Speaker 1: Bloomberg Audio Studios, podcasts, radio News.
Speaker 2: We consider the path forward for this conflict and of course,
Speaker 2: ultimately what it means for the global economy. That is
Speaker 2: a challenge that policymakers have to deal with not just
Speaker 2: on Capitol Hill, but inside the Federal Reserve Building, in
Speaker 2: the various buildings across the country that the FED inhabits,
Speaker 2: as they consider the economic picture, in the inflation picture
Speaker 2: that this has created. And it's on that note we
Speaker 2: turn now to the Rekuvic Economic Conference, where the Saint
Speaker 2: Louis FED President ALBERTA Muslim is sitting down with Bloomberg's
Speaker 2: very own Stephanie Flanders. Let's go live now to Iceland.
Speaker 3: Well, thank you so much. I am indeed here in
Speaker 3: Rekievik with Alberto Musalem. Thank you very much for joining us.
Speaker 3: In your speech here at this conference, you pointed out
Speaker 3: that the US has inflation running meaningfully above target, long
Speaker 3: run inflation expectations creeping higher, and yet a real policy
Speaker 3: rate that was below the level that the Federal Open
Speaker 3: Market Committee think is neutral, so not actually applying any
Speaker 3: restraining force on the economy. All those things together sound
Speaker 3: like someone who wants to raise interest rates crazy to
Speaker 3: be with you.
Speaker 1: That's right.
Speaker 4: The real policy rate right now is running at around
Speaker 4: half a percent, which is lower than the one percent
Speaker 4: that the Committee believes is the neutral rate. I think
Speaker 4: you have to look at the full picture, and it
Speaker 4: looks to me like policy is at or slightly below
Speaker 4: the committee's long run neutral level.
Speaker 3: But if you combine that with the other things you
Speaker 3: talk about, you had emphasized the risks of the inflationary
Speaker 3: pressures on the demand side and the supply side of
Speaker 3: the economy. It it sounds like you think they should
Speaker 3: be leaning towards tightening. It sounds like you probably you
Speaker 3: might have been one of the policy makers in the
Speaker 3: April meeting who actually thought they should have removed the
Speaker 3: statement against tightening in the statement.
Speaker 4: So yeah, I supported the interest rate decision, but I
Speaker 4: thought the easing bias was no longer consistent with the
Speaker 4: outlook and the balance of risks, which in my mind,
Speaker 4: the bouncer's risk has shifted a little bit towards the
Speaker 4: inflation side, unless towards the employment side.
Speaker 1: So whether the.
Speaker 4: Economy will require a hike or a cut or hold
Speaker 4: will depend on the scenario. There is a scenario where
Speaker 4: inflation remains high, there's no disinflation in the next quarter
Speaker 4: or two, and in that scenario, the economy will probably
Speaker 4: require a hike. There's also a scenario where the economy
Speaker 4: weakens materially in the second half of the year because
Speaker 4: real incomes are challenged and corporate margins are challenged. In
Speaker 4: that scenario, inflation could come down. In that scenario, we
Speaker 4: would be thinking of no hikes, maybe even a cut.
Speaker 4: So there are two scenarios to play with here.
Speaker 3: But looking down the track, at least the markets are
Speaker 3: now fully pricing a rate hike by March twenty twenty seven.
Speaker 3: Given where we are now, how we think things are
Speaker 3: going to proceed with oil prices and some of the
Speaker 3: risks on the supply side that you talk about, do
Speaker 3: you think that's a sensible thing for them to.
Speaker 4: Price again, I think there are two scenarios here, and
Speaker 4: I don't comment nor with on market pricing. I'm more
Speaker 4: focused on what's best for the economy and from main
Speaker 4: street markets, every price materially in the US and in
Speaker 4: other countries, and the front end of the curve, I
Speaker 4: think that's markets trying to understand what our reaction function is.
