Launch of the Geneva Report: What Else Can Central Banks Do?

Unedited Transcript

Adam Posen: Good morning everyone. Welcome back to the Peterson Institute for International Economics for the--if I can use the expression grand opening of our fall season and we are very excited to be following the NFL premieres with our own hard-hitting, exciting lineup.

I'm Adam Posen, President of the Peterson Institute. And, it is really a pleasure today to be able to be hosting the US launch and I think we're beating the European launch by a few hours, of the Geneva Report, the nth annual Geneva Report on the world economy importantly titled What Else Can Central Banks Do? This is of course an annual of very distinguished series and that's been out for many years under the leadership of Charles Wyplosz and CEPR.

But through sheer happenstance where I would argue quality, this year's four authors, three of them have Peterson Institute affiliations. Joseph Gagnon of course is Senior Fellow here at the Peterson Institute. Patrick Honohan who'll be doing the premiere in Europe, of course, the former of governor of the Central Bank of Ireland is a non-residence Senior Fellow with us since leaving that post. And Signe Krogstrup here with us this morning as well was a visiting fellow here last year while the report was written. We then decided in the spirit of fighting against Brexit to let Larry Ball immigrate across the border from Johns Hopkins and join us.

Joking aside, I'm very proud that we've assembled both directly and indirectly, such a great group have applied monetary economists and policymakers. We're bringing real analytical work to bear on this question of the central bank toolkit. As many of you know and certainly all of you have read, there is a great deal of fuss being made that central banks have reached the limit of their power to stimulate their economies in the major economies.

This, of course, as it should be gets conflated with other questions. The question of should central banks be doing more and then the question of is it optimal, wouldn't it be better if like the G20 says we all use fiscal policy instead of monetary policy to achieve our goals at this point. Those are legitimate questions and those are obviously going be part of the consideration of this issue.

But the report that we have is fundamentally about the question what else can central banks do. And I think that that's the important first step that we all have to get with. In particular, retrospectively to appreciate the effectiveness of central bank actions since the crisis, as well as prospectively to think about such things as negative, further negative rates for their asset purchases of varying kinds in different forms of forward guidance.

And so, this is part by its own description, is a primer for central banks on how to ease policy when short-term interest rates hit zero. Again, I'm not going to constrain the discussion but I'm grateful to my colleagues for taking it on in that practical purpose and obviously sticking their necks out in a real way.

I am not going to go through all the bios of the authors. They're all well known to those of us in the monetary policy junky community. I am however going to give a big thank you to our two discussants and frankly speaking, these were my two absolute first choice discussants and we could not have done better.

Speaking immediately following the presentation will be Jason Cummins of Brevan Howard. Jason is by, I think, all accounts and certainly by my accounting, the most useful and wise macro monetary economist in the hedge fund space, which undersells if anything his contributions to the public debate and to private conversations that he has enlightened all of us. He does a wonderful job of combining analytics with market sense and I'm sure he will have some appropriately critical and questioning comments for the authors based on his unique insights.

Following Jason as almost no one else could is of course Professor Carmen Reinhart of the Harvard Kennedy School of Government. Carmen is, at this point, more distinguished than I can care to recall. She was recently here as Senior Fellow at the Peterson Institute to Dennis Weatherstone Senior Fellow succeeding Morris Goldstein. But then, she of course ascended to Harvard along with the publication of her book with Ken Rogoff, This Time Is Different many other publications but that like Friedman and Schwartz, Reinhart and Rogoff is now a name that will go down in intellectual history. Carmen, however, is not only looking backwards. She's always looking forwards. And, it was very generous of her to come down on short notice from Boston to join us today and thank you very much for doing that, Carmen.

So, that being the batting order, I believe, Signe, are you leading off? Dr. Signe Krogstrup of the IMF.

Signe Krogstrup: Thank you very much for this introduction and thank you very much for accepting to launch the Geneva Report.

So, before I start, I have to give a disclaimer. I was at the Peterson Institute when we wrote this report earlier this year. I have since joined the IMF so I have to say that the reports have not be taken to reflect the opinions of IMF Board or Management.

And that said, let me start here. So, the background of the report of the starting point of this report is that the frequency and the cost of the zero lower bound restricting monetary policy have increased.

Now, if we for instance start out with the neutral real interest rate, let's say that the neutral real interest rate is the interest rate level at which we have full employment and staple inflation around the target. The nominal interest rate can then be seen or the policy interest rate on average can then be seen as composed of this neutral real interest rate and inflation expectations according to a simplified Fisher equation that I have here on the top of the slide.

Now, both of these components of the nominal interest rate or the policy interest rates has come down in recent decades. The neutral real interest rate, there's a lot of current focus and research on the level of the neutral real interest rate. There's a lot coming out documenting that there has been a downward trend in neutral real interest rate that reflects probably a reduction in a couple of percentage point over the past couple of decades.

And adding to that, inflation expectations came down strongly predominantly in the 90s when central banks adapted inflation targeting regimes and low inflation targets.

So these two factors have combined to bring nominal interest rates down closer to the zero lower bound on average. And that means that the lower bound constraint has become now a frequent reality whereas before it was considered a theoretical curiosity.

And this table here is supposed to show you or give you a bit of an impression of how the zero lower bound constraint has become a reality. It reflects average policy interest rates across 10 advanced economies from 1980 to 2015. And I'm perfectly aware that you can't read the numbers and that also doesn't matter. What you want to look at is the colors that I have up here.

So, average policy rates within the year that are below 3% are colored yellow, policy rates below 2% are in pink, and policy rates out or below 1% on average across the year are in red in this figure. And as you can see in the '80s, there was barely any incidence of the zero lower bound constraint on monetary policy. And if we were to go further back from that, 70s, 60s, you would see the same thing.

That changes in the 90s. In the mid-90s, we have a couple of countries getting dangerously close to the lower bound. The best example or what most well-known example is Japan, which has been in the lower bound since. In the early 2000s, more countries gets dangerously close to the lower bound. And as we're all painfully aware of, since 2008, most of these countries have been in the lower bound and are still there.

So, the point of this table I think is that the fact that we have widespread zero lower bound problems currently is not just an artifact of the global financial crisis. It is something that has been building up over the past decades and it is likely to continue being a problem even when we get out of current predicaments.

So, in the report, we want to assess the cost of this increased incidence of the lower bound. And what we do is we estimate a simple MacroModel. We quantify it for the US. And we assume that the neutral real interest rate is 1% and inflation expectations are 2%. And what we find from this model is that when the unemployment exceeds the NAIRU or the Natural Rate of Unemployment by 1.1 percentage points, the nominal interest rate will hit zero lower bound. That is not a lot.

When you look back at the history of US recessions, in seven out of eight of the past recessions, that was the case for the US. So that means that if we have similar macroeconomic dynamics going forward, basically, we will have the Fed being hit by the zero lower bound constraint in basically every recession.

We also estimate a counterfactual. That's what I have in the figures here. We assume in the counterfactual that there is no zero lower bound constraint on the policy rates.

So, on the top chart, I have the Federal Funds Rate from 2008 onwards and the red dash line is the historical outcome for the Federal Funds Rate. The blue line is the counterfactual where we allow the policy rate to ultimately adjust to the shocks that it was hit by in 2008. And here we find that ultimately, the policy rate should have been reduced to -6% in 2009. That if policy could have adjusted in that way and not been constrained by the lower bound, the policy rate could have been increased already 2010 and '11, it would have returned back to positive territory.

The mid chart shows the unemployment gap and shows that if we have had this policy flexibility, we would have had a substantially lower unemployment gap throughout this period.

The lower chart shows inflation. And again, shows that inflation would already in 2011 have gone up compared to where it has been and would have been on average much closer to the 2% target of the Fed than what we have actually seen.

