2021 Central Banking Series. Monetary Policy

Anna Paulson and Dennis Lockhart

On 23 March 2021, the Rafael del Pino Foundation, the Global Interdependence Center and BBVA organised the "Central Banking Series" meeting, in which they analysed, among other aspects, the deep links between monetary policy and employment. The session was attended by Anna Paulson and Dennis Lockhart.

Anna Paulson is a Vice President in the Research Department of the Federal Reserve Bank of Chicago, where she oversees a team of economists conducting research on finance and banking. She has also served as a Vice President in the Chicago Fed's Financial Markets Group and as a Senior Financial Economist in its Research Department. Prior to joining the Chicago Fed in 2001, she was an assistant professor at the Kellogg School of Management at Northwestern University. From 2009 to 2010, she served as a fellow at the Consortium on Financial Systems and Poverty. Paulson is an American economist whose research focuses on how households cope with risk and incomplete financial markets. His current research includes studies on the relationship between institutions and financial development, and the dynamics of entrepreneurship. In addition to her position at the Fed, Paulson has served as the editor of economy from Economic Perspectives and as a member of the editorial board of The Journal of Consumer Education.

Dennis Lockhart is a former president and chief executive officer of the Federal Reserve Bank of Atlanta, from 1 March 2007 to 28 February 2017. Lockhart is currently Professor Emeritus at the Nunn School of International Affairs at Georgia Tech. He also serves on a number of for-profit and non-profit boards. His career has included banking, private investment and teaching at Georgetown and Johns Hopkins Universities.

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On 23 March 2021, the Rafael del Pino Foundation, the Global Interdependence Center and BBVA organised the "Central Banking Series" meeting with the participation of Anna Paulson, Vice President of the Research Department of the Federal Reserve Bank of Chicago.

Anna Paulson noted that the last year has been a terrible one for many people, who have faced illness, death, uncertainty, unemployment. There has been a lot of suffering. The economy has suffered too. Things looked very bad in March and April, but the world economy has been able to recover and we have made even more progress than we had anticipated six months ago. Looking ahead, we are on the edge of a cliff of optimism. There are more and more vaccines, so it looks like we are going to be able to control the epidemic. There is going to be more economic activity. So, looking ahead to next year, things look good. We're looking at 6% or more growth for 2020 and 2021. We are seeing accommodative monetary policy and a lot of fiscal support. Unemployment remains very high. Right now, nine and a half million Americans are out of work, but I think there's going to be a lot of progress on employment this year. We could end up with an unemployment rate below 5%. Some even estimate it could be as low as 4.5%. We need to make a lot of progress in the leisure and catering sectors, where there has not been much normality due to social distancing. Households are doing well, the industrial sector is recovering almost to pre-pandemic levels and the demand outlook should be encouraging.

The virus is driving the economy, so, explicitly or implicitly, what is valued is the progress of the virus and what it is going to represent for economic actions. There are states where there are more cases, where there are more hospitalisations, so of course we have to be cautious. I think we are all armchair epidemiologists so we rely a lot on the experts. At the EDF we have medical experts who help us to analyse this reality from an epidemiological point of view. One of the challenges we face is that we were used to extrapolating in a linear way, but the pandemic doesn't work like that: things shoot up, they slow down. So we have to be very cautious when we think about variants, about speed. We hope that, in a few weeks' time, everybody will be able to get vaccinated, which we are doing not for ourselves but for the community. That is the only way we will control the virus.

As far as the recovery is concerned, many of the people who are now unemployed worked in the leisure and catering sectors. That part of the economy was growing before the pandemic. There is a fundamental underlying element. So that sector should pick up and jobs should be created. But people are not sitting at home waiting to be called and asked to go back to work. So there will be people who have already found a new job, who no longer have a relationship with their old employers, or maybe the needs have changed. It is easy at first to regain employment. But as the months go by, this recovery is going to be more complicated. We don't know if there is going to be long-term damage, or if in the longer term activities are going to change. We wonder if we are going to go back to the office five days a week or if it is going to be just two days a week. These changes, in commuting, are going to drive other changes. Where are the dry cleaners going to be? And the restaurants where people who work eat? We will see this as the months go by. We will see how much friction there is as we get back to business, or to what extent behaviours have changed in the long term. After the financial crisis it took a long time to bring back some workers and as the recovery continued we made a lot of progress and we brought down unemployment rates for the black population, for Hispanics, reducing that gap between whites and blacks in terms of employment. When the Fed talks about inclusive employment, we are thinking about the follow-on policy that supports that kind of recovery that is beneficial for everybody.

