John Williams Easing Us into Normalization
The President of the Federal Reserve Bank of San Francisco, John Williams, gave a presentation on March 5th about the outlook for monetary policy.
He basically is easing our understanding towards accepting the rationale for normalizing (raising) nominal interest rates. I personally am in agreement with what he says and how he says it. He is making the case that the Federal Reserve needs to start raising the Fed rate soon so as not to raise it more drastically later.
He is not worried about low inflation. He is not worried about low wage inflation. He recognizes that the unemployment rate is getting close to his projection of 5.2% as the full employment rate in the NAIRU sense. He anticipates wage inflation by 2016 and wants to be proactive in responding.
In his presentation, he refers to others, like Paul Krugman, who would rather see inflation return to target before raising rates.
“Not everyone agrees, of course. There are a number of people who think we should wait until inflation is very close to, or has crossed, the finish line. They’re mainly worried that raising rates too soon would allow inflation to fall further and possibly derail the recovery.”
His best response to them is…
“Monetary policy, as Milton Friedman famously reminded us, has long and variable lags (Friedman 1961). As I said, it usually takes a year or two for policy to have its full effect. As a result, policy must be forward-looking. When you’re driving towards a stoplight, you don’t keep your foot on the accelerator; you ease off so you’re ready to stop at your target. Otherwise you slam on the brakes—and probably wind up in the middle of the intersection.”
John Williams seems to be sensible in his projections. I agree with him that a slight rate hike in mid-2015 would not derail the economy. Of course, there will be some stress on the economy as rates tighten, but that stress is designed to balance vulnerabilities in the economy.
Moreover, how fast will the Fed rate rise after the first rate hike? That is the interesting question. How will the data respond to the first rate hike in the short-run considering that Williams says that the effects of monetary policy have a lag of 1 to 2 years? How will the Fed respond to incomplete data responses in the short-run?
John Williams is basically saying… Take it easy folks, a slight rate hike is a safe and sensible step toward the needed normalization of monetary policy.
“safe and sensible” for whom?
Williams is basically saying lets allow labor to take a interim hit in the form of foregone jobs and wages so as to minimize the risk of above trend inflation’s downside for holders of capital.
Now while it is both true that in the long run we are all dead and that in the medium term it is reasonable to target the mean in the balance between real wage and wage driven inflation what Williams is saying here, like 92.4571% of all Fed Governors ever is that if there is a little bit of risk of the inflation wolves ever catching up to that sleigh full of ‘sensible’ people fleeing through the snow that the most prudent course is to throw out the most available peasant or servant. Often enough in the name of “shared sacrifice”.
(apropos of not much “shared sacrifice” always reminds me of the truth about bacon and eggs. The chickens are invested but the pig is committed. I am tired of being Little Piggie.)
Wages will have their own dynamic of rising. But there are other vulnerabilities in the economy that a ZLB can exacerbate. We should not solely focus on wages. Like Williams says, there are wage cuts that were not done after the crisis due to rigidity. Those will work themselves out of the system. Then wages will rise. Something that I see more likely by putting the screws to unproductive firms that have been surviving on low rates. The economy has to get stronger through discipline, not by making the challenges easier.
Europe has severe problems because their monetary union is dysfunctional. The one size fits all interest rate helps Germany but hurts the periphery. They are in a trap to consistently lower rates. In the US, that problem does not exist. We have better labor mobility and fiscal transfers. The US can actually raise rates without severely affecting any one region due to our transfers and mobility.
A normalized rate is actually healthier for an economy. The US is in a position to normalize and get healthy.
Edward I would feel a lot better about all those lines of argumentation if it weren’t for the fact (meaning “what appears obvious to me”) that over the decades the Feds metric of choice has been NAIRU. That is good news for labor is bad news for the larger economy.
That is their “discipline” exerted against “unproductive firms” almost always results in direct harm to labor wage. Often enough excused by the fact (meaning “what is obvious to the Fed”) that the culprit is “wage cuts NOT done — due to rigidity”.
Shared sacrifice between unproductive firm’s chickens (management) and pigs (workers).
We all want a healthier economy. But you don’t cut back on the antibiotics the second the patient SEEMS to be getting better, instead you let the medicine take its entire course. As it is you seem to want to kick labor out of its sickbed because you know, anyone can work with a mild cough, and meanwhile the railroad needs to run trains and those widgets won’t build themselves.
