Good afternoon. I have the privilege of very briefly introducing our three distinguished panelists this afternoon. You'd better pay attention because otherwise you'll miss it. It's going to be so brief. Beth Hammack took office as the 12th president of the Federal Reserve Bank of Cleveland in August of 2024. Before taking that position, she held a 30-year career at Goldman Sachs, ultimately serving as co-head of global financing there. Jonathan Heath was appointed to an eight-year term as deputy governor of the Bank of Mexico starting in 2019, and his term will close at the end of this year. He's a distinguished economist with more than three decades of experience analyzing the Mexican economy across the private, academic, and public sectors. Boris Vujcic has been the vice president of the European Central Bank since June of this year. He wears many hats at the ECB, including serving as a member of the executive board. Prior to his current position, he served as governor of the Croatian National Bank and oversaw the country's accession to the Euro area in 2023. The topic of our panel, creatively, will be inflation. It's the most important challenge facing many central banks around the world. So that's why we've given it center stage right now and we hope that you will be preparing as you hear preparatory remarks from our three panelists your questions on this topic. The format is that I'm going to pose questions to each of the panelists in a predetermined order and then we'll take questions from all of you. So, please be prepping for that moment. And I'd like to start by asking each of you to describe your current outlook for inflation and the main risks that you see associated with that outlook. And Beth, if you would start us off and then Boris and Jonathan.
Great. Well, thanks so much. From my perspective, the biggest risk that I see with inflation right now is that an inflationary mindset could start to set in the US. We've been missing on our inflation objective for more than five and a half years. And we had a number of factors that have happened over that period. There have been a variety of supply shocks. Certainly the pandemic in the first instance. And then in 2024, after we'd made good progress getting inflation from above 7% to below 3%, we started to get a little bit focused on the other side of our mandate, on the employment side of our mandate. And so we reduced rates to help support that side of our mandate. But since then we've been hit with a couple of other shocks. Certainly there have been tariff shocks, the recent energy shock. But now what I'm seeing and hearing from businesses is that we have pressures on the demand side as well as the supply side. And so with us not really having tension in the mandate, growth has held up reasonably well. The employment side of our mandate has been right around my estimate of maximum employment. The concern is that could we see things heating up? If anything, right now when I'm out traveling the district talking with businesses, I hear that spending is very resilient. We've been expecting the consumer to step back for quite a number of years and they really haven't. They've continued to spend and that's been fueling the economy. The capex spend that's happening related to AI is another source of pressure and that is probably going to continue for some time. And so it's important given that we've been missing on the inflation side of our mandate for so long that we have a restrictive stance of policy to help bring that inflation back down to our target. And my concern is that if we don't make real progress in getting back there, you could have this inflationary mindset start to set in. And so what do I mean when I say inflationary mindset? It means that businesses and households become tolerant of inflation, that they expect this above target inflation to continue and to persist. For example, we have a retailer in the district that I was speaking with who said they've been hit with so many different supply shocks and different pricing pressures over time that when they're thinking about their costs for next year, they look at what their input costs are going to rise by and they add a little bit more on top of that to make sure that they're covered for any surprises that might happen. Now, I'm not hearing that broadly, but that's sort of that early evidence of that inflationary mindset setting in that I really want to make sure we can get on top of. And so to me, we need to make sure that policy is at a restrictive stance to help bring things back down to target.
In our case, it's a little bit different in a way that we have already brought the inflation down to 2%. We're running a victory lap and then came a second energy shock and now we're again in August up to 3.2%, with energy of course driving it being at 14% in August. And what we now see is that we will converge back to the target one quarter later than we projected in June. So we now expect the inflation to peak in the fourth quarter of this year with 3.6% and then only to converge to the target in the fourth quarter of 2027. We have already started a tightening cycle. We hiked in June and now in September. And we see the risk basically being mostly what also markets say, and that's why there has been this repricing of the curves, the higher for longer energy prices. This did not look like that in June. I think now the risks are much higher. Back in June there was a lot of hope that there will be settlement of the Gulf situation in one way or the other, that the prices of energy will come down. Today I don't think that neither us nor market see that anything will happen before the end of this year. And even then, unfortunately, it seems that the prices might stay high because the price of crude might come down but of refined products will not, given the shortages of the supply of the refineries. You have Russia who has been hit by drones, 204 out of the 32 refineries. You have the refining capacity in the Gulf which has been now strained with the Hormuz. And you have Chinese who have decided basically to produce only for the domestic market, who have quite a lot of reserves that they've bought before the crisis started but are not also refining and exporting. So it's quite clear now that in the foreseeable future we will not see the refining capacity coming back to the levels where it was before this conflict. And that's why the energy prices, particularly diesel, will stay probably high for long and then that will feed into the inflation because diesel is really in many products. If you think about the diesel, it also feeds into the core inflation. It's not that we're talking about the headline inflation only. And that's the biggest risk that we see at the moment.
