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San Francisco Fed’s Daly: Wholesome economic system wants much less assist

WASHINGTON — With interest rates ultra-low even as the U.S. economy swiftly improves, Federal Reserve officials are divided over how quickly they should adjust their policies.

Should they begin to withdraw their extraordinary support for the economy relatively soon? Or should they hold off until the job market has moved closer to full health?

The Fed’s policymakers do agree on one thing: The economy is strengthening faster than they had expected.

In an interview this week with The Associated Press, Mary Daly, president of the Federal Reserve Bank of San Francisco, offered up her own perspective. The economy, Daly suggested, “is really shaping up nicely right now” and is “able to start functioning more and more on its own, which means we can withdraw a little bit of our accommodation.”

Yet she remains cautious about pulling back on the central bank’s support, noting that “we’re far from full employment,” one of the Fed’s central goals.

On Friday, the government reported that employers added 850,000 jobs in June, the largest gain since August and a sign that the economic recovery remains in solid shape. Yet the unemployment rate ticked up from 5.8% to 5.9%, still far above the pre-COVID level of 3.5%.

Some other regional bank presidents have signaled that they want to start dialing back the Fed’s support in the coming months. The Fed has pinned its benchmark interest rate — which influences the cost of borrowing for consumers and businesses — at zero since March 2020, when the viral pandemic erupted.

The central bank is also buying $80 billion a month in Treasurys and $40 billion a month in mortgage-backed securities in an effort to keep longer-term rates low and encourage more borrowing and spending.

On Wednesday, Robert Kaplan, head of the Federal Reserve Bank of Dallas, told Bloomberg News that he favored starting to reduce those purchases “sooner rather than later.”

“If we take our foot off the accelerator gently now,” Kaplan said, “we’ll have more flexibility down the road to avoid more abrupt action or severe actions in the future.”

James Bullard, president of the St. Louis Fed, and Raphael Bostic, head of the Atlanta Fed, have expressed support for raising the Fed’s short-term rate next year — well before Fed policymakers as a whole have forecast that they will do so.

Since December, the Fed’s official stance has been that it needs to see “substantial further progress” toward its dual goals of full employment and annual inflation modestly above 2% before it would start reducing its bond buying.

“There is strong and visible disagreement surrounding … tapering and Fed rate liftoff amongst (Fed) members,” Kathy Bostjancic, chief U.S. financial economist at Oxford Economics, wrote in a note to clients. “It leads to confusion regarding policy direction.”

Daly, one of the voting members this year on the Fed’s rate-setting committee — a role that rotates among the regional bank presidents — discussed these issues and her view of climate change in the interview. The interview has been edited for length and clarity.

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Q. IN JUNE, FED POLICYMAKERS SIGNALED THAT A FIRST RATE HIKE COULD OCCUR IN 2023, AFTER PREVIOUSLY PREDICTING A HIKE WOULDN’T OCCUR UNTIL LATER. DID YOU CHANGE YOUR PROJECTION FOR A HIKE?

A. Let me start by saying I am growing more and more optimistic about the recovery in the economy. The vaccination pace has been faster than I thought, and the response of consumers and businesses to the newfound freedom has really been remarkable. It tells me that people are ready to re-engage, so this all bodes well for the economy, and I remain very bullish about the outlook. The projections are now three weeks old, and I wouldn’t want to go back in time and think about those. I’m looking forward: How persistent will the momentum be? Will there be additional risks that come on to our shores from the global economy still struggling with the pandemic?

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Q. IF THE ECONOMY IS IMPROVING FASTER THAN EXPECTED, HOW DOES THIS AFFECT YOUR VIEW OF FED POLICY?

A. Well right now, it’s affecting when I think we should start talking about our asset purchase plans, and we’re ready to start discussing the time of tapering bond purchases, the pace of tapering, the composition of tapering, all of those things are now on the plate. And I think that’s appropriate.

It is appropriate to consider tapering asset purchases later this year or early next year. I really see the economy as being able to start functioning more and more on its own, which means we can withdraw a little bit of our accommodation. Of course, not the majority of it. Because we’re still not near our full-employment goals.

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Q. DO YOU SEE INFLATION READINGS, NOW ABOVE THE FED’S 2% TARGET, AS ESSENTIALLY MEETING THE GOAL OF PRICE INCREASES MODERATELY EXCEEDING 2% FOR SOME TIME?

A. Let me just talk about what I mean by average inflation of 2%. That is average inflation that is sustainable of 2%. So temporary movements, either really high up or really far down — that’s not something I can count on as delivering price stability to the American economy. I wouldn’t put very much weight on that. What I’m looking for is sustainable, underlying inflation of 2% on average, and that is price stability.

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Q. SOME OF YOUR COLLEAGUES ARE TALKING ABOUT CUTTING BACK ON PURCHASES OF MORTGAGE SECURITIES MORE QUICKLY THAN TREASURYS, BECAUSE HOUSING IS HOT AND DOESN’T NEED THE FED’S SUPPORT. WHAT DO YOU THINK?

A. Should we think about mortgage purchases differently than we think about more Treasurys? Possibly, but I think those are open questions, because mortgage-backed securities are also keeping longer-term rates low. You can see the strong housing market has really helped people, not only in purchasing homes. But the thing that people often forget is that it helps people refinance. When people refinance, they get a lower interest rate. They have more money in their pocket, it supports consumer spending, it can support the overall economy.

Both Treasury and mortgage bond purchases contribute to overall financial accommodation, financial markets being supportive of economic recovery, and that’s why you can’t simply say, ‘Well, the housing market’s strong, let’s pull them away.’ It’s a little more complicated than that. How much is it supporting overall lower rates, not just this housing market?

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Q. WHAT’S YOUR INFLATION OUTLOOK?

A. I think the most likely scenario is one where we trend back down to what I think of as the underlying pace of inflation, and that’s the 1.8%-1.9% rate. And so I would expect with the improvements in the labor market, the resolution of these supply bottlenecks and temporary factors, that we would look at an inflation rate of 1.9%, maybe 2%, in 2022 and 2023.

___

Q. HOW DO YOU VIEW THE FED’S ROLE ON CLIMATE CHANGE?

A. When people say the Fed’s role, they often think of it as, we’re going to do climate policy or we’re going to be active in this space of changing how climate evolves. And I would say that’s not true. We don’t have those levers to pull. Those are for our elected officials. But the evolution of the economy depends very much on the evolution of the climate. You saw the record temperatures in the Pacific Northwest. A friend of mine actually had his transmission overheat, he was just driving his regular car. So imagine you’re using trucking, you’re depending on transportation services. These are real challenges.

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