 Welcome, everybody, and good afternoon. I'm Susan Collins, the Joan and Sanford Wildean here at the Gerald R. Ford School of Public Policy. And I'm very pleased to welcome you here this afternoon on behalf of the Ford School and the Department of Economics. Let me first recognize my co-host for this afternoon's event. Linda T. Sars, the chair of the Department of Economics. And Linda and I are extremely grateful to have such distinguished experts with us here today to share their insights on what's clearly the dominant policy topic, the crisis in the economy. As you all know, we've been in the midst of a very severe recession. The financial turmoil that began here in the United States in late 2007 contracted credit slash wealth undermined confidence, and during 2008 snowballed to economies around the world. These conditions prompted unprecedented monetary and fiscal policy actions in the U.S. as well as in many other countries. The data now suggests, however, that the situation has not only eased but that the recession may be ending. There, of course, remains a tremendous amount of uncertainty about where things really stand, about how the U.S. and the rest of the world economies are likely to evolve, and what could and should be done to move us most effectively towards recovery and to prevent future crises. So in that context, we have asked our panelists to launch a forward-looking discussion that emphasizes the role for policy. We've asked our experts to each first take a few minutes to share with you their views about the current macroeconomic situation with a particular focus on policy measures that they believe ought now to be taken to stabilize the economy and to restore robust growth. Following their introductory remarks, we'll have perhaps 30 minutes for dialogue among the panelists and for a question-and-answer session with the audience. So with much to accomplish in just the 80 minutes or so that we have for this event, I'm going to ask the panelists to pardon me in advance for introducing them not nearly as fully as their accomplishments would warrant. We have distributed more complete bios, however, and so let me just briefly both welcome and introduce our speakers. We're going to go in reverse alphabetical order this afternoon, and so our first panelist will be Alan Sinai, who is an alumnus of the Department of Economics and a very good friend to the Ford School. Alan co-founded Decision Economics Inc., a global economics and financial market information support and advisory firm that serves financial institutions, corporations, governments, and individuals around the world. Our second panelist will be our colleague Matthew Shapiro, who is the Lawrence R. Klein Collegiate Professor of Economics and a research professor here at the University of Michigan. Next, we'll hear from Charles Evans, the ninth president and chief executive officer of the Federal Reserve Bank of Chicago. We're very honored to have Charlie with us here today. These are obviously extremely busy times for the Federal Reserve, and we're quite grateful that he could join us. And last but not least, our final speaker will be Peter Borish, who is a distinguished alumnus of both the Ford School and the Department of Economics. Peter founded the Computer Trading Corporation, an actively managed hedge fund that focuses on macroeconomic investing. So on behalf of the Ford School and the Economics Department, I couldn't be more pleased to welcome these four panelists to the University of Michigan. Please join me in giving them a combined welcome before we invite Alan to this podium. Thanks very much. It's good to see so many Michigan people here, and a few people not from Michigan. The economy and recovery risks problems and policies for the short and long run. Those are, that's the title of my brief remarks this afternoon. The U.S. and global economies, we think, are in recovery. A year ago, it looked quite grim. Recovery doesn't mean health. Recovery has a technical meaning in economics and business cycle parlance, and I'll get to a kind of recovery in a few moments. Most likely, but not for sure, it will be sustained and will be sustainable. But there remain big risks and problems that are cause for considerable concern. Risks and potential problems that macroeconomic policies and policy makers should guard against. These risks and problems include sustaining the recovery, what we have going, joblessness, which I think is going to be the number one public policy problem over the next year and perhaps a lot longer. The consumer, the ability to spend and save. Federal budget deficits and debt, record deficits, record debt to GDP is the direction we're headed in. Appropriate exit plans for returning monetary policy to a more normal state. And fiscal policy to less government involvement and less deficits. And the appropriate mix and policies for the short and longer term to get the economy headed toward, and this now seems a long way away. Full employment, maximum growth, price and financial stability. Full employment, for me, is 4% unemployment rate. I do believe there are sets of policies that can get us there. And get us there at a non-inflationary situation. We're at 9.8%, we've gotten to 9.8% very fast. So 4% is a long way away and will occupy policy makers in all of us for unfortunately too many years. Make no mistake about it, although far from perfect the emergency and aggressive Washington policy actions over the past two years. Both monetary and fiscal have made a big difference. There would be no recovery now. And the Great Recession, which we are calling this episode, the deepest and longest since the 1930s that we had. Might have been a mini-depression or something more like the 1930s than a phrase like the Great Recession connotes. The zero interest rate policy of the Federal Reserve and some other central banks and quantitative easing by our central bank with support from the Treasury helped to keep credit functioning. And staved off the panic and flight to safety by investors and managed to keep our financial institutions, most of them, going. Also, that would have, if not for the actions of the Federal Reserve, intensified, led to intensification of the downturn, households and businesses would have cut back more. That would have caused more failed institutions problems and credit. The markets would have kept tumbling and the economy as well. The fiscal stimulus of the federal government, we've had two programs, $2,862 billion. 2009, February, $787 billion. While short on bang for a buck has helped and government programs to support mortgage finance, housing, states, individuals with transfer payments and income support. And outright federal government purchases, Keynesian like on public spending, to take the place of depressed private sector spending. Still not fully implemented, that program is having significant positive effects. Now the task is to use existing policies and devise new ones to make sure the recovery is sustained and to put the economy on a track toward full employment while at the same time working our huge federal budget deficits down to more manageable proportions. It's not an easy task. We need to remember that every time the US in almost any country has had a jobs and unemployment problem, what I am calling public enemy number one. Strong and dynamic real economic growth that is aggregate demand and macroeconomic policies to promote growth ultimately have been the solution. It's not to say that labor market policies, micro policies, governance, education and training, supply side incentives are not effective, it's just a comment about the relative magnitude. If you look at where we have had full employment, it's always been when we've had very strong growth for a long time. And behind it has been aggressive, stimulative, macroeconomic policies of some sort. Whether it was full employment post the 1930s, the latter half of the 1960s, the gold decade of the 1990s, and for a short time this decade during 2007. Well, let me make a few comments on the recovery and then some of the risks and the problems. I'm not going to deal with all the problems, only one or two, mainly the jobless