John Williams - XXVIII Annual Conference of the Central Bank of Chile

Well, good morning everybody. One thing I will say, I have no equations. I have no charts. I have no figures. I have apparently I have no slides. So, this is probably going to be a little bit easier. So it's really truly a pleasure to be here to celebrate the 100th anniversary of the Central Bank of Chile. Over my career, I've had the great privilege and experience of visiting the central bank for conferences. I was just reminded this morning that we held, when I was running the International Journal of Central Banking, we held a conference here as well. It's a great institution. I've been very pleased to be able to participate in events in the past and especially today. The topic of my remarks today is inflation targeting, which is both an important part of Chile's central banking history and a core foundation of successful monetary policy. Now, most central banks around the world have adopted inflation targeting regimes over the past 35 years, and Chile was among those leading the way. Although specifics vary across jurisdictions, these strategies share three principles: independence and accountability, transparency and the clear communication of an inflation target, and well-anchored inflation expectations gained from the credibility that central banks build over time. Today, I'll discuss the success of inflation targeting strategies in helping central banks achieve price stability and better economic outcomes. I also talk about how these strategies were critically important in managing uncertainty after the onset of the COVID-19 pandemic and how they help countries bring inflation down while minimizing disruptions to financial markets and economies. Okay, I've gone long enough. I have to give the standard Fed disclaimer that the views I express are my own and not necessarily those of the Federal Open Market Committee or anyone else in the Federal Reserve system. Okay, inflation targeting is like guiding an excursion through the Andes. Independence gives a central bank the ability to choose the best path to meet its objectives. Transparency ensures that people understand where they're headed and why the route may change. And a central bank earns public confidence by consistently reaching its goals even amid sudden detours and a jagged course, laying the groundwork for maintaining well-anchored expectations. Inflation targeting strategies were introduced and have evolved as central banks sought to avoid repeating prior mistakes. Too often in the past, some central banks behaved as if they were powerless to control inflation in the face of shocks. But over time, they found they could be more successful at delivering price stability when they owned the responsibility for that goal and had the independence of action and the tools to achieve it. Transparency, including clear communication of an explicit numerical inflation target, reinforces public accountability for price stability and focuses the internal policy debate on how best to attain that objective. The Central Bank of Chile established a 3% inflation target when it formally adopted its current framework back in 1999, and the Federal Reserve set an inflation goal of 2% over the longer run, which we first announced in an FOMC statement in January of 2012. By communicating an explicit inflation target and then delivering inflation consistent with that goal, central banks establish and reinforce trust with the public. But transparency does not stop with declaring a destination. It also means describing the road ahead to reach that goal. And many inflation targeting central banks, including the Central Bank of Chile, provide detailed analyses of their economic situations, the outlooks and risks. Transparency about goals, strategy, and what that means for policy helps to anchor expectations, which in turn contributes to low and stable inflation. And this feedback loop between effective policy actions and communications, well-anchored expectations, and price stability is now a core tenet of modern central banking. It short-circuits so-called second-round effects in wage and price setting that can exacerbate and prolong the effects of shocks. Inflation targeting regimes were instrumental in bringing about a prolonged period of price stability in many countries up through 2020. But it wasn't until the onset of COVID-19 that they were truly put to the test. The pandemic followed by Russia's war in Ukraine dealt the most dramatic supply shocks to the world's economy in generations. Starting in 2021, global supply chain disruptions along with acute imbalances between supply and demand led to inflation skyrocketing around the world. Inflation peaked at over 7% in the United States and at over 14% here in Chile. Other Latin American countries as well as Canada and Europe followed similar patterns. While the sources of inflation were comparable across countries, they affected countries differently. For example, supply chain bottlenecks and higher commodity prices hit Chile and some other countries especially hard. In addition, inflation accelerated earlier and with greater force in Latin American countries than in most advanced