An Overview of the Economic Outlook and Monetary Policy of the United States

Lael Brainard, a member of the Board of Governors of the Federal Reserve, discusses the current economic outlook of the United States and the monetary policies of the U.S. Federal Reserve. Brainard reflects on the challenges the U.S. economy faces with a potential interest rate rise on the horizon. She assesses the recent reports indicating a participation decline in the labor market, the rebounding of oil prices, the strength of the dollar, and the possible outcomes of persistent low inflation. Brainard also elucidates how global uncertainty, particularly as China undergoes challenging transitions in its economy and Europe grapples with the potential repercussions of a vote in favor of Brexit, might affect growth in the United States. 

HILLS: Ah, we’ve got a wonderful crowd here. Welcome, one and all. I’m Carla Hills, and I co-chair the Council on Foreign Relations, and I feel very privileged today to introduce our outstanding guest. And I know you’ve been told to turn off your cellphones and so forth, so I’ll go in and just tell you some few facts about Governor Lael Brainard, who became a member of the Board of Governors of the Federal Reserve System in June of 2014, and her term will end in January of 2026.

For four years, prior to her appointment to the board, she served as an undersecretary at the U.S. Department of Treasury and as counsel to the secretary of the treasury. And in those roles, she was the U.S. representative to the G-20 financial deputies, and to the G-7 financial deputies, and was a member of the Financial Stability Board. She was awarded the Alexander Hamilton Award for her splendid service. And she also served as deputy national economic advisor and deputy assistant to President Clinton, and was his personal representative at both the G-7 and the G-8. And prior to her government service, she served as vice president and as founding director of the Global Economic and Development Program at Brookings Institution, where she built a research program to address global economic challenges. In the 1990s, before she came to Washington, she was assistant and associate professor of applied economics at the Massachusetts Institute of Technology, and she published a number of articles and edited a number of books that were extremely well-received. She earned her Bachelor’s from Wesleyan University, and her Master’s and her doctorate from Harvard University in economics, and she was a White House fellow.

So it gives me great pleasure to give this very special guest of ours the podium. And so, Lael Brainard, please. (Applause.)

BRAINARD: Well, I want to thank Ambassador Hills for that very kind introduction, and it’s a real pleasure to be here today at the Council on Foreign Relations.

In recent months, financial conditions have eased, and there are encouraging signs that domestic consumption has regained momentum. But today’s tentative signs of labor markets slowing remind us that we cannot take the resilience of our recovery for granted. In today’s circumstances, prudent risk management implies we should wait for additional data to provide confidence that domestic activity has rebounded, and reassurance that near-term international events will not derail progress toward our goals.

As we consider the appropriate posture of policy, the most immediate question facing us is whether the data provide confidence that domestic economic activity has strengthened notably following two disappointing quarters. Today’s labor market report is sobering, and suggests that the labor market has slowed. Nonfarm payroll employment increased at an average monthly pace of 116,000 over the last three months, well below the 220,000 per month average pace over the preceding 12 months. Although the unemployment rate moved lower, to 4.7 percent, involuntary part-time employment increased and labor force participation declined.

The recent news on inflation, the second leg of our dual mandate, has also been mixed. The price of oil has rebounded significantly from the lows reached earlier in the year on expectations that supply and demand are likely to be in closer alignment. The dollar has receded a bit on net from its peak in January, though it’s still about 15 percent above the level in mid-2014 in real effective terms. As a result, non-oil import prices look likely to stabilize this quarter after a year and a half of declines. These developments coincided with the easing of financial conditions since mid-February. Thus the conditions supporting further progress on inflation are likely due at least in part to expectations of more gradual U.S. monetary policy, and could diminish if those expectations were to materially shift.

While there are thus signs that inflation will move higher over the medium term, measures of core inflation have yet to convincingly exceed the low levels that have prevailed over much of the recovery. The 12-month change in core PCE prices was only 1.6 percent in April, which is roughly equal to the average change from the end of 2019 to—from the end of 2009 to the end of 2014, which is noticeably below our target of 2 percent.

We can’t rule out that this stubbornly low inflation may be having an effect also on inflation expectations. Market-based measures of inflation compensation remain extremely low, with the five-year, five-year forward currently around 1.5 percent, which is 1 ¼ percentage points below levels prevailing prior to mid-2014. In addition, some survey-based measures, such as the Michigan Consumer Survey, also remain below historical norms. So, in short, although some developments point to a possible firming inflation, the persistently low level of inflation, together with signs of a deterioration in inflation expectations, suggests that the risks are weighted to the downside.

