Here is the newly formatted transcript of Federal Reserve Chair Kevin Warsh's address delivered Friday at the Jackson Hole Economic Symposium in Wyoming. The prepared remarks were titled 'Financial Innovation: Implications for Payments and Policy'.
I want to extend my thanks to everyone. It is a genuine pleasure to be back in this setting, surrounded by so many familiar faces. I have been eagerly anticipating this weekend, and I can think of no better venue to commemorate my 100th day in this role. For the exceptional hospitality, we all owe a debt of gratitude to Kansas City Fed President Jeff Schmid and his entire team. Jeff, we thank you all. Jeff and the other organizers have arranged some leisure activities for later today. My advice would be to choose your options with great care. As I discovered years ago, there are two distinctly different types of hikes available on the trails around Jackson Hole. To sum up my experience hiking with former Vice Chair Don Kohn in a few words: I survived. Those grueling, marathon-like death marches revealed a side of Don I had not previously seen. There is another type of hike, which I associate with my old colleague, former Chair Ben Bernanke. With Ben, the pace was far more leisurely, a pleasant stroll along the winding paths of the Rockefeller Preserve. So, before you set out, assess your physical condition and ask yourself, 'Is today a Kohn day, or a Bernanke day?'
The greatest value of this gathering is its ability to help all of us clear our thoughts and think soberly about the world and the times we inhabit. For me, this seems like the appropriate place to engage seriously with the most important ideas, and you are the right audience. Innovation is the theme of this conference, and I believe the public and the markets, through their collective wisdom, can understand that the Federal Reserve's innovations in how it executes policy will aid in achieving price stability alongside maximum employment.
Let me provide a brief overview of my remarks this morning. You could call it an outline, or perhaps a trail map, just as long as you don't call it forward guidance. First, I will discuss some of the longer-term questions the Federal Reserve is considering, concerning the latest general-purpose technology, artificial intelligence, and where it might take the economy. Then, I will offer some reflections on the practice of forward guidance and the interaction between central banks and financial markets. Following that, I will put forward some key principles that I believe should guide the conduct of monetary policy. Finally, I will give my assessment of the economy.
Preparing for Future Policy Junctures
Against the backdrop of the ever-present Teton mountain scenery, we have come here to examine an economic landscape that is by no means static. Not so long ago, in the lead-up to the 2008 crisis and the decade that followed, economists and policymakers were discussing secular stagnation and a global savings glut. A widely held view at the time was that excess capital would remain on the sidelines for a long time because there simply wouldn't be enough attractive investment opportunities. All the good ideas had already been invented. Consequently, growth would be sluggish and slow. Well, times have certainly changed. We now stand at a turning point in history.
To take the most obvious example, the latest technology known as AI, a name with an 80-year history, is advancing at a pace that has exceeded even the predictions of its proponents from just a few years ago. The potential for significantly higher growth is rising. Expanding pools of capital are flowing into various AI-related infrastructure. A kind of super Moore's Law appears to be unfolding. Scaling laws are also altering the methods and speed of innovation. Capital and labor are combining to create the large language models at the heart of AI. Users purchase tokens to gain access to these models. Reports indicate that the annualized sales of tokens for just two leading labs have already surpassed $100 billion, a growth of over 500% compared to a year ago.
The Federal Reserve is closely monitoring all of this. We recognize that AI represents a new variable, and perhaps a new factor of production, with implications for both the economy and the execution of monetary policy. This raises important research questions: Will the application of AI lead to a significant and sustained increase in productivity across the entire economy? If so, when might that occur? Are token usage and labor complementary or competitive? Will the next generation of AI models require even higher capital intensity, or will the models themselves help design capital-light solutions? Other unresolved questions concern the resulting market structure. The ultimate destination and timeline for returns on capital are not currently clear. In the early stages, how much surplus value will accrue to the owners of scarce assets, namely AI labs, chip manufacturers, energy producers, and cloud service providers? Over time, how much of that value will belong to businesses and consumers? What will be the broad impact on workers, and on the employment side of the Fed's mandate? Similarly, we do not currently know the equilibrium price for tokens. Will tokens become differentiated to the point where people are willing to pay more and more for access to the best frontier models? Will the prices of older model tokens fall to marginal cost levels?