John Williams stoplight analogy is a great example of why I usually hate argument by analogy. We do not want to come to a stop.
You have already identified that we need labor share to increase. Krugman and Baker are asking that rates remain low until wages increase. The mechanism by which this will increase labor share seems obvious to me. To convince me that rates should increase before then, you need to show me why bad things happen before the good things happen.
Let’s say that China has been suppressing wages for decades. Now China is raising wages and its growth is slowing down. We will now find less pressure to lower wages in the US. We are also seeing more pressure to raise wages in the US.
A raise in the Fed rate will not stop that process. We should actually see more investment as firms try to beat the increase in borrowing costs. Firms will also feel more confident that the economy is stable.
Also, if the Fed starts saying that the economy is truly recovering, you will see labor pushing harder for their share.
I see more advantages, psychological and otherwise, to initiating normalization now than waiting until inflation reaches 2% in 2 years or so.
I am in agreement with the Fed. The time is upon us to initiate normalization. Many advantages come from normalized policy. The economy will function better and safer.
Workers will have more power to demand higher wages once the Fed rate begins to normalize,
And your point about not wanting to come to a stop is not exactly the idea. In order to drive better, we have to stop and go. So we need to be proactive in stopping and going to better drive better. When we need to stop, we need to start stopping well in advance so as not to slam on the brakes. I would prefer to ride in a car where the driver is slowing down well in advance.
What then really is the stoplight? It represents possible imbalances that can harm the economy. If we go into those imbalances without caution, we increase the risk of a bigger problem. We need to go into those imbalances with caution to avoid that bigger problem.
I am in agreement with what the Fed is doing. And I do not worry about labor share being adversely affected. Actually, I see labor share benefiting from a normalization process of the Fed rate. I base this upon the work of Bruce Kaufmann and other labor economists who see higher wage rates related to unproductive firms being priced out of the market.
Just as a higher minimum wage can be socially beneficial, a higher Fed rate can be socially beneficial. The result should be more possibilities for higher wages.
They are looking at the surge in real wages and commercial paper since last fall. Those are the 2 biggies they use when to move up rates.
I have to agree with Bruce Webb here. We would do better, much better, to raise taxes and fund infrastructure jobs. More Jobs at Higher Wages would get us around the voodoo of appeasing “the markets.”
Disciplining unproductive companies just means making it easier for the predator (“productive”) companies to drive their competition into the ditch.
NAIRU was a bogus idea in 1980. Even more so today. Wages are so low and unemployment so high their is no danger of workers sitting around collecting unemployment waiting for a job offer at wages higher than what their work is worth. Except, of course, in terms of what organ donors in China will work for.
Keep in mind that the interest rate set by the ECB is correct for Germany and other core countries in Europe. Germany was doing well but is affected by the weakness in other countries. When the interest rate is set properly, it is like tuning the string of a guitar. When the string is in tune with the pitch, the resonance amplifies the sound. That is the effect of having the interest rate tuned to an economy.
The US economy is ready for a rate rise and a rate rise will not detour the economic progress.
I agree with you. Raising taxes and having more infrastructure spending would be great. But the GOP wants control for private interests, not good government for society at large.
That is part of the problem why the economy gets weaker and weaker.
However, your caricature of productive companies as being predator companies is not fair. Those productive companies are the ones that want to raise wages and employee benefits according to studies done by labor economists. Hindering their unproductive competition is good for labor, wages and raising social benefits over time.
Well, I see the Fed’s plan to raise interest rates as good. But it will only be maybe 25 basis points to start. And they will probably raise the Fed rate only 50 basis points per year. That is slow and steady and not fast enough to trigger a harsh reaction from the markets. And the raises will be well anticipated.
Another thing to keep in mind is that the Fed has lots of researchers with diverse opinions. There are camps that have been pushing for higher rates for some time. There are camps that do not want the Fed rate to rise. Janet Yellen and company at the top listen to the different camps with their persuasive arguments. The key is to blend all the different points of view into a holistic view of how to proceed with monetary policy. They have listened and have decided that a slow lift off now is appropriate if the data keeps improving.
They have access to all kinds of analysis. They are smart people who understand many factors. I support their plans to start normalizing the Fed rate.
i am not in a position to argue with you about the “economics.” i am not sure an “efficient” economy is good for human beings.
