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Hello and welcome to another episode of the All Thoughts podcast. I'm Tracy Alloway.
And I'm Jill Wisenthal Joe.
We are here in Jackson Hole for the Economic Symposium held by the Kansas Fed Kansas City Fed every year, and every year they choose a theme for the conference. So last year I think it was structural shifts in the global economy, something fairly generic. Actually, this year it is all about the transmission of monetary policy.
That's right, and there are some pretty big questions. So it's like, we all have this idea that you slow the economy or you fight inflation by hiking interest rates and then your lower interest rates for yourustom but how does that like actually work? And this cycle has raised a lot of questions, in particular because things that you might have expected to see, such as a sharp rise in the unemployment rate amid the fall in the rate
of inflation, hasn't really happened. So I think there's a lot of ambiguity still about like what is the process via which monetary policy, which is both interest rate policy and it gets balance sheet policy. What is the process through which these decisions actually transmit to the real economy.
Right, And we're going back to the debate that was popular maybe a year or two ago, which was, if you have major disruptions in the economy, like with shipping or whatever, and prices increase because of that, is increasing interest rates actually going to do anything about those particular constraints.
But then, just beyond those discussions, which we've been having for a long time and we now seem to be having in reverse, there are also a lot of things that central banks have done over the past couple of years that are unusual in one way or another. I think today we probably you know, twenty twenty was four years ago now, and so we've learned to live with them.
But if you think back, for instance, to the Fed's treasury program in March of twenty twenty, right, like that was a big deal and they rolled it out really quickly.
And they also bought a bunch of types of assets or entered into a number of markets. I mean, you know they're bond, yeah, corrabond, so other markets through which the FED is most never touched in the past. The other thing that's worth noting here in the preface to this conversation is that for the vast majority of people that are even vaguely aware of this thing called Jackson Hole.
It's to the extent that Chairman Jerome Powell give a speech, But it is an academic economic conference and they're over papers and presented. There is more here than just one speech from one guy.
No, absolutely, there is a series of presentations and papers that are presented. And I am very happy to say that today we are going to be digging into this question of transmission of monetary policy, and we are going to be speaking with one of the panelists from the event, and he's going to give us a sort of inside look at how all of this works. And also, yeah, so I am very excited. We have the perfect guest.
We are speaking with a Neil cashyapp. He is a professor of economics and finance at the Chicago Booth School. That's a very.
Ominous yeah, thunder.
Sound effect. There's a mountain storm rolling in right now. And Neil, thank you so much for coming on all thoughts.
Thank you. Mother Nature is going to supply liquidity.
It seems like it. Okay, so how does this work? How is it that you come to be at Jackson Hole and you are asked to give a presentation on You were on the Transmission of Monetary policy panel, but the particular angle that you were taking or the paper you were presenting was monetary policy implications of market maker of last resort operations. So how does that come to be as a sort of subject to topic for discussion.
Well, they start trying to put the program together sometime around January and they contacted a bunch of people saying, this year the theme is going to be X. You've written on some issue adjacent to X. Would you be interested in preparing a paper? So first thing it has to happen is they got to ask you, but you also have to have a room in your schedule to
actually produce something. Now, I was on a panel and the panel was about the linkages between the financial system and monetary policy transmissions, and that was our little bit of it. There were two other papers today about government debt markets and also about the Phillips curve. And so the conference surrounds the topic of monetary policy transmission through a bunch of cumulative papers that are written by different people, and then each paper has a discussant discussian's usually also
written on the topic. So in our case, I got a call just saying, you know, you, I've done a lot on financial stability and monetary policies are something you would be willing to talk about, And I said sure.
So when we think of monetary policy, we think of interest rates, or we think of other tools besides moving up and down rates that affect interest rates. So forward guidance can be a type of interest rate policy QI
in a sense can be that as well. During March twenty twenty, when the market basically broke, the FED intervened massively to stabilize the treasury market in a way that maybe mathematically in some sense looks like QWI, but it was not QUI in the way that QI was done like during the Great Financial Crisis, because it wasn't about rate gun and so that came somewhat separate, but it still was balance sheet operations in order to stabilize This
talk a little bit more basically about what your contribution the panel was about.
