The economic outlook: A conversation with the Fed’s Randal Quarles

[00:00:00] Speaker 1: GLENN HUTCHINS: Good afternoon. I'm Glenn Hutchins, co-chairman of Brookings and one of the many people on this call who work for David Wessel at the Hutchins Center. And it's my pleasure today to welcome Randy Quarles to Brookings, virtually and we hope physically in the future. Since October 2017, as many of you know, Randy has been vice chairman for supervision of the Fed, serving a term which ends in October 31st of this year, unfortunately. He also chairs the International Financial Stability Board, which was established by the G. Tony to coordinate worldwide regulatory policy, another very important role that I had the opportunity to witness him in earlier in the pandemic. Randy, in my view, brings two qualities to his work that are both unfortunately in short supply in Washington: business experience and erudition. He previously worked in money management at Carlisle and at the Sinusher Group, and as a result brings invaluable markets experience to the Fed Board, not to mention valuable experience that is lacking broadly in my view in the D.C. wide economic policy making apparatus and plays as a consequence a very important role. Also, he was trained as a classicist at Columbia and consequently peppers his speeches with quotes from the likes of Thucydides, Shakespeare, and even Alfonso, who I gather was a 13th century king of Spain. In my role as director of the Fed, New York Fed, I was there for the actions Randy and his colleagues took a year ago to stabilize markets and create the conditions under which the economy could absorb the shock of the pandemic, and which sets the stage for today's discussion about the future. In his erudite manner, Randy once described these actions as a gallimaufry, which is a 16th century French word roughly meaning hodgepodge, and a word that I understand was introduced in the English language by William Shakespeare in The Merry Wives of Windsor. On this, I would beg to differ, on this characterization of the Fed's actions, I would beg to differ with Randy, and instead would describe the Fed's actions using the words that Shakespeare wrote for a character in Cymbeline, which is "Boldness be my friend." The Fed's boldness was, in my view, a friend to us all. This summer, as I sit in the Delacourt theater at Central Park for my first post-pandemic theater outing watching The Merry Wives of Windsor, which they're putting on this summer, I do hope that I can think about the play rather than Fed policy. If not, like the stabilization of the markets and the recovery of the economy, Randy, I intend to hold you responsible. Over to you, and thank you for joining us. [00:02:46] Speaker 2: Thank you. Thanks, Glenn. Thanks to Brookings and the Hutton Center for the opportunity to lead things off and be part of this very distinguished panel today. So today, I'll explain why I expect the U.S. economy to continue growing strongly over the remainder of this year and what the implications of that outlook are for monetary policy. After the shutdowns and other measures taken in response to the COVID-19 outbreak last spring caused the swiftest and deepest recession in U.S. history, the economy has made a powerful recovery. Households and businesses adapted, supported by the flexibility and inherent strength of our market-based economy, by the continued resilience of our banking system, and of course, by significant fiscal and monetary policy support. Highly accommodated monetary policy by the Federal Reserve has fostered strong growth in interest rate-sensitive sectors of the economy, such as housing and durable goods, offsetting some of the historic weaknesses in the service center sector last year. Now, with the service sector reopening, while other household and business spending remains strong, I expect rapid growth to continue for some time before slowing to a still robust pace next year. Inflation is running significantly above the Federal Reserve's longer-run goal of two percent, primarily as a result of three factors: the surge in demand as more services come back online, while good spending remains robust, the emergence of bottlenecks in some supply chains, and the very low inflation readings recorded last spring dropping out of the calculation of 12-month inflation. For reasons I'll detail in a moment, I expect that a significant portion of that recent boost to inflation will be transitory, as many do, and that it will not interfere with the rapid growth driving progress toward the Fed's maximum employment goal. We've come a long way since last spring, but reopenings over the past year have been uneven, both within the U.S. and around the globe, so it will still be some time before we repair all the economic damage. Supply bottlenecks will likely hinder the quick expansion of production in some industries in the next few months, raise costs in some cases significantly. The progress in reopening has been slower in countries that are among our largest trading partners, and that will weigh on U.S. growth by reducing demand for U.S. exports, but even with those impediments, I believe that a very strong recovery will keep rolling forward, and let me walk through the evidence for that optimistic view. First, I see increasing recognition by the private and public sectors that reopening can be done safely. The Centers for Disease Control and Prevention has dropped most social distancing recommendations for vaccinated people. Although local COVID-19 restrictions on schooling and economic activity continue in some areas, most schools are teaching in person at least part-time, and more than half of states have dropped all capacity constraints on restaurants, bars, and retail establishments. More than a dozen more states are planning to do so over the coming weeks. With these reopenings, consumer spending, which is two-thirds of gross domestic product, will remain robust, supported by personal income that has, thanks to significant fiscal report, now surpassed the trend it was on before the COVID event. April's retail sales were flat, but that came after enormous gains in March that were boosted by the latest round of stimulus checks. Looking beyond the headline numbers, sales were up 13% in March and 3% in April at restaurants and bars, one of the sector's hardest hit by the COVID-19 event. April and March were the third and fourth best months for vehicle sales to consumers in U.S. history, if you filter out sales to car rental companies, which is a sector that's just beginning to recover. So you might expect this bounce will subside after consumption regains the strong trend that it was on pre-COVID-19, but one reason I think it will continue is the still high rate at which people have been adding to their savings. Even as personal consumption expenditures rose at a huge 10% annual rate in the first quarter of 2021, the savings rate averaged 21% over those three months. Again, a lot of that reflected the most recent round of stimulus payments, but as employment grows and people return to normal life and work, the accumulated stock of savings will support spending for many months to come. Business investment took a big hit in the first half of 2020, obviously, but it's come back strongly. It's now running above pre-COVID levels. Current indicators of business spending are pointing to continued elevated levels of investment in the months ahead. Supply bottlenecks have depleted inventories for many goods. Rebuilding those inventories will be an important supplement for business spending and factory output. I see two potential headwinds for the economy: the uneven global recovery and the supply bottlenecks that I mentioned before. Strong U.S. demand is boosting imports, but weaker demand outside the United States, where recovery is slower, is restraining exports, and that problem may not resolve for some time. Supply bottlenecks are more prevalent now, especially in the auto and housing industries, with shortage of inputs leading to slower production, and that reduces