Earlier this month, the Federal Reserve released all the full transcripts from its many scheduled and unscheduled FOMC meetings in 2020. For Alphaville, this is like a new Taylor Swift album dropping, on Christmas Eve, and it’s summer.

The US central bank already releases edited minutes from its meetings with a three month lag, but the full transcripts and accompanying internal agendas and presentation materials are only published after five years. And on January 16, the Fed released all the ones for 2020. This was obviously a fairly remarkable year in the history of central banking, so the transcripts are even more interesting than usual.

Bloomberg has already highlighted how the transcripts revealed an intense debate over Jay Powell’s controversial decision to introduce formal conditions that must be met before the Fed raised rates from zero. Reuters focused on internal worries over the central bank’s independence, and how this aborted a discussion of yield curve control. Axios zoomed in on the slowness to identify incipient inflationary pressures.

However, at Alphaville we laugh in the face of “word counts”, so we decided to write a complete oral history of 2020 made up entirely of quotes from Fed policymakers lifted from the transcripts.

The unexpected hero of these documents is probably the Minneapolis Fed’s Neel Kashkari, who comes across as prescient at several important junctures. But our main takeaways are that central banking is hard; the Fed did a pretty good job; Michelle Bowman’s cat is named Buddy after Will Ferrell’s character in Elf; and that pandemics really suck the fun out of everything — even FOMC meetings.

It’s important to remember that these are just snapshots of specific moments. There are still some big holes, such as the deliberations behind the March 23 statement that vowed that the Fed “use its full range of tools to support the US economy in this challenging time” — hello, unlimited bond purchases! Books like Trillion Dollar Triage by Nick Timiraos and Jeanna Smialek’s Limitless fill in a lot of these gaps.

But there are still lots of fascinating nuggets hidden away in the full transcripts, and they deal with some of the biggest questions in economics and finance, many of which are still relevant. We probably haven’t spotted all the good stuff, so holler in the comments if you see anything else.

Because this is a loooooong post, here’s a table of contents to help you navigate around the various meetings and the main theme we thought they vaguely focused on.

ToC

1. January 28-29 — The Super Bowl banter meeting

2. March 2-3 — The Covid-19 freakout meeting

3. March 15 — The Apocalypse Now meeting

4. April 28-29 — The March 2020 post-mortem meeting

5. June 9-10 — The yield curve control meeting

6. July 28-29 — The ‘other shoes’ meeting

7. September 15-16 — The fateful FAIT meeting

8. November 4-5 — The post-election, pre-vaccine meeting

9. December 15-16 — The ‘see no inflation, hear no inflation’ meeting

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January 28-29

Laughter count: 47

Full transcript

Lorie Logan — manager of the System Open Market Operations division, and now head of the Dallas Fed — was first to mention the Big C in her opening briefing to the FOMC:

Over most of the intermeeting period, there was a “risk-on” tone — suggesting some improvement in the outlook for growth, an increase in risk appetite, and expectations that U.S. monetary policy won’t tighten anytime soon.

However, in recent days, market attention has shifted to the economic implications of the spread of the coronavirus in China. This has pushed down Treasury yields and, to a lesser extent, equity prices.

The FOMC’s policymakers also discussed the virus, but mostly dismissed it as a major risk to a US economy that seemed to be humming along nicely.

Randal Quarles, first vice chair for supervision at the Fed:

Growth overseas looks fragile, even more so with what seems to be the growing reaction to the coronavirus outbreak — which people seem to be reacting to as if it were the Andromeda Strain.

Eric Rosengren, president of the Federal Reserve Bank of Boston:

. . . The recent outbreak of the coronavirus in China highlights the challenges facing a highly global and mobile world, and geopolitical risks remain elevated, as was highlighted by the recent tensions with Iran. I continue to be concerned about such economic and geopolitical risks. But these risks do not seem to have generated nearly as much investor concern, as a wide variety of assets here and abroad have seen significant price appreciation.

Instead, the most engaging topic at the January meeting was the upcoming Super Bowl between the Kansas City Chiefs and the San Francisco 49ers.

Esther George, president of the Federal Reserve Bank of Kansas City:

Despite ongoing weakness in the District’s manufacturing, energy, and agriculture sectors, our District contacts report sentiment at a 50-year high, as the Kansas City Chiefs advance to the Super Bowl. [Laughter] It is the first time since 1970. We are hopeful for positive spillovers to the regional economy.

Quarles:

I would note that, as I was born in San Francisco but was appointed to the Board from the 10th District, I have a conflict that would make it inappropriate to express a preference [laughter] or even a prediction about this weekend’s outcome, but I think I can say appropriately that there is reason to believe that America will get a strong boost to sentiment on Sunday.

Richard Clarida, vice chair of the Federal Reserve:

It has been 50 years since the Chiefs won the Super Bowl. And I’m a Jets fan, and it’s been 51 years. We may never get there in my lifetime, so I’m going to live vicariously through the Chiefs, and I wish you well. Sorry, Vice Chair Williams. I’ve got my little sign here. I can’t have a Jets sign, so: Go, Chiefs! [Laughter]

Neel Kashkari, president of the Federal Reserve Bank of Minneapolis:

Let me start with the most important matter. I stand with my colleagues on supporting the Chiefs.

Mary Daly, president of the Federal Reserve Bank of San Francisco:

The new year started very, very well for me. The team I cheered for as a kid and the team I enjoy as an adult are both playing in the Super Bowl. I’d say sentiment is up everywhere, except on the East Coast. [Laughter] But they had their fill in the baseball season, so — Now, if you’re wondering whether I’ll be cheering for the Chiefs or the Niners, I’d say it’s completely an impossible choice. [Laughter] I can’t say.

Charles Evans, president of the Federal Reserve Bank of Chicago:

I didn’t get a chance to compare notes with Vice Chair Williams on his thinking for the Super Bowl. I kind of tried to ask him, but he cagily didn’t tell me. So I just wanted to potentially anticipate a different viewpoint. It does seem that one possibility is, 50 years ago, apparently, when Kansas City won the Super Bowl in 1970, that was about the time when inflation started picking up, and so perhaps if Kansas City wins [laughter], we can meet our inflation objective. We can always hope.

Patrick Harker, president of the Federal Reserve Bank of Philadelphia:

I also support guidance indicating it will take a material change in circumstances to generate a policy response. For now, I think we should just watch and wait. And I can’t wait to watch the Chiefs and Andy Reid reign victorious [laughter]. Sorry, John.

John Williams, the Sacramento-born president of the Federal Reserve Bank of New York:

Finally, a remaining prominent risk is the slim chance that the Kansas City Chiefs could win a second Super Bowl trophy. [Laughter] As I’m sure I do not need to remind anyone here — although there seems to be some confusion at the end of the table regarding the history, so I will clarify — the last time the Chiefs won a Super Bowl, which was a half-century ago, the economy fell immediately into a recession.

Now, I understand kind of wanting your home team to win, but we are better than that. [Laughter] We are here to support the U.S. economy, and, in light of this evidence from 1970, I really think we need to think again about which team we’re supporting for this Super Bowl.