I have been having some experience with predator corporations (Wells Fargo et al) and i am sure they are “efficient.” that is if you want to maximize your short term profit by destroying the lives of your customers. also we have recently lost a mom and pop electrical supply company in town, leaving us with Home Depot to take our business to. not a step up for us or the employees, though i am sure Home Depot is efficient.
so let it stand: you may well be right. but i think my political sentiments offer a better chance for us “workers” (ordinary people) than the Feds best laid plans, which seem to me to be designed with someone else in mind. (as a person with money in the bank, i might well be one of those someone elses, but still….
I would just say that the Fed is doing their part, now it is up to the workers and us economists to fight for higher wages. The message is getting through. I would like the Fed to push higher wages too but that is not really their place. They just expect that wages will rise at full employment. And wages will rise more if the pressure is put on firms to pay better. The Fed is not rsponsible to fight for higher wages, though they are counting on it to happen.
as i said, i don’t know enough to argue with you. but it worries me when people say “the republicans won’t let us do it” and then everyone goes back to sleep.
as far as i can tell “republican” policies since 1980 have brought this country to an evil plight. there may be other factors that would have brought us here anyway, and i have no special love for the democrats we have with us today. but
“monetary policy” reminds me of pushing on a string. if the private sector cannot create jobs at a living wage, then the government needs to lead the way.
Edward let me quote your words back to you:
“He is not worried about low inflation. He is not worried about low wage inflation. He recognizes that the unemployment rate is getting close to his projection of 5.2% as the full employment rate in the NAIRU sense. He anticipates wage inflation by 2016 and wants to be proactive in responding.”
Per you Cummings is worried about NAIRU and wage inflation. And wants to be “proactive”. Which doesn’t suggest to me that he is using any other metrics.
Now you counter my concern about this with the following:
“Wages will have their own dynamic of rising. But there are other vulnerabilities in the economy that a ZLB can exacerbate. ”
Well yes I suppose. But on YOUR account it is precisely the fact that “wages have their own dynamic of rising” that Williams is intent on countering via monetary policy. I mean what OTHER vulnerabilities is he focusing on? Any concerns that WOULDN’T be eased by a slowing of wages even from their current anemic state and keeping employment from crashing into NAIRU?
If I was confident that he didn’t equate ANY increase in wage as an imminent sign of inflation and still less any actual increase in real wage then I might be okay. But you have given us no evidence that he is not making precisely that equation by evoking “wage inflation” as the culprit.
Maybe the late 90s was a total aberration never to be repeated (although oddly the idea that those conditions were permanent underlay the entire ‘Washington Consensus’ that the business cycle had been broken forever) but there really was a time when strong increases in Real Wage were not accompanied by out of control price inflation. Maybe that was all froth driven by the first Tech Bubble. Or maybe we were onto something that could only be sustained via continuation of then current rates of taxation as opposed to a combined policy of tax cuts and unpaid for wars. We will never know because at the time the Fed in the person of Chairman Greenspan plumped all out for tax cuts on the wealthy out of fear that we would run short on long term debt instruments.
Why trust Fed hawks now?
I don’t know where I came up with “Cummings” in my para 3. I hope it is obvious that I meant “Williams”.
Here is an analogy.
We have to cut SS benefits now so that we may not have to cut them in a couple of decades, just like we have to raise rates now to stop wage inflation that we may see in a couple of years.
Course, I have a hard time remembering the last time wage inflation was a problem in the US.
“The U.S. Congress established three key objectives for monetary policy in the Federal Reserve Act: Maximum employment, stable prices, and moderate long-term interest rates.”
Edward Lambert: ” The Fed is not rsponsible to fight for higher wages, though they are counting on it to happen.”
While the fed is not responsible to fight for higher wages, neither are they responsible to fight for low wages — which they do every time wages start going up, the fed cries “inflation”, then increases interest rates, which heightens the unemployemnt rate thus lowering worker leverage and salary. You may contend that it is not the direct fault of the fed, but like the guy who pulls the trigger and says it wasn’t him that murdered wages, but the bullet, the actions of the fed the way it works now suppress wages.
I agree with you. Government needs to lead the way. I do not like the republicans. They favor CEOs over labor. They do not like unions. They are stupid. Sorry for my blatant opinion. I do not like the democrats either. They have no clear vision. They have no clear method of succeeding.
