulty in finding workers with the right skills—a problem that required more education and training, not monetary policy stimulus. I didn’t think the evidence supported his view. But my basic argument to him was the simple point that had convinced me: Our progress toward our goals was too slow. So long as we thought that our tools were effective and their risks could be managed, which I did, we should do more. Ultimately, after many discussions, Narayana deserted the hawks and joined the doves—a rare example of someone willing to change his mind when confronted with compelling facts and arguments.

THAT AUGUST, MY father, Philip, died. After selling the family drugstore to a chain, he and my mother, Edna, had retired to Charlotte, North Carolina, where my mother grew up and where my brother, Seth, and his family lived. My parents lived in a small house before moving to a seniors’ complex. My father fell ill and, after a months-long decline, died of heart failure on August 8 in the intensive care unit of the Presbyterian Medical Center. He was eighty-five. Seth and my sister, Sharon, had sat by his bedside, comforting him by singing the Hebrew prayers and songs he knew so well. Anna and I had visited him in the hospital, but I had to go back to Washington. He died before we were able to return for another visit. Instead, we returned for the funeral. He was a good man—ethical, kind, and gentle. I deeply appreciated the condolences from many friends, and an unexpected phone call from President Obama. But I was most surprised (and also touched) by a handwritten note of sympathy from Congressman Ron Paul.

BACK IN WASHINGTON, I continued working to build a consensus for additional monetary policy action. We had done a lot, and we had thought it would be enough, but the moribund job market showed otherwise. The unemployment rate, still far too high at 8.1 percent in August, understated its weakness. That month, 12.5 million people were unemployed (5 million of them had been out of work for more than six months). An additional 8 million were working part-time but preferred full-time work, and 2.6 million wanted to

work but hadn’t looked recently or had given up. At Jackson Hole on August 31, stepping up the rhetoric, I called the jobs situation “a grave concern.” Firming up market expectations for a third round of securities purchases, I said we would “provide additional policy accommodation as needed to promote . .

. sustained improvement in labor market conditions.”

Two weeks later, at the September meeting, the Committee began what would become known as QE3. We couldn’t further expand the Maturity Extension Program because we were running out of the short-term securities we sold to finance it. So, we would expand our balance sheet once again by creating bank reserves to purchase $40 billion a month of mortgage-backed securities guaranteed by Fannie, Freddie, and Ginnie in addition to the continuing $45 billion in monthly Treasury purchases under the Maturity Extension Program. Even more important, we said that if we did not see “substantial improvement in the outlook for the labor market,” we would continue purchasing securities and employ other policy tools.

Like Mario Draghi, we were declaring we would do whatever it takes. Unlike QE1 and QE2, when we announced the expected purchase totals in advance, QE3 would be open-ended. It was risky. Either we reached our goal of substantial labor market improvement, or we would have to declare the program a failure and stop the purchases, a step sure to rattle confidence. But the advantage of open-ended purchases was that markets and the public would know that they could count on the Fed’s support as long as necessary, which we hoped would promote confidence and keep longer-term rates low. No more start and stop.

At our December meeting, we expanded QE3 by committing to purchase $45 billion a month in longer-term Treasury securities after the end of the year, when the Maturity Extension Program finished. With the $40 billion in mortgage-backed securities purchases approved in September, our balance sheet would be growing at a rate of $85 billion a month. We also recast our forward guidance once again. Instead of saying that we expected our short-term rate target to remain exceptionally low through a particular date, we introduced what we called thresholds, an idea that Charlie Evans had been floating publicly and that both Janet Yellen and Bill Dudley had advocated internally. We said that we expected the target to stay low at least as long as unemployment remained above 6-1/2 percent and that our projections for inflation during the next one to two years remained at or less than 2-1/2 percent. Importantly, these numbers were thresholds, not triggers; we were not saying that we would raise rates when unemployment hit 6-1/2 percent, but rather that we would have to see unemployment at 6-1/2 percent before we would even consider raising rates. Once again, we were saying that we would do whatever it takes.

Richmond Fed president Jeff Lacker objected to both the additional MBS purchases and the thresholds. He was the only FOMC member to dissent, but he wasn’t the only one who was nervous. I thought that we would be able to begin phasing out the purchases at some point in mid-2013, but I knew that would depend on the data (and on factors outside our control, like fiscal policy). We might be buying securities for a long time. In poker terminology, we were all in.

* By late 2014, total modifications under HAMP would reach 1.4 million.

† Nominal gross domestic product, or nominal GDP, is the dollar value, unadjusted for inflation, of the goods and services produced in the domestic economy. Growth in nominal GDP is the sum of output growth and inflation.

