Latest / The Capitalism and Freedom in the Twenty-First Century Podcast / Former Fed Vice Chair Richard Clarida Talks Pandemic Monetary Policy and Inflation

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Former Fed Vice Chair Richard Clarida Talks Pandemic Monetary Policy and Inflation · The Capitalism and Freedom in the Twenty-First Century Podcast

• 0:00
  >> Richard Clarida: One thing that is important is the Fed said, and
• 0:03
  I was a charter member at team transitory.
• 0:06
  That we thought in May of 2021 that the inflation overshoot would be transitory.
• 0:12
  That was wrong.
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  It's factually true that we have a lot of company, but
• 0:17
  that doesn't make it any less of a mess.
• 0:20
  And so I think that is also a fair point.
• 0:32
  >> Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast,
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  an official podcast of the Hoover Institution Economic Policy Working Group,
• 0:39
  where we talk about economics, markets and public policy.
• 0:42
  I'm Jon Hartley, your host.
• 0:44
  Today my guest is Rich Clarida, who is a macroeconomist and
• 0:47
  the C Lowell Harriss Professor of economics.
• 0:50
  And Professor of international and public affairs at Columbia University,
• 0:55
  which also served as the 21st vice chair of the Federal Reserve from 2018 to 2022.
• 1:00
  Previously, during the George W Bush administration,
• 1:04
  Rich was assistant secretary of the treasury for economic policy.
• 1:08
  In which he's served as chief economic advisor to two different US treasury
• 1:13
  secretaries.
• 1:14
  Rich also serves as PIMCO's global economic advisor,
• 1:17
  where he's been affiliated for many years when outside of government.
• 1:21
  Thank you so much for joining us today, Rich.
• 1:23
  >> Richard Clarida: Yeah, looking forward to this, Jon, thanks for having me.
• 1:26
  >> Jon Hartley: Well, it's an honor to have you on,
• 1:28
  I want to start with your early life.
• 1:30
  You've a lot of really great interests.
• 1:34
  For those who don't know, you've got quite a few musical interests.
• 1:38
  You performed with Chair Powell an acoustic version of
• 1:42
  God Rest Ye Merry Gentlemen and We Three Kings.
• 1:46
  Around Christmas time in the marble atrium of the Eccles building,
• 1:50
  which is where the Federal Reserve Board is headquartered in Washington, DC.
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  In 2016 you released a 13-track album, Time No Changes.
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  When did you decide you wanted to be an economist?
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  Were you ever considering other careers?
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  You grew up in Illinois, you went to University of Illinois for
• 2:11
  undergrad, Harvard for your PhD in economics.
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  How did your interest in economics first get started?
• 2:16
  >> Richard Clarida: Well, so, in terms of the music, I grew up in a small coal
• 2:21
  mining town in downstate Illinois, and my father, both my parents,
• 2:26
  were very musical, and they were both very educated.
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  In fact, my father had a PhD, which is unusual in downstate Illinois decades ago.
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  But he was a musician.
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  Indeed, in his youth he was a professional jazz musician.
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  So my brother and I were in elementary school.
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  We didn't have a choice.
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  I was gonna play clarinet and Bob was gonna play French horn.
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  Sort of the peak of my clarinet career was at the age of 13.
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  I performed the Mozart clarinet concerto from memory.
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  I mentioned that to one of my colleagues once, and
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  he replied that's not a big deal.
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  When Mozart was 13 he wrote the Mozart clarinet concerto.
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  But in high school I got more interested in jazz and rock and
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  was in rock bands in high school, wrote some music in college and
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  actually released a couple of songs in the local area.
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  But anyway, in terms of economics, it's going to sound corny, but it was true.
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  I took intro to economics as a freshman at the University of Illinois in a big
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  lecture hall, I think 600 people in the lecture hall, and was completely hooked.
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  And I basically, as a freshman, said this is what I'd like to do,
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  I'd like to be an economics professor.
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  And I was fortunate enough, when I was a sophomore, to have a mentor,
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  a gentleman named Matt Canzoneri..
• 3:54
  A very respected international macroeconomist who was my professor.
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  And Matt was my mentor and basically said, if you want to get a PhD take
• 4:05
  the following math courses and distinguish yourself.
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  And I basically followed that template.
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  And in those days it's much different today, as you know,
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  John, but in those days this is the 1970s.
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  So I started at Harvard in 1979.
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  Indeed, I only happen just quip sometimes that the reason that I got
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  into a top graduate school like Harvard,
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  I had good grades and all that, but this was the decade in which there
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  was a very popular book called the Over Educated American.
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  And the basic thesis was that Americans were over investing in education.
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  There was no college or graduate school premium.
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  And since that didn't really matter to me, I was doing it sort of out of love and
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  interest, you know, there was a spot for me.
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  So that was basically how it was.
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  I wanted to be an economics professor.
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  I had the opportunity to do that and went straight from college to,
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  to graduate school at Harvard in 1979.
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  So that's sort of the quick first 20 plus years of my life.
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  >> Jon Hartley: Well, ironically,
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  that's where The Overeducated American was written, right?
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  By Richard Freeman.
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  >> Richard Clarida: Yeah. Who was one of my professors at Harvard
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  actually.
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  >> Jon Hartley: That's too funny.
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  That's fascinating.
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  Do you have secular influences who loomed large in your
• 5:28
  time at the Harvard economics department?
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  >> Richard Clarida: My, yeah, Jon, I have to tell you,
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  it a very heady time to be interested in macro, in the early 80ss.
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  First of all, the US and the global economy was an absolute train wreck.
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  Inflation went from 2% to 15%.
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  There were four recessions in eleven years.
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  Forget jobless recoveries and
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  the unemployment rate spent half the time around 10%.
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  And so what was a train wreck for
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  prosperity was a stimulating world to be trying to understand.
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  Now,, precisely this time was something that was emerging out of the midwest,
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  which was called the rational expectations revolution.
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  And in those days that was a very contentious and
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  controversial line of research.
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  Now, not to graduate students.
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  I thought, of course, what's the alternative?
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  And I was very fortunate in several ways.
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  One, I had an incredible mentor at Harvard,
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  Benjamin Friedman, for whom I worked at the MBER.
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  And in those days the stipends and support for
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  graduate students were not what they are today.
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  So essentially, at Harvard in those days, although they didn't make you pay tuition,
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  but, you know, in terms of surviving, you had to have some sort of,
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  you either taught principles of economics or had an RA job.
