Reading of Richard Clarida: falcon or dove?

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The US Federal Reserve is in the process of appointing a new vice president: Richard Clarida has been appointed to fill the vacant vacancy opened by Stanley Fischer's departure in October. Professor at Columbia University and Executive Director at Pimco, Clarida has extensive experience in the money economy and financial markets. This experience provides a rich paper trail to try to understand his views and how he might influence the central bank.

Richard Clarida

Bloomberg News

Let's start with a detailed presentation that he gave in 2010 to the Boston Federal Reserve. There are two things to note.

First and foremost, Clarida admits that he played a key role in building consensus before the crisis and that this consensus was flawed. The antediluvian view was that monetary policy makers should focus on consumer price inflation – and nothing else. The price of assets, household debt and the leverage of financial institutions were all judged irrelevant because the system was indeed "self-regulating". Should a crisis occur anyway, aggressive interest rate cuts would be sufficient.

As he said:

The supervision and regulation of US investment and commercial banks during the great moderation was based on an assumption about how the financial system was supposed to work, not on a sufficient knowledge of its actual functioning.

While Clarida was complicit in these mistakes and seemed to be repressed by the crisis, he felt that financial supervision and regulation needed to change more than the way central banks set interest rates. His later writings do not seem to suggest that he revised his opinion.

Clarida's real-time policy recommendations on how to respond to the crisis were even more important. To simplify to the extreme, it was more "dovish" in 2010 than most, if not all, of the Fed at the time.

Clarida thought that the Fed could effectively respond to downturns by pledging to buy as many bonds – including mortgage bonds and corporate bonds – as needed to "cap "interest rates at the desired levels:

Much of the existing literature totally misses or underestimates the ability of an LSAP program [large-scale asset purchase] to reduce bond yields and / or credit spreads … a central bank can always and everywhere set a floor for everything nominal asset price (or a set of nominal asset prices) as long as it wishes … As long as the central bank is willing to buy an unlimited volume of these bonds (potentially the entire outstanding stock) at the interest rate she wants to cap on, it will succeed. And of course, the above reasoning also applies directly to an Lsap program for corporate bonds or mortgage-backed securities.

The Fed managed to limit the borrowing costs of the US government in the 1940s. This experiment was cited by its services in mid-2003. Although the idea failed to appeal to US policymakers, the Bank of Japan has successfully used "yield curve control" to limit returns on Japanese government bonds. since 2016. Clarida's position in 2010 suggests that he would be interested in something similar, perhaps also including a mortgage bonds and corporate bonds, should he be at the Fed at the next slow-down.

Clarida has also spent time developing and explaining what he calls a "Taylor rule of the future." He came back to this idea in several subsequent articles, so it is reasonable to think that he takes it seriously.

The basic idea is that central bankers should use market prices to guide their expectations in the economy, and then set the interest rates accordingly. Instead of looking at the current inflation rate, the Fed would be more concerned about the rate of inflation implied by the yield difference between US Treasury bonds and the Treasury's US Treasury-protected securities. . Instead of assuming that the "real neutral interest rate" is still 2%, the Fed should use the 5-year TIPS yield that starts in five years. *

The Clarida policy rule looked like this:

According to the privileged policy of Clarida, the Fed would have reduced short-term interest rates to -10%, or at least bought enough bonds to generate an equivalent effect.

It would have been much more aggressive than what actually happened. Jing Cynthia Wu and Fan Dora Xia have calculated "ghost rates" for the Fed, the Bank of England and the European Central Bank, although there is no single way out of it. Estimate the impact of Fed bond purchases. They believe that the Fed – at its lowest margin – has only made the equivalent of a reduction in the short-term interest rate to -3%.

Clarida's most recent scientific papers are less revealing of his views, but his frequent contributions to Pimco support the view that he tends to move towards the end of the Brainard / Evans spectrum.

In April 2011, he was very concerned that inflation would slow down as Americans revise their expectations for price increases in the light of recent experience. In February 2014, he seemed to support the idea of ​​making sure that the Fed targets the price level rather than the annual inflation rate. (The difference is that a central bank targeting the price level will attempt to compensate for exceeding or exceeding the target, while the current practice is to "let the past go". year, he argued that the acceleration of wage growth was not necessary. cause an acceleration of inflation.

Perhaps the most significant is that Clarida had correctly anticipated the gradual realization by the Fed that interest rates would be much lower in the future than in the recent past. He warned in 2015 that the Fed should "remember that the slowdown in potential growth that reduces the output gap is also an" obstacle "to demand, which would influence the pace of rate hikes as well as the final destination of the average policy rate. "

Last July, Clarida claimed that long-term bond yields remained stable despite the continued tightening of the Fed, as "the market has – and the Fed approves late – a new neutral for monetary policy (which Pimco had affirmed). for the first time in 2014) with a fed funds neutral rate much closer to 2% than the former neutral 4%. "

Another thing to consider: Clarida warned the Fed not to overreact to tax cuts and increases in spending. It was a sound advice, but it probably did not prevent him from being exploited for the position of vice president.

* The calculation is (yield of 1 + 10 years) ^ 2 / (yield of 1 + 5 years) – 1

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