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Interview with Laurence Meyer

Interview with Federal Reserve Governor Laurence Meyer

September 1, 1998


Interview with Laurence Meyer

When he was a forecaster in the private sector, Board Governor Laurence Meyer's firm was recognized as one of the most accurate in the country, winning prestigious prizes from Business Week and the panel of Blue Chip Economists. So he would seem a natural fit for the Federal Open Market Committee, the policymaking arm of the Federal Reserve System, and he indeed sees his current position as a sort of culmination to his career. "I must say at the outset that I believe I have been preparing for this opportunity my whole life," Meyer said in his nomination hearing before the Senate Banking Committee.

Photo of Laurence Meyer Meyer's responsibilities at the Board have required him to travel across the country and, among other things, to visit with community leaders about lending and development efforts. Those trips often take him to urban neighborhoods, but during a recent trip to Minneapolis, Meyer left the city and visited two northern Minnesota Indian reservations, and he shares his reflections of that trip in the following interview.

Meyer also discusses his decision to start a private forecasting firm, professional life at the Board and current changes within the banking industry, among other issues.

REGION: To begin, just a couple of questions about your career before you came to the Fed. Why did you decide to branch out from academia in 1982 and start your own business?

MEYER: First, I should clarify that I did not leave academics to start my forecasting firm. Washington University gave me the latitude to begin and run the firm while retaining my faculty affiliation and responsibilities—that was a challenge in itself, to be sure. As a matter of fact, I am currently on leave from Washington University while serving on the Board of Governors.

Why did I start the forecasting firm? An interesting question. My love of large-scale macro models began while in graduate school at MIT. I was a research assistant for Professors Franco Modigliani and Albert Ando during their work building a large-scale macro model that ultimately became the model used at the Board of Governors.

While I was serving as chairman of the Economics Department at Washington University I wondered about what new challenges I wanted in my career and decided that I would like to put into practical use my knowledge of macroeconomics by starting a firm specializing in model-based forecasting and policy analysis. I saw this as a natural extension of my academic work as well as an opportunity to provide a market test of the usefulness of my approach to macroeconomics. I enticed two of my former students—Joel Prakken and Chris Varvares—to return to St. Louis and begin the firm, and the firm's success was very much a joint product of our efforts. I had to sell my interest in the firm as a condition for joining the Board of Governors. But I take great pride in the continued success of the firm under the leadership of my former partners.

REGION: Was it a difficult decision to make?

MEYER: Easiest one I ever made.

REGION: Were your modeling techniques new?

MEYER: They built on the tradition of the work that had come out of MIT and the University of Pennsylvania and that were already embodied in the work that was carried on by the Board of Governors. It wasn't a dramatic change in vision, but we thought we were able to develop a model that we felt was the best one being used—certainly in the private sector for forecasting and policy analysis.

By the way, building a business was a very exciting prospect—that entrepreneurial challenge was a new one for me and I relished that aspect of it. That was very exciting. I think it becomes more exciting when you come so close to not making it. At the beginning it was so close—whether we were going to be able to pull it off. But when you're successful after that it's so much more meaningful, because it was difficult.

REGION: In your statement before the Senate Banking Committee at your nomination hearing, you said that your career had been, in many ways, a preparation for the opportunity to serve on the Board of Governors. Has there been anything that you've been unprepared for—any surprises?

MEYER: There are three surprises for me. First, despite all the warnings from former governors, it is still a surprise to be confronted with such a wide range of responsibilities at the Board. Most people believe that we attend eight FOMC meetings a year and spend the remainder of our time thinking about the economic outlook and monetary policy. The truth is we have responsibilities in bank supervision and regulation, consumer protection, fair lending, and community reinvestment, participate actively in various international fora, and have important management oversight responsibilities for the operations at both the Board of Governors and the 12 regional Federal Reserve banks. We're like the board of directors of a large business.

Second, I have been surprised by the amount of attention by the media, especially related to anything I say about the economic outlook or monetary policy. There is a virtual feeding frenzy that goes on, and the primary difficulty is the variety of interpretations that are given to what you say, especially by the different wire services. So, you try to be disciplined and communicate as effectively as you can, and then you give a speech and get 10 varying interpretations of what you said, often with a lot of liberties taken in the interpretation. But you learn to live with that.

There's nothing malicious about it: They're trying to do their job, and I'm trying to do my job. But I would say that one of my least favorable moments in this job is coming back from a speech and having to see the various wire service reports overdramatizing and overinterpreting what I had to say, and then waiting so see what shows up in the newspapers the next day.