employment growth. Although I expect employment to rise significantly in coming months, the picture is more mixed for the labor market than it is for spending. The unemployment rate remains at 6.1 percent, compared with three and a half percent pre-COVID, there are 8 million fewer jobs. Despite recent gains amid reopenings, employment in the travel, leisure, and food services sectors remains well below pre-COVID levels. My optimism here reflects the apparent recovery in overall labor demand. By many metrics, job openings are above 2019 levels, including for workers without a college degree, a group especially affected last year. In the job openings and labor turnover survey data for March, private sector job openings as a percentage of total employment increased to 5.6 percent, which is above the previous record for that series that was set in November of 2018. Job growth of 266,000 in April was a disappointing slowdown from recent months, but there was good news that was underneath the headlines. For those who were working, average hours increased. The number of people working part-time because they couldn't find full-time jobs decreased significantly, and wage growth was very strong. That underlying strength in hours and wages lends support to widespread reports that worker shortages are impeding hiring. Labor force participation remains about three and a half million people lower than before COVID-19. Among the many factors driving this shortage, as indicated in the Fed's own report on the economic well-being of U.S. households in 2020, is parents who need to care for their children because of remote school and aftercare. We've also seen a wave of retirements by older workers in the past year. And although the evidence is mixed because hard to parse out, we've received plenty of reports about the influence of generous unemployment benefits and large cash payments on the willingness of workers to return to work. But those benefits are slated to expire over the summer, and I hope that a fuller reopening of schools in the fall will ease the pressure on parents. The spike in retirements may well moderate in a stronger economy, as we saw in the year or two before the pandemic. So while labor shortages could weigh on job creation in coming months, I don't yet perceive this development as significantly slowing the U.S. economy beyond the next few months. Now let's turn to the other half of the Federal Reserve's economic goals: inflation. As I mentioned last week during congressional testimony, I agree with the widespread view among my colleagues on the Federal Open Market Committee and most private forecasters that the recent rise in inflation to well above 2% is driven by temporary factors. I expect inflation to begin subsiding at some point over the next several months to be running close to 2% again at some point during 2022. Market implied inflation expectation have risen only to the levels that prevailed in the early 2010s. And if you recall, after some of those readings, inflation never ran consistently above 2%. Most survey measures are sending similar signals. So I consider these recent increases in inflation expectations actually a welcome development, given the possibility that they may have been anchored somewhat too low before. It reverses the large declines that we saw last spring, perhaps edging up in response to the message in the FOMC's new policy framework. That said, my optimistic outlook for growth and employment places me among those who do see the risk to inflation over the medium term as weighted to the upside relative to this baseline forecast. And broadly speaking, there are three reasons for this. First, wage pressures. So a moment ago, I spoke glowingly of the upturn in wages in April, but it may be a sign that the torrid growth of the economy and labor supply shortages have begun pushing up wages faster than occurred with the moderate economic growth over much of the past decade. Wages are a large component of business costs that could pass through to prices more readily than increases in the cost of other inputs. It seems like a paradox that there could be labor supply problems and wage pressures at 6% unemployment, but it is also a fact. Some of this surprising outcome reflects temporarily lower labor force participation coming out of the enormous economic shock last spring. But some of the Fed's contacts have said that shortages of skilled laborers, particularly in manufacturing, transportation, and construction predated COVID and are likely to persist. Another factor that I referred to earlier, fiscal policy carries potential costs as well as the obvious benefits. Even as the huge amount of stimulus money in people's pockets has been boosting income and spending in eye-popping ways, much of that stimulus was still saved. A larger than expected or faster release of those accumulated savings while the economy is already growing rapidly could result in output exceeding potential output by more than it has in decades. It's reasonable to ask if the strength of spending stemming from this unprecedented fiscal stimulus will put significant upward pressure on inflation as households and businesses emerge further from the COVID event. But at least to date, the latest round of stimulus seems to be supporting spending and growth without causing an inordinate rise in interest rates or in inflation expectations. And that outcome aligns with the advice of those in the economics profession who produced research in recent years that leaves them much more comfortable with high deficits in debt, at least in countries with low interest rates, than they used to be. In 2006, when I was serving as Under Secretary of the Treasury, we were subject to harsh criticism for running a deficit of not quite $250 billion with total debt held by the public at 35% of GDP. By contrast, in 2021, the deficit is currently projected to be $3.4 trillion, and total debt held by the public at the end of fiscal year 2020 was 100% of GDP and rising. Further fiscal policy actions are, of course, the purview of Congress and the administration. But history tells us that once the dreadnought of government spending gathers speed, it's difficult to slow and turn around. Surely the deficits being run to offset the COVID-related shocks have made it even more critical to address the sustainability of government debt in the years ahead. And finally, recent monthly readings on import prices, producer prices, and consumer prices have all come in above consensus expectations. These upside surprises cannot be attributed to base effects. It's true that many of the factors driving the April consumer price index report and other inflation surprises continue to be supply bottlenecks. It's reasonable to conclude that these will ease over time. But clearing some of those supply disruptions will require additional investment and the time to expand production capacity. If these shortages persist into 2022, people may adjust their expectations higher for future inflation, and that could make above target inflation more persistent than we currently expect. I don't want to overstate my concern. I'm not worried about a return to the 1970s. We designed our new monetary policy framework for the very different world we live in now, which involves an equilibrium for the economy with slow workforce growth, lower potential growth, lower underlying inflation, and therefore lower interest rates. One of those differences is that the kinds of wage price spirals that characterized inflation dynamics in the 1970s have not been present for a long time. It's quite possible that this situation now prevails because inflation is never high enough for long enough to enter decision making in a material way. So what are the implications for monetary policy? I'm fully committed to the FOMC's new monetary policy framework and the two pieces of related guidance that we put in place for asset purchases and the federal funds rate to implement that framework. The conditions required to change the pace of asset purchases, those required to