"The return of retail margins to more normal levels could meaningfully help reduce inflationary pressures in some consumer goods,…"
…insistent with two percent inflation wage growth nonetheless has been running well below current inflation strong wage growth along with high rental and housing costs mean that inflation from core Services is expected to ease only slowly from currently elevated levels in contrast core Goods have been expected to return to something closer to the pre-pandemic trend of modest disinflation as a result of demand rotating away from Goods coupled with the healing of Supply chains and declining or import prices of course that disinflation in core Goods would be very helpful in offsetting the inflationary pressures in services during the five years before The Crisis Core goods made a small negative contribution to inflation but that swung sharply into positive territory last year and had only started to step down somewhat in the middle of this year so I think the surprise in the August inflation data was the large contribution of core Goods inflation at a point in the post-pandemic recovery when many forecasts had anticipated this can this contribution would continue moderating since the pandemic significant supply and demand imbalances have coincided with large increases in retail trade margins in several good sectors in some sectors the increase in the retail trade margin exceeds the contemporaneous increase in wages paid to the workers uh in that sector although that's not true in food and apparel.
so the return of retail margins to more normal levels would meaningfully help reduce inflationary pressures in core Goods considering that gross retail margins are about 30 percent of total sales dollars overall so among general merchandise retailers for instance where the inventory to sales ratio is about 20 percent above pre-pandemic levels retail margins have increased about 20 percent since the onset of the pandemic that's more than twice the increase in average hourly earnings in contrast in the auto sector the the real inventory to sales ratio is still 20 below its pre-pandemic level and there we see the retail margin for Motor Vehicles sold at dealerships up by more than 180 percent since pre-pandemic and that's 10 times the level of the increase in wages within that sector so there is a lot of room for margin recompression to help reduce Goods inflation but that will depend on demand Cooling Supply constrain easing and inventories restocking despite the higher prices for a broad set of goods and services market and survey-based measures of longer-term inflation expectations are within ranges consistent with expectations that inflation will return to two percent over the medium term in order to bring inflation down and to keep those expectations solidly anchored at two percent the Federal Reserve has increased the federal funds rate target range by 300 basis points in the past seven months and both market and policy surveys indicate additional increases through the end of this year and into the early part of next year in addition balance sheet shrinkage is now proceeding at its maximum rate reinforcing the move to a restrictive stance broader U.S financial conditions have tightened rapidly in response the two-year treasury yield has moved above four percent for the first time since 2007 and the 10-year yield is near its highest level in over a decade and we see similar kinds of moves and corporate bond yields mortgage rates and the dollar monetary policy tightening is also preceding rapidly overseas many central banks and large economies have raised rates by 125 basis points or more over the last six months and yields
The price drops aren't materializing because current inflation largely isn't demandor labordriven as it often is during inflationary periods, said Claudia Sahm, a former Fed economist and founder of Sahm Consulting. "High inflation is not workers' fault, but the Fed is waging a war on US workers," Sahm said.
Lael Brainard, Federal Reserve Board vice chair, even acknowledged the roles of pricing and supply chain disruptions during a speech this week before the National Association for Business Economics. Retail profit margins have increased 20％ since the pandemic's onset, Brainard noted, roughly doubling the 9％ increase in average hourly earnings by the sector's employees. In the auto sector, margins for vehicles sold at dealerships have increased by more than 180％ since February 2020 about 10 times the rise in the sector's average hourly earnings, Brainard said.
"The return of retail margins to more normal levels could meaningfully help reduce inflationary pressures in some consumer goods," she added.
The Fed has hiked rates five times in 2022 and indicated more increases are to come. Photograph: Jim Watson/AFP/Getty Images
A fresh round of US inflation data released last week showed persistently high prices, raising more questions about whether the Federal Reserve's interest rate hikes are missing what many economists contend are the real inflationary culprits: corporate pricing, energy costs and supply chain disruptions.
The news is further stirring fears of unnecessary economic pain should the Fed push America into recession.
"Raising interest rates isn't working, and the Fed's overly aggressive actions are shoving our economy to the brink of a devastating recession," said Rakeen Mabud, chief economist at the progressive Groundwork Collaborative thinktank. "Supply chain bottlenecks, a volatile global energy market and rampant corporate profiteering can't be solved by additional rate hikes."
The Fed and some economists maintain that demand generated by a hot labor market and higher wages are driving inflation, and higher unemployment and interest rates are panaceas.
To that end, the Fed has hiked rates five times in 2022 and indicated more increases are to come, moves the Federal Reserve board chair, Jerome Powell, has acknowledged will "bring some pain" to households and businesses.
Data shows the Fed is making some progress in its aim: mortgage rates are soaring and home sales are plummeting. Meanwhile, the latest employment numbers show a sharp decline in job openings, as well as slowing job and wage growth.
But Thursday's Consumer Price Index numbers for September revealed the approach has yielded few gains on pricing. Inflation inched up to 8.2%, while month-to-month it climbed 0.1% in August and 0.4% in September.
The price drops aren't materializing because current inflation largely isn't demand- or labor-driven as it often is during inflationary periods, said Claudia Sahm, a former Fed economist and founder of Sahm Consulting.
"High inflation is not workers' fault, but the Fed is waging a war on US workers," Sahm said.
Lael Brainard, Federal Reserve Board vice chair, even acknowledged the roles of pricing and supply chain disruptions during a speech ★ this week before the National Association for Business Economics. Retail profit margins have increased 20% since the pandemic's onset, Brainard noted, roughly doubling the 9% increase in average hourly earnings by the sector's employees.
In the auto sector, margins for vehicles sold at dealerships have increased by more than 180% since February 2020 – about 10 times the rise in the sector's average hourly earnings, Brainard said.
"The return of retail margins to more normal levels could meaningfully help reduce inflationary pressures in some consumer goods," she added.
'Fatter margins'
An April analysis by the Economic Policy Institute, a progressive economic think tank, put numbers behind the theory that corporate pricing is an inflationary driver.
Prices have risen at an annualized rate of over 6% since 2020's second quarter compared with 1.8% during the pre-pandemic business cycle of 2007-2019. EPI broke prices in the non-financial corporate sector into three main components: labor costs, non-labor inputs and profit margins.
Over half of the Covid recovery era increase "can be attributed to fatter profit margins" while labor costs represented less than 8%, the report's author, Josh Bivens, wrote.
That's nearly an exact flip of what was seen in the decades leading up to Covid, the report found.
"Companies are taking higher inputs, putting a bigger markup on them than they were previously, then passing that on to customers," Bivens said.
An April Guardian analysis of 100 top corporations SEC filings found 80 had increased net profits between 2019 and the corresponding quarter in 2021 or 2022, while inflation had eaten into most workers' wage gains.
Skyrocketing demand for durable goods coupled with supply chain problems has created "enormous pricing power" for companies that had stock on hand, Bivens said. Typically corporations attempt to widen margins by suppressing wages, but that changed during the Covid recovery, he added.
The situation is ever-evolving. Wages are falling, which should mean people are buying less and eroding corporations' pricing power, Bivens said, and some supply chain issues are resolving themselves – the cost of some shipping containers is down by 64% from the same week last year.
The producer price index, which tracks business inputs cost, showed deflation in July and August. It increased by 0.4% in September, but with food and energy excluded, it remained flat.
"That also supports the profiteering theory," said Lindsay Owens, Groundwork Collaborative's executive director. "We see input costs cooling more than consumer prices and companies aren't giving that pricing back to the consumer, or at least not yet."
Companies should "eventually" pass lower input costs on to consumers, Sahm said as marking down prices is "a really good way to draw in customers". Moreover, shareholders could ultimately be shooting themselves in the foot by relentlessly pressuring companies to increase prices, she added.
But in earnings calls, at least some executives have said they are not yet ready to lower prices, and told shareholders they plan to keep prices high as long as customers absorb them.
"You're not going to see a lot of companies chasing volume by discounting prices," a Colgate executive told shareholders in July while assuring them prices will remain high for now.
How to lower inflation
Observers say few politically palatable quick fixes exist, especially around curbing corporate pricing power.
Many supply chain issue resolutions are geopolitically difficult, Sahm said, like the US push for a cap on Russian oil prices. The US could also ban oil exports to bring down the cost of fuel here, she added, but doing so would devastate Europe.
"The most important things we are doing right now to fight inflation are these geopolitical decisions: how do we get Russia out of Ukraine? How do we get Europe through the winter?" Sahm said.
