Latest / The Capitalism and Freedom in the Twenty-First Century Podcast / Reducing the Fed’s Balance Sheet With Fed Board Governor Stephen Miran | Hoover Institution

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Reducing the Fed’s Balance Sheet With Fed Board Governor Stephen Miran | Hoover Institution · The Capitalism and Freedom in the Twenty-First Century Podcast

• 0:09
  - This also happens to be a live recording
• 0:12
  of the Hoover Institution's Capitalism
• 0:14
  and Freedom in the 21st Century Podcast,
• 0:16
  the official podcast of the Hoover Institution Economic
• 0:19
  Policy Working Group, where we talk about economics,
• 0:21
  markets, and public policy.
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  I'm John Harley, your host, and today my guest is Steve
• 0:25
  Myron, a a current governor of the Federal Reserve Board.
• 0:29
  And he's just written this very excellent
• 0:30
  and very interesting paper titled A User's Guide
• 0:35
  to Reducing the Federal Reserve's Balance Sheet.
• 0:38
  And Steve just outlined his speech, some
• 0:42
  of the key highlights there,
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  but I really want to spend this conversation really digging
• 0:48
  in and, and asking Steve some questions about this.
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  So, Fed's balance sheet, something that drew
• 0:58
  to to be a about $9 trillion in the aftermath of COVID.
• 1:03
  This we entered a, this phase of
• 1:07
  abundant reserves are no longer having scarce reserves
• 1:09
  following the global financial crisis.
• 1:11
  The feds now tighten its balance sheets
• 1:13
  around $6.7 trillion.
• 1:17
  In your, in your, in your paper, you've outlined a number
• 1:19
  of items that would essentially allow the Fed
• 1:23
  to reduce the balance sheet further.
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  First off, where do you think,
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  and I want to sort of get some numbers
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  'cause you've got some great numbers in, in your paper.
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  One, what do you think the sort of internal size
• 1:36
  of the balance sheet or, or how low can the Fed go right now
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  in absence of some of the changes that you've spoken about,
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  whether it's some regulatory changes around, you know,
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  some DOD van provisions around holding treasury securities,
• 1:49
  the banks, or destigmatizing the discount window.
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  Where do you think that floor is right
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  now for the Fed balance sheet?
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  And if the Fed were to make,
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  or if there were to be various policy changes
• 2:02
  that you've outlined made, how low could the Fed,
• 2:05
  the Fed then potentially go in your mind?
• 2:07
  - So, thank you. Look,
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  we are expanding the balance sheet now,
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  and I voted
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  to resume reserve management purchases in December.
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  I supported that policy and that's
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  because conditional upon the current institutional
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  framework, the regulatory framework,
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  the implementation framework,
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  we had run into area approaching scarce
• 2:26
  reserves in December.
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  And so if we were going
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  to maintain an ample reserves framework, we needed
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  to start reserve managing purchases
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  and increasing the quantity
• 2:33
  of reserves in the system and increasing the balance sheet.
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  Now what I've tried to do in, in the paper
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  and in the speech is to provide a set of options
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  for reducing reserve demand so that we don't have
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  to keep increasing our balance sheet like this
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  and we can go back to shrinking our balance sheet, which
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  to me is the right, is the right approach.
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  Now, once we undertake those options, those steps,
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  I see one to $2 trillion
• 2:55
  of potential reserve reduction while retaining ample
• 2:58
  reserves, which sounds like a, you know,
• 3:00
  that sounds like a good range to me in, in terms of thinking
• 3:03
  of reduction, but that's the type of thing that would have
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  to be weighed by the committee in the future in terms of
• 3:07
  how, what they wanted to do and how far they want it to go.
• 3:11
  - Okay. Well, speaking of the committee in the,
• 3:12
  in the future, the third chair nominee,
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  Kevin Walsh has spoken in the past
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  quite frequently about
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  how the Fed could potentially move back to a,
• 3:24
  a scarce reserve system when, when he was a Fed governor,
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  he, he was at the Fed when the Fed transitioned from being
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  scarce to, to ample in your paper, in in, sorry,
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  in your speech you say
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  that you lean toward still being more ample than scarce,
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  but I'm, I'm curious how strong is that lean
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  on scarce, for example?