‡ The yield curve relates yields on a given type of security—say, Treasury debt—to the term of the security. Since longer-term rates generally exceed short-term rates, the yield curve normally slopes upward.

CHAPTER 23

Taper Capers

The midwinter sun had set by the time my guests and I gathered in the chairman’s dining room, overlooking the western end of the National Mall. The Martin Building, on that chilly Thursday evening, January 17, 2013, was otherwise deserted, except for the catering staff and several security agents idling in the hallway.

Inside the dining room, an oblong table was set for eight. Through floor-to-ceiling windows, we could see the illuminated Capitol, the Washington Monument, the Jefferson Memorial, the Lincoln Memorial, and, across the Potomac River, the Pentagon. Those whose attention strayed from the predinner conversation could observe at intervals the blinking lights of descending airliners following the river to Reagan National Airport.

The occasion for the dinner was the impending departure of Tim Geithner as secretary of the Treasury. In addition to Tim, my guests included three former Treasury secretaries, Robert Rubin, Larry Summers, and Hank Paulson; two former Fed chairmen, Paul Volcker and Alan Greenspan; and a former Fed vice chairman, Don Kohn—the same group that attended my farewell dinner for Hank four years earlier.

As we mingled before sitting down to eat, Hank and Larry animatedly discussed developments in China. Both had recently returned from trips there. Volcker and Rubin chatted quietly. Paul still carried considerable influence in policy circles, as evidenced by the adoption of the Volcker rule as part of the Dodd-Frank reforms. But now, at eighty-five and remarried three years earlier, he seemed mellower and more prone to unleash his booming laugh. Rubin, seventy-four, had fought crises in Asia, Latin America, and Russia as Treasury secretary under President Clinton. He had served as mentor to both Summers and

Geithner before returning to Wall Street, where he had spent most of his career. He had witnessed the most recent crisis as a senior adviser at Citigroup.

I caught up with Tim and Don. Don seemed happy with his post-Fed activities, which included a position at the Brookings Institution (a nonprofit policy research organization in Washington) and membership on a committee at the Bank of England charged with preserving financial stability. Don had never headed an agency or cabinet department, but his presence raised no eyebrows. He had been in government longer than anyone else in the room and had been an indispensable adviser to both Greenspan and me.

Greenspan arrived late. He said he had been held up by appointments. At eighty-six, he shuffled rather than strode, but in other respects he had not slowed down. Along with his active social life and occasional tennis game, he continued to run his consulting business and was working on a new book.

Over steak and potatoes, we toasted Tim. The guest of honor was upbeat, telling stories and cracking jokes. I could never decide whether Tim’s dry sense of humor was a defense mechanism or whether he was as truly immune as he seemed to the stress and criticism that came with his high-profile jobs. If his casual indifference was an act, it was convincing. Although he still looked remarkably youthful, Tim had been in public service since 1988, when he joined the international staff of the Treasury Department. After nearly four challenging years at the head of the department, he had been hinting none too subtly for months that he was ready to leave. President Obama had persuaded him to remain until the end of the first term, but Tim felt that it would be unfair to his family to stay into the second term, and Obama had acquiesced.

Despite the lively conversation, in some respects it was an awkward gathering, colored by complicated personal relationships, strong egos, differences in policy views—and a lot of history. Volcker and Rubin, and to a significant extent Greenspan, were uncomfortable with many of the policies that the Fed pursued during and after the financial crisis. (I remembered a tense lunch with Rubin in the same dining room, when he had tried to dissuade me from pursuing quantitative easing.) Larry had been critical of some of our actions as well, at least within the confines of the White House. But we shared a bond formed of common experience. Differences notwithstanding, we each had felt the satisfaction of being able at times to have a positive effect on the world.

Government policymaking at the highest levels involves long hours and near-constant stress, but it is exciting to feel part of history, to be doing things that matter. At the same time, we all knew the frustrations of struggling with extraordinarily complex problems under unrelenting public and political scrutiny. Rapidly changing communications technologies—first, twenty-four-hour cable television, then blogs and Twitter—seemed not only to have intensified the scrutiny but also to have favored the strident and uninformed over the calm and reasonable, the personal attack over the thoughtful analysis. In a world of spin and counterspin, we all knew what it was to become a symbol of a moment in economic history— to serve as an unwilling avatar of Americans’ hopes and fears, to become a media-constructed caricature

that no one who knew us would ever recognize.