Beyond that, the third surprise is that I frankly did not expect that the workload would be as heavy as I have found it. My inbox is like a perpetual motion machine; I have more material to read than has been the case since graduate school, and devote especially long hours to my speeches on the outlook and monetary policy, in an effort to keep them appropriately balanced (I know they may not always seem that way) and to try to avoid misinterpretation (which I do not always manage to do).

REGION: Any particular case of media misinterpretation that stands out?

MEYER: There are many. One was the first time that I had a significant impact on the market, I think it was in January 1997. First of all, I gave a speech and a newspaper said something like this: Gov. Meyer gave a speech in Charlotte that was taken as very bearish by the markets, and the stock and bond markets took a significant dip right away; but Meyer proved he was no Greenspan—markets recovered by the end of the day and ended higher. [Laughs.]

A reporter came on a trip with me subsequently just to observe the reaction to the speech and write a story about the way it was covered. As part of that story he quoted my wife after the Charlotte trip as having said, "Well, you finally did it, you tanked the market." Of course, my wife claimed that she never used the word "tanked," that it's not in her vocabulary. So I called up the reporter and told him he had committed one of the gravest sins of a reporter—he had misquoted somebody. He said that I had given him that quote, and I told him: "You're supposed to check your sources."

In all seriousness, I try to be as effective in communicating as I can be, as balanced as I can be, while still getting the message across that I'm trying to convey—which is difficult. I'm known to be quite explicit, and have been told that I'm "recklessly clear." But I want to be explicit, particularly about how I have evaluated a situation in the past—how I interpret what went on, why it went on and what was appropriate or not about monetary policy. Looking forward I try to be a little fuzzier and don't tend to talk in very precise terms, but I do talk about the nature of the challenges pretty explicitly. Because I'm as explicit as I am, I give the media good material, as it were, and obviously I occasionally pay the price.

But I believe in transparency and that we have an obligation to explain to the public how we assess the economic outlook and the risks, and how we rationalize policy. Of course, I don't speak for the FOMC and I don't speak for the Board—I can only give my views. And we're all very careful about stressing that we are presenting our personal views when we give speeches or talks, and not the views of the entire Board or FOMC. If I ever read in a story that Gov. Meyer has hinted about the direction of the FOMC, I immediately call the reporter and stress that I was only giving my view and not those of my colleagues. If you want to know what the FOMC thinks, you've got to ask everybody on the Committee.

REGION: It sounds like it's easier to say nothing.

MEYER: It's easier to say nothing or to say things that are reasonably obscure. Of course, if you think that the goal is increased transparency, you can't handle it that way. But balance is very important, judgment is very important. Some of these things one learns from experience, but there's a great value in going over this with the staff; they've been through this a number of times over the years, and I do take their advice very seriously.

REGION: In a recent speech entitled, "Come with Me to the FOMC," you describe, in great detail, the workaday procedure of an FOMC meeting. [Reprinted in The Region, June 1998.] You clearly have great respect for the FOMC and the manner in which information is gathered and the meetings are conducted; having said that, is there anything you would change?

MEYER: Let me begin by emphasizing the effectiveness of the process. It is important to retain the encouragement that now exists for all views to be expressed and respected.

Still, it is worthwhile to critically assess the effectiveness of even those institutions that appear to be working so well, as I would say is clearly the case for FOMC meetings. Given how well the process works, I also am reluctant to view any of my suggestions as of very high priority. But since you asked ... First, I would prefer somewhat greater opportunity for discussion, for back and forth among members to clarify arguments and draw out viewpoints. I recognize the challenge of making this work in a group of 19 people. And, sequential presentations, with each member having an opportunity to participate in both outlook and policy go-rounds, ought to remain the core of the FOMC meetings. Still, I believe that the process and decisions would benefit from some give and take. There's not really a discussion to draw out positions, and generally questions to members of the FOMC in response to their statements are limited.

Second, I would prefer more discussion of broader strategy issues related to monetary policy, as opposed to focusing at each meeting almost exclusively on whether or not to change the funds rate at that meeting or sometime soon. We sometimes have these broader discussions in February and July (at our two-day FOMC meetings), but not at most other meetings, and I think a little bit more discussion of these strategic issues would be valuable.

