Sean Carr:                           

Alan Greenspan would say that the job of the Fed is to, right when the party gets started, take the punch bowl away. When things start to get good, then you start to tighten policy. Powell would say, "No, we need to let the party go for longer. We need a strong economy for a much longer time, so that we can enable all households to participate in the gain from a strong economy."

This is a pivotal moment for the United States and global economies. And the U.S. Federal Reserve holds a key position and influence. The Trump administration is on the way out, the Biden administration is on the way in. And all the while, the biggest wave yet of the Coronavirus pandemic is sweeping over the United States and many countries around the world. Simply put, what is the Fed to do? Where can, and should [inaudible 00:01:01]? Frank Warnock is a professor and an economist at the University of Virginia's, Darden School of Business, who is not only a former senior economist with the Fed, he currently serves as a research advisor with the Federal Reserve Board's International Finance Division.

I'm Sean Carr. Welcome to Darden Ideas to action. Hi Frank, thanks for joining us today on Darden Ideas to Action.

Frank Warnock:               

Thanks, Sean. My pleasure.

Sean Carr:                           

We're at a watershed moment, here we are amid a pandemic, the economy remains in crisis, there's a transition underway, in the office of the president. It seems like a very good time for us to examine the role of the Federal Reserve, particularly as it relates to the larger economy. How has the Fed faired under the Trump administration? At least pick us up through the time of the pandemic that we're currently in.

Frank Warnock:               

When Jay Powell took over, he continued to guide the economy as best he could from that position and I think he has done a nice job with that, and the economy was at the eve of the pandemic quite strong. So I think the longest post-war expansion that we've had, the unemployment rate had come down to very, very low levels that we didn't have inflation, we were getting a lot of job growth. So the economy was in a really good situation. There's been one big change, I would say, at the Fed, during the Powell administration. He has thought much more about the distribution of outcomes, the distribution of households and how different types of households were fairing even in the expansion. So he recognized that when we say that the U.S. economy is doing well, that does not mean that it's doing well for everybody.

And you might think that, that's an obvious point and it is an obvious point, but the history of monetary policy and the thinking behind monetary policy was that monetary policy is such a blunt tool that you can't think about the distribution. You can't think about how the very rich are different from the median or different from the very poor, because monetary policy is a blunt instrument and so you just think about the average effect on the economy. And that was the thinking for decades and decades. The Powell Fed has changed that to really think much more about the distribution of outcomes in the U.S. economy.

Sean Carr:                           

I assume that's not just a rhetorical position by the Fed, what can they do in order to address them in terms of policy levels?

Frank Warnock:               

They instituted, maybe through the year 2019, a Fed listens tour that went into the communities and listened to community leaders to hear how they were being affected by the economy. And again, this was a record economic expansion. And then if you think about practically, what does that mean for monetary policy it means that he will let the economy run hotter for longer than otherwise. So that is, he recognizes that you need more economic growth to really reach the lower income households so that when the economy does take off, it affects certain households first and other households much later. And he wants to think much more about the households that are affected later, that are slower to get back into the workforce and to get income gains. That means lower interest rates for longer.

Go back to Alan Greenspan, who would say that job of the Fed is to, right when the party gets started, take the punch bowl away. So right when things start to get good, then you start to tighten policy because it's going to take a while for that policy to work through. And so you want to get out ahead of any inflationary pressures. Powell would say, "No, we need to let the party," to use Greenspan's term, "Go for longer." We need a strong economy for a much longer time, so that we can enable all households to participate in the gains from a strong economy.

Sean Carr:                           

What is your assessment of the U.S. economy in terms of where we are kind of fast forward from March of 2020 to today?

Frank Warnock:               

So first when we go back to March of 2020, we knew back then and continue to know that the path of the economy is going to be a function of the public health response or the response to the COVID crisis. The economy has bounced back and took a huge hit in the first two months of the crisis. It's in many sectors, largely bounced back. The sectors that are still struggling are the sectors where you have to have face-to-face meetings and gather. And so you can think of a lot of service sectors and transportation, things like that, that are still having difficult time. Household spending has really picked up on durable goods and big ticket items. So the economy is bouncing back nicely. The problem is if we have more waves of the virus, then the economy is going to take a hit again. So that's been true since March, it's still is true.

