C. Peter McColough Series on International Economics With John C. Williams

John C. Williams of the Federal Reserve Bank of New York discusses monetary policy, the continued impact of COVID-19, and the economic outlook for the year ahead.

The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

PHILLIPS: Great. Thank you. And welcome, everyone, this morning. This meeting is part of the C. Peter McColough Series on International Economics. And we are thrilled to have John C. Williams, who is the president and chief executive officer of the Federal Reserve Bank of New York.

More about John. So, in that capacity, he how serves as the vice chairman and permanent member of the Federal Open Market Committee. From 2011 to 2018, in June, Mr. Williams was the president and chief executive officer of the Federal Reserve Bank of San Francisco. Prior to that, he was the executive vice president and director of research at the same bank.

Mr. Williams began in his career in 1994 as an economist at the Board of Governors of the Federal Reserve System. In addition, he served as a senior economist in the White House Council of Economic Advisers and as a lecturer at the Stanford University Graduate School of Business.

Mr. Williams holds a Ph.D. in economics from Stanford University, an M.S. degree from London School of Economics, and an A.B. from University of California, Berkeley in economics—hence, the career in economics. His prolific economic research focuses on monetary policy under uncertainty, business cycles, and innovation. He’s a research associate at the Centre for Applied Macroeconomic Analysis and served as a managing editor of the International Journal of Central Banking from 2011 to 2016. In addition, he has held associate editor positions at the American Economic Review and the Journal of Economic Dynamics and Control.

He is used to me peppering him with questions, however. So I served a term on the New York Fed Board when John was there. In fact, I got there a few months before we stole him away from the San Francisco Fed. But more importantly, I got to see his leadership and extraordinary accomplishment during 2020, during the pandemic era, when he had to stabilize the economy.

So, if you’ll recall, the Fed was asked to stand up nine new facilities to help businesses, households, governments, and financial markets—trillions of dollars to help the commercial paper market, for example, broker-dealers, et cetera—and they had to do all this at an unprecedented scale and do it remotely with workers not in the office. And so all of that went smoothly. I think it’s unappreciated how much he and his team contributed to stabilizing what was a very precarious time in the economy at the time. But more on that later.

So, with that, let me turn over an opening statement to John.

WILLIAMS: Well, good morning, everyone. Happy new year. And thank you, Charles, for that kind introduction and taking us—(laughs)—to a degree back to early 2020, which was obviously, you know, a very important time. And it is kind of remarkable how much the team and the New York Fed and around the Federal Reserve System really was able to accomplish working remotely at that time. I’d also like to thank Richard Haass for the opportunity to speak here with the members of the Council on Foreign Relations once again.

Now for the past few years I’ve begun my remarks by saying how much I wish we could meet together in person. Now, this time I really was hoping for a chance to rewrite the script. After seeing so much progress on vaccinations over the past year and a moderation in COVID infections during the fall, just a short time ago many of us had expected that we’d soon be turning the page. But the story of the pandemic is a complicated one. It’s writing itself as we live it. And the storyline has been far from predictable.

This is, first and foremost, a health crisis. And the unusual and extraordinary nature of the situation means that circumstances are constantly evolving. For the economy, this has meant that we’ve—what we’ve experienced is unlike any recession or recovery we’ve seen or read about in the past. While there have been significant improvements in the overall economy, setbacks persist in some areas and new challenges have appeared.

Now, I’ll always take an opportunity to quote something from the Lord of the Rings canon, so I’ll continue with the story analogy and say that for many people these past few weeks have felt like we’ve been there and back again. We again find ourselves in a period of extraordinary difficulty. The emergence and rapid spread of the Omicron variant to the United States and around the world are resulting in new peaks of COVID infections and hospitalizations, as well as severe strains on the health care and the essential services workforce. This is a reminder that the path of the economic recovery continues to be driven by the course of the virus.

In my remarks this morning I’ll share more—I’ll share more about what we’re seeing in the incoming data and how it relates to the economic picture, both in the United States and the world more broadly. I’ll also highlight the significant part—significant progress we’ve seen in the labor market in my outlook for inflation. Finally, I’ll discuss the Federal Reserve’s recent policy actions and what they mean for the future. Now, before I proceed, I need to give the standard Fed disclaimer. And that is that the views I express today are mine alone and do not necessarily reflect those the Federal Open Market Committee or others in the Federal Reserve System.

Now, when I look at the economy it’s through the lens of the Federal Reserve’s dual mandate. So these are the two goals that are set by Congress of maximum employment and price stability. And given these goals, my focus is to study and understand the wide range of developments that affect employment, unemployment, and inflation as they play out in real time. And as we start a new year, it’s worth highlighting the key economic developments of last year, which were defined by a very strong recovery here and abroad.

Now, we don’t have all the data yet, but I expect that U.S. inflation-adjusted or real gross domestic product increased by about 5 ½ percent last year, which would make it the strongest growth rate between fourth quarters in over thirty-five years. The economic snapback here and abroad has led to global supply chain bottlenecks and imbalances between supply and demand that have contributed to a sharp rise in inflation. Inflation in the United States, based on the personal consumption expenditure price index, will likely exceed 5 percent in 2021. And inflation rates are elevated in many other countries too.

Now, looking ahead, I expect the current Omicron wave to slow growth in the next few months as people once again pull back from contact-intensive activities. I also expect that the Omicron wave will temporarily prolong and intensify labor supply challenges and supply chain bottlenecks that we’ve been experiencing. Current staffing challenges for essential service workers in the health care, transportation and education sectors will likely have a ripple effect too.

But once the Omicron wave subsides, the economy should return to a solid growth trajectory and these supply constraints in the economy should ebb over time. Considering the effects of Omicron on the economy in the first part of the year, I expect real GDP to increase around 3 ½ percent this year. And while this is not quite the blockbuster growth we saw in 2021, it’s still well above its long-run trend and supportive of continued improvement in the labor market. Of course, experience has taught us not to be overly confident in predictions about COVID and its effects on the economy, and uncertainty around the economic outlook remains high.

