Central banks use scenario analysis and flexible inflation targeting to manage economic shocks, balancing price stability with employment goals through state-contingent policy decisions. The Bank of England's independent monetary policy framework, established in 1998, allows the Monetary Policy Committee to adjust the weight on output (lambda) based on economic conditions, enabling responses to supply shocks like energy price increases while maintaining the 2% inflation target. This approach recognizes that monetary policy must be flexible enough to respond to different economic states while remaining committed to long-term price stability.
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LIVE: Andrew Bailey speaks at Reykjavik 2026 economic conferenceAdded:
ation at the Bank of England where he was responsible for the supervision of banks and financial institutions.
He has also held numerous senior roles uh within the bank including work on financial stability, international economics and crisis management.
In addition to his role as a governor, he now serves as chair of the financial stability board, placing him at the center of global efforts to safeguard the financial system.
We will have a Q&A session with him moderated by Stephanie Flanters from Bloomberg. P Stephanie is one of the most experienced and uh respected economic commentators globally with a career Spanish journalism, markets and policym from the PPC to JP Morgan and now the head of economics and government Bloomberg where she leads the global team covering economic development in real time overseeing uh the research and journalism of 250 economists and reporters worldwide and hosting a weekly podcast Trumponomics.
Governor Bailey, we are very pleased to have you here with us. Welcome.
Thank you.
Well, good morning. It's a great pleasure to be back in Rekuavic um for this excellent conference. Um Asia, I my my ancestors were in the chocolate making business line of business. So, I I can't match you for either the sense of adventure or the sense of risk. I'm afraid you take the prize for that.
That's truly impressive. Um so when we were here last year and I I spoke um I set out how at the Bank of England we were building scenarios into our monetary policy processes in response to the review that Ben Balani did uh of our forecasting uh and particularly in response to the review as he undertook the review on the significant uncertainty around the COVID period.
And I said that these scenarios I anticipated would help us to explore what might happen if a particular shock were to hit the economy. How a given set of shocks might propagate through to inflation depending on the strengths of different economic mechanisms and how monetary policy might respond in different states of the world.
The use of scenarios I concluded would help us build resilience into our inflation targeting regime and help to secure the nominal anchor in a world prone to big shocks to supply as well as to demand.
Well, it's it's good to have foresight occasionally. I didn't have that much foresight a year ago as to what was going to happen. I will openly admit. Um but of course for all of us the conflict in the Middle East has led to sharp increases in global oil and gas prices uh as transit through the straight of Hormuz has been cailed and critical infrastructure has been damaged in the region or destroyed and this is a very big negative supply shock to the world economy and in the United Kingdom the outlook for inflation has been significantly affected before hostilities broke out in February.
UK inflation was on track to fall to around two the 2% target from April.
The task for monetary policy in my view would have been to keep it there with underlying disinflation building slack in the real economy and a softening labor market. Some further easing of monetary policy was on the cards.
Well, if you detect the note of frustration in my uh comments, you will be right. um because instead of course we had an inflation number for April that came in at 2.8% last week and we think that 0.8 percentage points of upside news uh to household energy prices relative to our pre-conlict expectations uh which is driven really by fuel prices uh is a reflection of of those events that overtook.
And in reality, inflation is likely to go higher over this year as utility bills rise and firms pass higher costs through supply chains.
And of course, there's nothing monetary policy can do to prevent higher energy prices from affecting businesses and households.
For net importers of energy like the UK, the terms of trade have worsened and real incomes will fall. The shock will push up inflation and weigh on activity.
How much it will do that will depend on how the situation in the Middle East evolves.
A resolution at the source which would be by far the best outcome. Reopening of the straight of horm and repairing the damage that has been done to the world's energy infrastructure can reduce the impact of the negative shock to our economies.
Equally, the longer the conflict continues, the worse the impact on our economies will become.
But regardless of what happens, the task of monetary policy is to ensure that as the adjustment to the shock happens, inflation does not become embedded. And in the United Kingdom, that means returning 12 month CPI to our 2% target in the medium term.
Now, since our founding in 1694, the Bank of England has worked to promote the public good and benefit to our people. That's our objective. And set out in our founding charter.
Exactly what that means has evolved over the centuries.
Suffice to say that since the Bank of England act of 1998 in respect of monetary policy, the bank has operated independently of government with a clearly defined objective to maintain price stability and this objective is further defined in the annual remmit letters from the government to the bank's monetary policy committee and in turn the MPC is accountable to parliament for its actions for the people and parliament.
delegation to an independent central bank in this way works as a commitment device to reduce incentives to reneg on the promise of price stability under the pressures of daily politics.
For monetary policy, the temptation previously was always to tolerate a little more inflation in the short run to support the real economy.
But as economic history has shown, it's likely that policy makers will deliberately reneg on the promise of low and stable inflation. people will factor that into their expectations, driving up inflation without any benefit to the real economy.
The promise of an independent monetary policy is that it will not succumb to such temptations.
And that's why in our remitt is clear that the 2% inflation target applies at all times.
The remmit recognizes, however, that attempting to bring inflation back to the target too quickly may cause undesirable volatility in output.
In some instances, monetary policy has to manage a trade-off between the speed with which it brings inflation back to target and the consideration that should be placed on the variability of output.
And in this sense, the UK inflation target, like others around the world, is flexible rather than strict.
But of course, the question that begs is exactly how flexible should it be?
While the MPC's remit specifies the inflation target explicitly as 2%.
It provides no explicit guidance on the precise weight that should be assigned to output relative to inflation.
In the common jargon of monetary economists and central bankers, the remmit leaves the value of the parameter lambda unspecified, except perhaps implying that it should be strictly positive.
So put that way, the remake can be regarded as an incomplete contract between the government and the MPC.
But I would argue that's a feature, not a bug. From the point of view of Parliament, the remitt is a commitment device. but it's one that leaves the MPC with constrained discretion.
This is consistent with the view that the appropriate way of managing a trade-off is state and shop dependent and so is not something that can be predetermined.
For example, to the extent that it's appropriate to look through temporary price level shocks, the appropriate value of lambda, the weight on output when managing the trade-off when such shocks arrive may be high.
Equally, in the face of risks to the anchoring of inflation expectations, the very low value of lambda may be more appropriate.
On this view, the remitt encodes delegation of lambda selection to the MPC depending on the situation that it faces.
The remitt recognizes that there are times when the MPC is likely to be faced with more significant trade-offs that need to be managed, but it also prescribes additional public scrutiny in those circumstances.
Whenever inflation moves away from the target by more than 1%.
The governor of the bank is required to send an open letter to the government to the chancellor of the exteka that is to set out the outlook for inflation and the action the monetary policy committee is taking to return inflation to the 2% target.
And in response the chancellor can opine on whether the government views the balance that the MPC is striking in managing any trade-off as appropriate or otherwise.
Now, alongside my remarks today, we've published a bank insight uh article on the Bank of England website describing these issues in much greater detail.
But let me add here that any monetary policy regime involves constrained discretion in some form.
Even under the gold standard when central banks were highly constrained by the task to maintain the convertability of their currencies into gold, managing the system required considerable discretion at quite a number of times.
In the 19th century, for example, the Bank of England had to manage a trade-off between convertability and the needs of commerce and trade.
And there's a long history of debate familiar to people in this room I know about how much uh monetary policy should be constrained by rules and how much discretion should be left to central bankers.
Reflecting that debate, different jurisdictions have arrived at somewhat different answers to how constrained discretion should operate when when you're in an inflation targeting framework.
