St. Louis Federal Reserve Bank president James Bullard joined Wharton finance professor Jeremy Siegel recently, along with Jeremy Schwartz, research director at WisdomTree, for a wide-ranging conversation about the future of interest rates, inflation, the state of the economy, overall monetary policy, the possible over-valuation of stock prices — and more — on “Behind the Markets,” on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.) Bullard oversees the Eighth Federal Reserve District, which includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.
Edited excerpts of the conversation follow.
Jeremy Schwartz: You have this very regime-based view of the world. [In 2016, the St. Louis Fed switched to a regime-based approach for near-term U.S. macroeconomic projections.] … What regime are we in today?
James Bullard: We continue to be in a low interest rate, low inflation regime, and the global aspect is something to keep in mind. Some of the numbers in the U.S. on the growth side do look a little bit better, but I would still say overall we’re in this rather low[-interest-rate] regime.
And that is making me think that the policy rate [federal funds target] is about right where it is, maybe with a little bit of upside risk. But in contrast to some of my colleagues, I would not think that we have to march up considerably higher from where we are now in order to keep unemployment at a low level and to keep inflation under control.
“We continue to be in a low interest rate, low inflation regime … the policy rate is about right where it is, maybe with a little bit of upside risk.”
The inflation numbers are low; that’s really been the surprise of 2017. That’s probably not going to improve by the end of the year here. And inflation expectations are running light as well, as measured by the TIPS market [Treasury inflation-protected securities]. I think that’s the situation for monetary policy right now.
On the New Fed Chair
Jeremy Siegel: Next year you are going to be sitting with a new chairman [Jerome Powell]. He’s been a fellow with you on the FOMC (Federal Open Market Committee), the board, you’ve heard his interactions. Tell us a little bit about your impression.
Bullard: Jay Powell has been a great colleague on the FOMC and in the Fed system. Generally since he came on as governor, he rolled up his sleeves, got involved in many issues including regulatory and monetary policy issues, but also including operational issues within the Federal Reserve. That, I think, exposed him to many people all around the system. And certainly my interactions have been very positive. He is a consensus builder, he is a very sharp business person, and has a lot of acumen. So I think he’s got a good future as the Fed chair.
Siegel: Are you at all concerned that he is the first chairman since G. William Miller decades ago that neither has either a Ph.D. or an undergraduate degree in economics?
And I know Charlie Plosser, the former president of the Federal Reserve Bank of Philadelphia. He expressed some concern about that — would he have the depth of understanding of economics, not being trained in that area?
Bullard: First of all, the Fed has lots of expertise both at the board staff and around the FOMC table, and at the Reserve Bank staff. So we have lots of input from professional economists. There will be no shortage of that I think with a Powell chairmanship. I think he’s been at the Fed for about five years or so, so he’s had plenty of experience himself in deciphering all of the arguments that are being made around current monetary policy.
So I think he will be very good. It might be a little bit different than having, let’s say the Princeton professor, Ben Bernanke, as your chair, but different people have different styles and I’m sure he’ll be able to manage very effectively.
Siegel: I think that he was a member of the Carlyle Group, in private equity, and he worked for Dillon Read. He’s not foreign to the capital markets.
Bullard: On that side he’ll have much better knowledge I think than some of our immediate past chairs, where he’s got a depth of experience there that, for all of their success and all of their credentials, Ben Bernanke and Janet Yellen could not bring to the table because they didn’t have that kind of experience.
Siegel: You mentioned Fed staff, and there are some very, very good people there. Then again, of course you could say virtually no one really foresaw the financial crisis. There are a number of people who said, “Are they the people you always want to listen to? Or do you want to have some independence and hear some other voices that might think differently in terms of what’s going to happen to the economy?” How do you feel about that? I mean, would it be more captive than someone like Bernanke to the Fed staff?
“The inflation numbers are low; that’s really been the surprise of 2017.”
Bullard: I’ll just give you my own take on the monetary policy debate. I say it’s a global debate that goes on 24 hours a day, 365 days a year. And so you’re getting input from all kinds of corners of the globe, and certainly from financial markets, the committee itself, the staff itself. But it’s not like it’s in a closed room where you’re not listening to the rest of the world.
You don’t really have to have a perfect alignment of backgrounds in order to get all of that input from all around the world. And I think we do that in some respects. So if you think about the run up to the financial crisis, it’s true that we did not predict the financial crisis, but I think there is some revisionist history that goes on because the housing bubble was a big topic of discussion for several years before it actually came to an abrupt end. And many people were talking about it, both inside and outside financial markets, and in academia.
