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00:00Good morning and thanks for having me. Those of you that know me know that usually I do slideshows much like what has just been done here and I didn't do it today but I'm kind of glad that I didn't because of my chance to be all the same ones that you just saw and a lot of the data would be exactly the same . So instead of so rehashing that I'm going gonna give you Jim's view of the world as it stands today and so we'll just go from there and then hopefully that will lead into the Q and A portion which I'm excited to get to. And in the Q and A we can probably talk about a lot of topics additional topics that we're able to address in these in this first set of presentations here so let me start off with growth and momentum in the U.S. economy. And I think there is a lot of momentum . GDP growth if you average over the last three quarters is about 4 percent or in the neighborhood of 4 percent. And you know that's a pretty fast rate of growth for this economy with because the potential growth rate for the U.S. economy has been marked down in recent years than the previous speakers were alluding to that to something around 2 percent. So you're growing at 4 percent but the long run average rate of growth is only 2 percent. So this is an above trend rate of growth . That's something to keep in mind in the past. You look at that past data on the U.S. economy and some of these charts petrol growth rate is considered to be higher. Closer to 3 percent but because it's been marked down so so so 4 percent against potential growth of 2 percent is is kind of like what used to be 5 percent a year of potential growth of 3 percent. So. So I do think there's considerable momentum in the U.S. economy and I think that's likely to continue into 2015 because I think there are important tailwinds for the U.S. economy. This has already been discussed but I'll give you my views on it. There's two important tailwinds that are supporting some momentum effects in the U.S. economy are lower long term interest rates in the U.S. and lower global oil prices now these lower long term rates in my view are driven by a single factor mostly which is the specter of ECB quantitative easing during 2014. So let me just tell you the story of ECB quantitative easing. I actually went to Frankfurt in the summer of 2013. I argued in a speech that the inflation rate was probably too low and headed lower in Europe and that maybe they should think about QE because I'm I'm being an advocate of QE when monetary policy is stuck at the zero lower bound the reception was chilly but now the ECB has come around. So basically what happened was that as of this time last year at the European Central Bank there would have been and looking at European financial markets and asking people about the prospects for quantitative easing in Europe you have got the answer that was very unlikely the reason was very unlikely is because the ECB is a multinational institution and the prospect of buying sovereign debt government debt of all the different nations in Europe was a scary prospect . It wasn't clear that that was something that was certainly not envisioned in the treaty that set up the European Central Bank . So this is why you've had in the U.S. you've had a lot of unconventional monetary policy a lot of bond buying a lot of forward guidance in Japan you've had unconventional monetary policy in the U.K. you've had unconventional monetary policy . What about the ECB. Up until now not really any unconventional monetary policy. So last year at this time it was considered very unlikely even even though inflation was low 2014 was supposed to be a good year for Europe . It didn't pan out. The data in Europe came in weaker than expected. They didn't get the recover that they were expecting . And as a result and inflation started to fall through 2014 even further inflation expectations started to fall. ECB credibility on maintaining their inflation targets started to erode. And all through 2014 it started to get more and more more likely that ECB would actually you know what make a momentous decision and go ahead with sovereign debt purchases. So this explains the major developments in global financial markets over the last year which is the global decline in longer term interest rates. As opposed to an increase in longer term interest rates which is what everyone would have been expecting last year when you were sitting here in this audience everyone thought rates are going up. Economy is getting better. It didn't turn out that way. Rates went down . Now it's not just European rates as a global market. So what has happened is that the 10 year Treasury is now down under 2 percent according to the left last number that we saw there an astonishingly low treasury yield 10 year Treasury yield. But that's because it's a global market. ECB then the specter or the expectation of European quantitative easing has put downward pressure on global rates and where the beneficiaries of that. So I've called this an unmitigated good for the U.S. economy what I mean by that is that this is a decline in longer term yields that we didn't doesn't have much to do with actual fundamental factors in the U.S. economy. It's coming to us courtesy of the ECB and you know lower rates you know based on historical data for the U.S. a very bullish factor for the U.S. economy. So number one we have a lot of momentum in the U.S. economy. Number two we got lower long term rates that came to us courtesy of the ECB. I liked the analogy earlier to the 1998 sorry the what was it the Thai currency crisis the Asian currency crisis in 1998. For those of you that remember that episode like the back of your hand like US Fed guys you remember that there was a lot of angst in the U.S. about Asia was in a terrible situation many countries in very severe recessions wasn't it all going to come ashore in the U.S. It didn't happen in 1998 because U.S. isn't that open up an economy that's number one and number two. We got the benefit of lower long term rates from the garage in this event. So this is very very similar to what's happening now. These lower long term yields are a tailwind for the U.S. economy also part of Jim's take on the global economy. This is the ECB decision was a highly anticipated event in global markets. You know they're very slow moving it's very bureaucratic organization and they're they're making tiptoeing their way toward actually making a decision. So what what do we know about financial markets. Financial markets tend to anticipate what's going to happen and pull the prices pricing forward to today. So what was happening was that many of the facts from ECB quantitative easing have probably already occurred in the run up to their actual decision. So much of what you might expect to see from that decision a weaker euro lower lower long term rates in Europe. You know those things already occurred before Mario Draghi even raised a finger and purchase a single bond. In fact they haven't even purchased anything and they're not going to start till March here. But the effects are already in financial markets because financial markets tend to anticipate things that also happened with U.S. QE 2 mostly effects from QE 2 occurred before November of 2010 which was the actual date we started buying bonds but mostly effects were during the fall of 2010 not after I think that's important because it's not clear now going forward how markets will treat say the euro dollar exchange rate or the longer term interest rates in Europe because they've already adjusted to the fact that he's TV is going to do these purchases I don't want to dwell on this for too long but if it was a momentous decision and they also did this open ended aspect to the decision referred to as QE infinity earlier in the talk . But I think the open ended aspect which is something I argued for here in the U.S. that if you're going to do this then you should do it and tie the end of the program to economic goals and that to actual dates or amounts of purchases. Which is what they've done. They said that they're going to purchase at a certain pace up until at least September of 2016 but they have a clause that they can continue beyond that depending on economic conditions at that time. You can interpret that as they're going to continuous the purchases until they can return their inflation rate back to its target of 2 percent or slightly less the other tailwind for the U.S. economy is the oil price shock and I guess one thing I'd like to stress to you is that this is no ordinary oil price shock. This is a 50 percent decline. It does look persistent and it is very positive for U.S. consumers . We've already seen data on that. And one of the charts this morning. It is putting more money in the pockets of U.S. consumers and by far that's the biggest effect coming from the lower oil prices for the U.S. economy so I see that as a very important tailwind . It's true that we have a larger energy sector than we had. And that's you know that sector is going to suffer from the lower prices but that effect is much smaller than the effect the positive effect on U.S. consumers . So that's an important tailwind. Oil spend. We're an oil consuming country and lower oil prices are very good for us . And this is no small matter. This is 50 percent down and persistent now though I'm pretty bullish on the U.S. economy. What sorts of features do we see an economy that manifest this bullishness . One of the biggest features is improvement in labor markets over the last year as Sorry been noted the unemployment rate nationally has come down to five point six percent. That's substantially lower than anyone on the FOMC projected including me and I was one of the most optimistic. I still got it wrong. I would wish I would've been even more optimistic. So at five point six percent unemployment and the current rates of decline unemployment in the U.S. will be below 5 percent by the third quarter of this year below 5 percent by the third quarter this year below antibodies almost anybody's notion of the long term normal rate of unemployment . The die is already cast. We have an easy monetary policy . We're going to be slow in