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Published By:Wall Street Journal

Transcript: WSJ’s Interview with Cleveland Fed President Loretta Mester

Discussed the U.S. economic outlook, the effects of the U.K. vote to leave the EU, and other topics

Loretta Mester, president of the Federal Reserve Bank of Cleveland, sat down for an interview with The Wall Street Journal’s Michael S. Derby on Thursday, July 7, 2016. She discussed the U.S. economic outlook, the effects of the U.K. vote to leave the European Union and the likely path of U.S. interest rates.

Here is a transcript of the interview, lightly edited for clarity and length.

MR. DERBY:  OK.  So I think I will just go ahead and start out with kind of the obvious point of just where we are in the economy right now.  Obviously, it seems like a bit of an uncertain time, or particularly uncertain time.  Maybe you’ll disagree with that, but just want to know your sense of where we stand just at this moment and where you think we’re heading in the near term.

MS. MESTER:  Yeah.  So, you know, going into the June meeting and coming out of that meeting, my view was the economy was in really good shape, you know. I was less concerned about the weak May employment report because I’d put it into context.  I’m always cautious about reading too much into one or two monthly reports because we know there’s volatility in there.

And, you know, if you looked at, adjusting for Verizon, the monthly growth rate over the last three months had been 127K, and we know from our estimates that somewhere between 70(,000) to 120(,000), or 75,000 to 120(,000) per month is about what would keep the unemployment rate constant.  So the –

MR. DERBY: I’m sorry, 75(,000) to 125(,000)?

MS. MESTER:  Yeah, that’s like a range if you base it on different models.  So the number—so 75(,000) to 120(,000) was about that range.  This was 127(,000), so it was above the level.  So that would still put downward pressure on the unemployment rate.  And a lot of other indicators were suggestive of continued strength in the labor market.  So we’re going to get the next report tomorrow and we’ll have a better sense of that.  But again, my read of the data at that point was, you know, we were still making good progress on labor-market conditions.

My own view is, from the point of view of what monetary policy can do about it, we’re basically at full employment.  And my read of the inflation data was that it was basically playing out the way the (Federal Open Market Committee) had anticipated, in that it’s been below our goal for some time, but as the value of the dollar had begun to stabilize, as oil price has begun to stabilize, the inflation measures were moving back up, and the core measures were moving up and were above the total—the headline number.  So again, the dynamics there were moving in the right direction.

And my read of inflation expectations were—I rely more on the survey measures than I do of the market expectation-derived measures, just because we’re in a period of a lot of volatility, so I think it’s harder to infer inflation expectations.  So those pieces together suggested to me that we’re moving towards our goal.  And as we continue to move towards our goal, you would expect to have a gradually increasing path of funds rates.  Obviously the slope of that path and the exact timing of when those moves would occur depends on how economic, you know, developments come about, what the outlook—how the outlook changes, what the—risks around the outlook changes.  So that’s a case for, you know—you know, continuing on our medium-run outlook.

Now, the Brexit decision, of course, was pending.  So it was coming up the week after that FOMC meeting in June and, of course, at that point it made sense, like, why—you know, no urgency.  We’re not behind the curve.  So it made sense to me not to take a move then.

Since that decision, of course, most people were surprised, I think, by the outcome of the decision.  And so there is increased uncertainty about the global economy, certainly bigger effects in the U.K. and Europe than I would expect to see in the U.S., but we still have to be very attuned to that—those developments.

And what I’m doing now—between now and our next meeting later in July—is just assessing conditions.  So, you know, we’ve seen an increased volatility in the financial markets.  We’ve seen safe-haven flows into U.S. Treasurys, which have meant very low, you know, 10-year Treasury rates.  I think we just have to keep monitoring the situation.  It’s going to take some time to play out, just because, you know, how the EU and the U.K., their negotiations are going to take time to play out.  Eventually the global economy will react, you know, and adjust to those things, but I don’t think we’re going to have certainty about that for some time.  And that certainty can affect activity.  And so we’ll just have to, you know, continue monitoring to see what those affects are.  I don’t think anyone knows right now what the magnitudes of those affects are.

As you know, the Bank of England, [Gov.] Mark Carney, did a—highlighted the uncertainty aspect of a Brexit.  And that was one of the rationales for making the move they made to ease conditions—credit conditions.

MR. DERBY:  Would an extended period of uncertainty, with events that take some time to play out, landing in the middle or at some point along this process where you had been expecting rates to go up –

MS. MESTER:  But the real question for us, as U.S. monetary policy makers, is, has the medium-run outlook for the U.S. economy been materially changed, right?  And that’s, I think, the way I think about it.  So I always think about, well, what are the underlying fundamentals, right?  Have they been affected, right?  And I think the underlying fundamentals remain very solid for the U.S. economy.  But then—right—then, has there been a material change in the outlook?  And frankly, I’m going to use the time from now until our meeting in July to sort of continue to assess that.

