John Williams was selected to succeed Bill Dudley as President of the New York Fed. He will be a major contributor to deliberations about how to adapt monetary policy in the low r-star world. He says that he favors three or four rate hikes this year. We think his dot for 2018 at the March meeting was likely for four hikes this year, given our view that he has been on the hawkish side of the center for some time.
What an Economy!
Williams applauds the state of the U.S. economy today. What’s not to like? 2.2 million new jobs in 2017. Growth projected at 2½% this year, well above his estimate of the rate of growth of potential. (He’s previously put his estimate at 1½%; however, not a single FOMC participant had a longer-run GDP projection below 1.7% in the March SEP.) The unemployment rate is projected to fall to 3½% by next year, with wage growth slowly ratcheting up. And inflation today already running closer to 2%. The only blemish is that inflation is expected to exceed the 2% objective for the next few years.
So What’s the Role for Monetary Policy?
The role of monetary policy, in Williams’ words, is to “keep growth on a sustainable footing to keep the strong economy going as long as possible.” He says the way to do that is to continue the gradual increase in the fund’s rate. He favors “a steady” three to four hikes this year, and gradual increases over the next two years, bringing the target funds rate to about 3½% by the end of 2020. That is broadly consistent with both our call and participants’ March median projections.
Recessions Don’t Die of Old Age, But…
He argued that recessions do not die of old age. Rather, they are precipitated by large shocks. He does not say, however, that one of the large shocks is sometimes the Fed falling behind the curve and having to raise rates more than otherwise. Avoiding this outcome is the challenge the FOMC faces today. And an important question is whether it has already lost this battle.
The Task Ahead Is Difficult
The initial conditions and forecast present a challenging outlook for the FOMC. Williams projected that the economy will grow well above potential this year, the unemployment rate will fall to 3½% by 2019 (more than a percentage point below the NAIRU), and inflation will slightly exceed 2% for the next few years.
This prospect suggests the Fed has a difficult balancing act. First, policymakers must set the pace of rate hikes fast enough to avoid an unacceptable rise in inflation above 2% without precipitating a recession. Given that the baseline forecast has the unemployment rate stabilizing a percentage point below the NAIRU in 2020, it is tough to get it back to the NAIRU without a recession. Another challenge is communicating the apparent tolerance for above-2% inflation for a “few” years and convincing the public that this outcome is consistent with appropriate monetary policy and with a 2% symmetric inflation objective.
A Great Start on Staffing the Troika
Jay Powell will indeed be fortunate to have John as president of the New York Fed, as someone beside him at FOMC meetings as the FOMC’s Vice Chairman, and as someone with whom he maintains an ongoing dialogue between meetings. This is an ideal outcome, as Powell now has at his side an excellent economist and an expert in monetary policy. They will be a potent pair. Perhaps Rich Clarida will ultimately become Vice Chairman at the Federal Reserve Board to complete the Troika.
San Francisco Fed President Search
With Williams’ imminent departure, the San Francisco Fed will begin seeking its next president. Perhaps even more so than for the New York Fed appointment, the San Francisco Fed plans to place diversity as a key criterion. But in monetary policy terms, that is unlikely to be consequential. The San Francisco Fed sees itself as the most important regional Federal Reserve Bank other than the New York Fed, as its district is the largest of the 12.
One obvious candidate would be Mary Daly, who is the current director of research. John Williams was director of research before being named president. Her policy views are close to those of Yellen and Williams. Daly, who shares Yellen’s particular interest in maximizing labor market potential and social welfare, appeared to support a “hot labor market” strategy at the expense of temporarily higher inflation. Last year, she saw 2.5% wage growth as surpassing its trend level for this expansion: “a full cyclical recovery in full-time worker wage growth.” To her, wage growth was held down by a percentage point by boomers retiring, people reentering the workforce, and younger workers joining it. She celebrated the participation rate holding steady in face of downward secular forces but expected this temporary aberration to cease by year-end 2018. Like Williams, she cited a 1½% trend real GDP growth. She also saw productivity growth below 1%. Consequently, she saw it as less likely that wage growth would exceed 3%.
Other candidates who would be considered likely include Christina Romer (of Berkeley, just as Yellen was), as well as some of the names previously floated for other Fed leadership positions, such as Karen Dynan and Kristin Forbes.