Challenges for U.S. Monetary Policy

Challenges for U.S. Monetary Policy

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from C. Peter McColough Series on International Economics

The Federal Reserve's Jerome H. Powell joins CNBC's Steve Liesman to discuss imminent challenges for U.S. monetary policy. In his opening remarks, Powell outlines the U.S. economy's progress and the path forward for monetary policy. He describes the Federal Reserve's approach to stabilizing inflation and suppressing unemployment after the financial crisis of 2008. Powell notes that with the Fed's intervention, unemployment is slightly above expected natural rates, and inflation is on track to reach the Fed's objective rate of 2 percent. Over the course of the discussion, Powell addresses financial markets, interest rates, and the effects of quantitative easing in Europe on the broader U.S. economy.

The C. Peter McColough Series on International Economics is presented by the Corporate Program and the Maurice R. Greenberg Center for Geoeconomic Studies.

LIESMAN: Jerome Powell took office as a member of the Board of Governors of the Federal Reserve in May 2012. It was part of an interesting bargain with Congress that came along with Jeremy Stein; I guess they—both had to be called Jeremy, was that right? Anyway, he was reappointed and sworn in on June 16, 2014. His term ends in 2028. Prior to joining the Fed, Jay (ph) Powell was a visiting scholar at the Bipartisan Policy Center and I'll skip around here. He was a partner at the Carlisle Group, served as an assistant secretary and undersecretary of the Treasury under President H.—President George H.W. Bush. He covered policy and financial institutions, the Treasury debt market and related areas. Before that, he was a lawyer and investment banker in New York. And I think it's very important that Jay (ph) also covers at the Federal Reserve—is in charge of the—the payment system and has been thinking deeply about changing the whole LIBOR schematic that we have in this world. In addition to, obviously, marketing (ph) policy.

Ladies and gentlemen, please join me in welcoming Jerome Powell.

(APPLAUSE)

POWELL: Thank you very much, Steve, and thanks everybody for turning out this morning. Must be a slow morning. It's—it's great to have the opportunity to speak to you today. I've got some brief remarks and there is a handout. I apologize for that, I—I thought I'd be able to do that in an audio-visual way but that'll be a short thing.

So I'm going to discuss the progress of the economy and the path forward for monetary policy and then I'll be happy to take questions.

The current expansion is now almost six years old and is now one of the longest since World War II. And while the pace of improvement has at times been frustratingly slow, by some measures the recovery is now well advanced. By other measures there's still room for improvement. And assessing the scope for further improvement as I will discuss will be important in judging the appropriate path for monetary policy.

At our most recent meeting, the FOMC modified our forward guidance to say that an increase in the target range for the federal funds rate will be appropriate when the committee has seen further improvement in the labor market and is reasonably confident that inflation will move back to our 2 percent objective over the medium term which is generally thought of as two to three years. And such an increase could come as soon as the June FOMC meeting. Of course, the timing of liftoff and the pace of subsequent rate increases will depend on incoming data and on realized and expected progress toward our congressionally-mandated goals of stable prices and maximum employment. Monetary policy works with long and variable lags so increases need to begin well before we reach our goals.

Let's turn to the two main economic conditions for liftoff that the committee articulated. We have already seen a great deal of progress in the labor market and I expect that progress to continue. Despite slowing in March, job creation has been particularly strong over the last two years. The unemployment rate has declined from 10 percent in October 2009 to 5.5 percent today, a level that is not far above estimates of its natural rates.

But the unemployment rate probably understates the amount of slack still remaining in the labor market. The labor force participation rate continues to be unusually low which suggests that potential workers may be waiting on the sidelines for further improvements in job opportunities and wages.

The number of working part time who want full time jobs also remains elevated and the low level of wage increases also suggests additional slack.

The committee also said that it wanted to be reasonably confident that inflation will move back to our 2 percent objective over the medium term. Now, on a 12-month basis headlined inflation in February stood at 0.3 percent, so well below target. Meanwhile, core inflation which excludes energy and food components was 1.4 percent. These—these low current readings are partly a consequence of two transient shocks: the dramatic decline in oil prices and the effect of the appreciation of the dollar on import prices. And before those shocks, both headlined and core inflation were running in the range of 1.5 percent. So when the effects of those shocks pass, I expect that inflation will return roughly to those earlier 1.5 percent levels and then rise gradually over our—over time to our 2 percent objective as labor and product markets tighten further.

Despite the low current inflation readings, survey-based measures of inflation expectations which are thought to be the main driver of inflation now have been stable. However, market-based readings on inflation compensation have declined significantly since mid-2014. I view this decline as more likely reflecting movements in risk premiums and other transitory factors rather than shifts in long-term inflation expectations. Still, it will be important to keep an eye on the performance of inflation break evens.

I do expect that economic conditions will support the first rate increase later this year, and I do not expect that such an increase or the associated market reaction will materially restrain the progress of the economy. From a macroeconomic perspective, the precise timing of liftoff is less important than the path of subsequent additional rate increases. And my view is if the economy continues on its expected path, it will be appropriate for a time to increase rates fairly gradually.

Of course, if the economy improves faster or inflation increases more than expected, it will be appropriate to raise rates faster. And if economic performance disappoints or inflation remains lower than expected, it will be appropriate to delay liftoff or raise rates more slowly thereafter. We will be driven by the data.

There's several reasons why it might be appropriate to raise rates somewhat gradually, including the proximity of the zero-lower bound for interest rates and continuing economic headwinds in the wake of the crisis.

I'd like to turn for a moment and explore a rationale for gradualism that has received somewhat less attention which is the unusually high level of uncertainty today about capacity measures such as the natural rate of unemployment.

Uncertainty about the price—the precise level of these indicators becomes more important for policy as the expansion continues and the economy approaches its potential. All else equal, a decision to return rates to more normal levels implies that the economy is nearing its capacity. The financial crisis did significant damage to the productive capacity of our economy and the damage was of a character, extent and duration that cannot be fully known today. And given this uncertainty, it's even more difficult than usual to assess how much slack remains in the economy.

