Interview James Bullard St. Louis Fed concerned about low inflation
The following answers are condensed excerpts, edited for brevity and clarity.
President Bullard, the Fed has made quite a strong U-turn at the beginning of this year. After four rate hikes last year it does not foresee any rate hikes for this year anymore. How do you assess that change?
I thought it was a very good move. I argued against the decision to raise rates at the December meeting. Subsequently we had a poor market reaction globally. Since January the FOMC has turned around and come closer to my view that we should not project additional rate hikes in 2019. I think this has been a very successful reaction to the situation.
I think it was a big change in policy because we were previously projecting further increases and now we are not. Monetary policy is not just about where the policy rate is today, most of it is about where it is going to be over the next two years. I think this is very much a sea change in US monetary policy. You can see that in the US ten-year-yield which last fall was trading around 325 basis points and now is trading below 250 basis points. I think most of this difference can be attributed to the change in Fed policy.
What is your current assessment of the US-economy?
I think the US economy is performing quite well. Year-over-year GDP growth is over three percent. Labor markets have been quite strong. Unemployment is very low. On the inflation part of our mandate our preferred measure of inflation which is core PCE inflation is only running at 1.6 percent year-over-year. This is a concern to me. I do think that this number plus relatively low inflation expectations warrant attention from the FOMC.
My main point here is that at this stage of the business cycle with the economy performing so well, I would normally expect inflation to be at or possibly somewhat above two percent. Instead, inflation is below our target. This has been going on for several years, so this is concerning to me. I do think it would be a possible strategy for the FOMC to try to re-center inflation expectations right on two percent instead of somewhat below two percent and to try to push inflation toward target during this period where the economy’s performing very well. That would set us up for better performance in the years ahead.
So if core inflation more persistently remains at 1.6 percent, the Fed should act and lower rates?
If this turns out to be persistent, I’ll get more aggressive in pushing the FOMC to lower rates in reaction and try to re-center inflation expectations at two percent. With an economy booming the way it is in the US, inflation should be at least right at two percent or even above. We are not seeing that.
And why are we not seeing that?
I think that the relationship between the real economy and inflation has broken down in recent years for a variety of reasons. We can’t just assume that because unemployment is low, therefore inflation is going to be at target or higher. It’s more important now to make sure that inflation expectations are right at the target. If they’re not at the target in good times, what’s going to happen when things are much worse?
What do you think is the most important point why it has broken down?
Central bankers have done a very good job in managing inflation expectations in the last two decades compared to the 1970s and 1980s, where things were much more volatile and inflation expectations moved around much more extensively. Because of that, actual inflation has been much more muted than it was in the earlier era. And that has broken down the empirical correlations between inflation and real variables like unemployment. In essence, we’ve cemented inflation expectations at a low level. The core problem is that we may have moved expectations to too low a level so that we cannot hit our two-percent inflation target. That’s why I’m concerned about this issue that inflation expectations seem to be a little bit below our two percent target. That’s eroding our credibility for our target.
How much do the trade tensions between the US and China weigh on the US economy?
That depends on how long they will last. One interpretation is that there would be a flurry of activity right before there would be an actual deal agreed to. I am hoping that that is what we are witnessing. I think financial markets are hedging their bets. They’re a little bit worried that it may not be that a deal’s right around the corner and that maybe this will go on for longer. But in order to do real damage to the US it would have to go on for some time.
It might affect China and Europe more than the US?
The trade war does have impacts inside the US and it does get discussed extensively. But it is more important outside the US. When I talk to people in Asia or Europe, I would say there’s a heightened level of concern about the US-China trade relationship compared to what it is inside the US. It could do damage certainly in other countries disturbing trade patterns and chilling investment outside the US.
Some studies also come to the conclusion that it would do much harm to the US economy.
I think the US is such a big and diversified economy that the impact compared to the size of the entire economy would be relatively small. But when you look around the world there are a lot of smaller economies and those economies depend in various ways on the trade relationship network all around the world. For them it can be very damaging, if the trade network is upset or even threatening to be upset. Smaller countries are caught in the crossfire.
President Trump has suggested that the Fed could support the government in a trade conflict with China. Could this be something that the Fed has to consider? Theory says if a tariff is introduced, the currency of the affected country would depreciate. So if the trade conflict escalates, monetary policy might get affected.
Those kinds of effects are for permanent or very persistent increases in tariffs. My interpretation is that both sides would very much like to get to a deal. I would be very reluctant to take monetary policy action based on events that prove to be temporary. If this dragged on for quite a while, then I think the FOMC would have to wait and see how much this is affecting inflation and other variables and think about a reaction at that point.
President Trump has also put pressure on the Fed to lower rates. Many people see this as a danger for the independence of the Fed. How serious is it from your perspective?
I am not that surprised that President Trump comments on monetary policy because of his background in real estate where interest rates are critically important to his business. So he is knowledgeable on the topic and has opinions. So we are probably going to hear plenty from him about what he thinks would be the best policy choice.
But is it not unusual that politicians’ comment on Fed policy in that way?
We get input from a wide variety of sources including other politicians because the chair of the Fed does talk in front of the House Financial Services Committee and the Senate Banking Committee and those politicians do get an opportunity to comment on monetary policy. I do not think it is that reasonable to say that one politician cannot comment and the other politicians can.
But the US-President has much more political weight.
It is just natural for the president who cares about interest rates to comment on policy. The FOMC itself has a mandate given by congress and we have to do the best we can to meet the mandate. We are getting plenty of advice from around the world. But when it comes down to decision time we have to think about the law and how we are going to meet our mandate under the law. And we’re doing quite a good job right now.
In what way is it natural?
