Okay. I would like to You have talked about the normalization process that the United States has started a few years ago, and frankly speaking, the achievement has been incredible. The performance of the US labor market has been extraordinary, and as you said, the unemployment today is the lowest in 50 years, from the mid-60s. And the inflation is about the right level of inflation. So I think this has been a tremendous achievement, but at the same time you were saying that you need to go to this neutral stance. Of course, neutral is very difficult to define, and perhaps the first question would be: can you help us think about what is a neutral stance in the future? What is a neutral interest rate level? Because this is a very vague concept. How we know that we are there is always a difficult question. But frankly speaking, I was very interested in your speech, and I liked particularly a lot that you introduced something that sometimes, and from my perspective, is missing in monetary policy perspective, which is the fact that you have to keep an eye—not both eyes, but at least one eye has to be looking at financial stability. And you mentioned directly that you are considering also not just the path to get equilibrium in the labor market and in inflation, but also financial stability. So perhaps a second question, the first one would be how to get this neutral concept. The second one would be if you could explore a little bit further the financial stability risks if this continues for too long, which was one of the two sides, and you wanted this balanced approach on the basis of being very prudent, very gradual, and data-based. So these would be my two questions on the first part that I would mention, which is this very important normalization process that you have started and other countries will start or are about to start very soon.
So as I said in my remarks, neutral is where—I didn't actually say these words, but this is what I meant—neutral is where we're not accommodating. We're not pushing the economy to go faster, but we also don't have our feet on the brakes, right? So we're not trying to restrict activity, but we're actually trying to let the economy stand on its own. Now in terms of what that is, usually when you hear people talk about the natural rate—the technical term people call it r-star—they talk about it as a range, right? The range that my staff tells me that the models are suggesting is somewhere between 2.5% and 3.5%. All right, so we're not at 2.5% now in our policy stance. So that tells me that there's still room to move.
Once we get in that range, this is where I think observation and data collection and intelligence gathering becomes quite important because we want to have signs: is the economy still showing extra momentum, or is the economy starting to contract in ways that suggest it might not be prudent to go further? This is where data is clearly important. But one thing that we do in Atlanta that I think is quite special is we have this REIN network. I have a team of staff who get paid to go meet with CEOs, meet with community leaders, meet with workers and ask them in real time: How is the economy working for you? What are the stresses you're seeing? What are the challenges that you're facing in trying to accomplish your business objectives? And what that gives us is a real-time picture of how the economy is being experienced, and we incorporate that into my understanding of how the economy is working and my understanding of how our policy is actually working.
And so I like that outreach because in many instances economic trends start happening before they show up in aggregate data. And so to the extent that we can detect some of these trends in advance early, then we can deploy the appropriate policy in real time and not have the economy get much further out in one way or the other and lead to more volatility. So my goal is to act, wait, watch, and learn, and then use that learning to figure out how much further we should go. But there is going to be some art there.
Your second question was on financial stability. So you started by talking about housing.
And I was a housing economist at the University of Southern California working on credit quality and credit risk. And then the crisis happens. And when the crisis happened, it rippled through the financial system in a way that I had not been sensitive to even the possibility. Then I went to Washington and tried to help clean it up. And then I became much more sensitive to the possibility because the proliferation of risk through the system was so complete and so poorly understood that we had put ourselves at risk. So one of the lessons I learned from that is that we always need to be thinking about this and we need to look in unexpected places, because before the Great Recession, housing in the United States was not viewed as a leading indicator of anything. It was viewed as unimportant. You didn't have to pay attention; the important stuff was happening in other places. And that was wrong. And so we should take from that that any place can be an important place, and so that we need to look in every place. And that's what I'm encouraging my team to do. As I see things that come up, I talk about them early because we need to make sure we're aware of all the trends that are happening.
What would be from your perspective the role of monetary policy in helping to avoid these kind of bubbles or situations or imbalances in the housing sector? Is there a role?
So there is some role. One of the reasons why I think normalization of Federal Reserve policy is important is because the price signal should give people a sense that there are costs to borrowing, that there is risk associated with certain activities. And when interest rates are too low or so low, then those risks might be underweighted or undervalued, and it could lead people to take actions that are more risky than they understood or more risky than they can actually survive, right? And so to the extent that we use the price mechanism to signal the presence of risk, that's a good thing. But there are a bunch of other things that also need to happen for housing to make sense.