There are downside risks, that's to be sure. The unemployment rate spiked up in the first couple of months of the crisis, and it's come back down. It's still higher than you'd want. But more troubling, many of the unemployed are now what you'd call long-term unemployed. So they've been unemployed for more than six months. That is a big concern because when you're out of employment for a long time period, your skills might degrade, it might be harder for you to get a job, and you're more likely to just remain stuck in this longterm under-employed or unemployed situation. And so that's something that is a worry. But overall, the economy is bouncing back, but it's not where it needs to be, but it's moving in the right direction.

Sean Carr:                           

The period of COVID-19 since March, we've seen both a fiscal and monetary response, where did the Fed come in, in addressing the economic crisis resulting from health crisis?

Frank Warnock:               

The Fed worked very closely with Treasury and Congress to design some lending schemes to help otherwise viable entities who the only thing they did wrong was they were hit by this COVID shock. So that's the one side, let's say quasi-fiscal side. It's really trying to get money directly to entities that are viable, but were hit hard by this shock and Treasury, Congress and the Fed are trying to make sure that they just don't disappear, they don't go out of business. That's one.

Two, the Fed had a massive increase in the size of their portfolio. So that is, they bought a massive amount of treasury bonds and also mortgage backed securities. So those two things will help the flow of funds do the housing sector and the housing sector has fully re-bounded, it seems. Their purchases of treasuries have lowered borrowing costs in the U.S. and supported other asset prices.

So when you reduce the discount rate, then a lot of other asset prices will be supported and we've seen that, a big rally in asset prices over the past few months. They've also through some of their programs, especially in the purchases of treasuries, have smoothed out a lot of issues in the financial system that could have caused problems. When I say could have caused problems, you can just think of important markets just seizing up and not functioning well. You don't know how important markets are until you lose them. And they've really been on top of trying to keep the markets functioning normally.

Sean Carr:                           

We see echoes of the response for the global financial crisis in 2008. Does that seem to have trickled into the Powell Fed in their approach to what's happening now?

Frank Warnock:               

Absolutely. Most of the programs that the Fed has done with Treasury and Congress are versions of what was done during the global financial crisis. The one that is definitely different is the Main Street Lending Program, where the Fed is trying to through the banking system, lend to small and medium-sized firms to keep them afloat during this period.

Sean Carr:                           

Over the summer leadership has been unable to come forward with a new fiscal stimulus. We'll see what happens in the next weeks and months to come. But coming back to monetary policy, does the Fed still have room to maneuver?

Frank Warnock:               

They still have room to maneuver, that's for sure. If you think that their only tool is interest rates and the Fed funds rate, which is just an overnight, and it's already at zero, and you think that it can't go below zero, then you might say that they're boxed in. But they have many, many different tools, including the treasury purchases. Buying five-year treasuries, 10-year treasuries will lower borrowing costs across many, many sectors in the economy. That's a tool. There are these more emergency tools for various sectors, they're purchasing corporate bonds now, they hadn't really done that in the past.

So they have a lot of different tools, not just the policy rate. That said, clearly what's needed is a fiscal response. So you need to support people who are in face-to-face sectors and you don't want them to work because of the pandemic. So, the public health response would say, "You want these people to stay at home if possible." There's got to be money flowing to these people, there just absolutely has to be as part of the public health response, that's not for the Fed to do, that's a fiscal response. So a lot of what needs to be done is on the fiscal side and the Fed will do what it can on monetary policy.

Sean Carr:                           

As we look towards a new administration in the White House, how does the Fed should react to those sorts of things and how can they anticipate change? What does it imply for the policies that they might want to pursue when things are so much influx right now?

Frank Warnock:               

First, they have a whole team that does try to predict what the fiscal policies are going to be, but I think largely they don't react to fiscal policy changes until the changes are real. They're not chasing things that might happen, but have not occurred. Once decisions are made on the fiscal side, there is time for the Fed to react. So yes, they analyze what's likely to happen, but I think for meaningful change in monetary policy, the fiscal policy actually has to adjust.

What do they expect going forward? This is more speculation on [inaudible 00:11:21] . Debt levels are high right now. Government debt levels are extremely high, so there's going to be people in Congress that will say, "Enough is enough." And they're going to fight hard against increases in fiscal spending. There's going to be tension there. If the fiscal authorities end up doing nothing, then that puts a whole lot more pressure on the Fed. And Powell has stated many times that the policy that is really needed to hold the U.S. and American households through this, is fiscal policy. If Congress can't agree with the president's office on fiscal policy, that will make the recovery more difficult.