But that’s the baggage that comes with consequential policy jobs, as we all knew too well. The deepest frustration we shared, it soon became clear, was not with the baggage but with government dysfunction itself. The founders had designed a system to be deliberative; instead, it was paralyzed. Too often, the system promoted showboating, blind ideology, and malice. Nothing productive could be done, it seemed, until all the wrong approaches were tried first. Those around the table who had served in the 1980s and 1990s assured the rest of us that nasty politics and government gridlock were as old as the republic. Rubin talked about the debt ceiling and budget battles of his era. They bore a striking resemblance to recent fiscal fights.

As the dinner wound down, I joked that I would soon become the last of the group still drawing a government paycheck. Afterward, my security team and I dropped Larry Summers off at his hotel. He had left his White House position two years earlier and now his not-so-secret ambition was to be chairman of the Fed after my departure. In response to my questions, he said he supported current monetary policy, including the hundreds of billions of dollars of securities purchases we were making under QE3. I didn’t know who would succeed me, but it was important to me that he or she continue our policies.

In a meeting in the Oval Office on February 5, I would repeat to the president what I had told him when he renominated me in 2009: I did not want to be considered for another term as chairman when my current term ended in January 2014. More than a decade in the Washington pressure cooker was enough. The president said that he understood. We talked briefly about possible replacements. He told me that his candidates were Summers, Janet Yellen, and Don Kohn, and he asked my opinion. I didn’t want to influence his choice too much, since my support for any one candidate could easily be misrepresented as opposition to another. I told the president what I believed—that all three were very well qualified and would likely continue the Fed’s current monetary policies.

GOVERNMENT DYSFUNCTION WAS on everyone’s minds at Tim’s farewell dinner because the federal government had, weeks earlier, teetered on the edge of the fiscal cliff—the nickname given a confluence of fiscal deadlines occurring at the end of 2012. (I was credited with inventing the phrase when I used it in congressional testimony a year earlier—but others had used it before in other contexts.) On December 31, absent action from Congress, the federal government would reach its borrowing limit, tax cuts enacted during the Bush administration would expire, and the sequestration would begin. Falling off the cliff would have dealt a huge blow to the recovery.

At the last moment, Congress and the administration managed to avert some of the worst outcomes. On January 2, President Obama signed legislation postponing the sequestration until March 1 and extending the Bush tax cuts for all but top earners. On the other hand, the temporary cut (2 percentage points) in the Social Security payroll tax that Americans had enjoyed for the past two years was allowed to expire. The debt ceiling was reached, but Treasury, as it had in past standoffs, employed accounting tricks to allow

the government to keep paying its bills for a while longer.

Although the worst was avoided, the net effect of all the budget brinkmanship was a powerful increase in the strength of the fiscal headwind. The tax increases and spending cuts that did go into effect were likely to be a significant restraint on demand, and the uncertainty generated during the standoff (as well as the prospect of more brinkmanship) weighed on business and consumer confidence. The nonpartisan Congressional Budget Office would later estimate that fiscal measures in 2013 would lop 1.5 percentage points off economic growth in 2013—growth we could ill afford to lose.

Tim’s last day as Treasury secretary was January 25. Legislation enacted on February 14 suspended the debt ceiling until May 18, giving Tim’s successor, Jack Lew, a little breathing room to work out a longer-term deal with Congress. Jack, sworn in on February 28, was a bright, savvy attorney with long and varied experience inside and outside government. He had served in the Clinton administration as director of the Office of Management and Budget (among other roles) and in the Obama administration, again as OMB director and then as White House chief of staff. In between, he had worked as vice president for operations at New York University and as a senior executive at Citigroup. I would meet regularly with Jack over breakfast or lunch, as I had with his predecessors—John Snow, Hank, and Tim. Jack’s reputation was as a fiscal expert, but he also knew a lot about financial markets and financial regulation. We quickly developed a good working relationship.

I DELIVERED THE Board’s usual twice-a-year report to Congress at a Senate Banking Committee hearing on February 26. Monetary policy accommodation continued at full throttle, following our declaration in December that we would buy $85 billion in securities each month until the labor market outlook improved substantially. To me, the need for continuing with these purchases remained clear. Since bottoming out three years earlier, payrolls had grown by about 6 million jobs, but we were still more than 2 million jobs short of the level of employment before the crisis (a comparison that ignored subsequent population growth). The unemployment rate remained high—7.9 percent in January—and 12.3 million Americans were unable to find work. More than a third of them had been without a job for six months or more.

