00:00What is the importance of a central bank articulating, conveying its reaction function, and where do you think the S.E.P. falls short at the moment?
00:09The advantage of conveying your reaction function is the markets can anticipate in real time as the economic outlook changes what the Fed is going to do in the future.
00:16And that actually speeds up the transmission of monetary policy to the real economy.
00:20If the markets know how the Fed is going to adjust, market prices adjust immediately.
00:25And so that makes the Fed's response communicated to the market, to the economy, more quickly.
00:30So that's a really good thing.
00:31Right now, the summary of economic projections is very much focused on the modal forecast of the 19 FOMC participants.
00:38And so it doesn't really tell you much at all about what the Fed would do if the tariff impact turns out to be larger on inflation or turns out to be larger on growth.
00:46How will the Fed pivot?
00:47How much will they cut rates?
00:49This is why a lot of central banks around the world publish staff forecasts with scenarios or publish committee forecasts with scenarios,
00:57which basically the scenarios give you some sense of what the central bank will do if things turn out differently than expected.
01:03Last week, Bernanke gave a presentation at the Federal Reserve, the second annual Thomas Laubach Research Conference.
01:09He basically outlined why the Fed needs to do this.
01:13The Fed is basically an outlier.
01:14Every other central bank does this in one form or another that are peers of the Fed.
01:20And this would actually help the Fed to both communicate and also pivot when things turn out to be different than they expected.
01:26If you had that scenario in, say, 2021-22, that inflation might stay higher for longer, that probably made it easier for the Fed to terminate its large-scale asset purchase program earlier.
01:37Bill, isn't this something that effective communication in the news conference could address?
01:41Well, I think the problem with the news conference is the questions are very much focused on the central forecast and the summary of economic projections and the dot plot.
01:50So we don't get into a lot of detailed analysis of what if.
01:55You know, when Paul is asked questions about what would you do if this happens, he usually says it's data-dependent.
02:01We'll see.
02:02If you have actually sketched out alternative scenarios, that gives you a little bit more meat on the bone to sort of see how the Federal Reserve would react if things turned out differently than expected.
02:10The Federal Reserve already does this.
02:12As part of the staff forecasts that are given to the Federal Open Market Committee participants, they do what are called alt-SIMs, which basically are simulations of if the world turns out to be different.
02:23So this is not like it's not being done internally already at the Fed.
02:27Just, I think, sharing a little bit more of this information with the public would be very helpful.
02:31Well, Bill, there is one argument that part of the reason market participants concentrate so much on that median outlook is because it is anonymous, that what we get in the SEP, we don't know what each individual member thinks.
02:41So it forces us to coalesce around that median.
02:44Should there and could there be a scenario where we do know what each individual member thinks, that it is no longer an anonymous survey put out to the public?
02:52Well, another shortcoming of the summary of economic projections is you can't connect the interest rate dot back to the forecast that that person made for unemployment, inflation, and growth.
03:03So you can't really discern an individual person's reaction function.
03:06There have been proposals that have been made from time to time that let's actually publish what each person's forecast is so you can actually sort of see that reaction function.
03:14I think that would be an improvement over what we have today.
03:18But, of course, then people are going to be, you know, trying to figure out, well, which dot is the chairman's dot?
03:24And I think, you know, communicating broadly to financial markets, to people who are less, you know, Fed watchers than me or you, I'm not sure that connecting the dots really allows you to provide that nuance.
03:35But what will the Fed do if things turn out differently than expected?
03:38It does seem like we're in an environment, though, where Chair Powell has been trying his hardest not to make news.
03:42And part of that bill seems akin to what's happening in politics, that President Trump is more likely to say something about where the path they're going and his displeasure for it.
03:51What changes if we do get something to what you're proposing, where you get more scenarios?
03:56Is there increased political pressure?
03:58Is that a risk that the Fed should think about?
04:00Well, I think the political pressure of scenarios is that you're writing down things that might be not so good.
04:06So let's imagine that the Fed wrote down a scenario where the tariffs are going to turn out to be higher for longer.
04:12That's going to feed more into inflation.
04:14You know, I'm sure President Trump wouldn't like that.
04:16But still, it's a it's a it's a possibility in terms of the economic outlook.
04:20And the Fed really does need to think about things beyond the central forecast.
04:25Can we just wrap it up with something you've touched on a few times, Bill?
04:28If the dual mandate is in conflict at the end of the year, which side of the mandate do you think they should prioritize?
04:35I think it's really difficult to say at this point because it depends on what the risks are of making a mistake.
04:40So let's imagine that you decided, oh, I'm really more worried about the growth side.
04:44And then as a consequence of that, inflation expectations became unanchored.
04:48Then you'd have a real mess in your hand.
04:50You'd be back in the 1970s.
04:51Not a great place to be.
04:52So I think it's really not just about which factor is more off target, but also what are the risks of being wrong?
04:59And I think why the Fed is paused right now is because they don't want to be wrong.
05:03This is a very tricky situation where you don't know where the trade policy is going to land.
05:07You don't know the impact of trade policy on the on growth and inflation.
05:10And you don't know how this is going to affect households and businesses in terms of their attitude to sort of future inflation.
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