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

Alex Mehran, Sr.:

Good morning everybody. Welcome, most particularly Mary. Welcome back to the Fisher Center.

Mary C. Daly:

Glad to be here.

Alex Mehran, Sr.:

It’s been two years since you were last here and we had a very illuminating conversation at that time, and you were able to prescribe what the Fed policy was going to be and in fact, we pretty much went along those lines in terms of creating a monetary policy that was more in line with the current economic patterns and I hope we’re able to do that same kind of thing today. What I wanted to do was just get a baseline as to where we are today in the economy and talk a bit about the neutral rate and the balance sheet, two of my favorite topics, and then drill down on the four pillars of the current administration’s policies of fiscal policy, immigration, regulation, and trade. So let’s start with baseline. In your view, where are we in the US economy today?

Mary C. Daly:

Yeah, and that’s the number one question really as a policymaker, and I think for all of you. So the US economy has been extremely resilient and in my determination is in a good place. I mean, think of the unemployment rate, 4.2% has been this way for a while that we’ve been near historic lows for a while. So that’s a good labor market and we’re hearing repeatedly that people can find jobs who want them, and importantly, employers can find candidates when they need them. So that’s a sustainable, solid labor market. Growth has come in remarkably well. Even though we’ve had the interest rate in restrictive territory for some time to combat inflation, growth remains quite good and is a pillar of how the economy expands. And then of course inflation has been coming down. It remains above our target, but we’re making gradual progress, ongoing progress, and that is reflective, I think, of the tighter monetary policy that slowed the economy to a sustainable pace and brought inflation closer to price stability.

So that’s the backdrop. Of course, the number one word if you search with Google or anything, is actually not tariffs. It’s uncertainty. And I think the uncertainty is the thing that’s across the business community, the consumer community, is that uncertainty is out there. So then the question is, is uncertainty just a big weight on the economy, or how are companies, how are firms, how are consumers dealing with it? And they all offer one thing that I think will help us have the rest of the conversation. When we talk to businesses, we’re hearing that businesses are still penciling out and investing in good projects. And you see this in the investment numbers, hasn’t fallen off the cliff. People are still out there doing things. There’s not a sense of, oh, we have to stop activity, but there’s just uncertainty about how much we could engage in.

Of course, for businesses that are directly affected by tariffs, say distribution, trucking, things like that, they are slowing down a little bit as companies try to figure out what the tariffs mean for them. But I think ultimately uncertainty hasn’t been this weight on the economy as of yet. It’s just something that’s out there and companies are continuing to move forward. So when I put that together with the retail spending numbers that came out and they were still positive, although slower, they’re heading down to a sustainable pace, people are still out there, which just tells me that the economy has good momentum, we’re in a solid place, and of course monetary policy remains restrictive to continue to put downward pressure on inflation.

Alex Mehran, Sr.:

So I want to ask a question about policy outlooks and data dependency. So we’re probably going to see some pretty good data in the next couple of months because of pulling forward of demand based upon expectations. But your policy prognostications are going to have to be based on something other than data dependency because you have to look through some of that. How are you going to do that?

Mary C. Daly:

Sure, and I still wouldn’t think of it as data dependency, but I want to broaden what I think people typically think of as data. So oftentimes when I say data dependency, people believe or think that we’re talking about the published data that comes out that is almost always backward-looking and definitely influenced by the things you just mentioned, Alex, consumers or businesses trying to ramp up before things happen. What we also do though is we’re out. One of the really important aspects of Federal Reserve banks and the presidents who lead them and all their teams, so we have 12 of those banks across the nation, as you know, is we’re out in the field as we call it all the time, talking to CEOs, talking to worker groups, consumer groups, community groups, and we’re asking questions about not what are you doing today, but what are you doing at the end of the year?

What are you doing forward? And those things are also data. And so as we make policy in this time where there’s more volatility in the information sets, especially the published ones, we really do have to lean towards talking with people about their future plans. And what we’re hearing so far is that there is a little bit of pulling forward, but not as much as you might think. I mean example is I like to do a lot of my own field work on weekends where I go to consumer outlets. So last week there were long lines at the electronics store before the announcement that electronics would not be subject to the immediate tariffs, long lines with people exchanging smartphones, buying TVs, and then it all stopped. And one of the things I learned in the last couple of days is many of those people who bought them are actually returning them now because they didn’t really need a new TV, they just thought they’d get ahead.

So I think the electronic stores are going to have a lot of accounting exercises they have to do, but I think ultimately what you see is there’s some of that noise, but the overarching part of the economy is what do businesses plan to do? And so far we haven’t heard a lot about layoffs. We haven’t heard a lot about pulling back and hunkering down. There are some industries of course that are directly affected immediately, but for the most part I haven’t seen that. So when I think of data dependence, I think of the collection of information we regularly do and then the importance of that information in our scheme of trying to project or forecast the economy.

And right now I put a lot of weight on the information we collect from businesses who are actually putting real money on the line to make investments that don’t even arrive at our shores necessarily or arrive and to break ground on until the end of the year. And I think that’s where I’m getting this sense that the uncertainty hasn’t stalled out activity. It might make you less willing to take a risk, but if projects still pencil out, the interest rates came down 100 basis points last year, people are ready to engage, you’re still out there.

Alex Mehran, Sr.:

So you’re looking at hard data and some soft indications based upon anecdotal evidence.

Mary C. Daly:

Well, that’s a really interesting conversation and I’m just going to pull that thread a little bit. So if we say anecdotal evidence, people think you mean I talk to two people. But what we’re doing is we’re collecting this information across. We’re doing surveys, actual written surveys, I have CEO roundtables almost every week and multiple ones and we are getting information. I have the nine Western states in case you haven’t memorized the Federal Reserve system. So that’s a lot of diversity. My district, the 12th district, is basically a microcosm of the activities across the United States. So I feel like I have a rich set of information, and when you add up qualitative information and you do it at scale, then that becomes as reliable as what we often think of as the hard data. And then of course there’s the sentiment data, and that’s what I think people are really talking about.

