St. Louis Fed President Bullard on Monetary Policy and Economic Inequality
Perspectives on Monetary Policy and Income Inequality
President and Chief Executive Officer, Federal Reserve Bank of St. Louis
Editor-in-Chief, Bloomberg News
St. Louis Fed President James Bullard joins Matthew Winkler of Bloomberg News to discuss monetary policy and its effects on economic inequality. Bullard describes the life-cycle model of the economy and explains that a significant amount of income and wealth inequality is normal in an economy where the young and old are much less productive than those in their peak earning years. He advocates for policy interventions that recognize this fact and are targeted narrowly toward the excess inequality that cannot be evened out through functioning credit markets. Bullard also gives his thoughts on the state of the U.S. economic recovery and declares his support for a return to a more conventional monetary policy environment.
This meeting is part of the C. Peter McColough Series on International Economics, presented by the Corporate Program and the Maurice R. Greenberg Center for Geoeconomic Studies.
WINKLER: Good afternoon. I'm Matthew Winkler. On behalf of the Council on Foreign Relations, it's a privilege and an honor to introduce James Bullard, president of the Federal Reserve Bank of St. Louis.
And you have already in your possession a distinguished biography. I wanted to give you a short perspective on his success as a leader of the Fed and start by something that he has referred to himself as the North Pole of inflation hawks. And he's been viewed as a bellwether for investors because his views have sometimes foreshadowed policy changes.
He's published a paper, for example, in 2010 entitled "Seven Faces of 'the Peril'" which called on the Fed to avert deflation by purchasing treasury notes. As many of you know, that was followed by a second round of quantitative easing or bond buying.
At the time, he also called for the Fed to engage in open-ended bond purchases without a set goal or ending date. And that approach was adopted in the latest round of purchases.
Since 2010, Dr. Bullard has expressed concern that slowing inflation could lead to deflation or a broad decline in prices and a Japanese style economic stagnation. He's also said the Fed needs to safeguard the credibility of its inflation target and defend the goal when price gains are either too high or too low.
This year, for example, Dr. Bullard has become more hawkish. He has suggested that a stronger economy could bring the need for the Fed to become less accommodative.
And I think it's revealing that Dr. Bullard's speeches and interviews have prompted moves in the 10-year U.S. treasury yield more than any other Fed official last year, including the then chairman, Ben S. Bernanke—and that's according to an analysis by Macroeconomic Advisers, a research firm that was co-founded by former Fed governor, Laurence Meyer.
So, we have a real newsmaker in our midst because I just want to remind everybody that a little before 10 a.m., Federal Reserve Bank President of St. Louis Bullard, who is not a voting member of the policy setting Federal Open Market Committee, and he won't vote again until 2016—but he did say earlier today, "My own dot is for the Fed's first rate hike to come at the end of the first quarter of 2015." And this is a reference to the Fed's graphical presentation that famously used dot graphs to forecast rate hike estimates of individual governors.
The S&P 500, which had been trading around 1,955 fell 0.6 percent to 1,944 in about 15 minutes earlier today. And Ryan Larson, who is head of equity trading at Minneapolis based RBC Global Asset Management U.S. said by phone, "St. Louis Fed President Bullard indicated a rate hike could come after the first quarter of 2015, which is putting a little pressure on the market right now.
"The consensus had been for the first rate hike would be somewhere in the latter half of 2015. So, Bullard's comments are somewhat contradictory to what Chair Yellen indicated last week. Certainly the contradictory language coming from Fed officials is putting pressure on the market."
So, today we are going to get, I daresay, a more illuminating perspective on not just the outlook for interest rates, but also the economy and all of its idiosyncrasies.
So, I give you Dr. Bullard. Thank you very much.
BULLARD: Well, thank you. And it's great to be here today to talk to you all. I know I'm competing with the World Cup, so if you whoop and holler in the middle, I'm going to assume that's for me and not for the U.S. team doing something interesting.
I'm going to talk today on—I prepared remarks on income inequality in monetary policy, a framework with answers to three questions. And—but if you don't want to talk about income inequality, I'm happy to answer other questions during the Q&A and I think we're going to be able to cover lots of things.
But I do want to focus on this income inequality question, because it is a key one. There's a raging debate in the U.S. on this issue. And I want to talk about how monetary policy might fit in or might not fit in in this debate.
So, I'll give my prepared remarks here and then we'll have plenty of time for questions. So, jot down your—jot down your questions.
OK, so, we start off with three provocative questions. Concerns about economic inequality have been voiced throughout history. Thomas Malthus, David Ricardo, Karl Marx were among the first, but they had little systematic data with which they could work.
In the 20th century, the advent of national income, tax return and other economic data have allowed for a more rigorous analysis of issues surrounding inequality.
Generally, the focus has been on income inequality, but wealth and consumption inequality are of much interest, as well. Consumption might ultimately be a more useful variable for assessing economic well-being—and I'm going to come back to that later in the talk.
Estimates suggest that wealth is much more concentrated that income in the U.S. Consumption inequality is generally thought to be less than income inequality. So, the ranking seems to be the wealth distribution is the most unequal, the income distribution is somewhat less unequal, and consumption—the consumption distribution is even less unequal; so, I want you to have that picture in your head as we go along.
