President Ron Liebowitz: Good afternoon everyone. I'm delighted to welcome you all today, where we have the opportunity to continue celebrating the Brandeis International Business School at its 25th anniversary. I know that many of you have traveled from across the US and from 18 different countries to be with us for this important milestone, for both IBS and Brandeis. The IBS community spans national and industry boundaries alike, and I hope that you have the chance to connect and re-connect with one another over the course of the weekend. This afternoon we are eager to hear from Professor Janet Yellen, former chair of the Federal Reserve Board and the first woman to serve in that role.
Before I introduce Professor Yellen, I would like to say a few words about IBS, which is not only a source of great pride for Brandeis but has also been educating principled, dynamic leaders in the world of international business for the past 25 years. IBS, like Brandeis itself, was a path-breaking endeavor from the start. As the turn of the century approached, IBS was conceived as a response to the rise of globalization. As the world quickly transformed around us, founding dean Peter Petri and many other of our economists on the faculty recognized the need for a new type of business degree, one that could prepare students to compete and succeed in an increasingly interconnected global economy.
Building upon the success of the Lemberg Program in International Economics and Finance, whose first-ever class received degrees from Brandeis just 30 years ago, IBS was established. Today, under the leadership of Dean Katy Kate Graddy, IBS is recognized internationally as a hub for academic innovation, one which attracts students from around the world and which prepares students to grapple with the emerging challenges of a data-driven world.
I'm sure that many IBS alumni here today can testify to the value of this new approach to a business degree. As we look ahead, both at IBS and at Brandeis, I'm confident that the international business school will continue to be a home for innovative, forward-thinking scholarship and teaching on the pressing questions and challenges facing business, finance, and economics. As we reflect on the accomplishments of the IBS community and imagine what the next 30 years of IBS might look like, I want to take a moment to recognize the legacy of the late IBS professor Rachel McCulloch, who not only left a lasting mark on Brandeis but also on many of those in the room here today.
Rachel McCulloch was a trailblazing economist and leading figure in the fields of international trade and economic policy, who joined the Brandeis faculty in 1978. She subsequently helped to establish the PhD program at IBS, served as a chair of the economics department, and was central in our efforts to bring together undergraduates, graduate students, and faculty members from the international business school and the economics department to create a culture of interdisciplinary collaboration that continues to define how we educate our students.
I am delighted to announce that, in honor of Professor McCulloch's legacy and with the support of our alumni and friends, we have established the Rachel McCulloch Endowed Scholarship. As this scholarship continues to grow in the future, we'll be able to honor the legacy of Rachel and provide a diverse group of future business leaders with an IBS education. Please join me in recognizing the members of Rachel McCulloch's family we are lucky to have with us this afternoon. Rachel's husband, Gary Chamberlain. Where's Gary? Daughter [Laura Gale 00:04:01], and Rachel's sister, Linda Rothschild. All welcome.
It feels appropriate that we are able to announce the launch of the Rachel McCulloch Endowed Scholarship on the same day that we welcome to Brandeis her friend, former colleague, and fellow pioneering economist, Professor Janet Yellen. Professor Yellen is no stranger to breaking glass ceilings. From Yale, to Harvard, to the London School of Economics and the University of California Berkeley, she established herself as a thought leader and sought-after strategist in the field of economics. Professor Yellen served as the vice-chair of the Federal Reserve Board, as president and chief executive officer of the Federal Reserve Bank of San Francisco, and as chair of the White House Council of Economic Advisors. Then, in 2013, Professor Yellen became the first woman chair of the Federal Reserve Board, where under her leadership, the nation saw a historic period of job creation, rising wages, and the lowest unemployment rate in decades.
Professor Yellen is currently the Distinguished Fellow in Residence at the Brookings Institution in Washington DC. Today, Professor Yellen will be talking with Steve Cecchetti, the Rosen Family Chair in International Finance here at the International Business School. Steve is a widely published author with expertise in macroeconomics, monetary policy, banking, central banking, and financial regulation, so I'm sure that he and Professor Yellen will have much to talk about today. Please join me in giving a warm welcome to Professor Janet Yellen.
Janet Yellen: Thank you. Thank you. I'm delighted to participate in this reunion celebrating the 25th anniversary of the founding of the Brandeis International Business School. It's a special pleasure to have the chance to join with all of you, Rachel's friends, colleagues, her former students, and Rachel's family, to launch the Rachel McCulloch Endowed Scholarship Fund, honoring the legacy of my friend, colleague, and co-author, Rachel McCulloch.
This is a fitting tribute, because Rachel played a very important role in this school. Rachel was a distinguished economist who made enormous contributions to the field of international economic policy. She weighed in on virtually all of the major trade policy debates of our times, the future of the World Trade Organization, the impact of trade on income inequality, the growing role of China and other large emerging-market countries on the landscape of global trade relations, the progress of liberalization in areas such as foreign direct investment and services, dispute resolution, the reliance of countries on safeguards, even the relationship between trade and the environment.
Rachel's contributions on these topics reflected a strong theoretical perspective, but it was coupled with a rare and deep appreciation of the relevant economic history and the complex institutional and legal arrangements governing trade and trade negotiations. Rachel's work reflected wisdom and good common sense. She knew all the issues in the literature but also was endowed with uncommon policy acumen, someone whose advice was sought by policymakers and prominent think tanks, because she got the answers right.
As you at Brandeis well know, Rachel made enormous contributions to the university. She long directed Brandeis's PhD program, and she was a superb teacher and caring mentor. She taught generations of students here at Brandeis and inspired many of them to pursue careers in the fields of international economics and business. Rachel took it as a given that women in the profession have the ability to succeed. She overcame obstacles in establishing her own career, demonstrating that women in the profession can thrive. She served as a role model for so many.