Some of it has to do with regulatory structure and making sure that banks and brokers and realtors and investors in securities are all following the procedures and processes that need to be followed, but also questions about compensation to make sure that the way that people get paid doesn't introduce incentives to just do any transactions without a consideration of risk. One of the things that came through the crisis that I discovered was that there was almost no one who got paid to stop a deal going through, right? And in that context, deals are going to go through like crazy—deals that the circumstances and the risk associated with them was not important to the agents because they didn't get paid based on whether that transaction lasted for five years; they got paid if we could do the transaction tomorrow, right? So to the extent that those types of rules can be amended to change the incentives in ways that there is a much more focus on the performance of tools and products, I think we can be better. But that's not a monetary policy function.
Right, that's a broader regulatory function. And so it's important that the whole system understands the reasons why we had problems so that the whole system then responds in a way that tackles them.
Yeah. When I moved from Spain to Washington, it was in 2006, and I remember the realtor telling me, "This is the time to buy. I mean, don't rent. This is the time to buy. Don't miss this opportunity. This is a great—" No, I didn't.
Let me just ask a little bit more because I am very interested on that part, which is how to integrate financial stability into monetary policy, and I think you have reflected a lot. Is that reflection formalized in some way at the Federal Reserve? I mean, is there a way that you have made progress in internalizing this kind of analysis of financial stability into your actual decisions of monetary policy?
So yes. Coming out of the crisis, the Federal Reserve didn't have a division of financial stability. We created one. So now there is a division of financial stability whose job it is just to monitor all the parts of the financial sector so that we are aware of trends and developments in that sector, and we have authority now to examine and explore and do things that we couldn't do before in this context. In terms of monetary policy, we are presented with reports from that group before every meeting, and so we have a sense of what the state of financial stability is in the United States and how capital flows are happening. And I will tell you, I go around and I talk to a lot of people, and questions and issues of financial stability come up all the time because many businesses were scarred because the financial sector didn't work. Many communities were hurt dramatically because the high-risk mortgages and underwriting that happened led to foreclosures and blight in neighborhoods like many, many communities. And so this is something that is still on people's minds, and I see that is shaping their activities as well. So we talk about this a lot. And one thing when I started at the Fed a long time ago, the idea that there was a close link between bank supervision regulation—or basically looking at the financial sector—and monetary policy, it was understood, but I don't think it was really understood. Coming after the Great Recession, I think it is understood much more deeply. And there is an intersection, there is an interaction, and we can't ignore it because that contagion can be quite important.
That's a very positive development. It's not easy, but it's very important. So if you don't mind, we can move now to the international environment. The United States is well advanced in the cycle; other countries are not so much. You are well advanced in this process of normalization. So perhaps a few questions. The first one would be: how do you internalize in the monetary policy the international outlook? How what is going on in the international scene influences your own policy decisions?
Just like we have for financial stability, we have a division on international economics as well, and they report to us on developments across the globe and their implications for US policy, the US economy. So we are very sensitive to developments here in the eurozone. Brexit has got our attention, and the financial implications of that are significant. We have very significant interest in emerging markets because one result of our policy changes has been a shift of capital across the globe, and that has implications for risk and support and sustainability of particular economies. So we think about all of those things. I've been pushing my team to give me as much guidance and insight as to: to what extent are we destabilizing other places, and to what extent is that destabilization likely to swing back and affect the US economy? And so we definitely have those conversations. It's an important thing for us to be mindful of. And frankly, I think that many of the developments that we've had in terms of our policy changes that have an international context has also got our attention around this. So things about trade and tariff policies and renegotiations and the impact that that has on businesses—if we don't fully understand that and appreciate that, I think we'll be surprised in very bad ways. So I'm trying to avoid being surprised and trying to stay on top of things as much as possible.
Now that you have mentioned tariffs and this—
Well, I figured you were going anyway.