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  And so that's how I supported myself.
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  So Ben was an incredible mentor and still a dear friend.
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  Tom Sargent visited Harvard in 81, 82.
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  And in comparison to what faculty oftentimes do when they go on leave, which
• 7:17
  is they get a nice office, lock the door and they write a book or finish articles.
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  Tom actually solo taught two PhD courses.
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  And of course, those of us who were interested in macro took them.
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  And it was both stimulating and exciting,
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  plus he's a very, very persuasive and
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  magnetic promoter of rational expectations in macro.
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  And then finally, a lot of my technical skills I was able to start building
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  up because young Olivier Blanchard, before he became an institution.
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  But Assistant Professor Olivier was There and was on my committee.
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  And also Mark Watson had arrived as an assistant professor.
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  And so it was an exciting time to be thinking about macro.
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  There was a toolkit that was being developed to sort of try to put
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  some structure on it, and it was just a great, great experience.
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  >> Jon Hartley: Well, it's an amazing time to be at the Harvard economics department
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  as a PhD student.
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  As you mentioned, there was a time when there was quite a bit
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  of a transition in thinking around macroeconomic models.
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  There was a lot of I guess, Harvard and MIT was for a very long time,
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  sort of the home of the old Keynesian sort of tradition.
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  And Ben Friedman and others very much being part of that
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  in some respects Larry Summers now still part of that,
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  sort of those for proponents of the old ISLM type static framework.
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  I want to get into your great academic contributions because
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  you very much laid some of the groundwork for the sort of success of thinking here.
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  So we had sort of the old Keynesian paradigm, pre sort of 1980s,
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  1970s, folks like Alan Blinder, Ben Friedman, and
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  then you had the sort of RBC rational expectations revolution,
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  but then folks like yourself came along.
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  You're one of the founders of New Keynesian economics.
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  One of your most famous papers is titled the Science of Monetary Policy,
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  a new Keynesian perspective with Jordy Galli and Mark Gertler.
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  I'm curious, how did that paper come about along with the whole
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  idea of taking the RBC paradigm and rational expectations and
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  adding nominal rigidities, which I think is sort of the successive
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  step that happened there and was a huge part of your contribution.
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  And those sort of early new Keynesian folks in the 80s and 90s,
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  when I think of folks like Ned Phelps, folks like yourself, Mark Gentler,
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  John Taylor, Greg Mankiw, you're very much a huge part of that.
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  I'm curious, what was the inside story there?
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  >> Richard Clarida: Yeah, well, okay, so there are different layers
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  to that onion, and I'll try to be concise.
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  Here's sort of the big, big picture.
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  So there were several things going on.
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  So once the macro profession bought into at least starting
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  with models where you had people who were optimizing and
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  had rational expectations, there was a big fork in the room.
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  Everyone agreed, yeah, you want optimizing agents and
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  you want to take some view on expectations.
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  And then at that point, there was a fork in the road and some folks said,
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  really influenced, I think by Eddie Prescott, that in order to sort of answer
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  what those folks thought were interesting questions, you didn't even really need to
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  take a stand on sticky prices or nominal variables at all.
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  So that agenda said, let's see how far we can get without going
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  into the complications of rigidities and the like.
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  And I think there was success in that literature, but it never resonated with
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  me cuz all the things I was interested in really could not.
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  That would have been putting a square peg in a round hole, but
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  I think here was the problem, Jon.
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  The problem was, among those subset of people of my generation
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  who thought about nominal rigidities, there were a couple
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  related issues that meant that the RBC literature made earlier and
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  more rapid progress than the subsequent we now call New Keynesian models.
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  The first, and actually,
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  I gave a talk at Hoover on this at one point that alluded to this.
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  One of the problems was that of the incredible influence of Milton Friedman
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  in his 67 presidential address, which is, I teach that still to my students,
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  I just taught it yesterday in my seminar at Columbia.
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  Arguably, I think it's ten pages, you can count the words,
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  but in terms of influence per page or per equation, it's completely off
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  the charts cuz I don't think there's one equation, there's only ten pages.
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  And there are, at least by my count, at least four and
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  maybe five seminal ideas in that paper.
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  And one of them was essentially, implicitly a real business cycle argument,
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  which is that a lot of what we call economic fluctuations are shocks and
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  imperfections in labor markets and they'll sort of grind to the right place.
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  And it sort of said, a lot of what we think is a problem is just really
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  an outcome of how an economy functions with shocks.
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  But Friedman was not dogmatic and in particular, I think he always,
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  at least in the Friedman that I read, I only had a chance to meet him once,
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  actually, I should say John Taylor.
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  I came out to a Hoover conference decades ago, and John kindly invited me to
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  a reception of his house, where I got to meet the great man,
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  which was a real highlight of my career cuz that was the only chance I had.
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  But Friedman had another argument that was influential, which is, yeah,
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  probably there are rigidities.
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  The problem is, it's not clear that given the lags in policy and other things,
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  it's not clear you can actually do any better if you try to offset them.
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  So the mindset in the 80s, among young folks in their 30s,
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  20s who had the rational expectations toolkit,
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  was there's a lot of interesting stuff that you can explain without rigidities.
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  And B, even though they're there,
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  it's not clear you can really do anything about it because of Friedman's
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  point about destabilizing the economy if you try to offset it.
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  And so what that meant is when Mark and Jordan and
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  I started working on this in the mid 90s, there was a great
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  deal of skepticism that it was a relevant research program.
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  And then I gave another talk at Hoover on this a couple of years later,
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  which is where the Taylor rule came in.
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  So I can't speak for the other new Keynesians, but at least for
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  Clara de Galle Gentler, when the light went off was when John's paper appeared.
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  And it provided the missing link between wanting to link RBC models to
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  what we thought of as realistic models with nominal rigidities.
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  And essentially, you had to take a stand on monetary policy.
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  You have to close a model, right?
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  You've got endogenous variables, you need as many equations and
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  you needed an equation.
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  And by thinking of the Taylor rules and
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  equation that related a short term interest rate to macro
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  variables in a sensible way was an important insight,
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  and we were among the first to have that.
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  And so then once we had a way to close the model, there was a lot of tools,
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  in fact, I told John this at the time when he and I used to get connect.
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  And I actually worked with John at the treasury back in [INAUDIBLE] when
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  he was undersecretary.
