James Bullard on FAIT, Nominal GDP Targeting, and the Fed’s Upcoming Framework Review

James Bullard was the president and CEO of the Federal Reserve Bank of St. Louis from 2008 to 2023, and he is currently the dean of the Mitchell E. Daniels Jr. School of Business at Purdue University. James is also a previous guest of the show, and he rejoins David on Macro Musings to talk about his time at the Fed, FAIT, and the upcoming Fed framework review. Specifically, James and David also discuss how to improve the FOMC’s economic reporting, the case for implementing nominal GDP targeting, the future of R-star, and much more.

Check out our new AI chatbot: the Macro Musebot!

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Jim, welcome back to the program.

James Bullard: Great to be here. Thanks for having me.

Beckworth: It's great to have you on. You've been a dean now for almost a year. Is that correct?

Bullard: Yes, about 11 months.

Beckworth: Okay, so you're well into your journey there as a dean. I'm just wondering, what is it like going from being a Fed president to a business school dean?

Bullard: Yes, I've been joking with people a little bit that it's not all as different as you might think. You certainly have an entity within a bigger system, which is very much what the Federal Reserve was like, and you have certain responsibilities in your group compared to the overall enterprise. So, [there are] lots of dotted lines, lots of committees, but, also, authority within your own unit. And there's a lot to like about the Daniels School. They're trying to reimagine the business school here. The technology on campus is fantastic. Purdue will turn out more engineers than anyone in the nation this coming year. So, I think the fact that technology is so important to the business world makes for a great combination between engineering and business and science here, and in other aspects of the campus. So, it's been really fun so far, and I've really enjoyed it.

Beckworth: Well, I have to ask, are you able to get to any of the sports events there, on campus?

Bullard: Oh, yes. We saw all of the basketball games, and we used that for some of our VIPs, and I talked to them, and, of course, the team went all the way to the finals, so it was great team.

Beckworth: Yes.

Bullard: Football is also really fun, and now the conference is getting even bigger, so we'll see even more teams from across the country here in West Lafayette.

Beckworth: So, one last question about being a dean. I know you love macro. I know you love monetary economics. Are you able to teach any courses, or are you too busy with your other dean duties?

Bullard: Yes, I love to teach, but I have not taken on teaching so far. I just think it's maybe not the right combination now, given the other things that we're trying to do to build this up and get going. But someday, I hope to get back in the classroom, because I do enjoy it.

Beckworth: Well, those students will be very fortunate to have you as their teacher, a former Fed official teaching money and banking, or a macro class. That'd be amazing. Well, you are a dean now, but previously you were a Fed bank president for a long time, and as you look back on the experience, what do you see as the big highlights of your tenure there at the St. Louis Fed?

Defining the St. Louis Fed and Bullard’s Fed Tenure

Bullard: I love the Fed, and it was a great experience. Of course, I started in 2008, but I was really at the Fed much longer than that, because I was on the research staff for 18 years. During that period, I was, what they call, in the “Fed FOMC Class I,” which means that you get all of the material for the FOMC meetings. So, it's really all of the FOMC meetings from the early '90s all the way up to last year. So, there's a lot to talk about in that entire era, but I certainly saw the whole era unfold before me. One thing about my tenure is that I moved into the presidency right as the world was turning upside down. So, it was probably a few weeks after the Bear Stearns deal.

Bullard: For those that recall that, it was a key moment in the global financial crisis, and so everything I thought I knew was basically turned on its head exactly when I became president. You had the summer of 2008 there, which was right at the beginning of my tenure, but I think that's a critical moment for macroeconomists to try to understand. I've made the argument that it appeared that we were doing pretty well up until about August of 2008. We can get into it more if you want, but the crisis really started at the Fed [on] August 9th and 10th of 2007, and so you got into this thing that you had been fighting the crisis already for a year by the summer of 2008.

Bullard: Then, of course, everything went dreadfully wrong in the fall of 2008. So, I've actually got ideas about how to understand that era. [It was a] very long period of low nominal interest rates and low inflation, much like the Japanese experienced over the last 25 years. I think that that's another important thing that macroeconomics has not really faced up to. Certainly, ink has been spilled on it, figuratively speaking, but I'm not sure that macroeconomics really has its head around what the Japanese trap, so to speak— low nominal interest rate, low inflation trap— really means. Then, of course, the pandemic was a huge disruption to the economy, and you had a— we can talk about it more, but I think that the initial reaction to it was quite successful by the Fed, and some of that was informed by the earlier crisis. So, [it was] a very interesting era to be part of the Fed.

Beckworth: For sure, and even throwing in the 1990s, before you were president, that's an amazing period, too. You had the stock market boom during that time, the initial IT kickoff. Then, you had 2001 and the recession then. And I was just recently reading, Jim, some of the discussions from that period, where there was a concern at the Fed and the FOMC about what to do if we run out of national debt. What assets will the Fed put on the asset side of its balance sheet?

