Media Q&A Transcript with Federal Reserve Bank of San Francisco President Mary C. Daly

Thanks for doing this call. President Daly, I was wondering if you could talk a little bit about… We’ve heard a lot recently about that these Taylor rules and the idea that you have to get the funds rate above some inflation rate–let’s say core PCE–in order to bring inflation down. How do you view those formulas?

I would be very much in line with Chair Powell’s comments at the press conference. This is just one of many–I mean certainly that’s a thought process, it’s a rule–but we look at a variety of things, including the real-time information coming in the economy; the lags in monetary policy; (and) I talked today about the proxy funds rate. So what rate are you going to put in this Taylor rule? Those are all things that you have to be thoughtful about. So, you know, I never exclude an input. But I also don’t think that we’ve had a history–and I certainly don’t think this is the right way to make policy, where you’re just looking at a single rule and saying that’s going to be what we execute on, no matter what–those rules of thumb are very helpful guideposts, but they do not make good policy in all these situations.

And so I really am, as you saw and heard my speech today, broadening that conversation–the cumulative tightening we have in place, the lags of monetary policy, the evolution of the data. And just to remind everyone. the evolution of the data includes the fact that 7.7% inflation on a year-over-year basis is not price stability. And so while we can look at some of the indicators and say, “Oh, we’re in a going in a good direction,” we’re still very far from our goals.

Hi, President Daly, thanks so much for taking our questions. I was curious to hear if you have heard from businesses a dynamic that I am increasingly hearing from economists and small businesses that I talk to, where maybe they feel like their personal situation is actually great. They’re still looking to hire, they’re not worried about having to lay people off or shutting down, but they feel this sort of greater sense of foreboding in the rest of the economy. So there’s basically a gap between the way they feel like their own footing is, and where the rest of the economy is going. I was curious if that rings true to the businesses that you’re talking to at all, or what your thoughts on that gap might be. Thank you.

Yeah, thanks for the question. Honestly, I’ve been hearing this for over a year, that people’s own situation feels different than the situations they fear out there or that they even see out there. Right? So, as inflation has been running really high, I hear from many businesses that we can make our margins, but I know many businesses that can’t. And we all see examples of that. Or “I’m okay in how I’ve got my situation set up. But I know many other people are struggling.” That’s what happens when inflation gets high, frankly: People find workarounds. They find ways to manage. And for small businesses–and I talk to a lot of small businesses, I just had another small business roundtable–and I heard that you know, right now our most important problem … We can get around some of the hiring pieces because we’ve figured out how to do it. We still wish there were more workers available who want to work, but we’ve figured out something where we can manage our staffing. But the thing that keeps interrupting us is inflation.

And I guess I go back to other periods of time in our history when we’ve had high inflation–I was a kid when we had high inflation the last time–and it creates a sense of anxiety that the economy can just tip over at any point in time, because everyone knows it’s unsustainable. And then as the Fed reacts to bring it down, that creates uncertainty, of course, in what exactly it’s going to look like. And then we have international uncertainties about how things are evolving. So I think we’re in a high uncertainty time, which is going to make people have that sense of foreboding that something could happen in the economy. And as I said in my speech today, one of the things that I think is important is that we talk about the things that we’re looking at as policymakers and we help people… We can’t reassure people by giving them an exact answer of what exactly will it look like it and when will it happen. But we can absolutely be transparent about how we go there. So I am hearing similar things to you. And I guess the question I have is where is the foreboding coming from? And as I push on that myself, I hear it’s coming from this [sense that], “We feel like we’re in an unsustainable place. Inflation is just too high and at some point, it just wears the economy out.”

Thanks, President Daly, for taking my question. I’m trying to understand how to think about or use this proxy Fed funds rate, both in understanding the stance of policy, and how you use it. On the one hand, it seems you’re suggesting that one of the aspects–or the research suggests that one of the aspects of it–is forward guidance. And so to the extent that you rely on it and say that it’s something that would attenuate further rate hikes, it would tend to reduce the forward guidance component of that. I guess my question is does that suggest to you some reason to stop earlier because of the effects–or pause earlier–because of this proxy Fed funds rate? Thanks.

