August 3, 2017 3:13 pm JST
Interview

Fed to shed $2tn in assets 'over long period'

Ex-vice chairman reckons Yellen wants to get started on balance sheet shrinkage

WASHINGTON -- The U.S. Federal Reserve has swung into policy normalization mode -- a shift that is bound to have ripple effects worldwide.

The Nikkei recently spoke with former Vice Chairman Alan Blinder about plans to raise interest rates further and reduce the Fed's balance sheet, which ballooned as the central bank fought the global financial crisis.

Q: What is your assessment of the U.S. economy? Do you have any projections for growth or inflation?

A: I'd say the current economic situation in the U.S. is quite good. Growth looks to be coming in over the next couple of quarters in the 2%-plus range, rather than the 2%-minus range. We're in the unusual position that the Federal Reserve is fretting that inflation is creeping down, not creeping up. I'm not very upset that inflation is 1.5% instead of 2%. It just doesn't matter that much -- a half a percentage point on the inflation rate.

To me, that is really swamped by the fact that we've got the unemployment rate down below 4.5%, with no signs of an inflationary breakout that stops that.

It looks like we might be able to push the unemployment rate even lower. Or maybe the right way is not to say "push it" -- it's doing it by itself.

Q: When will the Fed start normalizing its balance sheet? I think the market expects a decision at the September meeting. Do you agree?

A: I very much agree with that. The Fed started talking about balance sheet adjustment earlier than I thought they would. That caught me by surprise.

They will announce it at the September meeting and ... they'll announce a start date, which might be Oct. 1.

I think [Chair Janet Yellen] wants to get it started. So the upshot of that is you don't also raise interest rates at that meeting. When I say I expect the Fed to announce the balance sheet shrinkage in September, part of that is I don't expect them to raise interest rates in September.

You've got doves and hawks, as always. The doves would really get upset if the proposal was to shrink the balance sheet and raise interest rates, both in September. The hawks would really be upset if the policy chosen by Yellen and the Fed leadership was to do neither. So, doing one but not the other is kind of a natural compromise.

[They will start raising interest rates] probably in December.

Q: How much will they want to decrease the balance sheet?

A: The balance sheet size now is about $4.5 trillion, roughly. I'm guessing they're going to shrink it to about $2.5 trillion over a long period of time. This is not happening soon.

You know, an interesting little question -- only interesting to Fed watchers -- is whether in September they'll actually announce their targets for the balance sheet. They don't have to. They could just say, "We're going to start. Here is the rate that we're starting." They have already said the rates that they plan to reduce, but they may not even say what they think the endpoint is.

Q: If they shave $2 trillion off the balance sheet, what impact will it have on the U.S. economy?

A: First of all, it's going to happen very slowly. This is going to take years. Secondly, about 60% of it, I think, will be in unloading Treasurys. U.S. Treasurys are the biggest, thickest, most fluid financial market on the planet. So pushing, say, $1.25 trillion of Treasuries out of the Fed's portfolio over three years -- or maybe more, who knows -- it's just not that big a deal for the Treasury market.

Q: How about interest rates? What do you expect in the next few years?

A: That's predicated on the economy working out more or less the way the Fed thinks. If the inflation rate keeps coming down through December, I don't believe they're going to raise interest rates again. ... It's going to depend on the behavior of the economy and especially on the behavior of inflation.

So the notion that the federal funds rate is headed gradually to 3%, say, or something like that, is predicated on the notion that inflation will be 2%. So you get a 1% real rate. If that doesn't happen, if inflation just stalls or goes down, the Fed is not going to go to 3% on the funds rate.

Q: President Donald Trump's economic agenda could create other complications. What do you think about his tax reform and infrastructure spending plans?

A: First, I think the infrastructure spending program, if it even happens, will be a mouse, not a lion -- small. So [it will have] very, very negligible effects on the U.S. economy. That's point one.

Point two is, I don't expect any serious tax reform at all. Point three, however, is I am guessing that there will be a tax cut. That's not a tax reform, right?

Republicans love to cut taxes. So I expect there to be a sizable cut in taxes, probably mostly the top-bracket rate of the personal and the corporate tax, and those will provide some macroeconomic stimulus.

You should never forget that stock market prices are made by traders, not by investors, right? I have a lot of money in the stock market, [but] I almost never buy or sell anything. So I'm not affecting the price. Traders on the desk at Goldman Sachs and Deutsche Bank and all those, they're buying and selling all the time. They're affecting the price. They are high-bracket taxpayers, and take a lot of cheer from the prospect of themselves paying less tax. That makes them optimistic. This is my theory. 

If that goes away, that optimism will go away with it, and the stock market could take a tumble.

Q: A number of central banks are starting to devise "exit strategies." Do you think we have reached a turning point in the post-financial crisis era?

A: Yes, sort of, although the Fed turned a while back. The Fed is in the lead because the U.S. economy was in the lead.

It does look like the other major economies in the world, with the exception of the Japanese economy, are either beginning or on the verge of beginning a turn in central bank policy, away from the crisis-induced hyper-expansionary policies.

And then [they are] moving more or less in order of how well their economies are doing. So, you've got Canada. Canada is doing well. And England looks like it's on the verge. And Europe will probably be after that.

I think it is [sustainable] as long as the central banks don't overdo it. And I don't think they will.

Interviewed by Hiroyuki Kotake, Nikkei Washington bureau chief

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