In Conversation: Mary C. Daly with UC Berkeley’s Fisher Center for Real Estate & Urban Economics

Alex Mehran:

She got on the straight and narrow, achieved a remarkable education, and is today one of the most consequential voices in monetary policy in our country. So that is Mary Daly. And suffice it to say, I’ve had the opportunity to work with her and she is intelligent, diligent, and decisive. Mary, welcome to the Fisher Center. Let me introduce you to my colleagues who, like you, are serving the public. We provide housing, we provide offices, hospitality, retail, industrial space for the public. Money is an important part of our business and what it, we wanna know how much it is and what the availability is and where the trends are that are going to affect that. So today’s conversation really is an attempt to learn about what the cost of money is going to be, what the availability of money is going to be, and when we are going to achieve stability in the markets. So that gives us the ability to have some sort of predictability and reliability on funding because the markets are kind of confused in our business right now. So just to kick things off, let’s talk about where the economy is today and what role inflation is and just get it going. So welcome, a pleasure to have you here.

Mary Daly:

Well, let me first say that I’m just delighted to be here. I really enjoyed the dinner last night and so many of the conversations that I had there, and it’s just a pleasure to be here. So thank you for inviting me and thanks for the Fisher Center for hosting me. So let me just start with the headline. It may be surprising to you, inflation is too high. So that’s the thing that is most important. It’s the most resonant. Inflation is too high, and it’s not only high in the United States, it’s high across the globe. This is all against a backdrop, and let me return to the United States. This is against a backdrop though of a solid economy. We have a very solid economy. The job market is historically strong. The consumer has been able to stay in the game despite the fact that inflation has been high. So we see some slowing in consumer spending, but not the kind of slowing in consumer spending you might anticipate, which just tells me people wanna be out there, they wanna engage in the economy. And so now we find ourselves raising rates, raising the interest rate to get the economy back on a sustainable path that has both price stability and full employment, but more importantly than anything, just lay the conditions for a long and durable expansion. So high inflation makes us very fragile, makes us very vulnerable to episodes of volatility, to we get a shock. Our inflation’s already high. We can’t really bear it as well. So that’s why you hear the Fed officials again and again and again, Chair Powell in these press conferences. All of us, as we go out and speak to people like yourself, saying we are resolute and united on the commitment to bringing inflation down, ultimately that’s a foundational variable for everything else we want to do. I feel confident that this is achievable in part because, we again, have a really solid economy. We can name the hardships, but you can easily turn around and name the strengths that we are tightening into. And so that’s what gives me the confidence that we can get this done. And I know everybody wants to know, is it a soft landing, a smooth landing? This is a landing. So let’s take those words out for a minute. Let’s talk about a landing that is one where everyone recognizes that the tradeoffs of getting inflation down are worth the process we have to go through to get there. And I think that’s where I hear more and more Americans saying, yes, please give us the relief whether they’re in business, small business, real estate. We all know that things are too frothy on the inflation side and they really have to be, pulled into a more sustainable place. But ultimately the price of stability goal we have is 2% and there’s no number you can calculate on inflation right now that’s hitting 2%.

Alex Mehran:

So the concept of neutral rate is important in your thinking.

Mary Daly:

It is.

Alex Mehran:

And Milton Friedman famously said that monetary policy acts with lagging and variable effects. And let’s talk about the neutral rate and for the audience, why don’t you define it.

Mary Daly:

Sure.

Alex Mehran:

And go into where we are right now vis-a-vis that neutral rate. Neutral rate is the rate at which the interest rates are neither expansionary or contractionary. So tell us there, but they’re more dynamics besides that.

Mary Daly:

Absolutely. So we look at this concept. So the question that is really fundamental is what’s the rate that the funds rate would be set at where we’re either stimulating the economy or tightening the economy, that’s the sort of benchmark rate. And we came into the pandemic with that benchmark rate at about 2.5%, in nominal terms, that was 2% inflation plus 0.5 real neutral rate. That’s pretty low historically. And that’s why you saw interest rate space across the globe be really, really low is because 2.5 is, if that’s your study state rate, then anything above 2.5 is tightening and anything below 2.5, and there’s not a lot of room between 2.5 and zero. So that’s where you hear people talk about the zero lower bound being a binding constraint about how much policy we can support and provide. So those are the conditions we came in with. So now we find ourselves in a slightly different world. There’s not a lot of evidence that the real neutral rate has moved up. Some would, we run lots of models in academic circles. in the Fed and I looked at 11 models just thinking about today, looked at 11 different models, and the estimates range from, it’s really negative, the real neutral rate, it’s really, really positive. So in other words, there’s not a lot of, in my judgment, evidence to say we should change from that concept of the real neutral is probably 0.5. So that’s a good benchmark. And if you look at the summary of economic projections that the Fed puts out, that’s really the longer run sense of that.

Alex Mehran:

How do you get there?

Mary Daly:

How do you get there? So you get there because you ask the question, basically the neutral rate of interest is just the price of money in a study state economy. So when there’s no shocks to the economy that are pushing it forward or pulling it back, what do you think is the supply of funds and the demand for funds will deliver and why is it low? Why is the neutral rate lower than it was historically? Well, because two things are true. We have an aging population and that produces a large amount of savings because people hang onto their money and we have slow productivity growth, relative to periods in history, which means there’s less demand for investment. So low demand for investment and lots and lots of savings pushes the price of money down. And that’s just the demand and supply piece. And that’s what’s happening in the study state. And people will also talk about a variety of other things that might be doing it. But if you just think about the global savings plot relative the demand for projects, the demand for funding projects, then you can get to this idea. So there’s really nothing to suggest that the population demographics have changed and the aging of the population is a global phenomena. And we are just at the beginnings of that. the tsunami as people call it of aging, is a upon us and it’s only going to continue to move through. So that’s not going to be an important, that won’t change. There’s no evidence right now that productivity growth is surging in a fundamental way. It fluctuates from quarter to quarter, but there’s no fundamental change. There might be down the road, but there’s no sense of that. And global growth with a slower growth in the labor force, because more and more older people are retiring and there’s not new cohorts to take their place. Then the slower labor force growth globally and slower, average productivity growth just means slower growth globally than we are used to seeing. So all of those factors mean a low neutral rate of interest and that’s how you get to this 0.5. And you stay kind of at 0.5. Now I’m always open.