The Biden administration's most meaningful step to address soaring energy costs has been a new plan to wield the Strategic Petroleum Reserve – the nation's reserve of crude oil – as a price control tool by effectively setting a floor and ceiling on the price of oil.
Petroleum companies have said they are intentionally keeping production low and prices high because shareholders lost so much money in recent years in the oil market's boom-bust cycles. The Biden plan aims to bring stability to the market and incentivize production increases.
Meanwhile, the US Department of Justice has launched a price fixing investigation into the meat packing industry, and new US Department of Agriculture rules are designed to promote competition in it. The bipartisan Chips Act and Ocean Shipping Reform Act could help ease some supply chain issues, observers say.
But such measures are far short of those taken or seriously discussed in Europe, where the EU and UK have instituted windfall taxes on oil, gas and clean energy companies' profits. Meanwhile, hard price caps seem to be more palatable as the EU heads into winter facing a natural gas crisis. Such measures simply do not have enough political support in the US.
The Fed is restricted to monetary policy and can't directly do anything about corporate pricing or supply chains, though Powell "could be more vocal" in public about the need for a holistic approach, Owens said. If the US and other central banks go at it alone, then consequences will likely be dire and reach around the world, she added.
"This could result in global recession, sovereign debt defaults, bankruptcies, et cetera, and we are quite concerned because we really haven't seen this movie before so we don't know how it ends," Owens said.
um but now for the main event um it's my distinct honor to welcome Vice chair lail Brainerd to the 64th nabe annual meeting the conference is titled shocks and aftershocks finding balance in an unstable world Dr Brainerd is undoubtedly and uniquely positioned to give perspective on this topic the many many luminous events in Dr brainerd's career are many and too many to list today but I thought I would just give you a a little smattering of some of those experiences a diplomat's daughter she spent a childhood in West Germany and Poland an undergraduate at Wesleyan University a PhD at Harvard and a professor at MIT an advisor to Bill Clinton including stewarding his policy and interactions with APEC NAFTA WTO and the G7 deputy director at the National Economic Council under Secretary of the Treasury for international Affairs during the Obama Administration and she joined the Federal Reserve Board in 2014 and this fine year she became vice chair please join me in welcoming Dr lail Brainerd foreign for the kind invitation and Lisa amspo Mattingly for the very kind introduction also just want to um as always give a nod to lavon's amazing work over the years and a shout out to the nape Scholars the Next Generation uh so nice that you can be here today and of course it's uh it's a great day to celebrate uh the Nobel prizes uh including uh for uh Ben Bernanke who um I think in the world of both research and practice put his work to uh to good use um it's it's um it's an interesting time inflation of course is high in the United States and around the world we've seen Global Supply chains easing considerably but there's still more constrained at nearly any time uh since the late 1990s at the Federal Reserve we have tightened policies strongly to bring inflation down and that tightening in the U.S is being Amplified by concurrent foreign tightening and we're starting to see the effect on some sectors but it's going to take some time for that cumulative tightening to transmit throughout the economy and for inflation to come down and of course uncertainty is high so I'm paying close attention to Global risk so let me take you through each of those in turn so higher interest rates are working to temper demand and bring it into better alignment with Supply which is still constrained output has decelerated this year by more than many had anticipated suggesting that policy tightening is having an effect real GDP declined at an annual pace of roughly one percent in the first half and over that same time period uh real pdfp private domestic final purchases stepped down from a 6.4 percent Pace uh in 2021 to an annual rate of only 1.3 percent during the first the first half recent revisions to the Nipa data imply that the current stock of excess savings held by households is lower and has been drawn down faster in recent quarters than had been estimated previously indeed by some board staff estimates the revisions imply that the stock of excess savings by households is about a quarter lower which may imply a more subdued pace of consumer spending going forward and of course Market expectations for the level of the policy rate at the end of the year are more than twice as high currently as they were just six months ago and as a result I expect the second half rebound will be limited and that real GDP growth will be essentially flat this year the moderation and demand due to monetary policy tightening is only partly realized so far the transmission of tighter policy is already quite evident and highly interest sensitive sectors like housing where mortgage rates have more than doubled year to date and housing price growth has fallen sharply as and is on track to be flat soon in other sectors lags and transmission mean that policy actions to date will have their full effect on activity in coming quarters and the effect on price setting may take longer the moderation and demand should be reinforced by the concurrent global tightening of monetary policy in the labor market we're seeing some tentative signs of rebalancing for the second month in a row growth in monthly payroll employment step down slowing by about 50 000 to 263 000 in September and in the jolts there was a sharp over 1 million decline in job openings from July to August the ratio of job openings to job Seekers has declined to 1.7 by comparison that ratio was about 1.2 prior to the pandemic the sharp fall in vacancies at a time when initial claims held steady at low levels provide some support for the possibility the businesses that face significant challenges finding and retaining qualified workers following the pandemic may be more inclined than in past Cycles to retain rather than layoff workers as demand softens in particular there's still a sizable 1.2 million shortfall in employment levels relative to pre-pandemic in the in-person services sectors and those are the sectors that accounted for the majority of September payroll gains suggesting businesses in those sectors may still be trying to catch up a variety of indicators suggest labor demand is still strong overall relative to labor Supply which in turn remains below pre-pandemic conditions the unemployment rate is is now the same very low level that prevailed prior to the pandemic and the volume of quits is elevated the supply demand imbalance in the labor market is reflected in strong wage growth so if you look at the ECI it increased by an annual rate of 6.3 percent over the second quarter its highest level in decades and of course we'll have a read on the third quarter soon a more timely data source the average hourly earnings decelerated slightly to 2 to 4.4 percent annual rate over the third quarter compared with 4.6 in the second quarter while well above levels consistent with two percent inflation wage growth nonetheless has been running well below current inflation strong wage growth along with high rental and housing costs mean that inflation from core Services is expected to ease only slowly from currently elevated levels in contrast core Goods have been expected to return to something closer to the pre-pandemic trend of modest disinflation as a result of demand rotating away from Goods coupled with the healing of Supply chains and declining or import prices of course that disinflation in core Goods would be very helpful in offsetting the inflationary pressures in services during the five years before The Crisis Core goods made a small negative contribution to inflation but that swung sharply into positive territory last year and had only started to step down somewhat in the middle of this year so I think the surprise in the August inflation data was the large contribution of core Goods inflation at a point in the post-pandemic recovery when many forecasts had anticipated this can this contribution would continue moderating since the pandemic significant supply and demand imbalances have coincided with large increases in retail trade margins in several good sectors in some sectors the increase in the retail trade margin exceeds the contemporaneous increase in wages paid to the workers uh in that sector although that's not true in food.
and apparel.
