At the Bank of England where he was responsible for the supervision of banks and financial institutions. He has also held numerous senior roles within the bank including work on financial stability, international economics and crisis management. In addition to his role as a governor, he now serves as chair of the Financial Stability Board, placing him at the center of global efforts to safeguard the financial system. We will have a Q&A session with him moderated by Stephanie Flanders from Bloomberg. Stephanie is one of the most experienced and respected economic commentators globally with a career spanning journalism, markets and policymaking from the PPC to JP Morgan and now the head of economics and government at Bloomberg where she leads the global team covering economic development in real time overseeing the research and journalism of 250 economists and reporters worldwide and hosting a weekly podcast Trumponomics. Governor Bailey, we are very pleased to have you here with us. Welcome.
Thank you. Well, good morning. It's a great pleasure to be back in Reykjavik for this excellent conference. My ancestors were in the chocolate making business, so I can't match you for either the sense of adventure or the sense of risk. I'm afraid you take the prize for that. That's truly impressive. So when we were here last year and I spoke, I set out how at the Bank of England we were building scenarios into our monetary policy processes in response to the review that Ben Bernanke did of our forecasting and particularly in response to the review as he undertook the review on the significant uncertainty around the COVID period. And I said that these scenarios I anticipated would help us to explore what might happen if a particular shock were to hit the economy. How a given set of shocks might propagate through to inflation depending on the strengths of different economic mechanisms and how monetary policy might respond in different states of the world. The use of scenarios I concluded would help us build resilience into our inflation targeting regime and help to secure the nominal anchor in a world prone to big shocks to supply as well as to demand. Well, it's good to have foresight occasionally. I didn't have that much foresight a year ago as to what was going to happen. I will openly admit. But of course for all of us the conflict in the Middle East has led to sharp increases in global oil and gas prices as transit through the Strait of Hormuz has been curtailed and critical infrastructure has been damaged in the region or destroyed. And this is a very big negative supply shock to the world economy. And in the United Kingdom the outlook for inflation has been significantly affected. Before hostilities broke out in February, UK inflation was on track to fall to around the 2% target from April. The task for monetary policy in my view would have been to keep it there with underlying disinflation building, slack in the real economy and a softening labor market. Some further easing of monetary policy was on the cards. Well, if you detect the note of frustration in my comments, you will be right. Because instead of course we had an inflation number for April that came in at 2.8% last week and we think that 0.8 percentage points of upside news to household energy prices relative to our pre-conflict expectations, which is driven really by fuel prices, is a reflection of those events that overtook. And in reality, inflation is likely to go higher over this year as utility bills rise and firms pass higher costs through supply chains. And of course, there's nothing monetary policy can do to prevent higher energy prices from affecting businesses and households. For net importers of energy like the UK, the terms of trade have worsened and real incomes will fall. The shock will push up inflation and weigh on activity. How much it will do that will depend on how the situation in the Middle East evolves. A resolution at the source which would be by far the best outcome. Reopening of the Strait of Hormuz and repairing the damage that has been done to the world's energy infrastructure can reduce the impact of the negative shock to our economies. Equally, the longer the conflict continues, the worse the impact on our economies will become. But regardless of what happens, the task of monetary policy is to ensure that as the adjustment to the shock happens, inflation does not become embedded. And in the United Kingdom, that means returning 12 month CPI to our 2% target in the medium term. Now, since our founding in 1694, the Bank of England has worked to promote the public good and benefit to our people. That's our objective. And set out in our founding charter. Exactly what that means has evolved over the centuries. Suffice to say that since the Bank of England Act of 1998 in respect of monetary policy, the bank has operated independently of government with a clearly defined objective to maintain price stability and this objective is further defined in the annual remit letters from the government to the bank's monetary policy committee. And in turn the MPC is accountable to parliament for its actions for the people and parliament. Delegation to an independent central bank in this way works as a commitment device to reduce incentives to renege on the promise of price stability under the pressures of daily politics. For monetary policy, the temptation previously was always to tolerate a little more inflation in the short run to support the real economy. But as economic history has shown, it's likely that policy makers will deliberately renege on the promise of low and stable inflation. People will factor that into their expectations, driving up inflation without any benefit to the real economy. The promise of an independent monetary policy is that it will not succumb to such temptations. And that's why in our remit it's clear that the 2% inflation target applies at all times. The remit