Former Fed Vice Chair Richard Clarida Talks Pandemic Monetary Policy and Inflation

Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast, an official podcast of the Hoover Institution Economic Policy Working Group, where we talk about economics, markets and public policy. I'm Jon Hartley, your host. Today my guest is Rich Clarida, who is a macroeconomist and the C. Lowell Harriss Professor of economics and Professor of international and public affairs at Columbia University, which also served as the 21st vice chair of the Federal Reserve from 2018 to 2022. Previously, during the George W Bush administration, Rich was assistant secretary of the treasury for economic policy. In which he's served as chief economic advisor to two different US treasury Secretaries.

Rich also serves as PIMCO's global economic advisor, where he's been affiliated for many years when outside of government. Thank you so much for joining us today, Rich.

Richard Clarida: Yeah, looking forward to this, Jon, thanks for having me.

Jon Hartley: Well, it's an honor to have you on, I want to start with your early life.

You've a lot of really great interests. For those who don't know, you've got quite a few musical interests. You performed with Chair Powell an acoustic version of “God Rest Ye Merry Gentlemen” and “We Three Kings” around Christmas time in the marble atrium of the Eccles building, which is where the Federal Reserve Board is headquartered in Washington, DC.

In 2016 you released a 13-track album, “Time No Changes”. When did you decide you wanted to be an economist? Were you ever considering other careers? You grew up in Illinois, you went to University of Illinois for undergrad, Harvard for your PhD in economics. How did your interest in economics first get started?

Richard Clarida: Well, so, in terms of the music, I grew up in a small coal mining town in downstate Illinois, and my father, both my parents, were very musical, and they were both very educated. In fact, my father had a PhD, which is unusual in downstate Illinois decades ago.

But he was a musician. Indeed, in his youth he was a professional jazz musician. So my brother and I were in elementary school. We didn't have a choice. I was gonna play clarinet and Bob was gonna play French horn. Sort of the peak of my clarinet career was at the age of 13.

I performed the Mozart clarinet concerto from memory. I mentioned that to one of my colleagues once, and he replied that's not a big deal. When Mozart was 13 he wrote the Mozart clarinet concerto. But in high school I got more interested in jazz and rock and was in rock bands in high school, wrote some music in college and actually released a couple of songs in the local area.

But anyway, in terms of economics, it's going to sound corny, but it was true. I took intro to economics as a freshman at the University of Illinois in a big lecture hall, I think 600 people in the lecture hall, and was completely hooked. And I basically, as a freshman, said this is what I'd like to do, I'd like to be an economics professor.

And I was fortunate enough, when I was a sophomore, to have a mentor, a gentleman named Matt Canzoneri. A very respected international macroeconomist who was my professor. And Matt was my mentor and basically said, if you want to get a PhD take the following math courses and distinguish yourself.

And I basically followed that template. And in those days it's much different today, as you know, John, but in those days this is the 1970s. So I started at Harvard in 1979. Indeed, I only happen just quip sometimes that the reason that I got into a top graduate school like Harvard, I had good grades and all that, but this was the decade in which there was a very popular book called the Over Educated American.

And the basic thesis was that Americans were over investing in education. There was no college or graduate school premium. And since that didn't really matter to me, I was doing it sort of out of love and interest, you know, there was a spot for me. So that was basically how it was.

I wanted to be an economics professor. I had the opportunity to do that and went straight from college to, to graduate school at Harvard in 1979. So that's sort of the quick first 20 plus years of my life.

Jon Hartley: Well, ironically, that's where The Overeducated American was written by Richard Freeman.

Richard Clarida: Yeah. Who was one of my professors at Harvard actually.

Jon Hartley: That's too funny. That's fascinating. Do you have particular influences who loomed large in your time at the Harvard economics department?

Richard Clarida: My, yeah, Jon, I have to tell you, it a very heady time to be interested in macro, in the early 80ss.

First of all, the US and the global economy was an absolute train wreck. Inflation went from 2% to 15%. There were four recessions in eleven years. Forget jobless recoveries and the unemployment rate spent half the time around 10%. And so what was a train wreck for prosperity was a stimulating world to be trying to understand.

Now,, precisely this time was something that was emerging out of the midwest, which was called the rational expectations revolution. And in those days that was a very contentious and controversial line of research. Now, not to graduate students. I thought, of course, what's the alternative? And I was very fortunate in several ways.

One, I had an incredible mentor at Harvard, Benjamin Friedman, for whom I worked at the NBER. And in those days the stipends and support for graduate students were not what they are today. So essentially, at Harvard in those days, although they didn't make you pay tuition, but, you know, in terms of surviving, you had to have some sort of, you either taught principles of economics or had an RA job.

