Monetary Policy: Fed’s John Williams Feels Uncertainty Among Business Leaders

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I’m going to give you my own views on that. The unemployment rate has fallen to well below 5 percent, core inflation has been edging up over the last year or so, and other signs of good momentum, such as job growth, made a very convincing case to make this small step at this time. While there are a lot of tensions around fiscal policy and those developments, in my view this decision stands on its own. From my perspective, my support for the rate increase was based wholly on the data we have seen and the basic economic outlook over the next couple of years.

But surely the pace of future rate hikes will depend in part on fiscal policy?

The thing about conducting monetary policy in this time, it’s really important to reiterate that we’re focused on our maximum employment and price stability goals. There are decisions that are made by the elected representatives in Congress and the administration, and that’s the process that should happen. What we need to do and what we will do is focus on any changes in the economic outlook, what does that mean for achieving our goals and for the right path of policy decisions to achieve those goals. I know everyone likes to talk about fiscal policy in terms of what does it mean for the outlook. In the last couple of years we’ve also had some big shocks to the economy that came from across the globe. There’s a lot of things that can change and we have to stay focused on our goals and continue to be data dependent in terms of analyzing what do these changes mean for our outlook.

The Fed’s baseline for next year is three rate increases. Is that your view?

I will say that my underlying view for next year is broadly consistent with the central tendency of the committee. My view is that the economy is going to grow roughly as it did this year, unemployment is going to edge down a little bit, inflation moving back to 2 percent, and that calls for gradual removal of policy accommodation.

So Mr. Trump’s election hasn’t had a big impact on your economic outlook?

Obviously I don’t have any particular insights into what the new Congress or the new administration is going to do around fiscal policy. There’s a lot of uncertainty about what policies are going to be enacted, and that matters a lot in terms of thinking about any effects on the economy. I do think, even though I’m definitely “wait and see” in terms of learning what happens, the main effect on my outlook is that my view on the risks to the outlook have shifted a little. Those risks used to be maybe balanced and if anything a little bit to the soft side because of global developments and other factors that might cause growth to weaken. And I think that the possibility of greater fiscal stimulus and other changes in policies would if anything move those risks a little bit to the right. But it’s not a big effect.

If the economy is now growing at something close to its sustainable potential, what good can come of fiscal stimulus?

Changes in fiscal or other policies that can increase potential output of the economy or the growth rate of the economy in terms of the supply side obviously would be beneficial in terms of the low equilibrium interest rate. The kind of things I’m thinking about are policies that lead to increased investment, whether it’s public investment in infrastructure or productivity: enhancing business investment around research and development or just general expansion of investment in plants and facilities and things like that. We’re trying to have a game changer around longer-term growth prospects and boost the long-run strength of the economy. And it’s really going to have to come through things that either increase the productivity of the economy or on the other side improve and increase the labor force and give education or job training, improving the productivity of our work force. Those are the things that really matter for the long run.

Is there any value in deficit spending just to stimulate growth?

Any discussion around federal fiscal policy has to — at this juncture, given that the economy is near full employment and it’s in pretty good shape in terms of the business cycle — it should be focused on improving the longer-run performance of the economy. I think that’s beneficial to everybody in our society. The other issue that’s obviously important is that you want to have a federal budget that’s sustainable in the long run. So when thinking about fiscal policies, I would really think the key issue is, “What are policies that would improve the long-run performance of our economy and make our economy stronger in the longer run and put the federal budget on a sustainable long-run path?” So hopefully that’s the direction that things will go.

In an essay this summer, you argued that the Fed should be preparing for future crises. You suggested in particular that the Fed should consider targeting a higher inflation rate. Is that discussion happening?

There is definitely work going on in the economics community around these topics, among a lot of academics but also among central banks. Particular kudos to the Bank of Canada, who, through a process that the bank has with the government — every five years they review their framework for monetary policy – they have a very serious deep dive and thoughtful consideration of these issues. I think of them as conducting best practice in terms of the willingness to consider these issues and to think long term and to do it in a very open-minded way. So I think other central banks should follow the Bank of Canada’s lead here.