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  And we talked about it then, but I always thought in the late 80s, early 90s,
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  before we started working on this, I said, look, the questions are interesting.
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  The toolkit is all there.
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  Much of it was developed by John in the seventies and eighties.
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  We got an interesting set of questions.
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  We got this toolkit.
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  So, yeah, but I think it was the combination of the huge influence
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  that RBC had on people and the fact that it wasn't clear how to close the model.
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  I should also say it was certainly the highlight of my
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  professional career to be able to collaborate with Mark and Jordy.
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  In those days, Jordy and I had written a paper together on structural modeling,
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  open economy, macro modeling of different shocks.
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  Then Mark and I had written a paper commissioned for
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  a bureau conference on doing sort of a country or case study of the Bundesbank.
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  And then Mark suggested, well, why don't we just all three work on this?
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  That's what became the five Clarida, Gali, Gertler papers.
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  But I guess what I want your viewers to know is that even though this is now,
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  I think, a respected literature, there weren't a lot of folks thinking about
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  these things because of the factors I mentioned.
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  I should also say, in fairness, it was in the air in the mid nineties.
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  In the following sense.
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  Mike Woodford, who went to Princeton but
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  is now my colleague at Columbia, began to get independently interested
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  in the idea of looking at nominal rigidities in fully specified models.
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  And of course, Mike's pioneering treatise worked out exactly why.
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  The Taylor type rules not only are intuitive,
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  they actually have good properties in terms of macroeconomic performance.
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  Then people like Kang and Waldman also.
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  It wasn't just us, but I'd say where we were really focused,
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  perhaps where others weren't, was enclosing the models in a realistic
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  way with a policy reaction function, where some of the other papers worked
• 18:08
  with sort of money in the utility function and money demand function.
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  We just said, lets go for the gusto, lets just jammin a Taylor type rule.
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  The final thing, and I'll be quiet,
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  although we respected John's contribution enormously,
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  we did feel that there was an evolution of it that could actually be even as or
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  more useful, which was the idea of, and this was getting back to Friedman 67,
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  the long and variable lags is essentially taking John's insight, but
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  at having the reaction function not to contemporaneous inflation, but
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  to expected future inflation.
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  The idea being that if you raise the funds rate today,
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  it's not going to have any impact on this month or this quarter's inflation.
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  So implicitly, any policy decision to raise a lower rate is implicitly
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  an assumption about where the economy is going to be in the future.
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  All the CGG stuff worked with forward looking Taylor rules,
• 19:07
  which also have some interesting features as well.
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  That's sort of the quickest quick history.
• 19:17
  >> Jon Hartley: One thing that people talk about,
• 19:19
  the sort of RBC versus new Keynesian sort of debate, was something
• 19:24
  that I think the new Keynesian critics of RBC says in RBC models,
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  there's really no room for policy or that policy doesn't really matter.
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  And so the idea of having monetary policy that is not neutral,
• 19:42
  that's something that you can get in a new Keynesian model,
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  and that's one of the potential virtues of it.
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  I think there's interesting questions about whether it's sticky wages or
• 20:00
  other kind of rigidity, or maybe something completely
• 20:05
  different altogether that causes recessions.
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  I think there's arguably a lot of room to go.
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  I'm curious, as a practitioner, someone who's been at the very top of
• 20:19
  a central bank, this is something that I've spoken with a lot of guests about.
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  It's really important to highlight,
• 20:29
  these DSGE models are built by central banks around the world,
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  and their staffs around the world, and are updated and
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  do play a role in each monetary policy meeting of various central banks,
• 20:44
  in developing forecasts and developing counterfactuals and things like that.
• 20:51
  One thing I think that I've noticed is in having talked to a lot of former
• 20:55
  central bankers and talked to a lot of people in various central banks,
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  is that really a lot of central bankers themselves, who often come in as political
• 21:06
  appointees, certainly in the case of the Fed, aren't necessarily staffers,
• 21:11
  in many cases aren't very familiar with DSGE models, which over time have
• 21:16
  become increasingly complicated within these hundred page macro papers.
• 21:23
  >> Richard Clarida: You noticed that too.
• 21:24
  I'm not the only one who's noticed that trend.
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  >> Jon Hartley: I'm curious, do central bankers, in your view,
• 21:33
  actually use DSGE models, or is it more of a,
• 21:38
  I think VARS produce better forecasts in general.
• 21:44
  Is the thinking in your mind maybe a lot simpler than that?
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  Just following some basic monetary policy rules,
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  obviously not following it in a mechanical way in the sense that maybe
• 21:56
  John Taylor would prefer, but using things like that as guidelines?
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  I think that the Taylor type rules have been some of
• 22:04
  the most successful parts of the sort of Keynesian paradigm.
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  If you just run Taylor rules of regressions,
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  the fit is actually pretty good in a lot of developed economies.
• 22:17
  I'm curious, in your mind, are central banks, have they become
• 22:23
  just like a big subsidy to DSGE research that's really not in practice,
• 22:29
  used very much outside the seminar rooms and writing the papers?
• 22:34
  In your experience, certainly as someone who's written down DSGE models and
• 22:40
  basically helped invent that literature,
• 22:43
  were they useful to you as vice chair of the Federal Reserve?
• 22:49
  >> Richard Clarida: There are a couple things there at least maybe three.
• 22:54
  Some thoughts I'll share.
• 23:01
  My first conversation with Jay Powell when I was on
• 23:05
  the verge of being nominated by the White House.
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  I had never really had a chance to meet Jay.
• 23:15
  So we did meet in January of 2018, and it went very well.
• 23:21
  And I looked him in the eye.
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  I said, Jay, I think I may be here because your staff has
• 23:28
  told you that I've made contributions to DSGE.
• 23:33
  But I want you to know that if I'm fortunate enough to be selected as
• 23:38
  the vice chair of the Fed, I will not view it as my role to promote DSGE models.
• 23:44
  It will be my role to pull you aside in the privacy of your office and
• 23:49
  tell you when and why you should ignore them.
• 23:52
  I meant that as the reality of the way I thought about it coming in.
• 23:59
  So to me, DSGE, I'll make a confession for
• 24:06
  the first time ever on Hoover podcast.
• 24:11
  In my career in the last 25 years as DSGE has been taking off,
• 24:17
  I've thought to myself many times.
• 24:20
  It's really been a pleasant surprise in the following sense,
• 24:25
  that as someone who had taught intermediate macro to bright
• 24:29
  undergraduates for decades before those models took off.