It seems plausible that at least part of the supply-side damage could be reversed if the economy enjoys a period of sustained growth, and to encourage that outcome as monetary policy makers consider removing accommodation, we should look for a little more proof than usual that labor markets are tightening or other supply-side constraints are binding. Of course, if the effects of the crisis prove difficult to reverse and, as a result, inflation pressures do emerge, the Federal Reserve will use our tools to contain them.

Let's take a brief look at the implications of severe financial crises for economies, generally. Many studies document that severe financial crises around the world have typically left behind large and sustained reductions in the level of output. And the recent crisis is no exception. Figure 1, which is your first handout, shows just such an effect for the U.S., the U.K., the Euro area, and Canadian economies since 2008. And I want to—this is a great visual for showing how this appears. So the dotted line is the long-term trend from before the crisis, just extended into the present day and into the future. The red line is the actual performance of GDP. The solid black line is—once the crisis begins, is a parallel line. So if the red line and the black line are together, that means that we're—we're not making up any ground but we're also not losing more ground. So that's the case with the United States. We're a trillion and a half dollars below—in output below where we would've been if we'd merely stayed on the pre-crisis trend.

If you look at the Euro area GDP, you can see not only is Europe well below its pre-crisis trend, but it's—it's actually losing further ground in terms of its potential output.

The underlying pattern is an interesting one. Economists and policy makers have tended at first after a severe crisis to view a decline in—in output as a cyclical shock to demand and to realize only gradually over time that the crisis has done substantial and lasting damage to the productive capacity of the economy. As a result, estimates of the gap between actual and potential output often narrow over time, partly through higher actual output but also through lower estimates of potential. And that's the purpose of Figure 2 which shows that the Congressional Budget Office has essentially lowered its estimate of potential every year since 2007 and that's the way the gap has been closed. So the dotted lines are—are year upon year upon year estimates of potential output and the—the—the squiggly solid black line is actual output.

This supply-side damage has typically appeared in the labor market and in the capital stock, and that makes sense. Long spells of unemployment cause skills to atrophy and make it more difficult for workers to find new jobs, raising the natural rate of unemployment for those who do remain in the labor force and causing others to throw in the towel and drop out. Extended periods of weak demand appear to cause companies to invest less in plant and technology which slows the growth of the productivity of the labor force. The number of new business formations decline sharply, perhaps because of reduced credit availability which may depress hiring, productivity, business innovation and, hence, output. Corporate spending on R&D has also been strongly pro-cyclical which may have similar effects.

So turning to the recent U.S. experience, many economists now estimate that substantially more than half of the shortfall in gross domestic product relative to its pre-crisis trend represents a reduction of potential output and not just a shortfall in demand. U.S. labor force damage likely accounts for some part of the shortfall. The greater part appears to have resulted from lower trend labor productivity as a consequence of reduced capital investment and what's called multi-factor productivity which is often thought of as capturing the effects of technological innovation.

The employment rebound that we've experienced suggests that strong measures such as those the Fed took and others took during and after the crisis can prevent even sharp job losses from becoming permanent. But the productivity slowdown suggests that monetary policy cannot, by itself, advert all of the damage.

So this raises the question I mentioned a moment ago. Should we think of this supply-side damage as permanent or temporary? In many previous episodes around the world, post-crisis reductions in output have proved permanent. Nonetheless, it seems plausible that at least part of the damage can be reversed. As business confidence improves, employers may be more willing to take a chance on someone with an extended spell of unemployment. A stronger job market and rising wages may encourage more potential workers to join or rejoin the labor force. Over a longer period, stronger demand will produce higher capital investment which will drive higher productivity. And a long expansion could also produce higher productivity as companies strive to get more out of every dollar of capital and every hour of work, and as the strong economy encourages entrepreneurship and innovation.

To give us the best chance to recover lost ground we need policies that support labor force participation, business and household confidence, hiring and investment, and productivity growth. Policies that I hasten to add are for the most part outside the remit of the Federal Reserve. Monetary policy also has a role to play though by continuing to—to support the expansion as long as expectations for inflation remains stable and realized inflation stays close to our 2 percent objective.

Indeed, in the current circumstances, accommodative policy may not only help restore some of our economy's potential but should also help return inflation to our 2 percent objective faster.

There is no risk-free path for monetary policy. The biggest risk of tightening too early or too fast is that the economy may weaken more than expected, forcing the Central Bank to reverse course. And the records of—record of Central Bank's lifting off from the zero-lower bound suggests caution in this regard.

A second risk is that we could prematurely truncate the process of healing damage from the crisis, thereby ensuring that the admittedly severe cyclical effects become permanent. Overly accommodative monetary policy also poses risks. First, the economy could overheat and rising inflation could require the committee to raise rates faster which, if it's overdone, could produce a damaging recession. For now, I would be more concerned with a second risk which is that more accommodative policy could lead to frothy financial conditions and eventually undermine financial stability. And while I do not see a troubling buildup of these risks today, tighter monetary policy might eventually be necessary if such risks do appear.

To wrap up, with the support of extraordinary monetary accommodation, our economy has made substantial progress. As the FOMC moves to return monetary policy to a more normal footing, it makes sense to me to move fairly gradually as long as the incoming data evolve about as expected. Doing so would, among other benefits, give our economy the best chance to make up lost ground.

Thanks very much and I look forward to our conversation.

LIESMAN: So what we're going to do now is I'm going to spend about 15 minutes asking Governor Powell a few questions and then we'll open it up to the audience. Oh, we're right on time. This works in just fine. We'll have about a half an hour for questions from the audience.

Governor Powell, if I'm not mistaken, this idea of yours is a little bit controversial. As—as I understand it—at least as I've understood it, monetary policy takes the potential as a constant and its ultimate objective is to nudge back the economy towards that level of potential. Are—are you a little bit in danger of monetary policy mission creep here, to the extent that you're layering on this notion of there is a role here for monetary policy in increasing or restoring potential to an—to an older level?

POWELL: So thank you for giving me a chance to—to clarify that. The answer is no. I'm—I'm not taking on the—the accepted wisdom is that, in the long run, monetary policy does not affect supply side—does—does not affect potential output. That's really a function of fiscal policy, technology, innovation, labor force growth, a—a whole bunch of things. It's really not a function of monetary policy.

