Tracy: Hello and welcome to another episode of the Odd Thoughts podcast. I'm Tracy Aloway.

Joe: And I'm Joe Weisenthal.

Tracy: So Joe, Trump nominated Kevin Worsh to be Fed Chair last week. We've been talking about it on the show. Obviously, this has big market implications, but I'm starting to think that the sociological questions and aspects of this are more interesting.

Joe: I'm so intrigued by the constellation of people who have come out either in support or opposition of this name. It is not like any other nominee that I can recall where you have fairly mainstream, even liberal names like Jason Ferman or Gita Goponath saying there's a great pick, and then you have Paul Krugman and Neil Da saying this is a terrible pick and so forth. It cuts in ways that I would not have necessarily anticipated, not like any other Trump pick that I recall.

Tracy: Yeah, it is very split and it feels like there's a split within Worsh's own thinking as well. Right? Because here we have a guy who has talked about wanting to overhaul the Fed, and even break some heads, I think was a direct quote that we've mentioned before. He has given a speech that is literally titled "An Ode to Independence at the Central Bank." But at the same time, there's a big question mark about how and why he has suddenly seemingly gone from an inflation hawk to someone who's advocating for low rates.

Joe: Totally. And of course, I think, just to be blunt, this would have been something that any nominee from this administration, to some extent, there would have been question marks around because obviously Trump has been very critical of Jerome Powell, despite the fact that he nominated him himself, and it's clear that he wants a low rates now kind of guy in there. He said after the nomination, "He didn't make many promises, but I think he's going to be a low rates guy." And then he joked a couple of days later that he was going to sue about to bring that up, and that was a, he was joking. He said he was going to sue if War...

Tracy: Joke.

Joe: Joke, air quotes, you don't know it, but this has been the big thing. So the question is the degree to which an incoming Fed chair, if he passes the Senate, which isn't guaranteed, but if he passes the Senate, can establish his commitment to what he's long talked about, which is Fed independence, while also not immediately angering the guy who nominated him.

Tracy: Exactly.

Joe: To the extent that that matters. Exactly right. So, we need to talk about all of this, get a little bit more color on, I guess, Fed board culture, and political nominations as well, and market implications, of course. And we really do have the perfect guest. We're going to be speaking with Richard Clarida. He is, of course, global economic adviser at PIMCO, a professor of economics at Columbia, and most importantly for the purpose of this particular conversation, he's a former vice chair of the Federal Reserve Board. So honestly, the perfect guest. Rich, thanks for coming back on the show.

Richard Clarida: Thank you. Looking forward to our discussion.

Tracy: So why don't I just start with the very obvious question and we can dig in from there. But last week when the news broke about Worsh being selected by Trump, what was the first thought that went through your head?

Richard Clarida: I think it's a very sensible choice. It makes sense along important dimensions. In particular, it's important because I think based upon background and what he's been writing recently that wars will work very well with Scott Bessant at the Treasury. There is Fed independence that we'll get into, but it's important as a practical matter that the Fed work well with the Treasury and so it makes sense along a lot of dimensions.

Tracy: Actually, let's just get into that because I do find that to be very interesting. Say more about working with the Treasury. You know, some people would say that is not the Fed's job. In fact, I would say, you know, Kevin Worsh going back to the immediate post great financial crisis era had talked about how, for example, it's not the Fed's job to backs stop fiscal policy. It's not the Fed's job to enable larger deficits, which he, I believe, saw QE as enabling. But from your perspective, talk to us about what a positive relationship between the Fed chair and the Treasury Secretary looks like.

Richard Clarida: Yeah, thank you for letting me add some color to that because there are dimensions and domains where it would actually be a very bad idea for the Fed to be dominated by the Treasury. But along several dimensions, a collaborative working relationship is important and I'll name several. First is the Fed going back to its founding is the fiscal agent of the government. It has a responsibility to make sure that the treasury market has adequate liquidity that it functions properly. And so that's an important element of the job and always has been. It's also important because the Fed has an important role in bank regulation but not a monopoly role. The controller of the currency which is within Treasury also has a regulation responsibility as FDIC. So as a matter of necessity on bank regulation there needs to be a degree of coordination and so I would really highlight those two areas.

Tracy: So I mentioned at the beginning that I'm kind of interested in the inner functioning of the Fed board. From your perspective, how does communication between the Fed and the Treasury actually happen? I'm sort of envisioning like I don't know a WhatsApp or signal group chat.

