The New York Fed President Sees Interest Rates Coming Down With Inflation

On Aug. 2, 2023, John C. Williams, the president of the Federal Reserve Bank of New York, spoke with The New York Times. Below is a full transcript of his remarks during the 50-minute interview.

I have many questions. But before I get started with them, I wonder if there is anything that is on your mind that you want to talk about?

The main thing is how the economy is evolving, both in terms of, we’re seeing continued strength in the economy. At the same time, a lot of the indicators are moving in the right direction. We’ve seen the job openings and other indicators are telling us that supply and demand are moving closer together, I think that’s a really important data point for me, because we need to get supply and demand into balance in this economy for inflation to be sustainably at 2 percent, and on the inflation front I definitely think that the data are moving similarly in the right direction, but I think that similarly, the only way we’re really going to achieve the 2 percent inflation on a sustained basis is really to bring that balance back to the economy. Still a lot of the indicators tell us that the economy is strong — clearly we’re not in a recession or anything like that — but we need to see that process of getting supply and demand, from both sides, coming back into balance. I think the supply side has actually been the really good story, we’ve seen the labor force participation, labor force growth improve quite significantly and we’ve seen the supply chain bottlenecks really recede over the past few … so now it’s really about making sure that demand and supply are kind of in balance and seeing how that evolves. I think that’s the big — to me, I know the inflation data, absolutely critically important, but I think it’s also making sure that the fundamentals of our economy are in balance to get this sustained achievement of re-anchoring, or not re-anchoring, but restoring price stability, getting 2 percent inflation on a sustained basis.

Do you think that you need additional rate increases to achieve that?

I think that’s an open question, honestly. We definitely have a restrictive stance of monetary policy, real interest rates, both for now and you look at forward indicators such as one- to two-year yields, are well above what I think neutral is. I think that’s providing kind of downward pressure on demand, and on inflation through that, so I think we’ve got monetary policy in a good place, it is definitely restrictive, but we have to watch the data. Are we seeing the supply-demand imbalances continue to shrink, move in the right direction? Are we seeing the inflation data move in the right direction, in order to decide that?

Of course, there is another question, which is: How long do we have to keep the restrictive stance of policy? And that I think it’s going to be driven by the data. Right now, I expect that we will need to keep a restrictive stance for some time, to do that, but that’s going to be determined by the underlying fundamentals that are driving, supply and demand in the economy, inflation. From my perspective, monetary policy is in a good place, we’ve got the policy where we need to be, but whether we need to adjust it in terms of that peak rate, but also how long we need to keep a restrictive stance is going to depend on the data, and what we see in the totality of the data.

Does that include magnitude? Are we talking about one more rate increase, which was the projection in the last Summary of Economic Projections, or are we potentially talking about multiple additional rate increases?

Again, given what I see today, from the perspective of the data that we have, I think — it’s not about having to tighten monetary policy a lot. To me, the debate is really about: Do we need to do another rate increase? Or not? Now, that could change, depending on the data. I think we’re pretty close to what a peak rate would be, and the question will really be — once we have a good understanding of that, how long will we need to keep policy in a restrictive stance, and what does that mean.

Jeanna Smialek: When you say “what does that mean,” what do you mean by that?

John Williams: I think of monetary policy primarily in terms of real interest rates, and we set nominal rates. We’re setting the fed funds target. And assuming inflation continues to come down, it comes down next year, as many forecast, including the economic projections show, then if we don’t cut interest rates at some point next year then real interest rates will go up, and up, and up. And that won’t be consistent with our goals. So I do think that from my perspective, to keep maintaining a restrictive stance may very well involved cutting the federal funds rate next year, or year after, but really it’s about how are we affecting real interest rates — not nominal rates. My outlook is really one where inflation comes back to 2 percent over the next two years, and the economy comes into better balance, and eventually monetary policy will need over the next few years to get back to a more normal — whatever that normal is — a more normal setting of policy. So those all have to kind of come together.

Could you see a rate cut in the first half next year?

I think it will depend on the data, and depend on what’s happening with inflation. The first half of next year is still a ways off.

I don’t think the issue is exactly the timing, or things. It’s really more that if inflation is coming down, it will be natural to bring nominal interest rates down next year, consistent with that, to keep the stance of monetary policy appropriate for an economy that’s growing, and for inflation moving to the 2 percent level.