I'm really making a cyclical argument that as we recover—as we complete, really, this long recovery process from the financial crisis that this is a factor that would—that should cause us to seek a little more evidence that we're getting close to those—those supply-side constraints as we raise—just a little more than normal. It's a temporary thing. I'm not arguing in the long run that monetary policy should change the way we think about the—about the long-run supply side.

LIESMAN: What is your judge now—your judgement now of where we are in terms of supply-side constraints, either in a productive capacity or in the labor capacity?

POWELL: So I—I—my current estimate of the natural rate of unemployment is 5 percent. Let me say as I—as I mentioned in my speech and I cited a lot of authorities for this. The—the level of uncertainty around a thing like the natural rate is extremely high and—and we really don't know with any precision. We can't observe it at all. Essentially, the natural rate is the rate of unemployment that's consistent with stable prices. So we—we have to estimate it based on history, based on factors in the labor force, based on all the data that we have. And the—the confidence intervals around any estimate are—are quite large. So I—so that would suggest to me that we're—if unemployment is 5.5 percent, then there's a half a percent to go on that. There's also significant slack in the labor force in the form of a cyclical under—cyclical component of the decline in the labor force participation rate. That's probably another .5 percent in the labor force. There's also a big group that are working part time for economic reasons that want to work full time. And that is—that is high in relationship to the—the regular unemployment rate. It suggests there's an additional amount of slack there. Hard to say exactly how much it is but if you add all that up, if you look at the performance of wages which really have been lower than expected, given the level of GDP that we have and given estimates of where the natural rate is, it suggests that the—that the natural rate is—is low. It's lower than we had been thinking it is and it may be even lower than it is now. But, again, high uncertainty around those estimates.

LIESMAN: It—it just occurs to me that I'm not interested in Federal Reserve officials' estimate of the unemployment rate. I want to know their estimate of the natural rate of the U6.

POWELL: Yes.

LIESMAN: I mean, I think that's probably—given what you say, if all of those things are slack in the economy, then the U6 which is a broader measure of underemployment and unemployment, at 10.6. Do you have a number that you would feel comfortable that that would be a tight labor market?

POWELL: So I sort of do but that would be even more highly uncertain. And I'll explain why. So the U6...

LIESMAN: Sure.

POWELL: U6 includes those who are marginally attached to the labor force, haven't looked. I see all of the economists in the—in the audience nodding, but it—it includes people who're working part time for economic reasons who wanted full time. It's—it's a much broader measure. And as I mentioned, it's—it's—it's traditionally run at a gap above the regular unemployment rate which is U3. OK? So right now that gap is 5 percent roughly. And the—and the typical gap might be closer to 3 percent. The issue is we don't know whether that's the new normal or not. We don't know whether in the economy we're going to run with a higher group of part time for economic reasons or whether the truth is somewhere in the middle and we don't know over what period of time it will adjust. But, you know, we do—I do certainly think—think about—about the broader scope. That's why I—I—I mentioned that in my speech and my question.

LIESMAN: Let's switch gears and I'm sure there's other questions from the audience about the first part of conversation here, but I want to ask about the differential in monetary policy right now between the United States and Europe. How much concern does that give you in determining what you do here in the United States, especially the effect on the dollar?

POWELL: We took the position in 2010, I think all countries kind of have to take the position that we're—we're going to run monetary policy according to our domestic mandate and—and, you know, we're going to look at ourselves. We're also going to look at the global economy and (inaudible) it affects our domestic economy, right? So—and a strong United States economy is in the interests of the world. So now Europe is—is—the ECB is providing more accommodation; that has driven down the value of the euro. But it also supports demand in Europe. So in—in the long run, Europe certainly has the right to support the man (ph) in their—in their economies. So what's happened is in the short term here, the euro has—the euro has depreciated and—relative to the dollar and that has had some effect—actually the effect of the euro has had a modest effect on—on net exports.

But it's also held down—flows are leaving Europe and they're holding down long-term rates so that actually supports U.S. demand. A stronger Europe which we're—we're—we're already seeing optimistic signs that—that—that quantitative easing in Europe is supporting stronger (inaudible). That also helps us.

In addition, U.S. monetary policy reacts to—to weakness. So if you look at the difference between estimates of—the FOMC's estimates of—of the path of rates in December and the path of rates in March at the March meeting, you can see that the path of rates and the markets have adjusted. The path of rates is expected to be lower now. That also supports U.S. demand. So it's not at all clear that over a period of time, quantitative easing in Europe doesn't help. In the short term, we may feel some headwinds in net exports, but over a longer period of time, it could actually be a win for us as well.

LIESMAN: One of the profound effects we've seen quite a bit is certainly on corporate profits. Does that factor into thinking about monetary policy? The—the recent decline (ph)—looking at essentially flat corporate profits this quarter.

POWELL: So we focus on stable prices and full employment, maximum employment. Corporate profits are—are—they factor into the macro economy as well. They'll affect—it'll affect investment at the margin. We—corporate investment has been low really because of—of low demand and expectations that low demand would continue. So it does have an effect. It factors into the models and that sort of thing. Corporate profit margins are at all-time record highs though, and so I don't think it—it shouldn't have a dispositive effect.

LIESMAN: I want to ask you to respond to some of the questions and criticisms that we have around the table when we—when we talk about Fed policy on CNBC. One of those is why not just raise a quarter? Why is a quarter or the first rate hike such a very big deal that it's taken you guys all this time to do it, and—and along with that question is the notion of 5.5 percent unemployment, now you did talk about further slack, but an economy growing in the mid twos, it's hard to see a rationale for zero when it comes to the Fed (inaudible).

POWELL: I think we are getting to a point where—where zero isn't—isn't going to be the right rate. And as I mentioned in my speech, I don't think a 25 basis point increase or the market reaction to that should have a material effect on the economy. I don't think it should. You know, that doesn't really answer the question of when to raise rates, though. You know, we—we—I don't think we need to be in a hurry. I—we're no longer patient as we said in our statement, but I don't think we need to be in a hurry. I think the time is coming this year. And I—I do think that the—the importance of the—of the first hike is probably exaggerated. Really what matters is the path for rates; that has a much bigger effect. And so I—I—I think that's fair. I—I think the time is coming and I do expect it will be this year.

LIESMAN: I—I'd be remiss in doing my job, at least on behalf of my colleagues in the press out there, if I didn't press you on this issues of June. Is that a possibility? July? September? Do you have a preference for a month?

(LAUGHTER)

LIESMAN (?): So we're going to be...

POWELL (?): I knew you were getting into that when you...

LIESMAN (?): I did.

POWELL (?): (Inaudible)

LIESMAN (?): I did. I'm not shocked that he (ph) asked that but...

(LAUGHTER)

POWELL: So the data have been weak in the first quarter, weaker than expected, and the March employment report was weaker. But by the time of the June meeting, we'll have had the—the—we'll have had two more estimates of the March employment data. We will have had the—the April employment report and we will have had the May report. Also we've have had a lot more incoming data on—on just about everything in the economy so the June—June is a different world from today. And I don't have an opinion today on whether—on what the data will do. It—it—we're at the point where it doesn't really matter what your opinion of what the data's going to be between now and—and June will be. It will be what it is. And we have to be guided by the data as it comes in. And so I think—what will happen at the June meeting is they'll be for the first time a discussion about whether we should raise the—the target range for the federal funds rate at the June meeting. We said we wouldn't do that in all likelihood at the April meeting. And we've said we would do it at the—at the June meeting. So—and—and for every meeting thereafter, there will be that conversation. On the current path.

That's how I think about and I, again—I just, you know, we—we will have to be guided. We're at this point where—where, you know, where the incoming data is going dictate our actions.

LIESMAN: What is confidence that the inflation rate is moving back towards 2 percent mean to you?

POWELL: So this is what it means to me. That's—that's one of the two tests that the committee has set up for the first interest rate increase. So the narrative is that as I—as I went through in my speech, underlying inflation is about 1.5 percent, both core and headline, except for the effects of oil and the dollar which is depressing—even core is being depressed by import. Obviously, core is not depressed by—by oil prices but it's depressed by import prices. So if you look through that, you're look—you're looking at an economy that is at 1.5 percent so we're supposed to have reasonable confidence that inflation will return to our 2 percent objective over the medium term which is to say a couple of years, two or three years. So the narrative that would bring you to have reasonable confidence in that is that the economy is tightening. The labor market is tightening, the economy is tightening, and there's—there's good evidence over time that as—as unemployment goes down, that—that inflation goes up. It's not the tightest relationship here in the last 15 years or so but it's—it's absolutely there in the data.

So what we're—what I'll be looking for is data that either confirms that narrative or—or puts that narrative into question. So things that would confirm that would be, first of all, higher readings on inflation, a few months or a quarter of higher readings on inflation, things that confirm this narrative that the—you know, that, in fact, it's oil prices and the dollar that are holding down inflation and that we're really—that the underlying rate is still the same. The biggest thing would be the removal of additional slack. If we continue to see strong job market growth, you know, a couple hundred thousand net new payroll jobs a month that would help quite a bit. The things that would really worry you—me, would be principally, if inflation expectation—which really are the thing that drive inflation we believe now is inflation expectations. If there's evidence that they begin to decline, that would be very troubling. Realized inflation, if it declines in a way that's not consistent with that narrative, would be negative.

And let me just—the last thing I'll say is the reason to be really careful about this and one of the reasons to have waited this long is that if you look all over the world, every advanced economy essentially, you've got inflation readings—market—markets are sending a signal of low real returns and low inflation. Every advanced economy around the world. I'm a strong believer that we should listen to markets. They're not always right but we should be very open to the idea that markets are telling us something that we don't know. So what they're sending is a signal, in all likelihood, of—that there's a risk of low growth and low inflation outcomes around the world. So that's a pretty good reason to me to just listen carefully and be cautious. That's why I mentioned we need to watch inflation break evens. That said, I—I do think that's the principle narrative and that's—that's what it would take me to get reasonably confident.

LIESMAN: I believe the chair has said that she does not require an increase in the core inflation rate to hike interest rates. And I want to ask you very specifically. I believe the core is, you know, 1.3, 1.4 area right now. Could you see yourself voting to raise interest rates, do that first rate hike, at the current inflation rate?

POWELL: Yes, absolutely. Again, the test is reasonable confidence that inflation will move to that 2 percent objective over the medium term. And, again, we know that—we know that as the slack comes out of the economy, as we approach full employment, and as GDP continues to grow and other capacity measures as we reach full capacity in the economy, we know that inflation should increase. Wages should increase more than they're increasing now and—and inflation should go back to 2 percent goal. So you cannot wait until you see the goalposts coming because, you know, monetary policy works with these long lags. You've got to start well before you actually hit the goal. Again, we're at 1.5 percent. The narratives were 1.5 percent; we have to get to 2 percent over two to three years. It's not that big of a stretch. It's just—there's every reason for—for caution given—given readings around the world.

LIESMAN: Well, this is my last question. One—one other idea we kick around a lot in the morning is this notion that is the Fed too worried and too concerned about markets? And all of us kind of remember a time when it was sort of rare for a Fed chair or for a Fed official to say, you know, we're—even talk about markets at all, as if it even—even mattered, and I know that's changed for some understandable reasons. But the idea is are you too concerned about the reaction of markets and does that create the possibility that it could lead you down the wrong policy path?

POWELL: I must say I'm really not. And—and I don't think, in general, the Fed is. You know, volatility's at very low levels. I don't think that—I'm not seeking it or encouraging it but I don't think that return to more normal levels of volatility would have any meaningful impact on the economy. I don't think—you know, I—we—we saw the taper tantrum in 2013 in a hundred basis point plus increase in the tenure in the course of a month. I would tell you to look at the—look at the payroll job growth curve throughout 2013 and show me where the taper tantrum happened. It—it just—it didn't really seem to have much of an effect; 2013 was the year where we actually achieved 3 percent growth, we had strong payroll growth in 2013, so I don't think the—that—that modest increases in the level of—of volatility would have much of an effect on the economy. And I don't think about that. I think about the real economy and what's the right time to liftoff and what's the right pace for liftoff.

