Federal Reserve documents 40 page

On September 25, just before the shutdown began, the Treasury Department announced that it would soon run out of accounting maneuvers to circumvent the debt ceiling and that a default would occur on October 17. Fortunately, on October 16, Congress—once again skating uncomfortably close to the edge— agreed to legislation to suspend the debt ceiling and fund the government for the next year. The president signed the bill shortly after midnight.

IN SOME GOOD news in the midst of the shutdown, the president announced his nomination of Janet Yellen to succeed me. Three weeks earlier, Larry Summers had withdrawn his name from consideration, saying in a letter that “any possible confirmation process for me would be acrimonious and would not serve the interest of the Federal Reserve, the Administration or, ultimately, the interests of the nation’s ongoing economic recovery.” I was happy for Janet but sorry that the process had been so difficult and contentious.

At 2:00 p.m. on October 9, I waited with Janet, her husband, George Akerlof, and other family members in the Roosevelt Room. Valerie Jarrett, the president’s senior adviser, stopped by, introduced herself, and chatted with Janet. We were soon escorted to the State Dining Room. The president had asked me if I wanted to say a few words. I said no. It was Janet’s day. She stood to the president’s right

and I at his left, my hands clasped in front of me, listening as he called me the “epitome of calm” and thanked me for displaying “tremendous courage and creativity” in taking “bold action that was needed to avert another Depression.”

The president announced Janet’s nomination, lauding her as a “proven leader . . . exceptionally well-qualified . . . [and] as vice chair . . . a driving force of policies to help boost our economic recovery.” In truth, she had far more experience in Fed policymaking than I had had on taking office. In her acceptance remarks, Janet emphasized her commitment to both aspects of the Fed’s dual mandate—especially, given our circumstances, to putting people back to work. “The mandate of the Federal Reserve is to serve all the American people, and too many Americans still can’t find a job and worry how they will pay their bills and provide for their families,” she said. “The Federal Reserve can help, if it does its job effectively.” From that point forward, my mission was to ensure a smooth transition.

The FOMC’s next meeting was scheduled for October 29–30. This time, traders weren’t expecting us to taper—and, this time, we met their expectations. The delayed employment report for September (released more than two weeks late, on October 22) had shown the unemployment rate ticking down to 7.2 percent, but employers had added a lackluster 148,000 jobs. Besides, we were still trying to sort out the economic effects of the government shutdown that had ended only two weeks earlier. Waiting seemed the wiser course.

By the December 17–18 meeting, the conditions were in place for taking the much-anticipated step of slowing our securities purchases. By then, we had the employment reports for October and November. The unemployment rate was now down to 7 percent—reaching that level much sooner than we had anticipated—and, with a revision to September’s payroll figure, job growth had averaged nearly 200,000 over the previous three months. The FOMC approved a $10 billion reduction in the monthly pace, to $75 billion. Esther George joined the majority for the first time in her tenure on the FOMC.

However, Eric Rosengren of the Boston Fed dissented, arguing that slowing securities purchases was premature. He pointed out that inflation was still running well below our 2 percent objective. To accommodate his and other FOMC members’ concerns, we adjusted our forward guidance for the liftoff of the federal funds rate. We said we likely would maintain the near-zero federal funds rate target “well past the time the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.” The addition of the phrase “well past the time” was a signal that we would be in no rush to raise short-term interest rates, even if we continued scaling back our securities purchases. Evidently our message was received: Markets accepted our decision calmly.