Further progress towards our goals, which are full employment and 2 percent inflation, will depend importantly, therefore, on a rebound in growth. Following disappointing GDP growth that averaged only 1.1 percent over the past two quarters, I’ve been very focused on incoming data, especially on consumption, which points to a pickup in growth this quarter. Consumer expenditures rose strongly at 0.6 percent in April, and auto sales edged higher in May. Nonetheless, the data relevant for gauging second-quarter growth are still relatively sparse.

In general, demand growth in recent quarters has benefited from relatively strong households who are buoyed by strong employment, reduced oil prices, and low interest rates, but have been pulled down by weak business investment and exports. While consumption and housing investment more than accounts for the 2 percent increase in GDP over the past four quarters, business investment and net exports together subtracted on net ¼ percentage point. Of course, the rise in the dollar and the decline in foreign growth reduced demand for American exports, as well as profits and investment at U.S. firms, along with the declines in the price of oil.

So, if we look at the 12 months ending in April, manufacturing output increased only 0.4 percent, while total industrial production fell 1.1 percent, which, of course, also includes drilling of and extraction of oil and gas. Of course, if the easing in financial conditions since mid-February, and the firming of oil prices, and the stabilization of the dollar were to continue, business investment and exporters would benefit.

Of course, there are risks to the projection that future GDP growth will be strong enough to deliver further progress on inflation and employment. Most immediately, there is material uncertainty surrounding the United Kingdom’s June 23rd Brexit referendum. The IMF has noted that a vote in favor of Brexit could unsettle financial markets and create a period of uncertainty while the relationship between the U.K. and EU is renegotiated. Although it is very difficult to forecast the economic effects, we can’t rule out a significant adverse reaction in the near term, such as a substantial jump in financial risk premiums. Because international financial markets are tightly linked, an adverse reaction in European financial markets could affect U.S. financial markets and, of course, through them economic activity here.

We also cannot dismiss the possible reemergence of risk surrounding China and emerging markets more broadly. In recent months, capital outflows in China have moderated as the dollar has stabilized and pressures on China’s exchange rate have eased. Should pressures through the exchange-rate channel reemerge, we can’t rule out a recurrence of financial stress, which could affect not only China but, again, other emerging markets that are linked by China via supply chains or commodity exports, and ultimately to conditions here.

China’s making a challenging transition from export- to domestic demand-led growth, and the cost of reallocating resources from excess capacity sectors to more dynamic sectors could further impair growth in the near term. While China has taken steps to limit the extent of the slowdown, there’s an evident tension in policy between reform and stimulus, and the effect of the stimulus may already be waning. Vulnerabilities, such as excess capacity, elevated corporate debt, and risks in the shadow banking sector, appear to be building and could pose continued risks over the medium term.

The broader fragility of the global economic environment is unlikely to resolve anytime soon. Growth in the advanced economies remains dependent on extraordinary unconventional monetary policy accommodation, while conventional policy continues to be constrained by the zero lower bound. Conventional policy’s efficacy is more tested and better understood than unconventional policy, and it can respond readily to any upside surprises, but presently constrained in adjusting to downside surprises. This asymmetry in the ability of policy effectively skews risks to the outlook to the downside, and may amplify the sensitivity of the exchange rate.

The evidence suggests that over the past year dollar exchange-rate movements have become considerably more sensitive in response to monetary policy surprises than they were previously. That’s also consistent with recent research which suggests that cross-border financial transmission is likely to be amplified at near-zero interest rates, where the ability to provide additional support through domestic channels is limited.

In this environment, markets have become quite sensitive to the possibility of a prolonged period of low growth, low inflation, and economic underperformance, as we can see in the current negative term premium for the 10-year Treasury note, or the difference between the yield on the 10-year Treasury and expected risk-free short rates over the next 10 years. That is a big change from the period prior to the Great Recession.

So, as we look across these conditions, while the easing in conditions, in financial conditions in particular, since mid-February is very welcome, it’s important to recognize that some of the conditions underlying recent bouts of turmoil largely remain in place, and an important reason for the fading of this turbulence was the expectation of more gradual U.S. monetary policy. Should an event trigger renewed fears about global growth or a reassessment of the policy reaction function here in the United States, financial stress could well return.

