C. Peter McColough Series on International Economics With Mary C. Daly

Tuesday, October 4, 2022

President and Chief Executive Officer, Federal Reserve Bank of San Francisco


Op-ed Columnist, Washington Post

Join Mary Daly of the Federal Reserve Bank of San Francisco as she discusses the Fed’s dual mandate, the pain of high inflation, and the outlook for the U.S. economy.

The C. Peter McColough Series on International Economics brings the world’s foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

RAMPELL: So thank you, everyone, for joining us today. I’m Catherine Rampell. I’m an op-ed columnist at the Washington Post. And I am delighted to preside over this event with San Francisco Fed President Mary Daly, who has been at the San Francisco Fed for four years now, in your role?

DALY: As president for four years.

RAMPELL: As president. Trained as a labor economist. You have her full bio, so I won’t belabor, so to speak, all of the accomplishments and details, but just a set-up to our conversation today.

And this meeting is part of the C. Peter McColough Series on International Economics. We’re going to talk for about a half-hour, and then we’ll switch over to questions. So thank you, again, all of you for joining.

So I wanted to start by talking a little bit about the distributional consequences of policy decisions that the Federal Reserve is making right now. Back in 2020, the Fed released a new monetary policy framework that emphasized inclusive growth, which was widely interpreted to mean paying more attention to the outcomes for lower-income workers, more vulnerable workers, people of color, et cetera. And particularly, there were labor market outcomes. So how do you respond to criticisms today that the Fed’s actions to tighten financial conditions will disproportionately hurt that very same population, since they are the most likely to lose their jobs first?

DALY: Well, that’s a terrific question and I’m happy to answer it. Let me first just say thank you for having me here. I’m delighted to be here. And, so, yeah, let me tackle the framework. So let me first tell you a little bit about how I viewed our framework discussions, and then what we ended up doing. And I see Rich Clarida is in the audience. He presided over many of these discussions as the vice chair at that point in time. And so I want to just provide some clarity, I think, of the parameters around it for me.

So what I saw was a Fed that had for a long time, not just we did the framework and then we decided that there was a distribution of outcomes in the labor market that were present. We had been for a long time thinking about this, which is one of the reasons that the policy rate had stayed more accommodative than many at the time said it should be, even though inflation was running below our target, and we had a labor market that was, by every measure, sort of breaking through what people had estimated as the settling pace of the economy.

And so this led to a couple of things. One, a recognition, in my judgement, that, look, inflation—the problem we had for so many decades was pulling inflation down to a target, and now we had a decade of trying to push inflation up to a target. So that was one revelation that comes out of the study. But the other one is that the labor market actually doesn’t demonstrate a stopping point absent the information you have about inflation. I mean, if inflation is printing at 1.8 (percent) and wage growth is still 3.5 or 3 (percent), then the labor market continued to go.

And that long and very durable expansion that came—only ended with the pandemic—was a big portion of why you saw gaps between, you know, Blacks and whites, Hispanics and whites, all sorts of disadvantaged groups, less educated-more educated, start to close. And that happened in the 1990s for a completely similar reason, that the labor market was allowed to run a little bit because inflation was not a problem at the time. So that was the innovation.

And of course, in the—in the commentary about this, the frameworks said: We are going to eliminate employment shortfalls and we’re not going to say, oh, we’re getting to a labor market that says X, and X is what we think the natural rate is, and so we’re going to respond even if inflation is falling below our target. So I think that does lend itself to a more broad and inclusive growth, because you’re not short-stopping—short-circuiting the labor market simply because you worry that inflation is around the corner.

But it never meant in my opinion—and this is my judgement. There are other members of the committee, of course. But in my judgement, it never meant that we were going to simply ignore the outgrowth of inflation because were worried that unemployment might go up a little bit. Because, frankly, we have a dual mandate—price stability and employment. And even if we didn’t have a dual mandate, we would still have the experience that people need jobs, but they also need price stability. Right now, the pain that I hear every day, the suffering that people tell me they’re going through, is on the inflation side.

And this is true of low- and moderate-income people, not just people who are worried that inflation expectations will drift. They’re worried about their day-to-day living. And, you know, I think that—it’s overshadowed a lot in the commentary but is really a critical fact—average real wages, adjusted for inflation, have fallen nine percent in the last two years. So unlike it’s a great time to be a worker, workers have all this power, I don’t see a lot of power if your real wages are falling 9 percent.

And so that is sort of an example of why inflation is a corrosive—if we let it go, it’s a corrosive disease. It’s a toxin that erodes the real purchasing power of people and actually hurts the less advantaged more. They bear a higher tax because of inflation, and they’re the very people that we want an inclusive economy. So to summarize then, an inclusive economy goes both ways. It doesn’t mean just jobs. It means jobs and price stability. If you don’t have both, you’re not very inclusive.

RAMPELL: Well, the counterargument that I’ve heard to that understanding of the tradeoffs that you face, is, isn’t it better to have wage growth that is, yeah, occurring in nominal terms maybe it’s getting partly eaten up or entirely eaten up by inflation. But at least you have wages. Then if you lose your wages entirely because you lose your job—I mean, I think that’s the outcome that a lot of—a lot of Fed watchers fear. That you will have major dislocations in the job market. And not only will people’s wages not keep up, they will lose their job. They will lose their wages entirely because of layoffs.

DALY: So I think it’s important to recognize the spectrum of risks, right? We don’t live in a world where there’s one risk or another risk. It’s a spectrum of risk. So right now inflation’s not a risk. It’s a reality. So people are seeing their real wages erode and people are—I had one person characterize it to me, and I’ve used it regularly because I think it’s just so helpful, says: I’m running fast and falling behind every single day. I’m working as hard as I can, and I’m falling further and further behind. These are, you know, people working regular jobs, doing regular things.