The Fed considered revising its long-term strategy for about twelve months before it began to change it in August. There was a long trend of falling interest rates around the world. Such low interest rates create risks, they have implications for monetary policy. This is all due to structural factors - demographics, demand for short-term assets - that we think are going to be with us and probably have not been affected by the pandemic. Other factors we saw in the recovery from the financial crisis were very low levels of unemployment, with blacks and Hispanics participating in the labour market in a way that had not been seen for some time. This participation was accompanied by very low inflation, below the Fed's 2% target. All this is included in this new framework and we conclude that we do not need to worry so much if unemployment is very low. We need to worry only if it is too high, about insufficient employment. This is a change in how the Federal Open Markets Committee thinks. We are talking about heating up employment. Another way to do it is to think about the following. If the recovery is sustained for a long time, you can attract more workers into the economy who can benefit from employment. You also have to think about periods of low activity in the economy and look at the unemployment situation for different groups. There will have to be periods of low activity for whatever reason. Policy can be accommodative. Businesses will have to readjust to attract more people into the labour market. The framework indicates that, given the effects that are, in effect, depressing inflation, something has to be done. In good times we need to look at inflation a little higher, and that all has to do with anchoring at 2% on average. If we don't manage to get inflation to that point we run the risk of a collapse to lower levels. So you need to get inflation higher for some time to achieve that 2% average, but you always want expectations to be anchored. This is very important when you want inflation to be not too much, not too little.

When we see the new framework, let's be patient. Rates are at zero and they're going to stay there until we get to the maximum employment target, until inflation is at 2%, until it's on track to go above 2% moderately for a while. We are going to be very accommodative, very patient, we want it to be above 2% a little bit for a certain period of time. We have to think about how long inflation has to be above that level to anchor expectations. We cannot look directly at expectations. There is a scorecard of indicators that take into account many factors, to see which ones tell us something about inflation, which ones refer to risk premia, which ones refer to expectations about real activity. This year, this analysis is going to be very interesting, but also very difficult. The economy collapsed in the spring, suddenly. It was a voluntary political action to protect families. Now we are seeing the economy reopen again. Some sectors are doing well, where it is possible not to be together, and others have not done so well. Demand has gone up in some sectors and others have not done so well. So there is going to be inflation this year, it is going to go up for different reasons. Some of them are mechanical. The lows of last spring are going to disappear, supply and demand are not going to arrive at the same place at the same time. It's going to be a relatively short phenomenon because we're going to move from restricted activity to a situation that will allow a return to a much more normal set of activities. The question is what happens next with inflation. This depends on many factors. It depends on monetary and fiscal policies, on what happens with inflationary expectations, on the experience of seeing price increases, how to set prices and agree on wages. It is going to be a delicate year to see what is the short term and what is the effect of this exceptional measure.

When is inflation considered to be moderate and when is it not? We can think of higher inflation over a shorter period of time or somewhat lower inflation over a longer period of time. If we think about the last fifteen years, over that period we have had inflation below 2% for a long time. The concern is that expectations will be below 2% rather than anchored at 2%. The FOMC should look for policies that allow this longer-term framework to be met and anchor expectations at 2%. This would allow us to stay above that level for a while. But the risks are asymmetric. If inflation exceeds the levels indicated to meet the Fed's mandate, the Committee can remove these accommodative measures.

The Committee is very focused on the Fed's dual mandate, which is to have maximum employment and stable and low inflation. It is using all the tools at its disposal to achieve these goals. In March last year, financial markets were hit and the Fed started buying treasury assets and mortgage-backed securities to support the markets and to ensure this accommodative reality. This is still the case and is one of the factors that allow conditions to be accommodative. Longer term rates are likely to be somewhat higher. These low rates have facilitated the recovery. People have been able to buy a car, to mortgage their house, to borrow so that their business can survive. In other words, these policies using the Fed's balance sheet are accommodative along with low short-term rates. We are always going to look at whether the financial sector is overly affected, but it is important to consider these potential problems in relation to the objective of achieving this dual mandate. We have to think that the stakes are high and balance sheet policies are a tool that allows us to achieve that mandate. We follow it very closely and, so far, it seems to be working very well. The asset purchases are being really accommodative.

We have seen that the yield curve has shifted upwards in recent weeks, but it is the speed of the shift that is important, not the levels. The levels are very similar to what they were before the pandemic. Conditions remain very accommodative and supportive of economic activity, of recovery. The yield curve, therefore, does not seem to be warning of something that the Fed needs to react to.

Regarding risks to financial stability, it is very important to remember that low inflation and low unemployment are positive. When people have jobs and companies are earning money, they can pay back loans and banks will be able to provide the necessary support. Of course, low rates can alter incentives and there are stakeholders in the financial markets who worry about the yield curve. But this is part of the policy. We want to encourage a little bit of risk because it encourages job creation, but there is a balance to be struck. Financial stability issues are a spill-over effect of first-order policies that support stability in general terms.

The Rafael del Pino Foundation is not responsible for the comments, opinions or statements made by the people who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their sole responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio González, are the result of the debates held at the meeting held for this purpose at the Foundation and are the responsibility of the authors.

The Rafael del Pino Foundation is not responsible for any comments, opinions or statements made by third parties. In this respect, the FRP is not obliged to monitor the views expressed by such third parties who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their own responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio J. González, are the result of the discussions that took place during the conference organised for this purpose at the Foundation and are the sole responsibility of its authors.