The FOMC unanimously voted to hold interest rates at 1.5-1.75 per cent, the Chiefs smashed the Niners a few days later, and within weeks the US economy had fallen into one of the swiftest and biggest recessions on record — just as Williams had foreseen.

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March 2-3 (unscheduled meeting)

Laughter count: 0

Full transcript

By now, Covid-19 was no laughing matter. The Federal Reserve held an emergency conference call on the evening of March 2, where they voted to cut interest rates by 0.5 percentage points and promised to “use its tools and act as appropriate to support the economy”.

It was the first unscheduled emergency meeting since the 2008 financial crisis. Here’s what policymakers said behind closed doors at the time.

Jay Powell:

I just want to start by taking a step back and note that it was only 10 days ago or so that we were in a world in which the rate of new infections in China, particularly outside Hubei Province, was declining, and the number of infections outside of China was quite small. And it seemed reasonable to maintain hope that the infection would be contained, and many forecasts from that time reflected only modest effects here in the United States. But our awareness of the situation began to change, much for the worse, about 10 days ago, with significant outbreaks in Korea, Italy, and Iran.

. . . I had hoped — and I’m sure we all had hoped — that the virus would be contained in China, for the most part. Short of that, we hoped to be able to wait until at least the April meeting before seriously considering a response to these developments. And, as we’ve discussed, that is no longer a reasonable expectation.

. . . I think we all understand that a rate cut will not reduce the spread of infection or fix broken supply chains. It will not stop people from canceling travel plans. But it can provide a boost of confidence to markets and to households and businesses. And with the economy facing, in addition to a supply shock, the possibility of a large demand shock, our tools will provide meaningful support to the economy at a key time.

The entire FOMC agreed that a forceful emergency rate cut was appropriate, but many mainly saw the move as an “insurance” or “risk management” move. The San Francisco Fed’s Daly said:

I would have been more reluctant about it last week before the news came out and before I started meeting with my counsels and CEOs who are saying that the uncertainty that’s weighing down on their demand is already present. Even though we don’t see it yet in the hard data, they are seeing early signs of it, and I think this is an insurance against that spreading further.

The St Louis Fed’s Jim Bullard was even worried that an emergency cut could feed the growing panic in markets, or be seen as primarily a response to it:

Despite my support for this action, I am concerned that this policy move will be perceived and understood as a reaction to last week’s selloff in U.S. and global equity markets. I think this is a significant risk for this Committee, as it will set up expectations that any 10 percent selloff in equity valuations is likely to be met with major policy action. I don’t think that that is a pledge we want to make, because equity pricing is notoriously volatile, and some corrections are warranted, as pricing sometimes moves well away from what seems to be consistent with market fundamentals.

Many will, no doubt, argue that the current selloff is consistent with a move toward more rational pricing of the value of the U.S. corporate sector. Because of this danger for the Committee, I think we need to make the case as strongly as we can in the days ahead that this move is about the risks to the economy and not about equity prices.

Kashkari was notably less sanguine than other policymakers, and presciently argued that the Fed should start planning for the worst:

I think the biggest concern that I have is if what materializes is one of the really bad scenarios and this is a true pandemic, we could, and I think we will, get back to the lower bound of the federal funds rate, probably pretty quickly. And then what? You know, what are our policy responses going to be if we end up getting back to the lower bound?

I can imagine a scenario in which the Treasury yield curve is basically at zero, and the federal funds rate is basically at zero, and credit spreads are wide. What do we do in that type of situation?

So I would just encourage us going forward — I’d like to see us start doing work on that, on what the tools are that we might use to try to respond to that downside scenario.

However, Bullard thought that by acting forcefully in early March, it might even obviate the need to do anything at the regularly scheduled FOMC meeting later that month:

My sense is that, by moving today, we will eliminate any need to move at the March meeting. We will have very little additional information at that point. If we wanted to move more, why aren’t we doing it at this meeting?

So if we don’t move at the March meeting, that would set us up to monitor incoming data and to allow the implications of the virus to come into sharper focus. My baseline is that the near-term news that is days ahead on the virus will be negative, in the sense that we will see many more cases, I think, in the United States and probably around the world, but as the weeks go on, that will turn neutral to positive, as the number of new cases begins to decline and the virus comes under control.

So we need to maintain enough policy space and timing to be able to play that appropriately and give the appropriate reaction in order to handle this risk in the right way.

Umm, yeah, no. Not even close.

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March 15 (unscheduled)

Laughter count: 0

Full transcript

Underscoring how concerns had blown up into full panic by mid-March, this meeting was held by video conference on a Sunday, just two days before the scheduled meeting was supposed to take place.

Powell opened up with a few comments laying out the stakes and commending the Fed’s staff for the job they were doing:

This is a very difficult time for our nation — actually, for the world. The level of uncertainty and fear is unlike anything I can recall from my lifetime except, perhaps, the 9/11 attacks.

Of course, it’s not possible to know how this is going to develop. There is an upside case and a downside case to go with the base case, as there always is. We just don’t know.

I want to thank everyone, especially the staff, for your great work during this difficult time. We are making a difference, and the world is relying on us to continue to do what we can.

Logan then laid out a long list of bad, terrible, no-good developments, such as airline bonds trading as if they were already in default; massive outflows from bond funds; dislocated trading across the board; even investment grade corporate bond issuance becoming “sporadic” and commercial paper market liquidity becoming “nearly nonexistent”.

But the most alarming development was arguably happening in the US government bond market, as Logan explained:

Following several consecutive days of worsening liquidity in the Treasury market, market participants reported an acute decline in conditions toward the end of last week. A number of primary dealers reported that they had stopped making markets in off-the-run securities, and that this segment of the Treasury market had ceased to function effectively.

This disruption to intermediation was due to extraordinary flows from investors seeking the safety of Treasury securities, particularly in the on-the-run Treasury securities, the most liquid, and from those selling off-the-run Treasury securities, which included reserve managers who sought to raise cash, hedge funds facing margin calls or seeking to reduce leverage, and asset managers looking to rebalance their portfolios. Dealers reported having difficulty selling these off-the-run securities and constraints on their ability to absorb any additional inventories that were coming their way.

Given the central role of Treasury securities in pricing and in hedging, and as a store of value, this decline in liquidity spilled over into other markets and started to raise questions about the functioning of the financial system more broadly.

Logan explained what the Fed was already doing — primarily big repo operations — and what it now wanted to do to restore calm: buy a lot of bonds, starting with $40bn of Treasuries immediately that Monday.

She revealed that the Fed had already bought $37bn the preceding Friday, three times more than the central bank had ever bought in a single day even in the wake of the 2008 crisis. Now Logan was proposing to do more than that every day.

NY Fed president Williams reinforced the importance of buttressing the Treasury market as the essential and immediate priority:

We are seeing stress and illiquidity and market dysfunction across a number of key, I would say, cornerstones of our financial system. This isn’t about the volatility in the stock market or some of those other markets. It is really about — to me, the primary focus for us is the fact that the U.S. Treasury securities market, which is, quite honestly, the most important market in the world, has shown a rapid deterioration in liquidity over the past week.