But monetary policy seems like it is pushing on a string. It’s like weak lending for productive capacity implies that interest rates are too high. But there are other factors that create weak investment in US productive capacity. There have been better opportunities in other countries. And many companies are already flush with cash. Profits are high. There is liquidity in other countries too.
But the US economy is still weak. How do we get productive investment here and not speculative investment? We have to raise domestic demand by raising wages. But then that implies a hit to corporate profits and a bear market. So companies are maintaining their bottom lines by controlling labor costs. They have the power to do that, since labor does not have the power to fight it.
Why invest in productive capacity when your profits are growing overseas and domestic consumers have weak incomes?
Firms have not wanted to invest in the US like in the past. There has been some over building too. Like when they made the movie Pirates of the Caribbean, they looked for months for a bay that did not have a hotel built onto it. The producers were amazed they said in how many hotels were built all over the place.
Once you build things, society then has to give money to the people in order to buy the goods and services from what was built. And if society does not have money, then businesses are helped along by keeping interest rates low. It is a process similar to rolling over debts by keeping payment costs low.
As the Fed rate rises, many companies that have debt and weak consumer demand will have their cash flows and bottom lines affected domestically. But their ongoing survival is a drag on the economy. They keep rates from going where they need to go.
What is the priority? Keeping marginal firms alive? That is not a long-run healthy strategy for monetary policy.
If you are a healthy company and want to invest, but you have unproductive competition able to compete with you, why invest? Just take your market share and enjoy your profits. You cannot completely compete with your competition.
Interest rates need to rise to clean up the drags on the economy. This is my long-run view.
You make good points. What did happen in the late 90’s? Why did wage inflation not create price inflation? My view is that the wage inflation was not met with stagnating production. Production grew. There was more investment growing at a rapid pace as a percentage of GDP.
see this graph at FRED…
After you have a surge in investment, you have to have a surge in consumer spending growth. China is realizing this change now.
The key now is to create an environment that is conducive to raising wages. So therefore you need to make policy that favors companies strong enough to raise wages. That implies a higher nominal rate.
The fight for better wages will be more successful with higher nominal rates.
Low nominal rates support businesses that are not able or willing to raise wages. The presence of these businesses lessens the pressure on the other businesses able and willing to raise wages. Why pay more when your competition is paying less?
Also look at the total labor hours over the past decades…
Labor hours have not been growing. Even though real GDP is growing, total labor hours is not. Demand for labor is stagnant.
Productivity has increased since the early 90’s.
Where are we going to get wage inflation? The demand for labor has not grown enough. If we support the status quo, I do not think that firms will increase their demand for labor. We have to increase the cost of capital investment. You will then see labor worth more relative to capital equipment.
The low interest rates are benefiting capitalists much more than labor, because labor is having to compete with cheap capital.
I think the answer to your question is “government jobs.” If the government is paying a fair wage for workers, even “efficient” companies will have to pay more to “compete in the labor market.”
i am afraid your “inefficient companies” is likely to be one of those theoretical constructs that economists invent but would have a hard time finding in the real world.
though of course “mom and pop” enterprises are “less efficient” than giant corporations. but, except in the matter of national defense “efficiency” may not always be good for human beings.
Did you see the graph for total labor hours…?
Why are total labor hours the same as they were 15 years ago? Aren’t we producing much more in real GDP? It seems as though firms have gotten more efficient without the need for more labor hours.
First, capital is cheaper due to lower interest rates. That makes labor relatively more expensive. Generally, a firm buys capital borrowing, but it does not hire workers borrowing. Borrowing costs are related to capital investment.
Second, there is lower labor participation, which is related to lower demand for labor. And also related to lower supply of labor due to lower labor share compensating labor.
Third, a lot of firms are doing more business overseas due to growth prospects and lots of liquidity in the international financial markets. Many jobs have moved overseas. That truth did not go away… yet.
Fourth, we see inefficient firms in China because they over-built, over-invested. Those firms are now running well below profitable capacity utilization which makes them seem inefficient. But they are inefficient only because there was too much accommodative monetary policy pushing investment. The firms are not inefficient, but macro-economically, they have fallen into being inefficient. To a less extent, the same has happened in the US, but China’s production is affecting the US economy. China as well as the US is put under pressure to have even more accommodative monetary policy. But the supply side of the economy is over-built in relation to the demand wage side.