So now I’ll turn to the employment side of our mandate, where the picture improved dramatically over the past year. About 6 ½ million jobs were added last year, and the unemployment rate plummeted by 2.8 percentage points. In fact, with the unemployment rate now at 3.9 percent, we’ve retraced 96 percent of the COVID recession rise in less than two years. Now, this is lightyears faster than the more—than more than seven years it took for unemployment to retrace to the same degree after the global financial crisis.

And with the economy registering solid growth, I expect the unemployment rate will continue to come down further to about 3 ½ percent this year. Now, the strength in the labor market is seen in a wide variety of indicators, including job openings, quits, and wage growth. And the labor market has been especially robust in recent months for workers at the bottom of the wage distribution. Female labor force participation and employment have improved, especially for women with young children.

Now, one of the foremost concerns surrounding the outlook is inflation, which rose considerably last year. There were two main contributors to the current—to the current high inflation: very strong demand especially for goods and supply bottlenecks. And both have been prevalent throughout the pandemic. The shutdown of factories, particularly those in Asia, and widespread lockdowns led to disruptions to logistics networks, elevated shipping costs, and prolonged delivery times.

Now, a new index, as created by the New York Fed research staff, shows that global supply chain pressure shot up last year reaching historically high levels. Now, these challenges are not just top of mind for companies selling their goods or consumers waiting for their purchases to be delivered. Elevated prices have real-life consequences for so many, particularly for those who are struggling to cover the rising cost of food, housing, and transportation.

The circumstances we’re facing today are unlikely anything we’ve experienced in the past. Typical historical episodes cannot be used as reference points for current conditions. As an example, the very large increases in prices we’re seeing today are primarily for durable goods. Now, this is a striking turnaround from the past twenty-five years, when those prices had actually been trending lower. Now, in contrast, even with recent increases prices on services and non-durable goods are fairly close to their longer-run trends. And even though the Omicron wave is posing new obstacles, some supply issues are starting to work themselves out as the economy adjusts to the changing circumstances.

Now, just as the pandemic has followed its own script, I anticipate that the dynamics of inflation will also very different than previous cycles. With growth slowing and supply constraints gradually being resolved, I expect inflation to drop to around 2 ½ percent this year, much closer to the FOMC’s 2 percent longer-run goal. And looking further ahead, I expect inflation to get closer to 2 percent in 2023. Now, these developments in the labor market and for inflation inform the Federal Reserve’s policy response and recent actions.

In its December 2021 statement, the FOMC said it would keep the target range for the federal funds rate at zero to a quarter percent. With inflation having exceeded 2 percent for some time, the FOMC says it expects it will be appropriate to maintain the target range until labor market conditions have reached levels consistent with the FOMC’s assessments of maximum employment. Because of inflation developments and the notable improvement in the labor market, the FOMC has also decided to reduce the monthly pace of its net asset purchases. And with our actions, we have started the process of adjusting the stance of monetary policy away from one of providing maximum support for the economy. And this movement in policy reflects the gains the economy has made since the beginning of the pandemic and the evolution of the risks to the achievement of our goals.

The next step in reducing monetary accommodation to the economy will be to gradually bring the target range for the federal funds range from its current very low level back to more normal levels. Now, given the clear signs of a very strong labor market, we are approaching a decision to get that process underway. The timing of such decisions will be based on a careful consideration of a wide range of data and information, with a clear eye on our maximum employment and price stability goals. And we turn a page in the new year, it’s clear we have not yet reached the end of the pandemic story, but despite the challenges I am hopeful of a continued strong recovery this year. Thank you.

PHILLIPS: Great. Thank you, John.

I think we should probably start at the topic probably most people’s mind, where you mentioned something about inflation. Everybody’s concerned about kind of what direction this will go. So there’s backdrop—you know, consumer price index, as you know, hit a thirty-nine-year high of 7 percent in December. The PPI had a November record—a ten-year record. In December it came down a little bit, but not much. Yet, people don’t seem to be that worried about it. I mean, the survey by the University of Michigan of consumers showed them showing—thinking that this is temporary. The ten-year Treasury note’s still at 1.7 percent.

So why are people so comfortable, number one? You may have seen the article by Jason Furman this morning saying we shouldn’t be so comfortable, that demographic change is going to make this permanent. We have fewer people coming into the workforce—fewer immigrants, retiring Baby Boomers. This is something of a long-term trend. So what’s the difference between people being so comfortable in the short term versus other people who think this is the start or something secular?

WILLIAMS: Well, you know, obviously, inflation is very high, and far too high. We wouldn’t want to see it persist at very high levels. We have a 2 percent inflation goal. So that is—it is very much on my mind and my colleagues’ minds. And we have just—I’ll just reemphasize—we have a dual mandate, maximum employment and price stability. Maximum employment, I mean, we’re very close or near that. It’s inflation that is obviously the thing that we need to make sure we bring inflation—see inflation come down. And I do think there’s a lot of uncertainty around the drivers of inflation and the outlook for inflation. So we need to be humble about that. I do—you know, looking at market expectations and the private sector expectations around inflation, I think that, you know, perhaps they’re looking at a lot of these factors that are driving inflation right now as still related, in one way or another, to pandemic effects.

So, for example, you know, the issue we’re seeing around freight costs around the world, shipping costs, clearly are driven by some imbalances of moving goods around the world. And those will be resolved eventually. So, you know, and other factors like the significant rise in used cars and new car prices. You know, they won’t continue to go up at high rates forever. So I think there’s a number of reasons to expect that inflation won’t stay high for a long time. Importantly, we are, of course, you know, very focused on making sure that we see inflation come back down. So I think that’s another important factor. I think one of the reasons inflation expectations have been well anchored—longer-term inflation expectations that you’re referring to—is that, you know, we have at the Fed a commitment to achieving 2 percent inflation on average over time. I think we’ve delivered on that commitment over decades. And we’ve committed to do that in the future.

