Transcription
Governor, welcome to the program, sir. We've got tons of time to talk about what's going to happen next. Your thoughts on the labor market, the balance of risk, the broader economy. I actually wanted to lead the conversation with this one. Governor, what was your experience like? I'm sure this was unexpected 12 months ago. What was it like walking into the room and was it different to what you expected?
Good morning and thanks for having me. It's great to see you again. Look, you know, walking into the room, you know, I had had a good briefing ahead of time about what the meeting would what the meeting would be like. And so that was very helpful. But I will say that everyone was extremely friendly and welcoming and kind and collegial, and I really appreciated that. And, you know, it's important to understand that the FOMC is a body. The Federal Open Market Committee is a body that makes decisions by arguing on the merits of the economics and the economics and the merits of policy. And and that's how it was. And everyone was very collegial in hearing their views and and I the same. And that's why it'll continue to be you know, we make policy, as the chairman said last week by persuasion. And so I will continue to try to lay out my views and make the case as best as I can.
The governor essentially got the opportunity to articulate your argument. Just how much daylight did you sense was there was between you and everyone else on the committee?
Well, I mean, you know, sort of funny, if you look at the the dots in the summary of economic projections, you know, obviously there's a divergence between my my projection for privacy policy for 2025 versus where the weight of everyone else's is. But as you look at next year, in the year after, you know, I'm sure I'm still in the low end, but, you know, there's not really that much daylight between all the rest of the data in myself and following year. So it's really just about the speed with which we come down to what's closer to neutral.
Well, let's get into the neutral argument. I think that's what separates you from a lot of people. So you've got it in the mid twos, Governor, and you think we should get that quickly? Can you just build out why you believe that's the case and why we should get there so fast?
Sure. So, look, you know, I discussed a number of forces which have kicked in over the course of this year and which are, I think, in stark contrast to where they were last year. So I've argued that neutral was higher in the past than it is now, and that that neutral was higher for a variety of reasons. But I've highlighted recently a fiscal policy, you know, sort of driving up net national borrowing, decreasing that national savings as well as immigration policy, driving what was the biggest positive population growth shock in my lifetime and has now turned into the biggest negative population growth shock in my lifetime and in very rapid succession relative to to how changes in population growth normally normally occur in the data. And so to me, when you have huge swings in net national savings driven by fiscal policy and you have huge swings in population growth driven by changes to border policy, it would be bizarre for me to think that that wouldn't have implications for the fundamental structure of the economy. It gets reflected through for monetary policy in the neutral rate. So my view is that neutral was higher last year because of these reasons. And so last year policy was not as tight as a lot of people believed. And now neutral has come down or is in the process of coming down and now neutral. And now policy is more tight than people believe. And this is this has happened recently. You know, these policies didn't change, you know, sort of overnight. They've been kicking in over the course of the year. And and that means that policy is is becoming tighter every day as these policies continue to kick in. And my view is not one of enormous economic pessimism. You know, I don't think the economy is about to crater. I don't think the labor market is about to fall off a cliff. However, the neutral rate is drifting down and as a result of that, it's incumbent upon policy to adjust in response. And the longer that policy stays excessively, excessively restrictive, the greater the risks to the downside for the economy. If policy stays excessively restrictive for too long, then you do get to an a situation in which you have a meaningful, meaningful increase in the unemployment rate and an A and a failure of of the employment mandate. So that's the tension, I think.
In your view, that's worth exploring. Just a little bit more. On the one hand, you don't think the economy's at risk of breaking down, but you also think we are excessively tight at the moment and getting tighter. There are some people who would say and we've had this conversation around the table this morning, if we were as tight as you're suggesting, why is the market within 1% of record highs, why credit spreads super tight, and why is this economy still doing okay?
Yeah. So that's a perfectly natural thing to ask. Sorry. And let me say it. Let me say two things. One, I don't think that all financial conditions are are universally loose like that. In particular, if you look at the housing market, I think it's in quite a different state than, you know, sort of some financial markets and, you know, sort of security markets. So I don't I don't think that that's necessarily a holistic look at the world of financial conditions in the economy. But even that aside, I think that, you know, people in financial markets tend to focus a lot on monetary policy because interest rates are, you know, sort of huge tradable instruments. Right. But there's so much more that goes into determining economic growth and the state of the economy and inflation and employment, then monetary policy. And I think that attributing all changes in financial assets to monetary policy can be a mistake. In particular, that's what I tried to do in my in my speech, you know, was was to draw out some of these some of these effects from nonmonetary policies that are affecting the economy and of course, therefore, also financial markets. And so if you have changes in tax policy, right, like significant incentives for investing that lower the effective tax rate on capital, of course that's going to get reflected into capital assets. If you have significant changes to the regulatory environment where you have removing barriers to operations that companies can make more, more cheaply, which by the way is disinflationary and pushes out the apple cap. Then of course, that's also going to be reflected in asset markets. So I think it's a mistake to conflate the state of financial conditions with monetary policy. They're connected, they're related, they affect each other, but they're not exactly the same thing. And in the speech, I go line by line through these different items. And the reason why monetary policy doesn't have to react to the hawkish side in response to these factor into these policy changes is because they push out the supply side of the economy at the same time they push out demand. And so if you're increasing supply and demand at the same time, there's no change to the output gap. And of course, it's monetary policy job at the end of the day to be balancing the output gap, to be balancing aggregate supply and aggregate demand in the economy so it doesn't overheat or under heat.