Beckworth: And so, what was interesting is that they were looking at the discount window, doing more discount window lending, and this has come up in the context of the recent push to make the discount window more accessible to banks moving forward. You've seen a lot, so I imagine that you have an amazing biography, or some book that you can write at some point in your future [with] all of the changes and all of the experiences that you've been through. I want to go back to the St. Louis Fed, though, because that was a unique Federal Reserve Bank itself, and I think that many of our listeners know it very well for FRED, the amazing data service that you provide there. But what else is it known for? How would you define the St. Louis Federal Reserve Bank?

Bullard: I think that the St. Louis Fed is iconic and a great national resource for the country. I think it's been known as the place that really does nitty-gritty monetary policy in exasperating detail, but I think that serves us well with, we know all of the arguments, we know all of the data, and we're able to try to bring our best judgment to policy. So, I think that part is great, and I think that we've served as a leader within the system over several decades, maybe even 50 years, but now, many other banks also have research departments that are very strong and very powerful. So, I think that this has been good for the whole enterprise.

Bullard: I think that the US system, where you have decentralized groups thinking about monetary policy and weighing in on it, is one of the great strengths of US policymaking, and one of the reasons why the Fed has generally been pretty successful. So, on the production side of the house, we also provide a lot of services to the U.S. Treasury. We're actually the point bank for Treasury services within the Federal Reserve System. A lot of that is saving taxpayer money by upgrading systems in various ways. And so, we've had a lot of success on that dimension. On the banking side, the banking regulation side, it's all about community banking in the 8th District. There, I think, we've done a leading job in thinking about how to have a great regulatory framework for smaller banks in America as they're trying to navigate through a complicated financial landscape.

Beckworth: Well, one thing that I've appreciated about the St. Louis Fed beyond just FRED and knowing you, Jim, is its work in the past on money. The St. Louis Fed took money seriously. A lot of old monetarists were there in the years past. Then, it evolved into a number of new monetarists or people that do monetary search models, including your former colleague, Chris Waller. But Stephen Williamson was visiting there, David Andolfatto, people who took money and monetary liquid assets seriously in their thinking. I really love that about the institution.

Beckworth: Then, Jim, I believe that you're one of the few people at the FOMC who developed a fondness for nominal GDP level targeting, which, to me, is, again, a modern version of monetarism, at least one way to look at it is. So, I appreciate that you did that, and all of the work that your bank did going forward. Well, let's move into a topic that I'm dying to chat with you about, and that is FAIT, or the flexible average inflation targeting framework that was announced in 2020. And we'll talk about, shortly, the upcoming framework review, which should start anytime soon here, sometime this year, and then go into early next year. But [the] flexible average inflation targeting framework— I recall very vividly, and I was very excited when I saw you in an interview, Jim, say, "Oh, this is very similar, in spirit, at least, to nominal GDP level targeting or price level targeting. It has this element of makeup policy." Do you still feel the same way, and if so, how do you make that connection?

Comparing FAIT and Nominal GDP Targeting

Bullard: Yes, it does have some of that flavor. You've got this idea of a makeup strategy as a way to influence expectations when inflation is too low for too long and nominal interest rates sink into a very low nominal interest rate environment. So, it does have some of that flavor. I don't think that the committee— not everybody on the committee would interpret it that way, and I think that you have to have big tent language to make sure that you can bring everybody along on what the framework would be. But I would say this, a couple of things about it. We worked on it during 2019, and the idea was that we would be done in January of 2020. Now, it wasn't quite done in January of 2020, but this shows you that you should stick to your schedules, because by the time you got to mid-February or late February, it was looking like pretty cloudy weather.

Bullard: And sure enough, the pandemic was upon us within about 10 days after that. So, I think, unfortunately, then, we had to bring that out as part of the Jackson Hole [Conference] in 2020, which is right in the middle of a pandemic, and the timing didn't turn out to be so great. And, of course, the world, since right after that, started to turn upside down again, and many of the things were important to say in that document, but, obviously, the pandemic had pushed things in a very different direction.

Beckworth: Yes, I recently had Rich Clarida on, and he talked about the history or the development of FAIT. I was really surprised to learn that FAIT could have been introduced much earlier in the year, just like you mentioned. He shared that it was ready to go, and then things got postponed because of the pandemic. So, that was really fascinating, to learn that fact. Let me give you the case that I make to some folks of why FAIT is in the spirit, or at least in the direction, of nominal GDP level targeting. You can give me feedback and tell me what you think about this.

Beckworth: So, mentioning Rich Clarida, he had a speech where he invoked the temporary price level target that Bernanke first talked about, I believe, in 2017. He said, "Look, FAIT is kind of like a version of a temporary price level target. It's asymmetric in makeup. It makes up from below. It doesn't do it from above." Bernanke was very explicit as to why he wanted a temporary price level target. One of the reasons, he said, is because if you have, say, for example, a negative supply shock that pushes the price level up, do you really want to invoke a recession to bring it down?

Beckworth: As opposed to, if you have inflation low, and it's persistently low because of, like, a zero lower bound environment, weak demand, you want to bring it up. And a nominal GDP target does, effectively, that. It effectively sees through supply shocks, because it's focused just on demand, and it's a level target, so it does make up policy. So, to me, when I look at the intellectual history of FAIT, at least as Rich Clarida put it, going back to a temporary price level target, it looks very similar to what a nominal GDP level target would look like. What are your thoughts?