problem. And a few perspectives on the policy. The economy seems to have entered some sort of recovery. I say it that way because I don't want you to get all excited about this recovery, especially since I think this is going to be the parents, the parents or parents of all the jobless recoveries. You know, I looked at the audience when I said that there are slightly more females and males in the room. You can check that account later on, but I think I'm right. And so I can't call it the mother of all jobless recoveries. And yesterday I did call it the father of all jobless recoveries and I got booed for that one. So I don't know quite what to say, but the point is this is I think associated with this recovery is going to be a very high, higher than we have now unemployment rate, sticky high unemployment rate, and a tremendous army or pool of unemployed workers. Well, we have recovery. This came after the longest, 22 months or so, if the NBER dates at sometime around the last month or so, and deepest 4% on a real GDP basis, peak to trough, biggest downturn since the 1930s, the longest. How do we know we're in recovery? The high frequency indicator data with only a few, although notable exceptions, it's the jobs data. Down cycles, they suggest the beginning of an upturn. Down cycles in housing, consumption, and business capital spending have ended and some are turning up. And the lagged effects of massively easier monetary policy and a huge fiscal stimulus positively impact and hopefully more so in 2010. The brunt of the fiscal stimulus of the $787 billion program of this past February really should hit in 2010. It is a two-year program, so there are some issues about 2011 and 2012. And for that reason, we are looking at this recovery and then we think it'll be an expansion as a three to five year, unless other things change, three to five year cycle, up cycle in the U.S. That's not very long, historically speaking. The 1990s were a decade and even this last up cycle was seven years, three to five years on the short side. I hope that will change with events. What kind of recovery? What's the prospect? Well, it's easiest to use alphabet letters, though scientifically inappropriate here at a university to describe the look. For us, the picture, and this is for real GDP, it's a summary measure of the economy, up tilted L. So from your direction, I think it's that, and the up tilt is at the bottom. That says it's anemic, and anemic means we think we're growing, we grew 3.5% in the third quarter. We're going to slow down because of a slowdown in consumers spending in the fourth quarter. That may scare people, 1.5%. And then two to 4% up and down over the next year, averaging something on the order of 2.5% to 3%. That's okay, but in fact it's better for the first year than post-2001 and post-1990-91, but it's far, far less than the median first year recovery upturn after 10 post-World War II recessions where the average or the median GDP, real GDP growth rate was 6.7%. It's just 40% of the typical upturn on the GDP basis. The typical upturns described as a V, we give that one chance in 10. Up till L, we give it about 2 thirds. The V is typically powered by pent-up consumption demands, easy money, lots of credit. With autos, housing, and consumption up sharply, that then causes business to produce and to build inventories, and we get a big move in inventories, and usually we're getting some help from the government as well in one form or another, and that's the typical V. This time, we think the consumer has no power. This is very negative, this is very different. This is a seismic shift in our view that started several years ago for the American consumer, and the fundamentals around the consumer look very negative, ranging from income to wealth, the lack thereof, inability to get funds, and therefore on spending. The new normal for the economy is going to be the new trend rate of growth for consumption. It isn't going to be anywhere near it was in the past, 3.5% of year inflation is adjusted. It may only be around 2%, and the economy is therefore doomed to a slow growth rate. That then suggests that business, just not in a mood to hire anyway for various reasons, will not see enough demand domestically to do a lot of hiring, and we have an adverse feedback loop, less hiring, less income, growing pool of labor, less income, less spending, business hiring less, and that loop is going to keep us at a low rate and produce a big problem and big risk. The risk is the consumer, the risk of a double dip recession is the consumer, and the public policy problem number one is an unemployment rate going above 10%, which understates unemployment, a huge pool of labor, and a political and economic problem that we have not seen, I think, since the 1930s. So, what do policymakers do about this? Policymakers already, at least where it was yesterday, the Democrats in Congress leadership already worried about joblessness, and thinking about measures, not a big $800 billion stimulus program, but measures that can do something at the margin for the jobless program are problem. We won't see major policy thrust on this from the administration until next year. There are a lot of things that can be done, but the curve, the dynamics of the joblessness and how it interacts with policy, when policy gets behind the curve of what goes on dynamically, policy tends to be too late and you're stuck with the problem. Or policy and exit plan, which is a second big problem and issue, how do the policymakers exit from the tremendous amount of help that they have provided to get the economy into the state? My answer is, I don't think I care much about exit plans at this point, if the diagnosis of the risk and the problem of unemployment is what I described as the prospect. The Federal Reserve should stay the course where it is. With this kind of unemployment, standard inflation paradigms would not suggest that we're going to have any inflation problems soon. And if the goals are maximum, sustainable growth, full employment and price stability, they don't have to worry about the price stability at this point. So they should continue with the low interest rate policy to provide credit to the system until the system can, on its own, provide credit. And I think it's very straightforward. And fiscal policy is not so easy because any measures that will be taken in Washington will cost money. And money means a higher deficit. They're scared to death down in Washington, the Democrats are, on the budget deficits. They should be, it's a horrible potential issue, but you know, and the trade-off between accepting higher budget deficits and the kind of jobless problem and so little risk to inflation, for me it's a no-brainer. We need to accept higher deficits and worry about taking them down over the longer term with an appropriate set of policies and not accept in policymaking the kind of unemployment problem that we are already launched into and probably will continue to see. Thanks. I find myself sandwiched between a distinguished forecaster and an actual policymaker. And I'm a little reluctant to tell them their own business, but of course I'm a professor, so that entitles me. So I want to actually start off where Alan left this question of exit strategy and particularly focus on the Federal Reserve exit strategy from its current policy stance. Let me just elaborate a little more what the stance is. Interest rates are zero to a quarter percent and they've been there for a considerable period and I agree with Alan the Federal Reserve is likely to keep them low for a considerable period of time. Given the amount of slack in the economy, if you look at our models, the interest rate would really like to be lower. But zero, that's a technical problem, making it a negative interest rate and that explains why the Fed quite successfully in my eyes has done this non-conventional monetary policy essentially buying up assets other than short-term treasuries which they normally operate in to push down the interest rates to directly provide credit to the economy. And I agree with Alan that this has been an extremely successful policy. Maybe I would have done it