Do you think that the SEP inflation forecasts from June need to be revised down — is inflation falling faster than expected?

I’m not going to speak to what my colleagues will write down, and it’s still a ways off — as you know, we’ve got quite some time between now and the next FOMC meeting, so we’ll get a lot of data, a lot of information, and we’ll all take all of that information and the analysis that people do and come to our judgments, our assessments of that. My own view is that based on what we’re seeing now, I do think that overall P.C.E. inflation for the year will probably come in at 3 percent, that depends on a lot of different things, and I expect core inflation to be above that, based on all the information we’re seeing. You know, one data point that I do follow pretty closely is this multivariate core trend inflation that the New York Fed economists have developed, have been using, have been publishing regularly for some time. And if you look at that, which really tries to get into all the details of the components of inflation, and which are the ones that are likely to persist, and which ones are the ones that tend not to persist, that, based on the June data, that’s showing this underlying trend to have come down quite markedly. It was around 5, 5.5 percent last year, and now it’s at 2.9 percent. And if you take into account the fact that rents on new leases have been quite soft recently in terms of growth rates, and you run that forward about what it means for core inflation over the next 6 months, what does it mean for these underlying trend measures, you know, they’re moving down. So you could easily imagine by the end of the year kind of an underlying inflation rate that’s more around 2.5, 2.75 percent, something like that. So I do think that we are moving to an environment already where the underlying inflation rate has come down quite a bit. Mainly because of — or not mainly, but in large part because — the shelter inflation has come down so much. That’s been such a big driver of core inflation over the last couple of years.

Is it coming down as expected, or quicker than expected? How has this compared to what you would have forecast 3 months ago?

The data have surprised me and everybody a lot the past couple of years, because of the pandemic, the war, Russia’s war in Ukraine, all the things that happen. Surprises in data have become more the norm. For me, personally, the inflation data have been coming in as I had expected — and also hoped. We’re seeing the patterns that reflect the changing economic circumstances show up in the data. An example would be: Energy prices have come down quite a bit, so that’s brought down overall inflation, that’s not a big surprise. But we’ve seen a reduction in inflation in core goods, which is something I was expecting to see given the improvement in supply chain bottlenecks, given the effects of monetary policy reducing demand for goods. I’d been expecting to see that — the data don’t move every month exactly as you’d expect, and those used car prices can surprise you one way or the other. But this is what I was expecting. And seeing some, you know, reduction in the other parts of core services, including shelter, that’s’ basically what I was expecting. I do think on the so-called super-core inflation, the core services excluding housing, I do think that’s going to come down over time to levels more consistent with 2 percent. But I think a big part of that story is really making sure that supply and demand in all aspects of our economy are better in balance — and right now, I would say that demand is strong relative to supply. We really have to get that balance back in the economy to make sure that core services and all of these other components really do come down to levels consistent with a 2 percent inflation rate.

On that note, is continued strong job growth a problem for you?

Well, it is fascinating to watch this, because we often compare the payroll job growth to some notion of underlying labor force growth. But the labor force has been affected in major ways by the pandemic and everything that has happened since — obviously labor force participation fell during the pandemic, and it has rebounded. Now labor force participation with the 25-54 year old population is actually at or above levels before the pandemic. So it’s really hard to say that payroll or job growth has been faster than consistent with labor force growth, because the unemployment rate has been relatively flat for the past year. So what am I seeing or looking for? Definitely the growth of job growth to slow down to levels kind of consistent with supply and demand being more in balance — we’re seeing that. If you look over time, the rate of job growth has been coming down. The hires rate in the JOLTS data has definitely come down to more normal levels. So it’s really about seeing all of these indicators getting to more of a — you could say it’s a more sustainable pace. So far, we’ve seen the job growth slowing at the same time as the labor supply has been increasing, so that’s why the unemployment rate has been relatively flat.

What do you see as that sustainable pace of job growth?

I think that one point I’d make on that is, a lot of the labor force growth we’ve seen over the past year or so has been a rebound, and a return to a strong labor market conditions after the pandemic. That can’t continue every year forever: I mean the high labor force participation can continue, but it can’t continue to grow and grow and grow forever. From my point of view, assuming that these fundamental factors get to more normal levels, which they are doing, then job growth needs to get back down to levels consistent with the underlying labor force. Which is significantly lower than where it is today. But it will depend on various factors in labor supply.