So, you know, again, there’s a lot of uncertainty about the inflation outlook. And it will be, as I mentioned, importantly, influenced by COVID and other factors. But, you know, over the long run we all know that inflation is a monetary phenomenon. It’s really on central banks, whether the Fed or other ones around the world, to make sure that we create conditions that bring inflation to 2 percent and the average to 2 percent.

PHILLIPS: So, John, as you know, the Fed has been criticized for, I guess, reacting too slowly to inflation. And Chairman Powell used the term “transitory” a lot when he talked about inflation. He doesn’t use it anymore. He dropped that term. But nonetheless, it certainly feels like that’s the consensus, it’s somewhat transitory. But did that thinking delay action? And what’s the ramification of waiting so long?

WILLIAMS: Well, you know—(laughs)—you won’t be surprised what I’m about to say, is that we’re made independent. We’re driven by the evidence and the analysis that we have. And if you go back and roll back the clock a bit, you know, what we saw was a lot of—earlier, last year. So it’s in January. It’s, like, earlier in 2021 we did a lot of increases in prices very concentrated in specific goods that were affected by COVID, by, you know, everyone—you know, basically by moving into homes and buying things for the home. And a pullback from services. But then, as things got better with vaccinations and people started going to restaurants and traveling again, we saw those inflationary pressures actually come down for several months. So I think that that narrative was actually playing out more or less as expected, that those effects, you know, really were reversing in some cases. Like car prices—used car prices coming down. We saw lumber prices coming down. So, you know, I think that was, from my perspective, the analysis that these drivers of inflation would be transitory.

Then what we saw in fall, obviously, with the Delta wave was a reemergence, if you will, of the demand for goods, the pullback in labor supply, and the reemergence of some of the supply chain issues. So, you know, we’ve seen a shift back and forth in the last year of what was happening. I do think that with the—you know, the evidence we have now clearly some of the factors driving, you know, supply shortages around the world, labor supply issues, are obviously more persistent than, you know, at least I previously thought. Getting through COVID is taking longer here and abroad than we had hoped. You know, vaccines didn’t—you know, obviously a huge improvement, and a huge driver of better health and better economic outcomes—but, you know, we still have now the—you know, we had the Delta wave and now we have Omicron.

So I think a lot of it is really not so much about inflation’s behavior, but the drivers of inflation have been more persistent. And that’s why I and, you know, most people expect inflation to be higher for this year that we had previously thought. So to me, it’s really about the data driving, you know, kind of our policy decisions. And, you know, I think that the policy decisions we were making, you know, throughout last year were consistent with what we were seeing in the data. As the data changed, as the drivers of inflation and the economy changed, is that employment came way down, obviously, we needed to move our policy consistent with that. And we’ve done that and will continue to do that.

PHILLIPS: You know, one of your colleagues at the Philadelphia Fed, Patrick Harker, has publicly predicted three or four rate hikes this year. Goldman Sachs is out saying it’s four times, you know, for sure. I don’t know if we can nail you down on something that precise, but does that—does that sound in range?

WILLIAMS: Well, you know, first of all, you know, we’ll be driven by the data, driven by, you know, our goals—especially, you know, making sure that we have inflation—bringing inflation back down. You know, I don’t know exactly what the path of the federal funds rate will be this year or next year, because it will be driven by the data. That said, you know, I think that, you know, my colleagues, when we put our projections for the federal funds rate back in the December meeting, you know, we—you know, everybody saw rate increases starting this year and continuing gradually over the next couple years. I think that’s completely sensible, given the improvement in the economy, given the high level of inflation.

So, you know, my view is we’ll see about exactly the timing and, you know, the pace of raising interest rates. But clearly that’s the path we’re heading to. And that’s completely appropriate. I mean, given where the economy is now, it makes sense that we, you know, continue this process of removing the accommodation that we put in, which I thought, yeah, was very helpful to help the economy recover since the pandemic. It does make sense to bring—remove that accommodation over the next few years.

PHILLIPS: Chairman Powell also discussed the need to shrink the Fed’s balance sheet, but you’re the one who has to do that—(laughter)—with over a trillion in portfolio bonds. So I guess, realistically, how fast could that happen? What’s the natural level? How are you thinking about the slope of that curve?

WILLIAMS: Well, like rate decisions, those haven’t been made and those will be made by the committee. And we’ll have—you know, we’ll think through all that. I do think—here’s how I think about it. We’ve learned a lot from the normalization of the balance sheet from the last time. We clearly have, you know, found that we can control short-term interest rates through the various tools that we use, including administrative interest rates. So I’m very confident that when it is time to adjust, you know, monetary policy we have the tools to move interest rates as we desire, but also we have the ability to manage the balance sheet normalization, you know, smoothly, you know, when we decide to do that.

I do think the situation is different from last time in some ways. One is our balance sheet is much large. You mentioned that. (Laughs.) And the other is, you know, we have a much more kind of balanced portfolio of Treasury securities, shorter-term, medium-term, and longer-term Treasurys. And so, you know, clearly what we’ll want to do, from my perspective, is, you know, think carefully about, you know, the balance sheet normalization when that’s the appropriate time, as part of our broader strategy of adjusting the stance of monetary policy to achieve our goals, first and foremost. It’s a tool of monetary policy. So you want to think about that in terms of achieving those goals.

