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CNBC Exclusive: CNBC Transcript: Federal Reserve Bank of San Francisco President John Williams Speaks to CNBC’s Steve Liesman on “Squawk Alley” Today

WHEN: Today, Monday, January 4th

WHERE: CNBC's "Squawk Alley"

Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Federal Reserve Bank of San Francisco President John Williams on CNBC's "Squawk Alley" (M-F, 11AM-12PM ET) today. Following are links to the interview on CNBC.com:http://video.cnbc.com/gallery/?video=3000473609, http://video.cnbc.com/gallery/?video=3000473610 and http://video.cnbc.com/gallery/?video=3000473611.

All references must be sourced to CNBC.

STEVE LIESMAN: CARL, GOOD MORNING. I'M HERE WITH SAN FRANCISCO FED PRESIDENT JOHN WILLIAMS. AT THE AMERICAN ECONOMIC ASSOCIATION ANNUAL CONFERENCE. JOHN, THANKS FOR JOINING US.

JOHN WILLIAMS: WELCOME TO SAN FRANCISCO, STEVE.

LIESMAN: THANKS. LET'S GET RIGHT TO IT. THE MARKET LOOKS LIKE IT FELL OUT OF BED THIS MORNING ON CONCERN OVER CHINA. HOW MUCH CONCERN DO YOU HAVE OVER WHAT'S HAPPENING IN CHINA AND THE POTENTIAL FOR IT TO RICOCHET BACK ON THE UNITED STATES ECONOMY?

WILLIAMS: IT'S IMPORTANT IN THINKING ABOUT THE CHINESE DATA AND DEVELOPMENTS THERE TO REALIZE CHINA'S UNDERGOING A VERY SIGNIFICANT PIVOT IN TERMS OF SLOWER GROWTH, IN TERMS OF THE TREND SLOWER GROWTH PATH AND ALSO A PIVOTAL WAVE FROM MANUFACTURING, MORE TOWARDS THE CONSUMER SPENDING THE SERVICE SECTOR. TO ME IT'S NOT AS SURPRISINGS MAYBE TO SOME COMMENTATORS THAT WE'RE SEEING WEAKER DATA IN TERMS OF MANUFACTURING. IT SEEMS TO BE PART OF THE PROCESS THAT'S BEEN GOING ON FOR THE LAST COUPLE OF YEARS. WE'RE ALSO HAVE BEEN SEEING PRETTY GOOD DATA FROM CHINA ON CONSUMER SPENDING AND SOME OTHER AREAS. SO I'M NOT THAT AS CONCERNED ABOUT THAT. I THINK THIS IS AN ONGOING PROCESS CHINA'S GOING THROUGH. AND, AGAIN, IN TERMS OF THOSE DEVELOPMENTS RICOCHETING TO THE U.S. ECONOMY, I THINK WE HAVE REALLY STRONG FUNDAMENTALS IN TERMS OF CONSUMER SPENDING IN TERMS OF OUR ECONOMIC TRAJECTORY. SO RIGHT NOW AT LEAST, THIS ISN'T A BIG CONCERN FOR ME BUT OBVIOUSLY WE WATCH THE DATA CAREFULLY AND WE RECOGNIZE WE'RE IN A GLOBAL ECONOMY AND WE'RE AFFECTED BY EVENTS.

LIESMAN: WELL THAT'S REALLY IT. IN THIS POST-FINANCIAL CRISIS WORLD, THE BIG WORRIES ABOUT SYSTEMIC RISK, DO YOU SEE CONNECTIONS BETWEEN THE CHINESE FINANCIAL SYSTEM AND NEGATIVE THINGS THAT COULD RESULT FROM THAT, FROM THE SLOWDOWN THERE, THAT COULD RICOCHET AND AFFECT THE U.S. FINANCIAL SYSTEM AND CREATE BROADER GLOBAL SYSTEMIC RISK OUT OF CHINA?

WILLIAMS: I REALLY DON'T SEE THAT COMING OUT OF CHINA RIGHT NOW. I THINK A LOT OF US SEE THE CHINESE STOCK MARKET AFFECTS RELATIVELY SMALL SHARE OF CHINESE CITIZENS, IT DOESN'T AFFECT THE U.S. FINANCIAL SYSTEM THAT MIUCH DIRECTLY SO TO ME THOSE ARE NOT MAJOR CONCERNS IN TERMS OF SYSTEMIC RISK NOW.