My own association with Rachel dates back to 1970s, when she and I found ourselves the only two female faculty in the Harvard economics department. We shared an interest in international economic policy and quickly became fast friends. Over the next several years we co-authored a series of papers on global flows of technology, capital, and workers, and in the process, had a great deal of fun. Rachel had a wry sense of humor combined with a remarkable ability to look on the bright side of things. She helped me weather the trials and tribulations of life as an untenured assistant professor in an environment that was frankly challenging. We shared both professional and personal ups and downs ever since. I miss Rachel tremendously, and I'm delighted to have this chance to honor her today.
Steve Cecchetti: Thank you. Thank you very much. It's an honor for us to have Janet Yellen here with us today. As President Liebowitz said, Janet has had an extremely distinguished career, first as an academic and then as a public official. As an academic, I think it's important to keep in mind that she made a number of very important and long-lasting contributions. I knew about Janet well before she went into public service, something that she started, I want to emphasize, in 1994. So with only some breaks, it's basically been 20 years that she was inside working in one part of the government or another, mostly inside of the Federal Reserve, and as you all know, eventually becoming chair of the Federal Reserve Board, one of the most important policy positions in the world.
As I suggested, I've had the privilege of speaking with Janet on many occasions over the years. We've known each other for quite a long time, but I want to say that I learn something every time I speak with her and I'm sure that this is going to be no different.
Janet Yellen: Thank you, Steve.
Steve Cecchetti: So again, thank you for coming.
Janet Yellen: Thank you for that lovely introduction and welcome, Steve.
Steve Cecchetti: Let me start with something that I think is really quite timely. In early August, you joined your three predecessors as Federal Reserve Board chairs, Paul Volcker, Alan Greenspan, and Ben Bernanke, in writing a public statement which, if memory serves, was published in the Wall Street Journal. That statement went on at some length about the importance of central bank independence. Could you explain your views and why you felt that was a necessary thing to do?
Janet Yellen: Yes. The four living Fed chairs, myself, Bernanke, Greenspan, and Volcker, I think all of us share a concern about the independence of the Federal Reserve. Of course, it's generated by President Trump's almost daily criticism of my successor, Jerome Powell, and President Trump's expressed belief that he would prefer to see an arrangement in the United States more like the one that exists in China, where the central bank is not independent and decisions about monetary policy are taken in a political setup.
All four of us have had the experience of trying to formulate monetary policy facing different but difficult challenges and sometimes having to do things in pursuit of the Congressional mandate that we have, which is to try to achieve price stability and maximum employment. Some of us have had to take difficult decisions... certainly Chair Volcker was faced with very high inflation and had to raise interest rates to very high levels to bring it down to acceptable levels... but all of us felt we had an opportunity to take the long view, to work in the context of an organization that is highly professional and utterly non-political, and to make policy decisions with a committee that is large, diverse, not a victim of groupthink, contains many different opinions, engages in rich debate, but does its very best to make decisions in pursuit of that dual mandate based on facts and evidence and with politics absolutely never entering the room.
While I think all of us can probably look back and identify times when we feel we made mistakes or, with the benefit of hindsight, wish we had made a different decision, we try to do, all of us, our level best not taking politics into account. We all feel strongly that monetary policy works best, for the benefit of society at large, for economic well-being of Americans, when it's made in that way.
Many central banks around the world began to see that it's a virtue to have monetary policy made by an independent central bank that's kept out of politics. I think it's fair to say that in most countries around the world now, central banks are independent. Research that's been done on central bank independence suggests that, in countries where there is central bank independence, economic performance is generally better. Inflation tends to be lower and more stable, and the economy in terms of its real performance, the labor market and growth, also performs better and is more stable.
When politics and short-term political pressures enter monetary policy, it's common to see two things happening. One is a phenomenon called the political business cycle, that politicians tend to want to push the economy, make sure that unemployment is low. Prior to elections, there's a tendency to juice the economy, to try to achieve low unemployment and high growth. There's often a price to pay later down the line in terms of high inflation, which then needs to be countered, hence political business cycle.
In other countries, and this is almost always what happens in every country that experiences chronically high or hyperinflation, central banks are pressured by governments that can't balance their budgets to help them out, financing those budget deficits by printing money when the government loses the ability to issue debt at moderate interest rates. The consequence we can see, and there are many examples of this in modern times, of high inflation and even hyperinflation. That's what's really led the understanding that economic performance is better when central banks operate in a non-political way independently but, of course, having to explain what they do to the public and operating under a mandate that is given to them by the legislature or by the outside government, that performance is better. So we are worried about developments that we see happening in the United States, of the Federal Reserve, and feel that that would be a grave mistake.
Steve Cecchetti: Thanks. To follow up a little bit on that, the job of the Federal Reserve has changed somewhat, the job of central banks in the rest of the world has changed quite a bit more. If you look today, relative to, say, 25 years ago when you started, 25 years ago, at least externally, things looked rather straightforward. There was an interest rate that was set, there was an announcement, and then everybody went back to work for the next six to eight weeks. Yes, of course, the Federal Reserve and others do a lot of other things, they were taking up time of supervising banks and the like, but at least from the public perspective, it was the first...