. . . When I think about how these developments in the financial markets affect our ability to carry out our monetary policy and actually for those decisions to get to the businesses and households, it is absolutely essential that the Treasury security and the MBS markets are functioning well. That’s where our focus has been, and I think that’s where our focus needs to be, because without that, anything else we do won’t actually work the way we want it to . . . If we don’t get this right, then I don’t think we can have success more broadly.

Powell said that fixing the Treasury market was the main reason for the Sunday’s emergency meeting:

A broken financial system can wreak terrible damage on the economy, as we so recently saw in the Global Financial Crisis.

We could actually have waited until Wednesday to reduce the federal funds rate. In my view, it would have been unwise to let three more days pass before acting to address the growing liquidity issues.

Kashkari was once again prescient, asking why the Fed didn’t simply announce unlimited purchases by just saying it would buy “as needed until we get markets functioning again”, rather than announce headline targets ($500bn of Treasuries and $200bn of mortgage-backed securities was the concrete proposal being discussed)

He was unconvinced that the proposed statement was sufficiently clear that the Fed was willing to do whatever it took to restore calm:

. . . That’s language that we use all the time: “We will act as appropriate.” My own personal opinion is, I don’t feel like that’s that powerful anymore, because we’ve said that a lot. And people kind of know that we will keep playing catch-up.

I guess, just in the spirit of trying to get ahead of things, you could announce a bigger number, or you could just simply say, “We will step into these markets as we need to achieve market functioning.” Anyway, I just offer it for consideration.

To Rosengren, one way to send a clear signal to everyone that the Fed was not shrinking from the task at hand would be to tweak the language of the proposed statement.

So, following up on Neel Kashkari’s earlier comments, inserting the words “at least” before “$500 billion” and “$200 billion,” which makes the amount that we’re going to be doing for MBS and Treasury securities a minimum, might be a way of conveying that we are definitely going big and not just counting on us getting back.

So it’s a simple insertion of the words “at least” between those two. We could still stay exactly at those numbers if we thought it was appropriate, but it gives the flexibility to go larger if it’s needed. And I think, given the amount of disruption to Treasury securities and MBS, that ought to be a first-order thing that we need to get corrected.

So just highlighting that we’re going to do whatever it takes to get those markets functional, I think, is important.

The FOMC’s members also spent a lot of time talking about what the hell was going on with the economy, and exchanging anecdotes from their districts and contacts. The concept of “Knightian Uncertanty” was brought up a lot.

Clarida still thought that a recession might be averted, but stressed that the outlook was exceptionally murky.

Although the ultimate consequences of the virus pandemic for the United States are unknowable today, we do know enough already to dispense with rules of thumb and reliance on historical models to dictate our thinking as we navigate through this challenging time.

Barkin also raised just how uncertain the outlook was, given the novelty of the pandemic.

It’s impossible to know whether, in the letter language I’ve grown to know, we’re looking at a lowercase v, a capital V, a U, a W, or — God forbid — an L.

Daly was very much in the big nasty recession camp:

Just a week ago, I thought the more optimistic scenario was plausible. But I have now sat for a week here in the Bay Area and in the West, and the pace of the virus spreading and our lack of preparation has been surprising and actually startling.

Many of the FOMC members noted the obvious limits of monetary policy when the central crisis was a pandemic. As Quarles said:

Lowering the interest rate will not open schools, and it won’t finish the NBA season

However, Kashkari — drawing on his experience from the US Treasury in 2008 — argued that it was much better for the Fed to overreact than underreact, given the severity of the financial and economics shocks that flowed from the pandemic.

One thing I’m reminded of — and this echoes something that Charlie said — back in the financial crisis, the one mistake that, collectively, the Treasury, where I was, and the Fed repeatedly made is that we were always slow, we were always too little, and we were always timid.

And that was because we didn’t know “Is this it?”—right? Is this as bad as the crisis is going to get? We didn’t want to overreact. But, as Charlie said, when the downside scenario is the great financial crisis, the downside scenario is a deep, deep recession, the downside scenario is an Italy scenario, the right policy response is to overreact, because you want to clip that very deep — maybe it’s small, but very deep — hole.

I just think, as we think about policies for this and coming meetings, we should not worry about overreacting. We should be erring on the side of doing too much, not doing too little.

. . . I’m not going to jump ahead to the policy response. But, again, I just think, for our part of this that we can respond to, we should be erring on the side of doing too much, and that first and foremost starts with lender of last resort. Related to Treasury and agency securities, certainly, but I think very quickly we are going to get into credit markets. And then that’s where we are going to need to focus our attention and how to design those in a way that can support the economy, without having us “step out of our lane.”

Clarida also supported erring on the side of aggressive Fed action, pointing out that:

. . . the potential costs of easing too much, in terms of encouraging excess risk-taking or triggering a significant overshoot of our inflation objective, do not seem to be at all relevant, given the conditions we face.

All this seems to have convinced some of the of the more cautious FOMC members, such as Quarles:

I take the full force of the arguments that have been made from the people around this virtual table whom I respect. Again, if it’s the conclusion of the Committee, I can support a 100 basis point move, with reservations but no reluctance. And some day in the future when I’m telling my grandchildren about the events of March 2020, I may have decided in my own mind whether that is statesmanship or simply conflict avoidance.

However, as Williams identified, even taking interest rates back to zero and buying “at least” $700bn of Treasuries and MBS might not be enough.

One natural thing is, after we do this, people are going to ask, “What’s next?”

That’s not an argument against doing what’s right today, but it does mean that once we’re done tonight and maybe get some sleep — which would be nice for our team to get for one night — we’re going to need to be working tirelessly on thinking about what the next options are.

On thinking big, Kaplan was the first policymaker in the transcripts to mention breaking the glass on the Fed’s Section 13(3), even though it had clearly been discussed going into the emergency meeting.

This is an obscure part of the Federal Reserve Act that gives the central bank a lot of leeway to lend freely when the board votes that there are “unusual and exigent circumstances”.

Section 13(3) was the legal backing for some of the Fed’s main tools in 2008, and Kaplan broached the idea of invoking it again to resuscitate the commercial paper market and keep otherwise healthy companies from dying from a potentially short-term shock:

I’m most worried now that otherwise creditworthy companies, big and small — and I mean creditworthy investment-grade — are going to struggle to make it through this because of lack of access to capital.

And this is where I would echo — and we’ve talked, leading up to this meeting, about short-term funding for small businesses — that CP funding, including the old 13(3) program for creditworthy businesses, I think is going to be essential now, and essential very quickly.

Both a new Commercial Paper Funding Facility and a Term Auction Facility were in the works, but unfortunately the details weren’t quite ready yet. As Powell told the FOMC:

We’re ready to drop them. We’re not ready to drop them today. If the need arises, we’ll resolve — we’ll probably, later today, need to talk about these policy considerations. We’re well aware of the urgency of it. It just — to try to slam them together for today didn’t work.

Some policymakers and Fed officials raised the danger of another money market fund, which had proved so dangerous back in 2008.