We will be thinking through these issues with the help of our Productivity and Employment Working Group. My initial conversations with the heads of this and the other four working groups have been encouraging. However, let me be clear: their recommendations will come later and will not be relevant to the decisions we make at the current policy juncture. But I am confident that for future policy challenges, the intellectual investment we are making today will leave us far better prepared.
Forward Guidance and Its Alternatives
While our working groups do their job, I have not been waiting idly; I have begun innovating at the Federal Reserve to make us capable of fulfilling our mission. For example, I have started to change the form and function of what the Fed Chair calls forward guidance. As you may know, I have long felt uncomfortable announcing future policy decisions in advance. I prefer to go the other way and explain my reasoning. Transparency in communicating future policy decisions is not a virtue in and of itself. Communication must serve the Fed's most important responsibility: getting monetary policy right. During the global financial crisis, my colleagues and I made forward guidance a standard practice. It was vital at the time, and we introduced it with great fanfare.
However, like other legacies of that crisis, I believe this practice has now outlived its usefulness. In normal times, the role of forward guidance should be limited and its scope confined. Otherwise, it can create ambiguity in the name of clarity. Over-sharing policy discussions and making excessive commitments about future decisions can steer markets, businesses, and households in the wrong direction. And I believe that when policymakers make quasi-commitments through the interest rate path across the cycle, we restrict our own freedom to make the right choices when it truly matters. To get policy right, we also need to handle the relationship between financial markets and the central bank correctly. The Fed needs market signals that are as unfiltered and clear as possible, covering levels and changes in asset prices across all corners of the market, the price and volume of Treasury securities, the foreign exchange value of the dollar, the cost and availability of credit, and a broad range of commodity prices. These and other indicators should provide the Fed with its near-term outlook for economic activity and inflation throughout the business cycle. They should also reveal the broader financial environment, as well as risks and uncertainties in the financial cycle.
At the same time, market participants themselves should track real information throughout the economy. They should draw their own conclusions, form their own expectations for output, employment, and inflation, and remain highly attuned to risk. The Fed should be humble and never naive. The Fed plays a vital role in the economy and markets. Our tools are very powerful. We determine the path of short-term interest rates. Market participants will always want to anticipate our next move. However, we should not foster a mechanism where market participants primarily focus on the Fed to decide their next trade. The economics literature has long described this distortion: the 'Hall of Mirrors' problem. If markets rely heavily on Fed guidance, and the Fed relies on market prices, then we all are more likely to miss new developments, be caught off guard when conditions shift, and make mistakes in policymaking. Ironically, market participants are less likely to bear the brunt of the costs from the 'Hall of Mirrors' problem. The most severe damage may fall on those without financial assets. If the Fed misjudges inflation and the economy, who gets hurt the most? Not the titans of finance. It is hardworking Americans who ultimately face higher inflation or reduced job security.
So, if forward guidance is not suitable for normal times, should the new Fed Chair at least commit to giving a clear reaction function? Of course, he should tell us what his rate path would be if data, for example, came in hot or cold. I wish our understanding of the economy were precise enough to provide a mechanical, tried-and-true answer, a simple rule we could rely on rigorously, like the Taylor rule. But our knowledge is not at that level, at least not yet. Furthermore, what matters most for the correct conduct of monetary policy changes over time. Providing forecasts to illustrate the Fed's reaction function works better in theory than in practice, better in the lab than in reality. For instance, I am not alone in noting that forward guidance in 2021 likely slowed the policy response to high inflation. During my tenure, my colleagues and I will strive to build more reliable models and stronger rules to guide policy decisions. We will also remain soberly aware that the accuracy of economic forecasts is currently still an aspiration. Given how rapidly geopolitical, global supply chain, and technological changes are occurring, humility about what we can and cannot know is wise. In that same spirit, we should listen to a diverse range of views on the questions that may inform Fed policy decisions. If the goal is optimal decisions, we should not exclude different perspectives on the economy.
So, how should we chart a better policy path? In the remainder of my remarks, I will share some key principles that guide my thinking on the proper conduct of monetary policy, followed by the economic assessment I promised earlier.