For example, the Bank of England's monetary policy remit bears many similarities to frameworks with a dual mandate.
Given the widely held view that money is neutral in the long run, both involve a focus on inflation stability in the long run.
In the short run, both involve balancing inflation volatility with a concern for output volatility.
And both lend themselves to be formalized in terms of a quadratic loss function, which is where the Greek letter lambda comes into the story, of course.
But there are subtle differences between these two, however, and I would highlight two.
The first is the in the clarity with which the remmit acknowledges that inflation achieving the inflation target is the best and only contribution that monetary policy can make in the long run.
The primacy of price stability in the MPC's remit makes clear that there are times when the focus should be squarely on in returning inflation to target and there are limits to how high lambda should be.
In that sense, our remitt is more constrained.
But second, and subject to the first, the MPC's remitt affords more flexibility over how management of a trade-off should be approached than a dual mandate, which almost by definition can be taken to suggest that a balanced approach should be taken.
I would argue that this additional flexibility that we have can be useful in allowing monetary policy to approach trade-offs in different ways depending on the circumstances.
Explicit language on how trade-offs should be managed gives clear directions on how the choice should be approached however and a clear framework for accountability to parliament.
So that begs the question of course. So how does the MPC's remmit suggest we should respond to the recent rise in energy prices caused by the conflict in the Middle East?
Well, monetary policy generally looks through the direct effects of energy prices on inflation. It takes time for changes in interest rates to affect the economy and inflation. So higher interest rates might only push inflation below target once the energy price shock has passed, resulting in undesirable volatility in both inflation and activity.
And even if the lags in the effects of interest rate changes were shorter, offsetting the direct effect of an energy price shock would require pushing down core inflation by generating additional slack in the economy.
Looking through the direct effects of an energy shock avoids such output volatility as the MPC's remmit calls for.
In other words, a higher value of lambda is appropriate with respect to the direct effects of an energy price shock.
Because they take longer to come through, the argument for looking through the indirect effects is weaker and protracted indirect effects could keep inflation above target for too long unless monetary policy responds.
This suggests a moderate value of lambda for the indirect effects.
By leaning against indirect effects, monetary policy may also reduce the risk that higher inflation becomes embedded through the higher inflation expectations and second round effects.
Such effects could arise, for example, if a rise in inflation expectations leads workers to bargain more strongly for wage increases and firms raise wages to maintain real pay for their employees, which in turn would increase their costs and could lead them to set higher prices.
Monetary policy should not look through such effects. For second round effects, the appropriate value of lambda is low, consistent with the primacy of price stability in the remit.
But the size of course of any second round effects in addition to the direct and ind effects indirect effects is highly uncertain.
And in addition to being highly uncertain, second round effects build up more slowly than direct and indirect effects.
And that leaves monetary policy makers with a difficult judgment call.
Because interest rate changes take time to take their effect. We can't wait for conclusive evidence of the strength of the second round effects, but responding too early may generate undesirable volatility and output and inflation may drop below the 2% target in the medium term if second round effects turn out to be smaller than anticipated.
I would argue this speaks to the desiraability of a state contingent approach including with respect to the choice of lambda.
Given the context of softness in the real economy and uncertainty around the scale and duration of the shock, tolerating temporarily above target inflation to provide some support for the real economy is an appropriate way to approach the trade-off.
But that tolerance would weaken if signs of second round effects begin to emerge.
So this takes me back to the scenarios.
In the monetary policy report that we published at the end of April, we presented three scenarios A, B, and C for possible outcomes for the UK economy and inflation over the next three years without any one of them being designated as a central projection as we normally would do and without assigning any probability weights to them.
This is not because we expect this to be the norm for the future. Rather, it reflects the uncertainty we face with the unpredictability of the situation in the Middle East.
As and when we can be more confident about how world events will unfold, we will return to presenting a central projection, one that the MPC agrees is reasonable baseline, using scenarios as vehicles then for exploring the inevitable risks around it and exploring differences of views within the committee.
But for now, the scenarios we think give us a better way to think about the policy discussion. The reality of the situation we are in is that there is a range of possible outcomes and we have to be ready to respond to all of them.
Using scenarios like this is part of being ready to to make that response whatever happens and it allows us to set policy now with a clear sense of the risks we have to balance.
The scenarios are designed to capture the key questions that are relevant to the policy discussion. How long will the conflict go on?
What will be the scale of the effects uh of the sec on energy prices of the conflict?
And particularly important for us, could it lead to second round effects and inflation persistence? The scenarios do not pretend to be exhaustive of what could happen. They're meant to illustrate somewhere around the range of possible outcomes.
While we are ready to adjust course as needed depending on how the situation evolves, our decision to hold the policy rate at 3.75% at our most recent meeting was an active choice given the range of possible outcomes.
Having taken expected cuts off the table for now, we already tightened policy considerably in response to the shock relative to what had been expected by markets. And that's already affecting financial conditions and the economy.
key quoted rates on mortgages have increased since the onset of the conflict.
So the decision to hold reflected a judgment that continued weakness in the UK activity and the labor market is likely to lessen the strength of the second round effects from higher energy prices while recognizing that these effects are likely to be stronger the larger and more persistent is the rise in global energy prices.
Uncertainty about the strength of the second round effects means that monetary policy needs to balance the costs of leaning too little against these effects against the cost of responding too much.
And the right balance is likely to change depending on how events unfold and how the economy reacts.
To state the obvious, that means of course that we have to monitor very closely the situation in the middle Middle East and how it affects the UK economy and inflation and adjust policy as required.
But whatever happens, the use of scenarios and the flexibility that we've built into our processes following the Bankei review has prepared us well for responding to events as they unfold and to returning inflation to the 2% target in line with the remitt and for the good of the people of the United Kingdom.
Thank you.
We got a big choice of chairs.
>> Thank you very much, uh, Governor. Uh, that was great. Um, you were you talked a lot about the importance of of discretion and and I guess the other way the other way of thinking about discretion or another way of putting it is that it's just the ability to respond to different situations in a different way. Yeah.
>> Um, >> of course looking at the UK, what's happened in Europe, 2022 also saw an energy shock, also saw rising inflation expectations.
How different is the current situation?
>> That's a great question. Yeah. Um, I think there are several differences that are important here.
One is to remember that the energy shock in 2022 came in two parts. So we had a February 2022 initial outbreak of the conflict in Ukraine and then we had one in the bigger one came in around August really actually. So it it had a different characteristic but I think the bigger point I would make is the legacy of co and the problem and I I look back on this you you know particularly sharply now the problem we had I think was judging how tight particularly the labor market was.
Every forecast that I know and we publish a summary of outside forecasts in every monetary policy report we publish had unemployment going up in the UK. This includes our forecast by the way when the so-called furow scheme came to an end. In other words, when the state paying for people to stay in jobs but not be be at work came to an end. We all thought there was going to be I think I got asked repeatedly how much scarring do you think there's going to be? And we all thought there would be and we all thought there would be an increase in unemployment.
I I mean the fur scheme was a great scheme in in many respects but it obscured the the read of the labor market I think. So of course what happened was exactly the opposite. We had no increase in unemployment. Labor market became tighter and it became very clear talking to companies that they were quotes hoarding labor deliberately um that they were worried about if they lost people they wouldn't be able to get them back. Now I think today we're obviously not in that position. I mean, there's always a, you know, an interesting task with reading the labor market, but I don't think there's the that we're in that level of uncertainty.
The picture of a of a gradually softening labor market comes through pretty consistently.