Recognizing that the data we have on hand for the second quarter is quite mixed and still limited, and there’s important near-term uncertainty, there would appear to be an advantage to waiting until developments provide greater confidence. Prudent risk management would suggest the risks from waiting until the totality of the data provides greater confidence in a rebound in domestic activity, and there’s greater certainty regarding the Brexit vote, seem lower than the risks associated with moving ahead of those developments. That’s especially true since the feedback loop through exchange rate and financial market channels appears to be elevated. In light of this amplified feedback loop, when conditions are appropriate for a policy move, it’ll be important that it be understood that any subsequent moves would be conditioned on still further evidence confirming continued progress towards our objectives, and not as inevitable steps on a preset course.

Indeed, the appropriate path to return monetary policy to a neutral stance could turn out to be quite shallow and gradual in the medium term because it increasingly appears likely that the medium-term neutral rate, or the real federal funds rate that would be consistent with the economy remaining at full employment and 2 percent inflation, may be quite low. Earlier in the recovery, it seemed likely that the low level of the natural rate was largely due to temporary or cyclical factors, such as tight credit, weak consumer confidence, and the loss in household wealth from the crisis. However, the recovery is now well into its seventh full year, credit in most markets is widely available, while consumer confidence and household net worth are at high levels. As a result, it now appears more likely that much of the decline in the neutral rate is likely to prove persistent, consistent with a variety of estimates.

With productivity running very low, substantial overcapacity and disinflationary pressures abroad, and less favorable demographics, the medium-term neutral rate may be lower than previously anticipated. And this may mean that today’s federal funds rate is closer to neutral than previously expected.

Of course, one likely explanation for the persistence of the low neutral rate is the sharp drop-off in potential growth since the Great Recession. So if you look at the period from ’53 to 2003, potential output growth varied between 3 and 4 ½ percent, with one very brief exception. Over the recovery, it’s averaged only 1 ¼ percent.

One contributor to this decline has been a reduction in the labor force participation rate due to aging, but another has been a marked slowing in productivity growth. Over the six years from the end of 2009 to the end of 2015, productivity grew only a little over ½ percent per year, compared with average growth of 2 ¼ percent over the 50 years prior to the Great Recession. The reasons for such a dramatic slowing are still not clear.

So, in summary, recent economic developments have been mixed, and important downside risks remain. In this environment, prudent risk management suggests there’s a benefit to waiting for additional data to provide confidence that domestic activity has rebounded strongly, and reassurance that near-term international events will not derail progress. In addition, because the depressed level of the neutral rate of interest is likely to reflect forces that are persistent, the appropriate path of policy is likely to remain quite shallow for several years.

Thank you. (Applause.)

HILLS: Well, that was a wonderful presentation, and you raised a lot of questions that I want to ask you. And I’m going to start by taking a few minutes to talk about some of the issues, and then turn it over to all of you to come up with questions.

And let me start with saying talk a little bit about how you factor in exchange rates into policy recommendations.

BRAINARD: So the international environment has been extremely salient over the last really now two years in particular. The United States economy is tightly linked to the rest of the world, obviously through trade, but also through financial linkages. And some of that transmission takes place through changes in the exchange rate.

What we’ve seen since the middle of 2014 is a very significant increase in the U.S. dollar exchange rate, in part reflecting expectations that conditions would warrant a bigger divergence in policy between the United States and some of our foreign partners. But, of course, that change in the exchange rate, that tightening in financial conditions, then affects our exporters, it affects our import prices, which affects core inflation here. And so it, in turn, has a bit of a depressing effect on U.S. economic activity, which front-runs in some respects U.S. monetary policy.

HILLS: I was reading that an economist, Dr. Bill Cline, calculates that a 10 percent appreciation of the dollar worsens the U.S. account—current account position by about 1.7 percent, and the trade-weighted average of the dollar has appreciated 25 percent in the last three years alone. How do you see the current account deficit as a factor in the Fed’s thinking?

BRAINARD: Well, we definitely do see that net exports have been a drag on the economy since June of 2014 when we started to see that expectation of policy diversion showing up in a sharp appreciation of the dollar.

And so, you know, you see that in a way that is particularly evident in manufacturing, but you see it in net exports more generally that continue to be a drag today if you look at the data.

