Mary Daly on Fed Policy, the Economic Impacts of AI, and the Future of the Fed’s Framework

As the Fed closes in on its next framework review period, properly balancing inflation risks with labor market stability remains the core mission of the central bank moving forward.

Mary Daly is the president and CEO of the Federal Reserve Bank of San Francisco, a voting member of the Federal Open Market Committee (FOMC), and is also a 28-year veteran of the Federal Reserve System. President Daly joins David for this special live episode of Macro Musings to talk about her non-linear career path to the world of monetary policy, the long-term economic impacts of AI, the future outlook for Fed policy and the Fed’s framework, and much more.

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Thank you to everyone for coming out to this live recording. We have a very special guest, President Mary Daly, with us. Not only is she the President and CEO of the San Francisco Fed, she is a voting member of the FOMC, and that's why all of these fine folks are here with us today. She also is a 28-year veteran of the Federal Reserve System, so she brings a wealth of experience, knowledge, and insights to some of the questions we want to talk about today, so, thank you for joining us.

Mary Daly: Oh, it's my pleasure, and it's nice to be live.

Beckworth: It's great to have you here, and I'm excited to get into discussing monetary policy, Fed policy with you. Before we do that, though, you have an amazing journey, your story, you've overcome a lot. I'll just throw out a few quick facts. You dropped out of high school, you worked retail, paycheck-to-paycheck. You went back and got your GED, got a PhD, and here you are, a Fed President. That's quite a story, and there's a lot to learn from that, lessons you could probably share with us. So, you've seen it on that side, and you've also seen it from the side of a president hiring people. A lot of grad students, young people here, people who listen, who are thinking about a career in economics, what would you share with them based on that experience?

Mary Daly’s Background

Daly: I have had a very different path, but I reject the idea that it was crooked. Maybe it was exactly the way it was supposed to be, I think, and I think that's a really important message, and that's why I say it. Because so many people, young people— all kinds of people, but especially young people— think that they need a linear path, and that is the right path, and any movement off of a linear path is a mistake, a failure, a stop-and-go, and that's completely wrong.

Daly: If you ask most CEOs in the nation, they will tell you some version of a crooked path story, that they got into something, they moved over there, and it reminds us all that the thing we think we want to do when we graduate from school— and we might even get a job in that environment— may not be the exact thing that we end up doing and we find our passions and our talents meet. You have to have the passion for something and the talent, and that has to marry, and then you want to take it in alignment with your values, and if you put all of those three things together, well, then it's almost impossible to think you'll hit the ground running with your first experience.

Daly: So, as David said, my first jobs were in retail. I drove a donut truck. I really did, I drove the all-night donut truck delivering flour and things. I worked at Target, and I worked at a deli called Ruma's Deli. I used to go by a billboard while I was driving the donut truck, and it said, "Be a bus driver,” because if you're a bus driver, you're in a union and you get benefits. It's also one job. I thought, "Well, if I could drive a donut truck, I could surely drive a bus." It's harder than you think, actually, but the thing that is true is that, then, I had a meeting with who turned out to be my mentor.

Daly: She was in her early 30s at the time, Betsy. She says, "You know, you can't get a bus driver job unless you get a GED." And so, I got a GED, and that was just serendipity, right? I get the GED to be a bus driver, but the GED then opens up an opportunity to get a semester in college, which I had never heard of, really. I'm sure there were people around me who had been to college, your teachers and things, [but] I didn't know that. The only person I ever knew that had really gone to college took a community college degree in court reporting, and I remember that she had to sit in front of this tiny little machine and practice endlessly on that thing, and I said, "No way, I'm not going to college."

Daly: Then, ultimately, my mind opens. I end up at a four-year degree, and I end up here today. And so, what my journey— the main message of my journey that I will impart to all of you in the room is that you don't get where you are despite things. You get where you are because of things, so treat each of the little things you do, even if they seem sideways or backwards to others, as an integral part of who you're going to become, how you will lead, how you will contribute. That's the narrative. You're in control of your own narrative, and I think it's really important for me to impart that to you. You won't always know it at the time. There's a lot of external pressure that sometimes comes your way, but, ultimately, owning that narrative and realizing you get there because of what you do, not despite it, is the important thing to remember.

Beckworth: Great advice, and I will note that I got the chance to speak with President Daly before this for a few minutes, and learned that she does many other things outside of economics. She's an artist, a metal artist. What was the other [form of] artist?

Daly: I paint, I weld, make welded sculptures. And here's an important fact about that. It is a hobby. I do love it, but I have no formal training. I did take welding classes. I would go, because you have to use the big welding things, and that's dangerous if you don't know how you do it, but I taught myself how to paint. And one of the things that I have learned is that in your professional life, you obviously want to devote a lot of time to getting the skills that you need to make the contributions. In your personal life, don't let perfect be the enemy of the good or the fun. Do what you like. Nobody cares. You're not going to make a living out of it usually, so just enjoy it. It doesn't matter if you're good at it.