so the return of retail margins to more normal levels would meaningfully help reduce inflationary pressures in core Goods considering that gross retail margins are about 30 percent of total sales dollars overall so among general merchandise retailers for instance where the inventory to sales ratio is about 20 percent above pre-pandemic levels retail margins have increased about 20 percent since the onset of the pandemic that's more than twice the increase in average hourly earnings in contrast in the auto sector the the real inventory to sales ratio is still 20 below its pre-pandemic level and there we see the retail margin for Motor Vehicles sold at dealerships up by more than 180 percent since pre-pandemic and that's 10 times the level of the increase in wages within that sector so there is a lot of room for margin recompression to help reduce Goods inflation but that will depend on demand Cooling Supply constrain easing and inventories restocking despite the higher prices for a broad set of goods and services market and survey-based measures of longer-term inflation expectations are within ranges consistent with expectations that inflation will return to two percent over the medium term in order to bring inflation down and to keep those expectations solidly anchored at two percent the Federal Reserve has increased the federal funds rate target range by 300 basis points in the past seven months and both market and policy surveys indicate additional increases through the end of this year and into the early part of next year in addition balance sheet shrinkage is now proceeding at its maximum rate reinforcing the move to a restrictive stance broader U.S financial conditions have tightened rapidly in response the two-year treasury yield has moved above four percent for the first time since 2007 and the 10-year yield is near its highest level in over a decade and we see similar kinds of moves and corporate bond yields mortgage rates and the dollar monetary policy tightening is also preceding rapidly overseas many central banks and large economies have raised rates by 125 basis points or more over the last six months and yields on 10-year sovereign debt in a number of foreign large advanced economies saw increases on the order of 190 to 360 basis points this year the combined effect of concurrent Global tightening is larger than the sum of its parts we take into account the spillovers of higher interest rates a stronger dollar and weaker demand from foreign economies into the United States as well as in the reverse Direction I'm also very attentive to the risk of further adverse shocks for instance from Russia's war against Ukraine or China's zero covet policies or the pandemic and we're also very aware that the cross-border effect of unexpected movements in interest rates and exchange rates as well as worsening external imbalances in some cases could interact with financial vulnerabilities in this kind of environment a sharp decrease in Risk sentiment or other risk event that may be difficult to anticipate could be Amplified especially given fragile liquidity in core financial markets in some countries the realization of these risks could pose challenging trade-offs for policy that said the real yield curve is now in solidly positive territory at all but the very shortest maturities and the entire real yield Curve will soon move into positive territory with the additional tightening and deceleration and inflation that are broadly expected monetary policy will be restrictive for some time to ensure that inflation moves back to Target over time it will take time for the cumulative effect of tighter monetary policy to work through the economy broadly and to bring inflation down in light of elevated global economic and financial uncertainty moving forward deliberately and in a data dependent manner will enable us to learn how economic activity employment and inflation are adjusting to the cumulative tightening in order to inform our assessment of the path of the policy rate so let me wrap up there and we can turn to our discussion thank you foreign thank you um and I I do have this wonderful little app that we can use to send questions if you go into the name connect connect app you can send uh questions our way um and I think I will start it out with um a fascinating um panel that Elaine uh buffburg who's at GM hosted and I said it was she had actually curated it just for herself because it was about supply chain disruptions energy semiconductors and labor um and she said no it was uh Chad moutre who's uh the chief Economist for the National Association for manufacturers who had helped put the panel together but the my takeaway from that panel was wow Supply chains are disruptions are not probably going to go away the tight labor market is not going to go away anytime soon and and certainly monetary policy is a blunt instrument but um what do you hope to see on the supply chain front that will give you confidence that it's starting to work so it is a um a really unusual uh environment with constraints um on labor on Commodities on key intermediates such as semiconductors um all uh interacting uh in a sort of Perfect Storm um and so we're seeing we have seen just a less elastic Supply response than I think we had all become accustomed to over over several decades actually if you look at certain indicators things have gotten a great deal better shipping times have gotten a great deal better for instance but if you look at some metrics like the Federal Reserve Bank of New York index what you'll see there is a massive Spike and a massive easing to this point but the point where we are currently is still above just about every year with a three-month exception since the 9 1990 so it just gives a sense of how constrained things are of course in the labor market we are watching you know very um carefully uh in in terms of prime age workers we have seen you know month to month there's volatility but we have seen a big Improvement in labor force participation over the course of this year we're within um you know about 30 basis points about 0.3 percentage Point um of where we were pre-pandemic but if you look at labor force participation more generally we do have um a large number of early excess retirements retirements that were not earlier projected in the um uh in the pre-pandemic trend um and it's hard to see um we just don't know how many of those people there's a very substantial number above 2 million how many of those are likely to return um to the labor force of course there were also pandemic related restrictions associated with immigration so you also have a very large number of people that might have been anticipated um as uh immigration flows um had they been at normal levels so probably we'll continue to see um labor Supply um we're sort of below a pre-pandemic for some time and what do we look at um of course if you look across inflation core peace or headline PC inflation you know about a third of that um sorry the the overall um you know what is it like six uh six six and a quarter um the most recent monthly about a third of that is food and energy that is almost entirely associated with Russia's war against Ukraine so further shocks quite possible there um then we see um you know an another large amount that's in-person services so that's about a third there I think the labor Supply question that I was talking about earlier how many people come back into those sectors and how much wages um continue to uh grow there um and then the remaining third you might divide between housing which is a little sticky and there too you know you had a big demand shock with work from home so uh there too we had a big Distortion um and so mortgage rates should help to cool demand there and the remaining uh about a little more than a sixth is for goods and and we were talking about that earlier where we still have Supply constraints interacting with low inventories the sales ratio and and high margins right um so throughout our careers we've heard had a lot of handbringing over what has been called the Dual the the Dual deficits uh here in the U.S the current account and the fiscal deficit um if anything we're seeing a strong dollar Dynamic that doesn't seem to be an issue however should we watch with caution the experiences the UK has been experiencing and are there any takeaways for us coming out of the UK well I'd certainly say the Dual deficit story has now been um uh you know a good story for this cycle um the first we did see um a very strong fiscal support during the pandemic um but actually we saw some of that saved um so we didn't see that in a corresponding uh big increase in the current account deficit and likewise we've seen um as some of that's gotten spent out we've actually seen an increase in government savings so it's just worked um quite differently I think than we've seen previously um and and the current account has not been moving in the same direction um that said of course um there are really important just basic principles that we probably think would be wise to follow and you know one is um right now um inflation is a very significant um challenge for all Americans particularly low-income Americans who spend three quarters of their incomes just on on Necessities um and so we should have a you know very strong consistent uh set of policies that are focused on that you know we know what we need to do at the Federal Reserve and the more you have policy consistency policies working in the same direction you know the more um I think you'll see that process working um so on the other side of that strong U.S dollar our trade Partners Japan the UK China the Eurozone um and we have seen central banks start to intervene um in their markets um to offset that rapid rise in the dollar how is the Fed communicating and monitoring the impact of our monetary policy to our trade partners so we are very aware that we operate in a global economy in a Global Financial system we recognize uh you know very uh very uh much that um Financial conditions in the U.S transmit uh abroad um and uh that uh currency appreciation um where well it may be um disinflationary for the dollar to be stronger the the other side of that picture um is that some economies who may also be uh working to contain inflation may be getting some inflationary pressures we um stay in very close contact UM with uh certainly with uh central banks around the world um and I think generally uh we all you know with a few a notable exceptions most central banks are united in uh the fight against High inflation and so most important there is just being transparent um predictable about what policies we're going to undertake to combat inflation and I think that's generally appreciated we also um have regular interactions with financial stability authorities around the world where we try to think about what those amplification channels cross-border in particular might be um and we also have fora in which monetary policy and fiscal policy officials talk and so you know we are very aware of and also um you know sort of I we a lot of communicate uh U.S policies and potential Transmissions um so now I'm going to start asking questions from the audience that have been upvoted so you if you want to get angry at at me don't get angry at me um uh so uh uh given long and variable policy lags how do you calibrate the risks of the FED over tightening we are very cognizant um of you know uh past history um and you know we're aware um that there are different kinds of risks in a tightening cycle and the kinds of environment that we see currently especially where Supply Supply disruptions have been prominent um there's a really important risk that inflation expectation um could start to flip and that would make the task of bringing inflation down much harder so we've been very focused on making sure inflation expectations remain anchored and it's clear that our policies are going to bring inflation down and it's uh clear that monetary policy will be restrictive for some time there is a risk as we saw in the 1970s of uh easing prematurely and so that's why it's it's very important for us to be cognizant of that but at some point risks could become more two-sided um and there too you know we have to be cognizant of those risks and so there I would say um that by moving in um a data um uh informed uh data dependent uh and deliberate way it allows us to learn about how the tightening that we're seeing here abroad and in financial markets is affecting inflation employment and activity more generally and to take into account Global risks in order to calibrate the path of policy you brought up a very interesting point which is um the the scenario from the 1970s which was easing too early um and so it loud and clear data dependent um what are some of the Sentinel data points that you're going to be looking for to tell you that you have gotten inflation under control yeah so in an environment like this where you know you have um a more complicated supply side of the economy with all the constraints that we talked about earlier Commodities um labor Goods we just need to be cognizant of a much broader set of a bigger dashboard of data if you will so of course I'm looking at the most interest sensitive sectors uh the you know to see those early signs and as I said earlier you can really see the effect of higher mortgage rates on the housing market it's moving very rapidly but of course we're also looking across less interest rate um uh sensitive sectors like core Services um and uh sort of looking very much to see what kinds of demand Dynamics we might see there as well as wage setting Dynamics so we're really looking across the full gamut I'm looking very much at inflation expectations I think you know we had seen some deterioration there those now look really firmly anchored back in ranges that were characteristic of pre-pandemic and of course financial markets to make sure that Financial conditions are consistent with what we think the likely uh path of policy is right um so there's there's a question which is sort of like you get to to pick your your favorite cause of uh the global inflation that we're seeing is it is it the covet shocks is it the supply chain is it um uh you you mentioned actually excess savings um uh is it the labor market what what is the core driver of the inflation that we're seeing yeah so I don't think this is a simple uh inflationary Dynamic um what we saw was a sequence of very severe Supply shocks um uh stemming initially from the