Austan Goolsbee on Central Banking as a Data Dog

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0:28Hello everyone and welcome back to Conversations with Tyler. Today I'm very happy to be chatting with Austin Guzby. Austin is one of my favorite economists. He always thinks like an economist is how I would put it. He has had a long standing teaching post at the University of Chicago served in the Obama administration and now is president of the Chicago Fed. Austin, welcome. Tyler, thank you for having me and what a treat for me. This is, I really appreciate it. What is it in academic macro economics or just economics that you found surprisingly useful being a Fed president? I was a data guy, as you know, in the, in the field of economics.

1:12And as soon as I got there, there's all this pressure of from the press and from others, are you a dove or you a hawk? And I used to say, look, I'm not one of the birds. I'm in the data dogs, you know, and the first rule of the data dogs is there's a time for walking and a time for sniffing and knowing the difference between those. And I would say that discipline of academic economics getting into the data is super useful. And then we're used to thinking about causality and identification, and I do think we could use a little more of that in the macro context. But so you're trying to figure out the connection between the money supply and the rate of price inflation.

2:01What's the first mental model you put on as a hat? You might disregard it when the day to tell you otherwise, but where do you start? It kind of sniff around. I'd say there are multiple models. There's some people and embodied in the machinery of the furbus Official Federal Reserve Bank model is probably a kind of a canesian inflation comes from overheating I'd say the old -style Money supply is what's correlated with inflation a lot of those Relationships between M2 and inflation or or that sort of thing feel a little antiquated, they kind of broke down in the data. But why are those wrong? Like, what's the theory in your mind?

2:45You're trying to teach me, I'm in your class. I think there's two, let me finish one thought, and then let's come back to what's wrong about it. I still like the most of all the basic supply and demand framework, and that before you can conclude anything, you've got to get a taste of, is this a supply shock or is this a demand shock. And in a way, a lot of the machinery of central banking and macro analysis, let's call it, is oriented around demand. And I'm not disputing that in the past, that has been the source of the most frequent business cycle variations. But I've tried to caution everybody in weird moments like when you're getting major developments on the supply side, whether they're labor supply or supply chain or productivity growth or a number of things that are hitting the supply side, maybe all bets might not be off, but the training sample LLM version of being a central banker is going to be prone to hallucination problems because it's going to give you things that are wrong because supply shocks might be driving inflation not demand.

4:06So then go back to your other question of, well, what's wrong with taking M2 and why would it no longer be as correlated with price inflation? And I think that a lot of that is because of financial innovation that we have at great pride and I love the cash vault at the Chicago Fed. They don't like it if I say exactly how much money is in there. I'll just say many tens of billions of dollars of cash are in that vault and we run hundreds of millions a day in and out. There was a time when that cash use was central to the payments of the United States and bank accounts and checking accounts and writing a physical check.

4:54Again, central to the function of the financial system. And as we've spread to electronic payments and credit cards and debit cards and that sort of thing, it has made, I guess, in the old model, you would say it's radically changed the velocity of money. And so it wasn't just m equals p y, it was m times v. So if m is moving around and v is moving around at the same time, you're going to get a little, you're going to get a little mixed up interpreting to over indexing on that theory. Okay. So if the instability comes from the velocity side, that means that we should favor a monetary growth rule to target the growth path of a nominal GDP, m times v, right?

5:39Yeah, man. Now you're going to get me a trouble, Tyler. But here's the thing. You can just say yes, right? You're not in trouble with me. I'm not going to say yes. I'm not going to say yes because, remember, I don't like making policy off accounting identities. There's no economic content in accounting identity. And if you are trying to design a rule, that rule may work if the shocks are the same as what they always were in previous business cycles. But I called it the golden path when we came into 2023 you'll recall the Bloomberg economist said there was a 100 % chance of recession in 2023. They announced at the end of 2022 That's when I came in to the Fed system is the beginning of 23 and that argument was rooted in Then the past, there had never been a drop of inflation of a significant degree without a very serious recession.