If I look today, what I see is central banks that, at least in principle, do more things. They certainly have larger balance sheets, they accumulate lots of assets, sometimes not public assets, sometimes even private assets. Some of them have explicit responsibility for financial stability. So not only has the public perception changed but, in some cases, the laws and the mandates have changed. In thinking about central bank independence, where should we think about trying to draw the line to ensure that these things remain accountable in democratic societies? What can we think of legitimately delegating?
Janet Yellen: I think that's a very important question, Steven. I'd start with the example of the United States. The Federal Reserve, as you said, has many responsibilities, including an important role in bank supervision, but the only place that I really think the argument for independence is strong is when it comes to making monetary policy decisions. That needs to be, the central bank, in making those decisions, must operate under a mandate that's given to it. In the Fed's case, it's a congressional mandate for price stability and maximum employment and it needs to explain what it's doing. There, I think the case for independence is really strong.
There are other areas where there's relatively little case for independence and the Fed is not independent. For example, the Fed's role in bank supervision and regulation is something that's given to it by congress. It has rule-writing authority and a responsibility for supervising a group of banking organizations, but it does so subject to congressional scrutiny. Importantly, the government watchdog, an agency called the GAO, the Government Accounting Office, that looks at how tasks are being carried out throughout the government... There's only one area that congress exempted from GAO review and scrutiny, and that's monetary policy. The GAO comes in at any particular time. The GAO probably has 10, 15, 20 reviews taking place and it reports directly to congress on Fed performance... issues reports criticizing... sometimes extolling but often criticizing aspects of the Fed's performance. So I don't think the case there is very strong, but sometimes there are gray areas. During the financial crisis, we got more into areas where there were legitimate questions about exactly where to draw the line.
The Federal Reserve was given by congress the ability to lend to depository institutions, namely banks, through its discount window. In fact, the Fed was created in 1913, following the banking panic of 1907, where there were runs on banks and the only way to stop those from ballooning into a full-blown financial crisis was to create an institution that would have the ability to serve as a lender of last resort, lending against good collateral. The Federal Reserve was created to do that. That created a lender of last resort role. It's not common for the Fed to have to use that role, but it did use it extensively during the crisis. But sometimes there were situations during the crisis where interventions to stabilize what was really a full-blown financial meltdown that was taking place, also required not just loans, which the Federal Reserve is empowered to lend against good collateral when others are unwilling to do so, and even to non-banks if the situation is sufficiently serious, but not to commit taxpayer resources.
In some of the operations that took place during the financial crisis, taxpayer resources were needed. They were needed for the TARP program that injected capital into the banking system, there were rescues carried out of AIG, the insurance company, and lending to JPMorgan Chase, to acquire Bear Stearns. There was unusual lending and guarantees provided to Bank of America and Citigroup during the height of the crisis. The treasury needed to commit taxpayer resources where, in the end, they received money back and it wasn't costly, but they were certainly putting taxpayer money at risk. The treasury couldn't engage in these rescues without cooperation by the Fed, so you would often see the Fed chair and the treasury secretary huddling together and collaborating to figure out how to rescue firms that looked like they might blow up and take down the financial system or even the banking system as a whole. That got the Fed into areas that are legitimately gray.
In the middle of the crisis, because there were questions about what was the Fed's appropriate role, Fed and treasury actually issued a statement in which treasury made clear that the Fed's role was to lend against good collateral through the discount window and the treasury's role was to become involved when taxpayer resources were being put at risk. To me, that's where the dividing line is.
But, you know, you were saying the Feds now engaged in different forms of monetary policy than garden variety 25 basis points up or down on the interest rate. Beginning at the height of the crisis in 2008, the Fed decided, under authority it had been given in the Federal Reserve Act, to begin purchasing long-term assets. The Fed is only allowed to buy US Treasuries and Agency securities. It began to buy massive quantities of mortgage-backed securities guaranteed by Fannie and Freddie after they were put into receivership, as well as Treasuries. In some people's minds that raised questions as to whether that crossed the line into a fiscal commitment, and I guess we could have a debate about... That is, I'd say those types of purchases are a standard part now of the monetary policy toolkit, but some people might question whether or not that crosses the line.
Steve Cecchetti: If I recall correctly, some of your colleagues on the FOMC actually questioned that, even at the time.
Janet Yellen: Well, they did question at the time. They were particularly unhappy about purchases of mortgage-backed securities, because they felt that when the Fed intervenes to conduct monetary policy, that it should not have the character of credit allocation, favoring some sectors more than others. They felt buying mortgage-backed securities did have the character of trying particularly to help housing. I must say, I don't really personally share that concern, but housing was absolutely melting down during the crisis and was a special concern, and this was clearly authorized under the Federal Reserve Act.
Steve Cecchetti: Right, right. Let me continue on right now with the financial crisis, since you were so eloquent on the roles there, and ask about it a little bit more broadly. The crisis sort of began around... probably in 2007 at some point, and as you said, intensified through 2008. We're over a decade past that. There's been extensive reform of the financial regulatory system, and I guess the question is whether or not we're safer today than we were a decade ago. Also, whether you feel that we've done enough.
Janet Yellen: The reaction to the financial crisis on the part of Congress and the administration was that radical reforms needed to be made to prevent another financial crisis. The Dodd-Frank Act was passed in 2010 and gave rise to, really, a decade of rule writing to carry out its mandates. I was very involved in all of that work at the Fed. I feel it was by and large an excellent piece of legislation. It's led to a huge range of improvements that have made us a lot safer. I'll list a couple, but let me give you a sense of where I'm going with this answer, which is, we did a lot, it was a good piece of legislation. I don't regret anything that has been done, but I do think there are holes and I don't think we did enough. I worry that, as time goes by, the same kinds of vulnerabilities that led to that financial crisis can recur.