>> And is it, you know, obviously you had that experience, you you learned what some would say, you know, you learned quite a few lessons from that experience because the labor market was not as we thought, as many people thought. Um there's a lot of questions now around UK credibility both on inflation given the recent record um but also clearly the political uncertainty which we're seeing in in in market pricing particularly in bond markets but also uh in in inflation expectations. Is it harder for you to be using that discretion in this quite different situation given that sort of uh legacy that you're carrying?
Um I I think the legacy makes it a bit harder because I think it if you look on the other side of the picture to the sort of the softening labor market um softening activity going the other way put put on the sort of on the other side of the balance would be inflation expectations and you know I think we're very aware that um you know the legacy of four years ago does weigh in people's assessment of what inflation expectations are in response to the shock we're having at the moment. So you I I don't think we should be surprised that there's some element of what you might call hangover from that period.
But of course, we have to take that very seriously into consideration because it's real.
>> Um >> does sorry. But just does the change in inflation expectations mean something different this time because of the state because of what's in the labor market?
>> Well, I think that's where that's where it gets really interesting. Um because I think that's a judgment that weighs very heavily. You're precisely right because what you can end up with is somewhat more elevated inflation expectations but it isn't coming through in wage expectations um uh when they're measured and it isn't coming through in wage settlements at the moment particularly in the private sector in the UK. So again you know that's that's I think you know as I said in remarks that you know judgment is absolutely at the center of what we do and I think that judgment between those two things you know what weight do we put on the read from inflation expectations versus labor market expectations is is very important >> and I guess that means I mean at least on the on the outside it sort of seems that you wouldn't only be looking at inflation expectations as a as a clue to second round effects which is obviously thing you're worried about. So if it's not that, what other indicators are you going to be looking at?
>> So we look at I mean we look at a whole series. We're not going to be specific about a particular indicator. Um I mean there are elements of the inflation series because I think things like services inflation give you some reading on the sort of underlying state of the domestic economy more so than some of the other bits of the index.
labor market will the only problem in the UK will have is that there is a distinct seasonality to private sector wage settlements and we've passed that season before the shock happens so we we don't get as much information for the remainder of this calendar year on >> and that involves waiting quite a long time >> yes and that's the challenge going back to I was saying the other thing we do is we spend a lot of time I spend a lot of time going around the country talking to companies and we are doing a lot of that um and we come into this I I think with companies telling us quite consistently before the shock happened that they were finding it hard to pass costs into prices. So if you think back to sort of events that happened, you know, over a year ago, if you think back to things like the national insurance change, minimum wage changes, companies were telling us quite consistently, it is getting much harder uh to pass those through. And I think probably by the end of last year we were concluding that a bit more of it was coming through in in reduced margins.
>> So the the implication of what you were saying about a legacy is obviously you you feel conscious of that the trade-off between wanting to be seen to be responding quickly but waiting for those second round uh effects.
>> Have has the bond market tightening actually bought you some time on that?
um it probably has uh for but there's a number of things going on there I think so as I said in the remarks I mean one of the things we have in effect tightened policy in my view now this does depend this will you'll get different answers you know from different members of the committee on this because it depends what you thought you were going to do for the rest of this year before any of this happened I'd been quite clear I thought we probably would cut cut rates once or twice this year um that's off the table so you we've had as I said in my remarks we've had about 1% increase in in mortgage rates for new mortgages. So for two and five year fixed rate mortgages.
Um that's obviously a tightening of financial conditions. So that's that's that's real. Um I think the other thing we've had is that the UK bond market has responded somewhat more and this is linked because I think we've seen this very big change in the makeup of bond mark government bond markets including our own. So there was I think more than you would see see historically positioning particularly in the sort of the hedge fund world on the basis that we were going to cut and that positioning has has come off largely. So you had a bigger sort of reversal of positioning going on and I think that also has had some effect on the UK curve. It's it's coming down now progressively uh over the last couple of weeks. Um, you know, I hope it goes on that I think that will depend on events in the Middle East, I think.
>> Does the UK We're running out of time, but does the UK have a have a problem here? And is it a puzzle for the Bank of England? I mean, the neutral rate, the rate at which we can sort of not have a problem with inflation just seems to be meaningfully higher than you might have expected.
>> I mean, this is one of the the great puzzles I think that, you know, I think we all spend quite a bit of time on um as to you know, how you sort of square neutral rates. we do have a more open economy. That's one of the sort of arguments we we sort of come back to eventually. Um so that may that may have some bearing on the question. Uh I think uh but it is it is something that we you do look at very carefully. Um and I do think this you know this question about are we going to see you know market rates now come down will depend a lot now on on what goes on um in the Middle East. But I also would say this about the UK uh and it sort of goes to the I I don't comment on the detail of fiscal policy but I think if you look at it through the eyes of the market I think the market responded very positively to the budget last autumn um and and and they see that of course that with the with the shock uh and consequences of that in terms of energy prices. They obviously see a pressure on that.
>> Governor Bailey, we're under we want to make sure that we're not behind schedule all day as they were yesterday. So, uh, thank you very much.
>> Thanks, Stephanie.
Welcome back. Uh we now turn to our next keynote which will be livereamed.
It's a pleasure to welcome Jeffrey Smith, president and CEO of the Federal Reserve Bank of Kansas City and a member of the Federal Open Market Committee uh where US monetary policy is set. He brings more than four decades of experience in banking and financial supervision and today leads the Kansas City Fed's work across a large and diverse region of the United States. He is also host of the Jackson whole economic policy symposium, one of the most important global forums of central banking and economic policy. Following his his remarks, we will have a Q&A moderated by Stephanie Flanters from Bloomberg. Please join me in welcoming President Jeffrey Smith.
>> Thank you.
>> All right. Well, good morning everyone.
Uh thank you very much uh for that. And uh first of all, if you'll indulge me, I I do want to uh make a few thank yous.
Um first of all uh to Governor Y uh Jonen. Uh he's become a really good friend uh uh through the Jackson Hole Symposium. Uh he's also become a bit of a celebrity in Jackson Hole, which is kind of fun to watch. Uh and then Northwestern University. I had the pleasure last night of of having dinner with uh professor Professor Marty Iikenrom and that was delightful. Um just a couple quick comments uh because I've very much enjoyed uh my time here.
I thought uh yesterday's program and dinner experience was extremely uh enjoyable and and impactful includes including the music entertainment which was amazing. Uh I I'll just say uh one thing kudos to your teams. uh you know I as a as a host of the Jackson Hole uh symposium now going on 49 years uh it's amazing what the teams have to do behind the scenes uh in both hosting organizations and I have a real extreme appreciation for the teams that do this and how welcoming they are. Um also this uh uh this economic conference has what I call a bit of a a special sauce. Uh one, it it's got worldclass participants uh clearly. Uh it's in a stunning location uh for certain and and it has a rigorous agenda. Uh I did get a chance thankfully to experience one of your geothermal pools and I feel like I'm 25 years old again. So uh I I highly recommend that if you get a chance. Um also like to thank uh I'm sandwiched between two people I have great admiration for. Governor Bailey uh has become a friend and and I just really enjoy his uh his policy thinking mind.