pandemic um and then greatly compounded by the war um that Russia um has uh has pursued against uh Ukraine and the difficulty in that kind of environment where you see um a lengthy sequence of Supply shocks is that consumers and businesses might get accustomed to seeing higher inflation might start to change their price setting Behavior their wage setting Behavior so I think I wouldn't actually say there's a single uh cause here it was a combination of high demand along with a very protracted series of in some cases unrelated Supply shocks that brought us to the very complicated place that we are at today and I'd also say that you know if you look across most of the foreign large foreign economies inflation is high throughout even though the mix in each of those economies might be slightly different and the introduction of QE following the global financial crisis helped stabilize the fixed income markets and the disabled financial sector QE was again re-initiated in response to the dramatic dislocations we experienced during the covet shock lockdowns um today the pace of QT has begun to accelerate what are you watching watching what are you monitoring to see if QT is progressing if it's doing what you wanted to do and if there are any concerns on the QT front yeah so I think um as we shrink the balance sheet um you know we have uh agreed a plan that will allow treasury Securities to roll off at about twice the pace of the previous episode of quantitative tightening um and MBS a little bit a little bit less than than twice and we expect that balance sheet shrinkage to reinforce um the tightening cycle um and uh the effect of the increase in the policy rate but of course um we also recognize that liquidity is um a little fragile in core markets and so we're carefully monitoring liquidity conditions in those markets um you know we have now um One path uh full cycle to look back on which of course we didn't when we initiated QT the last time so that's very helpful and so I think we're better equipped with the particular market indicators that might have given us some signal last time around as we get a little bit closer to you know that ample reserves regime kind of um uh sort of stabilizing point but that's that's some distance in the future but we are working very we are watching very carefully as we go all right um so I'm going to ask a question that came from the audience and got upvoted and I'm going to add a little bit of a an addition to it the sep suggests that the fomc participants are comfortable with the terminal rate and the four and a half percent range what developments in financial conditions specifically would lead you to believe four and a half might be too high but too too high or too low um uh and actually I'll let you if you don't want to answer it that's fine but so um you know I think um that uh the summary of economic projections um represents um you know all the members of the committee's best effort to write down um a forecast um that's consistent with their projected policy path at any point in time and then of course you know what you look at is the median of that um and most of the people in this room also write down forecasts um so you know that those are you know very well informed by all the data to date as well as historical relationships um but things can change um and so uh while you know there's um Clarity that monetary policy um will be restrictive for some time until there's confidence about inflation coming down um and the committee has has taken um quite a quite strong action um and the Committees uh said that the policy rate will increase race further we also will be learning as we go and that assessment will reflect incoming data and you know the sort of balance of risks uh domestically and globally so I think it's a it's very uh helpful at a point in time to get a sense of you know where members kind of project the policy path to be going but it's also helpful to remember that the actual policy path will be data dependent so president Evans gave us a little bit of his view on this question um but as we went to the zero bound we introduced forward guidance to sort of create a more stimulative monetary policy despite hitting that zero bound now we're clearly off that zero bound um is the set something we should continue to do is it is it doing what you wanted to do um I won't tell you what president Evans said foreign you know I think it is important to distinguish between um the SCP um which is again uh individual members forecast um and um and forward guidance um again you know we are um we're moving um in a deliberate way and in a data dependent way and so you know we we are going to continue taking into account um how the economy is evolving um what's happening with inflation what's happening with the labor market as we go um so in that sense um you know I think uh there's been clarity about what our goals are um and our resolve and we've taken really strong action and shown that resolve inflation uh is going to come back to two percent we're going to take necessary actions um to get it there um but in terms of exactly what the path of policy is that's something that in my mind will benefit um from the incoming data as well as you know a sense of uh ongoing evolution of risks in an environment where I think uncertainty is clearly very high absolutely um we've been through quite a bit over the last dozen years we've had we've had covid we've had a repo event we've had lots and lots of shocks to the system how do you think the reforms that were implemented following the GFC are doing well um so critically important I think that um the resilience in the banking sector was greatly improved following um the great financial crisis um and you've seen the benefit of that as we've been able to um stress test Banks throughout pandemic and now of course um uh coming into a more period and that has I think both helped with Market transparency but also just the resilience of liquidity and capital at the core financial institutions the banks now we have seen um more um Financial amplification outside of the core banking system so you know the nbfi sector was a huge source of amplification both in the GFC and in the pandemic stress period And so reforms there I think are ongoing but certainly the visibility had improved somewhat um and the cooperation among authorities across borders and in the U.S across multiple Regulators had improved a lot so you know I think what it suggested was we had made some really important progress particularly on resilience in the banking system but we still have work to do and particularly outside of the mbfi sector and including the most opaque parts of that sector right um so sticky inflation um one of them one of the biggest stickiest parts of inflation is rent um and we are starting to see some significant slowdowns in the housing market house prices um maybe even some inflection points on um on on high frequency rent indicators what are your thoughts on um that part of inflation um coupled with maybe some of the challenges that might rise as we start to see some difficulties in the housing market yeah so um that um uh that the housing part of core Services I generally anticipate will be sticky and in general um just based on past patterns um expect for services to be a sort of bigger contributor to inflation um you know in this in this period and so that's why the focus on poor Goods would be so great uh to see core Goods um playing more disinflationary role um you know which which it could well do given um that core import prices um will help out put a bit there um and inventories are starting to get better but um but within housing I think the Dynamics that you just talked about are exactly right so mortgage rates have gone up a lot and house prices um are you know growing more slowly and will soon are likely on aggregate to to be flat um and in those parts of the country you saw the biggest um house uh house price appreciation we've actually seen some declines what that means for rents though is a little bit complicated because some people who you know might be first-time homebuyers with these mortgage rates are you know not perhaps going to be renting longer um so you might see some additional demand there um and uh as you said while high frequency indicators of of rent um you know may be starting to see a bit of a Slowdown which will be really important um average rents take longer because those uh those rents are only renegotiated slowly so it's we assume there's going to be some stickiness um in that Housing Services portion obviously not as big for pce as for CPI but that's why it's important to see some um you know some less pressure elsewhere so just following on on the housing market and and actually this is the commercial MBS Market um there's a question does stress in the commercial MBS Market due to higher rates cause concern for proceeding with balance sheet reduction yeah so I think um um feel pretty good then has um gotten off the ground so far um and of course we're monitoring those markets um very closely as I mentioned earlier we have a dashboard of indicators that we thought um you know were particularly with the benefit of hindsight valuable in the first episode of QT so we're monitoring that dashboard really quickly um really closely so my sense is you know so far um we're seeing uh the kind of absorption that you would wish to see but we are aware um that you know this is a moment where liquidity is somewhat strange and so we're we're going to remain alert to that possibility foreign the fed's regulatory stress testing scenarios do not feature stagflationary scenarios what do we know about our financial systems resilience to such outcomes yeah so I would say that first of all we have done a whole variety of different um scenarios over the years and we did have a bit of that flavor in the 2018 stress test we learned a lot from those stress tests in 2018. um the other thing is that you know we have the ability to do kind of top-down exercises that are more just to inform ourselves what environments might be more difficult for banking system resilience than others and so we're able to look at a variety of different kinds of environments in in that and we do um and you know I think that is uh the kind of an environment where you see um you know interest rates going up by a lot more than expected and Rising credit losses is a complicated environment with some offsetting effects depending on the business model of the bank but we certainly um you know we certainly want to be aware of how that would play out and so we do a bunch of internal analysis to just make sure we're we understand how different environments could affect different kinds of institutions so fair or not some people have been dusting off their analysis of the 1970s to try to get a sense of what can the Central Bank do Etc and certainly there's a lot of uh talking about uh Paul volcker and what Paul volcker did a question I would have is given the debt levels today in the U.S economy can we do can we have another Volker fed with the debt dynamics that we have today yeah so I think when we think about um the 1970s um and then the 1980s importantly I think there are a variety of um important um differences and lessons um and and I'll get to the debt point in a second but you know what's different now well first of all I think there's a general um understanding uh that monetary policy has both the capacity and the responsibility to get inflation down that wasn't clear when uh the inflationary shocks happened in the 1970s it's a very widely accepted tenant and we certainly um you know we we take it very very seriously that we have the resolves at the resolve and the tools another huge difference um is uh that um inflation expectations were unanchored in the 1970s and so you saw some really um some really uh toxic um uh dynamics of high inflation becoming entrenched and leading to higher of inflation again we carefully carefully monitor a whole variety of measures of inflation expectations you know and we have seen those moving to ranges that were um you know prevalent prior to the pandemic which suggests that you know there is an understanding out there that inflation is going to come back down um so those are those are enormous uh advantages that I think uh will help with the fight against inflation today in terms of debt levels I mean one of the interesting things uh that's different about this stress period the pandemic then perhaps past Cycles is that a lot of the fiscal support was actually used in ways that improved both business balance sheets and household balance sheets so coming into this tightening period you actually have healthier household balance sheets and businesses that have better debt servicing on average and so that gives us a bit of a better starting point than you might have seen otherwise because obviously those credit Aggregates are very important for thinking about potential Financial stability complications so if we think about the U.S corporate sector today they are pretty close to Peak profitability as a share of of U.S GDP and income and the capex levels that we've seen out of the corporate sector is actually pretty pretty close to you know all-time lows um do you think that the corporate sector is going to be investing reinvesting to address some of the shortages some of the labor market tightness Etc going forward well so there I think um obviously in a rising interest rate environment there's um it makes it more difficult for some of those Capital plans to be execute on so we recognize there's that macro effect but when we talk to businesses in different sectors at kind of the micro level there's a lot of really interesting investment that is going on some of it uh supported um for instance you know the semiconductor area and the energy transition area both you know supported by recent changes um in in law so you know my sense is there are areas where there's tremendous uh interest and over a longer period of time you know you'll see quite quite fundamental and important Investments that will go to some of the challenges that the nation clearly faced during this last period both on the energy front on the climate front and on key intermediate inputs to end this discussion thinking about total Factor productivity and how wonderful it is for the U.S economy and the wonderful role that the central bank bank plays in making sure that we stay on that path so thank you very much for taking some time with us thank you.