LIESMAN: OK. Let's open it up to questions, maybe give us your name, and try to keep your questions succinct. Let's start over here.

QUESTION: So I have a question about the mechanism both of when you raise the fund (inaudible) rate and how that feeds to the economy now that the Fed pays interest rate on reserves. Has that changed or do you also have to increase that rate as well?

POWELL: So the—the interest rate on excess reserves is the principle tool that we will use to raise the federal funds rate. The federal funds rate is our—is our monetary policy goal and objective. So we will raise interest on reserves and—and that will tend to put the—pull up the federal funds rate and then below that, we have something called reverse repo which—facility which will form a floor below that. So we'll raise both of them, symmetrically is the idea, when we raise the—the target range for the federal funds rate. That—that's how it will work. And I do—I do have confidence that we do have the tools and they will work.

LIESMAN: Lou (ph)?

QUESTION: Governor Powell, you talked a lot about potential growth and made the argument that actually what's more important than the timing of liftoff is the pace of adjustment. I wonder if you could relate how your views on potential going forward are related to the question of how quickly you think you can raise rates. Obviously, Chairman Yellen in her recent speech talked a lot about the equilibrium real funds rate and—and I think it's sort of a central question of how you think that's going to evolve and I'm just wondering how you think about potential and how you think that's related to the path of rates?

POWELL: So I was making the—what I'm making the point is we're—I wanted to say that we are—we're so far below the level of—of where the economy was headed in—in—before the crisis, and even if you allow for—even if you say, oh, that was a bubble or that was unsustainable, it's still the case that we're well below that. I mean, by a—by a wide margin. And that I'm sure you're familiar with—with the same papers (ph), Lou (ph), that I am and—and what they show is this damage. So—and I just have been thinking about this for a couple of years and looking at the kind of damage that we're talking about doesn't need to be permanent. You know, labor force participation, if it just goes sideways for three or four years, you—you will be making up—again in the—in the face of a—of a downtrend trend, you will be making up the supply-side damage. So it just seems to me—I mean, if you think about it in—in the—I would draw a parallel to the—the time in the late '90s when—when the Greenspan Fed didn't tighten in the face of productivity, effectively very high productivity growth is creating new slack in real time. And Greenspan was smart enough to figure that out. So I—that—that's really the point I'm making is it's another factor that suggests that a long—it's not—it's not going to be a fast recovery, we're not going to have super high growth rates and things like that, obviously, at this point. But a long expansion can do some of this repair for us and we—we ought to take that chance at a time when inflation is—is below target and projected to remain there for several years. That's all I was really saying.

LIESMAN: How about over here on the left.

QUESTION: Going back to the labor participation rate, how much do you see that impacted by demographic factors, particularly the retirement of the baby boom as opposed to economic factors?

POWELL: So the—in the—during the crisis the labor force participation rate dropped quite sharply by about 3—3 percentage points and the—the best—there's a big range of views on this but certainly a majority of that, in my view—more than a majority of that—a supermajority of that, is because of demographic factors and preexisting trends such as the—the long run decline in—in—in rates of work by working age males and things like that. So a lot of it is demographic and not going to be reversed by monetary policy. Some component of it though is cyclical, and that component—the low estimate would be around, you know, a half a percent and the high estimate is, you know, a lot—all of it. I don't really believe the high estimate but if you take the low estimate and think it might be a little—might be a little higher, that's a—that's worth going for, that's worth getting. And as—as I mentioned, I think we're already getting some of that. The—the labor force participation rate has now been flat for 17 months. It's actually not been flat; it's been like this. But it's gone effectively sideways at now 60—62.7 percent. So that's—that's really how I think about that.

LIESMAN: Maybe we'll do one in the back. Over here this gentlemen on the—on the—my right here.

QUESTION: When Treasury introduced the inflation-backed bonds (inaudible) very useful tool that they (inaudible) measure inflation expectations, you mentioned that you're watching that very closely.

LIESMAN: John (ph), wait one second. We're going to give you another microphone there.

QUESTION: OK. When we introduced the inflation-indexed bonds we thought that would be a very useful measure of the implicit market expectation for inflation. You mentioned that you're watching inflation expectations very closely. I was curious as to how much the index bonds had been helpful to you in that measurement.

POWELL: So I do think that was a highly useful innovation. When I was at Treasury 20 years ago, we looked at that and didn't do it and it's been one of my great regrets that we didn't take that project forward. Our successors in—in the Clinton administration did. So it's—it's a very useful indicator but the—the issue really is this. So there are nominal treasuries and then there are tips. And nominal

(AUDIO GAP)

POWELL: ... are much more liquid and when things happen, for example, when global flows come in across the Atlantic into the U.S. treasury market, people buy nominals. And the effect is it—so that—that drives the rate down on nominals and the inflation expectations are really—are really the difference between the real yield you get for tips and the nominal yield. So that will show up in the form of a decline in inflation compensation, in expected inflation compensation. Is it really that? It's really a liquidity premium, kind of an idea so—and it's—and I'll give you another example. To—to—to wonder exactly how accurate it is in—in the short term and that is when oil prices go up, expected inflation compensation between five and 10 years goes up almost basis point for basis point. The two have nothing to do with each other. It's just the liquidity kind of a thing, or that one's actually harder—harder to explain. So it needs to be taken with a grain of salt over short periods of time. Inflation expectations as measured in—in the markets with break evens have gone down a very large amount since last summer. So I would tend to discount it but as I—as I suggested though, you don't want to look at the markets and take no signal at all. It's—it's one of those things you need to watch carefully and—and just be alert to the idea that you might be wrong and that it might be signaling something that we're not—that we don't see. Which is the threat of lower inflation.

LIESMAN: Right here?

