By Megan Leonhardt
U.S. economic growth has surpassed expectations this year, even as inflation has cooled and the labor market has softened.
The outlook for 2025 is for more of the same, with an important caveat: The incoming Trump administration's fiscal policies could prove inflationary, creating headwinds for the Federal Reserve as it seeks to fulfill its dual mandate of promoting maximum employment and price stability.
John Williams, president and CEO of the Federal Reserve Bank of New York, is no stranger to navigating the intersection of fiscal and monetary policy. A 30-year veteran of the Federal Reserve System and former president of the San Francisco Fed, Williams holds the only permanent voting seat among the regional bank presidents on the Federal Open Market Committee, due to the New York Fed's responsibility for carrying out monetary policy operations.
A Stanford University--trained economist, Williams is an expert in the neutral rate of interest -- the theoretical rate that neither stimulates nor restricts economic growth. His insights will be especially valuable as the Fed moves to bring interest rates to a level that balances the U.S. economy.
Barron's spoke with Williams on Nov. 15 about his economic and inflation outlook, the Fed's goals, and the global implications of China's struggle to maintain growth. An edited version of the conversation follows.
Barron's : How does the economic landscape look to you?
John Williams: Economic growth has been very good. At the same time, we've seen a pretty steady cooling of the labor market. We're seeing inflation steadily come down from its very high levels. We're probably around 2.25% on PCE [personal consumption expenditures index] inflation over the past year -- so, a significant decline in inflation toward our 2% goal. Obviously, [we're] not quite there yet. The big story here is, how do you get strong growth, a cooling labor market, [and] inflation coming down all at the same time?
I expect gross domestic product for the year to probably be around 2.5%, or maybe a little higher. I expect the labor market to continue where it is, and maybe [show] a little further cooling. The current unemployment rate is 4.1% [in October]. Maybe it will get to 4.25%. And I expect inflation to continue to gradually come down. I'm expecting the inflation rate to be around 2.25% for the full year.
Members of the Fed's policy-setting committee publish their expectations for the economy, interest rates, and unemployment once a quarter. If you had to deliver a summary of economic projections today, what would it look like?
The disinflationary process will continue. I think the labor market is now in balance; it's not providing upward pressure on inflation. Inflation has also come down in countries around the world, and that's a good factor for restraining our input-price inflation. Wage inflation has come down quite a bit. I would expect [the decline in inflation] to continue.
I expect growth to be around 2.5% next year -- still solid. I expect the labor market to kind of move sideways, with an unemployment rate somewhere between 4% and 4.25%. So, I see more of the same.
Our goals are maximum employment and price stability. I want to see inflation coming down to 2% and staying around that level in the context of a still-solid labor market.
It sounds like there is no recession on the horizon, based on your forecast.
I see the probability of a recession -- which economists aren't good at forecasting -- as being normal. I don't see any signs [of a recession] in the data, from the labor market, spending, or any of the other indicators.
Where do you expect the federal-funds rate to be at the end of 2025?
Given my forecast, I expect it will be appropriate, over time, to bring the fed-funds rate down closer to more-normal or neutral levels. Now, I've just answered the question by posing a new question: What is normal? The honest answer is, we don't know. A lot happened in the past five years. It will reveal itself through the data flow that we see.
Based on the cooling of the labor market in the past few years and the disinflationary progress we have made, it is pretty clear that monetary policy is restrictive today. That is why it was very appropriate to cut the federal-funds rate in our past two meetings. My guess is the fed-funds rate will be lower by the end of next year than it is today. It will depend on the data and the progress we make.
Month to month, there are movements up and down in individual [data] series, but they are moving in the way that I would like to see. It's really just a question of getting policy in a position that continues that process.
How high is the risk that inflation will reaccelerate next year?
There are a lot of factors that could cause inflation to move in ways that are different than we currently expect. If there were factors that would cause inflation to sail a little higher than I currently expect, then that would guide the policy decisions. We're pretty well positioned for risks. If inflation stays higher than I expect, we can slow the pace of normalization. If inflation comes down more quickly, or the economy slows more than is consistent with maximum employment, then we have plenty of room to adjust to that.
In thinking about price stability, is 2% still a reasonable inflation target?
Yes. The way I think about it is, what is the inflation rate that can best balance achieving maximum employment and price stability? Some people might say price stability is 0% inflation. But if you really went for 0% inflation, then it would be very challenging to achieve maximum employment on a sustained basis because of the zero lower bound, or the deflation risks.
If inflation is too high, that has obvious costs. So, 2% inflation isn't too high in the sense of creating distortions or difficulties for the American people, but it does give us more room to achieve our maximum-employment and low-and-stable-inflation goals. The 2% long-run target made sense back in 2012, and it continues to make sense.
Will the Fed need to grapple with the question of central-bank independence from political concerns in President-elect Donald Trump's second term?
I can't make a prediction about what people will be debating, but it will be no surprise to you that independence in our monetary policy is important. It isn't important because I like it, or because it makes my life easier.
Based on evidence from around the world, we have seen that central banks that can make their monetary-policy decisions without political or other influence -- but just make them based on data, analysis, evidence, and [the goal of] achieving the objectives they have -- have worked better, especially at achieving low and stable inflation.
Independence is a good thing for central banks, not only here but around the world.
When you look at financial conditions and market performance, what does that tell you?
The stock market has done amazingly well in the U.S. Looking at the U.S. in the context of the global economic situation, we are the envy of the world in many ways. We're an economy that got through the pandemic and all of the challenges of the past five years. It looks like we're, in fact, stronger in many macroeconomic ways than we were before. Investors around the world and in the U.S. think this is a country to invest in. Much of this is about strong economic fundamentals. The outlook is good, and profits have been good.
When you look at the bond market, it's a similar story. The 10-year Treasury yield has risen quite a bit -- that's the benchmark I look at first. Most of the rise has been in real, or inflation-adjusted, yields, not inflation compensation. It reflects a similar set of factors: stronger growth, a more positive longer-term outlook. [The rise in yields] isn't so much a concern about inflation, but more of a relatively good-news risk. Credit spreads are narrow.
How sustainable is the recent uptick in U.S. productivity growth?
That's the hardest question of all here, because economists aren't good at predicting recessions. Economists also aren't that good at predicting trend productivity.
Before the pandemic, I would have said the potential growth rate of the economy was probably about 2%. Today, I'd probably say it is closer to 2.25% to 2.5%. I am hoping to be surprised on the upside if this continues. Artificial intelligence would be one of the factors that could be a source of longer, strong productivity. Lots of small businesses have been created in the U.S. There is a restoration of the dynamism of our economy and a lot of investment in new technologies. That's the story there.
But it could be that this is going to have a longer run. AI satisfies the requirements to be a general-purpose technology, the kind of thing that can generate a decade or more of higher productivity growth. That is a necessary condition, not a sufficient one. But it definitely has that flavor. It is something that has broad application, can change how businesses do things, how the economy is organized.
What are the biggest risks on the horizon?
Williams: Part of the story behind why the economy is doing well is on the supply side. It is on the productivity side. If that doesn't continue, it would shift the job for us as we try to keep supply and demand in balance. I'm a little bit on the optimist side of this, but you can be disappointed.
Obviously, geopolitical issues around the world are a risk. There is a lot going on in the world, and [that is] always on the list of what can disrupt the global economy.
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November 21, 2024 01:00 ET (06:00 GMT)
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