Broad-Based Job Gains Signal Rates Can Rise

In an interview with Bloomberg’s Michael McKee, Federal Reserve Bank of Kansas City/MO President Esther George said she sees ‘significant progress’ in the labor market in 2014, “We have seen significant progress in the labor market over the last three years, and particularly this year,” gains have been “broad-based, and that’s a very encouraging sign.”

George told McKee that “Inflation looks to be stable,” and “there’s every reason to think we should start talking about normalization.”

The Kansas City Federal Reserve President also said that we must return the balance sheet to the smallest amount we can and noted that the very large balance sheet has “complicated the process of monetary policy.”

Full transcript below:

MCKEE: Thank you for joining us, and thank you for having us here. This is your third year now running the conference as president. What do you want it to be under your administration?

GEORGE: That’s a great question because the conference has been successful for some basic reasons, which is to bring together relevant topics, to have the right people in the room to discuss those topics from different vantage points. And my goal is to continue that forum to bring relevant issues to policy matters that central bankers around the globe have to deal with.

MCKEE: Well it was set up originally for central bankers to discuss these relevant issues. For three years Ben Bernanke used his keynote address to talk about Fed policy actions to come. Did that change the conference?

GEORGE: I don’t know. The conference was never focused, and as we planned the conference in Kansas City it was never intended to be a policy platform. It wasn’t built into the program. The program was always focused on what is an issue that is relevant to global central bankers today and to really try to focus in on that.

MCKEE: Well the people on Wall Street who follow it so closely, do you think they expect too much of what comes out of here?

GEORGE: I don’t know. I’m delighted that people find value, that there is attention to the program. And I hope that’s because it’s bringing insight to issues that are in the current dialogue about monetary policy issues and other central bank (inaudible).

MCKEE: If we could turn to monetary policy issues, the minutes that just came out of your July meetings suggested that members of the FOMC were not just surprised by the speed of the drop in unemployment, but by the following (ph) other labor market indicators as well. Do you get the impression that the doves are nervous?

GEORGE: I don’t know. I think for myself when I talk about monetary policy, which is we have seen significant progress in the labor market over the last three years, and particularly this year. And they have been broad-based, and that’s a very encouraging sign.

MCKEE: Well you dissented seven times last year as a voter wanting to raise rates sooner. Would you vote the same way this year right now or are you on board with the consensus view of maybe mid-2015 for the first rate increase?

GEORGE: Well my concerns in 2013 were around the large-scale asset purchases or QE3. We now are not only well into that program. We’re beginning to decelerate the purchases each month. So there is a process to working through that. And I believe the economy will be ready if it continues the progress we’ve seen to begin to lift off of zero, to begin to have more normal interest rates as we go forward.

MCKEE: Well the chair has suggested that you wait a while because labor markets aren’t healed enough. Many of those who would oppose her argue that it’s an inflation danger, but where’s the inflation that we should fear?

GEORGE: Inflation today looks to be stable, but you have to look ahead. We have to be prepared to see where the economy is going and not where it is today. And so I think in that sense as we see the progress being made, 6.2 percent unemployment, not far from what may be full employment. Inflation looks to be stable. I think there’s every reason to think we should start talking about normalization.

MCKEE: Well are you worried about an overshoot of inflation at this point?

GEORGE: Inflation can move in funny ways. So we see components of inflation that are particularly healthy now with food and rent, even though the overall measures look calm. But as we know from history, those can change depending on the momentum of the economy.

MCKEE: Janet Yellen can make a reasonable case that the Fed increased aggregate demand with its extraordinary polices. But as those policies are withdrawn, is that demand going to be self-sustained?

GEORGE: Well that’s one of the things the committee will have to judge at the point of its decision to lift off of zero interest rates. And as we’ve looked at the performance of the economy over the last year, I think there are encouraging signs with (inaudible) job market, with how consumer spending has held up. It would lead us to think we might – we might be getting close.

MCKEE: The Fed did maybe contribute to aggregate demand, but that demand’s been weaker than in previous recoveries. The labor markets remain weaker than in previous recoveries. Does that tell you that the Fed has pretty much done all it can do to stimulate the economy at this point?