I want to add that these estimates of the cost of the zero lower bound constraint are quite conservative. So, in the historical case that we're comparing with, we already have a lot of QE and forward guidance. If we have not had that, of course the cost would have been even worse. We also in this model do not take into account long-term structural effects of having long slumps, how that can effect labor markets.

So, what are the implications of this? In the report, we look at exactly as Adam put very well just before, what we look at is what can central banks do to nevertheless meet their mandates when they are constrained by the lower bound? And I want to reiterate and emphasize that we have a very clear focus here in monetary policy. That is not a reflection of our views of the policy mix when going into a recession.

And there are clear, I think I can speak for all of my coauthors. There are clear arguments why fiscal policy can very useful in liquidity threat type conditions. But that's simply not the focus of the report. We're asking just as Adam said, what else can central banks do?

And with that focus in mind, we argue that unconventional policy measures will be relevant and will be necessary and will be useful going forward. We consider negative interest rates. We also consider how quantitative easing works. We include their helicopter money. We also look at targeted lending of central banks. We consider forward guidance both on policy and on inflation and we find that these measures can go a long way in alleviating the lower bound constraint in many countries.

They will not be sufficient to alleviate their lower bound constraint in all countries at all times and for all shocks. There will definitely be situations where this will not be enough. And so, we also consider what central banks can do to reduce the incidence of the lower bound.

And here, we particularly consider or propose that central banks should consider raising the inflation targets. And we don't just say inflation targets should now be moved arbitrarily from the 2% to an arbitrary 4%. We suggest the central banks should be considering on a recurrent basis what the optimal inflation target should be that will allow the central bank to reach its target.

And finally in the report, we also consider long-term implications for monetary policy and the lower bound constraint of switches to post-cash economies and the trends to work using less cash, and how economies without cash can function in terms of monetary policy in the future.

So, what we're going to do in the rest of this introduction of the report is go over these different measures and how we get to our conclusions about them.

So, I don't have the slide here, so I forgot to switch the slide. That was the slide that I just talked about.

So, I will go to the next slide, negative interest rates is where we start. So, what we do in the report is we consider the experiences of five countries that have recently used or lowered their policy rates into negative territory. And those are the ones that I have in the chart on the right hand side here: Japan, the Euro area, Sweden, Denmark and Switzerland.

And, what we get from considering the experiences of these countries is that negative interest rates or cuts in policy rates into negative territory have worked largely in the same way as cuts in monetary policy interest rates do in positive territory. There are a few things that change. Notably in banking, there are some anomalies in banking. But these are not the central part of the transmission mechanism, large parts of the transmission mechanisms work in exactly the same way as we would expect.

We also find that rates that we have not come close yet to the lower bound on interest rates and that rates probably can be lowered further compared to where they have been lowered until now. Of course, this has to be done with caution if the central bank considers doing that to avoid the risk of actually hitting a lower bound where you have a large-scale shift into cash. But we argue and I think many others also argue that we are not there yet.

And finally, the debate has brought up a lot of concerns about negative interest rates. In the report, we consider many of these or all of these concerns and we conclude that the concerns are important to keep in mind but most of them are simply overstated and have not come to bear in the experiences of these countries. And that means that this concern should not be arguments currently for central banks not to lose monetary policy through the use of negative interest rates if they need to do so and are constrained in the lower bound.

Quantitative easing--so in the report, we also consider the experiences of different countries that have conducted quantitative easing in recent years. We find and the literature generally finds that quantitative easing has ambiguously lowered long-term yields on bonds. More broadly, it has affected and transmitted to financial markets in the way that we would expect.

When we're considering quantitative easing, we also consider the many concerns that are put out there about the use of this tool. Many of these concerns are very similar to those with negative interest rates and we consider them in the same way.

A particular concern about quantitative easing has been fiscal implications. So we spent sometime in the report considering that and we find that in all plausible scenarios, the use of quantitative easing should have benign fiscal implications.

We also find that previous programs have been able to stimulate the economies that have used them for--with an equivalent measure of shortcuts of about 2% to 3%. Well, that's quite a lot.

We also find that there is scope for more in many countries in particular if countries consider bringing in other assets into the mix of assets that they purchase.

We based that assumption on taking an overview of the asset, the relevant asset markets in a number of advanced economies and we find that when we look at the availability of assets in most countries, there is a scope for large QE programs with a few exceptions perhaps Switzerland.

I'm going to hand over now to Joe who will continue with the forward guidance.

Joseph Gagnon: Thanks you Signe and thanks to everyone for joining us today.

So, the section on forward guidance is the section that we expanded in the latest draft of the paper. Some of you may have seen the earlier drafts and there was a conference to discuss it a couple months ago in Geneva and this is one of the outcomes is that we talk a bit more about forward guidance.

And there's two types of forward guidance. One I'm going to focus on is forward guidance on inflation. If you could credibly promise to people that you would raise inflation, that would lower the real rate of interest, which would help stimulate economies. And we think that to some extent that has worked, I'm going to get to the case of Japan in a minute.

But I think the key point here is that you can't just say it and expect it to work. You need to actually take actions that will make it work. So you need forceful explanation of what you're doing, supporting policies that would actually push you in the right direction to convince markets and actually move us in the right direction. But if you combine it with those actions, it can actually amplify the effects to have some synergy.

And, I'd like to discuss a case of Japan because this actually is in many people's minds and the Bank of Japan three years ago announced that it wanted to raise the inflation target. It was implicitly around 1% but they weren't achieving it and they decided to make it 2%, and take bold actions to get towards it and they launched the real major QE program when they did this.

And, if you look at this chart, the solid line, vertical line is the month in which Kuroda was appointed Governor of the Bank of Japan under Prime Minister Abe and that's when the new policy was announced.

If you look at the key target variable, core inflation, you see a remarkable inflection point at that time. This is inflation excluding energy prices, fresh food and the consumption tax. So, to some extent inflation went up because there is consumption taxes. We don't want to count that so that's not included but we do want to count the--it's a core close to what the US has long said, the Federal Reserve has long filed as a core.

And what you see is that core inflation rose almost 2 percentage points after this announcement over the next two and a half years. Also, the dash line is a long-term survey. Survey of consensus forecast of what people think inflation will be 6 to 10 years out, so long-term forecast. And that was falling and then the survey literally in the month--because this survey only is twice a year. This survey in the month in which Kuroda took over jumped right at the solid vertical line and then it continued to rise.

And along the way, you see that the rise in inflation wasn't steady but it was clearly going up. In late 2014, when it dips down a bit, the Bank of Japan announced a new expansion of quantitative easing and sort of got things going again.

Late last year when we see the second sort of tailing off, sort of leveling out of inflation, at a higher level to be sure but not at two, the Bank of Japan--people started to expect the Bank of Japan should make another action, take another step.

And in January, they did, they went to negative rates, which surprised markets because they had said they weren't going to do that and it was a very small move from +0.1 to -0.1 with a lot of exceptions. And it was not well received by the banks, by politicians, by the public. And, it has led people to believe that perhaps the Bank of Japan is stuck and it won't do anymore. And, in the past six to nine months, things had been sort of tailing off and the Bank of Japan has not decided what it's going to do about that yet. They're about to make an announcement soon. We'll see. But we are worried that they probably should have done either bigger cut into negative rates or expansion QE perhaps into equities or something, something bold but they didn't do it.

So, it shows that, yes, announcements can help you get to your goal but you need to back them up with actions and the actions need to be sufficient. You can't stop if you aren't there yet.