Like 100,000, 150?

I’m not sure exactly, but it’s more in that 100,000 range than where it is today. We can’t be really precise about what exactly that means.

What about wage growth? How much do you think you need to get wage growth down in order to feel confident that inflation is going to come down?

Obviously wage growth is really important. I view wage growth, in terms of your question, as more of an indicator, rather than a goal or a target. So I don’t sit there thinking: We need to see wage growth do one thing or another in the next year or two. But it’s definitely an indicator of two important developments that we’ve already talked about. One is: We’re still in an economy where demand exceeds supply, it’s a strong labor market, clearly, and wage growth has been very strong and it’s higher than inflation. So that’s a sign of a strong labor market. But we’ve also seen wage growth come well down from its peaks that we saw during the period of the pandemic where the imbalances between supply and demand were far larger. It’s telling us that in a level sense, we’re still on a pretty strong demand relative to supply situation, but things are moving in the right direction. That’s what we need to see. Now, in the longer run, when you think about — over the next five years or something — you would expect real wages, wages adjusted for inflation, to grow consistent with productivity trends. Right now, I don’t think that’s exactly what I’m focused on. I’m more focused on: what are all these indicators, all the different data telling us about the overall balance or imbalance between supply and demand and what that implies for inflation.

What are they telling you at this stage? If data continue to show the narrative we’ve been seeing recently — decent consumer spending, but slowing job growth, somewhat slowing wage growth — is that good enough to stop?

I think, again, it’s like I said before: It’s the totality of how all of these pieces fit together. Are they moving in the right direction? They are right now, but they need to continue to do that. We need to get the job done, if you will. We need to get inflation not only down to 2 percent, but keep it on a sustained level at 2 percent. To me, it is really looking at all of these different pieces and seeing a preponderance of the data. What is it telling us about: Are things moving in the right direction?

Because we have monetary policy, in my view, in a restrictive stance and definitely influencing the economy in the right direction, I don’t feel we need to take immediate action or specific action. I think we have the ability to watch the data, analyze it, figure out what’s appropriate, and then make the decision from that. I think there’s been a natural progression from, you know, when we started raising rates, we needed to get monetary policy from a very accommodative stance back to neutral and eventually to a restrictive stance, and we did that by rapid increases early last year, through last year, and then we’re able to slow that pace. And then now we’re able to use that ability to watch the data, analyze it, come to a conclusion, make a decision, and then rinse and repeat if you will — watch the data and assess on a meeting-by-meeting basis. Where are we, what’s the direction of travel, and what’s the appropriate decision that we need to make? And again, I think there are two aspects to it. One is: What level of interest rates do we need to have, but also, how long do we need to keep the restrictive stance in policy in place?

Does that mean you’d be potentially comfortable skipping September?

Well, I think it will depend on the data. I personally feel that — we get a lot of data between now and the September meeting, and we will have to analyze that and make the right decision. I personally don’t have any preference of what we need to do at a future meeting, because I think it’s going to really going to be driven by the progress we’re making in managing those goals and managing those risks. From my perspective, we have gone from a place — a year, a year and a half ago, where the inflation was way too high, not moving in the right direction, and the risks were all on inflation being too high, to one where the risks are on both sides. We have the two-sided risks that we need to balance, making sure that we don’t do too much, and weaken the economy too much — more than we need to in order to achieve our goals — and at the same time make sure that we do enough to make sure that we convincingly bring inflation back to 2 percent, really restore price stability, and put our economy on a strong foundation for the future. So that means we balance both sides, of what can go right and what can go wrong, and make the best decision that we can.

Given that we’re back at that state, do you think that unemployment needs to go up in order for inflation to come down?