Well, I pointed out that the Fed's process and explanation for what they're doing kind of all pretty quickly. So if you go back and look at what they said on March fifteenth, they said, you know, we've got to stabilize the markets. This is a financial stability intervention. We're going to buy this stuff because we think that they're kind of plumbing issues in the financial system that are messing up the US treasury market, and that market's the
foundation of everything. By a week later, their next unscheduled meeting, they said, and this is also going to support monetary policy. By April. You know, now we're six weeks later, they've got monetary policy and market functioning side by side completely there, and then by the time you get to September, they've dropped the financial stability rationale and now they're talking about a monetary policy operation by coincidence buying exactly the same
amount of bonds. So what I said is, you know, it worked out and it was certainly appropriate. I think there are at least some people in the FED system that we'll say, you know, we carried on then for another eighteen months buying this stuff, and looking back, do we wish we'd stop sooner? Maybe? So that was the entry into this discussion.
Yeah, Tracy, I remember at the time feeling as though the FED had sort of backdoored itself into QUEI starting with this big asset purchase for pure plumbing reasons, but then finding it hard to extricate in the same way that like the original QI was in the sense.
Well also the mission creep from the plumbing of the US treasury market, which I think we all agree is very important for the overall global markets and also the economy. But then they started buying corporate bonds as well, which was a huge step change. I remember in the sort of like early to mid twenty tens because I was covering the corporate bond market at the FT and I remember every once in a while I would say, like, oh, people say that if this market blows up, the FED
might have to step in and buy corporate bonds. And this was like a big deal. And then fast forward to twenty twenty and it happens, and it you know, there was so much else going on that it didn't get as much attention as it should have in my opinion. But anil the corporate bond purchase program, what did you think about that and how that fit into.
Well that Actually, you know, they did buy that stuff, but then they got rid of it pretty quickly. So there's a little bit of a distinction between what happened there and what happened with the treasuries where it kept going. So they kept buying the MBS and treasuries for much much longer. And what my paper was about was to contrast what happened there with what happened in the fall
of twenty twenty two in the UK disclosure. I was on the Financial Policy Committee of the Bank of England at that time, so for the beginning of that at least I had some first hand experience there, but I'm not speaking for the Bank of England here, And that program was conducted very quickly. There was thirteen days over which they bought and they actually the thing people dind not to know is that they sold it all in twelve days. So they really got in and got out.
Oh yeah.
And they managed to pull that off when they were buying for the Financial Stability Rationale at the same time they were starting their QT. So here you've got these two things. Wait, you're buying, you're selling, Which way do you want and habit But they managed to pull it
off pretty gracefully. And so what I was trying to suggest for the FED is maybe they should look at their institutional structure and see if they want to do a little bit of tinkering so that they would have some sort of advisory group that would make the financial stability call. That isn't exactly the same people as doing monetary policy.
That's super interesting. I had forgotten that point, how quickly, because I remember when the Bank of England stepped into the market and people were like, oh, they've backtracked, they've lost their heart, they're not going to do it. But actually they really had continued the fight against inflation, and
that ended fairly quickly. See more about like from the FED institutional perspective, why the FED has found it challenging or did find it challenging in twenty twenty to sort of delink asset purchases for the purpose of smoothing a market versus asset purchases for the purpose of conducting monetary policy.
Well, so to be fair to them, I got this question in the discussion. Somebody said, well, you know, what difference does it make. They bought the stuff. It was clear they were going to need to buy much more, so you labeled it financial stability. Imagine that they had stopped in April, and then the FEC a month later said, now we're going to start buying and we're going to buy the same amount, You really think it would be that different. Maybe in that particular outcome it wouldn't have
been so different. But my point is more like, you never know when the next plumbing problem is going to show up and what the circumstances are. And I think you would like the market to believe that if you do face a Bank of England situation, that you've got, you know, a recipe for dealing with it, and that you thought it through and people can kind of understand
the way it's going to work. And to me, if it's the exact same group of people who make all the same decisions and you want to call this is a financial stability, that's a monetary policy decision, I think it just muddles the communications. And it also I think for the financial stability decisions, there are experts in the Federal Reserve system that you might want to consult and actually give them a voice. Now, the way the FED works, the FOMC owns every decision about the Fed's balance sheet.