Rosengren raised the possibility that aggressive Treasury purchases and interest rate cuts could push bill yields into negative territory and further hurt money market funds. But, interestingly (at least to Alphaville), he was agnostic as to whether “prime” money market funds made it through the crisis alive:

I do view the difference between government funds and prime funds a little bit differently. The government funds are much larger than the prime funds. I think it’s very important that the government funds exist through the crisis and after the crisis. I’m not as certain that we should do much to actually support the prime funds, but that’s a topic for possibly another time.

Kashkari appears to have been the first to advocate for some kind of facility for investment grade corporate and municipal bonds too, by invoking 13(3):

I’m not talking about bailing out airlines, but I do think making sure industrial companies that are otherwise healthy — there needs to be a functioning bond market, and I think this is an appropriate role for central banks to play.

Same thing with the muni market. You can imagine, a lot of the health responses are going to be at the state level. You can imagine states wanting to tap the muni market to help them with their health-care response. I think us making sure that the muni market is functioning is a totally appropriate role for a central bank. Other central banks get involved in these markets, and I think we can do it, again, without going down the path of bailouts. We could put some parameters around it to make sure that we’re just ensuring functioning of markets for good credit, and we have the authority to do it.

We don’t have to reopen the Federal Reserve Act. Between our discount window authority, through which we can lend against almost anything, and our 13(3) authority, I know that Dodd-Frank constrained it, so we can’t do one-off interventions like Bear Stearns with Maiden Lane. But, in the extreme, you could imagine Maiden Lane for a very wide set of counterparties, a very wide set of assets. So the authority exists. We just have to decide if we want to use it

There were other policy options discussed, but often obliquely or to kybosh them. Bullard warned that the big rate cut meant the Fed should be prepared for pointed questions of whether it might take rates below zero, as had been done elsewhere.

Going back to the lower bound at this meeting will bring up the issue of negative rates in the United States within hours of our announcement. And I don’t think that the Committee is completely prepared for that debate.

We’ve talked about it a lot. I think most members have said — maybe all members have said — that they don’t like negative rates, and we don’t want to go to negative rates. But we’re in a crisis situation. We’re going to come under immense pressure on that issue. We have to have a very good argument about why we’re not doing that or why we think other avenues are more appropriate.

The Atlanta Fed’s Raphael Bostic also raised the possibility of negative interest rates, and pointed out that the Fed might also get questions about modern monetary theory:

Like President Bullard and others, I don’t think the issue of negative rates is clearly off the table. Similarly, what about modern monetary theory? Are we prepared to go there? We need a more concrete plan, and the Committee needs to have these deliberations quickly.

In the end, the FOMC voted to cut rates to 0-0.25 per cent, to buy “at least” $500bn of Treasuries and $200bn of mortgage-backed securities, and to reactivate swap lines with a series of foreign central banks. The Cleveland Fed’s Loretta Mester was the lose dissenter, but only because she preferred to keep the fed funds rate above zero.

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April 28-29

Laughter count: 0

Full transcript

Despite the massive package announced after the March 15 emergency meeting, markets still keeled over the following Monday. Although the blitz of bond purchases from Logan’s team helped send Treasury yields a little lower, the US stock market fell by 12 per cent — the worst day since the Black Monday crash of 1987 — and the financial system’s dysfunction worsened.

The Fed therefore ditched any remaining reservations over the next week, rolling out emergency facilities for commercial paper, money market funds, opened up swap lines to more foreign central banks and ramped up Treasury purchases to $75bn a day.

When even this didn’t arrest the slide, it spent the weekend working on an even bolder package, and on the morning of March 23 announced unlimited bond purchases and revealed facilities for buying corporate bonds — both in the primary and secondary market.

The scheduled March meeting was superseded by these events, so the FOMC wouldn’t have another formal meeting until the end of April, when things looked a little better, at least from a financial perspective.

Powell still had to spend the beginning of the meeting going over video conference logistics, technical issues and etiquette.

When you are speaking, please do remember to unmute yourself and speak directly into the phone in order to avoid feedback. We also have a parallel Skype session that participants and others can use to indicate when you have a question.

Please don’t use the Skype session to start running side debates or commentary because they will then become part of the meeting, and that would be awkward.

See, central bankers were just like us!

Logan then showed how markets had calmed down a little, allowing the Fed to reduce its bond purchases to a mere $10bn a day or so, before turning things over to Andreas Lehnert — the Fed’s top financial stability expert. He told the FOMC that US banks had so far proven “extremely resilient”, but noted that the pandemic had revealed some “notable vulnerabilities” in the financial system.

Fed vice chair Lael Brainard zoomed in on some of these “notable vulnerabilities” in her subsequent comments.

A wave of redemptions at bond funds and muni funds raises questions of whether liquidity management frameworks are sufficiently robust. Prime money market funds are once again under the spotlight, after a wave of redemptions led to stresses that required emergency interventions.

The need to exit crowded positions among hedge funds with relative value strategies contributed to the massive distortions in Treasury securities markets. And the capital- and liquidity-light business model of many nonbank mortgage servicers has come under stress, as a result of the forbearance provided by the CARES Act.

Which Quarles echoed:

I do think that this event has thrown into relief some vulnerabilities in the nonbank financial sector that we have talked about for some time but that had not been addressed in the wake of the previous crisis or not addressed completely, perhaps because of response fatigue or just the more difficult nature of the response.

But I do think that it will be incumbent on the Financial Stability Board to pick up some of these questions about nonbank finance and to look at them much more intently.

Kashkari thought some of the Fed’s forecasts were still on the optimistic side, worried about new rounds of infections and financial stress:

The 2008 crisis is just burned into me, and April 2020 reminds me of April 2008.

In March of ’08, Bear Stearns was rescued, thanks to the Federal Reserve’s actions. Markets started breathing a sigh of relief. In April, people thought, “Maybe we’re through it.” The banks said, “Oh, we’re fine. We’ve got enough capital.” They continued paying dividends. They refused to raise capital.

And, of course, the much bigger shoe was yet to drop in the fall. I obviously hope that doesn’t happen here, but I think we should be urging banks both to stop paying dividends and to be raising capital just as a precautionary measure.

But Kashkari’s most interesting comments were about the lessons from March 2020. Alphaville is going to quote him at length here, because this meshes with our own views:

I think the fact that this is happening 12 years after 2008 is just shocking to me and probably shocking to all of us. Over the longer term, I think it is going to raise many more fundamental questions about our regulatory system, not just for banks, but for nonbanks. I mean, the basic theory of our regulatory reforms coming after ’08 is that institutions should be self-insuring. And yet we’ve already demonstrated that that’s failed.

The Federal Reserve has taken extraordinary actions in the past month, and I support those actions. It was the right thing to do to stand up all of these facilities to support financial markets. And now everybody knows that we’re there. And we were there in ’08, we are there now, and we’re going to be there in the future. And so, even after we officially deactivate these facilities when the COVID-19 crisis passes, in a sense, these facilities are always on in the background now.

And so, to me, I think we have to ask, over the long term, much more fundamental questions about the structure of our financial markets.

