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"The upswing can go on considerably further"

Interview with James Bullard, President and CEO, Federal Reserve Bank of St. Louis

Mister Bullard, what danger does the recent escalation of the trade dispute between the US and China pose for the US economy? Will US President Donald Trump's trade war put an end to the US recovery?James Bullard, President and CEO, Federal Reserve Bank of St. Louis

The US economy is performing very well. Year-over-year GDP growth is over 3%. Labor markets are quite good. The St. Louis Fed’s labor market index suggests that U.S. labor markets are better than they were at any time in the last expansion, and are approaching where they were in the 90s expansion, which was one of the best in the post-war era. Over the past four to five weeks the attitude in the U.S. has changed quite a bit. In December and January we assumed that the first part of the year would be weak and the later part stronger. But the data surprised to the upside in the last several weeks. Growth in the first quarter surprised to the upside. After one weak jobs report, subsequent jobs reports were very good. In some areas of the economy the picture is certainly somewhat more mixed. This applies in particular to agriculture, which is negatively affected by the trade war.

So the US economy could even grow stronger than expected in 2019 - despite the trade conflict?

When it comes to trade, the biggest question is how long tariffs will last. Some tariffs have not yet been implemented – it takes a while to get them implemented – and there can be an agreement at any time, in which case all of this would be moot. For there to be a big effect from trade, there would have to be no agreement and high tariffs, and they’d have to stay in place for quite a while.. Even with the trade tensions I would say the US economy could surprise to the upside in 2019. Growth could be higher than expected at the end of last year.

So worries about a hard downturn or even an imminent recession in the US are exaggerated?

Fears of recession are premature and overdone. Of course, things can change at any time.

Do you see other major risks for the US economy in addition to the trade issue - or is that the central danger?

Some sectors that are more sensitive to interest rates seem to be slowing down. For example, the housing market, the auto sector, some industrial production and some manufacturing. The US economy is not running on all cylinders, but it is pretty close and probably about as good as it gets.

US inflation has slowed recently and is below the Fed target of 2%, and market inflation expectations have also fallen. How worried are you about that?

The Federal Open Market Committee’s preferred inflation measure is the core PCE. This is currently only 1.6%. I’m concerned about this. There are other inflation measures, but the Committee’s preferred measure is too low and that is surprising. The US economy performed better than expected in 2017 and 2018. The labor market has been very strong for several years. But inflation is still below target. I am also concerned that inflation expectations are somewhat low in the U.S. They are the major determinant of actual inflation.
I may be willing to entertain an interest rate cut at some point in order to re-center expectations on the 2 percent target. If we did that while the economy is booming, it would signal to the markets that we are serious about achieving our inflation target on average over a period of time.

So you have no problem with markets increasingly pricing in rate cuts, even though the key message from the Fed's decision-making body FOMC is that no rate hike or cut is in sight?

We have a flat rate outlook. If there is any bias, I would say that for me it would be to the downside, that we might cut rates on the inflation argument.  As far as the real economy is concerned, I see no motivation for lower rates. I think we can get 2.5% growth in 2019. That would be a good outcome.

What would be a trigger point to turn your bias to cut interest rates into an explicit vote for a cut? Would inflation expectations have to continue to fall or would it be enough if they remained at current levels?

If inflation expectations were to remain at recent levels despite the continued strength of the US economy that would make me concerned they have become anchored at too low of a level and something that is below our inflation target.

Do you see the danger that a rate cut in such an environment of strong growth and already booming financial markets could lead to financial exaggerations? Your Fed Kansas colleague Esther George warns of new financial bubbles in this case?

As central bankers, we are paid to worry, so I do worry. But at the moment we can argue that the financial imbalances are not terribly unusual. I don't see anything that causes me to want to raise interest rates based on the financial stability argument. Regulation over the past decade has changed the landscape considerably. A big problem before the last crisis was the housing sector. We are certainly not in the same situation today as we were then. And also we have much better radar.

