The Incoming New York Fed Chief Talks About Inflation and the Yield Curve

John Williams is poised to become one of the most important men in U.S. central banking when he joins the Federal Reserve Bank of New York as president on June 18.

Following the current San Francisco Fed president’s speech on Tuesday, he sat down with Bloomberg News in Minneapolis for a wide-ranging interview that hit on everything from yield curve inversion to the end of forward guidance. The following are excerpts from that conversation.

Yield Curve

“Am I worried today about the fact the yield curve is flat? No. Because I think that’s driven primarily by the fact that the Fed is tightening, long rates are moving up, but not surprisingly, not one-for-one. But I do think that we need to keep our eye on what happens to the yield curve in the next year or two as we continue to raise interest rates, to make sure… we’re not getting a mixed signal from markets that may tell us a more pessimistic view. Markets aren’t always right. It might be more of a warning sign if we saw the yield curve get really flat, but I would not ignore it.’’

Question: Would you be willing to hike rates into an inverted yield curve?

“That situation really depends on what was happening in the economy, what were the reasons why we would be continuing to hike. Again, I don’t see that as a situation that we would be running into in the next year or so, but I think the answer to that depends on the context. If we’re in a really strong economy with high inflation, then I think you need to have monetary policy to adjust to that. I definitely wouldn’t ignore signals we’re getting from the markets about views of where the economy is going, and making sure we understand them.’’

Forward Guidance

“I do think that the statement language will have to evolve over time, to reflect the fact that at some point, we’ve got monetary policy to more normal levels — we can’t keep talking about policy normalization once we’re around what we think of as a neutral interest rate. And so I think this forward guidance, at some point, will be past its shelf life.”

But he notes that the Fed’s economic projections and dot plots will still exits.

“Even if we move away from verbal forward guidance in the future, we’re still going to have this numerical forward guidance.’’

He acknowledges that the Fed’s statistical estimates are not forward guidance in the same way that the statement is, though.

“It’s not forward guidance in the same way: it’s not like, ‘further gradual increase in interest rates’, it’d be more about: well here’s the perspective of the participants. And if you think about it, once we’re closer to neutral, there will be a range of views about where interest rates should go, and it won’t be quite as clear cut as it is now, where the majority of people want to see us moving toward neutral.”

Communication Evolution

“We probably need to do more work on communicating our reaction function, and not spending so much time trying to communicate our forward guidance.”

“Now, in a perfect world, we’d find a way to use our economic projections to come up with a document that explained this in words. Right now economic projections are kind of a statistical artifact, and there’s no story to go along with that. Hopefully at some point, we’ll be able to provide, as a committee, a nice summary of — here’s where we see the economy going. Here are the big drivers. Here are the uncertainties. And here’s what we think appropriate policy will be. We’re not going to do that anytime soon, but this was a project we contemplated years ago, a consensus forecast or something. I still think — if we could figure out a way to do that, and make it practical, and make it effective, that would be a good way to get into this much more data-dependent, reaction-function mode.”

Inflation Goal

Question: You’ve started using the words “on average” occasionally when talking about the 2 percent inflation goal. Is that a soft form of price-level targeting?

“We obviously have not switched to price-level targeting or any version of that — we’re still in the regime of aiming to hit our 2 percent inflation goal. I just think what’s really important, I’ll be as blunt as I can, is we’ve been missing our target, so when we say inflation’s near 2 percent, it’s never been 2.2 –- it’s been 1.8 or 1.7. This word ‘near,’ for the past two years, has always been under.’’

“So the symmetry word — even on average — is just saying, I really mean that over the next few years I want to see inflation be 2 percent. So when I say near 2 percent, I mean, going from 1.8, to 2.2, to 1.8, to 2, to 1.8, not — 1.8, 1.9, 1.8, 1.9. That’s really all I’m trying to say.’’

Hot or Not?

Indicators “all tell you that the labor market is hot. It’s not that the unemployment rate is misleading us, but the wage data kind of suggests that either the labor market is not as hot as these other indicators, or there’s going to be this lagged effect.’’

“Maybe we just have to wait a little bit longer. But it is a reason, a serious reason, that I’m not that worried about inflation, or wage inflation, or price inflation, being on the cusp of a an outburst of inflation.’’

Inflation Expectations

“There’s not much worry about inflation taking off, and I think the fact that people aren’t worried about inflation is one of the reasons that inflation is just less sensitive to the economic cycle. Inflation didn’t fall that much during the recession, and it hasn’t picked up a lot in the strong economy.’’

“The kind of wage-price spirals that we saw in the 60s and 70s don’t look likely to occur for the foreseeable future.”

“But we also have to do our part to make sure that we’re not allowing the economy to get way out of equilibrium, either. If we can keep the economy in balance, and keep it strong, with low inflation, I think the expectation will be that we’ll continue to do that, and that’s a virtuous cycle.’’

On Jay Powell

Asked whether he and Federal Reserve Chairman Jerome Powell ever disagree on matters of monetary policy theory, Williams said it’s not about disagreeing — “it’s really about being open to the idea that the economy may be different than we have seen before — that the world may have changed. I view that he is very open minded about that, I try to be open minded about that, one of the constraints about having these models and having done this work is that it can constrain your thinking.’’

“One of the things I’ve had to un-learn as a policy maker is not to allow a specific model or framework to lock me in to thinking about it that way, but to try to be open, and listen.’’