No, that’s not how I think about it. Actually, I think about it this way: That we had in our FOMC statement–but I’ve been talking about this for a while, as have others–that you have to take account of the cumulative tightening in the system to know how much more you need to do. And it doesn’t tell you what the level the settling level should be at all. It simply tells you what measures to look at when you’re thinking about cumulative tightening. And then, we get asked rightly the question, Well, how do you take into account forward guidance or the rolling off of the balance sheet? And so when I asked my team, how should we do this and put it back into funds rate space, so we have some metric, this is the system they came up with.

So I use the proxy rate as a point of data–not as indication we should stop earlier. I said this on your program the other day–I’m actually on the upper end of rate hikes. In your parlance, not mine–I actually wish we could eradicate this from our parlance, but I know I’m swimming an impossible lane here–but I would be on the more hawkish side. And why would they be on the more hawkish side? Because I really do want to make sure that the job is well and fully done. Inflation is a regressive tax. It injures most the people least able to bear it. And ending early, in a hope that it will go away and we’ve done enough, is not at all satisfying to me. So I am definitely using the proxy rate to think about where the cumulative tightening is, as we think about where the where we should go–we’ve got to raise and then hold, so where should we raise to before we start holding?–but for me, there’s no reason to be using that to talk ourselves, or talk myself, out of raising to something in the areas I gave you. Which is 5%, for me, as a good starting point. But we could go higher. If the data keep coming in on inflation and it’s hot, and the labor market doesn’t show the necessary adjustments that we need to ensure that it’s back to a sustainable place, then we’re going to have to raise more. And of course, the data could go a different way, because we want to be balanced, and we could end up raising less, which is how I got to 4.75 to 5.25. But I tend to be on the more hawkish side of the distribution, if you will, as I think about what needs to be done here and where the risks lie.

Hello. You touched on this a little bit in your speech–are we at a bit of a turning point in inflation now? And to put some meat on that, how would you interpret any divergence that might come up between headline and core, if gasoline, prices are slower or more volatile?

So let me answer the first part of the question, first. In my judgment, it is way too early to call a turning point on inflation. It is one month of data. And I can’t caution everyone enough that one month of data does not a victory make, does not a trend make, and it doesn’t give me comfort. I don’t feel more confident about it. I just see that was a good month of data. But I’m going to need more good months of data before I would ever extrapolate this to the kind of pivot on inflation that we need to see. And the kind of relief that we need to see if we’re going to restore price stability. So that’s how I feel about the data. Obviously, we’ll keep watching it as the incoming information comes in, but it’s far too early to call this a turning point in my judgment.

The second part of the question was the divergence in core and headline. I’m always cognizant of the fact that economists use core to think about the underlying rate of inflation. What do you get when you strip out sectors that are very volatile and can easily give you a head fake—Oh, inflation is going down! Oh, inflation is going up! We don’t want to be reactive to sectors that reverse themselves month to month. But Americans pay for gas and food. So we can’t ignore that as it erodes economic, purchasing power, economic wellbeing. I don’t get comforted when gas prices go down. But I do feel that Americans get relief … when they don’t have to pay high and rising prices at the pump. When food prices go down, that is something that is important for Americans’ pocketbooks. But I don’t say, “Oh, well, we’ve got a good crop. So now underlying inflation is going down.” It’s just a volatile sector. I’m really looking at core services and core goods as the indicators of when we can start to build confidence that we’re on the right path for getting inflation down.

Hey, Present Daly. You talk about this balance between the Fed tightening too much and you know, tightening not enough. And you can correct me if I’m wrong, but it’ll be fairly clear if the Fed does too little–right? Inflation will still be really high. I feel like it’s going to be a little bit more difficult to tell whether or not the Fed has adjusted too much, and [when you get to the] point at which you realize maybe you’ve adjusted too much, won’t it already be too late? Any guidance you can give on that question would be great.