On U.S. Economic Growth
Schwartz: James, you just said that we have a global discussion, 24 hours a day, 365 days a year. When Yellen talked about it being global concerns, concerns from China impacting U.S. policy, is that something that is increasingly becoming an issue for you, just the global phenomena of low rates around the world, low growth, or scares from China being the driver of U.S. monetary policy? Should it be so global and focused for the U.S.?
Bullard: Well, I just want to caution people. One of the big issues for the Fed is the so-called R-star [sometimes referred to as R*], the real safe rate of interest, or the natural rate of interest in the global economy. And I would say here in the second half of 2017, we’ve got some of the growth numbers looking a little bit better. It looks like it’s tracking estimates for the second half; the third and the fourth quarter together will be maybe 2.75% growth at an annual rate over that time period. So that gets people kind of excited in the U.S., but I just caution them to look at the global situation. We’ve still got negative rates, nominal rates in Europe, far out of the yield-curve. We’ve got negative rates in Japan, far out of the yield-curve.
And you have to wonder if the U.S. can go very far in an environment where the Western world is basically still in negative rates, and will be for a while. Eventually that will probably get unwound but that’s still quite a ways in the future.
Siegel: Going back to that R-star, … that’s the long run rate that the Fed thinks is down to … 2.75%. Jim, I remember a year ago you thought that what we should be at is a little less than one. I don’t think it’s a secret by saying that we know where your dots are on the dot plot. So that does bring a little question. It looks to me that we’re going to have a rate increase of 25 basis points in the December meeting. That’s above your dot, am I right on that?
Bullard: Well, what I have said is that the regime view suggests that you should just take the evidence at face value, and you should not assume that the real rate is going to revert to some mean that existed in the 1980s or 1990s, or 2000s. The evidence is that the one-year ex post, real rate of interest has been declining ever since the 1980s.
And it’s declined a lot, as much as 700-basis points over that time period. And that’s kind of your base rate, or pretty close to your base rate for your Taylor Rule. [Economist John Taylor’s calculation for the appropriate fed funds rate in light of changing economic conditions.] And if something has been on a downward trend for 30 years, it’s probably not wise to predict that all of a sudden it’s going to turn around in the next year or two and start going back up to its mean.
“The appointments process has become very cumbersome, and appears to be on the verge of breaking down completely….”
The better way to handle it for policy purposes is just to say, there are somehow forces at work which has kept this rate very low, and we should accept that evidence, and we should assume that those forces are going to continue to be operative over the next two years. Therefore, our benchmark for our Taylor Rule is at a very low level, and then we can correct for gaps and inflation and unemployment from there. But the basic idea is that you shouldn’t assume the mean reversion that many people do, that you’re going to go back some general level of rates that existed pre-crisis.
On a Possible December Hike
Siegel: If you were a voting member, would you vote against a rate hike in December?
Bullard: Well I don’t know, we’ll have to wait until I get to the meeting and look at the data at that time. I have been concerned that with inflation falling below our target this year, farther than we expected, the core, PC [Phillips curve) inflation rate is only 1.3% year-over-year now, and has been falling this year. So I am a little concerned that we’ll send the wrong signal in December by raising the policy rate, and that depresses inflation expectations, and possibly cements in a lower inflation rate over the forecast horizon. And I think that’s maybe a downside of a rate increase in December.
Now, on the other hand, I have said that I am willing to go with data, and growth prospects have been better this fall, and to the extent that you think that extends into 2018, that might be a bullish factor for the U.S. economy. On that I would say that most forecasts that I have seen, even though they have 2.75% or so for the second half of 2017, most forecasters have that declining in 2018 and 2019, back down to something closer to the 2% trend that I’ve been talking about. To the extent that what is going on now is temporary, then that would lean against a rate increase in December for me. So we’ve got many factors to consider here.
On the Effects of Deregulation
Siegel: Some people suggest that even though we haven’t had the infrastructure spending that Trump has promised, and not even tax reform, … that the lower regulations that we have had might be some reason for better optimism on productivity going forward, which we know has been dismally low over the recovery period since the financial crisis. Do you give much weight to that? Or do you think that’s not an important factor?
Bullard: I am somewhat sympathetic to that. I think the deregulatory attitude probably is very different for this administration compared to the last one, and that has made business people far more confident than they were — you can see that in the sentiment surveys — and I think more inclined to invest in planned equipment than they would have been previously. You would think the more capital would improve productivity, and you would get improvements on that score. That process takes a while to play out, so I’ll kind of believe it when I see it.