I think the important thing to remember on this is that this is not an issue about the U.S. or Canada. It’s an issue that according to our research and an increasing number of researchers, this observation that the equilibrium interest rate appears to be at very low level and is likely to stay that way for a long time is more of a global phenomenon. The one piece of advice I give on this is: Stop thinking about this as a national issue. It’s really a global phenomenon driven by demographic trends and what economists call the global savings glut or heightened demand for safe assets. I think people around the world are starting to focus on this. The question of what’s the right remedy, that’s kind of the later discussion.

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John Williams, president of the Federal Reserve Bank of San Francisco, in an interview last year.

Credit
Stephen Lam/Reuters

If it’s a global issue, does it require a coordinated response?

If people came to the conclusion that given the equilibrium real rate [inflation targets should be increased], I do think there would be advantages: that the more countries that raised their target at the same time, I think the greater the benefit is. If you look at some of the research that’s going on, I think one of the most interesting and important conclusions from that is that the negative spillovers from other parts of the world, if they go into recession and hit the zero lower bound, and monetary policy cannot be fully effective in bringing their economies back to full strength, the negative spillover is greater if the rest of the world is also getting pushed down to the zero lower bound. When everybody is at the zero lower bound and they’re all being constrained, there’s a negative feedback loop. Weakness abroad spills over to the United States and then we can’t offset that as effectively. If we had a higher inflation target and didn’t come to the zero lower bound, we’d be free to adjust our policy to offset any effects coming from abroad, and that has a positive influence on the global economy. And with a very low inflation target around the world, the likelihood of all of us hitting the zero lower bound is higher. And if everyone had a higher inflation target — a modestly higher target, a 3 or 4 percent target — then the likelihood of all us getting to the zero lower bound at the same time is much lower. My punch line is: Yes, countries can do it one by one. That would work. We’ve seen it happen. But I do think there are some benefits to a more, I wouldn’t say coordinated, but perhaps a more correlated approach.

You mentioned the Bank of Canada’s accounting every five years. There are proposals before Congress to increase the Fed’s accountability. Do you think there are versions of that idea that would be desirable?

To my mind the most important feature of what the Federal Reserve operates under is the ability to act independently of short-term political influence. To me that’s the bedrock of any discussion of reforms around the Federal Reserve. Research has shown that independent central banks can work more effectively at keeping inflation low and stable and keeping economies performing up to their potential, and that’s a critical piece of any Fed reform. It’s essential that we retain the ability to make what can be politically unpopular decisions in the interest of the economy. That’s the way the Federal Reserve was constructed, and various reforms have maintained and strengthened that so we can focus on our dual mandate goals.

The specific proposals that would require a policy rule would be problematic in the real world. I’m a big advocate of having systematic predictable monetary policy. I agree with all of those principles, I just know from practice that given the uncertainties around potential output and employment – all of those aspects of actual decision-making means that trying to tie the hands of a central bank to some simple equations is misguided. I think rules are important inputs into policy making. I think we should make that clear. But it’s not a substitute for careful analysis and judgment around decision-making.

The other point I’d make that doesn’t get enough attention is that these efforts to tie the Fed’s hands seems to be completely at odds with the structure of the Federal Reserve in having a committee of presidents from around the U.S. together with governors, having a group of people with different perspectives and backgrounds and different understandings of how monetary policy works. That whole structure is designed to get away from groupthink and it’s designed to show that we don’t all agree and highlight different views.

But are there steps you think the Fed should take?

Obviously I believe strongly in transparency at the Federal Reserve in terms of our strategy or our policies. We’ve moved dramatically toward more transparency in the 20 years I’ve been at the Fed. I think those are all positive things and I’m a supporter of any efforts we can do to be more transparent around our thinking around policy decisions within that rubric of being independent of short-term political pressure.