Alex Mehran:

But Mary, do the math. Do the math. What numbers are you using to get there.

Mary Daly:

To .5?

Alex Mehran:

Right.

Mary Daly:

To .5? You really just take the amount of savings in the economy and the amount of demand for investment and it equilibrates on a price of money of 0.5, an interest rate that’s normal. And you can do it as a variety of ways. You can do it bottom up, top down. But that’s how these models work.

Alex Mehran:

And this is the real rate?

Mary Daly:

This is the real rate. So then the biggest question though is, most people don’t think in real terms. I know investors do, but average people don’t think in real terms and the funds rate is not computed in real terms. We computed in nominal terms to communicate about it. And this is the piece that’s different. So let’s just assume for the sake of, the discussion that 0.5 is the real neutral rate of interest and it didn’t change very much for the reasons I said, what has changed is inflation and inflation expectations even. So if you thought the nominal neutral coming into this was 2.5%, 2% inflation target and .5 real neutral, well then you, you think it’s a little bit higher. So there’s a lot of ways people think about this, but here’s how we think about it in San Francisco, and I think it’s a really good benchmark, is you just look a year ahead at inflation expectations, longer run inflation expectations one year ahead. So you can compute longer run inflation expectation one year ahead, two year ahead, three year ahead frequencies. And what you find is that they’re hovering around, between 2.5 and and three. So a good benchmark for the nominal neutral rate of interest right now is 2.5 plus 2.5 or if you want, there’s always a range. This is not a variable with that capital T truth, this is an estimated concept, rather than something we can observe. When you asked as how you get there, it’s based on models and data and it’s estimates. But I think a really decent benchmark is, the nominal neutrals between three and 3.5 right now. So this is really important as we talked about the pace of tightening. So we’ve just got the interest rate up, the funds rate up to three to 3.25. So depending on where you want to be in that range of the neutral rate three or 3.5, we are either at neutral and you know, kind of just at neutral, or we’re a little bit below neutral still. So essentially we’ve been doing all this, what people have set termed aggressive tightening, just to get up to neutral the place where we’re not stimulating the economy, anything preceding that was adding stimulus to an economy that’s already demonstrated it can function well on its own and in fact is so high functioning, it’s producing too much inflation. So those are the metrics that I use is, and you have to, one of the roles of a of good central banking is constant data dependence. We literally have to take an estimate of what we think it is and then watch all the time about whether our estimate is off and recalibrate it. And so some things that we would use to imagine, to think about whether we’re we’re missing on the neutral rate of interest is really, is the economy slowing much more than we anticipated, given where we are? And we haven’t seen any evidence of that. So I still came in with the idea that, you know, 3%, little bit over 3% is probably a good estimate of the nominal neutral and continued rate increases are gonna be required if we’re going to get ourselves into restrictive territory, which the inflation data clearly demonstrate that we need.

Alex Mehran:

So how do do you justify a 3% target when the PCE is over 6%?

Mary Daly:

It’s really about inflation expectation. So if we just.

Alex Mehran:

But still it’s been, we’ve gotten there and it’s stayed there, it’s sticky. How do you justify it?

Mary Daly:

So by justify, let me just go through this is the benchmark rate, that’s not the settling rate. We need to be up higher in terms of the actual funds rate. We have to be above the benchmark neutral rate in order to restrict the economy. So I wanna separate those two things. The estimate of the neutral rate really comes off inflation expectations because realized inflation bounces around the Fed reserve bases a lot. I mean our credibility holds the anchor on inflation expectations. That’s what we want. If inflation expectations get de anchored and they just move one for one with realized inflation, well then you’re back into the 1970s and that’s a painful experience. We haven’t, we don’t have that right now. If you look at the data on realized inflation, the 6%, versus inflation expectations, medium and longer run inflation expectations have remained remarkably stable, despite the fact that we’ve got these really high prints on inflation.

Alex Mehran:

And how do you get, how do you get that expectation number?

Mary Daly:

So there’s three ways that, there’s three concepts that we use and we use all of them. Another thing that is important I think for everybody to know is that if you are doing good central banking, you can’t rely on a single data source. We always say we’re data dependent, but we can’t be data point dependent. That’s a terrible way to, to think about policy because we need a dashboard of data. Janet Yellen actually famously started this idea of a dashboard of data. We’ve always been looking at a preponderance of evidence, I would call it as a, in my training as a research economist. But the data dashboard, I think that really makes a lot of sense. So think about three ways we can look at inflation expectations. There’s consumer surveys, the Michigan survey you might have heard of for consumers. There’s also the New York Fed survey on consumer inflation expectations. And they’re asking at the one year, short term, the medium term and then five years out, what do you expect it to be? The second way we get it is from what I would call market based inflation expectations. And those are really surveys of market participants and also trades they’re making on futures, on tips or inflation protected securities. We can back out what they expect inflation to be by based on how much money they’re willing to pay for for the protection. And if you look at all three of those, they start at different levels and and things of that sort. But if you look at all three of those, what you see is the same pattern. Short term inflation expectations go up because that’s just being reactive to the data. You think gas is high today, gas will be high tomorrow. But if you look at the medium and longer run, you see that the realized inflation we have coming in has really not moved those medium and longer run inflation expectations in the same way. So that’s why I, when I’m calculating the nominal neutral, I’m looking at those medium and longer run inflation expectations as opposed to just the short run, because I know the short run have all this, all this stuff that we already know is in train, gas prices, rental price inflation, which we know is starting to slow, but takes a while to fully move through the new leases are lower in price, but it takes a long time for new leases to be generated so that you get an average lease that’s lower in value. So those are things that I would think are in train in the inflation data and we don’t want to be too reactive to those pieces of information because you could easily find yourself over tightening and then putting the economy into an unforced downturn, unforced by meaning we don’t need to be that down in order to re restore price stability. So that’s how I think about it. And so, again, and maybe I’ll let you pull this further, but I want to, I would like to maybe talk about, Alex, the idea that there’s really two stages of monetary policy movements. One is the stage we’re just completing, which is get the rate up to neutral. And the second stage is how much do you have to tighten, how restrictive do we need to make policy to restore price stability?

Alex Mehran:

So where is the medium and long term, what, what, what, what, what kind of timeframe are you looking at?

Mary Daly:

So the medium and long term is really, the medium term is usually a three-year window.