Virtually all research shows that U.S. income inequality has increased over the past three decades, but there's much disagreement over the extent of the increase. Major controversies arise from different income measurements, pre-tax versus after tax versus after tax plus in-kind benefits; annual versus lifetime earnings. A clear message is that measurement matters.
Research also shows that income inequality across countries is considerably more pronounced than within the U.S. Moreover, over the past 50 years, income inequality across countries has declined if one weights countries by their populations. Rapid growth in China, India and elsewhere has reduced global income inequality and lifted many millions out of poverty.
For today, I will focus on wealth, income and consumption inequality in the U.S., which is where much of the recent debate has centered.
According to a January 2014 Gallup Poll, two out of three Americans are either somewhat or very dissatisfied with the distribution of income and wealth in the U.S. This dissatisfaction has led to opinions that government should pursue policies to reduce the income gap between rich and poor.
A recent CNN/ORC international survey found that nearly 70 percent of respondents felt that government should do more to substantially reduce these gaps.
What might these policies look like? What role might monetary policy play in this debate?
To focus our attention, I thought I would outline three provocative questions concerning monetary policy and income inequality that have repeatedly been asked in the rousing public debate over monetary policy options in the last five years.
To keep suspense at its very peak, I plan—I do not plan to provide my answers to these provocative questions until the very end of the talk, which coincidentally is when we'll get the score in the U.S. Germany match.
Here are the three provocative questions. Does—number one, does the Federal Reserve's quantitative easing program exacerbate income inequality in the U.S. by putting upward pressure on equity prices? That's number one. Number two—would a higher inflation target in the U.S. help or hurt the poor segment of society? That's number two. Number three—does current monetary policy hurt savers?
Interesting questions, indeed. We need a simple way to think about these issues before some tentative answers can be provided.
So, this next subsection is called "Framework." My preferred framework for—to approach these questions is a simple modification of a life cycle economy. And so, I planned to talk through some of the nice features of thinking of the macroeconomic world using this approach.
The life cycle model is a workhorse within modern macroeconomics, although it has been less popular in the past three decades than its single household cousin, the representative agent model.
The chief advantage of the life cycle framework is that, like the real world, it has plenty of heterogeneity—many different households making many different economic decisions. It also provides a natural and realistic setting for household borrowing and lending—an essential feature if we are to understand the impact of monetary policy on credit markets.
For our purposes here, I can describe the basic outline of this famous framework in just a few sentences. The life cycle concept is that people begin to enter the part of their lives where they make independent economic decisions in their late teens or early 20s.
They then live, quarter by quarter, making economic decisions about how much to work, how much to consume, how much to borrow and how much to save. They do this until death, which in the U.S., averages around age 80.
When people die off, they are replaced in the economy by new entrants in such a way that, at least in the simplest versions, the total population remains constant.
The key aspect of the framework for our purposes is the following: labor productivity varies over the life cycle. Labor productivity varies over the life cycle.
We can think of each person as entering the economy with a given life cycle productivity profile, which is essentially near zero initially, rises to a peak in the middle of adult life near age 50, and then declines again do a value near zero late in life.
Each person can sell the productivity they have at a particular point in the life cycle in a labor market at the competitive wage per productivity unit and this will produce income for that person.
However, those at the beginning and the end of the life cycle will have very little productivity to bring to the market and hence will have low incomes while those in the middle of life have a lot of productivity to bring to the market and thus have relatively high incomes. This latter group will be in their, quote, "peak earnings years," unquote.
Given these basic features, we will necessarily observe income inequality. One hardly needs a background in economic theory to except the basic outline I have just given. Indeed, nearly all participants in the U.S. economy understand that at an intuitive level, that their ability to earn income will vary substantially as they age.
This next section is called "Income and Wealth Inequality." Very simple versions of this type of model can generate substantial income and wealth inequality without adding anything further to the analysis.
Consider the case where the productivity profile begins at zero, rises linearly to a peak of one and then declines linearly to zero again. In this special case, 50 percent of the population would earn 75 percent of the income. That is, there would be a lot of income inequality on a—as an ongoing feature of such an economy.
In addition, only 25 percent of the population would hold 75 percent of the assets as an ongoing feature of the economy. Fifty percent of the population, the relatively young, would hold no net assets at all, but instead would be net debtors. Wealth inequality would therefore be substantial and would be even greater than income inequality.
These types of statistics have a broadly similar flavor to the ones discussed in the contemporary income and wealth inequality debate in the U.S. Yet while all of the figures I cite above are true, there would actually be no income inequality in this economy at all.
People are at different ages in the life cycle. Taking a picture of income earners at a point in time, as the figures I cited above do or as a Gini coefficient does, reflect the different productivity inherent in the life cycle.
For 20-year-olds, their peak earning years are ahead; for 50-year-olds, their peak earning years are at hand; for 80-year-olds, their peak earning years are in the past. These people have different incomes today.
But looking at their lifetime as a whole, these three groups have exactly the same income if they have exactly the same productivity profile.