I think the challenges of assessment are more equally balanced than that. And they didn’t used to be, I will give you that. Ten years ago, I think it would have been harder to know. But when we came out of the financial crisis, one of the developments that occurred during that aftermath was we really worked on developing a full labor market dashboard–one where you see signs well before you see it in the published aggregates. And while the unemployment rate and employment growth rate are good summary statistics, they’re lagging indicators. So we don’t look at those and wait to see those happen before we call it a day. That’s why you see so much focus on vacancy rates, on wage growth, on wage growth by sector, wage growth by group of people, geographic distribution, different wage levels, how they’re forming, what are small and large businesses doing in terms of their hiring. Those disaggregated variables can tell you early what is happening in the labor market so that you’re not waiting until you see the unemployment rate go up quite a lot and then say that must have been over tightening. I do feel we have a much more balanced impression.

And I’d say on the other side, it’s actually not that easy… I mean, neither one of these is easy. Knowing if inflation expectations are going to change is actually hard. So you have to monitor that constantly as well. And you have to use a lot of leading indicators. If you wait to see it really solidify in longer run inflation expectations. you’ve already lost the battle, and you have to go and do something more rigorous. So it’s not just that inflation remains high–that’s an easy one to spot. But we could be bringing inflation down, and it can still be too high. And we need to make sure it doesn’t get embedded in the in the inflation expectations.

That’s why continuing to say we’re going to keep doing this until the job is well and fully done–that means getting price stability, average inflation of 2%. Now as we get on a trajectory downward, that’s going to be a positive sign and we can hold rates in restrictive territory until we get the job fully done. But we really have to focus on getting the job fully done. And on the other side, continuing to raise rates, thinking that the data haven’t responded yet without paying attention to the lags–risks over-tightening. So there isn’t a simple answer.

And this is why I was joking with Steve just a moment ago, that I don’t like the hawk and dove. It’s really why it’s not an effective labeling right now. Because it isn’t a tradeoff between I only care about inflation, or I only care about the labor market. It’s about balancing these two objectives. And it really comes down to something simple: Be really resolute, focused, and committed bringing inflation down to 2% on average. And then be focused on doing it as gently as we can, so we don’t end up over-tightening. Because either one of those scenarios–where we under- or overdo it–is going to be really hard to measure if we’re only looking at the published aggregates. We’re going to have to look at the disaggregated data, leading indicators, talk to individuals, and see what’s really going on. Or we’re going to miss on either side.

Hi President Daly, thanks for the opportunity. I wanted to ask you about the necessary adjustment in the labor market that you’ve been alluding to, and what you’re seeing in terms of the dreaded wage-price spiral issue. What is it that you need to see in terms of labor market adjustment? And what are you hearing from people in your district on that wage issue in particular?

Sure. Let me start with the wage-price spiral, which of course is dreaded. But we don’t we don’t have any evidence that that’s happening right now. And we’ve been monitoring whether that was happening or occurring, or we saw any indicators of that, for the entire duration of this high inflation period. We’ve just really haven’t seen that.

A wage price spiral is one where prices rise, wages rise in lockstep, then prices rise again, and then wages rise again. The first starting point is wages aren’t rising in lockstep, right? Real wages on average are falling, not rising. And so that means we don’t have one of the fundamental ingredients of a wage price spiral, which is wages rise with inflation, and then a vicious cycle upward. We don’t see that.

So then when you think about what I’m hearing in my district, when I talk to my contacts, what I’m hearing is that they’re seeing wage growth still high but stepping down off the rapid pace of last year. So in my own district, the 12th district, we heard 4.5% to 5% wage increases overall last year. And now we’re hearing something like 3.5% to 4% for next year’s wage increases. Now that’s going to vary by sector and really hard-to-fill jobs. But that’s in general what I’m hearing.

I’m also hearing firms switching to more and different kinds of non-pecuniary compensation, like more flexible work hours, etc, as a way to help employees feel like they’re getting what they need, but not actually paying it through wages and salaries. So those are all signs, again, not of a wage price spiral, but an economy that’s adjusting to what is likely to be a slower pace of growth.

