Bill Dudley’s life’s work has been intertwined with with the Federal Reserve for more than four decades, from his early years on Wall Street at Goldman Sachs as its chief economist, to a key Fed job as head of the Open Markets Desk at the Federal Reserve Bank of New York, and finally to rising the third-highest position on the policy-making Federal Open Market Committee as president of the New York Fed, from 2009 to 2018.
And he isn’t stopping now.
The Federal Reserve’s 2025 Framework Review is in full swing and Bill is right in the middle of it. Not as consultant to the Fed but as a critic of the policies it adopted in its 2020 Framework Review that allowed inflation to get put of control during the pandemic. As a longtime member of the Group of 30, Consultative Group on Economic and Monetary Affairs Inc, he chaired the G30’s Working Group that published its own report entitled “The Federal Reserve Monetary Policy Framework Review: A Comprehensive Review to Improve Robustness.”
The release of the report came just before the Fed last week held a two-day conference where Fed Chair Jay Powell kicked of the event at the Board of Governors in Washington D.C. And where former Fed chief Ben Bernanke had a star appearance where he proposed that when the FOMC announces a policy decision it also publish “alternative scenarios” that map out how the latest decision is contingent on how the economy actually evolves.
Unlike many in the audidence who questioned the effectiveness of this proposal, Bill sees some possible merit in it. And in the Fed doing more to provide specific information about the forecasts that are made by the 19 members of the FOMC four times a year which yield the “Dot Plots” signalling where each one expects the fed funds rate to go by year’s end, as well as over an extended policy path.
So dive in and hear what Bill has to say as he explains the six key recommendations for the steps the Fed’s Framework review must take, as laid out in the G30’s report. He stresses the importance of a robust framework that can handle various economic scenarios, and emphasizes the widespread support that exists for Powell's decision to maintain the 2% inflation target. Simple, understandable language. And ideas that for many will make a lot of sense.
The 2020 Framework 00:02:28.890
Bill: So the 2020 Framework Review basically was a response to the environment post, the great financial crisis where inflation was below the Fed's 2% objective inflation expectations were also below 2% Interest rates were very low. Short term interest rates were very low, and the Fed was very concerned about not having a lot of room to cut rates and stimulate the economy if the economy fell into a recession. And so the Fed basically said, Look, we need to have something that does a better job anchoring expectations because we could be pinned at the 0 lower bound for interest rates, inflation, expectations could continue to decline, and that would inadvertently tighten monetary policy. Further, so what they basically said in 2020 is, let's let's do this. Let's say that when if inflation is below 2% for a while, we'll make it up by allowing overshoots of inflation of 2% for a while, so that inflation will average 2% over time. So they basically committed to make up the short, those shortfalls. The second thing they did is they changed their the employment objective
The Fed jettisons symmetry 00:03:33.440
<previously> It was sort of symmetric, and they changed it in 2020 to say that they want to minimize shortfalls from maximum employment. So they're basically putting more weight on the employment objective, and also saying, we're going to offset undershoots by overshoots. Now, how they operationalize this framework was also, I think, very, very important and probably doesn't get enough attention.
The Fed operationalizes its new framework 00:04:00.730
The Fed basically said, we're not going to lift off until three conditions are met. Number one, inflation has to be at 2% number two, we have to be at full employment and number 3, we have to be confident that inflation is going to go above 2% for a while to offset those misses to the downside. So, as a consequence, in March of 2022 interest rates were at zero. There's a big gap between where the Fed should have been and where they were, and so they were pretty late now. It turned out that they caught up, and inflation expectations stayed well anchored, and so the consequences of this mistake turned out to be relatively modest, but it could have turned out a lot worse than it actually did. So I think that going into the 2025 Framework Review, the word you hear from Fed officials all the time is robust. They want a framework that is robust.
A return to symmetry 00:04:49.960
A <robust> framework that will work can work for lots of different scenarios or situations. So not set, not set a framework in place. That's just worried about too low inflation getting pinned at the zero bound set up a framework that also can be responsive as inflation goes above the Fed's 2% objective. And the economy overheats. So we're definitely going to see changes in the 2025 framework. I think there's no question about that. Powell’s already teased that out a bit.
