A Conversation with John C. Williams

John C. Williams discusses the U.S. economy, monetary policy, and the role of the Federal Reserve Bank of New York.

LIESMAN: Good afternoon and welcome to the Council on Foreign Relations C. Peter McColough Series on International Economics. I’m Steve Liesman, senior economics reporter for CNBC. And it’s my pleasure to welcome today’s speaker: John Williams, president and chief executive officer of the Federal Reserve Bank of New York. (Applause.)

WILLIAMS: Good afternoon, everyone. And thank you for the introduction, Steve, and I’m happy to be here at the Council on Foreign Relations again. I’m going to try to keep my remarks relatively brief. That will leave plenty of time to Steve grill me—to grill me on interest rates, and hopefully get some more—perhaps more thoughtful questions from the broader audience today. (Laughter.)

So with the mention of interest rates, I have to remind everyone here everything I say reflects my own views and not necessarily those of the Federal Open Market Committee or anybody else in the Federal Reserve System. So I’ve gotten the—that out of the way.

I wanted to step back a bit and go back to something John Maynard Keynes said, or at least was credited with saying. And that’s “When the facts change, I change my mind. What do you do, sir?” And the economic—the economic era that we’ve experienced for the last decade or so has been defined by the Great Recession. There’s the world before and the world after the subprime crisis, the collapse of Lehman Brothers, and the ensuing financial crisis.

And governments and central banks have spent the intervening years working to get their economies going, creating jobs, and putting regulation in place to prevent another catastrophe. And central banks have instituted huge asset-purchase programs and brought short-term interest rates near to zero (percent), or in some cases well below zero (percent), to stimulate economic recovery.

Now, the good news is that for the most part monetary policy has done its job. Advanced economies have seen steady growth and significant declines in unemployment. But the recovery has been slow, and despite low unemployment inflation rates have been running persistently below central banks’ goals.

The Federal Reserve, like many central banks around the world, has a goal of keeping inflation near 2 percent. In the pre-2000 era—-2008 era, inflation was a major concern for the public and central banks alike. And while I will always be vigilant about inflation that gets too high, it’s actually inflation that’s too low that’s the more pressing problem today. The experience of the slow recovery and persistently low inflation is a symptom of deeper problems afflicting the advanced economies around the world.

Two changes that are unrelated to the financial crisis have been taking place. They’ve been causing a shift in economic conditions and quietly shaping the trajectories of advanced economies. So these are the “the facts” that have changed, and today I’m going to discuss in more detail and explore some of the options we have in dealing with these challenges that they present.

So let me go back to the facts. Shifts in demographics and productivity growth have fundamentally altered the economic environment in which we operate.

So why don’t we start with demographics? Two changes have been taking place.

First of all, people are generally living longer and population growth is slowing. Now, dwindling birth rates are bringing population growth to a standstill. In the OECD countries population growth averaged about 1 percent a year back in the ’50s and ’60s; now it’s running about half of that. And it’s expected to gradually fall before—continue to fall and dip into negative figures later this century.

Now, slower birth rate—slowing birth rates mean fewer consumers and fewer workers, and people planning on longer retirements will tend to save more. And so it’s undoubtedly good news in many respects; it does mean an overabundance or an abundance of supply of savings that’s having a big—a big effect on the global economic and financial conditions.

When it comes to productivity, there’s also been a sharp—stark stepdown in growth. Rapid changes in the kinds of technology we use in our daily lives—and all of us experience this; we have robot vacuum cleaners, self-driving cars, and everything else that’s going around—may make you think that this slowdown in productivity growth is either counterintuitive or actually just plain wrong. But the data are clear. In OECD countries, growth of labor productivity—that’s the amount produced per hour—averaged about 1 percent per year since 2005, which is about half the pace we saw in the prior decade.

So what’s all this mean for the future? Well, first, two things.

You got slower population and productivity growth. Those are the two kind of important factors for thinking about GDP growth. So with slower growth there, that means slower trend per economic growth.

Second, this abundance of savings and a decline in demand for savings resulting from slower trend growth have driven interest rates down to very low levels.

And for economists, we tend to think of this in terms of the neutral interest rate, or R-star. So while a central bank like the Fed sets the short-term interest rate, R-star is a result of longer-term economic factors. So it’s the rate you should expect to prevail when interest rates are neither giving the economy a boost nor slowing it down, and that’s why we call it the neutral rate.

So the evidence of a sizable decline in R-star across economies is compelling. If you take the weighted average of estimates of R-star in the five major areas—so that’s Canada, the euro area, Japan, the United Kingdom, and the United States, so the majority of the advanced economies—that level of neutral interest rates has declined to one-half of 1 percent. So that’s almost two percentage points below what the natural rate prevailed back before the—in the decades before the financial crisis. And importantly, this is not—like these demographic and productivity trends, these are not merely reflections of the financial crisis. In fact, even as economies have recovered—including the U.S. economy—we are still seeing very low levels of neutral interest rates.

Now, this poses some pretty significant challenges for us in monetary policy. If you start with a relatively low interest rate as your normal interest rate, we don’t have as much room to maneuver if we hit a crisis or a recession. We’ll only be able to cut interest rates by a relatively moderate amount before they hit zero (percent) or the zero lower bound. Now, of course, central banks can and indeed have gone to negative interest rates to try to stimulate their economies, but negative interest rates bring with them a separate set of challenges.

So the result is that future recoveries will be slow, and slow growth is usually associated with low inflation. And persistently low inflation can create a vicious circle where expectations of low inflation drag down current inflation, and as a result we’ll see inflation much lower than we’ve seen recently. And that means central banks will have even less room to maneuver in the next downturn.

So all this begs a question. We have these fundamental shifts. The fact have changed. What do we do to prepare ourselves and our economies for the next time we have a crisis or a recession? Now, there’s no silver—single silver bullet that can attack or resolve all these challenges, but we can think about changes in how we conduct monetary policy, fiscal, and other economic policies to help make our economies more resilient.