So, a key point which really we couldn't go into as much as we might have liked because it would really be another paper is how does this interact with financial stability. There is an issue. This is a big ongoing debate. How should monetary policy respond to financial excesses? People investing risky assets maybe take long too much leverage. We think that many people believe that macroprudential tools, things such as loan-to-value limits or capital requirements at banks are best tools for this and I believe they can be quite effective but we don't know how much effective or how much is needed.

People ask, well, if you can't do enough in that space, should you not do the monetary policy you'd like to enough for the macro side of the picture, out of concern about raising financial stability concerns. Well, this a debate. This is a major debate. And we felt that we really could not solve it.

There's people on both sides are going quite clearly that's sort of beyond our ability to go but we know that it seems that hitting the zero lower bound typically is going to be a problem when exuberance if anything is too low and people are not overly optimistic.

And we also think that if your economy is weak, it's sort of not obvious to us that raising rates or not lowering rates is going to help financial stability because it creates other financial -- it creates more risk of bankruptcies and failures, and losses from low activity.

So, it's not clear to us. It seems to us that probably this is not something that you want to--you really need to focus on the right tools, but we have to admit that this is an ongoing debate that we can't settle.

So, things as Signe said, things that you could do in the future to try to prevent zero lower bound events from happening. Basically, we think that if given the frequency, which we think we're likely to hit lower bound events in the future, if you thought 10 or 20 years ago that 2% was a good target and many people did including some of us, what have we learned in the past 10 years. Things that we didn't know 10 years ago are that maybe real interest rates have come down in a long-term way and maybe hitting us bound is going to be a much bigger problem than we thought.

And in face of that, if you thought two was a good number before, that would argue for something higher now, something that would get you away from that zero lower bound problem and that is our conclusion.

So, one big issue that people have raised including central bankers like John [inaudible 00:27:00] and Ben Bernanke is if you raise inflation target, will you lose credibility? Once you raise that, will people think that, "Oh, you can go higher and higher," and you'll anchor inflation expectations?

Well, we don't think that's a problem for a couple of reasons. First of all, we saw New Zealand do it in the '90s and they raised a target from one to two with little concern in anchoring and it's been stably anchored ever since.

I think more importantly, we think there's actually some evidence out there that the current targets of two are becoming a little less credible because in fact, financial market participants are concerned that central banks will undershoot and you can see this is not just inflation expectations average levels but also in options prices are inflation contracts, people are more worried about the downside risks.

So, in fact, people are worried that central banks can't achieve their 2% targets sustainably in the downward direction and that's actually hurting credibility. If you have central banks choose a target that they could hit more durably and credibly, it actually would improve credibility and then that might be a higher, slightly higher target, 3% or 4% perhaps. We don't come down strongly on how much and we certainly wouldn't want a very high target but something higher.

So we think that perhaps the way to do this is in a periodic process, not too frequently but maybe every five years or so to reexamine what we've learned as the central banks and to reassess what we should aim for. So basically, it seems to us that it's not credible to stick your head on the sand and not learn from reality how you've been to--yeah.

Now, one of the interesting parts of the report, but I won't have time to go into it very much is that we actually show that the economy is moving in a way in which people might not need cash, that's the paper money in your wallets, and that is sort of the thing ultimately that creates this lower bound problem. If that goes away, then all these concerns go away and that really changes the whole picture.

So we see this is a process that's happening and in some countries, it seems like it's happening, going quite far. But it still is going to take a while. It's not an immediate answer to the problem, but it's just a trend that we see coming that may lead us to a point, not clear yet, but may lead us to a point in which this whole issue goes away. Central banks would be able to have negative rates if they wanted or needed at least temporarily to manage economy and that would be a good outcome, and maybe we'd all look back on this and say, "Oh, wasn't it strange if they had this bound problem on their policy?" But that's more of a looking forward and not something that can be rushed.

So, just let me conclude then. We think that the recovery from the Great Recession was slower than we would have liked. It took a lot longer; everyone has been talking about that for years now. We think also that perception of failure, that has driven a perception of failure. That's actually harmful because it calls in a question whether monetary policy did any good at all. We believe it did. But it could have done more and nothing succeeds like success. If you actually do enough, you will validate beliefs in your policy and your ability to do good. And if you don't, you actually raise questions and I think that's not good.

So, what is the firepower? Well, we think that policy rates below zero have been helpful at the margin and they could probably go a bit more and still be useful. But second, we think that quantitative easing has been very helpful and could actually go quite a bit further, too. And perhaps committing to a higher inflation target could be combined with those two policies to further help and stimulate the economy. In the longer run, we should think about what the inflation target should be and think about infrequent reviews of what that should be. I'll stop there.

[Applause]

Adam Posen: Thank you very much Joe and thank you very much Signe. As expected and as I hoped, you've recognized, they stuck to their [inaudible 00:31:27] but there's a lot of things in those bullet points that are hardly uncontroversial. And, in a moment, we will turn to our distinguished discussants to raise perhaps some of those issues.

I would like to just make one historical footnote apropos Signe and Joe's remarks about raising the inflation target, which is obviously a very current topic. In 99, we published -- not the Institute -- published a book coauthored by Bernanke, Laubach, Mishkin and myself in inflation targets.

And if you were to dust-off your copy of said book, you would find that what we considered state of the art 99 included actually relatively frequent changes in the inflation target up and down, not as well developed, a process as Signe and Joe raised, which I think is very intriguing.

But that we put out very explicitly examples from New Zealand, Canada, UK that reconsideration of inflation targets at intervals would be assumed to be part of the process. And that I view it as sort of an unfortunate act of naivety at least on my part, I won't project for my coauthors. But that the inflation targets have since become sort of ossified like exchange rate picks. Once they're in place, nobody wants to change them because, "Oh my god, we'll look bad."

But if you channel Bernanke in 99 as was in the book he signed his name to, we didn't think inflation targets our priority should be so sticky and if there was room to change them, so just a historical footnote.

For the real world, I turn to Dr. Jason Cummins, please.

Jason Cummins: So, it's a pleasure to be here. Adam asked me a few weeks ago to speak on this paper and I would do anything for Adam. And I thought, "Well, this is going to be a chore," but it was a great pleasure.

It's customary when you're talking about a paper to talk about the paper, but I'm not going to do that today. For two reasons. The first reason is the Geneva Report and all of the reports in my experience are immensely valuable whole tomes on the subject.

So, I went through the paper, it's a long paper and then I got to the second half and there was all the comments. The comments were so smart. It's a bit like reading the annotated versions of Nabokov's works where the annotations are three times as long as the actual paper and much more informative. So I'm not going to do that. I'll commend the comments to you and I went through them all and I thought to myself, "Well, I'm not going to be able to improve on that."

The second reason I'm not going to talk about the paper is because the paper is too important to focus on the specifics in the paper. And I have talked to you in the body of my comments today about what I mean by that.

So, in preparing my remarks today, I channeled the spirit of two intellectual forces from Peterson. The first is from Mike Mussa. Mussa taught me that central banks are never independent. There are only varying degrees of dependent on the public's trust. And because we've operated in our books for so long, we've lost track of the fact that America's first demagogue Andrew Jackson abolished central banking. Another demagogue maybe more to your liking, FDR also kind of abolished central banking.

So what you need to understand about the broad script over time is that central banks do not have some independence imperative.

Second point, Jean Pisani-Ferry who's been associated with the Institute for many years articulated at least for me in the most impressive fashion, the public's anger and distrust around Brexit about expertise. People are tired of experts. They're tired of people like us and yet I'm going to try and organize in a constructive way the points I want to make to speak to both this kind of audience, as well as people outside this institution.

So, specific points under Mussa and Pisani-Ferry's intellectual umbrella. First, central banks are failing and more importantly, they were failing before the crisis. Signe's chart was a very persuasive chart about the damage done by the crisis, but I think it misses a very important point that central banks before the crisis were also missing on their inflation objectives. So, we're dealing here with a chronic problem exacerbated by the crisis, but not due solely in particular to the crisis.