And so that's how I supported myself. So Ben was an incredible mentor and still a dear friend. Tom Sargent visited Harvard in 81, 82. And in comparison to what faculty often times do when they go on leave, which is they get a nice office, lock the door and they write a book or finish articles.

Tom actually solo taught two PhD courses. And of course, those of us who were interested in macro took them. And it was both stimulating and exciting, plus he's a very, very persuasive and magnetic promoter of rational expectations in macro. And then finally, a lot of my technical skills I was able to start building up because young Olivier Blanchard, before he became an institution.

But Assistant Professor Olivier [Blanchard] was there and was on my committee. And also Mark Watson had arrived as an assistant professor. And so it was an exciting time to be thinking about macro. There was a toolkit that was being developed to sort of try to put some structure on it, and it was just a great, great experience.

Jon Hartley: Well, it's an amazing time to be at the Harvard economics department as a PhD student. As you mentioned, there was a time when there was quite a bit of a transition in thinking around macroeconomic models. There was a lot of I guess, Harvard and MIT was for a very long time, sort of the home of the old Keynesian sort of tradition.

And Ben Friedman and others very much being part of that in some respects Larry Summers now still part of that, sort of those for proponents of the old ISLM type static framework. I want to get into your great academic contributions because you very much laid some of the groundwork for the sort of success of thinking here.

So we had sort of the old Keynesian paradigm, pre sort of 1980s, 1970s, folks like Alan Blinder, Ben Friedman, and then you had the sort of RBC rational expectations revolution, but then folks like yourself came along. You're one of the founders of New Keynesian economics. One of your most famous papers is titled the Science of Monetary Policy, a new Keynesian perspective with Jordy Galli and Mark Gertler.

I'm curious, how did that paper come about along with the whole idea of taking the RBC paradigm and rational expectations and adding nominal rigidities, which I think is sort of the successive step that happened there and was a huge part of your contribution. And those sort of early new Keynesian folks in the 80s and 90s, when I think of folks like Ned Phelps, folks like yourself, Mark Gentler, John Taylor, Greg Mankiw, you're very much a huge part of that.

I'm curious, what was the inside story there?

Richard Clarida: Yeah, well, okay, so there are different layers to that onion, and I'll try to be concise. Here's sort of the big, big picture. So there were several things going on. So once the macro profession bought into at least starting with models where you had people who were optimizing and had rational expectations, there was a big fork in the room.

Everyone agreed, yeah, you want optimizing agents and you want to take some view on expectations. And then at that point, there was a fork in the road and some folks said, really influenced, I think by Eddie Prescott, that in order to sort of answer what those folks thought were interesting questions, you didn't even really need to take a stand on sticky prices or nominal variables at all.

So that agenda said, let's see how far we can get without going into the complications of rigidities and the like. And I think there was success in that literature, but it never resonated with me because all the things I was interested in really could not. That would have been putting a square peg in a round hole, but I think here was the problem, Jon.

The problem was, among those subset of people of my generation who thought about nominal rigidities, there were a couple related issues that meant that the RBC literature made earlier and more rapid progress than the subsequent we now call New Keynesian models. The first, and actually, I gave a talk at Hoover on this at one point that alluded to this.

One of the problems was that of the incredible influence of Milton Friedman in his 1967 presidential address [of the American Economic Association], which is, I teach that still to my students, I just taught it yesterday in my seminar at Columbia. Arguably, I think it's ten pages, you can count the words, but in terms of influence per page or per equation, it's completely off the charts because I don't think there's one equation, there's only ten pages.

And there are, at least by my count, at least four and maybe five seminal ideas in that paper. And one of them was essentially, implicitly a real business cycle argument, which is that a lot of what we call economic fluctuations are shocks and imperfections in labor markets and they'll sort of grind to the right place.

And it sort of said, a lot of what we think is a problem is just really an outcome of how an economy functions with shocks. But Friedman was not dogmatic and in particular, I think he always, at least in the Friedman that I read, I only had a chance to meet him once, actually, I should say John Taylor.

I came out to a Hoover conference decades ago, and John kindly invited me to a reception of his house, where I got to meet the great man, which was a real highlight of my career because that was the only chance I had. But Friedman had another argument that was influential, which is, yeah, probably there are rigidities.

The problem is, it's not clear that given the lags in policy and other things, it's not clear you can actually do any better if you try to offset them. So the mindset in the 80s, among young folks in their 30s, 20s who had the rational expectations toolkit, was there's a lot of interesting stuff that you can explain without rigidities.

And even though they're there, it's not clear you can really do anything about it because of Friedman's point about destabilizing the economy if you try to offset it. And so what that meant is when Mark and Jordan and I started working on this in the mid-90s, there was a great deal of skepticism that it was a relevant research program.