So let me start with monetary policy. Central banks should and are reassessing their strategies, goals, and the tools that we use to achieve them. And we just had the conference in Chicago where the Federal Reserve spent two days discussing and listening around ideas around how to make sure that monetary policy is successful in the future.

But outside—monetary policy can do a lot, as I said, but there are limits to that. So outside of monetary policy there are a number of ways that other policies can support the economy.

In the area of fiscal policy, one idea that’s been written about by a number of people is how to strengthen the automatic stabilizers of our—of our policies; basically, ideas that either reduce taxes or automatically increase spending during a downturn to help stimulate the economy. Obviously, another way is to make sure that regulation helps support an enhanced financial stability, making our economy more resilient to shocks.

Finally, fiscal and other policies can attack directly the sources of slow growth and low R-star directly. Now, demographics are not areas where most economists or policymakers want to meddle, and I’m certainly not going to stand here and say people shouldn’t be living so long. But there are a number of things we can do to improve growth. These include raising public and private investment in human and physical capital, investments in infrastructure and science and technology, as well as removing barriers in the labor force and the economy more broadly.

Now, it’s impossible to predict the future, but we can deal with it at the present. The economic environment in which we operate today is a direct consequence of these demographic and productivity shifts that have already occurred. And low interest rates are real and they’re here to stay.

So the facts have changed, and so it is time for all of us to change our minds as well. It’s often said that change is hard, but experience teaches us that it’s better to prepare for the future than to wait too long. Ultimately, failure to prepare often means preparation for failure. Thank you. (Applause.)

LIESMAN: So the way this will work is I’ll ask questions for about fifteen minutes and then we’ll open it up to the audience.

John, you started off with a quote and I’m going to start off with an older quote. There’s one that goes “everybody complains about the weather but nobody does anything about it”—

WILLIAMS: (Laughs.)

LIESMAN: —from the nineteenth century. So I just hear central bankers complaining about low inflation, and I heard you say we need to do something about it, but this has been around for six or seven years. And I heard your call for fiscal policy. What can and should the central bank be doing right now about low inflation?

WILLIAMS: Well, I think we are doing something right now about low inflation. And in the—in the Federal Reserve at the FOMC, we’ve, I think, worked very hard at fostering a strong economic expansion. We are very close, now in June, to the longest expansion in history of the U.S. economy going back to the Civil War. And fostering conditions that are both, you know, strong growth, strong labor market, and moving inflation back to 2 percent.

Right now we’re somewhat below that target. We’ve had some softer inflation numbers in the last few months. But I think with the strong economy, strong labor market, that we’ll achieve our 2 percent goal on a sustained basis.

LIESMAN: I tried to be a gentleman and ask the question indirectly, so I’m going to ask you more directly. (Laughter.) Is low inflation something that should be addressed with interest rates?

WILLIAMS: So, first of all, I do think inflation is a, you know, obviously, important goal for the Fed. We have dual mandate goals of maximum employment and price stability. We have set a 2 percent inflation goal, and we need to achieve that on a sustained basis. And so of course I do think monetary policy is one of the aspects of the—one of the decisions we need to think about in terms of our inflation goal, and we’ve been, I think, acting in that way pretty consistently.

Right now the inflation data, we were at our 2 percent goal towards the end of last year. It’s come in a little softer. I think, you know, when I look at thinking about policy over the next—over the next few years, obviously watching how does inflation behave—is it moving on a sustained basis back to our symmetric 2 percent goal—that will be one of the factors in thinking about do we have monetary policy in the right place. Obviously, on the other side of the mandate watching is the economy evolving in a way that’s consistent with maximum employment and a sustainable expansion will be—those are factors, the two—on both sides of the coin trying to manage those two goals and get policy right.

LIESMAN: John, there’s a lot of stuff that’s in flux right now. Sometimes it appears over social media at 7:30 in the evening. But I want to put that aside for a second. I want to come back to that. Give us your base-case outlook on the economy right now, say for the rest of the year and as much of 2020 as you feel like you can talk about.

WILLIAMS: Sure. And you know, one of the funny things is often when I’m introduced people read this little canned description of my bio, and it will say that I’ve spent a lot of time doing research on monetary policy under uncertainty. And if you ever thought that was a good preparation for today—(laughter)—it was. The other question I usually get is, what is monetary policy under certainty look like? (Laughter.) And I still—I’ve never seen it.

So you know, let me give you the—here’s where I think things are. Obviously, the economy grew about 3 percent last year, about 3 percent the first quarter of this year, so we’ve been seeing pretty strong economic growth. Really strong job growth; unemployment now down to the lowest level in nearly fifty years. So coming into the second quarter the economy’s been on a—on a—I think a very strong trajectory, both in GDP and in employment/unemployment.

So when I look at the first half of this year, my forecast is GDP growth is still well above what I think of as a trend rate of growth, and expecting unemployment to stay pretty strong. And I expect inflation, you know, to move gradually back up to 2 percent. So that’s kind of in the rearview mirror—here’s the data we’ve already seen, this is the data we have in hand, you know, which is pretty strong.

At the same time, looking ahead, which monetary policy always has to think about—where is the economy likely to go over the next year or two, given the lags in monetary policy’s effects on the economy—I think, you know, there are more uncertainties today. I still think that’s a good—my base case is an economy that continues to grow above trend, an economy that still has a very low unemployment rate and inflation moving back to 2 percent. But you know, no one has a perfect crystal ball and there are uncertainties around the global economic outlook, obviously uncertainties around trade and other aspects that could shift the outlook for growth or inflation in different ways.

And so from my position as a policymaker, my baseline is a very good one. But at the same time, you know, we obviously, as always, need to be prepared to adjust our views of what’s happening in the economy, where the economy’s likely to go, and then as a consequence think about what’s the right policy to keep this economy on a good, strong growth path with inflation around 2 percent.

LIESMAN: So since earlier—the first part of May there’s two new trade issues to deal with. One is this second round of tariffs against China, the threat of the third, and the second one is on Mexico. Tell us how you as a policymaker fold that into your base-case scenario.