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  - So as I said in the speech, it's a weak lean
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  and you know, I I I, it's certainly not a,
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  it's very far from a, a hill I would die on.
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  It's not even a hill I would take mild wounds on.
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  I don't think it's part of the reason for that.
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  There's, there's two reasons for that lien.
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  One is that we have ample reserves now,
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  and if we have a path to remaining in ample reserves,
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  but reducing the balance sheet by up to $2 trillion,
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  it seems if something's working reasonably well,
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  but you can reduce the balance sheet,
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  then it doesn't necess necess state an institutional
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  change back to scarce reserves.
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  It seems like less work.
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  And so that seems like a positive to me.
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  The other reason is that we still do live in a world
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  with Dodd-Frank and Basel
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  and you know, I do think
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  that you could have scarce function in a world of Dodd-Frank
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  and Basel, but there's some more questions in, in my mind.
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  So it it's a weak lean
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  and you know, I, I could be talked into, into, into scarce,
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  but that's sort of my, my thinking at the moment.
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  And, and because we're sort of still studying this subject,
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  I could imagine my thinking on it evolving
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  as we continue to do more research.
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  - Got it. So scarce reserves hypothetically possible,
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  but obviously would need, you know, congress to act sort of
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  outside the purview of the Fed to, to get there.
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  I wanna talk a a a little bit about the,
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  the paper in in particular, you, you outline a number
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  of items on the liability side of the balance sheet
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  that could minimize distortions
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  around shrinking the balance sheet.
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  These are things, you know, related to sort of
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  proper function of repo markets and things like we mentioned
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  before, some of the,
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  you know, the discount window and so forth.
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  But what about the asset side?
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  There's also this sort of risk as well of, you know,
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  potentially, you know,
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  as the feds winding down the asset side
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  of the balance sheet selling treasury securities,
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  if it did this too quickly, maybe it could enter sort of a,
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  a taper tantrum 2.0 situation.
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  This was an event that happened 10 years ago when, you know,
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  essentially some comments from then Fed chair Ben Bernanke
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  caused the, the term premium
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  or the difference between long term government bond yields
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  and short term government bond yields to,
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  to really jump pretty DMA dramatically.
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  What are the things that you think would be helpful there
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  if, if the Fed were to really continue on a very serious
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  path of trying to reduce the balance sheet, what sorts
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  of things could produce those frictions on the asset side?
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  - Sure. So, so I like that framing of it.
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  Let me just, let, just repeat it a little bit so that
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  to make my answer make a little bit more sense.
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  So, so when we reduce our balance sheet, you know,
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  the balance sheet is assets and assets and liabilities,
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  and if you reduce the balance sheet,
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  you're reducing both assets and liabilities.
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  Now, the bulk of the paper deals with the liability side
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  of it, which is reserves, you know, banks own reserves.
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  Those are assets on the bank side,
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  liabilities on the fed side.
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  And when we reduce reserves, you know, in the past we get
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  to a point where there starts to be a little bit
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  of mayhem in, in short-term funding markets.
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  And that tells you that you're approaching scarce reserves
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  and, and you need to stop
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  and a lot, it's like the 2019 repo, right?
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  Yeah. Or late 2025, there were some, you know,
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  higher repo rates, right?
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  And, and most of the options in the paper are deal
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  with reducing reserve demand to allow you to use the,
• 6:53
  the balance sheet further before you get to that.
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  And those are, I listed a number of those in, in,
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  in the speech as well without going into details
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  because it's a speech and not a 50 page favor
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  on the asset side, the Fed owns securities, treasuries
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  and MBS and you're referring to the taper tantrum
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  that happened in 2013.
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  You know, big increase in in in long,
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  long-term interest rates.
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  And, you know, on the, on the liability side,
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  we talked about sort of making sure
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  that repo markets don't go haywire when you're reducing the
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  balance sheet, but you also have
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  to think about the asset side too,
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  and how do you avoid a spike in long-term interest rates
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  that you don't necessarily want as a result of,
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  as a result of what you're doing.