increase the federal funds rate, are sequential. The latter increases in the federal funds rate requires improvement in the economy that clears a much higher bar than for the former. So let me address each of them in turn. The guidance on asset purchases introduced in December commits us to increasing our holdings of securities at least at the current pace until substantial further progress has been made toward the committee's maximum employment and price stability goals. My personal view is that the rise in inflation, even after discounting the temporary factors and inflation expectations since December, were proof sufficient to satisfy the standard for inflation in the guidance around asset purchases sometime later this year. But improvement in the labor market has been slower than I would have liked. For instance, the unemployment rate has decreased only six, uh, six tenths of a percentage point to 6.1%. And the labor force participation rate is still nearly the same as it was at the time of the December meeting. So we need to remain patient in the face of what seemed to be transitory shocks to prices and wages so long as inflation expectations continue to fluctuate around levels that are consistent with our longer-run inflation goal. For me, it's a question of risk management. The best analysis we currently have is that the rise in inflation to well above our target will be temporary. But those of us on the FOMC are economists and lawyers, not profits, seers, and revelators. We could be wrong. And what happens then? Well, part of the calculus and balancing the risks of either overshooting or undershooting our two percent goal is that the Fed has the tools to address inflation that runs too high, while it's more difficult to raise inflation that falls below target. If we're wrong, we know how to bring inflation down. But if our assessment is correct that inflation is temporary, it would be unwise for us to take actions that might slow the recovery prematurely while trying to stay ahead of inflation when our best estimate is that we're not far behind. If my expectations about economic growth, employment, and inflation over the coming months are borne out, however, especially if they come in stronger than I expect. Then as we noted in the minutes of the last FOMC meeting, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings. In particular, we may need additional public communication about the conditions that constitute substantial further progress since December toward our broad and inclusive definition of maximum employment. The standard presents inherent communications challenges because it can't be summarized by a single labor market indicator such as the unemployment rate thresholds used in the committee's interest rate forward guidance between late 2012 and late 2013. In contrast, the time for discussing a change in the federal funds rate remains in the future. The guidance for the federal funds rate commits to maintain the current rate until labor market conditions are consistent with our goal of maximum employment, and inflation not only has reached 2% but also is on track to moderately exceed 2% for some time. In the FOMC's most recent summary of economic projections, no participants, even those with optimistic growth forecasts such as I've outlined today, thought it appropriate that liftoff occur before 2022. Perhaps even more important than the timing of liftoff will be the expected trajectory of rate increases afterward, and you can see that even among participants with an earlier expected liftoff those paths are quite shallow. So I expect that monetary policy will remain highly accommodated for some time. Let me conclude with a few thoughts on financial stability. As the Fed's most recent financial stability report notes, the bright outlook, ample supply of credit, and accommodative fiscal and monetary policy have pushed some asset valuations to very high levels that could be subject to sharp reversals if expectations aren't met. Likewise, business debt is high relative to past experience, which is a good reason to carefully weigh the risks. But the strong economy is reassuring here. Earnings are growing, many businesses have ample stockpiles of cash, expected bond defaults are below their long-run medians, and the pace of credit rating downgrades has slowed to a trickle. When I think about financial stability, I think most directly about resilience to shocks, and it would be hard to imagine a better test of that resilience than what occurred in the spring of 2020. Banks met extraordinary demands for credit last spring from non-financial businesses and households, while simultaneously providing forbearance on millions of existing loans and building substantial loan loss reserves, all without significant strains to their overall health. The largest banks at the core of the financial system are better capitalized than they've been in decades, better capitalized actually than they were at the outset of the COVID event. These institutions are sitting on large amounts of highly liquid assets while relying on relatively low levels of short-term funding. The banking sector is strong. I also see a resilient household sector. Household credit is primarily owed by borrowers with prime credit scores. Rising home prices have most homeowners flush with equity, and as I noted earlier, households are sitting on a large stock of savings. It's true that there are structural vulnerabilities in the non-bank financial sector, particularly money funds and hedge funds, and these are being scrutinized by U.S. and international authorities, including especially the Financial Stability Board under my chairmanship. But I believe these risks are manageable, and I come down on the side of the research that concludes these and other concerns are best addressed by targeted financial regulation and supervision, rather than the blunt tool of monetary policy. At a crucial moment in our recovery from the COVID-19 event, the utility of using monetary policy to try to address financial stability concerns would be greatly outweighed by the costs to employment and growth. Before ending, I'd like to re-emphasize that I'm quite optimistic about the path of the economy. While prices will run above our 2% target this year, I believe most of this increase will be transitory. After an exceedingly difficult year, we're poised to enter a robust and durable expansion. Thanks again for the invitation to be here today, and I'm looking forward to our discussion. [00:22:16] Speaker 3: Thank you very much, Governor Quarles. I appreciate that very comprehensive account. I'm joined now by a few people who have a great deal of expertise in the areas about which the Vice Chairman spoke. Tim Dewey, who's at the University of Oregon and with SGH Macro, and my colleagues at Brookings, Louise Shainer, and Don Cohn, of course, who was a previous Vice Chair of the Federal Reserve Board. What we're going to do is I'm going to ask each of them to comment on the Vice Chairman's speech or pose a question, and then we'll try and have a conversation. So, Tim, I'd like to start with you. [00:22:56] Speaker 4: Tim Dewey: Well, thank you very much, David, and thank you very much, Governor Quarles, for this opportunity. It's a very interesting speech, a lot of great material here to work with. I'll kind of start this off with a question. You sort of said maybe it's going to be time to start talking about what constitutes substantial progress to the labor market. I was wondering if you had any thoughts about what that substantial progress might be yourself. [00:23:25] Speaker 2: Tim Dewey: Well, I think I said it would soon be time to start talking about what would constitute substantial progress. So, that would suggest it would be premature for me to be putting down some markers yet. But, you know, obviously, there's more to go, and we're still significantly short on any of the measures you want to look at, whether you're looking at the unemployment rate, whether you're looking at labor force participation, whether you're looking