Alex Mehran:

Cool.

Mary Daly:

And then the longer run is a five year window that doesn’t, I wouldn’t say, well let’s look at the summary of economic projections. I still think oftentimes, and I’ve been quoted as saying this, so it won’t be surprising to people if they hear it so, is that the summary of economic projections is SEP, which the Federal Reserve puts out four times a year and all FMC participants participate in it, sometimes is only as good as the day that is printed because it, it is telling you where we think as of that day and then the world changes. But I think in this case, the one we released in September is actually a fairly good indication of where things are looking. And if you look at the SEP and the projections, what you see is growth below trend in 23, GDP growth below trend, policy tightening that gets the rate up next year between 4.5% and 5%. That one policy tightening that raises and then holds, because we have to keep the rate at a tightened level, tightening level in order to fully reestablish price stability. And you also see the unemployment rate rise to the mid fours and you see inflation come down at the end of 23 to around 3%. So you might ask, well why isn’t it 2%? And that’s really because it takes time. I mean we were printing it at very high numbers and it takes time to bring it back down as these things work them their way through. And we get to something closer to 2% at the end of 24. But I think that’s a fairly good, from my vantage point, just speaking for myself, for me that still is a fairly good projection of what my expectation about the evolution of the economy will be. But all of that’s predicated on the, there’s not more additional shocks that we haven’t seen yet that come out. And also that we continue to raise rates to fully get the economy into that policy, rather, into that restrictive stance, so that the economy can actually get back to a sustainable pace that has price stability and a good labor market and strong demand for goods and services.

Alex Mehran:

So in the short term, you’re about three percentage points above that, that long term inflationary rate, right? Three and a half percent. So how do you deal with the issue of trying to contract things in the short term knowing that that long term rate is where you’re headed so you don’t overshoot?

Mary Daly:

Sure. So I think of it this way, ’cause I find it a helpful discipline. So if you look at the data, it’s really, this is a been a phenomenal period if you, there’s several charts out there that talk about this, but it’s really a phenomenal, it’s been a phenomenal period, the forward guidance. So we have three tools really, and I stack rank them in their, in their effectiveness this way, we have the funds, right? That’s a very effective tool. We have used it historically, we know how it works, it’s reliably deployed. We have forward guidance, which we’ve used for quite a while, but it is gaining in power if you look at the data and then we have our balance sheet policy. So forward guidance this time around has been very helpful because remember in November of 2021, it becomes clear that the labor market is actually not just having a reopening strength, but it actually has real strength. It becomes clear that inflation is going to be more persistent and spread to sectors other than just the pandemic related ones. It’s gonna move, starts moving out of used cars and into core services. And so we see that and so we’re, we’ve got this balance sheet that we are still purchasing and we don’t wanna disrupt financial markets. So we start talking about we’re gonna quicken the pace of tapering, tapering our asset purchases and be in position to start raising rates earlier than we had previously thought. Markets start repricing. If I had a chart I’d show it to you, but financial market, financial conditions start to tighten right away. So then we roll forward to march, we raise the rate, we’ve lift off 25 basis points and mortgage interest rates go from under three to close to five in a period of three weeks. And that is a remarkable response that says that the monetary policy transmission mechanism from words and forward guidance to financial market conditions and tightening has become very quick. So that’s a good thing. It means we’re much more nimble than we have been in the past because we do have that forward guidance tool. But it is not the case that the rates to the economy has really changed very much. So if I was talking to the late great Milton Friedman, you’d say it is long in variable lags. It might not be long in variable in the words to financial conditions, but it remains long in variable in the financial conditions to the economy. And you see that right now. So what what then can happen, well if you keep tightening and tightening and tightening until you see literally the lagging variables that we’re so interested in, what are the two most lagging variables in our portfolio variables? Inflation and unemployment. They lag, they lag, they lag. So if we were gonna tighten until those variables return to their study state values, well we could easily find ourselves in all likelihood would find ourselves in having over tightened the economy so significantly because we didn’t understand or we weren’t paying attention to, the fact that this tightening is moving its way through the system. So let rest assured we’re not, that’s not how we think about it. That’s not how I think about it. It’s really about how much of this pent up tightening, that’s already in the system, is moving its way through the economy. And I would say a little bit of it, right? We’re already seeing housing markets slow considerably, new leases on rentals are slowing, the consumer demand is, it’s not slow but it’s not rising at the rapid pace. The labor market came off of a north of 300,000 a month job pace to something over just over 200,000. So still pretty robust, but definitely slowing. So you see those things starting to take hold. But the question then is, do we need more? And in my judgment more is needed because you know, even if we said, wow, there’s a lot of slowing right now, 200,000 jobs, I’d just like to put in this terms, ’cause it’s easy to understand, 200,000 jobs is about a hundred thousand jobs more per month than we need just to hold unemployment steady, right? We’re only bringing in, depending on the month, a hundred thousand new workers are reentering workers, in the US economy. So every time we run job growth, every time job growth prints faster than that, that’s more pressure on the labor market. Wages go up, wage growth goes up, passes on to inflation and you find yourself with, things that are, the dynamics that push inflation up. So I think more is needed to get us into restrictive territory, but as we approach what restrictive territory, and this is the second stage of policy, so the first stage of policy is raise the rate to get it up to neutral and you can be fast, we know we shouldn’t be accommodating, so let’s be as aggressive and get up there fast. The second stage of policy making in my, this is how I think of it. I mean I should say all the remarks I make today are my own, and do not necessarily reflect any other fed reserve official. So that’s just the blanket. So then I can stop having the awkward interruption of myself. But I do wanna share how I think about it. The way I think of this is that now we’re in stage two and stage two of policy is we need to be thoughtful about how restrictive we need to be. And that means we have to be incredibly data dependent because we have to watch these incoming indicators. We have to make sure that we’re doing everything in our power not to over tighten and we can’t pull up too fast and say we’re done because you, that’s what we did in the seventies as a central bank. We stopped when it showed any signs of cooling and then we found ourselves with a redoubling of inflation, which actually really solidified inflation expectations because that change before we’re really done, is very injurious to psychology. People think, oh they’re finished, my prices are still high and rising. I don’t think they’re gonna really do this. I’m gonna price this into my wage contracts. I’m pricing to my rental contracts. And so that’s, we don’t want that. So the risks are on both sides, under tightening, over tightening. And that’s why this data dependence and not necessarily, and this is why you’re starting to hear, and I’ve said this myself, the idea that we don’t just keep going up at 75 basis point increments. We actually do a step down. And that doesn’t mean step down as in pause and don’t raise, it means step down into increments that are easier to manage 50, 25 basis points where you’re still moving up but you’re doing it in a way that’s not so aggressive that you, you don’t have to find yourself in the awkward position. I think you all would agree with this, I know consumers agree with this. It’s not a very good thing for most businesses, real estate in particular and consumers, to raise rates really high, only to reverse yourself because you found yourself over. That volatility, I mean, I just think of consumers, should I buy a house now or in three months when they might move? So I keep reassuring people that the optimal policy, the one’s historically delivered dividends and over time, is you raise and you hold and you let the holding part of the policy that tightening over a period of time, be a lot of the work. And I think Alex, from your opening remarks, you did say, when will we get to stability? So it’s, when will we get to the stability of the raid? And I think what you saw in the SEP, again, I’ll reference that document since it’s still relevant, is that you get there in 23 and then you hold for some period of time. And that’s very different than what market participants were betting on. I don’t know if you all saw the hump shape path and you know that I, that’s obviously not what we have in the SEP and not, certainly not something I would be supportive of in terms of optimal policy. You always have to be nimble, if conditions change, you change the policy. But as a policy projection, it’s the raise and hold that has paid the dividends.