economies. In response, central banks leaned into their inflation targeting strategies to guide their economies to bring inflation down. Many benefited from the public trust they built from years of low and stable inflation. As a result, longer-term inflation expectations remained well-anchored in the United States, in Chile, and other Latin American countries. And this was a key difference between this episode and bouts of high inflation of the past, boding well for the disinflation process to occur. The connections between the policy communications and actions and the inflation outcomes and expectations are at the core of policy strategies that are robust to extreme uncertainty of the kind we've seen in recent years. This is a topic that Athanasios Orphanides and I studied in a sequence of research papers including a paper that was presented at this conference quite some time ago when I was very young. If a central bank has credibility in achieving price stability, longer-term inflation expectations should remain anchored at levels consistent with the target. During my tenure at the Fed, the comment I've heard most often from economists and central bankers in emerging market countries is that the Fed's actions have meaningful effects on the capital flows and exchange rate movements in their countries. We saw this in action during the so-called taper tantrum in mid-2013 after then Fed Chairman Ben Bernanke indicated that the FOMC might soon start tapering the pace of its asset purchases later that year. US Treasury yields rose sharply causing significant volatility in global financial markets and in particularly in emerging market economies. What's striking to me is that after the onset of the pandemic, those concerns were not nearly so top of mind. Until COVID-19, central banks in emerging economies, including many in Latin America, typically had followed the lead of the Fed when responding to shocks. This time, because they did not want to risk a new episode of high inflation and thus potentially lose their hard-earned credibility, they moved first. Latin American central banks acted quickly and decisively to tame high inflation by raising interest rates starting with Brazil in the spring of '21 followed by Chile, Colombia, Mexico and Peru later that summer. In contrast, central banks of many advanced economies including the Bank of England, the Fed, the Bank of Canada, and the European Central Bank raised rates later and by smaller amounts. Around the world, inflation and the responses of central banks largely rose and fall along the same path. Following central banks' actions, inflation declined across the board and economies weathered the disinflation much better than anticipated. And despite big movements in interest rates across countries, disinflation occurred without dramatic disruptions to capital flows, exchange rates, or financial markets. It's a true testament to the success of inflation targeting. So this brings me to the current situation. As I've emphasized, inflation targeting is a strategic framework that provides the foundation for effective policy decisions and communications. But the decisions and actions themselves depend on the circumstances that policy makers face. Here in Chile, in the United States, and across the globe, strong actions have proven effective at restoring price stability. In some cases, inflation has returned comfortably back to target levels, while in others, including the United States, the job of bringing inflation sustainably back to target is not yet complete. So, I'll comment briefly on the current economic situation in the United States and what that means for monetary policy. Economic growth has slowed from its pace last year and the labor market has gradually cooled. In particular, indicators of the balance between labor demand and supply, including the unemployment rate, have gradually softened over the past year. They have now reached levels seen prior to the pandemic when the labor market was not overheated. I would emphasize that this has been an ongoing and gradual process without signs of a significant rise in layoffs or other indications of a sharp deterioration in the labor market. Inflation has declined from a peak of 7 and a quarter percent back in mid-2022 to 2 and three-quarters percent last year in 2024. Looking back at FOMC participants' projections in December of last year, the median expectation was for inflation to slow to 2 and a half percent this year and approach 2% next year. Since then, the effects of trade policies and other developments have boosted US inflation somewhat, offsetting the expected downward trajectory. As a result, progress towards our 2% goal has temporarily stalled, with the latest available data indicating that inflation remains at around 2 and three-quarters percent. It's not possible to measure the effects of trade policy actions on inflation with precision. My estimate is that increased tariffs have contributed about a half to three-quarters of a percentage point to our current inflation rate. I do not see any signs of tariffs contributing to second-round or other spillover effects on inflation. In particular, inflation expectations remain very well-anchored. There's no broad-based supply chain bottlenecks have emerged and labor markets are not creating inflation pressures and wage growth has moderated. As a result, I expect the effects of tariffs on inflation will play out over the rest of this year and the first half of next year and inflation thereafter should get back on track to 2% in 2027. So given this backdrop, monetary policy is very focused on balancing the downside risk to our maximum employment goal and the upside risk to price stability. My assessment is the downside risk to employment have increased as the labor market has cooled while the upside risks to inflation have lessened somewhat. Underlying inflation continues to trend downward absent any evidence of second-round effects emanating from tariffs. For these reasons, I fully supported the FOMC's decisions to reduce the target range for the federal funds rate by 25 basis points at each of its past two meetings. Looking ahead, it's imperative to restore inflation to our 2% longer-run goal on a sustained basis. It's equally important to do so without creating undue risks to our maximum employment goal. I view monetary policy as being modestly restrictive, although somewhat less so than before our recent actions. Therefore, I still see room for a further adjustment in the near term to the target range for the federal funds rate to move the stance of policy closer to the range of neutral, thereby maintaining the balance between the achievement of our two goals. My policy views of course will as always be based on the evolution of the totality of the data, the economic outlook and the balance of risk to the achievement of our maximum employment and price stability goals. In conclusion, central bank independence and accountability, clear communication and an explicit inflation target, and well-anchored inflation expectations have proven to be invaluable in ensuring price stability in the face of unexpected shocks and extreme uncertainty. Sharp turns and unpredictable terrain have been an unavoidable part of our journey. We must accept that shocks and uncertainty will continue to define our future. I am confident the inflation targeting strategies will continue to serve us well against any challenges we may face ahead. Thank you.

You want me to take them one by one or take a few?

So it's, I think it's a really, thanks for that question. I think it's a really important issue. I think a number of factors played into that. One is the inflation targeting regimes in many of countries had been in place for a long time. Central banks had really created a strong sense of credibility and commitment to that. So I think initial conditions matter a lot. Institutional features of the countries as well were very strong in many countries, not all, but many countries. I think that again, initial conditions matter and I think the clear and all the features of inflation targeting, if you think about it, I go back to grad school, so as a student of John Taylor, we think about monetary policy, you know, in policy rules and things, it's the supply shocks that you're most kind of concerned about, how do you deal with those. Demand shocks we later heard were more complicated because of lower bound and other issues. But these supply shocks are the ones that we've always focused on. So I think that existing credibility, well-designed frameworks, and we talked about this a lot yesterday, and then acting, I think decisively and strongly and early were very important. In a way, I experienced this with our BIS meetings throughout this period and especially the Consultative Council of the Americas, which is the governors from North and South America. We met regularly during this period. It's because the Latin American countries moved earlier and more strongly. In a way, the Fed's actions in particular were kind of just following behind, you know, based on our own circumstances. So I think that changed that dynamic. But so I think institutions matter a lot. I think the credibility of the central banks mattered a lot. And I think from our side, we also learned lessons from the taper tantrum. You know, I got asked, I remember my first BIS meeting and I asked before too, like, 'Hey, John, do you understand that your actions affect our economies a lot?' And the answer is yes. We fully understand. The Fed, we have domestic mandates. Everybody has domestic mandates. But at the Federal Reserve, we understand that our actions and our communications of our actions can have very positive effects on the global economy, but can also, when they don't go that well, be disruptive. And so there, we were very focused on clear communication, you know, clear as much as we can forward guidance in that period to make sure that even our actions were not disruptive. What was interesting about when we did raise rates and raise rates dramatically as was needed, even at that period we didn't see nearly the kind of disruptions that people feared. But I do think one of the lessons for all of us is that clear communication and not only about goals but kind of how you think you're going to get there reduces maybe some of that risk of confusion or market kind of disruption.