Secondly, central bankers' models are broken. The linkages between monetary policy and its transmission to the real economy through aggregate demand or normal sorts of models whether it's the Fed or elsewhere. The belief in those central banks is that those are structural econometric relationships or at least if they don't actually admit to that, they behave that way in practice.

However, it's my belief, at least, that behavior is changed over time and that's an important feature to take into consideration when thinking about some of the features of this paper.

Finally, the public is fed up with what's coming out of the Frankenstein lab of monetary policy. They've had enough. The metaphor I've been working with in my mind can only actually be used in this room with all the smart people. It's like the Court of Versailles before the French Revolution where it was so insular and incestuous. You talk only in your own way and you had no idea what was going on in the rest of the world.

So, to be more constructive though at the end of my comments, I'll try and offer up some hopefully effective suggestions to address this. But I just want to make the point. I think if you had the public actually sit through Jackson Hole, they'd be aghast on what's going on, aghast.

The central bankers have no idea what they're doing. "Oh, there's a smart guy who wants a big balance sheet. There's a smart guy who wants a small balance sheet. There is a chair of the Federal Reserve who says that everything we've done will actually achieve our objectives even though she has not achieved her objectives." The other people will say, "You should stop." If you have the public sit in on that, what would they conclude?

So, first point, let's consider inflation. So we all agree that inflation is actually the thing that central banks can control, at least over the medium-run.

So let's look over the medium-run. So this is a line chart. Well, I've done two things. It's the year over year change in core piece of the inflation, the Fed's mandated target, as well as a smooth version, which is a five-year annualized average of core inflation. I drew a horizontal line there at 2%, which is mandate-consistent inflation.

So, on a smooth basis, core inflation has been below 2% 90 percent of the time in this century, 90% of the time. On a year over year basis, core inflation has been below 2% 30% of the time. So, you might say, "Oh, well, you're cherry picking. Carmen and Ken told us the prices is damaging. You're just looking at this incredibly damaged period."

Well, I'm also looking at a period, which was most flattering to create inflation. It dovish central banker, global growth that was off the charts, oil at $150 a barrel, rental inflation that was off the charts, and you know what we did? We managed 2% inflation a few times.

So, Signe's chart showing the big red parts of cross-country inflation being too low in the wake other crisis, yes that's true. But sometimes, when you're so smart, you focus in on the details and miss the big pictures. Central bank in this century is a big failure. We have not achieved our goals as outlined by ourselves.

Sorry, you were there fighting a good fight.

Second point, this is more speculative. That's just a fact. More speculative, the thing I've been thinking about a lot lately is whether the linkages between financial conditions that central bankers can control and the real economy are broken.

Let me show you a couple of charts. They're not quite in the right order. Can I go--up. This one. So, this is little complicated because I actually did some work on this. So, this is not just something you pull off. So, this reflects effort.

So, the first thing, net worth the disposable personal income, that's a chart, a long chart you all know, perhaps don't love but are familiar with. Net worth to disposable personal income has a few features to it. The main features are the three humps. The first one was Mike Prell over there overseeing the internet bubble. The second one--I guess Dave is not here but he oversaw the second bigger bubble, so he outdid you, Mike. And the third one, I guess we don't have any Fed reps here that I can see today but the third one is the latest feature of wealth compared to income.

So, we can see is that there are obvious movements in this part of the balance sheet for household. What I did in the--I'm colorblind so I think it's the red line. The ratio--what's called there the ratio implied from regression on the [inaudible 00:42:29]. What that is, that's like an honest disclosure. What this is essentially is backing out from actual consumption behavior of households, what they think or what they're behaving like is their wealth.

So, it used to be to help fix ideas. It used to be that in the earlier part of the century, if I gave people a lot of money, they spent it. And then, moving forward a few years in the housing bubble, I gave people some more money, different source instead of pets.com, it was your condo. They spent all of that as well.

There was a cosmological constant when I was an economist at the Federal Reserve Board that four cents out of every dollar of your wealth would be spent on consumption. We argued interminably about the lags, sometimes we thought it was five cents, sometimes Dave Reifschneider would distribute it over different periods of time or different households.

But you're required by your employment contract at the Federal Reserve Board to believe that four cents out of every dollar was spent on consumption. That is no longer true. So, the saving rate in order to help take you away from a pretty abstract thought experiment here, I'll just give you a simple point.

Wealth has never been higher, almost never been higher as a share of your income and yet what you see in the official data is a saving rate going up. Now, it's gently going up, maybe if you turn the sheet, you could convince yourself that it's flat. This should not be happening.

What households have decided and it may be because the [inaudible 00:44:13], it maybe because they are still [inaudible 00:44:16], it maybe because they're behaving optimally and rebuilding their saving according to some kind of target saving model that is harder to specify. But households are behaving as if they don't have that wealth anymore.

We're using the wrong model. We thought it was an econometric structural model where $1 of wealth gave you four cents of consumption. That's no longer true. So you're sitting around the Federal Reserve Board and other places because actually, this is a cross-country phenomenon, not just the Fed, not just the Fed's analysis, the economy of other places as well.

You're sitting around looking at features of the economy that are no longer true and you thought they were true, they're not true. People aren't spending. You know what, they've got the wealth, they didn't buy another silver auto truck. That's the way it is now. So, it wasn't a structural econometric model. It was just an empirical relationship from the past because people thought they were richer. Now, people don't behave as if they're richer when central banks jack up asset prices.

Again, it's not a political comment. These are just [inaudible 00:45:20].

Second feature, the business behavior. So, obviously, there are parts of the business sector that are highly distressed. The oil patches contracting at a double digit rates in every feature of its economic performance.

The reason I put this chart on here is because not only in structures, which is the majority of what's going on in oil but also equipment investment is declining. It's been declining almost a year. It may this quarter level out, but something interesting and important is going on here beyond just the oil patch, businesses have stopped growing their investment.

So, you give households more wealth, they don't consume. Businesses, you give them an incredibly low cost of capital, they aren't investing. If I was still doing the forecast and Mike was still there, he would be water boarding, me saying, "Why is it the case that you don't have a stronger investment forecast? What's going on? The cost of capital has never been better. It's even going lower." I haven't even mentioned housing here.

Is there any intellectual curiosity among this group and elsewhere why 3.5% mortgage rates have caused the decline in residential investment this year? It's not just cherry picking one thing. It's business investment declining, residential investment being kind of flattish, let's hope for up and consumption is growing, but certainly not in a way that we would have thought based upon the fundamentals.

So, I make that point that there's something in the linkages between financial conditions in the real economy that is no longer the same as it has been in the past.

So, why am I saying this? Obviously, kind of to raison d'être of the paper is let's control financial condition so that we can achieve better outcomes in our overall objectives whether it's a Phillips curve translation and new inflation or some translation in aggregate demand, I'm showing you basic stuff that's broken that we need to be talking about and we aren't.

Investment has been declining for almost a year. The saving rate is going up. Residential investment is down two quarters in a row.

So, to sum that up, so I just did a--so the chief evangelist of let's raise rates are the Goldman Sachs investment research squad. And, what they do is they plot FCI, Financial Conditions Index, and say, "Look, financial conditions are super easy." Here, I've inverted it and then also brought it forward is kind of a--in a predictive fashion. They said, "Well, financial conditions are super easy. We know what we need. We need tighter monetary policy."

Well, the other thing I plotted here is their own current activity index. Current activity has rolled over and died in an environment where financial conditions have never been easier.