This next section is called "Benign Income and Wealth Distributions." The point of this is to say that the simplest life cycle framework will naturally generate relatively benign income and wealth distributions.
These distributions will reflect variable labor productivity over the life cycle and not more malevolent forces at work. This raises the question of whether the entire observed level of wealth and income inequality in the U.S. could be due to this benign force at work.
In other words, can a life cycle model like the one I have described generate income and wealth inequality on the scale observed in the U.S. economy today?
The answer to this is that the plain vanilla versions of the model I've described cannot give a satisfactory explanation of the observed income and wealth distribution in the U.S.
A textbook calculation due to Heer and Maussner is—researchers—is a sophisticated attempt to find out what a realistic version of this framework has to say about wealth and income inequality.
Their calibration of the model generates an income Gini coefficient of about 0.42. A Gini coefficient is a number between zero and one indicating the degree of inequality with zero indicating perfect equality and one indicating perfect income—perfect inequality; so, one is bad.
We want to compare this number with what other researchers think the income Gini is based on U.S. data. For this, we can consider estimates by Budria Rodriguez et al 2002 who suggest the U.S. income Gini is about 0.55. So, we're comparing what the model says—0.42—against what the data says, 0.55; and higher is worse as—for income inequality.
We conclude that the model fails—falls short of explaining observed U.S. income inequality. Similarly, Heer and Maussner find that the wealth Gini generated by the calibration of their model is about 0.58. Budria Rodriguez et al estimate the actual U.S. wealth Gini at 0.78; thus, the model again falls short on this dimension.
One evidently needs something else—something beyond the simple life cycle framework to explain the levels of income and wealth inequality we observe in the U.S.
There are many candidates for this something else, so I will leave it to you, dear listener, to insert your favorite villain at this point.
Still, let's not be too dismissive. The basic life cycle model evidently explains an important fraction of the observed U.S. income and wealth Gini coefficients.
If you'll permit taking ratios of Gini coefficients, the relatively unadorned life cycle model accounts for something in the order of 75 percent of the story of measured income and wealth inequality in the U.S., according to the estimates above.
One might want to think of the level of inequality generated by the life cycle model, as well as closely related estimates, as the natural or ordinary level of income and wealth inequality to be expected in a large capitalist economy with relatively smoothly functioning markets and stable policy.
One may want to be especially careful not to disturb this portion of income and wealth inequality through tax policy or monetary policy. Why do we want to be careful about this?
This next section is called "Shocking Secret." I thought it was really good for a monetary policy guy to have a section called "Shocking Secret."
So, it is because this model also has a shocking secret—shocking, at least, to those who are uninitiated. The secret is that smoothly functioning credit markets will work to fix the income inequality problem I am describing.
If everyone in this economy were to simply consume according to their income, if there were no credit markets, people would consume very little early and late in the life cycle and live like kings in the middle. This means there are powerful incentives for the relatively young, those in their 20s and 30s, say, to take on debt in order to smooth lifetime consumption.
There are also powerful incentives for houses in their peak—households in their peak earning years to save in order to move income into their retirement years. This happy coincidence creates a market—a fact that forms the foundation of U.S. household credit markets.
How large is this market in the actual U.S. data? According to researchers Mian and Sufi, the household debt to GDP ratio in the U.S. has ranged from about 1.15 to 1.65 in recent years.
In today's dollars, this would amount to something on the order of $19 trillion to $28 trillion—that's trillion with a capital T.
So, there's—these markets seem to be large, indeed, much of it mortgage debt being incurred by the relatively young in order to move housing services consumption forward in the life cycle. This borrowing simultaneously helps peak earning saver households move income into retirement years where they will need it.
The secret really hits home if you're willing to make enough simplifying assumptions to really get to the core of what this model says about income and wealth inequality. In the simplest and most transparent version of the model, all households alive at a point in time would consume exactly the same amount, even though their incomes are radically different.
A smoothly functioning credit market would completely solve the income inequality problem I am describing. Consumption inequality would be zero and the—so, the consumption Gini would be zero, as well.
This would be about the best outcome one could hope for because it would mean that even though income varies widely by household and even though asset holding differs even more widely by household, actual consumption would even out completely for all participants in the economy that are alive at a point in time.
To the extent that credit markets are doing their job reasonably well, one would not want to distort this life cycle consumption allocation process. And hence, one might want to be very careful in trying to design fiscal or monetary policies that might impact U.S. credit markets.
Well, you say, all very well in theory. But is this really what's going on in the U.S. economy? Certainly not in the extreme form I have described.
But still, the life cycle model does tend to predict lower—a lower consumption Gini coefficient relative to the income or wealth Gini, which is true in the U.S. data. This suggests that the framework has some merit—it gets that ranking exactly right.
Wealth inequality would be highest, income inequality would be second highest, consumption inequality would be lowest. Observed credit markets are surely facilitating considerable consumption smoothing over the life cycle.
In the beginning of this talk, I said that income inequality has been rising over time in the U.S. Could this happen in the life cycle framework? It certainly could.
One might think that those at the very beginning or end of the life cycle are relatively unproductive today and this situation will not change much over—50 years from now or a hundred years from now.