Again, what’s the mechanism through which the U.K. decision might impact the U.S. economy?  Well, one would be through financial market conditions.  And in particular the value of the dollar would be a factor, because we’ve seen that’s had a depressing effect on net exports here.  The uncertainty could affect activity here if investors and households decide that it’s too uncertain to take action.  But remember, net exports are a small part of the U.S. economy, so that direct trade impact is probably less.

I would think that maybe some of the financial market conditions and also uncertainty might have—be the mechanism through which it affects the U.S. economy.  But again, right, my expectation is that these effects would be larger in the U.K. and Europe than in the U.S.  But again, you know, I think we’re not going to know for sure and we’re going to have to make an assessment in our best judgment about that.  And again, looking over the medium-run outlook, because that’s the time frame over which monetary policy affects the U.S. economy.

MR. DERBY:  Well, a lot of officials have been talking about—you know, up until fairly recently—prospects of raising interest rates again at some point over the summer.  Do you think there will be enough certainty or clarity on the outlook to do that?

MS. MESTER:  So I don’t really want to predict the outcome of any one particular meeting, because I don’t know what the outcome is going to be until we get into the meeting.  I like to hear what the discussion is around the table every time I go in there because I learn from, like, different perspectives from my colleagues.

You know, again, I think we have to just focus on—we’re always operating in a world of uncertainty, right?  And we always have to, as economists and forecasters, sort of take onboard that we’re not going to know everything for sure, but we have to make our best assessment using our models, best analysis that we can, of what that medium-run outlook looks like.  And that’s the basis for then deciding whether, you know, a gradual upward path still is our best assessment at this point of where interest rates are going.

You know, what particular meeting or what that—how gradual that path will need to be is going to depend on economic developments.  And you know, we’re constantly assessing those.  We’re constantly assessing how that affects our modal outlook, but also the risks around that outlook.  And I think, you know, we’re going to gather data.

So Brexit is only one of the things that is going to affect sort of our viewpoint.  We’ve got—continuing to get incoming information about the U.S. economy, right?  The labor market report tomorrow is one of those, what’s happening with inflation.  You know, we’re going to always assess where we are relative to our goals, are we continuing to make progress on those goals; and then, based on that, decide what appropriate monetary policy will be.

MR. DERBY:  Does the dot plot guidance really have much to offer us right now, given the uncertainty?  I mean, because people do look to that and say the Fed is roughly eyeing a certain amount of rate rises over the course of the year or into the future.  Is that not—given the uncertainty right now, should people not be doing that?

MS. MESTER:  So I am—I think of the Summary of Economic Projections as a whole as actually a useful communications device.  Yes, it shows that there are different views on the committee about, you know, the economy, right—growth, unemployment, inflation—and the policy that’s appropriate.  But I think that’s actually healthy for people to see that there are different views on the committee.  And we’re in—as you say, there is some uncertainty out there.  So I would—I would anticipate that we’d see some difference of views out there.  So that doesn’t trouble me.  I think it’s a good indicator of sort of that diversity, and I think we owe the public to show that.

The one thing I would like us to do in those dot plots—and we talked about this at the FOMC meeting—is to put some uncertainty bands around that median path, right?  So we offered the median path as sort of a—as a summary statistic of sort of, you know, what’s the median view across all the participants.  I think it’s also important to indicate that there is uncertainty around those median paths because of some of the things we’re talked about.  There’s different views of the world.  There are different shocks that can hit the economy, and different economists and policy makers have different views of which ones are more likely.  I think if we added those uncertainty bands, I think that would be another thing that would increase the value of those, and help the public interpret those.

MR. DERBY:  Are you any closer to getting there?

MS. MESTER:  You know, I think it’s, you know, an ongoing discussion that we need to have.  I certainly have shown some error bands around forecasts when I’ve gone out and talked.  And you know, then you can explain a little bit about, well, look, you know, if you think about—and it’s not that there isn’t some indication of that in the SEP right now.  So there is a table—when the minutes come out in the SEP portion, there’s a table that shows the historic forecast errors, OK?  And if you look at those, you could—you get a good sense of, you know, the errors around those forecasts.

So, for example, an inflation forecast one year out, the error band is plus or minus one percentage point.  So that kind of gives you a sense.  And even though then the Fed is setting policy, there’s going to be an error band around that interest-rate path because shocks hit the economy and the view of what’s appropriate policy then is affected by the shocks that hit the economy.  So you know, predicting that path, there’s also an error band around that.  So again, I just think that would be a valuable addition to the—to our SEP if we could convey that.

MR. DERBY:  Well, I’m sorry, I’ll ask you again, just because this is the sort of thing people really want to know about.  But is the uncertainty going to be such that it would be a high bar to—if the economy continues—if the data holds together, if the jobs report pops back up to trend, is the uncertainty related to Brexit still enough that July would probably not be a good time—

MS. MESTER:  So I think there’s going to be a diversity of views around that table.  I can’t predict what the outcome of the meeting is going to be.  But I think you’re right in the sense that everyone’s going to be assessing, right, the whole gamut of data that have—that have come in, and assessing it again, OK, has that changed my outlook for the economy?  And that’s kind of a thought process that’s going to be happening between now and July, in subsequent meetings and subsequent meetings.  So again, it’s always thinking about, you know, what am I inferring from the data and what are the risks around that, right?