I felt a sense of urgency—the economy must make faster progress or many of the long-term jobless might never return to work—and I also felt frustrated that fiscal policymakers, far from helping the economy, appeared to be actively working to hinder it. “Monetary policy . . . cannot carry the entire burden,” I told senators. True, Congress had made progress toward reducing the federal budget deficit—a positive development, all else equal. However, from my perspective they were looking at the problem the wrong way. As I had been arguing for some time, the most serious threats to fiscal sustainability were some years down the road, tied in large part to the aging of the population and rising health-care costs. We needed to improve the cost-effectiveness of American health care and ensure the solvency of key benefit programs, like Social Security. We also needed to increase productivity and economic growth, which would allow us to better afford the costs of an aging society. But lawmakers had avoided tackling

those critical long-run issues in favor of near-term spending cuts and tax increases that weakened the already weak economy.

I didn’t say it at the hearing, but I was also wondering how much longer the FOMC would support the ultra-accommodative monetary policy needed to offset the fiscal (and other) headwinds. The vote at the most recent meeting, on January 29–30, had been 11–1 in favor of continuing our policies, with Kansas City Fed president Esther George (taking up where her predecessor Tom Hoenig had left off) the only dissenter. But the vote didn’t capture the extent of the concern and skepticism on the Committee. As everyone (including me) appreciated, the latest round of asset purchases was a gamble. I believed that the more open-ended approach of QE3 would prove more powerful at spurring growth and job creation than our previous efforts. But what if the economy stalled yet again, perhaps for reasons outside our control, such as fiscal stringency at home or a resurgence of the European crisis? We could find ourselves buying large quantities of securities for quite a while, a prospect that made many of my colleagues uneasy. I was particularly concerned that I could lose the support of three Board members: Jeremy Stein, Jay Powell, and Betsy Duke. Cleveland Fed president Sandra Pianalto, who was not a voter in 2013, also had concerns. Jeremy and Jay had joined the Board in May 2012 after the now standard confirmation delay in the Senate. Their swearing-in had brought the Board to full strength for the first time in six years.

I had been enthusiastic about their appointment. They would both help shore up the Board’s financial expertise, which had been diminished by the departure of Kevin Warsh. Jeremy, a Harvard economist specializing in finance, had served as an adviser at both the Treasury and the White House during the early months of the Obama administration. I knew him and his work well. As the economics department chair at Princeton, I had tried to recruit him to the faculty. Jay, a Treasury undersecretary in the first Bush administration, had gone on to become a partner at the Carlyle Group investment firm. He was a Republican (the president had paired him with Stein, a Democrat, to increase the odds of Senate confirmation) but certainly no Tea Partyer. After leaving Carlyle he had joined the Washington-based Bipartisan Policy Center, where in 2011 he had worked effectively behind the scenes to educate legislators about the risks of failing to increase the debt ceiling. He had a reputation as a moderate and a consensus builder.

Jay and Jeremy, having arrived at the Board at the same time, spent a lot of time together, and I often met with them jointly. They both wanted to be supportive, but neither was entirely comfortable with our easy monetary policy and our growing balance sheet. Jeremy talked about his concerns in a series of speeches that received substantial media attention. He was particularly worried that our securities purchases could stoke excessive risk taking in financial markets. It was not a new argument, but Jeremy made it in more detail and in a particularly sophisticated way. He acknowledged the merit of my long-held view that the first and best line of defense against financial instability should be targeted regulatory and supervisory policies, not monetary policy. But he did not want to rely only on regulation and supervision. Financial risks could be hard to detect, he argued, and only higher interest rates could “get

into all the cracks,” as he put it, and reduce the incentives for excessive risk taking wherever it might occur. I agreed that higher interest rates could get into all the cracks, in the sense of their affecting a wide range of financial and economic decisions; it was for that very reason that using this tool to cure a perceived problem in financial markets risked creating ills for the broader economy.

Jay expressed his concerns mostly within the Fed, as did Betsy. Sandy, like Jeremy, spoke about her concerns in public remarks. The four were by no means hawks; they agreed that the recovery still needed substantial help from monetary policy. But they worried about the implications of our burgeoning balance sheet for financial stability, for our ability to exit our easy policies in the future, and for the political risks to the Fed if losses on our holdings meant that we couldn’t pay remittances to the Treasury for a while.