WILLIAMS: Sure. First of all, as you hopefully all know, the Federal Reserve does not make trade policy or make—or fiscal policy, all those. We make, you know, monetary policy. So we have to take that into—try to take those developments into account in our thinking about the economic outlook. And we have a lot of economists who have studied this pretty carefully.

So you know, I think a few things come right to mind. One is that trade clearly does affect trade—the flows of exports and imports. We’re seeing some of that. Research from economists has shown that, you know, higher tariffs does show up in terms of higher consumer prices and producer prices in the U.S., and that’s boosting inflation a little bit and a drag on growth on some dimensions.

I would probably broaden this to—more to talk about what we’re hearing from businesspeople, though. If you look at the Beige Book, if you, you know, were to attend the meetings I and my colleagues have with business and other leaders in communities across the country, this is very much on people’s minds. People are concerned about how do they plan for the future, the uncertainty about what happens around trade. And when business and other, you know, leaders are uncertain about things, the tendency is to take a wait-and-see attitude, and maybe hold off on some investment or some employment decisions to see how this clarifies. So we’re definitely seeing signs, I think mostly anecdotal, about businesses, you know, concerned about, wanting to see how this gets clarified before they are willing to kind of invest. We’re also seeing, you know, investment data itself coming in a bit softer than we had—we had seen last year. So I think those are signs that it’s clearly having an effect on the economy, slowing growth somewhat. But I think this uncertainty part is an important part of it.

LIESMAN: So, John, you may not know what you’re going to do next, but the market knows for sure what you’re going to do next. (Laughter.) It’s quite incredible. Markets have priced in a plus-60 percent chance of three rate hikes this year.

WILLIAMS: I don’t think that’s right.

LIESMAN: No? That was—

WILLIAMS: You said three rate hikes.

LIESMAN: Three? Oh, three rate cuts, sorry. Yeah, three cuts. (Laughter.)

WILLIAMS: Trying to help you here, Steve. (Laughter.)

WILLIAMS: Maybe that’s Freudian. Maybe that’s Freudian on my part. Maybe I really want tighter policy, I think, if I—(laughter)—three rate cuts. OK. I thought I had the percentage wrong. (Laughter.)

Greater than 50 percent chance of a rate cut by—in July. Is this—are you comfortable with where the market is priced?

WILLIAMS: So you know, this is a question—(laughter)—this is a—

LIESMAN: That was pretty good as a—(laughter)—you know, are you comfortable? Plenty of room in “are you comfortable,” John.

WILLIAMS: So, you know, this has been an issue that we deal with in the—in the world, because of course people are in the—in the world of global finance, what the Fed does matters a lot and expectations of what the Fed does gets a lot of attention. So I do follow what happens in views—you know, the views of investors and views of the markets. You know, and then we have our own views. And it doesn’t worry me, really, if there’s—you know, one view is held by some group of people, another view is held by another group of people. First of all, there’s no one market. I mean, there’s lots of investors on both sides.

I do think that, you know, market participants—I talk to people. It’s part of my job, is to talk to market participants and other business leaders. There is some more concern about—especially around the trade issues and some of the broader geopolitical issues, and then how that spills into the global economic outlook. U.S. businesses are, obviously, very involved in global trade. They have a lot of activities in other countries. And this has a pretty first-order effect on their businesses. So you definitely can see that mood out there, and that I think translates into people’s concerns or worries about the economic outlook, which then affects their views on policy. Doesn’t mean I have to agree or disagree; it’s just a perspective that I can understand given the concerns I hear people have about, you know, the risks or uncertainties around the outlook. And they’re coming to their own views.

And of course, we’ll get together in a couple weeks. We’ll discuss and debate, and we’ll make our own decisions.

LIESMAN: Another side of that same coin is the yield curve, which is now—the three-month and ten-year is inverted now pretty substantially. It was, you know, south of twenty basis points when I last looked. And you guys at the New York Fed have this thing called the New York Fed Recession Indicator that essentially uses that inversion or that spread and calculates a probability, which I looked at this morning. You now have a 30 percent probability of a recession as part of your indicator there, and that’s the highest it’s been since 2007. Are you as worried as your indicator suggests you ought to be?

WILLIAMS: So—(laughs)—so first of all, I actually, you know, have studied this issue myself, and my colleagues at the New York Fed and, you know, many others have. Actually, the New York Fed economists back in the day were some of the originators of that research, back in the ’80s, on the yield curve and growth and recessions.

So it’s definitely one of the factors that I and, you know, many people look at it. Clearly it’s, I think, a pretty strong signal in the markets that they think that there’s a perception that rates are going to be lower in the future. Ten-year Treasurys are in the low twos, and that’s their perception given, I think, their assessment of growth prospects, inflation prospects, and obviously, the risk to the outlook. So I do take that seriously. It’s definitely an input into my thinking about what are the markets telling us about where the economy is likely to go and where the risk distribution is around different outcomes.

I don’t take the inverted yield curve as, like, the one—you know, I don’t go to it like an oracle and ask it: Tell me the answer; will we have a recession? Because there are some special factors that I think are affecting the ten-year yields, depressing them—the QE that the Fed’s done, QE that the ECB and other central banks have done. But still, I think it is—like other market indicators, it’s telling us that there is some heightened concern about risks on the outlook, and something I definitely take into account when I think about not only the baseline view of where the economy is, but where the distribution of risks are.

And I would highlight, you know, my own view is there’s, I think, heightened uncertainty about where—how this economy exactly is going to—going to evolve over the next year or so. And I think that’s what the markets are seeing and kind of telling us as well.

LIESMAN: So I’m going to ask this last question and then we’ll open it up to the audience. John, we began by talking about your base case, and it was for above-trend growth. Then we had a discussion about some of the risks that are out there and some of the signals being sent by the market. I guess I have to wrap up this section here and ask you this: Have you internalized those risks and that message of the market at all into your base case such that it is lower now than it otherwise would have been, or do you remain forecasting above-trend growth?

