How would Nobel laureate Bob Shiller approach tapering? Photo courtesy of Flickr user Bengt Nyman.
The Federal Reserve celebrated its centennial Monday, marking the 100th anniversary of the Federal Reserve Act, signed on Dec. 23, 1913. Former chairs of the Fed Paul Volcker, Alan Greenspan and current chair Ben Bernanke addressed board members assembled around the vast wooden table often associated with the board and its decision-making. This is a big week for the Fed. Starting Tuesday and continuing Wednesday, the Federal Open Market Committee will meet to decide on the Fed’s policy for the upcoming months. The big question is whether and if, then by how much, they will taper their stimulus policy.
In fact, this has been the prevailing question for most of this year each time the FOMC has met since the partial government shutdown and also after each monthly release of the official unemployment number: has unemployment reached the threshold the Fed considers low enough to gradually lower their purchase of $85 billion a month in bonds and mortgage-backed securities?
After the FOMC’s June meeting, Bernanke suggested 7 percent unemployment might be a reasonable target for tapering, sending markets into a tizzy. His subsequent public comments have been much vaguer on thresholds, although at Monday’s centennial, the outgoing Fed chair echoed his commitment to transparency and “two-way communication” with citizens.
The necessity of taking the pulse of America’s people and its institutions makes the Fed chairmanship what Nobel laureate Bob Shiller calls “the ultimate job that will not be replaced by a computer.” At the same time, Shiller explains, there’s always legitimate reluctance on the part of the Fed to communicate its judgments.
Here, for more of what he would do if he were Fed chair, is our (condensed and edited) conversation with Yale’s Robert Shiller.
For even more with Shiller, see our two conversations from last week on how the stock market reflects psychology and on why the Fed can’t say there’s a housing bubble. Learn more about the Fed and the FOMC’s meeting on the NewsHour Monday.
Paul Solman: The issue has been the Fed — if and when it’s going to taper. So, what do you think?
Bob Shiller: This is what I fear, in the sense that these are very different issues that we don’t have any scientific theory about. It’s all about expectation and public attitudes.
Paul Solman: Well, what would you do if you were the Chair of the Fed, which isn’t inconceivable…
Bob Shiller: You’re not filming this…
Paul Solman: Yeah, we are filming. Filming everything. What would you do?
Bob Shiller: Well, okay. If I became the Fed chairman, that would redefine my life, because now I would have a policy tool at my disposal that I find a bit unnatural, but historically important.
As far as I can tell, well, and this probably saved us from another depression. They’ve done things that made me feel uncomfortable, like expanding the Fed balance sheet to such a high level — almost $4 trillion dollars. They’re buying up $40 billion of mortgage securities every month. … I probably would not sound that different from Janet Yellen.
Paul Solman: Well, she’s a good friend of yours.
Bob Shiller: Well, that’s true. We are in a weak economy, and I also wrote a book with Janet’s husband [George Akerlof] called “Animal Spirits” where we talk animal spirits as a broader concept of confidence. It’s something about our emotions, our feelings — let’s get on and do something; the economy’s okay, everything is okay.
Paul Solman: Keynes, when he uses the term, he says, “spontaneous optimism.”
Bob Shiller: It has this spontaneous component. There’s what they call “endogenous depression” … People have nothing to be depressed about, but they’re depressed.
Paul Solman: Because “endogenous” means from within.
Bob Shiller: Yeah. I think there’s kind of a social component; society can become depressed because of a world view that develops.
Paul Solman: And there’s a feedback mechanism — you’re depressed, so I’m depressed; I then depress somebody else by being on television and saying: Oh, woe is me.
Bob Shiller: That’s why becoming Fed chairman is such a challenge. You’re dealing with psychology; even though economic theory recently hasn’t spoken about that so much; maybe it’s because they don’t know what to say about it. But Fed chairmen instinctively realize that every word they say has an effect on confidence and animal spirits.