So we all have to come up with a—we all write down our SEP predictions, right?  But we know that there’s some risks around those predictions, and the SEP gives some indication of those risks as well.

MR. DERBY:  What is your balance of risks right now?

MS. MESTER:  So I’m pretty much balanced because I think there’s—and of course, you know, we’ll get another round of those in September.  But you know, at the moment, if I think about the balance of risk around the medium-run outlook, right, I’m seeing balance, because I do think they’re—you know, I don’t think we’re behind the curve, but I do think that, you know, there are risks of waiting too long to move on interest rates, OK?  Some of them will have to do with financial stability, right?  And the FOMC has said, you know, we monitor conditions for that very thing because we know holding interest rates very low for a long time has the potential, right, to foment (inaudible) behavior and other kinds of things that could then feed back through the financial system on the—on the real economic outlook.  So we are continually monitoring that, right?

I think there’s also some chance that if we waited too long beyond what’s appropriate, that we’d have to then raise interest rates at a much faster rate than we’re currently anticipating.  And that could then engender a whole ‘nother set of risks to the longer-run outlook.  So we have to be careful for that.

And I also feel that, you know, there is some risk that if we don’t exit appropriately from this period of, you know, nontraditional monetary policy, that, you know, the public may begin to feel that it was not an effective policy.  And that may damage our ability to use these nontraditional tools in the future.

And that, I know, is not a standard kind of risk that we think about.  But again, you know, we are in a world of lower interest rates than probably before the crisis, for a number of reasons.  You know, you know about the work that’s gone on in terms of the equilibrium real interest rate and lower interest rates.  And in a world where that’s true, if it’s 3.25%, 3%, you know, your probability of getting low—you know, having a negative shock, right, and sending you into a place where you’re going to have very low interest rates, or appropriately low policy rates, where you may need to use some of the nontraditional tools, is higher than it would be if the equilibrium rate were higher.  And so I do worry about, you know, making sure that we’re attuned to that kind of risk as well, because that would affect the longer-run outcome of our economy.

So again, I see some upside risks in terms of, you know, us—if we leave—if we don’t properly assess both the upside and downside risks, you know, I think that could also get us into trouble.  So I think it’s very easy to say there’s a lot of downside risk.  There’s always uncertainty, right.  So the status quo is kind of always sort of a modal thing, right?  It’s hard to—it’s hard to move things.

But if you were to wait for every piece of data to line up perfectly to tell you, OK, it’s time to go, then I think you would have waited too long, because the world just doesn’t work that way.  Uncertainty doesn’t evolve that way.  The data comes in with lags.  There’s, you know, variability over—

MR. DERBY:  But you’re not making an argument that you have to raise rates in part because you know at some point you’re going to have to lower them?

MS. MESTER:  No, I’m not making that argument.


MS. MESTER:  I’m just saying that at some point, if we don’t get out of this period of extraordinary monetary policy at the appropriate time, then I do think that the public may conclude that it was not a successful endeavor, even though I do believe that it was.  And that would effectively take those tools—make it much harder for the Fed to use those tools if and when we get into a situation where they’re needed.  And so I think of that as part of, you know, why you want to be thinking about, right, when it’s time, when you’re not going to—you know, when you think that the economy’s moving in the right direction, which I think it is, that you’d want to continue on that path towards normalization.

MR. DERBY:  I mean, is it really just too soon to say how the Brexit risks could weigh on the economy?

MS. MESTER:  I mean, I think we’re going to be evaluating that.  So, yeah, I mean, we’re not going to know, right, how those negotiations between the EU and the U.K. in terms of their new trading relationships, their labor relationships, when they invoke Article 10 to actually start the process of making those negotiations.  So that’s going to be a longer time.

But we will get information on, you know, what’s happening in the financial markets.  You know, are firms, you know, taking—still doing safe-haven flows into other assets?  You know, we’ll have a sense on, you know, the dollar appreciated; is it going to remain appreciating, is the rate of appreciation going to continue?  So we’ll have more insight into that.  Will it be resolved?  No.  That’s going to take some time to play out.  We’re not going to know the magnitude of those effects for some time.  But we’re going to have to figure those in as we think about the outlook for the U.S. economy.

MR. DERBY:  Well, so, financial conditions.  I mean, the bond yields are down.  I guess the 10-year note hit a record low.

MS. MESTER:  Yeah.

MR. DERBY:  The safe-haven flows are here, and the dollar is up and the pound is down, and the euro is suffering.

MS. MESTER:  Yeah, yeah.

MR. DERBY:  So what is your assessment of financial conditions right now?  I mean, is this a—is this a fast reaction to what just happened or something more enduring?

MS. MESTER:  Yeah, so that’s the part we’re going to have to continue to evaluate.  I think we can’t say that for sure, like where things are going to settle out.  You know, credit risks—I mean, credit spreads were up a bit, right, because when the Treasury bill going down is in some sense a good thing for some parts of the economy, but it’s the credit spread that, you know, would be the financial condition you would look at.  If you look at sort of the value of the dollar, it went up a lot, like, on the vote, right?  It’s come back down a bit.