Well, there’s two parts of that — right now the unemployment rate is at 3.6 percent, it’s below many people’s view of a long-run normal unemployment rate, but not by a lot. [The unemployment rate fell slightly in data released after this interview, to 3.5 percent.] A few tenths or so. From that perspective, I would expect the unemployment rate would move back to a more normal level. Will it rise above that, in order to really get inflation back to 2 percent? I don’t know the answer to that, in my own projection, my own forecast, I expect that the unemployment rate will rise above 4 percent next year, but I can’t say with any conviction how much will that need to happen. It will depend on how all the pieces come together, how much inflation continues to come down because of the reversal of some of the factors that drove it up — like the pandemic-related factors, Russia’s war in Ukraine, all of the other things. As those reverse, how much does it bring us back to 2 percent. What’s happening in terms of other events that could be affecting the economy that are outside our control. So my view is: We have a path forward, where the economy continues to grow below trend and unemployment edges up somewhat, and inflation comes back down — exactly what that means for the employment rate, I can’t say with any certainty. My own view is that the unemployment rate, in order to achieve all of that, may rise to something like 4 to 4.5 percent, but we’ll have to see. Which is still, by historical standards, a very, very low unemployment rate.

What do you think the criteria will be for cutting interest rates next year?

I think that in my forecasts, the main thing will be is — assuming inflation is convincingly coming down, we’ll need to adjust interest rates down to keep real interest rates at least constant. And then as the economy eventually evolves, gets back to 2 percent inflation, you might think about getting real interest rates back to whatever neutral level is. So to me, I think the main criteria that I’m thinking about in my forecast, is that really about with inflation coming down, needing to adjust interest rates with that so that we’re not inadvertently tightening policy more and more just because inflation is down. That is my baseline forecast — obviously, if the economic outlook changes, or other factors happen, there are other reasons why you’d change interest rates. But that to me is the logical, consistent thing. Which you see in private sector forecasts, and you see in surveys of private sector economists, like the Blue Chip, where they ask them, why do you expect interest rate cuts: One major reason is: Well, inflation is coming down, so you don’t need interest rates as high.

Inflation is coming down now, so why not lower interest rates now, then?

I look at where real interest rates are, kind of: What’s the real interest rate, inflation-adjusted, going ahead for the next year or two. Those real interest rates to me are moderately above any reasonable estimate of neutral. So that’s kind of how I think about that. So cutting interest rate now, even though inflation has come down, would not maintain an appropriately restrictive stance to keep moving demand and supply back into balance. Even today, even with things moving in the right direction, most indicators would tell you demand much exceeds supply, so we still have work to do on that. From my point of view, much of that work will be done through the fact that we currently have a restrictive stance in policy, and obviously there are lags in monetary policy’s effects on the real economy and on inflation. It will take time to fully see those effects of our actions — both the ones we’ve taken and also the actions that I assume will be taken in terms of keeping a restrictive stance in place, and that will continue to put downward pressure on demand and inflation.

Obviously we’ve mostly been talking about interest rates here, but I wonder on the balance sheet side of the equation, how you’re thinking about or trying to assess how much is too much on QT?

[Note to readers: The Fed’s balance sheet consists of bond holdings, which it amassed in large quantities while trying to stoke the economy in the 2008 downturn and amid economic and financial disruptions in 2020. It is shrinking it now, a process called quantitative tightening, or QT. In 2019, a similar shrinking went too far and caused market ruptures, but the Fed has since created a program to help with that. Mr. Williams was a major protagonist in that story.]

We’re watching that, obviously, very carefully. Both looking at market prices and quantities and all that, but talking to market participants, talking to financial institutions, trying to understand the different factors. Right now, I think that all of the indicators are saying the same thing: the amount of reserves in the system, the stability of money market rates like the fed funds rate and other interest rates like SOFR, they’re all showing us that we’re in what we think of as an abundant reserves regime. We’re in a region where there’s plenty of reserves out there on a day-to-day basis. The federal funds rate doesn’t move around very much, and other short term interest rates are very stable and consistent with the setting of monetary policy by the FOMC. We analyze a lot of different dimensions of that, and they all say the same thing: There’s a large supply of reserves beyond what is absolutely needed to carry out monetary policy. And of course, we still have over $1.7 trillion in the reverse repo facility, which is another buffer, if you will, and we’ve seen usage of that come down pretty dramatically as the US Treasury has rebuilt their account at the Federal Reserve and issued T-bills. As the market has more short-term instruments that they can invest in, they’re pulling the money out of our overnight reverse repo facility, which is working exactly as planned, and exactly as we would want to do. So, I think that when I look at all the indicators that we follow and study, and the things we learn from talking to people, we’re still in a situation where there are sufficient reserves to carry out monetary policy, we’re well away from ending QT or anything like that. That’s well off in the future and everything is operating effectively. That said, we are also monitoring very carefully all of that and analyzing that on a regular basis.