um but now for the main event um it's my distinct honor to welcome Vice chair lail Brainerd to the 64th 0:08 nabe annual meeting the conference is titled shocks and aftershocks finding balance in an 0:15 unstable world Dr Brainerd is undoubtedly and uniquely 0:22 positioned to give perspective on this topic the many many luminous events in Dr 0:28 brainerd's career are many and too many to list today but I thought I would just 0:34 give you a a little smattering of some of those experiences 0:40 a diplomat's daughter she spent a childhood in West Germany and Poland an 0:47 undergraduate at Wesleyan University a PhD at Harvard and a professor at MIT 0:55 an advisor to Bill Clinton including stewarding his policy and interactions 1:00 with APEC NAFTA WTO and the G7 1:05 deputy director at the National Economic Council under Secretary of the Treasury 1:11 for international Affairs during the Obama Administration and she joined the Federal Reserve Board in 2014 and this 1:19 fine year she became vice chair please join me in welcoming Dr lail Brainerd 1:39 foreign 1:51 for the kind invitation and Lisa amspo Mattingly for the very kind introduction 1:57 also just want to um as always give a nod to lavon's amazing work over the 2:03 years and a shout out to the nape Scholars the Next Generation uh so nice 2:09 that you can be here today and of course it's uh it's a great day to celebrate uh 2:15 the Nobel prizes uh including uh for uh Ben Bernanke who 2:21 um I think in the world of both research and practice put his work to uh to good 2:27 use um it's it's um it's an interesting time inflation of 2:33 course is high in the United States and around the world we've seen Global 2:38 Supply chains easing considerably but there's still more constrained at nearly 2:44 any time uh since the late 1990s at the Federal Reserve we have tightened 2:50 policies strongly to bring inflation down and that tightening in the U.S is being Amplified by concurrent foreign 2:57 tightening and we're starting to see the effect on some sectors but it's going to take some time for that cumulative 3:03 tightening to transmit throughout the economy and for inflation to come down and of course uncertainty is high so I'm 3:10 paying close attention to Global risk so let me take you through each of those in turn 3:15 so higher interest rates are working to temper demand and bring it into better alignment with Supply which is still 3:23 constrained output has decelerated this year by more than many had anticipated 3:28 suggesting that policy tightening is having an effect real GDP declined at an annual pace of 3:36 roughly one percent in the first half and over that same time period uh real 3:41 pdfp private domestic final purchases stepped down from a 6.4 percent Pace uh 3:49 in 2021 to an annual rate of only 1.3 percent during the first the first half 3:55 recent revisions to the Nipa data imply that the current stock of excess savings 4:01 held by households is lower and has been drawn down faster in recent quarters 4:06 than had been estimated previously indeed by some board staff estimates the 4:12 revisions imply that the stock of excess savings by households is about a quarter lower which may imply a more subdued 4:20 pace of consumer spending going forward and of course Market expectations for 4:25 the level of the policy rate at the end of the year are more than twice as high currently as they were just six months 4:31 ago and as a result I expect the second half rebound will be limited and that real 4:37 GDP growth will be essentially flat this year the moderation and demand due to 4:43 monetary policy tightening is only partly realized so far the transmission of tighter policy is already quite 4:51 evident and highly interest sensitive sectors like housing where mortgage 4:56 rates have more than doubled year to date and housing price growth has fallen 5:02 sharply as and is on track to be flat soon in other sectors lags and 5:08 transmission mean that policy actions to date will have their full effect on activity in coming quarters and the 5:14 effect on price setting may take longer the moderation and demand should be reinforced by the concurrent global 5:22 tightening of monetary policy in the labor market we're seeing some 5:27 tentative signs of rebalancing for the second month in a row growth in monthly payroll employment step down 5:35 slowing by about 50 000 to 263 000 in September and in the jolts there was a 5:42 sharp over 1 million decline in job openings from July to August the ratio 5:48 of job openings to job Seekers has declined to 1.7 by comparison that ratio 5:55 was about 1.2 prior to the pandemic the sharp fall in vacancies at a time 6:00 when initial claims held steady at low levels provide some support for the 6:06 possibility the businesses that face significant challenges finding and retaining 6:13 qualified workers following the pandemic may be more inclined than in past Cycles to retain rather than layoff workers as 6:22 demand softens in particular there's still a sizable 1.2 million shortfall in employment 6:30 levels relative to pre-pandemic in the in-person services sectors and those are 6:35 the sectors that accounted for the majority of September payroll gains suggesting businesses in those sectors 6:40 may still be trying to catch up a variety of indicators suggest labor 6:47 demand is still strong overall relative to labor Supply which in turn remains 6:52 below pre-pandemic conditions the unemployment rate is is now the same 6:58 very low level that prevailed prior to the pandemic and the volume of quits is 7:03 elevated the supply demand imbalance in the labor market is reflected in strong wage 7:09 growth so if you look at the ECI it increased by an annual rate of 6.3 7:14 percent over the second quarter its highest level in decades and of course we'll have a read on the third quarter 7:20 soon a more timely data source the average hourly earnings decelerated 7:27 slightly to 2 to 4.4 percent annual rate over the third quarter compared with 4.6 7:33 in the second quarter while well above levels consistent with 7:38 two percent inflation wage growth nonetheless has been running well below 7:44 current inflation strong wage growth along with high rental and housing costs mean that 7:51 inflation from core Services is expected to ease only slowly from currently elevated levels 7:57 in contrast core Goods have been expected to return to something closer 8:02 to the pre-pandemic trend of modest disinflation as a result of demand 8:07 rotating away from Goods coupled with the healing of Supply chains and declining or import prices 8:14 of course that disinflation in core Goods would be very helpful in offsetting the inflationary pressures in 8:21 services during the five years before The Crisis Core goods made a small negative 8:26 contribution to inflation but that swung sharply into positive territory last 8:33 year and had only started to step down somewhat in the middle of this year so I think the surprise in the August 8:40 inflation data was the large contribution of core Goods inflation at a point in the post-pandemic recovery 8:46 when many forecasts had anticipated this can this contribution would continue moderating 8:53 since the pandemic significant supply and demand imbalances have coincided 8:58 with large increases in retail trade margins in several good sectors in some 9:03 sectors the increase in the retail trade margin exceeds the contemporaneous increase in wages paid to the workers uh
9:11 in that sector although that's not true in food and apparel so the return of retail margins to more 9:17 normal levels would meaningfully help reduce inflationary pressures in core Goods considering that gross retail 9:24 margins are about 30 percent of total sales dollars overall so among general 9:30 merchandise retailers for instance where the inventory to sales ratio is about 20 percent above pre-pandemic levels retail 9:37 margins have increased about 20 percent since the onset of the pandemic that's more than twice the increase in average 9:44 hourly earnings in contrast in the auto sector the the real inventory to sales 9:50 ratio is still 20 below its pre-pandemic level and there we see the retail margin 9:56 for Motor Vehicles sold at dealerships up by more than 180 percent since 10:01 pre-pandemic and that's 10 times the level of the increase in wages within that sector so there is a lot of room 10:07 for margin recompression to help reduce Goods inflation but that will depend on 10:13 demand Cooling Supply constrain easing and inventories restocking 10:18 despite the higher prices for a broad set of goods and services market and 10:24 survey-based measures of longer-term inflation expectations are within ranges consistent with expectations that 10:30 inflation will return to two percent over the medium term in order to bring inflation down and to 10:38 keep those expectations solidly anchored at two percent the Federal Reserve has 10:43 increased the federal funds rate target range by 300 basis points in the past seven months and both market and policy 10:51 surveys indicate additional increases through the end of this year and into the early part of next year in addition 10:58 balance sheet shrinkage is now proceeding at its maximum rate reinforcing the move to a restrictive 11:03 stance broader U.S financial conditions have tightened rapidly in response the 11:08 two-year treasury yield has moved above four percent for the first time since 2007 and the 10-year yield is near its 11:15 highest level in over a decade and we see similar kinds of moves and corporate 11:21 bond yields mortgage rates and the dollar monetary policy tightening is also 11:26 preceding rapidly overseas