Big change to solve small problem 00:05:50.300
The idea of offsetting undershoots by overshoots was to try to keep inflation expectations well anchored around 2%. But it's not really clear that the problem was quite as significant as the fed thought, because inflation expectations, they were a little below 2%, but only a couple tenths of a percent. So it wasn't such a big problem. The <real> problem is that this sort of committed them to being very, very late.
Changes coming 00:06:11.610
So I think one change that they're going to make, and this is a recommendation in the Group of 30 paper, goes back to no more offsetting undershoots by overshoots. Just target 2% inflation all the time. That also has the advantage that it's much, much easier to explain, because one of the problems they had with the 2020 framework. They said they were going to offset undershoots by overshoots, but they didn't say, how big an overshoot it would have to be… How long would they look at, look back, in terms of the cumulative amount of undershoots? So they didn't really provide a lot of details about how this is actually being implemented in practice. So I think that also created a little bit more confusion about the Fed's reaction function.
There is no going back 00:07:18.260
Well, that's the idea of like just targeting the price level over time… people are upset about the fact that the price level is much higher than what was 4 or 5 years ago, but the pain that you'd have to put the economy through to get back to the price level that we had, you know…
The 2% target is set; fixed 00:08:30.760
So Powell basically said that 2% is the the number, and he's not going to change it. And I completely support that. Inflation expectations are well anchored around 2%...if you were to move it to another number, you essentially would be unanchoring inflation expectations unnecessarily. If you can move it once you can obviously move it again, and I think it would also send the wrong signal that you're raising your inflation target after 5 years where you couldn't achieve it. So I think it would also be damaging to the Fed's credibility. So Powell has basically said, no, we're not going to change the 2% inflation target. And I think that makes a lot of sense.
The Objective 00:09:33.760
I mean, the point here is just that you're not trying to run the economy unnecessarily hot. So when the Fed said, We're going to try to achieve maximum sustainable employment. Basically, they were saying, we're going to sort of push the envelope a little bit and see if we can get more people employed. Now, I'm not arguing that we should, you know, make a guess about what full employment is, and then unnecessarily keep people out of work. That would be the wrong thing to do. But I think you do want to lift off a little bit before you think you've gotten to full employment. I mean, ideally like where we were in the late 2019 period wasn't a bad place to be, I mean, monetary policy was pretty much neutral. The economy was really at full employment. Inflation was a little bit below the target, but not a lot below the target. I think that's where you want to end up. Think of 2 choices. One is that you don't lift off until you actually get to 2% inflation, and then you have to tighten monetary policy quite aggressively. That's essentially what happened during the aftermath of the covid pandemic. Or, two, where you gradually tighten and you arrive at full employment. 2% inflation and a neutral monetary policy, all at the same time. That seems like a better regime to me.
Today’s risk 00:12:19.390
Bill: Right now. We think inflation is going to go up because of tariffs. We think the unemployment rate is going to go up because of tariffs, because it's going to be a tax on consumers. And so the Fed's going to be missing on both sides of their dual mandate objectives and I think the fed needs to explain more clearly, like, how are they going to weight employment versus inflation as they go through this process. I mean, in general, people need to know more about the Fed's reaction function. I mean, one theme that came out in the conference was.
The Fed’s hidden reaction function 00:12:50.940
One of the problems with the summary of economic projections is it's the Median forecast of the FOMC participants. But it doesn't tell you much about what they're going to do if things turn out to be quite different.
A framework and more for QE 00:14:16.350
I think that having a framework that is public would be very, very helpful if you remember what happened during the Covid pandemic. The first part of QE as all about supporting Treasury market function, and then it sort of gradually morphed into providing more monetary policy stimulus because the Fed was at the zero lower bound for short term interest rates. And one of the things that was very different about this last episode of QE compared to what happened post the Great Financial Crisis is the Fed actually lost a lot of money. When the Fed had to raise interest rates significantly, the cost of their liabilities exceeded the return on their assets that they purchased, and so the Federal Reserve is running up about 230 billion dollars of losses.
