Cleveland Fed President Loretta Mester wants the central bank to open the door to raising its benchmark short-term interest rate in June by moving away from assurances of continued low rates.
In a wide-ranging interview with The Wall Street Journal in her Cleveland headquarters Friday, Ms. Mester also expanded on financial stability risks, her strategy toward dissents at policy meetings and why she disagrees with Harvard University economist Lawrence Summers on a number of issues.
An edited transcript of key passages follows:
WSJ: (Kansas City Fed President) Esther George made the case this week for higher interest rates early in the cycle to prevent risk premiums from coming down in financial markets and creating excesses. What did you think of the argument?
MESTER: There are parts of it that I agree with, but I am less negative on the use of macro-prudential tools than I perceived in her speech. I agree (these tools) are untested, but I still think we should try them first and then, if need be, go to monetary policy (to address financial stability risks).
WSJ: Do you see financial excesses building now?
MESTER: I don't see a lot of them. We're monitoring things, like prices in commercial real estate. But I do not feel that there is something I can point to and say, "This is an emerging problem."
WSJ: Do you worry that conditions are in place for financial excess? We're seeing financial flows coming into the U.S. We're seeing the dollar strengthening. We're seeing what looks like capital from overseas going into U.S. Treasury bonds and restraining term premiums. Does that give you any pause?
MESTER: No. Not really. I think you'd worry if there was a big outflow of capital. But that's not what we're seeing. We're seeing capital come in.
I talk to a bunch of bankers and business people and I always ask them, "Do you see deals being done that are a little shaky in terms of underwriting?" You do get anecdotes that they've done all they can do on price and now they are competing on terms. You have to worry about that. That is something that I'm closely monitoring when I talk to the bankers and others. The search-for-yield stuff, I think there is something to it. But my feeling is that when we do get to the point of raising interest rates, it is going to be about the real economy and our dual mandate goals, rather than financial stability concerns. I think the economy is actually doing pretty well.
WSJ: You're going into a new economic forecast round in March. How is your forecast evolving?
MESTER: I'm not sure I'm changing it that much. Obviously inflation is low. I'm not sure I'm going to lower my forecast on inflation that much. I might drag out the timing of when we get back to 2%. I still see growth around 3% over the next two years. I have the unemployment rate coming down. I'm keeping my Nairu right now at 5.5%. I might revise that down a tad.
[Editor's Note: "Nairu" is an economic concept known as the non-accelerating inflation rate of unemployment, an estimate of how low the jobless rate can go before inflation kicks in.]
I prefer to call it the long-run unemployment rate, because I'm not a big subscriber to the Phillips curve, [which sees] tradeoffs between inflation and unemployment.
WSJ: Your growth forecast is around 3%, which looks like it's on the high end. Do you have any pause about that? The last batch of numbers looks like they've softened a little bit.
MESTER: I'm building in some of the things that people are concerned about, like the net export sector. I don't think it's going to be a contributor to growth. Housing I don't think is going to be a very big contributor to growth. The government sector is improving but the federal side is probably going to be a drag.
On the plus side though, a lot things are abating that were headwinds and that prevented monetary policy from having the transmission that you would have expected given how low interest rates were and the quantitative easing that we've done. Household balance sheets look much better than they did. Business balance sheets look very strong. Business confidence and consumer confidence are high. Banks had to recapitalize after the crisis and then they actually had to implement the new regulations of Dodd-Frank. Their attention now is back to doing banking. A lot of these headwinds I think are not as strong as they were before. I think we're getting to the point where policy is having an impact. There is less drag against the policy that we have in place.
Inflation of course is running low. A lot of that is being driven by the oil price shock. Most of the evidence I have read and the modeling I have seen suggest it is more supply side than demand. I don't think we're going to have a deflation problem here. The economy is growing.
WSJ: Putting aside the tailwinds that you're seeing. The growth data look a little soft at the moment.
MESTER: Not really. The fourth quarter came in after two quarters of really robust growth. The employment report actually was revised up for those last couple of months. There is this tendency to look at the last data point. I'm just not that concerned. I think we've seen growth pickup. I think there is more momentum in the economy.