And then I gave another talk at Hoover on this a couple of years later, which is where the Taylor rule came in. So I can't speak for the other new Keynesians, but at least for Clarida, Gali, Gertler, when the light went off was when John's paper appeared.

It provided the missing link between wanting to link RBC models to what we thought of as realistic models with nominal rigidities. And essentially, you had to take a stand on monetary policy. You have to close a model, right? You've got endogenous variables, you need as many equations and you needed an equation.

And by thinking of the Taylor rules and equation that related a short-term interest rate to macro variables in a sensible way was an important insight, and we were among the first to have that. And so then once we had a way to close the model, there was a lot of tools, in fact, I told John this at the time when he and I used to get connect.

And I actually worked with John at the Treasury back in when he was undersecretary. And we talked about it then, but I always thought in the late 80s, early 90s, before we started working on this, I said, look, the questions are interesting. The toolkit is all there. Much of it was developed by John in the seventies and eighties.

We got an interesting set of questions. We got this toolkit. So, yeah, but I think it was the combination of the huge influence that RBC had on people and the fact that it wasn't clear how to close the model. I should also say it was certainly the highlight of my professional career to be able to collaborate with Mark and Jordy.

In those days, Jordy and I had written a paper together on structural modeling, open economy, macro modeling of different shocks. Then Mark and I had written a paper commissioned for a bureau conference on doing sort of a country or case study of the Bundesbank. And then Mark suggested, well, why don't we just all three work on this?

That's what became the five Clarida, Gali, Gertler papers. But I guess what I want your viewers to know is that even though this is now, I think, a respected literature, there weren't a lot of folks thinking about these things because of the factors I mentioned. I should also say, in fairness, it was in the air in the mid-nineties.

In the following sense. Mike Woodford, who went to Princeton but is now my colleague at Columbia, began to get independently interested in the idea of looking at nominal rigidities in fully specified models. And of course, Mike's pioneering treatise worked out exactly why. The Taylor type rules not only are intuitive, they actually have good properties in terms of macroeconomic performance.

Then people like King and Waldman also. It wasn't just us, but I'd say where we were really focused, perhaps where others weren't, was enclosing the models in a realistic way with a policy reaction function, where some of the other papers worked with sort of money in the utility function and money demand function.

We just said, lets go for the gusto, lets just jam in a Taylor-type rule. The final thing, and I'll be quiet, although we respected John's contribution enormously, we did feel that there was an evolution of it that could actually be even as or more useful, which was the idea of, and this was getting back to Friedman 67, the long and variable lags is essentially taking John's insight, but at having the reaction function not to contemporaneous inflation, but to expected future inflation.

The idea being that if you raise the funds rate today, it's not going to have any impact on this month or this quarter's inflation. So implicitly, any policy decision to raise a lower rate is implicitly an assumption about where the economy is going to be in the future.

All the CGG stuff worked with forward looking Taylor rules, which also have some interesting features as well. That's sort of the quickest quick history.

Jon Hartley: One thing that people talk about, the sort of RBC versus new Keynesian sort of debate, was something that I think the new Keynesian critics of RBC says in RBC models, there's really no room for policy or that policy doesn't really matter.

And so the idea of having monetary policy that is not neutral, that's something that you can get in a new Keynesian model, and that's one of the potential virtues of it. I think there's interesting questions about whether it's sticky wages or other kind of rigidity, or maybe something completely different altogether that causes recessions.

I think there's arguably a lot of room to go. I'm curious, as a practitioner, someone who's been at the very top of a central bank, this is something that I've spoken with a lot of guests about. It's really important to highlight, these DSGE models are built by central banks around the world, and their staffs around the world, and are updated and do play a role in each monetary policy meeting of various central banks, in developing forecasts and developing counterfactuals and things like that.

One thing I think that I've noticed is in having talked to a lot of former central bankers and talked to a lot of people in various central banks, is that really a lot of central bankers themselves, who often come in as political appointees, certainly in the case of the Fed, aren't necessarily staffers, in many cases aren't very familiar with DSGE models, which over time have become increasingly complicated within these hundred page macro papers.

Richard Clarida: You noticed that too. I'm not the only one who's noticed that trend.

Jon Hartley: I'm curious, do central bankers, in your view, actually use DSGE models? I think VARS produce better forecasts in general. Is the thinking in your mind as a central banker maybe a lot simpler than a complicated DSGE model?

Just following some basic monetary policy rules, obviously not following it in a mechanical way in the sense that maybe John Taylor would prefer, but using things like that as guidelines? I think that the Taylor type rules have been some of the most successful parts of the sort of the New Keynesian paradigm.