QUESTION: In December, New York Fed President Bill Dudley talked a bit about the 2004 tightening episode, the so-called conundrum when long—longer-term rates didn't tight—didn't come—didn't move up with the short-term rate, and he said, with hindsight, perhaps the Fed should have been more aggressive. Now if we should experience something like that this time around, wouldn't it be useful to have asset sales on the table? The reason I ask is because the Fed in many statements has taken asset sales off the table. So I'd—I'd welcome your comments on that.

POWELL: So you—you posit a situation in which we—we're tightening and long—long-term rates don't go up, they don't tighten. This is what happened in '04, the so-called conundrum was that long-term rates refused to—to obey in a way. So—and if that were to happen—let's say that happens so that the sense is that policy's still too lose and you—you're worried you may be getting behind the curve and inflation, that kind of thing. I think at that—that would take some time to evolve. It—it isn't something it feels like we'll be facing here in the near term but I think you're right. There are—we have a lot of tools to deal with that, including the balance sheet. It's—but I—having said that, I, you know, for now we're not thinking about asset sales and—and I—I—if it came to that, and other tools didn't work such as further short-term tightening, then that would be available in my view. But, again, I want to stress that's—that's for way down the road. What we said about—about the balance sheet is—I should clarify, is that, you know, we'll stop reinvesting the proceeds for maturing securities at some point after the—after liftoff and we really said that we have no intention of selling securities and that—that is—that is where we are with it now.

LIESMAN (?): How far down the road is runoff in your opinion?

POWELL: That's to be determined at such time as it feels like the right thing to do.

(LAUGHTER)

LIESMAN: Anybody wants to ask a follow up to that question, you're more than welcome.

(LAUGHTER)

LIESMAN: Right—right here, in the middle.

QUESTION: Just a quick question. Where are your views personally most divergent from those of the committee and—and where do you see the most heated discussions? I mean, I know the policy comes out and it's a big statement and everyone's in agreement right now but—but what are the most heated? Is it slack? Is it the long-term rate? Where are those—what are those discussion points?

POWELL: So I'm really not supposed to characterize the views of anybody else on the committee. I—I will say, I mean, to try to get at your question in a different way, I will say that, you know, I—I'm the person on the committee with the most experience in financial markets so I try to bring that perspective to the committee. I think that's a useful and—and business more generally (ph). That's—I think that's been a useful perspective. I would also say I'm pretty well aligned with—there—there have been times when I—when I was uncomfortable with the direction of policy. This is not one of those times. I—I'm—I'm pretty well aligned with where—where the heart of the committee is and where the chair—where the chair has articulated the committee is.

LIESMAN: I guess I could observe I haven't heard a whole lot of—of Fed officials talk about the supply side. I don't know if it separates you from them but I think your speech this morning is interesting in that regard in that capacity is a really important part of making policy and it was something that people said lead to the mistake of the '70s was that—it was poor measurement of capacity. Capacity had been destroyed and perhaps that was part of the inflation so I think that's an interesting way—way to think about policy.

POWELL: Well and you—as you pointed out right at the start, it is a bit of a third rail...

LIESMAN: Right.

POWELL: ... so because there—there—people may be confused that—that I'm saying what I'm saying. I'm really not saying that—to repeat, that, you know—that we have some control over the level of—of where the supply side is. We don't. Monetary policy doesn't really affect that. But that's not what this is about.

Right now we have all this damage. It's a unique situation. Severe crises do huge damage to—to the productive capacity of the economy and you get one chance to—to sort of deal with that or not, and this was the way—this is a lot of the story of how unemployment became so high in Europe is a—is a failure of policy to react to it. Temporary cyclical increases in unemployment became permanent in Europe in the '80s because of this. So I thought it was worth taking the risk and—and at least putting this in the conversation.

LIESMAN: OK, the gentleman to David's (ph) right and then David (ph) will go next.

QUESTION: I wanted to ask a little about your guidance. Recently the chair commented in the gap between market prices and your—your dots, and said that it was sobering, presumably because the market is reflecting a different view of a lot of the things you've talked about in terms of growth and—and inflation and rates. Is it sobering to you and, if not, why doesn't the FOMC make a more active attempt to guide the market toward its—its view of rates?

POWELL: Your—your pointing out that the market expectations for policy are—are lower than what the committee writes down in our summary comment (ph) projection. So I'd start by saying there's—there's a little bit of a difference there. We're—we're looking at the most likely outcome, it's not risk-weighted. It's sort of what we call the motol (ph) outcome and risk-weighting can be very different if there's—if the—if the market is—is putting weight—different weights on all different kinds of outcomes and maybe putting more weight on—on low inflation outcomes, bad outcomes, low growth outcomes so there is a bit of a difference. Still, there's—there's a gap there. I don't worry about it so much because, you know, we're not—we're not on the very verge of raising rates. I think if—I think as the time to raise rates approaches, as the data confirm that it's time to raise rates, I would expect that there'll be better alignment there. It's something though, of course, I watch carefully.

But we—we need to do what's right for the—for the—you know, for the real economy. Really it is about—it's about, you know, stable prices and full employment. Markets shouldn't be in a—and I don't—I almost—I would think it would almost never be the case that we would change policy because of expectations like that. It's our job to be transparent about our reaction functions so that when it's time to do something, you know; the market sees it coming just like we do.

LIESMAN (?): But I do want to follow up. Do you worry that there's this rubber band that—that could snap in the sense that—I mean, some of the—I think the differences in just the past week since the jobs report have gotten even greater, right? You're looking at a—I last saw 34 basis point December 2015 Fed funds—Fed funds futures rate.

POWELL: Well, it's something you've got to watch and—and I, you know, I lived through the taper tantrum and, you know, it was—didn't expect it. I—I—I expected some reaction, didn't expect 100 and some basis point reaction in the tenure over the course of a month. So, yes, it's—it's something we've got to watch carefully. But, again, what—what do we control? We control transparency and, you know, a clear articulation of—of what we're looking at and the kind of things that would cause us to move. That's the part we control; that's all we control.

LIESMAN: David (ph)?

QUESTION: You mentioned the symmetrical movement between the interest on excess reserves and the reverse repo rate or the possibility of symmetrical moves there. There's a wide spread and it affects the—the cost of the Feds borrowing. How do you think about the tradeoff between borrowing more through the reverse repo market which is substantially cheaper versus the IOER? Do you think about that tradeoff and what if—what if the reverse repo rate tries to stay down, can you borrow enough through that market to push it up to the lower bound? Thanks.