The Fed is normally very profitable, since we typically earn a higher interest rate on our Treasury and mortgage-backed securities than we pay on the bank reserves that finance our holdings (1/4 percent at the time), and we pay nothing on the portion of liabilities represented by outstanding currency. After subtracting our operating expenses, we remit our profits to the Treasury, in turn reducing the federal deficit. Our remittances during and after the crisis were in fact exceptionally high—far higher than before the crisis—reflecting not only our larger securities holdings but also the profits we earned from our lending programs. But at some point a strengthening economy and rising inflation pressures would presumably force us to raise short-term interest rates. It was possible to end up temporarily paying more interest on banks’ reserves than we earned on the securities we held, which in turn might lead to several years in which we had little or no profits to remit to the Treasury. We thought that outcome was unlikely, but we were up-front about the risk. I spoke about it in press conferences and congressional testimony, and we released a staff study that examined a range of scenarios for our remittances.

Of course, profit is not the point of monetary policy. When interest rates started rising, it likely would mean our policies were working and the economy finally was growing strongly and producing jobs. The public benefit of a stronger economy and more jobs would far outweigh any temporary effect of lower Fed profits on the federal budget. Moreover, as a side benefit, a stronger economy would improve the government’s fiscal position—by increasing tax revenues, for example. That effect likely would more than offset any decline in our remittances. Still, despite these arguments, we knew we would have a political and public relations problem if our payments to the Treasury stopped for a time and we were still paying interest to banks, many of them foreign-owned. It was not a reason to make the wrong policy choices, but it was another source of concern.

Because they all had permanent votes on the FOMC, I couldn’t afford to lose the support of the three Board members—the “three amigos,” as Michelle Smith dubbed them. I needed to find a way to reassure them that our securities purchases would not continue indefinitely. As Jay told me, we needed an “off-ramp.” There was already something of an off-ramp in the FOMC statement. It said we intended to take into account “the likely efficacy and costs” of the purchases. In other words, if we concluded that the program simply wasn’t working, or if it was creating excessive risks, we would stop buying securities,

even if we hadn’t reached our goal of jump-starting the job market. Partly to accommodate the three amigos, I continued to highlight the potential risks of our unconventional policies, including in my Humphrey-Hawkins testimony on February 26. I made clear that I thought the benefits of our securities purchases had so far outweighed the risks. But, by drawing attention to the potential downsides of the program, I hoped to reassure the public as well as uneasy colleagues that we were not on autopilot and would throttle back if necessary.

I expected a thorough discussion of the efficacy, costs, and risks of continuing QE3 at the next FOMC meeting in March. As the meeting approached, I worked to keep everyone on board. I met with all the Board members. Unusually, I also gave Jay, Jeremy, and Betsy the opportunity to comment on the opening remarks I planned for the March news conference. I told them that while my view on securities purchases differed from theirs, I would do my best to accommodate their preferences. “My position as Chairman is untenable if I don’t have the support of the Board,” I told them. I said I expected that we would be able to slow our purchases by September, and possibly by June.

Meanwhile, journalists and traders speculated feverishly on when “tapering” would begin. That was the term the press had affixed to a strategy that involved gradual reductions in our securities purchases rather than a sudden stop. Though I had used it, I didn’t particularly like it, and I tried to encourage others on the FOMC to use alternatives. “Tapering” implied that, once we had begun slowing purchases, we would reduce them along a predetermined glide path. Instead, I wanted to convey that the pace of purchases could vary, depending on the speed of progress toward our labor market objective and on whether the risks of the purchases were starting to outweigh the benefits. As usual, though, I had little influence on the terminology the press chose to use.

Whatever the strategy was called, communicating it clearly would be crucial. I very much wanted to avoid a repeat of the missteps made in preparing markets for a shift toward tighter monetary policy in 1994. Under Chairman Greenspan, the FOMC had cut the federal funds rate target sharply during and after the 1990–1991 recession. Then, after leaving the target unchanged for nearly a year and a half, policymakers began in February 1994 to nudge the rate higher amid early signs of overheating in the economy. Greenspan had tried to warn markets of the coming policy shift, but long-term rates reacted much more sharply than the Committee anticipated—with the yield on ten-year Treasury notes jumping from 5.6 percent in early January to 7.5 percent in early May. Evidently investors saw the Fed’s February rate hike as the beginning of a much more rapid series of increases than the policymakers themselves envisioned. The FOMC at the time worried that the unexpected spike in long-term rates would slow the economy too much.

It worked out in the end. Greenspan achieved a soft landing that enabled the economy to continue growing, with low inflation. The 1990s turned out to be the longest expansion in U.S. history, and Alan, at least for a time, became the Maestro. But the ride had been bumpy. Now, nearly twenty years later, I hoped that the communication techniques we had developed—such as the unemployment and inflation

Date: 2016-04-22; view: 639