Alex Mehran, Sr.:

Let’s talk about that for a second. Let’s talk about Michigan and New York Fed consumer confidence. So where are they right now?

Mary C. Daly:

They’re feeling what businesses are feeling. So how many businesses in the room feel a little uncertain right now? Okay, so now take consumers. They feel that uncertainty. I mean when consumers have to show up and say, okay, I’m going to buy my smartphone, my TV, now I don’t need it. That’s just uncertainty. And so that weighs on sentiment because it’s fearful and if you read the news, I mean you think we’re at the precipice of decline, but if you actually talk to businesses, you see through that and the proof is in the behavior, not the sentiment. The proof is in the behavior. What did consumers do while they were feeling less positive about the future? They spent money, retail sales came in. And so ultimately I have a view that people vote with their feet and that can sometimes mean people can move, but sometimes it means that they can walk in and buy.

If you’re buying things, if you’re investing in a future in the economy, if you’re still finding jobs, if you’re able to do the things you want to do and inflation continues to come down, I think that’s going to ultimately spur the activity while we weather this. And fortunately, and I feel really good about this, we have policy in a good place. We had lowered the policy rate by 100 basis points. It puts us in a good place in the economy to just have more time to evaluate what the impacts are going to be over the longer term and then make decisions as we need to. But we’re in no rush to do so.

Alex Mehran, Sr.:

So let’s talk about the neutral rate. So last time we had a very informative discussion about the neutral rate where we were at 0.5, real neutral rate. The neutral rate is the rate at which the Fed is neither in an expansionary mode or contractionary mode, and I think that’s the kind of magic elixir that the Fed policy is looking for. So today, where do you think we are in terms of the neutral rate, in real terms and then we’ll talk about nominal.

Mary C. Daly:

That sounds great. So real terms, and I actually love talking with Alex because not everybody asks me about the neutral rate, but you do. So I appreciate that. A scholar of the Fed, so the neutral rate isn’t a truth with a capital T that we go and look at the wisdom books and we say, okay, there it is. So it’s an estimated variable and we often learn where it’s at experientially by seeing how our policy actions impact the economy. And then we can also look at the fundamentals, what drives the neutral rate up or down. And the consensus has emerged really that the pressures on the neutral rate have been upwards. And so instead of being 0.5 in real terms, it’s closer to one in real terms. Some people will put it higher than that, some people will hang on a little lower.

For me, I’m very comfortable saying it’s around one, and then if it turns out to be a little more than one or a little less than one, we’ll find that out. But I think the pressures on the neutral rate have been upwards, not downwards. And so we have to be conscious of that as we lower the policy rate. And I think this is something I’ve seen, you can see it in surveys et cetera, that the consensus is not just at the Fed or among policymakers. You can look at our Summary of Economic Projections and see it’s drifted up. It’s also in the marketplace and things. If you ask people are we going back to the low interest rates of the settling place of the pre-pandemic era, most people understand that’s not happening. And so you have to reset. So that puts the nominal at 3% instead of 2.5 if you had 2% inflation. So that’s where I think it’s going.

Alex Mehran, Sr.:

Where is the inflation expectation number now? The three-year expectation?

Mary C. Daly:

The short run inflation expectations have come up quite a bit in the last couple of months, well last three months. But the medium and longer run, which is what we look at for expectations, that’s still covering around 2%. And so-

Alex Mehran, Sr.:

So that’s come down.

Mary C. Daly:

It’s come down quite a bit from well, so in the high inflation period, longer run barely budged. It moved up to our 2% target. And I base all this not on if they run historically higher, I just take that constant away. So basically they’ve been stable at our price stability goal. Then medium drifted up a little bit, but has come down since we really got some traction on fighting inflation. And short run is very sensitive to food and energy prices and to the sentiment indices. So you see that drifting up a bit, but hopefully as people recognize that it hasn’t bled into medium term. And ultimately that’s what we want to keep true is that when short run bleeds into medium and longer run, then that’s when we worry about our anchor. But right now I’m very definitively guarding the anchor, but I’m not worried about the anchor.

Alex Mehran, Sr.:

So based upon where we are today, we’ve got a 1% neutral rate, a 2% inflation expectation medium term, which leads us to a target of about 3% over the course of the next couple of years.

Mary C. Daly:

That’s right.

Alex Mehran, Sr.:

We are at four and a quarter to four and a half. So that would mean we’d be reducing by a few reductions, all things being equal.

Mary C. Daly:

Right. We have room to reduce.

Alex Mehran, Sr.:

But all things aren’t equal at this point.

Mary C. Daly:

Yeah, we have room to reduce and I think as we reduce, I mean I’ve been an advocate for this for a while, we need to be gradual in our actions for two reasons. One to make sure we’re consistently getting inflation down to 2%, but also to ensure that the 3% is just an estimate of the nominal neutral if it’s higher, and you can look at the Summary of Economic Projections that we put out and you can see participants have different views about this and that’s because it’s not known. And so we have to be thoughtful about how we get there so that we don’t end up reducing too much.

Alex Mehran, Sr.:

But for the audience, the importance of where neutral is is critical because it dictates how contractionary or expansionary the Fed policy is.

Mary C. Daly:

It does. Absolutely.

Alex Mehran, Sr.:

So that’s why there’s some dispute about that.

Mary C. Daly:

No, absolutely.

Alex Mehran, Sr.:

So let’s talk about the balance sheet. So you have taken the balance sheet down by about $2 trillion from the $9 trillion peak, which is probably worth 100 basis points worth of contraction?

Mary C. Daly:

So the way I think about the balance sheet is that when we announced, so we had it-

Alex Mehran, Sr.:

First of all, let me give an explanation to everybody about the purpose of the balance sheet and what its composition is.

Mary C. Daly:

Sure. So that-

Alex Mehran, Sr.:

We’ve got a balance sheet of about seven-

Mary C. Daly:

Yeah, 6.8, something like that.