And then uh vice chair of supervision for the board of governors. You'll see later here today. Mickey Bowman uh is uh is really great. And then finally uh greetings to everyone that made the trip. Uh it it's kind of gotten me all kind of fired up. When I return from Kansas City uh to Kansas City next week, we'll be start welcoming about a half a million visitors. We're one of the host sites for the World Cup uh tournament that starts here uh in the middle of June. And um it's a bit uh daunting for a a city the size of Kansas City. Uh but uh just so you know, we've got Argentina, Algeria, Austria, Ecuador, Quaco Craco, uh and Netherlands uh joining us in Kansas City for the World Cup. Uh if any of you need tickets, our chief economist, Joe Gruber, here will uh help you help you with that. Uh he he'll he'll explain the economic theory behind why you should come to Kansas City and enjoy the World Cup. So um uh so I've got some prepare prepared remarks. I'm looking forward to chatting a little bit with Stephanie. Uh but uh today I'm going to discuss a topic getting quite a bit more attention lately. uh and that's the importance of regionalism and independence in central banking. Uh I'll speak uh to how regional regionalism defines my role as president of the Kansas City Fed and forms the basis of my approach to monetary policy and what doesn't get as much air as monetary operations and kind of the bridge between policy and and true monetary operations. Um and and then I'll give examples of how uh I think importantly local inputs uh have helped shape my views on three important global issues uh we're all discussing here the last day or two. That's oil, artificial intelligence, and demographics.
Uh but first, what does it mean to be original Fed president? Uh to answer this, let me start with a little background. The United States was some somewhat late in settling on a central bank despite or perhaps because of two earlier failed attempts. Taking lessons from these experiences, the Federal Reserve system as created by our Congress in 1913 consists of a board of governors in Washington DC and 12 geographically defined district banks, including the Kansas City Fed. The Federal Reserve system has proven extraordinarily successful and durable in part because it was designed to align with America's regional compos composition. The Fed is a system of distributed rather than concentrated power.
Hence, the Federal and Federal Reserve.
There is an understanding that decisions on monetary policy are too important to be left to Washington DC and Wall Street alone.
Much of the popular support for the creation of the Fed arose in the region of the United States now represented by the Kansas City Fed. Farming is a credit intensive industry and farmers and agricultural bankers in the Midwest and my region desired a more elastic supply of liquidity than provided by money center banks in New York and Chicago.
The provision of seasonal credit was an important function of the early Fed.
So, how does regionalism define my role today as pre as president of one of these regional feds? I view myself as being at the intersection of a two-way flow of information between my district and the Federal Open Market Committee in Washington. I am the voice of the region uh on the FOMC and I am the voice of the F FOMC in the region. The Fed was designed to ensure that the views of a wide range of industries and communities are included in the nation's monetary policy deliberations.
In the weeks before each FOMC decision, my team and I meet with business and community leaders, including the 30 directors who sit on our boards in Kansas City, Denver, Oklahoma City, and Omaha. We attend roundts, visit factories and businesses, and conduct outreach across the district.
Before every FOMC meeting, we hear from hundreds of individuals. This is the input that informs my contributions at the FOMC table. Each industry and community has a different way of understanding and expressing its interaction with the economy. This is true whether rural or urban agriculture or health care, Kansas City or Denver.
The function of the district bank is to understand each of the communities on its own terms.
By being fluent in the district economy, the Kansas City Fed can ensure that the district is heard when it comes to monetary policy. This fluency comes from investing in expertise, but also from being deeply rooted in the community.
Let me offer a few examples.
Agriculture is important in the Kansas City Feds region. To communicate the interests and concerns of the agricultural sector, our reserve bank must invest in understanding the issues, challenges, and perhaps most important, the vocabulary that shapes the sector's economic discourse.
This understanding provides the rationale for the Kansas City Fed's newly inaugurated Center for Agriculture and the Economy. The center will provide an anchor for the district's research on important issues in the agricultural and rural economies and will further our outreach in these areas.
Community banking is another industry that distinguishes the Kansas City Fed District. Almost 650 of the country's 3,800 banks are based in our sevenst state region. Kansas alone has just about as many commercial banks as California and Florida combined.
Understanding the concerns and needs of these banks requires fluency in their operations and the economic environment in which they operate.
Talking with community banks not only gives us insight into the economy, it also informs the operational side of the Fed's mission. The Fed has a public interest mission to promote the safety and efficiency of payments. The launch of Fed Now, the Fed's instant payments rail, was in part based on discussions with community banks and a desire to promote broad access to instant payment capabilities.
As the payment system continues to evolve both domestically and globally, it will be important that the voice of local community banks continues to be heard. In part, this will be the responsibility of the Kansas City Fed.
Importantly, our connection to the district runs deeper than the ex expertise of our economists.
The connection that allows us to speak for the region extends throughout the bank. I was born, raised, and made my career in the district. The same is true for my first vice president, general counsel, head of bank supervision, CIO, general auditor, and head of bank operations.
This is not to say that you must be from the 10th district to effectively serve the 10th district, but regionalism has many points of contact contact within an institution.
In addition to engaging with the economy of our region, the connection our 2,00 employees have to our district and the sense of purpose they show in serving their region provides significant benefits for our operational work.
Whether it's helping distribute cash, examining a local bank or providing IT solution in support of the nation's payment system. Why am I talking about this monetary at a monetary policy conference? Partly because I think these are issues of importance to all central banks but at the same time are issues that are largely overlooked in the academic discussion around monetary policy.
While most of the literature on the central on central bank communication is about how polic monetary policy makers talk to the public, my belief is that central banks spend as much time thinking about how to best listen to the public. This important aspect of central banking is all but ignored by academics yet key to understanding the structure of the Fed and the value and of investing in regionalism.
Now, let me uh turn to the economic outlook and what I see as the current big three topics of conversation in the United States and worldwide and among both policy makers and the public. Oil, AI, and demographics.
Let's start with oil.
Of the 12 Federal Reserve districts, the Ken City Fed has the second largest energy footprint after Dallas. The current energy sec secret secretary Chris Wright was a valued member of our board, our Denver branch board before stepping into his current role. Our region has deep energy expertise and recent events have given us a lot to talk about. We are living through the largest disruption to to global oil oil markets on record. Between diminished traffic in the straight of Hormuse and threats to oil infrastructure in the Middle East, it has been estimated that around 10% of the global oil production has been impaired. This exceeds all previous disruptions, including those in the 1970s, which left a notable and lasting imprint on the global psyche.
Unsurprisingly, prices have reacted.
However, the increase so far, at least in the United States, could be viewed as relatively moderate compared with historical experience. Even so, the sharp rise in oil oil prices have triggered a wave of anxiety, especially given that large oil price shocks have been associated with recession in the past. The primary channel for oil prices to affect growth is the impact of gasoline prices on household budgets. In the United States, consumers purchase about 375 million gallons of gasoline every day. Every $1 increase per gallon shifts almost a half a billion dollars daily into Americans gas tanks and away from spending on other goods and services. While this number is large and certainly is being felt by US motorists, we must consider it in the context of a $30 trillion economy.
Overall, the United States is much less energy intensive than in the past. For example, we use about the same amount of gasoline today as we did three decades ago, despite an economy that is twice as large and and a 40% increase in the number of miles driven a year. In the 1970s, it took roughly 12,000 BTUs of energy to produce $1 of GDP.
Now, it takes 3,000 BTUs.
oil is less important and we are more efficient in using it. Another development buffering the US economy and rooting rooted in the Kansas City district is the tremendous increase in domestic oil production following the shell revolution. The United The United States has shifted from being the world's largest oil importer to being an oil exporter. When the United States was a large importer, higher oil oil prices were a deterioration in the nation's terms of trade and a drain on domestic spending power. Today, there is still a transfer of wealth, but it is happening within the country.
US consumers are paying more, but US producers are earning more. Of course, there remain distributional consequences that should not be overlooked.
Higher oil oil prices could incentivize US producers to increase investment.