One of the issues in people's minds is, "What is different about this time?" We have seen these pickups before. Remember the green shoots. The difference is that a lot of these so-called headwinds are really dissipating. I see that the economy is actually not doing too badly. Not that we're at our goals yet. We're certainly not at our inflation goal. We're certainly not at full employment. But we're close.
WSJ: What is your framework for thinking about inflation?
MESTER: Inflation expectations are important.
I also think growth being above trend is important. Economics tells us this would be the condition that would lead to a pickup in inflation. Usually when you have growth above trend inflation goes up.
I'm not concerned that we're going to have all of these reserves sitting in there and flow out and get a big popup in the inflation rate. That is not the inflation dynamic we typically see.
WSJ: Can you describe the economic setting that will convince you it is time to start raising rates?
MESTER: OK. So I'll just say right off, I want June to be a viable option. We're close to our goals. I do think that monetary policy needs to be forward- looking. I think we're going to have to move before we reach our goals. And I think monetary policy is very, very accommodative. And so starting to move interest rates up makes sense.
The exact timing is going to depend on the data. Membership of the committee is going to make a decision about that. But I would be comfortable moving rates up in the first half of the year.
WSJ: When you say that, do you have April in mind or do you have June in mind?
MESTER: Given what we've communicated, June is a viable date. We have the patient language which has been interpreted as two meetings.
WSJ: You're not in there arguing you need to do this in April?
MESTER: No. We have to be consistent with our messaging. One of the things we've learned is that communication is very important. I'm really into making sure that we're transparent and that we communicate as clearly as we can. What's really hard about communicating is that people really want certainty. And there is no certainty. We are data dependent. That's why I've advocated that we really need to explain more about our reaction function. We need to give the public a model or a framework for thinking about how we're going to react.
WSJ: If you want June to be a viable option, then patient has to be altered in some way in the March statement.
MESTER: It is a natural conclusion.
WSJ: How do you do it?
MESTER: The hard thing about it is going to be how do you have June be a viable alternative, but not lock the committee into necessarily moving in June because we don't know if we're going to move in June. That is a challenge for communication.
I think we should try to simplify our statements over time. We talk in code. That's probably good for you guys because you have jobs that interpret what we say. We would probably do better to be a bit more plain-spoken. I was in London and I spent a lot of time looking at some of the recent Bank of England communications. They seem much more straightforward. Go look at their inflation report. But that is a long-term thing.
WSJ: Let's talk about patient.
MESTER: There will be a press conference, so the chairman can explain her views. If I were explaining it, I would explain the outlook. I would point to the Summary of Economic Projections and I would say, "Look we don't know exactly how the economy is going to evolve between now and later in the year, but it is possible that we will be moving rates up and we want to preserve that optionality to be able to do that. We are data dependent and here is what we want to see."
I think that can be done. I don't think it is difficult to do. I would like to have the optionality to be able to move in June if we want to, or not move in June if that is what the decision is. That is why I would like to see the language change.
WSJ: Some people out there in the market are taking about taking a nuanced step. The statement says the Fed can be patient in "beginning to normalize" the stance of policy. Some people are talking about just taking out the word beginning and keeping patient in.
MESTER: Oh my God. I would like us to be a little more plain-spoken about it all. That is almost like code.
WSJ: What do you want to see happening in the real economy before acting?
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MESTER: I do have a forecast of about 3% growth. If that continues, if the data comes in consistent with that, if we continue to see employment growing in the way we've been seeing in the last six months. I'm not as concerned about the inflation forecast. I'm not as concerned that it may take a while to get back to the 2% goal. It is a long-term goal. We've had the oil price shock. We've had the very deep recession and slow recovery. It seems reasonable to anticipate that it is going to take longer to get back to our inflation goal.
If I saw survey measure of inflation expectations destabilize, that would make me pause. But if the economy continues to look like it does right now, then I would be comfortable moving rates up. Remember, we're moving from zero.
WSJ: Larry Summers says wait until you see the white of inflation's eyes.
MESTER: I don't really subscribe to that because I really do think we need to be forward-looking. I would like to see us start. It is going to take a while.