a little differently in timing in the detail but has essentially saved us from the brink of the next great depression. And where it looks now is we have a glide path that looks good but by no means great. Sustained growth in the 3% range is basically what it would take to keep unemployment rate constant. We need more rapid economic growth than the potential growth of the economy to get unemployment to fall and no one is forecasting that. And it's very hard to know where that forecast would come from. Alan's a little more optimistic and I'm more pessimistic It's pretty easy to think of reasons why the path might be worse. We could get the double dip from the consumers, there could be other shoes to drop financially. Many of the problems in the banks are not fully worked out. Perhaps this virtuous expectation of equilibrium that we're in now relative to six months ago in March could turn around, expectations can move on a dime. All those things argue towards risks to the forecast. It's very hard to think of something that will get us a lot more growth than is currently expected. So I'm with maybe a little more down tone basically saying the same thing Alan is. It's very hard to see how unemployment is going to fall much in the near future. But eventually it will if we're on this virtuous path. And then how does the Fed get out of this situation? Now I'm going to start telling President Evans his business and I'll be interested to see what he has to say about this. So at some point in the nearest future if the economy recovers as we expect the Fed is going to have to start to think about raising interest rates, getting it off zero and what should it be thinking about and when should it be thinking about. And I agree with Alan that inflation is very well contained. It's very hard to see how inflation is going to pick up for a variety of reasons. One, there's a huge gap which puts downward pressure on inflation. Secondly, there's a great deal of confidence in the Fed's ability to contain inflation and that contains inflation expectations. So it would be very hard to see how inflation could get going in this environment and that leaves the Fed substantial room for keeping interest rates low for a considerable period. I want to say that that is in some ways a good position to be in. Certainly not having to think about raising interest rates next year is where you would want to be as a policymaker with unemployment so high but it does create some risks and to explain what I mean, you don't have to think back very far. This has somewhat of the feel of the earlier part of this decade when interest rates were kept low for a sustainable period in response to the previous asset market meltdown. Here we have the housing meltdown which created all these financial problems. Previously we had the internet meltdown. It didn't have the financial spillovers but nonetheless the Fed kept interest rates low for a sustainable period. Why did it do that? It was actually first afraid that prices would fall and then kept interest rates low for longer than it might have because inflation was well contained and indeed it remained so. But that keeping interest rates low for a long period can have some adverse side effects. You're providing lots of liquidity to banks. Bankers get creative when they have lots of liquidity. In 2003 I refinanced my mortgage and had a perfectly fine rate, thank you. 2004, 2005 most of the good risks had refinanced and the bankers started looking creatively for others to lend to and they had the wherewithal to do it because interest rates were very low and the Fed was providing an assurance that they remain low for the foreseeable future and the banks would get ample warning when the course of policy changed. That policy at the time was completely justified by the fact that inflation was well contained and the economy was humming along. Although I don't want to put... There's a lot of blame to go around for what happened and low interest rates are probably pretty far down on the list of blame for the financial crisis but it was an element of enabling the financial crisis and it's one I think the Fed is going to have to worry about independently of what's happening to inflation which is going to be well contained for the next couple of years. So the Fed might be facing a problem in say the middle of next year or to the middle of the following year of having to want to raise interest rates not because inflation is high but because the economy is getting frothy again because of the expectation of essentially zero interest rates. What can it do not to sort of face that difficulty? And there are the answers I have to put on the microeconomics hat. We really have to do something about regulation which is the other big macroeconomic item on the agenda now. So there are many proposals for improving the financial regulatory system. Basically there are many proposals we can discuss them in greater detail but part of what caused the crisis and certainly a more important cause was the fact that basically many, many loans which shouldn't have been made on prudential grounds were made. You might say fine that's just people's private business but when they all blow up together it's the public business and precisely we've precisely had to have these bailouts because of a combination of excess of credit going on in the middle of this decade and that was certainly abated by having interest rates too low and in my view too long and that could go on again unless of course we have these various proposals for financial reform such as increasing capital requirements, more scrutiny of financial organizations and so on. So I think it's very important that microeconomics and macroeconomics go hand in hand in this recovery and though it's quite important for reasons Alan highlighted to keep interest rates low for a sustained period the Fed's ability to do that will be much, much stronger if we get the kind of prudential regulation increased capital requirements that have been proposed. All right well let me say it's a great pleasure to be here. I spent a very nice semester here back in the fall of 1999 and it's always a pleasure to come back and speak. Now in my current speaker position I figured I would face a bit of a challenge because we have some noted forecasters and macroeconomic academic experts and markets experts and so I wasn't quite sure I didn't want to duplicate too much on this so I'll be very light on forecast numbers. I will say that Alan Sinai had perhaps the best alphabetic description of the economic outlook. I have heard about these, use, W's, double dips, L's. I've even heard some people talk about check marks which sounds good but doesn't quite describe it because the expansion is longer than the downturn. Sometimes they'll say swoosh but up tilted L does seem to capture things. My own outlook is for the economy to grow at about 3% over the next 18 months it'll be probably uneven on a quarter to quarter basis and there will be different drivers for different parts of that 18 month time period but I certainly agree that a big challenge facing all of this will be the very high unemployment rate and the job market, the unemployment rate almost very, very likely to go above 10%, maybe just a little bit above 10% and then it's going to be a slow retreat from there and that's not going to feel like a recovery for quite some time. And in terms of inflation I'm looking for underlying inflation which I would measure by core PCE to be somewhere around 1.5% for the next couple of years and that's below the inflation rate that I find consistent with the price stability objective that we have. That's my own assessment and I would put that at about 2%. So 1.5% is less than that. So I thought I would talk about the policy situation. Everybody's talking about it but at least I get to speak with the authority of somebody who's been there in the room and I would say that the Federal Reserve has a dual mandate from Congress that is we are supposed to support financial conditions which give rise to maximum employment which we often interpret as sustainable economic growth and price stability which I would say is on the