6:41And yet in 2023, there was. Inflation fell almost as much as it ever fell in one year without a recession. If you are, if you over index too much on a rule that implicitly is premised on that everything is driven by demand shocks, you just, I just think you want to be careful over committing. But I'm a little confused at the theoretical level. On one hand, you're saying M times V is unidentity, but on the other hand, it drives inflation dynamics. It's why I started back from, I bring a micro sentiment to the thinking about causality and supply and demand. And I said that you want to bring us to a let's let's agree on a monetary policy rule.

7:34And I'm inherently a little uncomfortable. I want to see what the rules say, but I fundamentally don't want us to pre commit to any given rule in a way that's not robust to shocks. Now you mentioned the post pandemic inflation and the role of the supply side. When I look at that inflation, I see prices really haven't come back down. They've stayed up and I see service prices are also quite high and went up a lot. So I tend to think it was mostly demand side. Now why is that wrong? Okay, there's two parts to that. I won't say why it's wrong, but here are my questions. if you're a firmly, uh, this all came from demand guy, a, you got to answer why did inflation begin soaring in the US when the unemployment rate is over 6 % or we could turn it into potential output terms if you want, but output is below our estimate of potential.

8:36Unemployment is way higher than what we think of as the natural rate. and inflation is soaring, that already should make you a little questioning. I can say them too. You may not like it. Them too, and up 40 percent over a few year period, right? Okay. Two, the fact that the inflation is taking place simultaneously in a bunch of countries of similar magnitudes that did not have the kind of aggregate demand fiscal or monetary stimulus that we had in the US is also a little bit of a puzzle. And then the third is if you don't think it was supply, then you kind of need to have an explanation for why when the stimulus rolls off, Okay, and this everything about the stimulus is sort of delta from last year.

9:35So we pass a big fiscal stimulus. We have substantial monetary stimulus that rolls off the inflation doesn't come down. And then in 23, when the supply chain begins to heal, you see inflation come down. So those three things kind of suggest there's a little bit of a puzzle if you think it was all demand. No, I don't think it was all demand, but you mentioned other countries. Switzerland and Japan, they import a lot, right? They were more restrained on the demand side. They had much lower rates of price inflation. That seems to me strong evidence for being more demand than supply. Wait a minute, wait a minute.

10:16I'm waiting. You're you're breaking, you're going to bring in Japan. And, and, and you're going to try to claim that Japan's low inflation is the result of something in COVID. I mean, Japan had lower inflation all along for decades before they were going through deflation. But if it was mostly supply, a supply shock would have gotten them out of the earlier deflation, right? A demand shock would not have. Well, let's back up and try to look at big countries that are not export oriented, that are primarily domestically driven. Like the United States, I think imports of what 10, 12 % of personal consumption, you take Nigeria, you take India, you take a series of big economies that are primarily domestically driven.

11:06Why was inflation high in all of these places simultaneously? I do think there's a puzzle. I don't think it's a 100 % supply. I do think there was a serious demand component, but you still got to explain when the demand stimulus rolls off, inflation doesn't go down, and then when the negative supply shock rolls off, inflation does go down. So I'm sort of back into my, I'm still curious about it, but I find the argument that this This was predominantly or entirely demand, unpersuasive, for some of those reasons. Let me try a question from the other extreme. Why does money matter at all? Isn't it a very close substitute for T -bills?

11:57You're paying interest on reserves. You balance that rate with other interest rates. There are slight differences in terms of maturity and liquidity profiles. But it could be like the proverbial swap if two nickels for a dime. So maybe money just doesn't matter. Could you teach me why that's wrong? I don't like you you're bringing me into I need to ask you to teach me via throng I know you've you've raised this before and it's not really an answer to say The market seems to feel like they're not the same that there are safety There's some yield to safety that we don't quite understand I'd say and it becomes more relevant perhaps in a world where people are creating money -like deposits all over the place.

12:45You know, we got stable coins, as well as the use of credit cards, debit cards, a whole bunch of things that look kind of like old -fashioned bank accounts or checking accounts. I guess the long answer is the definition of a money -like deposit. Why is it different from explicit money? I don't totally know, but that part of me wants to caution you back from going back to M2 in a world like that, where there are imperfect substitutes for money. But it's weird that we economists can't explain it, right? Yeah, probably. It's probably weird. But look, you're going to find yourself back into the data dog caucus and out of the pure theory.