LIESMAN: WHAT WAS THE LESSON FROM AUGUST? SOME THOUGHT THE FED OVERSTATED THE RISK IN AUGUST AND SHOULD HAVE HIKED RATES IN SEPTEMBER. DO YOU THINK THAT'S GOING TO MAKE THE FED LESS LIKELY TO BE INFLUENCED BY WHAT'S HAPPENING OVERSEAS?

WILLIAMS: I THINK WHAT WE NEED TO DO IS FOCUS ON OUR DUAL MANDATE GOALS MAXIMIZE EMPLOYMENT PRICE STABILITY. WE'RE FOCUSED ON THE MEDIAN TERM. OBVIOUSLY LAST SUMMER THERE WERE A LOT OF CONCERNS ABOUT GLOBAL GROWTH NOT JUST IN CHINA BUT EMERGING MARKET COUNTRIES. AND OBVIOUSLY THE EFFECTS OF THE STRONG DOLLAR ON THE U.S. ECONOMIC OUTLOOK. WE'RE FOCUSED ON WHERE THE U.S. ECONOMY IS, WHERE IT'S GOING OVER THE NEXT COUPLE OF YEARS, HOW WE'RE DOING ON OUR GOALS. SO I THINK THAT OF COURSE WE'RE ENTERING, YOU KNOW, A GLOBAL ECONOMY SO WE'RE AFFECTED BY THOSE. REALLY WHAT MATTERS IS HOW DOES THAT AFFECT THE ATTAINMENT OF OUR OBJECTIVES.

LIESMAN: ONE OF THE THEMES THAT I AM CATCHING FROM HERE IS THE CONTRAST BETWEEN WHAT'S HAPPENING OVERSEEING AND THE U.S. ECONOMY. COULD YOU GIVE US YOUR VERSION WHAT'S HAPPENING OVERSEAS VERSUS WHAT'S HAPPENING IN THE UNITED STATES?

WILLIAMS: SURE, I THINK IN TERMS OF THE U.S. ECONOMY, WE'RE IN VERY GOOD SHAPE. UNEMPLOYMENT'S AT 5%. GDP GROWTH AVERAGING A LITTLE OVER 2%. I SEE THAT MOMENTUM CARRYING INTO THIS YEAR IN 2016. I THINK WE'RE, RELATIVE TO MOST OTHER COUNTRIES, IN VERY GOOD SHAPE. I THINK PARTLY BECAUSE WE TOOK VERY AGGRESSIVE MONETARY POLICY ACTIONS AND OTHER ACTIONS TO GET OUR ECONOMY BACK ON TRACK SOONER. CLEARLY, EUROPE, ASIA, IS STRUGGLING MORE. THE STEPS I SEE HAPPENING THERE IN TERMS OF POLICY RESPONSES I THINK ARE GOING TO HELP GET THOSE ECONOMIES BACK ON TRACK OVER THE NEXT COUPLE OF YEARS. CLEARLY, WE'RE A LITTLE AHEAD OF THE PACK IN TERMS OF GETTING BACK TO FULL EMPLOYMENT ON A GOOD SUSTAINABLE PATH.

LIESMAN: AS A CENTRAL BANKER DO YOU FEEL DIFFERENCE BEING TOO FAR AHEAD OF THE PACK HERE? IS THERE A LIMIT TO HOW MUCH THE FED CAN AND WILL DO THIS YEAR BECAUSE OF THE WEAKNESS OVERSEAS?

