CFR World Economic Update Past Event — May 11, 2018

No shit.

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MALLABY: All right, let me just persist on this one point and link it up to what Karen was asking about and Greg’s answer.

So, you know, it feels like there’s a similarity between how the economy is poised now and the dilemma for the Fed with how things were, let’s say, in 2005 or 1999. So in those cases you had inflation that was fine. You had pretty much, you know, full employment, and if there was a source of instability in 1999, it was that tech stocks were going nuts, and in 2005, the real estate thing was already beginning to pump up.

So an inflation-targeting Fed looks at this and say, our job is to target inflation, inflation seems under control. We can tighten very, very gradually. And looking back, in both cases, there was a bubble, it blew up, and the bubble blowing up caused trouble.

So why, in the face of a sudden surge of fiscal stimulus, would you not have a sudden surge of commensurate monetary tightening given that you’ve got this risk that you’ve lived through twice before, which is that if you simply target inflation—the price of eggs may be very stable, but the price of nest eggs is going nuts. Why not run policy a little tighter—which is perfectly justifiable given the credit stimulus—I mean, the fiscal stimulus—and take some of that financial sector risk off the table?

REINHART: Because it is a remarkably risk-averse entity concerned about the reaction to a marked change in its policy. If the Fed—

MALLABY: What’s the worst that could happen? Are you—we talking about the market reaction or are we talking about political reaction first of all?

REINHART: Oh, I don’t think it’s political reaction.

MALLABY: OK, so it’s the market—

REINHART: I think it’s the market reaction, that we saw the 10-year flirting with 3 percent as a risk even for emerging market economies. Think back to the taper tantrum—this is an institution scarred by that, that if there is a deep irony that before the taper tantrum they were frank in criticizing the 2004 to 2006 policy realignment as too gradual and too telegraphed. It not just made the yield curve steeper than it would be otherwise, strengthening the carry trade and adjustable rate mortgage finance. It also made them safe because it was so clear what the Fed was going to do.

MALLABY: Right, right.

REINHART: After the taper tantrum, what are they doing? They are more gradual, they’re more contractual even as they continue to say all decisions are data-dependent and made meeting by meeting.

MALLABY: So you’re suggesting that the Fed is colored by the effect of its policy on emerging markets.

REINHART: Markets—financial markets generally.

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