REGION: In November 1996 you cautioned about allowing banks to engage in nontraditional businesses like securities underwriting, and you warned about the risks to the deposit insurance fund. Are the recent mergers in banking, or the calls for Congress to liberalize banking rules, cause for concern in this regard?

MEYER: My concern was not with banking organizations engaging in nontraditional financial activities, but rather with such activities being conducted in the bank itself or in an operating subsidiary of a bank. I believe that the new activities should be limited to affiliates of the holding company. There are several reasons why this restriction is prudent. First, because there is an implicit subsidy related to the federal safety net, banks can fund their activities more cheaply than nonbanks. I do not believe this funding advantage should be extended to the new activities.

Second, restricting the new activities to affiliates of the holding company better insulates the depository institution from the risks associated with the new activities. The holding company structure is a device for protecting the deposit insurance fund from risks associated with expanded activities within banking organizations.

Third, if banks had the option of locating all activities in operating subsidiaries, they quite likely would do so to take advantage of the cheaper funding that this would allow. The result could be a decline in the use of the holding company form of organization. This would in effect significantly erode the ability of the Federal Reserve to remain engaged in regulation and supervision of large, complex banking organizations. The Federal Reserve today is the primary federal regulator of only 5 of the largest 25 banks. The Federal Reserve, however, is the exclusive regulator of bank holding companies.

This authority is a critical component of the Federal Reserve's ability to keep its fingers on the pulse of the banking system, to understand changing patterns in risk profiles and risk management across the wide range of banking organizations, and to remain in a position to manage systemic risk and respond to financial crises. Some will view this argument as a "turf" issue. But who should be involved in what activities—and specifically to what extent the Federal Reserve should be involved in bank supervision—is an important and substantive public policy issue. Congress has always looked to the Federal Reserve to monitor and control systemic risk, guard against financial instability and manage financial crises.

REGION: What is your opinion of the Minneapolis Fed proposal regarding deposit insurance, calling for depositors at too-big-to-fail banks to take on some risk on deposits exceeding $100,000, and for a market-based assessment of risk in the pricing of deposit insurance?

MEYER: I view the Minneapolis Fed deposit insurance reform proposal as one idea for increasing market discipline on banking organizations. This is especially important with respect to large, complex and internationally active banks, where both the risks and difficulty in supervision may be greater. Deposit insurance allows depositors to be less focused on assessment of the risk of their banks, because they know that if the bank fails, their deposits are guaranteed, at least up to $100,000, and, in practice, often well beyond. The Minneapolis Fed proposal would limit payouts to uninsured depositors in systemic risk situations to the maximum of either 80 percent of the nominal value of their deposits or the market value of their deposits.

I am also interested in finding ways to improve market discipline. My preferred approach would be to require large internationally active banks to issue a minimum amount of uninsured subordinated debt to the public. Holders of such debt would have a strong incentive to require the bank to manage its risk prudently. Like the Minneapolis Fed proposal, I would like to see the current risk-based insurance premiums better reflect the risk differences between banks. That does not happen today, in part, because current law limits the growth of deposit insurance reserves, and as a result banks actually pay deposit insurance premia.

It is, however, important to keep in mind that movements toward increased market discipline often result in increases in systemic risk. So, in comparing proposals for increased market risk, I would focus on the following trade-off. For a given improvement in market discipline, which proposal results in the smaller increase in systemic risk? Based on this criterion, the subordinated debt approach may be preferable. Subordinated debt holders cannot run, whereas depositors facing uncertain losses might. Troubled banks with required levels of subordinated debt would face higher funding costs, and, importantly, the rise in the rate on such debt in response to higher risk would provide information to the market, the banks and the supervisors.

REGION: Big bank mergers, of course, have been in the news lately, and have raised questions for consumers, for the industry itself and for regulators. Are more mergers inevitable?

MEYER: We are in the middle of a wave of consolidations that is likely to continue for some time. There have been over 7,000 bank mergers since 1980, reducing the number of banking organizations cumulatively by 40 percent—to about 7,200 from about 12,300.

In recent years, many banks have been responding to the removal of barriers to interstate banking that restricted entry and divided markets. The adjustment to the freedom to diversify geographically will continue to encourage bank mergers for some time. Attempts to increase efficiency, in part by exploiting potential economies of scale, may also be a factor promoting consolidation. I might also note that product diversification—as in combinations of banks, securities and insurance—is also a motivating factor in some mergers. But each merger is somewhat unique and several motivations in addition to those I have just mentioned may also play a role.