Alex Mehran, Sr.:

Trillion.

Mary C. Daly:

Trillion, yeah T. That is a capital T, trillion. So the balance sheet has, the way we think of it, has currency, it has reserves, and then we have the TGA, the Treasury General Account and some other things. But the two things that are really important are currency and circulation. That’s a liability for us. And then the reserves that banks hold. So what we do in times when we are constrained by the zero lower bound, we have three tools really we have one principle tool. So you’ll always hear policymakers talk about two goals in one tool. So the price debility goal, the full employment goal, the interest rate is our tool, but sometimes that interest rate, the Fed funds rate, is constrained by the zero lower bound. You saw that in the pandemic, et cetera, in the financial crisis. When that occurs, then we have other tools that we can use to help support the economy.

So the second-best tool in my opinion, the first one is the funds rate. The second-best tool in my opinion is the forward guidance. What we’re going to do over time, so that can anchor people’s expectations, which can be an assistant to getting the policy where we need it to be and having people hold it for a duration. And then the third tool that we use in those situations is the balance sheet. And basically we put reserves into the system by buying treasuries and MBS. And when we do that, reserves go into the system and then that should facilitate banks lending to support activities. So when we started to normalize policy, so we had the interest rate very low, then we started to normalize policy by raising the interest rate to fight inflation. Then we began the process of normalizing the balance sheet. So the first thing is you stop purchasing, then you start running off. And so as you probably know-

Alex Mehran, Sr.:

Define the runoff.

Mary C. Daly:

The runoff is we’re letting the treasuries roll off at maturity and we’re not reinvesting them in to keep the balance sheet high. And so that’s how you get that multiple trillions of runoff already. So when are we going to stop? That’s the question. And what we have is a policy of ample reserves. We want enough reserves that it facilitates our funds rate policy, et cetera, but we don’t want them to be so large that we have an unnecessarily large footprint in the financial system and an unnecessarily large balance sheet. So this is what you’re going to hear sometimes the difference in abundant reserves versus ample. So right now, my own assessment, and this would be the assessment you heard Chair Powell say this in the press conference. Our reserves are abundant right now. We have more room to run off to get the balance sheet to be smaller and to get to that ample number.

But of course like the neutral rate of interest, ample’s not a number in the wisdom book, which I wish we had a lot of times, but we don’t. But you don’t have a number already prescribed. You find it as you go because ample is the ample reserves to provide liquidity across banks that they need to fund their activities. So we are still far away from what we think is ample, but how far away is not known. So what we do is we slow the pace of runoff and that’s what we did at the last meeting. Why do we slow the pace of runoff? Because as you approach getting to this ample, even if it’s sizably a number of months or a year away, you don’t want to run into it abruptly. And doing that causes disorderliness in the marketplace and we don’t want that. And so we are slowing the pace of runoff, but we have ways to go before we get to ample and that’s where think we will, we are just going to continue to go until we get to an ample point.

Alex Mehran, Sr.:

So what’s your estimate of the contractionary?

Mary C. Daly:

So that’s where we were. Yes. So how I think about it is the day we make the announcement that we’re going to run off the balance sheet, that’s when all the tightening occurs and then the rest of it’s just mechanical and markets expect it. So the one lesson you learn if you study monetary policy or central banking, and this is true for the last 20 years at least perhaps longer, is that it’s expectations, it not actions that really matter. And so it’s the expectations of what we will do.

So the moment the FOMC rather announced that we’re going to run our balance sheet down to ample, well then the markets priced all that in. And our runoff plans were really roughly worth 100 basis points in terms of tightening. And so if you think about the tightening cycle we were doing, it was the tightening, we got the interest rate increase, we got the forward guidance, and we got the balance sheet effect all at once, and that helped combat inflation. At this point, whether we go fast or slow is not that relevant for the tightening in the economy. It may be relevant to markets because markets have to react to our communications of these things, which is why we tend to communicate early and often on this and then tell people where we’re going to be for a while.

Alex Mehran, Sr.:

So of the seven trill, how much is currency?

Mary C. Daly:

About 2.3 if I’ve got my memory.

Alex Mehran, Sr.:

2.3. So it’s actually come down a little bit.

Mary C. Daly:

I think so. And I am looking at my fact-checkers. I had my little paper here. Alex likes to use late numbers, which I totally appreciate. So okay, 2.3, I hit it.

Alex Mehran, Sr.:

2.3. Good. Okay.

Mary C. Daly:

I looked it up and I hit it. I was like, okay, that’s what Alex is going to ask me. How much currency.

Alex Mehran, Sr.:

And what’s the Treasury account?

Mary C. Daly:

Look at this. Okay, here we go, 6.68 trillion in liabilities. I’m going to give you the whole thing. Currency 2.3.

Alex Mehran, Sr.:

6.6.

Mary C. Daly:

6.6.

Alex Mehran, Sr.:

Okay.

Mary C. Daly:

2.3 trillion is currency, 3.5 trillion is reserves, the TGA is 0.3 and other liabilities are 0.6.

Alex Mehran, Sr.:

So 3.5-

Mary C. Daly:

Want to keep this?

Alex Mehran, Sr.:

Okay, so we’ve got room for-

Mary C. Daly:

We’ve got room.

Alex Mehran, Sr.:

So you’ll continue to have some quantitative tightening.

Mary C. Daly:

Absolutely. Until we get to ample. And I think at this point, while people in the marketplace call it QT, I will emphasize that from my own perspective using the research of financial economists, financial outside academics, et cetera. Really the important point is that the big impact of the tightening occurs right when we announce and then markets price it in along the entire duration of the runoff and only surprises after that would be an additional change in policy stance.

Alex Mehran, Sr.:

And when you have market turmoil, does that lead you to believe you should have more reserves to deal with the liquidity issues that are demanded from the New York Fed?