recognizes, however, that attempting to bring inflation back to the target too quickly may cause undesirable volatility in output. In some instances, monetary policy has to manage a trade-off between the speed with which it brings inflation back to target and the consideration that should be placed on the variability of output. And in this sense, the UK inflation target, like others around the world, is flexible rather than strict. But of course, the question that begs is exactly how flexible should it be? While the MPC's remit specifies the inflation target explicitly as 2%. It provides no explicit guidance on the precise weight that should be assigned to output relative to inflation. In the common jargon of monetary economists and central bankers, the remit leaves the value of the parameter lambda unspecified, except perhaps implying that it should be strictly positive. So put that way, the remit can be regarded as an incomplete contract between the government and the MPC. But I would argue that's a feature, not a bug. From the point of view of Parliament, the remit is a commitment device. But it's one that leaves the MPC with constrained discretion. This is consistent with the view that the appropriate way of managing a trade-off is state and shock dependent and so is not something that can be predetermined. For example, to the extent that it's appropriate to look through temporary price level shocks, the appropriate value of lambda, the weight on output when managing the trade-off when such shocks arrive may be high. Equally, in the face of risks to the anchoring of inflation expectations, a very low value of lambda may be more appropriate. On this view, the remit encodes delegation of lambda selection to the MPC depending on the situation that it faces. The remit recognizes that there are times when the MPC is likely to be faced with more significant trade-offs that need to be managed, but it also prescribes additional public scrutiny in those circumstances. Whenever inflation moves away from the target by more than 1%. The governor of the bank is required to send an open letter to the government to the chancellor of the exchequer that is to set out the outlook for inflation and the action the monetary policy committee is taking to return inflation to the 2% target. And in response the chancellor can opine on whether the government views the balance that the MPC is striking in managing any trade-off as appropriate or otherwise. Now, alongside my remarks today, we've published a Bank Insight article on the Bank of England website describing these issues in much greater detail. But let me add here that any monetary policy regime involves constrained discretion in some form. Even under the gold standard when central banks were highly constrained by the task to maintain the convertibility of their currencies into gold, managing the system required considerable discretion at quite a number of times. In the 19th century, for example, the Bank of England had to manage a trade-off between convertibility and the needs of commerce and trade. And there's a long history of debate familiar to people in this room I know about how much monetary policy should be constrained by rules and how much discretion should be left to central bankers. Reflecting that debate, different jurisdictions have arrived at somewhat different answers to how constrained discretion should operate when you're in an inflation targeting framework. For example, the Bank of England's monetary policy remit bears many similarities to frameworks with a dual mandate. Given the widely held view that money is neutral in the long run, both involve a focus on inflation stability in the long run. In the short run, both involve balancing inflation volatility with a concern for output volatility. And both lend themselves to be formalized in terms of a quadratic loss function, which is where the Greek letter lambda comes into the story, of course. But there are subtle differences between these two, however, and I would highlight two. The first is the clarity with which the remit acknowledges that achieving the inflation target is the best and only contribution that monetary policy can make in the long run. The primacy of price stability in the MPC's remit makes clear that there are times when the focus should be squarely on returning inflation to target and there are limits to how high lambda should be. In that sense, our remit is more constrained. But second, and subject to the first, the MPC's remit affords more flexibility over how management of a trade-off should be approached than a dual mandate, which almost by definition can be taken to suggest that a balanced approach should be taken. I would argue that this additional flexibility that we have can be useful in allowing monetary policy to approach trade-offs in different ways depending on the circumstances. Explicit language on how trade-offs should be managed gives clear directions on how the choice should be approached however and a clear framework for accountability to parliament. So that begs the question of course. So how does the MPC's remit suggest we should respond to the recent rise in energy prices caused by the conflict in the Middle East? Well, monetary policy generally looks through the direct effects of energy prices on inflation. It takes time for changes in interest rates to affect the economy and inflation. So higher interest rates might only push inflation below target once the energy price shock has passed, resulting in undesirable volatility in both inflation and activity. And even if the lags in the effects of interest rate changes were shorter, offsetting the direct effect of an energy price shock would require pushing down core inflation by generating additional slack in the economy. Looking through the direct effects of an energy shock avoids such output volatility as the MPC's remit calls for. In other words, a higher