And of course, that is part of the reason that we have to be very, very careful in protecting and preserving the progress we are making here at home because in the United States, while consumption makes up a very large portion of the overall aggregate growth, it’s not strong enough really to carry the burden of global growth in a world where globally aggregate demand is quite weak.

HILLS: You know, you mentioned in your remarks, I would paraphrase them by saying take it step by step, and yet some economists are arguing quite vehemently that we should raise interest rates lest we create a bubble and the problem of tomorrow.

Give some information about how we would respond to those economists.

BRAINARD: So I think if you look across the set of economic conditions that we take into account as we assess what the appropriate stance of monetary policy is, you know, we have very specific goals of full employment and 2 percent inflation. And while we’ve made considerable progress on the employment leg of our mandate as we’ve seen from today’s, even on the labor market we’ve seen some slowing in recent months. And of course, on the inflation leg of our mandate we are still and have been persistently short of our 2 percent target.

So under those circumstances and given the very weak overall aggregate demand globally, the appropriate path of policy has been to continue to be very supportive of demand growth here in the U.S.

Looking forward, again, you know, as I see it, this is my take on it, current circumstances would dictate a risk management approach. There are important risks in the international environment, most immediately Brexit, but there are also risks associated with China and the broader emerging market complex.

And there’s also a fairly incomplete and mixed picture to give us a sense of how strong the second quarter is. In that context, I think prudence suggests that the risks of waiting are lower than the risks of moving ahead preemptively.

HILLS: You mentioned Brexit and China, and then Europe is slow. Give me some good news that makes you think that—(laughter) —that the future could be brighter.

BRAINARD: So American consumers are still relatively confident. Their incomes have been improving. And you know, the consumer confidence indicators are still relatively positive. So that is a very important bright spot that we want to carefully support and protect.

And again, you know, we have seen an important material easing in financial conditions that are more supportive, likely to be more supportive of our manufacturers and our exporters and of business investment than certainly conditions were earlier in this year.

HILLS: And you mentioned that, you know, the jobs report today, 38,000 was a disappointment. The U.S. banks reported their first quarter and they’re down 1.9 percent. Is that also something that causes you concern?

BRAINARD: So we in taking into account the sort of strength of likely business investment and the business sector, corporate earnings are very important. And obviously there has been some evidence that both the relatively elevated level of the exchange rate or the more elevated relative to what it was in 2014 on top of the very sharp decline in energy prices that we had seen together have depressed corporate earnings. And that is a very important indicator for business investment going forward.

And you know, business investment is important, not just for growth, but also for productivity. And I mentioned earlier that the numbers there, you know, are puzzlingly and disappointingly very low.

HILLS: You know, there are vacancies on the board of the Fed. And is that a concern?

BRAINARD: It would be great if we were at full strength of seven rather than being at five, absolutely, that would be very, very welcome.

HILLS: And explain a little bit about you’ve got 12 regional Federal Reserve boards. Talk a little bit about their role and how they fit into your responsibilities dealing with inflation and employment, looking at those as—

BRAINARD: Yeah. So the way that the Federal Reserve system is set up, the Federal Open Markets Committee, which is the committee that meets periodically to adjust and assess monetary policy, includes 12 regional presidents and should include seven board members here in Washington.

And you know, the 12 board presidents are supposed to and do bring their own independent assessment of economic conditions. Probably when the Federal Reserve was created and, you know, people had to travel across the country from the 12th district more slowly than they do today and data was not as widely available on national conditions, they probably were very focused on their own districts, which was critically important for assessing the overall U.S. economy.

Today they bring really important information from their districts, but we all look at the same data. And so the Fed deliberations, I think, is a very rich set of deliberations among the board members, who each have their own assessments as well, and the presidents, led by the chair.

HILLS: Well, you can see that we’re very fortunate to have the governor where she is today. And we’re certainly fortunate to have her on the podium, so let me turn it over to you to ask questions. And I would ask you to state your name and state your question.

Q: Thank you for being here. Rosita Najmi. I’m on the Financial Services for the Poor Team at the Bill and Melinda Gates Foundation.

I was really curious about if at all, if it’s on the radar, of the issue of de-risking. So we’ve been looking really closely at cross-border flows, so ranging from remittances, correspondent banking, humanitarian aid and trade finance as well, and the kind of unintended consequences on the poor when these flows are being cut off or when the cost of capital is raised.