Sean Carr:                           

I'm curious about the things that you pay attention to, or are paying attention to. Not just with respect to the Federal Reserve and its policies and actions, but also more generally as an economist yourself. What do you pay attention to and what would you suggest others do?

Frank Warnock:               

There's two things. If you're thinking about the health of the U.S. economy, a lot of the issues are going to be on the supply side, meaning the supply of workers and how well they're trained. That's important to keep an eye on. And that's why when I brought up the percentage of the unemployed that are now longterm unemployed. So I think we have to keep an eye on the supply side because that's going to be the main driver of our long run prosperity. Two, debt levels are enormous. There's going to be some default coming down the pike, one wouldn't think. There's financial stability concerns about the debt levels, but there's also concerns about a debt overhang, where the debt levels are so high that you're spending more of your energy and resources repaying your debt rather than investing in the future. And so that could be problematic. This year and for next year, it's all about the pandemic and the public health response. If we get through that, then we know how to deal with high debt levels. We know how to, I hope strengthen the supply side of the economy.

Sean Carr:                           

Well, Frank, thank you very much. This has been a really interesting conversation during a very difficult time. I really appreciate your thoughts.

Frank Warnock:               

Thanks, Sean. My pleasure.

Sean Carr:                           

I'm Sean Carr, and that's it for today's episode of Darden Ideas to Action. Frank Warnock is a professor at the University of Virginia, Darden School of Business. He's also a research advisor with the Federal Reserve board's, International Finance Division, and has previously served as a senior economist with the Fed. Join us next time for more research, analysis and commentary from the University of Virginia, Darden School of Business. You can subscribe to Ideas to Action on Apple Podcast, Spotify or Podbean. To read more expert insights on this topic and more, visit ideas.darden.virginia.edu.

The Trump Administration is on the way out. The Biden Administration is on the way in. And amid the transition, the largest wave yet of the coronavirus pandemic is resulting in new restrictions in the United States and around the world. It’s a pivotal moment for the U.S. and global economies, and the U.S. Federal Reserve holds a key position of influence. University of Virginia Darden School of Business Professor Frank Warnock, a former Fed economist and current research adviser with the Fed, discusses the tools available and possible next steps for the Fed with the Batten Institute’s Sean Carr.

Read full transcript here:

Sean Carr:                           

Alan Greenspan would say that the job of the Fed is to, right when the party gets started, take the punch bowl away. When things start to get good, then you start to tighten policy. Powell would say, "No, we need to let the party go for longer. We need a strong economy for a much longer time, so that we can enable all households to participate in the gain from a strong economy."

This is a pivotal moment for the United States and global economies. And the U.S. Federal Reserve holds a key position and influence. The Trump administration is on the way out, the Biden administration is on the way in. And all the while, the biggest wave yet of the Coronavirus pandemic is sweeping over the United States and many countries around the world. Simply put, what is the Fed to do? Where can, and should [inaudible 00:01:01]? Frank Warnock is a professor and an economist at the University of Virginia's, Darden School of Business, who is not only a former senior economist with the Fed, he currently serves as a research advisor with the Federal Reserve Board's International Finance Division.

I'm Sean Carr. Welcome to Darden Ideas to action. Hi Frank, thanks for joining us today on Darden Ideas to Action.

Frank Warnock:               

Thanks, Sean. My pleasure.

Sean Carr:                           

We're at a watershed moment, here we are amid a pandemic, the economy remains in crisis, there's a transition underway, in the office of the president. It seems like a very good time for us to examine the role of the Federal Reserve, particularly as it relates to the larger economy. How has the Fed faired under the Trump administration? At least pick us up through the time of the pandemic that we're currently in.

Frank Warnock:               

When Jay Powell took over, he continued to guide the economy as best he could from that position and I think he has done a nice job with that, and the economy was at the eve of the pandemic quite strong. So I think the longest post-war expansion that we've had, the unemployment rate had come down to very, very low levels that we didn't have inflation, we were getting a lot of job growth. So the economy was in a really good situation. There's been one big change, I would say, at the Fed, during the Powell administration. He has thought much more about the distribution of outcomes, the distribution of households and how different types of households were fairing even in the expansion. So he recognized that when we say that the U.S. economy is doing well, that does not mean that it's doing well for everybody.