value of lambda is appropriate with respect to the direct effects of an energy price shock. Because they take longer to come through, the argument for looking through the indirect effects is weaker and protracted indirect effects could keep inflation above target for too long unless monetary policy responds. This suggests a moderate value of lambda for the indirect effects. By leaning against indirect effects, monetary policy may also reduce the risk that higher inflation becomes embedded through higher inflation expectations and second round effects. Such effects could arise, for example, if a rise in inflation expectations leads workers to bargain more strongly for wage increases and firms raise wages to maintain real pay for their employees, which in turn would increase their costs and could lead them to set higher prices. Monetary policy should not look through such effects. For second round effects, the appropriate value of lambda is low, consistent with the primacy of price stability in the remit. But the size of course of any second round effects in addition to the direct and indirect effects is highly uncertain. And in addition to being highly uncertain, second round effects build up more slowly than direct and indirect effects. And that leaves monetary policy makers with a difficult judgment call. Because interest rate changes take time to take their effect. We can't wait for conclusive evidence of the strength of the second round effects, but responding too early may generate undesirable volatility in output and inflation may drop below the 2% target in the medium term if second round effects turn out to be smaller than anticipated. I would argue this speaks to the desirability of a state contingent approach including with respect to the choice of lambda. Given the context of softness in the real economy and uncertainty around the scale and duration of the shock, tolerating temporarily above target inflation to provide some support for the real economy is an appropriate way to approach the trade-off. But that tolerance would weaken if signs of second round effects begin to emerge. So this takes me back to the scenarios. In the monetary policy report that we published at the end of April, we presented three scenarios A, B, and C for possible outcomes for the UK economy and inflation over the next three years without any one of them being designated as a central projection as we normally would do and without assigning any probability weights to them. This is not because we expect this to be the norm for the future. Rather, it reflects the uncertainty we face with the unpredictability of the situation in the Middle East. As and when we can be more confident about how world events will unfold, we will return to presenting a central projection, one that the MPC agrees is a reasonable baseline, using scenarios as vehicles then for exploring the inevitable risks around it and exploring differences of views within the committee. But for now, the scenarios we think give us a better way to think about the policy discussion. The reality of the situation we are in is that there is a range of possible outcomes and we have to be ready to respond to all of them. Using scenarios like this is part of being ready to make that response whatever happens and it allows us to set policy now with a clear sense of the risks we have to balance. The scenarios are designed to capture the key questions that are relevant to the policy discussion. How long will the conflict go on? What will be the scale of the effects of the second round effects on energy prices of the conflict? And particularly important for us, could it lead to second round effects and inflation persistence? The scenarios do not pretend to be exhaustive of what could happen. They're meant to illustrate somewhere around the range of possible outcomes. While we are ready to adjust course as needed depending on how the situation evolves, our decision to hold the policy rate at 3.75% at our most recent meeting was an active choice given the range of possible outcomes. Having taken expected cuts off the table for now, we already tightened policy considerably in response to the shock relative to what had been expected by markets. And that's already affecting financial conditions and the economy. Key quoted rates on mortgages have increased since the onset of the conflict. So the decision to hold reflected a judgment that continued weakness in UK activity and the labor market is likely to lessen the strength of the second round effects from higher energy prices while recognizing that these effects are likely to be stronger the larger and more persistent is the rise in global energy prices. Uncertainty about the strength of the second round effects means that monetary policy needs to balance the costs of leaning too little against these effects against the cost of responding too much. And the right balance is likely to change depending on how events unfold and how the economy reacts. To state the obvious, that means of course that we have to monitor very closely the situation in the Middle East and how it affects the UK economy and inflation and adjust policy as required. But whatever happens, the use of scenarios and the flexibility that we've built into our processes following the Bernanke review has prepared us well for responding to events as they unfold and to returning inflation to the 2% target in line with the remit and for the good of the people of the United Kingdom. Thank you.
Thank you very much, Governor. That was great. You talked a lot about the importance of discretion and I guess the other way of thinking about discretion or another way of putting it is that it's just the ability to respond to different situations in a different way. Of course looking at the UK, what's happened in Europe, 2022 also saw an energy shock, also saw rising inflation expectations. How different is the current situation?