Richard Clarida: There is a tradition, it's not in statute, there is a tradition that the Treasury Secretary and the Fed chair meet on a regular basis, oftentimes over breakfast. And so during my time, that was the primary point of contact was bilateral between when I was there Jay Pal and Steven Minutuchin and then when Janet Yellen became Treasury Secretary. So that's informal. There are typically not staff in the room for that. There's also the financial stability oversight council which was a creation in DoddFrank which by statute is chaired by the treasury secretary and then the there fed among other agencies also participates in that process. And then thirdly as I mentioned anything involving a bank regulation is typically going to involve if the senior or even the vice chair for supervision level interaction on bank regulation.

Tracy: You know, let's get into some of the, I guess, criticisms or perhaps questions about Kevin Worsh. And there's a few different dimensions. One is, of course, there's perception that he's long been an inflation hawk and suddenly he's sounded more dovish over the last, you know, 12, 18 months or whatever. Setting that aside though, you know, some of the criticisms start early on, including his judgment around the great financial crisis. Concerned more about inflation, you know, even up into fall 2008 than employment right on the eve of collapse. Also seemed to get very anxious about inflation soon coming out of the worst of it, etc. But like when you think about okay like his qualifications and what we can expect from him, how much like when you go back to that era, how much should we hold that against him perhaps? Either that he was off the mark or that he was at least very far out of consensus at the time.

Richard Clarida: Well, I think you have to look at the entire picture and Kevin was also very involved with Ben and Tim Gner and Dudley and the crisis response to the global financial crisis which really played out over a period of 12 to 18 months and I think by most accounts in my judgment that was a you he actually added a lot of value in in the fog of war. Inflation as I myself learned especially in periods of crisis and unusual large shocks inflation forecasting can be can be challenging. So I don't think I would hold that particular episode against him. I think it does fairly characterize the way that most of us think about Kevin throughout during that period and really the last 15 years is he has been a pretty consistent critic of the Fed under the second half of Bernani and then Yellen and Pal and typically the criticism has come from the hawkish direction and certainly in that episode his his criticism of the Fed was that in some certain quotes would indicate that hawkish inclination as Well, maybe just I can follow up because in your earlier comment, you also mentioned his his recent advocacy for for lower rates.

Richard Clarida: Well, maybe just I can follow up because in your earlier comment, you also mentioned his his recent advocacy for for lower rates. Now, it's important this is in the context of a committee that under Pal's leadership beginning in September of 2024 already began to cut rates. In fact, when I did your show earlier and we were talking about that right after I think the initial rate cuts under under PAL, I made reference to what I've been calling for some time now the Fed is is running what I call the quote 2 point something inflation target which was they don't like it to start with a three, four, five, six or seven. But if inflation gets down to 2 point something, they can start to talk and think about rate cuts as they did under under PAL and in importantly at the December Fed meeting. So just about six weeks ago, the Fed indicated through those very imperfect dot plots that a majority of the committee of of that existing committee which Kevin will inherit felt that at least one more rate cut this year given the circumstances would be appropriate. So yes, Kevin has come out in favor of rate cuts in his public comments. Don't know what he said privately to the president, but I doubt that they differed what he said publicly. But that's in the context of a committee that at least a majority of whom think that in this year it'll be appropriate to cut at least once.

Joe: I'm just going to keep pretending to be an anthropologist and ask a bunch of cultural questions, but what actually is the role of Fed chair when you're in a monetary policy meeting? So, you know, let's say that Worish has some sort of outlier opinion. I don't know, he's prioritizing employment versus prices or whatever.

Tracy: Yeah. Can he convince everyone at the table, all the voting members to actually change their minds?

Richard Clarida: Tracy, it's a great question because a point that I like to make, at least in my professional time, which goes back to Paul Vulkar, we tend to talk about the Fed is the Vulkar Fed, the Greenspan Fed, Pal Yellen, Bernani Fed. And that's appropriate because in this era, Fed shares have been persuasive and they and they've usually got their their their way. But importantly, the Fed as an institution was specifically designed by the Congress in the 1930s in such a way that any material monetary policy decision, do they raise or lower interest rates or do they buy or sell treasuries, requires an affirmative vote of a committee comprised of 12 members. And so as I as I've liked to say and I'll say it again, really the power of the Fed chair is the power of persuasion because at the end of the day he or she only has one vote. Now it's often argued that well Rich that's silly because rarely do Fed chairs get outvoted and that that's true. It happened once or twice under Vulkar. It happened way back in the 1940s. And so yes, empirically it may appear as though chairs always get their way, but but remember Fed chairs know where the committee is leaning and often times or certain circumstances they may themselves decide not to be on the losing end of a particular vote but to try to persuade the committee over time to move in their direction.