But again, it’s depending on sort of—I mean, I think the central banks of the world, you know, reacted in the way that was appropriate on the announcement, which was basically to say we’re here, we’re standing ready to add liquidity as needed to backstop.  So that’s—I think that’s the first thing that you do when you have a situation like that, and that happened.  And of course, the U.K. has taken action based on their assessment of the risks to their—to their economy.

On the other hand, as Gov. Carney pointed out, right, the fact that the U.K. pound depreciated is actually supporting their trade flows.  So, again, again, we’re just going to be assessing those conditions as we go forward.  It’s going to depend how things settle down and the risks around that.

MR. DERBY:  Do bond yields bother you right now, at their levels?

MS. MESTER:  I mean, it’s a global phenomenon that they went down.  Again, I think that it’s really hard to determine whether that’s based on fundamentals or whether that’s really this flight-to-quality issue.  And so that’s what I’m going to be trying to assess, is how much is just flight to quality and how much of it is just more fundamental that we need to be thinking about.  So I know that’s a balancing act there.

MR. DERBY:  Yeah.  I mean, how long does it have to be before you can make that determination?  What’s your—what are you looking at—

MS. MESTER:  But again, I don’t think we’re—I don’t think that the Fed, in terms of our setting of monetary policy, is behind the curve.  So I think we do have time to assess conditions and to come to some, you know, determination of where the economy is headed.  As I said, I’ve been one of the most positive ones in terms of the outlook for the U.S. economy, and I continue to be positive about it.  But I have to take onboard, right, that there is increased uncertainty, and I recognize that that increased uncertainty can affect the U.S. economy.  Certainly investment has been low, productivity growth has been low, and that factors into my view as well.  I would expect both of those to pick up as economic growth continues to expand.  But again, I think that’s one of the things I’m focusing on, to see whether that happens.

On the labor side, obviously the May report was disappointing in a lot of respects.  And I want to see, you know, whether that was just the one-month aberration that I think it probably was, or whether it’s a more lasting thing.

But again, the other thing to remember about the labor market reports is, you know, we’ve had very strong reports at the end of the last year, beginning of this year.  And in some sense, that might have been the bigger surprise, given that as we get closer and closer to full employment, right, you would expect the growth rate of that payroll number to come down.  Again, the number is between 75(,000) and 120K per month as being sort of the steady state—no change in the unemployment rate.

MR. DERBY:  It’s just harder to get those kind of job gains, because, you know—

MS. MESTER:  Yeah, as you get closer. So again, right, the real issue for people—I think the way to assess this is, will we continue to make—see improvement in the labor market?  And I would say if the numbers hold up at the pace they have been over the past three months, adjusting for horizon, I would say yes, because that’s above that level.

And in some sense, we shouldn’t be expecting 200,000, 225,000 jobs per month to be maintained at that level, right?  That’s just not the equilibrium level.  So again, the closer we get towards, you know, maximum employment, the more you would expect the rate pace of improvement to slow down.

MR. DERBY:  What about wage gains?

MS. MESTER:  So wage gains typically lag improvement in the labor market.  Certainly that’s been happening now.

There was some evidence from even in the hard data now that we have seen a bit of an acceleration.  And certainly when you talk to employers, certainly in my district here, you know, they have been struggling for some time to find workers.  And what I think is striking is that—so early, those reports were really concentrated on, you know, hard-to-find job—high-skill in IT, certain specialty construction.  Now I’m hearing it more and more from a wider swath of industries, even banking, you know, retail, and for lower-skilled jobs.

So again, this is sort of showing that there is improvement on the ground in labor markets, not just in the data that firms are, you know, hiring; more reports of retention bonuses to try to keep workers, more reports from some of our employers that they have had to increase starting wages to bring people in.  I’d like to see it go faster, but I do see positive there, that we’re beginning to see some of that.

MR. DERBY:  And if I recall correctly, you don’t see big links between wage gains and inflation?

MS. MESTER:  No, I typically don’t because I think it’s based—from what we’ve observed in terms of the Phillips curve, is that that’s a very tenuous relationship.  I see more in terms of stable inflation expectations and just the overall growth rate being—I see growth—you know, my forecast is for growth to be maintained slightly above trend, which I put at 2%.

And, you know, if you actually look at the dynamics and the inflation path, you’ve kind of seen that as the earlier shocks to oil prices and the dollar kind of worked through, that the measures are moving back up.  So inflation today is higher than it was a year ago, right?  And headline inflation has been running around 1% for a while, and then the core measures have been moving up.  And inflation expectations look about stable.

So the Cleveland Fed does an inflation expectations measure that kind of combines the survey measures with market data.

MR. DERBY:  Is that the 10-year—

MS. MESTER:  Yeah.  So if you look at that and you look at, like, five-year—five-years ahead, which is nice because it takes out sort of the movements in, like, oil prices that can affect sort of the near term, that’s been stable at around 1.9 (percent), you know, for a while.  So again, you know, those indications are that things are moving in the right direction on the inflation front.