I was just curious, you know, we’ve been collecting stories. Some central banks in certain markets are actually considering filling in the role of the correspondent relations for the respondent banks. We’re also seeing some banks figuring out what the willingness to pay is to maintain correspondent relations.

Any thoughts in terms of what the role could be for the Fed? Or any other just high-level thoughts on this issue on how we could be supportive would be helpful.

BRAINARD: So on the question of how banks can continue to maintain their international correspondent banking relationships while also fulfilling their obligations under BSA/AML and doing so very fully is an important issue for us. We obviously do want to see those international relationships being able to provide the necessary financial services to allow people to send remittances back home or do a host of business kinds of transactions.

And so it’s an area that we have had conversations with some of the banks that we supervise, but also we’re in close communication with the Treasury Department that sets some of those rules. And you know, our hope is that the environment will, you know, become a more sort of supportive environment going forward.

I think banks can do what they need to do for BSA/AML and still maintain those relationships. And I think there’s also some developments in the technology space, the technology arena that holds some promise of making those linkages perhaps cheaper, more real-time, and also safe.

HILLS: Yes, up front here.

Q: Hi. Jon Colby from The Carlyle Group.

It’s been reported that the five largest technology companies in the U.S., for example, are sitting on $500 billion of cash on their balance sheets. What does that look like to you from your perspective and historically? And then what do you think it’s going to take to have some of that come unstuck and increase productivity?

BRAINARD: So this question of how much different kinds of firms, you know, have incentives to put their cash and their capital to work I think is one that’s extremely important for the strength of business investment, for growth more generally. And that’s on the short-term part of the ledger, and then, of course, medium to long term for the productive potential of the U.S. economy. So it’s certainly an area that we have a lot of interest in.

In terms of the tools that we have, obviously, you know, we’ve been very supportive, I think, in terms of the stance of monetary policy has been supportive of activity in the business sector, activity in the household sector. There are other policy considerations that may be relevant that just are well outside of our realm or our influence.

But certainly this issue of business investment is an important one, and trying to create the best possible environment for that investment to take place is really where we come into that equation.

HILLS: Yes, third table back.

Q: Bill Courtney, RAND Corporation.

The eurozone and Japan appear to be over-relying on monetary policy and under-relying on structural economic reform. Is that risky? And are there any prospects that the eurozone and Japan will gather the political will to undertake more structural economic reform?

BRAINARD: Well, I think obviously we have a common interest, the United States, Japan, euro area, larger markets, China, in seeing a broad set of policies in each economic area that supports global aggregate demand more broadly.

And you know, in each economy, that would entail a somewhat different mix of fiscal and monetary policies as well as structural policies. And those are very specific to the circumstances of the different economies.

You know, I do think that in today’s circumstances where aggregate demand overall in the world seems to be quite weak and deficient, there is a case for greater fiscal support in some economies, so places like the euro area potentially. Certainly, we’ve seen some moves in that direction in Japan to complement monetary policy.

And also, you know, there’s plenty of potential for infrastructure investment and productive investment that not only would boost short-term demand, but also would boost the long-term supply potential in many economies around the world.

So you know, the mix is an important issue. It’s going to be specific to each economy, but our interest is to see that, you know, everybody’s pulling in the same direction to try to lift aggregate demand. There’s really no good outcome where policies are just shifting demand across borders. That’s, in the end, going to be self-defeating.

HILLS: Yes, right here.

Q: Hi, I’m Teresa—

HILLS: Wait for the mic.

Q: Sorry. Teresa Barger from Cartica Capital.

So I’m just wondering if you all look at the ratio of inventory to sales, and it’s been going up very steadily the last 18 months and now reached almost the peak of the 2008 spike, and whether that’s of concern and whether you see that as a recessionary signal or not.

BRAINARD: So the board has incredible economists who know more about every data series, U.S. and foreign, than one could ever ask. And inventories is a critically important focus of, you know, the forecasting staff at the board, and is a very important input into our assessment of, you know, if you see weakness in the first quarter or the fourth quarter. How much of that is going to be remediated by a rebound in the first quarter is importantly associated with this question of whether inventory build was high or low relative to what one would have expected in our usual forecasts.

