Unconventional: A Policymaker's Reflections on Crisis to Recovery
"When the Fed lowered its key policy rate essentially to zero, many people thought it was out of policy options and that fiscal authorities would have to step in to provide short-term stabilization policy. Jim Bullard argued in his 2012 'Death of a Theory' paper that central banks can still be effective by using unconventional tools and can usually act faster than fiscal authorities can."
—David Wheelock, Group Vice President and Deputy Director of Research
James Bullard shared some reflections on his first 10 years as Bank president during recent conversations with staff. The following are excerpts from those discussions.
Stabilization policy means reacting to data and changing the direction of policy in a timely manner in response to changing economic circumstances. Before the financial crisis, the conventional wisdom suggested that fiscal policy was not very effective as a macroeconomic stabilization tool. Although calls for fiscal approaches to stabilization policy gained popularity during the crisis, the precrisis lesson has been borne out in the past 10 years. Namely, it is difficult in Western democracies to ask the political process to bear the burden of providing day-to-day stabilization policy. This type of policy intervention should remain in the realm of monetary policy.
Why was this the conventional wisdom? In the U.S., the FOMC can meet every six or eight weeks, or more often if necessary. Decisions and adjustments to policy can be made fairly quickly in response to changing economic conditions. One could argue about whether the FOMC made the right decisions at various junctures, but it is at least in position to take those kinds of quick actions. In contrast, going through the political process to change the tax code or government spending plans can be very complicated. It is doubtful that such a process could be completed in a timely manner and in a way that reacts to current developments in financial markets and the economy as a whole.
Thus, for the two decades before the crisis, the idea was that fiscal policy should be set over longer time horizons (e.g., five or 10 years) and that monetary policy should be used to make the day-to-day adjustments through interest rate policies.
In December 2008, the FOMC reduced the federal funds rate to a target range of 0 to 0.25 percent—the so-called zero lower bound. Many people said this meant that the FOMC couldn't do anything else to provide short-term stabilization for the macroeconomy and that, consequently, fiscal policy would have to fill that role.
The G-7 countries lowered their policy rates to near zero in late 2008 and early 2009. Some central banks, including the Fed, used unconventional tools to provide additional stabilization policy.
SOURCE: Haver Analytics.
However, the FOMC was not out of ammunition after hitting the zero lower bound. The FOMC used unconventional policy—QE and, to some extent, forward guidance—to provide stabilization policy. Other central banks also turned to unconventional policy, including QE in the U.K., Japan and the eurozone.
To the extent those ways of carrying out monetary policy are effective, this means that the monetary authority can still run stabilization policy and that going through the fiscal channel is unnecessary. My 2012 paper "Death of a Theory" argued that stabilization policy should be viewed the same way after the crisis—i.e., that monetary policy should still be used to respond to short-term fluctuations in the economy.
The older, precrisis idea about how to divide the responsibility for stabilization between monetary policy and fiscal policy remains valid today. Given the difficulty of going through the political process, the central bank should continue to have primary responsibility for stabilization policy even when the policy rate is at or near the zero lower bound. On the other hand, fiscal authorities should focus on tax and spending programs that will achieve medium- or long-term goals.
James Bullard joined the Research division in 1990 as an economist. But his academic research didn’t stop when he became president and CEO 10 years ago and, thus, became a participant on the FOMC, the Federal Reserve’s monetary policymaking body.
One of Bullard’s goals since taking on this role has been to strengthen the connection between academic research and monetary policy. He noted how the views of central bankers have been increasingly sought after for leadership regarding the overall economy, not just for monetary policymaking. In addition to encouraging innovative research among St. Louis Fed economists for this reason, Bullard has continued his own academic research as president.
"To be on the FOMC, you have to more or less be cognizant of all the issues that might affect macroeconomic outcomes, both in the U.S. and worldwide," Bullard said. "There's no better way to be in tune with those issues than to contribute yourself to ongoing research in various areas."
To be sure, academic research and monetary policy have not always been in sync. "I feel pretty strongly about this, because I think that the profession has long been bifurcated, where there is a certain group of people that did the research and then there's another group of people that did the policy, and the policy didn't look all that much like the research," Bullard said.1
Instead of having the profession split into two parts, he emphasized the need to merge them.2 He added that the two sides should communicate more and should challenge each other.
"The policy people can certainly challenge the academic types by saying that what you're doing isn’t helping me make policy, but on the other hand, there are important ideas in the academic world that should come across to the policy world," he said. "I think there’s been more of this in recent years on the FOMC, and I think we’ll see more in the future."
He likened the process to putting a man on Jupiter. In this event, "you don’t want to take seat-of-the-pants engineering. You would take the very best engineering that you could find, and then you would apply those ideas and you put the guy in the rocket ship and send him to Jupiter," he said. "I think the same is true here. You're trying to manage the U.S. economy and, to some extent, the global economy. You want the very best ideas deployed, and that’s going to mean wrestling with tough concepts and bringing those to the policy process."
In his time as president, Bullard has focused on three main areas of research that were particularly interactive with the current policy environment: fiscal policy in the post-crisis world, regime-based macroeconomics and alternatives to inflation targeting. Each of these is covered in more detail in other sections of this annual report.