Speaker 3: So I'm going to quit here because in your speech
Speaker 3: you talk very directly about the impact of AI on
Speaker 3: productivity and the long run impact that could have on
Speaker 3: monetary policy and on interest rates, But you warn that
Speaker 3: policy makers cannot depend on a potential productivity boom from
Speaker 3: artificial intelligence to ease elevated inflation right now in the
Speaker 3: short term, and in fact, you seem to suggest that
Speaker 3: the buildout of all the data centers associated with AI
Speaker 3: was actually putting upward pressure on inflation. Do you think
Speaker 3: the incoming FED chairman Kevin Walsh is one of those
Speaker 3: policy makers that's inclined to be hoping for that.
Speaker 1: So I'll speak about my views.
Speaker 4: I am an AI enthusiast and productivity optimist, but at
Speaker 4: present it's unclear that productivity, first of all, is higher
Speaker 4: than the long term average, is actually at or below
Speaker 4: the long term average, And so to rely on productivity
Speaker 4: to do the inflation job seems a risky proposition because
Speaker 4: what if the productivity doesn't materialize in the future, we
Speaker 4: could end up with higher inflation today and in the future.
Speaker 4: And what AI is doing right now, it is not
Speaker 4: really expanding the supply side of the economy. Yet what
Speaker 4: it's doing is is putting upward demand pressures. You know,
Speaker 4: through chip prices for the build out in my district,
Speaker 4: I hear of construction companies shipping workers all over the country.
Speaker 4: It is specialized trades persons to bill out the data centers.
Speaker 4: So at present, it's more of a demand story from
Speaker 4: AI than a supply story, and you see that in
Speaker 4: the AGGRI demand numbers, and the percentage of CAPEX that
Speaker 4: is coming from the AI build out is material.
Speaker 3: But of course a lot of this does come down
Speaker 3: to how you think in the scenario the next sort
Speaker 3: of year and a half, that that's what you're focused
Speaker 3: on when you think about where the policy is right
Speaker 3: now and in the next few quarters. There's obviously different
Speaker 3: pressures right There's some have emphasized, even John Williams has
Speaker 3: talked about the disinflationary forces that come from AI. If
Speaker 3: you start to see people lose their jobs, if you
Speaker 3: see jobs eliminated as AI is rolled out. You've highlighted
Speaker 3: more of the supply side, the sort of upside pressures
Speaker 3: that come from data centers and other things, those kind
Speaker 3: of pressures on resources. You seem pretty clear that those
Speaker 3: upside pressures are going to be the larger factor at
Speaker 3: least coming from the AI revolution in the next year.
Speaker 1: I think there are two things. In the short run.
Speaker 4: I think the demand pressures are more prominent than the
Speaker 4: supply relief. I'm prepared to change my view if and
Speaker 4: when I see AI actually contributing to agrig productivity growth,
Speaker 4: which we don't see just yet in the data, and
Speaker 4: when that becomes evident that that's actually putting downward pressure
Speaker 4: on inflation. At present, that's not where we are now
Speaker 4: in terms of the long run productivity and AI.
Speaker 1: If and when we get.
Speaker 4: Productivity to grow above its long run average where it
Speaker 4: currently right now is not. The impact on real interest
Speaker 4: rates will depend on how permanent that increase in productivity
Speaker 4: growth is expected to be. If it's expected to be
Speaker 4: very permanent, that will put upward pressure on real interest rates.
Speaker 4: If it's expected to be transitory, then the supply side
Speaker 4: will win and that will put downward pressure on interest rates.
Speaker 3: One other thing that's happened since the beginning of the
Speaker 3: Iron Crisis is a real change in bond yields, and actually,
Speaker 3: we certainly think of Bloomberg economics, we think that's been
Speaker 3: largely due to an increase in the term premium slightly
Speaker 3: an increase in what we're expecting on inflation, but mainly
Speaker 3: on the term premium. So in that sense, has that
Speaker 3: the bond market already done some of the Fed's work
Speaker 3: for it? I mean, is that producing a meaningful tightening
Speaker 3: even though you have a very low short term rate.