Mary C. Daly:

Well, the markets does those follow liquidity issues and pressures and you heard the chair mention debt ceiling issues. And so the slowing is really relevant for a whole host of things. I think of the slowing of the runoff as a baseline. This is what we did in the past runoff. It really is just an opportunity to make sure we’re not going too fast in a period of time where we might run into the ample quicker than we anticipate it. And so that can facilitate liquidity dynamics around the dead ceiling or around market issues, etc.

Alex Mehran, Sr.:

But you have a sense of what the landing place is.

Mary C. Daly:

I think right now I don’t have a sense. It’s really something that you don’t want to pre-commit to and then find out that you are making a mistake because it really reflects the demand for reserves in the system and that’s affected by a variety of things, appetite for liquidity, how they manage their own books. It also can be affected by regulation. Those are all things that are in play. And so I just want to be mindful that not knowing doesn’t mean we can’t act. And so we’re doing the slower runoff and it’s still running off and we’re still heading for ample. I mean I think that you hear in other people’s commentary, but let me speak for myself, a strong commitment to getting to an ample place. We don’t want to sit with abundant reserves when it’s not necessary. We really want to get to an ample reserves environment, but we have to do that in a way that is supportive of the activities we’re trying to accomplish, which is not to add to any concerns.

Alex Mehran, Sr.:

So we’ve seen some real volatility in the bond market in the last few weeks. What kind of global impact have you seen in terms of the flow of funds in and out of the system?

Mary C. Daly:

I think I’m going to back up a little bit, Alex, if you don’t mind and just reiterate what the Chair said yesterday in his remarks. Was it yesterday or the day before? I can’t remember. It all blends in when you’re here.

Alex Mehran, Sr.:

Wednesday.

Mary C. Daly:

Wednesday. So when he said Wednesday, and this is exactly how I think about it, so let me speak for myself here, is that the volatility we’ve been seeing in any flow of funds dynamics, are really just a reaction to the marketplace trying to digest the changes that are going on in policy environment, whether it’s the tariff announcements or other global trade negotiations taking place. Then markets need time to digest that and they’re, unlike the Fed, we look over the long term because our policy has long and variable lags.

Markets are making bets on an hourly or at least a daily basis. And so they’re trying to assess. And so this kind of volatility would be expected in the marketplace and movements back and forth as both the policy dynamics change and the understanding of how the policy changes will affect the economy evolve. So those are both things that are going to matter for this. And so as long as it’s orderly, and it’s consistent with what you see going on in the world, then that’s something that you would just expect. And that’s where my mind is on this is that this is all just settling out as we get more clarity about the tariffs.

Alex Mehran, Sr.:

But in terms of global flows, are you seeing anything unusual in global flows?

Mary C. Daly:

Nothing unusual if you ask the question, what would we expect to happen given the global trade renegotiation. I mean this is a very large renegotiation of trade relationships across the globe and those are going to have impacts on how businesses position and what people invest in, et cetera. I mean the easiest way to understand that is just to think about my experience at the electronics store. When people hear it, one thing, they behave one way, when they hear a different thing, they behave a different way. Global investors, global traders, and market participants domestically and businesses are all doing exactly the same thing. And so I would expect these things to move around. What I guess I’m cautioning against is thinking that whatever we heard yesterday will persist until next week.

Because investors will, once they hear where we’re going to land, then we have more clarity that they might stay there. But right now we don’t know. And so I think what’s really hard for all of us as humans, I mean I think this is a human condition. We don’t really like uncertainty. So we try to fix on whatever just happened as what will probably happen next week. And I think that’s the caution I want to have us all take, which is why you hear the Chair Wednesday, but I’m going to say today, that really we have the room to think through this to not react where we don’t have to be urgent in our reactions because the economy’s in a good place and policy’s in a good place, and we have the time to think about this as we watch these things settle out.

Alex Mehran, Sr.:

So let’s be a little predictive here. I want to go through the four elements of the administration’s economic policy.

Mary C. Daly:

It always makes me nervous when you say predictive, but I’m going to go ahead here.

Alex Mehran, Sr.:

The four pillars of the administration’s economic policy of immigration, trade, fiscal policy, and deregulation. Let’s go through them one at a time and talk about the spectrum of policy outcomes based upon the spectrum of monetary policy outcomes based upon the possibilities of administrative action on these four issues. So let’s take an easy one first, which is immigration.

Mary C. Daly:

So if I may, Alex, I’m just going to say before we start, and I’m happy to do this, but let me just say-

Alex Mehran, Sr.:

Before you say anything, the views you represent here are solely your own and do not represent those of the Federal Reserve Bank.

Mary C. Daly:

That’s true. I’ve been saying my views, my views, my views. I’ll give you the full disclaimer, but every time I say, as the Chair said Wednesday, but let me share my view, it is just this commitment that each of us have as members of, the participants in the FOMC, that when we’re speaking, it reflects our views and that’s the strength of the system, if I may say. There are 19 of us, we come with our own views, we debate, we discuss, it’s vigorous, and then we collectively determine what we believe and think is the best policy at the moment in time. And then we make those decisions and that’s what you see us release in terms of the statement and the decision.

Alex Mehran, Sr.:

Immigration.

Mary C. Daly:

Okay, I’m going to go back. I can’t stop without saying that because the world right now, I think the reason I brought this up, Alex, is that the world is asking, okay, how does the Fed work? And I just want to make sure you’re well-equipped to repeat how the Fed works. So that’s it. So now I’m going to go back and I’m going to back up. So as we talk about immigration, so right now, and this is true of any new administration, when a new administration takes office, they always have a slate of policies that they want to put forth. And policymakers, the discipline we have to have is while we can look at each one individually, we can’t evaluate them individually. We have to evaluate them in their offsetting and amplifying effects. And so I don’t think of just immigration policy, I think of immigration policy in the context of all the policy that you make.

