Kathy Bostjancic on Priorities for the Fed in 2021 and Beyond

Episode Summary

Executive Summary: Kathy Bosjancic discusses her Wall Street-to-Oxford career path and offers a detailed 2021 outlook on Fed leadership, average inflation targeting, QE, fiscal stimulus, and frothy financial markets. She sees Powell’s Fed as firmly dovish, believes Yellen brings continuity at Treasury, and argues that low rates and liquidity support recovery but also raise asset-price and exit-risk concerns.

Main Topics: Kathy Bosjancic’s career path and market experience (Priority: 4/5): Bosjancic traces her journey from economics/math graduate to foreign exchange research at Citibank, fixed-income desk economist, the Conference Board, and Oxford Economics, emphasizing how she moved from markets to the real economy. Biden administration and Fed personnel changes (Priority: 5/5): The conversation examines how Biden could shape the Fed through a governor vacancy, the likely reappointment of Jerome Powell, and possible roles for Lael Brainard and other dovish figures. Average inflation targeting and Fed credibility (Priority: 5/5): They assess whether the Fed’s new framework is credible, how much inflation overshoot it will tolerate, and whether clearer guidance on employment and inflation thresholds is still needed. QE, balance sheet policy, and exit risks (Priority: 5/5): Bosjancic argues QE helped most in the financial crisis but has diminishing returns and can create expectations of a Fed backstop; she also highlights concerns about taper tantrums and balance-sheet normalization. Financial markets, liquidity, and froth (Priority: 4/5): The discussion turns to elevated asset prices, low rates, massive liquidity, and the GameStop episode, with Bosjancic saying markets are partly justified by recovery hopes but also show some froth. Financial stability and macroprudential tools (Priority: 4/5): Both speakers argue against using rate hikes to prick bubbles and favor using macroprudential regulation, while noting that strong employment and income growth support financial stability. Structural causes of low inflation (Priority: 4/5): Bosjancic says low inflation and low rates are driven mainly by secular forces like technology and globalization, with central banks sometimes too slow to adapt.

Key Arguments: The Biden administration is likely to make only marginal changes to an already dovish Fed, with the most immediate effect coming from filling the vacant Fed governor seat. Jerome Powell is likely to be reappointed because presidents usually prefer continuity during crises and Powell has proven competent and dovish relative to his earlier reputation. Average inflation targeting is still in its infancy; its credibility depends on whether the Fed allows inflation to run above 2% long enough after years of undershooting. The Fed may need to provide more explicit verbal guidance about how high and how long inflation can overshoot before it tightens. A clearer statement on the employment side of the mandate is also needed because the new framework emphasizes shortfalls and a broader, more inclusive definition of full employment. QE was highly effective in the financial crisis, but later rounds have smaller marginal effects and can fuel perceptions of a “Fed put.” The Fed’s huge balance sheet is unlikely to be actively shrunk; instead, it will likely stabilize or drift lower relative to GDP. Market froth exists, but it is supported by strong rebound expectations, low rates, and excess savings moving into assets. The right response to suspected asset bubbles is not to raise rates sharply; macroprudential tools are more appropriate than using monetary policy to target asset prices. Low inflation is mainly a product of secular disinflationary forces—technology and globalization—rather than simply bad central banking. The Fed’s new framework may improve outcomes by prioritizing employment and spending growth, which also helps borrowers meet obligations and supports financial stability.

Data Points: Fed governor vacancy: 1 opening - Bosjancic says Biden could immediately shape the Fed by filling a current Board vacancy. Powell chair term expiration: February 2022 - She notes Powell’s chairmanship expires then, though discussion would likely start earlier. Fed policy meeting date: January 27, 2021 - Referenced as the first major test of the Fed’s new framework. U.S. job shortfall: more than 9 million workers - Bosjancic cites the pandemic-era employment gap as a reason for continued dovish policy. 10-year Treasury yield move: from about 90 bps to an intraday high of about 1.18% - Used to illustrate the reflation trade and market sensitivity to taper talk and fiscal stimulus. Prior fiscal stimulus: $900 billion - The December package is mentioned as part of the reflationary backdrop. GDP growth: 4% - She notes it was strong in annualized terms but still below the pre-pandemic level. Pre-pandemic output gap: 2.5% below - Current GDP remained below its pre-pandemic trajectory even with the rebound. Q3 GDP growth: over 30% annualized - Used to compare rebound dynamics and illustrate base effects. Fed balance sheet: about $7.4 trillion - Current scale of the Fed’s assets is contrasted with the pre-crisis level. Fed balance sheet before crisis: near $3 trillion - Baseline used to highlight the post-pandemic expansion. Fed holdings of TIPS: about 20% of outstanding, up from about 10% - Beckworth raises this as a possible distortion to break-even inflation signals. Aggregate savings: about $1.5 trillion total; roughly $700 billion extra - Bosjancic uses this to argue that liquidity and savings are helping fuel asset markets. Framework review horizon: 5 years - She references the Fed’s plan to revisit the new framework in five years.

Pivotal Quotes: "just being adaptable and being open-minded and trying to just learn as much as you can" — Kathy Bosjancic: Advice to young people considering careers in economics and markets. "it is dangerous, one, for the Fed to try to determine whether or not asset bubble because even strategists and people who are trading these assets can't say for sure" — Kathy Bosjancic: Her argument against the Fed trying to prick asset bubbles with higher rates. "the best defense is a good offense" — David Beckworth: He uses the sports analogy to describe keeping the economy strong as a way to bolster financial stability.

Implications: Listeners should expect a dovish Fed, continued liquidity support, and ongoing debate about whether average inflation targeting will gain credibility. Investors should watch for inflation overshoots, taper communication, and signs of asset-price froth as recovery unfolds.