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  And so I mentioned going slowly, I think that's important,
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  but I think another thing that you,
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  there's a couple other stuff that you can do that i,
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  that we mentioned in our paper
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  and they have to do with, with,
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  with some regulatory implementation things.
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  And so one of them is improve, one of them is going
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  to central clearing of, of, of treasury repo.
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  Because if you, you know, if you,
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  if you own a treasury on repo, you've got a risk,
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  a risk charge, not for the treasury on the risk weighted
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  side of the regulatory regime,
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  but for the repo exposure,
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  for the counterparty exposure and repo.
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  And if you can novate across partner, across trading,
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  trading partners, you've got a a long position with this guy
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  and a short position with that guy, they'll net out
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  and then you won't have the charge.
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  And so you reduce the, the regulatory burden
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  of owning treasuries on repo.
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  That's one thing that you could do
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  that we discussed in the paper.
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  Another is the gsib surcharge on the risk
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  based side as well.
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  And so treasury securities in the risk-based side
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  of the regulatory framework are supposed
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  to have a zero capital weight
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  because they're, they're treasuries,
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  but they don't actually have a zero capital weight in
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  calculating the zero in, in calculating the,
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  the gsip surcharge
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  because they make, they make banks more systemically
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  important if you own more treasuries.
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  And so it, so there's a little bit of a distortion
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  to the way that we think about zero risk weight in the, in,
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  in the risk based sign for, for treasuries.
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  And so there's, those are some reforms
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  that you could take on the regulatory side
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  that make it a little bit easier for markets
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  to absorb securities
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  that are coming off of our balance sheet.
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  - I I know academics like Carol Duffing
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  and others have talked about, you know,
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  centrally clearing treasuries as well.
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  A lot of very interesting ideas in, in this paper.
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  I I think it's a very bold, very bold paper
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  that we rarely see from Federal Reserve governors.
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  So, so I, I I commend you for making a, a bold stand
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  by answering a, a, a very attempting
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  to answer a very difficult and,
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  and very important question for the Fed.
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  I wanna talk a little bit about inflation.
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  We're still above 2% inflation.
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  We are now, we have a, a war
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  and engagement in Iran, the Strader from Rous.
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  So appears to be closed, oil prices have been volatile.
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  What do you see underlying inflation over the next 12
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  to say 24 months?
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  And does Iran in any way sort of change some of your,
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  I guess, prior comments on
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  how easy monetary policy should be?
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  Or should this may just be used as sort of a one-time shock
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  that that passes through and,
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  and sort of ignored by policy makers just a supply shock?
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  I didn't think about these sort of recent developments.
• 10:03
  - Sure. So I still see underlying inflation as, as,
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  as gradually moving down toward,
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  towards target over the next, you know, sort
• 10:11
  of 12 months let's say.
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  I think underlying inflation is remaining very well behaved
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  and with the labor market on a very,
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  very gradually loosening trend for three years now,
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  it's very difficult for me to imagine to,
• 10:22
  to imagine that changing.
• 10:24
  Now the oil shock, of course is, is very real,
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  but the way that oil shocks work when you think about
• 10:30
  inflation is they boost the price level pretty quickly.
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  You know, gas prices move up pretty quickly, right?
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  Or airline fares move up pretty quickly.
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  Anything that's really tied to oil in a very,
• 10:39
  very powerful way tends to move a very quickly,
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  but monetary policy hits the economy with lax, with long
• 10:45
  and variable lags, and most people think
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  that those are 12 to 18 months.
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  And so what happens
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  with an oil price is it lifts the price level pretty
• 10:53
  immediately because of the,
• 10:54
  because it feeds through into gas prices
• 10:56
  and, and other stuff immediately.
• 10:57
  But then unless there are second round effects,
• 11:00
  then you don't have inflation as a result
• 11:03
  of oil 12 to 18 months out.
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  Inflation, 12 to 18 months out is pretty much unaffected.