Alex Mehran:

So let’s just pause here for a moment to summarize. So your view is that the neutral rate is at half a percent.

Mary Daly:

Real neutral.

Alex Mehran:

Real neutral and that the inflation, medium term expectations of inflation are about three. So neutral is about three and a half.

Mary Daly:

Yeah and depending on the survey you use, it’s very other 2.5 or three. So I think you could easily say the neutral rate ’cause it’s, again, this is not precision estimating, so I’d be comfortable.

Alex Mehran:

Around.

Mary Daly:

Three and three and half.

Alex Mehran:

It’s around a three and a half.

Mary Daly:

Yeah, I totally think that’s a reasonable projection.

Alex Mehran:

Fed funds today are at three, three and a quarter. So where do you need to get to in the fed funds rate to be at neutral today?

Mary Daly:

So at neutral we’re, I think we’re close to neutral, right? We’re at three and a half, 3.25. So I think we’re at or near neutral. But I think in terms of looking.

Alex Mehran:

But that’s a nominal rate.

Mary Daly:

That’s a nominal rate.

Alex Mehran:

And we’re comparing against a real rate?

Mary Daly:

Oh and real rates are, real rates are still, real rates are just slightly positive if you do that, right? Slightly positive real rate from a negative real rate. So if you think about slightly positive real rate, so forget about where we’ve been, just ask yourself a simple question. If I told you that inflation was, in the monthly annualized 8% and the unemployment rate was 3.5% and we had modestly positive real rates of interest and since I asked, is that great policy, most people would say, no, we’ve got, money is too easy to come by in a world where inflation’s too high and the unemployment rates and labor market’s already strong. So I think through that lens, because we don’t look at the deltas, we don’t look at the changes we’ve made over the last year, we instead look at the levels, then it’s much easier to understand that more is needed. And so then from my perspective, I think getting next year to something between four and a half and five is still a very reasonable estimate of where we’ll need to go. But you know, I say that with a double and triple underlying that the key and core value of a central banker in this mode in my prudent policy is data dependence. Really being data dependent, really thoughtful because there’s much concern of underdoing and overdoing. And I don’t wanna be in a situation personally where because we were fast to get somewhere, we actually caused ourselves to have to either reverse or we realized it was a mistake. And I hear a lot of concern right now that we’re just gonna go for broke. But that’s actually not how we, I think about policy at all. I think about policy as we’re in stage two. We need to really think hard about how restrictive we need to be. Clearly, well at least in my view, clearly we need to be more restrictive than just barely positive real, real rates because the economy’s printing at very high inflation and we’re tightening into a strong economy. The labor market is very strong right now.

Alex Mehran:

So your view is we are at neutral now.

Mary Daly:

Roughly.

Alex Mehran:

Any future increases in the Fed funds rate will be restricted, the question is how restrictive you have to get in order to bring inflation under control.

Mary Daly:

That’s exactly, that’s a perfect summary.

Alex Mehran:

Okay.

Mary Daly:

You can write all my summaries.

Alex Mehran:

Okay. So you mentioned that the forces, the global forces that are deflationary, which are demographics, productivity, savings rates, and those things were what kept interest rates low for the past 15 years. Then we go into COVID and we have labor force disruptions, we have supply chain issues, we have China shut down and rates stay low. Then, and we have to remember that in February of this year, the tenure was at 175. So then we have the Ukraine on February 24th and we have energy and food become factors and things take off and the fed takes off, trying to get this under control. So the question before the house is how do you, these are, I don’t wanna use the word transitory, I’ll use the word temporary. The question is how temporary they’re gonna be. The issues of labor, labor force and supply chain and energy. These are temporary conditions that will go away over time and those global forces will come back into play. So how do you, as you are being contractionary, how are you going to avoid having monetary policy outrun the inflationary factors that we recognize are temporary?

Mary Daly:

Sure, that’s a great question. So let me kind of unpack it into how I think about it. So just because it’s a more durable language, it’s one we’ve used through my whole career as an economist, is that there are, and any time you get an economic disruption, a shock, an economic shock, then you have cyclical factors that are playing out and you have structural factors that still underlie the dynamics of the economy. So the structural factors are the ones that are always with us, demographics, productivity, growth, all the things that we can think about. Labor force participation usually is highly structural, but there are these cyclical dynamics that also affect the outcomes we observe. And I’ll wanna take you back to the great recession. So in the Great Recession, the biggest debate we had in the aftermath of the great recession was whether all the workers who were let go and lost their jobs, if they were permanently scarred and they would literally never come back. And so there was a rush, if you will, to declare that the cyclical factors we were seeing were really being transformed into structural factors that would never change. And I saw this happening. I didn’t think that was right. I actually wrote a couple papers about why it might not be right. It turned out not to be right. But here’s the lesson, that people, we all do this, we’re human, right? So now here’s what I hear that globalization’s over, nobody’s ever gonna do this, everybody’s gonna come home, we’re gonna go into protectionist mode. But people are entrepreneurial. It’s really hard to think that they’re gonna abandon all comparative advantage opportunities and go back to, single nations making everything for themselves. So I pushed back on that too. The question is, there’s really two questions. How quickly will the cyclical dynamics that have been born out of the pandemic and before the pandemic, we had a trade war, we had a variety of other things going on, how quickly will those cyclical dynamics subside and the more structural dynamics take up? And then the second question is what permanence from the big disruptions that we’ve seen, how permanent will be some of the things we’ve learned and some of the lessons. And so let’s just take globalization. ‘Cause I think it’s a really easy one to think about is will globalization be over? No. Do people who make goods now think that maybe they should have closer to home inventory management because the supply chain disruptions can be challenging in terms of delivery to customers? Yes. So putting those two things together, we’ve got several years where we’re gonna figure out what is near sourcing, what is, how does that look different than outsourcing and how do we think about this? So that’s where you have to be. This is why data dependence is so, is so important because I actually don’t know the answer for how long these cyclical forces will persist in affecting the outcomes that we observe. So if I knew we could just make policy beautifully, we could write out all the rates and we’d have all the information, but we don’t know. And so that’s why I think the step down mode is important, that we step down in terms of the, just the pace of increases, not the increases. We have to increase the rate, but the pace of increases is it’s, it’s not just about there’s vulnerabilities and fragilities and other things you have to think about, which is I think getting captivating much of the media, it’s really about, we are more, we are more uncertain now about where we will end than we were when we knew we needed to withdraw accommodation from the economy. And one of the uncertainties that you’ve highlighted, it’s a very important one, is when will the structural factors that have been pulling inflation down, that have been pulling the interest rate down, when will those things reemerge? And I think it’s not as quick as we might have thought because we’re not the only country with high inflation, other countries, every important country, every industrialized nation important in terms of economic size is dealing with high inflation. So all the major players to the global economy are really struggling with high inflation. And many of them, Europe, just look at Europe, they’re struggling with something the United States, doesn’t really have right now. They’re struggling with high inflation and slowing growth for other reasons. We’re tightening into a stronger economy and I think that gives us a little bit of a benefit on the domestic side. Well of course we have to kick into account global factors because they also affect our growth.

Alex Mehran:

So when do you think that that step down process should begin?

Mary Daly:

Well, my own view is that it should at least be something we’re considering at this point, but the data haven’t been cooperating, right? If only I could make the data do what I want them to do, but they haven’t been cooperating. And I think about this a lot because as a policy maker, I care deeply about the lives and livelihoods of all Americans and how they can manage and I know you all know this, but it always bears repeating, inflation is a very regressive tax. If you’re median income and above, you have ways to manage. It’s an inconvenience. It is annoying. It can disrupt some of your purchase plans and other things like that. But it’s not the devastating trade off that low and moderate income families have to make because it’s, and just the level set it, when I speak to, low and moderate income families and communities in the district. So I have the nine western states and as Alex said, it’s a vast environment with a vast amount of diversity. But here’s something I hear no matter where I go, I could be in California, Idaho, Arizona, Nevada, Hawai’i, Alaska, it doesn’t matter where I’m at. I hear that I’m making trade offs between rent, food, and gas. And I meet repeatedly, people who say I have plentiful jobs, but I can’t work as much as I’d like because I can’t afford the gas to get to those locations. And remember those people who live pretty far away from job centers because of the cost of housing. So this is, for me, while I think stepping down is important and at some point for me, it’s really challenging to step down right now when we have inflation printing so high and we have and core services inflation rising, and then we also have the unemployment rate at a historical low of 3.5%. So I’d like to make the distinction between when you start talking about it versus when you do it, and I think the time is now to start talking about stepping down. The time is now to start planning for stepping down. But that doesn’t mean, and I’ll go in a week, I go and deliberate with my colleagues at the FMC. And so I don’t wanna front run our deliberations because that’s why we go, to deliberate with each other and think about this. But you know, there is a distinction, and I hope this, if I can convey this, I’d like everybody to hear this one thing, at this point, we have to think about where do we need to get the rate to, and we have to think about the path of getting it there. And so we might find ourselves, and the markets certainly have priced this in, with another 75 basis point increase, but I would really recommend people don’t take that away as it’s 75 forever, right? Because there is a point where you say, okay, we’re getting nearer the terminal rate that by the terminal rate, I mean the rate will end at, and as we watch how this evolves, the the raise and hold, as we get closer to that, then incremental steps that are not 75 basis point increments would be appropriate. So I see myself as thinking hard about the step down, but also recognizing we’re not there yet in terms of where restrictive policy will have to be in order to deliver inflation that is at 3% by next year.

Alex Mehran:

So your colleagues are indicating like a four and a half percent rate into 2023, right?

Mary Daly:

That’s what the SEP said. And you know, the SEP I think remains, as I said, good is the, if you looked at the, it was relatively split if you looked at the participants, if you feel that you are wanna have a geeky fed experience, you can look at that dot plot and the dot plot show.

Alex Mehran:

Or read the minutes.

Mary Daly:

You can read the minutes. I mean I look at the dot plot first and then go to the minutes.

Alex Mehran:

By the way, the minutes are the, I find the minutes very interesting.

Mary Daly:

Me too. I’m glad somebody else is a fan of that. I find them very interesting as well. I find them very interesting. And the dot plot. So just I can share a, I put the dot plot up on my, so it is on my wall. Every time we do a new one, I put it up there because I’m thinking about it. I can’t remember all the dots, so I put ’em up there, but I think it’s useful. So what did it say though? So back to the serious component of this, what did it say? It said rates between four and a half and 5% by the end of next year. And that is I think still a very good assessment of where we will need to go. And then, and that’s the, what I would call monetary policy strategy. That’s our monetary policy path. That’s our stance of policy. The piece about 75, 50 is tactics. How do we get there? And tactics, as you all know from running businesses, strategy and tactics are different things. You wanna keep your strategy, but then you decide on the tactics based on the incoming information, how quickly you can do it, what other factors are going on. And so when I’m deciding on the tactics, I’m thinking about one, how much room do I have to make up to get to four and a half? And I’m also thinking about, what else do I need to be looking at? And one of the things I’m looking at is how much pent up tightening we already have in the system and we’re seeing it start in the housing market and things, I’m confident we’re gonna see continued step downs in some of these core variables. And I wanna make sure we don’t over tighten just as much as I wanna make sure we don’t under tighten.