Bullard: No, I think it is pretty similar, and I think it has some of those ideas in it. I've not liked the asymmetry aspect to the way people have talked about this, and that seems like you'd be shifting inflation targets around in certain circumstances. That sounds like a less credible inflation target to me. So, I think that, ideally, you would like to not have that feature. So, one thing that I've been thinking about is that you have one set of policies for the below target inflation situation, sort of, broadly speaking, the Japanese situation. Then, you have a different set of policies when inflation is well above target, as we are now.

Bullard: When you're way above target, I think that everyone implicitly agreed that, well, in that case, obviously, you're going to raise rates a lot and try to get inflation back down to target. So, there wasn't much disagreement about that, and that was what we learned from the Volcker era. And so, that was always sort of implicitly in the background. Sometimes people would say things like, "Well, if inflation is really high, we know what to do about that," as if it was easy. But when inflation is particularly low, then you have a new set of problems. Because of the effective lower bound, you can't go low enough, and people have written all about this and talked about it. So, I do think it's important to address both situations.

Bullard: Maybe one thing that they could do in the next round here is to just more clearly delineate those two possibilities. [If] high inflation develops, for whatever reason, we'll do what Volcker did, and if very low inflation develops, for whatever reason, then we'll do something more like what was outlined in the 2019, 2020 framework review. So, that may be too complicated, but I think that's the reality of central banking today, is that you have to be able to handle both situations. Then, in addition to that, maybe you've got ordinary monetary policy when inflation's just right around the target and you're moving the interest rate in response to macroeconomic events.

Beckworth: So, you're touching on the asymmetries within FAIT. There's both the asymmetry for makeup policy, it’s below 2%. You just resort back to the regular flexible inflation target above, but many people were surprised, or caught off guard, by that, I believe. They didn't fully understand what FAIT was. The other asymmetry, though, is with maximum employment. Now, it's just shortfalls from maximum employment. It almost invokes a Milton Friedman plucking model vision. Do you think any of those— just generally speaking, which one of those would you want to change more, or do you see as needs more improvement than the other? You just alluded to having a regime dependent approach, but [are there] any of those that you would tweak?

Assessing the Current FAIT Framework

Bullard: Yes, I thought that the shortfalls language did a better job of how the committee actually thinks about labor markets. I thought that we were communicating more effectively. And I think, instead of conforming to the literature, which has deviations and linear quadratic ideas, why do that? Why not just admit that you have an asymmetric loss function with respect to unemployment and then design optimal policy around that? So, I think that it helps the committee a lot to not be saying, "Hey, we're trying to get inflation down by throwing a lot of people out of work." Because I don't really think that people on the committee are thinking that way.

Bullard: And also, to get rid of the idea that that's the only thing that's driving inflation, the Phillips curve. The only reason you ever have inflation is that unemployment is too low, and I don't really think that the Phillips curve is holding up very well in the data. And, certainly, quantitatively, it's not a major factor in most situations. I think that it would be very hard to ascribe the most recent inflation to a Phillips curve framework. So, you have to appeal to something else. I think it's better to say that we'd like to have-- Our goal is to have low and stable unemployment. If it's low enough and stable enough, then we're satisfied with that. It's not like we feel like it's too low.

Beckworth: That's really interesting. So, you're saying that the sense that you read from the committee is that many of them did not see the Phillips curve as the most important or the only factor in the inflation process during that time?

Bullard: Well, you'd have to ask other members, but I think that if you look at the empirical evidence, it's not very strong. So, even if you look at Emi Nakamura of Harvard, she's done some re-estimates based on different methods, sort of decentralized methods of estimating the Phillips curve, and she gets about the highest estimate that you'll see, and it's a 0.3. So, 100 basis points of unemployment above the natural rate would cause three tenths of inflation above target. But other estimates, like Stock and Watson, are closer to zero, and you really have to stretch and work to get any estimates that are far away from zero. So, I just think that we don't want the public to be so fixated on this as the main tradeoff, when I think, really, what's going on is that expectations of future policy are really what's driving inflation today.

Beckworth: So, you could still use a New Keynesian Phillips curve. You're just going to say that that parameter, that weight in front of the output gap or slack term, is very low, but the expected inflation term is very important.

Bullard: After you look at the baseline New Keynesian model, the coefficient on expected inflation is close to one. It's actually beta in that model, so it's close to one, and the coefficient on a calibrated version of the output gap would be less than one tenth. It's even 0.025, I think, in some calibrations. So, it's pretty low. Not only that, [but] that gap in that model is the distance between the flexible price level of output and the sticky price level of output. So, the flexible price level of output is something that would be moving around tremendously with real developments in the economy, and that is— in the policy world, they don't do anything like that. They always take it as a deviation from steady state or a slowly moving trend.