THE RESERVE BANK presidents had flown into Washington earlier than usual that week so that they could attend a ceremony, held on December 16, to commemorate the upcoming one hundredth anniversary of President Wilson’s signing of the Federal Reserve Act on December 23, 1913. Two former chairmen

(Volcker and Greenspan), the current chairman (me), and the soon-to-be chair (Janet)—representing thirty-four continuous years of Fed leadership—sat side by side at the Board table. Familiar faces at the event included former Board members Don Kohn, Roger Ferguson, Kevin Warsh, Randy Kroszner, Mark Olson, Sue Bies, and Betsy Duke. The oldest attendee, ninety-five-year-old Dewey Daane, had been nominated to the Board by President Kennedy. Nancy Teeters, eighty-three, also attended; a Carter appointee, she had become, in 1978, the first woman on the Board. All told, sixty-two current and former FOMC members assembled in the boardroom—the largest such gathering in the institution’s history.

The event offered a fitting opportunity to sum up my thoughts about the Fed as my term wound down. I noted the values that had sustained the institution since its founding, as exemplified by the professional staff that serves it even as the top policymakers come and go—the commitment to dispassionate, objective, and fact-based analysis, and the dedication to public service. At least as important as any other value, I said, “has been the Federal Reserve’s willingness, during its finest hours, to stand up to political pressure and make tough but necessary decisions.”

My final month in office, January 2014, provided other opportunities to look back and look ahead. I had spent a lot of time thinking analytically about the crisis and its aftermath but, until an event at the Brookings Institution on January 16, very little about the emotions I had experienced. Historian Liaquat Ahamed (author of one of my favorite books, Lords of Finance, about the world’s leading central bankers between the two world wars) asked me whether I had had sleepless nights. Of course I had. However, as events unfolded I repressed my fears and focused on solving problems. Looking back, though, it was like being in a car wreck. “You’re mostly involved in trying to avoid going off the bridge; and then later on you say, ‘Oh, my God!’” I told Liaquat.

My last week in office was a mix of the familiar routines of policymaking and the unfamiliar rituals of leave-taking. I had one last FOMC meeting to conduct, on January 28–29. Earlier in the month, the Labor Department had reported an unexpectedly large drop in the unemployment rate in December, to a five-year low of 6.7 percent. We saw little reason not to reduce our monthly securities purchases by another $10 billion, to $65 billion. No one dissented for the first time since June 2011.

The delicate task of normalizing monetary policy would fall to Janet and her colleagues. Dan Tarullo and Jay Powell would stay on. Sarah Raskin, confirmed as deputy Treasury secretary, would soon leave the Board. Jeremy Stein was expected to return to Harvard at the end of his two-year leave in the middle of the year. The president, on January 10, had announced Jay’s nomination to a full term on the Board, along with two new nominees: Lael Brainard, who had served as Treasury undersecretary for international affairs through the worst of the European financial turmoil, and the venerable Stan Fischer, who would replace Janet as vice chairman. Demonstrating her self-confidence, Janet had pushed the administration to nominate Stan, a choice that I strongly supported. Not every new chair would be comfortable with such a strong number two. The press promptly dubbed them “the dream team.”

My FOMC colleagues feted me on the evening of the first day of the FOMC meeting. I had presided at

similar events many times but wasn’t used to being on the receiving end of so many kind remarks. Janet was extraordinarily gracious. “I believe the most remarkable aspect of your achievements of the last eight years has been your courage,” she said. “You faced a constant cacophony of doubts and criticisms . . . and the understanding that if these criticisms were borne out, they might echo for all of history. I never saw this affect you. You remained determined, open-minded, and creative in your effort to do what was best for the country.”

In return, I tried to do Janet a favor by urging the assembled FOMC members to be more constructive and less strident in their public remarks. Public airing of differences was understandable, and even beneficial, when developing new policy tools on the fly in unprecedented circumstances. “It’s not surprising that the crew of a ship that sails into uncharted waters might find itself engaged in strenuous debate about how to sail the ship and, even, about where to sail the ship,” I said. “Now, if not in sight of land, we are at least nearing known waters . . . [and] I urge you, in your public communication, to consider highlighting areas of common ground in addition to differences.” It was a tough sell, I knew, but I owed it to Janet to try.