So we’re certainly not there yet, but again, I don’t think it’s wise to wait until we have met both of our goals before we start moving interest rates back up gradually.  So again, it’s sort of balancing—you’re going to have to move before you hit the goals, because you can’t affect the economy until over the immediate run.  You know, it takes a while for monetary policy to act.  So I think you have to start moving, you know, before you actually reach our two policy goals.

And as I said on labor markets, I think from the standpoint of what monetary policy can do, we’re basically at full employment.  Now, when I say that, I sometimes feel that people don’t think that I fully appreciate some of the struggles that people are going through in the labor market.

MR. DERBY:  That’s the common response to that.

MS. MESTER:  Right.  Yeah, and I guess I do—I do really understand that there are a lot of people struggling still.  I think the recession—certainly the financial crisis and the Great Recession and the slow recovery really exposed and exacerbated problems that were longstanding problems in the U.S. labor market.  I think there’s a skill problem in terms of there’s new jobs coming in, right, that require higher skill sets.  And I know there are some people that find it hard to transition.

And I do think there is something that government can do about that; I just don’t believe that monetary policy is the effective way to address that.  And so I think of things like training programs, public-private apprenticeship programs that some people in our district are setting up, which is good.  I think of workplace development programs.  I think aid for students so they can get the necessary skills.  And it doesn’t have to be a four-year college degree.  It can be other kinds of programs that train people for the modern workforce.

I think all those things can help this problem.  And it’s going to be a continuing problem because there’s globalization and then there’s also technological change, right?  And that’s changing the nature of the jobs that are out there.  So I do think government has a role there.  I just am skeptical that monetary policy at this point can do much about that problem.  And I think there’s other things that can be done and should be done.

MR. DERBY:  Well, the Fed Up group, that may have been pushing not to raise rates, in part to help the—you know, benefit—to help extend the benefits of a strong labor market throughout the economy.  And there are cases that it hasn’t and there’s a lot of people who have been left behind.  And you’re saying—you’re making the argument there’s only so much we can do and that these other pockets are going to have to be addressed through other programs, correct?

MS. MESTER:  Yeah.  So Common Good came here, and they’re one of the programs that’s sort of associated with Fed Up.  And it was a very good conversation, I thought.  And, you know, they did talk about sort of their view of monetary policy and the fact that they wanted to maintain very low interest rates.  And I tried to point out to this issue, because in some sense I would hope that other groups like that would also recognize that there may be other methods that can help this problem.

And again, these are longstanding problems.  These are not just problems that have grown up over time.  You know, the Fed is—you know, (Federal Reserve Chairwoman) Janet Yellen, in her press conference, was asked this question about unemployment rates by gender and by ethnicity.  And it is true that there are—they’ve all moved in the right direction, right?  They’ve all come down, which is very good.  There are still gaps, but those gaps are longstanding gaps.  And there is something that should be done about those.  It’s just that monetary policy just isn’t going to be effective against that kind of thing.

And so, you know, there’s probably other things—other programs that—you know, government policies that could be effective in sort of solving those problems, and I’m in favor of doing that.  I just don’t think that monetary policy is the most effective thing.  And I get a little bit concerned that the focus on monetary policy as the tool for addressing that takes the focus probably off more effective policies that would—should be brought to bear, right?

So we don’t want to sort of put all our eggs into monetary policy, which, in my personal view, can’t at this point do much to solve those structural issues, because it diverts attention from perhaps programs that we should be thinking about encouraging that it could do something about.

MR. DERBY:  Does the Fed get looked to for these sorts of things because the political process seems to be in such a state of paralysis or just not producing—not able to come up with coherent responses to these problems?

MS. MESTER:  Well, I don’t know what the cause is, but I do think that monetary policy has been the go-to policy for a while now.  And, you know, there’s probably a lot of reasons for that in terms of, you know, we do know that we need a sustainable fiscal policy and we’re probably not on a sustainable path right now because we have some deficits—looming deficits in the future because of our medical and Social Security and other things.

So again, like, there’s a whole—it’s not just one simple answer that things can’t get done.  We need to be thinking about a sustainable fiscal policy that can help us in the short run and the long run.  And so this is a hard thing to do.  But locally there are things that are going on.

I’m sure you’re aware that the Federal Reserve has a focus on community development efforts across the system, and we all work very carefully with our—or closely with groups within our districts to sort of do the—help them do analysis and help to promote sort of what’s known and what can work and what, you know, is less effective and what’s more effective in sort of addressing some of these programs.

So, you know, this is something that the Fed has been doing for quite a long time.  This is not just a new thing during this crisis.  We’ve had a longstanding program where we, you know, try to bring the best work and analysis to bear on these issues that affect our communities.

MR. DERBY:  Well, this is a political question, but—and I’m not going to ask you to comment on the policies of the candidates, but the rhetoric of the campaign, especially in terms of Donald Trump, where, you know, the economy is—the economy is a wreck.  You know, the country is on the wrong track.  It’s terrible.  Everything is dreadful.  We’ve lost everything.  We’ve got to get it back.