Beckworth: So, one comment that's been made by former Fed officials, and some commentators as well, is that the FAIT strategy itself isn't so problematic. It was the forward guidance given with it— I believe it began later that year in 2020— that set these conditions that we wouldn't raise the target rate until we've been above 2% inflation for some time, and we know that we really have hit maximum employment. Do you feel that that language in the statements really made that much more difference than the understanding that was laid out, initially, about the FAIT framework?

Bullard: It's true that the December FOMC had more language in it about the dates at which, or the conditions under which, the Fed would switch to a more hawkish policy, but I would just talk— and I don't think this had much to do with FAIT or the framework. I think it had to do with December 2020. If you think about where we were, the pandemic had been going on for about nine months, and, obviously, [there was] a huge recession and unemployment [was] still very high, and the level of employment [was] still well below the pre-pandemic trend.

Bullard: So, the mentality at the time was, still, that this shock was going to be like the global financial crisis shock, in the sense that it would take many, many years for the economy to fully get back to trend, and a lot of the rhetoric at the time was that this is not going to be V-shaped. This is going to be an L-shaped recovery, and all of those kind of things. So, there's a lot of fighting the last war, and I would actually give credit to former Chair Ben Bernanke, who, I think, had a better analogy for the pandemic. He said that it's like a big snowstorm, and you have to wait for the snow to melt, but it's really just waiting for the snow to melt.

Bullard: So, it's not a fundamental disruption, the way that the financial crisis was, and you shouldn't necessarily expect this very long recovery. Well, if you look at the data now— it's about GDP anyway— It's about as V-shaped as anything that you'll ever see, and so I think that just this misreading of it and this kind of rhetoric around the idea that we were going to be in a very, very long recovery period, and so, therefore, if that's what you thought, then you should say, for monetary policy, look, we're not going to deviate from our balance sheet policy or our interest rate policy for a couple of years at least, because we think that the recovery is going to be so slow.

Bullard: Now, what happened right after that— so you get into the first quarter of 2021, second quarter of 2021, [and] the economy is growing at about 6% during the first half of that year. Unemployment is coming down very fast. Then, you’ve got these extra fiscal impulses at the very end of December 2020, because of the Georgia elections. That was bipartisan. Then, the Democrats come to power, and they put another bill through with a lot of the fiscal spending being the type that goes directly into people's bank accounts. So, I think that this is about as close to money printing as you'll ever get.

Bullard: It's those two fiscal things combined with the policy of the committee, which was to project super easy monetary policy well into the future, that sort of led us astray. Now, there's a lot going on here, so let me just talk about it a little bit more. So, in the spring of 2021— and I do think it was a bit of a miracle— but we had these pandemic vaccines coming out. So, you're starting to get people vaccinated in March. Then, most of the adoption was in March, April, May, and June of 2021, and there's a lot of noise around that and everything, but everybody that wanted to could probably get a vaccine during that time.

Bullard: You would have thought that that might have brought the pandemic to an end fairly quickly. Actually, deaths per day, per million, as of about July 10th or so were below one in the US. So, it did look like this had all been quite successful. Many things happened after that, but I think that, at that point, it was clear that you were going to get the pandemic under control, and the economy continued to grow at a rapid rate, and then the inflation was showing up because of the sort of money printing type of fiscal policy that we had. Then, you had to start to act much sooner than we had projected in December of 2020. That is only six months.

Bullard: I'm only covering a six-month period here, but things changed dramatically during that period. I actually went on TV shortly after the June 2021 meeting, and I was saying, "Sorry, the economy is really growing rapidly. It looks like we're going to have some inflation here. We're going to have to get more hawkish." At the time, more hawkish just meant that you weren't going to keep the policy rate at zero out into 2024. You were going to have to raise the policy rate much sooner than you had previously thought. People in markets were very upset with those comments, but I think that just shows you how fast things were changing as we were trying to come out of the pandemic there.

Beckworth: Let's talk about that V-shaped recovery. It was truly remarkable. As you know, in 2008, we did not have that V-shaped recovery, but [now], we did, and it surprised many, including myself. And I guess my question to you is, do you attribute the amazing recovery to the fact that it was a large supply shock, a snowstorm, or to the incredible support and policy from fiscal policy and monetary policy, some combination of the two? Why did we get the amazing recovery, where real GDP is now back on its pre-pandemic trend path, that we didn't get in 2008?

Evaluating the Recent V-Shaped Recovery

Bullard: I would give a tremendous amount of credit to the response during March and April of 2020, so, right during the onset of the pandemic. You had things being passed through Congress, and you had-- A lot of credit goes to Chair Jay Powell and Steve Mnuchin, then the Treasury Secretary. I think that everyone in Washington, to their credit, saw that, "Well, this is going to be really big, and it's going to be a really big disturbance." They had pretty good ideas, on the whole, about how you could protect the economy and move fast enough to actually get it done.

Bullard: And so, I think that response was very good, and that helped us. And the main thing that that helped us with is that there could have been a financial crisis, let's say, in the second half of March 2020 and [in] the first half of April 2020. It could have spiraled out of control, and not only would you have a pandemic, but you'd also have a financial crisis, and this would lead to the Great Depression or something. So, I do think that it was a dangerous situation, but because there was so much activity, and on such a scale, we were able to prevent the financial crisis from happening. Then, you got to the May jobs report. 