So it is an area of intense focus. I don’t think that I would say that it’s a, you know, a clean predictor. I think there are very few kind of individual, clean predictors of, you know, whether the economy is strengthening or going into a recession. But it is extremely important to try to understand when we do see some weak quarters, like we have, to try to assess whether there may be some very important temporary factors that are going to abate in the following quarter.

And you know, again, more broadly, I think we’ve seen some data on the second quarter, but I think it would be extremely important to have additional data to make a full assessment of what the second quarter is going to look like.

HILLS: Over here, yeah.

Q: Hi. Nelson Cunningham of McClarty Associates. Good to see you, Governor Brainard.

It’s been said in recent years that corporate profits were at an all-time post-war high as a percentage of GDP, whereas employee compensation was at a post-war low as a percentage of GDP. Are those measures in the same place today? And how do you view what has been higher than historically normal corporate profits and lower than historically normal employee compensation?

BRAINARD: So in fact, interestingly we have started to see a bit of an upturn in the labor share. And as you pointed out, the labor share had fallen to historically very low levels. And we’re only seeing the beginnings of tentative signs of an upturn there.

But obviously, you know, there’s good news potentially for households and for the domestic consumer, potentially good news from a distributive point of view given what we’ve seen in terms of distributive trends over a very substantial period of time.

But there, I think, is too little of a, you know, sort of trend in this direction so far to really make, you know, very firm conclusions about what we’ve seen so far.

HILLS: Way in the back of the room.

Q: Thank you. Howard Schneider with Reuters.

Lael, I was really taken with your discussion of the neutral rate. You’re suggesting that the rest of the world has kind of imposed an effective cap on how far the Fed might be able to go if in fact the world is what’s dragging the neutral rate down. And what I’m wondering is, what happens on day two when you all wake up and realize that 2 percent is about as good as you can get? Is that when you start having the discussion of a higher inflation target or some sort of hybridized policy where you’d include other things other than the interest rate, even though you’re off zero?

BRAINARD: So I think right now it’s a tentative kind of observation, but it does appear that what we have seen in the estimates to be a historically very low neutral rate and which I think many had assumed was attributable primarily to cyclical headwinds, it now seems, both in some of the estimates, but also just by watching the evolution of the economy, that that neutral rate may well be low, historically low for some time to come.

And if that’s true, it does mean that we are closer to neutral today than we thought we were or that many people might have thought we were, which in turn could mean that the path of policy, the appropriate path of policy is likely to be more gradual, more shallow over a somewhat longer period of time.

Now, that’s attributable to a host of things. And some of that may indeed reflect international factors. It also likely reflects some factors here, like the aging of our own workforce. And as I said earlier, too early to tell, but productivity, low productivity, could also be a piece of that puzzle.

In terms of what does it mean for policy, I think what seems to me to be the sort of most clear-cut observation is that we’re going to want to engage in a fairly cautious approach, a risk management approach, and move cautiously assessing the effect of any further moves as we go, rather than being tied to some preset course that might be derived from some previous tightened cycle that took place under very different circumstances.

HILLS: Yes, right here in the middle.

Q: Hi. Nancy Jacklin. Hi, Lael.

This is sort of going back to something that Carla asked you earlier, which is not just do you see any good news, but you talk about balancing risks. And you gave us a pretty good brief on the downside risks. The question is, do you see any upside risks? And in looking at that are you considering any issues in the financial sector, including some signs we see of things in the real estate market now, like house flipping, search for yield that’s leading to people buying loans from the peer-to-peer lending that may have no credit process attached to them, issues relating to the amount of derivatives that the SEC is seeing being used in retail mutual funds? What are you seeing as if you’re looking at balancing risks, are there upside risks that you worry about?

BRAINARD: So it is certainly a huge focus of our work at the board, is to carefully, systemically, periodically assess risks that might be building in the financial sector. And you know, we have a much more well-developed analytic framework, and a staff that is now dedicated to this in the wake of the crisis. And we have additional tools that are macro-prudential in nature that complement our monetary policy tools so that, to the extent we do see building risks in certain sectors, we have a broader set of tools that would allow us to, at least in part, preemptively, ideally, address some of those risks, without overly burdening monetary policy, which already has pretty clear dual objectives.

