SAN FRANCISCO — Federal Reserve Bank of San Francisco President John Williams said it would be more “constructive” to look at long-term monetary policy than at which meeting the Fed will next increase interest rates.
In a sit-down interview with sister publication American Banker at his office here, Williams discussed many issues including the possibility of another recession.
Following is an edited transcript of the interview.
How important is the next interest rate hike, relative to everything else happening in the global economy? Do we in the media make too much of it?
JOHN C. WILLIAMS: As a group, when I read a lot of the business section in newspapers, it's mostly about businesses — what is Apple doing, or what is Samsung doing, or whoever. I think the vast majority of reporters put the Fed right where it should be, that is, not the most important story for the U.S. economy. But if you're going to a press conference and asking about the Fed, it's not surprising to me that the focus should be on the policy decisions and the thinking around those.
I think if I had my [way] — and I don't speak for my colleagues, but I think many would agree with this — if we could have the conversation be less about the individual meetings and more about the path for policy over the next few years, I think that would be much more constructive. One of the advantages of the dot plots is that it allows us to talk not about individual tactical decisions at meetings, but really talk about where we see policy over the next few years. That's what's going to affect bond rates. That's what's going to affect financial conditions. If we were going to move in meeting X or meeting Y, it has virtually no effect — if it's the same total move — on the economy. What does matter is if interest rates two years from now are going to be higher than they are today, and how much higher.
How well-founded are market concerns of a slowdown or recession in 2016?
I don't see any signs whatsoever that there is more likelihood of a recession this year than there would be in any year. Recessions happen once every so often, so I don't want to say there couldn't be something, because things can happen. But when you look at past recessions, usually there's a factor or a group of factors that contribute to [the downturn]. In the past, it's often been an upward movement in oil prices, or we had the tech meltdown, or the housing bubble. So there are imbalances or risks in the economy that are growing and then they come to a head and the economy takes a hit. Right now when I look at those risk factors — household debt, where asset markets are, where business investment is, home construction, all these things that are typically correlated or connected to imbalances in the economy that lead to recessions or inflation — none of those are even blinking yellow, really.
Why hasn't the drop in oil prices been a boon to the economy?
Two things. One is that oil production has once again grown to be a significant factor — we're a bigger producer of oil today than we were five or 10 years ago. So that changes how it affects the economy. Jobs in drilling, extraction, all of the ancillary jobs — that whole industry grew rapidly when prices were high and got hammered when they came down.
The second is, the dynamic in the [hydraulic fracturing, or "fracking"] industry is very different than in the rest of the oil industry. Normally, when you're looking at big oil, if you're thinking about deep-water drilling, they're thinking about 10-year, 20-year investments and extraction. All of those decisions are based on long-term views of where things are going to be. Those tend to be, in economics parlance, "stickier" — if the decision makes sense based on our view of the next 20 years, then there's not much that's going to happen today that's going to change my view. And once you start drilling, the marginal cost of pulling that oil out is very low.
With fracking, it's the exact opposite. You only need a few months to start, you start pulling it out right away, and you're done in a couple years. So all the dynamics are more like your Econ 101 textbook: Price down? Close. Price up? Do more. That's something that has really changed to affect the economy. Basically we saw us lose a lot more jobs, a lot more GDP, a lot more losses to the banking industry down the road because this dynamic is quite different. We kind of knew that, but maybe our modeling of that took a little while to [catch up].
You might say, why don't we see the economy booming even more? I think these headwinds from abroad, the drop in net exports, other factors have been slowing the economy. I don't think it's that lower gas prices haven't been helping; I think it has. It just kind of loses the headlines when GDP is only growing at 2%. We are getting the benefit. That's why consumer spending is growing at more like 3%, car sales are near all-time highs.
Does the oil glut and the fact that it took everybody by surprise mean the Fed needs to rethink the way it predicts oil prices?
I have to admit, our own view here when we look at oil prices is [that] we've given up on trying to predict where they'll go because it's very hard to model the future of oil prices based on past experience. In our own forecasting exercises we tend to follow the futures curve, but we also have done an analysis that shows that the futures curve is no better at predicting oil prices than just taking the spot price and assuming it will stay the random walk.
There's really no good model of predicting oil prices, at least from a macro forecaster's point of view. So we, like [with] many things, plead ignorance and say, assuming oil prices follow what the futures markets indicate they will, what's our forecast? And then we do the risk analysis: what happens instead if oil falls to $20 [per barrel], to $60, that kind of stuff. It's the risk scenarios that, I think, are more informative.
Headline unemployment continues to decline and yet wages remain stagnant and there is persistent slack in the labor market. Why is that?
Normally, if you were to plot various measures of slack in the labor market — like the unemployment rate, various surveys of whether it's easier of harder to get a job from the Conference Board, is it hard or easy to fill a job — they all move together. When the economy is strong, they all say the economy is strong; when the economy is weak, they all say the economy is weak. What happened during the recession is very unusual, in that some of these indicators really did get out of alignment with each other. They all moved in the same direction, but they didn't move in the same proportionality.
The number of people who were part time for economic reasons rose a lot more than you would expect for an unemployment rate than went from 5 to 10 [percent] and now back to, essentially, 5. The part time for economic reasons [metric], with the depth of the recession, the length of the recession, and the very gradual recovery — there was just a more than proportional effect. There was a larger increase in the number of people who dropped out of the labor force but who still wanted a job than you would normally get in a recession. In every recession that number goes up it just went up more than you would expect from the unemployment rate. A lot of economists looked at why [that is] and in my own experience, you want to kind of average over those. If the standard employment rate is telling you that things are better than the other [metrics are], then maybe there's more slack than the unemployment rate is saying.
The good news is all these other indicators have improved a lot. My own prediction is that over the next few months is that more and more of the new jobs are going to be taken not by people who are unemployed officially, but people who are either out of the labor force or people who go from part-time work to full time work. As the unemployment rate gets lower and lower, employers are going to have to be pulling workers in form these margins.
In terms of wages at a superficial level, we're not seeing an acceleration of wages. Our economists have been scratching their head about that and wondering why that's happening. The simple [explanation] is that, we should be looking to real wages relative to productivity, so both adjusting for inflation and productivity. Inflation has been very low for the last several years, there's no question about that. Overall inflation has been very low. So if you look at wage growth of 2.2% and if inflation was only 1%, that's real wage growth. And productivity growth has been horrible. Last year it was about 0.5%. Inflation was below 1%. So that would tell you that wages would only grow about 1.5%, even in a strong labor market. It actually grew a little faster than that.