That's a great question. I think there are several differences that are important here. One is to remember that the energy shock in 2022 came in two parts. So we had a February 2022 initial outbreak of the conflict in Ukraine and then we had one in the bigger one came in around August really actually. So it had a different characteristic but I think the bigger point I would make is the legacy of COVID and the problem and I look back on this particularly sharply now the problem we had I think was judging how tight particularly the labor market was. Every forecast that I know and we publish a summary of outside forecasts in every monetary policy report we publish had unemployment going up in the UK. This includes our forecast by the way when the so-called furlough scheme came to an end. In other words, when the state paying for people to stay in jobs but not be at work came to an end. We all thought there was going to be I think I got asked repeatedly how much scarring do you think there's going to be? And we all thought there would be and we all thought there would be an increase in unemployment. I mean the furlough scheme was a great scheme in many respects but it obscured the read of the labor market I think. So of course what happened was exactly the opposite. We had no increase in unemployment. Labor market became tighter and it became very clear talking to companies that they were quotes hoarding labor deliberately that they were worried about if they lost people they wouldn't be able to get them back. Now I think today we're obviously not in that position. I mean, there's always an interesting task with reading the labor market, but I don't think we're in that level of uncertainty. The picture of a gradually softening labor market comes through pretty consistently.
And is it, you know, obviously you had that experience, you learned what some would say, you know, you learned quite a few lessons from that experience because the labor market was not as we thought, as many people thought. There's a lot of questions now around UK credibility both on inflation given the recent record but also clearly the political uncertainty which we're seeing in market pricing particularly in bond markets but also in inflation expectations. Is it harder for you to be using that discretion in this quite different situation given that sort of legacy that you're carrying?
I think the legacy makes it a bit harder because I think if you look on the other side of the picture to the sort of the softening labor market, softening activity going the other way put on the sort of on the other side of the balance would be inflation expectations. And you know I think we're very aware that the legacy of four years ago does weigh in people's assessment of what inflation expectations are in response to the shock we're having at the moment. So I don't think we should be surprised that there's some element of what you might call hangover from that period. But of course, we have to take that very seriously into consideration because it's real.
Does sorry. But just does the change in inflation expectations mean something different this time because of the state because of what's in the labor market?
Well, I think that's where it gets really interesting. Because I think that's a judgment that weighs very heavily. You're precisely right because what you can end up with is somewhat more elevated inflation expectations but it isn't coming through in wage expectations when they're measured and it isn't coming through in wage settlements at the moment particularly in the private sector in the UK. So again you know as I said in remarks that judgment is absolutely at the center of what we do and I think that judgment between those two things, what weight do we put on the read from inflation expectations versus labor market expectations is very important.
And I guess that means I mean at least on the outside it sort of seems that you wouldn't only be looking at inflation expectations as a clue to second round effects which is obviously the thing you're worried about. So if it's not that, what other indicators are you going to be looking at?
So we look at a whole series. We're not going to be specific about a particular indicator. I mean there are elements of the inflation series because I think things like services inflation give you some reading on the sort of underlying state of the domestic economy more so than some of the other bits of the index. Labor market will the only problem in the UK will have is that there is a distinct seasonality to private sector wage settlements and we've passed that season before the shock happens so we don't get as much information for the remainder of this calendar year on that.
And that involves waiting quite a long time.
Yes and that's the challenge going back to what I was saying. The other thing we do is we spend a lot of time I spend a lot of time going around the country talking to companies and we are doing a lot of that. And we come into this I think with companies telling us quite consistently before the shock happened that they were finding it hard to pass costs into prices. So if you think back to sort of events that happened over a year ago, if you think back to things like the national insurance change, minimum wage changes, companies were telling us quite consistently, it is getting much harder to pass those through. And I think probably by the end of last year we were concluding that a bit more of it was coming through in reduced margins.
So the implication of what you were saying about a legacy is obviously you feel conscious of that the trade-off between wanting to be seen to be responding quickly but waiting for those second round effects. Has the bond market tightening actually bought you some time on that?