Fifth, banks are reluctant to put the squeeze on unneeded firms which are now marginal. These firms are reluctant to raise wages. They are not real firms that are growing with a growing economy. It’s one of the reasons that we haven’t seen over 4% gdp growth since the crisis like after other recessions. They put a drag on the economy. They have debt that should eventually be written off, but the banks do not want to write it off yet.
Sixth, we may say that no firm is inefficient, but then we would need to say that the imbalances created over time through overly accommodative monetary policy are making them seem inefficient. Capacity utilization is still weak as compared to the past. Macro-economically the world has become over-built with debt overhang. And wages are not rising in order to consume the excess productive capacities.
Seventh, the EU is a mess. Their monetary union cannot survive. The one size fits all interest rates will always create problematic imbalances mostly in the periphery. These imbalances have led to incredible weakness which begs for ever more easy monetary policy. They are in a downward spiral that will eventually lead to a breakup. They have to change their monetary system. It will never work as it is set up.
Eighth, The US is not a mess. We have low wages, low total labor hours, cheap capital, large profits, assets hidden abroad and low effective corporate tax rates. But the US monetary system functions for the whole US economy because of the mobility and transfer potential within the US. The US is not in a downward spiral like the EU. We are in an upward spiral. Therefore we will see a bifurcation in monetary policy. While the EU gets more accommodative, the US will get more normalized monetary policy.
Ninth, there is uncertainty in the business world. Negative rates in bonds and in the Euro-zone are disconcerting. If nominal rates stay low in the US forever and ever, the uncertainty will grow.
The Fed is faced with very difficult decisions. I think they are going in the right direction by signalling a move to normalize rates in the US.
You wrote “Eighth, The US is not a mess.”
I would disagree. The US economy is just the tallest midget.
Our economy is huge and can lumber on for quite a while but it depends on consumers spending.
There is one practical solution to our problems. We should end Global Free Trade. That would force some production back into this country. That production would need US workers and those workers could increase consumption.
Or we can continue to rearrange the deck chairs.
Look at this FRED graph from 1984 to today. Why was this necessary?
I believe that the FED was masking economic decline.
It has been over 7 years since the beginning of the Great Recession.
I can go to Home Depot and buy what I need for a few cents less than it would cost me at Searing.
But Searing pays its workers a living wage and those workers will tell me how to install the part and lend me the special tool it takes to do it.
That makes Home Depot more efficient.
Meanwhile workers in this country haven’t had a raise in twenty years, have been laid off and had their homes stolen by the banks. And the roads and bridges are crumbling. People are living on the streets. The schools have been sold to Rupert Murdoch and Jeb Bush (No Child Left Behind)
And playing with the interest rate just masks all this.
You may be right about the “economics.” I wouldn’t know. But I don’t believe in “economics.” Or the Fed. Or the President. and sure as hell not the Congress.
I thought about it later, while driving, and I really meant to say that the US monetary system is not a mess while the European monetary system is a mess.
Yet, I am mulling over your comment about the Fed masking economic decline with the Fed rate sliding downward for so many years. At first it was a process of staying on top of inflation. Then wage growth began to sag more (but not in the late 90’s) due to labor competition opening up in other countries. Production was rising abroad. Total labor hours have been level for 15 years. There is just isn’t enough demand to push prices up when production keeps rising, labor share is falling and total hours are stagnant.
As inflation pressures keep subsiding, the Fed rate has drifted downward. Now the natural real rate is declining but still positive. Normalizing the Fed rate means that the Fed rate will eventually have to rise at least above 2.0% (1% core inflation & 1% natural real rate). It may take the Fed 2 to 3 years just to get to 2%. You know that I don’t think they have 2 to 3 years.
“It may take the Fed 2 to 3 years just to get to 2%. You know that I don’t think they have 2 to 3 years.”
Yes, I do, and I agree.
Your second paragraph beginning with “Yet, I am mulling…” is a thoughtful explanation of the dynamics over that period and I agree with most of it.
I certainly don’t believe that the FED meant to mask serious economic problems, but they did.
there are lots of factors that affect the economy. you identify several of them above, but talk as if there was an iron connection between, say, wage growth and competition from other countries. But some of that competition came from the Fed keeping the dollar “high” so that it paid American companies to locate abroad. Meanwhile the factors destroying the American workng class have more to do with the conquest of the United States by the predator class.
Perhaps, even probably, you are right about this particular “strategy” of the Fed, but I think they are, at best, putting mercurochrome on superficial scratches while the patient is bleeding to death internally.