at the underemployed, you know, any of those measures. We really, we're far enough away from where everyone would lay down a marker that I think financial theory says never exercise an option until it's about to expire, and we have plenty of time before this option is about to expire. So, if I can ask a related [00:24:18] Speaker 4: or follow-up question, so how about there be any sort of idea of a trade-off between higher than expected inflation now and meeting that employment objective? That seems like maybe a more relevant concern given the current environment where we're having these elevated inflation pressures. Is there sort of sense that those two things could be, that they're not equally weighted or could not be equally [00:24:43] Speaker 2: weighted? I, in my, at least in my own thinking, I, so I won't, you know, I certainly won't try to speak for the committee again because we're, you know, there are a variety of views on the committee and we're, and we haven't, you know, and we haven't begun sort of quantifying where, where we would put down these thresholds, but I, I, I do think it's, I think at least my base approach of thinking about the current conjuncture is that the trade-off is, is not that it's a trade-off, but rather that our experience over the course of the last decade, as well as our expectation about what's driving current inflation, uh, is that we can, uh, in fact, uh, be patient, uh, and allow, uh, unemployment to fall, allow employment to rise, uh, to fairly high levels and that patients will not, uh, engender a significant cost in inflation. So I would put it less of, we've, we've rejiggered our expect, our, where we balanced that trade-off. If I, if I'm understanding your, uh, uh, question correctly, or at least I don't view it as having changed where I would balance the trade-off and more that, you know, the, uh, experience of the performance of the economy over the decade preceding COVID, as well as what we would expect to see in the form of, you know, substantially higher temporary inflation coming out of a shutdown like this, uh, because it takes, you know, varying times for different parts of the production apparatus to re-gear up. Um, the, you know, all of that would say, you know, we wouldn't expect those macroeconomic relationships to have changed substantially from pre-COVID. And that's a world in which we can be much more patient, uh, before taking action to address inflation. I don't, if that [00:26:40] Speaker 3: gets to your, to your question. Let me, let me follow up if I might, Governor Quarles. So I'm having a little trouble understanding how you put the pieces together. You say that you think that the inflation conditions are sufficient to satisfy the standard for inflation. And you say that you think the risks of inflation are the upside. So doesn't that suggest that this patience, uh, runs a substantial risk of, uh, having patience, excuse me, for the labor market to, uh, evolve, runs a risk of getting more inflation than you would like? No, I think, uh, I mean, there, I was trying to draw the [00:27:20] Speaker 2: difference in the sort of, uh, sequencing thresholds between, uh, uh, you know, changes in our asset purchasing, uh, practice as, and then changes in the, uh, in, in our interest rate, uh, policy. So, uh, you know, I, I do think that the one, you know, and as we've indicated, uh, the, the one will happen before the other should happen before the other, uh, and that of the thresholds we've set down, I think that, you know, what we're seeing currently is, uh, you know, a sufficient inflation to satisfy the inflation condition for the asset purchase, uh, guidance that we put down. Um, I don't think that, uh, and, and I certainly, I, I don't think that indicates, you know, that I would expect that inflation will be, uh, sort of durably, uh, and worryingly above our 2% threshold, simply that it has reached, uh, a level that satisfies that condition for that step of, of, uh, the evolution of our policy, if you will, which is just the first step. I, I think we've got, uh, significantly more to go before we've moved to the second step with respect to interest rates. Louise. Yeah. So a whole comment that's [00:28:34] Speaker 5: followed by a question. So, so one, uh, question that I have, um, is sort of how do we think about the long run effects of it on the economy, which I'll ask you in a second. But if we sort of think that COVID is this transitory phenomenon, huge and unprecedented, but sort of transitory, and we're going to get back to the world we were in after COVID, then I'm going, my comment is more going to be about how to think about the long run fiscal, um, deficit and outlook and how to think about that. So if we're going back to a world where we're worried about secular stagnation, we're going back to a world where I would argue our big problems are mobility and inequality, then isn't important to think about, uh, I think that kind of removing to this point where we think about, you know what, a lot of what the federal government does is actually investment. It's infrastructure, it's climate change, and there's a lot of evidence of sort of giving money to poor families as very substantial long run growth effects. And so I just sort of, I'm worried that we're going to use this huge run up in debt to, um, fight COVID to then say that we shouldn't be making these investments, these public investments that I think we are moving towards this recognition that we should be making. So that's my comment. But my question sort of is more broad, goes to that question, which is, is the right, do you think about COVID as this transitory phenomenon? Or do we think it will have long lasting implications? It could be on sort of some of these labor market issues that you point to. One of the things that wasn't on your list could be preferences that people have gotten used to being home and being home with their kids and they sort of change their preferences or productivity effects from what we've learned about using Zoom. So how does the Fed think about, so the effects on potential of, of COVID, um, and do they think they're important? [00:30:21] Speaker 2: Um, so, you know, how does the Fed think they're, they're, you know, there's a lot of research that's going on, uh, on these issues, you know, around the Federal Reserve and in academia and, you know, throughout the financial system. And, uh, I think it's too early for, I mean, people can have views and, and people need to form views, but I think it's too early to say that there's a view, certainly not a view at the Fed. I do think that, and not particularly, uh, surprisingly, I think there will be some sectors of the economy where there are lasting impacts of COVID office space in large cities. I think, you know, everyone's talked about that. I do think that even in these, uh, durable, and for some of the reasons that you side, people working remotely, people not working there anymore, uh, you know, people wanting to work elsewhere for a variety of reasons and realizing, oh, one can. Um, the, I do think that even those effects are likely to be, uh, less pronounced, uh, than some are expecting. And that for the most part, you know, it, it has been a difficult year, but it has only been a year, uh, and, uh, think of the many dramatic things that have happened in all of our lifetimes, uh, that seemed very dramatic at the time. And you think back about it and say, oh, oh yeah, that happened. I mean, I don't think we'll, you know, all of us will remember that COVID happened, but I, I don't think that, I do believe that it's going to be a transitory effect as far as durable, measurable, significant material, uh, changes in the, uh, in the overall economy. [00:32:03] Speaker 6: Thank you, David. And, and thank you, Vice Chair Quarles. Uh, great to see you again. So I think, uh, one comment picking up on, and perhaps this is a topic we can explore some in our conversation, picking up on Louise's point. It's this broad and inclusive definition of full employment and, um, how to define