Literally, if you have -- contrary to some of your favorite regulators down the road, if you have a pulse, you can get a car loan. If you have a W2, you can get a mortgage. These things are facts. They can tell you as much as you want the creditor's type. But you go to a car lot, I'm sure many of you have not been to a car lot in a while. But if you go to a car lot, you will walk out with three cars. And if you wanted to get a mortgage, they're going to want to give you two. Current activity, not so great. Financial conditions, super easy.

So, you need to think about whether the linkages that we're studying in monetary policy are actually going to achieve your objectives and I don't think there's adequate discussion of this.

Third, this is my people are fed up, the folks at the [inaudible 00:49:24] are rising up. The maestro culture created by Greenspan has been one of the worst features of central banking. The public learned because they were told this that central bankers can control outcomes. Central bankers didn't even control inflation over a 16-year period. And yet, they are tuned to believe whether it's a town hall, official communications, the literature coming out of central banks that central banks are all powerful. We don't actually believe that when we have a cocktail conversation but that's what the public learns when we talk to them.

And, just this aside, Joe mentioned the abolition of cash, cash is a bad thing, we need to get below the zero lower bound. There's no greater evangelist for negative rates than I am in a textbook. You know what people don't like? People don't like chess grandmasters sitting around with other PhDs talking about getting rid of their money. That pisses people off.

So, you can -- but it really makes people angry. So, I have a fact for you, Ken's book has just come out, 67% of the reviews on Amazon and there are many, are one star. I read some of the two-star reviews and I think he needs a bodyguard. The Frankenstein lab of monetary policy producing the world's greatest minds, a man who's going to win the Nobel prize, books, that the public is rejecting by 67% vocal angry margins is a broken model for central banking and you need to wake up to it because you are not going to have independent central banks in the next 10 years if you keep on this path.

I showed you the behavior. People aren't consuming. Businesses aren't investing. They aren't buying houses when you have a 3.5% mortgage rate. What does this mean? You need to make the connection between that behavior and the inchoate anger of the populous that would vote for another demagogue that may make Andrew Jackson look like Abraham Lincoln.

So, I return to Mussa and Pisani-Ferry. Mussa taught me central banks can become a lot less independent. We've been living in the golden era of central banking. No volatility in the economy up to the great financial crisis, great outcomes. It was fantastic. And the speech that Chair Bernanke will rue is not the one where I said some [inaudible 00:52:25] contained. It's the one where he goes through a whole dissertation about how central bankers are in the main responsible for that. It was good luck. The econometrics say it's good luck if you talk to Jim Stock and Mark Watson.

The change in the behavioral relationships tell you it was good luck and we banked it as if we were the smartest people on the block. We aren't. Central bankers can go in reverse.

Pisani-Ferry reminded me that expertise is in decline everywhere. People don't trust doctors. People don't trust the science on climate change. People don't trust. And we can, as he did, in three or four ways, talk about ways to mitigate that but you need to take it as an empirical feature of the landscape.

So, Mussa and Pisani for a big shout out. What do I have to offer constructively since I have ranted a bit? So, central banks need to start meeting their mandate and stop making excuses. So how do they do this? There are all kinds of smart ways to do this in the paper. I have a very simple pair of suggestions that don't go into the Frankenstein idea lab.

First, appoint central bankers who actually want to achieve their mandate. Ben Bernanke, one of the greatest reflationists, living in the great reflationary age, weak dollar, $150 oil, rental inflation off the charts. He didn't do it.

We're talking about--I sit around all day worrying about small boring things, things that would just boggle your mind. We spent so much time on this. So, like worrying about whether the Feds are going to raise rates in September or December. It's insanity, insanity.

The Feds plan to raise inflation is to raise interest rates. Do you want to go out and then explain to the public? Like normal people, not even like the rotary club or something like that where these people give speeches. Go out to the public and explain to them that your big plan to restore prosperity is to raise interest rates. It doesn't make any sense.

You haven't met your mandate depending on how you define it, 90%, 70% of the time. And your plan now in the midst of real actual despair, weak fundamentals if you want, is to raise rates? That's crazy. That's literally crazy. It is the Court of Versailles talking about nobility when outside the Court of Versailles, they're rioting and we don't know it because we're just talking to ourselves.

So, achieve your central banking target by appointing central bankers who actually want to do it. It's much easier. You want to write a book about raising the inflation target? Why don't you just appoint someone who does their job? That's not complicated. I put on a tie sometimes. I do my job. Why don't they do theirs?

I don't get the point of promising to slow the economy as soon as it reaches some rate of prosperity. I just don't get it. I'm not like some great populist. But it doesn't make sense to me and it doesn't make sense to the public.

So, those two things are eminently achievable, appoint people who actually want to achieve their objective and actually, stop talking about raising interest rates when you want to raise inflation. That's pretty simple. Don't raise interest rates when you want inflation higher. Why not sideline the discussion about raising interest rates by saying, "Look, Charlie Evans has a great idea. Let's just wait until inflation is actually 2%."

You know what, listen, Governor Brainard gave a fantastic speech on Monday. It was a speech I wished I could give and I wished I had heard from the chair. It took her almost an hour and a half, and yet, it took her almost an hour and a half to utter the words, and this is and I quote, "2% is not a ceiling."

One of the foremost reflationists in the Federal Reserve System took an hour and a half to say 2% is not a ceiling. This is also crazy. Our best hope is someone who takes an hour and a half to say what is obvious to the public, which is stop trying to miss.

My biggest worry is that the public is going to conclude because of what we're doing that capitalism is just socialism for the rich. We made David Tepper a billionaire through asset purchases. We're going to try and reflate by doing things that bankrupt key stakeholders in the society and insurers and bankers, and we're going to tell them that we're smarter than they are and we know better, and we're going to achieve better outcomes when for the entire century we failed.

There's no more important topic. I'm sorry I didn't talk about the features of the paper. I kind of looked over Carmen's shoulder. She actually is going to show some real charts instead of rant. So, in that sense, there's a happy exposed division of labor. But I really want to leave here with a food for thought that there's no more important subject; great appreciation for Adam for giving me the forum to air these comments and I appreciate it. Thank you so much.

[Applause]

Adam Posen: Jason just said, Governor Brainard gave the speech, he wishes he could have given without saying I 100% agree with Jason. I should be so lucky as to give a rant as thoughtful and as provocative, and as solid as what Jason just did. Thank you, sir. Thank you so much.

We end with an even bigger bank. Professor Carmen Reinhart, please.

Carmen Reinhart: It's a pleasure to be here in my old stomping ground. I'm actually going to talk about the paper.

So, I thought I would preface my remarks though by reminiscing Morris, my dear friend and I were, I think, in 1998 in Hong Kong at a Deutsche Bank conference. And, much of the discussion in that conference had to do with the fact that Joseph Yam, the then Governor of the Hong Kong Monetary Authorities facing a speculative attack on the Hong Kong currency. And a simultaneous attack on the equity market had decided to intervene to keep the PEG, but at the same time provide support for the stock market by purchasing equity.

At that time in 1998, this was thought heretical. I think it is a measure of how much the crisis has changed our thinking that now Japan is doing purchases of equity that make the actions of the Hong Kong Monetary Authority seem like child's play.

So, what I'd like to do is just in one slide, recap the main message of what I took away as the main message of the paper. Jackson Hole Chairwoman Yellen suggested that there are tools available in the event of recession and this paper says why should we wait on conventional policy, can use of more resource slack and higher inflation goal bump up the zero lower bound insurance?

I very much enjoyed reading this report. I thought it was very thoughtful both in terms of covering what we know and then moving on to what possible options.

I'm going to divide my comments into three parts. First, I'm going to try to bring in some historic context to this discussion and in doing so, I would like to offer a critique, which is I think some of the statements could be more nuanced.