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  And you see this in the,
• 11:10
  you see this in inflation expectations.
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  So I like to look at the CPI swap market
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  and one year swaps, you know, moved up a lot.
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  But as you look at forward rates,
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  if you look at the one year rate, one year forward
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  and the one year rate two years forward,
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  and the one year rate three years
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  forward, they haven't really moved.
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  If anything, they're actually down since the January FOMC.
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  So, and, and, and you know,
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  they haven't really moved much in response in,
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  in response to the Iran shock at all.
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  So if we changed interest rates now,
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  it wouldn't hit the economy for 12 to 18 months from now.
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  But the market isn't really seeing any inflation from the
• 11:45
  oil shock 12, 18 months from now
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  because it all happens immediately.
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  What you would get is a much weaker economy as a result
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  of tighter monetary policy.
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  And so this is why classically central banks look
• 11:55
  through oil shocks.
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  And I tend to think of the traditional wisdom on, I mean,
• 11:59
  I'm very, as you can tell from the speech
• 12:01
  and you know, other things that I've, I've said
• 12:03
  and written in the last several years, I'm very happy
• 12:06
  to challenge conventional wisdom when I think it's wrong.
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  But in this case, I think conventional wisdom's, right.
• 12:12
  - Terrific. And on wanna shift to unemployment,
• 12:16
  unemployment's sort of been in this in between sort a three
• 12:19
  and a 5% handle in the past few years.
• 12:21
  It's sort of a sort of inched up little by little,
• 12:25
  but hasn't really, it's, it's still very low compared to,
• 12:28
  you know, the the long run, you know, post-war time series.
• 12:31
  How tight is the labor market right now in your mind?
• 12:35
  How close are we to what you might call for employment?
• 12:40
  - So the labor market, you know, was, you know,
• 12:44
  extremely tight in 20, 21, 22.
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  And then in, you know, in,
• 12:49
  and then as the Federal Reserve started, its,
• 12:51
  its tightening policy, sorry, tightening cycle.
• 12:55
  The labor market set into a, a very gradual cooling trend.
• 12:59
  That trend's been in place for three years.
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  I think given labor markets tend to show a lot of momentum,
• 13:06
  they tend to show a lot of, a lot
• 13:07
  of persistence in an underlying trend.
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  And that this trend has been going on for three years.
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  It seems to me that it should be the null hypothesis when
• 13:14
  you're thinking about, when you're thinking about
• 13:16
  how the labor market has changed.
• 13:18
  I haven't seen anything that's convinced me
• 13:19
  that this three year long trend has, has adjusted.
• 13:22
  There are, there are some folks who think
• 13:23
  that labor market is showing signs of stabilization.
• 13:26
  You know, I think that, I think the trend has, has continued
• 13:28
  and therefore mirror its additional
• 13:30
  support from monetary policy.
• 13:31
  Monetary policy is modestly restrictive
• 13:33
  and I don't think that the labor
• 13:34
  market really calls for that.
• 13:36
  - Got it. Wanna shift to R star?
• 13:39
  So, you know, the fed's fed funds rate is between three
• 13:41
  and a half, three, 3.75.
• 13:44
  Do you think monetary policy right now as restrictive,
• 13:47
  neutral or accommodative?
• 13:48
  I mean, do you think R star, this sort of measure of,
• 13:53
  you know, if the, if the Fed had interest rates at
• 13:54
  that level, then inflation would be neither
• 13:57
  accelerating or decelerating.
• 13:59
  Do you think R STAR has sort of recently risen in that the,
• 14:03
  you know, over the past few years as,
• 14:05
  as some people have claimed?
• 14:07
  And how do you think about measuring R STAR in general?
• 14:10
  Do you like model based estimates?
• 14:12
  Do you like survey based estimates that New York Fed's
• 14:16
  surveys of macro expectations, they out these sort
• 14:20
  of survey estimates from market participants of R star?
• 14:23
  I'm a big fan of those or do you have your own models?
• 14:27
  How do, how do you think about R star?
• 14:28
  I know, I know you've spoken about
• 14:29
  this in the past each of years.