many central banks and large economies have raised 11:32 rates by 125 basis points or more over the last six months and yields on 10-year sovereign debt in a number of 11:38 foreign large advanced economies saw increases on the order of 190 to 360 11:43 basis points this year the combined effect of concurrent Global 11:49 tightening is larger than the sum of its parts we take into account the spillovers of 11:54 higher interest rates a stronger dollar and weaker demand from foreign economies into the United States as well as in the 12:02 reverse Direction I'm also very attentive to the risk of 12:07 further adverse shocks for instance from Russia's war against Ukraine or China's 12:13 zero covet policies or the pandemic and we're also very aware that the cross-border effect of unexpected 12:20 movements in interest rates and exchange rates as well as worsening external imbalances in some cases could interact 12:27 with financial vulnerabilities in this kind of environment a sharp decrease in 12:32 Risk sentiment or other risk event that may be difficult to anticipate could be Amplified especially given fragile 12:39 liquidity in core financial markets in some countries the realization of these 12:45 risks could pose challenging trade-offs for policy that said the real yield curve is now in 12:51 solidly positive territory at all but the very shortest maturities and the entire real yield Curve will soon move 12:58 into positive territory with the additional tightening and deceleration and inflation that are broadly expected 13:03 monetary policy will be restrictive for some time to ensure that inflation moves 13:08 back to Target over time it will take time for the cumulative effect of tighter monetary policy to 13:15 work through the economy broadly and to bring inflation down in light of elevated global economic and 13:21 financial uncertainty moving forward deliberately and in a data dependent manner will enable us to learn how 13:28 economic activity employment and inflation are adjusting to the cumulative tightening in order to inform 13:34 our assessment of the path of the policy rate so let me wrap up there and we can turn to our discussion thank you 13:42 foreign 13:52 thank you um and I I do have this wonderful little app that we can use to send questions if 13:59 you go into the name connect connect app you can send uh questions our way 14:06 um and I think I will start it out with um a fascinating 14:11 um panel that Elaine uh buffburg who's at GM hosted and I said it was she had 14:18 actually curated it just for herself because it was about supply chain disruptions energy 14:25 semiconductors and labor um and she said no it was uh Chad moutre 14:31 who's uh the chief Economist for the National Association for manufacturers who had helped put the panel together 14:37 but the my takeaway from that panel was wow Supply chains are disruptions are 14:44 not probably going to go away the tight labor market is not going to go away anytime soon 14:51 and and certainly monetary policy is a blunt instrument but 14:57 um what do you hope to see on the supply chain front that will give you 15:02 confidence that it's starting to work so it is a um a really unusual uh 15:09 environment with constraints um on labor on Commodities on key 15:15 intermediates such as semiconductors um all uh interacting uh in a sort of 15:22 Perfect Storm um and so we're seeing we have seen just a less elastic Supply response than I 15:29 think we had all become accustomed to over over several decades actually if you look at certain indicators things 15:36 have gotten a great deal better shipping times have gotten a great deal better for instance but if you look at some 15:43 metrics like the Federal Reserve Bank of New York index what you'll see there is 15:49 a massive Spike and a massive easing to 15:55 this point but the point where we are currently is still above just about every year with a three-month exception 16:04 since the 9 1990 so it just gives a sense of how constrained things are of 16:10 course in the labor market we are watching you know very um carefully uh in in terms of prime age 16:18 workers we have seen you know month to month there's volatility but we have seen a big Improvement in labor force 16:24 participation over the course of this year we're within um you know about 30 basis points about 16:30 0.3 percentage Point um of where we were pre-pandemic but if you look at labor force participation 16:36 more generally we do have um a large number of early excess 16:44 retirements retirements that were not earlier projected in the um uh in the 16:50 pre-pandemic trend um and it's hard to see um we just don't know how many of those 16:57 people there's a very substantial number above 2 million how many of those are likely to return 17:02 um to the labor force of course there were also pandemic related restrictions associated with immigration so you also 17:09 have a very large number of people that might have been anticipated 17:14 um as uh immigration flows um had they been at normal levels so 17:20 probably we'll continue to see um labor Supply um we're sort of below a pre-pandemic 17:28 for some time and what do we look at um of course if you look across 17:34 inflation core peace or headline PC inflation you know about a third of that 17:41 um sorry the the overall um you know what is it like six uh six 17:46 six and a quarter um the most recent monthly about a third 17:51 of that is food and energy that is almost entirely associated with Russia's 17:58 war against Ukraine so further shocks quite possible there um then we see 18:04 um you know an another large amount that's in-person services so that's 18:10 about a third there I think the labor Supply question that I was talking about earlier how many people come back into 18:16 those sectors and how much wages um continue to uh grow there 18:23 um and then the remaining third you might divide between housing which is a little sticky and there too you know you 18:29 had a big demand shock with work from home so uh there too we had a big 18:34 Distortion um and so mortgage rates should help to cool demand there 18:40 and the remaining uh about a little more than a sixth is for goods and and we 18:46 were talking about that earlier where we still have Supply constraints interacting with low inventories the 18:52 sales ratio and and high margins right 18:57 um so throughout our careers we've heard had a lot of handbringing over what has 19:03 been called the Dual the the Dual deficits uh here in the U.S the current account and the fiscal deficit 19:10 um if anything we're seeing a strong dollar Dynamic that doesn't seem to be an issue however should we 19:18 watch with caution the experiences the UK has been experiencing and are there 19:23 any takeaways for us coming out of the UK well I'd certainly say the Dual deficit 19:29 story has now been um uh you know a good story for this 19:35 cycle um the first we did see um a very strong fiscal support during 19:40 the pandemic um but actually we saw some of that saved um so we didn't see that in a 19:45 corresponding uh big increase in the current account deficit and likewise 19:51 we've seen um as some of that's gotten spent out we've actually seen an increase in 19:56 government savings so it's just worked um quite differently I think than we've seen previously 20:03 um and and the current account has not been moving in the same direction 20:08 um that said of course um there are really important just basic 20:13 principles that we probably think would be wise to follow and you know one is 20:20 um right now um inflation is a very significant 20:25 um challenge for all Americans particularly low-income Americans who spend 20:30 three quarters of their incomes just on on Necessities um and so we should have a you know very 20:37 strong consistent uh set of policies that are focused on that you know we 20:42 know what we need to do at the Federal Reserve and the more you have policy consistency policies working in the same 20:48 direction you know the more um I think you'll see that process working 20:55 um so on the other side of that strong U.S dollar our trade Partners Japan the 21:01 UK China the Eurozone um and we have seen central banks start to intervene um in their markets um to 21:08 offset that rapid rise in the dollar how is the Fed communicating and monitoring 21:13 the impact of our monetary policy to our trade partners so we are 21:20 very aware that we operate in a global 21:25 economy in a Global Financial system we recognize uh you know very uh very uh 21:34 much that um Financial conditions in the U.S transmit uh abroad 21:41 um and uh that uh currency appreciation 21:47 um where well it may be um disinflationary for the dollar to be 21:52 stronger the the other side of that picture um is that some economies who may also 21:58 be uh working to contain inflation may be getting some inflationary pressures we 22:05 um stay in very close contact UM with uh certainly with uh central banks around the world 22:11 um and I think generally uh we all you know with a few a notable exceptions 22:17 most central banks are united in uh the fight against High inflation and so most 22:24 important there is just being transparent um predictable about what policies we're 22:29 going to undertake to combat inflation and I think that's generally appreciated we also 22:36 um have regular interactions with financial stability authorities around the world where we try to think about 22:41 what those amplification channels cross-border in particular might be um and we also have fora in which 22:48 monetary policy and fiscal policy officials talk and so you know we are 22:54 very aware of and also um you know