• 24:33
  For the subset, if you take the standard three equation DSGE model,
• 24:38
  there are only a limited number of shocks you can look at.
• 24:41
  You can look at a demand shock, you can look at a productivity shock,
• 24:46
  you can look at a monetary policy shock.
• 24:48
  The models are so simple, at least, declared a galley girdler,
• 24:51
  you don't have a financial sector.
• 24:54
  And I think what people should know is that the qualitative
• 24:59
  impulse responses from a DSGE model are virtually identical
• 25:04
  to the qualitative impulse responses that you would get from a 70s or
• 25:10
  80s style ad hoc dynamic ISLM model.
• 25:13
  Carefully thought through the way it was taught in the late 70s and early 80s,
• 25:18
  where you've got some long-run equilibrium condition you're approaching.
• 25:23
  It's the neoclassical synthesis, so there's a shock, there's rigidity, but
• 25:27
  you're reporting longer equilibrium.
• 25:28
  So at one level, DSGE models,
• 25:31
  at least the simple three-equation versions of them,
• 25:36
  really do not give different answers than you would get from
• 25:41
  a thoughtfully specified and solved old-fashioned model.
• 25:47
  So that's part of it.
• 25:51
  The other part of it is, I think it's not just at the Fed,
• 25:57
  in fact, for a year or so, I was an advisor to the Norwegian central bank.
• 26:04
  And this was more than a decade ago, maybe now,
• 26:08
  15 years ago, and they then, and I'm sure today,
• 26:12
  are really a leader in tightly linking the monetary policy briefings and
• 26:18
  scenarios to a very, very, very rigorous and thoughtful DSGE model.
• 26:24
  I think it maybe has 25 equations, not 100.
• 26:28
  I've seen that work and it can work well.
• 26:33
  But again, in that context,
• 26:35
  it's a structure within which you present the briefings and the scenarios.
• 26:40
  Now, within the Fed, and indeed within the Fed system, there are DSGE models.
• 26:46
  The board has several, and most, if not all, the Reserve Bank has them.
• 26:51
  And then the briefing- >> Jon Hartley: Effort Ferbus probably
• 26:54
  being the most notable model.
• 26:56
  >> Richard Clarida: Yeah, well, Ferbus is not a DSGE model.
• 26:59
  So I just say when I got briefings as a Fed official,
• 27:04
  for each FOMC meeting, there's multiple hundred-page briefing books.
• 27:12
  And in each book, there's a section on the staff forecast,
• 27:17
  and then a separate subset of that is the projections and
• 27:22
  decompositions from a suite of DSGE models.
• 27:26
  And so they're definitely part of the briefing.
• 27:31
  But at least in my time, they were not mechanically followed or
• 27:36
  not even really mechanically favored over projections from VAR models or Ferbus.
• 27:45
  And Ferbus, actually, I should say, since you asked, Ferbus actually has,
• 27:49
  from my perspective, some very nice features.
• 27:51
  So, for example, Ferbus Federal Reserve Board Macro Model,
• 27:57
  which I should say was very influenced by Taylor's work
• 28:02
  because the young John Williams, was really brought
• 28:07
  tailored to the Fed in terms of doing the modeling,
• 28:12
  putting in rational expectations, and lags and inertia.
• 28:17
  But Ferbus has some useful features.
• 28:20
  So, for example, you can look in Ferbus simulations, where you assume
• 28:24
  financial markets know the model and are rational, but the private sector,
• 28:29
  or some subset of the private sector, has some sort of a rule of thumb.
• 28:34
  Ferbus is also quite useful because it's much more elaborate in
• 28:39
  terms of a financial sector.
• 28:41
  So you can look at how a shock to policy or
• 28:44
  to tax policy changes the mortgage market.
• 28:48
  And so I don't really think it's either or.
• 28:53
  To paraphrase something I learned from Ben Friedman, if you're going to be
• 28:58
  forward-looking, then you wanna efficiently look at everything,
• 29:02
  every information variable that's helpful in assessing the future.
• 29:07
  So that would be sort of a quick way to summarize the way I think it works.
• 29:13
  >> Jon Hartley: Well, that's amazing, and amazing to hear from a former Fed
• 29:19
  vice chair that our models are often more, more helpful than DSGE ones.
• 29:26
  I'm curious, a few economists get to both research and practice or
• 29:30
  implement what they say is professional.
• 29:32
  Certainly, being a macro economist,
• 29:36
  then vice chair of the Federal Reserve is a great exception to that rule.
• 29:44
  You also served as Bush 43 treasuries secretary for economic policy.
• 29:49
  I'm curious, what did you learn as an economist from your time in Washington?
• 29:54
  >> Richard Clarida: Well, it was, I had three tours of duty in DC.
• 29:58
  So as an assistant professor, I had an opportunity to take a year of leave and
• 30:04
  go to work as a senior staff economist at the Reagan Council of Economic Advisors.
• 30:11
  And that was really transformative.
• 30:14
  First of all, you pick your mentors well [LAUGH].
• 30:19
  So I was so incredibly fortunate, Michael Musa,
• 30:23
  who passed away at a ridiculously young age.
• 30:26
  But among those of us who are of that generation, Mike was larger than life,
• 30:33
  and Mike was a member of the council and was looking for a staffer,
• 30:39
  essentially to be his right-hand person, right-hand man.
• 30:45
  And I got that job.
• 30:47
  And so to me, that was, and I was 28 or 29 years old,
• 30:52
  and so to be at the executive office building and
• 30:57
  also was a very fascinating time for economic policy.
• 31:03
  In fact, I went back and
• 31:05
  looked at some of the issues that the CEA was working on in that year,
• 31:11
  but such things as fundamental tax reform in 1986.
• 31:16
  There was then a very ambitious bit of immigration legislation that essentially,
• 31:22
  I think, has not ever been revisited, at least with formal legislation.
• 31:28
  You had something called the savings and loan problem,
• 31:32
  which later became the savings and loan crisis.
• 31:35
  The Plaza Accord had been in 85, and then there was the Louvre Accord.
• 31:38
  So to be a 28, 29-year-old macroeconomist not making policy but
• 31:43
  helping people who were thinking about the world.
• 31:47
  And so I made a vow to myself I definitely got to get back to do this,
• 31:52
  but I also wanted to get on with my academic career.