Paul Solman: In 1983, I interviewed Paul Volcker on camera. And off camera, he was lamenting the fact that he couldn’t say anything because when he made some speech the night before, the bond market reacted immediately.
Bob Shiller: Well, the general public knows that he’s being careful in what he says, so any slight nuance can suddenly be interpreted as much more than it is. So that’s a difficult position. Well, it’s like a physician. If a physician looks at you and says, “I don’t know…”, you suddenly think, I’m going to die. That is the same problem.
When Would You Taper?
Paul Solman: You’re not Fed chairman, but if you were at some point, you’d have to taper off the buying of securities — mortgage-backed securities for housing and United States bonds. When do you suppose you would?
Bob Shiller: Well, I would have to think of some economic indicator that suggests that the economy is fixed, is repairing itself. And now that the Fed has given a suggestion that they will keep interest rates near zero until the unemployment rate falls below 6.5 percent and, see, that sounds like a rule of thumb.
… But I would also temper it with — I suppose Janet Yellen will do this — with my judgments of our psychology and our politics. That would inhibit us from stimulating on a fiscal basis.
The reason we have a Federal Reserve Board as an economic metric model guarding these is that it involves so much judgment of people and institutions, judgment that really cannot be computerized. This is the ultimate job that will not be replaced by a computer.
Paul Solman: So what the Fed has been doing, and ought to be doing, going forward, in your view, is basically taking the pulse of the economy and if there’s enough optimism, “animal spirits,” or positive outlook, then the Fed perhaps should taper off its stimulative buying of bonds and mortgage backed securities, and so forth.
Bob Shiller: Right. That’s what I suppose they should do. It’s also what the public expects them to do. If they were to behave differently, it would be a surprise. It might be disruptive. That’s the Keynesian prescription that the economy is basically unstable and it is capable of falling into a funk, and you have fiscal and monetary policy. Fiscal policy seems odd, because of our deadlock in Congress.
Paul Solman: You can’t spend more money.
Bob Shiller: You can’t spend more money. And so this [stimulative policy] is what’s left. You wish it could be more scientific, or more precise, but I think it’s a good thing to do.
Paul Solman: The Fed has been accused recently of creating a stock market bubble — maybe now a housing bubble, too — by putting so much money into play and buying up government securities to keep interest rates low, and making every other asset, every other investment, attractive by comparison. That’s not a fair critique?
Bob Shiller: Well, that’s the policy tool left to them. … I wish they could conduct fiscal policy to expand our scientific research and increase funding to the NSF, bring in teaching assistants in our schools. How about dealing with prisoners who have been released and who are unable to find a job? There’s a million things that I can think of that would be good to do, but as Fed chairman I can’t do those things. People expect me to limit my policy to certain policy instruments. So given that, given the importance of keeping the economy stimulated, I suppose I would have done something similar.
Paul Solman: But, is there, as a consequence, a stock market bubble, for example?
I think the stock market bubble is related to the very low interest rates. Both at the short and until recently, at the long end. That’s because investors don’t see the alternatives in the debt market as attractive, so they pile into the stock market and bid it up. But I don’t think that’s the whole thing. The psychology of the market has so many dimensions to it. Back in 2009, when the market bottomed out, people were afraid of a 1929 style crash. I know because I was asking, “Are you worried about 1929 or 1987 again?” And I got record high numbers saying that. It’s the mindset that we had just a few years ago that people forget now. You think of it now as: That was the bottom of the market. They didn’t think it was the bottom. They thought it could go a lot further down and then, however, the market turned around and started going up.
That brought on people thinking: Hey, maybe that was too much. Maybe I should get into this. And so more and more people desired to get in at that price and that caused the price to go up. And it’s been a feedback loop for, you know, going on four years now. That’s a long time, and that is not just the doings of the Fed. People imagine that the Fed is more powerful than it really is.
Bob Shiller spoke to Paul Solman about winning the Nobel Prize.
This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions