Town hall with Neel Kashkari at the Chippewa Falls Area Chamber of Commerce

We'll go into our analysis of the underlying dynamics of the US economy. And so if the deficit is going to keep growing and growing and growing, all else being equal, that would crowd out resources to spend on other things. And on the margin, that would probably mean that the interest rate environment will be higher. And so again, I'm not saying good or bad, we just have to respond to that and balance out the economy so that we don't overheat the economy or we don't have an economy that's growing too slowly. What are we trying to achieve? We're trying to achieve what we call our dual mandate that Congress has told us to achieve, one of which is stable prices, which is 2% inflation. The other is maximum employment, as many Americans gainfully employed and contributing. Usually those things are like sides of a seesaw that we're trading off each other. But if the deficit goes to the moon the way it's forecast, then on the margin, interest rates will probably be higher to balance these things out.

Well, we get a lot of data. So before the Federal Open Market Committee meets every six weeks, and before every meeting, we get about 100 pages of analysis from our colleagues, the economists who work in Washington DC and other economists working around the Federal Reserve System. And that analysis looks in depth at the US economy but also looks at what's happening all around the world. Now we're not an island. So if the rest of the world is growing more slowly, that probably means that many of the businesses in this room that are manufacturers exporting, your exports are going to be lower. That probably means you're going to be hiring fewer people to build those exports to feed those markets. So we care a lot about what's happening in the global economy because ultimately it matters back for America. And you're right, there's always noise in the data. There's noise in the international data, there's noise in our own data. You know, is the economy growing gangbusters? Is it growing slowly? Is the labor market weakening? We're always getting confusing signals. So meetings like this can actually be helpful to try to figure out where's the signal from all the noise that we're getting. And that happens internationally and that happens here at home. And then we make our, use our best judgment to try to understand where is the underlying economy headed. Thanks for asking.

Well, you're right, there's a lot of activity that's happening. The nature of the economy is changing and so we're always having to pioneer new data sources to give us insight into what's happening. I don't think crypto, because almost, I mean, I don't want to, you're going to pull my thread on crypto and I'm going to go off on a little speech about crypto which I don't want to do, but if you force me to I'll be willing to do it. But very few transactions are actually happening on crypto. People are buying crypto and they're selling crypto, but they're not paying for goods and services using crypto. It almost never happens unless people are buying drugs or other illegal activities. But there are many new activities that are happening and we're constantly having to pioneer new data sources to try to understand what's really happening in the underlying economy. I'll give you a very, very simple example. When we had this huge inflation surge, one of the big surprises was how much housing inflation shot up. And as we dug into it to really understand what are the drivers of housing inflation, we realized that if you look at new rents and new leases, so if you went out and got an apartment today, what is the inflation on those leases? It should be a pretty good forecaster for overall housing inflation as the universe of leases turns over over the next 12 to 24 months. So now one of the things that we look at to try to get some sense of where is housing going are different measures of new lease rates. So for example, Zillow is a company you probably heard of, an online company, didn't exist 20 years ago I don't think, and they're a source of data for us to try to get a sense of where do we think housing inflation is going over the next 12 months to 24 months. That's just one example of many where we have to constantly look at new sources of information to try to figure out where the economy is headed because the economy is constantly changing. And so you're absolutely right about that.

Sure. So there's been some central banks have announced that they want to launch what's called a central bank digital currency. And at the Fed, we're studying what other central banks are doing to try to understand it. Digital currencies, digital dollars exist today. So I could send anybody in this room right now $5 with Venmo or PayPal, and you probably use those types of services all the time already. So the private sector has already created these type of digital currencies using the legacy payment systems that we have in the United States. The central bank is not issuing that, your bank is issuing it and Venmo and PayPal, etc. So the question that I have is what would a central bank digital currency do that Venmo and PayPal can't already do? And nobody's been able to answer that question to me. You know, we know that there's a problem in America where there's some small percentage of Americans are quote unquote unbanked, so they have some job, maybe they get paid in cash, maybe they have to go to a payday lender, they don't have a formal bank account, they don't have a credit card. That's a legitimate problem. And some people say, well, maybe a central bank digital currency would help solve that problem. But no one has offered any evidence that it would help solve that problem. So there's a bunch of things like that that I think are worth studying, but I haven't seen any evidence that any of these actual problems in real life get made smaller or better by the Federal Reserve issuing a central bank digital currency. The bottom line is, at the end of the day, ultimately, even if we wanted to, Congress would have to authorize us to do it. It'd have to be a decision by our elected bodies to do it, and then we could consider it. Right now, it's simply a topic of study to understand what other central banks are doing and why.