WILLIAMS: So you know, this has been an interesting last twelve months because I—we’ve seen the base case move around for various different reasons. I’m going to answer your question, but back in September I was seeing growth of probably 2 ½ percent this year, real GDP, for fourth quarter. Then we—you know, and late in the year, in December, clearly pretty significant signs of slowing globally, some signs the U.S. economy was slowing quite a bit. And then—so my base case kind of got down to the low twos. And now, you know, we got some pretty good data that was—you know, for a while that was suggesting maybe growth would be closer to 2 ¼ (percent) or something, to 2 ½ (percent) this year.

So I think the lesson I’m taking from this is my own base case is in this area of growth, of probably 2 (percent) to 2 ¼ percent, a little bit above trend right now. But the lesson of the whole, you know, experience is we’re getting a lot of mixed signals from different indicators, whether from financial markets, from the actual U.S. data, where the consumer spending looks pretty good, business investment is weakening. We’re seeing mixed signals around what’s happening in China and Europe. And what’s important for us from this is to just keep an open mind and keep being data-dependent in how you assess this data, how we assess the risks to the outlook, and then obviously how we come to the right policy decisions.

So one way I’ll say is yes, my forecast is still for slightly or somewhat above-trend growth. But I’m not going to put a lot of conviction that that’s what I expect to happen. What’s going to happen is, you know, as we go through the rest of, you know, coming months and through this year, is I think we’ll get some more clarity about what’s—you know, the slowdown in China, how the trade—various aspects of the trade negotiations play out, and other uncertainties around there.

LIESMAN: I lied; I’m going to do one more question. (Laughter.) The last time the committee spoke it was in a wait-and-see mode and they would be patient for some time. Is that still the right way to characterize where the committee is and where you are as to which direction rates need to go and where policy is?

WILLIAMS: Well, first of all, you know, I’m going to go back to a speech I gave here—well, actually in Columbia University in September, I think, last fall, and I talked about normal monetary policy. And the point of the speech was for the last—past decade, whether for me as a practitioner, for economists that—you know, who study monetary policy, or for people in the markets or the general public, the last ten years have not been normal monetary policy. We had zero interest rates for seven years. We had this very telegraphed/choreographed normalization of policy. And so for a lot of people—for all of us, we have to relearn what normal monetary policy looks like.

And normal monetary policy doesn’t mean saying we’re going to stay, you know constant for the next three years, or raise rates, or lower rates for three straight years. What it means is reassessing your outlook, changing your views as the data and the evidence changes, and really trying to calibrate or adjust policy as appropriate to achieve our goal.

So I think we’re in now the normal monetary policy world, where patience was a bit—in my view, a bit of kind of the stage of moving through these last stages of normalization as we got closer to a neutral rate. And I just think that the world we’re in now is there’s uncertainties. We may need to—you know, may need to keep interest rates the same or we may need to adjust them, and we just need to approach it from that way.

So to me this has been a long ten years of unusual monetary policy in terms of, you know, the whole response to the crisis, the recovery. And now we’re just more in a normal phase of adjusting policy as we best—to best achieve our goals.

LIESMAN: Let’s take a few questions.

WILLIAMS: Hello. You warmed them up. (Laughs.)

LIESMAN: You guys have questions here. Let’s start in the front right here. Do we want people’s names? Is that what—yeah.

Q: Yeah. Hey, John. Francisco Blanch with Bank of America. Good to see you.

A couple of—couple questions. First one, can you talk a little bit about the lessons of quantitative tightening in hindsight? Was it a great idea? Is this—how does the Fed think, having implemented it for some time now?

Second question is around fiscal policy. Obviously, we had a big bump up to the economy last year on the back of fiscal changes. How do you see that evolving and impacting monetary policy here? Thank you.

WILLIAMS: OK. So you know, I’m going to just explain this “quantitative tightening.” So “quantitative tightening” is a phrase that many of us in the Fed, including myself, you know, really don’t like this phrase. But we didn’t like “quantitative easing” for years and we gave up on that, so I’ll give up on “quantitative tightening.”

So quantitative tightening, as I understood your—you know, the way I think you meant it, was the fact that instead of expanding our holdings of assets and, you know, easing monetary policy by buying more assets, we’re reversing that. We’re shrinking the amount of assets we hold, which is, you know, the reversal of quantitative easing.

So I think that what I learned from that personally, from my experiences like the taper period several years ago, the communication around balance sheet policies or QE policies is still very challenging. It’s still viewed, I think by all of us, as a relatively new instrument, even though we’ve been doing this for about ten years. And unlike saying we’re going to raise interest rates or putting out dot lots, this is just something that markets—market participants and the public don’t have as much experience with. And so part of what we learned from this—from this last episode is when you do the reverse of quantitative easing a lot of people, of course, immediately say, well, that’s tighter policy. That’s going to have big negative effects on the economy.

I think that my lesson from this is that the communication is really important. And we need to be very clear why we’re doing what we’re doing, how we describe it and fit in the context of our general policy stance, and, you know, do our best to do that in a coherent, systematic way. I do take another lesson that this, moving quantitative—you know, asset purchase types of QE-type policies just carries with it a lot more challenges as you—it’s kind of like moving a super tanker. You know, when you bring it in, you bring it in slow. It takes a long time to build up. And then when you move out, it has a similar dynamic. And that’s just a lesson from that.

The second question, I’m sorry, was?

Q: Fiscal policy.

WILLIAMS: Fiscal policy. And that’s a great question, because definitely we’ve got some pretty strong tailwinds from the fiscal policy, both on spending side and on the tax cuts. It boosted consumption spending, investment spending. And you know, we knew that would—in terms of its effects in growth that would step down a few notches this year. It’s very hard to know how big those effects are. But I think what’s happened is we’ve gone from the pretty strong tailwind from fiscal policy to the headwind from the trade and some of the tariff issues, which are kinds of fiscal policy too.

So we—I think that—you know, one of the questions I get asked a lot, I got asked in a recent speech—is, you know, my view, and my colleagues’ view, has gone from pretty optimistic to perhaps more kind of moderate growth. And part of it is the shift from getting a big fiscal tailwind to more of a headwind from some of these other policies, is one of the things that’s I think shifted the outlook.