It probably has but there's a number of things going on there I think so as I said in the remarks I mean one of the things we have in effect tightened policy in my view now this does depend this will you'll get different answers from different members of the committee on this because it depends what you thought you were going to do for the rest of this year before any of this happened. I'd been quite clear I thought we probably would cut rates once or twice this year that's off the table so we've had as I said in my remarks we've had about 1% increase in mortgage rates for new mortgages. So for two and five year fixed rate mortgages. That's obviously a tightening of financial conditions. So that's real. I think the other thing we've had is that the UK bond market has responded somewhat more and this is linked because I think we've seen this very big change in the makeup of bond markets including our own. So there was I think more than you would see historically positioning particularly in the sort of the hedge fund world on the basis that we were going to cut and that positioning has come off largely. So you had a bigger sort of reversal of positioning going on and I think that also has had some effect on the UK curve. It's coming down now progressively over the last couple of weeks. I hope it goes on that I think that will depend on events in the Middle East, I think.
Does the UK We're running out of time, but does the UK have a problem here? And is it a puzzle for the Bank of England? I mean, the neutral rate, the rate at which we can sort of not have a problem with inflation just seems to be meaningfully higher than you might have expected.
I mean, this is one of the great puzzles I think that we all spend quite a bit of time on as to how you sort of square neutral rates. We do have a more open economy. That's one of the sort of arguments we sort of come back to eventually. So that may have some bearing on the question. I think but it is something that we do look at very carefully. And I do think this question about are we going to see market rates now come down will depend a lot now on what goes on in the Middle East. But I also would say this about the UK and it sort of goes to the I don't comment on the detail of fiscal policy but I think if you look at it through the eyes of the market I think the market responded very positively to the budget last autumn and they see that of course with the shock and consequences of that in terms of energy prices. They obviously see a pressure on that.
Governor Bailey, we want to make sure that we're not behind schedule all day as they were yesterday. So, thank you very much.
Welcome back. We now turn to our next keynote which will be livestreamed. It's a pleasure to welcome Jeffrey Schmid, president and CEO of the Federal Reserve Bank of Kansas City and a member of the Federal Open Market Committee where US monetary policy is set. He brings more than four decades of experience in banking and financial supervision and today leads the Kansas City Fed's work across a large and diverse region of the United States. He is also host of the Jackson Hole Economic Policy Symposium, one of the most important global forums of central banking and economic policy. Following his remarks, we will have a Q&A moderated by Stephanie Flanders from Bloomberg. Please join me in welcoming President Jeffrey Schmid.
Thank you. All right. Well, good morning everyone. Thank you very much for that. And first of all, if you'll indulge me, I do want to make a few thank yous. First of all to Governor Jonen. He's become a really good friend through the Jackson Hole Symposium. He's also become a bit of a celebrity in Jackson Hole, which is kind of fun to watch. And then Northwestern University. I had the pleasure last night of having dinner with Professor Marty Ikenrom and that was delightful. Just a couple quick comments because I've very much enjoyed my time here. I thought yesterday's program and dinner experience was extremely enjoyable and impactful including the music entertainment which was amazing. I'll just say one thing kudos to your teams. As a host of the Jackson Hole symposium now going on 49 years it's amazing what the teams have to do behind the scenes in both hosting organizations and I have a real extreme appreciation for the teams that do this and how welcoming they are. Also this economic conference has what I call a bit of a special sauce. One, it's got world-class participants clearly. It's in a stunning location for certain and it has a rigorous agenda. I did get a chance thankfully to experience one of your geothermal pools and I feel like I'm 25 years old again. So I highly recommend that if you get a chance. Also like to thank I'm sandwiched between two people I have great admiration for. Governor Bailey has become a friend and I just really enjoy his policy thinking mind. And then vice chair of supervision for the board of governors. You'll see later here today. Mickey Bowman is really great. And then finally greetings to everyone that made the trip. It's kind of gotten me all kind of fired up. When I return to Kansas City next week, we'll be start welcoming about a half a million visitors. We're one of the host sites for the World Cup tournament that starts here in the middle of June. And it's a bit daunting for a city the size of Kansas City. But just so you know, we've got Argentina, Algeria, Austria, Ecuador, Quaco Craco, and Netherlands joining us in Kansas City for the World Cup. If any of you need tickets, our chief economist, Joe Gruber, here will help you with that. He'll explain the economic theory behind why you should come to Kansas City and enjoy the World Cup. So I've got some prepared remarks. I'm looking forward to chatting a little bit with Stephanie. But today I'm going to discuss a topic getting quite a bit more attention lately. And that's the importance of regionalism and independence in central banking. I'll speak to how regionalism defines my role as president of the Kansas City Fed and forms