Bloomberg Television’s economics editor Michael McKee spoke with San Francisco Federal Reserve President John Williams in Jackson Hole, WY today, who said that very accommodative policy is what’s needed now.
Williams said, “…it’s clear unemployment is too high and inflation is still too low and it calls for a very strong accommodative policy, and I think that’s been a big factor helping our economy recover. And I wouldn’t want to see us tightening the policy until we’ve made further progress in that some time next year.”
Williams went on to say, “So as [Yellen] said, and I think I agree completely, right now my thinking is that sometime in the middle of next year in my own will be the time to raise the funds rate. But if the economy does better with — than expected, and I sure it hope does, then we would want to raise interest rates a little quicker. If it disappoints, we’ll raise rates a little slower.”
MIKE MCKEE, BLOOMBERG NEWS: …John Williams didn’t see the speech either, so we’re getting his first reaction to what Janet Yellen said. If you look at the way the markets are reacting, it seems to be a status quo speech.
JOHN WILLIAMS, PRESIDENT, FEDERAL RESERVE BANK OF SAN FRANCISCO: Yeah, but I think Chair Yellen did a great job of explaining the issues, describing the thinking going on at the Federal Reserve around the labor market, the improvement in the labor market and where we see it relative to full employment, and really highlighted the difficult issues in trying to understand what’s cyclical and what’s trend. And I think it’s just a very, very good — actually a tour de force of — of all the issues that we’re facing and we’ll be facing the next couple years.
MCKEE: Well it was certainly an even-handed, lengthy look at a lot of indicators besides job creation and unemployment that you’re wrestling with. But some of your colleagues have argued strongly that there isn’t that much information in those peripheral indicators. Do you agree?
WILLIAMS: Well, I think that one of the things we’re seeing now, which is a good thing, is we’re seeing a lot of coherence across the indicators. They’re all improving. We’re seeing job hires, employment gains, job vacancies improve, and all these things are moving together. So that’s a good sign. So there is still this issue that some of the indicators are suggesting the labor market’s not quite as strong as the unemployment rate. Some are suggesting maybe it’s a little bit stronger and we have to weigh that various evidence in basically trying to figure out where full employment and how much progress we’re making on that.
MCKEE: Well of course you have to decide what interest level will bring about full employment, so what do you want to see before you would decide to vote in favor of changing policy?
WILLIAMS: Well really it’s — it’s just the way Chair Yellen described. Looking at how much progress we’ve already made towards of our goals of maximum employment and 2 percent inflation, and then where do I see — how long is it going to take to get to those — those markets? And so for my — to my mind, I want to see further progress on the labor market in terms of job gains and reductions in unemployment. And I really want to see more signs of inflation moving back to 2 percent, and also some wage growth moving back from about 2 percent now towards 3 percent. So I really want to see some tangible evidence inflation’s moving back to our goal.
MCKEE: A lot of discussion about the labor markets. Not very much in her speech about inflation. She almost seemed to downplay it as a decision point given the level of inflation that we have right now.
WILLIAMS: Well inflation right now is below our target and has been for some time. My forecast is it will move back towards that. It is an important factor. I think one of the things that’s difficult is it’s — it’s hard to discern just from looking at wage or price inflation whether there’s slack or not slack on the labor market, something Chair Yellen highlighted some of the difficult issues around that. Still, it’s clear unemployment is too high and inflation is still too low and it calls for a very strong accommodative policy, and I think that’s been a big factor helping our economy recover. And I — I wouldn’t want to see us tightening the policy until we’ve made further progress in that some time next year.
MCKEE: She cited two papers in her speech from the San Francisco, one on wages suggesting that employers couldn’t cut wages a lot during the recession, so now they’re making up for it by holding wages down. Is that the way you see it, that that’s the reason we’re not seeing people get raises at this point? And if so, when does it change?
WILLIAMS: I agree with that. There’s some great research done by my colleagues at the San Francisco Fed on downward nominal wage rigidity. Basically you really don’t see many wage cuts even during severe recessions. And so the wage data may be a little bit disordered by that. What I’m again looking for — looking to is signs that wages are starting to pick up and move towards something like a 3 to 3.5 percent rate. So we still have a ways to go on that.
Now this year — the evidence that we’ve seen on downward nominal wage rigidity does suggest that we might start seeing some stronger wage increases as the labor market gets even stronger. But I think that’s a positive. It means more money in people’s pocketbooks. It’ll help consumer spending. I don’t see any risk of overshooting inflation right — right now.
MCKEE: Well one of the things the protestors who are here are arguing is if you raise interest rates, wages aren’t going to go up. Is there a connection between the two at this point?
WILLIAMS: Well it’s — it’s really hard to see the connection between wages and interest rates. To my mind, it’s really about we want to keep job growth and economic growth on a — on a good path to get us back to full employment over the next year or two, getting inflation back to full — a 2 percent target over the next year or two. So right now very accommodative policy is what we need, but we’re seeing improvement in the economy and as we get closer to our goals it will be time to start pulling back and letting the economy grow — grow more on its — on its own. That’s still a ways off in my view.
MCKEE: You were one of the authors of the other paper she cited suggesting that the long-term unemployed have difficulty coming back into the labor market. So that might mean there’s slack in the economy in the short run than people think, but over the long run those people buffer us from seeing higher wages because there’s more supply. How does that factor into the debate at this point?
