- Good afternoon, everyone.
My name is Kim Schoenholtz,
and I'm delighted to welcome you
to
the 16th NYU Stern Economic
and Market Outlook Forum.
The host of today's forum
is the Stern Center for
Global Economy and Business,
which serves the
university through outreach
to the broader community
including the academic,
business, and policy worlds,
as well as students and alumni.
We're especially pleased
today to have here
students and faculty from all
over NYU
as well as numerous alums.
Thank you very much for joining
us.
Today's program will
last about 85 minutes.
It will begin with presentations
of 5 to 10 minutes
by each of the panelists about
economic
and market prospects,
followed by audience Q and A.
We'll finish by 6:30 p.m.
Please note on the screen, there
we go,
that you can submit questions to
the panel
using your smartphone
by going to the website
www.slido.com.
And entering the code number
4444
in the box labeled join.
You can also vote on the
questions
that others have submitted.
Your votes will help us judge
the issues
that are of greatest interest to
you.
Let me now briefly introduce
our distinguished panelists.
Starting with Lewis and
moving to Mickey and Subadra.
Lewis Alexander is the US
Chief Economist at Nomura.
Before Nomura he served as
counselor
to Treasury Secretary, Timothy
Geithner.
He also had been Chief
Economist of Citigroup.
Earlier he led a distinguished
career
at the Federal Reserve Board,
eventually becoming the Deputy
Director
of the Division of International
Finance.
Lewis obtained his Ph.D.
in Economics from Yale.
Mickey Levy is the Chief
US and Asia Economist
for Berenberg Bank.
Previously he was Chief
Economist at the Bank of
America.
Since 1983, Mickey has served
on the Shadow Open Market
Committee,
a group of academic
and business economists
that comments on the actions
of the Federal Open Market
Committee.
Earlier in his career,
Mickey was an analyst
at the Congressional Budget
Office
and the American Enterprise
Institute.
He received his Ph.D. in
Economics
from the University of Maryland.
Subadra Rajappa is the
Head of Rate Strategy
at Société Générale.
She represented Soc-Gen
on the Alternative
Reference Rates Committee.
The ARRC, or the private
group that was convened
by the Fed to help
coordinate the transition
from LIBOR (London Inter-bank Offered Rate) 
to SOFR (Secured Overnight Financing Rate).
Previously she was a
Senior Rate Strategist
at Morgan Stanley focused on
macro themes.
She started her career at
Solomon Brothers
as a quantitative analyst.
Subadra also is an NYU alum, so
(clapping)
special congratulates for that.
(audience clapping)
Having obtained her
Master's in Mathematics
next door at Courant.
Please join me in welcoming our
panelists.
(clapping)
So Lewis will now begin the
presentations,
followed by Mickey and Subadra.
After their brief initial
remarks,
we'll begin the Q and A session.
This one has a light as well,
so.
- Thanks very much, Kim.
Thanks everyone for coming.
I'm gonna talk, I'm just gonna
lay out
at a very high level my
sort of outlook for the US
and then make a few comments
about interest rates
and a few things related
to the current political
environment
and then turn it over to Mickey.
First of all, last year was
sort of a transition year
for the US economy.
We had grown about 3% in 2018.
2019 we sort of transitioned
to a slower growth.
A lot of that had to
do with fiscal policy.
I think that aspect of
it was underappreciated.
Obviously we had increased
uncertainty around trade policy,
in particular, and weakness
abroad.
All of which contributed to the
economy sort of slowing down
to something like 1.5 to 2% zip
code.
At the moment, the US economy
faces
a couple of obvious immediate
challenges.
The shut down of Boeing's
production of the 737 Max
is probably going to take
8/10ths off GDP growth
in the first quarter by itself.
We're obviously dealing with
the coronavirus as well.
We are expecting a significant
slow down in China.
A severe slowdown in
China, a slowdown in Asia.
I'm happy to talk more about
that.
But it's one of those things
where,
things are gonna be bad for
awhile
but we think the growth will
come back relatively strongly
after we get passed the worst of
it.
That sort of gives you
an environment where
a weak first half, stronger
second half
is generally kind of how we see things.
We think inflation is gonna
remain kind of in the zip code
of where it's been.
Sort of struggling to get back
towards 2%.
Obviously with that weak
growth in the first half,
that's gonna be more of a
challenge.
There are some upside risks
to the outlook that we see.
I would note the fact
that consumer fundamentals
remain very strong.
Certainly one of the ways you
could get
a more positive outcome is
if consumers just decide
that they could lower their
savings rate,
which given how high it
is would not be crazy.
So strong consumer
fundamentals, I think,
provide one source of upside
risk.
Another one is just the
fact that interest rates
are as low as they are.
We obviously, part of
what happened last year
was a sort of further ratcheting
down
of interest rates.
We're starting to see
stronger activity in housing
and whatnot which is one of
the places you would expect it.
So I think that is another
aspect that sort of creates
some upside risk.
Obviously at the end of what has
been
a very long expansion already,
you start to wonder about
financial risk.
If I had to pick one, I
would focus on corporate
non-financial debt.
It's the most obvious
source of sort of risk
for the economy overall
but I think it's easy to
overstate how big a risk it
is.
Frankly, the very low level
of interest rates themselves
sort of mitigates the degree
to which a higher level
of debt is a problem for
the corporate sector.
If you actually look at the
distribution of corporate debt,
it's more evenly distributed
than it's been in the past.
An awful lot of the
accumulation of corporate debt
was actually concentrated in
firms
that started out with
relatively low leverage.
I think that's something which
limits the degree to which
we should see that as a problem.
The Fed is on hold at this
point.
Frankly, probably through the
election.
I think the bar for raising
interest rates
is certainly very very high at
this point.
I think you'd have to see a
significant and persistent
rise in inflation which is
just very hard to imagine,
to get an increase in interest
rates.
There's obviously questions
about how bad
the down drafts are to get you a
cut.
We don't have that in our
outlook
but I'm happy to talk more about
that.
But what I want to spend a
little more time talking about
is where interest rates
are and how to think about
what they're telling us.
So what I'm showing in this
chart,
this is pretty simple.
The red line is just the Fed
funds rate
so a measure of short rates.
The blue line on this chart is
just 10 year Treasury yields
and then this green line is a
measure
of nominal potential growth.
The gray vertical shading
areas are recessions.
The point is, obviously, one
of the things that we see
over cycles is, in a recession
short rates tend to fall,
you get a steeply sloped yield
curve.
What happens in recoveries
is short rates tend to rise
up towards long rates
and you see these periods
where short rates and long rates
converge.
It tends to happen before
a recession starts.
But, in fact, the length of
time between that convergence
and when you get to a recession
varies.
And so the simple notion that,
you know,
the steepness of the yield
curve necessarily means
a recession coming.
I would push back pretty
strongly against that.
But the other thing to
note about these periods
when you see this convergence
of short rates and long rates
is that tends to happen at
levels,
a level of interest rates
that is more or less
the same as potential growth.
Now, if you look at
where we are right now,
we've had a convergence of
short rates and long rates
but at a level that is much much
lower
than potential growth.
And in some sense, it's that
fact that I want to just
talk a little bit about
how to think about that.
So, the first question
is, well, why is that?
And, I'm not going to go into
this
but there's been this long
discussion
over secular stagnation.
that focuses on the fact
that there are reasons,
structural reasons why
investment is low.
There's structural reasons
why savings is high.
The economy seems to need
a lower rate of interest
to sort of keep on track.
That's the whole debate
about neutral rates.
There are other things going on
as well.
Like the fact that the
correlation
between stock and bond
prices is now negative.
What that means in very broad
terms is
your two primary asset classes
are actually hedges for each
other.
And that means that risk
premium in general can be lower.