For peak earners, however, new technology will likely increase productivity, leading to even higher life cycle peaks in income than we see today. In other words, future technological change will likely benefit the highest income earners rather than the lowest, increasing income inequality.
Variations on this theme go by the name of so-called skill-biased technical change in the macroeconomics literature. Recent research by Lansing and Markiewicz provides a detailed account of how skill-biased technological change can explain increasing income inequality in the U.S. in recent decades.
Interestingly—interestingly, the model suggests that all households benefit from skill-based technical change, not just those who enjoy higher incomes. But for more on that, I direct you to their paper.
This next section is called "Non-Life Cycle Households"—Non-Life Cycle Households. I said that one needs to—more than the one unadorned life cycle model to understand wealth and income inequality in the U.S. What might add to the simplest—what might we add to the simplest versions of these models? There are many possibilities.
Decisions to acquire human capital, for instance, would be an excellent addition to the model. We could then understand how and why the relatively young might or might not invest in education and therefore might or might not increase income in their peak earning years.
Another possibility would be to note that actual borrowing and lending goes through intermediaries. And in the U.S., the intermediation system has been rocked with controversy since the financial crisis of 2007 to 2009.
Surely a realistic intermediation sector with all its many dimensions would be important. But let's focus; for the purposes of this talk, I want to stress just one addition to the model. It is that not all households in the U.S. are likely to be well-described by the work every day, plan—completely plan out your life aspect of the life cycle model.
Many households, instead, struggle with attachment to the labor force, working only intermittently and earning income where and when they can. These households generally tend to have lower incomes and tend to suffer longer and more frequent bouts of unemployment. Their life cycle plans can frequently be derailed.
This group of people tends to rely much more on cash than the life cycle group. Yes, life cycle borrowers and savers use cash and other forms of money, but their most important transactions are accomplished through credit markets. The non-life cycle group uses cash to get by every day.
We might proxy this group by the unbanked. According to some accounts, the percent of households that are unbanked is perhaps near 10 percent and the nearly unbanked may add to this for a total of as much as 30 percent. This is essentially a relatively poor group of households that is heavily reliant on cash.
Suppose we add this group to our model. Now we can answer the three provocative questions posed at the beginning of the talk and move on to other questions after the end of the talk.
So, the last section is called "Answers to Provocative Questions." Does quantitative easing exacerbate income inequality in the U.S. by encouraging savers to move into risker assets such as equities? Many have suggested that the FOMC policy of buying U.S. treasury securities and mortgage-backed securities has depressed real yields on relatively safe assets and thus encouraged movements into equities, raising equity prices.
It is often said that only 50 percent of households hold equities in the U.S. and that they tend to be the wealthiest households, so this policy may be making the wealth distribution more unequal.
The life cycle model gives us some perspective on this type of thinking. The framework, indeed, suggests that relatively older households—only half the population—should hold the lion's share of assets, including equities.
In my opinion, equity prices have indeed been influenced by quantitative easing. But I would stop short of saying that this has made wealth inequality worse.
The relatively old are going to have to be the domestic holders of the capital stock of the U.S. and they will sell this ownership on to the next generation as they exit the economy.
Ideally, when each generation is holding the capital stock, they—they do so at, quote, "normal prices," unquote, neither too high nor too low. But actual equity prices were well below normal by conventional valuation metrics in 2008 and 2009 and they have recently returned to more standard valuations.
To me, this suggests that quantitative easing had no medium term implications for the U.S. income or wealth distribution. It's only as good or bad as it was before the crisis.
How about the second question? Would a higher inflation target help or hurt the poor segment of society?
"In my opinion, equity prices have indeed been influenced by quantitative easing. But I would stop short of saying that this has made wealth inequality worse."
For this question, recall that I added a non-life cycle group to the economy in the previous section. These households rely on cash for much or all of their financial life. They tend to have lower incomes than the life cycle households.
Higher average inflation is going to damage the well-being of these households directly. They're holding all of their income each year in the form of cash unprotected from inflation. A higher average inflation rate directly reduces the value of their financial wealth.
While it is true that this part of the population tends to have longer and more frequent spells of unemployment, monetary policy cannot influence the average unemployment rate in the medium or long term. The answer to this question is that a higher average inflation rate would hurt the poorest group in the economy.
The final provocative question is does current monetary policy hurt savers? Many have argued that the FOMC policy over the last five years has been to keep real interest rates low and that these low real yields have impaired the returns of those saving for retirement or in retirement.
I have kept this question for last because I think it is the most difficult of the three that I've posed here today. In my opinion, Fed policy generally and quantitative easing in particular have influenced the real yield earn by savers.
So, the question is then whether the Fed helped or hurt the situation by pushing real yields lower during the last five years. This hinges on whether credit markets have been functioning smoothly during the period when quantitative easing has been a popular policy.
If credit markets were working perfectly or nearly perfectly, then Fed intervention to push real yields lower than normal was unwarranted and the low real yields were indeed punishing savers. My University of Chicago instincts give me some—give some credence to this view; that is, Chicago would always argue that markets work very well, and if they're working very well, then we shouldn't have intervened to push real yields lower.