And you might think that, that's an obvious point and it is an obvious point, but the history of monetary policy and the thinking behind monetary policy was that monetary policy is such a blunt tool that you can't think about the distribution. You can't think about how the very rich are different from the median or different from the very poor, because monetary policy is a blunt instrument and so you just think about the average effect on the economy. And that was the thinking for decades and decades. The Powell Fed has changed that to really think much more about the distribution of outcomes in the U.S. economy.

Sean Carr:                           

I assume that's not just a rhetorical position by the Fed, what can they do in order to address them in terms of policy levels?

Frank Warnock:               

They instituted, maybe through the year 2019, a Fed listens tour that went into the communities and listened to community leaders to hear how they were being affected by the economy. And again, this was a record economic expansion. And then if you think about practically, what does that mean for monetary policy it means that he will let the economy run hotter for longer than otherwise. So that is, he recognizes that you need more economic growth to really reach the lower income households so that when the economy does take off, it affects certain households first and other households much later. And he wants to think much more about the households that are affected later, that are slower to get back into the workforce and to get income gains. That means lower interest rates for longer.

Go back to Alan Greenspan, who would say that job of the Fed is to, right when the party gets started, take the punch bowl away. So right when things start to get good, then you start to tighten policy because it's going to take a while for that policy to work through. And so you want to get out ahead of any inflationary pressures. Powell would say, "No, we need to let the party," to use Greenspan's term, "Go for longer." We need a strong economy for a much longer time, so that we can enable all households to participate in the gains from a strong economy.

Sean Carr:                           

What is your assessment of the U.S. economy in terms of where we are kind of fast forward from March of 2020 to today?

Frank Warnock:               

So first when we go back to March of 2020, we knew back then and continue to know that the path of the economy is going to be a function of the public health response or the response to the COVID crisis. The economy has bounced back and took a huge hit in the first two months of the crisis. It's in many sectors, largely bounced back. The sectors that are still struggling are the sectors where you have to have face-to-face meetings and gather. And so you can think of a lot of service sectors and transportation, things like that, that are still having difficult time. Household spending has really picked up on durable goods and big ticket items. So the economy is bouncing back nicely. The problem is if we have more waves of the virus, then the economy is going to take a hit again. So that's been true since March, it's still is true.

There are downside risks, that's to be sure. The unemployment rate spiked up in the first couple of months of the crisis, and it's come back down. It's still higher than you'd want. But more troubling, many of the unemployed are now what you'd call long-term unemployed. So they've been unemployed for more than six months. That is a big concern because when you're out of employment for a long time period, your skills might degrade, it might be harder for you to get a job, and you're more likely to just remain stuck in this longterm under-employed or unemployed situation. And so that's something that is a worry. But overall, the economy is bouncing back, but it's not where it needs to be, but it's moving in the right direction.

Sean Carr:                           

The period of COVID-19 since March, we've seen both a fiscal and monetary response, where did the Fed come in, in addressing the economic crisis resulting from health crisis?

Frank Warnock:               

The Fed worked very closely with Treasury and Congress to design some lending schemes to help otherwise viable entities who the only thing they did wrong was they were hit by this COVID shock. So that's the one side, let's say quasi-fiscal side. It's really trying to get money directly to entities that are viable, but were hit hard by this shock and Treasury, Congress and the Fed are trying to make sure that they just don't disappear, they don't go out of business. That's one.

Two, the Fed had a massive increase in the size of their portfolio. So that is, they bought a massive amount of treasury bonds and also mortgage backed securities. So those two things will help the flow of funds do the housing sector and the housing sector has fully re-bounded, it seems. Their purchases of treasuries have lowered borrowing costs in the U.S. and supported other asset prices.

So when you reduce the discount rate, then a lot of other asset prices will be supported and we've seen that, a big rally in asset prices over the past few months. They've also through some of their programs, especially in the purchases of treasuries, have smoothed out a lot of issues in the financial system that could have caused problems. When I say could have caused problems, you can just think of important markets just seizing up and not functioning well. You don't know how important markets are until you lose them. And they've really been on top of trying to keep the markets functioning normally.

Sean Carr:                           

We see echoes of the response for the global financial crisis in 2008. Does that seem to have trickled into the Powell Fed in their approach to what's happening now?