At the end of last year, the message from the FOMC was that the interest rate hikes would have to continue in 2019 and 2020 and that the key interest rate might have to be brought into a restrictive territory, which would tend to slow down the economy. At the beginning of the year there was a complete turnaround: Now there should be no more interest rate hikes in the foreseeable future and even a reduction is under discussion. Do you understand that not everyone can understand this U-turn?

Last year I argued for a flat interest rate path, but there were only a couple of others on the FOMC in favor of such a path. We raised our key interest rate in December and the market reaction was not very good. The problem was not so much the rate hike itself. It was the rate hike combined with a plan for further increases– perhaps 100 basis point more in 2019 and 2020. That concerned the markets. Then the yield curve inverted. I think we made a pivot that was appropriate to say that we will be data-dependent and won’t be projecting or penciling in future rate hikes in 2019. That was a sea change in US monetary policy.

What exactly do you mean by that?

Some might look back on this era and say, well they didn’t cut rates, so it wasn’t an easier policy. But taking future rate hikes off the table was a big dovish move. This is reflected in the yield on ten-year US government bonds. In the fall of last year it was trading at 325 basis points. At present, it is about 240 basis points. This is a decline of more than 75 basis points in a key benchmark longer-term interest rate. This is a big change, and most of this change was probably caused by a change in attitude at the Federal Reserve. I do think this will boost the real side of the US economy in 2019 and 2020. In that sense, I think we should get more data, wait to see how the second quarter comes in, and proceed from there.

So was the Fed too "hawkish" in 2018, i.e. too strong in the direction of a tighter monetary policy, and then had to correct this with a "dovish" U-turn?

Especially in August and September 2018, people started talking about U.S. interest rate levels that I think were unrealistically high, especially in the global environment. In the euro area, some key rates are still negative and it seems that they will remain so for some time to come. In Japan, the key interest rate is still negative and there is probably no realistic prospect that this will change soon. The U.S. has normalized our key rate to a level that appears historically low, but is actually high for the current international environment.

Would you say that the US key rate has already reached a neutral level at which it neither stimulates nor slows the economy - or is it still expansionary or already restrictive?

I have argued that the neutral real rate of interest for the US is probably still negative. But even if you assume 0% and add the 2% inflation target, the neutral key rate would still be around 2%. We’re currently at 2.25% to 2.5%.  I would say we’re a little bit restrictive at this point. Given the uncertainty surrounding the measurement of this kind of thing, this does not cause me any terrible concern. But I don’t think we are dovish at this level of rates.

Some critics argue that the Fed has ultimately bowed to Trump’s pressure, which has repeatedly railed against interest rate hikes and advocated interest rate cuts and more quantitative easing (QE). Is Trump's criticism a problem for the Fed's credibility?

US monetary policy is debated around the world every day and we get a lot of advice. All kinds of people weigh in, including the President. The President comes from the real estate sector. So he is naturally interested in interest rates and perhaps has more to say about this than presidents in the past. We’re used to getting lots of input from everywhere, which is great. But when we make our decisions, we have to weigh everything. And we do have a mandate from Congress: to achieve the best possible outcomes in terms of employment and inflation. So we are supposed to take all of this advice and somehow sift through it and get the best outcomes that we can. And we are doing pretty well right now when it comes to our mandate. Inflation is a little bit low, but not too bad, and the employment outcomes are very good.

So are you frustrated you when Trump says the Fed isn't doing a good job and with lower interest rates and a little more QE, US growth could be 5%?

We are trying to get the best outcomes we can, and even the current result seemed unattainable a few years ago. So I am pretty satisfied with where we are. A lot of the goal is to keep the economic expansion going and not to achieve a particularly high growth rate in a particular quarter. I think you want to get ongoing growth that is sustainable and does not lead to undue inflation pressure. That is the art of central banking. I am relatively optimistic that the economic expansion in the US could continue for quite a while in the U.S. 

At the end of the second quarter, this would be the longest economic upturn in post-war history.

I think the upswing can go on considerably further if we play our cards right.