But my basic view is that
those structural factors
that have gotten us here
are likely to persist.
And so when I think about it
and I think about the
economy going forward,
I think that basic
situation of interest rates
being lower than potential
growth is likely to persist.
Now what are some of the
other implications of that?
Well, there's an obvious one
which is
how much capacity does monetary
policy
have to respond to recession?
You'll note in these previous
cases
short rates fell a lot,
like five percentage points
even in what was
relatively mild recessions.
The recessions in the early
1990s
and the early 2000s,
those were mild recessions
and you've still got
these very large declines
in short rates.
But if you actually even look
at the decline in long rates,
you're talking about two to
three hundred
basis point declines in long
rates over these cycles.
We've got 10 year Treasury
yields at sort of 165
as we speak, right?
And so there's a fundamental
question of how much work
can interest rates really do
in the next recession?
So there's a whole set of
questions
and there's a whole debate
and Ben Bernanke gave his
AEA (American Economic Association) Presidential address
in January on the subject
of like how much can monetary
policy do?
I'm not gonna sort of dive into
that
but that's obviously a question.
Now the other thing
that's sort of interesting
about that gap is anybody
who's done any work
on fiscal sustainability
knows that one of the most
important fundamental things
in fiscal sustainability
is the difference between
the rate of growth,
the nominal rate of growth
and the level of the interest
rates.
This is the so called G versus R
ratio.
Now, it turns out that the
AEA Presidential Address,
not this year but last year
was given by Olivia
Blanchard who talked about
this fact that if interest rates
are a lot lower than growth
that gives you more fiscal
capacity.
So one of the questions that I
think
people need to think about
is that in this environment
is not only is monetary policy
constrained
but fiscal policy has more
space.
And I would argue, we're
in an election year,
one of the things people
should be thinking about
is what does that mean for what
we can do?
Now, let me, I'm gonna not
talk about financial stability.
Dick will no doubt ask.
We can talk about that later.
Let me stick to sort of fiscal
policy
and thinking about if
we're gonna think about
what's possible in fiscal
policy,
I think it's worth thinking
about that a little bit.
What I'm showing you just here
is
federal spending as a share of
GDP
going back to basically the
1890s.
So what broad things would
I take away from this chart?
First of all is like they're
two pretty big shocks.
This is World War I.
This is World War II.
This is The Great Depression.
This is The Korean War.
That's actually what we did
in the financial crisis.
Like, one of the things
people have noted is
when we talked about this
being a big fiscal policy,
when you look at it in
the context of this chart,
it's kind of like, well, not
really.
And so as you're thinking
about big questions
like climate change or
healthcare
and thinking about what's
possible in a world
where interest rates are
relatively low relative to
growth,
it's worth thinking about these
spectrums.
Now, of course, what I'm not
showing you
is where is debt in all these
things?
So, just to make the point,
at the beginning of World
War II our debt to GDP ratio
was about 30%.
We took it from 30% to 115%
in a matter of about three
years.
Now, the 1950s turns
out were another period
when growth was above interest
rates
and so the way, in some sense,
the United States dealt with
this incredible fiscal
shock of World War II
was we kind of lucked into a
period
when we had that positive
situation
where growth was above interest
rates.
And we used that positive
situation
to, in some sense, deal
with the fiscal consequences
of World War II.
Now, I'm not going to show it to
you
but if you look at where we are
right now
our debt to GDP ratio is around
90,
depending which measure you use
and which thing you're looking
at
but you look at the projections,
they are going up very rapidly.
We are currently running a
deficit of something like
5% of GDP at the end of a long
cycle.
So, while on the one hand it
looks like a very attractive
time to do it, you do have
to think about circumstances.
Now, the last thing I want to
focus on
is governance.
So, given what's going
on in Washington today
and given what happened
in Washington last night,
I can't not talk about this.
This is something about
partisanship.
So, there's some very good
political science research
that takes votes in Congress
and you can essentially
put individual Congressmen
on an ideological scale.
And what I'm showing you is data
that comes from that kind of
work.
So you think of it as you
take every member of Congress,
you look at how they vote
and you can statistically
put them on an ideological
scale.
In this case, a low number
sort of means to the left.
A high number sort of means to
the right.
And what I'm showing
you is various measures
of where the Democrats and
Republicans
were at different points in
time.
So again, this basically starts
in 1870.
This blue line here is the
median
for Democratic House members.
This blue dashed line
is the 90th percentile
of House members who were
Democrats.
The red line is the median
Republican
and the red dashed line
is the 10th percentile.
So one of the points I would
make is,
obviously we're living in a time
when there's an extreme
degree of partisanship.
One simple question to ask
yourself is
how unusual is that?
It feels very unusual.
If you in fact look
historically,
it's not that unusual.
In fact, you might make the
argument it's more the norm
than it is the exception.
In some sense, this period
around sort of World War II
was the period, frankly,
when there was more,
seems more anomalous.
Now, I look at that
and I kind of look back
at what it was like here and go,
well, maybe it's not so bad
we've survived that before.
But if I go back to this
previous chart,
when we had this level of
partisanship in the past,
the federal government was
spending something like
two or 3% of GDP.
We're now spending 20% of GDP.
We simply ask the government
to do an awful lot more now
than we used to.
And the fundamental
question I would ask is
how big a problem is that
partisanship
in a world where we're
asking the government
to spend 20% of GDP, and
to be perfectly frank,
governance doesn't feel
like it's working very well.
I'm gonna stop there.
(clapping)
- Let's see how do I end this?
- [Man] You're going to advance
to the next, there you go.
- So I'll take more of a
focus on globally to start.
Global trade volumes have been
very soft
since the financial crisis.
And they slowed a lot
in the 2015, 16 period.
Now they're declining.
And if you look at the
right side of this chart,
you see what trade economists
call
the trade elasticity of income.
And in prior decades,
trade grew multiples faster
than global output and now
it's a touch below that.
Now, the decline in the
last year and a half,
I mean, this has generated
a global industrial slump.
You have global industrial
production declining
in most advanced nations and
capital spending is also weak.
And in many nations you have
healthy gains
in consumption that are off
setting this.
The US is much better
situated than other nations
in this regard.
Now, if we consider the decline
and the weakness in global trade
and the decline in industrial
production,
this is in the last year and a
half,
it's been emanating from China's
material economic slowdown.
I don't have a lot of time to go
into this
but China's potential
growth is decelerating.
And its actual growth is
decidedly below
what the official government
statistics say they are.
Now, if you break that down,
China domestic demand is weak.
Some of its consumption
has slowed a fair amount
and then on the expert side,
keep in mind China, for the last
20 years,
has been the driver of global
growth and global trade.
And its exports and imports
which had been growing
double digit are now flat.
Okay, and so it's really
interesting to look
at international flows.
China has become the
global hub for production.
They import a lot of
materials and commodities
and capital goods and durable
goods.
They produce a lot of stuff
and then they export it out.
And so their exports and
imports are flattened
and there's no question but
that in the last year and a half
the US tariffs and trade
policy uncertainties,
they've accentuated China's
weakness in global trade.
But the slow down has been
occurring for years, okay?
So there's no question.
And it's very interesting.
A lot of the most recent
empirical work shows
that it's a trade policy
uncertainty that's having
a bigger negative impact
than the tariffs per se.
Now, when we look at this
flattening
of global trade volumes
relative to global output,
if you go back and review the
research literature on this,
what you find is all of
the factors that drove
the robust trade in the 90s and
the 2000s
they're all negative now.
And so you could list them off.
China's fundamental slowdown.
The fact that advanced
economies, you know,
whether you look at US
or Japan or core Europe,
their capital spendings
declined as a share of GDP.
The increased reliance on
services as shared GDP.
Note that Chinese leaders
three years ago said,
we want to rely more on
domestic demand and services.
There are now higher
barriers, not just to trade,
but to immigration and
unfortunately it's not just the
US.
And then on top of that,
multinational companies are
reigning in
a lot of their global supply
chains
and this started a couple years
ago
and it points to, if
things pick up in trade,
it's only going to be a modest
pick up.
Now, regarding China.
The way I think of this virus
epidemic,
it operates to me like a
negative economic supply shock.
So you have a decline in
aggregate demand
and a decline in aggregate
supply.
People save more and I'd like
to make an important point about
China.
There's a large portion of the
middle
and upper middle class that
doesn't trust the government.
So the fact that the
government has lost credibility
may accentuate this and what you
see is
China's consumers, they're
spending more on things
they think are necessary
and less on things
that they think are
discretionary like autos.
I mean, I don't think
you see many auto sales
this week in China.
Same for not just hospitality
and leisure
but things like consumer
electronics.
Now, if you just take autos.
Auto sales in China have
fallen a lot from the peak
two years ago because of
tightening loan covenants
and the like, this accentuates
that.
So you have weakness in demand
and that's gonna reduce China's
input.
On the production side,
if people don't go to work
production is tied up.
Here I'd make two points.
Firstly, if the true base
of China's growth now
is not 6% like the government
would lead you to believe,
but more realistic something
that's less than half of that,
it's serious there.
We don't know how long it's
gonna last
and the critical question
that we don't know
is how will this disturb,
distort, harm global supply
chains.
We just don't know.
All we have at this point
is anecdotal evidence
but there's no data.
Within a month, we'll
start seeing trade data
of South Korea, Japan,
Australia, and the like.
If we look at prices of
global industrial commodities
and oil, the market is starting
to expect
there's going to be a
sharp, a sustained slowdown.
I would say one of the
lasting impacts on this
is not just this virus per se
and the lack of credibility
but if you put it into the
context of what's going on
in Hong Kong and the like,
I think one of the long
term negatives for China is
global companies are
going to be reassessing
their global supply chains.
Okay?
Now, I mentioned that,
what else did I have here?
So you see, China's
manufacturing PMI,
it's a survey.
It leads world industrial
production
by about three months.
Okay, now the US is better
positioned
with, you know, you could
say sound fundamentals
but we all know what's
happening with the debt
and the allocation of resources
and the, you know, some
of the governance issues
that Lew mentioned and
the dysfunctionality
of Washington.
But the fundamentals
underlying the US consumer
are very sound.
Okay, employment gains,
rises in real wages
in part due to productivity
gains.
This is raising real disposable
incomes,
wealth, high confidence,
housing is strong.
These look like they should
continue to be strong.
The weakness, industrial
production and capital spending,
the way I think about capital
spending
being so weak here
despite the Fed's efforts
to lower the real cost of
capital
and stimulate capital spending
is the positives
that boosted business confidence
and led in part to some of
the stronger capital spending
due to the deregulatory
environment
plus some of the corporate tax
reforms,
as far as I can tell,
those are being just offset
by tariffs and the uncertainties
and now we have to see
what happens, you know,
post this US-China agreement
and, you know, the jury is out
on that.
Now, as for,
by the way, this employment
to population ratio
of prime aged workers, this
shows
that the supply of labor
is much more elastic
then standard models presume
and you see wages are rising.
Now, I would say the economy
looks solid
and I would emphasize that, you
know,
I'm not too far from consensus
on growth
but I would emphasize that the
probability
of recession is very low
and here's how I go about it.
Lew mentioned the funds rate
and inflation with respect to
nominal GDP.
I'll echo that and say, you
know,
yes, the yield curve is inverted
but there are other ways
to look at the economy.
So if you look at the real
economy
there are no apparent
imbalances.
On the financial side,
with interest rates so
low I think that'll mute,
it will continue to mute
the financial imbalances.
And here I'd like to show you
real wages which don't get as
much attention as they should.
Now, what this chart shows is,
it shows year over year real
wages.
Okay, in the 18 months prior
to every recent recession.
I put a dotted black
line where we are now.
Three month moving average year
over year.
I didn't know whether to put it
at a point
or just, so I put it as a dot
across.
And what you see is
with very very few exceptions
economies continue to expand.
They do not go into recessions
when you have rising real wages.
And there's a reason for that.
Real wages increase, you
know, purchasing power.
This happens to reflect
productivity gains.
I actually took, you know,
some of these estimates
of the probability of recession
like you do probit regression
analysis
that usually has, regresses
the probability of recession,
puts the deal spread
on the right hand side.
I tried it with real wages
and it doesn't provide as good a
fit
because it provides some type
one errors,
some false positives in the
middle stage.
But then what I did
is I just got a typical, like
a Stock Watson probit analysis
and I added to the yield curve,
you just add real, the real
funds rate,
and then you add real wages
and the probability of recession
is extraordinarily low.
Now, I'd like to broaden
that to the following.
Okay, what I did is I
went back and I looked at
every, you know, what happened
at the end
of all previous recessions.
And I looked at oil prices,
inflation,
the federal funds rate, and real
wages.
And the situation we have now
is just like almost the opposite
of what has happened before
every prior recession.
Real wages are rising,
inflation is low.
Who can disagree with Lew
about what the Fed is gonna do?
I mean, they're on hold now
and the barter raise rates
is just ridiculously high.
Inflation isn't the problem
unless nominal GDP accelerates
significantly so the
probability of recession is low.
Now, why's that important?
Well, because people like
expansions
but if any of you were
interested in the stock market,
I wrote a paper in the spring of
2018
and I asked the following
question:
What happens to the S&P 500
if corporate profits fall
and the economy keeps growing?
And what it showed is
and there's every expansion,
there's been a mid cycle peak,
whether you look at NIPA
profits or S&P profits,
guess what, the stock
market kept on going up
nearly as long as the expansion
did
even if profits fell.
Hey, that's where we are now.
Don't ask me why.
That's a toughie.
It's just an empirical finding.
Now, on the Fed what I'd like to
emphasize
is it's not just the Fed
that has what I think
is easy monetary policy
with excess balances
and very low interest rates.
The ECB (European Central Bank), with its negative rates
and QE (quantitative easing),
it is the BOJ (Bank of Japan) with its
persistent QE and negative rates
and I like to ask a few
questions about this
and that is,
what would have happened
if all the Feds QE
and negative rates had actually
worked
to stimulate the economy
as the Fed's model
had predicted it would?
And what I want to emphasize
here is
whether you're looking
at the Fed or the ECB,
one of the most interesting
areas to dig into is
why haven't the channels
of monetary policy worked
as they traditionally did
before the financial crisis?
And then I think there are real
flaws with forward guidance
in just, I could just mention
one thing.
You know, the Fed through
its forward guidance
perceives and builds into its
models
that, yes, it can influence
financial market expectations
but through its forward
guidance can it really influence
the expectations of
non-financial companies?
And so I think there's
some real issues here
and I would emphasize that
when we look around the world
and see these really really low
rates
and particularly low bond
yields which are pushing up
asset prices and contributing
to wealth inequality.
And they're driven by, in part,
by the central banks' forward
guidance.
Are the central banks
trying to do too much
and trying to push monetary
policy
beyond their natural scope?
So I'll stop there.
(clapping)
- I'll try to keep this short
and sweet.
So I'm not an economist.
So I'm not going to
argue with Mickey or Lew.
But, you know, from my
perch as a rate strategist,
I feel that the US
economy is at crossroads.
There are several key
risks to the economy.
Just from your questions
that we've received already,
it's trade, Brexit, US
elections, you name it.
But the way we look at the world
we feel like the risks
are sort of tilted towards
more to the downside.
Especially for yields.