coming off the euro. Unemployment is going to go down below the natural rate. No matter how you cut it over the next two years . So I think that's important says a lot of talk about hairsplitting about exactly what's going to happen to monetary policy. But in the big picture the policy's already been set . We've got low interest rates. Maybe we'll come off this year and you know I'm going to talk about that in a lot of detail but basically we're going to have very low interest rates and we have a rapidly improving labor market. We also have non-farm payroll employment. Our other main indicator you know it's already been mentioned 2014 the best year since the huge boom year in 1999. So really good numbers on the labor market now one of the things about labor markets is that people have said in this debate over the last couple of years while Sure unemployment is coming down and sure non-farm payroll employment is good. But there are other labor market indicators maybe that aren't so good . One of those might be labor force participation which has been on secular decline since the year 2000. I think that's mostly driven by demographics and if you're interested in that you can see an earlier speech that I gave in 2014 called The Rise and Fall of labor force participation in the U.S. demographic models that predict Labor Force Participation dating from 2006 got the labor force participation rate rate they correctly forecast the labor force participation rate seven years out in 2013. This never happens in macroeconomics so that's what convinced me that that a good demographic model explains everything that's going on with labor force participation. So what that's saying is that there's no cyclical component to labor force participation it's not being driven by the business cycle it's being driven by long run trends in all of us again and again that's how you should think about it. But let me just say Suppose suppose you wanted to say I don't want to just look at the workforce indicators of labor market performance unemployment and non-farm payroll employment . I want to look at something else. Part time for economic reasons quit hires all kinds of other indicators. OK OK you're talking to a nerdy guy so I'll tell you what I'll do I'll construct a Labor Market Conditions Index. I'll take all these indicators of crunched the math and I'll stick them all into one . Create an index that creates one indicator based on all these measures of labor market performance and then we'll just look at the ups and downs of this labor market index and that'll be our measure of labor market performance. That would be a way of capturing all this extra information that's coming from the JOLTS data and all the other data that we have on labor market performance. So let's suppose we do that the correlation of a Labor Market Conditions Index with the unemployment rate is about point 9 5. The correlation of a Labor Market Conditions Index with non-farm payroll employment also about point 9 5. So you can put all this other information and you can talk about you sick. You can talk about quests and horrors so you can talk about part time for economic reasons. You're not getting any more information out of putting all that together than what you would get from just looking at the unemployment rate and the non-farm payroll employment which are. That's why there are workforce indicators. That's why they get cited all the time because their correlations with everything else is going on the economy is very high. So the bottom line is labor markets are improving and they're improving rapidly and this you would get the same story. Even if you put a look at all labor market indicators together. So the bottom line is that there's been dramatic improvement in U.S. labor markets and that that's going to continue. Let me turn to global considerations and some of you might have noticed if you're if you're a nerdy Fed watchers that the Fed statement included a new word international in the statement and some commentators who are looking at that. My feeling on that is that we were just acknowledging in the statement that we usually put out didn't say too much about global markets but the actual discussion around the table does . You know we always talk about global conditions when we're talking about monetary policy. I think putting the word international just acknowledges that discussion. So that's in my view anyway you can ask other other participants on the committee what they think. But in my view that was the purpose of putting in a national statement. I've already said what's the most important global event was in recent in the recent data as the ECB quantitative easing. There's an important spill over to the U.S. in the form of lower long term interest rates. I do think Europe is likely to improve in 2015. I think they you know they were expected to have a better year in 2014 than they did. But now in 2015 I think they will improve some longer term medium term growth prospects are not that great. In Europe they've got probably a lower long term potential growth rate . But nevertheless I think they'll grow faster in 2015 than they did in 2014 and that will help the global economy. China has been slower but I agree with previous speakers not that slow . And as far as the dollar the dollar is stronger. That's true . But that's a natural consequence of better prospects for growth in the U.S. and also the easier ECB monetary policy. The trade weighted value of the dollar you look wait with all our trading partners appropriately and plot an index of that trade weighted value the dollar's not too different from its average value over the last 15 years. So I don't see that as certainly it has some effects but I don't see it as a huge factor for the U.S. economy. It's a natural consequence of an economy that's improving. And and also of what rival central banks are doing inflation in the US is relatively low inflation readings are being influenced importantly by the oil market dislocation. And again this is not just a minor move in oil markets this is a huge move in oil markets. So it's no small matter. Even core inflation has been infected by oil prices because core excludes food and energy. But it doesn't exclude some other sectors that use a lot of the energy like transportation. So even core being pulled down some by the dislocation in oil markets. Now one way to fix that a little bit better would be to look at a different measure of underlying inflation. My favorite measure is the Dallas as is something geeky for you. The trimmed mean . P.S. inflation rate personal consumption expenditures inflation rate. So what's good about this is it's easy. It's easy to understand. So there are a lot of prices out there in the economy. Core inflation was invented in the 1970s and he said OK. Well just because of the oil price shocks we'll just throw out the energy sector and we'll look at that and we'll throw out food as well. P.S. trimmed mean doesn't do that. It takes the whole distribution of price changes throw some of the high ones out and some of the low ones out. So you're not throwing out an entire sector you're doing something more statistically based . So if you look at the so it has better theory behind it. And I think it's a better measure eventually. I think the Fed should switch to the Dallas Fed trimmed mean but as a mantra as a measure of underlying inflation it's running at about one point six percent on a year over year basis one point six percent inflation in the U.S. that's below our target of 2 percent but you know four tenths below our target is not enough to justify a zero interest rate policy which is really an emergency level of interest rates 4 percent is a little bit low that would justify rates that were a little bit below normal. But that's not. But it's not enough to justify zero policy rate and I'm gonna come back to that thought in the remainder of my remarks here. Now inflation expectations which have not been discussed alas this morning are near and dear to my heart. And inflation expectations often determine what actually happens with inflation and inflation expectations have dropped substantially in the last six to nine months here the five year fired me or forward which is a measure of inflation not five years from now but five years following that that number has come down below 2 percent. So that's kind of disconcerting for a central banker because that number should never move off to. It should really be right around to all the time and it's dropped significantly. So I'm normally a big fan of these market based measures of inflation expectations that come out of the treasury inflation protected securities market . So this is just a way that you can read off market prices. What markets think inflation is going to be in the future. And they have fallen a lot. And normally I would put a lot of emphasis on it. But the oil price shock is so big and having such a big effect that I don't think you can just read the inflation expectations of these data right now what's happening is that the oil price movement is really big . That's affecting near-term inflation measures and that should affect near-term inflation expectations. What was the inflation rate going to be over the next six months one year even two years. It shouldn't really affect what the expected inflation rate is going to be over a period as long as five years and certainly not five to ten years from now because no one knows what the heck is going to happen in global oil markets over the next five to 10 years from now. But it is if you look at the data these distorted price movement is highly correlated with what's happening with the temps expected inflation measures. So here's what I want to do on this issue for now. I think we should set the tip back that inflation measures aside until global markets stabilize at some level maybe they're stabilizing now around 50 bucks. We'll see. But after they've stabilized for a while and oil price futures are saying oil prices are going to come up a little bit maybe they start coming up a little bit and then we go back and look at the chip space the expected inflation measure and we see what they say if they still say that expect that