If you just run Taylor rules of regressions, the fit is actually pretty good in a lot of developed economies. I'm curious, in your mind, are central banks, have they become just like a big subsidy to DSGE research that's really not in practice, used very much outside the seminar rooms and writing the papers?

In your experience, certainly as someone who's written down DSGE models and basically helped invent that literature, were they useful to you as vice chair of the Federal Reserve?

Richard Clarida: There are a couple things there at least maybe three. Some thoughts I'll share. My first conversation with Jay Powell when I was on the verge of being nominated by the White House.

I had never really had a chance to meet Jay. So we did meet in January of 2018, and it went very well. And I looked him in the eye. I said, Jay, I think I may be here because your staff has told you that I've made contributions to DSGE.

But I want you to know that if I'm fortunate enough to be selected as the Vice Chair of the Fed, I will not view it as my role to promote DSGE models. It will be my role to pull you aside in the privacy of your office and tell you when and why you should ignore them.

I meant that as the reality of the way I thought about it coming in. So to me, DSGE, I'll make a confession for the first time ever on this Hoover podcast. In my career in the last 25 years as DSGE has been taking off, I've thought to myself many times.

It's really been a pleasant surprise in the following sense, that as someone who had taught intermediate macro to bright undergraduates for decades before those models took off. For the subset, if you take the standard three equation DSGE model, there are only a limited number of shocks you can look at.

You can look at a demand shock, you can look at a productivity shock, you can look at a monetary policy shock. The models are so simple, at least, declared Gali and Gertler, you don't have a financial sector. And I think what people should know is that the qualitative impulse responses from a DSGE model are virtually identical to the qualitative impulse responses that you would get from a 70s or 80s style ad hoc dynamic ISLM model.

Carefully thought through the way it was taught in the late 70s and early 80s, where you've got some long-run equilibrium condition you're approaching. It's the neoclassical synthesis, so there's a shock, there's rigidity, but you're reporting longer equilibrium. So at one level, DSGE models, at least the simple three-equation versions of them, really do not give different answers than you would get from a thoughtfully specified and solved old-fashioned model.

So that's part of it. The other part of it is, I think it's not just at the Fed, in fact, for a year or so, I was an advisor to the Norwegian central bank. And this was more than a decade ago, maybe now, 15 years ago, and they then, and I'm sure today, are really a leader in tightly linking the monetary policy briefings and scenarios to a very, very, very rigorous and thoughtful DSGE model.

I think it maybe has 25 equations, not 100. I've seen that work and it can work well. But again, in that context, it's a structure within which you present the briefings and the scenarios. Now, within the Fed, and indeed within the Fed system, there are DSGE models. The board has several, and most, if not all, the Reserve Bank has them.

And then the briefing-

Jon Hartley: FRB-US probably being the most notable model.

Richard Clarida: Yeah, well, FRB-US is not a DSGE model. So I just say when I got briefings as a Fed official, for each FOMC meeting, there's multiple hundred-page briefing books. And in each book, there's a section on the staff forecast, and then a separate subset of that is the projections and decompositions from a suite of DSGE models.

And so they're definitely part of the briefing. But at least in my time, they were not mechanically followed or not even really mechanically favored over projections from VAR models or FRB-US. And FRB-US, actually, I should say, since you asked, FRB-US actually has, from my perspective, some very nice features.

So, for example, FRB-US, the Federal Reserve Board Macro Model, which I should say was very influenced by Taylor's work because the young John Williams, was really brought tailored to the Fed in terms of doing the modeling, putting in rational expectations, and lags and inertia. But FRB-US has some useful features.

So, for example, you can look in FRB-US simulations, where you assume financial markets know the model and are rational, but the private sector, or some subset of the private sector, has some sort of a rule of thumb. FRB-US is also quite useful because it's much more elaborate in terms of a financial sector.

So you can look at how a shock to policy or to tax policy changes the mortgage market. And so I don't really think it's either or. To paraphrase something I learned from Ben Friedman, if you're going to be forward-looking, then you want to efficiently look at everything, every information variable that's helpful in assessing the future.

So that would be sort of a quick way to summarize the way I think it works.

Jon Hartley: Well, that's amazing, and amazing to hear from a former Fed Vice Chair that some models are often more, more helpful than DSGE ones. I'm curious, a few economists get to both research and practice or implement what they say is professional.

Certainly, being a macroeconomist, then vice chair of the Federal Reserve is a great exception to that rule. You also served as Bush 43 Treasury Assistant Secretary for Economic Policy. I'm curious, what did you learn as an economist from your time in Washington?

Richard Clarida: Well, it was, I had three tours of duty in DC.

So as an assistant professor, I had an opportunity to take a year of leave and go to work as a senior staff economist at the Reagan Council of Economic Advisors. And that was really transformative. First of all, you pick your mentors well. So I was so incredibly fortunate, Michael Musa, who passed away at a ridiculously young age.

