Incompatible Browser
Looks like this browser isn't supported. We recommend you use Chrome, Firefox, or Safari instead.
X
  • Print
  • Email

Last Updated: 03/22/21

The Current State of the Economic Recovery

NICK VASSILOS: Welcome to today's webinar featuring President Charles Evans hosted by CFA Society of Chicago's Distinguished Speaker Series Advisory Group. Information about upcoming events can be found on the society's website at www.cfachicago.org. I'm your moderator for today's event, Nick Vassilos, co-chair of CFA Society of Chicago's Distinguished Speakers Series Advisory Group.

All mics for attendees will automatically be muted during the event. If you would like to ask a question, please use the Q&A feature. We will save some time at the end of today's event for some audience Q&A. This event is being recorded and is also streaming at the Federal Reserve Bank of Chicago website and will be archived there for later viewing.

Joining me for today's discussion is Charles Evans, President and Chief Executive Officer of the Federal Reserve Bank of Chicago since September of 2007. In that capacity, he serves on the Federal Open Market Committee, the Federal Reserve system's monetary policymaking body. Previously, President Evans served as director of research and senior vice president, supervising the bank's research on monetary policy, banking, financial markets, and regional economic conditions.

His personal research has focused on measuring the effects of monetary policy on US economic activity, inflation, and financial market prices and has been published in peer-reviewed journals. Welcome, Charlie.

CHARLES EVANS: Oh, thank you very much, Nick. It's a pleasure to be here.

NICK VASSILOS: I've been looking forward to this conversation. Let's begin with the economy. Can you briefly describe where the recovery stands today and how you expect the economy to evolve over the next few years?

CHARLES EVANS: Sure. Obviously, there's been tremendous uncertainty over the path of the economy, and 2020 was a terribly difficult and tragic year for Americans and businesses, households, the path of the economy. We rebounded in the second half of last year, and much of the economy is opened up to safe production and commerce.

If you could work remotely, you've had that advantage and have been able to maintain employment. And so we really have been looking for 2021 to be the year where we strongly rebound. And I think that's what we're looking for. That's certainly what I am looking for.

There has been good, strong support from fiscal authorities. We had the first a couple of rounds of the CARES Act. We had a December fiscal support, and now there's also legislation which is highly likely to add another $1.9 trillion or so of support. And I think that's going to be very helpful, very useful. It fills in some of the support for increased vaccine rollout and all of that. So those are really strong positives for the economy and maintaining our momentum.

Consumers on average are doing reasonably well. Now, I have to say on average because there is so much unevenness. And if your employment source is in the leisure, hospitality, travel, restaurant, in-person, close service provision, many, many people can't be going to work. And so they are suffering. And low and moderate income individuals are also disadvantaged in many ways.

And so on average, the consumer is doing quite well, and consumer spending has been strong. So that's helped lift the economy. There have been a number of sectors which have been able to learn how to produce safely. Manufacturers, by and large, have quickly figured out how to engineer a safe working environment. It's more costly. Social distancing is required. But that's been another important part of the rebound to date.

As I already mentioned, employment has rebounded quite a lot, but we've still got about 10 million people unemployed, who have not found jobs since a year ago when they were employed. So there is still quite a gap. The unemployment rate has come down to 6.3%. That's a mainstream headline number that shows a really strong improvement, but it masks more unevenness through reductions in labor force participation by a number of people who haven't been able to return to work, can't return to work. There might be childcare, adult care, other types of issues. So that's a challenge. Many analysts, economists have mentioned it's probably more like a 9% or higher unemployment rate, really, is what we are facing when you take into account employment to population measures and labor force.

But the good news is that the COVID cases have been coming down. People have been opening up, opening up safely, social distancing. Mask wearing has been very important for that. The level of cases continues to be a high level, but it's come down from very, very high levels. And the rollout of the vaccines is really very positive. And so I think everybody should be looking forward to being able to gain access to the vaccine, and that really holds open a lot of wonderful improvements and opportunities.