it. And if there are changes, sectoral shifts in the economy and some of the things like retirement or staying at home with the kids are more permanent. I think it's going to be harder for the federal reserve to figure out when you do get to full employment. And I think it's important to make sure that whatever, however you define full employment, broad and inclusive, it's consistent with stable inflation over time. And that's, that's going to be a difficult, so any comments you have on that would be interesting. But I also want to pick up on the last part of your speech, the financial stability part. And I agreed with that. I think the banks stepped up and did, made a lot of loans, um, and met the moment with the assistance of the federal government through PPP and, and, and other backstops. But the non-bank, uh, markets failed us at crucial time and required, as, uh, Glenn was, uh, referencing massive federal reserve intervention, uh, in non-bank in sort of in, in, in market-based finance. So I wondered you and you said, and I agree with that, that the way to approach that is through targeted, um, actions that are targeting the financial instability or potential financial instability, not through monetary policy. But I wondered whether you had any thoughts on what those targeted actions might be so that, um, the next time around the, hopefully not COVID, but something much less severe, the feds and the fed doesn't need to intervene so much in financial markets, the, the markets are more stable by themselves. [00:34:18] Speaker 2: So, uh, I do, I mean, obviously, particularly at where we're beginning the process, uh, domestically, uh, of thinking through what some of the, uh, implications for non-bank financial regulation are, uh, we're, uh, we're, we're, we're a little bit ahead of that process. I think in the international, uh, discussions at the FSB, um, uh, just inevitably there was an administration change in the U S and people have to find out where the men's room is, and then they get to pick up the issues and, and, uh, continue to run with them. And so, uh, uh, the domestic process will catch up pretty quickly, I think. Uh, uh, uh, but at the FSB we've identified both non-bank finance generally, uh, the fault lines that were revealed in, uh, in March and April of 2020 as, uh, you know, a high priority to address. To some extent you could say it's unfinished business from the financial crisis. Um, uh, uh, uh, but you know, uh, there, there are additional, uh, you know, there are additional things that we learned from the COVID event itself. I think some of the measures that were put in place that were intended to address financial stability, instability, and non-bank finance after the financial crisis actually didn't work that well. Some of them actually increased financial, uh, instability. Uh, I'm thinking particularly some of the liquidity regulation, the particular structure of liquidity regulation for money market funds, uh, uh, actually turned out to, you know, they, it ensured that they had liquid assets, but, uh, because of the consequences that would attach to falling close to that liquid assets threshold, it simply set a, a actually much fat, much more easily reached and faster reached, uh, threshold for potential, uh, contagion, uh, than existed before. So I think we have to address those, uh, the specific areas we're looking at at the FSB, uh, you know, the potential for pro-cyclicality of margining, uh, practices, money market funds, as I mentioned, other open-ended funds, uh, in general, the performance of other open-ended funds, uh, uh, uh, during the crisis, um, uh, you know, all of that, uh, I think the, the one thing I would, I would add to that is I, I think there were fault lines that reveal that were revealed in the structure of regulation, uh, across all of those areas throughout non-bank finance. Uh, I don't think we should try to structure a response or a regulatory solution, uh, to try to make extraordinary support faced with something like March of 2020 impossible or unnecessary, right? I mean, we, we shouldn't solve for March of 2020, uh, because there's nothing you can, if something like that happens, there's nothing you can do. Uh, and if you create a system that actually can shrug that off, you have, you, you don't have an efficient system, you know, for the other, uh, hundred years of the century. Um, uh, when, when we were building, uh, when we were building our house, my wife kept coming up with all sorts of, well, we need to do this because this, you know, this could happen, you know, we'll want to do this someday. It's like, well, that may happen, you know, two days of the remaining 40 years of our lives. And the rest of the time, the house will be awful because we addressed this problem. So, uh, so I don't think we should fall prey to, uh, uh, to that, but I do think that there, you know, that there are significant, uh, things that we can do to improve the resilience of non-bank finance. The other thing I'd say about non-bank finance is I don't think that we should, uh, I think it would be a mistake to conclude that the measures that we took to improve resiliency in the banking system are the same sorts of measures that will improve resiliency in the non-bank system. It's a, it's a much different system. As you know, it's, it's significantly more fragmented. You can't, the banking system, you can say there are a core of very large systemically important and connected, uh, institutions at the core of it. Uh, and then, you know, firms that approach that core, uh, and if you take measures to ensure the particular, uh, resilience of those firms, you've done a great deal, uh, to prevent, uh, the propagation of instability throughout the system and in times of stress, the non-bank financial system is structured much differently. You don't have those leviathans at the center of it with their interconnectedness and their runnability, um, much more fragmented, uh, much more important to look at activities rather than entities, I think, uh, and to structure your regulation that way. But that also doesn't mean that, oh, well, there's nothing we can do. I think that there are things that we can do and we're very [00:39:11] Speaker 4: active in doing it. Thank you. Yeah. So I want to, uh, come back to a theme of, of your speech vice chair. Um, um, so one, one of your, one of the premises is, is that, you know, we're basically taking a lesson from the last 10 years when thinking about what's going to happen, you know, after this pandemic. Um, but it strikes me that the next 10 years or that the current economy is actually very different than we had in the last 10 years. Um, and, and to name a few things is that after, after the pandemic, um, or excuse me, after the great financial crisis, the financial system was impaired. Um, the federal reserve did a great job at saving the financial system this time. So that's not a problem. As you mentioned, household balance sheets are much stronger. Uh, the housing market is much stronger. Uh, job openings, as you mentioned, have really leaped back up, uh, past pre-pandemic highs. Um, uh, and I would say too, that the demographic situation here is very different. Um, the last, last 10 years, we were really in the demographic hole of the Gen Xers. Uh, and now we're kind of climbing the demographic hill of the, um, uh, millennials entering into their home buying and peak earning years. Uh, and then as Don said, uh, there could be really, there, there could be longer lasting impacts in the labor market than we're, we're, we're, we're understanding at this point, the labor supply. Right? So it seems to me that we have, in fact, a very different setup going forward than we did over the last 10 years. And so my, my question is really, what should we be looking for as signs that yet that's going to really call for a different monetary policy than we've planned? Or what is the, when are we going to know whether this future economy is really as much like the past economy [00:41:02] Speaker 2: as, as we we've