Bullard: Just to put in people's minds how volatile this was, Wall Street was thinking that the May jobs report would be minus 10 million or so. It was actually plus three million, so it was the biggest miss of all time, of the Wall Street consensus. So, it just shows you what a shocking turnaround there was at the time. But anyway, I do think that that initial response was critical. What didn't go so well is that Congress wanted to repeat the trick of that in December 2020, and again in March of 2021. Both of those bills were not really in response to any new pandemic that was coming along or anything. And, by the way, you had vaccines that had been developed, and you knew that they were going to be implemented.

Bullard: Both of those were purely political stories; one about the Georgia election, and one about a party coming to power. So, at that point, you had a lot of borrowed money going directly into people's bank accounts in conjunction with a very easy monetary policy. So, that sounds like a recipe for a lot of inflation that has proven itself over many different times and places in monetary history. So, that's why I've emphasized the war interpretation of this inflation, is that if you're going to spend a lot and combine that with a monetary authority that's expected to keep rates low to help the war effort, that's known to generate a lot of inflation in a lot of different circumstances, and that's what I think happened here. But it was mostly about those last two fiscal impulses, not the first one, which I think was appropriate.

Beckworth: Okay. Well, let's move from talking about this period in the pandemic, the policy response, and let's talk about the future here. We've touched on it already, but the upcoming Fed framework review of 2024-2025, and you are no longer a part of the FOMC, but you know people well there, you know the Fed mindset, the culture, and you know what just happened. What do you suspect that they're going to be focusing on or thinking about? How big of a change, if any, would they make to the FAIT framework, in this review that's coming up?

What to Expect from the Upcoming Fed Framework Review

Bullard: Yes, I think that when people from the research world talk about this, they probably have too big of expectations, because they have models, they have-- They want, maybe, bigger changes than can really be accommodated by the committee. So, I think that when you look at what the framework really is, it’s just these paragraphs that state that, "Here's what we're generally trying to do," and I think that the most you can do here is tweak this somewhat, from where it is today, and try to get at this idea that, if inflation is high, we're going to do what Volcker did.

Bullard: If inflation is exceptionally low, we might do some quantitative easing, we might do some forward guidance, and we might even allow some overshooting a little bit, in that circumstance. When people were talking about overshooting in 2019 and 2020, they were talking about something between 2.1% inflation and 2.5% inflation. So, if you were the 2.5% guy, you were like the super dovish guy. So, just nothing like the 7% or 8%, depending on how you measure it, inflation that we got post-pandemic. So, I think the most that we can do is sort of tweak. So, I think that commentators should think of that, or should talk about that— whether that's what they want— and how to get this idea that, in a high inflation situation, you're going to behave one way, and in the very low inflation situation, you're going to behave another way, and then there would be ordinary monetary policy in between.

Beckworth: Well, I am that person who is guilty of hoping for too much for this Fed framework review. As you know, I'm a champion of nominal GDP level targeting, so I keep beating the drum, but I realistically expected what you just described, more of a modest tweak to the framework. In addition to tweaking the FAIT framework, do you foresee any changes to the SEP, or any more details about, say, balance sheet policy, in the framework statement, or is it just going to be about FAIT itself?

Bullard: Yes, so, the framework has flaws in it, but it's just been impossible to get the committee to really agree on enough to put more in, I would say, with respect to balance sheet policy in particular. I haven't said too much about it because it's unclear to different members, I would say, how important balance sheet policy really is. And is it maybe more potent in certain situations and not other situations? How would that affect things? How do you unwind balance sheet policy, which the committee is trying to do now? So, I think that, on the balance sheet side, and then even more fundamentally, I think, on the financial stability side, it's been very hard to get the committee to talk about the interaction between monetary policy and financial stability. 

Bullard: Would you be willing to have an easier monetary policy if you thought that financial stability was threatened? That's something that goes all the way back to Greenspan's irrational exuberance speech, and the committee debated this [for] over 20 years. They haven't debated it as much recently, but that's another place where, in an ideal world, you would have a comprehensive statement about, what do you really think about financial stability and monetary policy? They just haven't been able to agree on it. So, what's omitted, in some ways, is just as important as what's actually in there. I don't know if they can make progress on that. But if they do make progress, it has to be big tent language where lots of people can say, "Okay, I agree at this high level about these kinds of issues."

Beckworth: What about the SEP, the Summary of Economic Projections? Are you happy with it? And maybe this review is not the place to discuss it, but let's just throw it out there. Are there things you would change about the Summary of Economic Projections, to make it more effective?

Improving the FOMC’s Economic Reporting

Bullard: Yes, there are, but that won't be part of the review, because that's [inaudible] the statement. So, I think, on the SEP, many things are odd about it. One is that the various dots aren't really connected. So, you're not sure which unemployment dot is supposed to go with which interest rate dot, or which growth dot. So, that's a confusing aspect there. You don't know which dot is the Chairman's dot. So, that's another confusing aspect. The horizon changes as you go through the year. I think that's odd. That actually makes the September SEP very, very strange, because you're really just projecting out for the November and December meetings. And so, you're committing to what you're going to do at those meetings once you get to September. I've always felt like that, sometimes, put the committee in a poor position at the end of the year, if the data is not matching what they thought it was going to do.