inflation is very low. I'd be concerned about that if they turn around and go back toward more normal levels then that would give me a measure of comfort. So we have to wait till the oil the dust settles around the oil price shock. Let me turn to policy and then we'll then I'll be done and we'll be ready to go to our our roundtable discussion here on policy if you do what my good friend John Taylor would do . And you have your Taylor Rule which is a little mathematical formula that tells you what the setting of the policy rate should be what you get. Is that all these kinds of little rules of thumb tell you that it should not be zero. It should be something you know 1 percent 2 percent depends exactly what policy will you want to look at. But these policy rules are all telling us we should be off zero. So let me just talk about that for a minute . What. What are these. What is the math telling a what's happened is that unemployment is five point six percent and the committee the Open Market Committee the Fed thinks that it should just be the natural rate of unemployment is maybe 5.2 percent or five point three percent or something somewhere in there. So you're just a few tenths on a plane is just a few tenths away from what is considered normal according to the Fed and on the unemployed. I'm inflation. Inflation is low right now but no measures like core inflation or this. P.S. trimmed mean that I like to use there only if it's lower than 2 percent but only a few tenths lower than 2 percent. So these two gaps are pretty low. That's a way of saying economy is pretty close to normal behavior. Pretty close to normal behavior so these gaps are low and then you're multiplying them by some coefficient. These gaps are not big enough to drive the recommendation on the policy rate all the way down to zero. The policy rate at zero or close to zero is for 350 400 basis points below normal whereas these gaps unemployment's just 30 basis points from normal and inflation maybe 40 50 basis points from Rome. These are not big enough gaps to rationalize a zero policy rate so they could rationalize a policy rate that would be somewhat below the normal policy rate. So an easy policy they can rationalize an easy policy but not the emergency policy that we have which was set back in 2008 which pushed the nominal interest rate all the way to zero. So what just happened is that the economy has normalized a lot and we can no longer rationalize the zip zero interest rate policy . We can rationalize low interest rates. We can't rationalize zero interest rates. So how can we get off the zero interest rate policy. I think there's too much focus in maybe among some of you and in financial markets generally about the actual date at which we go from you know 25 basis points on the policy rate to 50 basis points on the policy rate that I suppose is a momentous occasion since we've been stuck at zero since 2008 . But that is not really that big a deal. You know you come off as if the policy if there's very short term interest rates are 25 basis points or they're 50 basis points no matter how you cut it. They're super super low. So even if you come off zero you've still got very easy monetary policy which would still be putting upward pressure on inflation and downward pressure on unemployment. So what's really important is not the data of left out but the path and the committee has already said that we're going to go gradually on this path and then we're gonna go carefully . You know I think a better a good way to do this would be to come off the euro break the ice I suppose. And then react to data see how the data come in and go up gradually over time. So I'm just going to finish with a story about two tightening cycle so since I've been in the Fed you can hardly believe it. Twenty five years I've had experience with two major tightening cycles. The 1994 tightening cycle one of the worst fears for the bond market ever and the 2004 to 2006 tightening cycle. One of the most mechanical things that you've ever seen in the history of U.S. macroeconomics so in 1994 interest rates had been at low levels for quite a while there'd been a slow recovery. Data came in better and the Fed started raising rates rapidly 300 basis points in one year. Some of those moves were 50 basis points at a meeting a lot of dislocation in bond markets considered very chaotic. But that up the economy for a brilliant second half of the 1990s some of the best outcomes we've had in the US we're in the second half of the 1990s but that was considered too violent . So in 2004 to 2006 that committee had the rates had also been low for quite a while. We had to raise rates and we did it to the polar opposite approach. There was none of this 50 basis points at a meeting or anything. We started in June of 2004 . We went up 20 basis points for every meeting for 17 meetings in a row . So that to me was not enough reaction to the data. Not sensitive enough to economic conditions. It was mostly in retrospect looks like it was done on a counter basis. Now that particular tightening cycle coincided with the worst part of the housing bubble and that ended in global macro economic disaster . So in retrospect I think when we were doing the 2004 to 2006 tightening we thought we were doing a good job because we were keeping markets very you know totally telegraphed what we're going to do. But in retrospect it doesn't look so good because the housing bubble really blew up on us after that was over. So what we're gonna do this time is going to be something in between 1994 and 2004 2006 and we're going to get it exactly right and we're going to have this perfect tightening cycle that's going to be not as violent as 94 and it's not going to allow bubbles and excesses the way we did in 2004 to 2006. So that's the end of my comments and I really appreciate your listening . So thanks a lot. As OK so now we we have some time first and questions and answers . I'm gonna start us off and then we're going to get into the audience . But before we start on the question answer session with our panelists I want to get the audience involved and I want to preface this by saying before every at every Fed meetings every quarter the central bank updates as she can on the forecast and a lot of its decisions about what to do with interest rates are driven by the forecasts that the Fed does. So I want to give the audience a chance right now to influence President Bowler's forecasts by ise. Some questions about the economic outlook . So Ken can we put up the first question compared to a year ago . Are you more optimistic about the US economy today. Are you less optimistic than you were a year ago or have your views not changed. So let's start the music OK. Fifty eight percent of the audience is more optimistic and only 13 percent less optimistic still a pretty optimistic crowd . Did you choose Don't Fear The Reaper. No I was actually going to keep asking questions until we get some Led Zeppelin so I don't know if we have a wild. So let's let's put up the next one . Compared to a year ago you were more optimistic about the job market. Less optimistic or no change. So this is the prospect for jobs or if you're a CEO a business owner the prospects for hiring we have Rolling Stones Led Zeppelin. OK more optimistic. Again this is even more. This is interesting. A greater proportion of people are optimistic about the job market than about the broader economy and very little pessimism about about the job market. So let's move on to. I hope you're marking this down in your forecast or going up is not a peak so on inflation do you think it's likely to accelerate. There's been a lot of talk about inflation this morning do you think it will accelerate slow down or disappear altogether . OK so maybe there's some credibility issues here. A lot of people here I think into a story but that might be to accelerate to 2 percent to the last thing I want to ask about is wages. Do you expect that this year and again if you're a business owner the question is are you going to give your employees a raise . If you're a worker are you. Do you think you're gonna get it . There's a lot of talk inside the Fed right now about wage growth and when are we going to start to see much wage growth. So let's start the music is this a good year for a raise. You expect a good raise a small raise or no raise at all . Small raise so little change will change. There we are. That's been the environment for the last few years and people don't see much change in that. Not a lot of wage growth. What is interesting inflation growth but not a lot of wage growth. Well I'm particularly because our earlier surveys showed that we had a lot of financial industry people present and financial industry really has seen some pretty good wages over the past few years embraces not doing not thinking this is going to be a great one. I guess not so. So let's move on to some questions with the audience . I want to start out with President Ford and I want to press you a little bit on the Fed tactics for the next few months. There's a meeting coming up in March. The Fed said in December and again in January that it would be patient before it starts to raise interest rates. Janet Yellen has said patients effectively means there's no rate increases for the next two meetings. So there's a meeting coming up in March. Do you think that it's time for the Fed to take that reference to patients out of its policy statement. Well I don't know what the committee is going to do. That's why we have meetings. We'll have to make a decision there. But if it was me I would take it out in order to provide optionality for the following meetings. After that if we take it out it doesn't mean we have to do anything. It just means that conditions are to the point where we're going to look pretty carefully at the data. We could go at any time we could wait longer. But to have this kind of patient language that says for sure we're not going to go at any of the next couple of meetings is probably a little too strong given the way I see the data. So how would you go about doing that if you want to preserve optionality without necessarily signaling that is a rate increase necessarily to meeting 10. How would