13:38To stable coins increase, you know, the true money supply or the rate of price inflation It is a kind of intermediation say they're backed fully by treasuries. Let's say it's for real. It's not fraud Okay, now you just sent a chill of you just sent a chill down my spine when you said it's backed by treasuries So they have the treasuries in there. Yeah, 100 % reserves and someone creates a stable coin I'm liking the sound of that. I'm liking the sound of that and I'm just a little nerf. I'm not a I'm not Anticrypto, there's a lot of Anticrypto, but I am nervous. If you tell me you're going to create money -like deposits that people are going to put their money in there and they can take it out whenever they want.

14:23I feel like either A, there better be some deposit insurance or B, there better be some pretty serious restrictions on what the assets backing that or restrictions on what the what the entity can do with the money or else that thing ends in bank runs and tears. We kind of have 500 years of financial history that tell us that. So I'll come back to stable corn. I'm just a little nervous about that. You ought to be very nervous. We'll come back to stable coins. But if you look at banking as a whole, I've seen figures that formal legal banks are about one -fifth of the lending total. Private equity is more important.

15:05The real sector of the economy. That's not FTIC insured. A lot of that is in fact runs prone as we learned in 2008. So you've just got to be hyper -super -nervous. Yes, that's the very essence of financial stability, the conundrum of financial stability that we face as a society and as central banks around the world are exactly this, that there is an official banking sector that we have oversight of, and then there's a shadow banking sector, which is getting bigger and bigger every year, and can be prone to runs, and that runs, and what is the role of a central bank as a lender of last resort in an environment where it doesn't play?

15:53By trying to keep banks special, haven't we created a world where 80 % of the lending is outside banks Which is much harder for the Fed to deal with even if you should sometimes step in and that at the current margin It's counterproductive to keep banks illegally special because we drive more and more business out of banks That was two different statements one is the how is that a problem and the second was the was the normative of, it isn't useless and we shouldn't do it. Jeremy Stein is an old friend and I'm a massive admirer of his work. When he was a governor at the Fed, he highlighted exactly this that we have to strike a balance and financial stability of if you squeeze really, really hard on one side, there can be regulatory arbitrage and can lead to activity to shift to the area where we don't control and oftentimes don't even have the information.

16:50I agree with you that part. I don't know if I would go so far as your second statement that therefore it's counterproductive oversight, raising capital ratios is on official banks. It's not effective because because it leads to shadow banks. I mean, we went through very early. I arrived at the Fed and then the Silicon Valley Bank events happened. And I was there back in 2009 when the big banks were the centerpiece of the problem. And the fact that in March of 23, the big banks were not the problem. I think a lot has to do with all of the efforts that were put in place to raise capital at those larger banks.

17:39And we can argue about whether it was done right, but you got to admit it made you feel better that it wasn't the biggest official banks that were facing critical deficiencies in capital. On the great financial crisis, I have a question. I'm curious how you frame this. In 2009, I was convinced we had had a housing bubble. Today, I look at real estate prices and I think most of the country didn't, maybe suburban Orlando did. But the prices were right and we had some anti -bubble panic and that was the problem. That's the fascinating point. But what's your view? I hadn't thought of it that way. My view has been more part of the job of the Reserve Bank presidents is we have a district.

18:24Our district in Chicago is kind of hard of the Midwest. Most of Wisconsin, Iowa, Illinois, Indiana, Michigan. So I'm out talking to business people. I'm talking to individuals and overwhelmingly what you hear is despair. I would even call it despair about the cost of housing, that housing they can't move. And this is not just in cities where you could argue a lot of it maybe has to do with building codes and zoning. We went out to the Iowa Farm Bureau and in rural Iowa, I asked them, what's the biggest problem. They said attracting workers. And I said, why is it so hard to attract workers? They said because they can't afford to buy housing here.