My feeling in this current
environment
is that the risks to yields
are somewhat asymmetric,
i.e. that the market is
going to react, you know,
by rallying a lot more
if the data is weaker
as opposed to selling off if
the data is actually positive.
So just quickly, these are the
forecasts
from our economist.
Clearly by looking at the GDP
forecasts
for the second and third
quarter,
our economists are calling for a
recession
so it's exactly opposite of
what Mickey was talking about.
You know, if you look at some of
the data
that's been coming in,
business investment has been
falling earlier and faster
than in previous cycles.
Trade uncertainty is
probably contributing to it.
Boeing, GM strikes are also
sort of contributing factors.
The key risk is that even if you
look
at the fourth quarter data, you
know,
broadly speaking we had a 2.1%
GDP for the fourth quarter.
But the household spending
sort of weakened a little bit.
Business spending is continuing
to fall.
Imports of consumer goods also
fell partly
because of tariffs but
these tend to be, sort of,
the leading indicators of a
decline in domestic demand
and that's ultimately my
concern is that the US economy
is sort of running on one engine
and it's a big engine, it's the
consumer.
So any time you see
any sort of a pull back
from the consumer I think
that that's going to quickly
translate to a slow down
in the economy and economic
conditions.
Really where I see the trouble
spots
are in capex (capital expenditure) spending.
Capex spending has declined
quite meaningfully.
As Mickey had pointed out,
after the tax cuts in 2017
I would argue that a lot of the
extra cash
that corporations had was sort
of
put to work either in equity buy
backs
or executive compensation.
Very little of that actually
went into, you know,
capex spending and business
investment.
CEO confidence, another
metric that we track,
you know, has been quite low.
I would say the third
quarter was the lowest
CEO confidence level in the past
decade.
And in the fourth quarter
it rebounded a little bit
but it's still below 50
which is the magical number
for a positive confidence
indicator.
The other trouble spot
is ICE and manufacturing.
I mean, the typical pushback I
get
when I show this chart is the US
economy
is not that reliant on
manufacturing.
But if you look at 10
year Treasury yields,
the chart on the top there,
there's a very strong
correlation
between 10 Treasury yield
changes and the ISM (Institute for Supply Management).
So the rates market, broadly
speaking,
seems to be trading much more in
line
with weakness in ISM than
positive sentiment in equity.
So to sort of counter was Lew
was talking about earlier,
I feel like the markets are
correlated.
I feel like the equity
markets and bond markets
are correlated.
Everything seems to be rallying
because the Fed is keeping
policy somewhat easy.
So really,
I do see Mickey's point on the
recession
but really the reason for
why economists are calling
for a recession is the fact that
we think
that corporate profit
margins are declining
and are going to continue
to come under pressure.
If you look at the rise in unit
labor cost
as well as the decline in
productivity,
that I think ultimately is what
leads us
to a recession and,
you know, in this cycle
we would argue that
corporate profit margins
peaked in 2014 and have been
sort of steadily declining.
And, you know, as we
progress through this cycle,
if we do see corporate profit
margins
continue to come under pressure
at some point you're gonna
see that corporations
are going to scale back
on investment and hiring
and if there's any sort of
slow down in the job market,
that's ultimately when you're
gonna see
a retrenchment from the
consumer.
And that's really what is the
concern
that's driving some of our
forecasts and our views.
I agree with both Lew and Mickey
that I feel like monetary policy
is actually reaching its limits.
So if you look at the chart
in the top right here,
you know, I'm kind of scratching
my head
as a market practitioner
when Ben Bernanke said
there's five percentage points
of room
and the Fed has more room to
sort of ease monetary policy.
Trump this time around is
negative
and a historic low.
So if the Fed does bring
interest rates
back to the zero lower bound
and starts either using
forward guidance or QE,
my concern is that they're
not gonna be able to deliver
the same level of easing
they delivered during QE
when they could compress term
premier quite meaningfully.
At this point, term
premier, in my opinion,
are extraordinarily tight
and it's gonna be very hard
for the Fed to deliver
the monetary policy.
The other concern for me is
the survey based measures of
inflation.
If you look at the Michigan
five to 10 year survey
base measures of inflation,
inflation expectations
have declined quite
meaningfully.
In the five and four, five you
break even.
Which is a metric that the
Fed tracks very closely.
Seems to be tracking the Soviet
based measures of inflation.
And that, I would argue,
ultimately
is the Fed's concern is
that they are concerned
that they're gonna lose control
over inflation expectations
so they want to act
preemptively by cutting rates
more aggressively in the cycle.
And my concern is they're
not gonna have nearly
as much room to cut rates.
The other concern to me
is inflation expectations.
If you look at five year break
evens,
in Europe it's at historically
low levels.
And so you have this sort
of gravitational pull
of inflation expectations
declining quite dramatically
overseas and that's keeping
inflation expectations
in the US low.
Even though if you look at
core CPI (Consumer Price Index) for the past year
it's been above 2%, yes,
core PCE (personal consumption expenditure) has been tracking
well below 2% but, of
course, CPI's been above 2%
but inflation expectations
are low and declining.
So in this context, broadly
speaking,
our 10 year Treasury forecasts
are at 120,
the lowest 10 year Treasure
forecast on this tree.
You know, again, my concern is
that
the risks to the economy
are asymmetrically skewed
to the downside so if there's
any sort of,
you know, the price action
I would say in the last
three weeks is sort of telling,
right?
I mean, we had the coronavirus
scare
and we saw 10 year Treasury
yields decline out to,
all the way down to 150.
So it doesn't take a lot
to sort of move the markets
towards low yields.
The other sort of point I'm
gonna make
is the counterfactual, which is,
I really don't see any clear
catalyst
for a sustained rise in yields
above 2%.
Yes, I don't profess to the idea
that business cycles die of old
age
but 10 years into this business
cycle
my concern is that if there's
any continued weakness
in manufacturing or
weakness in the job market
then the reaction in the bond
markets
is gonna be a further decline in
yields.
Global inflation recommendation
is relatively muted.
And monetary policy is,
it's not just the US.
Broadly speaking, monetary
policy
across the globe is biased
towards more easing than
tightening.
So in this environment
I think it's gonna be
very very hard for treasury
yields to rise meaningfully.
And, you know, the other demand,
the other metric that I track
very closely
is the demand for global bonds.
And the demand for global
bonds is extraordinarily high
in an environment where
you have, you know,
12, 13, 14 trillion of
negative yielding assets.
So we track the balance of
payments
coming out of Japan and
consistently
you tend to see demand for US
assets,
whether it be corporate
bonds or treasuries,
given the fact that yields in
the US
are a lot more attractive
than global bond yields.
So in this context I just
don't see a clear path
towards high yields from here.
With that, I think I stuck
to my seven minute target, I
think.
- [Kim] Thank you, Subadra.
(clapping)
- [Kim] So, thank you all.
So, you can now see above me
that
if you'd like to pose a question
all you have to do is go to
Slido.com.
S-l-i-d-o.com on your
smartphone.
Enter four, four, four, four in
the tab
for joining the conversation.
You have to submit your full
name.
We only accept questions
where you provide your full
name.
No anonymous questions.
But please do submit and please
do vote
on the other questions.
That's gonna influence what we
talk about
for the next 45 minutes.
So, with that brief
advertisement,
let me begin with the
question that's received
the most attention from my
colleague,
Professor Carpenter,
what is your perspective
on the recent phase one
trade agreement between
China and the United States?
Who would like to jump in first?
Mickey, go right ahead.
- I think it's,
despite not liking Trump's
approach
to looking at bilateral trade
deficits
and this and that,
I think it's a positive.