Speaker 4: So my interpretation of what's happened to bond markets is
Speaker 4: that they're seeing an economy that's resilient on the real side,
Speaker 4: they see a labor market that's been resilient on the
Speaker 4: real side. They see higher realized inflation, they see higher
Speaker 4: expected inflation. When I look at the decomposition, I arrive
Speaker 4: at a different conclusion than your team, which is a
Speaker 4: fantastic team. My understanding, it's about three quarters of it
Speaker 4: was an increase in the expected neutral rate policy rate,
Speaker 4: that is in about one quarter higher term premia. Now,
Speaker 4: if you look at forward markets.
Speaker 3: So just on that, you don't think it is hasn't
Speaker 3: meaningfully tightened financial conditions if you're looking on that kind
Speaker 3: of medium term.
Speaker 4: So I was about to say, if you look at
Speaker 4: the forward real interest rates, Marcus have raised the real
Speaker 4: implied forward so they real interest rate a year from now,
Speaker 4: they're real interest rate two years from now have come
Speaker 4: up meaningfully in the last month or two.
Speaker 3: But just going back to the things, you don't think
Speaker 3: that it's made that the incoming Kevin Walsh is not.
Speaker 3: His job hasn't been made any easier by the tightening
Speaker 3: in the bond market. You still you would still have
Speaker 3: to be focused on that short term rate.
Speaker 4: I think when he comes in, he's going to take
Speaker 4: a look at the Oh he has come in, he's
Speaker 4: been sworn in. You know, he's gonna he's gonna have
Speaker 4: his first meeting next the next two weeks, and he's
Speaker 4: going to have to look at the economy, and we're
Speaker 4: all gonna have to look at the economy and you know,
Speaker 4: exchange views on the economy and exchange views on what
Speaker 4: the best policy for the American people is at that
Speaker 4: point in time.
Speaker 3: Well, the other thing that the incoming FED chair has
Speaker 3: talked a lot about is changing the Fed's communication tools.
Speaker 3: He said he doesn't want to see so much or
Speaker 3: indeed any forward guidance. He wants to have fewer public speeches,
Speaker 3: he wants to get rid of the dot plot. Lots
Speaker 3: of people come in saying they want to have less
Speaker 3: less forward guidance and then they find they want to
Speaker 3: say things to the markets. Do you think that he's
Speaker 3: going to have a similar kind of learning curve.
Speaker 4: Well, he's been in the FED before, so his learning
Speaker 4: curve will probably be much lower than somebody who had
Speaker 4: not been there before. You know, he's expressed some views
Speaker 4: during the last year or so. Once he's in the seat,
Speaker 4: once he consults with the full committee, and I expect
Speaker 4: him to consult with the full Committee and all these matters,
Speaker 4: you know he will he will try and steer the
Speaker 4: committee in a direction or another.
Speaker 1: And I think it's always.
Speaker 4: Healthy to look at your communications policy, your monetary policy
Speaker 4: framework and see how to adjust each or both to
Speaker 4: make sure we're fulfilling the dual mandage as best we can.
Speaker 3: But you're kind of on the opposite side of this,
Speaker 3: because you wanted to actually connect the dots to the
Speaker 3: whole forecast, not review whose dots they were, but make
Speaker 3: a bit more sense of what the dots represented the
Speaker 3: bigger picture, whereas he, instead of elaborating on the dots,
Speaker 3: he wants to get rid of them all together. I mean,
Speaker 3: that's just a straightforward disagreement.
Speaker 4: Well, I would say what I think I would like
Speaker 4: the most favor of the most is that we have
Speaker 4: a communications policy that is very effective at transmitting what
Speaker 4: our reaction function is at any point in time. Right
Speaker 4: now we have the dots. We can make the dots
Speaker 4: more effective by connecting the dots in terms of transmitting
Speaker 4: our reaction function. Now you could also think of not
Speaker 4: having the dots, but replacing them with something else that
Speaker 4: is effective in transmitting to the markets and households and
Speaker 4: businesses what our reaction function is.
Speaker 3: The other big thing that certainly people in the financial
Speaker 3: markets have been very focused on in Kevin Walsh's comments
Speaker 3: is about wanting to shrink the fed's balance sheet, And
Speaker 3: actually Governor Michael Barr said just the other day that
Speaker 3: he thought that was just the wrong goal, that it
Speaker 3: would actually raise risk for financial stability, and that it
Speaker 3: wouldn't necessarily reduce the footprint in financial markets.
