Cleveland Fed President Loretta Mester spoke with Wall Street Journal reporter Nick Timiraos on Thursday, July 6, in Cleveland. She discussed Federal Reserve interest-rate increases, plans to beginning shrinking the central bank's portfolio of Treasury and mortgage securities, and the outlook on inflation. Here is a partial transcript of the interview, lightly edited for clarity and length.
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NICK TIMIRAOS: In the [June meeting] minutes yesterday there was a little bit of discussion, it said some participants had observed or had heard from businesses about changing expectations on fiscal policy. And so I'm curious if you've heard of businesses maybe dialing back their expectations because of less of a fiscal impulse.
LORETTA MESTER: That's interesting. So, I mean, we queried our businesses over time to see what their expectations were in terms of sort of what their plans were for investment. And certainly, there was increased sentiment. Business sentiment went up after the election and people were saying that they expected some fiscal policy action. But most of the businesses we talked to weren't putting in plans based on that kind of policy. They anticipated that we might see some pro -- what they would call pro-growth policies on tax reform and regulatory changes. But they weren't actually acting on it, even though if they were responding to sentiment surveys they would say positive sentiment. So that was kind of instructive in the sense that then if their sentiment changes, they were -- we weren't going to see a pullback in those plans.
But what they did tell me, because I was concerned about the same thing. It's like, oh, if you're putting in plans and then you don't get as much action -- because, as you know, it seems like it's less likely, at least from the beginning expectations -- are you still seeing that the environment has changed in a positive way for your business? And then they told me that even if it was just status quo, they viewed that as positive in a pro-business environment, because they were worried about increasing regulatory burden, not just from current regulation but even more. So they were sort of still positive about what they viewed as a good climate for business because of that aspect of it. So I found that was very interesting then. It was sort of like even the status quo, given the change in government, they viewed as a positive.
So we haven't heard that businesses are not re-evaluating things in terms of their plans. They're basically moving forward with their plans. Some are hiring people. Some are now saying that they have to increase wages because it's very difficult to hire the staff they need with the quality workers they need. We're hearing that more, not only in high skilled jobs but also in the lower skilled jobs now. So that seems to be -- so the labor market, both regionally and nationally, I think, is on track. It's strong. We'll get the report tomorrow to see what the number is. But if you look at the last three months, we're well above or at the high end of estimates of a strong -- a strong labor market.
So the labor market is on track. You know, 4.3 [percent] on the unemployment rate. The other measures that are broader measures that some people like to focus on, they're all coming down. So I think we're probably a little beyond full employment from that point of view. I have moved out my estimate of the natural rate of unemployment from 5 to about 4 3/4 [percent] because when you look at sort of the data on inflation, where unemployment has moved I have to take that on board. But even with that we're still beyond full employment from the point of view of what monetary policy affect. I know there are longer term structural issues in the labor market that we might be able to change, but not with monetary policy.
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MR. TIMIRAOS: Has your outlook changed relative to maybe where things looked in January about what were --
MS. MESTER: About fiscal policy or more general?
MR. TIMIRAOS: Yes, fiscal policy. What we're going to get or the timing of it. Has that changed? Has your view of that changed?
MS. MESTER: Not really, because I never built in a large fiscal policy boost. I was always a little skeptical that things would all of a sudden get all these changes. And I'm also wanting to see what's in the packages, right? If you're trying to evaluate what impact they're going to have over the medium run, which is the time horizon for monetary policy, you need to see what the packages look like. And we just -- there's still a lot of uncertainty about what's going to be in the packages or when they'll get enacted, just precisely what the details are. So it's kind of hard to assess it.
I did build in a little bit of a stimulus -- you know, near-term stimulus, because I thought that that was likely. But that wasn't what was driving my outlook for being a little bit above trend growth. It was really about the momentum in the economy, the developments we've seen in terms of businesses starting to actually invest now, which we hadn't seen before, which I think is a positive. And then consumer spending staying pretty good. I mean, we've got some little weaker reports there, but still it's a pretty good report ...
And so I still think that we're on basically the same trajectory that we were on, notwithstanding a couple of weak data points. But if you think about smooth through that. I think people tend to focus on each data point. And I -- and I don't like to do that because the data are volatile and cellphone plans can affect inflation numbers and prescription drug plans can affect them. So you have to smooth through some of that.