In terms of the necessary adjustments in the labor market, which you’ve heard almost every Fed official talk about. What do I look? One thing I look at is employment growth. So if you think about how labor markets adjust historically–especially ones that do so gently, and we know Alan Blinder has pointed out that we have many episodes of this you can go and refer to–here’s how it typically works. The first thing that happens is firms stop posting as many vacancies. They decide they just won’t refill their positions and they don’t post vacancies. We’ve seen vacancies come down over the course of the year–they bounce around month to month, but on average they’ve come down over the course of this year. The second thing that happens is firms stop recruiting with the intensity that they once were. So they might have that vacancy out there but they’re not spending night and day trying to fill it. And then the third thing that happens is they just stop hiring at the pace that they were hiring. So they don’t even have to go to a hiring freeze. They can just start hiring only what we would call the red jobs, the ones that absolutely have to be filled for the organization to run. And then the ones that are in yellow, that are nice to have, or ones that are in green–nice to have some day–they just stop filling those altogether. And so you can see the pace of hiring slow.

Right now, we’ve seen vacancies come down, as I mentioned. And we’ve seen the pace of hiring slow. But it still remains far above the amount of hiring per month that’s needed to keep pace with labor force growth. Depending on which calculation you’re using, that’s between 80,000 and 100,000 jobs per month. And as you know, we’re well over that. We’re in the 250,000 range per month on average. So one of the necessary adjustments is to bring the economy back in balance by having the number of jobs created be in line with the number of people coming into labor force to take them.

That doesn’t mean you’d need to see any increase in the unemployment rate?

Well, you would get a modest rise in the unemployment rate if the pace of hiring slows. You may not know this literature, but I’ll share it with you, and you may know it, is that most of the rise in unemployment doesn’t come from layoffs. It comes from a slower pace of hiring, a slower pace of job finding, right? There are several famous papers on this, but what drives it–and Rob Shimer at the University of Chicago wrote the most famous paper on this, and many papers after it confirmed the finding–what really determines the unemployment movements is the pace of hiring.

So I would expect some increase in the unemployment rate as the pace of hiring slows, because it takes workers longer to find jobs, which would increase the unemployment rate. But I wouldn’t expect it to translate–right now, I’m not seeing it translating into broad-based layoffs. I’m seeing these other margins of adjustment occur–vacancies are reduced, intensity of recruiting is reduced, and hiring is slowing.

President Daly, I wondered if you could tell us how you feel you’re leaning for the next FOMC meeting? Do you think it’s going to be another 75? Or do you think the Fed might be able to moderate to something smaller?

I’m not going to wait to front-run the committee discussions because they’re just in front of us. And we’re going to get additional data between now and then. So I will approach the decision–as I talked about it today in the speech–thinking about both sides of our job here. Both sides being, we have to be resolute to get inflation down and mindful that we actually don’t know what that destination–in terms of the rate we’ll hold at–looks like. And so even though I put it at around five… If I knew that with capital-C certainty, then I would go there. We could go there immediately. But we don’t know that with capital-T truth or capital-C certainty. And so we have to be thoughtful about how we do it. And I’ll be bringing that kind of a mindset to the FOMC, along with my colleagues, and we’ll deliberate and come to a decision.

Thank you so much for doing this. Hi, President Daly. Just sort of follow on that, and something else you said previously–sort of two questions, I guess is–you said we’re still well over 100,000 to 80,000 jobs. Is that really the level that you would need to see before you came off of hiking rates to hold them? And then secondly, on how you’re approaching the next meeting, if we were to get more hot reads on CPI and PCE, would that mean that 75 basis points is still on the table? Or given that the focus now seems to be shifting towards the yield ultimately, how high you go versus the pace, does that argue for a slowdown?

You’ve just described the complexity of the situations we face, and so I can’t give you a definitive answer. What I will say is it’s premature in my mind to take anything off the table. I feel I’m going into the meeting with the full range of adjustments that we could make on the table, and not taking anything off prematurely. I want to discuss this with the other members of the committee.

The second thing is, we could get another hot read on inflation. We could find ourselves with the slowing in the labor market occurring gradually. Those are all possibilities. And so I don’t feel that it’s appropriate to make policy based on one of those data points and say, “Well, you know, we don’t need state-based guidance at this point in my judgment. This would be state-based guidance, when you say the state of the labor market is X and so now we’re going to do Y. I just don’t feel that we need that right now.