Does that sort of rhetoric—I mean, because it’s obviously just plastered across every media outlet in the world, does that cause—does that affect the actual course of events in terms of how the economy is performing?

MS. MESTER:  I hope that people evaluate the policy programs being put out by any political candidate and sort of make an informed judgment about whether they support those policy programs or not, and then go into the polling booth and vote their conscience of who they want—you know, they think which policies are going to be the right one.  And I’m very confident in the American public that, you know, they look through the noise and focus in on the important things.

MR. DERBY:  But those kind of comments, do they—do they hurt confidence?  Do they affect investment?  Do they—

MS. MESTER:  Again, I think most people are knowledgeable enough to look at what are the programs, right, that each candidate thinks is the right way to go, and then to base their judgment on that and not, you know, necessarily listen to sound bites or listen to a political ad.

I think people need to focus on what are the policies that are associated with each of the candidates, whether—at every level of government, presidential down to local levels and, you know, assess are those policies that are the right ones, and go into the voting booth and vote that way.

MR. DERBY:  So one candidate saying everything is going to hell, that—and consistently saying that—because that’s somewhat unprecedented for a political campaign to have one of the candidates talking in this fashion about the state of the nation.  That doesn’t hurt—that doesn’t affect things?

MS. MESTER:  Well, again, I can’t speak for the world, you know.  I know that when I think about things, I go and I look at sort of what policies are they promulgating and what do I think is going to happen if this person gets in, in terms of where they stand, you know, what do they stand for, and then vote that way.


Well, one question that I wanted to ask you about, financial conditions that we missed, was the dollar issue, because that dollar has been a headwind–

MS. MESTER:  Right.

MR. DERBY:  —a lot over recent years.  And, you know, again, the dollar is, again strengthening.  And again, if we are in an extended period of uncertainty, it could remain strong for some time.  Does the dollar worry you right now as a longer-term issue?

MS. MESTER:  So I think it’s going to be about the rate of appreciation.  Will the rate of appreciation continue at the pace that we’d seen earlier?  And it hasn’t, if you actually look, even with those swings that we’ve seen recently because—after the Brexit vote, you know, we’ve seen ups and downs.  So again, it’s an assessment of, is the rate of appreciation continuing to move up?

No doubt net exports have been a drag on growth, but as the dollar stabilized, you actually saw that the drag has diminished over time too, which one would expect.  You know, the latest bout, we’ll have to see how long-lasting it is; you know, whether it means continued increases of the value of the dollar and therefore continued—you know, an increase of a drag on the economy.  But remember, exports are like—net exports are, like, 12 percent of the U.S. economy.

So again, you know, the trade impact, yes, it has had an impact, right, but it’s been offset by other strengths, including consumer spending.  And so the economy has been growing at 2%—2%-plus.  We saw that weakness in the first quarter, but the second—well, firstly, it was less weak than the original estimate suggested.  And secondly, there has been a pickup in the second quarter.

So again, right, the economy has been moving in a good direction in terms of growth, employment, and I would say inflation as well.  And I think the fundamentals are there to support that.

MR. DERBY:  So you had mentioned growth of likely just over 2%.  Do you have an expectation for further declines in the unemployment rate?

MS. MESTER:  Yes, so I have—my long-run unemployment rate is about 5%.  And I would expect to see unemployment, you know, go tick down below that before moving back up over the long run.

MR. DERBY:  Well, we’ve already ticked down below 5%.

MS. MESTER:  Yeah, yeah, but a little bit—

MR. DERBY:  Oh, a little bit further from 4%?

MS. MESTER:  I mean, I wouldn’t necessarily expect us to be at 4.7%, because we had that decline in participation rate, right?  So the monthly numbers will move around.  But, yeah, I would expect continuing improvement on unemployment, right, so we’re undershooting by longer-run value.

MR. DERBY:  So just to understand, so we could go below 4.7%, or you think it’s probably going to sort of bounce…I’m just saying by the end of the year, then—

MS. MESTER:  Yeah, I would expect some continued decline in the unemployment rate, a little bit, and then moving back up over time.

MR. DERBY:  OK.  And your outlook for getting to 2% inflation, you know, if things go—if your economic outlook happens—when you think we’re getting there?

MS. MESTER:  Oh, in the next two years.

MR. DERBY:  And I wanted to switch to some of the reform proposal ideas that have been out there—Andy Levin’s proposal. What do you think about that?  Do you think bringing the regional Fed banks fully into the Fed system, you know, as an explicit part of government, taking the bankers off the boards—what’s your response to those ideas?

MS. MESTER:  So my view of the system is actually that it was incredibly well-designed.  So remember, we had two central banks before the current Fed in this country, right, the First Bank and the Second Bank of the U.S.  It happened to be in Philly, where I kind of grew up—my professional growing up took place.  You’d walk by them and, you know, you’d have a sense of history, right?  They each only lasted 20 years, right?  They had 20-year charters and they weren’t renewed.

If you think about the current Fed structure, it was kind of incredibly well-designed, I think, to balance sort of this public sector and private sector representation in terms of sort of making sure that, you know, not only were Wall Street and New York represented, but the rest of the country was represented.  So we had the Wall Street versus “Main Street” setup.