WILLIAMS: SO YOU KNOW, WE TALK ABOUT DIVERGENCE BETWEEN THE U.S. AND THE REST OF THE ECONOMY. THERE'S A DIVERGENCE WITHIN THE U.S. ECONOMY TOO REFLECTING THAT. AND THAT SPECIFICALLY, OUR DOMESTIC DEMAND – CONSUMER SPENDING, INVESTMENT SPENDING – IS ACTUALLY ON A VERY GOOD TRAJECTORY. WHERE WE ARE GETTING HIT HARDEST IS IN TERMS OF OUR NET EXPORTS. THAT'S A BIG DRAG ON OUR ECONOMY. SO, YOU KNOW, THE WAY I SEE IT OVER THE NEXT COUPLE OF YEARS, WE'RE GOING TO NEED SIGNIFICANT MONETARY ACCOMMODATION, A VERY GRADUAL PACE OF RATE INCREASES TO KEEP OUR ECONOMY ON THIS 2, 2.25% GROWTH PATH GIVEN THE HEADWINDS WE'RE FACING, ESPECIALLY FROM ABROAD.

LIESMAN: SO LET'S TALK ABOUT THE PATH FOR FED RATE HIKES THIS YEAR. THE MEDIAN SEEMS TO SUGGEST FOUR THIS YEAR. IS THAT ALSO YOUR FORECAST?

WILLIAMS: WELL, I THINK THAT GIVEN THE FORECAST THEY HAVE FOR WHERE THE ECONOMY'S GOING, WHAT'S HAPPENING WITH INFLATION – AND INFLATION IS THE ONE THING THAT WE'RE STILL STRUGGLING TO GET BACK TO OUR 2% GOAL. THAT TO ME IS THE MAIN FOCUS. YOU KNOW, I THINK SOMETHING IN THAT 3 TO 5 RATE HIKE RANGE MAKES SENSE, AT LEAST AT THIS TIME. BUT WE'RE DATA DEPENDENT. WE CONTINUE TO BE DATA DEPENDENT SO THE DATA'S SUGGESTING THAT GRADUAL PACE OF RATE HIKES MAKES SENSE. BUT WE'LL HAVE TO RE-EVALUATE THAT, REASSESS THAT, BASED ON WHERE WE SEE INFLATION AND OTHER INDICATORS THAT KIND OF ARE FACTORS IN INFLATION AND HOW WE SEE ECONOMIC GROWTH OVER THE NEXT YEAR.

LIESMAN: GIVE US YOUR OVERALL FORECAST. IS THIS ANOTHER 2% YEAR FOR U.S. GDP GROWTH?

WILLIAMS: YES, IT IS THE NEW COSMOLOGICAL –

LIESMAN: EXCUSE ME WHILE I YAWN, RIGHT? I MEAN –

WILLIAMS: WELL, IT'S GOOD THOUGH. WE'VE BEEN AT, WE ADDED – WE'RE ON PACE, WE THINK, TO ADD ABOUT 2.5 MILLION JOBS LAST YEAR. WE DON'T HAVE THE DECEMBER DATA. I THINK WE'RE ON PACE TO ENTER THIS ECONOMY WITH STILL A VERY GOOD JOB MARKET AND CONTINUED JOB GAINS. SO, YOU KNOW, IT MAY BE A YAWN IN TERMS OF ONE MORE YEAR OF 2, 2.25% GROWTH. BUT I THINK, YOU KNOW, THAT'S ACTUALLY QUITE GOOD. WE'RE ADDING A LOT OF JOBS. WE'RE GETTING UNEMPLOYMENT EVEN LOWER. SO THAT'S A VERY POSITIVE VOTE.

LIESMAN: AND THAT'S THE KIND OF GDP GROWTH THAT LEADS YOU TO A MEDIAN RATE HIKE NUMBER, RIGHT? WHICH IS THAT THE 2% GROWTH WAS WHAT THE OVERALL FED IS LOOKING FOR AND THAT WOULD BE COMMENSURATE WITH THE FOUR RATE HIKES?

WILLIAMS: SO NOW I'M GOING TO GIVE MY NORMAL DISCLAIMER THAT I AM SPEAKING ABOUT MY OWN VIEWS, BUT YES. A GROWTH PATH OF 2, 2.25% GDP GROWTH, UNEMPLOYMENT EDGING DOWN IN MY VIEW BELOW 5% THIS YEAR. AND INFLATION CERTAINLY TO MOVE GRADUALLY BACK TO 2% THIS YEAR – ARE THE KIND OF INGREDIENTS I SEE AS FEEDING INTO, YOU KNOW, 3 TO 5 RATE HIKES THIS YEAR. BUT, AGAIN, YOU KNOW, WE'LL WATCH THE DATA.