What I feel what we need is the flexibility and the agility to adjust to the complexity of the economy as it emerges. Because right now, we have so many things going on at the same time. So we have to look for the prints on inflation–the headline and the core. And we have to look for the leading indicators by decomposing the inflation numbers and seeing where the adjustments are. We have to look at the labor market and all the details I just went through in a previous question. We have to think about the uncertainties in the global economy and what headwinds might be blowing against us. And we have to be mindful that all of those are going to change–or at least affect, if they don’t change it–they will affect what the final landing place will be before we hold the policy rate steady. And when we hold it steady, it’s still going to be restrictive.

And as I think I mentioned a couple of weeks ago, that’s actually going to be growing in its restrictiveness as we go because as inflation comes down, whatever policy rate we hold at will be becoming more restrictive to bring inflation down and the economy onto a sustainable path. So I’m definitely looking for all those indicators. But I can’t give you the recipe of indicators–it’s not a matrix for me where I say, okay, if we get these two things, it’s that policy. If we get these three things, it’s that policy. It’s really putting all of this together, discussing with my colleagues, deliberating it, debating it, and working out any difference in views we have, to come together, so that we can form the best policy for everyone.

Hi, and thank you very much. Hi President Daly, in today’s remarks you seem to be a bit concerned about the hiking of other central banks. Is there any possibility that the Federal Reserve would slow down the pace of tightening because of global economy, or development over financial market, or because overall financial stability? Thank you.

So let me be clear in my remarks to make sure I’m extra clear. I mentioned other central banks tightening because it is a factor that would affect the tightening of global financial conditions. And so obviously, when global financial conditions tighten, they affect global growth, which is then a headwind if it slows on the U.S. economy. So we have to be thoughtful about how that’s affecting the U.S. economic outlook and the U.S. economic outlook for growth and inflation. But we don’t make policy in this coordinated way. I mean, central banks are all raising rates for their own reasons, to support inflation reduction in their home countries. But we have to be thoughtful about how this plays out as it affects our own growth rates and things. Otherwise, we might miss if there’s a headwind. And so that’s why we do it.

I’ll also direct you to remarks President Williams made last week about financial stability and monetary policy—these are separate things. And so the best tools we have for financial stability are financial stability tools–micro and macro prudential tools; the things we put into place with other regulators to ensure that we have a stable financial system. The monetary policy part is really to achieve the two goals that we have been given by Congress, price stability and full employment. So absolutely, I monitor financial stability. I think about it. It’s one of the key things we think about, because a healthy and stable financial system is really important to a stable and sustainable economy. So if it starts to get worrisome in that way, that will negatively affect the economy. But when we’re making actual policy decisions, I’m coming there with these two goals, price stability and full employment. And it’s really the Board of Governors’ job to regulate. And then we supervise banks and our financial system to regulate and supervise the institutions in our jurisdiction so that we can ensure a stable financial system.

Thank you. Mary, there’s a lot of debate over whether rates are appropriately restrictive and whether financial conditions are also appropriately tight to impart the necessary downward pressure on activity and demand. If you look right now at the housing market, you’d be hard pressed to say that financial conditions aren’t tight, and obviously it’ll take some time for that to show up. But just looking at housing, what is the argument for continuing to raise rates? Isn’t the Fed risking the same mistake it made a year ago, when it kept policy very easy when the housing market was booming? And now tightening further when the market has rolled over and is very weak?

From my perspective, that’s putting too much focus on one component of what people pay for–and a component that is also affected by other things. If you think about housing markets, research at the San Francisco Fed–but other people have done other parts of this research–has shown that a big part of the housing boom was the fact that people were teleworking. They could move other places and they wanted really a big home. And so builders all switched and we started doing that, and then we quickly run out of supply. We also have a shortage of housing across the country that has never really recovered from after the financial crisis, when so many developers and builders were chastened by the fact that the housing market made a very severe correction, and then were very cautious about coming back up. So now if you look at it, we’re well behind where we need to be just to keep up with housing demand. Those are structural things that are taking place that are going on in addition to our interest rate changes. But when I look at the level of the funds rate that will be necessary–sufficiently restrictive to ensure that inflation comes down–I’m looking at other things than housing. I’m looking at housing, absolutely, and it’s been very responsive. It’s an interest-sensitive sector. It starts early in the process of lags and we’re seeing the developments we need. But we also know that core services inflation is continuing to either rise, or just stay very high. And so that’s obviously where more policy adjustments are going to be required. Because we’re watching for two things. One, get the inflation rate down. And two, ensure that it doesn’t get embedded into long term-inflation expectations, which so far has not. But we absolutely want to guard against that by ensuring that the job is fully done.