you go about explaining herself in a policy statement. Well I think you take patients out and replace it with other language that would be more state contingent more dependent on how the data come in. And then just go meeting to meeting after that and see where the committee is and how we want to play it from there . But but it would give the committee the option to move if the data comes in as good as I think it will. But you know allows everybody to weigh in on a decision make a decision. I really think that committee you really want the committee to be able to react to some good data when they get the chance so is there any reason to worry that you take that language out and the market blows up because it thinks that the Fed is getting ready to raise rates and its 1994 all over again . Well I mean you know we've got to keep committee intentions very much aligned with what markets are thinking. But I think this would be part of that process to say that look at state dependent and economies a lot more normal. We're not saying we're going to go in any particular meeting but but it's a lot closer to normal. Also the data lift off not fact critical compared to the path of rates that companies already said that the path of rates is likely to be shallow going to depend on the data. So Michael you're the market guy. How is the market going to react when President Bullard and his colleague signal that interest rates or some interest rate increases are coming. I was just thinking I think I feel like I'm being coached or played by the ECB they're promising. I get to anticipate for a long time that rates are gonna go up and I'm going to digest it and they want me to digest it. Speaking for the markets as slowly and as predictably as they can. So how you change those words. Now you may or may not know that the Fed goes through they hear from each of the different FOMC members at a meeting to get to say their piece. The chairman typically says something at the end whether she agrees or whether she wants to add. And then they go through the statement. Word by word and they basically all have to agree and majority if not unanimously word by word on the statements of how they change that statement to remove that word patience. If you saw the reaction in December to the introduction of the word patients it was just stupid. And markets went straight up. So we are very very sensitive to every change and utterance out of the Federal Reserve which makes me a little bit more nervous about underlying markets. If the Fed starts to get out of the way can I want to press you on this point. Can the stock market keep going up in a year when the Fed starts raising interest rates that's the question. If you. I can't remember last year the year before . If you look at a chart comparing the S & P 500 to periods of quantitative easing of QE 1 QE 2 etc. Every time they've actually hit the date where they've ended the QE period . Markets have come down period so will that be different this time. A lot of people have lost a lot of money believing it will be different this time . I do you have a response to that. Or go ahead. Okay okay. I've got it. I mean so if you go back and I think ninety four Woodstock work to do over the course of 94. There's three other basis points of tightening during that period of time. Stock market certainly did crash in 94 maybe was down a little bit. 2004 2006 rocketing ahead during that period of time. Now maybe multiples are higher now than they were back then. Right. And so I have no illusion that when they move remove the word tightening that markets are going to go up on not they're going to there's probably going to be downward price momentum at that point. But as long as the underlying fundamentals of the economy remain intact I don't think the markets could put forth one one or two day moves. But I don't say that I don't think the Fed was ever as important. I don't think markets wherever is dependent as every utterance and breath out of the Fed as we have been in the last few years and we certainly haven't seen markets that had been moved my collar hadn't been bullied as much as they have been by quantitative easing and so much monetary stimulus as I just said it's different this time they're just standing . And the point that when ever we pulled QE away markets tanked and we do it did do this tapering thing. So we we taper down QE from December of 2012 I guess. And then that was actually a very smooth process . At the end of the day. And it did not lead to market dislocation. So just want to get one when Bernanke when Bernanke first talked about the taper though right. In May of 2013. Yes. When he first talked about it we did see interest rates go up on the 10 year Treasury about a full percentage point from 2 to 3 percent. We saw mortgage originations slow . We saw revised really slow. There was a market reaction again by the time he got around to it. Not so much but we're still in that anticipation phase. The taper tantrum is a great episode because to study because that was a misalignment of what the intentions of the committee were worth which were to pull back on the QE soup sooner than what the markets thought. And when that clash then you've got a violent market reaction. So we're trying to do our best to not have that happen. So I want to ask you about another potential misalignment in the market right now . So if you look at Fed funds futures markets and if you also look at long term interest rates it looks like investors are making the calculation that because inflation is falling because headline and core inflation are below the 2 percent target there is no way the central bank goes in June. A lot of officials have talked about June but the futures markets are pointing towards sometime later in the year. Is that a misalignment . Yeah I mean let me push back against this again. You know so you move interest rates to 50 basis points you're still putting upward pressure on inflation. Sure inflation is below target but you can have interest rates below normal for two three years here. So the question is how do you want to steer the ship over the next two to three years is still all that period you'll be putting upward pressure on inflation not downward what is it . Does the market have it wrong particularly in the futures market when when it assigns a very low probability to a rate increase by June Yeah I mean I don't know what the committees what the committee's going to do. We've got to have these meetings and make decisions ourselves. I'm just not sure at this point even as an insider I'm not sure what the committee's going to do. Is it still on the table moving by June. What would it take to get the central bank to move by the middle of the year it is data dependent. It's going to depend on how things come in. You know good labor market reports GDP inflation we'll be looking at all that. And you know you've got a you've got to factor in well how should we think about the oil price shock when you're looking at the inflation numbers. All those things are money September. You know we haven't moved in here for September but not a minute before. If then. Well so I would say one of the issues for the committee is if you wait and go later you might have to go faster at some point and you might have to do more maybe a 50 basis point increase. I think the dynamic of the committee getting behind the market is not good . And so do you really want to go in that direction so this is what the committee has to weigh and where he it come What's a better strategy soon and slow or late and fast. Well I said in my remarks that you know I think get off zero but then make it really data dependent and go gradually at that point depending on how the data come in. So I think it's it works a lot better if you can say good. OK. We have good data on the economy inflation is going in the right direction. We moved that kind of thing is taken as good news for the US economy not bad. And I went around blasting that particular strategy will make a lot of sense to market. I want to ask you one other points related to your presentation. You talked about the need to wait and see how you're very concerned about inflation expectations and they've moved down and you want to see how they behave after oil prices settle. Given your desire to do that how long is that going to take to see whether whether inflation expectations really are on a downward trend and would you be reluctant to move towards rate increases before you have a sense of what's really happening there I'd like to get a sense of what's really happening but I think as long as oil stabilizes then we'll be able to read market based inflation expectations more clearly . But maybe then maybe oil won't stabilize. You guys are the forecasters So tell me what subject. Well Jay I ask you a point about another period you talked about 1994 and 2004 in your presentation you talked about this 98 period which I think President Ford agreed is an interesting analogy for today. So as was the case in 98 99 oil prices have fallen a lot. We're seeing a slowdown in emerging markets. Interest rates are being held that are being held down the dollar is getting stronger . There are a lot of parallels here that also happened to be a period when we had an asset boom. This one showed up in the stock market. Are we in an environment now where the dollar is getting stronger. Other economies look weak. Interest rates are low in the US where we could have an asset boom in the United States. So I mean that's the thing that springs to mind I'm not going to I'm not a stock market guys all of the fur to Michael on one point that I mean the thing that potentially could be a little frothy right now. I mean would be bond prices not only sovereign bonds but you know high yield and investment grade there's those spreads are pretty tight they've widened somewhat a little bit. And you know if the Fed were to you were talking about earlier what's better slow and steady or fast and fast and hard I would argue the slow and steady President board kind of referred to this in 2000 in 94 95 along and the curve melted down tenure would one of 200 basis points of time if you have some sort of dislocation like that now