Think about overnight funding markets. Is there any social value to allowing institutions — banks or nonbanks — to fund themselves overnight? The only social value that occurs to me is that they can maximize their profits in the short run, knowing that the Federal Reserve is going to be there in the long run when things get scary.

And so I know we’re not going to answer these questions today, this week, or this month, but I’m beginning to think about, if we have this very robust Federal Reserve — provided safety net behind the financial system — and I agree that we should, I’m not questioning that — I think it should lead to much more profound questions about the regulatory system that we have in the future so that taxpayers aren’t “on the hook,” with the private sector getting the benefits.

After a lunch break the FOMC turned to the economic outlook, which was . . . grim. Here’s Clarida:

This downturn will almost certainly feature the steepest decline in U.S. real economic activity since World War II. Since the March FOMC meeting, more than 25 million Americans have filed for unemployment benefits. The unemployment rate will soon soar to double-digit levels last seen during the Great Depression.

The main message of many FOMC members was that the Fed essentially wanted to build a bridge to take the US economy from its pre-pandemic health to the to the other side. As Mester put it:

Now, the duration of the shutdown has lengthened over time, so that bridge has to be longer than first assumed, and it also has to be wider, as more households and firms are in need of some kind of help.

The big challenge, as many Fed policymakers noted, was knowing how long shutdowns should, could and would last, with different states taking different approaches and the coronavirus spread still unclear, with a difficult balance to be struck. Bostic:

While I certainly acknowledge that — on the evidence of video calls that I’ve been on recently — many of my friends, family, and colleagues are in dire need of a haircut, that reality should not color how we balance the desire to get back to a functioning economy against the risk of potentially impairing public health by returning to business as usual too quickly.

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June 9-10

Laughter count: 5

Full transcript

Some mild mirth finally returns! Hardly Super Bowl level bants, but a sign of some normality.

And that’s despite Jay Powell starting the two-day meeting with a sombre statement about the murder of George Floyd and laying out how he planned to make it public at the subsequent press conference.

This FOMC meeting featured a timely “special topic” — a discussion of forward guidance, even more quantitative easing and yield curve control. The Bank of Japan had first introduced YCC in 2016, but the Reserve Bank of Australia had followed suit in March 2020. It’s interesting that this became such a hot topic at the Fed as well that summer, with Clarida laying out why:

Even allowing for a robust recovery to commence in the third quarter, the U.S. economy may well end the year 2020 with an unemployment rate near 10 percent, with core PCE close to 100 basis points below our target, and with an output gap of at least 7 percent of GDP. If so, we will enter 2021 further away from our dual-mandate goals than we were entering 2009.

. . . we’re at the effective lower bound now and likely to be here for some time, and the ELB is a binding constraint, and so it’s going to be important for us to rely on other tools. Indeed, that’s all we can do — we can’t rely on cutting rates.

In particular, we’ll need to be ready to consider using tools that are both familiar and perhaps also untried, and we may need to deploy bold and creative variants of both forward guidance and balance sheet policy to have a fighting chance of achieving our dual-mandate goals over any reasonable time horizon.

Harker was sceptical, however:

Simply put, it does not seem advisable to subordinate a tested tool — LSAPs — to an untested one — yield curve control — for what appear to be meager gains that come with an array of significant risks and challenges.

One obvious risk is that markets will put pressure on our yield target, requiring large increases in our asset holdings, potentially leaving our balance sheet with a very uneven maturity composition. Yet I am also concerned about what yield curve control could do to market functioning and the private sector’s balance sheet.

As was Rosengren:

while deploying yield curve control at this time may not be as effective as asset purchases combined with strong forward guidance, I would certainly not rule out yield curve control or targeting rates if financial conditions change. I would note that choosing yield curve control or targeting interest rates can also result in a more complicated exit strategy but may be worth doing if rates remain higher than is justified by appropriate policy.

And Kaplan:

I honestly have more questions and concerns than I do answers. I do understand the pro argument that, in a period when you’ve got very large and rising fiscal deficits and rising public debt, if Treasury yields start to be driven by that, I could see where the Federal Reserve is going to have to take a close look at that situation. Otherwise, I’m concerned about some of the destabilizing effects, potentially, of yield curve control, particularly if it’s a forward commitment.

Bullard was cautiously positive, but felt it was too soon, and warned that it could raise some awkward questions on the Fed’s independence, given how the last time something like YCC had occurred in the US was during WWII and its aftermath:

An important drawback is that yield curve targeting may prove to be incompatible with central bank independence. Central banks that lose their ability to act independently from the rest of government have a very poor track record with respect to macroeconomic goals like inflation control and stable labor markets.

George said she was open to further discussion, but was also wary — mainly because it might distort markets, be hard to exit from, and because it wasn’t really necessary anyway (even 30-year Treasuries were trading at 1.5 per cent at the time):

I’m mindful that as we intervene in markets and influence prices in a low-forlong environment, we risk losing valuable sources of market information. Market signals are important, and we smother them at some risk to ourselves and the economy.

As a corollary, I don’t think we should take for granted that, once we move so explicitly into a particular market segment, we can subsequently depart and expect things to go back to normal. So forceful an intervention as a price target is likely to have lasting effects on the market, even if we do plan to eventually exit.

And as a practical matter, with Treasury yields already near record lows, we may find we really don’t have much yield to control.

Kashkari, on the other hand, argued that the Fed might in practice be running contractionary monetary policy — given the scale of the economy’s woes and the inflation outlook — and that many of the challenges could be overcome with a well-designed yield curve control programme:

There are a lot of ways you could design this. My point is that the federal funds rate, a two-year or three-year yield curve control, and the LSAPs could all be put together in a very tight package that is all anchored on achieving the same inflation goal.

So what would this achieve? I think it would provide some accommodation today, primarily through boosting inflation expectations somewhat today, and I think that would be useful. But I think even more powerful is that this would be a way of defending our inflation target.

Let’s not forget that we missed on our inflation target for 10 years before COVID-19 came along. And now we are at even greater risk of missing our inflation target as this pandemic winds its way through society.

And so, to me, doing all we can to defend the seriousness of our inflation target, and that we’re going to do whatever we can to try to achieve it, is, in and of itself, a useful exercise beyond the fact that it would be providing some additional stimulus today.

Powell concluded this discussion by saying that that he was “open” to the idea of capping yields, but was sceptical that it worth deploying at the time:

The question for me, as others noted, is, under what circumstances would a short-term yield curve control program add thrust to the Committee’s deployment of forward guidance and asset purchases, thus fostering achievement of our mandated goals, which today are far in the distance? And the answer will depend on the situation we face.

Today, markets do find our forward guidance credible, and as long as that’s the case, I’m not clear that there would be much of a problem here to be solved.

So where were the laughs? Well, one came from a Powell joke about background music, another from Williams making a comment masquerading badly as a question, and finally from Evans’ scepticism that Notre-Dame would be able to prohibit tailgating when the football season restarted.