On the afternoon of January 30, hundreds of Board employees mobbed the ground floor of the Eccles Building atrium to say farewell. The theme of the event was baseball. We ate hot dogs, Cracker Jack, popcorn, and ice cream. But there was no beer. Monetary policy and banking regulation is a sober business. The staff distributed fake baseball cards with my career statistics: 86 FOMC meetings, 79 congressional testimonies, 226 speeches, and two 60 Minutes interviews.

The next day, my last as chairman, I attended a retirement breakfast for my secretary, Rita Proctor. She had stayed on past her planned retirement date to keep my front office running smoothly. I joked that there should be a new measurement of efficiency called “the Rita.” The majority of us could aspire, at most, to operate at a half Rita. I returned to my office and finished packing. Late that afternoon, a little earlier than usual, I walked out the office door—the cameras of assembled press photographers clicking as I walked down the long marble hallway to the wood-paneled elevator. I rode it down to the garage with security agent Bill McAfee and, one last time, was chauffeured home in the Board’s heavily armored SUV.

The following Monday, February 3, Janet took the oath of office, administered by Dan Tarullo, now the longest-tenured Board member. That morning, I dressed in a polo shirt and blue jeans, ate breakfast, kissed Anna good-bye, and drove myself to the Brookings Institution, where I had been named Distinguished Fellow in Residence. Assisted by Dave Skidmore, on leave from the Board’s Public Affairs Office, I started work on this book. My new office was smaller than the spacious quarters I had left on Friday, but the place had a familiar feel. My old friend Don Kohn was just down the hall.

EPILOGUE

Looking Back, Looking Forward

I am finishing work on this memoir a little more than a year after leaving the Federal Reserve. Anna and I still live in Washington. The program she founded for urban kids is flourishing. When not consulting or traveling to speak at meetings and conferences, I work on various projects at the Brookings Institution. As always, I follow the economy closely. But it’s liberating to read about policy debates knowing that someone else will have to make and defend the tough decisions.

Janet Yellen has moved seamlessly into her new role. After the usual frustrating delays, Stan Fischer was confirmed as Board vice chairman and sworn in on May 28, 2014. He leads a committee that oversees the Fed’s work on financial stability. Lael Brainard joined the Board on June 16, and Jay Powell was sworn in to another term the same day. Also in June, Loretta Mester, who had been research director at the Philadelphia Fed, succeeded Sandy Pianalto as president of the Cleveland Fed. In the fall, the three dissenters of 2011—Charlie Plosser, Richard Fisher, and Narayana Kocherlakota—announced their retirements. Charlie and Richard left in March 2015 and Narayana planned to step down in February 2016. Patrick Harker, president of the University of Delaware, was chosen to succeed Charlie. The long and staggered terms of governors and presidents ensure substantial policy continuity, as the Fed’s founders intended.

During 2014, Janet continued the policies that she and I put in place. The securities purchases wound down smoothly, without significant financial disruptions or harm to the economy. When the purchases ended in October 2014, the Fed’s balance sheet stood at nearly $4.5 trillion. That’s a mind-numbingly large sum, but, relative to annual U.S. output of more than $17 trillion, it is similar to the central bank balance sheets of other major industrial countries.

The condition for ending QE3—substantial improvement in the outlook for the labor market—had undisputedly been met. In August 2012, when I foreshadowed QE3 at Jackson Hole, the unemployment rate was 8.1 percent. In October 2014, as the purchases were ending, the unemployment rate was 5.7 percent and headed lower. The economy added nearly 3 million jobs in 2014, the largest annual increase since 1999. Those gains capped a cumulative increase of nearly 10.7 million jobs over the five years from 2010 through 2014.

The Fed’s securities purchases and lending programs turned a large profit for the government. The Fed sent almost $100 billion to the Treasury in 2014, another record, bringing remittances during the six years from 2009 on to nearly $470 billion—more than triple the remittances during the six years before the crisis (2001–2006) and nearly $1,500 for each man, woman, and child in the United States.