order of 2% for inflation and both of those are below these guidelines. The unemployment rate at 10% is unacceptable. I could differ on an assessment of what the natural rate is. I wouldn't put it at 4%. I'd put it at much closer to 5% and maybe even higher. There could even be some more recent structural reasons why it's a little bit above that but that's not worth talking about those differences during the current period and inflation is relatively low. So both of those are indicating policy accommodation and current policy is very accommodative. Certainly in the sense that the federal funds rate is about zero. It's close to zero as you can get. And we've put in place non-traditional policy measures by purchasing agency mortgage-backed securities, agency debt, additional treasuries. Our balance sheet has grown. Our purchases have been on the order of $2 trillion in addition to the additional lending facilities that we have put in place to support credit origination, asset-backed securities markets and the banking system more generally. So one of the questions which I won't answer today but I think it's worth asking is when the policy situation is relatively unambiguous in terms of calling for policy accommodation, how is it going to play out as we move from something that's unambiguous to something which exhibits shades of gray in terms of what the risk characteristics are and then to an ultimate policy path where we have to begin exiting from our current policy accommodation and how aggressive will that path be? I would have said when we first began our non-traditional policies that it would be relatively easy to see when accommodation was about to be removed because I originally thought that as we increased our balance sheet we would have to reduce our balance sheet in order to provide more restrictive credit policies. But in fact, we have studied many different ways, many different tools to provide policy restraint and now I tend to think that by offering interest on excess reserves the banking system has a large number of excess reserves in order to move to anything which is restrictive we would have to put pressure on those reserves and we could do that through raising interest on excess reserves and so we could do that hand in hand with our balance sheet still being on the sizable side but as we move towards neutral I'm not quite so sure that still begins to work so I think there will be a progression and I had originally thought it would be very easy to see this because we would have to work down our balance sheet but in fact it's probably not going to be quite so apparent. Now in terms of inflation I would say that our exiting from policy accommodation well we have to balance off the economic situation but I'm just going to take as given the fact that the unemployment rate is going to be high for an extended period of time so the question is at what point do inflationary pressures or inflationary concerns sort of lead you to want to balance out our policy stance and so that's going to depend on the evolution of inflation that will depend on inflation expectations and how the economy is responding in terms of resource costs and how firms are marking up prices what wages are doing and that's pretty well correlated with resource slack so that's back to sort of the labor situation so I find myself constantly thinking about arguments that I've heard in terms of how important is resource slack or inflationary pressures versus how important are changes in inflation expectations I think that resource slack is a big factor for inflation determination in fact it's sort of taken as given in intermediate macro the way we currently think about it but there is a lot of uncertainty certainly Atenacio's Orphanides has written about the 1970s which you could look at the US economic experience with high unemployment rates and kind of say there must be a lot of slack out there but in fact there were a lot of structural changes going on in the United States and the unemployment rate and the labor markets were more consistent with higher natural rates of unemployment there and so I think that's something that you would normally have to be concerned about making sure that what you identify as slack resources in the economy are in fact slack but even if I think the natural rate is 5% or even if it's 6% because of certain reallocation stories that might be evident now with an unemployment rate of 10% it's just a very large factor in the inflation situation so as I said my own forecast is for inflation to be more along the lines of 1.5% for the next couple of years in the face of this type of slack but it is a case that we must pay attention to all of the inflationary pressures that's my viewpoint that it's not going to be an issue but we have to monitor that so inflation expectations are really important and we have to think about that now inflation expectations are also unobservable a lot of people sort of point at resource slack output gaps, Phillips curves they embody unobservable variables and that's true but inflation expectations are not really any more observable than any type of resource slack yes there are survey measures of inflation expectations and a very important one is produced here at the University of Michigan we look at it very carefully and there are all kinds of ways that that data as I understand it when it's collected very scientifically still need some type of massaging in order to take care of outliers and things like that so as good as it gets it's still one measure of expectations and then there are market measures from the tips market and those could be pretty good but they also do suffer from certain market difficulties when there are liquidity or risk spreads and in fact last fall we saw lots of those pressures in all markets and so it's very important that we have to handle those and even when we get that right as if that wasn't hard enough the levels of these inflation expectations don't quite correspond to what I would say is an acceptable inflation rate when I look at longer term inflation University of Michigan inflation expectations I think it's on the order of two and three quarters to three percent and I just said that I think the two percent is most consistent with price stability and so I don't think that's a lack of credibility of monetary policy but I am mindful of that if inflation were to sort of begin to rise to those levels but I think there's a level issue that you have to deal with so all I'm trying to say here is that inflation expectations are important tough to measure we have to work hard at it and we have to scrutinize them very carefully but they are important because as we point to other risk factors in our balance sheet we've grown our balance sheet quite substantially and the monetary base has grown a lot and we know that money is a monetary phenomenon eventually not quarter to quarter, not month to month so we have to be paying attention to that and if money is an important driving factor of increasing inflation I would expect that to show up in higher inflationary expectations the same would go if fiscal issues were very important there and also if there was concerns about credible policy that we could follow through in the face of difficult decision making when the unemployment rate is high so inflationary expectations are really important so I guess my bottom line is I still see expectations as stable and there's a lot of slack out there that's meaningful so at the moment I do tend to agree with perspectives raised before that we have to think about our exit policy and we are looking at it very carefully but at the moment that's not our first order concerned, at the moment it's the policy accommodation. Thanks very much Thank you I can understand why probably speaking last I think I'm going to take a little bit different tacked here and just sort of thinking of the analogy a little bit just let's say that the Fed did a tremendous job as storm chasers going into a hurricane and we're in the eye of the hurricane right now the weather looks great everybody's happy when that plane hits the other side it is not going to be pretty so a year ago I was standing