• 31:56
  So that's what I got out of that, it gave me the interest to try to
• 32:01
  bring rigorous macro thinking into interesting questions.
• 32:05
  So I then had another opportunity to go back 1,512 years later in the treasury and
• 32:13
  in a higher level, this time as an assistant secretary.
• 32:18
  And sort of designed the job, which was enjoyable.
• 32:23
  I was essentially the chief economist for two treasury secretaries.
• 32:27
  And so there was an element of briefing and updating them, but there was also
• 32:32
  basically an element of being a resource for the other groups in treasury.
• 32:37
  So I worked very closely with John on some international issues,
• 32:40
  with Peter Fisher, who was the undersecretary for domestic finance.
• 32:46
  And that sort of reinforced a message that I had taken
• 32:51
  away from my CEA days, which is that there is value in.
• 32:57
  If there's a question posed to you by a policymaker,
• 33:02
  there is value in getting to 90% of the perfect answer in a week or a month,
• 33:08
  as compared to getting to 100% of the perfect answer in three years.
• 33:14
  And so there are a lot of things I worked on that I tried to give it
• 33:17
  my very best shot, knowing that if I were actually writing an AER or QGE paper,
• 33:22
  then there might be things I would do or think about that could be useful.
• 33:27
  But instead of thinking it's zero one, it's either QGE or bust,
• 33:31
  I actually thought there was a value in bringing good economics, but
• 33:34
  on timelines and subject to other constraints.
• 33:37
  To be frank, John, a lot of macroeconomists,
• 33:40
  when they go to Washington, hate that part of the job.
• 33:43
  They think, well, how can I answer this question from the treasury secretary or
• 33:48
  the director of the NEC?
• 33:50
  It's going to take me a couple years to actually think through this and
• 33:53
  write the paper.
• 33:53
  And so I think some people's brains are wired to actually find that
• 33:58
  something that is of interest and worthwhile in itself.
• 34:02
  And other people sort of chafe against it.
• 34:06
  So I'll give you one concrete example of that.
• 34:10
  So literally, my first day on the job at treasury was September 11, 2001.
• 34:18
  So everyone remembers where he or she was on that day.
• 34:22
  Well, I was sitting in Peter Fisher's office, who was the undersecretary for
• 34:29
  domestic finance, when the plane hit the second tower.
• 34:34
  And I think we both looked at each other.
• 34:36
  I probably said something like holy blank [LAUGH].
• 34:40
  But the relevance to this is when I saw Paul O'Neill actually was traveling
• 34:44
  that day.
• 34:45
  So when I saw secretary O'Neill the next day, he said to me, well, Rich,
• 34:49
  welcome aboard.
• 34:51
  He said, you know, I have a frustration.
• 34:54
  And the frustration is I had a much better sense of the global economy as the CEO
• 34:59
  of Alcoa than I do at treasury, because when I was at Alcoa,
• 35:02
  every day I'd have a computer terminal that would show me all of our production,
• 35:08
  our inventories, our delivery lags in 50 countries around the world.
• 35:12
  And I had a real pulse on the global economy.
• 35:15
  And here I get data, that's great data, but from the commerce department,
• 35:19
  that's three months stale and then revised.
• 35:22
  And so I took that as a motivation.
• 35:25
  And I benefited by having some really good career staff
• 35:30
  people in Treasury, a guy named Ralph Monaco and Kitchen.
• 35:36
  And I basically said to them, I said, look, there are these working papers out
• 35:41
  there by stock and Watson about this new thing called nowcasting.
• 35:46
  So let's get up and running a nowcasting model.
• 35:50
  And by today's standards, it was very primitive, but
• 35:54
  it used some regression approximations that stock and
• 35:58
  Watson had in the appendix to their classic paper.
• 36:02
  And so that's what we did.
• 36:03
  So the staff had the first us government fed nowcasting model up and
• 36:08
  running by November of zero one.
• 36:12
  And sort of in the category of in life,
• 36:14
  sometimes it's better to be lucky than good.
• 36:17
  Our first ever nowcast for
• 36:22
  Q4 of 2001 was that the GDP was roughly flat.
• 36:30
  And the Wall Street consensus was we've had this big shock,
• 36:34
  a terrorist attack, hit consumer confidence, GDP will be -4, -6.
• 36:40
  And whatever the first release was,
• 36:42
  it came in within a tenth or two of our nowcast.
• 36:46
  And that was far and away the best nowcast we had during my time.
• 36:52
  But it was the first one.
• 36:53
  So that's, I think, a good concrete example.
• 36:56
  So an academic might have said, yeah, sure, Secretary O'Neill, in 14 months,
• 37:01
  I think I might be able to have something that I could send off to a journal.
• 37:05
  But we had that up and running in a couple of months, and
• 37:10
  it was quite useful, it was the first time within the US government.
• 37:15
  I was told that briefings were actually being done not based
• 37:21
  on a forecast but on an explicit weekly updated nowcast.
• 37:26
  >> Jon Hartley: Wow.
• 37:27
  >> Richard Clarida: So that's an example of that, yeah.
• 37:32
  >> Jon Hartley: Fascinating history about the origin of nowcasting,
• 37:36
  I didn't realize that nowcasting went back as far as the early 2000s.
• 37:41
  That's quite amazing.
• 37:42
  >> Richard Clarida: Well, I'll share another anecdote with you.
• 37:44
  So O'Neill was very proud of this, and he got on the phone with his good friend
• 37:48
  Alan Greenspan and he said, Alan, you got to see this guy.
• 37:52
  Rich Clarida works for me and they've got this thing, nowcasting, and
• 37:57
  our nowcast was much better than your forecast [LAUGH].
• 38:00
  So Greenspan invited me over, cuz that was a huge
• 38:06
  honor to have a private meeting with him, and he was respectful.
• 38:13
  But I think I'll leave it at saying he wasn't actually persuaded that
• 38:17
  there was any incremental value in now casting versus the beige book.
• 38:23
  And of course beige book has its value as well.
• 38:26
  But of course now the Fed is a world leader in Nowcasting,
• 38:31
  but not quite yet in those days.
• 38:35
  >> Jon Hartley: Well, it's fascinating, and certainly I think perfection
• 38:40
  can be the enemy of the good in these very tight policy turnaround times.
• 38:47
  Amazing that you're at the Reagan CEA, Marty Feldstein was leading it, and
• 38:52
  folks like Larry Summers and Paul Krugman and John Cochrane and Greg Mankiw.