Siegel: So you don’t think the recent strength, as you said in the second half of the year, which has been a little bit of a surprise on the upside from what was expected, is not due to a regulatory decline, at least at this point?
Bullard: I don’t know if you can draw a straight line, but I am sympathetic to the story. But if you actually look at the evidence I think it’s hard to draw a straight line there. The thing about regulation is that it is a very broad category that spreads across all kinds of different aspects of the economy.
Which rules are we really talking about? Which ones have not changed? Which ones are changing? If they do change, are they changing for the worse, or are they changing for the better, from a productivity standpoint? So those are hard things to measure, and that would take a long time to sort out. But as a general idea I am sympathetic to it, and I think it has improved business confidence.
Schwartz: I am curious how you would even measure the regulation change from your perspective. In our show, we’ve had a few discussions [about seeing signs of a lower regulatory burden, such as] the largest drop in pages in the Federal register this year. I heard last week somebody said 800 different regulations were rolled back. Do you have a quantification of that concept, or it’s just too loose to figure out?
“If the stock market and the Fed see trouble ahead , equity prices are going to decline and the Fed is going to lower rates…. I would not describe that as a Greenspan Put, [but as] good monetary policy.”
Bullard: You have to look at every one of those and ask yourself, was this just a frivolous regulation that caused a lot of paperwork and therefore was unproductive from the perspective of the economy as a whole? Or are you removing a regulation that will come back to bite you later because it was safeguarding against a bad outcome that is now more likely to occur? That’s a pretty hard judgment to make.
But regardless, the sentiment in the business community has been very positive about it, and it has given them more confidence to invest in their businesses. And you would think that would eventually feed through to better productivity. But we need to wait to see if that actually happens.
On the Taylor Rule
Siegel: Jim, you mentioned the Taylor Rule. … You did work in the 1990s basically describing how the Fed has acted in response to unemployment, inflation, and actually making that response something that perhaps the Fed should follow.
Now that we have a Republican chairman — although we did under Bernanke too, not under Yellen — we know that the Republicans have supported legislation to not force the Fed to adhere to the Taylor Rule, but to explain deviations from it if that should occur. This is something the Federal Reserve has very strongly resisted. Do you think that Powell will also resist it now that it is coming from his own party? Or do you think there might be a different tack here?
Bullard: I don’t want to speak for Jay, and I’m sure he’ll be asked this in his confirmation hearing so he’ll have to decide for himself what he wants to say on that. But speaking for myself, I’ve been pretty supportive of the idea that we should talk to the public in terms of some kind of baseline, which is how I would interpret this, and then why we’re deviating from that baseline. I just think that’s a part of good communication for any central bank, really.
A lot of the debate gets framed around, well, ‘would you have to slavishly follow a particular version of a Taylor Rule?’ I don’t think that is what is being proposed. I think it’s looser than that, but it would guide the discussion in a way that would probably be informative to markets, and to other observers of monetary policy.
So I think it would be a good way to go. And one thing that we’re doing now, and I would like to do more of, is we have included Taylor-type rules in our reports to Congress. I would like to see those reports be quarterly, have a monetary policy report like other central banks do, and then as part of the discussion there, you could talk about various policy rules and what they would recommend, and where the committee is relative to those recommendations. So I think there is a lot of potential to do good things in this area.
Siegel: Let me drill down on this a little bit. Basically, the Taylor Rule depends critically on that R-star. The short-term, real, natural rate of interest. And when you put 2% as he usually did, and as we usually did years ago, and yes, it then says we should be much higher. But given the instability of R-star — something you in fact have been one of the leading spokespersons on the Fed saying that it has fallen, we can’t use the old R-star — I’m a little surprised on the support for a Taylor-sort of rule. Do you think people will know R-star, and be able to be flexible on that issue?
Bullard: Yes. Maybe I’m just so used to it that I think flexibly about this. But it’s true if you tried to be really rigid about it and tried to force the committee to take a prescription, then you might go astray. Because … like any equation there are a lot of assumptions behind it. And the environment could be changing over time that in a way you should be adapting to.
But what is being proposed is that the central banks should explain its deviations from typical Taylor Rules that are used, and I think in my mind it’s easy to explain why we’re deviating, and one of the reasons is because it looks like the safe, real rate of return has fallen consistently over a very long period. Therefore, we should be taking that into account when we’re making monetary policy.