When we look at the broader
context,
here you have China and the US,
the two biggest super powers in
the world
in every way, who that
are 180 degree opposites
in everyway and they've
come to an agreement
even though they know
it's best for their trade
and their economies and if you
look at
global flows, China desperately
needs
to keep its channels of trade
open
and so does the US.
On a more narrow perspective,
I actually read the 91
single pages of paper
in this document and there was,
I don't like the way it focused
on,
you know, attaining certain
trade goals
within the next two years.
It should be a long term
document.
I wish it would have been
a multi-lateral agreement
but it wasn't.
But there was some very
interesting detail within it
that revealed
the amount of debate that went
on
between the experts from both
countries
and I think it's a positive
and in the near term I'd love to
see
global trade uncertainties come
down.
I'm less concerned, I'm less
focused
on whether the agreement is met
over the next couple of years.
I'm most interested in
seeing the follow up
and what it means for things
like opening up China's
capital markets, to, you know,
the exchange of ideas.
I liked all the detail in it
even though, once again,
I would have liked
to have seen a multi-lateral
agreement.
- [Kim] Lewis?
- I'm probably a little less
optimistic.
Look, what I see is
US and China are on very
different paths.
And I see more things pulling
them apart
than pulling them back together.
And so there's the fact
that China has maintained
a predominant position for the
government
and the economy overall.
To be perfectly frank,
the rules of the game
for trade and international
investment
that were put in place at
the end of World War II
and we've kind of, some
of us have spent time
trying to promote,
never really anticipated
having a major part of the
system
that was just governed
in a very different way.
So that's one problem.
The interaction between
information technology
and national security in
the world we live in now
creates some very specific
problems
in that very important sector.
You know, in the last 30 years
we've gotten used to there being
one
kind of global IT universe
and I think we're headed for
two.
I think those gaps are very hard
to bridge
and, frankly, the phase one deal
doesn't really address that.
Thirdly, there's just a
fundamental difference
between how the US on the one
hand
and China on the other sees
issues
around, I will call it human
rights,
I don't want to take
a position necessarily
but if you just see the
way the issue of Hong Kong
and the Uighurs have played out
in the US Congress over
the last six months,
this is a problem that's not
going away.
Those are all reasons why the
interactions
between China and the
United States going forward
I think are going to be much
less
than they've been in the past.
And I think we're only at
the very beginning stages
of figuring out how to
manage that problem.
Look, it's in both sides'
interest
to try and figure out how you
can maximize
the positive interaction
within those constraints.
And I see the policy
challenge going forward
is very much, how do you do
that?
How do you find the
best way of maintaining
as much of the benefits of
interaction
as you can while accepting the
fact
they are just some very big
differences
that are not going to
be able to be bridged.
And I think we're only
at the very early stages
of figuring that out.
- But I would add, you know-
- I just want to give Subadra a
chance
if she wants to jump in.
- No, I mean, from my
perspective I feel like,
you know, from a market
reaction perspective,
I feel like the deal wasn't
necessarily impactful.
It probably is a 0.1,
0.2% impact on US GDP.
You know, for the
markets, broadly speaking,
I think the best way to
sort of phrase phase one
is it's a ceasefire.
It's a positive on business
sentiment.
It's a positive on
generally, broadly speaking,
gives some certainty on the
outlook.
But I can't say that anything
meaningfully
was accomplished from
a growth perspective.
I think it's more the bigger
picture items
that they were trying to tackle.
So I think there's a lot
more work to be done.
I think phase one is just
literally the beginning.
I feel like they have
a lot of wood to chop
and it has to come in phase two.
- I was just gonna say.
Super powers, whether
it's the Soviet Union
and the US or the US and China,
what do they do?
They fight with each
other and they squabble.
But I think this is a nice step
and I would note one of the
chapters
in the 91 page document was
about
setting up a very very high
level joint supervision
and resolution authority
of this committee.
And let's see if it works.
I understand a lot of people
like from Europe feel left out
and they say, oh, this
supersedes the WTO.
Yes, that's a problem
but I actually think
this is gonna work out
and it opens up some
really important channels
of discussion and oversight
that will be positive.
- [Kim] Let me just follow
up with one question
that might focus the discussion.
There's an old literature
in economics and trade
about whether a particular
action is trade expanding
or trade diverting.
How would you characterize this
trade one,
this agreement on that basis?
- [Lewis] Trade diverting.
- [Kim] And the reason?
- The goals that China agreed to
in terms of its additional
imports,
to be quite frank, we've looked
at
and don't think are terribly
plausible.
If you just simply do the math,
the commitments they made
for increased purchases
of goods from the United States
this year,
it represents 90% of what
we would have projected
for the total increase of
Chinese imports of goods.
Now, there are basically
three possibilities.
One possibility is
China actually increases
its imports by that amount.
I can't rule it out but it
raises fundamental questions
of balanced payments, capital
flows.
There are lots of questions you
would ask
if you wrote down a change in
China's balance of payments
that reflected that large
an increase in imports.
That's option one.
Option two, they meet the
objective
to the US but do so by importing
less from other countries.
That's the trade diversion.
There are obviously fewer
soy beans from Brazil,
less L and G from Indonesia and
Australia,
less cars from Europe.
You could certainly see that
happening
but that's your classic trade
diversion.
And, of course, the third option
is they simply don't meet the
objectives.
If I could just quickly respond
to Mickey's comment earlier,
I'd say two things.
One is, the things that
where real progress
in some sense were made
in the phase one agreement
were about intellectual
property.
It was both provision of
protection
for intellectual property
and technology transfer.
Those have been longstanding
issues
and to some extent I would agree
that that's progress.
The point I would make though is
that
in what's happening in
China's development is
they're going from being very
far
from the technological frontier
to being at the technological
frontier
and their objective is to be the
ones
advancing that frontier.
If you think about your
incentives
in terms of how you think
about intellectual property,
it makes all the sense in the
world
that China would want to go from
having a weak intellectual
property regime
to having a strong
intellectual property regime.
I'm not meaning this to be
critical on the Chinese side.
I'm merely saying it makes
perfect sense
from their perspective
to go down that road.
And I don't see that side of the
agreement
as dealing with the issues
which I see as being
the problematic issues going
forward.
In terms of the enforcement
mechanism
that was set up, forgive me but
it sounds
an awful lot like the
strategic economic dialogue
that was set up under Paulson.
Like, it's not like there
haven't been
regular, deep consultations
between the US and China going
back.
And to be perfectly frank,
this one doesn't look
that much different than the
ones
that previous administrations
have run.
Yes, it has a slightly different
framework
and, you know, Lighthizer is a
great guy
and it makes sense to have him
leading it
but the notion, I would just
push back
on the notion that that is
somehow fundamentally different
from what has structurally
been in place in the past.
- [Kim] Mickey, did you want to
follow up?
- Sure, I think it's
going to expand trade.
I agree with Lew, there is
slippage.
And they'll know that.
Let's look at what
they're doing in finance.
China's always had a very
closed financial system
that's driven by it's SOE banks.
Now this agreement allows
any US bank to open
a branch in China
and sell not only basic
banking and depository services
and CDs but also allows it to
sell stocks
and asset management and
insurance.
Of course, we don't know how
much capital requirements
there are and the like.
But I see this as very nice.
So my read is China and the US
are the world's biggest traders.
If you kind of do a game
theoretic,
not just thinking about China
but thinking about Germany
and every other country
and who they need and who they
don't need,
China and the US really need
each other.
And I think they made this
agreement
because they knew they had to
even though they're polar
opposites in so many ways.
So let's see what happens.
But, like I said, I'm less
concerned about
whether they meet the numbers
in the next year or two years.
I wish they hadn't come
up with those numbers.
I wish they had been longer term
numbers.
But I think we're all gonna be
pleasantly surprised.
And keep in mind, also
from China's point of view,
you know, we all use this
word, intellectual property.
