A Fed retrospective: Al Broaddus, until recently Chairman of the Richmond Federal Reserve Bank, tackles the bond market, inflation targeting, and Chinese capital flows. A TIE exclusive interview.

• Position: Interview

TIE: How do you compare the challenges facing the Fed today with those when you first became president of the Federal Reserve Bank of Richmond? Has much changed?

Broaddus: It has changed in two ways. When I first took over as president of the Richmond bank at the beginning of 1993, the Fed had not yet achieved price stability although it had made significant progress. Price stability remained a longer-term challenge. Now, however, I think it has established strong credibility for ensuring price stability, both on the upside and the downside. That was not the case earlier. The challenge now is to maintain rather than to attain price stability.

The other difference is that in early 1993 nobody had any thought of the possibility of deflation or what sometimes we euphemistically describe as excessive disinflation. Of course, over the last several years we've had to cope with that risk. We're past the immediate threat of deflation at this stage of the game. But when you have an inflation rate as low as the United States does now--despite the recent run-up in fuel prices--and given the roughly half-percentage-point upward bias in our inflation measures, then we need to be aware of the risk to inflation in both directions.

TIE: That's a good point. Given that the Fed is in this "maintain" mode now, do you see the transmission mechanism for monetary policy differently today than before? How does monetary policy work its way into the system now, and has that changed?

Broaddus: If you look at parameters and coefficients in a formal macro model, you may see some changes in some of the coefficients, but the basic overall structure is still pretty much in place. I think about it in two stages. In terms of real effects, monetary policy operates to a large extent through interest rates. If you look at the yield curve, the Fed directly affects the funds rate and--via expectations of its near-term policy actions--the short end of the curve. But our actions and our credibility also have a significant effect on the longer end of the curve. As far as inflation is concerned, I have enough monetarist blood in my veins to believe that this is largely determined by the rate at which we are supplying money. While we can't very effectively target the monetary aggregates any more, that's an underlying relationship that we need to at least keep track of as we conduct policy in the short run.

TIE: What do you make of what's going on with the long bond? It's interesting that the Fed has taken four tightening moves but the long bond yields have gone down at every stage. We've never seen this kind of flattening going on at the front end of a tightening cycle. What do you make of that?

Broaddus: That's a puzzle, but I don't see as much of a puzzle as some. This is the first early stage of a tightening cycle in decades where the United States has not had an underlying inflation problem. The Fed has significant credibility on price stability and that's bound to be one factor at work. The other is that the inflation rate is very low now, and in many market segments expectations of intermediate-term inflation and probably longer-term inflation are still quite low. I agree that it is an unusual circumstance. While there's still a lot of downside risk in the outlook, the data still suggests that the recovery is pretty healthy, especially with the strong October jobs report. So it's interesting that we haven't seen a little more of an uptick in real rates as we go out further on the curve.

TIE: Have you ever heard the theoretical argument set forth that in fact there was no 2000-01 recession? What we saw three or four years ago was essentially the dot-com and telecommunications bubbles being burst? Thus, unlike normally at the end of a recession where badly hit consumers show huge pent-up demand, consumers actually did fine this time. Consumers have already bought everything they can conceivably buy, so to induce them to buy further, retailers must offer large discounts and companies have very little pricing power. Therefore, the economy is really just in the middle to later stages of an ongoing expansion. Although we had a brief period of large monetary and fiscal policy stimulus post-9/11, a 3.5 percent growth rate is probably what you would expect right now in the latter stages of an expansion. By not overreacting, the Fed's policy of a short-term rate around 2 percent and a long rate around 4 percent is fairly reasonable, a 200-basis-point differential. What do you think of such a notion to explain the performance of the long end?

Broaddus: To answer your first question, I wouldn't rule out something like that as part of the explanation. The 2001 recession obviously had a very different profile from other post-World War II recessions. Whether it should be called a...