Frank Warnock:               

Absolutely. Most of the programs that the Fed has done with Treasury and Congress are versions of what was done during the global financial crisis. The one that is definitely different is the Main Street Lending Program, where the Fed is trying to through the banking system, lend to small and medium-sized firms to keep them afloat during this period.

Sean Carr:                           

Over the summer leadership has been unable to come forward with a new fiscal stimulus. We'll see what happens in the next weeks and months to come. But coming back to monetary policy, does the Fed still have room to maneuver?

Frank Warnock:               

They still have room to maneuver, that's for sure. If you think that their only tool is interest rates and the Fed funds rate, which is just an overnight, and it's already at zero, and you think that it can't go below zero, then you might say that they're boxed in. But they have many, many different tools, including the treasury purchases. Buying five-year treasuries, 10-year treasuries will lower borrowing costs across many, many sectors in the economy. That's a tool. There are these more emergency tools for various sectors, they're purchasing corporate bonds now, they hadn't really done that in the past.

So they have a lot of different tools, not just the policy rate. That said, clearly what's needed is a fiscal response. So you need to support people who are in face-to-face sectors and you don't want them to work because of the pandemic. So, the public health response would say, "You want these people to stay at home if possible." There's got to be money flowing to these people, there just absolutely has to be as part of the public health response, that's not for the Fed to do, that's a fiscal response. So a lot of what needs to be done is on the fiscal side and the Fed will do what it can on monetary policy.

Sean Carr:                           

As we look towards a new administration in the White House, how does the Fed should react to those sorts of things and how can they anticipate change? What does it imply for the policies that they might want to pursue when things are so much influx right now?

Frank Warnock:               

First, they have a whole team that does try to predict what the fiscal policies are going to be, but I think largely they don't react to fiscal policy changes until the changes are real. They're not chasing things that might happen, but have not occurred. Once decisions are made on the fiscal side, there is time for the Fed to react. So yes, they analyze what's likely to happen, but I think for meaningful change in monetary policy, the fiscal policy actually has to adjust.

What do they expect going forward? This is more speculation on [inaudible 00:11:21] . Debt levels are high right now. Government debt levels are extremely high, so there's going to be people in Congress that will say, "Enough is enough." And they're going to fight hard against increases in fiscal spending. There's going to be tension there. If the fiscal authorities end up doing nothing, then that puts a whole lot more pressure on the Fed. And Powell has stated many times that the policy that is really needed to hold the U.S. and American households through this, is fiscal policy. If Congress can't agree with the president's office on fiscal policy, that will make the recovery more difficult.

Sean Carr:                           

I'm curious about the things that you pay attention to, or are paying attention to. Not just with respect to the Federal Reserve and its policies and actions, but also more generally as an economist yourself. What do you pay attention to and what would you suggest others do?

Frank Warnock:               

There's two things. If you're thinking about the health of the U.S. economy, a lot of the issues are going to be on the supply side, meaning the supply of workers and how well they're trained. That's important to keep an eye on. And that's why when I brought up the percentage of the unemployed that are now longterm unemployed. So I think we have to keep an eye on the supply side because that's going to be the main driver of our long run prosperity. Two, debt levels are enormous. There's going to be some default coming down the pike, one wouldn't think. There's financial stability concerns about the debt levels, but there's also concerns about a debt overhang, where the debt levels are so high that you're spending more of your energy and resources repaying your debt rather than investing in the future. And so that could be problematic. This year and for next year, it's all about the pandemic and the public health response. If we get through that, then we know how to deal with high debt levels. We know how to, I hope strengthen the supply side of the economy.

Sean Carr:                           

Well, Frank, thank you very much. This has been a really interesting conversation during a very difficult time. I really appreciate your thoughts.

Frank Warnock:               

Thanks, Sean. My pleasure.

Sean Carr:                           

I'm Sean Carr, and that's it for today's episode of Darden Ideas to Action. Frank Warnock is a professor at the University of Virginia, Darden School of Business. He's also a research advisor with the Federal Reserve board's, International Finance Division, and has previously served as a senior economist with the Fed. Join us next time for more research, analysis and commentary from the University of Virginia, Darden School of Business. You can subscribe to Ideas to Action on Apple Podcast, Spotify or Podbean. To read more expert insights on this topic and more, visit ideas.darden.virginia.edu.