Secondly, I would like to highlight that it is a long report covering a lot of ground but I would have liked to have seen most on regulation of the financial markets has undergone a SeaChange since the financial crisis and its interaction with monetary policy is a big topic. It's a big issue and it impacts how monetary policy works in its transmission.

And then, I'm going to conclude by talking about what I agree with and what I do not agree with in terms of the policy recommendation so that is my roadmap.

Now, I am going to start by just a brief assessment of the effects of the post-crisis policies. In here, I am going to depart from both the paper and from Jason's conclusions that certainly Jason put it very clearly that he doesn't believe that central banks have been anywhere near successful.

In BGHK, I'm sorry for it, but it's four authors so I just abbreviate it. In BGHK, they do say, "Well, look, the outcome post-crisis has been disappointing."

For the last eight years, I have been trying clearly successfully to convince people that post-crisis recoveries are not the same animal as standard business cycles, that the degree of headwind faced after a financial crisis is much, much greater.

And I would highlight that because we do not observe a counterfactual, there's a tendency to compare to the last cycles, the last couple of cycles and the inevitable conclusion has been, well, look, policy--monetary policy really didn't deliver what--didn't really live up to its potential and the recovery was too slow, and we needed more stimulus. These things are indeed said in the paper, but it's not unique to the paper. This is a conclusion that is often reached.

Well, we had not had in the advanced economy a synchronous systemic crisis since the 1930, so maybe as a reminder of what that counterfactual could have look like and I am looking at Jason on this slide, this is the inflation performance for 22 advanced economies during the Great Depression and in the current crisis.

So, if indeed a systemic financial crisis produces major headwinds, there's the breakdown of the financial system, the monetary policy transmission, mechanism is damaged, households and firms are overleveraged and the economy goes into a major slump.

Well, what does this bar chart shows? This bar chart shows that the actual deflations that we saw in the early 1930s were to the tune of -4% to -14%. If that is a plausible counterfactual, then I would have to say that notwithstanding the fact that monetary policy started at low rates already at the outset, quantitative easing and forward guidance, and other more conventional policies may be more successful than they are given credit for. If you look at the performance of output and compare the two episodes, you will draw a similar conclusion.

I would note that also in that very vein, monetary policy did deliver negative interest rates, real exposed negative interest rates. It is true that we faced zero lower bound problems fairly early on but not withstanding the incidence of negative real interest rates post-crisis was nontrivial. I will show short-term rates later but I wanted to highlight the difference between the 1930s in which real rates were very high and positive.

So, my starting point is that before we plow ahead and say, "Well, much, much more needs to be done," although as you will see I agree with much of that, monetary policy, I think, has delivered in a way that is not often credited for.

Now, I would note that the incidence of short-term interest rates in the current post-crisis environment are not nearly also as unprecedented as what one frequently hears in the financial press. We are in unprecedented territory. We are at the lowest nominal rates, but certainly real rates have been there consistently for extended periods of time before.

And, I would highlight that if we think of that there is an array of policies that are much more complicated, much more opaque, much more numerous, I would remind everyone in this room that if you look at the history of the Federal Reserve up until the era of the Great Moderation, a lot of the more unorthodox policies that are discussed in this paper were part and parcel of the standard toolkit.

In effect, if you look from--I did with Ken Rogoff a couple of years ago, a short paper on the centennial of the Fed and if you look at many of the policies--and this now also extends to regulation, which I will talk too. But the very narrow definition of monetary policy of just having a single instrument, the short-term rate and a very narrow mandate, a much narrower mandate of price stability is fairly modern vintage.

So, what this paper is discussing is not really that out of line with the longer history of our central banking. And, just to highlight that real rates one last picture on this, one last chart on this, just to highlight that real rates, consistent negative real rates are not a novelty. What this chart does is it breaks the history of short-term real rates in the advanced economies from the end of World War II to the present into three eras. The era that I have often referred to as the era of financial repression, I know that sounds sinister, but basically, it's the era of much heavier-handed regulation, much more intersection between the treasury and the central bank, and higher incidence of negative real interest rates.

If you look at the dashed blue line, that is the frequency distribution of real rates for all the advanced economies during the financial repression era, the high real rates that we got accustomed to in the '80s and '90s was really the era of globalization and financial liberalization. And from the vantage point of the post-war era, more of an outlier than where we are now.

This is a longwinded way of saying that the issue of being close to the lower bound, the issue of dealing with real negative interest rates has a long history and perhaps what I would encourage the authors to do is to maybe look more into what some of those policies were between 1945 and 1970 that were also fairly effective in keeping nominal rates down.

One area that I would like to be more critical of the paper is the authors often convey the impression that central banks really know what potential output is. And, that there are the systematic relationships linking real interest rates and economic activity.

I would put to you that ex ante, it is very difficult for a policymaker to know what is trend and what is cycle. And, it is especially difficult when there are structural changes such as what we saw after the crisis.

To highlight the unhappy experience of the '70s, I would note that for too long, the Federal Reserve chased what they thought was their vision of potential output, which turned out exposed to be wrong. Potential output had moved significantly lower in the '70s and the pursuit of higher output was in the end just inflationary.

To highlight this, I have various vintages of the IMF forecast for world GDP growth and what you see are systematic markdowns. So, I would invite the authors to be more cautious on or nuanced on what we do know about differences between trend and cycle, and what we know about potential output and what we know about NAIRU, and equilibrium real rates.

Post-crisis regulation, I will go through this quickly because I do want to spend time on the policy discussion. I think this is a missing ingredient in the paper and the reason that I think it's a very important ingredient is significant regulatory changes have created a demand for risk-free assets. Liquidity ratios have been introduced not just in the US, but worldwide.

The cost of intermediation has changed significantly for banks and in effect, this year's Jackson Hole was importantly also devoted to seeing what some of the effects of these regulatory changes were on not only the transmission mechanism of monetary policy but also importantly their potential impact on financial stability and on real interest rates. In effect, the latest FOMC minutes also acknowledges this point indeed. So, I'll drop it there, but I think that that is food for thought on the policy recommendations.

Let me turn to this. Raising the inflation target. I am far more comfortable. I'm actually fairly comfortable with this recommendation. In addition to the arguments that the authors make about providing more safeguards against hitting the lower bound during bad times, for the past six years, I've been saying in periods of high leverage a moderate and steady dose of inflation was actually quite constructive in reducing the size of balance sheets. And, it was a fairly effective way of liquidating debt for the advanced economies almost without exception. The range is not significant, but the financial repression tax, which was delivered with inflation that seldom, seldom rose above 4%. So, we're not talking about the 1970s here. Let's be very clear about that. We're talking about the earlier era where inflation did oscillate between 1% and 4%.

In the US admittedly, it was lower than most advanced economies, but it was still safely within that range. Now, where do I really run into problems or disagreements? And here I tend to actually share some of Jason's views on what central banks should or should not be doing. I have a problem with the central bank taking on fiscal policy.

And, when we get into--let's start with the most obvious, the helicopter money. Helicopter money is really--should be in the hands of the treasury. People do not vote for central bankers. The policymakers who do get elected opted not to do these things and what makes it that the central bankers know better and without being elected should engage in these kinds of transfers.

To me, that is moving in the direction of taxation without representation. I think the idea of households getting checks from Chairman Yellen in a helicopter exercise is a little--will put you well underway of losing central bank independence one way or another.

Now, let me backtrack and say something about negative interest rates. Negative interest rates are also a tax. They're a tax on banks that will be passed to depositors and to borrowers. They have important redistributive effects and are completely opaque. Meaning, nobody votes for them.

The financial repression tax by the way is also a tax that is opaque. And, there is something to be said for opaqueness, but I'm not going to go that route right now.