Core Principles
Now, let me discuss the principles. First, I have noticed that in this business, yesterday's news can be mistaken for what is currently happening. The challenge is to discern the difference. In other words, we must examine reality and ensure we are not making forward-looking policy based on stale or inaccurate data. We also should not rely on isolated data points; trends matter most. The Fed is a decision-making body. We make choices under uncertainty, and the data we rely on must be as relevant, timely, accurate, and actionable as possible.
Second, the Fed's actions are designed to keep the economy's aggregate demand broadly in line with aggregate supply. However, we can only directly observe activity. What is happening on the supply side is something we can never see directly; we can only infer it. Therefore, our assessment of the current and expected balance between aggregate supply and demand is not precise.
Third, there should be no misunderstanding: the Fed's 2% price stability target, as measured by the personal consumption expenditures price index, is an unwavering goal. We must be equally clear on another aspect: price stability will not happen automatically, and inflation will not necessarily revert to its mean. Achieving price stability is the Fed's responsibility.
Fourth, the Fed also has the responsibility of achieving maximum employment. Achieving both aspects of our mandate over the medium term is not an either/or choice. I do not see the Fed's dual mandate as being in conflict. After all, high inflation itself severely damages economic prosperity.
Fifth, the short-term interest rate is the primary tool for achieving the dual mandate. Unconventional policies used to stimulate economic activity may be appropriate in a genuine crisis, but beyond that, their use should be cautious.
Sixth, money matters. This view is not popular these days, but my perspective is that money has an important relationship with monetary policy. We should pay attention to the money created by the central bank, and also to money originating from the banking and financial system. It is true that financial innovation and other factors have changed the mechanisms linking the monetary base, the velocity of money, and the broader economy. But this is hardly a reason to ignore the ultimate impact of money on financial conditions and prices.
Finally, a quieter, more purposeful Fed in its communications can better achieve its goals. And whether we have fulfilled our duties can be tested; it is the only true test of our credibility. To borrow the words of General Chuck Yeager: 'When the truth arrives, there is either a reason or a result.'
The Current Economy
Now, based on these principles, how do I view today's economy? What is actually happening outside the window? You may have read in the July meeting minutes the Federal Open Market Committee's unanimous view: the labor market is stable and output is solid. However, inflation remains too high. I, along with a significant majority of my colleagues, believe the wiser course is to wait for new information between meetings, especially given potential developments in supply chains, investment flows, and geopolitics, before deciding whether an adjustment to interest rate policy is appropriate. We have also collectively indicated we are prepared to act as conditions warrant.
On a personal level, the economy appears to me to be strengthening, and I am impressed by its overall performance. One measure of economic strength is its resilience to shocks. From that perspective, both the real economy and Wall Street have shown remarkable fortitude. A few observations: Business capital expenditure, the seeds of future economic growth, is rising rapidly. The four-quarter change in equipment and intangible investment has been running at around 9%, the fastest pace since 2021. More than half of this year's capital expenditure growth is likely attributable to AI-related construction. For companies in the S&P 500, profit growth over the past year has exceeded 20%. Profit margins are at quite high levels compared to historical standards. Overall equity market volatility is at a relatively low level.
We continue to monitor market internals closely and observe performance across various sectors. Expectations for capital expenditure and corporate earnings growth are at fairly high levels. I will keep watching their rates of change, which are essentially second derivatives. The subsequent effects on asset prices, business confidence, consumer income, and spending are also highly important and need to be assessed. Credit spreads on corporate bonds and leveraged loans are near the low end of their historical ranges, and issuance volumes in these markets have been quite strong this year. Shifting focus from the fixed income market to banking, in the July Senior Loan Officer Opinion Survey on Bank Lending Practices, banks told us that standards for commercial and industrial loans are on the looser end of their historical range. This helps explain the growth in this type of lending we have seen this year. There is little sign in credit and lending markets of policy being restrictive.