So the second piece of that, though, is that right now the U.S. economy—you know, we’ll get Friday’s employment report. But up until now, north of three hundred thousand jobs per month. The number of jobs we need in our economy to keep pace with labor force growth, to absorb the new entrants and reentrants, is a hundred thousand at most, and probably fewer than a hundred thousand per month. So we’re running well above the hundred thousand we need. And yet, we’re talking about people losing their jobs at high rates. But there’s so many things to do to slow the labor market before you ever have layoffs.

So we’re hearing about a smattering of layoffs as some companies restructure, but what we’re really seeing is vacancies—in fact, the JOLTS came out today. Vacancies are coming down. Firms are recruiting less intensively for even vacancies that are posted. And the pace of hiring will slow. And that translates into people taking a little longer to find a job, which can also push the unemployment rate up. But it’s not that stark tradeoff that people are—you know, that bimodal thing where you either have low inflation and no job, or you can have high inflation and a job.

I’m working towards, and this is true of all my Fed colleagues, we’re working towards achieving both sides of the dual mandate in a balance where people have jobs opportunities, and they have price stability so that their jobs continue to pay value and it’s not eroding day after day. To me, that’s not fulfilling our dual mandate. If people’s real wages are falling—even if they have nominal wages of 5 percent, if it’s being chewed up by inflation, I don’t feel like I’m delivering on the price stability—on the price stability or the full employment goal.

RAMPELL: The Fed, as well as fiscal policymakers, by the way, were widely seen as deliberately running the economy hot, both in the lead-up to the pandemic and in the time since the pandemic recession has ended. With benefit of hindsight, how do you think about the relative costs and benefits of that deliberate policy choice to run the economy hot? I mean, on the one hand if wage growth is growing faster at the bottom you do reduce some wage gaps. That seems, per your comments earlier about inclusive growth, to be a desirable outcome. On the other hand, is that sustainable if it results in recession? Does it necessarily result in recession?

DALY: Well, I mean, let’s go back to 2019. So let’s start with that episode, when we were criticized by some for cutting the internet rate against global headwinds and other developing things that made it a risk. But remember, inflation is at 1.8 (percent), really. We couldn’t get it up to 2 (percent)on a sustained basis. And so then the question I have is, why is that a hot economy? You know, we did a Fed Listens event. And I remember in Chicago a gentleman speaking there said: It’s always a recession in my neighborhood.

And it reminds one that if inflation’s not even hitting our target, really not even getting to 2 (percent), and the labor market’s continuing to add workers, the labor force is expanding, gaps are closing, people are—you know, firms are complaining that it’s hard to find workers, but they’re finding them. And workers are getting a look where they never did before, well, is that a hot economy or just a well-functioning, sustained expansion? So when I look at 2019, I feel like that was exactly the policy that we needed to make for those times. And importantly, the pandemic derailed the economy.

And I felt fortunate myself, even looking back now in hindsight—with hindsight, I feel fortunate that we came in so strong to the pandemic. I think it’s one of the contributors to why the U.S. has remained able to weather the pandemic, in addition to having the fiscal and monetary policy support to build a bridge. I just think the economy came in very healthy. And I’m glad for that. So that’s a different part of—the first part of the question. Now let’s get to the second part of the question.

That, I would—I’d debate the use of the characterization really that monetary policymakers, even fiscal agents—and here I’m not a fiscal agent. I don’t make fiscal policy. But just reading how they were thinking about it, I don’t see it as even attempting to stimulate the economy. That’s certainly not how I thought about the Fed policy. I thought about it as trying to offset a tremendous shock to the economy and the pandemic, and make sure—you know, the way I’ve described it, and I think this is the way I think about it, trying to build a bridge because people, through no fault of their own, were doing well and then suddenly got pushed out of the economy, pushed out of business. And we were trying to build a bridge.

Now, history will judge whether that bridge was too long or too—I don’t think anybody’s going to come around with it’s too short. And I think most people will settle on historically that it was maybe a little bit too long. But in real time, when you’re making those decisions, I would frankly rather have a bridge that’s a little too long and have—when we have the tools to fix the—the remedy the problem of inflation, than I would to have it too short and be scarred for, you know, their lives. Millions of people who didn’t get across the pandemic. And to me, I just—I think it’s easier to sleep with having to correct with high inflation than it would have been easier to sleep with, you know, kind of destroying the lives and livelihoods more persistently of generations of people who didn’t make it all the way over.

RAMPELL: But there were calls as early as, I want to say, two summers ago, at this point, for the Fed to be paying more attention to inflation.

DALY: Summer 2020?

RAMPELL: Summer 2021.

DALY: Oh, 2021. Yeah. It’s ’22, yeah.

RAMPELL: We’re in the fall—

DALY: You know, I don’t know what season it is. I live in California. We have one constant summer.

RAMPELL: No, it’s fine. Right, fair enough.


RAMPELL: So, I mean, as early, at least, as—

DALY: Sure, in 2021.

RAMPELL: Summer of 2021, for the Fed to stop stimulating. I mean, the Fed was still engaging—

DALY: We were in an accommodative posture, absolutely. And it was—and so when do you move from, you know, helping growth maintain itself to stimulated growth? Well, whenever it’s the point where the economy can function on its own, right? So we are accommodating, stimulating, et cetera. Totally.

So what happened in the summer of 2020? Well, in the summer of 2020, there was a really, I think, good debate about inflation. But remember, let’s go back to summer of 2020. In summer of 2020, inflation was really focused in on a few sectors. There—

RAMPELL: 2021, we’re talking about.

DALY: 2021, I’m sorry. 2021. Now I’m all messed up. 2021. Summer of 2021, airline prices, used cars, various other little things. I remember every day the—every time the inflation report was released, Twitter would blow up with various journalists, really, just decomposing the inflation things and saying, used cars got the big one, airline prices. But what it looked like at that point in time, and it was completely consistent with what we were observing from the pandemic, is that reopening effects—you can call it supply chains, but it’s really supply chains meet reopening effects. And at that point, you don’t want—I think we didn’t act, in part, because these weren’t broad-based pressures. But you’re watching broad-based pressures.

The second piece is that the unemployment rates in 2021, early, was over 6 percent, right? Just a bit over 6 percent. And it took a while for that to come down. So in the summer, we were evaluating—I was evaluated with my team, and the research economists are evaluating—how much of this labor market strength is, again, a reopening, right? Hotels have to open after being closed for a long time, get ready for summer tourism. How much of that will go away in the fall? By the fall, it didn’t. We had price pressures spreading beyond those sort of idiosyncratic sectors. And we had the labor market showing more durable strength than just a reopening effect. And so at that point it really starts to look like it’s necessary to move policy tightening forward. You know, to remove the accommodation.

And so I remember quite clearly in the fall we started thinking about that, talking about it. You know, at that point Vice Chair Clarida actually was out in San Francisco and said: We might have to taper faster. And I remember I was on Yahoo Finance the week of Thanksgiving. And why I picked that time, I don’t really know. But I was on there the week of Thanksgiving. And I said, I think we’re going to have to taper faster so that we’re in a position to raise interest rates earlier. And that started what—you know, those—there were other commentators, but I remember Rich and myself clearly—is that started the pivot. And then you could see that forward path of policy was starting to come forward earlier in time.

And so then you’re really asking—I think, for those kinds of did we start too late—you’re really asking, should we have started raising the rate in, you know, the fall, as opposed to in March? And I think that’s a good question. For me, I think the big lesson I take away from that is why did I feel like that was going to be hard to do? Because we have the speedboat of the funds rate and the tanker ship of the balance sheet. And we’re still purchasing assets. And we have to—we can’t have market dislocation with a sudden surprise.

And so the lesson I think we all have to grapple with and learn going forward is in these periods where we want to nimbly respond to changing—to changing economic conditions, what do we do when we’re carrying this tanker ship? And would it be enough to have a commentary that said: We’re going to start adjusting the policy rank and tapering, but that tanker ship takes longer to turn and they’ll meet over there sometime next year? And, you know, I don’t know what the right answer is, but that’s where they have studied because delayed us.

The catch-up, if you will, from that delay, in my judgement, is we offered a lot of guidance in March. And the mortgage interest rate went up quite quickly. We announced a 25-basis-point increase in March and a path, and all of a sudden, you know, mortgage interest rates go up quite expeditious, as we like to say these days. And that has been—the forward guidance has been extraordinarily effective this time around. And I think we now have the fastest pace of tightening that I remember in my time at the Fed.

So I guess that’s how I’d look at it, but history will be the judge. And I’ll let historians and economists, the young economists coming up now, decide how we could have done this better. There’s always room to do things better. But those are the ways I think about those two periods that you reference.

RAMPELL: Are there lessons that are applicable for future turning points from the Fed’s mis-forecast, shall we say, about—

DALY: On inflation?

RAMPELL: On inflation. I mean, would the—going forward, would you change how you model the effects of fiscal policy, for example? I mean, you mentioned that there were some supply shocks that maybe were idiosyncratic and are not applicable to whatever—knock on wood—(laughs)—to whatever future economic challenges might occur. But are there transferable lessons from the fact that the Fed, among others to be fair, got inflation so wrong? Got its forecasts on inflation so wrong?

DALY: So, you know, I think a lot about this. I’ve thought a lot about this, because you want to make sure that you’re, you know, doing all the necessary work to make sure that you can do better forecasting down the road. And so we went—I went back. I looked with my team and I, we looked over all the information. What did we miss? And this is really the thing that was most pervasive in the miss. And in retrospect, we could have done better, I guess. But I did not—I did not fully appreciate how long it was going to take to beat back COVID. I did not fully appreciate that with vaccines so available, that anybody could get them. There was no more queuing, you could get them. That we had a low take-up in the United States relative to, like, fully beating it back quickly.

I didn’t realize, didn’t fully appreciate, how geopolitical differences would play out in terms of countries sharing their vaccines or countries taking other people’s vaccines, you know? In a world what’s perfect and run by a—you know, a social planner, you’d say the best vaccine wins, and everybody gets it, and then you beat back a disease, and the pandemic ends earlier, and supply chains recover more quickly, and this wouldn’t have been some of the problems we had. But this is not how it’s worked. I mean, China is still today rolling lockdowns. You know, they’re softer lockdowns, but that are disrupting supply chains and rippling through the economy.

So this is something I didn’t appreciate. And I think over time we’re just going to have to get better at recognizing that. Because I don’t think—you know, it probably won’t be—we can’t imagine it’s going to be another hundred years for a pandemic. So every time I learn something about the fact that these things can happen, I want to keep that skillset handy and going. And so I think that’s what I didn’t fully appreciate. And the other part that I didn’t appreciate is strong demand was going to be. You know, I have a lot of people who do change management who come and talk to me. And they said, oh, you should have known this because once people have been kept from something for two years, they come bounding out and they’re unbridled.

But I did not appreciate how unbridled people would be in purchasing goods. I thought we would be filled up with things. But they pivot from even now today, the pivot back to a more normal pattern of goods purchases relative to services, good still remain quite elevated. So these are all things that I think we’re just going to have to may build more persistence into our thought process and our models. But maybe the health, perhaps other shocks that come, they’re just a little more persistent than we appreciated.

And, you know, fortunately—and I do think this is fortunate—we have the tools to fight high inflation. We know how to do that. And we’re using them now to bring inflation back down. And I think the other fortunate piece is that despite the concerns—and I think it’s useful to continue to watch, it hasn’t led into longer-run inflation expectations. Not of consumers, not of businesses, not of market participants. Which means we don’t have ourselves in a 1970s and ’80s position where we’ve lost inflation psychology. Now, we can’t be complacent. But so far, we haven’t lost it.

RAMPELL: You say we have the tools. We, being the Fed?

DALY: We, being the Fed.

RAMPELL: Meaning, I don’t have the tools, sadly—(laughter)—to deal with inflation. But a lot of the contributors that you just mentioned as leading to more sustained inflation than had been forecast are supply side issues. Now, the Fed has the tool to deal with the demand side, predominantly.

DALY: That’s correct, right.

RAMPELL: And not the supply side. And you can’t unwind bottlenecks around the world. You can’t reopen the factories that have been closed in China. And in fact, in some ways, raising interest rates may actually hurt supply-side normalization, or increased production. I’m thinking things like housing, for example. We’ve already seen building—housing permits fall recently, in part because of higher interest rates. Any industry that has to deal with, you know, major upfront capital investments, they’re affected by the high cost of borrowing.

So how do you—how do you think about those tradeoffs? You know, you’re obviously trying to get demand more in line with supply right now. But you’re not only—you’re not able to only depress demand, you might also be depressing supply in the process.

DALY: Sure. So can I impact that a little bit into a couple of things? The first thing is that, you know, the facts that I’m approaching this problem with are these: That there’s been a considerable amount of research, a lot of it done in the San Francisco Fed, and we’ve published it on our website, but we’re not the only people doing this. Where there seems to be an emerging—there’s hardly ever a consensus in economics, but there’s an emerging sort of span of estimates that say—let’s just say, for sake of argument, this is San Francisco Fed’s estimates—that about 50 percent of the excess inflation we observe is demand and about 50 percent is supply.

And you are quite right, the tools that the Fed has really to focus on the demand side, not the supply side. So still, if 50 percent of the current excess inflation we observe is demand driven, then we have a lot of work we can do in the economy before we ever have to really start to worry about the supply part of it being the constraint. But we’re not close to it’s all supply where tools are not useful. So I think there’s a lot of room for our tools to work.

Now, of course, as you said, as we raise the interest rate, interest rate-sensitive sectors, many things in the durable manufacturing, in small businesses, those are supplies to—housing is a good example—those are supplies that then respond to those things. But, like, let’s take housing. I think it’s a great example. You know, we have two mismatches in the economy on housing. One is just the sheer number. You can do the aggregate count of homes available and you can do the aggregate count of people who want homes, and you can see there’s a gross mismatch. Housing is under-supplied.

But here’s a—here’s a fact that I keep going back to. Even when we were building the homes, when there was rapid home permitting, they weren’t building the type of housing that is really for the entry families where the shortages are the greatest. So we have a mismatch not only in amount, but in type. And so, you know, that is something that has to be solve more by our planning and zoning and how we think about things, but it’s not going to be solved by a lower interest rate. And so, I think that supply and demand imbalance in housing is partly not solvable by the Fed. It’s got to be solved by other agents in local economies, state economies, et cetera.

But let’s return to, you know, tempering supply. While we had supply chain bottlenecks, and maybe you would think that we were underinvesting in sectors that were really high. You’re like, why don’t more people start building X, Y, and Z. So we went out and asked them. You know, we spent a lot of time talking to businesses, and small, medium, large businesses. Why aren’t you investing? And they said, well, because we don’t know if it’s transitory. If there’s an over-rotation onto goods, and then I build a factory to meet the over-rotation onto goods, and then it re-rotates back to a normal pattern, now I have a factory I cannot use.

So I don’t think it was simply that the interest rate environment has cooled the spending on these things. I think that there was just not the supply response, in part because it’s really hard to believe, if you look at history, that people are going to be rotated on this goods purchases relative to services when we fully come back and can fully participate back in services, or we just get back in the habit of participating in services.

So I think there’s more things going on, but there’s no doubt that interest rates going on up affects borrowing costs, which reduces business investment for the interest-sensitive sectors, those who aren’t funding out of equity. And that’s going to bridle that part of the economy. But it’s also going to bridle demand, which is—and more so, in my judgement—because more people are sensitive to that rising interest rates. And now it’s going to help us put the economy back in balance.

It ultimately comes back to this simple fact that I think is a foundational truth, is that without price stability a fundamental pillar of the economy is missing and even things that seem good are not sustainable. And so getting—restoring price stability ensures that we have the platform for sustainable growth and a healthy expansion. And we don’t have that right now with this high inflation number.

RAMPELL: You mention other policy levers that are not under the Fed’s purview that might be helpful in something like the housing market. Are there other things that would be helpful to the Fed in terms of what other policymakers could or could not be doing, that would make your job easier?

DALY: So I learned a valuable lesson in my four years: Don’t comment on things you don’t have decision power on. And I think that—you know, one of the things that I say—as an economist, I will say this. And this is something that all economists would say. I don’t think there’s an economist you meet that doesn’t say these things. That when you invest in the productive capacity of our society, whether the private sector does that or the government sector does that, then you actually invest in future growth. That is a good thing. And in the end, it’s much less inflationary than just investing in things that are consumed over a short period of time, when we already have a strong economy with a shortage of supply and an excess of demand.

So in the housing world, you know, I think that one of the things—it’s a piece of infrastructure. Education is a piece of infrastructure. Broadband’s a piece of infrastructure. We can itemize all of our favorites, but there are basic things that people need to have, either because they’re basic necessities or because they’re things that make our lives work better. And those productive infrastructure items will ultimately pay dividends not just today, but down the road. And so—but, you know, the fiscal agents, in my judgement, are working hard on all these problems, and trying to figure this out. And I have a completely full-time job with inflation where it is.

RAMPELL: OK, fair enough. I mean, I would argue that some fiscal policymakers are making decisions that make your life harder as well.

DALY: Well, you also learn another thing if you work—and I’ve worked at the Fed a long time. And it’s you really—you work with the economy you have and build towards the economy you want. And so the economy we have is—it’s being bounced around by all kinds of things, right? We have a pandemic, and then we have reopening, and then there’s supply shortages, and then there’s global synchronized tightening of the central banks to fight inflation, and then there’s a war in Ukraine. And, you know, we don’t control any of those things.

But our job at the Fed is to balance policy, to the best of our ability, to put the economy on a sustainable track with price stability and full employment. But it’s really all about the same thing, using those two pillars to get to sustainable—a sustainable growth, where you don’t have these ups and downs that are volatile. And volatility of those ups and downs in the economy can be harmful. And we started this conversation this way, it can really harm those who are less advantaged.

RAMPELL: And then my last question before we turn to member—

DALY: It goes fast.

RAMPELL: Yes. (Laughs.) Is something that I’m concerned about, which is that I think that we are likely to see some challenges to central bank independence in the years ahead. Not just here in the U.S., around the world, as many countries face economic challenges, in part because the synchronized tightening that you’re talking about, the fears of global recession, et cetera. I mean, I think we’ve already seen some foreshadowing of this in the U.K. with the prime minister’s comments about revisiting the Bank of England’s mandate.

How worried are you about public buy-in for central bank independence? What are the potential consequences if there is a perception that there is more political influence at this central bank or any other around the world? I mean, for those who are skeptical about the idea of outsourcing all of this power to—I know you’re going to take objection to this—to a bunch of unelected technocrats, who can force a recession if they wish to, give the case for what happens if there is a less credibly independent central bank.

DALY: So, you know, I probably don’t have to tell people in this room or listening that, you know, central bank independence has proven again, and again, and again to be really important to the sustainability of the—of economies. That, you know, examples—there are examples where fiscal and central bank policies have all been blended. And those have been ended in really challenging and difficult consequences. So the principle of central bank independence is, in my judgement, completely evidence-based. It is the thing that we need to have a strong and healthy economy, to have that separation, and that apolitical nature of the Fed or any central bank.

The question that I think it really comes down to for me is the idea of public trust. And I see trust, the public’s trust in us, as our most important tool. And it’s our most important tool because if people trust that we are doing our policies to deliver on the goals that we say, and then we do the things that deliver those goals, then that creates conditions where they don’t actually have to think about will price stability be something in my future. And I would say that we have some evidence that the public still does trust us, and that we haven’t lost that credibility because inflation expectations, despite the fact that inflation’s really high right now—and has been for a while, over a year—that they still are coming in at relatively stable rates around our inflation target.

And so for me, that is an indication. But I don’t just sit quietly with that. I go out and ask people. And, you know, it’s interesting, nobody ever asks me—nobody out in the public—I mean, if you’re in Washington, you get asked this a lot. But if you’re elsewhere you don’t get asked this very much—not in my district and not in other parts of the nation—about whether—they don’t want to talk about my independence as a central banker. What they want to talk about is when is inflation coming down and how soon will I get some relief? And so the best—to your answer, you know, I have a mantra in my life. And this is—I’m going to apply it here. When you’re faced with challenges you can either get worried or you can get busy. And I’m just busy. I don’t worry. I get just busy.

And I think if we do our jobs well, and we communicate to the public why we’re doing what we’re doing and why the interest rate path we’re taking is necessary to get inflation down, and that price stability for us is extremely important, as is doing it as gently as possible so that the economy can be in a balanced state as easily as possible—whatever that looks like, we’re going to take the easiest path we can find. Then I think that’s what delivers the trust. And independence is based on our—on the trust in us. And I think the trust goes up as inflation comes down.

RAMPELL: All right. At this time I’d like to invite members to join our conversation with their questions. And a reminder that this is all on the record.

We’re going to start with a question here in the audience. I think I saw this hand go up first.

Q: Hi.

DALY: Hi. I’m sorry, I didn’t—there were three people. I didn’t know which one went first. OK, it’s you. Thank you.

Q: No worries. Hi. Adam Silverschotz. I run an investment fund.

Could you please talk about quantitative tightening, and specifically how much base rate effect or base rate equivalent effect the 95 billion cap, you know, really means, in addition to the rate hike cycle. And if you could connect that to your thinking about the relationship between forward rate path and market impact from quantitative tightening over, you know, the next horizon? Thank you.

DALY: Absolutely. So, first off, I’m going to say this is not an exact science. It’s not like we have an exact equation for this that we know with certainty, because we just don’t. But let me tell you how I think about and how I view what is occurring now.

So the first thing I start with—and I’m happy if people want to tell me that this isn’t correct, but this is how I start—is that there’s a lot of pricing in of this balance sheet adjustment that gets done the minute we make the announcement. So we make the announcement, and when people feel certain the announcement’s really going to go, when we move into the higher cap, OK, now that gets priced into markets. And so that’s baked into some of the financial tightening we’re already seeing.

So, you know, when I started off the estimates of this effect vary widely. And they vary widely from academics to Fed officials, et cetera. And they can go from anywhere from zero to, you know, well-over a hundred basis points. From all the estimates that I’ve seen, I put it in my mind as one rate hike, maybe two. But we will learn that experientially as we see this. And so there’s this idea that there’s more tightening in the system than the fed funds rate is suggestive of.

And, in fact, a colleague of mine in San Francisco, and this work will be coming out in the next, like, probably month, he’s done this nice work which I really like. I said, what if we—how can we put the day’s financial conditions into funds rate space? Like, what am I looking at if I’m trying to manage taking into account balance sheet policy and all the forward guidance we give it? And his estimate—and this was before the last FOMC, before the announcement, before the new SEP came out. But he at that point, in the data that came out before the FOMC met, he had it at about 4 percent. This is, like, at a funds rate of about 4 percent, where we were before the meeting. And now it would be even higher, right?