Richard Clarida: Now one thing I can't really speak to the Greenspan Fed but beginning under Bernani and continuing under Yelen and certainly with Jay Pal there is a lot of premeating FOMC meeting communication and indeed Pal during my time there would have individual bilateral discussions with the other 18 people not just the voters but if you know there are 12 voters and another seven Reserve Bank presidents who don't vote in a particular year so Pal would have 18 individual phone calls or face-toface meetings before every meeting. I don't think that was the practice under Greenspan, for example. And so part of really what a Fed chair does is to get a sense of where individuals on the committee are, but really an important power that the chair does have is the chair sets the agenda for the meeting and the staff briefings for the most part are prepared by the board staff, sometimes with input from the reserve bank presidents and the board staff reports to the chair. And so the agenda for the meeting and often times details about the sort of analysis that would be useful for the discussion will be something that the chair will have a view on.

Richard Clarida: Now during you you asked for anecdotes you know during during my time because of my background in in monetary economics chair pal J pal did ask me to take a pretty hands-on role in interfacing between himself and the staff in particular the forecasting and the monetary affairs groups but ultimately my role was really in service to what he wanted to do to produce a successful meeting. The final thing I'll say, you got you got me sort of wound up.

Tracy: It's all great.

Richard Clarida: The final thing I'll say is, and I think this has been publicly reported, but at a typical Fed meeting, there is a policy announcement that comes out at 2 p.m. That's a decision, and the committee, of course, is discussing that decision, but it's discussing other options. And at a typical meeting, in addition to the Fed's statement and the policy action that was the outcome of the meeting, the committee is also discussing alternatives, actually tangible alternatives, alternative A, alternative B, alternative C. And there can be quite extensive back and forth in the meetings about those alternatives. And so even at the end of the day what the public sees is the Fed decided to keep rates on hold and there were two dissents which were governors and Waller a lot more was being discussed at the meeting as potential alternatives to that statement and that decision and a lot of discussion in meetings can be about what the committee thinks might be appropriate for the next meeting or the meeting down the road. Indeed, one of the many things I learned I made a promise to myself when I was in the job to to try to learn something new every day and I usually did and one of the things I didn't appreciate before I got into the to the Fed is especially the the chair and and the palett you you really need to have a sense of the arc of both the year in terms of the data flow you're likely to get and the arc of where decisions need to be made and how they're they're made. And so there's a lot sort of like an imperfect but not completely a bad analogy is we've heard of legendary football coaches who like script the first 50 plays of the game. Now sometimes they move away but they want to have a plan about how they'll react if the defense does a certain thing or the other. And it's not dissimilar to the way at least when I was at the pal Fed that that we would be thinking not only about the January meeting and then start thinking about March but really the arc of the of of the year you know based upon your view of the data and and a number of other considerations. So those are some tangible examples of the way chairs I think put their imprint on the on the process.

Joe: So, thinking of calling several plays in a row, we've seen Kevin Wars very skeptical of forward guidance and some of the monetary policy innovations that occurred in 2008, 2009, and so forth. I think it's easy maybe for people to forget that things like the dots, the press conference, and so forth, these are all very modern. For most of the Fed's history, there was none of this stuff. Do you think...

Tracy: I remember the invention of the dot plot? Remember that? We were trying I still don't get it but yeah.

Joe: Well, we were trying to figure out internally at Bloomberg like the best way to translate that information. Do you think I mean setting aside Worsh's view, do you think there's an argument to be made that some of these communication innovations that maybe made a lot of sense during a period of ZER where the Fed was trying to convince the market that it would be on hold for a very long time that maybe they can be revisited and we don't need so much of this stuff in normal times.

Richard Clarida: Yeah. So I think let's focus now on communication since that was your specific question but perhaps later also talk about Kevin's other critiques which are broadly the balance sheet sort of mission creep in the size and the composition of the balance sheet.

Joe: And then third critique is is grounding Fed policy both actions and communication more towards a policy rules framework and a less moving away from what he calls meeting by meeting discretion.

Richard Clarida: Let's talk about communication and having observed and taught this and actually done it for four years. I want to begin with a historically factual statement that's important to provide some context. It is perfectly possible to conduct a very successful monetary policy without any forward guidance.

Richard Clarida: Paul Vulkar did it for eight years and Alan Greenspan did it for 17. You know, there would be little hints and winks and nods, but forward guidance as we know it today is really something that was not really in the toolkit of Paul Vulkar or for the first 17 years, Alan Greenspan. Now, Greenspan's endlessly fascinating. And one of the fascinating things about Greenspan is that in his last two years, and I would say not coincidentally at the time that Ben Bernani was a Fed governor, right at the very end in 2004 to six, Greenspan began to dip his his toe into forward guidance. But for the most part, that was not really part of the toolkit.