LIESMAN: LET'S TALK ABOUT THE RISK TO THAT FORECAST. HOW CONFIDENT ARE YOU THAT YOU'RE GOING TO GET THOSE 2% – OR INFLATION MOVING BACK TO THE 2% NUMBER, PARTICULARLY WITH WHAT'S GOING ON OVERSEAS?

WILLIAMS: WELL, YOU KNOW, I'M REASONABLY CONFIDENT. THAT'S THE WAY WE PUT IT. YOU KNOW, OBVIOUSLY INFLATION IS INFLUENCED BY THE ECONOMY, THROUGH UNEMPLOYMENT, THROUGH OTHER FACTORS. BUT THERE'S ALWAYS UNFORESEEN EVENTS. THE DOLLAR HAS STRENGTHENED A LOT IN THE LAST YEAR, THAT HAS HELD DOWN INFLATION. OIL PRICES EFFECT INFLATION. SO WHAT WE HAVE TO DO IS FOCUS ON WHERE WE SEE THE MEDIAN TERM OUTLOOK – WHERE WE SEE INFLATION MOVING OVER THE NEXT COUPLE OF YEARS AND REASSESS THAT AS, YOU KNOW, GLOBAL DEVELOPMENTS CHANGE.

LIESMAN: HOW ABOUT RISKS LIKE WE'RE SEEING ON THE TAPE TODAY. WHEN THE MARKET WAKES UP OUT OF BED, 450 POINT DECLINE IN THE DOW. HOW DOES A CENTRAL BANKER REACT TO SOMETHING LIKE THAT?

WILLIAMS: WELL, AGAIN, I HAVE A MEDIAN TERM OUTLOOK. YOU KNOW, I HAVE SAID THIS BEFORE. I DON'T HAVE A TERMINAL ON MY DESK TELLING ME HOW THE MARKET'S GOING UP AND DOWN. REALLY, I WANT TO FOCUS ON WHAT'S HAPPENING OVER THE NEXT COUPLE OF YEARS, HOW OUR MONETARY POLICY CAN BEST BE CALIBRATED, IF YOU WILL, TO ACHIEVE OUR GOALS. AND SO THE MARKETS MOVE UP AND DOWN. THIS IS A CAPITALIST SYSTEM. THAT'S GOING TO HAPPEN. WE NEED TO STAY FOCUSED ON THE MEDIUM TERM. AND WHEN THE MARKET MOVES SIGNIFICANTLY, TRY TO UNDERSTAND BETTER, WHAT ARE THE FACTORS DRIVING THAT? RATHER THAN RESPONDING TO JUST UPS AND DOWNS OF MARKET MOVES.

LIESMAN: JOHN, JUST THE LAST QUESTION. YOU MENTIONED THE DOLLAR EARLIER. IS THAT – DOES THAT CREATE A LIMIT ON POLICY IN TERMS OF HOW STRONG YOU'RE PREPARED TO LET THE DOLLAR GO, OR BECOME, AS A RESULT OF CHANGING DIFFERENCES OR DIFFERENCES IN MONETARY POLICY?

WILLIAMS: SO YOU KNOW, THE DOLLAR'S DETERMINING INTERNATIONAL MARKETS. IT'S NOT SOMETHING THAT THE FED TARGETS OR HAS A GOAL OBJECTIVE AROUND. BUT OBVIOUSLY AS THE DOLLAR CHANGES, IT EFFECTS OUR NET EXPORTS, IT EFFECTS OUR INFLATION THROUGH IMPORT PRICES. SO CLEARLY, IT'S A FACTOR IN ALL OF THE FACTORS WE FOLLOW THAT EFFECT THE OUTLOOK AFFECT THE RIGHT POLICY MIX. BUT IT'S NOT SOMETHING THAT , YOU KNOW, WE TARGET SEPARATELY FROM FULL EMPLOYMENT AND PRICE STABILITY OF 2% INFLATION.

LIESMAN: JOHN, THANKS FOR JOINING US. YOU'VE AGREED TO STAY A LITTLE BIT FOR A WEB EXTRA WE ARE GOING TO DO.

WILLIAMS: GREAT, THANKS.

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