Below is the transcript of an interview with the Federal Reserve Bank of Cleveland's President, Loretta Mester, and CNBC's Joumanna Bercetche.
JB: I'm joined by Loretta Mester, the President of the Cleveland Fed. And just to pick up on some of the comments that you made in your speech earlier, you said that you believed the economy is beyond maximum employment. And of course, if we look at the most recent jobs reports, we're at 3.9%, almost levels we've not seen in 20 years now. Do you think that there is a risk that the U.S. economy is overheating?
LM: So I think we're slightly beyond full employment, but we're not yet back to our inflation target on a sustained basis. So again, we're trying to balance both of our goals with appropriate setting of monetary policy. So I think if we let things go on a little bit longer, without any change in interest rates, that would probably not be the right path. So I sort of ascribe to the outlook as being consistent with this gradual pace of taking back some of the accommodation that we added during the Great Recession.
JB: Now one other phrase that has really shut out to the markets here is you said that, perhaps there would be a need to move the rate to a level that is higher than the long term rate and that long term rate is around 3%. Are you implying that the Fed could hike beyond 3% in the near future?
LM: Well not in the near future. If you look at the median path within the Summary of Economic Projections which the FOMC puts out four times a year, the latest one was in March. If you look at the path in 2020, the median path gets a little bit above 3% and then we bring it back down. And that's a typical path that we've seen in past tightening cycle. So it's not totally unusual, but it's something that we need to be cognizant of, the fact that past interest rate past may go beyond 3% and come back down. Now 2020 is a long time away, and of course whatever path we follow will be consistent with changes in the outlook. It's hard to predict that far in the future.
JB: Now of course the Fed has said that the economy warrants a gradual tightening in the fed funds rate. I just wonder how far the Fed is willing to go if it means yield curve inversion, in the context of maximizing unemployment and keeping price stability in check?
LM: Well of course, the yield curve responds to changes in the economic outlook, and also changes in monetary policy. So, when we're thinking about approving monetary policy, we take it all in, looking at all aspects of the economy. I don't think the yield curve, shape of the yield curve per se, is an exogenous factor, it's basically endogenous; it changes with what market participants view of the economic outlook is. So, before you can say sort of like - why is your curve flat or why is it a certain shape. You have to kind of take a step back and say, is it because bondholders think that the economy outlook is changing or not. So again we're going to always be focused in terms of setting our monetary policy on our dual mandate goals of maximum employment and price stability.
JB: Even if the yield curve inverts?
LM: Well again, I don't think you can say, like the yield curve would do that independently of what's happening with monetary policy.
JB: Now, also in your speech you've also said that the rise in oil prices and the value of dollar are worth watching. On the dollar of course, the last couple of weeks we've seen quite a big appreciation of the currency - a tightening of financial conditions so to speak. Would you say that a stronger dollar has become a risk to the outlook and the tightening cycle?
LM: I just think we should we need to be monitoring those things. I think at this point, no, I don't see those as huge risks to the outlook. But again, we need to be cognizant of what's happening in asset markets including financial conditions, in terms of what they're telling us about accommodation in the economy.
JB: And also in a broader financial context, what we've seen is emerging market currencies have begun to get quite disrupted from the strengthening of the US dollar. You've seen an Argentinian Peso, you've see in the Turkish lira. How is the Fed thinking about outside emerging market currency depreciation in the context of global financial stability?
LM: Well I don't speak for the Fed, but my own view is that we have to take into account the financial markets when we're setting monetary policy. But in terms of how we go about setting policy we're always focused on the U.S. economy and our dual mandate goals. And so, yes, we are in a global financial market. Different currencies, different assets will respond the way they do, and then that'll feed back into our outlook for the U.S. economy. But when we're setting policy, we're going to always be focused on our dual mandate goal.
JB: And of course Governor Powell recently said that policy tightening will be manageable for emerging markets. If information were to materialize that would suggest otherwise, then would you take that into consideration?
LM: So one of the things that Chairman Powell also said, and I think I agree totally with this is, one of the things that we try to do in monetary policy is be transparent about where we see the economy, what our medium-run outlook is, where we see our economy is relative to our mandate goals and therefore what we think appropriate policy is. And I think that transparency has served both the U.S. economy and the global economy well.
JB: We haven't really talked about the ongoing trade discussions between the United States and the rest of the world. U.S.-China are set to have more talk on potential tarrifs this week. How are you thinking about it? Because, on one hand, you could say that the tarrifs could potentially be inflationary for the U.S. economy. But, then on the other hand, perhaps there's some concern about the hit it might have to business confidence and investment. So, how are you thinking about that?