the basis of my approach to monetary policy and what doesn't get as much air as monetary operations and kind of the bridge between policy and true monetary operations. And then I'll give examples of how I think importantly local inputs have helped shape my views on three important global issues we're all discussing here the last day or two. That's oil, artificial intelligence, and demographics. But first, what does it mean to be a regional Fed president? To answer this, let me start with a little background. The United States was somewhat late in settling on a central bank despite or perhaps because of two earlier failed attempts. Taking lessons from these experiences, the Federal Reserve system as created by our Congress in 1913 consists of a board of governors in Washington DC and 12 geographically defined district banks, including the Kansas City Fed. The Federal Reserve system has proven extraordinarily successful and durable in part because it was designed to align with America's regional composition. The Fed is a system of distributed rather than concentrated power. Hence, the Federal in Federal Reserve. There is an understanding that decisions on monetary policy are too important to be left to Washington DC and Wall Street alone. Much of the popular support for the creation of the Fed arose in the region of the United States now represented by the Kansas City Fed. Farming is a credit intensive industry and farmers and agricultural bankers in the Midwest and my region desired a more elastic supply of liquidity than provided by money center banks in New York and Chicago. The provision of seasonal credit was an important function of the early Fed. So, how does regionalism define my role today as president of one of these regional feds? I view myself as being at the intersection of a two-way flow of information between my district and the Federal Open Market Committee in Washington. I am the voice of the region on the FOMC and I am the voice of the FOMC in the region. The Fed was designed to ensure that the views of a wide range of industries and communities are included in the nation's monetary policy deliberations. In the weeks before each FOMC decision, my team and I meet with business and community leaders, including the 30 directors who sit on our boards in Kansas City, Denver, Oklahoma City, and Omaha. We attend roundtables, visit factories and businesses, and conduct outreach across the district. Before every FOMC meeting, we hear from hundreds of individuals. This is the input that informs my contributions at the FOMC table. Each industry and community has a different way of understanding and expressing its interaction with the economy. This is true whether rural or urban, agriculture or health care, Kansas City or Denver. The function of the district bank is to understand each of the communities on its own terms. By being fluent in the district economy, the Kansas City Fed can ensure that the district is heard when it comes to monetary policy. This fluency comes from investing in expertise, but also from being deeply rooted in the community. Let me offer a few examples. Agriculture is important in the Kansas City Fed's region. To communicate the interests and concerns of the agricultural sector, our reserve bank must invest in understanding the issues, challenges, and perhaps most important, the vocabulary that shapes the sector's economic discourse. This understanding provides the rationale for the Kansas City Fed's newly inaugurated Center for Agriculture and the Economy. The center will provide an anchor for the district's research on important issues in the agricultural and rural economies and will further our outreach in these areas. Community banking is another industry that distinguishes the Kansas City Fed District. Almost 650 of the country's 3,800 banks are based in our seven-state region. Kansas alone has just about as many commercial banks as California and Florida combined. Understanding the concerns and needs of these banks requires fluency in their operations and the economic environment in which they operate. Talking with community banks not only gives us insight into the economy, it also informs the operational side of the Fed's mission. The Fed has a public interest mission to promote the safety and efficiency of payments. The launch of FedNow, the Fed's instant payments rail, was in part based on discussions with community banks and a desire to promote broad access to instant payment capabilities. As the payment system continues to evolve both domestically and globally, it will be important that the voice of local community banks continues to be heard. In part, this will be the responsibility of the Kansas City Fed. Importantly, our connection to the district runs deeper than the expertise of our economists. The connection that allows us to speak for the region extends throughout the bank. I was born, raised, and made my career in the district. The same is true for my first vice president, general counsel, head of bank supervision, CIO, general auditor, and head of bank operations. This is not to say that you must be from the 10th district to effectively serve the 10th district, but regionalism has many points of contact within an institution. In addition to engaging with the economy of our region, the connection our 2,000 employees have to our district and the sense of purpose they show in serving their region provides significant benefits for our operational work. Whether it's helping distribute cash, examining a local bank or providing IT solution in support of the nation's payment system. Why am I talking about this at a monetary policy conference? Partly because I think these are issues of importance to all central banks but at the same time are issues that are largely overlooked in the academic discussion around monetary policy. While most of the literature on central bank communication is about how monetary policy makers talk to the public, my belief is that central banks spend as much time thinking about how to