• 14:31
  - Yeah, so I like, I like model estimates.
• 14:33
  So first of all, our R star is the neutral
• 14:36
  rate of monetary policy.
• 14:37
  It's the rate that's neither accommodative
• 14:38
  nor stimulative for the economy.
• 14:40
  If you're at neutral, you're not hitting the gas
• 14:42
  or the brakes, you're coasting.
• 14:44
  If you're above neutral, you're hitting the brakes.
• 14:45
  If you're below neutral, you're hitting the gas.
• 14:48
  And I, I I,
• 14:50
  and it's very difficult concept to measure.
• 14:53
  It's, it, it doesn't, you know, it's an abstraction.
• 14:56
  It doesn't exist in the real world.
• 14:57
  You know, you can, I can tell you the interest rate on a
• 14:58
  treasury bond, I can't tell you, you know, I can't go out
• 15:01
  and sort of find our star.
• 15:02
  It has to be estimated, right?
• 15:04
  And so I, I tend to like some
• 15:09
  of the time series methods for estimating our star,
• 15:12
  however, they take quite a while I think often to update
• 15:17
  and the world changes more quickly than they can arrive at
• 15:21
  arri arrive at new estimates in some, in some cases.
• 15:24
  And so I like to sort of start with that
• 15:25
  and then sort of adjust it with things,
• 15:27
  salient things in the economy
• 15:29
  that I think are first order importance
• 15:30
  that have, that have changed.
• 15:31
  And so what I'll do is I'll, I'll sort of start with that
• 15:34
  and I'll think about something like,
• 15:35
  and I've talked about this a lot, think about something like
• 15:37
  population growth, right?
• 15:38
  Population growth is something that, you know,
• 15:40
  I think is not controversial to think
• 15:42
  of it as affecting our star.
• 15:43
  I think that's a very well accepted concept.
• 15:45
  It wasn't that long ago that we were all talking about
• 15:49
  ification of the whole world
• 15:50
  because, you know, converging fertility rates coming down
• 15:53
  and, and demographics and aging
• 15:55
  and was that gonna lead to
• 15:56
  low interest rates everywhere, right?
• 15:57
  You know, that that conversation is very common pre COVID.
• 16:01
  And I think those, those pathways, you know,
• 16:03
  I I I think are, are are are good or valid pathways.
• 16:06
  I don't think they ever went away.
• 16:07
  Just other stuff happened in the meantime that we sort of,
• 16:09
  you know, we're paying attention to other stuff.
• 16:10
  But I think those economic mechanisms have always been valid
• 16:14
  and we just had the largest population growth shocks
• 16:17
  of our lifetimes in both directions in the
• 16:20
  last few years, right?
• 16:21
  We had a huge population growth spike
• 16:23
  and then a huge decline in population growth related
• 16:26
  to changing border policies in the last few years.
• 16:28
  And so it totally 180
• 16:30
  and so the idea that that wouldn't sort of feed
• 16:32
  through into short run neutral rates
• 16:34
  that had consequences from Ontario policy is, you know, is,
• 16:38
  is is, you know, is is sort of, is sort of strange to me.
• 16:42
  So I will tend to sort of think, okay, let's take some
• 16:46
  of these, some of these models that, that do a good job
• 16:50
  of estimating these things,
• 16:51
  but maybe they're a little bit slow to adjust
• 16:52
  to something like that and then, and then adjust them
• 16:55
  based on some salient changes that I think will,
• 16:58
  will be relevant for it.
• 16:59
  - So like the, the Lawback Williams and Lu Mathis.
• 17:02
  - Yeah, I, I I think those are, those are,
• 17:04
  those are, that's great work. Yeah.
• 17:06
  - Well, I want to talk just a little bit
• 17:08
  about Journal of ai.
• 17:10
  AI I feel like is something
• 17:12
  that is just pervasive right now,
• 17:15
  but it seems to come up quite a bit in monetary policy
• 17:17
  conversations as well.