And so I think there’s a recognition, and I certainly have this as I go into thinking about what more is needed, that we announced what we were doing, both on the QT and also on the funds rate path. We had the projections. And markets priced those in. And we got to some tightening. And there’s been some volatility around those tightenings but imagine that things got tighter. And now we’re raising the funds rate in part in lockstep with some of those, but the rates are up. And part of that’s QT, and part of that is our forward guidance. And which part is which, I don’t really—I don’t really know.

But the main message, I think, is that I believe it’s already built in. I don’t think of it as it’s tightening every time we let things roll off. It really is already planned in, and markets are reacting to that and know that path. And only if we made a big change, would things change. And right now we’ve picked a level of balance sheet reduction that’s meant to weather, you know, a whole series of different circumstances, so that we don’t have to use it as a surgical tool, because it’s really not a surgical tool. I think that’s the lesson we’ve learned. So hope that answers your question. But right now I would say it’s in there and we have to be thoughtful as we figure out where to end. In terms of the terminal rate, how much pent-up tightening is already in the system that’s yet to show through in the data we see in the real economy.

RAMPELL: We have a question right here.

Q: I’m Lucy Komisar. I am a journalist.

The Federal Reserve Board of Governors Annual Financial Stability Report released in May, in a second on life insurance, said leverage was near its highest level of the past two decades. That over a decade the share of risky, illiquid assets on balanced sheets increased, with heavy investment in corporate bonds, collateralized loan obligations, commercial real estate debt, and funding agreements. Which leaves their capital positions vulnerable to sudden drops in the value of these risky assets. In the current volatile period, with a system where life insurance companies don’t have to meet even the stress tests that banks do, are you concerned about this situation? And what do you think should be done?

DALY: So, you know, this comes out of our Quantitative Surveillance Report. And we do this on a regular basis. And we identify sectors, the board of governors’ team working with all the reserve banks, of course, identifies sectors where there’s pockets of vulnerability and sectors where there—and it’s really to try to figure out and to give an assessment of what’s the state of financial stability. And so that was a sector that was called out as more vulnerable. I can’t remember the color, but it was more vulnerable. But overall, the financial system is well-capitalized. Banks are well-capitalized. Households are well-capitalized. Most corporates are well-capitalized.

There are pockets of risk. And so those are continuing—we will continue to watch all of those. But in terms of our assessment of those, it’s less about what to do about them and more about where are they, and what risks do they pose for the system. And I think the way I read the Financial Stability Report and augmenting that with other things that we are collecting outside of the Financial Stability Report, is that we come into this cycle of tightening in a better position, a less vulnerable position, than we were back when the financial crisis occurred. You know, the household sector being a really big asset right now, in terms of they’re well-capitalized. Banks are well-capitalized.

But there are other sectors. You know, it’s the unknowns, the things we don’t know. Right now the big one is actually crypto, that everybody’s worried about. But of course, it’s a small sector and not with a large, systemic footprint. But I think these things are worth watching. This is certainly always worth watching. But it’s important to watch them in a tightening cycle, especially when there’s global tightening. And the volatility we’ve seen in markets over the last several weeks, really, is something that, you know, makes any vulnerability more likely to show through.

So I appreciate you bringing it up, but I think the main point of that report was that there are sectors that are vulnerable, but they’re not the big dashboard of indicators. And so we still have a very healthy, stable financial system. But, you know, we’re having another report. I can’t remember the exact time it’ll come out, but we’re having another report coming out. And, you know, we’ll have a new assessment that takes into account all the things that have happened since May.

RAMPELL: Right here.

Q: Hi. I am Robyn Meredith with BNY Mellon.

One of the things that you pointed to as surprising the Fed was the slowness in coming out of COVID, particularly China’s COVID zero policy, holding down growth there, holding down factory production. It seems to me that we have seen two big things happen. One, interest rates, instead of going down, are staying low, are now going up worldwide. And the second is kind of the end of globalization, you know, where partly because of the China COVID zero policy, but also the war in Russia and, you know, politics around the world, including in the U.S. become more nationalist, we’re seeing that. How is the Fed thinking about this sort of end of the globalization era? Which is a longer-term question.

DALY: OK. So let me start by saying I should say I don’t know if the whole Fed was surprised by those things. I was speaking for myself at that point. But it’s useful just to remind people that some people—you know, we have a big committee. Lots of people have different views. But that’s what surprised me.

Now, in terms of globalization, you know, I think we want to—this is my own view—but I think we want to avoid going from one side of the pendulum to—swinging the pendulum from one side to another. So obviously we learned a lot about the vulnerabilities of a completely global supply chain. And I’ve heard all kinds of ways that my contacts in the corporate sectors describe it that, you know, resiliency is the new efficiency, and they want, you know, just nearby as opposed to just in time. And they’re willing to trade off cost reduction in order to get some inventory that’s nearby. And there’s a lot more vertical integration.

So I have several companies that used to outsource most of their things, and then bring it back for assembly or production, and now they’re really insourcing it and they’re building vertical systems so that they have complete control over the supply chain, really. And so all of that is taking place. But there is still this reality that countries have comparative advantages, and that we do all benefit when we trade with each other. And that’s not going away. And firms are smart. They’re going to figure out where the right settling point is. And they might have over-rotated to the global, and then we didn’t realize how vulnerable that would be to something like a health event.

You know, there are also climate-related events now emerging where your supply chains get cut off for other reasons. And I think—I think companies are just smarter now about how you need to be nearby and you also need to be making sure that you’re efficient, and getting things done where the workers are, and where there’s obviously a skill, you know, place where you can get this material produced, or this knowledge produced. So I don’t think it’s the end of globalization.