And then we have to do the net-net, which I know you’re very familiar with in real estate. You have to net out the effects so that you actually know the impact. So let me start with immigration. So if you just drew a balance sheet chart and you had positive/negative for the economy, positive/negative for inflation, then the basic math of economics or models would say that if you constrain labor force anyway, whether it’s by reducing the flow of immigration or anything else, then that way we have a negative impact on growth and a positive impact on inflation. But the big conditional component of that, if I may, is what’s happening in the economy. So right now, the labor market is slowing anyway to a sustainable pace. And so the lack of immigration flows, which have dropped off quite considerably, hasn’t really impacted the unemployment rate.

And you saw that in the incoming data, hasn’t really impacted firms ability to find workers. One of the things we ask, so I think right now the immigration changes are not having an immediate effect on the labor market because the labor market’s already slowing to a place where the domestic workforce can meet the demands. If this had happened when we had a real shortage, might’ve had a different effect. But right now, so far, in theory it could have an effect, but so far we haven’t seen it in wages and we haven’t seen it in hiring. And now that doesn’t mean particular industries that rely heavily on an immigrant workforce haven’t been affected, but my job is to look across the entire economy and ask the question what’s occurring? And right now we’re not seeing that. And part of it is because our domestic labor force participation rate is rising, which is a positive thing.

Alex Mehran, Sr.:

And productivity.

Mary C. Daly:

And productivity.

Alex Mehran, Sr.:

So trend growth is a pretty simple formula of population growth times productivity growth gives you trend growth. And so are we getting a little bump in productivity that helps offset this reduction in immigration?

Mary C. Daly:

So we have had two positive, what I would think of as supply effects. One is labor force. And the labor force growth has been both immigration, but it’s also been the domestic labor force participation rate. San Francisco Fed has some research that’s shown that women in particular had an increase in labor force participation since the pandemic. Remember after the pandemic, everybody said women would never work again? I did say that I have the headlines to prove it, and it’s the same thing when men had gotten displaced from jobs after the financial crisis and men would never work again. But what’s true is people work when there are jobs available. And so the jobs available, women came back into the labor force and you saw this, if you’re interested in the details of it, you can look at the San Francisco Fed website, but people are coming back to work.

Now it’s true that we have these other issues like I just released a working paper actually with colleagues that said that male labor force participation over decades has been declining. And that’s a real structural thing, but the cyclical response is people are coming back to work. So that’s a positive supply boost to our growth rate. The second one is of course productivity. And the number one question I get when I say productivity, we’ve gotten a little boost on productivity, is that AI? And I said, well, I think if you define AI in a very general way, not the way people think of when they think of ChatGPT or any of the other models, Grok, etc.

It really is a reflection of when firms have a tight labor market, what do they do? They invest in automation. So you probably have noticed when you go to any retail outlet, travel, etc, they’ve really gone to kiosks, self-service, order here on your phone and get things. All of that is just a response to the fact that the technology’s there and the labor market was so tight for several years that you were willing to pay the price to invest in that. So that’s going to give us a productivity boost. The question for policymakers is how long does it last?

Alex Mehran, Sr.:

Yeah, let’s talk about fiscal policy for a second. So let’s put the current budget proposal as a possibility and move from what that spectrum is of where the fiscal policy might end up and what monetary policy implications are associated therewith.

Mary C. Daly:

So monetary policy and fiscal policy, completely separate where we just take the economy we’re given and we react to it against our dual mandate goals. So we look at full employment and price stability. So right now we have elevated inflation. We’re still working on that, a good labor market. So that’s the context. Then for decades, fiscal has been coming in and spending more and investing in more, whether it’s direct transfers to consumers during the pandemic, or investments in infrastructure. And this administration seems to be wanting to do some of the same things. They invest in different things perhaps, but they’re all doing those same things. When that happens, the impact on the economy depends on whether or not the economy’s already at capacity or not. So if there’s excess capacity, it’s not inflationary. If there’s not excess capacity, it can be inflationary. It is usually growth oriented, but the growth and the inflation are often mistimed or untimed.

So you get the inflation first, you get the growth later. But the truth about all fiscal expenditure that is sometimes left behind is it takes time to roll it out. You get the money, then you do the planning, there are very few shovel-ready projects that get it and start immediately. Then you do the planning, then you do the shovels, then the investment, and so it pours out over a period of time. It’s not immediate. So I think this is fiscal, if you just did the model, would be a positive on growth, a positive on inflation. But that really depends on what the fiscal is doing. Is it direct-to-consumer transfers? Is it investment? How long does it take? Is the economy able to absorb the demand that’s coming from fiscal, or is it on top of an already hot economy? And all of that matters.

Alex Mehran, Sr.:

But if you have tax cuts and government cuts, how does that net them? How does it net?

Mary C. Daly:

So tax cut would typically, depending on where the tax cut goes, and if it’s material, would have a positive on growth. And especially in businesses, you think positive on growth. If it’s consumers, you think more household income, disposable income, that can be a positive for spending. So that’s going on. If government’s cutting its expenditures, then that can net out. But if government’s still spending, then you run deficits. And I know that’s ultimately what the administration, and this is I think the importance of Fed independence. So the administration’s making a set of decisions that they’re our elected officials, we’ve empowered them to make these decisions. The Federal Reserve and Congress foresaw this, I think, said, well, we don’t want the Fed responding to the daily activities of any administration since 1913. We want the Fed to think about longer-term goals of price stability and full employment. And if we always look through that lens, then that’s the discipline we have about when we change the policy rate.

Alex Mehran, Sr.:

So tax policy runs into deficits?

Mary C. Daly:

Sometimes.

Alex Mehran, Sr.:

Yes, sometimes. But in this case it certainly would be increasing the deficit, barring other changes in the budget. And that’s going to put pressure on the long-term bond market. Is that going to have an implication for you all or not?

Mary C. Daly:

When we think about the long-term bond market, I don’t think domestically, I think globally, because financial markets are global. And so there’s ultimately this question about the neutral rate of interest, which is where we more or less began. And what sovereigns across the globe are dealing with is they spent a lot of money in the financial crisis, then they tightened the belt, then the pandemic came, spent a lot of money to get out of the pandemic. And now the question is what’s their trajectory for sovereigns? Are they going to keep spending money to get out? Are they going to keep running deficits? If there is this deficit in accumulation of debt, which you could just get to simply from the aging of the population across the globe, then you’re going to find the neutral rate of interest drifting up a bit, which I think it’s already done.