So what did it do that was good? It really saw there were weaknesses in bank supervision and regulation and it mandated, especially for the most systemic banks, a massive improvement in terms of the amount of capital that they would have, with ever more stringent requirements the more systemic the bank in question. Requirements that banks hold more liquidity and that they be subject to a particularly rigorous form of capital requirement called stress testing.
Stress testing is something the Federal Reserve began to do in 2009 when there was very little confidence that the major banks in the country were safe and sound and could support a recovery. It was decided that the Federal Reserve should undertake a rigorous evaluation of the ability of all banks in the United States above $50 billion, was the cut-off at that time, to see what would happen if there were a severe economic downturn, to really carefully look at their books and evaluate how large the losses would be, and to see whether or not those institutions would have enough capital to be able to support the credit needs of the economy after a very severe shock. People at the time really didn't know how large the losses were that were sitting on those banks' balance sheets.
I will always remember that exercise. It was an all-hands-on-deck, 24/7 exercise that lasted for months, involved me in many weekends in 24-hour conference calls, going over all of the details. At the end of it, there was an evaluation that was provided and it was made public for all of the largest banking organizations, on what their losses on each portfolio they had would be in such a severe situation. At the end of that, these banks were told, you must have enough capital. At the end of that, if you don't have enough capital, we're going to force you to go to the markets to raise capital or accept injections of capital by the US government so that we can declare you safe and sound and capable of supporting the US economy. As it turns out, a number of the banks did need additional capital. They went very quickly to the markets. Publication and evaluation of the banks' financial situation restored market confidence.
I think it's fair to say the United States recovered faster and in a more robust way than other countries did, particularly Europe that didn't do this. Stress tests are now, I would say, the core supervision tool. Every year the major banks undergo stress tests and engage in these evaluations and new risks that come along. Possibly it's that we're worried about Brexit or what would happen, some years ago, if Greece was to fail and leave the Euro area and there were a collapse of the Euro area. Other risks that emerge are tested in different rounds of the stress test. I think this has resulted in much better understanding in the banks themselves of the risks that they face. It's a much better form of supervision. So these, on the banks' side, are important.
Other changes, derivative markets have been very meaningfully reformed. We now have central clearing of standardized derivatives and much higher margin requirements on those that are over the counter and not cleared. There have been reforms of some parts of the shadow banking system that caused problems. Remember, there were runs on money market funds that have fixed dollar net asset values and, after several years of negotiations, the SEC put in place rules that mitigate, possibly not completely solve but at least mitigate those risks. Mortgages, mortgage lending I think is now safer than it was due to rules that have been put in place since the financial crisis.
So I think a lot's been done, but I'm still worried. I don't think it's enough because let's think about why we ended up with a financial crisis. Everybody understood and long understood, at least since the bank runs of 1913, if not for centuries before, that banking organizations can be subject to runs. They promise people their money any day they want it and use the funds that people deposit to invest in liquid assets, like loans to businesses or households for homes. Should something happen that provokes a loss of confidence in the bank and people decide they want their money, that leaves the bank in the situation of possibly not being able to satisfy those demands. Runs can be contagious. When one bank looks like it's in trouble, we can have runs on the entire banking system. So that was always understood, but it turned out that banks are not the only organizations in the world that might come up with the great idea that a money-making opportunity is, borrow short, tell people they can have their funds very rapidly, tomorrow or in a week, and use the funds to invest in liquid assets.
For example, before the crisis, investment banks. Some investment banks were even part of banking organizations, but many were standalone entities, like Lehman, Bear Stearns, Morgan Stanley, standalone entities. They had enormous leverage, they were like gigantic, risky banks, funding holdings of risky asset portfolios heavily with overnight borrowing. What the financial crisis was really about was, these shadow banks suffered runs but they didn't have a lender of last resort. They weren't supervised, they didn't have meaningful capital or liquidity requirements, and ultimately, when Lehman failed, we saw what the consequences were.
Money-market funds were very similar. They promised everyone, deposit a dollar and you'll get a dollar back. They invested in pretty safe assets but not totally safe assets. When Lehman failed, people saw there was a small fund called the Reserve Fund that held a lot of Lehman commercial paper and maybe that fund was going to break the buck. Those people who realized that decided they wanted their money out first, and before long all the money markets were suffering dramatic runs and the government had to step in and guarantee money-market deposits. So that's the shadow banking system, entities that operate like banks, a lot of leverage, borrow short, hold the liquid assets. When they have runs, they cause contagion because they start to sell the liquid assets, that pushes down the prices in fire sales and transmits contagion to any other financial institution that holds similar assets.
Well, I would say shadow banking remains a problem. I said we addressed money-market mutual funds and put in place some meaningful reforms. Now, almost all major investment banks are a part of bank holding companies and are supervised in that regime, but there are lots of other entities that engage in activities of this sort, from hedge funds to insurance companies to... We have open-end mutual funds that promise you that any day you want your money, you can have it, but they hold longer-term or liquid assets that, when they turn around and have to sell, you can have runs and contagions. We don't have any system in place to regulate these things that emerge. Of course, when you carefully regulate and heavily regulate one area, the natural incentive is going to be for these activities to migrate away, outside the regulated sector, so you can be quite sure that, over time, these risks will migrate.
Dodd-Frank set up the Financial Stability Oversight Council, which is a group of regulators, and gave them some powers. One of the powers that they were given with respect to shadow banking was the ability to identify a financial company that's not a bank, that if it thought its failure would pose systemic risk to the economy, the FSOC could designate that company and subject it to enhanced bank-like supervision.