Siegel: But that isn’t something that John Taylor has talked about.
“It appears that the statistical relationship between low unemployment and inflation is very, very small at this point — possibly even zero.”
Bullard: I just want to get one other thought in here about this. The Fed already does this, because you have members — often in their speeches and their public communication — they’ll use various types of Taylor Rules as a proxy for how monetary policy is going to evolve in the future.
I’ll give you examples. Then chair Bernanke gave an entire speech about the run up to the housing crisis, and how he didn’t think the Fed had contributed to the housing crisis through monetary policy, and he used Taylor Rules all through that speech in order to illustrate the kinds of things that were going on at that time.
Chair Yellen also has given very detailed speeches — she even went out to Stanford, to the Hoover Institution where John Taylor is, and gave a whole speech using Taylor Rules and describing current monetary policy in terms of deviation.
So this already goes on anyway. What is being talked about in Congress would codify to some degree that they maybe would like reports that do that and come in that direction because that makes it easier to understand where current monetary policy is relative to a benchmark.
Siegel: Republicans have generally been more critical of the Fed, I would say, than the Democrats over the last decade or so. Obviously you’ve got extremes like Rand Paul who says abolish the Fed, and certainly it is not at all a position of the GOP. Your appointment does not go through Congress, right?
Bullard: That’s correct.
Siegel: You are vetted by the board, which appointments do go through Congress, but all of the bank presidents, of which there are 12, although only five are voting at any one time, are picked by their board, a board of directors of the regional bank, and then approved by the Board of Governors without a Congressional approval. The Board of Governors in Washington has to be approved before the Senate in hearings. Is this a good structure? Many people are calling for reform — more Congressional oversight, or do you see any way that the current system could or should be improved in that manner?
Bullard: As far as having the presidents of the banks also being presidentially appointed and confirmed by the Senate, I think the main problem with that is that the appointments process has become very cumbersome, and appears to be on the verge of breaking down completely, where it’s very hard to get all of the positions filled.
There is ongoing warfare over this on Capitol Hill, and that, I think, has also led to even the governors’ positions not being filled. We haven’t been at full strength for the number of governors for quite some time. So I think it’s probably not a good time to start thinking about even more appointments that have to be confirmed by the Senate.
Siegel: So you think it is a basically good structure now that should be maintained?
Bullard: I think it has worked very well, and a person like me [has] to get approved by the Board of Governors, which originally occurred when Bernanke was chair. So there is plenty of accountability there, and ultimately the Board of Governors has oversight authority for the system as a whole. You can bring in people certainly with monetary policy perspectives but also with operational expertise to help run the Federal Reserve System. We have done that in recent years, and that is very helpful I think. So I think it actually works pretty well the way it is.
On the Fed’s Mission Creep
Schwartz: Do you think that the Fed is becoming too concerned about markets — if you’re trying to coddle the markets — whether it’s the equity markets, the ‘taper tantrum?’ Some people from the Fed were talking about inequality. Is the Fed going away from its original mission of focusing on employment, inflation and thinking about the markets too much?
“I think we are at a low enough unemployment rate that we actually are …. getting marginal workers back into the workforce.”
Bullard: No, I don’t think so. It is monetary policy, which you might think of as being relatively narrow. But in order to understand the context for monetary policy, you really have to understand the entire economy, and not just the U.S. economy but really the global economy. So that’s why the debate always spills over into very broad issues, and reaches into many quarters that might seem somewhat distant from monetary policy itself.
But at the end of the day we have our regular meetings, and we are making decisions on our policy rate, and on supplemental policies. When we were at the zero bound [zero nominal short-term rates], and so it all does come back home at the end even though the discussion is very wide ranging.
Siegel: I guess during Greenspan’s tenure, there was the discussion of the so-called Greenspan Put, which was if things went bad the Fed would lower rates and rescue the markets. … If the markets tanked for whatever reason, would it put the Fed on pause? Maybe it should. If tanking the markets means there is doubt about the future economy, shouldn’t it be the job of the Fed to pay attention to that?
Bullard: I’ve always felt, on this issue, that it looks like the Fed pays a lot of attention to financial markets, but that isn’t really what’s going on. The Fed is trying to look out for the U.S. economy going forward, and the stock market of course is trying to value corporations by looking at the economy going forward.