Richard Clarida: So why did forward guide first of all then what is forward guidance and why it become part of the toolkit? Well, at its most basic level, forward guidance is providing information to observers and importantly to financial markets about the committee's expectation of the path for interest rates. Now, there's a huge academic literature. I've contributed to it myself. And one of the interesting things that you might find that's might be surprising about that literature is it spent a lot of time 20 years ago arguing that forward guidance was irrelevant because the Fed's looking at inflation data. The market's looking at inflation data. If inflation's too damn high, the Fed will raise rates. If it's low, they'll cut rates. So you don't really get any you don't really get any incremental benefit by telling people what you're going to do if they know you're going to do it anyway. And so the the case for forward guidance then has to then rest on something other than it's okay to talk about what you're going to do. And and where forward guidance really became a focus of the Fed was out of desperation at the zero bath.

Richard Clarida: So rates got cut to zero after Lehman Brothers. The economy was in freef fall. The financial system was on the verge of collapse.

Richard Clarida: And the Bernani Fed could not use conventional policy to lower rates because they had hit, you know, a zero bound. And so they began to provide guidance to the markets to essentially reassure markets that they were not on a hair trigger to hike rates because they kept noticing that even though the economy was weak, inflation was low, unemployment was high, the bond market kept pricing in rate hikes that they had no intention of delivering. And so forward guidance really took on an important role when the Fed was trapped at at at the zero bound. Now an interesting correlary then is what do you do when you raise rates above zero and of course the pal Fed did that beginning well yellen and then pal did that and I was actually there for the rate hikes in that in that cycle and the fed by the time I had arrived importantly because of the dots the Fed had begun to had continued to use forward guidance even after rates got above zero and oftentimes the dot plot was an input into that since it provides imperfect but potentially useful information about the committee's intention to adjust rates.

Richard Clarida: Let me say, however, that I think it's entirely appropriate that Kevin Worsh or anyone who becomes a Fed chair now think about the cost and benefits of forward guidance. Indeed, I've said for at least a decade, including before when I joined the Fed, that forward guidance and quantitative easing are not exempt from the laws of economics. They they have benefits but also costs. There are probably diminishing returns. And so I don't think it's at all inappropriate for the Fed under the leadership of the chair to think about benefits and cost of forward guidance in circumstances when it may be useful and circumstances when it may not be.

Richard Clarida: Let me just add a little kota here. Another dimension of Fed communication that's changed is really been the result of a change in technology and access. So, you know, if you go back to the 1980s, yes, when Vulkar gave a speech, people would read it and the Times and Wall Street Journal would report on it, but other than that, Fed communication was was pretty limited. And of course now of course we all have access to the internet and financial news and each Fed president and and Fed governor give speeches and so there's a lot more individual discussion of what individuals on the committee think would be appropriate policy as well as formal guidance as well. So I think that's that's sort of where we are on on forward guidance as of today.

Tracy: Just one followup to that. The way I think about it from a market perspective is that forward guidance you know since 2008 2009 has had the effect of dampening volatility especially in the bond market and now if you have less forward guidance it would seem perhaps there's a risk that volatility makes a return. Putting on your your PIMCO hat from the perspective of the bond market what would less forward guidance actually mean?

Richard Clarida: I think you hit the nail on the head. I think the most robust prediction I would make is it would it would in increase to some extent market volatility in particular interest rate volatility and importantly and I'll just be very direct and and and and blunt in the decade remember rates were at zero for seven years after the global financial crisis. Janet Yellen did not hike rates until December of 2015. And they've been on hold for seven years. And so not only was realized rate volatility low at the front end of the curve, but the Fed was using a lot of forward guidance and a lot of quantitative easing. And that was suppressing interest rate volatility for a very long period of time. And then even once the Fed began to lift off because it was deploying forward guidance that also served at the margin to suppress rate volatility. And you see this for example the move index which is a basically a bond market index. So volatility got down to very low levels.

Richard Clarida: So, so part of what has been happening really in the last several years under the PAL Fed is bond market implied volatility has gone up relative to the suppressed levels of the decade before the pandemic, but not really up to levels that were at all unusual back in the 1990s. And so I think my first order assessment is we may be going back to what I would call more normal or preGFC levels of rate volatility. Now the Fed is not the only only game in town when it comes to rate volatility. There's reasons for rate volatility to be elevated because of uncertainty about fiscal policy for example as as well. You know first of all I want to say you know I remember the concern that the Fed had in 2009 about does the market see the Fed as a hair trigger on inflation? I don't think a lot of people remember this, but in early 2009, the market was pricing in rate hikes by the end of 2009, which seems almost unbelievable in retrospect when you remind us that the Fed went seven years without a hike. So, there really was a very intense challenge on the Fed's hands to convince the market that it was going to stay on hold for a very long time. And I think forward guidance clearly played a sort of specific tech role there.