Alex Mehran:

So we’re gonna see another 150 to 200 basis point increases in the Fed funds rate over the course of the next six to eight months.

Mary Daly:

Well, I wouldn’t wanna be so definitive. So I wanna go back to that piece. It’s funny, I say it a lot, but it never makes it into the summary, the data dependence part.

Alex Mehran:

But based upon what you said.

Mary Daly:

So I think.

Alex Mehran:

People kind of gotta anticipate that kind of.

Mary Daly:

I think the starting point, is look at the SEP, say interest rate going four and a half to 5% by the end, by next year, end of next year. And so let me go three things, raise and hold. Not something to take in mind, keep in mind, right, that this is a, you raise the interest rate and you hold it because the holding part is also policy tightening and that’s really the first piece.

Alex Mehran:

But we’re gonna be in a restricted monetary policy.

Mary Daly:

Yeah, we’re gonna be.

Alex Mehran:

Based upon the neutral rate of three and a half, you’ll be restrictive.

Mary Daly:

So we’ll stay there for a while. Second thing is, right now with all the things we’re, I’m looking at, I see three and a half, I’m sorry, four and a half to five being a reasonable place to land. I do, but I, I want to hesitate to say that will definitely happen because we have a lot of things going on. First of all, we have a global economic situation. that’s quite.

Alex Mehran:

That was my next question.

Mary Daly:

Erratic. And it’s not just.

Alex Mehran:

The Liz Truss effect.

Mary Daly:

Yeah, well let’s move it, if I may. I know it’s the topic of the day, but if we can move away from the UK.

Alex Mehran:

But let me just, I just want to finish that one paragraph. So if that’s the case, the question really is about tactics. Is it 75, 50, 25, 25, 20. But the fact is that we ought to an, these are all long term thinkers in the room. That tactics are really less important to us than the result.

Mary Daly:

Exactly.

Alex Mehran:

So we should all kind of anticipate that kind of number.

Mary Daly:

Absolutely.

Alex Mehran:

In the middle of next year. It’s a question of how, how the Fed gets there and how long it stays.

Mary Daly:

So let me add a better caveat than I had before. Here’s a caveat that’ll help you, I think. If we’re thinking about the rates, that’s why I keep saying the SEP is a decent, a really good projection and you know, Chair Powell’s gonna go out and give another press conference after the next FOMC meeting. So here’s how I see it. We are projecting those kinds of increases right now and we’re also data dependent fed. So we will be communicating with you if our views change and you’ll be able to adjust your own views based on those communications. So that means watching the press conference of the chair, looking at the SEP that comes out in December, that is where you would see any adjustments to our projections based on the incoming information we’re getting. So both can be true. I think it’s reasonable to have that as a benchmark, four and a half to five. And then in the markets the price is in four and a half to five is about where our futures markets are on the funds rate. And then the data dependence comes in and you hopefully know our reaction function, but you also will get additional communications, right? This is the benefit of a very transparent fed, a communicating one, you don’t have to just hope and guess and then, take the risk of being right or wrong. It’s really that we’ll continue to communicate as the data evolve, we’ll talk through how we’re thinking about them and what it means for our projections for policy.

Alex Mehran:

So hopefully next year’s, we’ll see some softening in some of these temporary factors that are, that are causing inflation, that the global factors of deflation begin to play in. The rate hits somewhere in the four and a half, 5% and then it begins to moderate to, to accommodate those, the reduction in those temporary conditions. So let’s get to the Liz Truss effect. So it used to be that the, that the politicians dealt with fiscal policy and the central bankers dealt with monetary policy and those were the two important players in creating our economy. Now we’ve got Mr. Market who shows up in London and says not so fast. So talk us through the global impacts of what happened in London, how you are attuned to that and what should we be looking for in terms of the kind of boomerang effect that happens globally when some local incident occurs.

Mary Daly:

So let me, let me just sort of broaden this conversation just a little bit because while the UK is the thing that people have been focusing on in the news, this is a phenomena of how things get figured out that we’ve seen many times in our history. And here’s the phenomena is, monetary policy is reacting to the economic conditions we have. We’re, in economics terms, we’re a residual claimant on the economy, right? We see the conditions we have and then we adjust policy to achieve sustainable growth, full employment and price stability, against those conditions. So that’s our role and we’re independent and we don’t, move to the, to the changes in administrations or political needs. We just do that. That’s the work. It’s always the work. That’s what the work that congress gave us. So then the fiscal agents make decisions about, okay, what do we need to do to do other reliefs for inflation or other reliefs for, or things to spur investment? And that’s what they do. And then the markets, and this is where the markets are always in play, the markets, ’cause they’re forward looking and they’re buying and selling all the time. They’re deciding whether or not they think these interplays are gonna be harmful or beneficial to the economy and can we fund it? Can we not fund it? And that goes on all the time. And so I think, it’s not, although the situation in the UK because it was so large, attracted a lot of attention. The dynamics of how this all works, I think are very, they we’ve seen ’em in different periods of history and they’re always there. So at this point for me, I think of global conditions this way, it’s much less about the UK in fact not, not thinking about those fiscal decisions or those fiscal issues or even what’s happening there, because we’re nonpolitical, we don’t think about those things. Here’s what we think about, here’s what I think about, I think about what’s happening in global tightening of financial conditions. So global tightening of financial conditions, the first and foremost effect on global tightening is the fact that we have synchronized tightening by central banks because of high inflation. So that’s the first order piece of information. All central banks are tightening at the same time. That causes a considerable amplification effect on global financial conditions tightening. And we have to be very aware that synchronized tightening is something we have to take account of. So then if there’s tightening, more tightening or less tightening because of other variations in country’s positions. So the war in Ukraine escalates, that looks bleak for the European winter, right? Because prices of commodities rise and they’re already, they’ve already got inflation that’s too high. So they’ll have real shortages, which is gonna constrain growth and it’s gonna push up inflation. So that’s a bleak outlook if the war in Ukraine escalates further for the European economy. So that’s a headwind against US growth. So now we have a headwind against US growth. We have global financial tightening that’s more than just our tightening alone would be. And then we have the no COVID policy in China, and that’s a policy that they seem they’re gonna hold onto pretty rigorously. But that really isn’t great for supply chains. It hopefully is less disruptive than it has been because they don’t have to come down so much like down so much. But it still has a ramifications for our growth.