Beckworth: And President Daly has agreed to come back on at a later date to talk about her hobbies, a special bonus episode of Macro Musings, so stay tuned, and we will get back to you on that.

Daly: You'll find out how I got to these hobbies.

Beckworth: Yes. It’s a great story, but let's go to monetary policy and the economy. So, something that's happened, as we all know, is that inflation was really high, but it's come down dramatically since 2022, although, recently, it's been a lot more sticky, a little more stubborn.

Daly: Stubborn. I like stubborn.

Beckworth: And you are a voting member of the FOMC. You're thinking about this. How has this past year changed— these past few months changed your outlook on monetary policy, the expectation of rate cuts going forward?

Recent Inflationary Trends and the Future for Fed Policy

Daly: Sure. So, I think it's really important, answering this question about three months of data, to just back up and roll back to last year. First of last year, inflation was still printing high. There was a considerable amount of concern, that I had and other committee members had, that we were really going to have to raise the interest rate even higher than it is now to try to get a hold of this. That didn't materialize, of course, because inflation came down rapidly at the second half of last year, and that gives people a lot of optimism. But, myself, I didn't read as much as others— not other committee members, markets would be an example.

Daly: I just smoothed through that, got to stay steady in the boat. So, inflation's going to be a bumpy ride. It's going to come down rapidly sometimes, maybe get stubborn in three months. And before we can jump to the conclusion that— if we had jumped to the conclusion last year that we were on a downward trajectory and everything was golden— I think you've probably heard all of us, but me, I said it repeatedly, [that] we can't declare victory. It's far too early to declare victory. And the three months that we've just seen is why you don't declare victory before you get confidence.

Daly: So, at the beginning of this year, the confidence bands— think of the confidence bands that you have. You have confidence bands around projections. Well, the confidence bands coming out of last year and as we [started this] year, they looked like they were tightening up, getting more confidence that inflation's coming down. And what the last three months of data have done is widened those confidence bands back out. So, there's considerable, now, uncertainty about what the next few months of inflation will be and what we should do in response. The important thing that I go back to is that the reaction to uncertainty, to me, isn't to make more projections with definitiveness.

Daly: I just say that the confidence bands have widened, and we are now prepared, I am prepared, to think through the scenario. So, a scenario that would be a very nice scenario is that inflation got a little bit of a slow start, but it continues to come down, because the labor market is starting to slow, the economy's slowing. We see a continuation of what we saw during the second half of last year. If that happens, then, of course, starting to normalize the policy rate would be appropriate.

Daly: But if we get a different scenario where inflation stays level, just doesn't make much further progress, then it's not appropriate to start adjusting the rate unless we see the labor market faltering, which it's not showing any signs of doing. So, that's a scenario. There's a range of scenarios under which you would do different policy actions, and I think the best way I can talk to people is to go through those scenarios and really reveal the reaction function, as opposed to trying to get a probability statistic on something where, really, what's happened is that the uncertainty bands have widened.

Beckworth: It sounds very data-dependent.

Daly: It is data-dependent, and it's interesting, there's not a clear narrative of what data-dependence means. Let me be as clear as I possibly can be: it is not a backward-looking variable. Yes, the information that's coming in, that comes in and everybody looks at it, is an input to the process, but that input isn't definitive, because things can happen. So, that's one leg of the stool, because if you take the data and you put it into our models and theories and things, you can project out, but there's other legs to that stool, which is what's happening in real time, week-to-week.

Daly: What do you see going on in terms of price increases that people are making, and what are our contacts telling us? Reserve bank presidents, in particular, spend a lot of time out in what we would call the field, talking to businesses— small, medium, and large businesses, unions, different kinds of worker groups, communities, and we're asking firms, in particular, are you raising prices? Do you think you're going to pass through? Do you think about, is this a slowing inflation? What are your input prices? What are your forward contracts looking like? That gives us that data-dependence that we see.

Daly: And so far, that's why I say there's just a lot of uncertainty, because we're getting some different signals. Firms are saying, "I don't think I'm going to be able to pass this much through. Consumers are getting more choosey about looking for bargains, but my input prices aren't going down quite yet, so I'm in wait-and-see mode." That, coupled with the stubbornness of the last three months of data, means that the uncertainty bands are wider.

Beckworth: So, you have the largest district in the Federal Reserve System. So, I can just imagine all of the trips you have to make through that district to get this data.

Daly: I'm a well-traveled citizen. It's true.

Beckworth: Going to the other part of monetary policy that we think of, and that's the balance sheet, and there was a big announcement, big change, at least a reduction in how quickly you will reduce the balance sheet, roll it over. What are your thoughts on that? Does that signal anything about the stance of monetary policy?