Short-term interest rates remained at rock bottom early in 2015, consistent with the FOMC policy guidance of the past few years, though markets expected the Committee would finally be able to raise rates from near zero sometime later in the year. Of course, how far and how fast rates would rise depended on the economy. Despite falling unemployment, wages grew slowly in 2014, an indication that the demand for labor was not yet outstripping supply. Consequently, the Fed appeared to have room to keep policy easy, supporting further job growth without risking too-high inflation.

Slow growth of the global economy, together with a stronger dollar, crimped U.S. exports early in 2015, contributing to a first-quarter slowdown in the overall economy. Still, in the United States, positive economic signs abounded. American consumers, whose spending accounts for roughly two-thirds of the economy, were in their best shape in years. Households had reduced their debt, their interest payments were low, and the value of their homes was higher, as was the value of most retirement accounts. A sharp drop in oil prices, from $100 a barrel in July 2014 to around $50 in early 2015, though a problem for U.S. energy producers, provided what amounted to a large tax cut to consumers in the form of lower gasoline and heating oil prices. Consumer confidence, as measured by surveys, had rebounded. Housing, though still weak, had picked up significantly since the recession. And, on average, the fiscal policies of the federal, state, and local governments had moved from restrictive to about neutral, neither supporting nor restraining growth. Inflation remained quite low—below the Fed’s 2 percent target, even excluding declining energy and food prices—and seemed likely to remain so for a while. It will be important for the Fed’s credibility to show that it is serious about keeping inflation near its 2 percent target. As the world has learned, too little inflation is just as bad as too much inflation.

WE CAN’T KNOW exactly how much of the U.S. recovery can be attributed to monetary policy, since we can only conjecture what might have happened if the Fed had not taken the steps it did. But most evidence, including research inside and outside central banks, finds that unconventional monetary policies— including both quantitative easing and communication about policy plans—promoted economic growth and job creation and reduced the risk of deflation.

One reason to believe that the Fed’s policies were effective is that, when compared to the experience of other industrial countries, the recovery in the United States looks particularly good (Figure 4). At the end of 2014, U.S. output of goods and services was more than 8 percent higher than at the end of 2007, the pre-crisis peak. That’s not great—only 8 percent total economic growth over seven years (a period including the crisis and the recession). But output in the eurozone at the end of 2014 was still about 1-1/2 percent below its peak. German output, which is about one-third of total eurozone output, was 4 percent above its peak, implying that the rest of the eurozone has done exceptionally poorly. British output was a bit more than 3 percent above peak, and Japanese output remained slightly below its pre-recession highs.

FIGURE 4: Aggressive Monetary Policy Helped the U.S. Economy Recover

Faster Than Other Industrial Economies

At the end of 2014, U.S. output was more than 8 percent higher than at the end of 2007, the pre-crisis peak. Output in the eurozone was about 1.5 percent below its peak, British output was a bit more than 3 percent above peak, and Japanese output remained slightly below its pre-recession highs. The data begin in 2007 Q4 and continue through the end of 2014. Sources: U.S. Bureau of Economic Analysis, Statistical Office of the European Communities, UK Office of National Statistics, and the Cabinet Office of Japan

Some of the international variation in the pace of recovery reflects longer-term factors, like differences among countries in labor force growth. But differences in economic policy appear to explain a significant portion of the variation. Though it was the epicenter of the 2007–2009 crisis, the United States

has had the strongest recovery because the Fed eased monetary policy more aggressively than did other major central banks, and because U.S. fiscal policy, although a headwind during most of the recovery, was less restrictive than elsewhere. Our 2009 bank stress tests also deserve some credit, since they helped set the U.S. banking system on a path to better health relatively early in the recovery.