• 38:57
  All those people and yourself, and many, many others, were there during that era.
• 39:02
  I'm curious, I want to sort of focus on your time at the Federal Vice Chair and
• 39:08
  maybe a lightning round, a few questions for you.
• 39:12
  Certainly one of the major contributions you made while at the Feds
• 39:17
  was the Fed's framework review, this released four years ago.
• 39:22
  And the new framework that was introduced is that flexible average
• 39:26
  inflation targeting are fate.
• 39:28
  The idea that you should be targeting an average inflation target of 2%
• 39:33
  over the years, and this grew out of the period in the 2010s,
• 39:37
  inflation fell short of the target.
• 39:40
  The idea that running a bit over 2% was okay.
• 39:44
  There were some questions about how flexible the target is over what time
• 39:48
  period we're doing the averaging for.
• 39:50
  And then we got this massive inflationary surge
• 39:54
  in well above 2% in 2021, 2022, CPI.
• 39:59
  Since then, fate is, I think, gain its fair share of critics.
• 40:03
  I'm curious, in your mind, what's the legacy of fate, and
• 40:06
  what do you think the next Fed framework review should do differently, if anything?
• 40:11
  >> Richard Clarida: Sure, well, it won't surprise your listeners and
• 40:14
  viewers to hear that I've done a lot of thinking about this.
• 40:17
  I've also done a fair amount of writing about it.
• 40:20
  So I've just completed a piece for
• 40:23
  an NBER conference that will be coming out in the JME, but
• 40:28
  the working paper version is available on my personal website.
• 40:33
  And I did an international Journal of Central Banking article and
• 40:38
  an NBER working paper that also summarizes a lot of my thinking.
• 40:42
  So for those who want the deeper dive, it's out there in print.
• 40:46
  But briefly, I'll say the following things.
• 40:49
  First of all, I always thought of fate as being an evolution,
• 40:55
  not a revolution, that clarified that under certain circumstances,
• 41:02
  it would make sense for the Fed to not only tolerate,
• 41:07
  but to actually put in place a policy that would allow
• 41:12
  a modest overshoot of the 2% inflation target.
• 41:16
  And those circumstances, as you summarized, were if the economy
• 41:22
  has been in a prolonged period, operating below the target.
• 41:26
  And also when policy has been constrained by the zero lower bound,
• 41:31
  then the alternative to allowing for
• 41:34
  an overshoot is the real risk that inflation expectations drift lower.
• 41:39
  The way I put it at the time was,
• 41:42
  suppose that outside of being constrained by the zero bound,
• 41:47
  you are on the Mount Olympus of monetary policymakers,
• 41:52
  in that you can always get inflation quickly to two from below,
• 41:57
  and for any shock, it will never go above.
• 42:00
  But your only problem is that the zero lower bound is a constraint.
• 42:05
  So in those circumstances, if you do not allow policy to tolerate an overshoot,
• 42:11
  then you are guaranteed to have expected inflation fall below 2%,
• 42:17
  because inflation can only be below 2% or two, it can never be above.
• 42:24
  And if you repeat that game cycle after cycle, you can get into the risk that
• 42:29
  I think occurred in Japan and that was beginning to occur in the eurozone,
• 42:35
  that inflation expectations drift down.
• 42:38
  And then, of course, as inflation expectations drift down,
• 42:41
  actual inflation drifts down.
• 42:43
  And so what it said is that under those circumstances, if you've been below 2% for
• 42:49
  a long time and you've been constrained by the zero bound,
• 42:53
  then policy should not only tolerate an overshoot, but it should,
• 42:58
  essentially, allow an overshoot.
• 43:01
  Now, it was explicitly asymmetric, and that was clarified in a dozen
• 43:05
  speeches that I and others gave after the fact, in the sense that once you're
• 43:11
  away from the zero bound, and once you're satisfied that inflation and
• 43:16
  is in a neighborhood of 2% from above, then you just run traditional policy.
• 43:21
  In fact, in the Fed models, you run a Taylor rule.
• 43:25
  It was very closely linked to and motivated by a proposal of
• 43:30
  Ben Bernanke's around that time- >> Jon Hartley: With the temporary price
• 43:35
  level targeting >> Richard Clarida: Temporary price level
• 43:38
  targeting, which is, if you're not constrained by the zero bound,
• 43:43
  just do what you always do, but if you are, don't lift off rates until you have
• 43:48
  either been at or above 2% for some time, and there are different flavors of it.
• 43:53
  So that's the first point.
• 43:55
  So, fast forward to today, is fate relevant to the Fed today?
• 44:01
  No, because we have not gone through a period when inflation has been below two,
• 44:05
  it's been above two.
• 44:07
  And so fate is silent.
• 44:09
  In fact, what fate says is just do what you would always do under inflation
• 44:13
  expectations, if the problem is not inflation is too low.
• 44:19
  The second thing I'll point out about the post pandemic surge in inflation, and
• 44:23
  this is specifically discussed in my recent paper that's coming out in JME,
• 44:28
  is what's striking, and what I'm sure,
• 44:31
  what I'm confident future monetary policy scholars will look at,
• 44:35
  even though many current monetary policy scholars have ignored it.
• 44:39
  What's striking is the similarity across advanced economies
• 44:44
  in the inflation surge and in the central bank reaction function.
• 44:48
  So here's some facts.
• 44:50
  Among all the advanced economy central banks, no advanced economies central
• 44:56
  bank began to hike rates before inflation had exceeded the top of its target range.
• 45:02
  So by that metric,
• 45:03
  all advanced economy central banks under inflation targeting fell behind the curve.
• 45:08
  Secondly, all but two advanced economies central banks, Switzerland and Norway,
• 45:15
  delayed hiking rates until core inflation had exceeded the top of the target range.
• 45:21
  And so if the recent episode is an indictment of fate,
• 45:25
  it's also an indictment of inflation targeting as practiced by Canada,
• 45:31
  by the UK, by the eurozone, by Sweden, by Australia, and by New Zealand, okay.
• 45:37
  What I say in the JME paper is I don't think that this
• 45:40
  episode tells us much about fate versus inflation targeting, or
• 45:45
  about single versus dual mandate central banks.
• 45:48
  I think what it tells us is that this was an enormous and
• 45:52
  unusual shock, in that it influenced aggregate supply.
• 45:57
  It triggered a policy response which boosted aggregate demand, and
• 46:01
  it also changed equilibrium relative prices.