So I recommended this Purchase Facility Committee a PFC, And I don't think the PFC could legally order the FED to do anything. They could make a recommendation in the FMC could then ratify. But I still think there would be some benefits to saying, well, our Technical Plumbing Committee, you know, is looked at this, decided that there's a problem and said why don't you go ahead and act on this recommendation. And then presumably then the PFC would a few months later say we think this is done.
You could end it and you can go ahead and start selling. And ideally you would have announced the rules under which you would sell, you know, or how are you going to determine how much you're going to sell? Who are you going to sell to? All these kinds of things. But there's a bunch of technical issues that need to get worked out. And again, if you want to convince everybody this is separate, then having a whole separate playbook that you point to I think would be valuable.
I have a Jackson Hole related question on this, but you mentioned that someone asked you a similar question at the event. What's reception like at these things? How do you know if your presentation has been successful? Because something like your paper, you're making constructive criticisms of a program, but they are to some extent criticisms. Nonetheless, so what do people say after you present?
Well, most of the people that are in that room know each other. I've known a lot of these people for a long time. Some of them will tell you if they think you're full of it, they'll just say, I don't you convince me at all. Had somebody tell me that just fifteen minutes ago. But there are others that said, hey, that's pretty good. I'd like to think about that more. Let's stay in touch, you know kind
of thing. So you're never going to get unanimity in a group that diverse, and I think you figure out if what you were arguing in favor of actually changes what they do. So if they bother to set up a PFC or some other central bank, does I think that would be fantastic and I think it could happen.
You know, you mentioned the Bank of England episode in twenty twenty two. Similar questions arose in March twenty twenty three when SVB blew up and there was once again these questions, will the FED have to do something that, at least on surface, is in contravention of the ongoing fight then against inflation. I'm actually curious this distinction between asset purchases for the conduct of monetary policy versus asset
purchases for the conduct of market stabilization. I would actually be curious your story of what does asset purchases for monetary policy to do? How does that transmit? How does Q transmit?
Okay, so can I do it in two steps? So let me first say, asset purchases for financial stability should only be deployed when a lending facility won't work. Going back to Badget, everybody understands central banks lend, you know, and all of that. So the thing that's weird about asset purchases is you're finally admitting, Okay, the lending facility isn't enough. In March of twenty twenty three, the lending
facility work. They didn't actually have to buy anything. So it's a little different, and I think making that distinction, it's true your balance sheet grows for a little bit when you do the lending, but I still think it's worth for analytic clarity to separate those two. How does QI work? Well, you could have five conferences on that. So the fed's theory of this has always been that you take duration, you're buying longer term securities. You're taking
that out of the market. There's people that crave duration, that want to have that in their portfolio, and so the first thing you do is you reduce the supply that's available to market. That lowers interest rates to some extent, but it also probably changes term premium because people have to now pay a premium. If they want to get the treasuries that you've taken away, they're going to bid that up, and then if they wanted duration, they're going to go find it somewhere else, so that they think
that that's going to spill over into adjacent markets. It's incredibly contentious as to how wide the spillovers are. We know the best evidence for QE comes when markets were very dysfunctional, and whether this was just a signaling thing that's the Fed's got your back, or whether it was really this complicated theory I just gave you is very hard to know, but I guess that's the state of play.
Joe.
Do you remember that Ben Bernanki quote where it was like the problem with QE is that it works like in practice but not in theory. Yeah, yeah, Okay, Well, on that note, maybe we can broaden this out a little bit and talk about the transmission of monetary policy in general. But it feels like a lot of the debates that we had post twenty twenty are now potentially happening in reverse, where we're asking, like, Okay, the Fed's going to ease what does that actually mean for the
economy and for markets? How are you thinking about that?
Okay? I think that question is related to the thing that the two of you talked about at the beginning, which is, Okay, the Fed's going to hammer the economy. They've raised rates, you know, five hundred basis points. The economy has not fallen into recession and crashed. So part of the motivation for the conference is how did that happen? And now inflation is starting to come down? How did that happen without slack opening up nearly still happen? I
think we don't know. Part of it is the stuff that we didn't understand or see coming on the way up has certainly reversed itself. So some of it they got maybe for free. Some of it is people are not still asking for aggressive wage increases, so we haven't seen these second round effects where because you discover your grocery bills higher. You go to your boss and say I need a raise, and then he gives you a raise, and he has to raise his prices and so on.