But among those of us who are of that generation, Mike was larger than life, and Mike was a member of the council and was looking for a staffer, essentially to be his right-hand person, right-hand man. And I got that job. And so to me, that was, and I was 28 or 29 years old, and so to be at the executive office building and also was a very fascinating time for economic policy.

In fact, I went back and looked at some of the issues that the CEA was working on in that year, but such things as fundamental tax reform in 1986. There was then a very ambitious bit of immigration legislation that essentially, I think, has not ever been revisited, at least with formal legislation.

You had something called the savings and loan problem, which later became the savings and loan crisis. The Plaza Accord had been in 85, and then there was the Louvre Accord. So to be a 28, 29-year-old macroeconomist not making policy but helping people who were thinking about the world.

And so I made a vow to myself I definitely got to get back to do this, but I also wanted to get on with my academic career. So that's what I got out of that, it gave me the interest to try to bring rigorous macro thinking into interesting questions.

So I then had another opportunity to go back years later in the treasury and in a higher level, this time as an assistant secretary. And sort of designed the job, which was enjoyable. I was essentially the chief economist for two Treasury Secretaries. And so there was an element of briefing and updating them, but there was also basically an element of being a resource for the other groups in Treasury.

So I worked very closely with John on some international issues, with Peter Fisher, who was the undersecretary for domestic finance. And that sort of reinforced a message that I had taken away from my CEA days, which is that there is value in. If there's a question posed to you by a policymaker, there is value in getting to 90% of the perfect answer in a week or a month, as compared to getting to 100% of the perfect answer in three years.

And so there are a lot of things I worked on that I tried to give it my very best shot, knowing that if I were actually writing an AER or QJE paper, then there might be things I would do or think about that could be useful. But instead of thinking it's zero one, it's either QJE or bust, I actually thought there was a value in bringing good economics, but on timelines and subject to other constraints.

To be frank, Jon, a lot of macroeconomists, when they go to Washington, hate that part of the job. They think, well, how can I answer this question from the Treasury Secretary or the Director of the NEC? It's going to take me a couple years to actually think through this and write the paper.

And so I think some people's brains are wired to actually find that something that is of interest and worthwhile in itself. And other people sort of chafe against it. So I'll give you one concrete example of that. So literally, my first day on the job at Treasury was September 11, 2001.

So everyone remembers where he or she was on that day. Well, I was sitting in Peter Fisher's office, who was the Undersecretary for Domestic Finance, when the plane hit the second tower. And I think we both looked at each other. I probably said something like holy blank. But the relevance to this is when I saw Paul O'Neill actually was traveling that day.

So when I saw Secretary O'Neill the next day, he said to me, well, Rich, welcome aboard. He said, you know, I have a frustration. And the frustration is I had a much better sense of the global economy as the CEO of Alcoa than I do at treasury, because when I was at Alcoa, every day I'd have a computer terminal that would show me all of our production, our inventories, our delivery lags in 50 countries around the world.

And I had a real pulse on the global economy. And here I get data, that's great data, but from the commerce department, that's three months stale and then revised. And so I took that as a motivation. And I benefited by having some really good career staff people in Treasury, a guy named Ralph Monaco and Kitchen.

And I basically said to them, I said, look, there are these working papers out there by Stock and Watson about this new thing called nowcasting. So let's get up and running a nowcasting model. And by today's standards, it was very primitive, but it used some regression approximations that stock and Watson had in the appendix to their classic paper.

And so that's what we did. So the staff had the first us government fed nowcasting model up and running by November of zero one. And sort of in the category of in life, sometimes it's better to be lucky than good. Our first ever nowcast for Q4 of 2001 was that the GDP was roughly flat.

And the Wall Street consensus was we've had this big shock, a terrorist attack, hit consumer confidence, GDP will be -4, -6. And whatever the first release was, it came in within a tenth or two of our nowcast. And that was far and away the best nowcast we had during my time.

But it was the first one. So that's, I think, a good concrete example. So an academic might have said, yeah, sure, Secretary O'Neill, in 14 months, I think I might be able to have something that I could send off to a journal. But we had that up and running in a couple of months, and it was quite useful, it was the first time within the US government.

I was told that briefings were actually being done not based on a forecast but on an explicit weekly updated nowcast.

Jon Hartley: Wow.

Richard Clarida: So that's an example of that, yeah.

Jon Hartley: Fascinating history about the origin of nowcasting, I didn't realize that nowcasting went back as far as the early 2000s.

That's quite amazing.

Richard Clarida: Well, I'll share another anecdote with you. So O'Neill was very proud of this, and he got on the phone with his good friend Alan Greenspan and he said, Alan, you got to see this guy. Rich Clarida works for me and they've got this thing, nowcasting, and our nowcast was much better than your forecast.