And I think the second is, you know, the primary tool of monetary policy, we’ve decided this, you know, a number of times in the past and said this publicly, is the federal funds rate. So we really want to think of the federal funds rate as our primary tool that we’re adjusting, you know, to changing circumstances. We’d rather have the balance sheet normalization, when it occurs, to be happening in the background, if you will. Just be happening in a predictable and reasonably—you know, a well-understood way. And so those are some of the things I think we’ve learned from the past experience and have worked, you know, well. And we’ll take—you know, when we think about, you know, what’s the timing and the appropriate pace of that, those are all decisions the committee will make with—again, with the very clear focus on our maximum employment and price stability goals.

PHILLIPS: All right. Let’s turn to one of the biggest innovations in our monetary system in a while, digital currencies. And so some central banks are issuing their own digital currency. We kind of got beat by El Salvador—(laughter)—and I think Mexico. So will there be a digital dollar? And if there is, what’s the impact on the other digital currency? And does that materially change the cost of exchange of money and value?

WILLIAMS: Well, you know, this is such a fascinating set of topics you’re bringing up. (Laughter.) Of course, it also covers, you know, a stablecoin and, you know, crypto, and central bank digital currency. So there’s so much to think about. And it’s an area that we’re very focused on here at the New York Fed, the Federal Reserve System, and around the world—discussions around thinking about how is technology fundamentally affecting our—people’s ability to transfer not only money but actually, you know, you think about smart contracts and all the—you know, clearing and settlement? There’s just a lot of things in our financial system that—where technology potentially can be a game-changer in the efficiency, the speed, and the security of things like that. So I think, you know, we’re going to see a lot of technological drive—technology-driven change in financial services over time.

In terms of, you know, starting with digital, I have to say this. You know, already payments are digital. When you look at the trillions and trillions of dollars that move through our Fed wire systems, those are—those are—you know, it’s a digital system. And that’s true of a lot of—most—the vast majority of payments today. I do think that the—you know, the big question out there is how does—how does new technology, whether blockchain or other kind of variants of that—does that create a great—an opportunity to lower the cost of transactions to make them more convenient, and also to make sure that they’re secure? So there is—you know, I think when you think about stablecoin or central bank digital currencies, this is—these are issues that need to be—you know, are actively being studied, thought about, both in terms of what’s the proper regulation for the private sector to secure—to make sure that they’re secure, obviously satisfying anti-money laundering and other issues, but also to—you know, to make sure that they’re safe and sound.

But also, from the central bank digital currency point of view, I know that—you know, we haven’t made any decisions around that. Watching what’s going on around the world, studying, is this a—does it make sense to add this to our payment system? These are going to be important questions. I think there’ll be coming up this year. To my mind, I think technology is, you know, really changing a lot in financial services. So I expect this will be a very important topic, and we’ll, you know, be very engaged in it. And in terms of, you know, thinking about a central bank digital currency, I just think it, you know, does bring up a lot of very important questions about how do we make sure that we’re creating, you know, a very safe, efficient, and potentially more inclusive payment system?

So but nothing’s—you know, like I said, you know, right now I think this is still actively under study. I’m not worried about being behind the curve relative to what may be happening in China or other countries. I mean, obviously the U.S. dollar and the U.S. economy is, you know, very prominent in the global financial system, global economy. I think a lot of these things, it’s more important to study this, get it right, and make the right decisions rather than trying to be in a race and to be the first, or second, or third.

PHILLIPS: One of the concerns of people who watch the Fed closely is potential mission creep, as you know. So when you stood up all those facilities in 2020 which were needed, you know, well, they’re getting in the lending business, they’re administering PPP, they’re doing a lot of other things. And now more recently Chairman Powell talked about climate stress tests for banks, and that’s quite a new role. So is the mission creep a result of pressure from outside groups? Could this distort bank regulation, monetary policy? I guess, where does this end up as things keep evolving?

WILLIAMS: Well, you know, you mentioned the 13(3), or the Emergency Lending Facility from 2020. I think one of the things is those were emergency programs, clearly, you know, thought of when—you know, when the Federal Reserve Act was created to—so that the Federal Reserve could act in the case of emergency. But because they are—they are for an emergency, they are only used for a short period of time and—you know, and then, you know, the programs were ended, you know, when they were no longer needed, and successfully so. So I think that’s an important thing to remember on those, is that those were there only, you know, for an emergency, brought out, and then put back away.

So, you know, the second thing, on climate—you know, I do think on climate and other issues like that, to my mind, it gets back to our core mission. So what’s the core mission of the Federal Reserve? We have a mission understanding the economy and monetary policy. We have core responsibilities around the supervision, regulation of financial institutions, mostly banks. You know, I think we have an important mission around—in the area of financial stability and make sure that we not only understand the financial system, but, you know, have a strong and resilient financial system.

And to the extent that climate change or climate policies or all the things related to that affect the economy, affect the financial system and the risks to the financial system, and potentially financial stability, those are things we need to be expert at. These are things that we need to be, you know, actively involved in, only to the—you know, to support our ability to carry out our core mission. So to my mind, you know, we’re focused on our work. We’re not changing our mission. We’re not changing what our—you know, our goals are. It’s really—when you think about climate, it’s about how do we make sure that we have the expertise, the data, and obviously the policies that will help us achieve our goals. And with climate, I think that just again is going to be an important part of understanding and the economy, and the financial system.

PHILLIPS: I’m going to ask one more question then—and then we’ll turn it to the audience. But I had to touch on cyber risk. I mean, one of the beautiful things about our system and the Fed is that people think it’s rock solid. They have total trust the system is reliable. And yet, you see cyber incidents in every other part of the economy. And so people wonder, OK, you know, how do you protect yourself? Is this a risk for the entire monetary system? And how do you compare yourself to other agencies, I guess?

WILLIAMS: Yeah. So, cyber, you know, is one of, I think, the greatest risks to—you know, especially around financial stability. And, like you’re saying, it’s a growing issue. It’s not a receding issue. (Laughs.) And so we are very focused on obviously, first and foremost, our own systems. You know, we do run a significant part of the payments in the U.S. economy. We carry out monetary policy. We carry out options for the Treasury Department for the government debt.