Trump recently called on the Fed to support the government in its fight against China and to relax monetary policy, similar to what the Chinese central bank is already doing.

I wouldn't like to act and two days later there is a trade deal. If there are six months or more with high tariffs and no prospect of a resolution, at that point, I think you would have to make an assessment of what to do in terms of monetary policy. But we certainly do not react to every   development - just as we do not react to any single economic data point.

To what extent do Trump's statements pose a threat to the independence of the Fed? Recently, even ECB President Mario Draghi showed himself to be very worried in public - a quite unusual occurrence.

I actually think the US administration, based on comments from people inside, respects the independence of the Fed. I think the US Senate has been very supportive of the Fed. I’m not seeing the kinds of things on the horizon that are going to erode Fed independence. This is just debate about where policy should be set right now. Fed independence comes directly from the Federal Reserve Act. There are many provisions in place to ensure the independence of the Fed and the stability of US monetary policy, including the reserve banks, which are not led by political appointees and also provide institutional memory as the presidents are in place much longer, providing stability to monetary policy. The Fed is not designed to be independent, exactly. I say “arm’s length from politics.” It’s designed to be a step away from the day-to-day elements of politics, and more technocratic, and I think we’ll continue along that path.

The Fed, in particular, is currently engaged in a review of the monetary policy framework. Is the time really ripe for this, given all the uncertainty about how economic structures and financial markets have changed since the crises of recent years?

Since the economy is performing well and is not in a crisis, now is a good time to review the framework. It is best practice for any central bank to periodically review what it is doing, why it is doing it and what might work better. For us, this is a one-year process. We are hearing from a wide variety of stakeholders. I do not think that the expectations of a major change in our framework should be terribly high. But there may be some things that could be done better. That is something we should think about and discuss.

What could be done better?

The things that have been discussed the most are different versions of price level targeting, which is about making up for past misses in the inflation target. We have been missing our target to the low side more or less since 2012. Since then, the core PCE inflation rate has averaged 1.65%. There is also the threat that if something bad happens in the future, we will go back to the effective lower bound on interest rates again and have zero or even negative interest rates. That would be concerning. So the question is: How can we then shore up our ability to reach our 2 percent target?

And your answer?

One idea is to promise somewhat higher inflation in good economic times to compensate for the times when the target is missed to the low side. I think most of the issue on the academic side is around something like average inflation targeting.  But there are a number of practical issues around that: How many years do we look back? Over what period do you aim for the average? What happens if you haven't been successful - do you double down the next year?

But this average inflation targeting could be a possible result of the Fed review, yes?

I would say it’s a potential outcome. An alternative would be to target nominal gross domestic product targeting. But average inflation targeting is a very tangible and practical application.

Some experts, especially the advocates of Modern Monetary Theory (MMT), argue for closer cooperation between monetary and fiscal policy. What do you think of such proposals?

We try to be careful about the relationship with the US Treasury. They have to fund the government and run many of its financial aspects.  We have a very specific mandate - full employment and price stability. We do that taking as given whatever the Treasury decides to do. It works best if you don’t take it too much farther than that.  If Congress wants to decide on a spending program and attack some of the issues that they think are important, that is certainly up to them, and we would take that into account with monetary policy.

If, contrary to your expectations, the economic situation were to deteriorate significantly in the near future, or if there were even a recession, would the Fed have enough ammunition to take countermeasures now?

Our former Fed Chair Janet Yellen said at the annual Economic Policy Symposium in Jackson Hole in 2016 that the Fed could have handled a recession even at that time through a combination of lowering the policy rate to zero, and quantitative easing or forward guidance, or both. Today we are even in a better position than a couple years ago because we have raised the key interest rate further and reduced our balance sheet. The situation is certainly not ideal because a recession would push us back to the lower bound. But I do think we have enough tools at our disposal.

The interview was conducted by Mark Schrörs. The answers are condensed excerpts, edited for brevity and clarity.

James Bullard is President and CEO of the Federal Reserve Bank of St. Louis.

Börsen-Zeitung, 22nd of May 2019