What have you changed in your monitoring from the last time you were doing QT, when obviously you missed and got to that point of reserve scarcity?

John Williams: I think there are several things that are different from September 2019. One is, at that time, the committee, the Federal Open Market Committee, was really aiming to get to a minimum level of reserves that was consistent with the efficient operation of monetary policy. There was, at that time, a desire to really bring the level of reserves down as much as possible consistent with the operating framework that we have. Now, our public statements around this, our framework today, is really making sure that we have ample reserves — that we don’t get to a point where there’s a shortage of reserves. So I think our basic approach is maybe more conservative, if you will, of making sure that we have the ample reserves in place and really learning the lessons about how you can have unanticipated sudden shifts in supply and demand for reserves that are larger than maybe expected.

The second factor: We have the standing repo facility, we have the ability to provide extra liquidity, reserves into the system on an automatic basis, that provides a backstop for the market. In the end, what we needed to do in late 2019 was really actively add reserves into the system through our repo operations, and other operations after that. If there is stress in the market, or interest rates are going up, that facility is there, and everyone knows it’s there.

That is a second lesson of the Fall of 2019. It wasn’t just that on a given day that there was a shortage of liquidity in the market, and that caused interest rates to go up somewhat, it was also a concern in the market about tomorrow, and the day after, and the end of the month, and the end of the quarter. Market participants are understandably, when there’s a shortage of liquidity, worried about: What’s going to happen in the future? Do I need to hunker down and preserve my liquidity because I’m not sure where it’s going to be? I think our framework that we have in place now, the standing repo facility, all of these not only give us a good starting point to make sure there’s ample reserves, but they also provide that assurance that if for some reason there’s a shock to the demand or supply reserves, that liquidity will be there automatically.

The third thing is that — I think our monitoring of these markets, and study of these markets, has taken lessons from that experience. Even then, we focused a lot on market intelligence and things, but now we have a lot more analytical tools that can tell us — what are some of the warning signs, that even though markets are functioning well, there are signs that interest rates are getting more sensitive to the daily ups and downs. There’s some research we’ve done here at the New York Fed that’s really trying to develop some statistical methods, saying — hey, you know, everyday we’re seeing more volatility in market interest rates when things happen, maybe that’s a sign that we’re getting closer to ample reserves. We saw some of those signs in 2018, 2019. We saw some of those things, but it wasn’t as clear maybe that — because markets were functioning so well, it wasn’t as clear at the time that maybe there was perhaps less elasticity in those markets when the shocks kind of got bigger.

When you survey financial markets right now, what keeps you up at night?

There are different versions of that question. I always say that the one that’s number one on my list, mainly because it’s so hard to know, is really cybersecurity issues — cyber risks. Obviously, there’s a lot of work that goes in at the financial institutions, here at the Federal Reserve and at other central banks, we put a lot of effort into making sure that our systems and the financial system is secure, but there’s also a lot of effort to break into that, or create risk to the financial system that way. So that’s just something that’s always on our mind, my mind, and it’s something that we’re very focused on, there.

I think the other concerns, that come up, is — we look at the Treasury market. The U.S. Treasury market is the number one, central, most core market in the global economy. As we saw in the spring of 2020, if the Treasury market is not functioning well, other markets don’t function well, and we watched — over many years — as liquidity in the Treasury market has come down to lower levels as the market players there and how the market dynamics work there has changed over time, and that has led, at different points in time, to greater sensitivity to interest rates, to sudden changes in interest rates, due to various shocks that happen. So I think that’s another concern. Anything we, broadly, in government can do to strengthen the resilience in liquidity in the Treasury market and other closely-related markets I think is very important because it’s just so core to everything.

I don’t go back to March of 2020, and say, well: We saw that, we have to protect against March of 2020 as the one example, or the one data point. Because that is so extreme, what happened then in kind of the dash-for-cash kind of set of issues. But I look at the broader context. Well before the pandemic, there were clearly events in Treasury markets that gave concern about liquidity there, and they have occurred since, so I think that’s a number two area that we want to make sure we invest in.