here it was actually the day that Congress for the House the second time passed the tarp and I was scared to death of what was going to happen in the markets and that was going to lead the economy now today I'm scared to death of what's going to happen in the economy and how that's going to affect the markets afterwards so there's a little bit different causal effect so when you look at this and I'll try to keep it brief within eight minutes so where are we just a show of hands how many people think that the dollar is at an all time low and just in the worst shape ever I just see the show of hands there nobody has an opinion or everybody reads the paper every day but they don't follow it okay so where we are is that we've done a little bit of a mini pre-2008 right the correlations in all the markets are the same except the year I was at 150 160 then but the world is coming to an end right gold is strong just as it was then it's $20 difference and oh by the way gold is $30 higher than it was at its peak in 1980 so everybody that held gold for all those gold bulls let's throw a party you made your money back after all these years I think it's fantastic right the Dow is back to $10,000 I think except one was the first time the Dow was at $10,000 March of 1999 so I have an 18 year old daughter who's a freshman in college and in 1999 I thought I was smart I took $100,000 I invested it I thought 7% a year guess what's gonna happen in 10 years I'm gonna double right 7% compounded over 10 years it's really 96 but we're economists we can round guess what happens it's Michigan's tuition continues to go up so I have that $200,000 in my mind I'm gonna be able to pay for it except I only have $100,000 right now because I'm back to where I was except I pay for the tuition room and board and everything else so now I've got $60,000 left to pay for the next three years how's that gonna work that is the microcosm of what's going on in the economy tremendous tremendous deflationary pressures underneath I like to say and I know this is on the record but so I'll say it anyway that state and local government finances are essentially the equivalent they make Bernie Madoff look legitimate right we have a series of legacy healthcare and pension fund issues that how are they gonna be addressed why is it that state funding for Michigan continues to go down every year it can't work we have a gigantic math problem and that's why the Fed is in a very very difficult situation I hate to be next to the president of Chicago Fed and talking about this and you know obviously in terms of a policy perspective and I'll get to that in a second but when you think about it if you're a public service worker I like to call it you get 20 and then you get 40 right if you're a policeman if you're a fireman you get to work for 20 years you come in at 22 you have 20 years you get a pension you come out at 42 age expectancy is 82 you get paid for 40 years how does that math work how does that work so then we have record on employment and it's going to continue so we have another math problem right so we have a social security we have a Medicare trust fund we have people who are age specific so we have record on employment for those here who are in college go to graduate school right and by the way it will work because I graduated in 82 and I got lucky and I came out and that was the worst recession so you're much better off coming out at a low than you were three years ago and getting a job and getting laid off so stay in it things get better it's just that's the other side of the math problem okay then we have record on employment and this is a part of age 45 and over so in your highest earning years when you should be saving and planning for retirement you have record on employment so the demands on social services are quite high but the replenishing of the coffers are there too and so politically and I want to give a tremendous amount of credit to congress to the fed and there's zero credit you get zero credit for disaster averted in the political system right so everybody says well we're okay now we shouldn't have spent this money but we don't know where we would have been if we didn't spend that money I think we would have been a lot worse off but what makes me nervous more nervous than I already am maybe just because of big crowds so I'm really nervous but is the fact that there's already discussions so the first thing that the chairman said and the first thing that Secretary Geiger said when they testified is we don't want to make the same mistakes that we made in the last time around and oh by the way I love the fact that this is a great recession it's the worst this we've had four consecutive quarters of negative growth we may have a positive quarter here and so when you're into markets you can't necessarily look backwards right the one thing is when you drive if you continually are looking in the rear view mirror you're going to run into a light pole when you manage money you've got to try to look forward you have to deal with expectations so you have one certain path and then that path going forward is full of uncertainty and there's likely to be policy mistakes and the one thing I would come up here and I want to shout out to my friend and my mentor, Ned Gramlich who was at the Fed at the time in 2005 2006 talking about predatory lending standards and what was going on and of all the people I think on the Fed at that time and it's great credit to Ned and who was my professor and I worked with and wrote the book and was on top of that so it's a credit to this institution but problems are seeable when it comes to that so I look at the fact that we've done a many things all the correlations are the same the power's down commodities are up the equity market is up we're talking about unwinding policies but beneath the surface we have record unemployment in these two different areas and it's likely to go up and then if you look at the surface beneath people that stop looking and everything it's a lot worse so the question is in terms of a policy perspective I think there's one thing that we have to do we have to change the incentives and make labor relatively cheaper compared to capital right now all our policies are geared towards utilizing capital accelerated depreciation by this and everything relative to capital to labor is more expensive I hire somebody I now have to pay a special MTA tax on them I'm going to hire somebody for additional health care costs if we have an employment problem and everything stems from that and I agree completely we have to change the incentives to make it better for people to hire workers rather than replace workers with technology so I'm going to leave it at that and we can address in questions thank you thank you very much to all of our panelists before I open the floor up for questions can we invite any of them who would like to make a brief rejoinder to one of the other comments Alan for Charlie the 4% number was not an assessment of the natural rate it was a societal goal notion and the notion behind it is to devise policies that will get us there along with in terms of the natural rate at that time which involves labor market policies as well as macro policy and the natural rate actually I'm agnostic all the empirical work I've done I've not been able to to support the notion so theoretically and empirically I'm agnostic on that issue and suggest to policy makers they ought to be too because it sometimes gets a conceptual view if something happens and it doesn't always work that way the 90s, the 1990s as an example for monetary policy, we can talk about that later it's a very interesting episode the central bank gave up on the conventional natural rate at that time and the US economy had a very good decade but you're thinking about that so one for Peter I don't want to leave the impression that I'm monolithic and looking at a particular unemployment rate and measuring it against that let me ask you to move forward so that they can hear in the microphone I very much look at the entire sweep of the economic data and how that looks and I personally find it useful to have these sort of benchmarks so