MR. TIMIRAOS: On the labor issues, have potential changes in immigration policy -- do you see any potential affect that could have on the labor supply and potentially exacerbating some of these ...
MS. MESTER: Well, I think we are in a -- you know, the demographics suggest that we're going to continue to need to import labor. And immigration policy obviously affects that. And we want to -- we want to attract high-performing, high-skilled workers to this country. So I do have some concerns, and I think I mentioned this in the speech you just mentioned that that's one of the policies that actually could be a pro-growth policy, if you have immigration that actually brings in skilled workers.
So it could either way. And again, that's another one of these policies that we don't know what the details are going to be. But we do have -- you know, 16 percent of our workforce is immigrants. And we want to have an immigration policy that is pro -- you know, can help us get the skills that we need for the U.S. economy.
MR. TIMIRAOS: Right. And then, thinking about the jobs report, not just the report tomorrow but in general now that we have an unemployment rate that is below I think the median forecast of Nairu [non-accelerating inflation rate of unemployment], now that -- and it has continued to tick down, I think, in each of the last three or four months -- what would be the most constructive data points you would be looking for, again, not just in one jobs report but over the -- over the near term here? What are the things that would kind of give you the most comfort? And would a continued decline in the unemployment rate be a sign of concern at this point?
MS. MESTER: Well, so we're at the lowest point -- I think we're at -- we're below the lowest -- we're certainly at the level of, I think, 2001. And we're below the unemployment rate that we got in the last expansion. So we're getting to a point where -- and we had to take on board sort of what we've learned over history. I know a lot of people want to say, like, well, this time it's different. And there certainly are things different, but you can't throw away all your history.
And in the past, what we've learned was that we can generate sustainable expansions and what people have called soft landings. But typically what you have to be doing is preemptive monetary policy. You have to move before you've hit your goals. In other words, so even in real-time estimates of that natural rate of unemployment, right, you need to sort of begin taking away accommodation preemptively, so before you get there. And coupled with that, you need to have had some -- once the economy does start slowing from there, you need to have good shocks or at least small shocks at the economy.
So soft landings are difficult to navigate, but we've been able to do that. And one of the key components is being a little preemptive. So there's some people who have advocated, well, let's just wait until inflation gets up to our goal or even beyond our goal, since we've been below our goal for a while. And I guess sure, this time could be different. Our estimates of unemployment, the natural rates, have come down, no doubt. But history tell us that you want to be preemptive. And so I always like to think about we have to be moving policy, right, before we get to our goals. You have to -- because monetary policy takes a while to work.
So I'm still viewing the economy as on track for that gradual pace of funds rate increases. I don't think we're behind the curve yet. So you're saying, well, what do you -- how would you assess whether you're behind the curve? So I like to look at models. I like to look at the data. I like to talk to businesses to see how much difficulty they're having hiring workers. And, sure, you want to see whether firms are raising their wages as part of that -- you know, as a metric ...
[Wages] are rising. Are they at the levels -- the accelerations we saw in past cycles? No. But also, a big component of that is the low productivity growth we have, right? So if you're paid the marginal product of your labor, when productivity growth is low, wages are going to be low. And I think that explains much of it. Also, wages are lagging indicators, right? So you don't see wages go up, and then you get sort of inflation up.
So again, I think it's a prudent path that we're on, in the sense that we have begun taking back some of the accommodation. The path of, at least in the [Fed's Summary of Economic Projections], is a very gradual withdrawal of that accommodation, which takes into account some of the things we're talking about, some of the uncertainties around where is the natural rate of unemployment, some of the fact that we haven't seen inflation accelerate. You know, we're still below our goal. So that prudent path, I think, balances some of these tradeoffs, right? And it also takes into account that we've been at very low interest rates for a very long time.
We do see stock prices moving up. We have very low equity premia. We have low volatility. So we're balancing those kinds of aspects too of a low interest rate policy, some of the potential risks there. And this prudent upward path, I think, takes those things into account. So that's why I think that's -- I'm still on board with that as being sort of the thing that balances, because the whole idea is to calibrate policy in a way that sustains the recovery.