sort of I we a lot of 23:00 communicate uh U.S policies and potential Transmissions 23:07 um so now I'm going to start asking questions from the audience that have been upvoted so you if you want to get 23:12 angry at at me don't get angry at me um uh 23:18 so uh uh given long and variable policy lags how do you calibrate the risks of 23:25 the FED over tightening we are very cognizant 23:31 um of you know uh past history um and you know we're aware 23:38 um that there are different kinds of risks in a tightening cycle and the kinds of environment that we see 23:43 currently especially where Supply Supply disruptions have been prominent 23:49 um there's a really important risk that inflation expectation 23:55 um could start to flip and that would make the task of bringing inflation down 24:01 much harder so we've been very focused on making sure inflation expectations 24:07 remain anchored and it's clear that our policies are going to bring inflation 24:12 down and it's uh clear that monetary policy will be restrictive for some time 24:20 there is a risk as we saw in the 1970s of uh easing prematurely and so that's 24:29 why it's it's very important for us to be cognizant of that but at some point 24:34 risks could become more two-sided um and there too you know we have to be 24:40 cognizant of those risks and so there I would say um that by moving in 24:47 um a data um uh informed uh data dependent uh and 24:55 deliberate way it allows us to learn about how the tightening that we're 25:02 seeing here abroad and in financial markets is affecting inflation 25:07 employment and activity more generally and to take into account Global risks in 25:13 order to calibrate the path of policy you brought up a very interesting point 25:19 which is um the the scenario from the 1970s which was easing too early 25:26 um and so it loud and clear data dependent 25:31 um what are some of the Sentinel data points that you're going to be looking for to tell you that you have gotten 25:38 inflation under control yeah so in an environment like this where you know you 25:43 have um a more complicated supply side of the economy with all the constraints that we 25:49 talked about earlier Commodities um labor Goods we just need to be 25:56 cognizant of a much broader set of a bigger dashboard of data if you will so 26:02 of course I'm looking at the most interest sensitive sectors uh the you 26:07 know to see those early signs and as I said earlier you can really see the effect of higher mortgage rates on the 26:14 housing market it's moving very rapidly but of course we're also looking across less interest rate 26:20 um uh sensitive sectors like core Services um and uh sort of looking very much to 26:28 see what kinds of demand Dynamics we might see there as well as wage setting 26:34 Dynamics so we're really looking across the full gamut I'm looking very much at 26:40 inflation expectations I think you know we had seen some deterioration there those now look really firmly anchored 26:48 back in ranges that were characteristic of pre-pandemic and of course financial 26:54 markets to make sure that Financial conditions are consistent with what we think the likely uh path of policy is 27:03 right um so there's there's a question which is sort of like you get to to pick your 27:10 your favorite cause of uh the global inflation that we're seeing is it is it 27:15 the covet shocks is it the supply chain is it um uh you you mentioned actually excess 27:22 savings um uh is it the labor market what what is the core driver of the inflation that 27:29 we're seeing yeah so I don't think this is a simple uh inflationary Dynamic 27:35 um what we saw was a sequence of very 27:40 severe Supply shocks um uh stemming initially from the pandemic 27:46 um and then greatly compounded by the war um that Russia um has uh has pursued 27:53 against uh Ukraine and the difficulty in that kind of environment where you see 27:58 um a lengthy sequence of Supply shocks is that consumers and businesses might 28:06 get accustomed to seeing higher inflation might start to change their price setting Behavior their wage 28:13 setting Behavior so I think I wouldn't actually say there's a single uh cause here it was a combination of high demand 28:21 along with a very protracted series of in some cases unrelated Supply shocks 28:26 that brought us to the very complicated place that we are at today and I'd also 28:31 say that you know if you look across most of the foreign large foreign 28:37 economies inflation is high throughout even though the mix in each of those 28:42 economies might be slightly different and the introduction of QE following the 28:49 global financial crisis helped stabilize the fixed income markets and the disabled financial sector QE was again 28:57 re-initiated in response to the dramatic dislocations we experienced during the covet shock lockdowns 29:04 um today the pace of QT has begun to accelerate what are you watching watching what are you monitoring to see 29:12 if QT is progressing if it's doing what you wanted to do and if there are any 29:18 concerns on the QT front yeah so I think um as we shrink the balance sheet 29:26 um you know we have uh agreed a plan that will allow treasury Securities to 29:33 roll off at about twice the pace of the previous episode of quantitative 29:38 tightening um and MBS a little bit a little bit less than than twice and we expect that 29:48 balance sheet shrinkage to reinforce um the tightening cycle 29:53 um and uh the effect of the increase in the policy rate but of course 30:00 um we also recognize that liquidity is um a little fragile in core markets and 30:06 so we're carefully monitoring liquidity conditions in those markets 30:11 um you know we have now um One path uh full cycle to look back 30:17 on which of course we didn't when we initiated QT the last time so that's very helpful and so I think we're better 30:25 equipped with the particular market indicators 30:30 that might have given us some signal last time around as we get a little bit 30:36 closer to you know that ample reserves regime kind of 30:41 um uh sort of stabilizing point but that's that's some distance in the future but we are working very we are 30:48 watching very carefully as we go all right um so I'm going to ask a question that 30:54 came from the audience and got upvoted and I'm going to add a little bit of a an addition to it the sep suggests that 31:01 the fomc participants are comfortable with the terminal rate and the four and a half percent range what developments 31:07 in financial conditions specifically would lead you to believe four and a half might be too high but too too high 31:13 or too low um uh and actually I'll let you if you 31:20 don't want to answer it that's fine but so um you know I think 31:26 um that uh the summary of economic projections um represents 31:32 um you know all the members of the committee's best effort to write down um a forecast 31:38 um that's consistent with their projected policy path at any point in time and then of course you know what 31:44 you look at is the median of that um and most of the people in this room also write down forecasts um so you know 31:51 that those are you know very well informed by all the data to date as well 31:56 as historical relationships um but things can change um and so uh while you know there's 32:04 um Clarity that monetary policy um will be restrictive for some time 32:09 until there's confidence about inflation coming down um and the committee has has taken 32:16 um quite a quite strong action um and the Committees uh said that the 32:22 policy rate will increase race further we also will be learning as we go and 32:30 that assessment will reflect incoming data and you know the sort of balance of 32:38 risks uh domestically and globally so I think it's a it's very uh helpful at a 32:45 point in time to get a sense of you know where members kind of project 32:51 the policy path to be going but it's also helpful to remember that the actual 32:56 policy path will be data dependent so president Evans gave us a little bit 33:02 of his view on this question um but as we went to the zero bound we 33:08 introduced forward guidance to sort of create a more stimulative monetary 33:14 policy despite hitting that zero bound now we're clearly off that zero bound 33:20 um is the set something we should continue to do is it is it doing what you wanted to do 33:26 um I won't tell you what president Evans said foreign 33:33 you know I think it is important to distinguish between um the SCP 33:40 um which is again uh individual members forecast um and um and forward guidance 33:47 um again you know we are um we're moving um in a deliberate way 33:53 and in a data dependent way and so you know we we are going to continue taking 33:58 into account um how the economy is evolving um what's happening with inflation 34:03 what's happening with the labor market as we go um so in that sense um you know I think uh there's been 34:10 clarity about what our goals are um and our resolve and we've taken really strong action and shown that 34:16 resolve inflation uh is going to come back to two percent we're going to take 34:22 necessary actions um to get it there um but in terms of exactly what the path 34:27 of policy is that's something that in my mind will benefit um from the incoming data as well as you 34:36 know a sense of uh ongoing evolution of risks in an environment where I think 34:42 uncertainty is clearly very high absolutely um 34:48 we've been through quite a bit over the last dozen years we've had 34:54 we've had covid we've had a repo event we've had lots and lots of shocks to the 35:01 system how do you think the reforms that were implemented following