that I can kind of say that looks like a dashboard type of perspective I suppose I agree with you that those things are dynamic they'll move around over time so if you fall in love with any one particular indicator you will easily run into problems well thanks we're totally on the same page Peter our empirical research supports your notion that is to say we just did some recent work in the context of recommending social security tax cuts for businesses and individuals as a policy to create jobs and we found in our employment equation so a bit technical I'm sorry about this the second employment equations that the employment cost index which is an employer cost has a lot of power and intuitively I see it all the time just as you're a common somewhat anecdotal business just doesn't want to hire people they're just too expensive when you're rolling all the costs health care and retirement costs and we've had I think a huge change in the structure of the business cycle the last three post recessions and this is one of the major reasons so totally agree with what you said thank you just briefly and then we'll open the floor President Evans a question I didn't state this but I want to you know everybody thought that the or people here right think that credit default swaps cost was a major problem and so what about if we can't beat them what about joining them so we as a U.S. taxpayer have put a tremendous amount of money into a number of financial institutions the marketplace obviously loves it right because they've all rallied significantly so why don't we buy CDS's to protect our investment just as Goldman Sachs would well I think that confused I think it confuses the public policy role that we have versus private institution you know requirement to hedge their their risk you know the CDS market I you know I would get this question you know for some time in the run up you know before well sort of the summer of 2007 but before things were really evident that there were problems and they would usually take the form of a question like the CDS market is 62 trillion dollars what do you think of that stated that way there's a lot of different ways to respond I mean 62 trillion is a notional value of all of these you know 10 million dollar bond and what's your real risk aspect so we're not very good at understanding sort of gross exposure versus net exposures and so I think that the proposal to move more towards netting out CDS exposures through clearing mechanisms is a useful one I agree but that doesn't answer my question so your question was what we should how do we protect our taxpayer money but why don't we protect our taxpayer money in the same way if we've had this tremendous run up if there's a decline well the market if the market is rallied if city bank is rallied from 97 cents to 5 dollars right so you've got a 300 percent increase kind of default swap is an arrangement with somebody who basically takes an insurance role and it just doesn't strike me that from a public policy standpoint we want private markets to offer insurance when it's actually the government that is more but our money as a taxpayer our money's at risk though right so that's why we have you know risk management to look at you know our portfolio the main lane aspects of that and while you know it's the case that at any point in time some of those assets may not be worth exactly what we paid for them we have been making money on other forms of lending through interest payments on our program so the real question is how we come out at the end of all of this and at the moment we expect that we'll do fine but that doesn't change the fact that there's risk with that why don't we open the floor up if there are additional questions because we are recording I will briefly repeat the question and then invite panelists to respond if there are thoughts questions from the audience yes in the back speak loudly please thank you so the question briefly was whether socializing healthcare would reduce the labor costs in ways that could help address the unemployment problem would any of our panelists like to I thought that was your that is that is an intriguing notion I think we ought to try to deal with analytically I mean the problem is politically it's dynamite and by the time politically and societally you could settle the issue of whether to nationalize it a lot of time would pass on an analytical basis there is a first of all the issue is you put your finger on a huge issue if we were able to get the healthcare right to deliver more healthcare goods and services to more people in a cost efficient way and to get the rate of healthcare inflation down I think that could do more for our macro economy than the end of the cold war ultimately did for us but I don't see that that's happening in Washington in what we're getting out of that so nationalization remember what you're saying you're saying the government does it all runs it and you really are kind of saying they're going to set the prices and as economists we would probably tend to say we like to see the price mechanism work and I think one of my reaction is I think what's wrong with what they're doing in Washington now is that the price mechanism isn't working because the end user doesn't know how much doctors or individuals how much they're paying and so the costs just keep on running higher and higher so I think it's not being considered for political reasons not because it's not analytically something worth thinking about thank you any of the other panelists that it's a very very complicated issue as Alan was just saying but the issue it's would you rather sort of go to the DMV or would you rather get on Facebook or Twitter in terms of efficiency so you have to be very very careful there when you have something where there's no competition it's a single government option the issue with healthcare is if the vast majority of money is being spent in the last six months of people's lives it becomes very difficult to say right as an economist at the margin don't spend that money on this particular thing or this experimental technology it's not an issue for you fortunately yet it's not an issue for me but in 20 years for me it will be and that's a tough one thank you I think we're going to shift gears it's certainly an important point and we've had some responses from the panelists are there additional questions or comments that people would like to make can you speak a little louder please so the question was if panelists could comment on the new consumer protection legislation in terms of usurping the power of the Fed well it's not a question of usurping power it's sort of where the best use of that regulatory authority might lie currently the Federal Reserve has responsibility for rule writing but also supervision of financial institutions post-order institutions to make sure that they are complying with the consumer regulations and we find it useful in our monetary policy making role to have a pretty good window into financial institutions through our supervisory policies we have found we argue that our supervisory effectiveness is stronger when we have this additional responsibility when we're looking at consumer compliance aspects because we think that there's synergies in looking at the safety and soundness of those institutions but it's certainly a controversial issue and it's occupying a lot of Congress this time we'll see how it comes out perhaps I could put it in the panelists all seem to be optimistic in some ways although talking about how long a recovery might take and how slow it might be but we didn't hear much discussion of what remaining tools there may be if in fact we were to have more of a W-type of behavior so if we were to find out that actually we got some bad news and things started turning down again how long space is there for policy to actually weigh in and make a difference why don't I take that I think actually options are kind of limited so there's a lot less headroom than we had going into this crisis there is a limit on how much we can borrow to stimulate the economy so one reason why we've been able to have this very aggressive and appropriately so in my