However, my discussions with firms in my region suggest a high degree of caution.
Over the past decade, my contacts have moved toward far greater capital discipline and are reluctant to increase production while prices remain so uncertain.
While the effect of oil prices on economic activity may be unclear, what is clear is that higher prices are contri contributing to higher inflation.
CPI in price increased 3.8% in the 12 months ending in April and higher gasoline prices were a big part of this but not the only part excluding energy inflation is also running hot with prices increasing 2.8% 8% over the last past year. There is an active discussion among academics and policymakers about how monetary policy should respond to relative price changes such as the recent surge in oil prices. Textbooks suggest that central bankers should look through such price changes. But there's also realization that inflation can become embedded and persistent.
With inflation running above the Fed's 2% definition of price stability for over 5 years now, now is not the time to let our guard down. We must continue to signal our commitment to price stability and our willingness to take actions necessary to achieve our mandate.
One word I hear repeatedly traveling my district is resilience. Despite unprecedented shocks to global trade and oil markets, most economic indicators suggest continued steady growth. Many commentators attribute this resilience to the ongoing massive buildout of AI infrastructure, which brings me to a second topic. On the surface, tech investments appear to account for about 3/4 of GDP growth in the first quarter.
But AI investments rely significantly on imports and imports of techreated capital equipment subtracted considerably from growth in the quarter.
On net, the import and the importance for AI growth is undisputable, but the contribution is likely a bit less than it first appears. Outside of growth, the discussion of AI disruptions to the labor market has reached a fevered intensity. A key motivating fact has been the weakness of employment growth.
Over the last 12 months, the economy added 250,000 jobs, the slowest pace outside of a recession. The question on many people's minds is, is AI replacing workers? From my district reports, I sense this is not the case. Is AI depressing hiring? Here, the anecdotal evidence is more supportive. Many firms are excited about the possibility of expanding production while expanding headcount without expanding headcount.
The reality is that most industries have seen a decline in headcount over the past year independent of their rate of AI adoption. This suggests a more general cause behind the weakness of hiring. One possibility is that we're seeing the after effects of the labor hoarding that swept through the economy in 2022. Then with labor market churn at record levels, employees were hiring all available workers. There was bound to be some rebalancing as this urgency dissipated.
Another explanation for slow hiring is that we are seeing the pastor of a steep decline in labor labor force growth. The US working age population showed almost no increase last year, something that has never happened outside of war or pandemic. A sharp fall-off in immigration and the accelerating retirement of the baby boom generation have weighed on the working age population. Fewer workers require fewer jobs, explaining both the slow pace of employment growth and the relatively low and stable unemployment rate. This brings me in my final topic, demographics and health care. This issue has gained attention in the Kansas City Fed due in part to what I hear from contacts in our region, including executives in the healthcare industry.
The fact is that an aging population has continued to uh to grow in the one industry that has been adding a lot of jobs lately, healthc care. The health care and social assistance sector added 650,000 jobs over the past 12 months, significantly more than the 250,000 total, implying that non-healthcare employment has shrunk. The aging of the population is a driving factor. We tend to think of demographics as a slowmoving trend, but in reality, the United States is now at a relatively sharp inflection point. The proportion of the population age 75 and older, an age associated with a step up in healthc care spending is increasing rapidly. Over the next two decades, from 2020 to 2040, the share of population age 75 plus is set to double from 6 to 12%.
Recent work by my staff uh looking at state level data reveals a tight correlation between the growth of the over 75 population and employment in healthcare.
Even more striking has been the increase in the number of care aids that is home health aids and care assistance for the elderly. This sector has been adding about 300,000 jobs a year recently making it one of the brightest spots in the labor market. The importance of care aids for overall health care employment has been on a steep upward trajectory over the past decade now accounts for about 17% of overall healthcare employment. With the transition to an older population just starting in the United States, health care will likely be a steady source of employment growth in the years to come. The bigger question is whether the workers will be there to fill these roles. One might expect that the pull of the care aid sector would boost wages and costs across industries that that draw from the same labor pool. An obvious source of such workers as child care, likely increasing costs in an already stressed sector. This raises the unfortunate linkage that an aging society could further raise the already high cost of having and raising children, initiating a sort of demographic downward spiral.
A more optimistic alternative is increased productivity in the elder care sector, perhaps driven by AI. Given the tremendous projected growth in the elderly population, not only in the United States, but around the globe, it is almost hard to it's almost hard to imagine that numbers adding up without the help of AI, robotics, and increases in productivity.
I covered a lot of co topics today, all of which are touch on the Fed's dual mandate for full employment and price stability and therefore contribute to shaping the outlook for monetary policy.
To synthesize, I believe the labor market is in balance notwithstanding the potential though yet unrealized disruptions of AI. I expect healthc care to be a steady source of employment growth and a source of labor market stability. My primary concern is inflation which is too hot and has been above target too long. I place little stock in assuming that the most recent runup in price prices is transitory within an acceptable time horizon. As such, my focus remains strongly on inflation and setting the correct course for policy. Thank you very much.
Thank you, um, President Schmidt. So, we're, um, we are now running a little bit late, but we're going to go through till we're going to probably take a little bit off lunch and go through to about, um, 5 11.
>> Um, you've said now is not the time to let our guard down on inflation. I guess what constitutes letting your guide down uh, depends on how you're defining vigilance. So if you just look at policy right now, is it accommodative or restrictive?
>> So I've uh I've been fairly public that uh the it would appear that we are in a a phase where uh the whole concept of higher for longer exists. We've been a we've been in this inflation battle for over five years now. And and I I believe there's some equilibrium in where rates are today. Um even though uh late last year I I dissented in a couple of meetings that I thought the rate at the time was fine. Um so I think uh you know the the concern now is there there was a decent trend line to 2% uh kind of pre-tariffs and now now uh into the oil shock process where inflation now is trending higher. So I I would say we're not very restrictive uh at this stage. uh uh and uh I think there's some dialogue that that we need to start considering what tools we have to to really make it a little bit more restrictive depending on how this pull through of the oil shock occurs. So that's a very that's a very diplomatic uh it's a careful answer, but I guess you know if you're if you're if you're focused on inflation, you've also said it's the most pressing risk to the economy.
>> The idea that the you know still the Fed has in its statement a bias towards easing. Does that make sense in this environment?
>> Did it make sense in April in your view?
>> Yeah. uh it I mean if in fact uh we believe that the that the inflation numbers that are occurring here most recently are something that uh need to be bent back toward too. I would say yeah there's there's there probably is room at some point to use the policy rate again as a tool to try to calm and and reverse that trend. Um there might also be some ways in this particular phase depending on where where we see this oil pro uh price shock going that maybe we look at the balance sheet again as as another tool to to uh you know create some restriction in that. So I I think uh as we >> in what s in what sense? Well, I I think uh there's been some discussion uh we have a new chair now and about taking a look at the dynamic of you know a balance sheet that went from 9 trillion to 6 and a half and and we're in a an an ample uh uh reserve regime now. Is there a way that we could continue to bring that balance sheet down which would create a more which would create restriction?
>> That's interesting. So you think of that as being a tool for for tightening for replacing a Fed funds change?
>> I I I would say that there there there are there's discussions in in the academic world and in the policy world that that we we probably have two major tools. One's rates and and one's the balance sheet. So >> although although it's I don't want to get too sidetracked by this but I think the reason that uh chair Walsh has talked about that was actually that he didn't want the balance sheet to be he just thinks the balance sheet is too big and he thinks over time it should go down. My impression from the way he's talked about it is that he wanted to get out of the business of using the balance sheet as a tool sort of dayto-day for policy.