Yeah, I was going anyway, but you brought it up. Could you give us a little bit your expectation and what is the impact that you think it is having? Obviously we have been in a very strange situation in which inflation was not anywhere. But one of the reasons probably is globalization. There may be technological reasons, other reasons, but one of the things that could also influence the expectations and inflation path could be if there are some trends in terms of tariffs or trends in terms of more protectionism. So it has implications from many different angles. It's not just trade; it can have impacts through many channels. I would like to see how you think about it and to what extent this is already happening, and to what extent, for example, tariffs are influencing prices in the United States and how this is incorporated in your own thinking at the level of monetary policy.
So tariffs, the theory is pretty clear about what happens when you have tariffs: prices go up, right? And we are seeing prices go up. I will say they go up with a lag, right? The way that tariffs have been introduced in the United States, there's an announcement that there may be a tariff in a particular area, and then there's a 90-day comment period. Over that 90 days, businesses are not just sitting on their hands, right? So they know that if there's a risk that there's going to be tariffs, they better get as much of their input as possible at the pre-tariff price. And so we see businesses actively working to increase their inventories, buy goods at the cheaper prices, and then just hold them so they can produce that way. Because of that, it takes the time required for them to work through that inventory before you see it in the final goods area. And the experience this time suggests anywhere from three to six months can pass before that will actually show up into the marketplace. And so in many regards we have not seen the effect of tariffs in the United States in final prices.
Another piece to this is what tariffs have been chosen to be placed on and the size of the tariff. Many of our tariffs have been at the 10% level. Most businesses that I've talked to tell me, "We can maneuver around and manage 10% without having to effect big changes in terms of how we price." If we go to 25%, which is one of the proposals, the businesses have told me, the leaders have told me that's a game-changer for them and that they will have to pass on prices much more directly and aggressively. So we haven't seen impact on prices yet, but we're not at the end of the game, and we're going to keep our eyes open to see how policy shifts, and then that will inform how a lot of business leaders act.
Now there's another piece to this which you don't see a lot in the news, but I think is quite important, which is the introduction of tariffs. The whole transition of trade policy has introduced a lot of uncertainty about what the rules of the game are going to be 6 months from now, 12 months from now, 24 months from now, and beyond. And so when we talk to business leaders, they say, "I have some investment options, but I have no idea which one to do because I don't know what the rules are. And without knowing what the rules are, I can't rank order them in terms of which is most effective or most profitable." And so business leaders in my district at least are stepping back and saying, "We're going to wait. We're not going to invest. We're going to hold back until we get a better sense of what the rules are." And so when you think about sustaining economic growth, when you think about increasing levels of productivity in the workforce, we need these investments. We need businesses to be willing to invest. And so one of the things that's happening is that this is pushing it out. Now depending on the reactions, it could just be a delay, but in some instances the cost structure of the business model might change such that some investments don't happen at all. I have no idea what the outcome is going to be; we'll just have to wait and see how it all plays out and what solutions businesses have to the new environment.
Very good. Well, I have just started to receive some of the questions from the floor. There is one theme that, now that we are in the international discussion—I think there are some questions that will require us to go back to domestic policy, but let's get this international environment. One of the themes that is in the questions is: you have been in this normalization process; what tip could you give to the European Central Bank that is starting now in the process of moving to higher rates? What have you learned in this process that could be useful for the European Central Bank?
Two tips come to mind. The first is communicate, communicate, communicate. Be fully transparent on what you're trying to do, how you're going to do it, when it's going to start, and be repetitiously boring, right? When I started in my job, my staff originally said, "Never say the same things in a speech twice." That's wrong in this space. You need to say it 400 times and make sure that everybody understands it at such a level that it's just understood. Because we tried the normalization process and balance sheet once before; we did not take that strategy, and the bond markets were unhappy, and we had to reverse that. The reversal was painful, and it really pushed us back in terms of our policy by two years. So getting that communication function up and running and robust and repetitive is critically important. The second tip I would say is start small and watch, right?
One of the things that I think is important to remember is that the whole quantitative easing approach, the whole approach to using the balance sheet as a tool, was unprecedented. We had not really done this before on the way up, and so it's hard to know in advance what's going to happen on the way down, right? Doing things dramatically on the way down when you don't want the action to have a dramatic input or impact doesn't seem right. And so we've started, we go very slow, very small. We put out a formula. Everybody knows what the formula is; everybody knows when the stuff is going to happen. And because they're small, the incremental impact has been small and you don't even see the markets really respond to this at all. My expectation is that if the ECB can do the same—start small, but monitor and watch, because we had the advantage of being first, right? So the cumulative impacts will be different in the ECB case. So they're going to have to watch more carefully. We're all going to have to watch as this moves forward. But just putting it on a formula, on a machine, just crank it out—I think that's a wise approach.