that would have a lot of macroeconomic ramifications. But we had to slow and steady in 2004 to 2006 and that didn't end very well either . Well as you said they're going to get it right this time. I want to ask you about another point that you raised in your comments and that's China. There's this question about whether China is going to have a hard landing or a soft landing. Having covered financial crises for the last 25 years I stopped believing there's such a thing as a soft landing. But as you pointed out the central government of China has a lot of resources to play with are those resources really enough to prevent the economy from hitting a hard landing given all of the overbuilding we've seen not only in the housing sector in the property sector there but also in the manufacturing sector which create a lot of overcapacity that's affecting the whole world . Okay. So so if you look at household debt in China as a percent of GDP it's roughly 30 percent 35 percent right now. And so if you look at our country as a percent of GDP I guess it's 90 80 90 something like that. But it was higher during the housing boom. So the point here is I'm not worried about the Chinese household sector. And you say so how could it be so low. And the answer is in China they make mortgages the old fashioned way . You know you either have you if you want your first house you gonna put 30 percent down if you want your second house you're looking at 50 to 60 percent down and then the other reason was essentially two asset classes versus bank deposits. And there's real estate got a little bit of a stock market but not much right. So some people just take some of their massive bank deposits they're gone they buy a house but no mortgage we're very low for the money. So I'm not worried about them. The guys I would be worried about would be the non-financial corporate sector like you said manufacturing are more more worried about the construction companies and the real estate sort of guys there. So how big is how big of percent of GDP is that. I think it's like a hundred and forty percent. The depth of the non central corporate sector compared to nine states you're looking at 80 percent is much lower here. How much that's going to go bad. I don't think a hundred forty percent is the say is call it 70 percent it's got half of it goes bad . Okay. So therefore what the Chinese government would do would be essentially it would be and Michael can talk about this when he was showing earlier and kind of making a debt swap if you will. You know you're you're you're taking it it's going to show up as non-performing loans in the banking sector and that's gonna be put on the government's balance sheet. And so the debt to GDP ratio of Chinese government goes from called 10 percent to 80 or 90 percent is kind of in line with us where we are now . So so that in that scenario I think of the best case scenario . I mean there are going to be bumps along the way. Yeah obviously the overcapacity is overcapacity if you've built and the Chinese have 80 that are unoccupied. And if you build factories that just have no one to sell to anymore. Even if it doesn't cause a financial crisis doesn't that create dislocations that are going to have big implications. And so the Chinese economy for a period maybe a year or two or whatever is going to go from 7 percent growth rate so I don't know two or three or maybe even less than that for a period of time but I don't necessary I don't think it's maybe naive but I don't think it necessarily is another sort of Lehman moment. The reason I say that is because you go back you look at Lehman Brothers. A lot of us debt. Strictly mortgage backed securities was held outside the United States. And so when those mortgage backed securities became worthless it affected financial institutions everywhere. There's not a lot of financial assets of China that's held outside of mainland China. Like I want I want to ask you about investment flows related to this conversation about China. So a lot of the rest of the world looks pretty scary right now. Well when you whether you look at the Middle East or Russia and Ukraine or Greece and the rest of Europe or or China we have a dollar strengthening. Are you seeing in your portfolios an investor and investor base foreign investors coming in looking for ways to to plant their flags to plant their cash here in the US. Are you getting more calls with foreign area codes right now just dribs and drabs not so much but it is after 9/11 it became really really difficult for any foreign entity to start transferring cash to the U.S. investing it or setting it up to custody foreign money at a U.S. bank and start an investment account is almost impossible. So there is some interest we've been hearing more but not on. So I want to ask you also about valuation. What's your assessment. You used a couple of valuation metrics and in your presentation these just one of them was this the Robert Shiller's valuation measure which looks back over 10 years but that seems to be a little distorted to me because there was a financial crisis right in the middle of that of that period. How did valuation stock valuations look to you today when you compare them to a year ago or two years ago. Are they stretched they feel that way to me. Yes I think the stretch. I think they're very full. I talked to other guys in my business on Wall Street. I talked to folks on the floor of the stock exchange who have been there for 30 years . All are saying this feels full. This feels pre correction . What we learned in 1999 you remember nineteen ninety six and November Greenspan said irrational exuberance right. The Dow had just gone above six thousand for the first time. In fact it had gone through 4000 5000 within the preceding 12 months. So here we were up from 4000 six and Greenspan say it basically suggests markets are overvalued eight months later they were eight. How was Greenspan wrong . Greenspan wasn't wrong. What we learned was the things that are very expensive can continue and become a lot more expensive. So that trends once in place can last a lot longer than you can rationalize them to continue. So that's when I go back to the arrogance cycle. I think we are in the beginning of another one where complacency is taking hold. We never had a bubble I talk about in this book without a whole lot of leverage. We have a whole lot of leverage right now and people are feeling pretty confident. You ask somebody to invest in 2009 and March and say OK now's the time to put some money in the market. They don't hedge you don't hold away in a long sleeved jacket. I mean what's going to happen. Ask them to invest today and they think . Yeah I kind of like the stock market now. I think the stock market's OK really it's gone from seven thousand eighteen thousand and now you like it really and it's at 18000 and you know that the rules buy low and sell high and you're saying it's eighteen thousand I'll buy it in the lobby makes a great Valentine's Day so I want to come back to you and talk about long term interest rates. There was a lot of talk in your presentation and in Jay's presentation about how low long term interest rates are . Some of this is because of as you mentioned foreign inflows into the U.S. So it looks like there's the potential that that foreign inflows could distort U.S. interests interest rates maybe keep U.S. rates too low even at a time when the Fed wants to start tightening financial conditions. Well the central bank now has a tool that it can use to influence long term interest rates directly. You have trillions of dollars worth of mortgage bonds and treasury bonds on your portfolio. Should the Fed use that portfolio and sell some of its long term holdings. If long term interest rates get too low in its judgment and it wants to move them higher. Well I don't think that committee's in any mood to do that. Some of you that know me know that I've lobbied to get to get that committee to consider that policy exactly that policy that was on the way up we were buying a lot of bonds and then on the way down you would sell but you would sell in a controlled way and in response to economic developments that would do just the right thing for the macro economy that would be the idea. But it's been very clear. I've tried to I've tried to get people to buy into this and I'm not wanted to do it so well. What the committee has done instead is say we're going to when we're in the tightening cycle we're going to do interest rates first and we're going to we are going to let the bond portfolio run off but not and we're not going to start that until after the first interest rate increase. So that's where we stand on that. My best efforts. That's where we stand. I haven't given up the argument 30. Are you ready . The committee has definitely had a fulsome discussion of it and they didn't they didn't want to go in that direction. So I it's not completely off the table but something would have to change a lot in the economy to get the committee to start thinking about that kind of policy. So I want to ask you you and Jay finally before we go to the audience questions about the outlook for business investment. Some of the numbers we've gotten lately have been on the soft side. Durable goods orders were were pretty soft. Where we now are seeing a collapse of oil prices which is affecting investment at least in the energy sector rig counts are going down quite a bit. Is there any reason for concern at this point that business investment is slowing down rather than clocking in at at a time when a lot of economists have been expecting it to lock in that's a great question. I liked Jay's presentation and I didn't see a lot to disagree with there. You do one aspect of this is that you do have big global manufacturers. You know Caterpillar and Emerson is in our district and they are affected by global the global situation the dollar. I will say a couple of things about that though. You know a lot of these guys are manufacturing in one country but they may not be bringing the goods actually back to the US. They're actually shipping them to some third countries so it's not always the dollar that matters. It can be you know that currency versus some