It's not all bad.
It's not all illegal stealing
of intellectual property.
The US relies on China
and China relies on the US
for exchanging ideas
and China wants to keep
those channels open
and so there's quid pro quos
along the way
and I think you're gonna see
progress over time.
- [Lewis] I want to be clear-
- But they're gonna disagree.
- And look, I want to be clear
that it's certainly better
that we have the deal
than we not have the deal.
And certainly relative to
where we were last summer
with the prospect of
further tariff increases
we are much better off with the deal
than not.
And you're a little bit glass
half full.
I'm more focused on, I am just
struck by
relative to where I thought
this relationship was
three or four years ago,
we're in a much more difficult
place.
And I see a very long road
ahead to getting to something
that I would think of
as being an equilibrium,
if I may put it that way.
- [Kim] Subadra, anything else?
- No, my concerns are on
enforcement.
My concerns are around
what the longer term impact
is gonna be of tariffs
because, I think, both parties
regardless
of Republicans or Democrats,
they're gonna remain hawkish on
China.
So if you do get a Democratic
president,
I don't see a pull back in
tariffs.
So, I think that there's
probably a better solution
out there and I'm probably not
the expert
on this topic to comment on
that.
- [Kim] Okay.
So, I'm gonna ask you guys
to keep the answers short
so we can get through a lot of
these.
At least a few of them, anyway.
The next one you've all
addressed a little bit
so let's just be more specific.
This is the question
of how the coronavirus
 
1179
00:56:47,104 --> 00:56:50,774
is affecting the outlook of
China globally and of the US?
So maybe start at the far end.
Subadra, how do you want to go?
- I see this as very different
than the SARS pandemic
or the SARS incident that
happened back in 2003.
In the sense that, you know,
I think, like Mickey pointed
out,
We don't have a lot of
information
so from the market reaction at
least
thus far in the last couple of
days
has been one of problem solved.
I feel like there could be a lot
more
as time goes by we'll
have to sort of reassess
what the impact is gonna be.
But, you know, to me I
feel like this could be
a bigger issue than meets the
eye.
- [Kim] Mickey or Lew?
- Once again, I think it's
a negative supply shock.
You know, when we see
pictures of a 10 lane wide
boulevard in Beijing
and there's one person
walking across it and no cars
and you talk to friends
who live in Shanghai
and you say, what are you doing?
And they say, well, I'm
holed up in my apartment.
Well, if people can't go to work
you can't have the factories
move
and then the point is, we don't
know
how it's going to affect
global supply chains.
We just don't know.
And we're not gonna know for
awhile.
And it's hard to add up
the anecdotal evidence
but it seems negative.
And one point about, you know,
one way this is different
than SARS is China is the
hub of global production.
It's the biggest trader in the
world.
You know, so we gather anecdotal
evidence
about what companies are saying,
oh, you know, we had to stop
production
or we need that component
and we just have to add it up
and kind of
go along and figure it out.
You know, it's too bad.
It's negative with, you know,
with risk to the downside.
When we think about,
it's not gonna hit everybody
evenly.
It hits China the hardest and,
once again,
the lack of credibility of the
government
is gonna have a lasting impact
on global supply chains.
It hits some countries like
Australia, you know, its
exports to China alone
are 18% of GDP and it's reeling.
Germany stands out like a sore
thumb.
Its exports to China are 7.25%
of GDP
and that's mostly autos
and parts and components.
And auto sales are falling there
and then you have to think
about the feedback effects
and, you know, if Germany's
labor laws
don't allow people to lay people
off
then their productivity falls
so you have to think
about all the secondary
and tertiary feedbacks
and it seems negative
and we all wish we knew more
about what was going on.
- Yeah, we really don't know
but what we do know is pretty
significant.
Look, Chinese GDP fell
by two percentage points
in Q3 of 2003 when SARS hit.
I think all the evidence
suggests
that this is gonna be more
disruptive than that was.
I would stress the fact that at
this point
what we're fundamentally dealing
with
is a public health response
which is significantly
disruptive
to normal economic activity.
That is a very unusual thing.
There are very few things
that can move Chinese GDP
by three percentage points in
one quarter.
But the good news is, I
think it's very likely that
you will, once you're
on the other side of it,
that those things will be eased
and activity will come back very
quickly.
So this is a big thing.
It is going to be a
big initial down draft.
You will see big movement in the
numbers
but it is likely to come
back relatively quickly.
And I think partly what's
hard for those of us
who aren't kind of in the middle
of it is
thinking about how do
you deal with something
that's like that but comes back?
And I think that's what
we're dealing with.
- [Kim] Okay, this got
mentioned but very briefly.
Do you have predictions
for the effects of Brexit?
Either economically or in market
terms.
Subadra?
- Yeah, no we do and I think
Brexit
is a decent risk for this year.
I think the UK is very
ambitious in thinking
that they can negotiate a deal
with the Eurozone by the end of
the year.
I think Johnson is very
adamant to get that done
and that's a very very
aggressive timeline.
So my concern is that if they
don't apply
for an extension in the middle
of June,
which is the deadline,
and they're not able to
negotiate a deal
by November then it's
basically going to be
a no deal Brexit.
- [Kim] Mickey?
- There's no question there's
some very thorny issues
surrounding Scotland and
Ireland and passporting
but think there are very
few concerns in my mind
about trade flows.
And it comes from the following.
The UK and Europe traded
for hundreds of years
before they became a semi-union.
Keep in mind during the union
the UK
always had one foot in and one
foot out
with its own foreign
policy and own military
and own central bank and own
currency.
And they'll continue trading
and once again, if you
look at trade flows,
let me just give you an example,
if you look at for example trade
flows
between Germany and the UK,
German politicians would
love to punish the UK now
for what it's done.
German industrialists who
have some say in the matter
will say, we can't punish them.
That's our third biggest export
market
and we're already reeling
from what's going on in China.
And so trade occurs,
is going to continue to unfold.
And I would say the UK will do
just fine and I think,
March 10th you're going to see a
roll out
of a big fiscal package and
a lot of it's going to be
for infrastructure
spending outside of London
and I think the pound will
appreciate.
And then, you know, six
months and a year from now
people will say, gee, the
world is still going on.
You know, Britain is still
here and Europe is still here
and there were a lot
of negative disruptions
but things are kinda okay.
- [Kim] Okay, actually no
economic forum these days
can go without asking this
question.
How does climate change
affect your outlook
on the global economy?
Lew, why don't you pick up?
- This is something I'm still
trying
to sort of think through.
I would note the fact that we've
had some
positive data surprises this
week
that we think are related
to the fact that the weather
was unusually mild in the month
of January
and so on the one hand I'm
tempted to say
it's gonna create some inherent
variance
in the statistics short term.
Obviously over a somewhat longer
horizon,
a lot depends on what the
response is.
As I've sort of think about
this,
it seems to me that some
sort of large carbon tax
seems almost inevitable.
When I say inevitable I
mean over the relevant set
of political cycles which
certainly may not mean
the next four years in the
United States
but that's got to be part of it.
I think there's also probably
got to be a significant
burst of public investment
in really two directions.
One is coming up,
facilitating the development
of alternatives as well
as trying to change
the energy infrastructure
in ways that are supportive
of whatever the alternatives
are.
I think that means that
is part of the sort of
different attitude around fiscal
policy.
And so I think if you're
thinking about the outlook
for Europe and thinking
about fiscal constraints,
this is the obvious kind of
political way out of that.
I'm not sure I'm far enough
along in my own thinking
to have anything more
coherent to say than that
so I will stop there.
- [Kim] Anybody want to add
something?