Bullard: So, there's a lot to do better, here. I've advocated, for a long time, that you should just have a monetary policy report, which is quarterly; something like what the Bank of England has done or the ECB would do. And it's been hard to get people to agree to that. In my mind, you wouldn't have to all agree. You could just let the staff put out a forecast, and then the individual banks could maybe just comment on that forecast that, “I think that unemployment is going to be higher or lower than what the staff forecast has,” or whatever, or they just put out their own if they wanted to.

Bullard: So, you could do something like that that would be more comprehensive. And what would be good about a quarterly monetary policy report would be that it would be a thicker document, and then you could do various scenarios. You could talk about hurricanes and what impact do you think that's having, and what about the war in Ukraine or in the Middle East? Is that impacting things, or what are the estimates around that? So, you could talk about a wide variety of things that are hard to talk about if you're just going to reduce everything down to a couple of dots.

Beckworth: So, would you replace the SEP altogether, with this quarterly report?

Bullard: Yes, I think that would be better.

Beckworth: Okay, so, you're suggesting that, among other things, a quarterly report, as opposed to the SEP. If you keep the SEP, you would connect the dots so that you could see the underlying model or reaction function that's implicit behind them, [and] then, also, identifying the Chair. On that one, I want to push back on this a little bit. If that were available, would people focus only on the Chair’s numbers and ignore everybody else, if that was available?

Bullard: Yes, they would.

Beckworth: Oh, that's the point. Okay.

Bullard: Yes. But I think that the chair doesn't want to do that, but the Chair's dot is in there. So, everyone is trying to guess what that is. But that's why I say, just maybe do something more like a staff forecast, and then put that out as part of this wider monetary policy report. Then, everyone could just say, relative to that forecast, “maybe I'm a little more hawkish or a little more dovish,” and then everyone could reveal their ideas, relative to that. But a lot of it is just the cumbersomeness of putting these things together on a quarterly basis, and how valuable are they to markets, really?

Beckworth: Okay, now, the Fed framework review is coming up soon. Last time we had this— something I really appreciate about you, Jim, is that when Lars Svensson gave a presentation on his paper, he kind of dismissed, out-of-hand, nominal GDP targeting. And as I recall, you got up, I guess, at the Q&A part, and you kind of pushed back a little bit. A few people did, [and] you were one of them. Now, unfortunately, you won't be there for this next Fed framework review, to push back. My hope is that we get some conversation, at least, about nominal GDP targeting. So, yes, I'm under no illusion that we're going to go there, but just have it on the table, talk about it. We're doing what we can at Mercatus to make sure that happens. But tell me, how did you land on nominal GDP targeting? Because you weren't always an advocate of it, but you did end up there. So, tell us your journey to becoming a proponent of nominal GDP targeting.

The Case for Nominal GDP Targeting 

Bullard: Well, it really comes from the research side of my life, and I have a new paper that's going to come out in the IMF Review, which is having a special issue on the future of macroeconomic policy. So, during my tenure as president, I got a lot of questions about, don’t low interest rates hurt savers? How does monetary policy impact the income distribution? A lot of things like that, and I wanted to build a model that could address these types of questions, because I didn't think that we had— I still don't think that we have very good answers to these kinds of things as macroeconomists.

Bullard: And they're kind of fundamental questions. People are asking— outsiders from the literature are asking very reasonable things of us when we still don't have very good models. So, since I do a lot of life cycle models— I built, with my co-authors, a life cycle model that has enough richness in it that you can answer these kinds of questions and, at least, talk about it from a basic toy model point of view. You get Gini coefficients that are close to the data. You get an array of macroeconomic policies that you would need to get the optimal allocation of resources.

Bullard: The point of the paper is to say that there are some frictions in the economy, both in the model economy and, also, out there in the real economy, but there are also some policies that can mitigate these frictions. And if these policies worked well, then you would be able to completely mitigate the frictions with this set of policies, and the policies that turn out to be on an unidealized unemployment insurance program, some redistribution across agents to hit a desired level of the consumption Gini, and some issuance of debt that would provide an extra asset in the economy. But the main thing is a monetary policy that looks like nominal GDP targeting.

Bullard: Now, how does that happen? That's because I've become enamored with the idea that the main nominal friction in the economy is nominal contracting. We all contract, on a daily basis, tens of trillions of dollars, I guess, in nominal contracts. So, this means that we agree to borrow and lend fixed nominal amounts at fixed nominal interest rates. So, it's known, in economics, that that's not optimal. Those contracts should not be fixed in nominal terms. They should be responsive to the real growth in the economy, which is a stochastic thing.