I would say the third, which I will just now cross off officially, was the Libor transition. That took a long time, about 10 years, but Libor was a fundamentally flawed reference rate that was used in hundreds of trillions of financial instruments. It was an incredibly hard project to move off of that, and it was to me one of the top financial sector risks. And — we’ve moved off of it in the U.S., and globally moved away from a lot of those types of reference rates to much more robust, resilient reference rates. In the US, SOFR has taken over that. And to me, that is a great success, but it’s also kind of a reminder that things can creep up on you over years. Because LIBOR started as a relatively small thing and then spread, and spread, to the point where nobody, I’m sure, in the 1980s thought that this was going to be a $400 trillion thing — so just keeping an eye on things that are small but that are growing over time, is another thing.

What about — we’re obviously sitting in the financial district in Manhattan, surrounded by partially-filled office buildings. What about the commercial real estate market?

Obviously something we’re really focused on here, at the New York Fed, because this is a huge office commercial real estate — it’s a huge issue for New York, San Francisco, other major cities. It affects cities around the country, but it affects us even more. And I think that there are a couple of different things that I’m very focused on there.

One is, who holds the risk. Lending into commercial real estate, or office commercial real estate in particular, because I think that’s where the real concern is. Banks lend into that, there’s commercial mortgage backed security market, the CMBS market, there’s other investors that own parts of this, so making sure that we understand who’s on the hook for that has been very important.

Obviously, there are banks that have exposure there, and we’re watching that and studying that carefully. But also understanding who else owns that risk, or has that risk, and how that can spill over. One concern I have in this area is beyond the risks in the banking sector or elsewhere, is also where you see uncertainty about the future of office space — meaning that basically, lenders, and investors, and everyone just pulls back, and says: I don’t want to put money at risk in this, because I’m not sure how this is going to play out.

And it’s not just about the value of the buildings, because that’s a big issue right, how much could you sell the building for if you needed to. It’s also, what’s the income you could get, or net income you could get, if you needed to, from these buildings. Office buildings — the economics of them are kind of challenging, because they have a lot of fixed costs. Obviously interest costs and maintenance costs, but also a lot of costs of upkeep and making the building something that’s attractive to businesses to want to be in that space. So with the excess supply of office space, I think that’s really challenging for owners of these buildings.

I think there’s a lot of factors. We’re watching this in terms of financial risks, potential pull-back-from-risk in the sector, so that leads to more challenges in the sector. The final thing is for New York City itself. I think this is a huge thing for us — as we look at: If, in the end, we have too many office buildings for what we need for our economy, it’s really important that we find good uses for that space. We don’t want a bunch of empty buildings just sitting there.

Think about conversions or other ways to move to taking this space, which of course is hugely valuable here in New York City, and putting it quickly to good use. That’s, I guess, a longer term worry, but it’s one of our concerns, you know, New York City is this amazing place that you can’t replicate in other places — so how to think about, ok, well demand for office space has changed, we can figure that out and move the city forward and think about how to use some of those buildings or that space in ways that helps New York to be vibrant and vital in the future. And of course, that’s not the Fed’s policy, but I think it is really important for groups in the communities, and the business community, and government, to really be thinking through some of those things.

Another risk that a lot of economists bring up is the longer-run risk of climate change, and I feel like it’s really relevant with the heat waves that we’ve just had. How do you think about heat, and climate, and the future of the economy?

All of these climate issues affect, directly, our core responsibilities at the Fed. And by core responsibilities, I don’t mean climate policy, because that’s not one of our core responsibilities — it affects our understanding of the economy, our understanding of the factors that influence employment, inflation, growth, you know all the things we’ve talked about, and obviously thereby affecting thinking about how does monetary policy achieve our dual mandate goals.

It affects the risks in the financial system, in terms of prudential, from a prudential oversight point of view. The risk of losses on loans, or obviously with the insurance industry, too, outside of banking. And I think it also has a really important global aspect to it — not just locally, or regionally, around the country, but globally, it’s going to affect movements of population, movements of capital across different regions and across borders.

So I think there is so many different ways that over time, I’m answering your longer-run question, that these affect our understanding of the US economy, the global economy, the US financial system, the global financial system and how those are interconnected. And then there’s the final thing, which is that: the policies that governments and societies take to address the climate change issues, those obviously affect the economy and the financial system too.