Now, you can have risks that have to do with an activity, not necessarily centered in one or two companies, so that was never a sufficient way to address shadow banking risks. There, over the last year, the FSOC has essentially got... tied its hands, in such a way that it has made it extremely difficult to ever designate another firm. I would say that we're now in a period in which there's deregulation, deregulatory fever. Regulations are being dialed back and FSOC's designation powers have now been, I would say, all but neutered, so that concerns me.
I guess the other thing I'd mention that concerns me is that... While the core financial system is more resilient, one of the things that happened in the run-up to the crisis, and this is common in financial crises, is that excessive exuberance develops about something. In the late 1990s, it was about technology companies and we saw a massive run-up in the prices of technology stocks and the stock market in general. In the run-up to this crisis, it was housing. Also, I would say leveraged lending was an area... It's not what caused the financial crisis, but there was a lot of exuberance in leveraged lending as well, asset price bubbles also that form. When those begin to go bust and there's been a lot of credit extension, credit growth is very rapid and people are borrowing to take positions in these assets that are rapidly appreciating, the unwinding of those bubbles and the credit and the leverage that is involved, that's a common cause of financial crises.
Many countries around the world have created financial stability councils and given those councils powers to restrict credit growth when it looks like it might harm the economy. For example, in China, in England, in many countries where housing prices run up rapidly... Now, there may not be a problem of worrying about banks that are extending lending, but when you see very rapid growth in credit, very rapid growth in house prices, history suggests there's likely a problem coming at the end of this and it may be really wise, for the sake of the economy and its financial and economic stability, to do something to constrain the growth of house prices and lending or other areas where this may develop.
In the United Kingdom, for example, they have put in place restrictions on the maximum loan-to-value ratios that you can have in mortgages when these concerns have arisen or limits on debt-to-income ratios in mortgage lending. The purpose of that is to try to constrain the formulation of a bubble that, when it bursts, is going to create, at a minimum, a serious recession. I believe we need those tools too.
Steve Cecchetti: Thank you. Excuse me. So... Oh dear. I recall the stress tests very well. They were definitely a very positive thing and something that I think that we should all be grateful that the Federal Reserve saw their way to doing that. I am worried that they're being watered down though as well. Not just the FSOC, but the stress tests themselves.
Janet Yellen: I agree with you. I mean, we are now in a regime were, to many people, it feels like the financial crisis is history. There was too much regulation put in place and gradually fine-tuning is... You know, it starts by saying there are areas where we went too far and let's just tailor things a bit better so regulation is more appropriate to the problems, but in some areas, including stress testing, I think we've gone beyond that point and are beginning to engage in changes that are dangerous. I certainly agree with that and I worry about it.
Steve Cecchetti: Yeah, no. You mentioned lending. Let me turn to debt in a slightly broader context. 20 years ago or so, federal US government debt was less than $4 trillion dollars, you know, in the range of 40% or so of US GDP. It was actually falling throughout much of the late 1990s and early 2000s. Today, federal US government debt exceeds $16 trillion. What's more interesting is that it's now over 75% of GDP and it's rising. Now, some people have said that, for a combination of reasons, like the fact that interest rates are low and that we print our own currency, that we shouldn't really worry about this. You've expressed concerns about the sustainability about US debt. Why are you concerned and what might we think about actually doing about this?
Janet Yellen: Okay, so I am very concerned. On the other hand, it is true that interest rates are very low so... Okay, in 2007, the US debt-to-GDP ratio was, I believe, 38%. Then we had the financial crisis, the economy had a significant downturn. During that time budget deficits naturally grow... with a weak economy, less tax collection, more spending... and we actively used fiscal policy, at least for a couple of years, to try to help the economy get back on its feet. And of course, more recently, we've had huge tax cuts. Even before the cut, the debt-to-GDP ratio had roughly doubled, to 78% today.
But the share of GDP that goes to pay interest on the debt during that same period, 2007 to this year, is almost completely unchanged. It's now 1.6% of GDP, and it was 1.7% before the crisis, so twice as much debt relative to the economy, no increase in interest expense relative to the economy. That's because interest rates are so low. I think that means that our capacity to have a higher debt-to-GDP ratio than we would've thought, say, before the crisis... I'm perfectly comfortable with the debt-to-GDP ratio we have today and think it could even be a little bit higher, but that's not end of story at all. With the low interest rates it's okay, I think, to have more debt in the economy. I'm not worried about the level of the debt. What I'm worried about is the trajectory that the debt-to-GDP ratio is on.
Now, in an economy where interest rates are lower than the growth rate of the economy, and that is true in the United States and it's true in many developed countries, if a country only issued debt for no purpose other than to pay interest on the outstanding debt, that would be a perfectly sustainable thing to do. In fact, the debt-to-GDP ratio over time would actually decline. So the so-called primary deficit is the difference between government spending on everything but interest and tax revenues. That primary deficit, if it was in balance, that means you're only issuing debt to pay interest, would put us on a declining debt-to-GDP path.
Some people think, eureka, interest rates are lower than the growth rate of the economy, it's fine to have... You can even have a small primary deficit and still have a stable debt-to-GDP ratio, but we have a 2.8% primary deficit today and that is not small. That is a path that, if you left the primary deficit at 2.8%, would result in a run-up over time in the debt-to-GDP ratio. That would be worrisome, but things are even more worrisome than that because deficits are going to rise a lot more quickly.