Bullard: So, what happens in the model is that the nature chooses the real growth rate of the economy. But what the monetary policymaker can do is make sure that the expected rate of nominal growth is the one that was in place when the contract was signed. So, if you're going to borrow for a house and you're expecting 10% nominal growth, and then nature only chooses, let's say, 5% real growth over that horizon, then the policymaker's role is to provide 5% nominal growth so that the person that borrowed has enough resources to pay back, in nominal terms, that contract. So, if you do that, you'll actually get optimal contracting, and it'll completely mitigate the nominal friction. So, this is why I've gotten into nominal GDP targeting. Then, there are lots of interesting things that can be asked from there about this, but in the basic case, if there was just ordinary IID shocks, and the policymaker could move the price level at every period, it would be pure nominal GDP targeting.

Beckworth: Fantastic. I'd like to throw out the past crisis that we went through. The pandemic is an illustration of what you just said. Now, it's not a perfect illustration, there's a lot happening, but you can think of all of these nominal contracts [and] people who had signed mortgages, leases. We hit the pandemic, incomes temporarily collapsed, but the government steps in and restores nominal incomes, and we don't have a major financial crisis. So, the fact that nominal incomes were preserved, I think, speaks to what you're saying there. But what you're making is a financial stability argument, one that kind of fixes an incomplete market story for nominal GDP targeting.

Beckworth: And let me tell what I consider the layman's version of your very sophisticated argument. Correct me if I'm wrong here, but this is how I would tell it. If we had nominal GDP targeting, and in a perfect world, the Fed could implement it and do it perfectly, [then] there would be no demand shocks. Demand would be completely stabilized, growing along some targeted growth path. So, what you would have would be supply shocks. And if you only had supply shocks that created recessions, you would then have counter-cyclical inflation. So, a negative supply shock hits, the economy tanks, [and] inflation goes up. Vice versa, [if there is a] positive supply shock, the economy sores, [and] inflation falls.

Beckworth: Well, if you have counter-cyclical inflation, then you're going to have a pro-cyclical real debt burden. So, you've got these fixed nominal debt contracts. During a recession, for example, the inflation goes up, your real debt burden goes down. During a boom, the flip is true. Inflation falls, your real debt burden goes up. So, you have real debt burdens moving in a way that is stabilizing, and some have said that it's effectively turning nominal debt into something that acts more like equity, because the real debt burdens are shifting. You're sharing risk appropriately between creditors and debtors.

Bullard: That's exactly right. What the monetary policy would be doing is turning non-state contingent nominal contracts into state-contingent real contracts. That's equity share contracting, which is known to be optimal from the literature, at least for homothetic preferences. So, that's exactly what this means. What we should be doing, but we would never do it in the real world, is saying, "I'll pay you back over the next five years, depending on how many raises I get, in real terms, and how well my career goes, and the lender should accept that I'm going to somehow report this accurately” and everything. So, we never do this because I think that there are real frictions to doing that kind of thing, but from a contracting point of view, that's what you should do if there was perfect information. That's definitely the spirit of it, and that's definitely what's going on.

Beckworth: If you're an advocate of state-contingent debt contracts— which many people were after the great financial crisis— [then] you should also be an advocate of nominal GDP level targeting.

Bullard: That's right.

Beckworth: I'll leave it at that.

Bullard: I will say that, given these seminars and stuff— and sometimes you get people reacting, saying, "Well, what you should do is change the contract so that you have real contracts out there." I think that that's actually a reasonable economist’s response, but I don't think that's going to happen. I think there are good reasons, probably, why we do nominal contracting, because of what I was just saying, and that you probably won't see real state-contingent contracts anytime soon for most things. So, in that sense, I think that the monetary policymaker has a clear role to play.

Bullard: And let me just say, also, that I think that the time horizon is important here. So, I think what you're really talking about is over, maybe, five years into the future. So, the firm is going to borrow in nominal terms. They're going to pay a certain fixed interest rate on that. They want to make sure that they've got the nominal income to pay that back five years from now. So, if you're providing a nice monetary policy, then this works very well. If it's a volatile monetary policy, [then] you're introducing additional uncertainty into that contract that might not have anything to do with whether the business was actually successful or the investment was successful or not.

Beckworth: So, Jim, let me throw out the other arguments that have been made for nominal GDP targeting, and, apparently, these did not excite you enough, earlier on, to get you on board. One story is, well, it's great. It's useful when we have limited information, in terms of supply shocks. We don't know what's happening on the real side of the economy, so let's keep it simple. Let's just focus on stabilizing demand. Another one is, it's a good nominal anchor. These all kind of overlap, but it's a good zero lower bound tool, makeup policy, which is true for a number of other makeup policies. It's also something that could be viewed as a velocity-adjusted money supply target for monetarists, but you see it as its linchpin. It's a really convincing point, the financial stability argument.

Bullard: Yes. I think that those were practical arguments, and I come from a wing of the profession that was skeptical of sticky prices as a fundamental of why we want to have the monetary policy that we have. I think that the Calvo pricing idea has been carried about as far as it can be, and I use it myself. I'm not totally immune to it, but I never liked it, because the prices are moving around for good reasons, and there's supply and demand in all of these markets. And actually, this era, right here, was one where I thought that this is exactly what happened. Inflation went up, and all of a sudden, everyone that I talked to— they were changing their prices every week, and they would not guarantee prices out more than 7 days or 10 days or something like that, whereas they used to say 6 months, they didn't say that anymore. And the ones that didn't got burned on that, because they signed contracts that were way out of date, even three or four months in the future.