Tracy: Let's talk now about balance sheet.

Joe: Bill Dudley wrote a column for Bloomberg Opinion after the Worsh nomination and he was sort of critical. He said he didn't think that Worsh was going to be able to shrink the balance sheet much further unless there were some other changes perhaps relating to banks capital requirements etc. Worsh's own criticisms of the balance sheet seem a little bit of a moving target at some point. How well do you I mean maybe I would ask how well does any economist have a handle on the effects of balance sheet policy but what's your read on sort of the reality of wars coming intersection perhaps with the balance sheet.

Richard Clarida: Yeah, so I think there are two related but distinct elements to this first is that Kevin has been publicly and consistently critical of every expansion in the Fed's balance sheet since the first QE1 program so he very famously said he was opposed to the QE2 program in 2010. Although I think he did vote for it, but then he left soon after. And so there's the issue of backwardlooking, oh, the Fed should not have been buying treasuries and mortgages as it did. And I think there's no reason to think he's changed his mind. Indeed, Secretary Bessant wrote a piece with a very provocative title, the Fed's, you know, gain of function monetary policy. And he was also critical in retrospect of the expansion in the Fed's balance sheet. The important question of course for for OddLot's listeners and for markets is okay that's the past looking ahead and one of the many interesting things that Kevin Walsh said during his I guess campaign to become Fed chair was to call for a new accord between the Treasury and the Fed with regards to the balance sheet.

Richard Clarida: Now he hasn't provided a lot of details. What we do know is what the first accord between the Fed and the Treasury looked like, which was back in 1951. And what was interesting about that, it was essentially the Fed's declaration of independence to raise rates without getting approval from the Treasury, which is why Fed historians think of it as really a signal event in Fed history. So, I don't think that's really an issue. Now, presumably what Kevin means when he talks about an accord is a mutual understanding between the Fed and the Treasury about the size and composition of its balance sheet. And so, for example, you could agree that the Fed needs to have the current size balance sheet, but it should not own mortgage back securities or 30-year Treasuries. It should own T bills. So, that's a conversation you can have. You can also also have a conversation about the Fed having a a smaller balance sheet. Admire of Bill and I I read that column and agreed with almost all of it.

Richard Clarida: The point being is is to get from here to there is is not straightforward and in particular it involves the banking system in terms of the level of reserves in the banking system. The Fed has been very reticent although it's been tempted and it's discussed selling mortgage back securities. You can find it in the transcripts going back a dozen years and two years. And so right now there is no appetite in the existing Fed to think about shrinking the balance sheet through any sort of a any sort of a sale.

Richard Clarida: And then finally and I and I do want to get this on the table because I think it's a very important point that is often imperfectly appreciated is the following. In 2008, coincident with the global financial crisis, the Fed also achieved from Congress the statutory authority to pay interest on bank reserves. Until that point, the Fed created reserves by buying securities, but they earned a zero interest rates. And that not just the Fed, but most other central banks now pay a market rate of interest on bank reserves. And the reason why that's important is the following. What it means is that when the Fed does do a QE program, when it buys a mortgage security or a Treasury, it's not really printing money in the sort of money and banking sense that you're buying a coupon and paying for it with a $100 bill and thus extinguishing the coupon payment. What you're really what the Fed really does now with modern QE and interest on reserves is it's not extinguishing government debt. It's just changing the maturity composition of government debt from fixed to floating. Because at the end of the day, the Fed's balance sheet and the Treasury's balance sheet are consolidated. When the Fed's profitable, the the the Treasury gets that interest income. In recent years, the Fed has not been profitable and it's been withholding those remittances. And so once once you think of it that way, then you start to think about a scenario where a Treasury Secretary could, if he chose to say, you know what, I want to be the big sheriff in town when it comes to maturity composition. So if I think there are too many 30-year treasuries, I'll buy them and sell T bills and the Fed can buy the T bills. And so there are scenarios over time where we could rethink what QE is in addition to what the size of the balance sheet is. But this is not, you know, a 30 minute or you know a oneweek exercise. This will be a pretty complicated intricate process. But I don't want to rule out of hand that it's something that is you know beyond considering or discussing.

Joe: So other than his distaste for the size and potentially composition of the Fed balance sheet, there's something else that Worsh doesn't seem to like, and that's I guess traditional economic models. So he's been critical of the Phillips curve for instance. He's been critical of data dependency at the Fed which kind of leaves the question if you're not going to focus on data and you're not going to focus on models what are you actually using to formulate monetary policy? Do you have any any read on what that could be?