So we are very focused in our own systems around making sure that they’re very secure, but also, you know, very focused on the cybersecurity in the banking system, the financial system. And we’re seeing, you know, there’s obviously, you know, rising concerns, you know, of cyber around that. So in terms of making sure that supervised banks, you know, have really very strong programs in place around that. And working closely with the other, obviously, government agencies and, you know, with other entities to make sure that, you know, everyone’s bringing their best—getting the best talent, the best programs in there.

I think—you know, I think what’s maybe a little bit another issue—I would just say, you know, maybe underappreciated, but maybe that’s not true—but is the financial stability aspects of that too. When you think of cyber, you really start thinking about what would happen with, you know, major cyberattacks, and how those connect across institutions, across countries, and things like that. So again, we’re very focused on studying those issues and working closely with others to continue to strengthen around cyber-related kind of issues.

PHILLIPS: OK, great. We’ll take some questions from the audience now. So can we get that process started?

OPERATOR: (Gives queuing instructions.)

We’ll take our first question from Jay Bacow.

Q: Hi. Thank you very much for taking the time. It’s always a pleasure to hear you speak. Jay Bacow at Morgan Stanley.

My question for you is around a possible normalization of the balance sheet. How do you think about quantifying the impact of that on financial conditions? Thank you.

WILLIAMS: (Laughs.) OK, so we’ve gone from Charles’ hard questions—(laughs)—to another hard question. I mean, you know, that’s a—I think we—obviously, the way I think about this is the Fed’s holdings and longer-term Treasury securities, mortgage-backed securities puts downward pressure on longer-term interest rates. So it is an important tool of monetary policy, and I think it’s one of the—one of the factors that’s holding down long-term rates here and abroad. I mean, this is a global phenomenon of central banks doing QE. So when you think about an expectation or eventual normalization of the Fed’s balance sheets to more normal levels, I think the way I think about this is over time, you know, some of the relaxation, that downward pressure on long-term yields and term premium, if you will.

In terms of quantifying it, I think that’s really challenging. That’s the hard part. I think directionally I would expect as we—you know, as we normalize the balance sheet, you would see the term premium move back up somewhat from very depressed levels and longer-term rates move back up. I think, you know, knowing how big those effects would likely be, or what’s the, if you will, the steady state level of the premium or longer-term interest rates is left pretty uncertain. You know, coming out of the last period of normalization, you know, we think about 2018-19, I mean, long-term rates weren’t that high, even after we had normalized the—finished the normalization of the balance sheet.

So it’s—you know, it’s something that I view that there’s a natural process that as we normalize the balance sheet we’ll see long rates move up somewhat, but—and it would happen I think, you know, kind of over time. It’s harder to know exactly how big those effects are. So we—you know, I think we just have to be humble about being overly precise in our knowledge of these effects. But, again, I see this as something that is a part of a process of normalizing monetary policy. It’s both about normalizing the balance sheet over time, but also, you know, obviously the short-term interest of the fed funds.

OPERATOR: We’ll take our next question from Tara Hariharan.

Q: Good morning and thank you. My name is Tara Hariharan and I work for a hedge fund called NWI in New York.

Dr. Williams, thank you so much for your comments. Here’s a question for you: Real interest rates in the U.S. are quite negative. For instance, five-year real yields are now minus 1.31 percent. Do you see the Fed targeting real rates as a focus of the policy normalization process going forward? Thank you.

WILLIAMS: Well, you’re highlighting a really important issue. I mean, often we talk about nominal interest rates, the target fed funds rate is obviously a nominal interest rate. But, you know, the way I think about the economy it’s really the real, or inflation-adjusted, interest rates are what matter. And when you think about a five-year yield, like you mentioned, it’s really about the expectations of inflation over the period—over the next five years. So it is striking how low real yields are, not right—not in the short term, because of course that’s a factor of the Fed policy of, you know, interest rates being very low and inflation, you know, being well above 2 percent. But it is a striking feature that you go out five years, or even the five- to ten-year yields, real yields are still quite low.

And that, you know, that’s a question about—to me, about what is the market thinking, or what do market participants—obviously, it’s not one person—thinking about that? It’s not, to me, a decision of monetary policy. It’s more information we get from that. So I think we do have to focus when we think about our monetary policy actions about real interest rates, not just focus on nominal interest rates. But it’s—you know, one of the reasons that I think we do need, you know, to raise interest rates over the next few years is not just to get nominal rates up, but to make sure we’re getting real rates back to more normal levels. But I do think that there’s an interesting question out there of why even today, after yields have gone up somewhat over the last few weeks, real yields, even five to ten years out, are quite low.

And, you know, I think one of the big questions that we have to continue to analyze is as we get out of the pandemic period, which I’m hopeful—(laughs)—you know, that we’ll do that—is, you know, what has changed structurally in the global economy? You know, we came into this—the pandemic with a very low natural rate of interest, or R-star. We came in, you know, with demographics and other factors that were kind of holding down growth and holding down real interest rates before the pandemic. And then, you know, coming out of this are we going back to that situation of low interest rates and relatively low growth? Or has the pandemic fundamentally changed some of those?

Right now I don’t think we can answer that but, you know, the signal you get from financial markets, at least, is that expectations of interest rates quite far out in the future are really quite low. But, you know, my view of this is that’s highly uncertain. That’s not really a driver of, you know, policy decisions right now. But it’s definitely something that we’re—you know, I’m watching closely to think about what’s happening further out. But, you know, your question, should we be focused on real rates and not just nominal rates, I completely agree with that.

PHILLIPS: OK. Next question.

OPERATOR: We’ll take our next question from Paul Sheard.