>> Yeah. I think to do that you you there might be opportunities to unwind it uh to a degree depending on where we want as a policy for reserves to settle >> but you I mean just again the way you're describing it it sounds like you you're at the very least you think there's a balanced outlook so the bias in this case would not be in favor of easing it would be you'd be if anything you'd be expecting the next you'd be you'd be sharing the market's view that the Fed is more likely to increase rates from here than to >> Yeah. Well, I I say would once we see how the data comes in and trends in, then I think you have to have at least optionality to go up or down relative to that policy rate and how it reacts to the inflation you're trying to fight.
>> And you talked about AI. We had a lot of discussion on that yesterday. Um, and you mentioned that there's uh or there's lots of discussion that, you know, AI could be a disinflationary supply shock for the US in a sort of positive way. um and companies being able to expand production without taking on workers.
But people have also talked about and President Mousalam mentioned yesterday, there's the short-term pressures that come, the upside inflation pressures that come from the buildout, the enormous amount that we see pouring into um data centers and other things. How do you weigh those two things? Is it gonna is AI going to push up inflation before it brings it down?
>> Yeah. So, I don't really look at it that way. I think that uh and we're trying to do this at the Fed, at least in the Kansas City Fed, is how do we operationalize what's available in the AI market. I think there's a couple what's interesting to me I a lot of the intellectual operationalization of AI is happening. I what we've been seeing in the district in some of our tours is there's a pretty sizable robotic uh uh push uh where I where I think as I mentioned in my healthc care comments um I've signed more retirement letters in the last two months than I have in the last two years and I we've having this discussion about losing this intellectual uh uh uh you know muscle that uh with people that are retiring and how are we going to supplement that muscle just by pure numbers, just demographically. So, I think intellectually we'll use AI to do that.
We'll also bring new talent in, but there there's a robotic element that's going to replace and move people to different jobs, I think, over the next uh 10 years.
>> I can't just to go back on that, I can't resist when you talk about having seen more retirements in the last year. Of course, this was a period where there was quite a lot of conflict and tension around uh the central around the Federal Reserve. some questions around even the the security of the position of the regional Fed reserves. You don't think that's had a little role in some of these early retirements?
>> Uh I think m maybe a little bit. I mean, we uh we are in the middle of a 10% reduction initiative that Chair Powell initiated and and uh but it what's interesting to me is we're I think the numbers right now is about 300,000 people a month are are aging out or retiring out of the workforce. That's almost 4 million a year. If you layer on top of that new immigration policy that there's there's a there's there's an attrition going on that allows institutions like ours to reduce headcount and and not not just to reduce headcount to to to reduce cost, but actually what we're doing is looking at what the new jobs are over the next 10 or 15 years and realigning those a little tighter to the mission. So it's actually had a a net positive effect, but we've been leveraging that attrition and that retirement demographic to kind of thinking about the new jobs of the Fed.
>> The way you've talked about AI, the way you've talked about the demographics potentially coming in at just the time when employers are finding other ways to to um you know avoid replacing people.
It you sound like you're not one of those people who's really concerned.
You're concerned about inflation, but not specifically coming from the AI buildout.
>> Yeah, I I I don't see that. I I mean, we, as I said, we we're on a pretty good trend line. We were down in the mid to low twos uh before the tariff experience and then later uh the oil shock experience. So, I I think what I'm trying to understand and we're doing more work on is what is it going to take to to run that last mile? because it it was things were getting really sticky above too and and so I think that's that's the piece AI AI buildout might be a little bit a part of that but there's a dynamic I think postco where supply chains have changed and and it just seems like people uh businesses have more uh at least the more courage to increase prices above that 2% number >> and what specific things are you looking at you say It's important for the Fed to have optionality. So, I suspect you you'd support them taking away that easing bias, but ju but in sort of in the next few meetings, as I said, people in the financial markets are now really fully pricing in at least one hike before before March. What are you waiting to see?
>> Well, so here again, I think everybody's a little bit on pins uh regarding the issue in Iran and and the straight home moose. And so uh you know you you can see these oil prices fluctuate wildly relative to just uh information that comes out of both sides. And I think I think I'm with most of the uh academics and and market folks who would um believe that if if there's a solution there then you get a pretty good downdraft in oil prices and maybe you maybe you start to trend back down to the 2%. So that I think there's time right now uh to to just take a breath, see how this goes and and then just see how much long-term pull through the the oil price issue uh occurs into the 27 cycle.
>> So I had one last question because you were talking in your remarks, you were focusing on the the value of the regional feds and in part that's about being able to bring Kansas City to Washington. Uh we also had a conversation we had a Bernie Sanders uh debate earlier. You know, obviously one thing we think it seems very striking at the moment when you look at the US economy, the K-shaped nature of the recovery as we talk about it, this divergence between a higher income assetowning households, their consumption is often driving a lot of the sort of headline demand in the economy, but the broader population seeing weakening labor market as you described and potentially quite sensitive to interest rate changes. Does is that making do you think we you should be focusing in Washington on the on what that means for even just neutral policy?
>> So, uh I've said publicly, look, I I believe inflation is an economic thief and then and and we get questioned a lot about the K-shap economy and then even maybe more importantly uh the wealth gap and and it the question usually is what can the Fed do about that? And I would argue that our mandate to keep uh prices stable and keep inflation at or around 2%. Is really the one thing that we have to do because what that at least does is give people an optionality where prices aren't increasing dramatically and if they can earn more they they should be able to have the option to build wealth.
But does it make your hard so I'm not asking whether you can do anything about any of that but I am asking does it make it the job harder because you have such a bifocated state state of different parts of the economy. Oh, I I think I think the job is hard right now because of what's happening, you know, globally uh uh and uh what what what happens with things like tariffs and oil price shocks and and how long that's going to going to, you know, transmit into the economy. And I I think we've got to be very cautious to be there for uh the actions that we can do to try to tamp that what uh inflation is caused by. So, >> President Jeffrey Smith, thank you very much.
>> Thank you very much.
Welcome back. I hope you had a good lunch. We now continue with our next keynote speaker and this will be live li live streamed. Uh it's my pleasure to introduce Michelle Bowman, vice chair for supervision at the Federal Reserve Board. Since joining the board of governors in 2018 and more recently taking on the role of vice chair for supervision, uh she has been responsible for overseeing the regulation and supervision of a financial institutions in the United States placing her at the center of discussion on financial stability and the resilience of the banking system.
She brings a unique perspective to this role, combining experience in banking, regulation and public service, including as a state bank uh commissioner and as a member of the federal financial institutions examination council. She is also actively engaged in international cooperation through her work with the parcel committee and the financial stability board. Vice Chair Bowman, it's a pleasure to have us with her with us today. Welcome.
>> Thank you so much. It's a pleasure to be here with you today and I want to give a special thank you to Governor Jansen and um and Northwestern University for hosting this conference and for including me in it. It's my first year participating and my first time in Reikuic and it is stunningly beautiful and I've had a fantastic opportunity to meet a number a number of people um with the central bank and uh and others here at the conference. So, thanks again for the invitation to be here with you. Um so it's a pleasure to be here in Reikuic with you to share my thoughts on formulating a practical approach to monetary policy decisionmaking.
As you all know the Federal Reserve conducts monetary policy to support a strong and stable US economy. In doing so the Federal Open Market Committee, the FOMC pu pursues the congressionallymandated goals of both maximum employment and price stability.