You know, our supervisors work really hard to try to make sure that banks are following the rules and that are operating in a safe and sound manner. But banks make mistakes and we make mistakes. We don't always get it right. And the most visible example of this was a year and a half ago when Silicon Valley Bank in Silicon Valley got into a crisis. They had loaded up on long-term bonds. When interest rates went up, the value of those bonds went down. That wiped out their equity kind of on a mark-to-market basis. And that scared a lot of their customers who then pulled their money out. And then talking about online payments and these kinds of transactions, the what we call the speed of the run, how fast people were able to pull out money, was unprecedented. And then that led to concerns about other banks that might have similar exposures. So that's an example where clearly the bank didn't get it right, but I would say we didn't get it right in overseeing the bank and making sure that they were only taking a risk that they fully understood. And so I think overall our supervisors do a good job. They work very hard, they're very conscientious about their work, but they are human, we are human, we make mistakes, and hopefully we can learn from our mistakes so that we avoid repeating them. I will say this, in 2008, Jerry mentioned this in my bio, I was one of the first responders in the 2008 financial crisis. I was at the US Treasury Department. I was shocked that so the major banking crisis happens in 2008, then in 2020 when COVID hit, financial markets were also facing massive fragility because of the pandemic. The Federal Reserve had to step in to stabilize markets. And then 2023, we had to step in again to stabilize regional banks, which there's a lot of concern about some of those, some of the regional banks. And so it's frustrating for me that as focused as we have been and continue to be on banking, that problems continue to emerge. And so I just think we're not done.

Well, my, one of my biggest lessons from the inflation episode is, excuse me, going into the pandemic, we struggled because we kept thinking we're at maximum employment. And meanwhile the unemployment rate kept ticking down from 4.5% to 4% all the way down to 3.5%. And yet inflation didn't really budge. We didn't even get 2% inflation. We were stuck at around 1.5% or 1.6% inflation. And that was an odd thing that was happening. You know, maybe we weren't really at maximum employment and that's why inflation didn't come. And then COVID hit, then supply chains got screwed up, and then inflation soared. And we called it transitory. Me too, by the way, I was part of the transitory team. So what ended up happening is it was not the labor market that caused the inflation. And most of our energy, my energy, has focused on understanding how do wages lead to inflation. And if the labor market gets really tight and the unemployment rate drops and wages go up, that's going to cause inflation. So we're looking, but that's not what caused the inflation. The inflation was a constellation of events. So during COVID, when the services economy was shut, couldn't go to restaurants, you weren't getting on airplanes, people were stuck home by and large, so we all shifted our behavior and were buying goods online. So the balance in the economy shifted away from services and towards goods. That had never happened before. And then the goods supply chains for those very goods was disrupted because of the pandemic. So we're overloading the goods sector at a time when the goods sector is disrupted because of supply chains. Those are both inflationary. You also had a lot of stimulus put in the economy because folks thought, I thought the pandemic would last a lot longer. The vaccines that came along came along much sooner than expected, which thankfully shortened the pandemic, but that meant that there's probably more stimulus than was needed. That was inflationary. And then you had Russia invading Ukraine, sending commodity prices to the roof. That was inflationary. So each one of those individually was inflationary. You put them all together and it was a huge inflationary impulse that shot way up. And then it took a lot longer to unwind than we had expected. And so what's the lesson for me? One lesson is just a reminder that there are many different sources of potential inflation. It's not just the labor market. The other one that we focus a lot on are inflation expectations. So this is a tricky thing in economics. If you and I all believe that inflation is going to be high, then we're going to go to our employers and say you need to pay me more because inflation is coming. And if we all demand that, then your employer is going to have to turn around and charge his or her customers more. And then it becomes a self-fulfilling spiral. And so keeping inflation expectations anchored at 2% is really, really important. We were monitoring inflation expectations throughout this episode. They stayed anchored. And so it's a long answer to your question. My big takeaway is yes, inflation expectations are absolutely paramount, they matter a lot. Yes, the labor market matters a lot to understanding inflation, but there are a lot of other sources of inflation too. And that was a rude reminder of the last few years.