At the same time, it seems odd to argue that credit markets were working perfectly or nearly perfectly over the last five years in the aftermath of one of the largest financial crises the country has ever experienced and one that was largely driven by mortgage debt run awry.
The policy of the FOMC has been that unbalanced, low real yields will help repair the damage from the crisis more quickly and I have largely sided with the committee in this judgment. As time passes, however, it becomes more and more difficult to argue that credit markets remain in a state of disrepair and thus harder and harder to justify continued low real rates.
I hope these answers are as provocative as the questions I have posed. I appreciate your kind attention and I look forward to taking your questions. Thanks very much.
Is this my seat?
WINKLER: So, President Bullard, that's a rather provocative perspective in the context of a subject that has taken probably the most attention lately. And I'm referring to this book by Thomas Piketty, "Capital in the Twenty-First Century."
I don't suppose you and your colleagues at the Fed have had any discussions about this book lately?
BULLARD: The FOMC does not directly discuss income inequality on an ongoing basis because the perception is that it's more of a structural issue and more of long-term issue than what we're usually dealing with meeting-to-meeting.
So, I think while members all have perspectives and are concerned about income inequality and wealth inequality, it's not really a day-to-day sort of discussion that we would have at the FOMC.
WINKLER: I don't want to be presumptuous, but one of the conclusions in that book is that there should be a global tax on wealth to help correct what he sees as a widening inequality.
Now, hearing your talk just now and especially the last three points that you made—one, that the Fed and its monetary policy did not contribute to wealth inequality through quantitative easing; two, that having a rising inflation target did not—would not, in fact help—in fact, it would hurt people because you said earlier that so much...
WINKLER: Of the economy's in cash. And finally, you also said that monetary policy was not punishing savers, even though you qualified that a little bit.
But you said that the markets were so dysfunctional between 2007 and 2009 that's—or even to the present—it's hard to believe that credit markets were behaving as they should.
So, in that context, I take it you are not someone who would encourage a global tax on wealth?
BULLARD: Yeah, I—I don't know if I can evaluate Mr. Piketty's arguments here. Obviously we're not a taxing authority, so I don't have any say over it, anyway.
But if you think about what I said, you know, if you're going to look at the wealth distribution that comes out of the model, it's going to say something like, you know, 25 percent of the population's holding almost all the assets. Do you really want to tax them? I'm not so sure.
That's why I describe these as benign income and wealth distributions. You don't really want to screw that up because that's the natural order of things. If you believe my number that 75 percent of the income and wealth distribution is really this—has this benign character to it, then it's only the other 25 percent of the distribution that's coming from somewhere else—some malevolent source. It's that part that you want to fix.
So, what I'd be worried about with this type of tax proposal is that you'd screw up the good part of the income and wealth distribution and—in an effort to fix the bad part of the income and wealth distribution.
I'd like to get the discussion going that there's actually a good part of the income and wealth distribution and then there's maybe a bad part. And if you're going to propose policy remedies, they have to be targeted toward that bad part—and you don't want to screw up the normal credit market that's—that's supposed to be allocating consumption over the life cycle.
WINKLER: I think this next question might lead us to—back to where you are in general on your thinking of the U.S.
So—but it's related to this issue of inequality. The International Monetary Fund has said that inequality and unsustainable growth may be two sides of the same coin because inequality leads to increased borrowing by those less well-off as they seek to—to keep up. I take it you don't really agree with that.
BULLARD: I—I am not a big fan of that. I think it's hard to relate income and wealth inequality directly to growth.
If you read the growth literature, what do they say? Oh, it's all about technology, technological diffusion; it's about human capital—how does human capital get deployed through the economy. These are the kinds of things people that work on long-run economic growth talk about—and I think those are the right drivers of long-run economic growth.
So, I don't—I—I think it's hard to make arguments that income and wealth distribution by itself is a growth driver. I think it's a stretch.
WINKLER: And speaking of growth, you had said that your unemployment rate target for this year is 5.8 percent. I think that would be considered perhaps more optimistic or encouraging or bullish—however you'd categorize it—than some of your colleagues.
So, if the job rate falls—jobless rate falls—to—to that target and it falls faster than your colleagues are forecasting, are you concerned the Fed could be behind the curve in raising interest rates?
BULLARD: Well, I suppose it's a—I suppose it's a possibility. But I like to think the committee will do the right thing and come around to the right point of view, which is my point of view. So...
So, I'm confident that we'll—we'll get that. I do have unemployment falling to 5.8 percent by the end of the year.
I won the unemployment forecasting contest last year at the FOMC; I had the lowest unemployment rate by the end of the year. We actually hit that unemployment rate.
You think about last year at this time, Chairman Bernanke went out during his June press conference. He said that he thought we would be at 7 percent unemployment by now—right now, one year in the future. We're at 6.3 percent—we're way ahead of schedule; way ahead of schedule.
And so, it wouldn't take that much to go from here and go five-tenths down and be at 5.8 percent by the end of the year. So, I think we've got a—I think St. Louis Fed has that right.
I also think inflation is picking up now. It's still below target, but it's been moving up in recent months and recent reports. And I think inflation—so, I think inflation will be much closer to target.