Daly: No. Hard no. No signal about the stance of monetary policy. It's truly something we had already set out in our principles and in our talks and discussions over a year ago about how we would do a balance sheet runoff. So, the idea is always to get back to a level that is ample reserves. That's the regime that we're running to conduct monetary policy. But if you roll back to September of 2019, you recall— if you were there, paying attention at that point in time— that we were running the balance sheet down, and then we ran into, in balance sheet lingo, the kink of the reserve demand-supply. We ran into that, and that caused market volatility. You want to avoid that.

Daly: Our goal isn't to create market volatility that has literally nothing to do with the stance of policy. We always have forecast and communicated that we would decrease the pace of the runoff as we got nearer to ample [reserves], and we would do it well in advance of being at that place, so that we could make sure that we don't run into that place again. But the benefit of doing it this way is that you then don't have to stop short of getting to ample [reserves]. The goal is always to get to that level that's ample, but if we found ourselves in a disruption, we might have to stop short of getting to that what is really, truly ample. So, this is a way to get a smooth landing on that, and it has nothing to do with the stance of monetary policy.

Daly: So, the stance of monetary policy is all about the funds rate and any forward guidance we have given and the forward guidance right now, as you know, which I think is very frustrating for many people. I don't think people in the economy as much as-- I'm sorry, I'm looking over at the media corps. The media corps wants to know exactly what we're doing in our markets, but, essentially, it is true that a projection— a strong forward guidance, at this point, other than, "Here's what we do under these scenarios," isn't actually going to lead to better outcomes, because we don't know how the economy is going to evolve. We only know how we would react to the evolution of the economy.

Beckworth: So, the Fed has a dual mandate. We've been talking a lot about the inflation side, but there's also the employment side. So, you feel pretty good about that, the risk there. Any chance that you keep rates too high for too long and you're going to jeopardize that side, or do you feel that it's a good balance between the two?

Daly: As you might imagine, as a labor economist by training and just a policymaker who holds both sides of that dual mandate at the top of my mind, [I’m] laser-focused on the employment part, because the risks have come into better balance. When inflation's printing at the high sixes and sevens and the labor market's going strong, well, then we obviously need to turn our attention to the inflation side, [since] it's so far away from our goals. But as inflation's come down and the labor market is slowed, then both of the risks are more balanced, and we have to keep our eye on both sides of the mandate.

Daly: Now, right now, I don't see any evidence that the labor market is approaching a worrisome position, but we did see initial claims rise today. We saw the labor market report come in weaker than expectations, still strong relative to what people think is the steady state level of job growth. There is evidence already out there that firms are a little more picky about hiring, and many firms— especially in tech, for instance, which is dominant in the west— they're rebalancing their portfolios of employees. And so that's something we have to watch. But, today, no, I see a really healthy labor market where people who want a job can get one. What I see is that we still have inflation too high, and that's creating some uncertainty for people about, are we really going to bring it down? And the main message there is, absolutely, over time, down to 2% is our goal. We're resolute to keep it.

Beckworth: Alright, 2% it is. What about R-star? I want to come to this--

Daly: Oh, I love R-star.

Beckworth: So, R-star is the natural or equilibrium interest rate, the one that would clear the economy on a sustainable path. There's a lot of discussion about where it is going. Put aside the near term, but long-term, are we at a place that's different than, say, pre-2020, when R-star was viewed as really low? There's a couple of things you could look at, demographics. That seems to be very similar to what it was before.

Beckworth: If anything, maybe even worse, because the aging planet's still with us, which would— I know you can take two views on this, but [it could] push down R-star. Also, some people worry about fiscal deficits, pushing up R-star. I know that's beyond your policy purview, but you have to at least respond to it when you see it happening. Another area would be AI or productivity, and I will tie it to AI. I want to spend more time on AI later in our conversation. But AI, in theory, could be raising productivity, pushing up R-star. So, where do you see us going over the mid to long-term horizon with R-star?

The Trajectory of R-Star Over the Medium to Long-Run

Daly: Sure, and it's a terrific question, and one that, really— I was just talking to a group of economists at Stanford at an event we were doing, and I said that academics would really help if we could all just pitch in and study some of the fundamental things we're grappling with. One of them is, what's happening with R-star? The truth is, we don't know. You name the things that could affect it, but we don't really have a good sense of where those things are heading. For my own views, I've put in— If you came in pre-pandemic, just thinking about the consensus estimates, 0.5 for the real R-star, for R-star, the real neutral interest rate, was about right.

