For a conversation on Monetary Policy and the possibility of inflation in the u. S. Economy. Former Federal Reserve chair bernanke and Larry Summers speaking. Live coverage just getting underway. Will undoubted lly weighing. Thats the fun. We think that the question of rethinking the two Percent Inflation target is one of the most important questions facing Monetary Policy makers at the moment. You might say the backward looking question that we need to think about which we are thinking about is how did unconventional policy really work and should unconventional policy really be considered conventional policy. We look forward i think you have to argue that one of the biggest questions now is whether given everything we know whether a two Percent Inflation target framework is the right one for Monetary Policy. After all, when it was conceived nobody anticipated we would have so many years of trying to get inflation up to two percent and nor did we think that the long run equilibrium Interest Rate would be so low that in the last federal open Market Committee survey of Economic Projections the members said that they expect long run rate to be 2. 8 to 3 which means there is not a lot of room to lower rates below 0 as we usually do in a recession. When we first conceived this event one of the reasons we did it is we felt that this was a discussion that was really important but hard for the members to have because if you Start Talking about this you frighten the markets and bad things would happen so you just dont talk about it in public. I think we were right that this is an important issue. We were wrong that members are afraid to talk about it. The minutes of the meeting suggest that it has been discussed and a number of Regional Fed Bank president s have raised it. But i think that this is not a decision that can be left to Federal Reserve policy makers or the economists who spend time thinking about Monetary Policy. This is too important a decision to be left to the fed and the economics profession itself. It has to involve a broader array of people, a broader discussion in our society. This is our attempt to try to explain what the issues are, what the choices are, what the pros and cons are for the broader audience. We will try to synthesize this at the end. We have a very crowded schedule which we are extremely pleased about. It is hard to imagine you could have assembled a better group of people to discuss these issues. Im making a public plea to our speakers which is try and stick to our time schedule so we can get a fair shot. We will start with a conversation with Larry Summers who will set the scene and then my colleague will come up here and introduce a panel that we will have to discuss the alternatives. So with that, Larry Summers. My job at a conference like this in a moment when i am not in government is to surely be provocative and hopefully be sound. My propositions are two. One, first proposition, our current framework is likely to involve unnecessary costs in lost output on the order of a trillion dollars a decade or 100 billion a year relative to what otherwise would be possible. And, two, a proper better framework which we shouldnt necessarily move to immediately, but we should ultimately aspire to would involve normal nominal Interest Rates in the 4 to 5 range. Let me develop these arguments in several stages. First proposition, within the current policy framework were likely to have by historical standards very low rates for a very large fraction of the time Going Forward even in good economic times. David just shared the feds view which is that the neutral real rate is in the neighborhood of 1 . Were at more risk at least currently of falling short of the 2 inflation target than we are of exceeding the 2 inflation target. Its a good rule with official projections to think about the Weather Bureau that when they keep being revised in one direction there is positive correlation in the revisions so it would be my judgment that further reductions in the real predictions of the neutral real rate are more likely than further increases. The market essentially shares this view. The long run forecast is 2. 3 . 2. 3 is less than 2. 8 but the market is projecting the expected value. The fed is projecting the mode. That is a reason for some discrepancy. On the other hand the markets forecast builds in a term premium whereas the feds forecast doesnt build in a term premium. Reasonable judgment, then, if we continue to operate in our current framework, its a reasonable expectation that in good times rates will be in the 2 to 3 range typically. And it seems to me hard, obviously, that is a projection made with substantial error, but i cannot see good reasons for thinking that the fed and the markets estimates are massive underestimates. Second proposition, recessions will come. What is the likelihood of recession . My reading suggests that the best thinking is that recoveries unlike people do not die of old age, that the probability of recession once one is significantly advanced into a recovery is essentially independent of the length of the recovery and that that probability depending upon just how far back one looks is something in the neighborhood of 15 to 20 on an annual basis. Thats a historical reading looking back through 50odd years of u. S. Business cycle history. Is it the right view Going Forward . You can make a case that its an under statement to the risks Going Forward. That case would emphasize that normal growth is now 2 rather than 3. 