There is one question: what could be the measures that Europe could take to reactivate the economy when interest rates are so low? And I can add a second one that is related: what do you think about negative rates? Would the United States go for negative rates, the case being?
So I don't know what the United States would do. I'm a little uncomfortable with that. I think that conceptually getting the public to understand exactly what was going on would be a significant challenge. In terms of what the ECB or anywhere else can do to spark more growth and more productivity, that's a complicated question because there are many different elements or components that contribute to robust growth. Innovation is one area that's important. Having the capacity to produce at higher levels, making sure businesses have the capital they need, making sure businesses have the workers to execute that capital—in the United States, I talked in my remarks about shortages of labor in many sectors. If you have shortages of labor, that is a natural constraint on how fast or how big you can grow. For me, the challenge is none of these things are within the purview of the US central bank, right? So this will require the actions and activities of a whole bunch of other folks. Now I'm happy to show them what my staff has shown, the things that we know about the history of economic performance, but ultimately it's a political decision that governments across Europe and actually across the United States are still grappling with as to how to work through those things.
Another question is about the complications that could come from diverging monetary policy between the United States and other central banks. And I think this is an interesting question: how do you think about that? To what extent does what happens in interest rates in Europe influence your own decision? So to what extent is this part of your process? And perhaps even more in detail, do you think that now that you have started, but Europe has not started yet to raise rates and it will take some time, when both are doing the same movement, do you expect some kind of acceleration in financial tightening that could have an important effect? To what extent is this not linear—one plus one could be three or four in the interaction of different monetary policies?
There's no reason to expect it to be linear, right? This is one of the things with balance sheet normalization: because it's a cumulative effect and not being the first actor, it's hard to predict ex-ante how that will play out. I think in all of these spaces, we need to be mindful that it's a global economy, right? The things that happen in one part of the world have implications for other parts of the world, and that trend has increased dramatically over the last 40 or 50 years. So the need for us to be sensitive to these things is much greater. I don't think there is consensus in my group about exactly what a particular signal might mean for the US, or what things we might do, how that will affect the European countries as well. And so we're working on this, right?
I said this earlier today: policy evolved to a place it had never been before, right? We were in an unprecedented territory in terms of the responses that central banks needed to do across the world. So in this unprecedented environment, there's no reason why we should expect the things that happen in normal times to also happen in the unprecedented time, right? So it requires more diligence in terms of paying attention to what developments are happening and trying to understand, as close to real time as possible, whether the reactions and responses of workers, families, and businesses are the same as they've been historically or have changed in fundamental ways. If we see changes or divergences that are significant, we really have to work hard to understand that to make sure that we do not exacerbate a negative trend or are too passive so that the economy overheats, because overheating typically leads to a violent and pretty dramatic contraction, and that kind of volatility is also not good. So we're trying to find a sweet spot, and that sweet spot is going to require us to really be on top of things as much as possible.
And we have seen examples of how monetary policy in one country moves obviously the bond market, but monetary policy in other countries also influences the global bond market. Global markets are really well integrated, so it's difficult to incorporate that in monetary policy. There is a question about how far is the neutral situation in the Fed. You already talked about that. They were asking also if you have any idea on the European case—is it much farther away than the United States?
I don't know that for sure.
Yeah, I don't know that for sure. As I understand the demographics of Europe, they're more severely tilted towards aging of the economy, aging of the population. In that case, I would expect neutral to be a little lower than it would be in the US, but I have not studied that that closely to know that for sure. Maybe I'll put an intern on that when I get back.
Someone would like you to develop a little bit further what are the principal international financial stability risks that you see now at the global level, not just at the US level, but at the global level? How do you see the international financial risks, and if I may add, how does this influence your own thinking? You started to develop a little bit of that, but perhaps a little bit more detail. Emerging markets have started to have some issues. The dollar moving up has tightened financial conditions for a few countries that have started to suffer. How do you analyze that? What are the risks that you see there?