MR. TIMIRAOS: So you mentioned some of the inflation softness, but also easier financial conditions. Since December, a period in which you have raised rates three times by a quarter point, do you see the easier financial conditions right now? I know they're kind of apples and oranges, but offsetting the softness in inflation when it comes to kind of charting the policy path forward?
MS. MESTER: So we certainly look at financial conditions as part of the economic outlook, right? And so I'd like to take those into account. But you kind of ask yourself, well, why are they -- you know, why are long rates lower? You know, why did -- the first time we raised rates the long rates went down. Well, why is that happening? Some of that was not the real rate, it was part of the -- you know, the premium on long rates. So in other words, there's, like, flights to quality, so people buying U.S. assets, given some of these things you learn in -- abroad, right, that also affects those long rates.
So I don't see anything in the long rates that suggest to me that we have a fall off on demand that I would be worried about in terms of, like, going into recession, because people like to look at the shape of the yield curve as an indicator. There's a correlation there, but there's not causation. And given where the economy is, I suspect that as we continue to raise the short rate, we'll see the long rate go up. And we've seen it bounce around. It has gone up, if you look at --
MR. TIMIRAOS: Yeah. The last week or two --
MS. MESTER: Yeah, exactly. So again, we certainly want to take that into account. When it's easier to borrow you look at that and say, OK, that could be stimulative. And so you want to calibrate your policy to it. But I don't see anything in there that would say we're going to trade that off, right? And because that's lower we may have to raise the short rate more. I mean, I like to look at sort of, like, what our outcomes are in the real economy, not sort of do a one-for-one on long rates versus short rates and twisting the yield curve. I think that's hard to calibrate and manage.
MR. TIMIRAOS: [Fed] Chair [Janet] Yellen and others have said they think the softness in inflation will be transitory. I think you said that in May. Is that still your view? How concerned are you that some of the -- obviously the wireless and the prescription drugs are idiosyncratic and they'll fall out -- the drops will fall out in a year. But some of the health services measures, even I think housing -- the shelter components is -- it's slowed down a little bit. How do you judge kind of the balance of risk there?
MS. MESTER: I certainly am looking at all those measures, right, because when you get a couple of reports you kind of look under the hood to see sort of, like, is that telling you that demand is falling off, because that's the concern, right? The concern on what does the inflation numbers tell you? Well, when it's going down, it's -- if it's going down because demand is weak, then that's telling you that you need to take that very seriously. Or, is it supply-side things, like the prescription drug prices or competition or other things which would be less indicative of sort of the demand side of the economy.
At this point, I still think that an upward path, inflation moving back to 2 percent, is the right forecast, certainly my projection. But we want to look at those data and we want to keep monitoring it. I haven't changed my outlook yet, but certainly when you see a couple of weak reports you got to look at it seriously. I think these changes to the cellphone plans -- they can take -- even though it's a one-off thing, depending on when it comes in the month, it could last, like, three months and affect the numbers. So again, it's transitory, but maybe more transitory than at first blush someone might think. And so I think that's something also you have to take into account.
And I always think on all of these things, is that there is this tendency to react or at least in the headlines to react to one month's number. And I really don't think that's a good way of thinking about monetary policy. I think we got to be sort of thinking deliberately about, OK, data comes in, does it change your economic outlook? Yes? Then you might change your policy math. If it isn't significant enough to change your medium-run outlook, then you're still on board with sort of where you think the trajectory is.
So some people have said, well, the fact that the Fed moved interest rates up even though they got some weaker data suggests that they're not data dependent. I reject that. I mean, we are very much looking at the data. But we're not going to react to any one data point. We're going to react to whether the -- you know, the group of data is telling us -- what it's telling us about our outlook. You know, is growth still at or slightly above trend? Is inflation on a trajectory to move toward our goal of 2 percent? Is -- you know, are we at maximum employment from the point of view of where monetary policy are. And if that's still intact, then I think the policy path that we've been saying for quite a long time is what we think is appropriate is still the appropriate path.