POWELL: Thanks, David (ph). So, just to repeat for everybody, the—the interest on—interest on excess reserves is something that—that we pay and we—we pay it to banks that are on reserves and that—that's going to pull up the level of federal funds rate—the RRP, reverse repo facility will be below that and will—will push up. So David's (ph) question really is what if—what if rates don't go up? You know, what if they go down? So we have plenty of tools and I—and I think they'll work. We—you know, we've got term deposit facilities, we—we have flexibility in—in the—in the terms and conditions of the RRP. We can raise interest on excess reserves more. There are lots of things we can do and, you know, the thing is, we're going to be in a period of super abundant reserves for—for quite a while and, you know, so there may be—there may be some—some learning—undoubtedly, there will be some learning along the way. But we've—you know, we've—we've done lots of testing, as you know, in the markets and I think—I think, aside from actually lifting off from the—from the lower—zero lower bound, we've—we've tested a lot of different dimensions. The big test will come when we liftoff and I'm—I'm pretty confident that interest rates—we can—that we can raise interest rates and keep them in the band (ph).

QUESTION: And the fiscal trade off?

POWELL: There isn't really a—the fiscal tradeoff is a bit of misnomer because remember reserves—the reason we have a reserve is that we own it—a Treasury security that—that earns a lot more than the reserve pays. So that—that's how you create a reserve is you buy a Treasury security so you've got an asset and a liability. If you just look at the liability, that's one thing, but the—the asset that—that opposes it—that which is why we've been sending a hundred billion dollars a year in seniorage (ph) to the Treasury every year for the last several years. So we can't really let fiscal issues get in the way of doing the right thing for the economy.

LIESMAN: (Inaudible)

QUESTION: Governor Powell, you mentioned in your speech one of the risks of low interest rates is financial bubbles. Is the Fed more prepared to identify bubbles now than you were in 2008 and are you prepared to take action if you do see a bubble in the financial world?

POWELL: I've got to say probably no in—in—this is my personal view. So we're talking here about financial market bubbles. So, I mean, let me say they're—they're—financial stability, there are a couple of different ways to think about it. The first is that we want to build the financial—build resilience into the financial system so higher capitalized institutions. We want to fix the parts of the infrastructure that proved to be broken and—and things like that. And I think that—that part is—is well in hand.

If you just look at—at, you know, high stock prices and things like that, you know, it—I don't see the Fed as—as putting its toe in that water and saying we're calling an asset—we're calling that stock prices are too high and, therefore, we're going to—we're going to raise interest rates. I don't—I don't see that happening at all. It's more about, you know, making the system resilient to hurricanes than it is hurricane prevention. Because I don't—I don't know how good we're going to be at hurricane prevention and—and I think—and—let me also add, the things that—that really—the things that I would really be concerned about are things like housing bubble, very fast credit growth, really leverage—household leverage, corporate leverage, bank leverage. If those things are growing really fast, housing bubble as I mentioned, a bubble, also structurally in the markets, you now, the tri-party repo market really failed. It was—all these sort of places in the—in the financial markets where there could be runs which would bring down, you know, the financial system. Those are the things that you need to worry about for financial stability. Actual asset valuations are important but—and we monitor them very carefully and, frankly, don't see them at—at troubling levels now. Equity prices are high but they're not—they're not out of historical ranges.

LIESMAN (?): What about prices on corporate debt?

POWELL: So depends on what you mean by the price. The spreads on corporate debt over risk-free debt are not at unusually low levels. They're not. In actual, you know, nominal levels, they're quite low but the—really the—you're getting—the risk you're taking on is that credit risk component which dictates the spread and liquidity risk as well. But those—that—that price is actually not particularly low right now. Now leverage—leverage has been a little bit high in—in—in, you know, in the—in the leverage markets. But not—not at historically high levels.

LIESMAN (?): There's concern out there that because of Dodd-Frank and some of the rules about—that have affected the big banks and their ability to make market in high-yield instruments and in fixed-income instruments, that there isn't the market liquidity out there. Is that a concern of yours?

POWELL: Yes, it is, and many have noted that liquidity in—in fixed-income markets is much, much lower than it was. And a big part of that is that the firms coming out of the crisis, you know, sort of reached a new understanding of what their risk was in—in, you know—in holding big inventories of fixed income and—and risky fixed income and other kinds of financial assets. So—so they changed their own risk management practices a lot after the crisis. The—the crisis showed so many mistakes that everybody had made and, you know, hindsight is always 20/20, right? But—so I'm not pointing any fingers but they changed their practice a lot. In addition, from a supervisor's standpoint, the bank regulators, supervisors have—have really encouraged that. So you have a market where fixed-income markets around the world are much less liquid than they were and it—it does raise concerns over time. And it's something I—I—I suspect we'll be thinking about a lot and spending a lot of time on for some years. The answer isn't obvious. There—there aren't a lot of obvious answers on what we're supposed to do about that but it does—does raise significant questions.

LIESMAN: Other questions here? Right there.

QUESTION: Could you elaborate on the intriguing comment made in the introduction about your work on payments and the more significant aspects of that?

POWELL: Sure. So we—I'm—I'm the—the person on the board who we—we divided up in—in committees and I'm the chair of the committee that oversees payments so I'll talk briefly about retail. Most of what we do is in the wholesale space. But we have, as a system, noticed and—the fact that the U.S. is really behind in terms of mobile payments and electronic payments and I—we're behind lots of other advanced economies and many emerging economies. So—and no one really has authority. One thing is there's no government by the—has the authority—pull everybody together and say, OK, this is what we're going to do. But many participants in the payment system have sort of said to us, "Can't you guys do something here?" Just, you know—just try to get everybody together so, in fact, that's what we've done. So we've—we've—we're in the process now of pulling together Silicon Valley, you know, tech companies and also credit card companies and banks and all—essentially all consumers, regulators, everybody around a table to look at two things. One, a faster payment system and, two, a more secure system. Faster and more ubiquitous so that everyone has mobile access. So this is a—what we're going to do is we're going to spent the next two years coming up with a variety of paths to getting that. Now, it may be that there isn't even a role for the Fed in—in that. It may be that we just come up with a plan, we give it to Congress, we give it to the—to the various stakeholders. It may be that there is a role; we don't have a—a prior view on that. If we do, you know, if we want to carry that initiative and—and build a new system of some kind, we have to pass pretty stringent tests on cost recovery and we have to conclude that the private sector can't or won't do this. So those are pretty high hurdles to doing something. But—so we're doing that in the—in the retail side, which I think is very exciting and I'm—I'm one of the chairs of the oversight committee. Esther George of the Federal Reserve Bank in Kansas City is really running that.