I think there are a lot of people, Governor Myron, who would agree with you that probably the neutral rate is quite a bit below where we are now. You said even though other Fed governors did seem to agree with that, but not necessarily the speed and I'm still unclear. Why do you think it is so important to get rates down by 125 or 150, a 550 basis points more this year if inflation is still running hot and you're not seeing anything alarming in the underlying economy.
Yeah. So this year is merely a function of where the calendar is. So my my view is that policy's quite restrictive. And so I'd like to adjust quickly to get back to a more neutral area. Right. That just means a series of fifties until you get until you get much closer to zero. The fact that it's this year is just just a function, just a function of the calendar. But again, it comes back to the longer that you stay restrictive, the greater the risks. And let me put it this way, like it was just a few years ago, that we were having endless conversations about declining population growth rates in the whole world, becoming Japan in terms of interest rate profiles. Right? Those forces are still real. Those dynamics are still real. They didn't go away. Those channels, you know, those channels by which population growth effects neutral rates didn't disappear. I would rather react. I would rather proactively write in sort of we know that we just had the biggest population growth shocks in many people's lifetimes, mine included. Right. I would we know what the consequences of those are economically. I would rather act proactively and lower rates as a result ahead of time rather than wait for some, you know, giant catastrophe to occur because you suddenly wake up and find out that you you are sort of resuming those dynamics in my mind if you wait to sort of to see the result of that. You have waited too long and there will be there will have been a potentially quite material downside, downside risk to the employment mandate.
A lot of people on this show have been wondering what the reaction mechanism is going to be for a Federal Reserve that does start to see inflation as transitory. Once again, the idea that we have been above 2%, the 2% target for the Federal Reserve for 53 consecutive months for more than four years. If there is an upsurge in inflation, how long are you willing to look through that If you are cutting rates before you say, hold on a second, maybe we need to stop?
Yeah. So I would want to understand why there was an upsurge in inflation and what was driving it. And then sort of think about whether that shock is likely to be persistent or whether the shock is likely to be transitory. And it's the nature, it's the nature of the shock. It's not just is inflation higher for a certain number of months, it's why is it higher or why is it lower? And how long are those and how long are those shocks likely to persist? And if you have a situation in which inflation is much higher because there's, you know, sort of, let's say, a very significant expansion in national borrowing that drives up demand, could be driven by fiscal, could be driven by something else. That might be the type of thing that you would expect to be to be more persistent. In my mind, if you have the type of shock that's driven by a, you know, basically one off change to tax rates, right, Whether it's a VAT tax or tariffs or anything else, you know, that in my mind is not the type of shock that would lead you to think that inflation is going to is going to be sticky for a long period of time. And in fact, there's, you know, most central banks around the world, actually, all of them would sort of, you know, encounter this in a much more direct manner through changes in value added taxes. And they always look through them. You know, they always say, okay, look, the VAT went up or the VAT went down, and that's going to affect the inflation systems for a period of time. But then we all know that this is basically a fiscally mandated price change, and monetary policy shouldn't respond necessarily to fiscally mandated price changes because that's not indicative of changes to the underlying supply demand balance in the economy, which ultimately drives the type of persistent inflation that the central bank cares about.
Governor Martin, I'd love to get your thoughts a little bit more deeper on housing, something Matt Miskin, Neil Dutta have talked a lot on this program about going into next year. Do you think the housing market will weigh on a deceleration of inflation? Is that part of your thesis on inflation coming down?
Yeah, I mean, it explicitly is. I mean, look, you know, supply and demand dominates all things economically, right? And if you're increasing the demand for housing by dramatically increasing population growth without a material increase in the supply of housing, at the same time, of course, you are going to get upward pressure on shelter inflation and then vice versa. If you start decreasing population growth because of a change in border policies without destroying shelter, supply or shelter supply keeps on expanding at a rate that it has been in previous years. Then you get a relative change in shelter inflation once again. So it's just it's it's simple, You know, it's simple supply and demand. If we have a material downward population shock because we have negative net migration, that's a net increase in the supply of shelter. And I think that the study that I cited in the speech on Monday, work by Albert says, found that an elasticity of one basically that a 1% increase in the in the in the number of immigrant renters leads to a one percentage point change in the rents.
But immigration is short term right this is a short term story. Would you be willing to revise up neutral if immigration is not much of a drag?
Well, I mean, you know, I, I have good reason for expecting that the immigration story is going to persist, at least for another three and a half years, and I think quite likely potentially after that also. So I'm not convinced that immigration is really a short term story.
Stephen, I just before you go, because I know you've got to run, have you got a taste for this? Is this a position you'd like to keep beyond the end of this year?
Look, you know, I love this country and I'm happy to serve this country in any way that I'm asked to do so. But personnel decisions are not decisions that I make.