view fiscal policy the government is currently able to borrow at 3 or 4 percent for 20 or 30 years that there's still more capacity there but it's not unlimited so I think it would be the option the choices would be much more difficult if we had a second downturn and I think if we did you'd want to target the policies on essentially the sort of thing that Alan was talking about where if you needed a second round of stimulus which I don't think you should be looking yet now but nothing wrong with contingency planning you'd want to do things which would reduce the cost of hiring workers which could involve something like the social security tax holiday the other thing I would do more as a precautionary measure is build up an inventory of infrastructure projects so one of the most effective ways to stimulate the economy is to do good public works projects that are worthwhile to have and they also are quite effective in the short run for stimulating the economy when the administration asked the governors when it was coming into office give us your list of projects it only came up with about a hundred billion dollars per year's worth of projects and quite appropriately only put that amount into the stimulus package the rest of the stimulus had other forms it would be good to have an inventory of bridges that need to be built schools that need to be renovated have them online have blueprints ready and I think one good policy that we should be thinking about now would be to build some of these up in case we do get a double dip so these projects could go online say in 2011 or 2012 Alan I'm kind of going to work backwards and this is a question that you have to answer later which is why is it so many economists want to have an inventory of infrastructure and have the government spend money on infrastructure because my problem is once you get one of those projects done I guess they could go on forever I guess you could think of things forever spend government money on but once you get one of those done and if nothing else is happening in the private sector economy it's all over you just have to do it again and that means more deficits more debt because you have to finance it if you finance it by raising taxes then that's depressing on the economy anyway in response to your question I think there's a lot on the fiscal side Charlie can answer if there's anything left on the monetary side you may have to think a while about that but I'm just kidding Charlie I think there's a lot on the monetary side but on the fiscal side there is a lot on the monetary side there are additional spending there are say in the House Democratic Congress now they're thinking of pay for it's one of them is carried interest to eliminate that there's a fair number of billions of dollars that's a loophole in the tax law I floated yesterday others have floated at transactions tax Peter you might not like that but transaction tax could raise a lot of money carbon which is dead in Congress now had revenues extra revenues associated with it you then take those and decide where those monies would go and I would rather than see them go in infrastructure so far I'm not seeing much from the $7 $7 billion spending part of the program it may come but I'm not seeing much now I would rather see it go for tax cuts to use those monies for tax cuts and I think there's a lot of room for fiscal policy to provide some stimulus if we have another double dip I for once I can just one more two-hander and then we'll go back the advantage of having an inventory of infrastructure projects or other useful government projects is they essentially have no permanent tax burden these are things that you would do in a couple of years doing the middle earlier for macroeconomic reasons basically doesn't add to the permanent budget deficit but it can stimulate the economy now so that's why I think it's so attractive huge don't think they no maybe it's too late now that two-hander plans why for instance now they're being rebuilt to a certain extent maybe in the early 70s when the economy was very soft why didn't they consider working with IRAs and retirement programs for instance giving people a holiday maybe the first $100,000 to $200,000 tax-free then there'd be a lower tax rate 15% on withdrawal rather than a maximum rate of 35% or if you live in a state with a high tax rate up to something like 52% and 47% if they had done something like that first consumption it would be a shot in the armpit consumption it certainly would be now even though these people they can't get it at their money without paying taxes on it but two there are people that have a tremendous amount in their retirement plans in their retirement accounts they do pay taxes on money that Uncle Sam might not collect for 25 years and I live in Cincinnati people with the worker first they don't want to touch that money so they might never make withdrawal so the question was while it may be too late given what's happened to retirement account wealth why was there not more consideration to various kinds of tax holidays and other measures that might have made those retirement accounts more accessible for consumption any comments from the panelists well first of all deferred compensation is a risk if you ask people at a number of firms that went out of business and a lot of executives held deferred compensation that was gone so that's the reason why there's risk to it the notion of how we handle retirement and I think it's an apropos question is very important right the biggest government decisions over the last 30 years since the 70s have been putting more decisions on individuals relative to the government going back to that and I think that's probably been a good thing and we have to be very very careful we've had tremendous growth in wealth and assets even where we are today from 1982 to 2007 the beauty of capitalism of course is that every good idea gets driven into the ground like a tomato stick you know you just bang it till it's dead so do we need to make some changes at the margin as people mention in terms of regulation and policy absolutely but should we unwind everything and go back and that's a concern to me some of the policies that are floating right now including the consumer protection agency where emphasis off the individual and on to the government and expect the same results and expect to see the same wealth creation see the same innovation I would disagree I don't think that that's possible so your idea of dealing at the margin with some of these issues and encouraging people to save and for retirement is an excellent idea whether that's the right approach or what the tax rate is of course I'm in favor of taxing everything that I don't use right so so transaction tax is terrible tax and cigarettes is outstanding and that's that is the political dilemma right there see that's why we want to tax you because you sit in front of that green screen and we're not sure you make anything that means anything I just want to say that I invest I spent a lot I'm an investor I'm a small owner of twitter okay so I invested a lot of different things in addition to trading a lot of futures there's a question back in the back there yes so the question is as China integrates further into the global economy are there things that could be done now to make it less likely or to prevent a major recession initiating in China this one is called Stump the Exit Stump the Exit by the way your idea is a very good one to stimulate consumption isn't a big deal it's a little bit like we patriot funds a lot of funds sit unused because people companies don't want to pay the tax they're overseas so the government doesn't get the tax money it's not tax it sits overseas and the funds aren't used by business in the United States to spend on things in the United States the senate turned down a bill last fall because the companies didn't really use the money to hire and they were angry about the last time they did this but I heard something like that it's actually a good idea in the context of what's happened to consumption to the extent I can I'll carry it and throw it down into the lap of the congress China at the moment