LIESMAN: Jim Grant, right there.

Q: James Grant, Grant’s Interest Rate Observer.

Mr. Williams, given that very low interest rates tend to foster debt formation, speculation, other kinds of financial mischief, has it occurred to you that the Fed, without ever intending to, has thrust itself in the dual role of arsonist and fireman?

WILLIAMS: OK. So that’s a very colorful way to put a question that I think we all take very seriously. And that is, is that a very low interest rate environment—and intended consequence of low interest rates is to get people to spend more. It’s to get people from a risk perspective to go out further on risk. I mean, that is an intended part of how monetary policy works. What you’re bringing up, of course, is the risks of the unintended consequences, of a—perhaps an excessive buildup of debt, excessive asset prices, or other concerns, which have defined previous expansions. So I think it’s a very real concern.

So one challenge for us is that when you look at our dual mandate goals of maximum employment and price stability, when we had unemployment, you know, reaching 10 percent and inflation falling quite a bit during the recession, is we have to use the tools we had to get the economy back on track, to try to get unemployment down and the economy in a sustainable expansion, and get inflation back to 2 percent. But we always thought, and obviously talked carefully with our, you know, colleagues who work in bank supervision and regulation, and with other regulatory bodies, about where are the risks in the financial system, and to what extent is low interest rates perhaps contributing to buildup of debt. And the history over the last year or two has been around corporate—non-financial corporate debt.

So we’re very focused on that, and trying to think about, well, what are the best policies and approaches to deal with those risks. But I do want to go back to what I think of as a different way of thinking about the low interest rates. So if you’re going to say that the Fed lowered interest rates from 5 percent to zero (percent) during the recession to get the economy going, but we’re still at pretty low interest rates today of roughly 2.4 percent fed funds rate. My view is we’re at neutral. So there’s two things that have happened from ten years ago, or before ten years ago. One is, is that we—the neutral interest rate, or the normal interest rate has come down pretty significantly. So—and that means just that the normal is very low interest rates, which—it’s not a fed decision. It’s kind of that’s the normal or the hand that we’re dealt.

And so that part of normal low interest rates, that’s just a reality. And we’ve actually gotten interest rates back to this normal. So I don’t think right now we’re—you know, if you’re worried about debt buildup and those concerns, that’s in the context of interest rates that I think are basically at neutral level. So we really—it’s not monetary policy that’s the issue. It’s really thinking about other policies or other things they need to do to mitigate some of those risks.

LIESMAN: Gentleman right here. And then I’ll get to the back.

Q: Thank you. Rodolphe Costanzo—can you hear me?

WILLIAMS: Yeah.

Q: Rodolphe Costanzo, JPMorgan.

As a monetary policymaker, do you incorporate considerations about the greater oligopolistic power within the economy? If not, why not? And if so, how do you incorporate that within R-star?

WILLIAMS: Yeah, so this—another—I mean, these are all terrific questions, obviously. Equal opportunity questions.

So this is a big issue, OK? And there’s a couple issues. You brought up oligopoly and kind of monopoly pricing. So there’s a lot of research today on two dimensions of this—two dimensions on this. One is in pricing, in how our economy is changing. Kind of more a superstar economy and more market power. So that clearly gets into our thinking, or my thinking, about inflation dynamics, maybe productivity dynamics, and other aspects. So when you think about the industrial organization issues, they do have, I think, macro implications. And we’re trying to weigh all that in thinking about how the economy is performing.

The second side is the wage side, because we’ve seen similar changes in the structure of labor markets and ability to negotiate—or, the negotiating power of workers versus employers. And that is affecting, I think, wage inflation as well. So these are clearly, to my mind, big issues. But they’re big issues to think about how inflation and wage dynamics have changed, and maybe what the new normal is for labor share, but also thinking about productivity and some other aspects. So, yes, these are issues are people are actively researching.

And if I were, like, a young Ph.D. economist, if I were just coming out of grad school. This is the kind of stuff I would be working on, because the microdata is amazing. The big data is amazing. The techniques and tools to analyze this are just far beyond what I learned. I’m a time series economist. For those who know what that means, you look at a long string of data and try to look for patterns. But today people aren’t looking at thirty years of data. They’re looking at millions of datapoints, and things. So these are areas that people in the Fed and the New York Fed are very focused on, but I think are also very important.

LIESMAN: The gentleman in the back there.

WILLIAMS: Hey, Paul.

Q: Hello. Paul Sheard from—me? Harvard Kennedy School. Good to see you again, John.

I’d like to ask you a question on the Fed’s review. Now, a key part of that review, of course, is the listening tour component. But a factual question: To what extent is the Fed taking inputs from or consulting with other arms of the government, the administration or the Congress? And related to that, do you see a case, and if you do what are your thoughts on a much broader review of the macroeconomic policy framework, not just the monetary policy component?

WILLIAMS: Yes. So those questions actually came up at the—at the conference. You know, first of all, there were—there are definitely members of the—of the public sector and different parts of government staff. We had—in the New York Fed we had Fed Listens events here at definitely connected with staff from members of Congress and elsewhere. And that was true of the—of the conference in Chicago, which I was just—I just got back from. So, you know, when you—I think—here’s how I think about it.

Our first six months has really been listening—you know, Fed Listens. It’s been about collective perspectives from market participants, economists, from members of the general public, including, you know, leaders of communities and businesses and things, to try to get a broad perspective. We’ve been doing this in New York. My colleagues have been doing it around the system. And the conference was the capstone of all that. And now we go into the normal Fed mode, where, you know, we all get into the room, shut the doors, close the curtains, and really think hard about how—and the question is simple.

How in this world of a very low neutral interest rate, in a world where inflation dynamics have changed in important ways, we’re in a global economy, how—you know, in all the ways that the economy that we are operating have changed, how do we best achieve our dual mandate goals of maximum employment and 2 percent inflation? What tools should we use? What have we learned from that? How do we best use them? What’s the framework? How do we communicate? And that’s what we’re going to be working on.