And the structure I think has served the country really well for over a hundred years.  So I think that you had to take a lesson from that, in that, you know, we have had two other central banks in the U.S. that did not last beyond 20 years, and yet the Fed structure, which is this complicated balancing act, has lasted, right, for over a hundred years.  And I take that to heart saying, like, wow, you better be very serious about thinking about how to change that and not just, you know, think that you can make one change and it will somehow fix a problem that I don’t think exists.

I would be very wary of that public sector-private sector—mucking that up, that balance, because I think that’s really effective.  I think it’s very good that when I go to the FOMC meeting, I can bring in information from my district, talking to a whole swath of, you know, constituents here about what they’re seeing in the economy.  And I make it a point at every meeting to bring that in, because I know that’s one of the values of the current Fed structure is that we’ve got regional presidents coming in and bringing that perspective.

MR. DERBY:  But how would that change—I mean, if the regional banks were—because I don’t think Levin’s proposal called for ending the regional Fed banks.  It was just that they would not be owned, in the current structure, by—you know, by stock in—

MS. MESTER:  No, but they would become—the way I read it is they would become agencies, right?  And so there would be much more power in Washington, right, than is today.  So you’re concentrating power, right, in the political—in a more political realm.  And I think that’s what I would be very wary about.  I don’t think it would be the same at all.  I mean, Federal Reserve Banks are overseen by the Board of Governors, but we have our own views on monetary policy.  We have our own research staffs that support us in terms of our ability to analyze the economy.  And I think that’s incredibly valuable.

Yes, the structure is one of a corporate structure as opposed to this federal agency structure.  And yes, the banks have stock.  But that’s not owning the Fed in the sense of a corporation, right?  It’s making sure that there’s representation from the district as part of the Fed structure.  And I think that private-sector involvement, again, is very important.

You know, bankers do not influence any decision that’s being made in the Fed on supervision, right?  I know that’s one of the arguments, is that is there a conflict of interest because you have bankers on your board and you have supervisory responsibilities?  And they’re not involved in that at all.

MR. DERBY:  And the supervision’s run out of Washington.

MS. MESTER:  Right, but delegated back to the Reserve banks.  So in that sense you could imagine that—I think the people who are critical of the structure worry about a conflict between, you know, bankers sitting on the boards of the Reserve banks, and yet the Reserve banks going in and examining banks and supervising.  But they’re not involved in any of those kind of, you know, activities at all.

But they do bring a perspective of what’s happening in the economy.  Certainly, you know, as we’ve seen, the financial system is very important for how the economy evolves.  So they bring that expertise.  You know, there are heads of companies that are important in the districts in terms of, you know, being corporate citizens.  And so, you know, I’m very proud that Beth Mooney sits on our board because she’s been—brings a lot of value to our discussions about the economy, economic conditions, and you know, what she’s seeing out there from her banker’s perspective in terms of her clients, et cetera.

But we have representation for other things other than banks as well.  So again, you know, if you look at the Cleveland and Cincinnati and Pittsburgh boards, right, we try to pick over a very vast array of constituents, right?  We have a labor representative.  You know, we try to get the consumer side of things, Procter & Gamble.  So there’s a lot of different areas that we’re trying to makes sure that we have that broad perspective of what’s going on in our district, and that our makeup of our board of directors is reflective of our district. And you know, the Fed has been, you know, working on that for quite a while in terms of being cognizant of this issue.

MR. DERBY:  So you don’t—I mean, you fully support continuing to have bankers on the boards?

MS. MESTER:  I think there’s not a problem to be fixed, frankly.  I think there may be an appearance issue, but maybe that’s because we haven’t explained as well as we should, right, what value we get out of having this structure.  But I think it’s basically one of this private-public partnership; independence, you know, not only being D.C. and New York, but also having the regional representation; and the fact that the board meetings of the institution, right, are not conflated with the examination/supervision, which as you rightly pointed out is delegated to the Reserve banks.  So again, those decisions are made in D.C.

So again, there may be an appearance issue, but I do not believe there’s a conflict of interest.  And I don’t think the structure should be changed, frankly, because I think the structure has served the country very well over the last 100-plus years.

MR. DERBY:  So the other critique was—and I guess you’ve alluded to it somewhat—but the diversity issue, that—and I mean, this is about boards, but this is about, you know, the makeup of the regional bank presidents and governors, I mean, it being heavily tilted towards white men and people from—who are generally economists, coming from that.  So I mean, there’s only a small, little group of people who were bankers, and some people don’t even like the fact that there are people with financial backgrounds on there, but I mean, that’s how the makeup is.  And so the racial diversity, the gender issues, do you—do you think more can be done there or more should be done there?