is a major force for the global upturn and so your concern which is probably a longer run that is countries get going they have long booms and then the booms have bubbles and busts Chinese stock market might end up in a bubble someday we don't think it is now but right now without the Chinese fiscal stimulus and the upturn in Chinese economic growth and the effects on Asia and then those effects reverberate through trade around the world and back even on the United States the third largest economy in the world that China is a major positive force from a macroeconomic point of view your concern for the long run is well taken because the kind of thing you're pointing to happens all the time financial crises booms bubbles busts we just went through that in the United States Japan went through it before the US went through it in the 30s and yeah but I think it's a long way off it could be China 20 30 years from now so I don't think anybody is going to do anything about that worry right now one of the biggest issues for policy makers and this is actually was a question for Charlie is in a forward looking way policy makers to avoid the next crisis and thing that goes wrong one of your colleagues made a very interesting speech and comment that's Kevin Warsh a few weeks ago in which he let's forget what he said about interest rates maybe having to take them up sooner in Chicago when he said that probably your conference I think yeah that's right and you didn't clear the speech before I don't clear mine with him so but what was interesting to me was his comment about watching and flows into your comments about inflation expectations watching certain nontraditional indicators like market prices, asset prices and as providers of information I think he meant in terms of inflation expectations of a certain segment of the world and whether those kinds of indicators should be watched more as early signals of potential inflation fed by inflation expectations I don't understand the mechanism by the way but along with the other indicators that the Fed uses so this is a fair question for you because it's not about interest rates it's more analytical well I think he's talking about market indicators for example the ones that come to my mind are commodity prices and you know back of that here's another question for you he asked two questions for the price of one but the other question is the question I get all the time after I give a talk no matter how grim it is to senior level executives or senior level financial people the first or second thing they ask me is all about runaway inflation when is inflation good and I don't understand I say what makes you think that look at the world out there and they all ask that so there's something going on in the inflation expectations mentality and Kevin's comment seemed to me to be we want to watch that in terms of inflation expectations so as not to be blindsided I wonder what your reaction is to that so I've experienced that type of response too in the sense that and that's one reason why I made the comments that I did I went to an event in London and I talked to a number of people in financial markets and it was as if I was walking down a hallway I would go into a room I'd have a conversation and all of the questions were my gosh deflation is coming look at all the resource lack look at all the problems there's a worldwide slow down this was the summer aren't you worried about that etc etc finish the meeting it's inflationary pressures we're going to have a hyperinflation if these keeps going on look at commodity prices look at your balance sheet and any combination in between it's the most variable period in terms of people's expectation people's assessment of inflation and policy that I can remember in the time that I've been looking not nearly as long as yours but that's what you spoke for Elton your wealth of experience I tried to get a job with your firm but I'm sending my grandchildren to the federation the inflationary expectation goes into your China question right in the history of man we've never run out of anything right that's a good thing the cure for high prices is high prices the question of a policy mistake takes place when there's a perceived permanent shift in something relative to supply so if you believe as I do that the dynamic is such that technological progress in production of commodities right in oil I guarantee you if the price of oil gets high enough we'll drill for natural gas right here Michigan will do it in the heartbeat is that the demand that's coming in the short run so supply is relatively inelastic of a lot of these commodities you're seeing an increase in demand through the stimulus and the development of coming online of all the different and that's a great thing right world growth is good it causes short run supply shocks which raises prices but the underlying deflationary pressures are still there and technology increases so you've seen this repeatedly I can replay this newspaper articles from 1973 1979 1988 et cetera et cetera so the biggest issue as far as China goes that we do is to make sure we don't make the policy mistake that thinking that inflationary pressures are a result of a increase in demand of more global growth which is a good thing relative to the fact that supply is short run inelastic and technology and our productivity will increase I'm very bullish on that if anybody's invested in a stock market in your long technology stocks you have to believe that as well otherwise you have a conflict in your mind and you've got to resolve that one last question yes so there is yeah there's a lot of awareness, vigilance concern about commercial real estate and commercial back securities just earlier this year when the Federal Reserve along with the OCC and other regulators did the supervisory capital assessment program for the 19 largest bank holding companies that exercise was meant to look at the banks and see where their risks were where the systemic risks might be to the financial system and get an assessment as to whether or not they had enough capital to weather the coming losses that were likely coming due on their balance sheet over the next three years and to make sure that they had enough capital to weather this over a two year period so commercial real estate was an important aspect of that obviously are up, property values are down and that's a huge challenge that's a large challenge for community and regional banks really because the way the banking system has sort of carved up the various investment opportunities the large banks do the capital market type of investments and securities and big deals and the community banks are left more with the high level of much business investment consumer type of opportunities so they often have portfolios which are as we look at them they're concentrated in commercial real estate more than we would hope and given the current situation coming out of the S cap we you know I was surprised that the financial system didn't need as much capital as I might have guessed going into it that seemed to be pretty manageable we're now taking into account what we've learned from that in looking at bank portfolios and we're looking at it very carefully but it is certainly the case that a lot of financial institutions have loans on their books that have lost a lot and it's going to be a problem for them and so we have to make sure that those banks are as safe and sound as possible and that we handle that situation appropriately and also allow for lending capacity so be as strong as it possibly can for everybody else who's in a better situation I just think you asked the ultimate game theory question which is bank X is going to lend to refinance the debt of bank Y where is the Fed going to have to step in I don't know the answer to that I'll leave it to George but that is the game theory it's way above my pay grade but it's a very important question any last thoughts from our two other panelists well we do have a reception to follow and so we can continue some discussion informally but with that please join me in thanking our four panelists for their insights on the inflation expectations side