REGION: For many years now, there has been a concern within the banking industry of dominance by big banks and, by extension, a disadvantage for smaller institutions. Yet, small banks continue to do well and every year more banks—small ones—are chartered.

MEYER: That's very true, and we often hear from smaller banks that they're licking their chops whenever another merger is announced, that there will be more business for them. The fact is, if two banks combine in a community it immediately ends up losing some of that combined business and often has trouble growing in the community afterward. I think it's really important that what we emphasize in antitrust is not national concentration, but local competition. Despite the number of mergers, there are some indices that show that local market concentration hasn't changed very much from 1980 until the present time. So, the mergers that we've had so far have not severely undermined competitiveness from the standpoint of local market competition.

REGION: What will the banking industry look like in 10 years?

MEYER: I appreciate well the difficulty of forecasting, especially over a period as long as a decade. But for the reasons I mentioned above, it seems reasonable to expect a continued high level of merger activity for the foreseeable future. Studies based on historical experience, and based on continued implementation of the antitrust laws, suggest that in a decade there will likely be about 3,000 to 4,000 banking organizations, down from about 7,000 today. Although the top 10 or so banking organizations will almost certainly account for a larger share of U.S. banking assets than they do today, the overall size distribution of banks will remain about the same. That is, there will likely be a few very large organizations and an increasing number of firms as we move down the size scale. Importantly, a large number of small banks are likely to remain.

REGION: How will bank supervision fit into the picture?

MEYER: Mergers and especially mega mergers are increasing the challenge for bank supervisors in several respects. Geographic diversity requires more coordination for the Federal Reserve across districts and with state supervisors in different states. Increased product diversity, especially if financial modernization legislation passes, increases the need for coordination across banking, securities and insurance supervisors. Moreover, in a world of more sophisticated and complex financial products, supervisors will have to continue to develop and use examiners with special skills and expertise in such areas as capital markets, risk management, internal modeling and information technology. Increased globalization requires increased coordination with supervisors in other countries. Another challenge, again potentially under financial modernization legislation, would be to learn to blend functional and umbrella supervision.

Finally, supervisors are adjusting and must continue to adjust examination practice to the changing banking environment. One adaptation is the move toward more "risk-focused exams." Exams increasingly focus on assessment of the risk management process, internal controls and corporate governance, rather than the evaluation of individual transactions. This is important because the quality of the assets in more complex institutions can change quickly, making static snapshots of their portfolios of limited usefulness. Supervisors will also have to make maximum effective use of information technology to collect and process information in order to monitor on a more timely basis the impact of market developments on banking organizations' financial profiles.

REGION: In your work at the Board, you have been involved with community development; as you travel around the country, what are some of the issues that are commonly discussed?

MEYER: First, there is much discussion of the successes in affordable housing and small business lending programs. This success reflects the encouragement of CRA for depository institutions to focus on the needs of the low- and moderate-income communities and people. That encouragement combined with the creativity of both banking and local non-profit community organizations has resulted in private/public partnerships that lever a modest public sector commitment of funds with substantial private sector participation. These partnerships have facilitated housing and economic development in neighborhoods and communities all over the country.

However, there is also much talk of the challenges that lie ahead, challenges in part related to the rapid pace of change in banking. There is concern about an erosion of public subsidy funds. Leverage is good, but it helps to have something to lever! There is concern that mergers and deregulation may undermine some of the recent community reinvestment successes, either because of loss of local control, because of greater difficulty in working with larger banking organizations, or because new activities that banks might be allowed to engage in might divert energy and resources away from community reinvestment.

In order to effectively address these challenges, it is essential that financial institutions and local community organizations continue to work together. The community groups must recognize that opportunities exist for the development of new products and services for their communities. The larger institutions will need to rely, more than ever, on the community groups' knowledge of local markets. By working together, and mustering that creativity which has served the communities so well in the past, banks and nonprofit groups will continue to be effective agents of change in our neighborhoods.

I should also say that often when I make such visits I spend some time at the beginning explaining what the Federal Reserve is doing in that context. So I have to explain what the Federal Reserve's interests are. Most people associate the Federal Reserve with monetary policy, but Congress also gave us a wide range of responsibilities, and one of them is to encourage banks to serve the needs of their communities, with specific reference to low- and moderate-income consumers.

REGION: What was your impression of your trip to northern Minnesota, including visits to the Mille Lacs and Fond du Lac reservations?