best listen to the public. This important aspect of central banking is all but ignored by academics yet key to understanding the structure of the Fed and the value of investing in regionalism. Now, let me turn to the economic outlook and what I see as the current big three topics of conversation in the United States and worldwide and among both policy makers and the public. Oil, AI, and demographics. Let's start with oil. Of the 12 Federal Reserve districts, the Kansas City Fed has the second largest energy footprint after Dallas. The current energy secretary Chris Wright was a valued member of our board, our Denver branch board before stepping into his current role. Our region has deep energy expertise and recent events have given us a lot to talk about. We are living through the largest disruption to global oil markets on record. Between diminished traffic in the Strait of Hormuz and threats to oil infrastructure in the Middle East, it has been estimated that around 10% of the global oil production has been impaired. This exceeds all previous disruptions, including those in the 1970s, which left a notable and lasting imprint on the global psyche. Unsurprisingly, prices have reacted. However, the increase so far, at least in the United States, could be viewed as relatively moderate compared with historical experience. Even so, the sharp rise in oil prices have triggered a wave of anxiety, especially given that large oil price shocks have been associated with recession in the past. The primary channel for oil prices to affect growth is the impact of gasoline prices on household budgets. In the United States, consumers purchase about 375 million gallons of gasoline every day. Every $1 increase per gallon shifts almost a half a billion dollars daily into Americans gas tanks and away from spending on other goods and services. While this number is large and certainly is being felt by US motorists, we must consider it in the context of a $30 trillion economy. Overall, the United States is much less energy intensive than in the past. For example, we use about the same amount of gasoline today as we did three decades ago, despite an economy that is twice as large and a 40% increase in the number of miles driven a year. In the 1970s, it took roughly 12,000 BTUs of energy to produce $1 of GDP. Now, it takes 3,000 BTUs. Oil is less important and we are more efficient in using it. Another development buffering the US economy and rooted in the Kansas City district is the tremendous increase in domestic oil production following the shale revolution. The United States has shifted from being the world's largest oil importer to being an oil exporter. When the United States was a large importer, higher oil prices were a deterioration in the nation's terms of trade and a drain on domestic spending power. Today, there is still a transfer of wealth, but it is happening within the country. US consumers are paying more, but US producers are earning more. Of course, there remain distributional consequences that should not be overlooked. Higher oil prices could incentivize US producers to increase investment. However, my discussions with firms in my
Region suggest a high degree of caution. Over the past decade, my contacts have moved toward far greater capital discipline and are reluctant to increase production while prices remain so uncertain. While the effect of oil prices on economic activity may be unclear, what is clear is that higher prices are contributing to higher inflation. CPI increased 3.8% in the 12 months ending in April, and higher gasoline prices were a big part of this, but not the only part. Excluding energy, inflation is also running hot with prices increasing 2.8% over the past year. There is an active discussion among academics and policymakers about how monetary policy should respond to relative price changes such as the recent surge in oil prices. Textbooks suggest that central bankers should look through such price changes, but there's also realization that inflation can become embedded and persistent. With inflation running above the Fed's 2% definition of price stability for over 5 years now, now is not the time to let our guard down. We must continue to signal our commitment to price stability and our willingness to take actions necessary to achieve our mandate.
One word I hear repeatedly traveling my district is resilience. Despite unprecedented shocks to global trade and oil markets, most economic indicators suggest continued steady growth. Many commentators attribute this resilience to the ongoing massive buildout of AI infrastructure, which brings me to a second topic. On the surface, tech investments appear to account for about 3/4 of GDP growth in the first quarter. But AI investments rely significantly on imports, and imports of tech-related capital equipment subtracted considerably from growth in the quarter. On net, the importance for AI growth is undisputable, but the contribution is likely a bit less than it first appears. Outside of growth, the discussion of AI disruptions to the labor market has reached a fevered intensity. A key motivating fact has been the weakness of employment growth. Over the last 12 months, the economy added 250,000 jobs, the slowest pace outside of a recession. The question on many people's minds is, is AI replacing workers? From my district reports, I sense this is not the case. Is AI depressing hiring? Here, the anecdotal evidence is more supportive. Many firms are excited about the possibility of expanding production without expanding headcount. The reality is that most industries have seen a decline in headcount over the past year independent of their rate of AI adoption. This suggests a more general cause behind the weakness of hiring. One possibility is that we're seeing the after effects of the labor hoarding that swept through the economy in 2022. Then with labor market churn at record levels, employees were hiring all available workers. There was bound to be some rebalancing as this urgency dissipated.