So I'm optimistic about the recovery. This year, I think we'll have a pretty strong rebound. I think by the end of the year, the headline unemployment rate should be closer to 5%. I think we'll probably have some job matching and scarring issues in terms of people coming back. But by and large, I'm looking for a rebound.

NICK VASSILOS: Great. Thank you for those comments. The president of the Chicago Fed is a voting member of the Federal Open Market Committee, or FOMC, in alternate years, with 2021 being one of those years. How does your preparation and research approach change when you're a voting member of the FOMC?

CHARLES EVANS: So that's a really interesting question. The first thing that we always say is I prepare for every meeting. I go to every meeting whether I'm voting or not. We have a discussion among all of the participants. And the chair and everybody listens to everyone, whether you at the end of the meeting raise your hand and vote. So everybody participates very fully.

Now, I'm a little bit on the fortunate side when it comes to 12 Reserve Bank presidents. There's only five voting presidents on the committee. New York takes up a full-time voting spot, so you have to allocate 11 presidents to four voting spots. And I'm lucky enough to vote every other year along with Loretta Mester at the Cleveland Fed. My other nine colleagues only get to vote once every three years.

So if, in fact, you don't get listened to unless you're voting, wow, that's a lot of time that my colleagues wouldn't really be having an impact. Now, the chair listens to everybody. And we prepare the same way. We look at all the data. We share comments between meetings as well. We do public commentary like this, and we get some insights into how everybody's thinking. So it's a really rich process. And I've got quite a talented expert staff of economists, financial market analysts, and other policy analysts that help me a lot.

NICK VASSILOS: OK. Thank you. And has the pandemic altered the committee approach in any way? I mean, obviously, many of us are working from home and have adopted to the remote environment. I imagine it's the same with you and the FOMC. Is that fair to say?

CHARLES EVANS: It is fair to say. It's very interesting. Once we went to a remote work posture-- that first March, 2020 weekend meeting was still early enough that I did that from the bank. After that, we've all done them from remote locations, which are basically your home. I think we started off with phones, but then we worked up to video. And we have special encrypted videos for security reasons and all that.

We end up with a pretty robust discussion. There's always been quite a bit of structure and discipline to the way the meeting proceeds. And so as it turns out, I think that we've had every bit as effective meetings as we have in the past, with the exception that you don't have during the break, before and after, the cross-talk, which is actually very important for sharing viewpoints too. So I do miss that.

NICK VASSILOS: OK, great. That's very interesting. I am curious-- when you start work for the day, which economic and market numbers are on your market watch dashboard?

CHARLES EVANS: I saw this question on the list, and I had to stop and think, because sometimes people probably think that the first thing that I do is I open up the financial markets dashboard or something and look at that. I will say that every morning, I do get a summary from the New York markets desk folks, and it gives you a pretty good accounting of what's taken place over overnight.

And I usually look at the 10-year Treasury rate as a bellwether for how things are moving. And certainly, when it goes from 1 and 3/4 down to very low levels like we've seen, that's an indication that US treasuries are very safe assets, and people are piling into them. And they also have a more pessimistic view about the future.

I look at the German bund as well, because for Europe, that's the bellwether there. And that's negative rates, which always get a lot of people's attention. But how that changes is an indication of how people might have sentiment for going forward. Before that, or most recently, you look at what the COVID caseloads are. That's an important part of all of this. And so I get an email every morning from what that looks like, seven-day averages and things like that.

I have to say, before that, I probably spent a little more time looking at commentary about tariffs and trade because that was such a big issue starting in mid-2018 between the president's trade negotiation posture, between Brexit and how that was going to be playing out and the implications for foreign trade. I think I probably spent much more time looking at commentaries, headlines about how people were thinking negotiations were going.

So you go with what the key leading factors are during a particular cycle, and you're lucky when it's a little more boring run rate. I think we're in pretty good shape until something else happens, good or bad.