Alex Mehran:

And demand.

Mary Daly:

And demand. And so you put all this together and that’s why I can’t emphasize enough that we have to continue to watch the data because we don’t live in just the United States. We live in a global economy and those global economic conditions are going to affect us. So that’s what I’m really focused on. And if I stack rank the things that are important, it’s global tightening, really thinking hard about what that means, what that looks like, how does it affect us. Then the second one is just the continued disruptions from the war in Ukraine and what that does to global commodity prices, food and energy being the number one, and then what does that do to the economies in Europe. And then the third is, what’s happening in China with the zero COVID and they also are trying to work through a property bubble or boom I guess, and they’re trying to work through other kinds of things themselves. So these are just a period, we’re in a pretty tumultuous period where there’s a lot of uncertainty. And so the uncertainty just means continue to act, but do so with the recognition that uncertainty is present and we need to remain agile data dependent and frankly quite thoughtful about the impact of our policies in this environment that’s changing.

Alex Mehran:

But the trust tantrum really highlighted the thinness of the market and the fragility of the market and how something like that can reverberate around the world. So let’s transition for a moment over to our situation where we’ve got a balance sheet of, just short of 9 trillion and we are trimming back at 95 billion a month and you’re gonna continue that for some time. So we’ve got, recognizing that that 9 trillion is up from 900 billion in 2017, 2007, 2007 we were at 900 billion. Today we’re at at 8.9 trillion. And now currency has gone up to include about $2 trillion worth of that. So we’ve got about six and a half, 7 trillion. You’ve got some reserves that have to be in there and you’ve got reverse repos that are in there. But we still have some serious contraction that’s gonna happen. Who is gonna buy all of these mortgage backed securities and treasuries and at what price are they gonna buy them and how will you most importantly avoid crowding out that is gonna seriously drive up rates?

Mary Daly:

So, so, so far, let’s just do facts on the so far, so the New York Fed, the market’s desk at the near fed monitors this hourly, daily, we talk about this in all of our deliberations to think about financial market functioning and so far our balance sheet policy hasn’t disrupted financial market functioning. So that’s where we are today. Second thing I wanna say about this is that we’re mindful of that always being a possibility. So we watch it and we think about it and this is where the third thing I wanna say comes into play. So there was a bit of confusion I think that came out of the discussions around the UK and I just wanna clear it up in the US that there’s a very, we have balance sheet policies for two reasons. One is to stabilize financial markets. So think about March of 2020, think about other times we’ve gone in. Treasury market dislocated in March of 2020. The Federal Reserve goes in to, because our job, that’s the congressionally given job, is to assure that financial intermediation can continue, that we go in and stabilize market functioning to stabilize financial stability. This is critical in the treasury market because of the important role that treasuries play across the global financial system. So that is a job. Think of it as a technical job, in my my mind. We are meant to do this. We go in, we do it, and we stabilize. And that’s what the UK did, the Bank of England did, in their interventions. You’re stabilizing financial markets so that they can trade. That is very different than quantitative easing or quantitative tightening. Those are policies meant to change the yield curve when we have hit the zero lower bound, so we hit the zero lower bound, we want the rates to be lower. So we’re buying assets in those markets to get those rates lower. And that’s a monetary policy initiative as opposed to a financial stability remedy. And so the important thing about this is we can do both. If we had a dislocation, and I don’t see one right now, but if we had a dislocation, we could solve the dislocation without changing our stance of policy because they’re just different things. So we could continue to raise rates, we could continue to roll off parts of our balance sheet. We can continue to do things, while we stabilize markets? And that’s the key piece. The other thing about the balance sheet that often gets lost is that, in the discussions, is that the effects economists, financial economists, monetary economist analysts, by and large, the sense of the balance sheet is that the day we announce the path is the day everything’s priced in. And then the rest of it’s just mechanical. So only a change would cause that mechanical piece to unravel. So my own sense is that the tightening and financial conditions has been done when we announce the balance sheet and the plan for rolling it down for shrinking it, that’s been priced in. You know, depending on who you are, people estimate that’s worth one or even two rate hikes. Hard to know. But it’s another factor in why we need to be thoughtful as we continue to tighten. But say it’s a rate hike, well that’s already in there.

Alex Mehran:

So you and I could go on forever.

Mary Daly:

Especially about the balance sheet. But you love balance.

Alex Mehran:

I love the balance sheet.

Mary Daly:

Our star and the balance sheet.

Alex Mehran:

Our star and the balance sheet. And the minutes and the minutes. But I do want to give the audience an opportunity to ask some questions. So if I could see a show of hands please, Ron.

Ron:

Is there an on button, oh, there you go. Ah, there you are. So first, thank you for being here and perhaps more broadly, thank you for your service. I mean, the reason we’re able to do what we do in this room and the way that the reason the US economy has been so strong and so robust for so much and for so long is because of the stability and transparency of our financial institutions. And you and your colleagues at the Fed just do a tremendous job to accomplish that, so thank you for that.

Mary Daly:

Thank you.

Ron:

By the way, having been under your thumb before, I am happy to be able to say we appreciate.

Alex Mehran:

He’s from Bank of America.

Ron:

We appreciate your scrutiny and what you’ve done.

Alex Mehran:

There is a regulatory component of the Fed as well.

Ron:

Yes, there is.

Mary Daly:

Indeed.

Ron:

So my question goes to the stress test. So yesterday we had a number of commercial real estate lenders talking about their willingness or lack of willingness to lend to real estate right now. And they kept going back to how the stress test administered by the Fed impacts bank’s willingness to lend to certain sectors and impacts their willingness to lend specifically to real estate. So could you give us a little context around how use view the stress test, whether it’s accomplishing what the Fed wants it to accomplish, and how we as users of capital might be able to react to how banks are willing to lend us money based on the stress test?