other currency so and they hedge their bets their career you know they're completely aware of what's going on in the global situation . You know and they shift investment if they're going to make investments. They might make it in Malaysia as opposed to the US or they might make it in the US and Malaysia depending on currency situation. So a lot of leverage that these companies can pull to try to mitigate currency risk. You're comfortable with the appreciation that we've seen in the dollar but like I say I think we're not very different on a trade weighted basis from where we've been on the last 15 years. What people are really noticing is that came up but it came up from very low level. And what would it take a concern you that it's going to put real downward pressure on inflation and make it harder to meet the 2 percent inflation target. And we're not that open in the economy so I don't think the inflation effects that we saw a slight about this earlier they're just not that big. And actually they're the effects on. I mean it's not it's not zero . But those are relatively small effects compared to other things that are going on in the economy. So the other factual Domini if they have that who has been living with tough rhetoric about exports obviously investment. So when you do a statistical analysis of exports what have you there's two variables that goes in there. One is growth in the rest of the world. The other is the dollar. OK. And the coefficient on export or on the rest of the world as positive that is if growth in the rest of world picks up export growth picks up. And then on the dollar and the dollar has the right the right sign that is negative delegate stronger export growth slows down. But the biggest determinant of export growth is growth in the rest of the world. The dollar has the quote right side but it's a very small sort of effect. Terms of investment I mean we kind of showed in our chart there near term we have some softness in investment due basically to equipment. But if you thought you know particularly as it relates to the oilfields and things of that nature we step back from that. You look at other things going on investment construction investment what's called structures remains pretty resilient here. We think that's probably gonna continue to continue to increase their software . We think we'll be OK to be pretty good. So outside of that things are related to the oil sector we think investment spending will remain solid. I would say it's rock solid I mean I would say it's a one off chance we think growth will be solid . I'd simply let's open up to questions from the audience try to get everyone involved. We have I think we have Mike's coming here and we have one right down here from a student down down front right here in the middle to Dr. Bryson You mentioned that the rising oil prices. Well not really that but you mentioned that oil is a scarce resource and it's going down in where we've been drilling oil within the within our country. But with for oil why not go for other sources of energy as well since they are obviously less scarce than oil. You mean other sources of oil or other source other alternative source of energy alternative source of energy. Well that's certainly is a I guess a public policy sort of question and I would certainly certainly support efforts to bring about alternative source of energy sources. I'm just you know one one opinion here. What makes it a little bit more challenging in this sort of environment though is is alternative source of energy whether it's wind or geothermal or things like that make a lot more sense when oil's at one hundred dollars a barrel than when it's at fifty dollars a barrel. And so the collapse in oil prices over the last few months may actually dampen some of those explorations at least over the next few years OK. Let me see. We have sent our senators student out there . OK. We have another one around the corner here . We have around the corner down down here and then here come on. Keep going . A year ago thank you for not presenting your personal opinion today. And as Mr. Prosser has done the last two years I appreciate that very much. I've been asking the same question for three years now I'm not getting an answer and my question is as former Senator Kaufman said in his article this past Sunday in the News Journal there is a growing recognition in Congress that the failure of the Dodd-Frank Act and the Volcker legislation the Volcker amendment to contain the risk of another bailout in the event that the banks don't do very well and I will as Dodd-Frank also provides for a Cyprus style bail in and my question for the past two years is has the Federal Reserve studies the return to prudent banking act which was previously called the Glass-Steagall Act. And that was used by President Roosevelt to save the country from the bank failures that recession. And that has been introduced into Congress for the past three years. And what is the result. That analysis. I have looked on the Web site which Mr. Prosser told me to do for two years and I'm still not seeing anything there. I mean if one day everybody has a president board to jump in to jump in here on an on two point addressing my question to what is from the Fed. So I just want to I want to give him a chance and also give the rest of the audience a chance to ask questions. Under Dodd-Frank and the Dodd-Frank Act and the implementation of the various rules. Two questions. One is as your guest in the audience yes. Has that made the financial system safer and more safe and stable. And then related to Glass-Steagall. Is there an argument to be made for breaking up the big banks and taking the trading activities out of them OK so has Dodd-Frank worked. I think Dodd-Frank did some sensible things. Certainly more capital there's better liquidity coverage than there was. But this is only a small effort against a very big financial sector including a very large nonbank financial sector so-called shadow banking. So by itself Dodd-Frank is not going to present totally prevent another crisis that might lower the probability somewhat but it cannot totally prevent a future crisis. And because of that what we need to do is combine the advantages that we have in Dodd-Frank or the improvements that we have in Dodd-Frank with sensible monetary policy to prevent the future bubble. So what I mean. What I'm getting at here is that I think sometimes people have the attitude Oh we passed this legislation. Now there can never be another financial crisis. Now we can run whatever monetary policy we want. That's moral hazard. You think you're insured against something so you're willing to push really hard with your other tools. I'm warning against that. I think you have to use monetary policy in conjunction with Dodd-Frank. Your question is excellent. Have there been. There has been a lot of work I think on the initial crisis and better integrating financial crisis into financial into macroeconomic models. I don't think it's satisfactory at this point. I don't think we have good answers at this point. As for Glass Steagall I have always felt like the time for Glass-Steagall is probably past. The markets are too complicated these firms are too integrated now to be able to have a simple dichotomy. Even though it worked for a long time arguably worked for a long time I'm not sure that that's really the best strategy going forward. So that's where it stands . But you know wish I had a better answer for you but so why not follow on to that maybe the two of you can talk afterwards but I just want to move on and give give everyone else the chance to ask questions and I also want to ask a follow up on that which relates to the macro prudential tools. So there's this question that's been around the Fed for since the financial crisis about how do you deal with the next bubble. And the consensus now seems to be that first you use what's called macro prudential tools regulatory tools to make sure that access is don't build up in the financial system that you don't use monetary policy to stamp out a bubble. So here's my question What are these macro prudential tools and how will they be used to present to prevent the next crisis and are they fully developed in a way that could that could prevent the next moment of excess from bringing down our economy . Yeah. This is a line that you hear often and I'm what I'm saying is that it's naive to think that macro prudential tools as they exist today are sufficient to prevent the next crisis . They can help a little bit. They can reduce the probability they can totally prevent future crises. So and what are these tools. Well mostly it's higher capital in mostly in banks . Forget about shadow banks and liquidity coverage ratios again mostly in banks. Forget about shadow banks. But the actual crisis was mostly shadow banking. So. So we don't have you know we don't have enough going on at this point. We have better monitoring I think than we used to have. That's good . Certainly better monitoring at the Fed. You've got FSA Financial Stability Oversight Committee. There's supposed to be . They've designated cities and other other types of things but this is an incomplete package and we can I guess I'm putting on a warning. Is not enough to prevent future crises. A lot of people say that so it has to be done in tandem with a sensible monetary policy. And this seems to be the experience of other foreign central banks. I don't know if you want to speak to that but the Bank of Israel the Bank of England the Bank of Spain have all tried the Bank of Korea using macro prudential tools for instance to tamp down real estate boom. A simple thing to say about macro prudential tools is that they're untested. It's unclear if they would really work . And while looking across countries that's certainly been the experience. One other comment about this don't get me. Don't get me going too much on it but you know when bubbles form they're way too powerful for these know to make small changes one way or another. It's over in Hong Kong and they've got all these low prices housing prices in Hong Kong are really really high. And they put a 70 percent downpayment requirement at this price is still one of