The eurozone’s poor performance, including an inflation rate well below the European Central Bank’s objective, resulted partly from monetary and fiscal policies that were much tighter than demanded by economic conditions. Markets also saw the early rounds of European bank stress tests as less credible than the American stress tests. European policy choices reflected special circumstances, including the debt crises in Greece and other countries, as well as the structural defects of the eurozone, most importantly the lack of coordinated national fiscal policies. But faulty macroeconomic analysis also led to Europe’s problems. As Tim Geithner and I had warned, Germany and its allies within the eurozone pushed too hard and too soon for fiscal austerity in countries (including Germany) that did not have near-term fiscal problems, while at the same time resisting unconventional monetary actions (like quantitative easing). The European Central Bank, under Mario Draghi’s leadership, finally did implement a large quantitative easing program, but it did not begin until early 2015, almost six years after similar programs were initiated in the United States and the United Kingdom.

Without economic growth, Europe’s unemployment worsened. The divergence from the United States is striking. In 2009, at the end of the financial crisis, unemployment was about 10 percent in both the United States and the euro area. But by the end of 2014, eurozone unemployment had risen to about 11-1/4 percent, compared with a decline to less than 6 percent in the United States. And, much more so than in the United States, European unemployment has been concentrated among the young, denying them the opportunity to develop their skills through work experience. A less experienced and less skilled labor force in turn may worsen Europe’s longer-term growth prospects.

The United Kingdom and Japan are the intermediate cases. In the United Kingdom, the Bank of England under Mervyn King and Mark Carney generally pursued monetary policies similar to Federal Reserve policies, helping to produce a moderate recovery. That the United Kingdom did not perform quite as well as the United States likely reflects tighter fiscal policies put in place by Prime Minister David Cameron’s Conservative government and the country’s close trade ties to the eurozone.

Japan, although better off than Europe, had essentially zero growth from 2007 into 2015, even though the crisis hit Japan’s financial sector with less force than it did other industrial countries. Japan’s ongoing problems with deflation and poor fundamentals (such as a shrinking labor force) help explain its disappointing performance. However, under Prime Minister Shinzo Abe and central bank governor Haruhiko Kuroda, Japan in 2013 adopted more expansionary policies, including a quantitative easing program that is much bigger, relative to the size of Japan’s economy, than anything undertaken by the Federal Reserve. By 2015, the results suggested that Japan had made progress against deflation. To achieve a broader revival, Japan must definitively end its deflation, as well as reform government

regulations that protect entrenched interests and block competition in domestic industries such as services, construction, and agriculture.

Emerging-market economies, including China, India, Brazil, Russia, and Mexico, now account for about half the world’s output. Emerging markets were also hurt by the crisis, in large part because global trade collapsed. Since the crisis their performance has varied, depending on policy choices and on other factors such as whether the country is an oil exporter. China, for example, recovered relatively quickly from the crisis, in part because of a large fiscal stimulus program in 2009, and is now again focused on longer-term economic reforms. For continued success, China must reduce its dependence on exports and reorient its economy toward producing goods and services for its own people. China also urgently needs to clean up its environment, strengthen its social safety net, improve financial regulation, and reduce corruption. As China’s economy matures, its population ages, and it catches up technologically with the West, its growth will slow from its breakneck pace of recent decades, though it should remain high compared with developed countries.

Importantly, after the taper tantrum in 2013, policy changes by the Fed and other major central banks had not stressed the financial systems or economies of emerging markets, at least as of early 2015. And, as we predicted, they were benefiting from the rebound in the U.S. economy as Americans imported more.

THE FEDERAL RESERVE changed substantially during my time as chairman. We became more transparent and more focused on financial stability. At the same time, new threats emerged that could hamper future Fed policymakers’ ability to act forcefully to preserve financial stability and support the economy. Our inability to foresee or prevent the crisis, and some of our responses, especially our rescues of AIG and Bear Stearns, hurt the Fed politically and created new risks to its independence.