Well, it kind of ties into the previous question and a lot of the themes yesterday. I mean again, I go back to institutions matter a lot and having, I think Olivier described it in a very clear way about what does it mean to have sustainable fiscal policy in the long run, which is different than about, I'm not going to use the term fiscal discipline here because that has a lot of different meanings to people, but having a path, I think Olivier you talked about, you think about a path for fiscal policy that is sustainable in some well-defined way, it's well understood way. So I think that is critically important. We're not in a situation I think in the United States for sure but in other advanced economies where this dynamic that you're talking about is happening, you're talking about a risk of that happening. So you know, again I see that as something that it's very important for fiscal policy to be on a sustained longer-term path which we have not been for a while. But what's maybe more of the surprise is that that issue has not really arisen in the dynamics that you were describing. And so even in the periods of the COVID or the financial crisis or even more recently, the importance and centrality of the US Treasury market in fixed income markets and things has held up. I understand your point. It's a bit of a fiscal dominance argument that eventually if fiscal policy is so unsustainable then that spills into monetary policy and that's obviously a concern. That's why we don't want to be in that kind of situation. I will say one thing that you said that I guess separate from the fiscal policy because I think it's very important. There is no question that in the global economy, starting with the US economy, but the global economy, that the heart of the global financial system is in this US Treasury market and when that's working reasonably smoothly then other markets usually work reasonably smoothly. Doesn't mean everything works perfectly but that without that one, it's really, so much of asset pricing is off the Treasury market, so much of liquidity is through that market and that's what we saw in March of 2020 again, a shock, the COVID shock, is when that market became disrupted that that just started spilling over to not only every adjacent market but then every tertiary market too. So I think you're starting point that having these markets work effectively is critically important for economies not only in the US but around the world.

Exactly the right question. Let me clarify something in my remarks that I think is very important. I personally don't like this notion of a short-run neutral rate. I think it came up yesterday. The sense of well things are happening today, next year that's moving some, you know, kind of forward-looking kind of thought of a short-term neutral rate. I think that's really hard to know what that is. It's affected by fiscal policy in the short run. Every shock is kind of folded into that. I tend to focus on a longer-run kind of neutral rate, a medium or longer-term R-star concept when I'm talking about a neutral rate. But your point is very relevant. In the US for example, the fiscal policy changes enacted this year will be giving some boost to growth over the next year or so. That said, immigration policies and tariff policies may be having other counterveiling effects, definitely on the labor supply. These are first-order effects. So from my point of view, we're getting quite a few supply shocks as well as demand shocks at the same time. So the critical thing is how are these affecting the supply side of the economy? How are they affecting the demand side of the economy? And from a maximum employment, price stability point of view, it's how are they affecting the balance between supply and demand in our economy? I think that again there's some negative supply shocks, maybe some positive supply shocks and then the demand. So from my point of view in the near term, yes, fiscal policy may be a near-term boost. There's some other factors I think holding negative effects on the economy. Of course there's AI and a million other things happening too and you have to take all of those into account. My own view that we're going to have growth somewhere in the vicinity of trend growth this year, next year is kind of saying that the balance isn't significantly to one side or the other, although as I mentioned on the labor market we've been seeing this cooling. In terms of longer-run neutral rate, I'm definitely of the view that the longer-run neutral rate, a real interest rate, natural rate of interest is still quite low relative to historical norms. My model estimates, my preferred model estimates around three-quarters of a percent for the real Fed funds rate, though with a 2% inflation rate that gets you to two and three-quarters. Of course, there's other models and estimates that are different from that. But I think that the primary drivers of the longer-run neutral rate which are demographics, trend growth, some other factors, Arvind talked about this yesterday around convenience yield, net-net many of them are still holding the neutral rate very low, especially demographics gets even lower. But the fiscal policy maybe boosting it by a quarter or half a percentage point, something like that. Again, at the end of the day when I see an estimate like from the FOMC, the median estimate of long-run neutral rate is around 1%, that seems somewhere between half to 1% seems pretty reasonable to me, still very low, maybe a little bit higher than we thought it was in 2018, 2019 when it seemed very, very low. I will say our estimates for the euro area are still extremely low for the neutral rates. So I think that globally we're still in a world of low neutral rates. Last thing I'll say in this because I swore not to talk about R-star unless asked. So thank you for that. I think the market's pricing which says the real rates are going to be like 2% in 5 to 10 years from now or even higher, I don't take a lot of weight from that. There's term premium, liquidity premium, a lot of other things in those markets. Also the markets seem to be very, very bullish on AI and the economy. That may be true, so you see the stock market high, you see bond yields higher, that seems to be in part a market perception that we're going to have a very high period of growth in the US from AI and other things which again could happen but we haven't seen it really yet in the data.