thought? Um, you know, well, I think that, uh, you know, the, you know, as we, as we pursue the current monetary policy framework, you know, obviously it is calibrated, uh, for the economy that we have seen obtained for a long time. And really, uh, longer even than a decade. If it had just been a decade, I might've been of the view that, well, decades come and decades go. Uh, uh, but I'm, you know, but, but it has been a long, uh, period of time. Uh, you know, the points that you're raising are perfectly plausible. And I attach plausibility to the, uh, you know, to the Charles Goodhart thesis as well, that in addition to our own domestic demography, uh, you've got, uh, you know, a change in the international demographic, uh, downward pressure on, uh, wages in the United States. Um, and, you know, and so it is, you know, it's certainly possible, uh, that, you know, that transition was, you know, COVID hit just at the inflection point in that transition, uh, in order to mask what could be a significantly different, uh, uh, kind of response of the economy to our monetary policy framework. Um, that said, you know, inflation expectations have been so low for so long inflation itself, so low for so long, uh, you know, we will see, you know, if we, you know, if we pursue, uh, the, the policy path that's indicated by this framework and we see inflation quite a bit above 2%, uh, for, you know, for a longer period of time and not reacting as quickly as we would, uh, expect, uh, under this framework, you know, then we'll need to begin to say, oh, okay, well, you know, maybe the world has changed. There, you know, there, there are things that could obtain, I'm particularly, at least I myself, I, again, I'm not speaking for the committee, but I, I, I, I press this in our discussions, these demographic points that you're raising, uh, you know, could mean that the world will react differently, but we have a lot of headroom. We, we can respond. We'll see that that's happening. If this were happening when we were at, you know, if we changed our monetary policy framework at say 6%, uh, inflation, that would be a different sort of thing. Uh, but we have room to, you know, we have some elbow room to be wrong here, uh, as long as we're conscious of the fact that we could be and looking at, uh, closely at the data as they come in to see if it's consistent with what we were expecting them to be. I want to channel some of [00:43:41] Speaker 3: the questions we got from people in the audience of vice chair. One is, look, one of the most interest rate sense of sectors of the economy is housing. Housing prices are going up at a pretty good clip. Why should the fed continue to buy mortgage backed securities in an environment like this? What's the [00:43:58] Speaker 2: purpose? Um, well, uh, you know, I think that it's a perfectly fair question, uh, is, you know, is that practice, you know, right for reconsideration? Uh, and, and we'll certainly be, you know, we'll certainly be looking at as we consider our asset purchase policy, uh, policy generally. Uh, we put the policy in place, uh, you know, during the, uh, you know, during the crisis last year, uh, when it was, uh, sort of pretty obviously useful. Um, the fed is a leviathan, moves cautiously, uh, but surely, uh, in, uh, in changing direction. Uh, and so, you know, that we'll certainly be considering that as we [00:44:45] Speaker 3: deliberate over asset purchase policy. Okay. And one other question, completely different, uh, topic, um, in your testimony at Congress this week, you were asked about the regulation of cryptocurrencies. And you said that the fed, the control of the currency and the FDIC are engaged in what you called a sprint, uh, so much for the leviathan, like trying to capture the leviathan sprinting, a sprint to pull together views on, uh, a common regulatory framework, capital treatment, operational treatment, and so on. I wonder if you expand a little bit about what are you talking about [00:45:20] Speaker 2: here? So first I should give, uh, credit where credit is due, which is, uh, this is something that the new acting controller, Mike Sue, uh, formerly, uh, of the fed, uh, you know, has, uh, uh, placed on the table, but enthusiastically adopted by the FDIC and the fed, of course. Second thing I should say, just as framing it is that, you know, as you noted, sprint needs to be interpreted in the context of the entities that are doing the sprinting. Uh, so I wouldn't set our chronological expectations, uh, sort of at Olympic levels, uh, for sprint speed. Uh, but we do have a, um, uh, you know, there's, there's, you know, there are increasing activity of the banks, uh, involved, uh, with crypto, uh, that didn't exist really even a few years ago. You had plenty of crypto activity a few years ago. Um, there's, uh, uh, you know, evolutions in crypto that make it, uh, sort of less of, uh, uh, sort of, uh, yeah, again, a few years ago, my view was, you know, crypto assets as we called them, no longer cryptocurrencies were going to be a perpetual oddity, uh, and speculation, but, you know, the development of, uh, sort of, you know, a variety of stable coins, uh, versus, uh, you know, purely crypto, uh, assets makes that, you know, uh, makes them potentially of much broader use in the financial sector. Um, so as we look at all of that, there's been enough activity and enough, uh, sort of isolated one-off responses to it in each of our agencies, uh, that we need to get together and say, okay, well, what, uh, financial institutions are now holding crypto assets? What will the capital, uh, charge, uh, for those assets be? And it should be uniform among the three agencies. Uh, what's our supervisory guidance for, uh, you know, sort of an operationally safe way to handle some of these partnerships, uh, that are being developed, uh, with crypto firms, uh, with custody, uh, crypto assets for customers as there's increasing interest in that. Um, uh, and, you know, I, I think there is both enough that's happened, uh, that we can, in a relatively short space of time, come up with some joint views that will be useful, uh, and informed, um, and, uh, and it's become a broad enough, uh, phenomenon that that's worth addressing. Thank you. Louise. [00:47:55] Speaker 7: Uh, yeah. I want to go back to the question about inflation. Um, and obviously it's, uh, one that where there's a lot of controversy and a lot of disagreement. And, and so you talked about the risk to inflation and you talked about, um, sort of whether or not the data were to come in differently than you expected. And so one question I have is on inflation expectations. What is it that sort of you're expecting to go along with this transitory period of high prices? What would make you worried? And do you focus more on sort of the market expectations and the tips rates, or do you really care about how household, what do you think is more important for the dynamics of inflation? Is it the household expectations, the business expectations, or the market? So, um, [00:48:42] Speaker 2: uh, the reason I, we, we just had a, uh, a longish discussion about that is I've, uh, pressed on exactly the same questions in our internal, uh, uh, uh, discussions. Um, I, uh, so first, uh, you know, what would be worrisome, uh, with respect to inflation expectations? Um, I, you know, I, I, I, I think it would be first, you know, a number of the survey, uh, uh, expectation, uh, surveys of inflation expectations are volatile. So I'm not going to be worried about, you know, particularly high, uh, uh, result one way or the other, um, you know, out of Michigan, for example, or, um, uh, and even across, you know, a broad range of surveys, uh, I think one would expect as you start seeing high prices because of the temporary factors we're seeing here, that that will result in the surveys of inflation expectations to kind of go up sharply and then probably go back down. That would not surprise me, if that happens. So I wouldn't be particularly worried if I saw that happening over a quarter or two. Uh, if at this time