MEYER: My recent area of specialization at the Board has been consumer and community affairs because I chair the oversight committee for this area. When I travel to Reserve banks, I usually try to visit with community nonprofit organizations, bankers and local government officials to learn about the success of banks—and private/public sector partnerships in which they participate—in facilitating affordable housing, small business lending and general economic development in low- and moderate-income communities.

Because the Ninth District has a large number of Indian reservations, we decided to use this opportunity to acquaint me with the special challenges of banks lending and providing financial services on Indian reservations. The two reservations I visited each had casinos and both had taken advantage of the revenues from the casinos to invest in community development projects. In one case, I visited a quite extraordinary elementary school—both high-tech and attuned to the cultural values of the tribe—as well as a health clinic that incorporated traditional healers with all the modern facilities. It was very interesting to see this blending of technology and long-standing cultural tradition. On the other reservation I visited a very impressive community college. In both cases I met with the Indian leadership and bankers, and had a good opportunity to explore ways to facilitate more effective relationships between banks and the reservations.

Most of the time, on these trips, I'm looking at urban areas, and this is one of the first times that I've seen these challenges in more rural communities.

REGION: Did you come away with any new insights?

MEYER: I think I understand better the need for a two-way education process. Bankers have to be better educated about tribal law and about how the tribal court systems work. Also, tribes need to be better educated about what banks need to make loans—on Indian reservations or anyplace else. There have to be, sometimes, adaptations that take place; we have to sit around the table and build those relationships so they work more effectively. As we all know, bankers do not like uncertainty, so what we need to do is find ways to reduce what they view are the special uncertainties having to do with misunderstanding and the variation from tribe to tribe of the legal systems.

REGION: Researchers at the Minneapolis Fed have looked at questions regarding the nation's ability to increase its standard of living, and why some countries are more economically successful than others. In brief (and at the risk of oversimplifying), our 1996 Annual Report argues that openness to technological progress is the key to economic growth. What is your take on this issue?

MEYER: The discussion in the 1996 Annual Report follows a theme developed, among others, by my colleague at Washington University, Douglass North, on the effect of institutions on economic performance and living standards. Institutions involve rules of the game and incentives that affect the amount of output that a society can produce from its fundamental endowments in the form of labor and natural resources.

I often began my introductory economics class by explaining the concept of an aggregate production function. The output of a country depends on the amount and quality of inputs—labor, capital and natural resources. But it is important to appreciate that the quantity of output that can be produced with a given volume of inputs is affected by the institutions and policies of a country, including property rights, regulatory systems and tax structure. That is, institutions and policy affect the position of the aggregate production function. Moreover, the inputs into production—the amount and quality of physical and human capital invested—are themselves influenced by policy and institutions. Deregulation and reduction in trade barriers, particular policies cited in the Minneapolis Fed discussion, are excellent examples of changes that potentially increase competition and allow the economy to achieve a more efficient allocation of resources and higher living standards.

REGION: You have been recognized as one of the most accurate economic forecasters. What's your secret? Have you brought any particular tools or methods with you to the Board?

MEYER: I have said many times that my recipe for forecasting was quite simple: mix one part science, one part art and one part luck. The science is the model, that incorporates both a vision of how the economy works and empirical regularities that form the basis for forecasting future developments. The art is the judgment that is always required in constructing a forecast. And good luck—well that speaks for itself!

When I put my forecast together in the private sector, it was a team effort, with my partners and our staff at my forecasting firm. This was a full-time job for several people. I do not put a forecast together in the same way at the Board. I judgmentally adjust the forecasts produced by the staff at the Board and from many of the private sector forecasters I worked with before joining the Board. This is part of the transition from being a specialist (forecaster) to being a generalist who makes decisions with the support of specialists.

REGION: In the past, it seems we were able to rely on the unemployment rate as a predictor of inflation; recently, though, a plunging unemployment rate has apparently had little effect on inflation. Is the unemployment rate still a reliable predictor? How low can NAIRU go [nonaccelerating inflation rate of unemployment]?

MEYER: I too have been surprised by the combination of declining inflation and unemployment during my first two years on the Board. I have focused a lot of energy on trying to understand the source of the exceptional performance and the implications for monetary policy.