Richard Clarida: I think you know and I've known Kevin I think for a dozen years. I didn't our our terms as fed officials did not coincide, but I've gotten to know him since and we've met many times and had many conversations and the like and I read most if not all that he writes. You know, my my sense is really that his his critique is that a lot of economic models in macro tend to to put a lot of emphasis on on the demand side of the economy. Now I can point you to my first speech as Fed vice chair in October 2018 where I also put on the table that policy need to think about the supply side of the economy and the Fed doesn't want to be in the business of raising rates because too many people have a job if that's not inflationary and the the way you sort of square that circle is your outlook on on on productivity. And so it is correct that if you get more growth because you've got a more productive economy either through innovation or deregulation then the Fed should not get in in the way of that.

Richard Clarida: And indeed during my time the pal Fed didn't you know the models both in the Fed and outside in 2019 were saying and indeed if you look at Fed communication in 2017 it was saying if the unemployment rate falls below 5% we'll have to hike rates because that's going to be inflationary and by the time I got there the unemployment rate was in the fours and we didn't have inflation and it got down to the low threes. And so it is correct that there is a supply as well as a demand side to the economy. And if the supply side can grow faster with higher employment without inflation, the Fed should not get in the way with that. So I I 100% agree with with with that.

Richard Clarida: Now the the challenge is the economy, as Jay Palace said, the economy is constantly changing. And maybe just a little a little bit of a wonkish comment for the the wonks in your audience. And and let me set the record straight. You know, the old saying, facts are stubborn things. And we all live, you know, we're all three of us were around in the 1990s. And Greenspan is justly complimented as he should be indeed what I teach this material. I always emphasize this period for recognizing that because of the internet and connectivity and personal computing that there would potentially was an eminent increase in pickup in productivity. And the staff and other governors were saying we should hike rates and green spend. And I said, "No, let's see. We may get this may be a productivity-led boom and that's indeed the story between 1995 and 1999.

Richard Clarida: But if you look at the greenspan Fed in 1999 it was hiking rates even though we had very strong productivity growth and we had strong economic growth in the face of a very buoyant stock market and what people forget is that by 2000 the federal funds rate was at 6 and a half% so it is true that Greenspan did hold off for several years, but by the end of that of that tech internet boom and dare I say irrational exuberance, his famous phraseology, Greenspan was hiking rates very aggressively in the face of very strong productivity growth. So when people refer to that period approvingly as a reason for the Fed to hold off from from you know hiking or certainly continuing to cut rates because of productivity you have to look at the entire decade. You just can't cherrypick three or four years.

Tracy: This is interesting. You know, just while we're here, talk about Green Greenspan. I mean, why did he raise rates so aggressively? And did Greenspan's own rate hikes in the late '9s not really gel with his own comments about the capacity for the economy to grow during a time of expanding productivity?

Richard Clarida: The explanation, I would argue, was really was really twofold. I I do think by that time although I haven't memorized the memoir but but I think by that time the the irrational exuberance piece was a factor there is a there is a wealth effect so if stocks are going up people are wealthy they spend more and so central banks don't like to be in the business of of pricking bubbles but there is a connectivity between a very very fully valued stock market and your macro outlook you know we all remember some of us remember Pets.com you know the sock puppet Super Bowl commercials and also I just think by that point although inflation had not moved above I should also mention the other fascinating thing about that period is it's clear now from the transcripts that the Greenspan Fed by the mid to late 90s was in essence running what we would now call an inflation targeting regime and that the target was two but Greenspan was always resistant to the idea the Fed should ever publicly say that they were targeting 2% inflation.

Richard Clarida: But by the late 90s you have inflation moving up close to 2% and you could really I view this as a period where Greenspan's basically saying I don't want to go back to the bad old days of 8 7 5% you know inflation and so it was probably preemptive as well not resisting the productivity but merely trying to to keep the economy in in balance and then the final thing I'll say sorry to be wonky is that as a matter of economic modeling other things being equal if you've got faster productivity growth, you'd expect that to move up what economists call the neutral rate of interest anyway. And I think actually Bill Dudley made that point in his column as well.

Tracy: Never apologize for being wonky on this show.

Richard Clarida: Good.

Tracy: I want to go back to the question of central bank independence. So if if we assume that Worsh truly wants to do his own thing outside of presidential influence and again there are there are some people who doubt that is the case but if we take that premise how does he actually display or demonstrate the central bank's independence when you have a president who likes to talk about interest rates and likes to joke as we were saying earlier about you know I'm going to sue War if he doesn't lower rates.

Joe: You also use the word campaign in you Kevin Wars's campaign, which I thought was an interesting choice of words to describe the last several months.