NICK VASSILOS: OK. Very, very good perspective there. And certainly within the market, what many of us have noticed is that we have seen rising yields along the yield curve, and from five years and up, especially over the last couple weeks, concurrent as well with some rising inflation expectations. So that has been occurring over a little bit longer period. It's obviously interesting to monitor that going forward.

We're coming up on the year anniversary of the series of Fed emergency lending facilities to stabilize a number of markets last March during the severe market shock. Looking back, which ones were the most successful, and are there any learnings you have taken from that experience?

CHARLES EVANS: Right. So I think the most successful aspect of this was the fact that we were able to redeploy so many programs right at the outset. So many of the programs that had been put in place in the aftermath of the Lehman Brothers bankruptcy, 2008 financial crisis that took weeks and months to develop, we were able to very quickly put them back into action. I think those have been very important.

I think that as much-- and so this time around, we spent quite a lot of effort, the New York Fed in particular, in working to make sure that the overnight repo market and repo markets generally had market-functioning liquidity. We weren't manipulating or anything, but just making sure that markets could function and that liquidity, the strong desire for liquidity, was high. And so getting our balance sheet up was actually very important.

So increasing the level of reserves so that it was in line with good, efficient market functioning during times of more uncertainty and some distress was a huge part of that, making sure that short-term money markets had adequate funding in order to-- again, not to guide rates in any way, but to allow them to function properly as investors were redirecting their investments and as they wanted to pull out of certain short-term funds. They weren't really as liquid as you would think, some of these ETFs with corporate debt or something.

And if you can get your money out quickly, well, you can't get the corporate debt out quickly. And so there's a liquidity aspect to how those are managed. And so by making sure that short-term markets had the liquidity that allowed for efficient functioning, then markets could determine what the appropriate prices were. That's what they do, and they would price risk.

And at times, risk was very, very high, very costly. And then things got better, and people could see how the path forward was going to go. And that's what was important. Because by smoothing out that volatility, then we helped ensure that unnecessary bankruptcies don't take place for the wrong reasons-- just because of illiquidity, but they're really still sound organizations and institutions. So those are some of the aims.

NICK VASSILOS: Right. That makes sense. And certainly, we did see a lot of issues in those short-term funding markets. And as you noted, those can quickly cascade down the line. And so addressing those straight away certainly was very helpful to the market.

One interesting thing, certainly, that many have noticed-- the usage of these facilities was actually quite low. But I think it was a great point that you were able to stand them up quickly. And just the announcement, just for the market to know that those facilities were out there, really helped reduce that pandemic-induced volatility at that time.

CHARLES EVANS: Right. That s me as very insightful. That did seem to be what we were aiming for. The greatest value of so many of these programs was their backstop ability. The primary credit and the secondary corporate credit aspects-- it wasn't that there was so much activity there. But for borrowers, corporations that were trying to get their funding right, and then investors, everyone knew that for the good-quality credits, that those bonds could be issued and settled and all of that. And if there was a problem, there was this backstop ability for appropriate, high-quality credit goods.

One of the challenges that the Fed always has is we do lending. We don't do grants. We have to get our money back. We absolutely have to get our money back. Everybody wants their money back. But in the private sector, you're willing to take risks. And some investments pay off really big, and then others, you might take some losses. And on net, you can make really good returns.

We are always first in line to get our security, our money back. It's got to be guaranteed like that. And so the CARES funding and the partnership with the Treasury was so important that they allowed-- they stepped in and gave us the funding that provided the first loss cushion in the event that some of these facilities, which did have some risk, were not really supposed to do risky lending. And by and large, we don't. But under those circumstances with the agreement of the Treasury Secretary and the funding from Congress, we were able to do that. The backstop ability was very useful.

NICK VASSILOS: Next I'd like to turn to inflation, which is certainly top of mind for many people. Since inflation has persistently undershot its 2% target, as of last year, the new Fed approach is to target 2% average inflation, and thus purposely aim for inflation at times higher than 2%. In early January, you said, "I welcome above 2% inflation. Frankly, if we got 3% inflation, that would not be too bad." Is there a risk that inflation does not just creep over 2%, but actually shoots fat past it?