• 46:04
  And with the exception of the Swiss, other central banks, essentially,
• 46:10
  given that the prior decade had been where inflation was too low,
• 46:15
  delayed lifting off beyond what their inflation targeting or
• 46:20
  fake frameworks would have tolerated.
• 46:24
  But I do think there are lessons learned, and in particular,
• 46:29
  I think the lessons from the Fed's case to be learned are much less about fate.
• 46:34
  Indeed, I really don't expect major changes to flexible average
• 46:39
  inflation target.
• 46:40
  Another thing that perhaps useful, Jon, for
• 46:45
  your listeners and viewers, is that within the Fed system and
• 46:51
  culture of the Fed, the reserve banks and the board,
• 46:56
  there is a real distinction, both conceptually and
• 47:01
  in discussion between the Fed's framework statement and
• 47:06
  the way the Fed tries to achieve its goals through
• 47:11
  FOMC decisions on rates in the balance sheet.
• 47:16
  So one of my colleagues, who I won't mention, but I think he would not mind,
• 47:21
  said to me when I got to the Fed, and Jay Powell had said he wanted me to
• 47:26
  quarterback the framework review, he said to me, he said, Rich,
• 47:31
  this is great, but one thing you should know about the Fed is that the framework
• 47:36
  statement is a crown jewel and is a quasi-constitutional document.
• 47:41
  It lays out broad goals and priorities.
• 47:44
  It doesn't say do you cut the funds rate 25 or 50.
• 47:47
  It doesn't say do you do an open-ended QE program or a finite program.
• 47:53
  It doesn't say should you use threshold forward guidance?
• 47:57
  It doesn't say any of that.
• 47:58
  Those are FOMC Decisions that need to be consistent with the framework,
• 48:04
  but they are not compelled by it.
• 48:06
  And so the framework statement itself, I think, holds up quite well.
• 48:11
  It was released and unanimously approved in August of 2020.
• 48:17
  However, the committee, in the depths of the pandemic collapse,
• 48:23
  millions of people dying, no vaccines in sight.
• 48:26
  And I very much supported this, the committee in September of 2020,
• 48:33
  after the new framework statement was released,
• 48:38
  did make FOMC decisions that deployed and communicated very,
• 48:44
  very muscular and binding forward guidance.
• 48:48
  Now, those decisions were decisions were certainly consistent with
• 48:53
  the new framework, but they were not compelled by it.
• 48:56
  Indeed, two members of the committee, Neil Kashkari and Rob Kaplan,
• 49:01
  who supported the new framework, voted against the FOMC decisions precisely
• 49:06
  because they thought it went beyond what the new framework necessarily required.
• 49:12
  Or called for under those circumstances.
• 49:16
  I do think there are lessons learned in terms of forward guidance.
• 49:19
  In particular, as with anything in economics,
• 49:23
  there are always costs and benefits, there are always trade offs.
• 49:28
  And I do think that an important lesson learned is in deploying muscular
• 49:33
  forward guidance, as in the Fed will not lift rates until inflation exceeds to,
• 49:39
  and the labor market is returned to full employment.
• 49:43
  Ex post, there was a cost to that guidance in the face of a huge supply shock.
• 49:49
  And it's not clear in retrospect that the incremental benefit from
• 49:55
  that guidance outweighed the cost in the scenario that we got hit with.
• 50:01
  And I would say with even greater conviction that that applies to
• 50:06
  the forward guidance the committee offered in December of 2020,
• 50:11
  that it would not even begin to slow the pace of QE until it had made
• 50:16
  considerable progress towards its dual mandate goals.
• 50:21
  Again, it's not clear to me that the incremental benefit
• 50:25
  of making that commitment exceeded the ex-post cost.
• 50:30
  Cuz the ex-post cost,
• 50:32
  as I actually discussed in a talk I gave at Hoover several years ago,
• 50:38
  and I do in this IJCB paper, the cost is that we basically said
• 50:43
  we're not gonna begin to hike rates until we end QE, but
• 50:48
  we didn't start to roll back QE until the fall of 2021.
• 50:53
  However, one last thing I say on this is I do think that in the big scheme of things,
• 51:00
  although in retrospect, you can always go back and
• 51:04
  talk about this meeting versus that meeting.
• 51:09
  The reality is, even in real-time, [COUGH] the committee
• 51:14
  did not have a sufficiently useful signal of the persistence
• 51:19
  of the inflation surge till arguably the September of 2021 meeting.
• 51:25
  >> Jon Hartley: At that point, it was clear it wasn't just kind of used car.
• 51:29
  >> Richard Clarida: It wasn't just used car, yeah-
• 51:31
  >> Jon Hartley: [CROSSTALK] Other
• 51:32
  things that were rising, too, by then.
• 51:34
  >> Richard Clarida: And I've given public comments in which I've said correctly that
• 51:38
  in March and April of 2021, almost all the inflation overshoot was used cars, and
• 51:43
  I wasn't prepared to throw people out of work as used car prices went up.
• 51:47
  But anyway, certainly by September of 2021,
• 51:51
  it was clear that this was broad based,
• 51:54
  that the labor market was definitely beginning to reflect it.
• 51:59
  I think one can make a case, and indeed,
• 52:02
  something that will resonate at Hoover is that if the Fed had just been
• 52:07
  outsourcing policy to the Taylor rule, at least the inertial Taylor rule.
• 52:13
  As Patel and Pradhan have shown in real-time,
• 52:16
  Taylor rules would have said, start lifting off in September 2021.
• 52:21
  So were really just talking about September 21 versus March of 2022.
• 52:27
  And of course, as youre going through it in real-time, that seems like a long time.
• 52:31
  But in the big scheme of monetary history,
• 52:34
  I think it turned out not to be that important.
• 52:37
  One thing that is important is the Fed said, and
• 52:40
  I was a charter member at team transitory, we said that we thought in
• 52:45
  May of 2021 that the inflation overshoot would be transitory.
• 52:50
  That was wrong, and it's factually
• 52:55
  true that we have a lot of company, but
• 53:00
  that doesn't make it any less of a mess.
• 53:05
  And so I think that is also a fair point.
• 53:08
  >> Jon Hartley: Lemme ask you one last question about groupthink and
• 53:13
  just sort of talk about maybe, why was it that so
• 53:17
  many people thought that inflation was maybe transitory,
• 53:23
  that inflation would come back down on its own without any kind of fed rate hikes?