the GFC are 35:08 doing well um so critically important I think 35:14 that um the resilience in the banking sector was greatly improved following 35:20 um the great financial crisis um and you've seen the benefit of that 35:26 as we've been able to um stress test Banks throughout pandemic 35:31 and now of course um uh coming into a more period and that 35:39 has I think both helped with Market transparency but also just the 35:45 resilience of liquidity and capital at the core financial institutions the 35:52 banks now we have seen um more um Financial amplification outside of 35:59 the core banking system so you know the nbfi sector was a huge source of 36:06 amplification both in the GFC and in the 36:12 pandemic stress period And so reforms there I think are ongoing but certainly 36:17 the visibility had improved somewhat um and the cooperation among authorities 36:23 across borders and in the U.S across multiple Regulators had improved a lot so you know I think what it suggested 36:30 was we had made some really important progress particularly on resilience in 36:35 the banking system but we still have work to do and particularly outside of 36:40 the mbfi sector and including the most opaque parts of that sector 36:46 right um so sticky inflation 36:52 um one of them one of the biggest stickiest parts of inflation is rent 36:57 um and we are starting to see some significant slowdowns in the housing 37:02 market house prices um maybe even some inflection points on 37:08 um on on high frequency rent indicators what are your thoughts on 37:14 um that part of inflation um coupled with maybe some of the 37:19 challenges that might rise as we start to see some difficulties in the housing 37:25 market yeah so um that um uh that the 37:31 housing part of core Services I generally 37:36 anticipate will be sticky and in general um just based on past patterns 37:44 um expect for services to be a sort of bigger contributor to inflation 37:50 um you know in this in this period and so that's why the focus on poor Goods 37:55 would be so great uh to see core Goods um playing more disinflationary role um you know which which it could well do 38:03 given um that core import prices um will help out put a bit there 38:08 um and inventories are starting to get better but um but within housing I think the Dynamics 38:15 that you just talked about are exactly right so mortgage rates have gone up a lot and house prices 38:21 um are you know growing more slowly and will soon are likely on aggregate to to 38:26 be flat um and in those parts of the country you saw the biggest um house uh house price appreciation 38:33 we've actually seen some declines what that means for rents though is a little bit complicated because some people who 38:39 you know might be first-time homebuyers with these mortgage rates are you know not perhaps going to be renting longer 38:47 um so you might see some additional demand there um and uh as you said while high 38:52 frequency indicators of of rent um you know may be starting to see a bit 38:57 of a Slowdown which will be really important um average rents take longer because 39:03 those uh those rents are only renegotiated slowly so it's we assume there's going to be some stickiness 39:09 um in that Housing Services portion obviously not as big for pce as for CPI 39:17 but that's why it's important to see some um you know some less pressure elsewhere 39:24 so just following on on the housing market and and actually this is the commercial MBS Market 39:31 um there's a question does stress in the commercial MBS Market due to higher rates cause concern for proceeding with 39:38 balance sheet reduction yeah so I think um um feel pretty good 39:46 then has um gotten off the ground so far um and of course we're monitoring those 39:53 markets um very closely as I mentioned earlier we have a dashboard of indicators that we thought 39:58 um you know were particularly with the benefit of hindsight valuable in the first episode of QT so we're monitoring 40:05 that dashboard really quickly um really closely so my sense is you 40:11 know so far um we're seeing uh the kind of absorption that you would wish to see 40:18 but we are aware um that you know this is a moment where 40:24 liquidity is somewhat strange and so we're we're going to remain alert to that possibility 40:29 foreign the fed's regulatory stress testing 40:34 scenarios do not feature stagflationary scenarios what do we know about our 40:40 financial systems resilience to such outcomes yeah so I would say that first 40:46 of all we have done a whole variety of different um scenarios over the years and we did 40:52 have a bit of that flavor in the 2018 stress test we learned a lot from those stress tests in 2018. 40:59 um the other thing is that you know we have the ability to do kind of top-down exercises that are more just to inform 41:06 ourselves what environments might be more difficult for banking system 41:12 resilience than others and so we're able to look at a variety of different kinds of environments in in that and we do 41:20 um and you know I think that is uh the kind of an environment where you see 41:25 um you know interest rates going up by a lot more than expected and Rising credit 41:31 losses is a complicated environment with some offsetting effects depending on the business model of the bank but we 41:37 certainly um you know we certainly want to be aware of how that would play out and so 41:43 we do a bunch of internal analysis to just make sure we're we understand how 41:49 different environments could affect different kinds of institutions so fair or not some people have been 41:55 dusting off their analysis of the 1970s to try to get a sense of what can the 42:01 Central Bank do Etc and certainly there's a lot of uh talking about uh 42:06 Paul volcker and what Paul volcker did a question I would have is given the debt 42:12 levels today in the U.S economy can we do can we have another Volker fed with 42:19 the debt dynamics that we have today yeah so I think when we think about 42:24 um the 1970s um and then the 1980s importantly I think there are a variety of um 42:31 important um differences and lessons um and and I'll get to the debt point in 42:37 a second but you know what's different now well first of all I think there's a general 42:43 um understanding uh that monetary policy has both the capacity and the 42:49 responsibility to get inflation down that wasn't clear when uh the inflationary shocks happened in the 42:55 1970s it's a very widely accepted tenant and we certainly 43:01 um you know we we take it very very seriously that we have the resolves at the resolve and the tools another huge 43:08 difference um is uh that um inflation expectations were 43:14 unanchored in the 1970s and so you saw some really 43:19 um some really uh toxic um uh dynamics of high inflation 43:25 becoming entrenched and leading to higher of inflation again we carefully 43:33 carefully monitor a whole variety of measures of inflation expectations you 43:38 know and we have seen those moving to ranges that were um you know prevalent prior to the 43:45 pandemic which suggests that you know there is an understanding out there that inflation is going to come back down 43:52 um so those are those are enormous uh advantages that I think uh will help 43:58 with the fight against inflation today in terms of debt levels I mean one of 44:04 the interesting things uh that's different about this stress period the pandemic then perhaps past Cycles is 44:13 that a lot of the fiscal support was actually used in ways that improved both 44:18 business balance sheets and household balance sheets so coming into this tightening period you actually have 44:26 healthier household balance sheets and businesses that have better debt 44:32 servicing on average and so that gives us a bit of a better starting point than 44:39 you might have seen otherwise because obviously those credit Aggregates are very important for thinking about 44:45 potential Financial stability complications so if we think about the U.S corporate 44:53 sector today they are pretty close to Peak profitability as a share of of U.S GDP 45:01 and income and the capex levels that we've seen out of the corporate sector is actually 45:07 pretty pretty close to you know all-time lows um 45:12 do you think that the corporate sector is going to be investing reinvesting to 45:18 address some of the shortages some of the labor market tightness Etc going 45:23 forward well so there I think um obviously in a rising interest rate 45:29 environment there's um it makes it more difficult for some of those Capital plans to be execute on so we recognize 45:35 there's that macro effect but when we talk to businesses in different sectors at kind of the micro level there's a lot 45:43 of really interesting investment that is going on some of it uh supported 45:49 um for instance you know the semiconductor area and the energy transition area both you 45:55 know supported by recent changes um in in law so you know my sense is 46:02 there are areas where there's tremendous uh interest and over a longer period of 46:08 time you know you'll see quite quite fundamental and important Investments that will go to some of the challenges 46:16 that the nation clearly faced during this last period both on the energy 46:22 front on the climate front and on key intermediate inputs 46:29 to end this discussion thinking about total Factor productivity and how wonderful it is for the U.S economy and 46:36 the wonderful role that the central bank bank plays in making sure that we stay on that path so thank you very much for 46:43 taking some time with us thank you.
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