next year, you were still seeing, uh, uh, surveys of inflation expectations, you know, substantially over two and a half, then I might be saying, okay, well, the world seems to be evolved. That, that is not what I expected. The world seems to be evolving in a different way. And that's long enough that maybe that starts to durably, uh, affect expectations. Um, I, from my own point of view, I think that, um, I mean, we look at both, obviously I put a slightly higher weight on, uh, survey, uh, surveys of inflation expectations, uh, than the market-based measures. Uh, you know, I think that ultimately what drives, uh, ultimately what drives inflation, uh, is people's expectations about, you know, what they're going to need in the way of wages, which then feeds into prices, which then feeds into wages. And, uh, and if that cycle starts, that's really what drives, uh, kind of an inflation spiral that gets difficult for the Fed to control. Uh, and I think those are imperfectly measured, obviously, but better measured by surveys, rather than the market-based measures. John? [00:51:10] Speaker 6: So, uh, I'm picking up on that theme, uh, with another, another aspect, uh, Mr. Vice Chairman, and, uh, I was thinking about the inflation expectations thing. Sometimes I wonder whether inflation expectations isn't what we use to hide our ignorance of the whole inflation process. And I think Dan Tarullo spoke eloquently about that at Brookings events some time ago. Uh, but the other aspect is wages. So I think I, uh, maybe this is a comment rather than a question. I think the other thing to look at would be, if, as we're expecting labor supply to pick up, to meet this demand, that should take some of the pressure off wage increases. And I think another risk sign, a sign that, as you pointed out, I, I thought it was very constructive that you noted the upside risk to inflation. And I think maybe one aspect of that would be, uh, continued increases in wages that businesses rates at higher rates of increase in wages that businesses would then have to eventually build into, build into prices. That would be an important thing to watch. Uh, so my question, I want to return to my financial stability theme for a second. One of the things you didn't mention was the U S treasury market, and that's a U S problem. So perhaps closer to things that you can control, or at least, uh, can control and cooperation with only a couple other agencies, rather than global, uh, dozens of agencies. Uh, so what, what are your thoughts on what happened in March, 2020, when treasury prices went the wrong direction, how to, um, how to produce better market liquidity, um, and then tying that in one of the things tying that to would be the, uh, leverage ratio. So, uh, um, I was actually surprised. I wonder whether you were that the Arkansas community bankers, uh, were responding to, uh, or were concerned about the constraints from the leverage ratio constraining their ability to buy treasury, hold deposits at the fed. So overall, where, where do you think your, you and your colleagues should be focused on the treasury market? And then on the leverage ratio, you guys said in March that we would have some proposals soon. I know Leviathans having been part of the Leviathan for a long time, I know it moves very, very slowly. Um, but give us, do you have any clues about when [00:53:52] Speaker 2: and what might be coming on that? Sure. So, uh, so a few things. One, um, uh, you know, so the, the treasury market, um, you know, what I, I, I guess I would repeat, although in a more condensed fashion, what I'd said before that as we think about, uh, sort of ways to improve treasury market functioning in light of what we learned in March of 2020, uh, I don't think we should try to solve for March of 2020. We should be informed by, you know, by, uh, sort of frictions and weaknesses that we saw. Uh, but, you know, there were a few days in March of 2020 where there were simply only sellers and no buyers. Uh, and if you create a market that will somehow clear when there are only sellers and no buyers, uh, you're going to have a very inefficient process for the, for the rest of the time. So, um, uh, you know, in a world like that, there's nothing to be done, but for the, uh, fed to step in and provide the, uh, you know, and purchase as we did. Um, I do think, uh, though, that then, as you look at how the treasury market functioned, uh, in, in the face of that stress, even if you acknowledge that you're not going to be able to completely, uh, solve for that, but there would have, you know, there were clearly ways, uh, that, uh, there were clearly some, uh, pressures on dealers, uh, as a result of our regulatory framework, uh, that didn't exist before. I don't know whether, uh, I mean, at the end of the day, the change that we, the temporary change we made to the supplemental leverage ratio, which was designed to help treasury market functioning principally, um, had that much of an effect on treasury market functioning. I don't, um, uh, again, I think what basically, uh, solved the issue there was our stepping in to act as a purchaser. Um, but it's also true that we calculated, uh, these leverage ratios and for our largest firms, there are a series of leverage ratios. There's the, there's the tier one leverage ratio. There's a supplemental leverage ratio. There's the enhanced supplemental leverage ratio. There's a whole, uh, wedding cake of leverage ratios. And we calculated them in a world where in 2014, when we calculated the supplemental leverage ratio, the staff at that time projected that at this, on this day in 2021, there would be $25 billion of reserves in the system. Uh, we're now, uh, projecting, you know, by the end of the year, $5 trillion, uh, in reserves. Uh, so we calculated a leverage ratio that would, you know, sort of accommodate, uh, a banking system that would attract a capital charge on $25 billion of cash, not on $5 trillion of cash. Uh, so, uh, you know, so I think it's fair to say that, you know, it's, it's, it's worth thinking about recalibrating that somehow. Now, how could you recalibrate it? And that that would improve, you know, in general, the, uh, the efficiency of the financial system in a world where there was going to be a much greater number of treasuries, uh, as a consequence of much greater, uh, continuing, well, and a much greater continuing issuance of treasuries, uh, and as a consequence, a much greater amount of reserves in the banking system. So I, you know, you could either turn down the numerator, uh, and say, we turned the, we set the numerator where we did expecting a much lower level of reserves. You could exclude reserves, uh, from the leverage ratio. Um, uh, the, the, the difficulty of turning down the numerator is that if the level of reserves continues to grow at some point that in itself, uh, will be a constraint. So if you exclude reserves, you've solved the problem forever. Uh, but you solve the problem at a potential significant decrease in the sort of aggregate level of capital in the system, unless you do something somewhere else with respect to risk-based capital to try to keep the total cushion roughly the same. Uh, you could do that within the structure of the leverage ratio itself. So ratchet up the numerator of the leverage ratio as you exclude, uh, reserves. And as the amount of reserves continue to grow, ratchet up the numerator even more. I think that would lead to sort of a perverse disincentive, uh, to provide credit, uh, to the private sector, uh, if you will, because you're increasing the capital cost of, of, uh, sort of non-cash, particularly if you added to that, because another, but another way of doing it would be to the reserves and treasuries to exclude both reserves and treasuries in order to allow the banking system to hold the much larger amount of these safe assets, uh, that we currently have than we expected when the leverage ratios were calibrated. Uh, but you could end up, you know, having calibrated the system now to provide a great incentive for the financial