So for monetary policy, it really means what we’ve already talked about. That we might find that the neutral rate of interest is higher than we thought, which we’ve already penciled in. You see this again in the Summary of Economic Projections. More than that, I don’t think we need to worry about, because ultimately this is about where we settle the interest rate, but it doesn’t change the dynamics around that level. From a policymaker’s perspective, you still raise the interest rate, you still lower the interest rate, it’s about estimating that number right. And the factors that we’ve already talked about are pushing the neutral rate of interest up in all likelihood.

Alex Mehran, Sr.:

Okay, so let’s talk about regulation for a moment.

Mary C. Daly:

So regulation is again something like-

Alex Mehran, Sr.:

Deregulation.

Mary C. Daly:

Yeah, but changing regulation, whether you change it to make it harsher or less harsh, it takes time to come through. And so when you think about the administration’s policies they want to deregulate, if you trace back to the sentiment surveys in businesses, that gave people a big boost. And when we went out and did our CEO round tables and talked across the country, my other colleagues and I heard in the 12th district, were really excited about some of the deregulation because it can speed us up on projects, anything from housing to manufacturing. And when we do that, we will grow faster. So, the question is how quickly can that happen? Now, one thing that I have been hearing is that, and this is about posture more than changes in the law, so even before you’re going to change in the law, you can change the intensity of how you think about or interpret rulings.

And so we were in different states across the district, not California, and we’re hearing that just the basic things about how long it takes to get a permit approved, how long it takes to get something built when you had to get approval from the federal regulators, that’s just speeding up a bit. And so that’s a positive for projects being able to develop. And the fossil fuel industry is very much feeling this because they’re able to move forward on projects like in Alaska and other places where resource extraction is important to their economy. That’s been sped up a bit. And so that’s a positive for growth.

Alex Mehran, Sr.:

And the 800 pound gorilla, trade.

Mary C. Daly:

So trade is something that is in process of being reconsidered. It depends really on who you talk to, whether you think this is a positive or a negative. Because if you’re in an industry that you feel has been not getting a great deal in the global trade, then you’re excited about a rebalancing of the equation. If you’re in an industry where, like in agriculture is really one of them, where they feel like if our commodities are tariffed going into other countries, that’s a market we won’t have anymore. And so there’s a transition dynamic. Ultimately the Federal Reserve, we don’t commentate on whether we should have trade changes or not, but what we do is collect the information about how that’s likely to affect the economy, and how long that effect will take. And this is where I want to say three words that I think you have to keep in mind, scope, magnitude, timing.

Okay, let me tell you what I mean by that. It matters what the scope of the trade rebalancing is. If it’s narrow, then it’s different in the economy than if it’s broad. So that’s one thing. The second is the magnitude. If it’s large, the impact is greater than if it’s small. And finally, it’s the timing. If it’s a light switch, then it’s going to have a bigger impact on the economy than if it’s a slow roll. So right now we actually, I don’t think know exactly how this will play out. Because we had the scope, magnitude, and timing all look very large, broad scope, large magnitude, immediate timing. But then subsequent to that, countries were coming back to the negotiation table by the reports. And then you’ve seen the scope narrow or exemptions be granted, the magnitude decline, and the timing stretch out. So again, as a Fed official, what I’m considering is not what is announced, but what people are taking as this is happening and now I’m going to change my investment strategy, et cetera.

And what I’m hearing so far is that companies aren’t changing their investment strategy, they’re not doing large-scale things until they have more clarity about what the final result will be. And so ultimately, this is where patience really matters because if this is, and the administration has said that this is what they’re trying to do, negotiate, well, then we have to figure out or wait to hear what the final is, and so this is why it’s so important, I keep saying it, but it’s so important to remember the economy’s in a good place and then we go from there.

Alex Mehran, Sr.:

So if we can just look through the expectations in these four areas, immigration will slow, but the economy can absorb that reduction in the work workforce-

Mary C. Daly:

Absolutely.

Alex Mehran, Sr.:

… and do well. Fiscal policy, we’ll probably have some tax reductions, we’ll probably have some fiscal tightening and the budget deficits will continue to be elevated.

Mary C. Daly:

I can’t say that for sure, but you know.

Alex Mehran, Sr.:

But I’m just saying that let’s posit that as where we end up in a few months. That we have some deregulation, but it doesn’t have a dramatic impact on project delivery. But it has some, it depends on how that plays out. And we have some trade restriction, but not this broad-based, worldwide embattlement that we’re faced with. It’s going to be very targeted, probably China being the largest issue that we’ll be faced with, but it’s not going to be broad-based. The scope will be less. So if those are the results of these policy actions, where do you think the Fed will be going?

Mary C. Daly:

Well, ultimately I think of it as what you saw in the Summary of Economic Projections. And I’m pointing you back to that because that reflects all of my colleagues and myself, not just me, but in that I’m very comfortable with where that median ended, which is a little less growth, a little slower growth, transition dynamics will do that. A little more stubbornness on inflation, and a policy rate that is roughly responding to that, which I think the median, well, I know the median in the SEP was two rate cuts this year. We could have fewer than that if inflation stays stickier, there could be more if inflation comes down, or if the growth in the labor markets start to falter. But none of those things seems completely clear right now. And so for now, I think continuing to gradually reduce the policy rate with no urgency to react fast is the right thing to do.

Ultimately, we made a single promise to the American people, I think you all remember what it was. We are going to restore price stability. That is the critical foundation of all other things we do. So it’s really challenging to get to full employment if you don’t have price stability. So right now we have full employment, we have a stable labor market, but we need to get that price stability. So my reaction function, if you will, to what’s happening is how much progress are we making on inflation so far? And what do I think is going to happen going forward? And right now I see ongoing, gradual, but very, very gradual progress on inflation. It would require restrictive policy stance.