19:10So I've spent a long time trying to think that through. And it's not wrong that it's just more extreme. The last couple of years, the house price inflation has been radically higher than goods price inflation. So if you just kind of compare buying a house to buying stuff at Costco or Target, there have been a big differential. But what's important is that's not new in the last three years. That's been going on literally for decades. Okay, so if you take the 12 years before COVID, house price inflation was 3 .5 % or 4 % a year and goods price inflation was actually deflation of around 1 % a year.

20:04So the relative price of housing has been rising for 5 % per year for a decade and a half. And it doesn't take a PhD by any means to recognize that something compounding at 5 % a year is going to add up to a big number. So I think it goes to your question of well, maybe it wasn't a bubble. I don't fully understand why the relative price of housing has been trending upward like this. I find it hard to explain. I have a paper you might have seen with Chad Severson that's about negative productivity growth in the construction industry over long periods of time, which is itself a puzzle. Maybe that's part of it.

20:49But some component of it may be regulatory in nature. But as I say, you see it in rural areas too, where the land use regulation is not as prevalent. I think that's a real puzzle. On the construction productivity puzzle, what do you think is the main reason for that? That it's negative. If it were zero, that would be a little easier to understand. But we're forgetting how to build homes. Yeah, somehow we're forgetting. We're doing it worse. And we tried it every way we could think of to analyze this. Maybe it's just mismeasurement. So we got evidence on the physical number of homes and the value of those homes that you could deflate by the very localized price deflators at the best at zero.

21:38And it mostly looks like we're getting worse at it. And Ed Glazer was an old friend of mine, and I know you're a fan of his work as well. He believes that it is very much tied to land use regulation and other regulations on the construction industry. But if you go back to the 1970s or 60s, they were moving in a modular direction. Think of it as a kind of higher brow pre -fab housing, turning construction more into manufactured good and that the regulations in some sense have forced an inefficient scale on our producers, but I don't know. We documented it, we showed what it was not, but we were able to find a smoking gun for what it was.

22:31Now, in your role in running the Chicago Fed, which is like running a corporation, right? What is it from micro -economics that you have found especially useful or helpful? Because you face a lot of managerial problems. But if nothing you do, headlines about the Fed, right? Yeah, it's true. The first thing to know about the Reserve Banks is there is a professional COO called the first vice president. And Chicago's first vice president is a woman named Ellen Brahmogen, who is the best. Everyone says, amazing. I was at an early meeting. Well, I've been at the Fed for, I don't know, maybe five months.

23:12And one of the other presidents said, seemed like he was being nice. He said, you know what seems like? Seems like it's going great. You've been really doing a good job. I said, thank you. And he said, or that's what I was thinking. And then I realized, Ellen is your first vice president and Anna is your research director Anna Paulson. How big of an idiot would you have to be not to look like you were doing a good job? And as the lecturers, there's something to that. The micro theory of delegation, I think is important. And things that have a marginal cost of zero, it's fine if you do more of those things.

23:51That's kind of the idea of what is a cost, what is an opportunity cost, and what is a marginal cost? Are some of the most important micro -economic ideas that I think we can apply to management? So what would be an example of something with a marginal cost of zero. Well, if you look at marginal cost of zero things, opening meetings to include others and having folks work together, sharing of information can often have very low cost, if not literally zero, and strong benefits is in the same way in our growth models, knowledge is a public good. Information can have a very low marginal cost and can help us facilitate working together.

24:45And so I've tried to emphasize those internally. Now we live in an age of fiscal pressures as you know and recent experience with Doge has shown that even if the amounts of money at stake are small, people will go after highly visible targets. do you think say 10 years from now that will have so many different federal reserve branches that each have their own research staff in any large numbers? Well, that's what you mean might they kill that system? Or someone? Right. That's a system we have. And someone might ask, why does the federal reserve bank of Dallas need as many research staff as it has?

25:25Okay. So then let's back up to a little bit about how the Fed is created and it was made in 1913 So it's a little bit clujy and like every politically created thing It involves some compromises, but there are a couple of pieces I think of genius or at least very durable important contributions about how the Fed is is built that we should not lose Okay, the first thing to note is is, we have a hybrid federal system in which, yes, there is a chair and there are seven governors that are political appointees, named by the president, confirmed by the Senate. In 1913, as today, people were deeply uncomfortable with the idea that either Washington, D .C.