What I do think that we have to do as Fed officials, and what I do as a Fed official, is you’re always looking forward. But you—I think the important thing about looking forward is you—I do not like to run to, oh, globalization is over. I like to run to, OK, not even run. I like to think about, OK, what is this going to mean? What’s the settling point? And how would we get there? And what does that transition look like? And we were just having a conversation before we came in here for the meeting that, you know, I think the big lesson is that you can look at data, you can look at published data, you can look at your models, but you have to talk to people. We have to ask firms, what are you doing? What decisions are you making?

And when I talk to firms, I’m hearing this. And this is one of the great things about the regional reserve banks is the twelve presidents are out there talking to—not to say governors don’t do it, but we have—we even have districts we serve. And we’re out there talking regularly to companies. How are you thinking about this? And what I see is a much more balanced approach. Companies that, say, were offshoring everything, are now saying we’re near-shoring, or we are—we’re thinking about we’ll do some of that over there because it’s so much more effectively done, and then we’ll do some of it over here, or we’ll have backups. You know, we all think of computer backups being geographically dispersed. Now they’re thinking about people backups begin geographically dispersed.

So I do think there is a settling point. And it won’t be at either extreme. It’ll be taking on lessons from the pandemic, but also not giving up the lessons that people can work remotely and do so quite well. And you don’t have to be right by each other to trade knowledge. I think those are all the lasting effects. And the Fed has to look forward on all of those things. Like, we have to look forward on everything to understand potential growth, the effect of policy, what the capacity—what the inflation trends are going to be, you know, what—I think there’s a big debate right now about what’s going to be the settling rate or the neutral rate of interest and whether inflation is reset to a higher level. Are we still going to be finding ourselves after this is over fighting inflation from below our target, like we were before we went into the pandemic? We haven’t—those debates are not settled. But I think it’s the right questions to ask.

RAMPELL: Back here.

Q: Hi. Tim Ferguson. I’m a business journalist.

You suggested that the synchronized tightening going on around the world—(coughs)—excuse me—is a kind of external force that the Fed has to consider. But I believe you’re getting increasing feedback internationally that the strong dollar is in fact not only their problem, but your problem. I’m wondering how you would respond to the international pressures that are growing with regard to the dollar. I’m just thinking back to the 1980s, and the tightening cycle under Volcker, which ultimately culminated in Jim Baker having to do some arrangements to bring down the dollar at that time. I’m wondering if you think it is ultimately going to be the Treasury’s problem to deal with.

DALY: So I’m going to say things I think you already know, but it’s useful say. The Fed doesn’t make dollar policy. That’s not how—that’s not how our country works. That’s the Treasury’s decision. What we do, and this is our mandate. We don’t have any room for other things. Our mandate is to make monetary policy for the domestic economy. But that’s how all central banks in the world really work. They’re meant to create monetary policy that works for their country. And that’s what we have to do.

So with that, we have to acknowledge and understand the impact that raising the interest rate, or dollar appreciation against other currencies, has on global growth and on global financial conditions, because ultimately those things feed back into—onto the U.S. I mean, we could think of them as a global headwind. If Europe goes into a recession, that’s a headwind. If China falters, that’s a headwind on our growth, and we have to take that into account so that we don’t end up over-tightening policy.

But you know, I’ve been reading a lot of academic work right now on this issue. And I think, you know, it’s well- characterized by the following statement: That coordinated—so, synchronized is not coordinated. So synchronized tightening is something all central banks have to recognize, because it matters for the policy you take in your own country, depending on what the synchronized global tightening is doing to overall global financial conditions, which are clearly tighter than if only one country was tightening.

But the—but coordinated policy tightening doesn’t have an obvious positive effect. Some people argue for it. Some people argue against it. I don’t think there’s any real conclusion that that would make us better off. But even if it would, that is not our mandate. Our mandate is to do domestic policy, monetary policy, to restore price stability and, you know, full employment price stability in the U.S. economy, and be aware—that’s why I mentioned synchronized global tightening—I think of it as, like, forward guidance and QT.

It’s another variable, which is hard to pinpoint the exact magnitude, but we know it’s affecting financial conditions. And failure to take it into account would mean that we would be more likely to over-tighten, because we wouldn’t understand, if we were ignoring it, just how tight global financial conditions are, and what the effects on global growth are going to be that would affect our economy. So that’s how I—how I answer. And, I mean, it’s one of those things. The Fed has a limited set of tools. We have really one tool: interest rates. We have different ways to adjust them, but we have one tool, the interest rate. It’s a blunt tool. We have two goals in our own country, and we don’t take on the goals of other countries, because that’s not the mandate that we have.


Q: Hi. Veronica Clark. I’m an economist at Citi. Thanks for your comments today.

My question is with regard to the labor market and inflation. We hear Chair Powell often cite that ratio of job openings to unemployed people, which is about two. Today it fell to about 1.7, which doesn’t sound that different from two, but it’s the lowest it’s been since April of 2021. How would you see generally—how much looseness do you need to see in the labor market generally to be convinced that underlying inflationary pressures are easing? Are you watching that measure? What exactly are you watching?

DALY: So I think that vacancies is a useful measure, but let me go through why. You know, there’s really three things to—that you can watch that I think are really relevant. One is this vacancy to unemployed workers ratio, which has just skyrocketed. And that was a measure of just how many opening we had that couldn’t be filled with the labor supply we had. Just how tight the labor market was when, you know, the unemployment rate sort of stops at a certain level. You just still see these vacancies. And right now they’re coming down. You know, I learned an interesting fact, because I was very curious about vacancies. How do firms post these vacancies? What are they doing?

This is a pretty new metric for people to look at. So I asked the firms in my district. You know, and they told me something really important, and I think it’s a useful piece of information for the data—to understand the data. They said that the way that vacancies work is—if you’re in the private sector—is your post a vacancy, but you take out a contract for the platform you want to run it on. And then when you don’t want to hire in it, you don’t go take the vacancy down, because you have a contract. So you just let it hang out there. And so depending on what your contract is, is it three, six months—three months, six months, or a year, it can have—it’s a really lagging variable.