GEORGE: I think we have seen – this recession was not like some past recessions either in terms of its consequence to the economy. So the transmission of monetary policy has been different this time. In an economy where there was too much debt, the appetite to take on debt has been different. And I think now as we look at the healing we’ve seen in the economy and that progress, we’re in a good place to begin talking about normalization.

MCKEE: Well one of the concerns you raised in your dissents last year was about market stability, financial market stability. A lot of people worried about what happens when QE ends, when the Fed starts talking about raising rates. Is that still a major concern for you or do you think markets have absorbed that the process is coming to an end?

GEORGE: It looks like so far that between communication from the committee, the market has responded and the Fed has not reacted to some movements in data that we’ve seen. We’ve kind of kept a more long-term focus. So so far, so good. When we move into the next phase of our stance of monetary policy, there could be some volatility. We’ve been at lows for a long time, and so it will be important to communicate and to be communicating how the path of interest rates will go.

MCKEE: Where are you on the debate over whether the Fed should sell off parts of its balance sheet?

GEORGE: We have a very large balance sheet right now and the process of unwinding is something the committee’s been talking about and it has complicated the process of monetary policy. The issue about whether to reinvest the maturities on that bond portfolio have ranged from whether you do it before lift-off, whether you do it after. My objective and the principles that were laid out in the minutes is to return the balance sheet to the smallest size we can, to conduct policy, and to return to an all-treasury balance sheet. And those would be the principles that I would support.

MCKEE: How quickly do you need to do that?

GEORGE: Well, that will be a function of how the economy performs. That’s why the committee has been talking about what the size (ph) balance sheet how normalization will work, how the Fed funds rate will respond, how we’ll control short-term interest rates. And that has been the discussion over the last few meetings with the committee.

MCKEE: One of the controls for short-term interest rates, overnight reverse repos, put a floor under rates (ph), but there have been a lot of concerns raised about how they’ve worked in practice since you’ve been testing them. Are you worried that they may have adverse consequences?

GEORGE: They could, and that’s been discussed to make sure we’re thinking about not only what value they could bring to us during the process of normalization but what the consequences might be. And I think for that reason you see in the minutes an effort to say we’ll consider this tool during the normalization process but to be very aware of what some of those consequences could be in a time of stress.

MCKEE: When you put it all together, what are you going to look for when it’s time to decide to raise rates? What’s going to be the trigger for you? What indicator or indicators tell you that the economy is ready?

GEORGE: Well, I think we’re getting close to that. And of course the committee will work through this systematically in terms of the process to do that. But in my own view, some of the policy benchmarks that we looked at and have been looking at for some time are already signaling that we should be above zero interest rates. So we’ll continue to watch the economy unfold, but I think that we’re – we’re getting to a good point.

MCKEE: Do wages have to go up first?

GEORGE: We’re at least wages going up. In fact if you look, compared to last year we have seen wages move up. I don’t think that that should be the indicator, so I think we’ll be looking broadly at how the economy is unfolding. In fact, some of the research my staff has done suggests that where wages are today relative to past times with similar slack in the labor market, we may not be so far off track.

MCKEE: You have also been quoted as worrying about asset price inflation because you watch farmland prices. Farmland prices have started to come down. Is that issue off the table then?

GEORGE: Farmland prices have cooled at a high level and that has been in the face of projected declines in farm income. So we’ll see how that – but I would say more generally, Mike, the issue around risk in the markets, the pricing of risk, is when you have an environment where there is a strong incentive to reach for yield. And that’s really what I look at broadly, not just for farmland but other parts of the market where those incentives exist. I think it’s important for policy to take those into account.

MCKEE: You have some guests coming from other central banks to your conference. How concerned are you about what happens to the global economy as central banks decouple over the coming year?

GEORGE: We live in a global world obviously, and the connections are growing between our countries. As the Fed thinks about monetary policy, of course its focused on the US and its mandates there. But we talk about the geopolitical risk. We talk about what’s happening in the economy of other countries because they – we affect one another.

MCKEE: Has Mario Draghi called and said, come on, get on with it already? (Inaudible).

GEORGE: No. He’s – Mario Draghi has it well in hand I’m sure.

MCKEE: All right. Esther George, thank you very much for being with us.

GEORGE: Thank you, Mike.

Video for viewing here.

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