Monetary Policy Ten Years After the Crisis: A Conference Recap

monetary conference, unconventional monetary policy, Federal Reserve, Cato Institute
Cato staff

Founded by Cato’s vice president for monetary studies James A. Dorn in 1983, the Cato Institute’s Annual Monetary Conference has kept the monetary policy conversation alive in Washington, DC, for nearly four decades — even at times when a calcified consensus made the topic seem unimportant. The events of 2008 thrust monetary policy issues back into the fore and, on a snowy November 15th, more than 150 people gathered in the Hayek Auditorium for the 36th Annual Monetary Conference, exploring monetary policy ten years after the financial crisis.

The all-day affair consisted of two keynote addresses, three panels, and a roundtable discussion, and featured such esteemed speakers as former Senator Phil Gramm, Claudio Borio of the Bank for International Settlements, and former Richmond Federal Reserve Bank President Jeffrey Lacker. Topics included  the effects of a decade of unconventional monetary policy, the Fed’s post-crisis operating system, and lessons learned since the financial crisis.

President and CEO of the Cato Institute Peter Goettler’s opening remarks touched on the importance of monetary issues in people’s everyday lives and in the functioning of a free market economy.  Other than starting a war, there is no bigger way that a government can disrupt people’s lives than to mismanage their money. Ten years after the most disruptive economic event in recent memory — the financial crisis of 2008 — that lesson is as clear as ever as we continue to face the consequences of the policy responses to such mismanagement.

If you missed the live event, here’s a synopsis with links to videos.

Keynote Address: Claudio Borio, Head of the Monetary and Economic Department at the Bank for International Settlements

Borio kicked things off with a speech about what makes a well-functioning monetary system, entitled “On Money, Debt, Trust, and Central Banking.” The speech focused on the fundamentals of monetary systems and their role as the foundation of an economy — establishing a solid base for the rest of the conference to assess the state of monetary policy. Borio alternated between the basics of money — its roles as a medium of exchange, unit of account, and a store of value — and how a central bank must conduct itself if it is to provide a money capable of filling those roles. The overriding point, Borio emphasized, is that the foundation of a monetary system is trust. Sound and robust institutions are necessary for that trust to exist, and to achieve the ultimate prize: lasting price and financial stability.

Panel 1: The New Operating Framework: An Evaluation

The first panel of the day was moderated by the Wall Street Journal’s Josh Zumbrun. Speakers were George Selgin, director of the Center for Monetary and Financial Alternatives at Cato; Stephen Williamson, professor at the University of Western Ontario; and Peter Ireland, professor at Boston College. Zumbrun introduced the panel by reminding the crowd of a simpler time — before the financial crisis and subsequent rounds of quantitative easing — when the Fed’s operating system was based on the buying and selling of short-term Treasury bonds to affect the federal funds rate. As readers of this blog well know, that is no longer how the Fed does things.

Stephen Williamson spoke first, giving a rundown of the mechanics of both the pre- and post-financial crisis operating system at the Fed. His presentation concluded with weighing the pros and cons of the current “leaky floor system,” which he said appears to have no advantages over the pre-crisis “corridor system” but has disadvantages such as adding inefficiency to financial markets by withdrawing good collateral from the system.

George Selgin followed Williamson. Rather than prepare a paper for the panel, he devotes 172-pages to it in his new book: Floored! How a Misguided Fed Experiment Deepened and Prolonged the Great Recession . In his remarks, Selgin outlined his proposal to switch to a modified corridor system in which the Fed would still be allowed to pay interest on reserves (at a more appropriate and modest rate) while open market operations would again be the Fed’s main tool to achieve its monetary policy target. He also made the point that moving away from the Fed’s current floor system is required to truly “normalize” monetary policy, particularly when it comes to reducing the size of the Fed’s balance sheet — as long as they keep the floor system, the Fed must keep a fat balance sheet to run it. A large balance sheet has the second order effect, as Williamson mentioned, of crowding out lending to consumers and businesses.

The panel rounded out with Peter Ireland who focused on what he would like the Fed to do going forward as it normalizes its monetary policy. Namely, to generate slow but steady growth in the money supply to stabilize both inflation and interest rates at low levels. This, combined with winding the balance sheet down as quickly as possible to pre-crisis levels and abandoning interest on reserve payments, would allow the free market to prosper.

Panel 2: Unconventional Monetary Policy, Interest Rates, and Asset Prices

The second panel, moderated by Jim Dorn, addressed the effects of unconventional monetary policy — specifically, quantitative easing and ultra-low interest rates. Speakers were Tobias Adrian, director of the monetary and capital markets department at the International Monetary Fund; Vincent Reinhart, chief economist at BNY Mellon Asset Management; and Lawrence H. White, professor of economics at George Mason University.

Drawing on data from the IMF’s Global Financial Stability Report, Adrian spoke first and made the case that U.S. financial conditions — credit spreads, equity market valuations, and the like — are unusually easy for this stage of a monetary tightening cycle. As underwriting standards are beginning to deteriorate, the question has become at what point does current monetary policy tightening translate into tighter financial conditions?