MS. MESTER:  I think we can always do better of trying to stay focused on diversity.  Are we representative of the public that we serve, right?  And so we should always be very cognizant of that.  And certainly I do support the efforts going on to do that.  We’re cognizant of that.  We’ve been working on, you know, making sure that we have not only diversity on our board of directors, but you know, for the employees at the bank as well, because I believe that different perspectives, actually, you end up with better work.  So just like I believe the FOMC works well because we do have different perspectives, I think the same thing applies in the workplace and, you know, the processes by which, you know, presidential candidates are selected.  I do think we should be thinking about looking far and wide for the best-quality candidates that we can get for these positions.  And I would expect that there would be a diverse slate because we know there’s very good diverse candidates for most jobs.  And I would see no reason to think that we couldn’t do—you know, continue to try to seek the best candidates we can, keeping in mind that diversity is a—adds value to the operation of an institution.

MR. DERBY:  Well, I’ll raise a point that (former Minneapolis Fed President) Narayana Kocherlakota had made on his blog about—I know it was a—it wasn’t like a direct jab or anything, but talking about the—he connected the lack of African-Americans in leadership roles at the Fed to talking about, say, the unemployment rate of black Americans, and just the idea that because the racial balance is what it is, it’s caused the Fed to maybe not take full attention or full account of the employment problems or particular problems of a minority group.  Do you—I mean, I guess it’s a hard question to answer, but would the Fed benefit by having more of that sort of diversity in the leadership ranks?

MS. MESTER:  I mean, maybe that would be—I guess I would go back to the premise of the—of the quote, which is not being fully cognizant of, you know, the data or the—you know, what the data across gender—and I guess that’s not true.  I mean, we have lots of labor economists in the Federal Reserve System, and many of them look at disaggregated data by gender.

I think the issue is, is monetary policy the tool that can really address differences between, right, unemployment rates by gender, by race, by ethnicity, right?  And so, you know, we certainly care about, you know, those issues.  But again, as a policy focus, there’s really not—other than bringing down the average unemployment rate and therefore bringing all of them coming down, I don’t think monetary—and this is what we talked about before—I don’t think monetary policy can do that much to address those kind of issues.  That doesn’t mean those are not important issues.  Those are very important issues for the health of the country in the longer run, over the medium run.  But again, as a monetary policy maker, right, you don’t have a tool that can really fix that problem.

I think our community development area within the Federal Reserve certainly is attuned to that.  It certainly understands that different neighborhoods are affected differently by different kinds of policies.  You know, one of the issues that have been discussed about the zero-interest-rate policy is that there’s a differential impact on savers and borrowers, and that means there’s a differential impact by demographics, right—age, you know, older workers and—or older retirees, even, and younger ones who depend on fixed income.

So you know, I think these issues have all been there.  Monetary policy always acts through that channel, right?  But I think that the differential impact across groups has been exacerbated by the length of, right, the—and the depth of the Great Recession, right, and also the slow recovery. And so, you know, we’ve held interest rates very low for very long, and so these kind of differential impacts have been illuminated, right?  It’s not a new thing in the sense that monetary policy is acting in a new way, it’s just that interest rates have been very low for a very long time, and so these differentials are showing themselves up.

In terms of the unemployment rate, it’s the same thing.  Unemployment went up to 10% overall, but much higher for the categories where they always have been higher, so African-American unemployment rates went up more.  Those differentials are now, you know—I mean, all the rates have come down, but the differentials remain.  And so that’s, I think, a(n) issue that the country needs to take on.  I just don’t believe that monetary policy is effective against that.

So again, it’s going back to is it a lack of attention to it by monetary policy makers, or is it knowledge and understanding that this tool, right—the best that we can do with policy is to get the country back on our goals of price stability and maximum employment, and then to address these kinds of differentials in terms of income inequality or differential of unemployment rates by ethnicity, you know, gender.  There are other policies that need to be brought to bear.

I mean, I am concerned that—you know, technological change and globalization raise or can raise living standards, but it’s also important that people can get trained to take on the jobs that will be in that workforce.  And so I have some concern that, you know, if we don’t invest in that human capital, right, that we may not be able to capitalize on some of that—you know, on some of the benefits of those things.  And so I do have some concern about that.

MR. DERBY:  It all just comes back to that issue of, like, monetary policy is a blunt tool and can’t really target the fortunes of one particular group.  It’s targeting national aggregates, and–

MS. MESTER:  Right, right.  Yeah, so the best we can do is try to support the economy and, you know, promote our monetary policy goals.  But that doesn’t mean that we don’t think these other things are important policy issues, it’s just not monetary policy.

MR. DERBY:  OK.  Well, is there anything that you wanted to put out there that I didn’t ask you about?  Any issues that you think aren’t being discussed enough or any just sort of general point you want to make about where we are right now?

MS. MESTER:  I mean, the main point, I think, is that, look, we’re all going to come in to the FOMC meeting in July and all the ones subsequently, and we’re going to do the best we can of assessing, right, current conditions, what they imply about, right, the future in terms of the medium-run outlook.  And then, based on that and the risks around that, we’ll set the policy that we think is appropriate.  And there will be differences of opinion around that table, but that’s OK because we’ll come to a consensus view on where policy should be.  And that’s, I think, the benefit of having the structure that we have at the Fed, is it allows for that kind of diversity of views, which I think ultimately leads to, you know, good policy.