Bullard: So, I wanted to say one thing about demand shocks and supply shocks. So, one thing that we did in the model was— we did something that I think is profound, and it's not our idea. It's Victor Rios-Rull and co-authors, Kjetil Storesletten, I guess, and I'm forgetting the third co-author, I apologize. But they had a paper that was called, [*Demand Shocks as Technology Shocks*]. They have the idea that you have this restaurant model. So, the restaurant model is that the restaurant is set up during the day, and you get your staff lined up to work, and then you wait and see who shows up at the restaurant.

Bullard: If a lot of people show up at the restaurant, they have to work pretty hard to provide all of the meals, and if not that many people show up, then it's a light day for work. So, if you put that kind of shock into the preferences, and you make enough simplifying assumptions, [then] that will come right back out and show up in the front of the production function just like a supply shock would. But I think it gets at this idea— When I'm thinking about how much I want to consume in the future, I'm not sure how much I want to consume.

Bullard: I might be euphoric that day, [and] I might want to consume a lot. It might be a sunny day, and I want to consume a lot, or it might be a bad day, and I want to not consume much. So, if you have that going on at the aggregate level, and then you have it come back into the production function, you can talk about demand shocks or, really, supply shocks after all. They have a far more sophisticated version, but what I just told you is a simple version. Then, you get this thing that you just described, which was that all of the shocks that are going on, demand and supply, are affecting production in the same way that a technology shock would. Therefore, you can make the statements that you're making, that that actually makes nominal GDP targeting the optimal monetary policy no matter where the shocks are coming from, which has been a longstanding confusion, I think, in the literature. So, I think that there's a lot to say on this, in the years ahead, [in] the research world.

Beckworth: That sounds very promising. Alright, let's look ahead at the profession and monetary policy in the time we have left in the show, and I want to do so in terms of R-star. Where do you think R-star is going? And I specifically want to bring this up in the context of a talk you gave in 2018, sometime around then, where you talked about R-star, and you actually gave it another name, R-dagger— being dependent on the regime; a low-growth regime, a high-growth regime. It seems to me that this would be a great time to apply that concept, because are we truly entering a new high-growth regime and expect higher R-star permanently, or is this just something we're experiencing temporarily? Where do you land today on that?

The Future of R-Star

Bullard: Yes, I think that listeners who want to look into this could look at the *R-Star Wars* slide deck, and I think that they're archived.

Beckworth: We'll provide a link in the show notes to it.

Bullard: The concept was that there are three things that would affect your steady-state real interest rate. One would be the growth rate of technology or productivity. Another would be the growth rate of the labor force. And a third would be the demand for safe assets. You could think of all of those as following regime-switching processes. So, you get that the '80s would be a period of high labor force growth, high growth in productivity— I'm not sure you can actually make that case— and low demand for safe assets. Then, it goes the other way, and then all of these things switch as you go through time, and you end up with all of them in the state that produces the lowest R-star.

Bullard: Now, the question [is], if you take that view, you would have to ask yourself, is anything really changing today? I've struggled with that a little bit, to argue that R-star is moving up, unless you think, of those three, the demand for safe assets was the most important. Is that really changing today? I don't know. Maybe the rest of the world is issuing more safe assets. Maybe some private sector assets are considered close substitutes to sovereign debt, so that you might have more assets out there than you used to. But if those are the things that you're talking about, another place could be that you get a regime shift in productivity growth. The models that I follow say that that's not quite happening yet, but it does seem like there's a lot of great technology out there that might drive that in the future. So, I think those that are saying that the real interest rate, R-star, went from a minus two to a plus four— that's a pretty tough argument to make unless you've got some very drastically different concept of what we're talking about.

Bullard: But I think, sometimes, people have very short time horizons in the mind, and they're just saying that this thing is fluctuating around a lot every day. But that isn't the spirit of the original types of analysis, like Laubach-Williams. They just had the that the idea real interest rate was quite high by most metrics in the '80s, and by the time you got to the 2000s or the 20-teens, this thing was down 600 basis points from where it used to be, and it didn't look like it was going up. So, if you have that type of analysis, [then] it's hard to see what has changed to, all of a sudden, make the R-star much higher.

Beckworth: I'm sympathetic to that. It seems like a lot of the structural forces that we had prior to 2020 are still in place. Maybe there's been a level shift in the supply of safe assets, but the growth pattern seems to be the same. I guess what's been striking to me, Jim, is that, in 2008, R-star fell so dramatically, [and] relatively quickly too. And if, in fact, it has gone up, it's another dramatic reversal in a short period of time. So, I guess that time will tell what actually is the final verdict on this, but the changes have been remarkable.

Bullard: It’s been a lot, and it is an important consideration for policy, but I'm not sure at the sort of short horizon frequency, like people in markets sometimes talk about.

Beckworth: Okay, well, with that, our time is up. Our guest today has been Jim Bullard. Jim, thank you so much for coming back on the program.

Bullard: Thanks so much for having me.