CHARLES EVANS: I mean, you can never know exactly how the future will play out. I don't think there's great risk of that. I think a lot of the concerns about inflation at the moment-- we've been under-running our 2% objective ever since we announced back in January 2012 that we were shooting for 2%. We've had very few instances where inflation has actually gotten up to 2%. And often, if it did do that, it came back down very quickly.

I think when we said 2%, everyone should have expected that we would average 2%. We didn't say average 2%. But if you say 2%, I don't-- we never intended that it was supposed to be a ceiling. And so if it's not intended to be a ceiling, you ought to spend some time above 2% as well as time below 2%.

So in the current environment, we've continued to undershoot 2% inflation during the downturn. Given the closing of so many activities, prices have really fallen quite a lot. Now, with the rebound, we're expecting them to reprice. And so we're going to have these relative price adjustments which are probably going to lead to overall price indexes being above 2% for a little bit.

But the question, really, is, is it going to persist, or is it just going to be a temporary, one-time readjustment that takes place over six months of relative prices back more towards where they were? And if that's true, then if you don't have the sustainability, then we're probably going to be facing a little bit under 2% inflation.

Now, with the good rebound, with labor markets improving over the next 18 months, I expect labor markets to become much more vibrant, and that should lead to a better pricing and inflationary environment. But our experience has been that inflation doesn't really respond very strongly, even to the most vibrant labor markets when we were down around 3.5% not long ago for a while.

So it's that history that makes me say, I think the responsiveness of inflation to the economy is not nearly what it used to be. And I really want to see above 2% inflation before I even begin to think about getting nervous. I think in our briefing preparations here, I think it came out that we both are University of Virginia graduates, Nick, I graduated in 1980. When did you graduate?

NICK VASSILOS: 2002.

CHARLES EVANS: 2002. So my memories go back to the '70s when inflation was extremely high. And I remember Herbert Stein, a professor, coming in with his radio to play the press conference of Paul Volcker and Jimmy Carter talking about what they were going to do to get inflation down from double digits. We haven't seen double-digit inflation in a long time.

So I think the current environment that we're looking at-- when people say I'm really worried about inflation going up-- I mean, I've sort of experienced that before, and it makes me nervous. But our inflation expectations are really anchored in a very, very different and much better place. And so I think that it would be extraordinary if inflation got up to 3%. And if it did that for some period of time that helped us average too and didn't unsettle longer-term inflation expectations, that would not be a real problem.

NICK VASSILOS: OK. Thank you for that. And I do want to build on that. What would it take to get that persistent inflation? I think many of us can understand as the economy opens up, you can see some goods prices spike up later this year just from a supply and demand imbalance. But because of the service nature of our economy, it seems like we need persistent wage growth to really have that persistent inflation. There obviously has been a push to raise the minimum wage. But from your perspective, what needs to happen to trigger a sustained wage inflation and thus broader inflation?

CHARLES EVANS: So wages are going to respond to inflationary pressures in the sense that if inflation started to rise much more rapidly, workers would insist on being compensated for the higher prices that they had to pay. And if they didn't receive that, then in a good job market environment, people would switch to somebody who would pay. So competition would drive wages up if inflation went up.

Now, if wages went up by themselves, then a lot of that comes down to whether or not firms are able to pass those cost increases along in terms of higher prices. So if you go back to the '70s, there was more of an environment where monetary policy was accommodating those wage demands so that firms could pass long prices. And then it did that again a couple of times.

And so that's too much accommodation when the economy at that time was doing quite well. And so I think the Fed didn't do a very good job during that time period. There was a lot going on, and so it was easy not to see all of the structural changes. But keeping your eye on your inflation objective is really a key ingredient in all of this. And so that's why I'm so excited about our new long-run framework. We've said that we're going to average 2%. If we've been under-running for a while, we're going to make up for that somewhat.