Unemployment will be much closer to the natural level by the time we get to the end of the year and I don't think financial markets have internalized how close we really are to our ultimate goals. And I don't think the FOMC has internalized how close we are to our ultimate goals.
WINKLER: So, before we get to—to the target rate, behind your 5.8 percent unemployment rate is a 3 plus percent GDP growth rate from here on in? Is that...
WINKLER: Is that a fair translation?
BULLARD: Yeah. I mean, I know that everyone's wringing their hands, including me, about the first quarter GDP growth rate, which came in very negative; it's been revised down. I think there were some special factors going on—surely weather was a big one with cold air sweeping down through the Midwest and through the Northeast, even into the South all through the winter months. So, I think weather was a—was a factor.
And weather's a fickle thing. It's not just the wrong temperature at the wrong time; it's, you know, how does the weather line up with where the GDP is being produced and how many factories are you shutting down with the weather? And it matters if you get a little bit a snow in Atlanta—you're probably going to shut down Atlanta for a while. So, I mean, it's a very fickle thing. But I think we did have a very bad winter, so that's one factor.
But also, exports are a big factor. Inventory adjustment, which we knew was going to happen in the first quarter did in a big way. So, you kind of had this—and you've got this health care issue—how to measure health care.
So, I think you've got several special factors in the first quarter that made that number come in very weak. But generally, I think the economy was pretty strong in the second half of 2013 and I think if we ignore the first quarter then going forward from the second quarter on out through the rest of the year and into 2015, I've got 3 percent growth; everyone seems to have 3 percent or better growth.
The jobs number seem to be consistent with that; claims numbers coming out today seem to be consistent with that. If you talk to business leaders, they're all very confident about their underlying demand. They seem to have plans to invest.
"I think you've got several special factors in the first quarter that made that number come in very weak. But generally, I think the economy was pretty strong in the second half of 2013 and I think if we ignore the first quarter then going forward from the second quarter on out through the rest of the year and into 2015, I've got 3 percent growth."
So, for now, I'm sticking with that forecast. I think that's the best bet to make right now in the U.S. economy.
WINKLER: OK, another forecast—judging by their median forecast, the Federal Open Market Committee participants expect the Fed's target rate to be 2.5 percent at the end of 2016. If you look at trading in futures and swaps markets, investors believe the rate's going to be less than 2 percent through March of 2017. So, what are investors missing here, do you think?
BULLARD: I think investors should be listening to the committee. But they're not—of course, you can do what you want. But I think the committee is giving as best it can its guidance based on all considerations, including how the economy will perform going forward.
Yes, it's a dovish committee, but I don't think investors should be pricing in an even more dovish committee than what we've already got. So, I think when the committee says we, you know, as a group, we're saying this is what we think the path will be and Chair Yellen is right in the middle of that group—she's the leader, I think you should believe her and I think you should believe the committee that that is the intention as of now, given the data that we have right now.
WINKLER: So, you dissented a year ago because in the—in the voting, you felt that the FOMC wasn't defending its inflation target against the risk of too low inflation. And what's—what's driving your thinking today that's sort of transformed you from being perceived as a leading dove; now you're seen as a hawk?
BULLARD: If you'll recall last year at this time, if you looked at the inflation numbers year-over-year, PCE inflation or other measures of inflation, they were quite low and they were declining. And simultaneously, at this time last year, we were downgrading our forecast for the U.S. economy.
So, at that particular juncture, I thought that, you know, that was not a good decision to make that we made at the June meeting last year.
Now, since that time, inflation firmed up. It kind of leveled out during the second half of 2013. And as we got here into the spring of 2014, the numbers have actually started to move up again—both CPI inflation has moved higher, but—PCE inflation has moved higher; core PCE year-over-year is now sitting at 1.5 percent.
So, you're not longer in this sort of 1 percent inflation environment threatening to go lower, which is what they have in Europe. Instead, we were at this 1 percent, which had me worried, and now it's moving higher, which was what I've been predicting.
And now I'm saying it's going to continue to go higher if this growth forecast comes to—comes true and unemployment forecast comes true, then I think inflation will continue to move higher through the rest of this year and actually go above 2 percent in 2015; you heard it here first—above 2 percent in 2015.
So, I think it's a very different situation than it was last year at this time when I dissented.
WINKLER: And so, related to that, the committee's 2011 exit plan called for the Fed to stop reinvesting in maturing bonds in its portfolio before raising the interest rate. So, now this is being discussed again. Is the FOMC close to reaching a consensus, would you say, now?
BULLARD: I'm not sure what the other committee members think on this issue. I'll give you my view. I would very much like to keep reinvestment on the—ending reinvestments on the table as a possible move that the committee could take if we wanted to, based on the data.
Because what's going to happen is the Q.E. program will—will likely come to an end here in the fall. And then there—there'll be a period and everyone will be asking me, and in forums exactly like this, when are you going to raise interest rates?
And I think it would behoove the committee to have an extra move that you could make in there during that type of a period where you could say, OK, we're going to go ahead and end reinvestments and that would sort of set up the table for a possible rate increase at some point in the future after that.