Hi, thanks for taking our questions, President Daly. I wanted to ask you a little bit about how you’re looking at the pace of tightening, especially after the December meeting. With your kind of emphasis on both being mindful and watching incoming data–and things shifting to more of looking at where the terminal rate is, rather than the pace of the rate increases–could we potentially see a meeting where we have a 50-basis point increase and then one where we have 25? And then maybe one where it goes up again to 50? How do you kind of see the pace when you look out at 2023?

Sure. Let me just say that all of those things you just named are absolutely possible. I can’t rule out anything, because part of being agile and flexible is responding to the incoming information and adjusting policy as we as we get that information, and [to]calibrate appropriately.

But let me step back from that and just talk about how I think about it. I said this before the last FOMC meeting even, in my last public comments, at some point it does become appropriate to step down the pace. Why does it become appropriate to step down the pace? Because we’re exiting that phase one, which we now are clearly exited, in my judgment. We have moved the rate up to modestly restrictive territory, so we no longer know the exact destination. We had clarity on that when we knew we need to get the accommodation out, so we could raise the rate really rapidly in these 75-basis-point increments.

Now we’re to a point where we are less clear on the destination. And so being more judicious in the pace to me seems like an appropriate thing to consider. But I don’t want to call it even because we have more information coming in. So it’s an appropriate thing to consider, and I’m writing down 50 or 75 or 25 for incoming meetings–those aren’t the same thing.

So if I were to be very cautious about of writing down a specific number, and actually more thoughtful about what were the conditions in which a particular path would be appropriate, then once we start stepping down the pace, I personally don’t start out saying well, we can go 75, and then 50, and then 25, and then 75. I think more of a gradual stepping-down to the pace that leads to the place where we’re getting closer to the stop point before we just hold the rate. And why is that? Well, I think it’s less confusing basically for people, if they say okay, you’re doing that as we get nearer. You slow down as you get closer to the destination, but the destination isn’t completely certain. You slow down.

There’s many analogies. None of them seem to work without somebody flipping it on the other side. But let’s use a car. It seems the safest. As is I get closer to the place where I’m going to stop, but I don’t exactly know where someone wants me to park, I do slow down. So I start slowing down when I get to the parking lot. Then once I get to the parking lot, I’m looking at where they’re waving me in. If I’m going into a concert or something, I slow down even more so that I don’t miss what they’re trying to get me to do. That same principle to me holds on interest rate policy.

Thanks, President Daly. Your team in San Francisco has done some interesting work trying to sort of break up inflation into the part that is demand driven, and sensitive to your rate policies, versus the part that’s driven by supply shocks, and therefore less sensitive. How do you think that mix has changed over time, and as inflation has broadened out, do you think more demand-driven now?

It’s still about 50/50 with the latest data–50% demand-driven, 50% supply-driven. For a while it looked like supply was gaining, and supply was contributing more than demand. But you’re absolutely right: As it’s broadened out, it’s in core services and demand gets more of that weight.

And then also supply chains are starting to improve. We’re seeing that in inventories for retailers. I’m here in Southern California [where] the ports are not nearly as stacked up as they once were. We’re hearing about shipping prices from my contacts–shipping prices are coming down. People are we more willing to write forward contracts because they don’t think that the price is going to unravel around them. So we’re seeing supply chains start to repair. It’s too early to call out a victory out there but they’re starting to repair. So we’re still in that 50/50 bow, which means that we still have 50% of the job to do in terms of combating excess inflation and bringing it down.

You’re absolutely right. You said inflation is broadening out. But one of the places I really pay a lot of attention to is core services. Core services is where our levers have a lot of power. And the first part of core services, of course, is housing services and shelter. And we know how that’s shaping up. We’re actually pretty good at knowing where that’s headed because we have that information. But it’s the other parts of core services that I’m watching very carefully–along with the core goods–to see what’s really going to happen to underlying inflation. Are we going to get enough traction to bring it down at a reasonable pace so that we can restore price stability? That’s how I think about it.