And we've indicated that in our most recent policy announcements, that we're going to keep interest rates where they are, at 0 to 0.25%, until the employment market gets closer to maximum employment and inflation gets to 2% with the expectation that we're going to overshoot. Well on our way to doing that. I want to see the inflation. And I think that's an environment where hopefully, we'll see stronger wage growth.

Now, wage growth-- over a longer period of time, it's going to depend on productivity improvement. Productivity improvement is going to depend in part on firms' investment and also workers' additional skill acquisition and how that translates into more output. And then the firms and the workers share that. So that's part of it.

Now, there has been a tendency over the last 15 years or so that the share of income going to labor versus capital has moved more towards capital. So labor share has declined, and part of that is because bargaining power of labor has been reduced. And also, I think firms have more power to dictate things. Maybe that's competition. Maybe that technology with digital aspects and things like that.

So there is a lot going on. Any type of rebound in what used to be a cyclical change in labor share might also portend higher wages somewhat. That need not be inflationary, but if firms are able to pass along that price increase, then we'd have to be thinking about that. So I would say that wage growth would be a very good thing. It would generate higher incomes.

There's a lot of income inequality. I think the employees that would benefit most from that would be on the middle of the income scale and below, so I think that might help with reducing inequality, which I think would be good for the economy generally. But we really need to put everything together as a central bank and be thinking about the inflation objective.

NICK VASSILOS: That makes sense. The current $120 billion in monthly Treasury and agency mortgage-backed securities that the Fed is purchasing is spread across a wide range of maturities. Have recent economic numbers hinted at a possible lean towards either further accommodation or adjusting the duration one way or another?

CHARLES EVANS: So I think if you go back to the last economic downturn and recovery, the Federal Open Market Committee spent a number of distinct efforts to try to inject more accommodation into the economy, whether it was March, 2009 when we did the first quantitative easing package, which seemed extraordinary-- how big was it? It was, like, 1.7 MBS, 300 treasury, and another 100 or 200 agency money. So it was over $2 trillion. That was quite a lot.

But then we found out the next year that now we needed more, so we did QE2. And then at that point, a year later, we needed to do more. But there was nervousness about the size of the balance sheet, and so we did a maturity extension program, Operation Twist. Your question is getting at, where do we invest our purchases? They're currently spread throughout the curve.

But if we invest them in long duration, then we take duration out of the market. We hold it, and that incents risk taking at the longer end. Then we had to do open-ended QE3 in September of 2012, and then we did that until we saw significant improvement in the labor market.

So in the current environment, we've indicated that we're going to continue to do asset purchases until we see significant progress towards our dual mandate objectives. We're currently doing it across the curve. I think, as your question hints at, if the economic data were weaker and we thought that we needed to provide more accommodation, maybe we would focus on the long end of the curve more in terms of our purchases.

I'll say at the moment, I think the rebound that I'm expecting is really quite a strong one. I think that the fiscal stimulus that is currently being proposed, and if enacted, would be very strong. And I think that would be to the point where I would not expect that we'd have to change the duration aspect of these purchases. We'd still have to be paying attention and wait until we see significant further progress towards our dual mandate objectives. But I think that doing across the curve works out well.

After all, eventually, many years from now when we want to right size the balance sheet and all of that, it's going to be able to run off a little more quickly if we've got more shorter maturity assets, because that's the way we tend to do it.

NICK VASSILOS: Right. So right now, there is some downward pressure on the short end of the curve. And obviously, we have seen some of those longer-term rates rise. I think a lot of the comments so far by Fed officials have indicated that seems to be a healthy rise and reflecting a positive economy. So is it fair to say you share that view at the moment?

CHARLES EVANS: That is my take right now. It's always interesting when I say that I start my day and I look at what the 10-year Treasury rate is. And during those times with QE3 where we were actively trying to keep the 10-year rate down because we wanted to incent additional risk taking-- Chairman Bernanke would talk about the portfolio balance effect all the time-- eventually, eventually, you want that rate to go up. That's a good sign because it means the economy is doing well. Real interest rate inflation and compensated interest payments would be higher, and that's a signal that the economy is stronger. And so that's just the market response to improvements in the economy.