sector to prefer financing the government to financing the private sector, uh, which I don't think that we'd want to do. So there are pros and cons of all of those approaches. Right now, we're trying to work through all of that, uh, as to what we think would be the best thing to propose. Maybe we propose a number of options, uh, for some public input. The, the system is handling the amount of reserves that are in it currently. When we allowed the exemption on the supplemental leverage ratio that we imposed during the, uh, that we implemented during the crisis to lapse, um, there was basically not a bump, uh, in anything. We thought that that might lead to some, uh, volatility and it did not. Uh, but that, you know, that tightness is going to continue to grow over time. And we're working through all of those options. Thank you. Um, before we close, I want to, [00:59:44] Speaker 3: uh, give Tim, Louise and Don a chance to say something, Tim, I'd like you to, if you would, uh, Mary Daly, the president of the San Francisco fed the other said yesterday that the fed is talking about talking about tapering. I wonder whether you could sit from where you sit as someone who analyzes the fed having heard governor quarrels and all the other speakers in the last few days, what do you expect the fed to do in terms of tapering and Randy, I'm not going to ask you to [01:00:13] Speaker 4: respond. So you're safe. Uh, so my expectation is that, uh, the, the minutes put us on the very long runway toward tapering, uh, that that was like the first hint of we're going to start having this conversation and speakers, uh, since then I think have, have, have really coalesced around that, that, that point that we're going to start talking about, talking about tapering. Um, my expectation is over the next couple of meetings, uh, that conversation will grow. Uh, we'll see, um, uh, uh, people start to talk about what is substantial progress, start to think about what that is more publicly. Uh, my expectation is that conversation is going to get to the point that by September, uh, or excuse me, by, by Jackson hole, perhaps chairman Paul will give us some more guidance on that. Uh, and then, you know, carry that conversation on through the end of this year and possibly begin tapering at the beginning of next year, possibly moving that forward. If, uh, uh, the inflation, um, turns out to be more larger or less transitory than, uh, uh, our current expectations. [01:01:18] Speaker 3: And Louise and Don, I wonder if you could offer briefly something you think it's really important for the fed not to lose sight of as they go through this period of transition. What is it something that you want to make sure is on, on, on the post-it on governor quarles, uh, computer monitor, Louise. [01:01:38] Speaker 5: So, um, I think it's really important to remember how incredibly effective a very low unemployment rate was at bringing people into the labor force that had not been in and that raising wages at the bottom. And, um, I'm worried that, um, we will get to an unemployment rate of four or four and a half percent and sort of say that's good enough, um, and lose the value of this experiment that we were running of really seeing, you know, how much bigger potential is and maybe we thought it was. And so it looks like that's the course they're on is to continue that. But I bet to me that's really important, um, that continue and hopefully the inflation picture will remain muted enough that, that, [01:02:24] Speaker 6: that, and done. So I'll pick the other leg of the dual mandate price stability. Maybe that's because I, uh, joined the federal reserve in 1970 and lived through that period. Uh, but I think it's really important not to lose sight of that piece. And, uh, as we know, once it does get out of control on the upside, it's, can it, you're right. The fed has the tools to deal with it. That could be extremely painful. So, and now with the federal reserve saying it's not going to anticipate inflation pressures, although it, I mean, it is forecasting inflation. Now it's saying, well, it'll go up and down again, even though it says it's database policy. It's not really database policy because it's forecasting inflation, but when it gets to full employment, it won't forecast it won't full forecast employment and it won't forecast inflation based on employment. So I think there's, because of the experience of the last 20 years, they've, you've got a system that's well adapted to a low inflation environment. But I think the protection for federal reserve independence, which could be challenged when you start to raise interest rates will be, you need to point to that price stability mandate and maintaining that. And I think it's been con some of the discussion I've seen in the last, uh, week or two has been constructive because people are pointing out that inflation is not good for, uh, uh, is not good for people of lower income as well. And people just don't like inflation. And, and I think you're going to need that, need to keep that in mind as people operating on Louise's leg of the dual mandate say, let the unemployment rate get lower, let it get lower, let it run hotter. So I think we've, we've got both, both the, both pieces covered [01:04:34] Speaker 3: here between Louise and me. Uh, governor calls, any, any closing thoughts or questions you want to ask [01:04:40] Speaker 2: our distinguished colleagues? Uh, a very helpful discussion. Uh, and, uh, you know, I guess I'd say uh, maybe just in response, uh, uh, to the, uh, uh, to the dual injunctions, uh, from Don and Louise, uh, uh, uh, that I'm, I'm probably, uh, taken among the members of the committee as, uh, as, as one who is closer, uh, to Don's camp, uh, generally. Uh, but I am, I was, it was, uh, undeniable the benefits that there were from the willingness that we had pre-COVID to, uh, uh, to, uh, maintain an accommodative monetary policy in the face of an unemployment rate that was lower than most of us thought would be inflation accelerating. It did not accelerate inflation. Um, uh, as I've said, uh, publicly, uh, more than one time, you know, I, I think one of the, uh, biggest things that Janet Yellen did as chair, I was not, uh, on the board, uh, during the time that that was, uh, being architected, but she, uh, sort of held back and held back in order to allow the labor market to continue to improve. I thought that was a mistake. I said so at the time from outside the fed and I'm, I'm very happy to admit now that she was right and I was wrong. Uh, and so, uh, you know, I think we should be driven by, uh, by experience and data, uh, in looking at the evolution here on the basis of the best we've got in our most recent experience, we can achieve Don's, uh, goal, uh, uh, which again, I edge more towards that camp, uh, while being more patient and getting the benefits from that, uh, greater level of employment, uh, which were significant. [01:06:45] Speaker 3: Great. Well, I want to thank, uh, Governor Quarles for his time and his, uh, good nature of taking all these questions and Tim, Louise, and Don for asking such good questions. And, uh, some of the questions in the audience we didn't get to, a number of them came up in the conversation. And, of course, I want to thank Glenn Hutchins for his entertaining and erudite, uh, introduction. Uh, I was disappointed, Governor Quarles, that you didn't quote Thucydides, Alfonso X, or Shakespeare at all, but, uh, we'll let you, we'll invite you back so you can do that next time. [01:07:20] Speaker 2: I did quote P. G. Woodhouse, but you'll have to look hard for it. [01:07:24] Speaker 3: That's the thing about your quotes. You have to read the footnotes to find out that it was actually a quote. It's very clever. It's forced me to the footnotes of your speeches and that's not my one. Glenn Hutchins, did you want to have a close to say something? Thank you. Well done. Good job to everybody. Really enjoyed it. Thanks, everyone. Have a good day. Bye. [01:07:44] Speaker 7: Thank you so much. Thanks for having me. Bye-bye.