If we leave the current set of tax and spending programs that are on the books in the place, we face a completely unsustainable rise in the deficit and in the debt-to-GDP ratio. That's true even in a world of very low interest rates. The reason is that we have a rapidly aging population, and three programs, social security, Medicare and Medicaid are increasing relative to the economy very substantially just over the next decade and over the several decades after that. They will go up by about 50% relative to the economy because of aging population and also because health care costs, even though the pace of inflation in health care costs has come down somewhat, which is great... Health care costs per capita are still growing more rapidly than per capita income. If that trend continues, the combination of health care cost trends and aging population is going to lead to a runaway path of the debt. There's just no way around it. You can hope for faster GDP growth or other kinds of changes, lower interest rates, that mitigate it, but this is just a mathematical outcome of the programs we have in place.
This is isn't a pleasant set of choices. This is sometimes called root canal economics. No politician in recent memory has wanted to discuss how they're going to address it. What are the options? The options are, raise more revenues or spend less. We're now at a point where, if we don't address this quickly, it becomes ever more difficult to do it. If we would address it now, for example, raising taxes, some of the burdens would fall on people with hair color like my own. The longer we wait, the more the burden of either the spending cuts or the taxes is going to fall on younger generations.
At a time when, really, we are investing, I think, far too little in young people and children, in infrastructure, in our economy, other things we need... If we don't do something reasonably soon, we go to a point where Congress will have very, very hard choices. These programs' expenditures will grow, the deficits will grow, interest on the debt will grow. Eventually, it's going to start squeezing out spending on almost everything other than those three programs, so this is a really hard set of choices.
Modern monetary theory, it says you never have to worry about debt in a country that can print its own money, and we do print our own money, but you do have to worry about inflation. I think that's where it's going to go and that's where it has gone in most economies that can't get control of their budget situations. Financial markets are paying no attention to this now at all. If you listen to the little lecture I just gave, and you're investing in 10-year or 30-year Treasuries and you see that you're going to get under 2% over 10 years on a 10-year Treasury with that trajectory, you might worry a little bit about whether or not that's a good investment. But we have a 10-year Treasury rate that's under 2% and market participants are obviously not focused on it.
As the situation gradually gets worse, it would not surprise me if the day came when suddenly market participants are looking at that. I worry about what that means for the dollar, I worry about what it means for inflation, for interest rates on government borrowing, and for crowding out of productive investments in the US.
Steve Cecchetti: Well, I guess current politicians are no different from past ones, that it's always better to promise people things. You can promise that you're going to give them things then somebody else can worry about paying for it, but eventually the bill does come due so...
Janet Yellen: Well, I think it will come due.
Steve Cecchetti: And it will. I have a few more questions about sort of some longer-term things. We have a few minutes left. Let me turn to issues of inequality, which I think are things that you, I know, have thought about and spoken about. In the United States, income inequality has been increasing now for a number of decades. I believe, if you look sort of at rough numbers, the 1970s were the lowest point, there was the least, and it's been getting worse.
Janet Yellen: By the 1980s it began to get worse.
Steve Cecchetti: It began to rise and it's been getting worse since then.
Janet Yellen: It's been getting worse and worse.
Steve Cecchetti: Right. So if I look at the last 20 years anyway, the fraction of wealth held by the top 10% rose from an already high 67%, these are the data that happen to be around, to closer to 77% now. That's from a very high level to an even higher level. By this measure, the US is currently, I think, at the top of the inequality tables of advanced countries. I'm not sure this is a contest that you really want to win, but this country is winning. What is your view on this? What do you think that might be done? Some people believe there to be a role for central banks and central bank policy on this, if you have any views on that.
Janet Yellen: Sure. I mean, as you said, Steve, this is a long-term trend. It dates back, at a minimum, to the early 1980s. I think one important aspect of it is technological change that has favored those with more skills. It's tended to raise the reward to those with more education and skill and reduce the rewards to those with less education. Globalization is probably also part of it, and I think those two things go hand in hand. We've had a decline in the role of unions, but I think labor's bargaining power is diminished and the decline of unions partly reflects that. We've done less than many other countries to try to push against these trends. These are trends that the Federal Reserve policies are not able to affect. They're very disturbing trends. So when you ask does the Fed have any role, my temptation to say the short answer is no, but let me say a little bit more than that.
I think the Federal Reserve can play some role and some positive role, although certainly, it can't do anything about these longer-run trends that are going to be with us, but the Federal Reserve was given a dual mandate by Congress to achieve price stability and maximum employment. When the Fed is successful at really achieving maximum employment, that is a very important contributor to less skilled, less educated individuals doing better and seeing better times. We're seeing that now in the US economy. At 3.7%, the unemployment rate is the lowest in 50 years. Maybe the normal rate of unemployment has declined so we should have a tougher benchmark but I think, by almost any measure, the labor market's tight.
What has that meant? Almost every firm in the United States, if they have to fill out a survey, will say it is exceptionally difficult to hire workers and they're having a tough time filling jobs. It's gotten worse and it's been that way now for a while. So what are firms doing? When you can't find people that you think are qualified for the jobs you have to offer, firms now are realizing they need to provide more training. They need to partner with colleges and universities and community colleges and high schools and develop training programs and give people the skills to qualify for the jobs they offer. They need to provide and are providing more training, lowering their hiring standards, and training people to give them the skills they need to do those jobs.