And that's kind of where I am at this point. But of course we have time to look at sort of the incoming data, and assess the situation. I don't think we're far behind the curve in that sense. So I don't feel this need like, oh, we have to move preemptively because we're way behind. But I do think it makes sense for us at this point to continue on this gradual reduction in the amount of accommodation out there. And we knew kind of going into this nontraditional policy where we brought interest rates down to zero and then we added asset purchases -- we knew at some point the economy would return to health and start expanding and moving, that we'd have to move back from those policies. And I think we're in that mode. And so I think that everything's intact for that. And I'd like to see us continue on that path.
MR. TIMIRAOS: So if it does prove that the declines were transitory, do you think that would justify more than one rate increase for the rest of this year?
MS. MESTER: So I think the median policy path in the SEP is about right. You know, you can -- you can argue about a rate here, a rate there. But I mean, that path, that gradual path, I've probably built in a little bit stronger rate increase farther out because I see a bit stronger economy. And probably my new star of that natural rate of unemployment is a bit higher than -- I think the median is below 4 3/4 , right? But in general I'm on board with that. And you know, that policy path, as we go forward, we'll see where the economy is and we'll adjust to that as needed to keep the expansion going. So I think that that median path is right pretty much where I am ...
MR. TIMIRAOS: Sure. So the balance sheet has gotten more attention, including in the minutes that were out yesterday. And I wonder what, if anything -- what would be holding you back from -- I mean, you've said what you're going to do. The committee has said what it's going to do. Why wait much longer to initiate it?
MS. MESTER: Yeah. So I -- one of the things that we wanted to do was make sure that we were telling people early -- right, market participants, the public, the Treasury -- what we planned to do. And so as you saw, right we mentioned in the minutes earlier, when we had discussions -- started discussing it, and then as you say, right, at the last meeting, we actually put out, OK, here' the plan, here's how we're going to do it. If you notice the details of that plan, it's a very, very gradual reduction in the amount of reinvestment, is the way I would say it, right? So again, it's meant -- it's designed to be sort of set it in the background, get it going stuff.
So I'm in favor of us moving forward with that at the appropriate time. And I would anticipate that we would do it this year, which is I think totally appropriate. Which particular meeting? I mean, that's obviously a discussion that the committee will have. But I'm very comfortable, given the parameters that we've set out, that the economy could handle that. And I think the public, as long as they have enough forward knowledge -- advance knowledge of when we'll actually start to implement it -- I don't anticipate there'll be a big reaction in the markets, or at least a long reaction in the market.
The markets always react to things. Even if they know it's coming, they'll react when the actual announcement is made. So I wouldn't be surprised if we get some market reaction. But I wouldn't anticipate it would be a long-lasting negative reaction to it, because I think we've been -- we've tried to be as clear as we can be about what the meaning of it is, in terms of it's a gradual reduction in the size of the balance sheet over time, it plays out over -- you know, a little bit over a year to get the limits on how much we'll -- or the caps on the flows out. So, again, it's very, very gradual, very concrete, so people know what we're doing.
And the intention, I think, is well understood. We're not trying to change everyone's expectations about policy. And that's key. It's -- right? The announcement effect could have a long-lasting impact on market expectations if they changed their expectations about policy because of the announcement. But again, I think by being as forthcoming and -- you know, in advance communicating, I think we -- I hope have communicated that this is part of just the natural normalization, and not we've changed our view of the economy, and therefore we've changed our view of policy.
MR. TIMIRAOS: Right. Are you surprised there hasn't been more of a market reaction to this point?
MS. MESTER: I don't think so, because, again, we -- the minutes -- you know, the meetings I think have been -- you know, we've been telling people what the discussions of the meetings have been, in the minutes. So again, my hope is that that's actually good communication and that we have been -- we've been trying to be transparent. And my hope is that the reason we haven't seen huge market reactions is that it's very consistent with what we've been communicating all along, is that this isn't, like, a whole change in the way we're viewing appropriate policy. It's just consistent with what we've seen saying all along.
And similarly, with the fed-funds rate gradual path, right? We've been consistent, I think, all along that that path is -- that's consistent with how we see policy. And, yeah, it may move a little bit from meeting -- you know, SEP to SEP. But in general, that's been a very consistent message.
MR. TIMIRAOS: In terms of the exact timing, I've talked to people who have said maybe we should do it in September and wait on rate increases, so we can figure out what's going on in this inflation puzzle. And even some of the people who have been resistant to raising rates further seem perfectly fine putting the balance sheet into play now. I wonder, do you see that as a -- you know, the preferable path at this point, to do this in September and then wait until December to do the next rate increase?