Covid Policies go awry 00:15:39.680
We go into 2021. The vaccines are being rolled out, the Biden administration passes a 1.9 trillion dollars fiscal package. And the fed continues to do QE. For another year. I don't think that last year of QE Really accomplished much that was good, and I think it actually caused a lot of harm. It caused the housing market to overheat by more. I think it probably helped drive up inflation faster.
Mistaken fears drive policy 00:17:25.250 There were a lot of worries about having a repeat of the Bernanke taper tantrum. If you remember, when Bernanke mused about the end of Qe. Bond yields went up about almost a full percentage point over the next 3 or 4 months. And so the fed was, you know, I think, fed officials were nervous about a repeat of that. But this is the classic problem of looking backwards at the lessons of the past, and then sort of reining yourself in sort of fighting the last war.
Scenario analysis could be helpful 00:17:54.060
I think the Fed could have been more willing to take more risk in terms of tapering early. This is something that came up during the Fed Conference, Ben Bernanke said. One of the reasons why we should have scenario analysis. Different scenarios is that if you had a scenario that inflation is going to be higher than expected, that the fed would then we would obviously have to end QE. Earlier, and we'd have to lift off earlier. If the Fed had had that scenario out there, it might have been easier for the Fed to shift course, so he his view. His view, which I actually, you know, subscribe to is that if you have multiple scenarios, it might make it easier for people to anticipate how policy will be adjusted, as things turn out differently than expected, rather than just being locked into what you've committed to do.
Fed Structure makes scenario analysis difficult00:19:18.970
Yeah, I'm very much aligned with Ben on this one. I mean, you know, ideals. Ideal would be for the Fomc to put out a monetary policy to reflect the views of the principals. But that's just very hard to do when you have 19 people on your Federal Open Market Committee, and there are a lot of them are spread all over the country. So I think the problem of doing the first best, which is, that is just the geographic setup of the of the Federal Reserve system. The European Central Bank <does it with a staff forecast> because they have a huge committee. <So>, if we can't do first best, we can still do something that's better than what we're doing today.
(contd from above soundbite) The Dots are a mess
<The Dots> are a mess. They’re a mess, because ..they focus people too much on a modal forecast. And you can't extract the Fed's monetary policy reaction function. The summary of economic projections, the dot plot, is not forward guidance. That's just a forecast that the Fed has about about what they think is they're going to do based on their current forecast. So I think there's a lot of confusion among Fed watchers about what it forward. Guidance is and isn't, and I think it'd be useful for the fed to clarify that.
Forward guidance is important and difficult 00:24:19.180
I think that you know forward guidance. The Fed needs to explain what it is needs to explain that it's basically something that could be important, mostly at the Zero lower bound for interest rates the Fed, you know, when the Fed's talking today about, how we're data dependent, that's not forward guidance. That's just saying that as things change, we'll update our views and we'll change along with it. And I think there's a lot of confusion when people talk about when the Fed says we're data dependent. Some people think of that as forward guidance.
William C. Dudley
William C. Dudley became the 10th president and chief executive officer of the Federal Reserve Bank of New York on January 27, 2009. In that capacity, he served as the vice chairman and a permanent member of the Federal Open Market Committee (FOMC), the group responsible for formulating the nation's monetary policy.
Previously, Mr. Dudley served as executive vice president of the Markets Group at the New York Fed, where he also managed the System Open Market Account for the FOMC. The Markets Group oversees domestic open market and foreign exchange trading operations and the provisions of account services to foreign central banks.
Prior to joining the Bank in 2007, Mr. Dudley was a partner and managing director at Goldman, Sachs & Company and was the firm's chief U.S. economist for a decade. Prior to joining Goldman Sachs in 1986, he was a vice president at the former Morgan Guaranty Trust Company. Mr. Dudley was an economist at the Federal Reserve Board from 1981 to 1983.
Mr. Dudley received his doctorate in economics from the University of California, Berkeley in 1982 and a bachelor's degree from New College of Florida in 1974.
In 2012, Mr. Dudley was appointed chairman of the Committee on the Global Financial System of the Bank for International Settlements (BIS). Previously, Mr. Dudley served as chairman of the former Committee on Payment and Settlement Systems of the BIS from 2009 to 2012. He was a member of the board of directors of the BIS.
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