If you go back to the height of the crisis, when unemployment was 8%, 9%, 10%, if you filled out a job application and you checked the box that said you have a criminal conviction, you did not have a prayer of getting a job. I met quite a number of people in that situation and a large share of Americans do have some sort of arrest or a criminal record. That's actually changed. It's still not easy, but that's actually changed. Firms are hiring people who have, you know, marks against them, who are checking the box, and if we can keep a good, strong labor market going and expansion going for a long time, I have the hope... I can't say there's firm evidence of this, but there's this term called historesis. Historesis means history makes a difference, so what I mean is that individuals who are getting this training, who have less education or had criminal records, are establishing good job performance, getting training, forming job networks. We may have another downturn, but maybe they will be different people and much more able to get jobs after the next downturn because of that. Right now, wages are rising the fastest for people at the bottom of the bottom in terms of education and skill.
Now, when the economy weakens, the unemployment rates rise the most for minorities and those with less skill. The African American unemployment rate peaked at 16% after the financial crisis when the US overall unemployment rate was half that. The African American unemployment rate has dropped to about 6%, which is the lowest in the history books. I think '57 is when they started collecting that information. So a good, strong economy does really help.
Beyond that, I mean, I would focus... These are matters for Congress and the administration and for states and localities, but my first emphasis would be education and training. As we've seen a continual widening of the wage gap between college, or some college, and high school or less, that seems like a signal that the rate of return to education is high and rising, even though education costs have risen. So it's a good investment. There are lots of different... from early childhood education to college, community college, there are lots of good opportunities for education and training. That would be first on my list.
Lots of things that would make the US just a more productive economy, investment in infrastructure and R&D. Things that would improve productivity growth would be on my list. Also, the tax system and trying to make sure that it's fair and there's a fair distribution of burdens. I think we could expand the earned income tax credit and I'd certainly, at this point, be in favor of raising the minimum wage.
Steve Cecchetti: Well, hopefully, the next Congress and the next administration will listen to this. You mentioned the earned income tax credit. This is a fascinating thing. What's most fascinating to me is it was originally a Republican program and they seem to have disowned it at some point. I want to make sure that we have time for this one. It's an even longer-term issue, but it may be the most important one. For those of you that noticed, this week's issue of the Economist focuses on climate change. Now, I don't know about other people here, but I do not think about the Economist as a bastion of progressive policy advocacy. It's basically, you know, the sort of right-wing of the British establishment, but they write the following, "Climate change touches everything this magazine reports on. It must be tackled urgently and clear-headedly." I'm sure most of you would say it's about time.
Now, you're a founding member of the Climate Leadership Council, which among other things, has published an economist's statement on carbon dividends. In the interest of full disclosure, I should say that I am one of the 3,500 signatories. There's a lot of people that signed this. Climate change may be the single biggest global challenge that we face. As an economist and as a former public official, what is it that we should be thinking about and what is it that we should be trying to do?
Janet Yellen: Well, I agree with the assessment that climate change is maybe the top issue facing the globe, global policy issue. You mentioned some numbers that they had. We have 15 government agencies that collaborated in the United States to produce a national assessment of the impact of climate change. As you may have noted, government agencies in the executive branch these days are not exactly being encouraged to publish findings saying that climate change is a critical problem. These 15 agencies, nevertheless, published a very hard-hitting assessment that said that climate change is already negatively impacting growth and will do so to a very substantial extent unless we take rapid and effective mitigation steps in the near future. So it is having an enormous impact, rising sea levels, hurricanes, extreme weather events, droughts, heatwaves, lots of impacts that we're seeing already.
What my colleagues and I, at the Climate Leadership Council, have tried to do, is ask ourselves, is it possible to form a bipartisan consensus around steps that would be effective and could command broad support? The letter that Steve mentioned, that 3,500 economists signed, it's the biggest economists statement of agreement on a set of principles I think we've ever had. I should mention, there were 27 Nobel Prize winners, 15 living chairs of the Council of Economic Advisors, all four living Fed chairs, and a number of treasury secretaries, bipartisan, republican, democrat... is the core of a program. So a number of things, I don't mean this is the only thing that's needed, but the core of an effective climate change program would be to make sure that the incentives we face and the prices we face in the market take account of the damage that greenhouse gas emissions cause to the planet and to economic and societal welfare. Right now they don't do that.
If I drive my car, burn a gallon of gas, heat my home, I have no incentive to economize on the emissions that my activities cause, other than I am worried about the climate and I want to be a good global citizen. A carbon tax would be a carefully targeted way to make sure that the damage that's imposed by emitting greenhouse gases is priced into everything that we do that involves greenhouse gas emissions. It is a so-called Pigouvian tax that recognizes that burning carbon-intensive fuels, emitting greenhouse gases, causes an externality, harm, that an incentive needs to be created to counter that harm and to make individuals incented to take those adverse impacts into account in their decisions. So we would favor a carbon tax.
Now, there's a question of what to do with the revenues of a carbon tax. Although I am worried about deficits and I was very attracted by the idea of using some of the revenue to deal with the deficit, but I think to make it broadly acceptable, our group agreed that the revenue should be rebated to the American public. They will, after all, be paying taxes. We found broad bipartisan agreement on a plan that would rebate those revenues on a per capita basis. That means every American would get a dividend representing their share of the carbon tax. Starting, we were thinking of something like a $40 a ton carbon tax. That would generate, for a family of four, a dividend check of $2000 in the first year, so it's quite meaningful.