Let me also conclude in this part of the--before I get into the issue of central bank independence and conclude, actions by the central bank and this does echo something that Jason said also can preclude what could be potentially first best solutions. In other words, if bank balance sheets need to be cleaned up, is it not the first best to actually clean up the balance sheet rather than have Mario Draghi buying corporate paper to help clean up the balance sheet so that the credit channel works again in Europe. So, central bank action can actually be a second best that may preclude some first best solutions.

So, last two slides. There's more than one way of losing central bank independence. And, the traditional one that everybody thinks of is where the central banks is the passive financier for the government but what we're seeing here is quite different. Is the central bank wanting to take on fiscal responsibilities and acting as both treasury and financier?

And, it may be that this comes about because the people doing fiscal policy are inept. But I would highlight that those inepts are usually the ones that drafted the charter for central banks and may decide to change their mind.

Last observation, I know we're overdue. What about cashless? I think the issue that in different parts of the world, financial systems are moving towards a cashless or less cash than in the past at different speeds that's fine, that's an organic outcome. However, however, I would note that any measure that penalizes cash holdings.

In the old days, we would call them capital controls or the like. In effect, if you look at May 1, 1933, at that time, President Roosevelt was concerned that people were hoarding gold and the law to abolish gold hoardings, everybody had to surrender their gold. Now, we're talking gold has replaced cash and I am very, very skeptical that as much as I may like, some elements of financial repression maybe this is a little bit too much. I know this is not a central point of the paper by any means. But since you devote some discussion to this, I thought I would conclude with some observations on that.

And, to reiterate, I really think this is a significant contribution. And that if I had to bet, I do think we are going to move to higher inflation targets and understanding that sooner rather than later is high value added, and I'll conclude there.

[Applause]

Adam Posen: Thank you so much, Carmen. If I can invite Carmen, Jason and BGK to come up on stage, we've run over because the content was simply outstanding and we will take questions from those remaining.

Just a note to our friends online and to reassure everyone, we will by tomorrow have up the transcript and the videos of this session. So not only can you already download what else could central banks do, the Geneva Report by BGHK, but you will be able to download and watch, and review the comments by our two distinguished discussants.

One last note before we start. Carmen like I was at the Jackson Hole conference and I think we both saw a lot of what Jason was referring to. I mean, we had papers about people -- if central banks eventually issuing their own bills, we had discussions that do seem rather strange. In the word war, people hoard guns and avoid immunization, of the idea that they wouldn't get a little annoyed of people took away their cash strikes me as odd. That doesn't take away anything from however our discussants today.

I'm designating Larry Ball who did not present as the main responder to questions on the main report but let's open it up. We have a microphone in front and a standing mic in back. Would someone like to offer a question or a comment?

Male Speaker: Not to [inaudible 01:25:51], could we reply just [inaudible 01:25:53]?

Adam Posen: No, because we're out of time. I already [inaudible 01:25:55].

Male Speaker: All right.

Adam Posen: Next question, please. Anybody?

Male Speaker: [inaudible 01:26:05] from the Peterson. I have two quick questions. One is a follow-up from Professor Reinhart question about the uncertainty about future potential growth or the uncertainty about the decline of the real interest rates. So I was wondering your report is a lot about--focuses on the decline in the point estimate but it doesn't really address if that increase in uncertainty should lead to different monetary policy framework.

The second quick question is to Professor Reinhart, I was curious to have your view on the difference between FDR's reflation effort in the 1930s and abenomics, and what you see as the difference between the two, is it the fiscal drive that explain why abenomics hasn't worked as well as the reflation policies of FDR or is it something different?

Adam Posen: Yeah, and also our authors may also want to comment and say abenomics in the paper. But Larry, why don't you start-off on the first question?

Laurence Ball: Which was the first question?

Female Speaker: Potential growth.

Male Speaker: [Inaudible 01:27:22].

Laurence Ball: I think there's a lot of uncertain about R-star. I think what, maybe one that I would emphasize actually in a sense and might [inaudible 01:27:35] correlated with my coauthors maybe are exactly the same, the R-star issues maybe even a little overemphasized in the sense that even if we assume that R-star is at 2% as John Taylor did in the '90s, the resulting [inaudible 01:27:51] are different.

We have the simulation that says if unemployment goes, 1.1% above the natural rate, you'll hit the zero bound so that will happen all the time. If you recalibrate it, so R-star is 2%, I think you get that unemployment has to go 1.4% above the natural rate or something like that. So, still with the 2% inflation target, you're on very thin ice that a modest downturn will push you up against the bound and that's pretty robust to what R-star is.

Adam Posen: Great. Carmen, do you want to comment on the historical comparison of FDR and abenomics?

Carmen Reinhart: The reflation efforts in the US came when inflation was oscillating between -5% and -10%. The deflation was very significant. The approach, the Japanese approach towards balance sheets was also dramatically different, so initial conditions were very different.

And, the whole approach to balance sheets in Japan, balance sheets had been preserved. We've lived with extend and pretend, which lengthens the process. So the bottom-line, what we see in the '30s is a much sharper collapse and therefore much more upside potential for rebound than what we've seen in Japan in which the initial collapse is simply not there.

So, the process may drag on and drag on. It's a tip of the iceberg what I've said but I'll leave it there.

Adam Posen: Great. Pedro.

Pedro da Costa: Hi, Pedro da Costa here at the Institute. My question is for your Jason. I really enjoyed the presentation and I have some sympathy for the notion that a lot of this monetary policy discussion gets very insular and intellectual, and that it may be interesting to us but the general public might kind of laugh it off.

But I wanted to nail you down on what your policy prescription might be because when you started off, it sounded like you were saying that by tinkering too much, that monetary policy was ignoring the fact that it was being ineffective and therefore that policymakers have perhaps done too much. But then you ended your presentation by saying that actually they've been falling short of their target, which implies that they should be doing more and therefore perhaps delving into some of the tools these guys are presenting.

Could you square that circle a little bit?

Jason Cummins: Sure. Thanks for the question.

Adam Posen: Can you hit the on button I think?

Jason Cummins: Thank you for the question.

I like simple. And so, what I was trying to say and maybe it got buried in the rant was a simple policy would be to stop doing things that don't make sense and start explaining to the public a very simple policy rule, Taylor rule too complicated, too many parameters. Just do something simple.

So, what I think the public is hearing now and has metastasized into the Fed zone and the Michigan surveys, inflation expectations and certainly it's prevalent in the market is deflationary mindset or disinflationary mindset. As Governor Brainard pointed out and again, there are 17 people sitting around that table and she's really the only one in a fulsome way pointing out that inflation expectations are unanchored on the downside, which hasn't happened in our lifetimes.

So, what you need to do is stop explaining to the public, then when the economy succeeds, you're going to punish it. It's very Japanese. We sat around a decade ago making fun of the Japanese as if they were some [inaudible 01:31:57], irrelevant to history. They aren't irrelevant to history. The math, the economics, the sociology, the politics, they were just before us and what the central bank did was either declare defeat or said, "Whenever we're going to succeed, we're going to punish you." It doesn't make any sense.

So, a sensible policy is one advocated by my public policy betters Larry Summers, former president Kocherlakota somewhat quietly because he has to remain within the confines of the system still in Versailles if you will, Charlie Evans. They say, "Look, what's the rush? Why are we using models?"

I was taught a long time ago that macrodynamics are only identified by rare events, crazy things that happen. What we actually know as macroeconomists? Not that much. What we know about normal times? Almost next to nothing. I mean, it's really kind of funny, right?

So, what we need to do is go out and say, "Look, why are we using a model from the 70s?" We're taking a Phillips curve that was identified of extreme behavior in the 70s and using that to drive policy now when we all agree. That's irrelevant if we actually sat around and discussed it.