Then you get to the question of, well, will we talk to Congress and others about this? And I think, you know, based on past experience where we—when we rolled out our 2 percent inflation goal that will happen. You know, Fed, you know, leadership—obviously I’m looking to the chair here of the Fed, will obviously consult and talk to those. That’s—you know, that’s something off into the future. We’re going to be spending quite a bit more time on this internally and thinking through these issues. And I think the goal that Vice Chair Clarida talked about was putting out a report and coming to some decisions the first half of next year.

Now, your second question was on a broader review of macroeconomic policy. I think that’s absolutely essential too I was kind of hinting at that. I don’t like to tell other parts of government what they should do, hoping that they won’t tell me what I should do. (Laughter.) But I think—

LIESMAN: How’s that going? (Laughter.)

WILLIAMS: Hope is a strategy. So the—but I think, you know, like, these issues about fiscal policy, issues around whether—you know, other types of policy, I think these are important. And where it came up in the conference is really thinking about financial stability. And you know, out of Dodd-Frank was created the Financial Stability Oversight Council, FSOC, which has the leadership of all of the major regulatory agencies. And the idea was to create some structure for that. And I think, you know, revisiting, you know, how do we best work not only within the Fed but across other agencies, other parts of government to work together?

I mean, in the Fed—I’ll tell you something. You know, we do value our independence a lot. I mean, this is a very important thing for us. And you know, we know that central banks who don’t have independence from short-term political influence end up having—the economies perform more poorly. So we think it’s an important part of it. But when you think about working together with the—you know, the Treasury, with other parts of the government to help have a stronger more resilient economy, to respond more effectively to economic shocks, I mean, that is in our interests. And I think that would be a healthy thing for us to do.

LIESMAN: The gentleman over here.

Q: Thank you. The federal funds rate target is about 2 ½ percent. The ten-year government yield is 2.1 percent. Is that relationship continues to prevail, it would suggest that monetary policy is becoming restrictive. Will this require you, if it prevails, to lower the federal funds rate target?

WILLIAMS: It will not require us to do that. But, again, I think it gets back to the inverted yield curve topic, which is clearly the market participants—you know, the markets are speaking pretty loudly. If you look at the—not just the fed funds ten years, if you look at the whole yield curve, I mean, two-year yields are very low, relative to short rates. There’s clearly a view in the markets of where they expect interest rates to go. That doesn’t force us to do one thing or another, but I do think it’s—like I said, it’s informative about where markets see the economy going and where they see the risks going.

One of the really hard things they get out of—you know, when you look at the, you know, yield curve, which we do study a lot, is there’s a risk aspect of this too. I mean, the U.S. dollar is the international reserve currency. The ten-year Treasury is the is the safest asset when you think about economic downturns. So the fact that the price of these assets are going up, which is the yields going down, is—you know, to me, is a—you can think of this as a measure of people’s kind of risk-on, risk-off, or sentiment. And similarly, when you think about how other markets are moving.

So I do think there’s a signal from there about some of the risks that people perceive. But, again, what we do is—you know, I haven’t started yet, obviously. Obviously, if I’m speaking publicly we’re not, you know, in the FOMC mode yet. But starting next week, you know, we’re going to get together and we’re going to get—you know, do all the analysis and the careful thought, and figure out what we think is best.

LIESMAN: John, I want to pushback a little bit on your answer to the gentleman’s—

WILLIAMS: I thought you were taking questions from the audience, Steve. (Laughs.)

LIESMAN: Yeah, but moderator’s license. If I can show it to you, if you want to see the license. (Laughter.) At some point, the gentleman is absolutely correct—you are too tight. In other words, if it’s a temporary thing, then it’s a message of the market and you take it into account. If it persists, however, you have to acknowledge you are too tight and you cannot let that go on.

WILLIAMS: So, now I feel like we’re having a philosophical debate. I mean, I think what it is a signal that there’s a different view of where the economy is—

LIESMAN: Right. But if it’s a year from now and you’re still inverted, then he’s absolutely correct. You are too tight. If short-term rates are above long-term rates for a persistent amount of time, that tells you definitively, right, that short term rates are too high.

WILLIAMS: No—

LIESMAN: No?

WILLIAMS: No. OK, so I think—

LIESMAN: Five years from now?

WILLIAMS: So let me throw—OK. So one thing that we have in our minds, I think all of us, and we’re certain age, is that the yield curve is upward sloping. OK, so there you go, confirmation. (Laughter.) The—and so—

LIESMAN: I don’t know very much, but it’s definitely upward sloping.

WILLIAMS: OK. So why is the yield—OK, so it’s a basic, you know, question people have asked for a long time. Why is the yield curve upward sloping? Well, my view—and this, of course, is my own perspective on this—is that after the ’60s and ’70s and early ’80s, the markets were pricing upside risk on inflation on interest rates. So if you’re holding a ten-year Treasury, what are you—what are you most worried about? What you’re worried about, based on the history of the U.S. in the post-World War II period—or, much of the post-World War II period, was a bout of high inflation or high interest rates. So you were basically paying a lower price for a ten-year yield—lower price, higher yield, that gives you the upward slope.

So in the last decade, what we’ve seen from investors around the world—not just the U.S., because of course it’s a global financial system—is that that assessment of where are the inflation risks in the U.S. and in Europe and in Japan and in many countries, has shifted from one of I’m really worried about what happens if we get double-digit inflation to I’m worried about a sustained deflation. Now, I can’t prove this point, but you definitely see in country after country a view that inflation risks are even—are either evenly distributed or more—or are heading more to the downside. And of course, we see very low inflation in almost every advanced economy, near zero—you know, very low inflation in Japan.

So I think that in a world where you thought that the risks to inflation, and the risks were symmetric, I don’t see any reason you would have anything but a flat yield curve. So I’m not sure that this idea that the yield curve being inverted is such a—as strong a signal as it would have been, say, twenty years ago.

LIESMAN: OK. The woman right here, yes, please. Then I’ll get to this side of the room, yes.

Q: Thanks. Paula DiPerna, Carbon Disclosure Project and NTR Foundation.