Specific sectors, such as housing and agriculture, are showing signs of strain. But overall, I find it difficult to characterize broad financial conditions as restrictive. Despite various shocks, real consumer spending has remained healthy, growing by more than 2% over the past four quarters. Combining consumption with the robust investment we are observing, private domestic final purchases (PDFP) are also on the rise. So far this year, PDFP growth is close to 3%. This metric often carries more signal than GDP, and the trend here is also positive.
On the employment side of the Fed's dual mandate, our country is performing well. The labor market is fairly stable. The unemployment rate is 4.1%, which remains low by historical standards and has changed little over the past few years. The four-week average of initial jobless claims, which is an empirically robust real-time indicator, is also near multi-decade lows. In my view, the relatively low turnover rate in the current labor market is partly a result of the large-scale re-matching between employers and employees in the post-pandemic period. When labor supply is barely growing, it is natural for monthly job creation to be at a low level. There will always be some concerning areas in the labor market, such as new graduates.
However, overall, people who want jobs are essentially keeping or finding them. They may be worried about potential future disruptions, but as of now, I believe the labor market is consistent with maximum employment. But on the price stability side of our mandate, the numbers are more concerning. The Fed's preferred inflation gauge, the 12-month change in the PCE price index, is currently at 3.7%, while the six-month change is 4.1%. Comparable measures for the consumer price index are also elevated, as are core measures of both PCE and CPI inflation. None of these indicators is perfect, but they tell a similar story: inflation is above our 2% target.
Therefore, the Fed's current priority should be price. The task for policymakers is to capture the underlying inflation trend, which is the broad movement of prices in the economy, abstracting from special factors. We want to judge whether underlying inflation is rising, falling, or stuck. We want to know not only the direction of the change but also its speed. All these broad inflation indicators have come down significantly from their 2022 peaks. But progress over the past two years has been modest. Moreover, although the PCE and CPI data this summer were better than expected, they do not lead me to believe the underlying trend has improved meaningfully.
Data also point to modest wage growth. However, for a long time now, wage growth has not proven to be a reliable indicator for predicting future inflation when tracking the underlying trend. In an effort to measure underlying inflation, I find it instructive to break down the 199 individual components of the PCE price index. Over the past 12 months, 54% of goods and services in the PCE basket have risen by more than 3%. This is far below the post-pandemic peak of around 77%, but it is still well above the 32% average in the 20 years before the pandemic. If we look only at the last six months, the conclusion is similar: 49% of the goods and services in the PCE basket have annualized price increases above 3%. Again, this is well below the post-pandemic peak, but it remains at a fairly high level.
The recent rise in overall commodity prices is also worth watching. We need to judge whether these trends signal upside risks to inflation. Equally important is whether the inflation data of the past five-plus years have seeped into inflation expectations. The good news is that, overall, medium-term inflation expectation indicators appear stable. Inflation compensation indicators from the swaps market also send a strong and similar message. Especially given recent developments, the market pricing reflects confidence that we will achieve price stability. This is a testament to the institution of the Federal Reserve and is in its finest tradition. And I can reassure you that they are right. A feature of market-based inflation expectations in economic history is that they often appear strong and durable until, suddenly, they are not. These expectations are not easily shaken, and they remain firmly anchored at present. But they must be monitored closely. The Fed's job is to ensure that inflation expectations do not become unanchored.
There is a signal no one can ignore: 65 consecutive months of high inflation, with full responsibility resting on the central bank. That is as it should be. My standard is this: we must be confident that underlying inflation is moving decisively and fast enough towards our target. Otherwise, we have work to do. That is our duty, our mission, and the responsibility we must bear.
Conclusion
Standing here today, I am committing to a discipline, not to a specific decision. In this critical period, my colleagues at the Fed and I are by no means the first to hold these positions. We are determined to cherish the time we have and do our jobs to the best of our ability. We will take our responsibilities seriously with humility and resolve. Much depends on the choices we make. Sound monetary policy allows households and businesses to prosper. If executed effectively, it will broaden and deepen the momentum of our economic development, and help ensure America's leadership in the world. And I know that our country needs us to think carefully and act wisely. It is a tremendous honor to serve at the Federal Reserve once again. I am deeply grateful for the encouragement and valuable advice I have received from my colleagues, and from so many of you here today. For that, and for your patience this morning, thank you.
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