I do think we need to be data dependent after that. I'm not saying that once we start raising rates we then move every meeting. That is just not the way this Federal Open Market Committee is working. Think of it this way. You have a forecast, then data comes in and you re-evaluate your forecast as data comes in. It should take in most situations more than one data point to move you off your forecast.
WSJ: Let's talk about how the cycle is likely to play out after liftoff. It sounds like you're saying your inclination is to act and then observe and then consider acting later on.
MESTER: It is not on a preset course.
WSJ: Could there be pauses in the process?
MESTER: Yes, but I can't say now whether there will or won't be pauses. We need to see how the economy reacts and evolves over time. It is hard to sit here today and say that is how we're going to behave. It is really going to depend on how much momentum there is in the economy. How much is employment growing? How much is inflation is it stabilizing? Is core inflation moving back up? You need to observe the economy. It could very well be that we move rates up and we decide to pause. It could very well be that we move rates up and say, "You know what, the economy looks pretty good we can continue moving." I don't think you can say that today.
WSJ: What is the end point for rates?
MESTER: I'm at 3.75% for the long-run fed funds rate. My hope is that we don't have to overshoot and come back down.
WSJ: So you also don't agree with Larry Summers on secular stagnation.
MESTER: I'm not a big subscriber to secular stagnation. It is hard to imagine that the things that are going on in technology and biotechnology aren't going to lead to things that we are going to be able to use in a very productive way. I've lowered my long-term growth rate a bit. I was at 2.75% before the crisis and now I'm at 2.5%. I understand there are demographics and other things going on. But I'm not as negative on that. There are a lot of inventive things and innovation going on.
WSJ: Can you talk a little bit about some of the longer-run steps the Fed can take to communicate more clearly?
MESTER: I would like us to try to simplify our statements so that they're clearer. There is work to be done there.
I would like us to think about the Summary of Economic Projections. Can we make that a more useful tool for the committee? Our policy is related to the forecast. The committee a while ago had worked on trying to come up with a consensus forecast. That didn't end up working, I think because it was probably the wrong time to do it. We were still using nonstandard tools. I think there is more hope now that we can perhaps get to that.
WSJ: You worked side-by-side with [Philadelphia Fed President] Charles Plosser for many years. How close are you to him in terms of how you think about monetary policy and the economy. Were you two peas in a pod?
MESTER? No. We're independent thinking. There are a lot of things that President Plosser ascribes to that I would ascribe to too. You don't want to overreact to one data point. I do think that if we can be systematic we should. At this point I don't think we have one rule that we should be using to guide policy, but I do look at rules. It does help to inform my view. That is sort of in the realm of where Plosser is, but a lot of economists do policy that way.
I don't believe necessarily in the Phillips curve. I don't believe he does either in terms of the way it forecasts inflation. So there are similarities.
[Editor's Note: Ms. Mester was research director of the Philadelphia Fed for more than a decade, before becoming Cleveland Fed President. Mr. Plosser is a policy "hawk," meaning he was skeptical of the Fed's easy money policies, and he dissented against many of them in the past.]
WSJ: How do you think about dissenting?
MESTER: I think about the whole package. There may be certain things at a meeting or in the statement language that wouldn't be my preference. But you have to look at the big picture. I wouldn't dissent on a small thing, even if it didn't go my way. Is policy going in the right direction? Are we being as clear as we can to the public? Those are two things that I care a lot about. It has to be more than, "I would say moderate instead of modest." That is too small a thing to dissent on. Is policy moving in the right direction and are we explaining it?
WSJ: You wanted to get rid of "considerable time" early on. Were there any close calls for you last year?
[Editor's Note: The Fed said in several statements last year it would wait a "considerable time" after the end of its bond-buying program before raising rates.]
MESTER: I was comfortable with my votes.
WSJ: But were there any close calls?
MESTER: I was comfortable with my votes.
Write to Jon Hilsenrath at jon.hilsenrath@wsj.com
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February 16, 2015 17:09 ET (22:09 GMT)
February 16, 2015 17:09 ET (22:09 GMT)
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0 Response to "Cleveland Fed President Mester: June Rate Increase is 'Viable Option'"
Thanks for give comment.