Presidents in the past have commented on Fed policy. Only the recent administrations of Clinton, George W. Bush and Obama took a policy of not commenting on Fed policy. But George H.W. Bush famously said that he appointed Greenspan and he regretted it. He blamed Greenspan for his inability to get re-elected in 1992. And previous administrations to that had often commented on Fed policy. So it is not unprecedented.
So the recent period of not commenting has somehow been exceptional?
My personal reading is that a lot of that came from Robert Rubin when he was in the Clinton administration. Because he had a lot of market experience and Bill Clinton did not he advised him to stay out of it. The subsequent administrations took that on as a kind of good government way to approach things. I think you should always recognize that the Fed chair does talk to the treasury secretary weekly. They usually have a weekly lunch or breakfast where they talk about events in the economy and policy. I think the Clinton administration saw that as their way to get their view heard and use that forum instead of tweeting. Obviously, President Trump has a different way of operating but I think even past administrations had made their views known.
Some people like the former ECB chief economist Otmar Issing point to the fact that central bank independence has been a very short episode in history and that one could not take it for granted.
I would very much agree. I think it is not a given that central banks will stay relatively independent of politics. There are dozens of examples in postwar global macroeconomic history where the government gets the idea to use the central bank more aggressively. Usually they raise money to pay their bills and that leads to a lot of inflation. Argentina is one example and Venezuela is another one.
One way for President Trump to exert political influence on the Fed is through nominations to the board.
He has appointed four of the five governors that are sitting today. He picked people that are very much in Fed tradition, very technocratic and experienced in the field. I think he has done a good job with those appointments. If he wanted a more radical policy, he would have had to probably made those appointments in a different way sooner.
But the recent nominations of Stephen Moore and Herman Cain have been quite controversial and ultimately failed. What will happen with the empty chairs?
That is up to the white house. The FOMC is a large committee. At full strength it would have 19 people. One particular new voice is not going to change the direction of US monetary policy that much. I welcome all kinds of views. We have had a wide variety of governor types in the past.
Even ECB president Mario Draghi has recently expressed concern over Fed’s independence. Do you think there are reasons to be worried?
The Fed is a creature of congress. Congress could open up the Federal Reserve act and make changes. In that sense I think the Fed has somewhat less independence than the ECB which is a multinational organization that was set up by a treaty. It would be more difficult to change the treaty. Nevertheless in both cases it is pretty difficult to change the arrangements of the institutions and that’s what gives both institutions some protection against the political ebb and flow, day to day.
I’ve started to stop using the word independence of central banks because it seems to imply that we’re not accountable to the political process. We’re living in democracies and it’s important to be accountable to ultimately the voters and their representatives. It’s just that you don’t want to be wrapped up in everything that’s going on day to day in the political arena because you want to be able to make decisions that are at arm’s length from that process and more technocratically oriented than that process typically is. I think we’ve continued to achieve that.
Is it helpful if Draghi comments on the Fed independence?
I think there was a time when central bankers would not say anything about other central banks. But it is a global environment and you have many central banks and it is perfectly reasonable to talk about things across borders because it is important for the global economy.
But there also seem to be difficulties when it comes to international cooperation for example at the level of the G7. How is the international cooperation between major central banks?
I have long felt that the formal multilateralism as embodied in the G7 or the G20 tends to be wrapped up in very complicated negotiations between the countries and their ultimate statements turn out to be quite bland and the enforcement is very weak. The central bankers meet at a lower level. It is more technocratic, and you talk at an academic level. It is not that we are telling each other what to do. But we are getting a very good understanding of what the others are doing and that is helping us inform our policy. I think that’s a great model for how you can do a lot across international borders without having to sign formal documents and have formal meetings. Because it’s more informal communication, it’s more successful.
Let’s talk about the recent monetary policy review of the Fed. One topic which is very much discussed in the public is the two-percent inflation target. What is your position on that
Chair Powell has said that he does not want the two-percent target to be part of the review. I think this target has become an international standard. Many other countries have the two percent target. For the US to now depart from this target, I think would set off international chaos in foreign exchange markets because other countries would then wonder what their appropriate response should be for their inflation target. That would be very problematic.
But what could the review bring up?
It is more about how to more reliably hit that target and pin down inflation expectations at the two percent target. Overall, inflation targeting since the 1990s has been quite successful. The question now is more about why are we missing our inflation targets to the low side. One way to maybe improve policy would be to go to something like average inflation targeting. You could say, if we miss the inflation target on the low side in one year, then we’ll aim for a little bit higher inflation next year in a way that inflation averages out and really does hit the two percent target.
But is this not a bit too complicated?
I think if we decided to go in this direction, it could be communicated effectively.
Another aspect is some form of yield-curve management by targeting longer-term rates. What is your position on that?
I am open to it and it should be part of the debate on the Fed’s policy review. I was surprised after the financial crisis that there was not more focus on that. The argument that was made at the time was that if you tried to target longer-term yields, the balance sheet would run out of control. In retrospect, over the last ten years, that is exactly what happened anyway with QE. The balance sheets of the BoJ, the ECB and the Fed have become much larger than they were before the crisis. The fact that the Japanese have gone to yield curve control—and arguably seems to be keeping the 10-year JGB yield where the central bank wants it and they’ve been able to reduce the amount of asset purchases—certainly suggests that this could be a tool on the table for discussion.
Why has it not been discussed more widely?
I think one reason is because in the US you have the World War II experience where the Fed did target longer-term yields successfully during the war and afterwards continued with that practice. It actually did turn into quite a bit of inflation in the late ’40s and early ’50s and led to the Federal Reserve-Treasury accord which allowed the Fed to run an independent monetary policy. This experience has long made economists feel this kind of yield curve control policy could lead to a lot of inflation. But we are in a very different era. I think more discussions and studies of that would be welcome.