With regard to the assessment of risks today, you know, earlier we had called out some concerns about leveraged lending and put out some guidance there. And we saw some dissipation and some correction in that, to some degree. I think more recently we have taken a look at CRE and particularly concentrations of CRE in some bank balance sheets as a potential risk. In terms of the real estate market, you know, there it’s hard to generalize, because these are—to some degree the developments there are very specific to different regions. But we are very focused. There’s some signs of a very, you know, extended, subprime auto set of lending. But not to an extent that you would see it as a macro risk at this point.

But we are very, very focused on the potential for risks to build up in particular financial sectors, and then to pose risks more broadly. And you know, we’re much more systematic about assessing those risks and trying to connect those risks to tools that we have at our disposal to address them.

HILLS: Yes, in the back of the room, in the center.

Q: I’m Haik Gugarats with Argus Media.

How concerned are you about the asymmetric effects from the rise of price of oil, in the sense that it may nullify some of the gains in consumer spending we’ve seen in the past year, without boosting business investment because producers don’t seem to be drilling more as a result?

BRAINARD: Yeah. So I would say that I can’t give you a very precise answer to that question. I mean, as oil prices declined, you know, I would say our previous historical experiences and the kind of macro estimates that you get from those didn’t prove to be very good guides. We probably got more of a response in terms of the very sharp deceleration of investment in drilling and mining, for instance, than we had seen in previous historical episodes. And it’s hard to tell because these consumers respond over time, but it also seems that consumers didn’t respond as much as one might have predicted based on older macro estimates.

And similarly, just as I don’t feel that the historically rooted estimates were particularly accurate in thinking about the period in which the oil price was declining, similarly now that we’ve seen a bit of an increase there and a bit of a stabilization, I don’t have a huge amount of confidence in how that is going to show up in, you know, consumers responding to higher prices at the pump and therefore, you know, seeing a little bit of a moderation on the consumption side, versus providing more incentives for producers to go back and—certainly go back and start investing in exploration and trying to expand capacity. I think it would be very hard to generalize.

The other thing that’s very important is that our oil and gas sector has changed dramatically since some of those earlier estimates were put in place. And so, again, what the price point is, I don’t think we have precise estimates. But certainly it’s a very important driver, and we’re looking at it very closely.

HILLS: Further questions? Yes, over at this table, right in front of the mic.

Q: Thank you. Governor Brainard, Rod von Lipsey, UBS.

The question that I have just goes to your sense in the Fed being data driven, but the economy and the markets being somewhat sentiment driven, is there a possibility that we could have a sentiment-driven recession or trend?

BRAINARD: So a part of the data we look at relates to sentiment. (Laughter.) And you know, again. So if we look at some of the consumer—the most recent consumer sentiment indicators, they actually look pretty resilient, which is reassuring. But you know, there’s different lags in terms of how people respond to changes and their perceptions. And so, you know, we don’t really know going forward whether consumers are going to continue to feel buoyant and continue to see the kinds of consumption numbers that we saw in April carrying through further into the second quarter, which of course is very important factor in driving U.S. growth.

But it is I think just an argument for being a little bit patient in terms of reading more signals on the economy, not just on actual spending but also on how both consumers and businesses are feeling about spending an investment. I think it just goes in the same direction, which is that we want to have greater confidence that growth rebound is really in place before making a policy judgement.

HILLS: This table in the middle. Yes.

Q: Thank you very much Sherry Stephenson, International Centre for Trade and Sustainable Development, Geneva.

I want to go back to the discussion on productivity. To me, that really seems to be a very, very significant concern. The ½ percentage growth in productivity that we’ve had since 2009 just isn’t enough to have a very dynamic longer-term growth prospect. And yet, you’ve stated that we don’t know the reasons behind this slowdown. So if we don’t know the reasons, how can we effectively address it, I mean, other than saying we need more business investment? And maybe that isn’t an issue the Fed works on, but could you comment on this and what you think? People say the IT—the spurt from the IT revolution has now run its course and we don’t have another big, you know, positive stimulus in sight. And that’s of definite concern. So how do you boost long-term growth in the absence of productivity gains?

BRAINARD: So I—there are a bunch of reasons that people are pointing to as possible explanations. And you know, I don’t think any of them are definitively—you know, in terms of the evidence—are definitively known to be the answer. And one of the reasons that’s out there, as you suggest, is that somehow the earlier investments that had been made in information technology have now been fully diffused and run their course. Others are looking at the question of measurement error, that we had some good work at the Fed which looks at this question of whether it’s possible that we’re just not capturing some of those productivity gains because of the way that we measure, services in particular.

