Reading Richard Clarida: Hawk or Dove?
The Federal Reserve Board is set to get a new vice chairman: Richard Clarida has been nominated to fill the slot opened by Stanley Fischer’s departure in October. A professor at Columbia University and a managing director at Pimco, Clarida has experience both with academic monetary economics and financial markets. This experience provides a rich paper trail for trying to understand his views and how he might influence the central bank.
Start with a detailed presentation he gave in 2010 at the Federal Reserve Bank of Boston. There are two things to note.
First, Clarida admits he was instrumental in shaping the precrisis consensus, and that this consensus was flawed. The antediluvian view was that monetary policymakers should focus on consumer price inflation – and nothing else. Asset prices, household debt, and the leverage of financial institutions were all considered irrelevant because the system was effectively “self-regulating.” If a crisis happened anyway, aggressive interest rate cuts would be sufficient.
As he put it:
The supervision and regulation of US investment and commercial banks during the great moderation was based on an assumption about how the financial system was supposed to work, not upon sufficient knowledge about how the financial system actually worked. While Clarida was complicit in these errors and seemed to be chastened by the crisis, his view was that that the practice of financial supervision and regulation needed to change more than the way central bankers set interest rates. His subsequent writings do not seem to suggest he has revised this opinion.
Even more important were Clarida’s real-time policy recommendations on how to respond to the crisis. To grossly oversimplify, he was more “dovish” in 2010 than most if not all of the people actually at the Fed at the time.
Clarida thought the Fed could effectively respond to downturns by committing to buying as many bonds – including mortgage bonds and corporate bonds – as necessary to “cap” interest rates at the levels it wants:
Much of the existing literature either misses entirely or under-appreciates how robust an LSAP [large-scale asset purchase] program can be at lowering bond yields and/or credit spreads…a central bank can everywhere and always put a floor on any nominal asset price (or set of nominal asset prices) for as long as it wants…So long as the central bank is willing to buy an unlimited volume of those bonds (potentially including the entire outstanding stock) at the interest rate it wishes to put a ceiling on, it will succeed. And of course, the above reasoning also applies directly to an Lsap program targeted at corporate bonds or mortgage backed securities. The Fed successfully capped U.S. government borrowing costs in the 1940s, and this experience was cited by the Fed’s staff in mid-2003. While the idea failed to gain traction among American policymakers, the Bank of Japan has successfully used “yield curve control” to limit yields on Japanese government bonds since 2016. Clarida’s position in 2010 suggests he would be keen on something similar, perhaps also including mortgage bonds and corporate bonds, should he be at the Fed during the next downturn.
Clarida also spent time developing and explaining what he calls a “forward-looking Taylor Rule.” He has come back to this idea in several subsequent papers, so it is reasonable to think he takes it seriously.
The basic idea is that central bankers should use market prices to guide their expectations about the economy and then set interest rates accordingly. Instead of looking at the current inflation rate, the Fed would care more about the inflation rate implied by the difference in yields on U.S. Treasury notes and U.S. Treasury inflation-protected securities. Instead of assuming the “real neutral interest rate” is always 2%, the Fed should use the 5-year TIPS yield that starts five years in the future.*
Clarida’s policy rule looked something like this:
In Clarida’s preferred policy, the Fed would have cut short-term interest rates to -10%, or at least bought enough bonds to generate an equivalent effect.
This would have been much more aggressive than what actually happened. While there is no single way to estimate the impact of the Fed’s bond-buying, Jing Cynthia Wu and Fan Dora Xia have calculated “shadow rates” for the Fed, the Bank of England, and the European Central Bank. They reckon the Fed – at its loosest – had only done the equivalent of a short-term interest rate cut to -3%.
Clarida’s more recent academic papers are less revealing of his views, but his frequent contributions to Pimco corrorobrate the view that he has tended toward the Brainard/Evans end of the spectrum.
In April 2011, he presciently worried that inflation could slow down as Americans revised their expectations for price increases in light of recent experience. In February 2014 he seemed to support the idea of having the Fed target the price level rather than the annual inflation rate. (The difference is that a central bank targeting the price level will try to make up for undershooting or overshooting the target, while current practice is to “let bygones be bygones.”) Later that year, he argued that accelerating wage growth did not need to cause accelerating inflation.
Perhaps most significant is that Clarida correctly anticipated the Fed’s gradual realization that interest rates will be much lower in the future than in the recent past. He warned in 2015 that the Fed must “remember that the slowdown in potential growth that is closing the output gap is also a ‘headwind’ to demand, which will influence the pace of rate rises as well as the ultimate destination for the average policy rate.”
This past July, Clarida crowed that long-term bond yields were holding steady despite continued Fed tightening because “the market is pricing in – and the Fed belatedly endorses – a New Neutral for monetary policy (which Pimco first asserted in 2014) with a neutral fed funds rate much closer to 2% than to the old neutral of 4%.”
Something else to consider: Clarida warned the Fed not to overreact to tax cuts and spending increases. It was sound advice, but it probably didn’t hurt his chances of getting tapped for the vice chairman job.
*The math is (1+10yr yield)^2/(1+5yr yield) – 1
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