5 and so you have to slip less far to fall into recession. It would emphasize a higher degree of geopolitical risk now than in the past. It would emphasize that we have a more financialized, more levered economy with higher ratios of wealth to income that is therefore more at risk of financial disturbance. A case for more optimism would be that the past probability is an overestimate would emphasize lower inflation and less risk of inflation getting out of control forcing the fed to hit the brakes hard. It would emphasize smaller inventory cycles in a less tangible and physical economy. Im not compelled that one of those sets of considerations is far more important than the other so i think 15 annually is a reasonable estimate of the probability of a downturn. Third observation, Monetary Policy of the standard form will lack room to do what it usually does. On average rates are reduced nomally by five Percentage Points. The low numbers are at the beginning of the period when there were very substantial credit rationing effects that were important in understanding how the economy functioned so that five percent strikes me as if anything slightly on the low side. If you look at nominal rates you conclude a five percent reduction is necessary. If you look at real rates you similarly conclude that about a five percent reduction in rates is necessary. You can see where this is going. Five is substantially more than two to three. So the likelihood, i would argue the overwhelming likelihood is that when recession comes, policy will not have sufficient room to cut rates as much as it would like to within the current framework. If one believes that neutral real rates will decline further or a risk of further decline, this effect is, of course, magnified. These conclusions are not very far from those reached in a much more elaborate way by Kylie Roberts concluding a 30 to 40 that 30 to 40 of the time we will be at the bound. If you assume once every seven years we will be in recession and assume that once we get into recession rates will be constrained by the zero lower bound for three years, one gets that we will be at the zero lower bound about 30 of the time given our current framework. Observation four. If the expected output losses are large. Roberts estimate an output loss above one percent of gdp on average. That would be at current magnitudes over the next decade about 200 billion a year. I think its plausible to suppose that their estimates are too high. I have a much more of a back of the envelope approach. I said suppose when we get into one of these episodes and we are constrained for three years about 40 as long as we were constrained after the 2008 crisis, that well lose one percent of gdp the first year relative to where we would have been, two percent of gdp the next year and one percent of gdp in the last year. If you take that number you get a loss of about four percent of gdp once a decade. That works out to about a trillion dollars over the next decade or 100 billion a year. Calculation can be wrong if recessions were more frequent or a spiral development. You can imagine reasons why the calculation would be an overstatement, but it seems to me hard to argue that what i have said is way off as an estimate of the cost of the insufficient ability to adjust Monetary Policy. How could this calculation be way off . I have addressed the question of whether im way off on the frequency of recessions or way off on the amount of Interest Rate cut that is necessary when you have a recession. The main challenge seems a suggestion that alternative forms of stimulus can be provided and so the zero lower bound is not an important constraint because monetary stimulus can be provided none theless. That is what janet yellen tried to argue in her speech in 2016. I am far from convinced and i would make these points. First, starting ot2. 5 ten year rates. If you simply imagine that the economy goes into recession and then you imagine that the fed cuts rates four or five times to a 25 basis point fed funds rate and nobody does anything else, the ten year rate will find its way down to 1. 5 or in that range. And it seems to me quite questionable how much extra stimulus would be developed by any further reduction below 1. 5 Percentage Points that argument applies with respect to any monetary device that might be developed. With respect to quantitative easing i would note that there is less room now than there was previously, that it is far from clear in retrospect that it is as effective once periods of major iliquidity are removed as is often supposed. As ben has acknowledged it doesnt really work in theory and i think the evidence now is much less clear than it once appeared that it works in practice especially in light of the awkward fact which most discussions pass over that the quantity of u. S. Public debt that markets have to absorb has increased rather than decreased during the qe period given the activities of the treasury and given the further observation that the swap spread is negative, somewhat inconsistent with the suggestion that there is an induced short supply of treasury debt. So i am completely unconvinced that qe can be our salvation next time around. What about Forward Guidance . The fact that the fed is moving with some vigor towards tightening while inflation is at this moment well short of two percent, the fact that the fed is not willing to predict inflation above two percent at any moment even a hypothetical moment of the tenth year of recovery with an Unemployment Rate of four percent, must be under cutting whatever credibility might previously have attached to the idea that a Federal Reserve would be willing to live with substantially super two Percent Inflation rates. Finally, there is the possibility of fiscal policy. I would only note that growing levels of the debt to gdp ratio coupled with readings of the political process and the way the political process responded to the aftermath of the recovery act suggests little basis for serenity that substantial fiscal policy will be quickly entered into the