Alex Mehran, Sr.:

So if we see slower growth in the two and half percent range inflation at two and a half, two and a half, 3% range, PCE and unemployment hovering around four, do you think you’ll start moving towards that 3% target?

Mary C. Daly:

Well, I think ultimately with a little more inflation, a little stubbornness on inflation, but what you ended up saying by the end of the year, getting closer to two than to three, and the growth stays at something around two, or a little below two, and the labor market looks good. I think we do have to make gradual reductions in the interest rate. Something like what we said in the SEP, in order to ensure that we don’t over-tighten the economy.

You don’t want to make either mistake, you don’t want to under-tighten and then have inflation pick back up, but you don’t want to over-tighten and constrain activity for no good reason. So as long as we continue to see inflation coming down and the labor market and growth continuing, then I think gradual adjustments to the policy rate that gets us closer to the 3% is appropriate policy. So all of that depends on what happens with inflation and what happens with the labor market. And where the risk set has really expanded is on the inflation side because we know that some of the transition dynamics associated with trade policy can actually push up prices. And when they push up prices, that means inflation is staying a little more stubborn than we had anticipated, and we will have to manage that.

Alex Mehran, Sr.:

Okay, so let’s open it up for questions from the audience.

Audience Member 1:

Hi, how are you? Thank you again for being with us. Always a treat. I’m curious in your two roles. One is the president of the 12th district and two is you’re a citizen of the Bay Area doing field checks on electronics companies. We’re all interested in what happens in San Francisco and the Bay Area. So what are your senses in either or both of those roles as to the transition that San Francisco in particular is going through and California second?

Mary C. Daly:

Yep, absolutely. Happy to talk about that. So if you’ve followed any of my previous remarks on San Francisco, even when it wasn’t popular, I was bullish on San Francisco and about two years ago on X, they made a little bit of fun of me because they said, oh, that’s impossible, but I’ll tell you, it’s not impossible. So I am bullish on San Francisco, and I think the data are starting to prove me right and probably a lot of others that if you just look out the windows of any of the spaces, the Federal Reserve’s one-on-one market, if you look out our windows, you can see, and if I had one of those time-lapse cameras, I would see no people in the pandemic. Few people for the couple of years after the pandemic. And now the public transportation is full. You’re waiting in line to get on, you’re queuing up, you’re not going onto an empty car.

People are coming back to work, they’re working in the office, which is really important. They’re using the retail outlets. I can always have a barometer for how well San Francisco’s doing because the ferry is really close to us, and I see all the people getting off the ferry wearing shorts, and you know they’re tourists, so they’re wearing shorts, they think we’re Southern California, and they’re wearing those somewhat expensive jackets you buy on the ferry that say San Francisco, and they’re all one size. I bought one of those back in the ’90s. And so they’re coming off and they go in a little herd back to the trolley car. So I see positives in San Francisco, but what are the fundamentals of San Francisco, or the Bay Area writ large? The fundamentals are we have a very educated workforce. We have innovative, entrepreneurial people who come to change things and build things, and that’s always going to be a spark.

And then we have a beautiful place to live, and right now we have some real estate that you could actually buy and think about. So I think all of those things, yes, there are problems of any larger city and they’re here and we can be representing what that looks like. But I think ultimately the people who are living here want to participate and that makes me bullish. And so I think we’re also in a transition dynamic and we’re seeing that play out. I asked somebody. I think it was you, Alex, but it could have been somebody else, if you don’t want it to be mis-attributed to you, ultimately said, are you bullish on San Francisco? Yes. Here’s the things that would have to happen, and it won’t be a light switch. It’ll take some time. And I think we’re seeing that play out. All of you will be part of that. And so that’s a positive thing.

Alex Mehran, Sr.:

Other questions.

Audience Member 2:

So the big banks have processed the value disruptions that we’ve gone through over the last several years, frankly, as efficiently as I’ve ever seen it over a bunch of cycles. We have not seen that same level of workouts, et cetera, through the smaller regional banks, et cetera. Can you comment a little bit on what you guys see within the regional banking sector and your assessment of risk there?

Mary C. Daly:

Sure. So the first thing to note is that the banking industry came out of the pandemic and into the commercial real estate processing in really good shape. Of course, everybody knows where the challenges were, but they have been thoughtful about this. And so they’re being particular about how they manage these workouts, etc. So that’s piece one, that’s the foundation. The second piece is that the composition of commercial real estate held by larger institutions, versus smaller institutions, is quite different. And so one of the things I talk about when I talk about commercial real estate is just what’s in commercial real estate. So you have, and all of this. But I think it’s really important to remind ourselves there’s industrial, there’s retail, there’s multifamily-

Alex Mehran, Sr.:

Office.

Mary C. Daly:

… and office. Yeah, I know, I know. And then there’s the scary office. So retail, industrial and multifamily have been fairly stable. Where we saw the problems was in office, but then depending on what office market you’re in, are you in class A, class B, class C? So class C has been okay in terms of the bank’s balance sheets, class B, I mean it’s like a zombie world in some places. Class A is good. So then you have companies or banks, they’re all trying to figure out, okay, what do we do with our class B? Do we take it to ground? Do we wait it out? Do we refurbish it? How do we manage that? And I think that’s going on. So ultimately though it’s not atypical for the bigger institutions with more abilities to offer these bigger things, get some of these office places repriced and orderly. But I haven’t seen disorderly in any of the portfolios. And importantly, once you get outside of San Francisco, Seattle, LA, you see commercial real estate not looking the same.

I could go to Boise, Idaho, Salt Lake City. They just don’t have some of the challenges in those markets. They’re oversubscribed, their vacancy is low, they’re building big office plazas and trying to get people into those things. So I do think there’s some of that there. So I guess I think it’s not unnatural or unusual for the bigger banks to do things more quickly than the smaller banks. But the smaller banks also have different portfolios and they have to manage those portfolios and do well. And certainly the banking stresses in the March of ’23 caused regionals and other small banks to really think hard about what they offer and what they give.