Richard Clarida: That's okay. He's he's he's a very he's a good choice. And there there were three other candidates and and and it worked. I think I think there'll be a couple things Tracy that that we'll we'll see pretty soon. In fact, I'll let I'll let you and your listeners decide if it's a it's a joke. But one thing I find humorous, I'll share with you is that, you know, if if if JPL really wanted to complicate the situation for his successor, you know, he cut rates at the March and the and the April meeting to get the funds rate down to the level where at least the committee seems to think is the destination so that there's nothing for the next person to do.

Richard Clarida: I don't think Powell's going to to do that because I don't think it's...

Joe: Monetary policy by trolling. I don't know if that's a that doesn't sound like a Powell thing, but that would be funny.

Richard Clarida: Yeah, but you know, but but but but there is a kernel of of truth to it, which is as we said earlier in the in the podcast, the power of the chair is the power of persuasion. Wars will only have one vote. You've got some very very highprofile and confident people. There's a voting rotation as your listeners know. So right now you've got folks like Beth Hammock and you've got Lori Logan, Neil Qashqari in Minnesota are are voting now and and Anna Pollson in in Philadelphia. I I believe and you know and Lori Logan and and and and Hammock and and Kosh Curry will not will not be shy publicly or I'm sure in the meetings if they disagree with what they would perceive and I'm not saying wars would do this as you know we're going to keep cutting rates below a level where the committee seems to have a broad sense that the neutral rate the destination rate is going to be somewhere in the low threes you know three and a quarter three whatever.

Richard Clarida: And so I do think that we'll under the sort of baseline scenario for the economy we we may get to that level of rates sometime this year and then at that point the issue would be depending on if there's political pressure on on how the worst Fed would navigate that and my sense is notwithstanding all the discussion of the supply side benefits of of AI and and deregulation you know if if the hint or the discussion of a future rate cut would would trigger nervousness in the financial markets, break even inflations go up, expected inflation measures go up. You know, I think Worsh would and I think War and the Fed would take that seriously. So my my read is that he will he will navigate the data as it comes. He'll he'll want to focus on the supply side, but but at the end of the day, look, no no no no no Fed chair wants to go down in the history books as the Fed chair that squandered 40 years of price of stability. And and so at the end of the day, and this is I think perhaps what the president was referring to on more than one occasion when he was thinking about who he was going to choose. I'm paraphrasing, but he said something like, you know, people will say one thing and then they get in the job and they disappoint you. And so I think that that's an element of the of the institution and of the committee structure that will continue to be relevant.

Tracy: It's so interesting. I mean something that's interesting is when we you mentioned the 40 years of general price stability. It's interesting that like Arthur Burns that is a name that has a lot of it's been tarnished right because of the inflation. And yet Bernani, who you know went through the the great financial crisis, the worst downturn ever, by and large is remembered as having been a very good central bank chief. And so it's striking that, yeah, you have a few years of inflation, everything, oh, you're a disaster. But if you have a great recession underneath your term, by and large, you could still have a pretty good reputation. I want to ask though, you know, the thing is right now we still have above target inflation and maybe AI will drive a productivity boom and allow the economy to grow very fast with low rates etc. In the here and now though we we haven't even gotten back to 2% yet and so and a lot of these benefits of AI still very theoretical.

Richard Clarida: Yeah. Well, I I I'll I'll be even more blunt. I I think you can make a case that although longer term AI will be disinflationary as the productivity benefits arrive, you can I think you make a very plausible case that between between now and then the capex buildout to train the models is going to be increasing demand in a fully employed economy before the productivity benefits arise. And so if I were still teaching intermediate macro, this would actually be a pretty interesting case study to go on on the chalkboard that in 5 years you've got more GDP per worker. That's great. That's disinflationary. But between now and year five, you're going to be double doubling your tech capital spending investment, which is adding demand before the productivity benefits show up. So it's not a slam dunk to me at all about what about what AI means for for monetary policy near-term even though maybe in five years the productivity benefits are so large it it will it will have a different you know tend to be disinflationary. So I think it's AI is complicated along every dimension you can think. It's a complicated technology. It has complicated economics and social potential ramifications and I think it's it's not a slam dunk easy situation for the for the central bank either.

Richard Clarida: I have one last question about central bank independence. Setting aside Wars's comments, something we haven't talked about at all is the subpoena to Jerome Powell over the um over the offices over the renovation. Powell was very specific in that he thought the subpoena was motivated by punishing him or trying to get back at him for doing rate policy that the president didn't like. Two things related to that. A, does the subpoena in your view sort of add to your worry either medium or long term about how long the central bank truly will be an independent institution in the United States. And a correlary to that, you mentioned Powell control the uh wars by cut doing all the rate cuts. Now, what do you see as the odds that he stays on the board until his term as governor ends even if he's no longer chair?