So Greenspan invited me over, because that was a huge honor to have a private meeting with him, and he was respectful. But I think I'll leave it at saying he wasn't actually persuaded that there was any incremental value in now casting versus the beige book. And of course beige book has its value as well.

But of course now the Fed is a world leader in Nowcasting, but not quite yet in those days.

Jon Hartley: Well, it's fascinating, and certainly I think perfection can be the enemy of the good in these very tight policy turnaround times. Amazing that you're at the Reagan CEA, Marty Feldstein was leading it, and folks like Larry Summers and Paul Krugman and John Cochrane and Greg Mankiw.

All those people and yourself, and many, many others, were there during that era. I'm curious, I want to sort of focus on your time at the Federal Vice Chair and maybe a lightning round, a few questions for you. Certainly one of the major contributions you made while at the Feds was the Fed's framework review, this released four years ago.

And the new framework that was introduced is flexible average inflation targeting (FAIT). The idea that you should be targeting an average inflation target of 2% over the years, and this grew out of the period in the 2010s, inflation fell short of the target. The idea that running a bit over 2% was okay.

There were some questions about how flexible the target is over what time period we're doing the averaging for. And then we got this massive inflationary surge in well above 2% in 2021, 2022, CPI. Since then, fate is, I think, gain its fair share of critics. I'm curious, in your mind, what's the legacy of fate, and what do you think the next Fed framework review should do differently, if anything?

Richard Clarida: Sure, well, it won't surprise your listeners and viewers to hear that I've done a lot of thinking about this. I've also done a fair amount of writing about it. So I've just completed a piece for an NBER conference that will be coming out in the JME, but the working paper version is available on my personal website.

And I did an International Journal of Central Banking article and an NBER working paper that also summarizes a lot of my thinking. So for those who want the deeper dive, it's out there in print. But briefly, I'll say the following things. First of all, I always thought of fate as being an evolution, not a revolution, that clarified that under certain circumstances, it would make sense for the Fed to not only tolerate, but to actually put in place a policy that would allow a modest overshoot of the 2% inflation target.

And those circumstances, as you summarized, were if the economy has been in a prolonged period, operating below the target. And also when policy has been constrained by the zero lower bound, then the alternative to allowing for an overshoot is the real risk that inflation expectations drift lower. The way I put it at the time was, suppose that outside of being constrained by the zero bound, you are on the Mount Olympus of monetary policymakers, in that you can always get inflation quickly to two from below, and for any shock, it will never go above.

But your only problem is that the zero lower bound is a constraint. So in those circumstances, if you do not allow policy to tolerate an overshoot, then you are guaranteed to have expected inflation fall below 2%, because inflation can only be below 2% or two, it can never be above.

And if you repeat that game cycle after cycle, you can get into the risk that I think occurred in Japan and that was beginning to occur in the eurozone, that inflation expectations drift down. And then, of course, as inflation expectations drift down, actual inflation drifts down. And so what it said is that under those circumstances, if you've been below 2% for a long time and you've been constrained by the zero bound, then policy should not only tolerate an overshoot, but it should, essentially, allow an overshoot.

Now, it was explicitly asymmetric, and that was clarified in a dozen speeches that I and others gave after the fact, in the sense that once you're away from the zero bound, and once you're satisfied that inflation and is in a neighborhood of 2% from above, then you just run traditional policy.

In fact, in the Fed models, you run a Taylor rule. It was very closely linked to and motivated by a proposal of Ben Bernanke's around that time.

Jon Hartley: With the temporary price level targeting

Richard Clarida: Temporary price level targeting, which is, if you're not constrained by the zero bound, just do what you always do, but if you are, don't lift off rates until you have either been at or above 2% for some time, and there are different flavors of it.

So that's the first point. So, fast forward to today, is fate relevant to the Fed today? No, because we have not gone through a period when inflation has been below two, it's been above two. And so fate is silent. In fact, what fate says is just do what you would always do under inflation expectations, if the problem is not inflation is too low.

The second thing I'll point out about the post pandemic surge in inflation, and this is specifically discussed in my recent paper that's coming out in JME, is what's striking, and what I'm sure, what I'm confident future monetary policy scholars will look at, even though many current monetary policy scholars have ignored it.

What's striking is the similarity across advanced economies in the inflation surge and in the central bank reaction function. So here's some facts. Among all the advanced economy central banks, no advanced economies central bank began to hike rates before inflation had exceeded the top of its target range. So by that metric, all advanced economy central banks under inflation targeting fell behind the curve.