So from my perspective, if we’re going to do our job well — and I’m speaking for myself here — but if we’re going to do our job well, just like we need experts in economics and international trade and experts around the financial system, experts in understanding banking and the broader financial system, we have today to do our job, today, we need to have that same level of expertise and understanding how all of these issues around climate and everything else are affecting the economic landscape that we’re operating, again, so that we can carry out our monetary policy, our supervision, our payments, and other responsibilities as effectively as possible. Investment here is really about building up that understanding, that knowledge, that expertise. In the same way that we hire people who are experts at consumer theory or international trade, we need to have an understanding of how these issues play out in the medium term, and also in the longer term.

Another risk that people are talking about right now is this possibility of not just no landing, but re-acceleration. It’s possible that the economy takes back off and you guys have to do more down the road. I wonder if you see that as a risk, and how you think about the possibility?

It’s a possibility. Being data-dependent means that if we see the data moving in that direction, we’ll need to act appropriately, as we have in the past. So I think that’s a possibility. I think it would really depend — there’s different ways that something like that could happen — but I think it’d really be coming through demand in the economy being much stronger than I currently expect, and that means you need a higher level of interest rates to get supply and demand in balance. I don’t see — and I should have mentioned this earlier — but we don’t see any signs in the data on inflation expectations or other measures of expectations that says that people have kind of shifted to a view of “I expect high inflation in the future,” so we’re fighting against that tide, or anything like that. So inflation expectations have really come down a lot, at the one year, or the three year level. Longer-term inflation expectations have been well anchored throughout that. So I don’t see any of those kind of drivers. To me I guess if that risk were to materialize, it probably would be more that, demand is a lot stronger than I had been expecting, and we need to have a more restrictive policy to bring supply and demand back into balance.

A question we get from our readers all the time is: Are mortgage rates ever going to go back down to where they were before the pandemic disruptions? And I wonder what you think of that, as the person who’s done all of the research on interest rates?

On your question about: Do interest rates go back to more normal, what is that? I think there’s two aspects of that: One is, when inflation comes back to two percent, and the economy is growing more at trend, and we’re in an economy that’s in good balance and on a sustainable path, that I assume those real interest rates — right now we’re raising real interest rates in order to have restrictive policy, and if that’s correct, then eventually monetary policy moves back to a more neutral stance.

Part of the question is, today, interest rates are higher than neutral because we have high inflation, because we have demand-supply imbalances. So my expectation is that over time, over years, real interest rates will actually come back down from the levels they’re at. So the question is: What’s neutral?

The research that has gone on about this over the past decade or so has really emphasized that the level of neutral interest rates depends critically on factors that drive supply and demand for savings and investment.

So the big drivers in the long run of how much people save and how much people want to invest — and the interest rate is the price that equates supply and demand for that — you know big drivers of that have been demographics, low birth rates means, if you think about it, if you have a slow population growth you don’t need to build as many schools, and build as many roads, and invest as much to help provide for that investment for the bigger population, the bigger economy, so with lower population growth in most countries around the world, you don’t need as much investment as you did in the past, when we had more population growth.

With people living longer on average around the world, and people presumably not working equally longer, that increases the demand for savings relative to before, and that’s been another factor that’s been identified that increases the supply of savings and therefore lowers interest rates.

I think on those demographic factors, those have moved, if anything, more in the direction of lower interest rates. We’re seeing — ten years ago, we were talking about population growth in Japan and in China, and in some countries, in Europe. Now, obviously Korea, China is an even more profound reduction in population growth, and you see that more broadly in a lot of countries. Not all countries, but a lot of countries. So I think that those factors are pushing the neutral interest rate lower.

The other factor is productivity growth. If you’re a fast-growing economy, you tend to need to invest more to keep up with that — we’re not seeing that. Productivity growth seems to be more or less where it was before. I think that holds the neutral interest rate down.

The last one, which is one that was often associated with the secular stagnation kind of theories, I think is just as relevant today. And that theory — and again it’s a kind of way of thinking about the world — is that we are moving more and more to an economy that doesn’t need factories and lots of capital investment to produce a lot of output. You think about streaming services. Sure, streaming services need the internet, they need a certain capital stock, but you don’t need to have all of the movie theaters. And I’m going to be very retro. You don’t need the record stores, and the trips — shipping the vinyl records to the stores as much as you did. And so a lot of that physical capital, logistics, transportation, and all that is now being replaced by, this is just going over the internet.