It would also start to shrink the balance sheet, but it would do so in a relatively mild way that I think would not affect market functioning. And so, I think it would be a good—a good tool to keep on the—on the table as a signaling device.
WINKLER: So, in the...
BULLARD: Before we actually get to the rate raise.
WINKLER: In the context of your really pointed and illuminating discussion just now about life cycles and the economy and we're hearing and reading about new normals, new neutrals. I just wondered, do you accept this notion that the long-term growth potential of the U.S. economy is lower now than it's been in the past and that the Fed will therefore have to adjust accordingly?
I know you just said that we heard it here first—inflation's going to be where it is in 2015. But it—does the Fed have to keep short-term rates lower because of this? Or is this a short-term—I don't know.
BULLARD: I have actually adjusted my potential growth rate down for the U.S. economy, but I did so about two years ago. And I went down to the low 2 percent range—2.25, let's say, or something in that range.
Some now are going to too low a level, I think, below—some people are going below 2 percent as the potential growth rate in the economy. I think that's too low. So, I'm keeping it up a little bit higher.
So, it does have an influence on what rates would be in sort of a medium term outlook. I think longer term, the best projection is that interest rates will go back to the normal levels that they have been in the U.S. economy.
But that—the key to that is what does longer term mean? You know, I think five years, seven years, 10 years out in the future, you know, the best guess is that the economy will be back to its old potential growth rate.
WINKLER: I know there are a lot of people here who probably want to ask you a lot of questions. So, if you don't mind, President Bullard, I think we'll open it up to people.
BULLARD: No, sure—that would be great.
WINKLER: If that's OK.
Yes, sir, right here?
QUESTION: Sy Jacobs from Jacobs Asset Management. So, you've presented yourself as moving towards the hawkish end of the spectrum on monetary policy. Can you play devil's advocate and tell us what the majority is thinking of the following—basically, what you described.
We have an emergency sort of low interest rate and monetary policy, five years into an economic recovery with record high stock prices, record corporate profitability, cyclical high home sales, car sales, everything; things really seem to be improving as reflected in the markets and in many measures of the economy.
What's the dovish case for why we need zero percent interest rates and Q.E.? And then back to your normal self, shoot that down.
BULLARD: Well, I can't speak for others on the committee, so you got to—you got to ask them what they think. But I think some of your characterization, you know, is—is what I'm thinking.
You know, if you look at where we are with respect to our goals, we're not that far from where we've been historically. I think we're actually closer to goals today than we've been 75 percent of the time since 1960.
So, you know, it's not—I think a lot of people—maybe some of you and maybe some on the committee are—are thinking that it's still 2010. It's not 2010 anymore. We've actually made a lot of progress; unemployment has come down a long way. We're not quite to where we need to be, but we're getting very close and it may not be very long before we're right on where we need to be.
And inflation—we were wondering about inflation, but now that's moving up. So, we're going to be very close to where we need to be on inflation, too.
So, we're going to be basically at goals. You look on the monetary policy side—we're still buying bonds. We haven't even ended the Q.E. program, much less started the process of slowly getting back to normal. So, that's why I'm turning a little more hawkish here.
I'm starting to—to think that we're—we're pretty close to goals, but that monetary policy is still quite a ways from—we've still got the zero policy rate; we've still got promises to keep the policy rates quite low; we've still got a very large balance sheet; we're still buying bonds. So—so, I'm starting to think that, you know, the economy could tolerate at least a little bit of the Central Bank getting back to a more normal stance.
"So, we're going to be basically at goals. You look on the monetary policy side—we're still buying bonds. We haven't even ended the Q.E. program, much less started the process of slowly getting back to normal. So, that's why I'm turning a little more hawkish here."
WINKLER: The gentleman in the back?
BULLARD: I don't call that hawkish—I call that centered.
QUESTION: Kenneth Bialkin, Skadden Arps. I'd like to ask you about how one calculates the amount of inequality that actually does exist. That is, the difference between the rich and the poor or the needy or the un-needy.
And how do include in that calculus services provided, let's say, to the under economic classes? For example, the building of roads, the building of parks, the—or the collection of garbage, the building of highways; that is, the—the erection in—in a society of luxuries and benefits that go all over the economy, but for the most part, may lend to—benefits to the lower compensated people and takes from the borrowing or taxing people.
To what extent, when you approach the question of how much inequality actually exists, in terms of what people have to enjoy in the aspects of life, how does those things enter into your measurement before you get to the cures?
BULLARD: Yeah. That's a fantastic question and I did have a paragraph at the very beginning of the talk that said—had about three sentences. But it basically said, you know, there are a lot of measurement issues in this very—very complicated topic, exactly for the reasons that you said.
What should we be counting? Should we just be looking at incomes before tax incomes, which is usually the way this is done? Or should you really look at after tax incomes? Or should you look at after tax incomes plus in-kind benefits that people are receiving?
And then, like, is usage higher of the kinds of things like a park or something—maybe usage is higher among people with lower incomes than they would be among people with higher incomes, so they're, you know, further getting transfers in that sense?
So—so, it's not at all easy to get this number. And so, this is—it's—measurement's a big deal. It's a big deal. There's just no getting around that.