The Fed uses a variety of tools to carry out its monetary policy strategy and implementation.
But as uh others have said already, uh we have a number of Federal Reserve speakers um with us uh for this conference. Our primary monetary policy tool is the Federal Funds rate, which is a key interest rate for commercial banks and over for overnight borrowing that influences other interest rates throughout financial markets and the economy.
Lower interest rates reduce borrowing costs and they tend to raise asset prices and wealth uh thereby stimulating consumer spending and business investment especially on vehicles and other durable goods, housing and equipment and intangibles and ultimately supporting employment by stimulating demand. Lower interest rates also have the potential to raise inflation. In contrast, higher interest rates generally exert a drag on economic activity and employment and tends to lower inflation.
Over my tenure at the board and the FOMC, we revised our monetary policy framework twice. While I appreciate that frameworks may evolve over time, I am pleased that the FOMC returned the framework to basic principles last year.
Since joining the board in 2018, the committee's faced a number of significant economic challenges, including both very high inflation and unemployment and many economic shocks.
This experience has given me valuable perspective in assessing economic conditions and the balance of risks to the labor market and inflation in considering the appropriate stance and direction of our policy rate. Today, I'm going to describe the decision-making framework that I use to guide my approach to setting the target range for the federal funds rate. And specifically, I'll discuss how I consider the conditions that would lead to a decision to cut, increase, or hold the policy rate constant. I'll also share a few specifics and specific examples to illustrate how my own decision-making framework has informed my votes on policy decisions since I joined the the Federal Open Market Committee.
A critical input into the monetary policy decision-making process is an analysis of current economic conditions and the economic outlook. As we approach each FOMC meeting, I consider a range of indicators for economic activity and our maximum employment and price stability objectives. These inform my assessment of whether the existing stance of monetary policy is appropriate.
Frequent discussions with a broad range of contacts including businesses and other market participants ensure that I understand the conditions and expectations and provide context to my uh economic data and analysis and it helps to shape my views about how the economy is evolving.
This has been especially valuable because data can be difficult to interpret in real time and in recent years it's been more volatile and subject to significant revision.
My analysis often begins with a broad measure of economic activity looking at the recent path and the composition of GDP.
Economic growth is not one of the Federal Reserve statutory goals, but it carries signals that may indicate which conditions drive changes to inflation and to employment.
When the economy is near full employment, strong GDP growth could lead the economy to overheat and to spark inflationary pressures. On the other hand, GDP growth below its potential may signal that aggregate demand has weakened and that unemployment could rise above its natural rate as a result.
Looking deeper into GDP, I focus on private domestic final purchases. This measure aggregates personal consumption expenditures and private fixed investment and it can provide insights into the underlying momentum in aggregate demand because it excludes components of GDP that are volatile and hard to measure or not related to the business cycle.
As I look at employment, I focus on the unemployment rate and payroll employment.
Assuming that the underlying data are reliable, the unemployment rate can help determine whether the labor market is tight or whether it's experiencing slack.
Comparing the published unemployment rate with my own estimate of its natural rate allows me to gauge how close we are to achieving our maximum employment objective, which our latest consensus statement defines as the highest level of employment that can be achieved on a sustained basis in a context of price stability.
Payroll employment growth can be an indicator of labor market momentum and it can help identify shifts in the path of the unemployment rate.
Strong payroll gains relative to trend labor force growth point to an unemployment rate and a stronger and stronger labor market conditions whereas weak payroll gains can point to a higher unemployment rate.
One caveat is that since these data can be volatile or unreliable, as I mentioned earlier, for a variety of reasons, I pay closer attention to average payroll gains over a few months time to help understand whether the labor market is moving closer to or further away from full employment. Of course, I look at a multitude of other data both from the employment report and other public and private surveys to assess momentum and slack in the labor market. On Slack, data on discouraged and marginally attached workers and involuntary part part-time employment can indicate the extent of hidden employment and fragile employment.
Data on wage growth can help assess the relative strength of labor demand and supply. And the ratio of vacancies to unemployment is also a measure of labor market tightness.
On momentum, the composition of job gains by industry indicates the breadth and depth of employment gains. And I adjust the payroll data for persistent bias or expected revisions.
Indicators of layoffs like unemployment insurance claims can detect early signs of a pickup in unemployment. And data on job openings also provide a signal about the strength in labor demand.
On price stability or inflation, in 2012, the FOMC established 2% as the inflation goal as measured by the annual change in the PCE price index. As a result, policymakers closely monitor the recent path of total PCE inflation and how it's expected to evolve going forward. But because food and energy prices tend to be volatile, core PCE inflation excludes changes in these categories and tends to be and tends to predict future total PCE inflation more accurately than total PCE inflation itself.
Excluding volatile components from inflation measures filters out noisy price changes and is generally thought to improve their ability to be predictive.
Given that monetary policy affects the economy with a lag, it's important to look at core PCE inflation because it helps us understand how inflation will evolve once our policy actions begin to take effect.
Over the past year, when I've referred to core PCE inflation, I have specifically excluded temporary effects like tariffs on goods prices. I've also referred to PCE trimmed mean inflation, which excludes items with outsized price changes as an alternative measure of the underlying trend in inflation that can look through large one-time factors that are affecting a few goods categories.
As I mentioned earlier, monetary policy actions take time to work their way through the economy. Therefore, looking through temporary inflation shocks may be appropriate to achieve optimal policy as long as doing so does not affect our credibility to bring inflation back to 2%.
The tricky part is understanding what may or may not have persistent effects on inflation.
Ahead of each FOMC meeting, my analysis also relies on regular interactions with a broad range of contacts to better understand how the economy is evolving.
This provides insights into how households and business leaders, including financial market participants, are experiencing the economy and how they expect the conditions to evolve.
This can give me an early indication of changing conditions that will be reflected in future official data releases, but likely with a significant delay.
Relying on the most recent data or even modelbased forecasts based on this data provide an inherently backwardlooking assessment of economic conditions. This increases the risk that policymakers fall behind the curve in addressing risks to employ employment and inflation.
In extreme cases, the policy delay ultimately requires larger and more rapid policy adjustments than would otherwise be necessary.
An economic outlook that is informed by ongoing engagement with the priv with the private sector is more likely to reflect how the economy is performing and how it will evolve going forward.
This enables policymakers to be well positioned to act in real time and to support a strong economy.
In addition to paying close attention to the economic indicators and forming a view about how the economy will likely evolve over coming months, another consideration is where the current federal funds rate stands relative to my estimate of the neutral rate of interest.
The neutral rate is the level of the policy rate that is consistent with the FOMC's inflation and maximum employment goals. This is essentially equivalent to having a view about the degree to which the existing policy stance is restrictive, close to neutral or accommodative.
This view helps clarify whether conditional on my assessment of the ex existing economic conditions and the outlook, the current level of the policy rate is appropriate for achieving the dual mandate or whether an adjustment is needed.
At each FOMC meeting, my colleagues and I evaluate the incoming data, the evolving outlook, and the balance of risks to our dualmandated goals of maximum employment and price stability.
With regard to the policy decision, each FOMC member carefully weighs all of these factors before voting to support a policy action.
As our recently revised FOMC consensus statement notes, monetary policy plays an important role in stabilizing employment and inflation in response to economic and financial shocks. If unemployment is above its natural rate, other things being equal, the policy rate needs to be accommodative or below its neutral setting in order to stimulate demand and raise employment.
In contrast, if inflation is high relative to our goal, other things being equal, the policy rate needs to be restrictive, meaning above neutral, in order to moderate spending and reduce upward pressure on prices.