Yes. Sorry. Our inflation, our target is 3%. And just two months ago, we had reached 3.1%, so we were pretty close but we were not having a victory dance or anything yet because we knew that it was just a temporary thing. Our noncore component had dropped to I think 0.6% year-over-year, which is typically low. And our noncore component is extremely volatile. So, we knew that it was just going to go back up and the inflation number, which I announced yesterday, it's already edging back up. It's at 3.4% and we expect it probably to edge back up a little more. What we really have to do is concentrate on our core component, which has remained high. It had been above 4%, about 4.3% for quite a while. Now it's starting to edge down, still just slightly below 4%. But the two kind of I think big risks or problems that we face here. One is we have an extremely persistent services component which has been fed through by a very, very aggressive minimum wage policy. The minimum wage has increased over 10%, double digit, every single year for the last eight years. In real terms, it's increased like 130% or something like that. And the president has promised to keep on increasing it at that same pace for each year until 2030 when she finishes. So we know that we're facing a huge challenge to bring that component down. The second part that we're facing is the expectations component is definitely against us. Our path for inflation is supposed to be going down continuously and converge into 3% at the end of next year. However, nobody believes us. Everybody thinks that inflation is going to end this year closer to 4%, next year closer to 4%. When we look at longer-term expectations, they're well anchored, but they're well anchored at the wrong rate. They're anchored at 4%, which means that nobody really believes that we're going to bring inflation down to 3%. And in the very short term now we're starting to face an additional problem thanks to the Federal Reserve where they've decided to increase rates and we had finished our downward cycle. We were on hold and the dollar depreciation has created a sharp appreciation of the peso which has helped bring merchandise prices down quite a bit. However, it's the services component now that we need to work on. But if the Fed keeps on increasing and we keep on pausing, our interest rate differential will go really, really low, which means that it's very likely that the peso will stop appreciating and go the other way, start depreciating, and then with maybe a six month lag or so, that should feed into merchandise prices, which will also start going back up. So, we're facing a big challenge here. We voted just yesterday for a pause, but my vote was kind of a more wait and see. And if the Fed, I think, has another increase before I leave, I will probably have to be a dissident voter, which I've been quite a few times in the past.
Thank you. I have one more question in common for all three of you and then the question after that will be tailor-made for each of you. But because this is a research conference dedicated to examining inflation, could you please tell us some topics for future research you think would be particularly important for improving our understanding of inflation dynamics? And Boris, this time we'll start with you.
Now I think that inflation expectations are very important but this is very well known. We have a lot of papers being produced also at this conference. There are I think some new topics which are important for us as policy makers that we need your input in because we don't know much about these things. One is obviously geopolitics that has not been a topic for a long time. Now it is and it definitely impacts the inflation outlook, volatility, surprises that we're seeing. There is some literature on the geopolitics which pretty much shows that when you have geopolitical shocks, when you have trends of deglobalization rather than globalization, that affects also the prices, inflation goes up, activity goes down. So it's not a happy thing but there's not that much of the literature. It's a relatively new thing. Then we learned quite a lot about for example energy inflation now over the last couple of years. I know now where the refineries are, where the ships are, who owns them. Had no idea about that before. So this is also an area where we are learning as things unfold. Food inflation also was surprising us. I didn't understand fully food inflation. Now we found out that the food inflation cycle is actually very long. You know, something, a food supply shock that happens today affects retail prices 12 months from now. So we're finding out more about that other very important component of the headline inflation. Then of course there's AI. Yeah, it's everybody is now trying to figure out how this huge investment that is going into AI will affect the inflation. I would say maybe consensus now is that in the short run it increases demand so pushes prices up, while in the longer term if it increases the productivity it should work in the other direction. But it's definitely an area which will be very interesting for research. And finally the other global important factor which is kind of slow changing but has impact on the prices is the weather, climate change. Where we see that the higher frequency of the weather shocks that affect the production in different parts of the world is also reflected in the prices of for example food that we can already document, there are papers that are out, but this will also be I think an important area of research where we don't have that much research yet. So I would think these are the like this new trends, future will have, we know will have profound implications on the inflation. This is something that we should learn more about.
Yes. And I'd like to see three different areas that would be very helpful for me or would have been very helpful because I'm soon leaving. But the first one which is something that has really caused a lot of anguish in me is the fact that Mexico has never been able to achieve its 3% target kind of in a permanent basis ever since we established it as our medium to long-term goal in 2003. Only in one period, 2015 and 2016, we achieved inflation at about 3% and kept it there but for very specific circumstances at that moment. We've never been able to do it and what's missing is, is monetary policy just not effective enough? Do we have structural impediments here? Just what's going on because we really need to find out how we can achieve our goal. The second part is I think something that's already been starting, already been ongoing but I'd like to see a little better understanding. It's the new dynamics in service prices. Why do we have this persistence in services? I mean we have I think hypotheses and we have certain things there that are going but it doesn't quite end and doesn't quite convince me at the end of the day. And then the third part that's something that I've always been arguing internally at the bank is I just think we need better estimates of non-observable variables. And here I'm talking about potential GDP which feeds into the output gap and our r-star. I'm just not quite sure that the estimates that they give us are really robust and I'd like to see a lot more research on that side.