Secondly, all but two advanced economies central banks, Switzerland and Norway, delayed hiking rates until core inflation had exceeded the top of the target range. And so if the recent episode is an indictment of fate, it's also an indictment of inflation targeting as practiced by Canada, by the UK, by the eurozone, by Sweden, by Australia, and by New Zealand, okay.

What I say in the JME paper is I don't think that this episode tells us much about fate versus inflation targeting, or about single versus dual mandate central banks. I think what it tells us is that this was an enormous and unusual shock, in that it influenced aggregate supply.

It triggered a policy response which boosted aggregate demand, and it also changed equilibrium relative prices. And with the exception of the Swiss, other central banks, essentially, given that the prior decade had been where inflation was too low, delayed lifting off beyond what their inflation targeting or fake frameworks would have tolerated.

But I do think there are lessons learned, and in particular, I think the lessons from the Fed's case to be learned are much less about fate. Indeed, I really don't expect major changes to flexible average inflation target. Another thing that perhaps useful, Jon, for your listeners and viewers, is that within the Fed system and culture of the Fed, the reserve banks and the board, there is a real distinction, both conceptually and in discussion between the Fed's framework statement and the way the Fed tries to achieve its goals through FOMC decisions on rates in the balance sheet.

So one of my colleagues, who I won't mention, but I think he would not mind, said to me when I got to the Fed, and Jay Powell had said he wanted me to quarterback the framework review, he said to me, he said, Rich, this is great, but one thing you should know about the Fed is that the framework statement is a crown jewel and is a quasi-constitutional document.

It lays out broad goals and priorities. It doesn't say do you cut the funds rate 25 or 50. It doesn't say do you do an open-ended QE program or a finite program. It doesn't say should you use threshold forward guidance? It doesn't say any of that. Those are FOMC Decisions that need to be consistent with the framework, but they are not compelled by it.

And so the framework statement itself, I think, holds up quite well. It was released and unanimously approved in August of 2020. However, the committee, in the depths of the pandemic collapse, millions of people dying, no vaccines in sight. And I very much supported this, the committee in September of 2020, after the new framework statement was released, did make FOMC decisions that deployed and communicated very, very muscular and binding forward guidance.

Now, those decisions were decisions were certainly consistent with the new framework, but they were not compelled by it. Indeed, two members of the committee, Neel Kashkari and Rob Kaplan, who supported the new framework, voted against the FOMC decisions precisely because they thought it went beyond what the new framework necessarily required.

Or called for under those circumstances. I do think there are lessons learned in terms of forward guidance. In particular, as with anything in economics, there are always costs and benefits, there are always trade offs. And I do think that an important lesson learned is in deploying muscular forward guidance, as in the Fed will not lift rates until inflation exceeds to, and the labor market is returned to full employment.

Ex-post, there was a cost to that guidance in the face of a huge supply shock. And it's not clear in retrospect that the incremental benefit from that guidance outweighed the cost in the scenario that we got hit with. And I would say with even greater conviction that that applies to the forward guidance the committee offered in December of 2020, that it would not even begin to slow the pace of QE until it had made considerable progress towards its dual mandate goals.

Again, it's not clear to me that the incremental benefit of making that commitment exceeded the ex-post cost. Cuz the ex-post cost, as I actually discussed in a talk I gave at Hoover several years ago, and I do in this IJCB paper, the cost is that we basically said we're not going to begin to hike rates until we end QE, but we didn't start to roll back QE until the fall of 2021.

However, one last thing I say on this is I do think that in the big scheme of things, although in retrospect, you can always go back and talk about this meeting versus that meeting. The reality is, even in real-time, the committee did not have a sufficiently useful signal of the persistence of the inflation surge till arguably the September of 2021 meeting.

Jon Hartley: At that point, it was clear it wasn't just kind of used car.

Richard Clarida: It wasn't just used car, yeah-

Jon Hartley: Other things that were rising, too, by then.

Richard Clarida: And I've given public comments in which I've said correctly that in March and April of 2021, almost all the inflation overshoot was used cars, and I wasn't prepared to throw people out of work as used car prices went up.

But anyway, certainly by September of 2021, it was clear that this was broad based, that the labor market was definitely beginning to reflect it. I think one can make a case, and indeed, something that will resonate at Hoover is that if the Fed had just been outsourcing policy to the Taylor rule, at least the inertial Taylor rule.

As Patel and Pradhan have shown in real-time, Taylor rules would have said, start lifting off in September 2021. So were really just talking about September 21 versus March of 2022. And of course, as you’re going through it in real-time, that seems like a long time. But in the big scheme of monetary history, I think it turned out not to be that important.

One thing that is important is the Fed said, and I was a charter member at team transitory, we said that we thought in May of 2021 that the inflation overshoot would be transitory. That was wrong, and it's factually true that we have a lot of company, but that doesn't make it any less of a mess.