Alex Mehran, Sr.:

Fritz.

Audience Member 3:

You’re more optimistic than I thought you were going to be.

Mary C. Daly:

Have you met me before? I’m always optimistic.

Alex Mehran, Sr.:

Fritz, just hold on just a sec.

Mary C. Daly:

I’m evidence-based optimist, though. A completely evidence-based, there you go.

Audience Member 3:

Thank you for the evidence-based optimism that I don’t feel.

Mary C. Daly:

That’s why I came.

Audience Member 3:

But my business focuses on agriculture. We grow a lot of different crops in the Central Valley and construction and development. And just from the narrow lens there, maybe I’m not seeing it. You said you have to look at it from your job as a balance, but if you’re the guy in jail, you look at it through those bars.

Mary C. Daly:

Sure. No, and that’s why I mentioned agriculture specifically. So the two areas, there’s more of course, but two areas that we do here is agriculture, which is affected both by the trade policy changes and potentially by immigration and ability to get workforce. So both of those things are pressing agriculture. I’m happy to chat more about your specific situation, but when I talked to agriculture in general, we had a roundtable of agricultural producers. What we’re hearing is that the trade policy is really the thing, because you’ve got the crops already growing, they’re big harvested, now you have them. A wine grower was the same thing, wine producer. You’ve got the things, now the tariffs are affecting the thing. It’s a perishable. It’s not like you can stock it up and wait until next year. So that it is very high-pressured.

On construction, the construction industry is trying to manage the input costs. Is it what’s happening with lumber, what’s happening with steel? What’s happening with other things? So that’s an immediate, you have to find out what can you produce with what you have. Some of the people though who are in construction have forward contracts on these things. They locked in prices. So for them, it depends on where you sit, whether this is uncertain or disruptive. And I am not saying there aren’t industries or even firms that feel the disruption. I’m just saying when you look across the entire economy, you see less of that having an impact. There’s a gap between, so two-thirds of our economy is services, first of all. So only a third of it is even manufacturing and ag together. So those things are going to have a lesser impact on the economy at large, even if they have a specific impact on that firm or industry. So I appreciate that. I mean, I’m hearing that from where I sit too, but it hasn’t reached the proportions of affecting the whole economy, although we might see it in food prices.

Alex Mehran, Sr.:

Other questions?

Mary C. Daly:

I think I see someone over there.

Alex Mehran, Sr.:

Yeah.

Audience Member 4:

We’ve been talking here and we see in the marketplace large numbers of credit-oriented funds and in effect call it a shadow banking system developing, or growing. Part of that may relate to the regional banking crisis of a year and a half ago, but I’m interested in your observations and the Fed’s thoughts about this system of credit much larger than historically available appearing in the last few years.

Mary C. Daly:

Well, I think if you go back and you look over a longer period of time, you’ve seen the provision of lending and liquidity outside of the banking system rising as a proportion. And then of course, it rises in different times. One, it could be because of changes in the ability to get something in your own bank, your regional or your larger bank, or it could also be technology. Technology, when interest rates are low, people look for places to invest. And so these funds emerge. So there’s all these pressures that are saying how can we provide funding outside of banking, traditional banking system? And so we’re about to get a new, well right now she’s had her hearing, Miki Bowman, she’s been nominated to be the vice chair. She had her hearing. She hasn’t been confirmed yet, but she is very aware of this and I will defer to her how the Fed is going to think about this broader thing.

What I will say is when you think about the financial conditions writ large, one of the things we have to look at as a policymaker is how are financial conditions in general. So we count not only what the banks are doing, but also what other funding opportunities we had. And so a good example is with commercial real estate. One of the things that we kept hearing and Alex you hosted a couple of roundtables for us, is that even though banks were feeling tight, and that made people worry about commercial real estate, this is about two years ago, private equity was standing ready.

They stand ready to invest if the prices get low enough. And so that provides a floor on this type of thing. So I think we don’t want to just discount the helpfulness of the other funding sources, but we have to be aware that we have to understand where they might have vulnerabilities, where we have to think about them. And so I know Governor Bowman, she’s currently the governor, Governor Bowman, but as she gets more clarity on her confirmation, then I think she will have a plan to think about this more broadly.

Alex Mehran, Sr.:

So if I can just summarize what we’ve heard this morning. First, the Fed feels they are in a good place right now. They are being patient to see how the policies and the reactions to the policies evolve over the course of the next several months. That there is room for easing, given the current position of the balance sheet and the rate structure and that there is a hopeful target of about 3%, 3, 3.5% in the first part of 2026. Is that a fair summary?

Mary C. Daly:

Yeah, I think with one, just a fair summary of the modal outlook. I think ultimately for me, what I really am thinking of is, and so let me say it for myself here and for my committee members, my colleagues. Ultimately the economy is heading to where we wanted it to be, on a sustainable trajectory, where we can bring the rate back to neutral. The one challenge of course is that inflation remains above our target and the risks to inflation are more elevated than they were a year ago.

So the consequence of that is we might have to hold policy tighter for longer than we had thought. But that doesn’t mean tight forever. And because ultimately inflation is coming down and barring the transition dynamics, pushing this up in a more persistent way, from the trade renegotiations, I could imagine a place where we can adjust the policy rate over time, but we don’t have to be urgent about it. We have plenty of time and we’re in a good place to wait this out a bit to see and get clarity about this because the bottom line is, that the consequences to the American people if we don’t restore price stability is more significant than if we keep to the story and keep to the work of restoring price stability.

Alex Mehran, Sr.:

Well, I look forward to having you back here in hopefully sooner than two years to evaluate where we are.

Mary C. Daly:

I’ll come next year we can evaluate how we did.

Alex Mehran, Sr.:

Okay. There, a deal. Thank you, Mary. Thank you very much. Thank you.