Now, there's also the inflation side of that. If inflation is expected to increase, then that would also increase those longer-term rates. And so I'm also looking for that to happen. We want to have an idea of exactly what the market is looking for there.

Now, I suppose that some of the adjustment that you alluded to has taken place also at the short end of the curve. And there, I have to always look at what the particulars are, if there's some kind of market functioning or there's some special story about that. But for the most part, you wonder if the markets and the public are feeling good about the Fed's commitment.

We've indicated that we're not going to raise the federal funds rate target range until we're very close to maximum employment, and inflation is at 2%, and we're on our way to overshooting. If they think we're not going to live up to that and raise rates sooner, that creates a problem, because this-- what we say, what we mean is very important for actually delivering on our objectives.

And I think a lesson from other foreign central banks over the years has been if they get nervous about low interest rates too early, before inflation actually gets up, they actually don't get inflation up. The Bank of Japan ran into that problem for decades. And the European Central Bank struggled with that early in 2011-12 until 2014 when they really became even more committed to getting inflation up. And they still struggled.

So you never want to lose your credibility that you were going to deliver on your inflation objective. Because if markets question that, then if they start thinking that your objective is a ceiling, and once you get up to it, you're going to get really nervous, and then you're not going to do that, that is a problem. And so that is why I'm always among the first-- maybe the only one-- who says, 2.5% inflation, that doesn't worry me.

We're trying to average 2%, and 2.5% might get us to an average sooner than if we just get to 2.25%. And we try to stay there. And 3%-- let me see what 3% is. Is 3% on its way to 4%? That would be a huge problem. Is 3% just up to 3%, and then it's going to start coming down? That's not such a problem.

NICK VASSILOS: OK. And just one other quick question in terms of the future taper when the Fed eventually does taper those purchases. What takeaways, if any, were learned from the so-called 2013 taper tantrum in terms of communicating that message to the market?

CHARLES EVANS: My own takeaway from the 2013 episode-- a couple of things. One was it began with what I thought of as a very straightforward, innocent comment from Chairman Bernanke when he was asked, hey, when are you guys going to think about stopping these asset purchases? And then he began to give a very good economics-- it wasn't even professorial, but some people might have thought it was. And it was like, look, there's a future, and there's a future where things are better. And when things are better-- and I think he might have said even in September-- then we're not going to need the same program.

And my own take is a lot of investors listened to that go, oh, I wasn't thinking about that. What? Oh. And they had really gotten out over their skis, perhaps, didn't understand. But still, that was pretty early. And then there was just a lot of nervousness.

There would be less nervousness if everybody had full confidence that we were going to be in it to win it, we were going to do everything until we got unemployment down to a vibrant labor market setting, and inflation got up to our 2% objective, and we were not worried about overshooting. But I think that because there was nervousness about that, that also made it really hard.

We kind of stabilized things in the summer, and then by the end of the year, we began to stop purchasing $85 billion every month. And we went to $75 billion. And we said we weren't on a preset course, but we did end up reducing the asset purchases by $10 billion each meeting pretty much until the end of next year. So it was a gradual reduction. I think looking back on it, I was pretty pleased with the way that went.

And I know that Chair Powell has pointed back to that episode and others. That's a playbook, and that's going to be the first thing that we're going to be looking at is, is that still appropriate. How gradual should it be? We're not going to even think about doing this until we're confident we're seeing gradual further substantial improvement in our dual mandate objectives. But those are a lot of the things that we're thinking about.

NICK VASSILOS: OK. Thank you. Quick question on financial stability. Do you feel the liquidity the Fed has injected into the economy has contributed to any speculative risk in some components of the equity market? What has the experience of '08 and its aftermath taught Federal Reserve officials about possible asset bubbles for financial instability? And I guess it shouldn't be limited to the equity market. Any market, really.