Richard Clarida: First of all, there is there is precedent and the Fed's a very very president focused institution. Legendary Fed chair indeed had a building named after him. Mariner Eckles was an FDR appointee and then when Harry Truman became president, Harry Truman named another Fed chair and Eckles stayed on and and actually became a real thorn in Truman's side. I would be surprised if J. Pal stays on for the remainder of his term as governor, which which runs through January of 2020. Would I be shocked if he stayed for a meeting or or two? No. Only Powell knows. He's been asked that question two dozen times and he always gives the same answer. But but I sense he's probably not going to be staying on, you know, in terms of this case, you know, I pal's comments can can um you know, stand for themselves.

Richard Clarida: I won't weigh in. What I will say though is we have not only this the current thing that you just mentioned about investigation on the on the building, you know, we also have the Lisa Cook case. Is going to weigh in on on on that. And this is all sort of tied up into this idea of can Congress establish a central bank with a degree of independence to raise or lower rates. And an important element of this is this idea of four cause removal. You know, beyond that, it's just going to play out and I don't have any particular expertise about where it will end. But I will say is at the end of the day I do expect that the Fed is an institution and it's will have sufficient independence to raise or lower rates because of its institutional structure and I think ultimately the courts are going to back that up.

Joe: All right, Richard Clara truly the perfect guest. Thank you so much for coming back on All Thoughts.

Richard Clarida: Thank you. Thanks, Rich. That was great.

Joe: So, that was a really fun conversation. I like the idea or I'm not sure I like I am intrigued by the idea of monetary policy by trolling.

Tracy: That'd be so funny if there was like no room left to cut by the time Kevin got there and then he couldn't fulfill any inclination to cut. But I think it actually raises an important point and I'm thinking back to the conversation we did with Emmy Nakamura where she talks about central banks building up a sort of store of credibility and then having to spend it at various points. If you have a president who is so opinionated when it comes to interest rates and certainly not shy about tweeting or talking about them, I feel like it inherently starts to spend down some of that credibility because it just becomes very very difficult I think to demonstrate your own independence.

Joe: Yeah, I think it's going to be really tricky. You know, it's obviously something we talked about with Scand last week, which is that there's multiple potential nominees who would have come in with a willingness to cut rates further at this point. Christopher Waller being an obvious one. He's been voting for rate cuts, but he also has a lot of credibility because he was voting for rate hikes and, you know, 2022, 2023, and so forth. I think it's going to be uh, you know, it'll be tricky for War and But on the other hand, look, I would say also, you know, it's easy to say, oh, he's got to come in, he's got to build credibility. A lot of people really like him. A lot of people who have worked with him at various times, who have known him think he's a serious thinker, that he knows what he's talking about, that even if he doesn't always agree with them, particularly on things related to the balance sheet communication, that he's a honest broker. So maybe, you know, maybe we are overstating the risks or maybe it's easy to overstate the risk that he comes in and has a real fight on his hands to get the policy agenda that he wants.

Tracy: Oh, to be a fly on the wall of the first meeting with War, right?

Joe: Yeah, that'll it'll be uh it'll be super interesting. I also really like I wonder if he's going to get rid of the press conference. That's my prediction.

Tracy: I would not be surprised. And you know what I'll say like these are new things. It's not a it's it's not like he'd be overturning 80 years of president here. This is a very modern thing. And a lot of the communications innovations were as rich said a very specific purpose when the Fed was at Zerp to convince the market that it would stay low because and they needed to make that case. So if there's a sort of honest look at all of these postGFC monetary policy changes, I don't I I certainly think that's totally fine.

Joe: I think Jackson Hole might be in danger, too.

Tracy: You think so?

Joe: Yeah, maybe. Just out of pure self-interest. I hope not.

Tracy: I hope not, too. I like enjoy going to one of the most beautiful places on Earth every year. But we'll see.

Joe: Yeah. I hope I hope it doesn't go away.

Tracy: All right. Shall we leave it there?

Joe: Let's leave it there.

Tracy: This has been another episode of the Odd Thoughts podcast. I'm Tracy Aloway. You can follow me at Tracy.

Joe: And I'm Joe Weisenthal. You can follow me at the stalwart. Follow our producers Carmen Rodriguez at Carmen Dashel Bennett at Dashbot and Kalebrooks at Kalebrooks. And for more OddLots content, go to bloomberg.com/odlots or the daily newsletter and all of our episodes. And you can chat about all of these topics 247 in our Discord, discord.gg/odlots.

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