There are really two problems with the unemployment rate as a measure of demand pressure in the economy. First, the amount of demand pressure depends on the unemployment rate relative to some threshold rate, NAIRU, which is not directly observable and can vary over time. I, like most other students of wage-price dynamics, believe that NAIRU has declined from its level in the late 1980s and early 1990s. Nevertheless, careful attempts to update the estimate of NAIRU based on recent data still leave most students of the Phillips curve with estimates of NAIRU near 5.5 percent.

Second, the unemployment rate is not the only measure of demand pressure and specifically measures demand pressure in the labor market. Other measures worth looking at include product market-related indicators, including the capacity utilization rate. Usually the unemployment rate and the capacity utilization rate move together (inversely of course). But in the current expansion, these two measures of utilization rates have diverged. Specifically, capacity utilization rates are below the level that is usually associated with rising inflation. Based on historical performance, the capacity utilization rate in manufacturing would ordinarily be between 4 and 5 points higher than it is today, to be consistent with current unemployment rates, and at a rate well above that associated with stable inflation.

How low can the unemployment rate go? That depends, of course, in part on how low NAIRU is. It depends also on how large and persistent favorable supply shocks continue to be, since I view such shocks as being instrumental in restraining inflation that otherwise would have resulted from the very tight labor markets. I have noted many times that I believe the unemployment rate is significantly below a level that is sustainable in the long run without rising inflation. The trick is to make a smooth transition back to more balance in labor markets as the favorable supply shocks abate or reverse.

REGION: In recent years there has been much discussion about the rate of productivity. Have we seen a permanent shift in the rate of productivity growth? If so, what bearing does this have on our understanding of inflation?

MEYER: There remains considerable debate about whether and to what extent there has been an increase in trend productivity growth. Productivity growth has been robust in recent quarters, but much of this strength can be explained as a normal cyclical rebound. Productivity is, after all, one of the most aggressively procyclical variables in the economy. Even so, I have raised my estimate of trend productivity growth since I joined the Board. This is partly due to technical revisions in the measurement of price indices used to compute productivity and partly due to my reading of the productivity data. It is also supported by evidence of capital deepening, a rise in the amount of capital available to each worker because of the investment boom in this expansion.

An increase in trend productivity contributes to keeping inflation low, at least for a while, for several reasons. First, it raises aggregate supply and makes it more difficult for demand to overtake supply. Second, if unanticipated, it initially does not raise nominal wages, but lowers the cost per unit of output, for a given wage rate. Some of that cost reduction goes to profits, but competitive forces transmit some of the cost savings to prices.

The key question is to what degree the recent increase in productivity growth reflects a normal cyclical acceleration and to what extent it might signal an improvement in the trend rate of productivity growth. The simple answer is that it likely reflects some of both; but it is important to parse out the overall increase between these, and perhaps even other, transitory influences. While I have revised upward my estimate of trend productivity growth in response to the recent data, I, nevertheless, continue to believe temporary favorable supply shocks have been a more important factor explaining recent inflation experience than a permanent increase in the productivity trend.

REGION: When you describe the U.S. economy, you've been known to use such descriptions as "temporary bliss" and "permanent bliss." Could you please describe those terms? Which state of bliss, if either, describes our current situation? [Interview was given in May 1998.]

MEYER: Temporary bliss and permanent bliss are two "stories" that might explain the recent exceptional performance of low unemployment, rapid growth and declining inflation. Temporary bliss refers to the role of temporary factors in producing this exceptional outcome. Falling oil and import prices, exceptionally sharp declines in computer prices, especially benign food prices, and unusual restraint in health care costs have collectively restrained inflation over the last year and a half and some of these factors have been in play for the last two and a half years. I refer to this explanation as "temporary bliss" to emphasize that the exceptional performance in this case reflects temporary factors. The implication is that the current state is not sustainable and monetary policy must be concerned with making the transition back to a still good, but more sustainable state.

Permanent bliss is an alternative story that explains recent exceptional performance as a reflection of permanent structural changes, which have allowed the economy to operate at a lower unemployment rate without inflationary consequences and allow the economy to grow faster on average. A decline in NAIRU and an increase in trend productivity growth would fall into this explanation. In this story, the exceptional performance is sustainable and monetary policy has to be careful not to interfere with the economy achieving its new and lower sustainable unemployment rate and new and higher sustainable output growth.

The two "stories" highlight potentially different explanations of recent performance and highlight how the different explanations have different implications for monetary policy.

The complicated truth is almost certainly a mixture of the two "stories," in which case the weights of the two explanations has an important implication for monetary policy.

REGION: Thank you, Mr. Meyer.