So we haven't had a huge wage price spiral, so that's been helpful. Chairman Powell today talked about inflation expectations being anchored, and because people kind of trust the Fed, they're content to go back for asking for normal raises because they think prices are going to grow at the normal rate. So I think it's a complicated story. On the question of why didn't the economy tip over, I
think that's a very other contentious debate. Some of it looks like the fiscal stimulus was bigger and more targeted in ways that impacted monetary policies. So what do I mean by that? Well, Number one, auto industry normally gets crushed when the Fed hikes interest rates five hundred basis points. People still can't get cars from the shortages from four years ago, so the auto market hasn't tipped over quite
so much. Construction normally gets crushed. Well, the Inflation Reduction Act, aptly named, has generated all kinds of construction spending, so that hasn't tipped over. So those are two of the engines that normally tightening would work through that haven't been crushed. Now the housing market has been hurt some. But I think it is very much an open question as to how they've pulled this off.
What does it say that there are so many open questions, like we're like, okay, good time.
We could have five.
Conferences on how QUI works alone. We don't really know the degree to which interest rate hikes have depressed inflation versus some of the reversal of these distinct factors like big picture, the fact that like so much and so much energy it spends in markets and everyone else thinking about monetary policy, and yet these core fundamental questions are like massively open for debate, Like what's your take on that.
I think we got lulled into a sense of false security by twenty five years of pretty good luck where we didn't have big shocks and where central banks built a theory of the case of this is how the economy works. We know we can fine tune and land things just right. You know, we need to worry about
these one or two variables. We've got this kind of conventional consensus, and you know that kind of got blown up in the global financial crisis, where the simple models, the Phillip's curve and all that didn't work out so much because if you saw the size of that recession, you should have had massive disinflation. It didn't happen there. Then we didn't see this inflation spike coming. It came.
Now it's dissipated again, no recession. So I think part of it is the period between about nineteen eighty four and now has been an anomalous period. We didn't have deep recessions, we didn't have these wild external shocks to deal with, And I think that also means that it's really hard to do empirical work because there's not a lot of variants, and so there's lots of theories that
work just about as well. Like I think inflation is going to be what it was last year, that model's incredibly hard to beat.
Speaking of empirical research, I wanted to ask you about one of your I think probably one of your most well known research projects or papers, and this was on price setting. During your PhD, Joe asked you how QY works. So I'm going to ask a very simple question and then hopefully you can talk about your paper. But what changes prices or why do prices change.
Well, businesses will try to pass through cost shocks when they come, but for lots of goods, the cost just keep following because automation and just supply chain efficiencies keep getting ever greater. If you just look at the way that prices for so many goods have evolved, the cost just falling, and so we haven't had a great amount of cost pressure, at least for goods. Now for services
it's rather different. And you certainly saw after the pandemic if you tried to go on vacation or come to any place where it was you could go hiking and be away from people, it got really expensive and the market cleared by price, just like you got taught in your econ one on one class. So I think it depends on what you're looking at. I think for the service sector the usual story is kind of right. It's its demand versus supply, and if the demands urges, price
is going to go up. In many cases, what you actually see, like in supermarkets, is you just see fewer discounts, so there's a lot of loss leaders to draw people into the stores. When the economy's running really hot. They just they do less of that, so that's a hidden price increase, but the effective price paid is going to go up.
You know, it occurs to me, you know, you talk about this like long stretch of stability, or people talk about it the Great moderation and this confidence that like central banks or maybe just the FED in particular, has this power to sort of solve any problem or smooth over any problem. And then there was a lot of questions about whether that was true during the Great Financial Crisis. But then the economy maybe not as fast as we'd like,
but it slowly resumed it's ascent. Then COVID comes and we get a very different kind of shock and inflationary shock. But here we are in August twenty twenty four. Unemployment is below four and a half percent, inflation seems to be back to target basically, Like, I feel like you could tell a story in which all of the belief about the omnipotence of the FED actually kind of keeps getting vindicated.