But the most amusement seemed to come from Williams making fun of the roaring fire in Quarles’ background and Bowman’s snooping cat:

It’s been a very long day, but it’s been great to actually see people and interact a little bit. And I would like to thank Governor Quarles for not actually cooking, preparing some s’mores in front of us, which would have been very painful. [Laughter]

But I do have one concern that you should be aware of, and maybe this is something for Jim and Matt Luecke to look into. I just want to know whether Governor Bowman’s cat has signed the information security forms, because, you know, we just want to make sure everybody’s following the rules. [Laughter]

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July 28-29

Laughter count: 7

Full transcript

We can’t believe we committed ourselves to reading all these transcripts. We must have been mad. Anyway, we go again.

This was another meeting dominated by discussions of just what was going on with the virus, the economy and how to adjust forecasts and potentially policy for a horrifically large span of scenarios.

But the FOMC also discussed a memo by the Fed staff on “other shoes” that could plausibly still drop. Mester found it “particularly useful, if sobering” and zoomed in on the Treasury market’s remarkable opacity:

So one thing that I took away from the memos is that, in a variety of places, we don’t have sufficient data to make a clear assessment of the risks. This includes data on central counterparties, principal trading firms, and nonbank funders.

Available data that’s needed to monitor the very important Treasury securities market in real time are also found to be wanting. This is unacceptable. And we should do all we can to ensure that the data we’ve identified as being particularly helpful are acquired.

Bostic was also alarmed at this, and wanted more clarity on prop trading firms and clearing houses.

I hope that, as resources become available, we will aggressively follow up on the suggestions to, one, improve our data on Treasury securities markets, as suggested by President Mester; two, examine regulatory and market structure proposals related to the principal trading firms; and, three, increase our readiness to provide liquidity to a CCP.

Kashkari once again marvelled at how little had changed since the Global Financial Crisis and remained worried that the Fed’s staff were still underestimating the vulnerabilities.

I continue to be amazed that, 11 or 12 years after the 2008 crisis, we had to do a full-fledged bailout of the funding markets in March. I mean, that’s just astonishing to me.

And it wasn’t just the markets that we bailed out. We bailed out all of the market participants who would’ve been in a world of hurt, if the Federal Reserve had not stepped in. I totally support the actions we took, but this was a massive bailout of the financial system.

At this stage, the US stock market had rallied over 40 per cent from its March 2020 nadir and was approaching a new record high. This was something that also befuddled policymakers. Barkin called it “a bit surreal” and Daly worried it might mean it was acutely vulnerable to setbacks on any bad news:

Now, finally, let me say a few words about the stock market — something I always think of as a risky business, but I’m going to go do it anyway.

The most common question I get asked by my contacts is actually not “When will COVID end?” It’s “How is the stock market so out of whack?”—or so out of line with what they see as the pervasive uncertainty and unpredictable future that we have in our economy.

The stock market’s ebullience given the economic devastation they saw and the resurgence of infections over the summer. Bostic noted that the “risk picture is concerning”, with the only potentially good news on the horizon a vaccine — and he thought caution was prudent.

Since May, most if not all of the upside risks for a faster recovery have vanished as the path of the pandemic has worsened in nearly all parts of the country.

It seems that the sole remaining upside risk involves the rapid rollout of a vaccine. And, while I certainly hope this rapid rollout happens, my view of the overall risks has certainly shifted to the downside.

Kashkari was also doubtful that a vaccine was forthcoming any time soon, and even if one was developed it might not be particularly effective, he warned:

The best news is that there continues to be progress in vaccine development. Almost every day, the media covers the latest results of the many clinical trials that are being conducted, and some of those early trials are coming back with promising results. But health-care experts warn us that many vaccines and drugs show great promise in early trials, only to fail in later stages.

The Merck CEO, Ken Frazier, made headlines a couple of weeks ago when he said that the public was being done “a grave disservice” by the discussion of a vaccine arriving by year-end. He noted how long it takes to make sure a vaccine is safe, and not just on average — and this is what takes time — but for specific vulnerable communities that might each respond differently.

I think the staff is being prudent in assuming that there will be no widespread vaccine until late 2021. But even that may be optimistic. Health-care experts have told us that great unknowns remain about vaccine performance, even when one or more are approved.

Of course, we now know that strong, effective vaccines were being developed much faster than feared. But these doubts explain why the Fed was still overwhelmingly discussing what more they could do to support economic growth and prevent second-round financial mishaps.

At the end of the July videoconference we did get some closure on the yield curve control debate from the previous meeting, with Powell concluding:

Like most of you, I believe that our forward guidance remains credible on its own. And I don’t see a strong need for yield curve control as long as that remains the case.

The revised consensus statement, combined with clearly articulated forward guidance, should serve to support that necessary credibility.

And he also indicated that he was sceptical that more bond purchases would move the needle:

I admit I am more uncertain regarding the benefits of additional large scale asset purchases (LSAPs). I have a lot of confidence in their ability to stimulate stock markets and prices of risk assets. I have less confidence, with financial conditions this loose, in their effect on the broader economy.

Which set up forward guidance as the big debate at the next meeting.

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September 15-16

Laughter count: 2

Full transcript

A somewhat more subdued FOMC meeting, perhaps due to the recent passing from cancer of Thomas Laubach, the hugely influential head of the Fed’s Division Monetary Affairs. “His absence leaves a space that cannot truly be filled,” Powell told policymakers at the beginning of the meeting. “We will miss Thomas Laubach’s intellect and his insight. More importantly, we will miss Thomas Laubach.”

Powell used his annual speech at the Jackson Hole conference in August to announce a big fateful shift in the Fed’s policy framework, vowing to tolerate inflation running above its target for a period to make up for periods where it had run under it. This became known as “flexible average inflation targeting”, or FAIT, and would cause plenty of consternation in future years.

The main debate at this meeting was the concrete shape, strength and nuance of the Fed’s forward guidance — should it set out formal conditions that must be met before it contemplated raising rates again, and if so what should they be?

As Powell set out:

With the expansion well under way, now is the time to focus our policies and communications on supporting the economy as it travels the long road to a full recovery. I see no need to wait further.

In particular, I would not wait until financial markets start to doubt our commitment to a highly accommodative policy path. I am glad that we stood pat for six months. I think we were wise to do that. But we are a very long way from our goals, and further delays would risk undermining the credibility that we’ve built.

Our new consensus statement puts us in a good position to guide households, businesses, and markets to a new set of expectations that will serve the economy and the nation well. I see us as having two main chances to do that — maybe the only two.

The first chance is right now as the world gets its first look at how we will follow through on flexible average inflation targeting. The second chance, if it does come, will come some years down the road when we get back to low unemployment and inflation above 2 percent.

If we disappoint or fail to follow through persuasively in the near term, it could be a long wait and a difficult job to restore credibility, so I do believe it’s time to follow through on our proposed framework with strong forward guidance.

The FOMC discussed three different alternative approaches. You can see the full wordings and details in the presentation materials prepared by the Fed’s staff, which has also been made public alongside the transcripts. But here’s a quick rundown of the options:

— Alternative A was the strongest version, promising to to not raise rates until inflation had actually run over 2 per cent “for some time”;

— Alternative B was softer, promising to only do so when inflation was at 2 per cent and “on track” to exceed the target for some time;

— Alternative C represented the status quo — that the Fed only expected to raise rates when it was “confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”.