There are many risks happening in many corners of the globe. If you look at Argentina, for example, their relationship with the IMF and those policies, how that plays out has important implications for many institutions that operate in my district. Miami is a big banking center and a link between the US banking system and South America, and so Argentina's role there is significant. What happens in Venezuela and how that plays out, and in particular the pressures that Venezuela and the exodus from the country places on the neighbors, could have a significant implication for their ability to manage their economy. If you go to China, China is now injecting a lot of stimulus into their economy. There were questions 5 and 10 years ago about whether the amount of stimulus China was putting on was sustainable and whether there was going to be some bleeding over into other financial institutions. They're putting on a lot more now, so that risk is there for sure. In Europe, you have this situation with Italy and their budget and the amount of debt that they are proposing to take on and how that will play out from an EU perspective. Greece is still there; they have their issues. And then you have issues in the Middle East around what's going to happen with oil prices and the viability of new strategies that might be coming up. So there are risks that we're trying to monitor. Have I missed any continents? I think we got everywhere. There are just a lot of risks that we need to be mindful of in terms of how this plays out for the US economy.
Let me say it like this: trade was an indirect notion for many of the constituents in my district. Businesses and families understood that—they had heard people say we're part of a global economy, but what that really meant in terms of their day-to-day was not as clear. I think the developments that have happened through tariffs and trade, and seeing businesses respond and seeing prices start to shift and hearing about the uncertainty, has made real the reality that we're much more connected and interconnected. And that means that these risks are things that we're going to pay attention to, and I think more people will appreciate them. Ultimately, there being so many is not a great thing, but that we're aware of them, and we pay attention to them, and we react and respond on time—that awareness is a great positive.
One question coming, well, perhaps one related question, and I'm coming back to the domestic arena: US trade policies have been restrictive. The question is: do you fear a pass-through to inflationary expectations? We already talked a little bit about that, but it's not just materializing in direct effects, but just through expectations—to what extent do you fear that this could happen?
I've not seen any indication that that's imminent, right? But when I talk to business leaders, what they tell me is, "We don't know what the endgame is. We don't know if this is a short-run negotiation that will revert back once whatever goals the US has are achieved, or whether this is the new steady state." I think if this was understood to be the new steady state, then we'd have issues potentially around inflation expectations, but I haven't seen those yet. And so I'm not in any of the negotiating rooms to know exactly where this is likely to go. All I can do is watch with everyone else and just be ready to respond as policy...
becomes clear. Again on domestic, have you any concern that the US economy has peaked and could face headwinds next year as fiscal stimulus fades and previous Fed rate—well, I don't read it very well, but that's basically the question. What is your fear in terms of slowing down? And after the United States, I would like to see your views on the global situation, to what extent this is peaked, and perhaps the question is how well prepared are we for the next downturn? I don't know when it will happen, but how well—
Hopefully not while I'm still in this chair, right?
In this chair, don't worry. No, but—
In any chair in this capacity, right? So, you know, what I tell people is my goal is for there not to be a recession while I am a part of the Federal Reserve system. That's my goal. And so, I'm going to do all I can to make sure that that doesn't happen. In terms of the path of the US economy—thank you very much—in terms of the path of the US economy, I would say my team and my view is that the US will return to its long-run capacity potential, which is somewhere in the 1.8 to 2% range in 2021, something in that space. Now that assumes that nothing changes in terms of the US capacity, and this is where going back to the business investment becomes important because if businesses invest in ways that increase the productivity of the workforce, that increases our capacity without putting upward pressure on inflation, right? So, I'm looking pretty intensely to see if we're seeing signs of those sorts of investments because if that happens, then my long-run forecast will change. We've not seen that today, but there are reasons why we might have expected not to see it.
So, the tax changes that we had were far more complicated than I think most businesses expected. And so, many businesses are still just figuring out what it means for them and what it means for their investment strategies. We talked about the uncertainty in the trade space, which is delaying a lot of activity. So it may be that we're not going to see signs of, or the evidence to suggest whether those investments are happening, for some time. So I think we've got a couple of years where the economy is going to perform above potential. It will slowly go down. My hope is that our policies will facilitate an easy path that is not disruptive. But I do leave open the possibility that there are going to be some things that happen on the business side that increase the productivity of our workforce, and if that happens, then we could be in a much stronger economic position.