MS. MESTER: Well, I don't think I can make -- I don't think there's anything, like, fundamental that says you couldn't do both at the same time, all right? So really what we do with our funds rate path depends on what the economy is doing and how we see the outlook, et cetera. The balance sheet, again, because the change in the reinvestment policy is such a gradual one, other than the signaling effect that it might have -- which we're hoping that the communication is handling -- there isn't any reason not to start that early, just because it's a very slow reduction in the size of the balance sheet. And to get the balance sheet down significantly it's going to take several years. I mean, it's not like something that'll change overnight.
So again, that's sort of in the background, right? It's not really an active, what I would say, policy tool at this point. The idea was set it and forget it -- you know, like that old Ronco ad. You know, right? You just sort of do it, set it, let it go in the background. And then our main policy tool, of course, is going to be the short-term interest rate. And that's the way I view it. And so could we do both at the same time? Sure. It depends on what the economy is doing. But I think the end of the reinvestments or the -- you know, the change in the reinvestment policy and the beginning of that normalization of the balance sheet is -- you know, that can be sort of done sooner rather than later, get it going. And then we'll focus on the funds rate as being our main policy tool. So I'd be comfortable with that.
MR. TIMIRAOS: Right. But is there any -- is there any argument then for waiting until after December to initiate the reverse QE [quantitative easing]?
MS. MESTER: So I would do it this year. I think it's consistent with the outlook that -- my outlook. And I'd be very comfortable with doing it sometime this year. ... I don't think of that as being tied necessarily to what we do with the funds rate, right? So I'd be probably in favor of doing it sooner rather than later, as long as everyone understands the parameters of our communication. And so far, it seems like they do. You'd want to make sure that there's a lot of communication around this isn't a change in the outlook, this is really just in the background, et cetera, et cetera. And that's kind of what we said we wanted to do. We want to well communicate that this is just -- you know, we had to start reducing the balance sheet at some point. The economy can handle it. It's a very gradual reduction....
MR. TIMIRAOS: The Trump administration has quarreled a little bit with other Washington institutions, like the CBO [Congressional Budget Office]. Has there been any concern -- have you detected any concern at the Fed that this administration might try to remake the Fed or that there would be some kind of a challenge to the institution itself?
MS. MESTER: Well there's legislation -- you know, proposed legislation from various parties about sort of changing some of the structure of the Fed. And I am concerned about that because we know that you want the Fed to be apolitical. You want it to look farther out and not be concerned with short-run political considerations because we know, from many, many years of study both here and abroad, that you get much better economic outcomes, because you get much better policies, if the central bank is not -- and monetary policy is disassociated with short-run political consideration.
And so I do worry about legislation that seems to not fully appreciate that. And thinks that look from the outside as being reasonable, but really aren't. So this -- the nomenclature "audit the Fed," I've always had problems with because it's like, from a -- from a layperson saying that it's like, well, of course the Fed should be audited. They're in control of the economy. And of course, we are audited. All our balance sheets are audited. But some of the provisions in "audit the Fed" aren't about that. They're really about making monetary policy less independent from the short-run political influences. And that's what's dangerous about that.
This bill that's going to try to put the Fed under appropriations, again, looks like, from a layperson's view, like, well, that seems like a good idea. Why aren't they subject to it? Well, again, it's another thing that if you don't really understand what it means is it could affect the way we do bank regulation and supervision, and then feed back through how we do monetary policy. So again, things that look benign are not necessarily benign. So I do have concerns about that.
Corrections & Amplifications
This item was corrected at 5:32 p.m. ET because the original version incorrectly quoted Cleveland Fed President Loretta Mester as saying 60% instead of 16% in the 15th paragraph.
Cleveland Fed President Loretta Mester said 16% of the workforce is made up of immigrants. "Transcript: WSJ Interview With Cleveland Fed's Loretta Mester," at 3:21 p.m. EDT, incorrectly quoted her as saying 60% in the 15th paragraph. (July 11, 2017)
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July 11, 2017 17:46 ET (21:46 GMT)