those shows you know that there are limits because these bubbles when they get going a lot like you're talking about in your book . They are they're psychologically driven and you no amount of dampening through regulatory policy is enough to stop the bubble . And while a lot of this policy in my opinion has addressed and made safer certainly the banking system the financial institutions too big to fail hasn't been solved. Too big to fail is still too big to fail those institutions are still out there and if anything they're bigger than they were and I'm not sure that the central bank knows exactly what to do about that other than regulated more. I know what to do. Thank God . We need a smaller institution but I would split them up. So and in. OK so I was Charlie Plosser was talking about this last year and he said we should have some sort of progressive tax on the financial institutions those that require more supervision those that are bigger and more complex should have to pay more for the regulated regulations they require oil that at a not like central planning actively happening already in short form of capital requirements on the big banks. But the argument against this is that one it would be too disruptive to the financial system and to that if we break up our big banks then we don't have banks to compete with other big multi-national banks in other countries that are service servicing their multinational companies. Maybe you don't agree with. Let me dispel you from both of those. I mean a lot of the arguments are that we because we have Microsoft we need Bank of America. Well Microsoft has perfectly good access to capital markets all by itself. These big companies they don't need banks. That's not who needs banks. So that argument I don't think is right. The idea is that it would be disruptive to financial markets. Well the whole point is that if one of these guys falls down the whole the whole market falls down on top of it and we're in terrible condition so no I don't think either one of those arguments is really right. So I need smaller institutions in the U.S. I can't resist asking for the view you have to be allowed to fail. We think we have to be allowed that we yes if they screw it up they've got to be allowed to go out of business. He needs to hear from the chief economist at Wells Fargo whether we should have big banks and there's pros and cons. This is why I love it. OK. Let's get the audience back back in this conversation. I think I see a hand up right down here . Question for President Bullard with QE in the U.S. and now more recently in the eurozone. So in the eurozone recently we've seen a negative bond yields with certain sovereign sovereign bond yields. What do you think are the either negative or unanticipated effects of QE when you start to have negative interest rates like we're seeing in Switzerland Denmark . Yeah that let me say I don't think quantitative easing is a panacea . The only reason I've been an advocate is that once the policy rate hit the zero and you're wondering what else can you do. It's a it's the best among a set of bad options. That's that's how I would viewed QE but I think there are unintended consequences. It tends to reduce returns to savers and if if a 65 year old household gets zero return for a year or two that's one thing. But this has been going on six seven years in the US. I mean this you know. So this really affects their ability to consume. They're consumers too. So I think it does have these unintended consequences. I think it's now perfectly understood how it works. Even ise tried to think about a lot over the last five years. And so it's experimental in that sense. So it's not a panacea but I think it's so you know among a set of bad options is by the least least bad option. The negative rates in Europe will be fascinating to see how that evolves going forward . We're certainly not used to that historically. I've been an advocate in the U.S. at times talking about the Fed possibly going to negative rates. We never did that. Hopefully we're going in the other direction now. So but I'll be interested to see how the experiments in Europe turn a chair. I want to turn to you on this. First let's define quantitative easing this is the Fed's big bond buying programs of mortgage bonds and treasury bonds. Trillions of dollars worth. It's got a four and a half trillion dollar whole holdings of bonds and other assets. I'm sure you've looked at this. What's your assessment . Did it work. And what what were the drawbacks. Yeah I would say it worked. And I would you know if I had to give letter grades out I would give the Fed in its behavior over the last year since the crisis. You don't have a solid day or a minus or something like that. You know President Bullard said to paraphrase Winston Churchill you know democracy is the worst form of government except that everything else is kind of the same thing with quantitative easing. It's certainly worked and you know so but now we're in terra incognita unknown territory . And how they shrink the size of the balance sheet going forward will be interesting. That's going to present some some challenges as well and that's where you're going to see some of these potential unintended consequences. But the alternatives . What was the alternative. The alternative is the economy is probably going to just don't collapse in a severely depressed state for a long long time one of my favorite lines about quantitative easing was Ben Bernanke's he said it's one of those things that works in practice but not in theory. I think we have we have another question have here great speculation of the stock market versus corporate performance can you repeat that question what's the greatest speculation . Stock market action or or. I think Michael Barr is now going to sell you his book ready to respond to that. Nothing says I love you on Valentine's this is speculation and corporate performance are separate and distinct . And in many many cases speculation is often in anticipation of corporate performance promise or dreamt up . We saw in that one slide that I showed you that the companies that were trading at 37 multiple 37 times earnings had given you the best performance recently. That shows you that we're moving into a more speculative phase of of a market psyche. Markets go through three stages psychologically denial. It's like the stages of death and dying forward and reverse denial acceptance and then either exuberance or great despair depending on which way you're moving. We're moving into that exuberance phase where all I want to do is buy the damn things get out of my way . I want to own it I need it. It's gonna go. This is gonna be great it can't go down and that can last a while. And what you need to hear and we haven't really heard this yet is how much money your neighbor made in the market over the past couple of years. Your brother in law starts to need the needs to start bragging to you and making you feel stupid for not being more aggressive. When people start making you feel stupid for not taking more risks then we're nearing the end of this cycle. But it started. I want to hear from both of you on this president forward to you . Do you think we're heading into a period. Or are you seeing any signs of fervor in financial markets that make you unsettled I don't my standard answer and this is I don't see a bubble in the U.S. economy on the scale of the tech bubble or the housing bubble. At this point and we are doing a better job I think of monitoring for that. One thing that you could argue is Bonds Nikkei mentioned bonds. But a lot of that is being driven by central bank behavior so it's kind of harder to interpret. So I don't see anything right now. I would say about your chart earlier showing Tesla Amazon. There's a sense in which the tech boom lives on because the tech technology Internet technology continues to diffused through the economy continue to find new ways and the future of business. A lot of it is how to use I.T. in the you know in the business more effectively and there are many many many things that still have to be done. And I think investors are somehow trying to speculate on what what those kinds of firms are going to deliver in the future. So I think that that's a long term trend in the U.S. economy. Do you think we're in the first phase maybe starting to get there. I don't know if we're necessarily going to kind of I don't think this is 1999 yet but I think we're leaving the beginning phases of it. You know we're talking about leverage earlier. You're talking about every financial crisis is associated with leverage. But I look at the leverage in the U.S. economy today I mean look at households that has come down the government certainly went up the debt has kind of stabilized was starting to happen is businesses are starting to lever up again. I mean we're not at the point where it's this is going to deeply remember the lost in space. The danger will Robinson sort of moment. I mean we're not we're not at that point yet . But what I have said before is what's going to cause the next U.S. recession assuming it's not one of these exotic and the shocks that I'm going to put high on my list of top five. The next U.S. recession will probably be a business led recession because that's where this looks at levels of debt instruments . You always have to worry that the instruments that are used in the next period of speculation as tech stocks in the 90s it was it was exotic mortgage instruments in the 2000s. What instruments right now are corporations using or is the financial sector providing to lever up the corporate sector. Well with corporations you know President Bush made this point earlier. We look at big corporations. They don't really need the banks because they're issuing the corporate bond markets. And that's where I'm not going to say that there's a speculative bubble going on the corporate bond market today but that's where the leverage has started to come in. In the end the high yield market and also in the investment grade well how that bond funds. We've heard talk about bond funds as being a potential risk some risk to run if you see outflows they could be forced to sell their bonds. I want to hear