Ah, yes, and no. I mean I think that they showed tremendous courage hiking interest rates as fast as they did. One of the other panels on my panel was talking about communications policy and pointing out how much more predictable FED policy has been, which I thought was quite interesting to show just how systematic is and it's not just the FED, all the central banks have gotten away from this. We got to surprise them, you know.
They thought about that.
Yeah, think about green Span. I used to give a handout to my class of a nineteen ninety one FMC meeting where he talked about the journalists are going to be watching you at Jackson Hole, the tilt of your head, which way you look, and how you answer a question. We can't let them know what we're thinking. You know now how it used to be like that.
Yeah, so you surprise their ability to surprise.
So they've done a lot of good stuff. And if you looked in December, somebody raised this at the meeting in December of twenty twenty one, if you asked how much higher interest rates for forecast to be, I think at the end of twenty twenty two it was something like seventy five basis points. Well, they blew through that, so even they didn't know what they were going to do, but once they got going giddy up.
So the panel where you were speaking it was about you know, the financial stability and the transmission of monetary policy, and we are coming off of quite a dramatic market event. So we're speaking on August twenty third, and then, you know, a couple of weeks ago, we have this huge sell off in markets, lots of talk about the unwind of the carry trade, and at that particular moment in time, there were some calls or maybe at least one call for the FED to do some sort of emergency intervention.
Given your knowledge of financial stability and your work on this topic, how did you view that episode and what's your sense of the response that the central bank should have taken if any.
Well, look, the markets always want to get bailed out, so the fact that people were saying that this should happen is no surprise. But I use that as an example in my talk. I said, you know, it turned out in the event that there was not so much instability at the beginning of the month as to have
any central bank have to go intervene. But if they had intervened, I think they would have wanted to use the Bank of England playbook and they would have wanted to say this just like what the Bank of England did, and so the spirit of my comments were, Okay, not everybody has the legal infrastructure that the BOE does. So there is a financial policy Committee, it's by statue, there's all these rules around it. If you don't have that, why don't you go ahead and set up something that
would approximate it. So let's suppose the thing in August had gotten much worse and had gone on for a few more days into a week or two, and then somebody was going to buy What would they have said about it? You know? And I think they're having the playbook worked out and agreed amongst yourselves in advance and communicated to markets probably would make that easier next time around.
Yeah, I remember this was potentially one of the differentiating factors of March twenty twenty was that the FED kind of had a playbook of what it could potentially do, and so it could kind of pull it off the shelf. I have just one more question, which is looking over your career history and research, it is incredibly varied, probably like one of the most varied academic careers that I've seen.
So you've done work on Japan's economy. I think maybe you came up with the term zombie firms, or at least you did some of the early work on that topic. You did early work on contingent capital Coco's living wills, Like how do you decide what you want to look at and examine and what do you think you're going to be looking at next?
Well, I mean, one thing kind of leads to another. So I started out. I was I was on the staff at the board actually, and Greenspan was talking about stuff in nineteen ninety that I couldn't understand. And my colleague, my longtime co author, Jeremy Stein maybe you've had him on here. Jeremy and I were talking and we started trying to figure out, like, how do we understand what he's talking about? So we started studying banks, how monetary
policy transmission worked through the banking system. Then we started learning about banks and started to think about financial regulation because it's kind of tied up. And Japan had this really terrible productivity ten year long crisis where the banks were in the middle of that. So a lot of this is all tied together by banks. Actually, the next thing I'm working on is actually money laundering. So imagine you think about where the global economy is going to
be in five or ten years. My guess is there's going to be more fragmentation. There'll be a lot of stuff on sanctions, there's going to be friendshoring, there's going to be all these forces. And that kind of economic policy involves the state compelling the private sector to do stuff that it wouldn't otherwise do. Okay, when you think about most regulation that the government engages, and it's to correct an externality, it's some adverse bill over. You know,
private incentives don't align. This isn't that. This is like, okay, we think there's a risk of another nine to eleven. We're going to compel you to do a bunch of stuff. It might cost you half a billion dollars, but you got to do it. Where do you draw the boundaries on that, and how do you think about it? Well, economists don't have a great way of thinking about problems of that sort, because you can't do cost benefit. If you know, you think about the value of a human life.