next time the economy goes into recession. My conclusion, therefore, is that we are living in our current framework in a singularly brittle context in which we do not have a basis for assuming that Monetary Policy will be able as rapidly as possible to lift us out of the next recession and therefore that a criteria for choosing a monetary framework when we next choose a framework should be that it is a framework that con templates enough room to respond to a recession meaning nominal Interest Rates in the range of five percent in normal times. Whether that is achieved through changing conventions on how one permits above target inflation, providing for adjustment to changes in based on the price level rather than the rate of inflation or whether that is done in the context of relying on nominal gdp seems to me to be a question of second order importance. What is of primary importance is that we establish a framework in which our best guess is that we will have room rather than that we wont have room to respond to the next recession. So i would suggest as a design criterion that an appropriate framework allows for a five percent nominal Interest Rate in normal times. I would just conclude by observing that if i am wrong and we assume i am right, we will live with marginally, perhaps slightly more than marginally higher inflation, but if i am right or if the trend towards a declining neutral real rate continues and we ignore it we will put ourselves as risk of very substantially exacerbating the next recession and that the consequences for welfare not to mention political economy i would suggest dwarf those of marginally higher inflation. So i would hope that all consideration of monetary frameworks emphasize centrally the need to provide for adequate response to the next recession. Thank you very much. [ applause [ applause ] thank you, larry. I will ask one question and then we will take a few questions from the audience. So if you had to decide today what the new framework should be without regard to the difficulties of changing it, do you have a horse in this race . Which one would you choose . I really wanted to emphasize that something that would have a normal Interest Rate of five percent is much more important to me than the tactical choices. If i had to choose one, i would choose a nominal gdp target of five percent to six percent. I would make that choice because it would atin wait the issues around explicitly announcing a higher inflation target which i think are a little problemityic and because it would build in the property which i think is desirable that the slower the underlying growth rate and therefore the less likely to mean lower neutral real rate and is likely to mean less productivity growth which is relevant for the zero floor on wages. A nominal gdp target has that as an advantage. That would be my bold big step. My smaller i think more practical step would be an explicit acknowledgment by the central bank of an objective of super two Percent Inflation in the late stage of an expansion based on the confidence that a recession would come at some point and would provide for some further disinflation. And by doing that one could preserve the two Percent Inflation target, justify a more expansionary policy today and it seems to me be entirely responsible. I dont think it is possible to reconcile the forecasts of two Percent Inflation with not a single dot above two Percent Inflation on forecasts assumed continued expansion with the claim of being symmetric about the two Percent Inflation mandate. I should have noted people are welcome to stand in the back if you like. In the room just across the hallway we have a big screen and you can sit down if you like. Anybody who wants a seat im going to take a couple of questions and let larry respond. Roberto. There is a mic coming. If you would tell us who you are and please make it a question which has a question mark at the end. Ill try to. All of this discussion assumes that the neutral rate will stay low. Is there anything in your view that can be implemented that changes that . Thank you. Tech another one. Steve . Larry, do you envision any fiscal response. I know the horse has left the barn with this particular year but envision creating fiscal capacity right now in order to let fiscal play a part and not put all of the recession response on the monetary side . One more. Please tell us who you are. Patrick lawler. Our experience with inflation in the im guessing three percent to four percent range which might be consistent with your target nominal rates, our history doesnt show any ability to keep a rate in any kind of narrow band at that point. Are you at all concerned that raising inflation that much might engender much wilder swings in what kinds of things Monetary Policy is expected to respond to . Larry, three good questions. Answer them in the order you like. All questions in the form am i at all concerned, the answer is yes. I do not share your reading of the 1980s, for example, when inflation was in the three percent to four percent range and seem to me to remain in control. Furthermore, i think that there is a natural corrective in the form of intermittent recessions which we tend to bring inflation down. I can conceive that this would become a problem but i guess as more and more time passes i come to see the 1970s more as the worlds first experiment with pure fiat money from which it learned painful lessons and less as a prototypical evechbt that characterizes what is going to take place Going Forward. I dont have that as a concern at the level of the trillion dollars a decade at least that i think we are putting at risk from this problem. Steve, if we really could work Counter Cyclical stabilization policy well in our political system that would attenuate somewh