from President board and also Michael about corporate bond funds if that's any reason for right now . I don't see the bubble right now but bond funds. I don't see a bubble in bond funds at all but I do see bond funds at risk because they're because they're funds and because they are high those prices have really gone up when they start to come down because they're funds. The funds have to liquidate some of the bonds to meet redemptions. They start selling and add more pressure onto an already falling market. And Fred and Ethel and Fred and Ethel are there's still a lot of the fund holders and Fred and Ethel now aren't a lot of money showed up here who don't know a friend I'm sorry . Know Fred Nestle is think about your grandparents who are typically the bond holders and bond fund holders and for one k plan holders they see bonds starting to fall in those funds starting to fall and they say I want to sell them to I can't. I didn't think my bond fund was supposed to go down so that can spiral but I don't I don't see a big bubble I just always see risks in funds particularly when they've gone up as long and as continuously as bond funds have for the last 15 years in this country. OK we have we have another question up here. I'm gonna get a five minute warning when we're OK. I think we've got it about 10 minutes. We have. OK. I Good morning. Thank you for your presentation. They were very interesting you all showed charts about death and talked about death in your conversations. We hear about it all the time obviously too much debt is bad. You got to have a little bit of debt to grow. I'm just curious what your perspective is . What's the optimal level of debt we should have as a country and then for households. Given our demographic trends the relatively mature economy or dire infrastructure needs and the accumulated deficit that we've got. That's a tough question . Does anyone want to answer an optimal level of debt. Let's all look at it from two government sort of sectors. There was a study done a number of years ago by two noted academics saying that once once you get above 90 percent of GDP you start to have all sorts of issues. Then it turned out they made some mythological mistakes in that particular paper. And I don't know if they're I think that the United States can probably get away with a larger debt to GDP ratio than most other countries because we still are the reserve currency. You know if you are Tanzania you don't even issue in your own currency. You're not gonna be able to run a very high debt to GDP ratio. No one's going to want to buy the Tanzanian currency because the U.S. dollar is completely different. There's not going to be another currency that's going to supplant the U.S. dollar anytime soon. Maybe the euro is chipping away at the edges but it's not going to be the Chinese one anytime soon. So the point is we as a country can get away with it higher but higher debt to GDP ratio. I don't know if it's 90 percent 100 percent or whatever but I don't know if we're necessarily there. I don't think we're at there at this point. But if you believe the projections that the CBO has done over the net the long run as under those long term projections that debt to GDP ratio of our country is going exceed a hundred percent on its way 120 and you probably need to take some corrective action at some point. Japan is over 200 pounds over two hundred point duration but it's also not a collapse and hasn't collapsed. I think it's a great question . If you look at the Maastricht Treaty which is the treaty that set up the ECB it famously had some limits on the size of the debt to GDP ratio for all the member countries. That number was 60 percent. The calculation that they did was that you know 3 percent interest normal interest rates plus 3 percent growth would make a 60 percent debt to GDP ratio sustainable over the long run. You can carry that indefinitely. So that's where they came up with the 60 percent number. So I think that's maybe a good rule of thumb to have in the back of your mind. A lot of countries today are over 100 percent Japan at 200 the highest I've ever heard British Empire 350 percent in the 19th century. I've often wondered about that number whether that counted just GDP in the British Isles or if that kind of GDP across the whole empire. But certainly a powerful country with a lot of resources at its disposal can borrow a lot more. That's what the 350 percent number about 10 percent now shows our federal government is focused on reducing that however what where the US the federal government is over 60 percent should it be focused. I think ideally you'd want as a rule of thumb anywhere you'd want to get to the Maastricht level. That would be the most sensible. I'm going to have another question right here. I'm gonna sell that in the sense of I don't I my own personal opinion is I don't think the US government at this point in time should be focused on reducing the debt. If you really focus on reducing the debt right now you're going to become if you look at Europe right now the countries that are sucking wind the best the most over there are the countries where austerity has really bitten. You got to get the guy to get the recovery fully going and then we can start talking about reducing the debt. But you're trying to reduce the debt today I think you're putting risking putting the economy back into recession and then you're not going to be able to reduce the debt. But that's not a difference of what we should do. It's just a question of when we should do it. I've it's it a. It's a very important distinction because there have been very. And we've had two continents go in different directions in part because of the fiscal policies that they adopted. I mean aren't they are the issues right now are fiscal issues. So if you want to reduce the debt how do you do that . Well it's pretty easy right. Either you raise taxes or you cut spending. So let's focus on everyone's raised taxes. Let's focus on the spending sort of side of things. What do we 70 percent of the federal budget is is for Medicare Medicaid and Social Security and defense that's where the cuts have to be. You can throw everything else out and it doesn't really matter. And right now just nondefense discretionary spending ise percent of GDP is the lowest it's been close to 60 in the 1960s. We don't have to sell this house I wanted there's challenge and I do it. I'm in the. I just I did want to make a comment about Europe and austerity so you have five countries that were in trouble. Ireland Portugal Spain Italy Greece. For those countries are borrowing at under 200 basis points today one country's borrowing. Greece borrowing over fourteen hundred basis point. If you want to borrow a lot you have to inspire confidence. And this is the number one thing that you have to do so the other governments that have followed you know more of an austerity program in Europe are actually doing quite well in being able to get their debt load down and get to a sustainable level Greece of course is having tremendous difficulty. And it's only getting worse because they want to renegotiate so part of the sovereign debt crisis part of the solution to the sovereign debt crisis was to settle things down and get these rates down so that these countries didn't have to pay such high interest costs to outsiders. We have we have one last question and then we've got to wrap it up . There's been much discussion about the reduction in leverage and that's generally true except for one very important group and that's our young people are. What is the implication of student loan debt now being at one point three trillion larger than credit card debt larger than car loan debt. And I realize it's mainly government but it's impacting these people's lifestyle . They're not obviously buying homes as rapidly. They're not investing in other things as rapidly as debt that doesn't get forgiven in bankruptcy. That is correct. And there's only a whole question about culture and consumer being important. I think we have a lost not a lost generation but we had to rethink that a little bit. Given what kids are graduating we're not graduating from college with 55 60 thousand Hundred thousand our debt what. What do we this problem. Yeah. So I've got two thoughts there. The first would be I mean in terms of those individuals who have that high level of debt is it going to impact their ability to buy a house at some point. Yeah absolutely. Now our staff are younger Americans kind of moving away from that anyway and moving into apartments and things like that. Yes maybe they're being forced to do that maybe it's a lifestyle decision. I don't know but certainly that's going to affect I think the housing market for a while at the time the bigger picture item though is sometimes you hear the question phrased is what about the student loan bubble. OK. And my answer to that is I generally don't use student loans and bubble in the same sentence because that implies when it collapses you're gonna be systemic consequences and so you mentioned the one point three at the height of our housing bubble there was like 13 trillion dollars worth of mortgages out there. So will it impact individuals and individual institutions who own the bonds that are securitized by those student loans absolutely but is it the next thing that's going to cause the U.S. economy to collapse. I don't think so. Will it be a drag. Yes in the future OK well I want to thank you all for coming. I think when you reflect on the day what did you learn today. I learned that I'm going to sell all my assets go to cash and open up an Italian water ise store down the Caribbean somewhere. Anyway John thank you again. John Hilsenrath Michael Barr day Bryson. President Bullard thank you all for coming .

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Bullard Urges Fed to Drop `Patient' to Give Flexibility

Federal Reserve Bank of St. Louis President James Bullard speaks about monetary policy, the U.S. economic outlook and the labor market. Bullard, speaking at an event in Newark, Delaware, also speaks about the European Central Bank's quantitative easing. (Source: Bloomberg)

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