Q: Thank you very much. Paul Sheard from Harvard Kennedy School. Thanks very much, John, for your very insightful remarks.

I wanted to just ask you if you can share a little bit about how you’re thinking about the average inflation targeting framework in the context of these new conditions. It looks a little bit like that framework has been sort of overtaken by events, given that it was—it was envisaging moderately above 2 percent, not much above 2 percent. So how are you thinking about what point you would feel that I’ve sort of got back to average 2 percent, given the high readings? And perhaps the second part of the question, if it turns out that quite high inflation continues for a much more extended period, would you be thinking about targeting moderately below 2 percent inflation for a period? Or would that be a point at which you’d think about, you know, changing the framework and updating it in some way?

WILLIAMS: So, you know, I would—just to be clear, that when we wrote down the framework of an average inflation rate of 2 percent and when we, you know, highlighted that since inflation had been running below 2 percent we’d want it to be moderately above 2 percent, to get the average to 2 percent, in no way was that thinking about an inflation rate of 4 or 5 percent. I mean, clearly this is a major shock to the global economy, a major movement in inflation that we’ve see in the last year, and we’re still, you know, seeing right now. So that’s not—that’s in no way, shape, or form is this, like, about a moderate, you know, exceeding of 2 percent.

So, I mean, how do I think about this? So, to me, how do I think about this? So this is really basically, you know, a set of, I would say, demands, supply shocks, but all just also COVID-related shocks. I was just a lot of factors that have been moving inflation both down earlier in the pandemic and moving it dramatically up in the last year. And, you know, so the real question I think is not, you know, is this moderately above? No, this is, you know, way above. And it reflects a number of shocks. It’s thinking, you know, ahead, over the next several years, like you’re asking. I mean, I would still want to come back to I want inflation to be, you know, on average 2 percent. Not in a mathematical sense of average over, you know, three years or something like that, but, you know, inflation expectations anchored at 2 percent looking forward.

So as we come out of this, to get inflation to 2 percent clearly is the goal. The second goal is to make sure that inflation expectations also emerge, you know, to a level consistent with 2 percent. So that’s how I’m thinking about it. And, you know, you asked a question, well, if you overshoot do you undershoot? You know, in my view, you know, we chose not to do some kind of version of price-level targeting that would have a feature like that, that you would mechanically have to undershoot because you overshot. It’s really the framework that, as I think of it, is making sure that on average—that, you know, we deliver 2 percent inflation consistently over time, and that we have the inflation expectations anchored at 2 percent.

You know, when I go back to some of the kind of, you know, research and analysis that was done, and comparing standard inflation targeting to our average inflation targeting, one of the things that comes out of that research is in response to state supply shocks you basically respond the same in these two kinds of frameworks. So there’s nothing—we didn’t really change anything about how you respond to, like, a major supply shock, like we’ve experienced. So this is not—you know, the situation that we’re dealing with now, it’s not like we were—it’s different really for average inflation kind of targeting, more flexible average inflation targeting, or flexible inflation targeting. This is just a major supply shock, and the goal really is to bring inflation back down to 2 percent. So that’s how I see it.

PHILLIPS: Great. OK, great. Next question.

OPERATOR: We’ll take our next question from Tim Ferguson.

Q: Thank you. I’m a business journalist in New York.

And I’d like to focus for a moment on the Fed’s relationship to fiscal policy, Dr. Williams. There was a—for better or worse—a huge stimulus passed and implemented in Spring 2021 that may or may not have had a bearing on the inflation rate since. Do you think in retrospect the Fed accommodated that fiscal stimulus appropriately? Or was there something surprising about it that you and the Fed have learned from that experience? Thank you.

WILLIAMS: Well, you know, when I—to be honest, if you think about 2020 and 2021 and even now, I mean, we are all—we’ve all been dealing—whether the Fed or, you know, governments or everybody—dealing with just extraordinary and unusual circumstances with a high degree of uncertainty. So, you know, when you ask have things played out differently than you expected, the answer is yes, because it was just very hard to know back in March of 2020 or even, you know, March of last year how the situation would play out. You know, I think the good news—and I don’t want to lose track of this—is that the recovery and jobs, the recovery in incomes in the U.S. and in many other countries, has been far better than, you know, many—most people expected, I think, you know, if you go back to, you know, early 2020.

So the good news is we’ve been having a stronger recovery and, like I mentioned, a much, much faster, stronger recovery than we had from the global financial crisis. So I think that is good—that is a surprise, and that is good news. Obviously the inflation, the supply chain bottlenecks, some of the labor shortages, those were, you know, worse or bigger than anyone, I think, anticipated a year and a half ago or two years ago.

In terms of were the fiscal policies, you know, properly calibrated, or monetary policies properly calibrated, I mean, this is the kind of—you know, I think I personally am not going to comment specifically on the actions of fiscal policy, because those are decisions made by others. But I do want to just remind us that there was a moment of crisis last spring, last—I’m sorry, in 2020 and through much of this period. And what we saw was basically all parts of government, you know, and central banks, including the Fed, acting aggressively to forestall what could have been a much, much more severe economic and even potentially financial, you know, problems.

And so, you know, my view is, you know, from a monetary policy point of view, we’re not—you know, not some—not trying to act in a way to support fiscal policy, or impede fiscal policy, or anything. It’s really that we’re focused on our goals of maximum employment and price stability. I think we’ve, you know, been helpful in helping the economy get back on its feet to some extent. I think fiscal policy has played a huge role. But for us, you know, it’s really about focusing on our goals and, as we move policy forward, making sure that both we—you know, we achieve our maximum employment goals but also, very importantly, bring inflation back to 2 percent. So to me, it’s not—fiscal policy is part of this story. It’s an important part of this story. But it’s not really a driver of the monetary policy thinking or decisions for us. It’s just a factor that’s in the economy and we just need to make the best decisions we can to achieve our goals.