Going back to failing to prepare, and also I think you gave some remarks the other day on banking culture, in which you spoke about some soft things like diversity and climate change and things that perhaps are outside the obvious realm of monetary policy. I wonder if you could just expand on your thoughts in those areas, and why you thought it was important to raise them.

WILLIAMS: Right. So in the speech about banking culture, first of all, this is the fifth conference—fifth annual conference we’ve had at the New York Fed on banking culture. And, by the way, banking culture is really—you know, we’re talking about the failures of culture and conduct in the financial services industry broadly, whether it’s around FX fixing, LIBOR scandal, other scandals. And what can we, as regulators, do to promote stronger, healthier cultures and conduct? And what can the institutions themselves do to do that? And bring in academics and people—experts from around the world.

So the reason I bring up culture is that a lot of people think of this as—and these issues as very much a compliance issue. It’s a legal issue. But what we’ve learned from experience around the world is often misconduct—fraud and other issues at institutions—is really not about a bad apple or an individual who’s conducting themselves poorly, but much broader-based issues of misalignment of incentives, misalignment of behavior from what the institution was at least saying they wanted to achieve.

So for us, as supervisors who care about compliance with, you know, the law, who care about having well-run and safe and soundly run institutions, we think the New York Fed, this is an important role for us to highlight these issues as part of making sure that we have a financial system that’s actually—a banking system that’s serving the American people well. And given that these culture—or, these misconduct issues are not going away. I mean, you just have to open the newspaper, you can see that.

The reason I brought up climate change and cybersecurity in the speech was that often people, when they think about hard problems like culture, or they think about hard problems like cybersecurity, they tend to think, you know, I don’t have an easy fix for this. This isn’t something I can put in the 2019-2020 budget. This is something that’s going to take years and years. And what happens is that those things often get shunted aside. And you kind of focus on what needs to happen this year, as opposed to these longer-run issues. And we know that—we know in supervising banks, for example, the back office and cost center parts of the organizations—you know, those are the ones that tend to get cut and not get the investments.

And so, you know, when I think about whether we’re in our bank supervision regulation activities, or I think about the economy and monetary policy, we need to take a longer-term view on these issues. And that’s what I was highlighting in my comments today about thinking about how do we build a strong resilient economy for the future as a long-term issue. It’s not a are we going to, you know, change interest rates and, you know, here or there.

It’s really about building a stronger foundation for our economy and that’s—and the reason I brought up climate change also is that, you know, if you were to ask me what are one of the issues for cybersecurity, what are the issues that are going to be on the top of our list, at least my list, for changes in the environment that bring risk to the financial system, cybersecurity is right at the top of that list. Thinking about how climate change affects the safety and soundness and other aspects of our economy, I think, are very much on the list. But those are the long-term questions, not the—you know, 2019.

LIESMAN: Right here.

WILLIAMS: Just 2019.

Q: Cy Jacobs, Jacobs Asset Management.

So while you’ve struggled to achieve your inflation targets as measured by government indicators, you’ve helped create the conditions for asset inflation to be—to be wildly successful in creating asset inflation in the equity market, the bond market, the art market, for instance.

Does the Fed think about that any more than it has in the past and as you, it sounds like, you’re considering embarking on yet lower interest rates, will that be more on your mind than in the past? It’s become a political hot potato, obviously, so I’m wondering whether, you know, as people connect QE with income and wealth disparity, whether you would think about that any more than you have in the past.

WILLIAMS: Well, I definitely think we think about it. I mean, the last two—the last two recessions were not—were not the historical type of recessions. We think about when we—you know, like, when I went to school and studied the post-World War II recessions, it was often that you had a run-up in inflation, the Fed tightened, the economy stumbled, and then it expanded again. Those are the V-shaped recoveries.

But the last two—you know, the dot com bust, the housing crash—those were not inflation-led things. They were actually led by these asset price build-ups and risks in the economy. So these are very much on our mind. We’re looking for them regularly. We now have the Financial Stability Report, which we made public. At the Federal Reserve, we’ve been doing that work internally, you know, for a long time. Now we’re putting it out publicly.

So, you know, I think this is definitely something we think about and analyze. The hard choices—the hard part of this is that we don’t have a lot of tools. You know, when you think about monetary policy you’ve got interest rates, you know, that you’re moving to try to either boost the economy or maybe slow the economy a little bit. Those influence some of these risk taking but a lot of other factors affect the economy and risk taking and some of these debt or other build-ups, and we’re not—you know, the Fed doesn’t have all these levers to control all of the decisions that are made out—made in the economy.

So that’s why when I think about some of these issues and the lessons from the last few downturns is that what we should do is make sure that our financial system—I mean, you know, our banking system, the one that we regulate and supervise is resilient, has solid capital liquidity, strong resolutions plans, has all of those so that even if we do have another downturn—whatever the source, whether it’s an asset-price correction, whether it’s some foreign economic development, whatever it is—that our financial system is strong and resilient and it doesn’t kind of get pulled into that, and that we can then use monetary policy, hopefully fiscal and other policies, to help keep the economy alive.

But these are—you know, the question you asked was do we think about these things. You know, we do a lot and, you know, I think that—when I think about it, it’s all about resilience—how do we make sure that our economy and our financial system is resilient, because there is going to be shocks. I mean, that’s going to happen. We just want to make sure that we can manage things.

LIESMAN: John, how do you feel about your ability to see risk in the nonbanking sector and do you think it’s higher now than it was, say, three or four years ago?

WILLIAMS: It is higher. I mean, clearly, the regulations have moved more activity out of the regulated banking system into the nonregular or less or differently regulated shadow banking system. That’s kind of Economics 101, that as we’ve tightened the expectations and the standards for the banks that that activity has moved out of the banking system. That’s a positive, actually, because the banking system is highly leveraged. They do a lot of maturity transformation, which puts them at risk if things go badly. So getting the risk away from the banks and more into other parts of the financial system, that’s healthy.