- Lew mentioned a carbon
tax and, of course,
that would reduce the demand for
carbon
but, you know, as we're speaking
there's a huge amount of capital
and expertise pouring into the
field
to develop new technologies and,
you know,
once again, despite all of
President Trump's crazy tweets
on this issue,
the US reliance on wind
and solar has skyrocketed
at the same time its reliance on
coal
has fallen significantly to the
point
where the US's reliance on
alternatives,
some alternatives, will
exceed Europe's next year.
So there's a lot going
on behind the scenes
and so Lew talks about
suppressing demand
and I'm in favor of that
and I would also say
we very well could be surprised
by some technological
innovations that
have a long run impact.
It's not gonna affect
anything in the near term.
- So, let me pick up on that a
little bit.
One of the things that has to
happen is,
there's got to be a bunch
of changes in behavior.
I mean, unless we think
that we're just gonna
somehow solve this
entirely by coming up with
alternative sources of energy
that somehow
magically don't produce carbon,
there's gonna have to be a
bunch of changes in behavior.
And one of the fundamental
questions is
what do you need to have that
happen?
I start with carbon taxes
because I'm an economist
and it's kind of naturally
how you think about it.
Some of the most interesting
research I've seen recently
is sort of trying to make the
argument
that there may be a
behavioral response to this.
That you can actually get
people to change their behavior
without changing the prices.
That's interesting.
I'm not sure I'm kind of there
yet
but if to the extent that a big
part of this
has to be we all are going
to live our lives differently
because of this, it
seems to me a carbon tax
has got to be part of it.
The fundamental question
of what can you do
to try and facilitate the
fundamental innovation
that could ease the,
because there's obviously
a trade off between
how much we all have to change
our lives
and fundamental innovation
that can sort of solve the
problem.
Obviously the more innovation
you have,
the better off you are.
That's an interesting question
and I tend to think that there's
a role
for both public investment
and public policy
and trying to facilitate that.
It's unfortunate things like
Solyndra,
kind of got as much attention as
they did
and I think undermined what was
arguably,
I think, an attempt by
the Obama administration
to kind of move in that
direction.
But those are challenges.
And, look, I certainly don't
pretend to-
- [Kim] We'll move onto the next
one.
And pass it first to Subadra.
What do you think about
high income tax rates
on the rich and specifically
about the potential impact
on innovation or
entrepreneurship?
- I'm not an expert on this
topic
because I'm not an economist
but clearly there's enough data
over the last, you know, three
decades
that trickle down economics
does not work, so.
I don't know if the solution
is taxes on the rich.
- [Mickey] I feel strongly
you should tax the rich after
they die
not while they're alive.
So do it for estate tax.
I mean, I think it would,
I just think that's the
right way to go conceptually
and ethically.
- [Kim] Okay, Lew?
- Look, I think we have,
we and I include myself in this,
have not paid enough attention
to income distribution,
wealth distribution, and
we've kind of gone along
without thinking about that as
an important social objective
and I think inevitably we're
gonna move in that direction.
I think tax, you know,
efficient tax design matters.
And so, I don't consider
myself an expert in this.
And so, I'm not gonna, I don't
want to sort of come down
on exactly what I think
the right answer is.
But I think we have to move in a
direction
where we are effectively,
in some form or another,
taxing the people who sort
of win the job lottery.
I consider myself somebody
who has won the job lottery.
And I think we need to think
hard about
how we do it in a way
that is least disruptive
to overall economic outcomes.
So I endorse the premise
of the question, if I may,
without giving an answer.
- You responded to income
taxes whereas the question
was about wealth taxes.
- [Kim] No, it was about income
tax rates.
- About income taxes?
- [Kim] High income tax rates.
- [Lewis] I think we have to do
both but-
- [Subadra] The problem is,
is there's a lot of people
who are high income earners,
who've won the job lottery,
that are not paying any taxes.
Right, things like carried
interest and the likes
which are very controversial,
there's just not an equal
contribution.
I mean, I know that I pay taxes.
If I make more money, since
I work for a corporation,
I'm still going to
continue to pay, you know,
the max amount of taxes
that I'm supposed to
but because I don't have any
loopholes
that I can take advantage of.
But there's a lot of people that
do.
- [Mickey] That's a tax
efficiency argument.
- [Kim] The question was what
do you think about the impact
particularly on innovation
and entrepreneurship
of high income tax rates.
- Then we introduced,
you know, the loopholes.
I mean, if we would actually go
back,
there is some great research
that began in the late 1960s
about the tax expenditure budget
and the losses in revenue
stemming
from deductions, credits,
exemptions, and the like.
And if we would close
those, you could actually
make the economic system more
efficient.
You would allocate resources
more in the right way
and you generate revenues
and you would reduce
some of these egregious violations
of what we think about
as income inequality.
- [Kim] There's several
questions about
an issue that you've all raised.
Interest rates are low so
the Fed's monetary space
is substantially reduced.
What's the role for the Fed
going forward?
Subatra, why don't you kick off?
- That's a very good question
and I think that it's
a struggle for me because if you
look at
the ECB, I mean, they've cut
rates into negative territory
which I'm not a big fan
of, generally speaking.
They're doing a lot of QE.
They own about 50% of
the debt outstanding.
And broadly speaking, my
concern is the transmission
mechanism between monetary
policy and broader utilization
rates in the economy is just
broken.
I mean, even back in 2008,
before, prior to 2008,
as soon as the Fed cuts rates,
you would see a mortgage refi
wave.
People would take out home
equity loans
and be robust consumers,
spending on the back of that.
Yes, after the last three
rate cuts last year,
you did see a pop in some of
the industry sensitive sectors
of the economy like housing
but not to the extent
that you would want to see,
the impact of monetary policy
having on the broader economy.
So as we go towards the zero
lower bond,
my concern is it's gonna
get more and more difficult
for the Fed to really
meaningfully move the needle
on stimulating the economy.
Especially on the inflation
side.
- [Kim] Jump in where you wish.
- Lew, go ahead.
- Look, I say a couple things.
One is, yeah, so there's no
question that
kind of where we are, all these
things we've talked about,
in some sense, reduces
the capacity of the Fed
to sort of provide stimulus in a
downturn.
The fact that it's been
reduced doesn't mean
they shouldn't try.
And, in fact, I would argue
the right response is to be more
aggressive
on the tools that you have that
can work.
And if you go back and read
Bernanke's presidential address,
he makes a strong argument
that there's still substantial
capacity to do it.
I personally support
his robust defense of QE
and its effectiveness.
I'm not sure I share
his degree of confidence
that it's going to work.
But let me make one observation.
One of the things which I
think is really interesting,
and you mentioned it over the
last year,
is in some ways you can
interpret the way interest rates
have moved over the last year
is we got a bit of a whiff
of a recession and rates just
collapsed.
I would actually argue a big
part of that
was the market anticipating how
the Fed
would respond in a recession.
What the Fed has said they
will do in a recession
is number one, move short
rates to zero quickly.
Number two, engage in forward
guidance
and number three, engage in QE.
All of those things are
good for long rates.
And in some sense, that
very downside flexibility
I would argue is in fact
stabilizing.
In fact, I think of it
as a sign that, in fact,
monetary policy is working.
Because the market is responding
to that
in a way that is ultimately
stabilizing.
So yeah, it's a problem.
I think we need to be
thinking about alternatives
but in some ways that
doesn't to my mind mean
we should just go, okay, there's
nothing the Fed could do,
they should just be passive.
- I'm a constructive critic of
the Fed.
I think it's expanded the
scope of monetary policy
beyond what it's capable of
doing
so once again, if you look
at the channels through which
monetary policy is supposed
to effect, you know,
aggregate demand
whether you look at a monetary
textbook
or you look at what Bernanke
said in 2012
when he rolled out QE,
a lot of those channels
are not working now.
And the Fed continues to
behave and communicate
as if they're working.