PHILLIPS: Great. Next question.

OPERATOR: We’ll take our next question from Merit Janow.

Q: Good morning. And thank you so much for these remarks.

Could in invite you to say just a little bit more about the digital economy? You are really an expert here. And I know the Fed is—and the New York Fed is thinking or developing sort of sandbox experiments around CBDC and thinking also—the Treasury is speaking about regulation of stablecoins. Could you say a little bit more about what you think the next steps are to develop confidence around the evolution of these alternative payment systems?

WILLIAMS: Absolutely. I’m actually glad you asked that. I think on CBDCs, I should just be clear, you know, there’s been a lot of research and there’s been some great work done at the Boston Fed working with MIT thinking through the technology, understanding, you know, conceptually all the issues around this—around security, around efficiency, cost, how would it fit in with other payments. So there’s been a lot of great work. This is all the kind of work we do, you know, that I’m very proud of in the Fed, of trying to understand things, as opposed to a sign that we’re, you know, making any decisions on something. This is just work that’s being done to help us understand the issue. So again, you know, on central bank digital currency, that’s an issue that, you know, the board of governors will have to think about and make whatever decisions they want to.

But what I have seen in this research is that, you know, the technology is available to be able to do, you know, digital payments. I think that a lot of the research has also shown that it can be done at relatively low cost, and without some of the negatives associated with certain, you know, cryptocurrencies, which, you know, use a huge amount of energy or other of those problems. I mean, if you think of a digital currency like a central bank digital currency or even a stablecoin, that can be done very cheaply, very efficiently, you know, potentially.

OK. So what’s the real issue to me? So with stablecoin the issues get back to the classic issues of any kind of payment system or asset, is really it gets to investor protection, you know, for people who are buying these, that the—you know, that they’re safe and, you know, there’s good transparency and information. Obviously, consumer protection and payments to make sure that, you know, people are not being taken advantage of, that they have the information, you know, the laws on that. I also worry about security and cybersecurity. Charles brought, you know, that topic up. I think those are the issues that you think about.

I also think about financial stability. So one of the things about stablecoin—and, you know, I do think the technology is a gamechanger. So we need to be thinking about, you know, these new technologies and how they can be used. But the one issue with stablecoin is really thinking about are we recreating some of the issues around financial stability that we’ve seen in the past with other, you know, kinds of products? And the example with stablecoin that I think of immediately is money market mutual funds, or specifically prime money market mutual funds, which can, you know, during a moment of stress investors run out of that, which created a huge, you know, financial stability issue for us and, you know, for the global economy, but for the U.S. economy in 2008 and 2020.

So we really want to make sure—and I think that’s the focus, you know, of the—of the various parts of the regulatory—other regulatory agencies, like the SEC and the U.S. Treasury, is to make sure that when we create an environment where, you know, you have digital currencies in the private sector, that these kind of meet all the requirements that you would have, you know, in terms of investor, consumer protection, and also designed not to, you know, add financial stability risks to our economy. So I think there’s ways that that can be done. But, again, I think those are the things that from a policy point of view that I think are really important. Similarly, with a central bank digital currency you want to make sure that any—that the design of it has that same set of features, that it supports sufficient, you know, safe payments and doesn’t create unintended financial stability risks. So those are the—I think the things that I would prioritize.

PHILLIPS: OK. Great. Next question.

OPERATOR: We’ll take our next question from Vincent Reinhart.

Q: Thank you, President Williams. Vincent Reinhart, Dreyfus and Mellon.

You have historically been associated with estimation of the equilibrium real federal funds rate. What do you think it is now? And if you are somewhat hesitant to tell us, what does that say about its focus on monetary policy over the last two decades? Thank you.

WILLIAMS: Well, Vincent—(laughs)—I think that it is a—I do think it’s an important concept. You know, in my view, going into the—to the pandemic was that the neutral federal funds rate was—you know, in real terms was, you know, probably around half a percent, zero to half a percent. So in nominal terms, with a 2 percent inflation rate, you know, in that range. I think what’s hard about the pandemic—and this isn’t just true about R-star; it’s true of pretty much anything—(laughs)—is that during the pandemic separating kind of underlying, you know, structural or longer-term, you know, factors from the short-term swings in the economy is just very challenging. I mean, this is just a—in a way, it’s a classic statistical problem of, you know, separating, you know, trend from cycle. And, you know, with the movements in GDP, inflation, employment, you know, are way behind historical experience. It’s much more similar to a period of, you know, natural disaster or war.

And so I think we just have to be humble about the ability to take the incoming, you know, GDP data or inflation data, and immediately read from that mechanically a statistical model, view, of the natural rate of interest or, quite honestly, a lot of things. So I tend to go back to what I think of as the driver, whether it’s on the natural rate of interest or trend growth or the unemployment rate, or things like that. And think of, like, well, how have they changed? Instead of trying to look at the model and say, you know, what am I learning from the—every quarter of data, what am I seeing in the drivers? And so demographics—I don’t think demographic trends have really shifted at all. They move slowly anyway. And those are an important driver. I think productivity trends haven’t—you know, it’s not obvious that those long-term trends have changed. You know, maybe we will learn that they have in some way, but right now I don’t see that.

And the global demand that, you know, obviously Ben Bernanke and many others highlighted years and years and years ago, global demand for safe assets, that doesn’t seem to have changed either. (Laughs.) So when you think about the various drivers that economists around the world identify as drivers of low—globally low interest rates, I think those are still with us. And so, again, I guess my base—to answer it straight—my base case would be that the neutral interest rate is still low as it was before.

One thing I would mention, because I know there’s this argument that the retirement of the Baby Boomers and things has shifted that and we’re going to now have a higher R-star, maybe even higher inflation trend. You know, for my reading of the literature—and, you know, it really—it’s not so much about the Baby Boom generation in the U.S. or other countries. It’s really about the slow birthrates, the longer lives that people are having around the world generally that’s driving the demographics, right? I still think the demographics are pushing down neutral interest rates globally. But again, as you know, as we all know, these are highly uncertain investments, and we have to be humble about knowing exactly what they are.