On the wholesale side, you know, it's—we—we just have a lot going on. This includes things like central clearing of derivatives which has been the thing I've spent a lot of time on. In—in the financial crisis we—we decided that we should centrally—centrally—afterward, centrally clear derivatives to reduce risk through netting and that kind of thing. So that's all being put together and, you know, we spend a ton of time talking about the banks and the kind of risk. I actually think that the agenda for the large banks is pretty well advanced and has been pretty clear for a while. The agenda for the designated financial market utilities is—is far less well coalesced and thought out and implemented and—and also very important. It doesn't get anywhere near the kind of attention so I'll put a little bit of a plug in there for the—for that, if I may.

LIESMAN: (Inaudible) right here (inaudible) question?

QUESTION: I understand that traditionally it's the Treasury that makes comments about the dollar but I'm interested to know to what extent the impact or the possible impact of interest rate increases on the dollar enter into your deliberations.

POWELL: Let me first agree with you that...

(LAUGHTER)

POWELL: ... we don't take positions on the—on the dollar. We don't talk about the dollar. So—so we have a model of the economy. We have a bunch of models of the economy, as you can well imagine. And at the margin, of course, the foreign exchange value—the exchange value of the dollar matters to some extent and is the—isn't (ph) affected by interest, you know—interest rate decisions. But it's—it's not—it's not like you—you talk about that as the objective. We're looking at stable prices and full employment. You can see that the significant appreciation of the dollar against a lot of our trading partners' currencies is having a—a—a restraining effect on growth this year and that will probably continue. And that'll be reflected and I think was reflected in—in the—in the rate projections of FMLC members, not the dollar but the fact that the economy has—has weakened in the first quarter and part of that is the dollar. You can see it in manufacturing. You know, manufacturing PMIs and—and sales and that sort of thing, and exports, certainly, were much weaker. So it does—everything affects monetary policy. All—all readings in the economy but we—we don't look at the dollar and say the dollar did this so we need to do that. We look at things like net exports and that's how we look at.

LIESMAN: Will you maybe have time for one more question? All the way in the back there.

QUESTION: Does the—for you and your colleagues, does the presidential debate cycles which begins this fall—does the Audit the Fed bill, do these considerations play into the rate hike cycle decisions and communications with the market and policy makers?

POWELL: No.

(LAUGHTER)

POWELL: They do not. The Fed is strictly apolitical. We don't talk about politics. It is—in fact, it's always jarring when—when, you know—when we get into political—when we get in the political spotlight because we're focused very much. There are no Republicans and Democrats, we don't work across the aisle, there is no aisle. And—and so we—we're not focused on that. We're focused on—on the economy.

LIESMAN (?): Do you have a reaction to some of the political bills that are now being discussed in the political circles? Audit the Fed as well as a rule-based market (inaudible) policy bill?

POWELL: So, Audit the Fed, yes, in fact, I—I'm happy to comment on—on that. So Audit the Fed is really—is really mislabeled—badly mislabeled. It's—you know, it's misleading to call it an audit. We are subject to a full financial audit. I would know that, I chair the committee that—that oversees the audit of all the reserve banks and of the Board of Governors. We have a full financial audit. We actually have a pretty simple business model where if you want to look at our finances, they're publicly available, they're on the website. We're—we're simpler than the average regional bank by far. You think about it. Think about what our business model is. It's not that complicated. So, of course, everyone thinks, oh, yes, the feds should be audited. Well, we are.

What—what this is about is ongoing congressional involvement in monetary policy on a meeting-by-meeting basis. I—I ask you to go read the bill that has been offered on the—on the—on the House side and has, in fact, I think passed the committee. So—and the Taylor rule idea is—is an interesting one as well. I'll talk about that. Essentially, we'd have to adopt a—a Taylor rule which is a—a rule to dictate the level of—a rule to tell you where to set monetary policy based on a sense of the real rate, a sense of how far you are from your employment target and your inflation target. It's that simple.

So—and then we'd have to either follow it or be subject to immediate oversight by the GAO. So this is just—no one thinks about Taylor rules in that way except maybe now John Taylor and he didn't think about them for that way for 25 years after he—after he invented them. It's an incredible contribution that he's made. Go back and read his original article. He's made a remarkable contribution. Every central bank in the world, I think, now looks at Taylor rules to help guide policy. But no one thinks of them as something you must follow or be accountable for not doing so. It just—that's not what they're there for. They're there to tell you—to get you maybe 70, 80 percent of the way there but that last 20 percent makes all the difference. So I—I don't think that would be a wise bill, Steve.

LIESMAN: As a Republican, though, do you have an understanding or a frustration, either one, with the Republican Party's interest in these two bills?

POWELL: You know, I don't do the politics. I—I think in—in all of these—in all of these things, the—the question I would ask is, "What is the problem that we're solving here?" What is the problem? So—and in—in many cases, I just think the conversation ends there. There is no obvious answer to why you would want—you know, congressional committees to be actively involved in helping us make monetary policy on a meeting-by-meeting basis. You would want lots of accountability, lots of transparency. You would want the chair to be testifying, you'd want governors to be explaining themselves and answering questions and things like that. But you would not want Congress hauling the chair in after a meeting to say, "Why didn't you raise rates this week?"

LIESMAN: Jay (ph), thank you very much. Please join me in thanking (inaudible).

(APPLAUSE)