• 17:19
  I mean, how do you see one generative ai,
• 17:22
  let's start I guess with the labor market, any thoughts on
• 17:24
  how generative AI is is, you know, potentially
• 17:27
  gonna affect labor market in the future?
• 17:28
  - Sure. I mean, we may already be seeing it.
• 17:30
  You know, the labor market is, is weakest for new entrants
• 17:33
  and, and, and reran to the labor market.
• 17:35
  And, you know, those are, those are areas
• 17:38
  that generative ai, you know, sort of
• 17:41
  is arguably, is arguably affecting.
• 17:44
  And by the way, the fact that those labor,
• 17:46
  that those labor market segments seem weak seems
• 17:48
  to me an argument against assuming
• 17:51
  that low payroll growth is a function of border policy.
• 17:55
  I think a lot of people like to dismiss low jobs numbers
• 17:59
  as a result of changing border policy
• 18:01
  as being a negative labor supply shock.
• 18:04
  If that were the case then cohorts
• 18:06
  that were sharp substitutes that were strong substitutes
• 18:08
  for, for immigrant labor would be,
• 18:11
  would have the hottest labor markets in the country
• 18:13
  and they'd be experiencing rising, rising wage growth.
• 18:16
  You know, if you sort of hold demand constant
• 18:18
  and reduce supply, you get higher prices
• 18:20
  and you don't see that in the data, especially in a period
• 18:22
  of high productivity growth, you would expect
• 18:24
  to see much sharper, much stronger wage growth.
• 18:27
  And so to me the labor supply story isn't
• 18:29
  really consistent with it.
• 18:31
  I wanna say something else about ai, which is that,
• 18:34
  you know, 1, 1, 1 criticism that I've heard,
• 18:39
  that I've heard people make is
• 18:40
  that we keep getting these negative supply shocks and the,
• 18:43
  and the Fed keeps asking people to look
• 18:45
  through the negative supply shocks.
• 18:47
  Look, oil absolutely is a negative supply shock.
• 18:49
  And as I explained before,
• 18:51
  it doesn't affect the economy on a timeline
• 18:53
  unless there's changes to inflation expectations
• 18:55
  or a wage price spiral, which is not happening.
• 18:57
  It doesn't affect the economy in a timeline
• 18:59
  that monetary policy can respond to.
• 19:02
  But there also are positive supply shocks
• 19:04
  and AI is a great example of a positive supply shock.
• 19:07
  AI allows people to do more with less, right?
• 19:10
  It boosts productivity, it reduces barriers to entry,
• 19:13
  it allows people to produce more fewer inputs.
• 19:15
  That's a positive supply shock that really matters
• 19:18
  for economic growth, for inflation, for unemployment
• 19:21
  and for monetary policy.
• 19:22
  And all of that is, and all of that is really something
• 19:24
  that's very important that I think we
• 19:25
  need to take into account.
• 19:26
  Another positive supply shock is the change in,
• 19:29
  is the change in the regulatory environment.
• 19:31
  I gave a speech in January in Greece in which I looked at
• 19:35
  the lit, the modern literature, some of which is
• 19:38
  by your Hoover colleagues, Patrick McLoughlin.
• 19:40
  I looked at the modern literature on, on trying
• 19:43
  to quantify the regulatory code
• 19:45
  and there's people like Patrick and,
• 19:47
  and Joseph Kitz who do very,
• 19:48
  who do very good work using modern AI and machine learning
• 19:51
  and quantitative methods to reduce the regulatory code
• 19:54
  to numbers that you can then study.
• 19:56
  And I used this literature
• 19:58
  and I calculated that the deregulatory shock
• 20:00
  that's been ongoing since last year would weigh on inflation
• 20:02
  by about half a point per year over the next few years.
• 20:05
  Now there was a federal reserve research paper
• 20:08
  that was published a couple weeks ago
• 20:10
  by two fed staff economists, Danilo Kadi Garcia,
• 20:14
  and Mateo Yako Yako, who
• 20:19
  using an entirely different quantification method
• 20:21
  and an entirely different empirical method came up with a,
• 20:24
  you know, did similar estimates
• 20:26
  of the deregulatory shock we're living through.