You read a speech like one by President Williams, third to fourth paragraph in his last speech. He says, "The economy is running hot." It looks like a speech that was written two or three years ago. There's no sense in which the level of activity is above potential in a way that's generating hotness. There's no sense in which you're cruising along so fast that you're going to blow through the level of potential. It's a speech not anchored in reality. The charts I showed you.

And so, I would just say to people, "Look, we're not raising rates until we get to 2%." I don't have to do anything fancy like the inflation target and have one of the foremost academics in the study of monetary policy. Literally, someone who wrote the book on this stuff explain the cost and benefits to higher inflation target just go ahead and give a speech saying we're not raising rates and then people like me to go on and do other stuff than worrying about whether they're going to raise rates in September or December. It's crazy to be having this conversation. Crazy. And yet we are.

Adam Posen: I think I should let Larry and Carmen, and maybe Joe if he wants to also comment on this issue.

Laurence Ball: I basically very similar--I mean, the Versailles analogy certainly resonates with me speaking for myself and maybe even I propose the amendment that they say we're not going to raise rates until inflation is 3% or 3.5% or something. I mean, we've aired enough on the side of caution. We really need something pretty aggressive I think.

And again, on the Versailles, the speech about--I mean, Williams of course--Reifschneider--the history is interesting. Reifschneider and Williams were the ones who proved in early 2000s the chance at hitting the zero bound, the 2% inflation target were very small. And Williams now seems to have learned a little bit from history and he's a little more equivocal. But I guess I have [inaudible 01:35:12] it carefully because Janet Yellen is citing Reifschneider's latest research and assuring us that with the 2% target and most circumstances were okay, nothing to worry about, that does certainly have a not paying attention to the reality over the last 10 years flavor to it to me.

Adam Posen: Carmen?

Carmen Reinhart: I would note that, again, I echo some of the sentiment that rate increases or normalization should be a very gradualist process. But I would note that we really don't know what potential output is. And I think the idea that's saying the economy doesn't look hot because it isn't growing the way it was 10 years ago, 15 years ago, it says nothing. And just for all we know, we could be at potential right now. But I completely agree with the policy prescription that if one wants higher inflation, why stop even if you're at a potential.

Adam Posen: Thank you. Joe?

Joseph Gagnon: I'd just say I agree with Jason on the current situation but I would just say put yourself back in 2009, would it had been enough just to say, "Well, we're going to keep rates at 0 until inflation is above 2?" I think more would have been needed then.

Adam Posen: Very good. Ted, you can have the last question.

Ted Truman: Thank you. Ted Truman from the Peterson Institute.

Isn't one of the issues here that--and I don't know whether you guys and I only read the earlier version of the report. So, one of the issues here is that central bankers--all warriors fight the last war. In the last war, at least still for the most of the central bankers of the world was inflation, not deflation that we've gotten. That's this war, but without fighting the last war.

And, the people who articulate that war are people who grew up in the 70s or early 80s where we had high inflation and the cost of bringing inflation down was very high. In fact, it was a global financial crisis. I would count the early 1980s as a good example of a coordinated global financial crisis in terms of both growth and other things that were going on, not on the order of the 30s but post-war.

And so, the problem is those people worry about inflation and all the--the Volcker's of the world if I may put it that way worry about why can't price stability be price stability and price stability is zero inflation? And so, maybe you could comment on that aspect of the question and whether, in some sense, by moving the inflation target, you actually ignore or what do you do about this sort of cost of inflation and there's a big literature on the cost of inflation. And maybe that's changed somewhat, but it tends to drive one down to something like two. It could well be three or four by accept--as I accept that but a comment on that. Thank you.

Adam Posen: I suggest we will let Larry have the last word but if anyone wants to comment before Larry. Oh, Jason, you look eager.

Jason Cummins: So, since Larry is going to get the last word, I'm going to the answer the question that I wished you had asked, which is sort embedded in the question that you did ask.

You touched briefly on the kind of history of what's going on in central banking by mentioning the 70s and the very material social welfare or cost of inflation in that period of time. On observation suggested to me by Ken, Carmen and Steven coauthor, which I've ruminated on many times is that central banks essentially, we wrote their DNA in response to that episode, and if not, revisited it. And it's going to take--I mean, it may be because the public actually does a whole best deal and overthrows the royalty and the institution.

But I think over the next 10 years, we're going to see a rewriting of that DNA to undo the Volckerness and some of that is embedded in the Geneva Report where we're experimenting. I mean, it is a pejorative for me to call it the Frankenstein idea lab but it's necessary to have this kind of debate in order to surface these points, in order to rewrite the DNA so that we don't have the foremost reflationist on the Federal Reserve's Board talking about 2% is not a ceiling an hour and a half after she began to speak.

That's going to take 10 years minimum to redo this stuff. And I was glad you mentioned the 70s and I just wanted to point out that what we need to be doing is rewriting that DNA, so we actually have some hope of achieving mandate consistent inflation. Forget about all the other stuff. I mean, smart more people want to talk about hard topics. I got a kid--sorry, just one second.

I got a kid who once talked about hard stuff and then he'll fail easy tests. When you have a pupil who fails an easy test, that's the worst outcome of all. And I pointed out to you that over this century, we're talking about really hard stuff, I mean, the financial crisis, all this stuff, I mean, Larry's paper on Lehman and so forth. I mean, really, really, really hard topics but you know what, before that, we had an easy test and we failed it.

What do you do with a kid who fails an easy test? Do you give him a harder test and he might do all this crazy stuff? No. We got to figure out just the basics and rewrite the basics, and get rid of the 1970s--I'm sorry, you were there actually in the institution as the person in the audience who's most familiar with this and I'm trying to kind of bring out your point.

We need to stop and fix it.

Adam Posen: For what its worth before Larry does get the last word. And obviously, it wasn't worth much. I gave a speech while I was on the Monetary Policy Committee at the Bank of England saying, "This is not the 70s," and calling on us to forget that and the speech was of course forgotten. Larry.

Laurence Ball: Well, briefly, I think we did learn in the 70s that inflation has cost lead double-digit inflation and there is a large literature on the cost of inflation. And our reading of that literature is that the difference within the cost of 2% inflation and let's say 4% inflation is pretty trivial. And, in contrast, the benefits of having an extra 200 basis points of easing before you hit the lower bound is large.

So, just on a cost benefit analysis, I think it seems to us not even close. I think some people including Ben Bernanke and Ric Mishkin and orthodox people have said, "Well, of course, 4% inflation per se isn't that costly if it could really be stable?" But we'll lose credibility and if it's 4%, it becomes 6% and becomes 8% sort of--and again, we discussed this at length in the report that we don't think that acting as though 2.0% must be in some religious text that we cling to that regardless of anything even though we can't really meet that because we can't use our instruments, that's especially good for credibility and that saying.

Actually, I didn't actually--it's been a while since I read the four-author 1999 book.

Adam Posen: It's okay.

Laurence Ball: But saying that having an inflation target has some good properties and we should periodically rethink what's the actual inflation target based on learning from what's happened to the economy, that doesn't seem especially destructive of credibility does.

Adam Posen: Thank you very much. Thank you all. I think this has been a spectacular session obviously building off the terrific work that BGHK, Krogstrup, Gagnon, Ball, and Honohan is not with us today, did in the Geneva Report. But also obviously, Carmen Reinhart and Jason Cummins did an incredible service to this Institute, but also to the public debate by meeting that quality of report with equally brave and insightful discussion.

We're going to promote the hell out of this because I think this is an important contribution to what our critical issues as Jason said, we're stuck with the hard test no matter what our performance was on the easy test. And, I'm grateful to our authors led by Joe.