Yeah, it's a great point, Jerry. I do the grocery shopping most of the time for my family too, and my brain is still wired into the prices of four or five years ago. I still see these prices, I say, oh my gosh, I can't believe how much oranges cost or peaches, or the one that I've written about which got some attention, frozen lasagna, which I served yesterday as a matter of fact. My wife is traveling so the kids and I had frozen lasagna. We cannot bring prices back down across the whole economy. To bring prices back down across the whole economy, we would basically need to have an economy that's shrinking, and nobody wants an economy that's shrinking. What we can do, and what we are on process of doing, is stop prices from climbing quickly from here. So we're on our way back. Inflation is running right now, depending on how you measure it, kind of in the mid to high twos on an annual rate. And we need to get it all the way back down to 2%. But we're making good progress. Over the last year, it's come way down. But mid to high twos is still climbing. It's not going back to what it was in 2019. And that's just a fundamental disconnect. So that when I say, hey, we're making good progress on inflation, you might look at me and say, what are you talking about, buddy? And we're both right. Because I'm talking about the change going forward, and most people are saying, yeah, but I remember what prices were like five years ago and they're not even close. And you're right.

Nice try. As I said when we started, we take whatever policies are enacted by the Congress and signed into law by the president as an input into our analysis of the economy. And whether it's tariffs or it's taxes or it's spending, all of that just goes into our analysis of what do we think, where do we think the US economy is headed, what does it mean for inflation, what does it mean for maximum employment. And I'll give you, this is not about the election, I'll give you a specific example of how recent dynamics have complicated our analysis of the economy. Normally, prior to the pandemic, we thought that the US economy needed to create about 100,000 jobs a month to keep up with population growth. So every month there's a job report that comes out, gets a lot of attention, and we said, well, if it's more than 100,000, that means the labor market is getting tighter because you're not simply absorbing the new entrants, you're actually drawing from the margins. Well, over the last couple years, we have seen a big increase in immigration. By some estimates, maybe a million more, maybe two, maybe three million more people than had been traditionally expected based on the trends. That complicated our analysis of, well, what's the break-even rate of job growth that's needed to not overheat the economy and not have the economy cool down too much. And so I mentioned the Congressional Budget Office, they did very important work trying to estimate what these immigration dynamics are, and then we use their analysis as an input to our models to figure out what do we think this means for inflation going forward. So that's an example. If immigration policy going forward looks different, then that'll affect our reading of the labor market, and we'll just take it as it is.

You know, we think that a tariff, at a rough level, we think that a tariff leads to a one-time change in the price level. So if we were buying a good from China, some widget, and now there's a 10% tariff put on it, we think that of course Americans are going to pay 10% more, but that shouldn't by itself lead to ongoing sustained high inflation going forward in the future. It's probably just a one-time change in the price level that we think we got to be able to analyze fairly in a very straightforward manner. What becomes difficult is if we do some tariffs and then China retaliates, and then Europe retaliates six months later, and then we come back and do more, then that becomes kind of a vicious cycle that not only leads to higher costs but it makes our job a lot more challenging in analyzing what do those dynamics mean. But at a basic level, a one-time tariff should just be a one-time change in the price level. Again, though, for those of you and me paying that, we're not going to be happy about that. But from an inflation perspective, it shouldn't change the dynamic very much.

Why half a percent in terms of our interest rate cut and not a quarter percent? At our last meeting, the judgment ultimately was, I think either of those would have been appropriate. There were many signs that the labor market was slowing. So the unemployment rate got down to around 3.5% and it then ticked up to around 4.2% or so. Historically, when the unemployment rate has gone up by that much in America, it has presaged recessions. It says, hey, recession's around the corner, and the unemployment rate would take off from there. We definitely want to avoid that. And so we saw a lot of signs that the labor market was weakening. And so we said, you know what, we have made a lot of progress on inflation, let's dial back our interest rates a little bit. Now, even after the 50 basis point cut, I still think monetary policy is still putting our feet on the brakes of the economy. We're not yet back to what we consider to be neutral. And so moving 50 basis points just moved us further along back towards neutral, but we're not at neutral yet. So I think some folks argued for 25, some argued for 50. I think either of those or both of those were reasonable. We decided to go 50. Going forward, we're going to look at all the data. We're going to look at the GDP data, the inflation data, the labor market data. You know, one surprise over the past couple years for me has been how resilient the US economy has been. You know, we've raised rates a lot and the US economy has basically absorbed them and still continued to perform quite well. And the labor market has remained strong. And that's really good news. But it's a little bit hard to figure, that makes me wonder maybe that neutral rate that balances everything out is higher than it was before the pandemic. We're just not sure.