• 20:28
  And if you apply their model to the size
• 20:30
  of the deregulatory shock that they estimate,
• 20:32
  it causes about a 30 basis point drag on inflation reduction
• 20:35
  in inflation per year for the next few years.
• 20:37
  Right. So I estimated about a 50 basis point
• 20:40
  persistent drag.
• 20:42
  They estimated about a 30 basis point persistent drag.
• 20:44
  I think those two are within noise of each other.
• 20:46
  I wouldn't, you know, I wouldn't reject 30 basis points
• 20:48
  as being outside of the conference spans,
• 20:49
  given the uncertainty in these things.
• 20:51
  But this is an example of a positive supply shock.
• 20:54
  Like AI is another example of a positive supply shock
• 20:56
  that I feel is underappreciated in all
• 20:59
  of the talk about negative supply shocks.
• 21:00
  And whereas oil is generally a one-off shock, again,
• 21:03
  unless there's changes to inflation expectations,
• 21:05
  unless there's a wage price
• 21:06
  spiral, neither of which is happening.
• 21:08
  Both AI and deregulation are gonna have persistent effects
• 21:13
  when you look at the way that these models work.
• 21:15
  And so as a result, these are things that I think are, are,
• 21:17
  are gonna be, are are gonna be pushing out the supply side
• 21:20
  and we all know their supply and demand.
• 21:21
  And if you hit the,
• 21:22
  if you hit the gas on demand while you're holding supply
• 21:24
  constant, you get inflation, right?
• 21:26
  If you push out supply as well, you know,
• 21:29
  you're not gonna get inflation.
• 21:31
  - So, so I guess taking it all together, would you say
• 21:35
  that AI will push the neutral rate down or,
• 21:39
  or, or up in your mind?
• 21:40
  - No, so AI definitely pushes the neutral rate up.
• 21:43
  And so it, you know,
• 21:45
  so I gave a speech on my view on the
• 21:46
  neutral rate in September.
• 21:48
  It was the first speech that I gave
• 21:49
  as a member of the Federal Reserve Board.
• 21:51
  And in that speech I described a number of policy changes
• 21:54
  that I thought had pushed around the neutral rate and,
• 21:56
  and a lot of them brought the neutral rate down,
• 21:58
  things like population growth,
• 22:00
  things like reduced fiscal deficits due to tariff revenue.
• 22:04
  AI is something that pushes the neutral rate.
• 22:05
  Higher deregulation also pushes the neutral rate higher
• 22:09
  by improving productivity.
• 22:10
  Positive supply shocks will push the neutral rate higher
• 22:12
  because they improve the return on capital.
• 22:14
  Now in that paper I started at
• 22:16
  what I thought was a very high neutral rate,
• 22:18
  and then I applied sort of changes from population growth
• 22:20
  and increased fiscal revenue, you know,
• 22:22
  decreased national borrowing,
• 22:24
  and then I came down to a low level.
• 22:26
  So in, in, you know, I started probably at the top end
• 22:29
  of the range of my colleagues
• 22:30
  and then I ended up at the bottom of the end
• 22:32
  of the range of my colleagues.
• 22:33
  But in neither case was I, was I above them?
• 22:35
  But I baked AI into my, into my sort
• 22:38
  of starting points or I tried to
• 22:41
  - That That's, that's fascinating.
• 22:44
  I guess now that you bring up any, any just thoughts on,
• 22:46
  on fiscal and you know, we often talk about,
• 22:49
  in your paper you actually mentioned this idea of
• 22:51
  for regulatory dominance.
• 22:52
  We'd love to hear a bit about that
• 22:54
  because we often hear about, you know, fiscal dominance,
• 22:57
  monetary dominance.
• 22:58
  There's a lot of takes right now about, you know, the size
• 23:00
  of the federal debt.
• 23:02
  You know, it's obviously been ballooning over sure many
• 23:04
  decades and, and not just in the US
• 23:06
  but many, many countries in Japan being one of them.
• 23:10
  How, how does that in your mind, sort of affect the sort
• 23:12
  of constraints of, of central bankers?