And I think there's a
real problem here because,
for example, the ridiculous,
the very low interest rates
and the lower real cost of
capital,
either by rates coming down
and the stock market going up
have not stimulated capital
spending,
as any textbook will tell you,
or as the Fed's model predicts.
The Feds forward guidance
has kept rates low.
It's been very successful in
pumping up
asset prices and encouraging
risk taking.
Just as Bernanke said it would
in 2012.
But it hasn't led to an
acceleration in nominal GDP.
I think there are a lot of
problems
and this creates a lot of
communications problems.
And I think all of us around,
you know,
whenever anything goes wrong
people say, oh, the Feds should
ease more.
Oh, the ECB should ease more.
And for what purpose if it's not
working?
Does that just mean do more of
it?
Okay, so the Fed, people who
have worked
at the Federal Reserve
and most people there
now, their response is,
oh, if we hadn't done what we
did,
you know, things would have been
horrible.
And I completely agree with them
about their responses
to the financial crisis.
But I don't agree with
them with regard to a lot
of what they've done since then.
And they're very well
intentioned
and the ECB's very well
intentioned.
They've got a more difficult
task
because they're the
financial backstop of Europe
and if they hadn't done what
they did,
you know, the EMU (Economic and Monetary Union of EU) 
probably wouldn't have stayed together.
But I think it's time for the
Fed
to be a little more circumspect
and they've convinced themselves
and convinced financial markets
that whenever there's a
problem, go to the Fed
and they'll ease and then
everything will be better.
And I don't think it
makes things much better
and it does accentuate wealth
and income inequalities.
- [Kim] Okay, in the last
few months there was,
several months ago there
was some turbulence
in the repo market and
the Fed has expanded
the supply of reserves,
purchasing Treasury bills
in substantial quantity since
then.
To what extent is this going to
continue?
Is there a prospect for
this coming to an end?
And would it help to have a
permanent standing repo facility
as an alternative to these
discretionary interventions?
Subadra, why don't you kick off?
- Yeah, so I think that at some
point
the Fed is going to start
pulling back
on the repo operations.
I think that the level at which,
I mean,
we know that back in September
reserves were way too low
at 1.3 trillion.
We found out where the steepest
part of the demand curve is
for excess reserves.
Since then the Feds pumped
in about 200 plus billion
in excess liquidity and
I think excess reserves
need to get to maybe 1.7
trillion-ish.
That's kind of where I
think you're gonna see
some long term stability
and that's when I think
the Fed is going to sort of
ease up a little bit on the
repo.
So we see them continuing
to purchase assets.
You know, I think I've
said this many times
in many public forums.
I'm just sort of not a big fan
of the standing repo facility,
per se.
I think that the Fed is
ultimately
becoming the repo market in some
respects.
So I would prefer that they
just sort of organically
grow their balance sheet.
We know that they have to
maintain a large excess reserve
regime to avoid volatility
in the repo market.
But I'm not sure that
the standing repo facility is
the answer.
I think that that's
really the internal debate
that the Fed is having right now
is
what should this facility look
like,
who the participants of
the facility should be,
at what rate the facility should
come at.
It can't be too close to IOER (interest rate on excess reserves)
because that's going to sort of,
they're gonna become the repo
market.
It can't be too much
higher than where IOER is,
in which case it's gonna
stigmatize some of the market
buyers from partaking in the
facility.
So and that's why, I mean, the
first paper
that came out was March of last
year
from the St Louis Fed.
The Fed has had a lot
of time to come up with
sort of a roadmap for what
this facility should look like
and yet we don't have
much by way of specifics.
And I think that excess reserves
are going to become part
of the Fed's mandate over the
longer run.
And which is how it used to
be in the past, I believe.
So, I don't know.
Mickey's kind of puzzled.
- Okay, so let me make
the following observation.
That was all really
articulate and it's obviously
a very complex problem, okay?
But hasn't the Fed boxed
itself into making things
much more complex than
they really need to be
to conduct monetary policy?
Okay, so for 95 years from 1913
to 2008,
the Fed managed the effective
funds rate
through a quarter system.
The FOMC would give the
New York Fed Operating Desk
the mandate and they managed
the effective funds rate.
And there were virtually no
excess reserves in the system
and then, you know,
beginning in the last week
in November 2008, the Fed
moved to aggressive QE
and Bernanke said, this is
extraordinary,
it's temporary, we'll unwind it.
And then they kept on
adding more and more.
And so when you have such
large excess reserves,
you have to, they switch to a
floor system
rather than a quarter system.
And the reason why they
switched to a floor system
for managing the effective
funds rate is they say
so now we won't have to
intervene
on a discretionary basis.
So what happened in September is
exactly
what they had been saying we
have to do
so that type of thing won't
happen.
And I think the Feds just made
things
way way too complex and they
really haven't explained
carefully how maintaining
such a high level
of excess reserves is working
to achieve their dual mandate.
Nor have they explained
that in the context
of paying IOER and the list goes
on.
And so I wish the Fed
would step back and say,
okay, we've been given a
dual mandate by Congress.
Have we articulated it the right
way
in our long run strategy
and are we going about
operationally achieving it
in the most efficient
operational way?
And I don't think they have
and I think they know
they've boxed themselves
into a corner.
- [Kim] Lew, do you want to jump
in?
- [Lewis] There's not enough
time.
(laughing)
- [Kim] All right, well,
(laughing).
In that, then, let me ask you.
Each of you have one minute to
answer
this very simple question,
how will the US elections effect
the economic and market outlook?
- I'll just make one
observation about that.
I think the thing I, the
investors I talked to,
I don't think they fully
appreciate
how much the debate on economic
policy
has moved within the Democratic
party.
A lot of people have this image
of what
economic policy was
like under Bill Clinton
and under Obama.
And it's, regardless
of who the nominee is,
it's going to be different.
- [Kim] Mickey?
- Let me put things in three
buckets.
If a moderate Democrat
is elected president,
it won't have much impact.
It may boost confidence.
I think it would lift the stock
market.
If Trump is reelected,
however distasteful,
it will be kind of more of the
same
in the marketplace and the
economy.
If you were to get
a hard left candidate
and I'm in the middle
of doing a side by side
of all the candidates on
their economic platforms.
When I'm talking about
hard left, you know,
not just raising taxes and
spending
but fundamentally changing
the economic structure,
it could be quite jarring.
And to Lew's point, I think
this is what you're getting at,
if you look at-
- [Lew] I think any Democrat.
I think Joe Biden would have
that.
- Would what?
- [Lew] Would have that agenda.
I disagree with your notion
that there's a material
difference between them.
I think that's overstated.
- If you look at their official
websites,
I'm trying to take them
literally.
- [Lew] That's fine, I'm just-
- But this brings up
another point, of course,
if you go back through history
as frequently as presidents
have actually followed
their platform when they become
president,
just as frequently they do the
opposite.
- [Kim] Just one last chance.
- My concern, ultimately I
think it really depends on
not just who gets elected to
president
but also who's in charge
of Congress and the Senate.
I think if you have the same
divide that you have right now,
where the Senate is Republican
and the House remains with the
Democrats,
I think it's gonna be another
four years
of nothing getting done
except executive orders.
- [Kim] Thank you.
Please join me in thanking
our distinguished panel
for their excellent
(clapping)
contributions.
Just a last word.
We hope to see you again.
We have two more events this
semester.
On February 19th, FDIC
Chairman, Jelena McWilliams,
will visit us for a fireside
chat
with my colleague,
Professor Richard Berner.
And on March third we'll have
another chat
with the head of the
Federal Reserve System
Open Market Account,
Executive Vice President
of the Federal Reserve Bank
of New York, Lorie Logan.
Hope to see you again soon,
thank you.
(peaceful chord)