I do think that there’s analysis that we go through in preparing for Federal Open Market Committee meetings that does not necessarily tell us what we’re going to choose to do but definitely are inputs into our policy process that we could be more open about. The specific example is that we do look at policy rules and optimal control policies of the kind that [Janet] Yellen has highlighted in her speeches over the last several years. It’s not a substitute for decision-making. It’s an input. And we could do a better job and be more willing to put that out there in different ways to help people understand better, in a very practical way, here’s the kind of analysis that goes into the decisions. I always find that Chair Yellen is really good at this. She says, “Here are the issues; here are the caveats.” I read her speeches and think could we make this more of a regular feature of our communications. Whether it’s in the monetary policy report or in some other way. She’s shown us the way of how to explain it and put it out there, nicely framed, not telling you what we’re going to do but how I think about these issues. So I think there’s a path forward around providing more information about the various scenarios and getting that information out there more publicly.

Our monetary policy report [sent to Congress twice a year] as currently constituted doesn’t really provide this kind of information – the analysis around monetary policy – the stuff that you see around monetary policy reports at the Bank of England or the Riksbank. You look at those other reports and you’re saying, these are quite amazing documents in terms of how much content they put into those. Our report, I don’t think we’re anywhere near best practice in terms of having that kind of report. That’s a big undertaking and a lot of work, but that’s again what I look at – is there a way even with our structure to come up with a monetary policy report that would give that depth to the analysis. We hide from the public how much work and thought goes into these, how much assessment of risks to the outlook in policy decisions, how much thinking goes into that.

Have you been surprised by the strength of job growth? Was there more room for the economy to improve than you expected?

Labor force participation has held up a little better than we had thought. And we’ve got a lot more research on this, in the context of “Hey, maybe we were missing something.” One approach is to say, let’s just treat everybody in the population as potentially in the labor force. Everyone over 16, let’s look at that whole pool and construct a nonemployment index and for each group — a person in school, a person who’s in retirement — you ask statistically, what’s the percentage of those people who get a job in the next month? The punch line is when you look at this broader statistic, that number is basically consistent with an unemployment rate below 5 percent and it’s very similar to the figure you get in 2005, when the economy was at full employment. What that tells me is whatever has been happening over the last year, where we are today is essentially consistent with being at full employment.

That does leave the huge question: If we really are at trend, why is participation so much lower than it was 10 years ago? And that’s something economists have really turned their energy to understand: Why today the normal is so much different?

Trade with China, and immigration from Mexico, have been huge drivers of economic growth in your district. Are you concerned about the potential impact of Mr. Trump’s plans to limit both?

We’ve been collecting a lot of perspectives from business leaders and community leaders in our district. And it was fascinating to me. It was one of the most interesting conversations I’ve had. First of all, everybody who came to these meetings, that’s what they were thinking about. Obviously there are people very excited about perhaps a little more business-friendly regulation. A lot of people are excited about lower corporate taxes. But it was striking because in that same conversation where people said I’m bullish on this or cautiously optimistic on that, it was striking how much concern business leaders in my district expressed around immigration and trade. Obviously trade is a big deal here on the West Coast. Our industries are very export-oriented. That was an area where there is uncertainty around where that would go, not as a political statement, just “How would this affect us?” given how many industries and jobs are really tied to a global economy.

In terms of the agriculture industry, which is still a big part of the Western economy, clearly issues around labor availability came up quite a bit. That’s tied to immigration, but it’s also tied to concerns about our education system and making sure that if we’re going to restrict the availability of labor into our market one way or the other, we’re going to need to train and prepare our work force for the jobs that we need to fill.

Similarly you heard comments in tech about H1B visas. Nobody knows what’s going to happen but this is a region of the economy that really has been built over a very long period of time around global trade, around openness, around bringing in the best talent from around the world into the technology world, superlative universities that attract people who come here and end up staying here. What I heard a lot of was more about the uncertainty of this, and people saying in the end this either means more mechanization if we don’t have labor available, to have this done even more by machines.

And then in the tech world and quite honestly entertainment too we know that this is a very fungible industry. If it’s hard to get the labor to come here, you’ll have to have your offices, your research-and-development shops and other things where the labor can be. There’s always a discussion around Canada being very open to having tech centers open up where they do research and do other things. It’s not a political thing. It’s more about the uncertainty.

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