26:20or or just a combination of those two would control the US financial system with no input from the rest of the country. So they didn't set it up that way. They added 12 reserve banks from around the nation to be part of the FOMC and we go and we sit around the table. There's 19 people. Seven of them are political appointees. Twelve of the people sitting around the table are not political appointees. They're chosen by boards of directors out in the flyover states like us, where business leaders, civic leaders, and people from the region choose to have representation. I think it's critically important that we maintain that kind of monetary policy independent and thought that it's not just New York City and Washington, DC that are coming with one perspective.

27:18And you probably seen some of the analyses over the years that a lot of the new ideas about monetary policy, about banking and supervision came out of the reserve banks. And that's why we have our own research departments. And that's why we take very seriously the The idea that when we go to the FOMC meeting, I love hearing what the other presidents and the governors have to say. I said with no irony, I consider the FOMC to be the world's greatest deliberative body at this point, no offense to the US Senate or to anyone else. It's an amazing group. And if you're an econ nerd, you go into that room and it is just about the coolest thing.

28:05There is on this planet, you know, the shades come down. There's a giant table and they go around the table and Jay Powell is going to say, here's what I see in the economy. And then it's going to go to Chris Waller and it's going to go to the, you know, President Barkan and President Blastick, you know, what are you saying? And I think that's really important. So if we put ourselves on a path that we're going to go chip away at that and that somehow it would be more efficient to hammer away and get rid of the national representation on the FOMC. I think that'd be a terrible mistake. I like the structure of the committee.

28:44I think that's excellent. But if someone said to me, well, there should only be five feds with the staff, but say you should have complete access to all of them. If macro is mainly about data rather than new theories, and I agree with that, five staffs should be enough. It's not like the old days where you needed them in the soda school, run it, or is it Absolutely. Lewis, but then why any? Why not just one? Why not say, hey, to hear the data sets will give you all the data sets. We only need one opinion. You of all people, Tyler, you know how dangerous that is. Well, if we need to let some flowers bloom because monocultures are prone to group thing.

29:21That's why I say five. You could talk me down to three perhaps. Look, as I say, the thing was invented, there's two of them in Missouri at the time, 1913. It's like baseball teams, right? Nothing in this. Yes, it's kind of like baseball teams, but in an era where almost all the teams are in New York City, you know, baseball is the worst for it. What should the regional feds be doing, manage, usually, to prepare for the arrival of AGI, or just very strong A .I. Whatever you want to call it? I don't know. I'm still curious and I hope we will. Let's have a little extended discussion about AI and what does it mean for productivity and how real is it?

30:04The thing that banks do, I always say it's kind of a handful of things and it's five basic functions, one of which is monetary policy and I consider that the opposable thumb, you know, that's what separates us from the animals. And you got monetary policy and then there's directing the payment system of the United States. People probably don't understand, unless they get into it, that the plumbing of the financial system, the wired transfers, ACH direct deposit fed. Now there's a whole bunch of payment system things that are operated by the fed system that are critically important. The biggest thing in terms of employees is bank supervision and regulation and oversight to make sure that our official banks are safe and sound.

30:56We're a bank to banks, so the fourth is financial services like we send cash for their ATM machines. We do a whole bunch of financial services for the member banks. And then the fifth is to participate, be upstanding members of the community. We have a community development function. We have a regional economics focus. We are absolute experts in Chicago, for example, on the auto industry. We have by far the most auto production and the highest manufacturing intensity of all the districts. So we have expertise in that. And I think all five of those are quite important that we maintain them. Where AI fits in, I could see it fitting in in supervision and alerting you at least red flagging.

31:49Here's a place to look more. As of now, though, there is a rule for bidding the use of AI tools for general Fed usage. And I understand it. If you take secret information, confidential information, and start plugging it into these, and it starts getting out, I think that would be a problem. But you could put this on your hard drive, right? We're very close to being able to do that. The Fed is incredible data. You could take everything all the Fed's now about banking failures, build an AI, keep it on the Fed hard drive, and they would do much better than any human in predicting bank failures. Maybe that's a hypothesis.