We normally refrain from commenting in print on personnel changes at the Federal Reserve, but there have been so many questions and press commentary about the expected nomination by the Trump Administration of Carnegie Mellon monetary economics professor Marvin Goodfriend that it warranted a response.
*** We are deeply skeptical there are significant policy differences between Goodfriend, if he is indeed nominated and confirmed, and Chair Janet Yellen. Nor do we think his arrival would mark an opening to a fault line between the current policy normalization strategy and alternative policy priorities of a Trump-appointed Board of Governors. Goodfriend is conservative in his approach to monetary policy, but is very much in the mainstream traditions, sharing many overlapping priorities with Chair Yellen and the current Federal Open Market Committee policy consensus. ***
*** Goodfriend can be quite eclectic in his research choices and has long displayed an independent streak that defies an easy hawk or dove labeling; above all, the touchstone to his policy approach has been a singular focus on price stability and the importance of policy credibility. In that, he can be as dovish as he is hawkish on rates policy, depending on whether the threat to stability is inflation or deflation. As something of a Fed historian, Goodfriend’s main contribution to the Fed may well prove to be as a staunch defender of the Fed’s institutional and operational independence. ***
*** To a fair degree, the heightened market interest in Goodfriend’s nomination is due to his academic paper last year on the merits of negative interest rates. Our sense is that it has become something of a linking middle premise in a market logic to price out Fed rate hikes beyond next week and to price in a Fed “policy error” on the probabilities of further rate hikes leading to recession. In such a scenario, the debate over QE versus negative rates is filtering back into market expectations and in a flattening yield curve, signaling an important theme near-term Fed policy messaging will need to address. ***
While we have no sense the White House will not follow through with the reported Goodfriend nomination — along with those of Randal Quarles as the vice chairman for banking supervision and, we believe, Indiana banker Bob Jones as the community banker nominee — this is the Trump White House, so predictability is hardly a given.
The three could take their seats on the Board in time to attend the FOMC’s important September meeting. But until the nominations are publicly announced, it is always possible President Trump could reopen the search process. Doing so, with the Senate’s already overburdened legislative calendar after the August recess, could mean delays in the confirmations until close to year-end.
Price Stability and Policy Credibility
Goodfriend is a certainly conservative in his approach to monetary policy, but he is very much in the mainstream of macroeconomists. One of his better known academic papers in the late 1990s was on a “New Neoclassical” model that, in its inclusion of sticky prices and rational expectations, reads an awful lot like an expectations-augmented New Keynesian model that Chair Yellen, and most Fed staff and her colleagues on the FOMC would feel perfectly comfortable with.
His reputation for conservative monetary policy in large part built on two core beliefs that are threaded throughout his thinking and academic papers. The first is an almost singular attention and adherence to price stability as a primary policy objective, and the second is an equally fierce focus on the importance of credibility to Fed policy.
Goodfriend puts far less importance than Yellen and many other Fed officials on the role of the labor market and wages in the inflation process — the Phillips Curve never featured high in his policy arguments — but in Goodfriend’s synthesis, it is policy credibility in seeking price stability that enables the Fed to avoid any painful trade-offs between its unemployment and inflation mandates. The measure of that credibility is firmly anchored inflation expectations.
As something of a Fed historian in the tradition of his mentor, Allan Meltzer, Goodfriend has commented extensively on the lessons learned in former Fed Chairman Paul Volcker’s success in breaking the inflationary cycle and psychology of the 1970s, especially in countering a “second inflation scare” in the early 1980s after the first sharp escalation of rates in 1979-80.
Alan Greenspan likewise defeated another inflation scare in the pre-emptive 1994-1995 rate hike cycle before inflation pressures were readily apparent, which went a long way to locking in the Fed’s anti-inflation credibility and ushering in the long period of the Great Moderation of anchored low inflation expectations.
The pay-off to that success with counter-inflation credibility came in the late 1990s when Greenspan so famously opted against rate hikes — favored by a hawkish then Governor Yellen at the time — despite a tightening labor market on the bet for a high productivity boomlet. In some sense, Yellen took Goodfriend’s lessons to heart in aggressively pursuing an accommodative policy of QE and a “lower for longer” forward guidance on the bet that inflation in the aftermath of the 2009 financial crisis and collapse in demand would be too inertial to substantially threaten a sustained, excessive overshoot of the inflation target.
Facing the same circumstances, Goodfriend would not necessarily have been overly critical of the Fed’s policy normalization framework. In fact, one of his concerns in recent years has been a perceived absence of a policy credibility to counter deflation risks to the same degree of its hard fought credibility to counter inflation.