With Republicans in control of both the House and the Senate after the 2014 elections, three proposals particularly concerned me. Senator Rand Paul of Kentucky had taken up his father’s cause and was pushing so-called audit-the-Fed legislation that would give members of Congress the power to order reviews by the Government Accountability Office of the Federal Reserve’s monetary policy decisions. If that authority had been in place in the years following the crisis, opponents of our policies could have used GAO investigations as instruments of intimidation and possibly prevented many of the steps we took to help the economy.

Second, a proposal emerged in the House in 2014 that would require Fed policymakers to follow a formula for setting interest rates, such as the one devised by John Taylor of Stanford, rather than independently exercising their judgment. As with audit-the-Fed, the subtext of the bill is the desire of some in Congress to exercise more control over monetary policy. Of course it is Congress’s right and responsibility to set the broad goals for monetary policy and to hold the Fed accountable for achieving them. To be truly accountable, however, the FOMC must also be given the flexibility to pursue its mandated goals free of short-term political pressures.

A third proposal, under development in early 2015 by conservative Republican senator David Vitter of Louisiana and liberal Democratic senator Elizabeth Warren of Massachusetts, would place new restrictions on the broad-based Federal Reserve emergency lending facilities that contributed so greatly to arresting the crisis. Significant restrictions were already put on the crisis-fighting powers of the Fed, the FDIC, and the Treasury as part of Dodd-Frank, on the presumption that the FDIC’s new authority for winding down failing systemic firms would reduce the need for those powers. However, still further restrictions on the Fed’s ability to create broad-based lending programs and to serve as lender of last resort could prove extremely costly in a future crisis.

I hope that the Fed’s increased transparency will help it maintain its independence, even as it remains democratically accountable. The Fed now fashions monetary policy within a formal framework that includes a 2 percent inflation objective and a commitment to take a balanced approach whenever its inflation and employment goals conflict. The chair’s press conferences, the expanded economic and interest rate projections by FOMC participants, and the lively debate evident in Fed policymakers’ speeches continue to provide the Congress, the public, and the markets with considerable information about the Fed’s strategy and its rationale. The days of secretive central banking are long gone. Today, the Federal Reserve is not only one of the world’s most transparent central banks, it is also one of the most transparent government agencies in Washington.

Transparency matters for markets and for monetary policy, but it also matters in other ways. As chairman, I expanded the Fed’s communication with Main Street Americans by appearing on TV shows like 60 Minutes, by giving a series of university lectures, and by leaving Washington to meet with people from many walks of life. Janet Yellen—who was raised in a middle-class family in Brooklyn, and who focused her academic studies on the unemployed—has continued this outreach. For example, at her instruction, the Fed created a new advisory council of consumer and community development experts who will make sure that Board members are well informed about Main Street concerns.

Besides leading the Fed to be more transparent, the crisis drove it to restore the preservation of financial stability as a central part of its mission. Maintaining stability requires attention to both the “trees” and the “forest” of the financial system. At the level of the trees, we rethought and strengthened our traditional supervision of banks, using powerful new supervisory tools, such as the annual stress tests of large banks. At the level of the forest, we greatly increased our attention to the stability of the financial system as a whole. Staff members now regularly monitor shadow banking and other parts of the financial system outside the Fed’s primary jurisdiction. This more holistic perspective should allow the Fed to identify vulnerabilities and risks that an institution-by-institution approach might miss.

The Fed’s understanding and conduct of monetary policy itself changed considerably during my chairmanship. The Fed and other central banks demonstrated that monetary policy can still support economic growth even after short-term rates fall close to zero. The tools we developed, including large-scale securities purchases and communication about the expected path of monetary policy, likely will go

back on the shelf when the economy returns to normal. I expect monetary policy once again will consist mostly of changing short-term interest rates and that the Fed’s balance sheet will shrink gradually as its securities mature. Still, the unconventional policy tools we developed can be revived if needed.

Date: 2016-04-22; view: 649