00:00We were all watching that news conference, and it didn't start terribly, and then progressively it just got more and
00:05more confusing.
00:06What was the point in that news conference where you sat up and said, this is weird?
00:11Well, it's weird when you're not explaining why free people are dissenting, yet the committee is deciding on no change
00:18in policy.
00:18There really was virtually no information about how the Federal Reserve is thinking about monetary policy,
00:23how the Federal Reserve is likely to react to incoming information in terms of how they adjust monetary policy.
00:30The silence of Worsh was really quite deafening, and the financial markets basically said thumbs down.
00:36I mean, the fact that the 30-year yield went up, the 10-year yield went up, and two-year
00:39yields dropped really was a sign that there was a loss of credibility from that press conference.
00:45Bill, I want to highlight a distinction because I think it's important, and it's in the body of your op
00:49-ed, and I want to say it for you.
00:50You're not against reducing forward guidance. This is important.
00:54I think that the complaints about the people doing the complaining often are around the idea that somehow we still
01:00want our hands being held,
01:01that we want to hold on to the post-GFC communication architecture.
01:06And, Bill, I don't think that's what your criticism is about.
01:09No, I mean, I wrote a group of 30 papers that we published in April, and one of the recommendations
01:15was to get rid of forward guidance.
01:16The only time you really need forward guidance is when you're at the zero lower bound for interest rates,
01:20and you're trying to provide additional monetary policy stimulus.
01:23But the rest of the time, it really just sort of inhibits the Fed and probably makes the Fed a
01:27little bit slower to react to incoming information.
01:29But that doesn't mean you don't want to know what the Fed's monetary policy reaction function is.
01:34And I think that's the real problem.
01:36Warsh, in his comments, is conflating the two, and they're very, very different.
01:40If I don't understand how the Federal Reserve is going to react to incoming information, I can't price financial markets
01:44correctly.
01:45And it's also creating a lot of uncertainty about what policy is going to be in the future.
01:49You know, the market response on Wednesday was really Fed credibility has lessened.
01:56And I think this is really own goal on Kevin Warsh's part.
02:00You know, I think one of the problems here, I think it's he's over-promised and under-delivered.
02:04You know, he's talked about, you know, sea change at the Fed, you know, radical regime change.
02:08But then the markets are actually getting very little in terms of guidance on how to think about the new
02:14Fed.
02:14Bill, we were discussing about whether maybe some of this was by design.
02:18There is going to be more volatility.
02:19There has been more volatility both at the front end and the long end in response to every economic data
02:24point and comment coming from anyone on the Federal Reserve
02:27as a result of an absence of some sort of reaction function articulated by the FOMC chair.
02:33Do you think that this could be by design to help reduce inflation without hiking rates?
02:37I don't think this is a really great strategy for a couple of reasons.
02:40Number one, it's a very inefficient way of tightening financial conditions.
02:44You know, basically, you're driving up risk premium in markets.
02:47That's a deadweight loss to the economy.
02:49Number two, how well can you actually control the market process to generate the impulse that you want to slow
02:55the economy down sufficiently?
02:57And lastly, you know, it's a credibility issue.
03:00I mean, if the extent that the markets reacted the way they did on Wednesday, that's telling you that people
03:03are more worried about the Fed's resolve to do the job.
03:07That means inflation expectations are less well anchored than they were prior to the press conference.
03:12That in itself makes the Fed's job harder.
03:14Bill, how high is the bar for there to be, I don't want to say mutiny, but the bulk of
03:19the FOMC committee voting against the chair, potentially with the governors joining suit?
03:24I don't think we would get to that.
03:26I think at that point, Worsh would throw in the towel and vote with the majority.
03:29I can't imagine a situation where the chairman allows himself to be outvoted by the committee, because if you had
03:36that result, it basically would be saying that the chairman has lost control of the committee.
03:40And that's just not a very good look for any head of any organization.
03:44Bill, he was also vague about the inflation target.
03:46That was confusing, too.
03:47Vague on the inflation target, whether they'd respond to it and what tool they would use to respond.
03:53Can I pick up on that last point, Bill?
03:54Bill, he's flirting with the idea of using balance sheet instead of short-term policy rates, short rates.
04:00What do you think of that?
04:02Well, I think the problem here is that even if you reduce the balance sheet, you're probably going to be
04:05able to reduce it by about a trillion dollars or so if you want to continue to have an ample
04:10reserves regime.
04:11And I think the commitment of the committee is to maintain the ample reserves regime.
04:15And then the question is, how much restraint is shrinking the balance sheet by a trillion dollars going to be?
04:19It's actually going to be very, very small.
04:20So the idea that, you know, you pull on this balance sheet lever and that allows you to not have
04:25to tighten monetary policy, I think, is very much exaggerated.
04:28It's obvious that for the market, the primary tool is still the policy rate.
04:32Because you can see that in the reaction this morning to the sensitive economic data that we got moments ago
04:35on wages.
04:36They came in hotter labor costs.
04:38You saw yields rise at the front end of the curve.
04:40Bill, we've talked about this all morning, the credibility here.
04:43You say credibility has been here.
04:45Others agree with you.
04:46Let's talk about how you repair it.
04:48When you do a job really badly, sometimes you have to do more than you otherwise would have had to
04:53do.
04:53How much more do they need to do now at this Federal Reserve to regain that credibility?
04:59Well, I think you have to follow up talk with action.
05:02So I think that what's happened in financial markets over the last, you know, 72 hours or so basically increases
05:07the pressure on the Fed to act in September.
05:10If it's a jump ball in September, you almost need to tighten now because you have lost credibility over the
05:16last couple of months.
05:17Do you think that it increases the chance of a larger than expected rate hike?
05:21It's possible.
05:22But I don't think that you're so far away from your inflation objective that, you know, you need sort of
05:27shock therapy.
05:28If the Federal Reserve did 50 basis points move, that would be, in my mind, a little bit of a
05:33sign of desperation.
05:34Why didn't you hike in July and then you do 50 basis points in September?
05:38I think that actually is a confusing narrative as well.
05:41What do you think the overall motivation is here?
05:44I mean, we've been talking about this and a lot of people said Kevin Worsh is a 100 percent respected
05:49person by the mainstream of the financial markets, by the establishment.
05:54Do you think this is just Rookie's error, the classic kind of first press conference of a Fed chair?
06:00Or do you think that there is some political motivation here trying to dodge the ire of the president going
06:05into the midterm elections?
06:07I can't judge that, but I generally think, no, that he's not trying to do it to sort of mollify
06:12the president.
06:12I think he really does believe that somehow outsourcing this to financial markets will improve the conduct of monetary policy.
06:19But you can't outsource it to financial markets for a very simple reason.
06:22Markets don't price to what the Fed should do.
06:24They price to what they think the Fed will do.
06:26And so if you try to outsource it to markets, all you have is the markets looking at the Fed,
06:30the Fed looking at markets, and the interest rate path is indeterminate.
06:34It's the spite of it.
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