• 53:30
  And I'm just gonna spitball a few different kind of ideas here.
• 53:35
  Just thinking about Federal Reserve, I don't want to say reform, but
• 53:39
  just things that some people think the Fed should do differently.
• 53:44
  One of those things is, for example,
• 53:49
  there not being enough dissent.
• 53:53
  For example, we just were in September 2024, today, the Fed just its first rate
• 53:58
  hike since the 2020 inflation cycle began, the super size cut of 50 basis points.
• 54:03
  But notably, it was the first FOMC meeting in almost 20 years where a Fed board
• 54:08
  member actually dissented.
• 54:10
  And I'm wondering,
• 54:11
  people say personnel is policy, there were three republican nominees, or
• 54:16
  likely nominees that didn't get through Senate confirmation during the Trump era.
• 54:22
  And one would think maybe the composition of the FOMC
• 54:25
  would look very different if those nominees actually got through.
• 54:30
  Perhaps there's a lack of sort of diversity of thought on the Fed,
• 54:35
  I'm curious if you have any thoughts on that.
• 54:38
  Also, do you have any particular thoughts on, for example,
• 54:43
  just how fed communication is done for example, there's now eight press
• 54:48
  conferences a year, one after every FOMC meeting there's four under Bernanke.
• 54:54
  Before that under Greenspan, there were none.
• 54:58
  There's increasingly fewer economists that are actually on the FOMC now as
• 55:02
  well as compared, say, 1020 years ago I mean,
• 55:06
  some might say that that's a welcome thing and that would maybe have less groupthink.
• 55:11
  But I'm not totally sure that that's the case.
• 55:15
  I mean, some people might say there's also a dearth of
• 55:19
  talent from the GOP economic policy side of things.
• 55:24
  And as part of why some of these candidates didn't get through
• 55:28
  the confirmation.
• 55:29
  I'm curious if you have any thoughts on all this, particularly as we go to another
• 55:34
  election, whether it could be another republican administration where for future
• 55:39
  personnel discussions become central if not the next election or future elections.
• 55:44
  >> Richard Clarida: I think there were five parts to that question,
• 55:50
  and so lemme give it a try.
• 55:53
  On groupthink descents are not unusual, but historically in the last 20 years.
• 56:00
  Before this week, dissents had always been by Reserve bank presidents.
• 56:06
  If you go back in the longer history of the Fed, that was not true.
• 56:09
  Indeed, there were some cases during Volcker's time when not only were there
• 56:14
  dissents, but his vice chair dissented.
• 56:16
  And so why that has evolved.
• 56:19
  Larry Meyer has written on this.
• 56:23
  One thing I can only comment on during my time at the Fed,
• 56:28
  but the Pal Fed J Pal, before each FOMC meeting,
• 56:32
  has a private bilateral meeting with each person on the committee.
• 56:39
  And so oftentimes folks who might be on the bubble between 25 and
• 56:44
  50 will have a chance to convey their views.
• 56:49
  And oftentimes there's an intertemporal dimension as well.
• 56:56
  And so there are ways to signal that through the projections or
• 57:01
  through the communication.
• 57:03
  So rate decisions are relevant.
• 57:06
  But there are other elements of communication and
• 57:09
  policy that are also subject to back and forth.
• 57:12
  So I think that's one piece of it.
• 57:15
  In terms of groupthink, I think there was an aspect of groupthink
• 57:19
  both among central bankers and among private sector forecasters.
• 57:25
  My one example of that is in April of 2021,
• 57:28
  after the American Rescue Plan passed, the Wall Street Journal gave its
• 57:33
  75 economists a chance to update their forecast, and they did.
• 57:37
  The average for PCE inflation was revised up to 2.1.
• 57:43
  And the highest projection, that is the most,
• 57:46
  the highest rate of inflation projected for 2021 was, I think, 2.6.
• 57:50
  So this was not just that the average economist got it wrong,
• 57:53
  every got it wrong.
• 57:54
  So I think that's another subject.
• 57:57
  In terms of Senate confirmation,
• 58:01
  I've been through it twice, it is an intense process.
• 58:06
  Senators do take the advice and consent role very seriously.
• 58:13
  But certainly in the case of the time I was there,
• 58:18
  Jay Powell, Rich Clarita, Randy Quarles,
• 58:23
  Mickey Bowman, and Chris Waller were all nominated
• 58:28
  by Republican presidents and got confirmed.
• 58:32
  In terms of, in terms of your last question, in terms of a perceived
• 58:38
  imbalance between, you know, GOP and democratic leaning folks,
• 58:43
  in terms of serving in Washington, that's an important one,
• 58:48
  but one I think maybe we can take up in a future conversation.
• 58:53
  >> Jon Hartley: Well, that's fascinating.
• 58:55
  And too, I guess, on the press conferences, I've often wondered, too,
• 58:59
  why we need so many, in the sense that you compare the Fed to the Supreme Court.
• 59:03
  If the Supreme Court makes a pronouncement and it doesn't have a press
• 59:08
  conference where journalists can sort of second guess the decisions.
• 59:13
  And I think it's good to have some healthy amount of questions and things like that.
• 59:17
  But to me, it seems like each press conference is like an opportunity for
• 59:21
  maybe more volatility in financial markets than needed.
• 59:25
  A real honor to have you on, Rich, and to hear about your career and ideas.
• 59:29
  I think you perfectly embody what Greg Mankiw calls an economist as
• 59:34
  a scientist and engineer or what Esther Duflo calls an economist as plumber.
• 59:41
  You've had such an amazing career, both in academia,
• 59:44
  coming up with such great macroeconomic ideas and then putting them into practice
• 59:49
  in your various policy rules, and as vice chair in your various policy rules and
• 59:54
  as vice chair of the Federal Reserve in Washington.
• 59:57
  Thank you so much for joining us today.
• 59:59
  >> Richard Clarida: Thank you.
• 59:59
  And look forward to continuing the conversation.
• 1:00:02
  Thank you, Jon.
• 1:00:02
  Been a pleasure.
• 1:00:04
  >> Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast,
• 1:00:07
  an official podcast of the Hoover Economic Policy Working Group,
• 1:00:09
  where we talk about economics, markets, and public policy.
• 1:00:12
  I'm Jon Hartley, your host.
• 1:00:13
  Thanks so much for joining us.
• 1:00:14
  [MUSIC]