Achieving Market Balance Through Price Regulation

At the Federal Reserve Bank of New York's Exploring Innovations in Central Banking conference, a joint effort between the Bretton Woods Committee and the New York Fed, the following remarks were prepared for delivery.

 Speech by John C. Williams, President and Chief Executive Officer

 Greetings to all! We are delighted to be jointly hosting this event with the Bretton Woods Committee at the New York Fed.

 In my address today, I will be talking about the economy of the United States, along with the current monetary policy decisions and my prediction for the future. It is important to mention that the opinions I am expressing are my own and not necessarily those of the Federal Open Market Committee (FOMC) or any other part of the Federal Reserve System.

 The concept of a Dual Mandate is one in which two objectives or goals are sought to be achieved. This can come in the form of balancing economic growth and price stability, among other things.

 Congress has instructed the Federal Reserve to pursue maximum employment and price stability. We have seen positive results in terms of employment, evidenced by the fact that the unemployment rate has been below 4 percent for over a year and a half - the longest stretch since the mid-20th century. This is in line with my prediction of a long-run unemployment rate of 3-3/4 percent.

 The pandemic has caused a prolonged imbalance in supply and demand, resulting in unacceptably high inflation. According to the PCE price index, inflation was recorded at around 7 percent in June of 2020, which was the highest rate in 40 years. Fortunately, the inflation rate has dropped to 3 percent since then. Nevertheless, this level of inflation is still not acceptable.

 The FOMC is devoted to bringing inflation back to its long-term objective of two percent, which is a crucial element of our economic success and of guaranteeing maximum employment in the long run. Price steadiness is the foundation of our economic prosperity.

 Analogous to the layers of an onion, the concept of inflation can be broken down into its various components.

 For the past twelve months, I've been utilizing a vegetable metaphor to illustrate why inflation rose and is now moderating.1 That metaphor is an onion, with each layer symbolizing a distinct part of the economic environment.

 The outer shell of the inflation onion is made up of commodities traded on a global scale. After the start of the pandemic, a surge in inflation was observed due to the heightened demand for commodities. This incline in prices was once again observed in June of 2020 when Russia occupied Ukraine. During this period, sustenance inflation had reached 10 percent while fuel prices had skyrocketed to more than 40 percent.

 Throughout the last 12 months, the balance between global supply and demand has been restored, largely due to the restrictive fiscal plans imposed by a number of central banks across the world. Commodity prices have significantly decreased and food prices have declined to approximately 2-1/2 percent - even the price of a Thanksgiving dinner was lower than in the previous year. Furthermore, the cost of energy has been on a downward trend over the last year, resulting in a lower overall inflation rate.

 The second layer of the onion is composed of core products not including food and energy, where the rebalancing of supply and demand is clearly visible. The worldwide supply-chain problems that were observed during the pandemic are mostly gone by now. According to the Global Supply Chain Pressure Index of the New York Federal Reserve, October marked the most beneficial reading ever recorded since 1998.3

 The equilibrium between supply and demand has been restored and supply-chain issues have been alleviated, leading to a core goods inflation rate of approximately one-fourth of one percent. This inflation rate appears to be going back to the pre-pandemic level.

 Not only have the outer layers of the onion seen the most and quickest changes, but the inner layer has experienced improvement as well. Core services inflation, which reached a peak of nearly 5-3/4 percent earlier in the year, is now at around 4-1/2 percent. Moreover, the latest numbers suggest that inflation in this area is continuing to ease.

 The primary factor in the jump of core services inflation has been the steep upticks in the cost of shelter. The demand was high and the supply was short during much of the pandemic, and thus, rental fees for newly signed leases have been rising close to pre-pandemic levels. As this information is added to the official statistics, the inflation rate for shelter will likely continue to decline. Additionally, inflation for services excluding housing and energy is beginning to move in the positive direction. In the last six months, inflation in this area has decreased to around 4%, a far cry from the 5-1/4% peak in December of 2021.

 Signs of What May Come:

 It is now possible to glean an idea of what the future may hold by examining current indicators.

 In conclusion, what are the implications of the onion's various layers? What does it suggest regarding potential inflation in the future?

 The New York Fed's Survey of Consumer Expectations indicates that expectations for future inflation, including those for the medium-term, have returned to pre-pandemic levels. This is in line with the Federal Open Market Committee's (FOMC) goal of a 2 percent inflation rate. 4

 Since last June, when one-year-ahead inflation expectations reached almost 7%, they have decreased significantly. Now, they are approximately three quarters of a percentage point above the regular levels seen from 2014-2019.