CHARLES EVANS: Well, so that's a great point, and all of it is. We have a very large financial market sector. It's grown tremendously over the last 50 years from pretty much a commercial banking-centric investment environment where funding comes from life insurance companies and things like that that don't increase leverage or something to one where now there's a lot of derivatives contracts or a lot of different ways that leverage can find its way into investments. And you post safe securities like treasuries, and you're able to use that to expand that for other investments.

And so that's why the entire market functioning and the repo market, early 2020 was so important-- because, well, that's a system that determines prices that determines treasury liquidity and things like that. And that's sort of like a beginning point for all of the price discovery and determination and how banks go about doing so many things. They price off benchmarks. And so getting that right was very important.

Now, once you stabilize that and you end up at very low interest rates, well, we're trying to incentivize a little more risk-taking on the part of households. Hey, go out and think about buying a car. It's cheaper now. Hey, why don't you refinance your mortgage? That's a possibility to people. And then they have a little more income, and then they can go and spend.

For investors, well, maybe some type of asset looks cheaper, and then they bid up the price. And that could be certainly related to lower interest rates that they're able to lock in if they're able to lock it in. Then there's a risk that they face of rising rates and whether or not they're protected from that. So there's a lot of things going on. That is part of the monetary policy transmission mechanism. Strong asset valuations make people more confident about going out and making purchases, so households are more confident, and businesses too.

But it is something that we have to always be monitoring. We have to be monitoring the state of the financial instability risks. Are investors properly aware of the risks that they're facing? I mentioned interest rate risk. If you think that interest rates are going to be in a certain place and risk premia that you face as a risky borrower are going to be really low, but then they reprice, then are you prepared for those additional calls on your funding?

And so we need to have an opinion about the state of that, our. Supervisors and the regulators have to have their own opinions for a number of other reasons. But we're constantly looking at the risks that the US economy might face if there was a quick repricing that changed the situation.

But at the moment, I would say the economic rebound looks good. Our monetary policy stance is accommodative. I think that's appropriate. I think the fiscal support that is already in place and likely on its way will help us all so that we can get to our dual mandate objectives that much more quickly. And then when it's appropriate, we will be able to reprice our interest rate targets so that people who are savers can enjoy higher interest rates when it's appropriate for-- that the entire economy is doing better. So--

NICK VASSILOS: OK. I think we'll have time for a few audience questions. So the first one here-- if the US were to fall into a disinflationary trap similar to Japan, China, and now the eurozone, what tools can the Fed deploy to counterbalance deflationary risk with Fed rate policy already in ZIRP and the asset purchases where they are?

CHARLES EVANS: I mean, I'm worried about disinflationary forces quite a lot. And that's why keeping monetary policy accommodative for a long period of time, lower for longer, has been an important element in protecting against that. I think at the moment, the US economy is doing better. The world economy is likely also on a similar path.

There seems to be more challenges in rolling out the vaccines in a number of countries and then countries that don't even have adequate access to it as well. I think, again, world wealth inequality is a problem there. And there's a role for the more advanced economies to help everybody else, because it puts us all at risk. So those are definitely issues.

I think we can continue with more of our policies if we found ourselves facing lower inflation risks. We could do asset purchases. I think the QE3 playbook is an important part of that. What we're doing right now-- we're maintaining the maturity of the purchase across the maturity spectrum. We can make that type of adjustment. But those are kind of the tools that we would use.

Now, I got to say, that's a lot harder than fighting inflation risks because with inflation risks, we know that we can raise interest rates. And I can raise interest rates. But we only take the short-term policy rate down to 0, 0 to a quarter point. And other foreign central banks have experimented. They've used negative interest rates.

But even the magnitude of the negative rates they've used are really small relative to what all economic models suggest you would really need them to be negative to have a much larger effect. And so back in 2008, 2009, I think, by some accounts, we needed to be able to set the federal funds rate at minus 4% if that was the only tool available to us. And nobody was going to do that. And it's arguable as to whether it's feasible, let alone whether you would care to do that.