Next came Reinhart, who emphasized the drastic, unprecedented nature of quantitative easing — an experiment with resources equal to a 1/5th of nominal gross domestic product. He then addressed three topics: (1) the arguments presented in papers he co-wrote with Ben Bernanke on the efficacy of unconventional monetary policy, (2) the application of finance theory to assess the effects of unconventional monetary policy, and (3) the "normative issue of the appropriateness of a large and lingering Fed footprint in markets."

Finally, White discussed the change in the makeup of the Federal Reserve’s balance sheet as well as the harmful effects of its preferential credit allocation practices; in particular, the Fed’s focus on helping the housing and banking sectors. According to White, the Fed’s post-crisis actions are indicative of a problem of regulatory capture that must be addressed through strict rules to bind the central bank.

Luncheon Address: Hon. Phil Gramm, former Chairman of the Senate Banking Committee

Before his speech entitled “Monetary and Fiscal Headwinds to Sustaining the Recovery,” Phil Gramm was introduced by Rep. Jeb Hensarling, his former student at Texas A&M and departing House Financial Services Committee Chairman. The two have a long history together and share a passion for monetary and financial policy issues.

During his luncheon address, Gramm shared some illuminating statistics as he spoke about the strains that unconventional monetary policy has on the economy. For example, at the time of the financial crisis, banks held on average 14 cents of reserves for every dollar of demand deposits, while today they hold $1.31 — the consequence being less money lent out in the private sector. The unprecedented current monetary environment is a challenge for the Fed to navigate. This, combined with the fiscal headwind of a national debt that has doubled since the crisis, leaves many unanswered questions. Gramm concluded his speech with five suggestions for policy fixes to address these issues.

Panel 3: Lessons Learned

Following Gramm’s luncheon address came the third panel of the day, moderated by CNBC’s Ylan Mui. Panelists speaking about lessons learned in the ten years after the financial crisis were Michael Bordo, director of the Center for Monetary and Financial History at Rutgers University; Joseph Gagnon, senior fellow at the Peterson Institute for International Economics; and David Beckworth, senior research fellow and director of the Monetary Policy Project at the Mercatus Center at George Mason University.

Bordo was first to speak and touched on some of the same themes as when he presented a paper with Anna Schwartz at the first ever Cato monetary conference in 1982, including how to ensure monetary policy is systematic, transparent, and effective in preventing adverse shocks. However, while it was thematically similar to his 1982 paper, Bordo’s subject of discussion was decidedly 2018: principles for the design, and near-term steps for the establishment, of a Federal Reserve digital cash, which he believes would enhance all aspects of the monetary system.

Up next was Gagnon, who made the case that the Federal Reserve should not be limited in what types of assets it can buy. Allowing the Fed to buy a wider range of assets will enable it to provide stronger countercyclical policy and thus a stronger, faster economic recovery. Gagnon also proposed allowing the Fed to provide so-called “helicopter money,” albeit with strict rules limiting its power to do so. (For more on the issue of permitting the Fed to buy other types of assets, see this latest piece by Selgin, "On Fiscally-Neutral Monetary Policy.")

The final speaker on the panel was David Beckworth. He began his presentation by outlining two broad lessons that were made evident by the crisis: household budgets matter and financial crises matter. Along with macroprudential regulation and state contingent debt contracts, a proposed policy response to those two lessons is that changes to central bank monetary policy, such as nominal GDP level targeting, could provide better risk sharing in the economy. Beckworth concluded his presentation by modeling the countercyclical benefits of a nominal GDP level targeting regime in several countries.

Roundtable Discussion: Should the Fed Be Subject to a Monetary Rule?

The final presentation of the day was a wide-ranging and insightful roundtable discussion moderated by CMFA’s managing director Lydia Mashburn and featuring Jeffrey Lacker, former president of the Richmond Fed and current professor at Virginia Commonwealth University; Scott Sumner, Ralph G. Hawtrey Chair of Monetary Policy and senior research fellow at the Mercatus Center; Jeffrey Frankel, professor at the Kennedy School of Government at Harvard University; and John Allison, former CEO of BB&T and former president and CEO of the Cato Institute.

Sumner kicked off the conversation by defining what rules mean in the context of monetary policy, noting the important distinction between policy rules, such as establishing an outcome goal for the Fed to achieve, and instrument rules, those that target a specific instrument of monetary policy, such as inflation. Lacker, who has thought about this topic in both a policy and academic setting, touched on the academic arguments for rules over discretion starting with the famous Kydland and Prescott paper published in 1977. Next, Frankel commented on the optimal tradeoff between rules and discretion. Later, he discussed the advantages of a nominal GDP targeting rule over inflation targeting — a view Sumner agreed with, joining Frankel in explaining the merits to Lacker, who was more skeptical. As a former bank CEO, Allison provided a real-world perspective on what it is like as a market participant operating under a discretionary monetary and regulatory regime. In fact, he wouldn’t call such policies “discretionary” — he prefers “arbitrary” and “ambiguous."


Check out full video coverage or podcast audio of each panel, along with more information about the conference and speakers, here. Papers presented at the conference will be published in the Spring/Summer 2019 edition of the Cato Journal.