To his credit, Goodfriend was among the very first to see the deflation risk looming in late 2001 and 2002. In his capacity as chief economist and policy advisor to former Richmond Federal Reserve President Al Broaddus — one of the more hawkish of the Fed presidents — Goodfriend was instrumental in convincing Broaddus of the deflation dangers and on the need to support Greenspan’s aggressive front-loading of rate cuts that brought the fed funds rate all the way down to a then unprecedented 1%.
Indeed, Goodfriend believes interest rates are much more effective tool in achieving monetary policy objectives compared to QE, but then, who doesn’t among Fed officials feel the same way? But Goodfriend can get downright German in his taking his preference for rates over directly steering long rates through asset purchases as a cleaner, more effective tool of monetary policy, even if it means going deeply negative.
In the academic, and controversial, paper he presented at Jackson Hole last August, Goodfriend mapped out how the policy rate could be pushed even below the effective zero bound, mostly through all sorts of legal and political steps, in order to reach deeply negative neutral levels.
He was not necessarily arguing that this should be policy nor was he “calling” for anything. After all, he was speaking as an academic, not as policy maker. But he does believe the main channel of central bank influence on long term rates is through the expected forward path for short rates, and adjusting the overnight policy rate remains the primary and most effective, least disruptive way for the Fed to execute policy.
It is unlikely, for instance, that if Goodfriend was on the Board early last year when the speculation over negative rates was having an impact on US yield levels, he would have argued against the Fed messaging at the time it would not be resorting to negative rates as the European Central Bank did.
And while his case for negative rates is theoretically possible, he would no doubt be the first to concede it is would not first require an awful lot of pre-emptive messaging by the Fed to diminish an adverse market reaction; equally, it would likewise require a major communications effort to explain a move to negative rates to the public and to a Congress that could quickly question, if not limit, the Fed’s operational options.
Staunch Defender of Fed Independence
A central bank, in the thinking of a conservative monetary economist, should conduct policy with a minimum of intervention or policy activism. Not only because it is the most effective and efficient way to conduct monetary policy; it is a central bank’s best protection against political interference.
On this point, much of the initial commentary on Goodfriend’s possible nomination and his views were too limited to simplistic takeaways from his recent testimonies and shorter Shadow Open Market Committee presentations as overly critical of the Fed current policy. We think they missed a consistent thread running through his expressed views on the importance of the Fed’s operational independence to achieving its primary policy objective of maintaining price stability.
As a member of the SOMC, for instance, he has endorsed the conservative mantra of a “rules-based” policy to limit an excessively discretionary policy. Our sense is that in Goodfriend’s framework, the rules are as much about binding Congress, and keeping it at a safe distance from meddling into the Fed’s operational and execution decisions, than it is restricting or narrowing the Fed’s policy options. In any case, we would wonder how forceful he would be in pressing the case for the rules-based proposals to become law.
Along the same lines, our impression of his dislike of QE is not with large-scale asset purchases per se, but more about which assets were purchased or the risks in maintaining a large balance sheet for too long. On two counts.
First, the Fed strayed from the core principle of “treasury-only” assets on its balance sheet in its massive purchases of mortgage-backed securities. Doing so was a clear form of credit policy in favoring one sector of the economy over another, even if one so crucial to monetary policy transmission as housing.
As a fellow monetary conservative, former Philadelphia Fed President Charles Plosser recently asked at a Stanford conference, once venturing into credit policy, where would politically advantageous asset purchases stop once the Fed has opened that door, infrastructure bonds, student loans, or state debt?
A Fed portfolio of “treasury only” assets is a long-standing principle for any card carrying monetary policy conservative. But Goodfriend has thought through issue more than most conservative purists, daring to venture into pragmatism. He would not be opposed to every asset purchase program that could be construed as credit or fiscal policy; under extraordinary circumstances, it may be necessary to protect the financial system, for instance, but his point is that the Fed would need to strike a “New Accord” with Treasury to define its exact parameters and the exit, preferably with a sign-off by Congress.
And where Goodfriend is uneasy with a prolonged large balance sheet, his concern is that the longer the Fed holds the assets or waits to roll them off, the greater the interest margin risk down the road as the Fed eventually is raising rates to remove the abundance of monetary accommodation.
Once the years of enormous profits through its “carry trade” of rapidly expanding its balance sheet give way to waning remittances to Treasury if not an outright loss, the market may sense a political resistance to further rate increases, and begin to doubt the Fed’s ability or willingness to keep hiking to counter inflationary pressures. At minimum it could force the Fed to raise rates higher and faster to keep expectations anchored than they might have otherwise have had to do. That could chip away at the Fed’s prized anti-inflation credibility.
Indeed, the Fed’s need to prudently protect its prized operational independence is a theme Goodfriend comes back to over and over, and may prove to be his lasting mark if he is indeed nominated and confirmed to take up one of the three vacant seats on the Fed’s Board of Governors.