Where it worries me, which I think, a couple of these questions have been about, is, well, the risk is still there. It didn’t go away. It’s not like, you know, you got it out of the bank and therefore it’s gone. It’s gone into other areas. And so we spend now a lot of our time trying to track this down. Who owns—so there’s this big huge growth in nonfinancial corporate data in the U.S. through the leveraged loans and the high-yield bonds. OK. So we know that. We can see that data from the borrowing and the, you know, activity there. Who owns these?

They’re being securitized in CLOs. Who owns the CLOs? And, really, it forces us to do a lot more digging in tracking down, not just in the U.S. but globally, to understand who’s holding the investments, what are the risks in those structures, and what are the potential spillovers if that market were to go through a correction. So it is more complicated. We don’t have the same data and perspective that we have on the regulated banks because we see, you know, all of the information we need there. And that’s just a changing part of our landscape, though.

When I talk with the New York Fed—what do we need to grow in our capacity—it’s really in this area of understanding what’s happening outside of the regulated sector or at least the regulated sector by us and making sure that we understand where that risk is, where it’s hiding, and how it may interact back into the economy.

LIESMAN: On this side. This gentleman right here.

Q: Thanks. Yves Istel, Rothschild’s.

You had talked about making sure you had some margin to act if there were a weakening or recession. But I’d just like to broaden the question just a bit. We have over 10 trillion (dollars) of bonds at negative interest rates with modest effect on helping growth. We have the Japanese experience. So I’m wondering if you could broaden your comment a bit to talk about what are the challenges to the effectiveness of monetary policy at all in this new and different world.

WILLIAMS: So this is, I think, gets to the heart of the matter, right. You look at what Japan has done—the Bank of Japan and the government Japan have done. They’ve done enormous monetary stimulus. Ten-year yields in Japan are zero or negative—have been for quite some time. The Bank of Japan has held them at that level. They’ve been at zero interest rates for most of the last few decades. Fiscal policy has been mostly expansionary.

Structural policies in Japan have—you know, the three arrows of Abenomics—you know, the structural policies have also worked hard to build a stronger—a longer-term growth. And yet, so what have we seen in Japan? Unemployment is at very low levels. The economy is growing actually in a pretty steady or is pretty much consistent with their underlying trend growth, given the demographics of Japan.

Inflation, though, they can’t get it anywhere near their 2 percent objective. Look at the euro area countries—the countries in the—under the European Central Bank. Pretty similar picture. Unemployment is still a little elevated but unemployment has come way down. The economies are growing. Inflation is still well below target.

So what I—you know, what I take away from this is that monetary policy is kind of a glass half full. When it came to economies getting hit by, hopefully, the hardest economic downturn of our lives, monetary policy and other policies—fiscal policy in many countries—helped get, you know, the country growing again, the unemployment back down to normal levels, and that’s a success. That’s an important success. What we found is in a world of very low neutral rates, in a world where everybody was hit by the same shock kind of at once where the global economy is weak, it is just very hard to get inflation back to normal levels.

And you might say, well, is that the worst thing that can happen. You’ve got people back to work. Maybe, you know, that’s good enough. The problem that—you look at Japan, you can see what that means. They have zero interest rates for as far as the eye can see. They have no inflation whatsoever, which means that they have, you know, very limited ability to respond to another shock. So they’ve accomplished a lot and I think that they should be given a lot of credit for what they’ve accomplished.

But they’ve kind of done, you know, about as much as you can imagine doing and still they haven’t been able to get inflation going and I think that just—it makes them a little less resilient for the future and I think that of the ECB and other countries, and that’s what I worry about with the U.S. I mean, if I—if you were to ask me what’s the thing I worry about in this, it’s not today. U.S. economy, obviously, there’s uncertainties. You know, you have to make good decisions. But how do we make sure we set the stage so that, you know, in the future we’re in a better position to—in our economy to kind of withstand the next shock?

So that’s, to me, the big lesson of what I’ve seen around the world is that monetary policy was important. It did a lot. But it kind of—it reached I won't say its limits because, you know, you don’t know what the limits are, but used about as much monetary stimulus globally as you could imagine, and yet still we’re in a situation where inflation is incredibly low around the world, not just in the U.S.

LIESMAN: John, I want to take one more for the audience but I just want to make sure you have this opportunity. The president has not been shy about giving you advice about monetary policy. Do you want to tell him anything about whether or not—(laughter)—he ought to put additional tariffs on China or additional tariffs on Mexico?

WILLIAMS: I do not want to opine on that.

LIESMAN: I just want to make sure you have an opportunity.

WILLIAMS: Thanks, Steve.

LIESMAN: Last question here. How about all the way in the back there? The gentleman there.

Q: Ed Cox.

You say 2 percent inflation is a goal. Would you really like to—is that a ceiling or would you like to see it go over for a period of time, more of a long-term goal than a ceiling?

WILLIAMS: Yeah, I’m glad you asked that because I meant to answer a(n) earlier question—kind of a couple earlier questions. This is what the framework discussion really is about. So, you know, a lot of people ask me, you know, you’re worried about inflation. Steve, you asked this. You know, it’s a reasonable question. Inflation is a little low. The point of this framework review that we’re doing at the Fed is to just really think hard.

What we want to do is we want to have a strategy and a—you know, execution—operational and execution parts of that that get you the symmetry—that inflation half the time is above 2 percent, half the time below. It’s OK. It moves around a little bit. But as long as, you know, over, you know, a longer period of time it averages 2 percent, it’s not something that people are worried about or having to plan around but that we’re hitting that 2 percent, and it’s not a ceiling. It’s not a floor. It’s right—you know, it’s just a symmetric—you know, inflation moving around 2 percent that way.

We’re not there yet. I mean, right now we’ve had ten years of inflation, on average, and thanks, Steve, for not, you know, over—not bringing this up, but we’ve been missing our inflation target on the low side almost the entire time. So we need to find a way to get this right, on average, and that’s really what this review is—to help us think through that and, you know, make sure we can do that in the future because it’s going to be—it’s, you know, it’s a challenging environment for monetary policy.

LIESMAN: Please join me in thanking John Williams. (Applause.)

(END)