And I think that net, net, that’s actually a lower demand for investment than it would be in the traditional industries. And I think that’s not just about music, or movies. It’s actually I think broadening to a lot of services that we get. We’re just doing less with physical manufacturing of things and more with moving electrons around. So that’s an argument that has been made for: You can grow the economy, add to consumer welfare, without necessarily building lots of investment in factories and other things. I think that’s just as true.

A.I. might be another reason that that process continues further along, so those are the reasons that I think the neutral rate is probably just as low as it was. Below 1 percent, somewhere between 0 and 1 percent real interest rate, as it was before the pandemic. It’s hard to know exactly where it was.

What are the arguments that people use for: Oh, it’s got to be higher?

One is that we got a lot of fiscal stimulus. That presumably adds to the cost of funding. So I think that’s logical — I haven’t seen a big effect of that so far, but that’s a possibility.

The other ones you hear a lot about are some big investment boom is around the corner, whether it’s on green investment, on building electrical grids or new power supplies, so there’s going to be a big investment boom in green energy and things, and the other similar story is that we’re going to have a re-shoring of investment into the U.S. So those are things that are going to increase investment demand. On both of those, I think it depends quite a bit on how that plays out. Re-shoring globally is probably just — I’m going to move a factory from one country to another — on a global basis, that doesn’t change investment very much. The neutral interest rate is really about the global supply of funds, and global demand for investment. So moving one factory from one country to another, it’s not clear that has a first-order effect on interest rates in the long run.

And on climate policy, it really depends on how it’s funded. If this is funded through big government subsidies, or tax credits or something, that could be a big driver of investment for a long time. If it’s funded through other sources, higher taxes or something, it could have different effects. I think there’s a lot of “ifs” about how big those effects will be. And remember, if there’s a big boom in green economy, there’s probably going to be a negative boom in other parts of the economy. So I think there are a lot of “what ifs” about the future, and those have the possibility of moving neutral interest rates back towards the more normal levels of the past, going back to the ’70s or ’80s or something like that, but those are things we haven’t really seen materialize in the data, and those are things we’ll have to continue to watch. I haven’t seen really any strong evidence that neutral rates have yet risen much beyond what they were, say before the pandemic.

If there’s a risk of going back to very low neutral rates, which obviously carries this inherent risk of ending up at the zero lower bound, why not just raise the inflation target now? It seems like you could deal with two problems at once, both giving yourself more headroom and making it easier to hit the inflation target.

It’s clearly a decision that central banks have analyzed and made, and the F.O.M.C., we decided back in 2012 to have the 2 percent inflation target, and that wasn’t just a number drawn out of thin air — it was thinking about, how do you best achieve price stability and maximum employment, knowing that if you set the inflation target too low, that could hinder your ability to achieve maximum employment on a consistent basis.

But there’s also the view that if you set your inflation target too high, that’s not really consistent with price stability, and it may interfere with the economy working effectively and achieving maximum employment over the long run. I think the experience of the past few years has taught me that 4 percent inflation is not considered price stability — it has not felt like price stability by the general public, or quite honestly, by policymakers; 4 percent inflation seems very high in the modern world; 3 percent seems high; 2 percent was already the compromise, of saying: Why not go all the way to zero?

And there’s some technical reasons that you might not want to go all the way to zero, but 2 percent was to provide a buffer, partly because of the zero lower bound and other things, but at the same time keep inflation low and stable.

I think we’ve also learned, with our experience, that between using what used to be called unconventional policy — like forward guidance — being more transparent about our policy approaches, and using Q.E., Q.T., we actually have the tools to manage a 2 percent inflation target and achieve our goals over time.

I feel like, when we did the framework, the recent updated framework a few years ago, we thought about all of these issues and all of the lessons of: What is it like to make monetary policy in a low r* world, a low inflation world?

[Note: r* is the neutral rate of interest, the one that neither stokes nor slows growth, and it had fallen sharply in the decades leading up to the pandemic.]

I personally felt comfortable that a 2 percent target, along with a commitment to achieving 2 percent inflation on average over time, positioned us well to achieve those goals.