 The New York Federal Reserve's Multivariate Core Trend (MCT) inflation is another useful barometer of inflationary trends. This figure saw a high of 5.5 percent in June of last year, and then dropped to 2.9 percent in September. Other indicators of inflation have also experienced a substantial decrease since the beginning of the year.

 The job market is an area of particular focus, due to its importance in the economy. It is an area that is constantly in flux, and often changes with the times. As a result, understanding the nuances and mechanics of the labor market is essential in order to properly negotiate the workplace. This includes knowing the different types of jobs available, the salaries and benefits being offered, and the current job trends. Taking the time to research and understand the labor market can provide invaluable insight into the job market.

 At this point, I'd like to discuss the other aspect of our mission: job creation.

 The labor market's rebound from the COVID-19 crisis caused an imbalance between demand and supply, resulting in an upswing in wages and inflation.

 There is a clear indication that progress towards equilibrium is being made. Job postings have seen a decrease. The quit and hire frequencies have returned to the same levels as before the pandemic. Perceptions of job availability and the capacity to fill positions are likewise back to pre-pandemic conditions. Although wages are still elevated, the growth rate has significantly diminished.

 It is clear that the labor market has experienced a marked improvement due to an increase in labor force participation and immigration rates back to pre-pandemic levels. Nonetheless, the ability to further grow the supply side is limited, and therefore a decrease in demand is necessary to restore equilibrium.

 A Firm Monetary Policy Posture is being taken by authorities.

 The Federal Open Market Committee has adopted a policy of restraint in monetary affairs, which is designed to create a balance between supply and demand and cause inflation to return to the 2 percent goal in the long run. At the start of the month, the FOMC kept the target range for the federal funds rate steady at 5-1/4 to 5-1/2 percent.5

 The implementation of our strict regulations has led to a tightening of financial conditions, largely due to the rise in long-term Treasury yields since the summer. Statistical models have attributed much of this to a higher term premium, but there is a lack of consensus among market participants on a single cause. The increase in yields and the heightened volatility may be indicative of the current uncertainty surrounding the economic future and interest rates.

 Given the present stringent fiscal and lending conditions, I anticipate that GDP expansion will decelerate in the upcoming year to approximately 1-1/4 percent, and that the joblessness rate will increase to around 4-1/4 percent.

 It is my outlook that inflation will gradually decrease towards the 2 percent longer-term objective. Factors like the slowing of shelter price inflation should help bring the inflation rate down. Additional disinflationary effects could be observed based upon research from the New York Fed, which reveals a strong relationship between the Global Supply Chain Pressure Index and goods price inflation. I anticipate that PCE inflation will be close to 3 percent for 2023, decrease to approximately 2-1/4 percent in 2024, and then move closer to 2 percent in 2025.

 Despite this, it is still difficult to say what the future holds; our choices rely on data. Both sides pose a risk: inflation could stay persistent, or the economy and employment could suffer.

 Considering the various risks and present facts, I believe we are currently at, or near, the peak of the targeted range for the federal funds rate. According to model predictions of the long-term neutral interest rate and forecasts for the present quarter, monetary policy is remarkably restrictive - it is estimated to be the most restrictive in 25 years.7 In order to reestablish balance and achieve the long-term goal of a 2 percent inflation rate, I think it will be necessary to maintain a strict stance for a considerable amount of time.

 I will stay observant of all the data to determine if the present policy position is enough to reach our inflation target. If price levels and imbalances remain more than anticipated, then extra policy firming may be essential.

To conclude, some words on our balance sheet. During our last assembly, the FOMC declared that they will proceed to diminish their possession of Treasury securities and agency debt and agency mortgage-backed securities, as declared in 2022. Our plan to reduce our security holdings is functioning precisely as expected. We have already cut our securities holdings by more than $1 trillion, and we have not noticed any adverse effects on the market.

We are devoted to achieving our objective.

It has been a year since I began to investigate inflation, and this endeavor has resulted in notable developments in the reduction of inflation and the stabilization of the economy.

 I am determined to fulfill our aim of reaching a 2 percent long-term inflation rate, laying a solid groundwork for our economic prospects. Nevertheless, we still have plenty of work to do.