The subsequent Fed statement indicated that Alternative B had won through, with only Kaplan (Team C) and Kashkari (Team A) voting against. However, the transcripts reveal that the debate was far more contentious than the statement and abridged minutes imply, with several non-voters veering in different directions and some vocal misgivings among even the voters for Team B.

Harker supported B, but “with some reservations”. Daly admitted that B “wasn’t something I slam-dunk knew that I wanted or thought was the right thing to do”. Mester and Harker would have preferred to take longer to study the options and refine them. Quarles admitted that Alternative B was “much more aggressive than I had originally expected it would be”, even though he supported it.

Bowman said she would have preferred more focus on the long-run inflation goal of 2 per cent rather than “our tactics of inflation averaging”. Bostic and Rosengren were not voters at this meeting and both favoured Alternative C — Bostic because he felt it was too early, and Rosengren because he felt it might only help markets, not the economy.

Here’s Rosengren’s rationale:

When we provided forward guidance during the financial crisis, it was intended to lower borrowing rates. Specifically, we provided guidance on short-term rates and securities purchases with the intent to lower long-term rates. Currently, the 10-year Treasury rate is a little below 70 basis points, well below where it was during the financial crisis. I do not expect that the proposed forward guidance will materially lower the 10-year rate.

The public already knows we have no intention of raising rates anytime soon. Hence, the guidance is already fully reflected in bond pricing. What is the transmission mechanism of our forward guidance if it is intended to have little effect on long rates, as I assume?

While it will have little effect on borrowing rates paid by individuals and businesses, it will have an effect on asset prices. The guidance will serve as an announcement to traders that a risk-on strategy has no interest rate risk, and that it is time to bid up risky asset values.

Asset price inflation is a transmission mechanism for monetary policy, but primarily relying on this mechanism is not helping Main Street. It will only be artificially pumping up Wall Street. These asset pressures will build up over time and might set up the economy for a financial contraction down the road.

Kaplan shared the same concerns that it might just encourage “excessive risk-taking” and cause “distortions” and “greater fragility” in markets, but seemed primarily concerned with the prospect of binding the FOMC’s hands.

At the same time, I’m concerned that as this recovery unfolds and we get greater visibility into a post-COVID-19 economy, we may change our views regarding the wisdom of this guidance.

And, although there are escape clauses, my own view is that the bar is very high to activate them. I would guess that it would be very costly to activate such escape clauses in terms of damaging the credibility of the Federal Reserve and the effectiveness of forward guidance as a tool down the road.

Non-voter George supported B, but presciently worried a little about “upside risks” to inflation and how that could upset things:

The large disinflationary impulse coming from the COVID shock has largely been concentrated in a few hard-hit industries up to this point. In other sectors in which demand has surged and supply has sometimes been constrained, inflation has strengthened, sometimes noticeably.

While inflation remains well in hand, I would be uncomfortable if inflation were to move firmly above 2½ percent and long-run inflation expectations climbed similarly.

In contrast, non-voter Evans though that the language of Alternative A was “much simpler” and thus more likely of successfully delivering on the Fed’s inflation goal. Team A’s Kashkari was unconcerned with the danger of inflation:

What might be wrong under my scenario? If inflation is climbing and it crosses the 2 percent threshold, then we’re free to raise rates. So inflation doesn’t scare me.

We heard in the previous expansion that there might be nonlinearities in the inflation process. Again, we can’t rule it out. That was not revealed in the previous expansion, but it’s possible in the future.

If there’s some nonlinearity in the inflation process, that would be a situation in which we might regret this. But, again, that’s not yet been demonstrated to be true.

Powell, as expected, voted for B, and urged the committee not to wait. It was “important” that outsiders didn’t detect the chance of any backsliding on accommodation remaining strong for a very long time:

I also just think that this is the right place to be. I’ve come to the view, strongly, that this is the right place for us to be. I do think it works. I think it will be very good for the economy, to the extent monetary policy can have effects.

However, the truly historical, momentous event at the September 2020 meeting of the Federal Reserve was undoubtedly the immortalisation of Bowman’s cat at this critical juncture for global monetary policy:

Williams:

Many years in the future, when we’re retired and thinking back to 2020 and thinking about the decisions made in March and the decision we’re making today. And as I think about that and maybe even writing about that in the far-distant future, there’s one thing I will highlight, and that is, of course, Governor Bowman’s cat, who once again made a very visible appearance today throughout much of this discussion, which I really like.

So I just would like to know the name of your cat so I can memorialize this at some point in the future. Thank you, Mr. Chair.

Powell:

Thank you. Miki, can you share the name of your cat, please?

Bowman:

His name is Buddy, after Buddy the Elf — from Santa.

Powell:

Excellent. Thank you.

Okay. Thank you very much, everybody, for a truly interesting and thoughtful round of comments. This is, without question, an important meeting, an important decision, a difficult meeting, and a difficult decision.

No [laughter]! C’mon people. By the standards of FOMC meetings this is gold. I’m beginning to suspect that the transcripts simply don’t capture instances of mirth in virtual meetings. Anyway, here’s a topical meme.

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November 4-5

Laughter count: 1

Full transcript

We’re on the home stretch now. Thanks for joining me on what has ended up being a stupidly time-consuming project, with the effort is probably wildly out of whack with the final value derived from it. But by the time I realised that I was in too deep.

This meeting took place just days before Pfizer and BioNTech announced they had developed a Covid vaccine that was over 90 per cent effective, triggering a spasm of optimism in markets and inspiring this absolute banger.

There’s no hint that the FOMC were aware of this at the time (probably a good thing, given how trade-happy some of its members proved to be), but it means that the discussions were quickly overtaken by events.

Many policymakers were still pessimistic that a vaccine would arrive even by 2021. Brainard, for example, was understandably more focused on the near-term probability of a Covid surge over the winter months and renewed lockdowns.

Risks are to the downside, with the virus spread and the government’s response to it at the top of my list. The risks that cold weather will bring even higher case counts and hospitalizations that might necessitate the return of more stringent restrictions is more salient in light of what we have seen last week in Europe.

An earlier-than-expected vaccine still is a legitimate upside risk. But, in my view, changes since the September meeting place more weight to the downside on net.

Although Harker was notably more optimistic, at least by the standards of the FOMC:

I’m in general agreement with the baseline forecast in the Tealbook. And like the staff, I acknowledge the unusually high degree of uncertainty surrounding this forecast or, frankly, any forecast. It is an uncertainty that we have never dealt with, and the medical landscape is one that can change rapidly and unexpectedly as we are seeing. But I remain cautiously optimistic that an effective vaccine will be widely available in a year’s time, and that life will slowly return to a more normal setting.

One of the issued debated in November was to adjust the scale of the Fed’s ongoing bond-buying programme, which was slower than at the peak in March-April but still continuing at about $120bn a month.