WILLIAMS: Right. Well one of the things that we highlighted was in the short-term unemployed, the people who have been unemployed for less than six months, that rate is actual back to more or less normal levels now. And really what we’re trying to do is work off the high rate of long-term unemployment, people who have been unemployed for over six months, over a year, over two years. So one of the good signs in the economy is we’re seeing long-term unemployment come down as the economy continues to improve. That’s very good.
The other thing we thing emphasized in our paper really was that maybe we’re not getting as much downward wage pressure right now from the labor market as you might normally expect. And again, Chair Yellen talked about that I think in a very balanced way in her — her speech that these temporary factors that may make the wage growth versus the slack kind of have some differences there, make it a little harder to read what — how much slack there is. But again, the long run I think — the long-term unemployed will get back — get back in the labor force, get back into jobs. And I see that as not a — a long-term problem. It’s really more of a short-term dynamic around wages.
MCKEE: We were talking earlier about how people are analyzing this speech trying to pull out some sort of signal from it, and maybe you can’t. But in terms of how you think about timing, people on Wall Street want to know when you’re going to raise rates. What should they look for and — and what matters in terms of timing at this point?
WILLIAMS: Well I think that a couple things. One is, again, back to where are we relative to our goals of full employment and — and 2 percent inflation. As we continue to make progress towards that, it’ll be closer to the time to raise interest rates. The other factor I think that’s really important is not just when we raise interest rates but how quickly we raise interest rates.
And my thinking now, and I think that you’ve seen this in our various projections we’ve given in the past, is that most FOMC participants expect us to raise interest rates relatively gradually, reflecting the fact that the economy still doesn’t have a really strong momentum on its own and we will be withdrawing accommodation over — over an extended period of time. So I think both of those factors, how far — how far are we away from our objectives, how quickly will be get there, that’s one thing.
But the other is we’re not — we’re not looking at least in my view to remove accommodation really rapidly. I think it’s going to be a drawn-out process.
MCKEE: Well there are two things she said in there. One is she referenced the minutes and the Fed statements suggesting that if the economy picks up more quickly than expected then rates could rise sooner than expected. She also said the economy is picking up more quickly than you guys expected. So is the idea that we have to wait until mid 2015 or late 2015 sort of going by the boards here and the timing may be moving up a little bit?
WILLIAMS: Well I think, again, it depends on the data and — and as Chair Yellen pointed out, the unemployment rate’s come down faster over the past 12 months than we had been thinking. But looking forward, really watching how are we doing in terms of full employment, in terms of employment and unemployment, how are we doing on inflation.
So as she said, and I think I agree completely, right now my thinking is that sometime in the middle of next year in my own will be the time to raise the funds rate. But if the economy does better with — than expected, and I sure it hope does, then we would want to raise interest rates a little quicker. If it disappoints, we’ll raise rates a little slower. Hopefully we’re kind of getting back to the normal time where markets have to figure out what we’re going to do based on what the economy’s doing and not wait for us to tell them.
MCKEE: Well, do you worry that markets are going to overreact and maybe slow the economy before you actually ever do anything?
WILLIAMS: Well clearly this is a concern for us, and one of the — our big emphasis in trying to communicate as well as we can both our thinking about the economy, our forecasts about the economy, and our views about where policy is going. We have to do this in a way that tries to avoid an overreaction but at the same time in a way weans markets off this forward guidance that we were using during the last few years when we were at the zero interest rates when we were being so explicit about when — when we would likely raise interest rates. Because in a — once we’ve got interest rates away from zero, we don’t want to be using that kind of explicit forward guidance in — in my view as much.
MCKEE: Where are you in how you signal what happens? Would you like to stop reinvesting the proceeds from your balance sheet or would you wait until after that happens? What would you tell them?
WILLIAMS: So my own view is that — and again, at the FOMC we’re talking about this, the decision we’ve made, and I’m just speaking on my own view. I think that what we want to focus on right now as we end the taper and end the asset purchase program and start moving to thinking more seriously about when are we going to raise interest rates, we want to really have the focus on that, try to communicate it as clearly as possible around that, and push off the — the decision and the — the — ending the reinvestment of the — of the — of our portfolio really to a later point just so it doesn’t send confusing signals about what we’re thinking and what we’re doing.
I think our main focus once we end the asset purchase program is really communicate around the Fed funds rate, how we’re going to normalize, what approach we’re going to use, and focus on that.
MCKEE: Well you’re going to use, according to the minutes, basically the interest on excess reserves as your ceiling, reverse repos as your floor. But a lot of concern about the repo rate and whether or not that disintermediates banks. How big do you think that program should be and how long do you think that runs as part of your strategy?
WILLIAMS: Well this is something under discussion obviously at the FOMC. One of the things that Chair Yellen has done a great job about is teeing up this discussion very early, well before we’re going to raise interest rates, making sure we have a thorough discussion and really worked out these plans, and then make them public before we raise interest rates.
My own view on the reverse repo is we don’t want that program, because it’s temporary, we don’t want it to create long-run harm to the functioning of money markets and those markets. We also don’t want that market or the reverse repo facility to become so big that it causes some financial stability issues. So my — I think my own view on this is we want to keep it limited in size and basically as a secondary tool to — to support the interest on reserves, which is really our primary tool of raising interest rates.
MCKEE: All right. Thank you very much. John Williams. He’s the president of the San Francisco Federal Reserve. You’re getting the first reaction from a member of the Fed to Janet Yellen’s speech.
Video for viewing here.