LM: So, I think of the trade situation as a risk to the outlook. You're right, it can have multiple effects on both sides of our mandate. I think there's a lot of rhetoric and ultimately how the U.S. economy performs, it's going to matter what actions are actually taken. So the uncertainty around it, is certainly a factor that we need to be keeping tabs on. We're getting some anecdotal reports that perhaps some firms are taking a little bit of a wait and see attitude. But overall, I would say the firms that we spoke to, are watching it but haven't changed their behavior as a result of it.
JB: How would you say the balance of risk is in this environment? Would you see there's more potential for upside risk to materialize? Or, are you conscious of downside risk?
LM: I think we're in a pretty balance, of a balance of risk, there are upside risks, and certainly upside risks for the first time in quite a while, because of the fiscal policy changes that we've had and the fact that the economy is quite strong and monetary and financial conditions are still accommodated. On the other hand, there are some geopolitical risks, and the trade rhetoric adds some uncertainty to the outlook, which is the downside risk.
JB: Now one other statement that popped out of the FOMC minutes was the introduction of the word symmetry around inflation. Can you talk me through why the Fed decided to introduce that word, or reintroduce that word into the statement again?
LM: All right, so it's actually not a new word in the sense that it's in our longer run strategy document that we agree to at the beginning of each year, or reaffirm at the beginning of each year. And I think it's just a reminder to the public that, you know, we do take a balanced approach when we're looking at our inflation target. So if we were, you know, above the target or below the target for a sustained time, that is something that concerns the FOMC, whether we're on the upside of inflation or the downside of inflation. And, I think we've shown that since the Great Recession, that we were concerned with inflation being too low. We also want people to know that we care about inflation going above our target, for a sustained period of time, that would concern us as well. And we just want to remind people that inflation, when we're thinking about the inflation target, it's a symmetric. That 2% is not a ceiling. You know, inflation might go above 2% for a little bit, below 2% for a little bit. But, we're always aiming for 2% as our goal. And so it's basically just a reminder to people that we are looking for 2% on a sustained basis, and it's a symmetrical.
JB: Some people have taken that as a dovish interpretation, in the sense that the Fed might be preparing the market for inflation to overshoot in coming months due to base effects transitory effects, and therefore the market should not read too much into it if inflation does overshoot that 2%.
LM: So I do think that the near term readings could go up a little bit above 2% just because we know that some of last March's readings are falling out. And so that puts upward pressure, and there's some commodity price increases. On the other hand, I don't think they're going to last. So again, we don't really want transitory movements to be influencing, you know, our view of where we are relative to our goal. We have to look through those transitory movements and we have to always be focused on 2% over the medium-run on a sustained basis.
And I think adding that to the statement would make perfect sense, in the sense that, we're always trying to be transparent and I think of that as being, our being transparent about how we're thinking about inflation.
JB: I want to ask you a little bit about the language around the rate hikes, the words gradual. And suppose the Fed in June, raises it's thought projections to four hikes for year and then three hikes next year, would that still be construed as gradual in your esteem?
LM: So, of course, we don't project what we're doing over you know two years ahead of time, what we're doing. We give you what we think consistent with our view of the outlook and each person writes down their projection and that's what goes into that summary of economic projections. But of course, we're always going to be looking at how the economy is really evolving. But I would say three or four hikes is gradual. But as we go forward, we're going to always have to be evaluating the stance of policy. And one of the things I talked about is, that can change over time because the short run equilibrium rate is changing over time. And so, it's a little bit of a deeper question, because we're always sort of looking at relative to where the equilibrium rate is. Right now, I view policy is still accommodating, and the FOMC said that in its statement. But as we go forward, we're always going to have to do that calculation and ask; are we accommodating or not? And then adjust policy appropriately.
JB: Finally one last question for you on the state of the U.S. public finances. We heard from the IMF only a couple of weeks ago and they said that, out of all that that all of the advanced economies, U.S. is the only country where Debt to GDP is scheduled to go up in the next five years. Does that worry you?
LM: I think we have to be taking into account the health of the U.S. economy, in terms of, are we on a sustainable fiscal path. And, I do think that's something that we should be thinking of now, as we go forward and not waiting until things get too far out of hand.
JB: Thank you very much. Loretta Mester, the President of the Cleveland Fed.
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