John Williams, president of the San Francisco Fed, is reportedly now being considered for Vice-Chair of the Federal Reserve Board. In that case, he would join Larry Lindsey on the shortlist, with Rich Clarida reportedly no longer under consideration. Williams would be an excellent choice; indeed, it is hard to think of anyone better qualified and better prepared. We suspect that Yellen, as well as John Taylor, provided a list of candidates to Trump. Williams would have been at the top of both lists. Both Yellen and Taylor have long
time relationships with Williams: Yellen while he was an economist at the Federal Reserve Board and head of research at the San Francisco Fed; Taylor was Williams’ teacher at Stanford and has collaborated with Taylor on research over the years. Williams has a Ph.D. from Stanford, is a highly respected scholar, and is a highly experienced monetary policymaker. A perfect complement to Powell.
His research has had a profound effect on how monetary policymakers think about the neutral rate. First, he is the Williams in the Laubach-Williams (2001) estimation of the neutral rate which has been taken by Chair Yellen as the estimate of its “current” level. It fell to near-zero by 2009 and has stayed there since. Their estimate was recently updated in a paper with Holston (2016), and that estimate is now close to ½%. Consistent with that, Williams estimates that the nominal neutral rate is 2½%, slightly lower than participants’ median estimate (2.75%). However, unlike Yellen, Williams sees this level as the new normal, the rate today and expected to prevail in the future. He has proved prescient in that participants’ estimate of r-star has been falling toward his more stable estimate and now has almost converged fully.
He is outspoken about the need for monetary policymakers to rethink the policy framework to adapt it to a low r-star world. He has suggested that an increase in the inflation objective should be considered and that negative rates should also be on the table. But price level targeting is his preferred option. Although he would support a change to that framework, he has also said that the FOMC should not conduct policy in that way without making an official decision to do so, including a formal announcement. He believes it could take a couple of years to study, build consensus, and make such a change, but the change should come well before the next recession. As Vice-Chair, we expect he would lead a subcommittee of FOMC participants to consider the options.
He believes that we have now exceeded full employment, given that his estimate of the NAIRU is 4¾%. His estimate of potential growth is only 1½%, below the median estimate. He expects 2½% growth this year and the unemployment rate to fall to 3¾%. Unlike many of his colleagues, he says he is not that surprised at recent soft inflation. It was higher than expected earlier in 2017, lower than expected thereafter, and its softness today is overstated. He has a traditional macro paradigm, including a Phillips curve, and the latter underpins his expectation that inflation will move to 2% over the next couple of years.
He obviously favors running a “hot” labor market, given that he projects that, with the rate path he sees as appropriate, the unemployment rate will be a full percentage point below his estimate of the NAIRU. He expects this to draw discouraged workers back into the labor force and put a little more upward pressure on inflation. He said in October 2016, “I think we’re actually doing that” and “I think we are going to run this
the hot labor market for a while.” Favoring a hot labor market is a dovish policy view. Given his lower estimate of r-star, he says the FOMC does not have “far to go” to get to the neutral rate and, as a result, he calls for a gradual pace of rate hikes.
Nevertheless, we see him today as to the hawkish side of center and in the camp that has become worried about the FOMC getting behind the curve if it raises rates too slowly, “risking the sustainability of the expansion and creating conditions that could lead to a recession down the road.” He says three hikes this year is appropriate, but we see him in the three-to-four-hike camp, and we expect him to ultimately favor four hikes if core inflation picks up this year in line with the median forecast of participants. As such, we see him as strongly supporting a March hike.
|Topic||Williams||FOMC Median (December)|
|2018 Pace of Hikes||3 hikes||3 hikes|
|2019 Pace of Hikes||2 to 3 hikes||2.25 hikes|
|Neutral Funds Rate||2.5%||2.75%|
|Potential GDP Growth||1.5%||1.8%|
|Unemployment Rate Trough||3.7%||3.9%|
|NAIRU||4.6% to 4.7%||4.6%|