 PHILLIPS: OK. I think we have time for a couple more. Next question.

OPERATOR: We’ll take our next question from Grace Gu.

Q: Hey, Dr. Williams. Thank you for a very illuminating conversation.

So I have two questions for you. The first one is you are describing policy tightening as, you know, having two tools. One is interest rate tool, which is data dependent and active. Another one is a balance sheet runoff tool, which you described as somewhat passive. What’s your thought on the timing and the pace of the balance sheet runoff, if it were to happen in the background? And the second question is on financial conditions. So despite the backup of yields over the course of the last few months, financial conditions overall is still at a very easy level. And one of the purposes of policy tightening is to potentially tighten financial conditions somewhat so that we can cool down the economy. So I’m curious to your thoughts of how you can interact with the market to bring some tightness to financial conditions. Thank you.

WILLIAMS: Great. And on the first question, again, this is going to be—the topic of normalization of the balance sheet is in the future. I mean, right now we’re in the process of tapering the asset purchases, which will be done, you know, by the middle of March, or end—and this be ahead of us. I think it’s the next—to me, the next decision for the FOMC about removing accommodation that would be about, you know, liftoff, or raising the target federal funds rate. And my own view is I see the beginning of the process of normalization of the balance sheet as coming after that.

In terms of how do you do this in a way that’s, you know, predictable and, you know, it’s in the background, as you were asking, I think that’s—you know, that’s really the topic that we’ll have to, you know, talk about, learn from experience about designing in a way that is removing accommodation, but is not doing so in a way that’s either disruptive to markets and also doesn’t require a lot of adjustments along the way. Although, we always have to be flexible that we have to adjust things when conditions change.

I think your second question is really—is one that, you know, obviously we’re very focused on. The financial conditions are very strong, here and around the world. We see asset prices at high levels. We see, you know, credit spreads very low, very narrow. And so, you know, it’s thinking of—when I think about monetary policy, and of course I’m focused on employment and inflation, but it’s clearly—financial conditions are one of the big drivers of the economy. And it is true, right, you know, monetary policy primarily works through—you know, through the effect on financial conditions.

So the way I see it is, you know, we have partly very capable financial conditions because of the actions of central banks, also because the economy is doing well. And I think people often mistake about the future for this year, but I think there’s a lot of positive news around that. But, you know, as we adjust monetary policy, as I expect we will in terms of the fed funds rate and, eventually, you know, on the normalization, I would expect that to influence how accommodative overall financial conditions are. We have seen movements in financial conditions as people—as we’ve taken actions, as people anticipated we’d take actions. And I would expect that to continue. But your statement is right on that, you know, financial conditions are still very accommodative. And, you know, I would expect that to, you know, be less accommodative over time as we shift policy.

PHILLIPS: OK. One more question.

OPERATOR: We’ll take our next question from Hani Findakly.

Q: Thank you very much. And thanks for this very good discussion.

My question also relates to real interest rates and the Fed balance sheet. There’s a common narrative historically that the Fed can only control short-term rates, and that long-term rates are determined by markets. And my question is, the fact that the Fed balance sheet has grown from $1 trillion in 2008 to third level, having doubled twice over the last—over the last several years, has that inadvertently put the Fed in control and manipulation of long-term interest rates? And second, to the extent that you speak about the normalization of the balance sheet—of Fed balance sheet, what does normalization mean to you? Is there a target of, for example, Fed balance sheet as a percent of GDP or other things? And where do we go? Do we go back to 2019 level or do we go back to earlier times?

WILLIAMS: (Laughs.) That’s, again, great questions, and highly relevant ones. So I’ll do a quick answer because I see we’re low on time. We aren’t—we have not ever been targeting long-term interest rates through this—through this period. We’ve been making decisions on our asset purchases in order to influence longer-term interest rates, as I said, but not trying to achieve a certain level of long-term interest rates. As you, you know, suggested, you know, long-term interest rates are being determined by market forces and it’s an important source of information for us. We’ve influenced that in a way, but not trying to target that. And that’s—you know, that’s been our approach and will continue to be our approach.

In terms of what’s the—you know, what’s the end state of the balance sheet after normalization, that’s, again, a topic that we—you know, we’re going to need to discuss and think carefully about in the future and communicate that to people. Again, going back to the experience of the last balance sheet normalization, I think one of the things we introduced then was this notion of an ample reserves framework, which basically means that we’re not trying to get back to a 2007 balance sheet. We’re trying to get to level of reserves where interest rates that are, you know, the level consistent with efficient operation and monetary policy, and the setting of the short-term interest rates, is really controlled by these administered rates, like the rate we set on the reverse repo facility or interest on reserve balances, or something like that.

So, again, these decisions haven’t been made for what that end state looks like. The experience I—you know, we had from before I think is, I think, very informative to my thinking that, you know, having an ample set reserve is way below where we are today in the financial system is the right one. And, you know, we could control the fed funds rate, our administered rates. But again, that’s well off in the future.

PHILLIPS: So our guest today has been John C. Williams, Dr. John Williams, who’s president and chief executive officer of the Federal Reserve Bank of New York. Thank you for those insightful comments. Great, great discussion. Thank you for your stewardship of the New York Fed, as well, and the impact you’ve had on the U.S. economy, and the global economy for that matter.

I just want to remind people, there’s a lot of great research on the New York Fed website under the brand Liberty Street Economics. I got hooked on it while I was on the board of the Fed there. Really great work there.

But, John, thank you, again, for participating in this. And it was fascinating comments. Thanks again.

WILLIAMS: Thank you. Thanks.

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