Private 2010 Records Show Dudley’s Staff Urging Bold Fed Actionby and
Bloomberg obtains eight New York Fed ‘Blackbooks’ through FOIA
NY Fed staff urged novel inflation-linked stimulus policy
The Federal Reserve’s eyes and ears on financial markets were starting to sense trouble.
A year into the economic recovery in late-2010, unemployment rates of more than 9 percent weren’t improving. Inflation was too low and decelerating, and across the Atlantic the Greek debt crisis was catching fire. The central bank’s policy rate was at zero and the first round of asset purchases was over.
About a week before the Sept. 21 Federal Open Market Committee meeting that year, Federal Reserve Bank of New York staff produced the Blackbook, until now a confidential document that would guide William Dudley, the FOMC vice chairman and New York Fed president, on policy strategy and forecasts.
The staff recommendation in the September 2010 Blackbook was urgent and bold: Keep track of how much the Fed had missed its inflation target and promise to make it up with a longer period of easing or securities purchases, possibly even of private securities.
“Because the economy remains very susceptible to negative shocks, we believe it is important for the FOMC to contemplate further balance sheet expansion if conditions deteriorate,” the Blackbook said. “We believe that the committee should explicitly link the evolution of the balance sheet to price level developments.”
Bloomberg News obtained the New York Fed’s Blackbooks for 2010 through a Freedom of Information Act request, which focused on that year because FOMC transcripts are made public with a five-year lag.
The eight documents, one for each scheduled FOMC meeting that year, provide insight into how the advisers to the No. 2 official on the Fed’s rate-setting committee saw the world just a year after the worst recession since the Great Depression, and how those views meshed or differed with Fed staff and governors in Washington.
The do-whatever-it-takes attitude of New York Fed staff contrasts sharply with the message the central bank is now getting from House Republicans, who have criticized the unconventional strategies the Fed pursued in the wake of the crisis and would like to see more restraint. Such an all-out approach by staff in late-2010 marked something of an evolution from earlier in the year, when worries about runaway inflation in financial markets from the excess liquidity pumped into the system during the crisis caused them to strike a more cautious tone.
Still, with unemployment running at 9.6 percent in August 2010, and inflation of 1.5 percent, the miss on the central bank’s goals was so severe they had little choice but to pursue their congressional mandate of stable prices and full employment.
The New York Fed is first among equals among the 12 reserve banks around the country that comprise the Fed system along with the Board of Governors in Washington. No reserve bank president is more involved in FOMC strategy than the New York Fed president. Dudley, a former Goldman Sachs Group Inc. partner and chief U.S. economist, has spent enough years in financial markets to understand how quickly negative sentiment could feed on itself in financial markets, his former advisers say.
A young economist named Gauti Eggertsson at the New York Fed presented the disinflation risks in 2010 at the time this way in the Blackbook. If new data come in and point to further deceleration in prices, then the public’s expectations of future inflation starts to fall. Because the Fed can’t reduce its policy rate, the so-called real interest rate -- the cost of borrowing money minus inflation -- actually rises in a period of disinflation, slowing demand even further.
“This puts even more downward pressure on the price level making the problem potentially more severe,” wrote Eggertsson, now an economist at Brown University in Rhode Island. “This is what has been coined as a ‘deflationary spiral.’”
Longer-run inflation expectations had in fact fallen steadily through the U.S. summer. At the top of Dudley’s briefing, the New York Fed staff wrote: “Our view is that additional stimulus is most effective through a strategy that keeps explicit track of the cumulative deviation of actual inflation.”
“We had several people who really understood this and felt that it would be a good alternative for providing more accommodation,” James McAndrews, who was co-director of research in 2010, said in an interview. McAndrews retired in June after 28 years at the Fed.
When the discussion turned to Dudley at the Sept. 21 FOMC policy meeting, he was blunt: “We should provide additional monetary accommodation,” he said, according to transcripts of the meeting. “The economy is too weak, inflation is too low, and we are too far away from our full employment objective.”
The question, Dudley said, is how. “My own opinion is that exploring a price-level target regime is worthwhile because such a regime does have advantages,” he said. The FOMC vice chair “strongly” encouraged Fed Board staff to investigate the strategy further.
In a memo in Dudley’s briefing book, Eggertsson called it “inflation budget accounting.” If a central bank misses its 2 percent inflation target for more than four years -- as the Fed in fact has -- it would commit to keeping an easy policy in place for a longer period of time. At the time, the FOMC hadn’t even disclosed its inflation target to the public, however.
Eggertsson added that the strategy needed to be followed up with actions. Buying more long-term securities was one way. Another: “Other assets, such as purchases of various private securities could serve the same aim,” Eggertsson wrote.
The Federal Reserve Act doesn’t permit purchases of securities issued by private corporations for monetary policy operations. “But the staff’s job is to explain the logic of the models and the policy makers have to fit that to the conditions and constraints they face with the law and everything else,” McAndrews said.
In October 2010, the Fed Board staff took Dudley’s advice -- the advice his own staff had put forward a month earlier.
In a special conference call, Fed board economist Michael Kiley discussed three possible new approaches to policy strategy, including a price level target. One opponent was Janet Yellen, who was then the newly installed vice chair of the Fed Board and is now the chair. While possibly very effective, “these strategies entail very significant risks, so I would not pursue them,” she said. One policy maker in favor was Charles Evans, the president of the Chicago Fed.
In November 2010, the FOMC launched a second round of quantitative easing, purchasing $600 billion of longer-term Treasuries. By January 2012, they adopted the 2 percent inflation target.
After the Nov. 8 U.S. presidential election, expectations on inflation and economic growth began to move higher on the back of President-elect Donald Trump’s still undefined plans for fiscal stimulus, tax cuts and less regulation. That’s alleviated some of the risk for the Fed of another recession with inflation at a low level.
Discussions at the Fed about what to do in the next downturn have continued. Earlier this year the Fed published a paper that said asset purchases and forward guidance on its policy rate should be able to provide sufficient stimulus after the policy rate hit zero.
“The preferred tool would be quantitative easing and communication,” said Laura Rosner, senior U.S. economist at BNP Paribas in New York. Still, “a lot of different options would be considered” if the next recession occurred at low inflation with the policy rate close to zero.