Bostic, for one, thought that it should be pared back now that the acute stage of the crisis was clearly over:

I remain doubtful or skeptical that continuing asset purchases at the current pace for an extended period is without costs or risks. Therefore, were it not for the fact that markets expect asset purchases to continue, I might even go so far as to suggest stopping the purchase program altogether and redeploying asset purchases in the future when they will have more significant power to influence economic activity. That said, I can support the continuation of purchases, as stopping the program now could appear to be at odds with our federal funds rate guidance. I do, however, think that the restoration of market functions may be a good opportunity to reduce the size of our monthly purchases somewhat without imperiling the funds rate guidance.

Williams argued that while the Fed could formalise some guidance on when it might ratchet back the purchases there was still space to increase them further should the economic outlook remain dim:

We are not running out of ammo. If the economic outlook calls for additional accommodation, we can extend the duration of our Treasury security purchases by repurposing the shorter-maturity purchases to longer maturity Treasury securities and thereby provide more downward pressure on longer-term yields. In particular, we’re currently buying each month about $35 billion of U.S. Treasury securities with maturities of three years or less. So there’s considerable room to expand the amount of duration we’re taking out of the market, without increasing the overall size of our purchases

Yet most policymakers agreed that staying the course was the best option for the time being, and the vote to simply tweak the language of the Fed’s statement a little was passed unanimously.

And for conspiracy theorists who think the Fed is far more politicised than it admits, there was remarkably little discussion of the US presidential election that had happened just two days earlier and the almost-immediate attempts at overturning the result.

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December 15-16

Laughter count: 3

Full transcript

By now the positive news of vaccine was everywhere, and front-line healthcare workers were starting to get the shots. This naturally lightened the outlook for the Fed’s policymakers, despite the resurgence of Covid as winter set in.

But the optimism was still cautious, given probable delays in the rollout, with Daly summing up the vibe nicely:

The strength of the recovery has been surprising so far. Consumers and businesses, with the aid of fiscal and monetary policy support, remain really resilient, reengaging in the economy as the virus allows. And this underlying momentum, along with news about effective vaccines, has boosted my confidence about the medium-term outlook.

That said, we are not there yet, and several things in the current environment do give me pause. COVID-19 cases are surging across the country. In addition to the toll on health and hospitals that this takes, many small businesses and households are ill prepared to deal with the second wave and another step back in economic activity as we try to control the spread of the virus.

Why had the US economy surprised positively? It might be related to a somewhat haphazard state-by-state approach to restrictions, Rosengren suggested:

Since the spring, I have been worried about a second wave of the pandemic emerging during the late fall and winter. It did not require clairvoyant powers, as most epidemiologists anticipated that outcome with their models. Unfortunately, a severe new pandemic outbreak has ensued, with daily death rates last week starting to exceed 3,000 people a day and with hospitals in many areas of the country at or exceeding capacity. What I did not anticipate was the United States’ public health response would be so muted in the face of these frightening statistics.

Unlike Europe, which began lockdowns as deaths rose and hospital capacity fell, many states have done little to stem infections. Apparently, these states place a lower value on human life and health outcomes and a higher value on keeping businesses open even when a vaccine is only months from widespread availability. Particularly striking is the willingness in many states to continue to allow group gatherings and bars to remain open despite rampant community spread of the virus.

But what of inflationary dangers? The headline US inflation rate was just 1.4 per cent when the December FOMC meeting happened, but we now know that this was quiet before the inflationary storm.

How well did the Fed foresee at least the possibility of this? Not well. At all. Despite being generally pretty optimistic, Powell badly whiffed his inflation forecast.

I too have inflation peeking its head over the 2 percent line in 2023, as continued above-trend GDP growth pushes the unemployment rate down to 3½ percent by the end of that year. In this base case, I see liftoff as being plausible in 2024.

Despite downside risks in the near term, I now see the overall risks to GDP and employment as balanced. The vaccines substantially reduce the negative tail risks. I also see significant upside potential in the medium term. However, the risks to inflation seem to me to remain weighted to the downside.

😬😬😬

The inflation rate was actually above 2 per cent by March 2021, and hit a peak by 9.1 per cent in the summer of 2022. Interest rate lift-off was then both far swifter and more aggressive than Powell had foreseen.

He wasn’t the only one to badly miss the inflationary pressures that erupted over the coming year. Here’s Daly:

I think inflation is likely to remain soft as these sectors are held back by containment measures for COVID and then come back as we put COVID more behind us as the vaccine rolls out. But that will only be part of the battle. Returning inflation to 2 percent, on average, will take sustained policy accommodation to moderately overshoot the target, and I don’t see that occurring in the forecast horizon that we have.

And Kaplan:

Although I remain vigilant with regard to a large sustained deviation of inflation from target in either direction, I don’t anticipate that a likely temporary postvaccine surge in demand will generate sustained inflation pressure absent considerably tighter labor markets.

Evans was more worried about a too small inflationary overshoot:

We need much more than the de minimis 0.1 percentage point found in the Tealbook’s longer-run projection or in the monetary policy simulations under discounted average inflation targeting. I worry that attempts to fine-tune such a minimal inflation overshoot will limit our success. After all, how will the public judge averaging 2 percent? What if they just look at a simple time-series graph over many years?

After a prolonged period of large shortfalls, I do not believe that the picture with a couple of years of 2.1 or 2.2 percent inflation is going to convince the public we have successfully achieved an average of 2 percent.

Consequently, I see substantial risk that such a meager overshoot, or any communication that signals that such an outcome is acceptable, would fail to increase inflation expectations sufficiently or budge the underlying inflation trend.

Kashkari — returning to the FOMC after a brief stint of paternity leave — brought some worrying alternative data to the discussion, but was otherwise in Evans’ camp:

My wife tells me that my request to get a Sony PS5 for Christmas is going to lead to paying three or four times the list price. So there are signs of possibly large price increases that will show up in the December CPI, at least if she carries through on her promise to deliver the PS5 that I want, but we’ll have to see on that.

In the FOMC’s defence, it wasn’t as if bond investors were overly worried about inflation at the time either, with the five-year US break-even rate — the future inflation rate implied by comparing the yields of conventional and inflation-proofed Treasuries — still below 2 per cent.

That inflation went high in 2022 was also partly caused by Russia’s invasion of Ukraine in February that year, which is hardly a forecasting failure you can pin on the Federal Reserve.

However, the failure to anticipate that inflation could surprise so strongly is clearly the biggest blot on an otherwise sterling 2020 report card for the US central bank, its policymakers and staffers.

Powell closed out the final FOMC meeting of a historical year for central banking

Before we wrap up, I just want to say a couple of words. This year, 2020, is finally about to end, or at least we think so. I’ll believe it when the date actually changes. [Laughter] And I just want to say how proud I am of the work that we’ve all been able to do together this year.

There is no greater honor and no more important task than serving the public in a time of dire need. And I think, on balance, we acquitted ourselves very well when this great task fell to us. We intervened to prevent a global health crisis from “morphing” into a financial crisis and perhaps a depression.

And I hope everybody knows we all share in and I hope can take some satisfaction from what we’ve accomplished together. That’s something to reflect on as we all take some time off, I hope, and relax a bit and get ready for what 2021 will throw at us.

That’s all for us as well.

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Further reading:
— No, that’s enough