But of course, the question there is whether that same measurement error wouldn’t be equally applicable to earlier episodes with a lot of IT. And so not clear. There are other questions or explanations, that it takes a while for potentially productivity-enhancing investments to diffuse. So if you looked at artificial intelligence today, or maybe robotics, or genetics, that maybe these are things that are quite promising, but really haven’t been diffused to any great degree. And so, you know, maybe we will see a pickup.

I don’t know the answer. I don’t have a strong view one way or another. But it is obviously so critically important in terms of driving potential that we need to understand it. And investment is a big piece of it. Education is an important piece. Having a very vibrant environment for innovation not only to take place, but then to diffuse through investment is extremely important. So, you know, it is something that is very important to our work. But again, you know, our tools in this area are limited to the ones that try to create a—not create, but support a productive environment for investment.

HILLS: Yes, in the back. Way in the back.

Q: Thank you. Jang Zhen (ph), Voice of America.

Just wonder, what’s the China factor in the Fed’s decision? Because there’s talk about this rumor on Bloomberg News, and talking about the S&ED, Strategic and Economic Dialogue, which is being held in Beijing. It said the officials in Beijing would just ask the U.S. officials about the Fed interest rate hike issue, but Central Bank in China denied it. But do you think that China—the Chinese economy might be a factor? What do you think about this? Thanks.

BRAINARD: So what I can say is that in assessing the appropriate stance of monetary policy for the U.S., you know, we have a very clear objective function that is established in law by Congress, which is domestic focused—full employment and price stability, which has been interpreted as 2 percent inflation. So that’s our focus. And then, of course, because we are so tightly integrated into the world—you know, the dollar is viewed as a reserve currency, we have some of the most liquid, deepest financial markets in the world—but of course we’re also tightly linked on the trade side. How our policy path and expectations of our policy path are then affecting financial conditions, and of course importantly through exchange rate channels, does, through a very important feedback loop, come back around and affect U.S. domestic conditions.

So in the past year, I would say, China has figured prominently in terms of global risks and global financial conditions, as China has managed challenges on its domestic front. And so those kinds of considerations naturally have to be taken into account when we think about risks to the outlook. And they naturally will affect policy deliberations, and potentially the path of policy. And so that is the way in which risks emanating from China—and of course, you know, China was the really predominate source of global investment growth for several years following the recovery. And that was a very important source of demand and growth for emerging markets that were linked to China, both through commodity exports as well as through supply chains.

So we’ve seen that kind of as China’s attempting to rebalance its growth path—rely less on investment, less on resource-intensive, export-oriented sectors, more on domestic demand—that has rippled through supply chains in other emerging markets, and very importantly through commodity markets. And so those things do matter for our domestic objectives back here in the U.S.

HILLS: All right, question here.

Q: Irving Williamson, U.S. International Trade Commission.

You touched on fiscal policy in Europe and in Asia. I was wondering if you might want to touch on fiscal policy in the U.S., and how that might be complicating your efforts, particularly in regards to the question Mr. Cunningham raise about income inequality in the U.S., achieving full employment when you see the number of people dropping out of the wage—the labor force increasing. Thank you.

BRAINARD: So in the U.S., and we are differently situated than many of our foreign partners in the sense that we have been recovering and, you know, we have made quite a lot of progress on the employment leg of our mandate. You know, the labor market has come a long way although, again, we’ve seen some signs of slowing in the last few months. A little bit less progress, but nonetheless, you know, we’ve also seen core inflation around 1.6 percent, which is below our objective. But we are seeing progress. And so we are differently situated relative to some of the other economies, particularly Japan and the euro area.

Nonetheless, you know, in a period where in particular, you know, it may be that the neutral rate is low for some period of time, and a period where, you know, there are reasons to want to both support aggregate demand in the short run, and also the productive potential of the economy and productivity in the longer run, there may be a case to be made, for instance, for infrastructure investment complementing the goals that we’re trying to achieve in monetary policy. But again, you know, those questions about really needing to bolster aggregate demand are even more important in other parts of the world where they have a bigger challenge.

HILLS: Well, I’m afraid we’ve run out of time. But I hope you’ll join me in thanking Dr. Brainard for not only a wonderful presentation, but also the most comprehensive responses to a great variety of questions. So thank you so much for taking your time to be with us. (Applause.)

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