Conducting monetary policy to achieve both dualmandated goals can be challenging since the policy objectives of price stability and maximum employment can often be in tension.
In the past, I have advocated for a flexible approach to policym that supports adjusting the focus on policy objectives when they are not complimentary.
Our dual mandate places equal weight on maximum employment and price stability.
Consequently, when there's tension in achieving the two objectives, in my view, it's important not to favor one side of the mandate over the other.
Instead, we should be flexible and focus on the one that deviates the most from its goal or that shows the greater risk of persistently departing from it. In my view, flexibility in addressing existing or emerging departures from our goals allows policymakers to approach policy decisions in a timely and measured way.
Policymakers should also consider how the economy will evolve and help to support employment and price stability while limiting the risk of unnecessary volatility.
I consider this flexible approach to be consistent with the framework's balanced approach which considers both the extent of departures of employment and inflation from their goals and the time horizons over which they're projected to return to levels in line with our goals.
Another challenge in setting monetary policy is that important indicators about the state of the economy and the actual monetary policy stance can only be estimated with a considerable degree of uncertainty and may vary over time. For example, due to structural changes in the economy.
Since variables like the natural rate of unemployment and the neutral interest rate are fundamentally unobservable, policymakers face uncertainty in assessing the degree of slack or tightness in the labor market and restraint or accomod accommodation for the existing policy stance. This further emphasizes the need to be flexible in setting monetary policy.
So, I'll turn now to describing how economic conditions influence my policy assessment, and I'll note a few specific cases to connect prevailing economic conditions to my policy votes over the over my tenure at the FOMC and how I think about future policy actions.
So, I'll start with a hypothetical set of conditions that could lead to lowering the target range for the federal funds rate.
Most often, this occurs when inflation is already near or expected to run below 2%. And the labor market is fragile or expected to deteriorate with rising unemployment and relatively weak job gains.
In these conditions, when the policy stance is somewhat restrictive or close to neutral, policymakers should cut the federal funds rate to bring it into an accommodative position. And if the policy rate is already accommodative but not sufficient to align inflation and employment to their goals, it would be appropriate to gradually add additional accommodation.
These conditions existed during the second half of 2019 when I supported reducing the federal funds rate by 25 basis points at three consecutive FOMC meetings. Another case that could lead to reducing the policy rate is when the inflation and unemployment objectives appear to be in conflict and policy starts from a restrictive position.
Specifically, when inflation is above target and the labor market is fragile and at risk of deteriorating, it could be appropriate to cut the policy rate and slowly removes restraint to bring the dualmandated goals into better balance, provided that weak labor market conditions can also contribute to bringing inflation toward its target.
Under these conditions, waiting to lower the policy rate could lead to persistent labor labor market damage that would be very difficult for the committee to address with our monetary policy tools.
This view informed my FOMC policy votes during the second half of last year. At the July 2025 meeting, I dissented from the committee's decision to maintain the target range for the federal funds rate at its current level and voted for a 25 basis point cut to support the labor market.
With economic growth slowing, the unemployment rate continuing to rise, signs of less dynamic labor of a less dynamic rate labor market becoming clear, and inflation inflation excluding tariffs descending toward 2%. I preferred to begin the process of moving the policy stance from restricted toward neutral.
That action would have begun the process to proactively hedge against the risk of greater and more persistent damage to the labor market and weakening economic activity. One meeting before the committee acted.
For the same reasons, at our September meeting last year and again at our meetings in October and December, I supported the committee's actions to lower the policy rate by a total of 75 basis points.
And we may now be seeing that those rate cuts contributed to a pause in the deterioration in our labor market conditions in the United States.
In the alternative, let's consider the conditions that would warrant an increase in the target range for the policy rate. One straightforward case that would call for raising the policy rate reflects elevated inflation that is likely to continue to move higher with the labor market showing no sign of slack and GDP rising much faster than its potential.
The question would be by how much and how quickly to increase the policy rate.
If the existing monetary policy stance is accommodative or close to neutral, in my view, it would be appropriate to withdraw any remaining accommodation by raising the policy rate deliberately or even expeditiously.
For example, over the course of 2022, I strongly supported the FOMC's forceful policy actions to sharply increase the target range for the policy rate to curb high inflation, which was more persistent than many forecasters had expected and reached levels not seen in the United States for 40 years.
Strong demand, fueled in part by extraordinary monetary policy and fiscal stimulus and reduced labor supply from the pandemic resulted in a tight labor market that amplified existing inflationary pressures. In 2021, I noted that those pressures would likely take longer to subside. And in early 2022, I saw a substantial risk that high inflation could persist and began to argue in support of prompt and decisive action to tighten monetary policy to lower inflation under conditions in the above target inflation and no labor market slack. If the policy stance is already restrictive but not yet sufficiently restrictive to achieve the price stability and maximum employment goals, it would be appropriate to add additional policy restraint and raise the policy rate but at a measured pace during 2023 with monetary policy already restrictive. I supported raising the federal funds rate in smaller increments than in 2022.
So finally, I'll discuss the conditions that would support keeping the target range for the federal funds rate unchanged, including examples in which policy is already well positioned. This was the case between our September 23 and July 24 policy meetings. At the time, the FOMC decided to hold the federal funds rate at a restrictive level to address persistently above target inflation in a tight labor market. I supported the decisions because the degree of policy restraint was appropriately calibrated to reduce inflationary pressures.
Another example is when inflation is at or below target but employment seems near or higher than estimates of its maximum level and the policy stance is close to neutral or accommodative.
As described in the FOMC's consensus statement, maximum employment is not directly measurable and evolves over time due to factors that are largely nonmonetary.
Changes to the underlying structure of the economy that are expected to persist in the longer run may result in employment rising above existing assessments of maximum employment without necessarily generating upward pressure on inflation above 2%.
The combination of low inflation and low unemployment may reflect positive supply shocks that are working their way through the economy. And in that case, absent price stability risks, the dual mandate objectives may not necessarily be intention. And employment that appears stronger than its estimated maximum level may not require a policy response. This dynamic occurred during the second half of the 1990s when then chairman Greenspan led the FOMC to hold off on rate increases even as employment moved below the estimated natural rates as strong productivity growth allowed for a combination of strong output growth and low and falling inflation.
So I'll conclude this part of the discussion with an example of tension between our goals and inflation somewhat elevated, a weak or weakening labor market and a policy stance that is already accommodative. Under these conditions, balancing the maximum employment and price stability goals would would call for holding the policy rate at an accommodative level.
I'll turn now to talk about the current economic conditions and how this framework applies in today's economy.
The US economy has been resilient, but the labor market remains vulnerable to adverse shocks and PCE inflation has moved up due largely to higher energy prices. And my outlook remains influenced by the conditions resulting from the conflict in Iran. Over the past few quarters, the real GDP growth has been rising at a moderate to solid pace supported by strong AI related business investment. Growth has slowed since last summer as softness in real personal income and the severe winter weather in the United States have weighed on consumer spending. The US economy seems to be benefiting from a favorable technology shock that has boosted productivity and investment demand. The surge in AI related investment may be exerting some supply chain pressures, but strong productivity growth may put some downward pressure on inflation due to lower production costs in the medium term. Supportive supply side policies, including less restrictive regulations and lower business taxes, will also likely favor these conditions. And while the labor market appears to have become more stable in recent months, there are still signs of fragility. The unemployment rem rate remained at 4.3% in April with stronger payroll employment gains so far this year. But other indicators continue That's Yeah, that's not how it is now.
>> Okay. No.
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