That proposal takes me back to days at the Federal Reserve Board when many a board member came to me and said, 'Can't you get me something better on r-star than what you're giving me?' Beth,
Yeah, I mean, we've covered a lot of ground. And I have a number that I think overlap. I mean, certainly in the AI space, I think there's real questions around what is this going to mean? How do you think about the intertemporal effects from the capex spend that's happening now, that buildout and what that might yield from a productivity perspective over time? How long can you wait to see those productivity gains and what's the right reaction function? What does it mean for policy? How should policy be thinking about some of those trade-offs and dynamics? I think Boris's comment on geopolitics I think is an enormous one. You know, we've been in an environment in the US where maybe we've had all these successive supply shocks and it could be that we're now just in an environment that is more fragile and just more susceptible to those types of shocks. And so is that the new norm? Is that a factor of deglobalization, globalization, however you want to think about that? Is that something that we should be thinking through? I think that would be super interesting. I think there's still more to do. I know there's a lot done on inflation expectations but I think there's still more to be done. I did appreciate a lot of the work that was presented at this conference, particularly on firms' inflation expectations. I think there's a lot to be done there. But I think looking at the history, right, we've now got basically a generation of people in the US who've grown up without really knowing inflation at target for a sustained period. We had the period from 2008 up until the pandemic when we were running at or slightly below, the last five and a half years we've been running materially above. How does that impact businesses, households, their behaviors? How does that shift their thinking? And then what does that mean for policy? How should policy react to that? And then the last one that I would point to, which is something that my staff's been spending a lot of time looking at, is just underlying trend inflation. How do you try to piece away what's actually going on and kind of what that through line is for inflation when you have so many different factors coming in? You know, we look at a variety of different cuts of inflation, whether it's headline, core, market-based core, services, medians, trim means, like all of those different pieces. But how do you get a sense of kind of where the puck is headed? Kind of where that through line is on inflation. And what that underlying trend is. And if that underlying trend is elevated, as I suspect it is right now, our estimates put it more in the 2.5% to 3% than closer to 2%, what should policy do about that? Is there something that policy can do to help bring it back down towards target and how quickly do you need to react?
Was there a hockey metaphor in there?
There was. That was the puck. Yes. Yes.
Okay. Yeah. That's the Wayne Gretzky quote, right? About you, I mean monetary policy because it works with long and variable lags. You have to be focused on not where the puck is today, but where it's headed, right? Because we've got to align policy towards where we think the path of the economy is going. Thank you for decoding that for somebody mostly unfamiliar with hockey.
Yes. And probably, well, I mean, the Canadians are into hockey, but maybe not the Mexicans or the Croats.
Should pick better metaphors.
Yeah. I would think about shooting a duck, you know, is here, but actually should...
It's more like a creation thing.
Poor shooting ducks. Keep shooting. Hockey pucks are harmed less than the duck. Jonathan, for our final round of questions, there's a tailored question for each of you. In a world characterized by uncertainty and supply shocks, central banks have difficulty stabilizing both output and inflation at the same time. How did the Bank of Mexico approach this tradeoff recently? Mexico is currently closer to your inflation target of 3% than the US and the ECB are to their respective goals, though you've indicated there's some fragility in that situation. What lessons does that suggest for other central banks that you would offer?
Well, I mean, again, we're closer in terms of the headline inflation, but for circumstances that I had just said. But it's the core component that we're worried about. We have actually a slightly different definition in terms of core and noncore where what we try to do is separate prices not only in terms of those that have higher volatility but put in the noncore all prices that are not determined through a normal interaction between supply and demand. So you have your noncore which is not really susceptible to monetary policy and your core which is. So we can concentrate on trying bringing core down and that we haven't done and that's where monetary policy has evolved. So you can see better results on the headline inflation because of a drop in noncore but it's nothing to do with us. It was just good luck. I think that's the first thing. The second thing and very important is we don't have a dual mandate. So maybe there's a trade-off in the long term. Supposedly there isn't. I don't know. But we concentrate on bringing down inflation because we think that the best contribution that monetary policy can do to foster growth and development is a stable price environment and that's the best contribution we can do and that's why we concentrate on that side. And I mean in terms of what we can I think talk about in terms of all central banks, especially in our class which is more emerging markets, is I think we were coming to a moment in time where we should reassess the shortcomings and the good part of what's happened with inflation forecast targeting framework. I think that we're starting to see in the Fed that they're starting to bring up new doubts about the benefits of good communication. Inflation forecast targeting is based on transparent, concise communication. It's kind of the pillars of the policy and is it working and has it been successful? I think we've had it now for a time where we can now really truly assess and maybe have a 2.0 version of it after a good examination.
And I take it you don't want to make news here about some early thoughts about how if you were in charge beyond December you would move things.
