Professor Marvin Goodfriend Discusses the Fed on Bloomberg Radio

PROFESSOR MARVIN GOODFRIEND DISCUSSES THE FED ON BLOOMBERG RADIO

JUNE 24, 2009

SPEAKERS: MARVIN GOODFRIEND, ECONOMICS PROFESSOR, CARNEGIE MELLON UNIVERSITY

TOM KEENE, BLOOMBERG NEWS

KEN PREWITT, BLOOMBERG NEWS

(This is not a legal transcript. Bloomberg LP cannot

TOM KEENE, HOST, 'BLOOMBERG SURVEILLANCE': Right now, we go to Pittsburgh, Pennsylvania. Marvin Goodfriend with us, Professor of Economics, Chairman, The Gailliot Center for Public Policy, Carnegie Mellon. Professor, good morning. MARVIN GOODFRIEND, PROFESSOR OF ECONOMICS, , CARNEGIE MELLON UNIVERSITY: Hi, Tom. KEENE: Late 2007, "How the World Achieved Consensus on Monetary Policy" - that was a must-read from Marvin Goodfriend. Is there consensus at the FOMC today? GOODFRIEND: Probably not. These are very difficult times. My feeling is - after listening to the news this morning and thinking about these things for the last few weeks, is this is about as difficult a period as I think there has been for the Fed throughout the credit turmoil. The problem is the economy is still contracting, even though people are talking about green shoots. And it's very hard to know where the turning point is going to be, and it is very hard to know for the Fed how to adjust its language in the statement today. KEN PREWITT, BLOOMBERG NEWS: So, Professor, what sort of grade would you give Chairman Bernanke so far? GOODFRIEND: Well, I think under the extreme circumstances, my sense is that he has done essentially what I might have expected a Fed Chairman to do, and that's the way I've been putting this. You know, I was - I attended the Open Market Committee Meetings for over 10 years, and I used to read about 5 or 6 inches of briefing documents before each meeting. So I wouldn't criticize any action in particular. But I do think the Fed has to be worried about the perception of independence from the Treasury and from monetizing the debt, because it needs to manage inflation expectations perhaps a little bit better than it has been doing. PREWITT: Well, when you look at interest rates about as low as they have ever been, and you - certainly no increase expected to be announced this afternoon, what about inflation expectations? GOODFRIEND: They still remain anchored as far as we can see. But the problem is the Fed has not articulated yet its exit strategy. And the exit strategy is what people are looking to, to remain confident that inflation will remain low over the next few years. And that's what I think the Fed ought to be doing, is articulating an exit strategy so that it gets ahead of a potential weakening of that expected inflation anchor. So far, the Fed has not done that, and I really wish it would. PREWITT: Might we get it in the statement the Fed will release at 2:15 this afternoon, or will it come in another venue - say, a Bernanke speech or something? GOODFRIEND: It is hard to tell. I sense that there are two views on this. One is just - the Fed - many people in the Fed think that it is premature to worry about the exit strategy. And I think there is enough doubt, personally, about the direction of the economy in coming months, in the next year, that an exit may not be necessary. And so, people don't - many people say, "Well, let's not talk about it because we get a premature increase in expected interest rates." KEENE: If you are just joining us, folks, Marvin Goodfriend of Carnegie Mellon, this Fed Day. Of course, full coverage at 2:15 p.m. and on through the afternoon with Pimm Fox taking stock. Marvin Goodfriend, Steve Labaton with a terrific article in "The New York Times" this morning - John Taylor quoted. Professor Taylor will have a book out soon, "The Road Ahead for the Fed." Vincent Rinehart quoted, as well. This is Taylor, "If the Fed goes further off its course and doesn't focus on what it did in the '80s and '90s, it will have less control over inflation." Is there an existing bureaucracy at the Fed to pick up the new duties expected, or will that have to be created from essentially scratch if they are given new duties by Congress? GOODFRIEND: Well, I think they're - clearly, they will need to expand their ability to handle - or their capacity to handle what may be given to them. But I might add, it is not completely clear to me that they will receive the new duties that have been suggested. But, if that's true, there is no question that they will have to build up the capacity to deal with them. They have a core capacity to deal with many of these issues, but in some cases it is not very - there's not a very deep bench. KEENE: Within your experience of being at the Richmond Fed and the Marvin Goodfriend experience, they are spending most of their time looking at price change, aren't they? GOODFRIEND: You mean inflation? KEENE: Yes. GOODFRIEND: Oh, yes. That is the Fed's core job, and of course, that is where most of the energy and the economic staff around the Federal Reserve System goes, is they are thinking about stabilizing inflation, because they believe that is the best route to stabilize economic activity and growth. So, this is not an agency that really is positioned immediately to take up the responsibilities that are being discussed. PREWITT: I want to ask you about regulation. Are we going to see the Fed assuming more responsibility? GOODFRIEND: Well, it depends what Congress wants to do. My own feeling is that there is - we have an independent central bank. Independence is a special thing. Independence is granted to a central bank to do those things for which it is reasonably coherent to provide instructions such that the decisions can be more or less technical, and not political. When it comes to regulation and banking, it is very hard to imagine instructions that allow an independent bank - an independent central bank - to carry on many of the things that are discussed in the recent debates. So, I think, there is only a limited sense in which the Fed can take on additional regulations of the sort that have been discussed. PREWITT: Of course, the Supreme Court is independent, too. But there is that famous line from Mr. Dooley, that it reads the election returns. Does the Fed, as well? GOODFRIEND: Well, that is true. These things are all imperfect, and independence is an imperfect concept. Nevertheless, I believe there is an issue of compatibility. Over the long run, the Fed is an off balance sheet agency which has great independence to buy and sell securities, to change the money supply. It needs the flexibility to do that and it needs the public to believe that it has; that it is basing its decisions mainly on technical matters. So to the extent that the Fed has asked to do things which are questionable, "which are questionable" in the sense that they can be handled entirely technically, that can be incompatible in the long run with the public's perception of the independence of the Fed. So there is kind of a Catch-22 here. If you try to give the Fed more regulations because of independence, it may lose some of that independence. KEENE: And don't we have to understand - just in a minute or so here, Professor, and we will have you back for another block - the idea here of the game theory of it all. Here's Chairman Bernanke trying to get an announcement out at 2:15 p.m., and those ornery Swiss have jumped in here with a presumed intervention this morning. I mean, the fact is they are working within a continuum of many central banks, aren't they? GOODFRIEND: Well, absolutely. This is - the modern world is one which news is happening all the time, and it makes it even harder for the Fed to get its message across, especially when its messages are written from meeting to meeting outside of a longer term - what I would call "exit strategy," or policy, within which we can judge the Fed's changing position. KEENE: Well, let's come back. Marvin Goodfriend with us at Carnegie Mellon. I want to come back and talk about, Ken, those exit strategies. I mean, what is the to-do list that Professor Goodfriend sees as go to Jackson Hall at the end of August and Ans (ph) for 2009 into next year. What is an appropriate exit strategy; an appropriate mechanism to put in place to pull in all that liquidity out there? PREWITT: Or do the markets just want a strategy? KEENE: Well, yes. PREWITT: Not a particular strategy - just have the Fed say, "Okay, here's our plan." KEENE: Yes, it's more of an FDR thing. Just do something. (BREAK) KEENE: And on this Federal Reserve Day, with the FOMC at 2:15 p.m., folks, we will have full coverage. With us, Marvin Goodfriend, of Carnegie Mellon University - what is the mechanism that you would like to see? What is the method that the Fed uses? Do they just raise rates first and then adjust QE later? Do they start with what they did last and pull it back first? GOODFRIEND: Well, Tom, I think in practice what is likely to happen, as you have already seen a little of this, is the credit programs are being run off gradually, and that would probably be the first signal that the Fed would want to exit. But then, I think the Fed at some point would want to raise the interest on reserves. It has this new power to pay interest on reserves and interest on reserves, if it works well, would put a floor under the Fed funds rate, no matter how large the Fed balance sheet is. I don't believe that is likely to happen for quite awhile. I do not think that circumstances are such as to require the Fed to move interest rates up, possibly for a year or more. But, I think the Fed must be prepared to do that. And, more importantly, it should make the public understand that it has the capacity to do that if need be, because what the exit strategy is all about, is about creating confidence that the Fed can act against inflation in a hurry if it needs to do so. PREWITT: Well, you said rates will stay down for a year or more. There are plenty of forecasts around that the economy will start recovering long before then. GOODFRIEND: Well, that is true. But again, I have 20 years experience at the Fed, and what I am saying is based on that experience, not what I think will happen or what I think the markets believe - PREWITT: Oh, sure. GOODFRIEND: - will happen, and I just think that given what the Fed likes to think of as the output gap being so large, it seems unlikely that is going to move rates up anytime soon. KEENE: Go ahead, Ken. PREWITT: Well, Greenspan was getting a lot of criticism for keeping rates down too low for too far. Are you suggesting a repeat of that kind of thing? GOODFRIEND: Well, circumstances - the conditions are somewhat different. We really have, at this point, a historically large output gap. And if it continues to stay large, it is conceivable to me that rates would stay down. This is going to be a judgment call, and it is very hard for me to - KEENE: Marvin, just in 20 seconds here. We are unfortunately running out of time. Could we see a dissent today, or is it just critical that everybody is onboard? GOODFRIEND: It depends what they are discussing. It seems unlikely that we would see a dissent, but if there is a decision to change the language in some substantial way in one direction or another on the statement, we could see one. I tend to think not, but who knows. This is a very, very difficult time within the community. There are people, as a whole, with very different opinions about what the risks are going forward and which way to go on these so-called announcement effects within the statement. KEENE: Well, we greatly appreciate your perspective. Marvin Goodfriend, folks, at Carnegie Mellon University, working quite closely with Alan Meltzer among others there.