So I think the other central banks have experimented with minus 40 basis points, maybe as much as minus 70 basis points, but not so much. So I think we've got the tools to fight higher inflation risks. I think we've got tools to fight lower inflation, disinflation risk, but that is a harder job. And the willingness of fiscal authorities to provide additional funding has been really critical for changing that outlook.

Because back in 2011, '12, and '12, one of the laments I know I had was that we were embarking upon fiscal austerity programs. And you were asking monetary policy to do more, and we were already at 0. And it was very difficult to do more. So we need more partners in all of the policy responses. And this has been a much more successful time period this year, last year. It's very, very important.

NICK VASSILOS: At least one more question. Looking back to the 1950s, M2 money velocity peaked in 1997 and has dropped ever since precipitously, especially since the onset of the pandemic, to an unprecedented level of 1.135 as of 4Q. What is at work here? What are the implications for inflation if money velocity increases?

CHARLES EVANS: Yeah, that's interesting. MB equals PQ, so if velocity goes up, P or Q goes up, prices would go up. Gosh, we don't look at the monetary aggregates much-- maybe not at all, actually. I mean, back in the '70s, '60s, monetarism was all founded on the belief that velocity was very stable, constant. And because it's constant, and if I know what money is doing, money is telling me what P times Q is going to be doing. And so then if I understand where the economy is going, that tells me where P is going.

But as soon as velocity starts moving around at a completely random and less predictable fashion, the monetary aggregates, unfortunately, just lost all their explanatory power. This is sort of harkening back to when I said commercial banking 50 years ago used to be the heart of lending. Well, as financial markets expanded, became more complicated, and weren't going through the banking system, it became very challenging to understand what monetary aggregates really told you the state of underlying inflation might be.

People constructed some pretty abstract alternatives, M3. M2 was invented, I believe, by Milton Friedman and Anna Schwartz to try to track something closer to nominal GDP. So it's-- yeah, so monetary aggregates are very complicated. This ends up being really important in the sense that once you start talking about inflation determination, it would be really useful to be able to fall back on money. But since money left us dry, we can't really do that. Even the ECB doesn't refer to money like they used to when they first started.

NICK VASSILOS: Thank you for that, Charlie. Last quick comments. I know we're nearly out of time Here. Any comments or observations about the transition and end to LIBOR?

CHARLES EVANS: LIBOR has been the focal point for so many lending contracts and everything, mortgages and whatnot. And it's really been embedded in that legal framework. LIBOR just wasn't reliable based upon the way those quotations were put together, and they really needed to go to something different.

And so there are other benchmarks now, so far which are based on market overnight risks. And I think that financial markets and lending markets can work well with that alternative benchmark. I think a big challenge has always been just integrating that benchmark into all of these types of contracts. And the way we've always done-- it's sort of like, I guess it was easier to decide not to go to the train to go into work, but to stay here and turn my computer on. But anything that requires a lot of effort and all of that-- yeah, no really hard.

NICK VASSILOS: Would you say, though-- I mean, does the Fed feel that the industry is moving at a reasonable pace? I mean, obviously, deadlines spur action in these regards. And we've got some upcoming deadlines.

CHARLES EVANS: I know everybody's been working really hard to communicate that. I think that during the COVID crisis, it's probably been more challenging, that everybody's had a lot of things to work on. I'm not actively a part of that part, but I think the expectation is that it will go well.

NICK VASSILOS: OK.

CHARLES EVANS: Probably still needs more effort to get everybody online. Anything that everybody has to sign up for always takes the last-- I don't want to say the last mile, but the last component is always hard.

NICK VASSILOS: Yes, absolutely. Well, thank you very much.

Contact Us
Media Relations
(312) 322-5768
Having trouble accessing something on this page? Please send us an email and we will get back to you as quickly as we can.

Federal Reserve Bank of Chicago, 230 South LaSalle Street, Chicago, Illinois 60604-1413, USA. Tel. (312) 322-5322

Copyright © 2021. All rights reserved.

Please review our Privacy Policy | Legal Notices