New York Fed’s Williams on Yield Curve, Neutral Rate

(Bloomberg) -- John Williams left the helm of the Federal Reserve Bank of San Francisco to assume the same post at the New York Fed in June, boosting his role to vice chairman of the Federal Open Market Committee and giving him a permanent vote on monetary policy.

Williams’ elevated status at the central bank, along with his credentials as a Ph.D. economist whose work on neutral interest rates is widely respected, gives his public appearances gravitas among economists and investors. That’s why his comments Thursday at the University of Buffalo in New York attracted some attention.

Following his public remarks at the conference, Williams sat down with reporters to discuss the economy and his outlook on monetary policy. The following are excerpts from that conversation.

Inverting the Yield Curve

“In large part, the flattening of the yield curve is a natural kind of result of the fact that we’re normalizing interest rates.”

“I would expect in any tightening cycle like this to see some flattening of the yield curve. So, I don’t think that’s particularly extraordinary.”

“In thinking about the historical experience of the yield curve, we do have to be cautious about applying it to this current situation. We and other central banks around the world have taken aggressive actions to buy lots of long-term assets, which has arguably pushed down the term premium, or the yield, on 10-year Treasuries and other securities like that. So, I would argue that some of the flattening of the yield curve also reflects the fact that there’s a lot of asset purchase, or QE, policies around the world that’s pushing down long-term yields.”

“In terms of monetary policy decisions, I just think we need to make the right decision based on our analysis of where the economy is, and where it’s heading, in terms of our dual-mandate goals. If that were to require us to move interest rates up to the point where the yield curve was flat or inverted, that would not be something I would find worrisome on its own.”

“Our policy decisions, in my view, should be based on our dual-mandate goals and how to best achieve those, and I don’t see the flat yield curve or the inverted yield curve as being a deciding factor in terms of thinking about where we should go with policy.”

Laubach-Williams Neutral Rate Estimate

“Despite being one of the letters in ‘L-W’, I do not just study the one model. We have the other model -- the Holston-Laubach-Williams model -- but also, now, in the Fed there’s a cottage industry of models of r-star, which is terrific.”

“The average estimate out there has been relatively flat over the last couple years -- maybe a slight tick up.”

“If you were to ask me, based on all of these different analyses, could you get a tenth or two higher r-star than we were thinking a couple years ago? I think the evidence is somewhat -- can back that up. On the other hand, I don’t see any clear signs why I would expect that trend to change very much over the future. I don’t see any reason to think, oh, we’re on some kind of cusp of a big move.”

“These things go up and down, but there’s not an obvious kind of trend that would tell you, hey, something’s happening that’s suggesting this thing is going to get back up to one -- or higher than one -- percent.”

Laubach-Williams Output Gap Estimate

“Again, averaging over different views, I think the output gap is probably lower than what that shows. The model -- I’m going to speak about the model as if it were a person -- but the model is interpreting the rise in inflation over the last couple years, more generally the fact that the economy is growing, I guess slightly above its long-run trend, as a sign that the output gap is positive.”

“It’s just telling you that the economy is running well above potential, from that perspective.”

Does Chairman Jerome Powell Care About These Models?

“I’m not going to speak for the chairman, but I think that this analysis about where the endpoint is, and our best understanding of it, is, again, part of the analysis that we do. I think that it’s important to say I, first of all, don’t trust any specific estimate. I said that I look at a broad set. And the second question which you get is, how much should monetary policy be guided by the stars? And that’s kind of a separate issue.”

“I think this is more, hey, let’s look at a bunch of different models, different analyses, and get a snapshot of where the economy is, which I think is useful, even if it doesn’t drive monetary policy decisions tactically.”

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