And—and hard work of getting good numbers and sorting out these issues is—is a very difficult—difficult issue.
Also, another way to do it is to look at, you know, what you really care about is consumption inequality at the end of the day. And so, what you really like to measure is, OK, we already have policies in place—progressive taxation, but many other things in place, some that you just described, that are reallocating consumption, essentially, across households.
So, what you want to do is measure consumption inequality and then you want to say, well, how uneven is that? And, you know, could we do—could we do better through redistributive policies?
But that requires accurate measurement. And the consumption part of it is actually the hardest part to measure—even harder than income or wealth. So, all I can say is it's hard to measure.
WINKLER: The—I think I see—right there, yeah, thank you.
QUESTION: Hi, Thomas Custer (ph) from Central (ph) Insured (ph) Bank.
Just a quick question about the technicalities of the first rate hike. Is there any religion about 25 basis points, or do you think they could—you could hike by 10 or 15 basis points for the first rate hike, as you did Q.E., by the way, through 10 billion, which is quite small amount?
And also, just a quick question about—because you're advocating a Q1 rate hike—that would be in the middle of the debt ceiling debate that will come up at that time. You don't see any issue with hiking rates when there's a debt ceiling debate?
BULLARD: You know, on the debt ceiling, I think we'd have to cross that bridge when we come to it. But generally, we like to conduct monetary policy based on what's going on in the economy and not be too influenced by other debates that are occurring at the time.
As for making a move in, you know, smaller increments than 25 basis points, I guess I would describe that as being out of character with the nature of how the committee has behaved in the past. So, I wouldn't really expect anything like that.
The committee has not wanted to go to the situation where a few other central banks worldwide have done this where they go, you know, we're going to change things by 18 basis points or six basis points or something like that.
I think the idea has been it's—it's—it gives the appearance of overly precise or—or maybe impractically precise movements. And so, we probably can't do that—even though I know basis points matter on Wall Street.
WINKLER: You know, you alluded earlier to the—the need to not be disruptive, or the Fed would not like to be disruptive, I take it. And I just wondered, you know, we went through a year ago, a real hiccup. And what can you do to make sure that the markets are...
WINKLER: Smoother in their behavior?
BULLARD: Last June, we had—we made a decision that was going to—you know, the chairman went out and gave this roadmap about ending quantitative easing. And the experience with that was lots of volatility, not just in the U.S., but globally. So, that didn't work very well.
But the reason I think that didn't work very well—it was—it was basically a hawkish move that day—and I did dissent against that—on data that was not supporting us making a hawkish move.
Now, if you fast forward to December of last year, in December of last year, we actually—we didn't just talk about, you know, tapering; we actually went ahead and did it, and the market went up on the day.
What was the difference between December and June? Well, we were taking a hawkish action in December, but we were doing so with data on our side. We had some good jobs reports, we had some good growth reports; the economy definitely looked stronger at that point than it did earlier in the year.
And so, markets said—oh, yeah, this makes all the sense in the world. And—and so, I think that that's really what you need—is you have to do things that are in reaction to economic events and are not based on some calendar idea that you have in mind that I wanted to do it at this meeting, you know, no matter what the data said, so.
WINKLER: I want to go to this part of the room which we—we ignored. Go ahead, you, sir.
QUESTION: (OFF-MIKE) from Mackenzie. You've described in your life cycle model the factor you've added to account for the unbanked, under-banked or the under-unemployed. To what extent is a remedy to the situation to reduce that group? Where does it fall on the list of—of remedies, and then what actions or policies would you suggest to do so, if it makes the list?
BULLARD: I mean, totally what you'd like to do—I mean, it's a reality that this group of people is part of the—part of this economy. And so, I think you have to—just have to realize that, first of all.
But totally what you'd like to do, you'd like them to be life cycle consumers just, you know, like the rest. So, you'd like them to, you know—you know, get plenty of education when they're young; you'd like them to have nice peak earnings in—in the middle of life; you'd like them to be able to borrow and save for retirement and so on; you'd like to move them into that group.
And—and, you know, a lot of what we do is—is try to think about how we can get that to happen. But those are policies that are far away from anything the Central Bank can do.
So, I was just—in this talk, I was just thinking about, you know, some of the things that are recommended to the Central Bank like raising the average inflation target; that's definitely going to hurt that particular group. I mean, you—you kind of want to do more structural things to help that group behave more like the life cycle consumers.
WINKLER: Dr. Bullard, we have a promise to get you out of here by 2 o'clock and to let everybody get on with their...
BULLARD: Well, I...
BULLARD: I appreciate...
WINKLER: I want to thank you very much.
BULLARD: Yes, I appreciate the opportunity. A lot of great questions here. Thanks for your patience and—and listening to my talk. So, thanks a lot.
WINKLER: Thank you very much, doctor.
Michael Gfoeller, advisor at The Chertoff Group, David Goldwyn, president of Goldwyn Global Strategies, and Angela E. Stent, professor at Georgetown University, join CFR’S Michael A. Levi, David M. Rubenstein Senior Fellow for Energy and the Environment, to discuss the geopolitical implications of low oil prices.
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