• 23:15
  - Sure. So look, you know, the, in the long,
• 23:17
  in the long run we need to get our fiscal house in order.
• 23:21
  In the shorter run, I think that I, I I think that,
• 23:25
  I do think that tariffs have started raising revenue
• 23:28
  that changed some of the trajectories in,
• 23:29
  in the short to medium run.
• 23:30
  Now they don't, I don't see them solving the very long term
• 23:34
  budget issues, which of course matter for the,
• 23:36
  for the interest rate market
• 23:37
  and for things that matter to monetary policy and our star
• 23:40
  and, and the economy.
• 23:42
  But I think in the short term, in the medium term,
• 23:43
  those dynamics have definitely changed.
• 23:45
  So the, you know, if you expect about a point
• 23:47
  and a third of GDP of additional revenue from tariffs
• 23:50
  or, you know, per year over the course of a decade, I think
• 23:53
  that's a pretty powerful reduction in
• 23:56
  reduction in the deficit.
• 23:58
  Also, you know, better productivity growth,
• 24:00
  better GDP growth also improves, improve the deficit
• 24:04
  because revenues will go faster than outlays.
• 24:06
  And so between the two of those,
• 24:07
  I think it's not far fetched to think
• 24:09
  that the primary deficit can get better by a couple points
• 24:11
  of GDP, which of course again,
• 24:13
  does not solve our fiscal problems on a multi-decade
• 24:16
  timeline, but it will ameliorate those problems
• 24:21
  over the course of coming years.
• 24:24
  Right? So I do think that this is, this is an area
• 24:27
  for important work, but I think things have gotten,
• 24:29
  have gotten somewhat better in the recent past too.
• 24:32
  And I think that that starts,
• 24:33
  that's starting to be evident in the data.
• 24:35
  And so if you look at the time period
• 24:37
  after tariffs were implemented, if you look at calendar Q2
• 24:40
  through Q4 of 2025 versus calendar Q2 through Q4
• 24:45
  of 2024, you see the deficit starting to come in.
• 24:48
  Now, not all of that is tariffs, not by any means,
• 24:51
  but it's come in by, by hundreds of billions of dollars.
• 24:54
  And so I think that that, I think that that is,
• 24:56
  is, is worth acknowledging.
• 24:58
  - Yeah, I mean, I, I guess some you,
• 24:59
  there's some possibility of, of refunds,
• 25:03
  but of course, you know, the, i the administrations,
• 25:06
  you know, said they're gonna reinstitute these tariffs using
• 25:09
  2 32 and, and 3 0 1 and other other methods.
• 25:13
  This is, you know, really, you know,
• 25:15
  such a fascinating conversation
• 25:16
  and, you know, it's a, it's a real honor to have you, Steve,
• 25:20
  really, I, I know your term is, is already expired
• 25:23
  and that, you know, that Kim war has been nominated
• 25:27
  to replace, to be put into your seat,
• 25:31
  at which point you'll leap.
• 25:32
  But, you know, it wouldn't surprise me at all if,
• 25:35
  if you're renominated to Jay Powell when he leaves,
• 25:40
  potentially shortly after.
• 25:41
  But really, this has been a fascinating conversation.
• 25:43
  I think your, your paper is again, very bold in,
• 25:47
  in talking about Fed Balance sheet reduction.
• 25:50
  You know, it's a topic
• 25:51
  that caused you massive consternation in treasury markets
• 25:55
  in, in years past with, you know, the taper tantrum
• 25:57
  and obviously the re repo crises of past years.
• 26:00
  But I really admire you for, for trying to take it head on.
• 26:04
  I really wanna thank you, Steve, for, for coming
• 26:06
  and a again, this is a live recording of the capital
• 26:11
  and freedom of the training first Century podcast,
• 26:13
  official podcast with the Hoover Institution,
• 26:14
  where we talk about economics, markets, and public policy.
• 26:17
  I'm Don Harley, your host. Thank
• 26:19
  you so much for joining us Steve.
• 26:20
  - Thanks so much for having me.