Another explanation for slow hiring is that we are seeing the aftermath of a steep decline in labor force growth. The US working age population showed almost no increase last year, something that has never happened outside of war or pandemic. A sharp fall-off in immigration and the accelerating retirement of the baby boom generation have weighed on the working age population. Fewer workers require fewer jobs, explaining both the slow pace of employment growth and the relatively low and stable unemployment rate. This brings me to my final topic, demographics and health care. This issue has gained attention in the Kansas City Fed due in part to what I hear from contacts in our region, including executives in the healthcare industry. The fact is that an aging population has continued to grow in the one industry that has been adding a lot of jobs lately, health care. The health care and social assistance sector added 650,000 jobs over the past 12 months, significantly more than the 250,000 total, implying that non-healthcare employment has shrunk. The aging of the population is a driving factor. We tend to think of demographics as a slow-moving trend, but in reality, the United States is now at a relatively sharp inflection point. The proportion of the population age 75 and older, an age associated with a step up in health care spending, is increasing rapidly. Over the next two decades, from 2020 to 2040, the share of population age 75 plus is set to double from 6 to 12%.
Recent work by my staff looking at state level data reveals a tight correlation between the growth of the over 75 population and employment in healthcare. Even more striking has been the increase in the number of care aids, that is home health aids and care assistance for the elderly. This sector has been adding about 300,000 jobs a year recently, making it one of the brightest spots in the labor market. The importance of care aids for overall health care employment has been on a steep upward trajectory over the past decade and now accounts for about 17% of overall healthcare employment. With the transition to an older population just starting in the United States, health care will likely be a steady source of employment growth in the years to come. The bigger question is whether the workers will be there to fill these roles. One might expect that the pull of the care aid sector would boost wages and costs across industries that draw from the same labor pool. An obvious source of such workers is child care, likely increasing costs in an already stressed sector. This raises the unfortunate linkage that an aging society could further raise the already high cost of having and raising children, initiating a sort of demographic downward spiral. A more optimistic alternative is increased productivity in the elder care sector, perhaps driven by AI. Given the tremendous projected growth in the elderly population, not only in the United States but around the globe, it's almost hard to imagine the numbers adding up without the help of AI, robotics, and increases in productivity.
I covered a lot of topics today, all of which touch on the Fed's dual mandate for full employment and price stability and therefore contribute to shaping the outlook for monetary policy. To synthesize, I believe the labor market is in balance notwithstanding the potential though yet unrealized disruptions of AI. I expect health care to be a steady source of employment growth and a source of labor market stability. My primary concern is inflation, which is too hot and has been above target too long. I place little stock in assuming that the most recent runup in prices is transitory within an acceptable time horizon. As such, my focus remains strongly on inflation and setting the correct course for policy. Thank you very much.
Thank you, President Schmid. So, we're now running a little bit late, but we're going to go through till we're going to probably take a little bit off lunch and go through to about 5:11. You've said now is not the time to let our guard down on inflation. I guess what constitutes letting your guard down depends on how you're defining vigilance. So if you just look at policy right now, is it accommodative or restrictive?
So I've been fairly public that it would appear that we are in a phase where the whole concept of higher for longer exists. We've been in this inflation battle for over five years now. And I believe there's some equilibrium in where rates are today. Even though late last year I dissented in a couple of meetings that I thought the rate at the time was fine. So I think the concern now is there was a decent trend line to 2% kind of pre-tariffs and now into the oil shock process where inflation now is trending higher. So I would say we're not very restrictive at this stage. And I think there's some dialogue that we need to start considering what tools we have to really make it a little bit more restrictive depending on how this pull through of the oil shock occurs.
So that's a very diplomatic, it's a careful answer, but I guess if you're focused on inflation, you've also said it's the most pressing risk to the economy. The idea that the Fed still has in its statement a bias towards easing. Does that make sense in this environment?
Did it make sense in April in your view?