Speaker 1: What do you make of that.
Speaker 4: I think that's something that needs to be studied and
Speaker 4: we need to all review what the options are for
Speaker 4: doing that if we so desired. And I think it's
Speaker 4: very different to reduce the balance sheet from the supply side,
Speaker 4: which could be very disruptive, or reduce the balance sheet
Speaker 4: from the demand side for reserves. Demand for reserves are
Speaker 4: supposed to apply for reserves. If we went in the
Speaker 4: direction of taking measures that would reduced the banking system's
Speaker 4: demand for reserves, then that would be I think a
Speaker 4: smoother path towards a lower balance sheet and percenta GDP
Speaker 4: or a lower growth of the balance sheet in nominal
Speaker 4: terms than simply reducing supply, which could be disruptive.
Speaker 3: But other things equal, do you do you kind of
Speaker 3: share the desire on balance to have a smaller balance sheet.
Speaker 4: I think I'm going to do a two handed economists. Now,
Speaker 4: there are some benefits having a large balance in terms
Speaker 4: of financial stability, but it's also I think healthy for
Speaker 4: the Central Bank to have the minimal or minimum balancee
Speaker 4: that it needs to have to operate its monetary framework
Speaker 4: and to promote financial stability. Now, so I think we
Speaker 4: need to understand that where that is.
Speaker 3: Just a last question when you talk about communications, and
Speaker 3: we've certainly had a lot of communications about the FED
Speaker 3: from the White House, but also we have ordinary people
Speaker 3: who are coping with the impact of higher gasoline prices.
Speaker 3: We're definitely having a conversation about higher interest rates now
Speaker 3: that we wouldn't have expected to have six months ago.
Speaker 3: And I think a lot of people, whether in the
Speaker 3: White House or in the broader economy, would say, hang on,
Speaker 3: what is the Fed doing thinking about raising interest rates
Speaker 3: in an environment where it can't affect the global energy
Speaker 3: price that's the thing pushing up inflation, and it definitely
Speaker 3: can't affect the rollout of AI because that seems to
Speaker 3: be just an unstoppable force.
Speaker 1: So why raise.
Speaker 4: Interest So our mandate is price stability and maximum employment.
Speaker 4: And right now we're above target on inflation, and so
Speaker 4: the possibility or probability that we might consider and interest
Speaker 4: rate increase in the future I think has to be
Speaker 4: greater than zero. You know, the economy has been robust,
Speaker 4: GDP growth has been at or around potential, The lave
Speaker 4: market is right around in terms of unemployment, right around
Speaker 4: its natural rate around four point three four point four,
Speaker 4: And so we're missing on one side of the mandate.
Speaker 4: Inflation expectations are drifting higher to some degree, and we're
Speaker 4: not missing on the other side of the mandate. So
Speaker 4: you have to take all all the factors, and you know,
Speaker 4: we have a statutory responsibility to hit both sides of
Speaker 4: the mandate.
Speaker 3: And finally you did mention. Kevin Walsh was sort of
Speaker 3: as in the building and has been sworn in. He
Speaker 3: talked in the past about wanting to shake break, break
Speaker 3: some heads and have a sort of revolution, be an
Speaker 3: agent of change in the FED. Is that the way
Speaker 3: that he's presented himself Internally?
Speaker 4: I think the new chair or Chair Warsh i should say,
Speaker 4: will be asking some very profound and deep questions about
Speaker 4: many ways in which we operate monetary policy, communications operations,
Speaker 4: and so I think that's refreshing. You know, a new
Speaker 4: leader should always come in with a vision and asking
Speaker 4: very deep questions about how things were done in the past.
Speaker 1: I expect that to be the case. All A bet Massalam.
Speaker 3: Thank you very much for joining us, and I think
Speaker 3: we'll even forgive you for disagreeing with our US economics team.
Speaker 1: Thanks very much,