Mary Daly:

Sure. So the first thing to know about the stress test and that is that the Federal Reserve system works on them, but the regulatory component of that is done by the Board of Governors. And now we have a new vice chair of supervision, Michael Barr. And when Governor Corals was there, he was focused on this. We were all, they’re always, since the first area of reassurance, I’d like to give you, they’re always thinking about the impact because the stress tests are meant to protect us from financial instability caused by, banks not being well capitalized enough and then finding themselves, then we’ve got much more systemic problems than just the shock itself. So that’s the purpose. And then there’s always this calibration exercise of are we doing it well? So I know Vicer Barr will be thinking about all of these things, but let me just speak for myself. Do I think it’s working in the way we intended it to work? Well, let me talk about a lot of positives. We came into the pandemic with extraordinarily well capitalized banks and those extraordinarily well capitalized banks were well prepared to lend through the pandemic, which is ultimately what you want your banks to do. Now we did some forgiveness, not forgiveness, some direction basically that said, don’t buckle down on these folks, let ’em have a little more time forbearance, etcetera. And those all were thoughtful and I think helped the banks. We had the community bankers in this week from our district to talk about this and they said this was so helpful that there was this, we were well capitalized, but then there was some guidance from the supervisors that don’t lock everything down when you want us out there intermediating loans and making sure that people can get from one point to another. So from that perspective, the stress test, which are only applied to the big banks that the G SIBS that, those I think have been effective at helping banks look at their own portfolios, get some continuity of how they look at their portfolios. So, I think most people were aware that banks of all sizes regularly do scenario analysis, risk testing, etcetera. But the stress test put it in a formula that says it’s going to be consistent across all banks. And I think that has been a benefit of getting banks well, making sure banks were well capitalized and prepared to serve as we come through the pandemic. So now as we look at the tightening, I mean, where do you, I know I’m in a real estate conference, but think about where are we most vulnerable right now. I mean, commercial real estate is a highly vulnerable area. There are gonna be, there’s gonna be some transformations that are required in commercial real estate with the change in how people wanna work. So I have this, I’m an internal optimist. I think that probably would be consistent with all of you, it doesn’t mean we can just go back to where we were. The idea that people are gonna come to San Francisco, for instance, five days a week, all the weeks of the year just isn’t right. So we’re gonna need some transformation there. And so I think that rhe stress test and the lending and that scrutiny will be important. Plus we are in a period where we need lending, we need the economy to slow. I mean that’s how monetary policy works. We raise the interest rate, lending slows, borrowing slows, and we get ourselves right sized, getting demand back in line with supply. So I see these right now as positives rather than constraints. But I wanna reassure you that, the vice chair of supervision and all the colleagues across the Fed system regularly ask themselves the question, we want the protection, but we don’t want to clog up the financial system. And that’s the challenge. If you don’t allow innovation, you don’t allow lending, you don’t allow borrowing, well then you can, restrain our rate of growth. If you don’t think about how it’s done and where the vulnerabilities are, then everybody suffers. And so finding that in the continuum is not a one time process, it’s a continuous experience. It a continuous exercise.

Alex Mehran:

So the clock has hit, hit 9:30. Let’s take one, one more quick question, Jim.

Jim:

Thanks and thanks for coming. It’s great to hear the analysis. So you mentioned San Francisco and while you have nine states that you’re responsible for and the, all these big issues, you are a chief executive of an important San Francisco organization and I dare say probably the one most likely not to leave San Francisco. Of course you, you never know. But I was just wondering if you could mention in terms of your local responsibilities to the city, the region, the state, what’s the role of, the president of the Fed, what concerns that you’d like to address?

Mary Daly:

Sure. So one of the things that, and this is really about, this is how I approach the job. So when I got the job in October of 2018, we do have a head office in San Francisco, but I have branches in other locations. We have LA, Salt Lake, Phoenix, Seattle, Portland. Those are places that also would like us to be a presence. And we also, the Bay Area is big and so Oakland and you know, San Mateo and not just the San Francisco area. So what we did is we committed to saying we need a bigger presence. We need a bigger team that focuses on local issues and our importance in the community. And actually we had a phrase, I developed this cause I was trying to change people’s mindset. It’s we wanna move from being a bank that does community engagement to a bank that is community engaged. And so what does that look like? Well, it means meeting with our local leaders. We have been done office of civic engagement. So we meet with local leaders, not just national leaders. We meet with the governors, the mayors, etcetera. Next year, one of the things we’re working on is, you’d be surprised that, well maybe you wouldn’t be surprised. The mayors in every area that I go to are grappling at different scales. Of course, with the same problems we grapple with in San Francisco. It’s not different. Homelessness has risen. There’s not enough homes for first time home buyers. There’s concerns about safety and cleanliness. When are we gonna get people back and will our city centers have the culture that they once had, now that people wanna stay out in the suburbs, what are we gonna do? How are we gonna grow? How are we going to attract? These are all issues that mayors across the district are grappling with. So one of the things we’re gonna be doing is starting a program where we bring mayors in if they would like to and bring their staffs into the Federal Reserve Bank of San Francisco and have people talk to each other about lessons learned. How do you grapple with this? What are the things so that we can create networks? One of the things that Fed does best is convene. ‘Cause we don’t have the tools to solve the problems that most cities and states face, but we definitely have the power of convening. And when we bring people in public and private sector people, the people from all these different areas, as diverse as they are, we find that they have similar problems, similar challenges, and they are idea generators then with each other and form a community. So I feel very strongly that one of the things we are, we’re redesigning our front lobby. If you happen to walk past our building right now, you’ll notice the front’s all in construction, we are fundamentally changing how we interact with the public. We met with the designer who’s gonna build the architecture out and we said, he said, what do you want? I said, I want everybody who walks past this to know that this is their fed, that they belong here. This isn’t some big government building where nobody can get in. This is your FED. ‘Cause we’re honestly, all we are is public servants. Everything we do, we have a banner at the front of our building. Our work serves every American and countless global citizens. And I think of that in the Bay Area and also all the other states that we serve, all the other cities we serve. So that’s the way I want to be. I wanna be present everywhere we are and I wanna make sure that we’re bringing people everywhere we are together.

Alex Mehran:

So you mentioned encouraging lending from us to you. What encourages lending is stability. When we know where stability is, there are a lot of bankers in this audience and when they know their stability, they will lend into that stable market at a price. So we started the conversation with what is that price going to be and when are we going to see it? The answer is somewhere around four and a half percent, somewhere around the middle of next year where we’ll start getting stability, barring any unusual circumstances that might come up. So hopefully that answered all of your questions. Mary, thank you very much.

Mary Daly:

Thank you.

Alex Mehran:

Thank you very much.