So the stock market and the Fed are both looking at the same thing, and if both of them see trouble ahead then the equity prices are going to decline and the Fed is going to lower rates, or have an easier policy than otherwise. But it’s going to be because both entities are seeing trouble ahead. So I would not describe that as a Greenspan Put; I would just describe that as good monetary policy and rational judgment in financial markets about how they see the evolution of corporate profits.
And corporate profits, one thing about that is that most of the traded companies have a lot of their profits overseas. So the profitability often depends importantly on the global macroeconomic situation. Profits have been good recently in part because the global economy doesn’t seem to have any weak spots right now. That has been the first time in quite a few years that you couldn’t point to obvious weak spots in the global economy. That has been helping equity prices this year, and that’s not exactly the same as just having the U.S. economy booming all by itself with the rest of the world maybe not doing as well.
On Low Unemployment and Stock Market Levels
Schwartz: We were talking before on the show on trends in unemployment, which have been dipping down to levels we haven’t seen. We’re getting close to 50-year lows in the unemployment rate and we still haven’t really seen budding inflation pressures, wage pressures. Jim, do you have any sense of how low the unemployment rate is going to go, and is it ever going to lead to wage growth?
Bullard: I think unemployment can trend lower here, but I don’t think that it has much of an impact on the inflation outlook. If you look at Phillips curve estimates, even by advocates of Phillips curve relationships, it appears that the statistical relationship between low unemployment and inflation is very, very small at this point — possibly even zero.
This suggests you could go to … 3.5% or even lower, and you wouldn’t actually see very much inflation — maybe a tenth or a couple of tenths or something like that. And we’re below our target anyway. So I’m not sure that this low unemployment environment is really something to worry about from an inflation perspective. I think you have to make some other kind of argument about it if you’re worried about unemployment going too low.
The other thing is that you’ve got labor force participation, which has been declining since 2000, and I was projecting that labor force participation would continue to decline, but it’s actually flattened out some in the last 18 months or more here.
Siegel: Even longer. Almost three or four years actually flattening.
Bullard: I suppose it depends on how you cut the data there. So I’ve been a little bit surprised on that, but I think we are at a low enough unemployment rate that we actually are starting to attract some people off of the sidelines. You’re getting marginal workers back into the workforce. I think that’s good development for the economy, and with low productivity growth the only way we can get enough output is to have more hours worked.
Siegel: You bring up something really important. We’ve been talking about the natural rate of interest, the long-term dots for the Fed funds projection. We don’t supply those individual dots for the natural rate of unemployment, which is of course another variable you’re asked to do every quarter. Jim, it sounds [like] you are well below what the Fed is now putting up there as the median estimate.
Bullard: We’re below the committee’s median, that’s a fair assessment. But what I am saying is that whatever you want to assume for the natural rate of unemployment, and however big you think that gap is, it still doesn’t have very much of an implication for inflation according to the latest Phillips curve estimate.
Siegel: Shouldn’t it matter at some point for wage increases? We’ll talk about whether they go into inflation, but the concept of tighter labor markets and wage increases, do you think that is the part that is broken? Or it’s coming from the wage increases into the prices that might be the questionable relationship?
Bullard: I have felt that the wage increases — if you go on an ECI [Employment Cost Index] measure — maybe 2.5% per year, have been pretty reasonable. If you think labor productivity is growing at half a percent per year, and the inflation target is 2%, then that comes to 2.5% nominal wage growth, which is about what we’ve seen.
That is all very consistent with the idea that you are at this 2% growth trend, and not too much is going to change, and there isn’t very much going on in terms of cyclical dynamics now because you’re way past the big recession, and all of the cyclical dynamics have settled down. So you are just on this trend growth path, 2% growth, and so wages are increasing the same way they would along a balanced growth path. So that all makes sense as far as I can tell.
Siegel: If productivity was down to a half of a percent, we wouldn’t get even 2% GDP, would we?
Bullard: Well you could say productivity is 1%, but the inflation rate has only averaged 1.5%. That would be another way to get to that 2.5% wage growth. But either way I think it is pretty consistent with what has actually been happening over the last several years.
Bullard: I thought with Jeremy Siegel here we would be talking about the over-valuation of equity prices.
Siegel: I don’t think it’s a bubble. The Fed has said they are high [stock prices], but not that high given the low interest rates. I can see a 20 P/E [price-to-earnings ratio] with a low interest rate structure, and you’re one of the believers that we’re in a low interest rate structure. Do you share my view?
Bullard: I’m sympathetic that we’re okay for now. But I am definitely keeping an eye on it. I think it is an important issue for the Fed in 2018.