It's a very progressive distribution. Something like 78% of Americans would end up ahead. Of course, you're paying something in the carbon tax, depending on what your habits are with respect to driving and other things, but for almost 80% of Americans, and certainly for the lower part of the income distribution, they would come out ahead, so this is a progressive system. In return for doing this, to attract the support of business... and I will say that most of the major oil companies, British Petroleum, Exxon, Shell, have signed on, endorsed this plan. A carbon tax that starts around $40 a ton and then rises over time, so in real terms it continues to rise, would generate reductions in greenhouse gas emissions that would significantly exceed the commitments that the Obama administration made in the Paris Climate Accord. In return for that, some of the kinds of climate policies that businesses really don't like, that are command and control and involve detailed directives about technological choices in various industries, some of those could be rolled back. This would be a market-friendly incentive that, at the end of the day, would accomplish quite a lot more.
We have environmental groups that agree with this, because it's a way to be more aggressive about achieving broader targets. I think the Paris commitment, of only seeing temperatures rise by 2°C, that's almost impossible to achieve. So we're looking. We think this is the core of a plan that could achieve consensus. I believe that roughly half of the democratic candidates for president have endorsed something like this as a piece of a larger climate plan.
Steve Cecchetti: Thanks. We've basically run out of time, but I don't want to leave without asking you about this week's... We might as well ask a little bit about current policy, seems fair that we have you here. This week, on Wednesday afternoon, there was an announcement by the Federal Open Market Committee that they were easing policy by 25 basis points, quarter of a percentage point. The committee was very divided in doing this, as they were last time when they did the same thing, although this division looked even worse. So my question is, did you agree with the decision and what is your view of the dissent?
Janet Yellen: I think this is a tough time for policy and, as I said, the Federal Open Market Committee is a thoughtful and diverse group. There's really not groupthink there and you see that, the committee's quite divided now. I see why they're divided, but I would've voted for the 25 basis point cut. My logic's pretty simple, which is the economy's in a good place right now. We have a good, strong labor market. I'm thrilled to see a 3.7% unemployment rate, the lowest in 50 years. I think that brings great benefits to many people and particularly those who've been having the hardest time. I want that to continue.
A reason to be careful and not to want to raise rates is inflation, which is the other mandated goal of the Fed. But inflation's been running below the Fed's 2% target now for almost 10 years, the better part of 10 years, and even now, inflation is still running just around 1.4% over the last 12 months. I think it's moving up toward 2%, but I don't believe that high inflation is a concern. It would be a concern, to me, if we were still in an economy that we're creating 200,000 jobs a month, which is where we were nine months ago, and if the unemployment rate were drifting down from 3.7% to 3% to 2%. Then I would be sitting there and saying, I know we don't have inflation now but, boy, I'm seeing it come down the road and I'm really concerned about it. But the economy's been slowing. It's still growing a little bit above trend, but the pace of job growth has declined. I don't think we're at a point when we need to worry very much about inflation.
I see considerable downside risks to the outlook. Mainly they stem from weakness in the global economy and from the trade war that we're currently involved in, which has weakened the entire global outlook and has created so much uncertainty that businesses in the United States and elsewhere are saying, gee, not understanding what the rules of the game are, I think I should put investment decisions on hold. They're doing that in the United States and they're doing it in China and they're doing it in all the countries in Asia that are linked into global supply chains. They're doing it in Mexico, in Canada, and in Europe that sells goods all over the world, including into Asia. You know, we've got a drying-up of investment spending, in part just because of the uncertainty, which I don't think is going to diminish any time soon.
Now look, I still think, even if you didn't have this cut, probably the US economy would grow pretty close to trend. I can understand the people feeling it's not necessary. They don't see any evidence that the economy is weakened. Manufacturing's weakened but the labor market's still doing fine. Maybe inflation is picking up, and we shouldn't totally forget about that, but I guess I see significant downside risks to the economic outlook and I think trying to maintain accommodative financial conditions is important to keeping the expansion going. My own top priority would be to see the expansion continue.
Steve Cecchetti: Thank you. Thank you very much. Let me turn this over to Katy now.
Katy Graddy: So thank you very much, Professor Cecchetti and Professor Yellen. That was really fascinating. I'm especially pleased that all the students in the room were able to hear this. That was great. It's truly an honor to have both of you on stage for our 25th anniversary of the International Business School and the 30th anniversary of the Lemberg Program. I'd also like to thank President Liebowitz for joining us this afternoon and for offering such a warm welcome. The business school and all of Brandeis University is truly fortunate to have you as a leader, President Liebowitz. Also, to the family of Rachel McCulloch, we're really pleased that you can be here today.
Before we continue with our reunion weekend program, I'd like to take a moment and just reflect on Professor Yellen's remarkable career. First as a professor at Harvard, the London School of Economics, and the University of California at Berkeley, and continuing as a pioneering policymaker who rose to the very top of the Federal Reserve System, and now as a Distinguished Fellow at the Brookings Institute. Professor Yellen has set the highest possible standard for what it means to succeed as an economist. Even more importantly, there is no public figure that I know that has demonstrated more integrity, intelligence, and leadership.
Janet Yellen: Thank you. Thank you so much.
Katy Graddy: Professor Yellen, your service has been impeccable and you're an inspiration to all of us.
Janet Yellen: Thank you. Thank you.
Katy Graddy: It is with these many contributions in mind that I ask Professor Yellen to please come forward. I'd like to present you with the Dean's Medal. We all at Brandeis extend our sincerest thanks and gratitude.
Janet Yellen: Dean Graddy, thank you so much. It's a tremendous honor. I really appreciate your selecting me for this. It's been a pleasure to participate in this reunion, to have the chance to honor my good friend and colleague, Rachel McCulloch. Let me thank you, not only for the medal but also for the wonderful and important job that you're doing in training a generation of leaders who will be prepared to lead in the global economy, to address the complex challenges that we face and to understand the need for global cooperation in addressing those challenges.
Katy Graddy: Thank you.