And so I think that is also a fair point.

Jon Hartley: Let me ask you one last question about groupthink and just sort of talk about maybe, why was it that so many people thought that inflation was maybe transitory, that inflation would come back down on its own without any kind of fed rate hikes?

And I'm just going to spitball a few different kind of ideas here. Just thinking about Federal Reserve, I don't want to say reform, but just things that some people think the Fed should do differently. One of those things is, for example, there not being enough dissent. For example, we just were in September 2024, today, the Fed just its first rate hike since the 2020 inflation cycle began, the super size cut of 50 basis points.

But notably, it was the first FOMC meeting in almost 20 years where a Fed board member actually dissented. And I'm wondering, people say personnel is policy, there were three republican nominees, or likely nominees that didn't get through Senate confirmation during the Trump era. And one would think maybe the composition of the FOMC would look very different if those nominees actually got through.

Perhaps there's a lack of sort of diversity of thought on the Fed, I'm curious if you have any thoughts on that. Also, do you have any particular thoughts on, for example, just how fed communication is done for example, there's now eight press conferences a year, one after every FOMC meeting there's four under Bernanke.

Before that under Greenspan, there were none. There's increasingly fewer economists that are actually on the FOMC now as well as compared, say, 1020 years ago I mean, some might say that that's a welcome thing and that would maybe have less groupthink. But I'm not totally sure that that's the case.

I mean, some people might say there's also a dearth of talent from the GOP economic policy side of things. And as part of why some of these candidates didn't get through the confirmation. I'm curious if you have any thoughts on all this, particularly as we go to another election, whether it could be another republican administration where for future personnel discussions become central if not the next election or future elections.

Richard Clarida: I think there were five parts to that question, and so let me give it a try. On groupthink descents are not unusual, but historically in the last 20 years. Before this week, dissents had always been by Reserve bank presidents. If you go back in the longer history of the Fed, that was not true.

Indeed, there were some cases during Volcker's time when not only were there dissents, but his vice chair dissented. And so why that has evolved. Larry Meyer has written on this. One thing I can only comment on during my time at the Fed, but the Fed Chair Jay Powell, before each FOMC meeting, has a private bilateral meeting with each person on the committee.

And so oftentimes folks who might be on the bubble between 25 and 50 will have a chance to convey their views. And oftentimes there's an intertemporal dimension as well. And so there are ways to signal that through the projections or through the communication. So rate decisions are relevant.

But there are other elements of communication and policy that are also subject to back and forth. So I think that's one piece of it. In terms of groupthink, I think there was an aspect of groupthink both among central bankers and among private sector forecasters. My one example of that is in April of 2021, after the American Rescue Plan passed, the Wall Street Journal gave its 75 economists a chance to update their forecast, and they did.

The average for PCE inflation was revised up to 2.1. And the highest projection, that is the most, the highest rate of inflation projected for 2021 was, I think, 2.6. So this was not just that the average economist got it wrong, every got it wrong. So I think that's another subject.

In terms of Senate confirmation, I've been through it twice, it is an intense process. Senators do take the advice and consent role very seriously. But certainly in the case of the time I was there, Jay Powell, Rich Clarida, Randy Quarles, Miki Bowman, and Chris Waller were all nominated by Republican presidents and got confirmed.

In terms of, in terms of your last question, in terms of a perceived imbalance between, you know, GOP and democratic leaning folks, in terms of serving in Washington, that's an important one, but one I think maybe we can take up in a future conversation.

Jon Hartley: Well, that's fascinating.

And too, I guess, on the press conferences, I've often wondered, too, why we need so many, in the sense that you compare the Fed to the Supreme Court. If the Supreme Court makes a pronouncement and it doesn't have a press conference where journalists can sort of second guess the decisions.

And I think it's good to have some healthy amount of questions and things like that. But to me, it seems like each press conference is like an opportunity for maybe more volatility in financial markets than needed. A real honor to have you on, Rich, and to hear about your career and ideas.

I think you perfectly embody what Greg Mankiw calls an economist as a scientist and engineer or what Esther Duflo calls an economist as plumber. You've had such an amazing career, both in academia, coming up with such great macroeconomic ideas and then putting them into practice in your various policy rules, and as vice chair in your various policy rules and as vice chair of the Federal Reserve in Washington.

Thank you so much for joining us today.

Richard Clarida: Thank you. And look forward to continuing the conversation. Thank you, Jon. Been a pleasure.

Jon Hartley: This is the Capitalism and Freedom in the 21st Century Podcast, an official podcast of the Hoover Economic Policy Working Group, where we talk about economics, markets, and public policy.

I'm Jon Hartley, your host. Thanks so much for joining us.