Federal Reserve Bank of San Francisco

Fed’s Williams Says Economy Is Stronger Than It Looks

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A. You look at the jobs data, the gross domestic product data, all the data on how the economy is doing, and I think those have done as well or even better than we were expecting. Obviously, the employment report showed the drop in jobs in September, but we know that was because of the hurricane. I think unemployment will be below 4 percent by this time next year and it’s remarkable — assuming we get below 4 percent — we’ve only seen that a couple of times in the last 50 years.

Q. Yet a lot of prime-age adults have not returned to the work force.

A. Labor force participation is one of those big questions. I won’t say it’s a mystery, but it’s a big question. What we’ve seen has actually been fascinating. As the labor market has improved and unemployment has come down, the labor force participation for prime-age females, 25-54, looks like it is moving back up quite a bit. But for the men, the same age group, this has been pretty flat. That’s something a lot of economists are trying to sort through. To what extent is it structural? To what extent can policies affect that?

We’re in a good place to kind of let this economy run a very strong labor market, with inflation low and no signs of inflationary pressures really picking up yet. A couple more years of roughly 4 percent unemployment and we’re going to learn a lot more about this labor force participation issue and really test this out to see if there’s more people who can come back into this labor market.

Q. Your staff has produced some interesting research suggesting that wage growth has been stronger than it seems. Tell us about that.

A. What my colleagues have highlighted is that a lot of people who are at the end of their careers are retiring, and at the same time we’re pulling in a lot of younger and less experienced workers who are being paid less because they’re new to the work force.

By the way, during the recession this worked the other way. Younger people were laid off and the more experienced workers stayed on, and that helps to explain why we saw wage growth during the recession. To the average person, this is all backward, and that’s why it’s important to look under the hood.

Q. A longstanding economic theory, known as the Phillips Curve, is that inflation increases as unemployment declines. Given unemployment is low, why haven’t we seen stronger inflation?

A. If you look until 2015 or so, the inflation data basically followed our models, emphasizing the role of weakness in the economy. Where this mystery has happened is really in the last year or two. I view both inflation picking up faster than expected in early 2017 and now the pullback as just part of the variability that’s going to happen. I don’t see any signs that somehow the inflation process is fundamentally changed.

I’ve been doing this a long time, and the Phillips curve has been declared dead far more times than Mark Twain.

People say that foreign factors matter a lot. I feel like I’ve read this book before. I’ve read it a few times. It’s a plausible hypothesis — obviously global factors are more important today than they were 25 years ago. But you have to test that on the data, and every time we’ve tested that, it generally doesn’t show a robust relationship with U.S. inflation.

Q. So onward and upward?

A. If you look at a dart board view of our objectives, where to the right and the left is unemployment relative to the normal rate, and up and down is inflation relative to 2 percent, we’re not right at the bull’s-eye but we’re about as close to that bull’s-eye as we’ve ever been. This is pretty good.

Q. Beginning in December?

A. My own view is we want to continue this gradual pace of increase. One more rate increase in December and three more next year is a pretty good starting point. I am still data dependent, but that is my baseline view.

My view is that the normal fed funds rate in the future is 2.5 percent, which is pretty low. That’s not a lot of rate increases to get to that normal level, but I do think we want to be moving gradually toward that over the next two years.

Q. Does your outlook include a boost from fiscal policy?

A. My baseline view is that there won’t be a change in fiscal policy that has a significant effect on the economic outlook — not a major tax cut or a major infrastructure package.

Q. Would a tax cut benefit the economy?

A. We don’t need fiscal stimulus in the short run — our economy is strong, we’re in a good place — but I do think it would be valuable if we could find a way to improve the supply side of the economy, labor force participation issues, productivity growth.

I think that the research on corporate tax changes of the kind we’re talking about here is that they have relatively modest positive effects on the supply side. We also know that if major tax changes create much larger deficits and debt, we know that’s going to squeeze out the availability of credit for productive investment too.

Q. You spend a lot of time talking to business leaders in the western U.S. What is their view of the state of economic policy?

A. The word uncertainty comes up far more in my conversations with business and community leaders than it does in the economic data. You look at these market-based indicators, and uncertainty measures are near all-time lows. But when you talk to businesspeople, they’re just very nervous about all of these things. As time has progressed, they’re not seeing the positives and they’re not seeing quite the things they were worried about, but they’re still just nervous about what’s going to happen. How much that’s actually affecting hiring and investment, I can’t say. We’re actually in a strong economy now. It’s not like businesses are struggling. But they do mention uncertainty a lot.

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Wendy Pettit

Wendy Pettit is a writer for NYT and writes for other publications on her spare time. She lives in Chicago with her husband and her dog Zuko.

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