You could try to start adding this stuff up, but it's not very satisfying. It turns out there is one part of the US economy where we've run an experiment. It's a fifty year old experiment, and it's where we compel the private sector to deal with money laundry. And so if you look at the history of how money laundering laws have evolved, there's a lot of lessons in there for once the state starts compelling the private sector to do stuff. So, Kate, Judge and I are working on a book on this.
Can you tell us some of the lessons? You know, we'll read the book still vite lessons come back?
Yeah, I mean there's so many. I mean it's gonna be a book, but many many analogies about you know, you you start out, you don't have an overall set of principles and objective, So what do you do? You're reactive, So think about the way we did Russian sanctions. It's kind of pulled out of the air, made up. You look at often their competing aims with respect to money laundering. So we don't want to push people out of the financial system. But if we make the know your customer
stuff too onerous, we drive them out. So there's a trade off. It's kind of hidden. We don't have a good formula for dealing with think about all the things we're going to do with which Chinese companies do we cut off? Where are we going to draw the boundaries? So there's many, many, many analogies.
All Right, you're going to have to come back on All Blots or Kate will to when the book is out, to give us all the lessons and all the detail and nuance. But in the meantime, and Neil, thank you so much for coming on All Blots. Really appreciate it.
That's fantastic.
Thank you, Joe.
That was interesting, and part of me thinks it's kind of crazy that that was the first time we had Aneil on.
Yeah, he was great, and I know all these different topics. We didn't even really talk about Japan at all.
Yeah, we could.
Have done a whole separate episode just on Japan totally.
I really enjoyed that. And I do remember thinking in March twenty twenty that this massive balance sheet expansion that the FED engaged in was not the same thing as the QWI, even though in the monetary aggregates it looks like it's all the same thing on the chart, that there was clearly something different, And I remember thinking like, oh, it's sort of got a tricky situation here, because then they had to figure out the sequence of the unwined Yeah,
then to the first rate hike, and so it's interesting, you know, and then we sort of forgot about that. It's ancient history. But the idea that there are costs if a market intervention for financial stability purposes ends up in intersecting with whatever you're trying to fight on the macro front.
Right with monetary policy, and then you get those sort of cross currents. The other thing we'll have to watch out for going forward is if there is a PFC created. Yeah, we'll know where it came from.
Well, because everyone listened to odd Lots or either that, or maybe it came from all present the room at Jackson Hole. It's got to be one of the other though. But the intuition there makes a lot of sense. And I had forgotten. I didn't forget the whole Bank of England liz Trust Pound mini crisis in late twenty twenty two, but I had forgotten how quickly the Bank of England
was able to extricate itself. Yeah, and because there were a bunch of you know, people like ah, you like lost your will and the fight against inflatia is there. They do it again and of course, you know, there was the opening of the discount window or discount window activity in March twenty twenty three in the US.
It kind of.
Got lost in the political drama. Totally happened afterwards, but it wasn't.
Both of those are examples of how there are certain aspects of the balance sheet that don't evitably have to interact with like the macro fights you're trying to have, right.
Like, you can design these sort of last resort programs to fine tune certain aspects with financial markets totally.
And this is where, like, if you accept the premise that there is a fundamental difference between asset purchases for financial stability versus asset purchases to drive interest rates lower take duration out of the market, then this is where the problem of a sort of pure money supply approach comes from, because again, on paper, it's all the same M like M one on or M two whatever it is,
but they do have different functions. And I do think this is where sometimes people get led astray simply by looking at that aggregate chart and not realizing that at different times those purchases, even though it's still just you know, reserves for securities can do different things.
Yeah, I think that's right. All right, shall we leave it there.
Let's leave it there.
This has been another episode of the All Thoughts podcast. I'm Tracy. You can follow me at Tracy Alloway.
And I'm Jill Wisenthal. You can follow me at the Stalwart. Follow our producers Kerman Rodriguez at Kerman Arman, Dashel Bennett at Dashbod and Keilbrooks at Kelbrooks. Thank you to our producer Moses ONEm. More odd Loots content go to Bloomberg dot com slash odd Lots where we have transcripts, a blog in a newsletter and you can chat about all of these topics twenty four to seven in our discord Discord dot gg slash odd Lots.
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