So two to three months ago I started hearing the firms in my district say: We’re really just not intensively recruiting for those positions. And one of the tech firms in our district said, you know, we just try to help people understand we’re not hiring in those areas by saying that we’re slowing the pace of hiring, we do press releases. We’re restructuring our business lines. We’re doing things, so that people know that our recruiting intensity has gone down quite considerably. And then we just let those vacancies roll off.

So I do think the drop from two to 1.7 is a pretty big drop, even though it’s a small number. It’s a small—I mean, it’s not a very—it’s a narrow space, right? So three-tenths of a percentage point’s a big jump. But I just think more of that will come. But that’s one way you can get some of the pressure off the labor market, is just have fewer openings that firms are anxious to fill. And I think that’s already happening. Ultimately, that will spill into the pace of hiring.

And I mentioned at the top of our discussion that, you know, we’re—the job report, three-hundred-thousand-plus jobs per month on average in the U.S. economy, on a need of a hundred thousand just to absorb new entrants, that’s well above. So there was a lot of room to slow the pace of hiring and still not dig into the third and more painful place that everybody fears, which is just outright layoffs, to get the cuts in your firms. And so I’m hearing a few of those, but I’m not hearing—I’m not hearing right now pervasive layoffs. What I’m hearing is slower hiring, more focus on retaining the workers you have, things of that sort.

So when you ask how much looseness I need to see, I’m really looking for those vacancies or that recruiting intensity—knowing that vacancies come down with a lag—that recruiting intensity continue to come down, that the pace of hiring is slowing down to something that’s more like a sustainable pace, with the labor supply we have. And that will be, to me, consistent with, you know, indicators of inflation coming down. Quits are also coming down. The other thing I’m starting to hear, and there’s been some news reports about this but we’re doing it in our own contact surveys, is we’re hearing that firms are planning for a lower rate of wage increases in the coming year of merit and adjustments.

And so, you know, last year it was 4 ½ to 5, 5 to 5 ½ (percent). Now I’m hearing from my own district contacts it’s 3 ½ to 4, maybe 3 to 3 ½, depending on the sector you’re in. So that’s a very different pace. And, you know, one of my contacts said that they’re really turning their attention—this is a big employer—really turning their attention to—a lot of that wage growth was—the outsized wage growth relative to the norm, was for new hires. That was driving their compensation. And now they’re turning to equity adjustments within their firm, to try to make sure that they’re rebalancing to keep the existing workers happy.

Another little fact that I’ll leave you with on this point is that I’m hearing more and more that workers are not just not quitting at as many rates, but there’s a tech firm I met with—it was a medium-sized tech firm in L.A. And he said that his whole conversations have shifted from people coming in saying: I want more money or I’m leaving, or I’m going to resign and find myself, to can I have my job back? And then other people who are at the firm are saying: I just want you to know, I’m not even looking. I really like it here. So I think that is an indication that people are finding their footing to stay in a place, and some of the churn that’s been going in the labor market might be settling. And that’s better for—ultimately, for sustainability.

RAMPELL: Other questions here or online?

Q: Joseph Gasparro, RBC Capital Markets.

So you’ve written extensively about income inequality. And you’re also a first gen, you know, college graduate. You know, what are—and its impact on, you know, GDP development and competitiveness. What are the solutions? Is it more mentorship? More STEM development? You know, in your seat, what can we do to actually impact it?

DALY: Sure. Well, you know, that’s—those are the big questions, honestly, we were grappling with before we had a pandemic. And now we have high inflation. But I think it’s really—I’m glad you brought it up because it’s a critical question. Is that, you know, one of the things that’s most troubling about the labor force participation rate right now to me, and the labor supply, is we started with the lowest labor force participation rate—if not the lowest, one of the lowest in the industrialized world.

That was before the pandemic. And we haven’t gained ground after the pandemic. And so ultimately potential growth in our country is, just like it is in every country, a product of productivity growth and labor force growth. And productivity growth is doing what it does. We don’t have any signs it’s going to start growing—it’s going to be rising much faster. So now we’ve got constrained labor force growth. And that is a worrisome piece.

And so one of the things we have to do is not only, you know, perhaps involve as many people as we can in our labor force, but also use the skills we have. And one of the things I see going on with this market we have, with high inflation—I just wrote about this, because it’s really—it’s troubling. You know, college enrollments, two-year, four-year, certificate programs, training programs, enrollments are all falling. Even in our community services where people do workplace development—workplace services development where you can come and get a training or a course, they’ve just dropped off.

And the people who are serving these individuals say it’s a double-edged sword. The job market really right now is so competitive that they can get multiple jobs. It feels like they’re getting a good wage, but they’re also just being pushed into these situations because the opportunity cost, because of rising inflation, just makes it too hard. It’s really hard to go to these classes, pay for these classes, and then actually, you know, pay for your wellbeing and your living when inflation is high. So I think right now what I’m really focused on is bringing inflation down. It’s one of the reasons the Fed’s really resolute.

But then we have the longer-term issues of just involving more people, giving—at the San Francisco Fed, we’re actually starting—we’re in the beginning stages for asking the question: Have we over-skilled our jobs by saying college degree, college degree, college degree? And we’re bringing in people who are right-size for the job, and then if they don’t have a college degree—a college degree can sometimes be a screening device. And the question is, when many people don’t have access to a college degree, should we use a different screening device? And I think that’s something all firms could do. But we’re in the infancy of this. And I don’t think it’s something we’re all used to. But reskilling—reclassifying our jobs so that they’re about skills as opposed to degrees, I think that could be very helpful.

RAMPELL: All right. I think we are at time. Thank you, again, for our great member questions. And thank you especially for President Daly’s time. (Applause.)

DALY: Thank you.




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