Daly: And so, that put the nominal neutral [rate] at 2.5— 2% inflation, 0.5 R-star. That is, in all likelihood, gone up a little bit. And so, then you ask, "Well, by how much?" and “What's a good assessment?” So, I’ve really got a band for myself of between 0.5 and 1. Then, if you think about where we are with policy, and you use that one instead of the 0.5, you say, "Okay, I'm just going to be thinking it went up," for all the reasons you named. Well, you still have restrictive policy, and if you look at a diagram of a time series, the only time we've had more restrictive policy is really in the Volcker disinflation.

Daly: Otherwise, we have restrictive policy, which is what we want to have at this point. So, I think the R-star conversation is important, and all of the factors you named will influence it, but I don't feel the press to know exactly what it is today, because we don't have the research yet to really think about that. And what's important for monetary policy today is, are we restrictive? And, clearly, even under that higher estimate of R-star, we are restrictive, but it might take more time to just bring inflation down. So, when I think about the factors affecting it, I think you're right. It's demographics, it's fiscal positions of--

Daly: Because R-star, we talk about it locally, as in domestically, but it's really a global variable, because financial markets are global, and so you have to look at what other countries are facing as well. And other countries are facing the same demographics, some idea that productivity growth might be stronger, for the reasons you mentioned, and a lot of deficits, and now debt, from the pandemic, and trying to get right-sized after that, and all of those things have to play out. And it just really depends on how they evolve, particularly productivity and fiscal.

Beckworth: Well, I was hopeful that productivity would continue to go up. There's been a surge. One of your economists, Andrew Foerster--?

Daly: Foerster, yes.

Beckworth: Andrew Foerster, he had a little post that he has this probability model.

Daly: He does have a probability model.

Beckworth: He's like, "It's not happening, folks. Don't get too excited about it." But I want to believe. I want to believe that productivity is going to go up, that AI is making a difference. And we just had a conversation with my boss, Tyler Cowen, in here the other day, and AI is very interesting because, on one hand, you could see it improving productivity, pushing up R-star, and it'd be a great world to live in.

Beckworth: On the other hand, AI— and this is something Tyler mentioned— could cause us to live longer, too. It could help find cures to diseases, live to 100 years old. That would increase this issue of demographics, having to save more for a longer life. So, you could see AI, depending on the magnitudes, going both ways. But I want to segue into a broader discussion of AI, because you have talked about this a lot. You're from Silicon Valley, San Francisco. What are your thoughts on AI and its long-term impact on the economy, on labor markets?

The Long-Term Economic Impacts of AI

Daly: Let me think about it. There's a lot in there, so I'm trying to think about all of those aspects of it. But let me think first, step back, and say that the bottom line on AI and what its impact will be on the economy, the labor market, is that it’s going to be up to us. The most important thing to know about technologies is that technologies don't make decisions. People make decisions, societies make decisions. So, if we get to 10 years from now and say, "This didn't work out like we want," then we can't blame technology. We have to think about where we could have done something different.

Daly: So, I think, one of the things I see that is very encouraging is that you're already seeing conversations at firms, but, importantly, among workers. Whether they're in a union or not, they're thinking about, what's the impact of this on the labor force and maybe the healthcare system? How do we get better? But, also, how do we utilize the folks we have and the people who should be integrated into the economy? So, stepping back from that, then, what are my ideas? Well, I came up to the Fed— you mentioned I'm a 28-year veteran. Okay, so I started at the Fed in 1996. I'm a rookie economist, I got my PhD, went to a postdoc, came to the Fed.

Daly: So, I'm at the Fed, and my early interactions are with Chairman Greenspan's staff calling me saying— Because, look, I'm in charge of going to Silicon Valley, looking in Seattle, and seeing what's going on, and are people investing in this, and what's happening. It's the famous Bob Solow quote of, you see productivity everywhere except in the productivity statistics. That was really true in the late '90s. You weren't measuring it yet. We started to measure it after the real-time data came out, but you could see it everywhere. And I remember, so clearly, two things that made me completely understand that this was going to be transformative in terms of the productivity.

Daly: One was, I went to Salt Lake City, and they were installing meters on the houses that could be read from the truck so that they didn't get bitten by dogs and they couldn't read them and then people have bills they didn't want. And so, they had just invested in this, and so we went and asked them, "Why did you invest now?" Here's the three things they told us. The technology is available. The labor market is tight, and so it's really hard to get meter readers. And this seems like it's going to be transformative and live for decades. And so, I thought, okay, those three ingredients that Salt Lake City did— and then, also, you go somewhere, [and] this luggage company was doing the same thing.

Daly: They used to hand inspect all of the suitcases, and they built a machine that can inspect the quality of the suitcases so they would know if it's going to break. That was all done by computers, and they had one person sitting in the back figuring out all of this and sorting them. Those things about business processes, the investments in the technology, but also the tight labor market was the forcing function to get businesses moving on this, because computers have been around for a long time. I see similar elements today. So, we do these roundtables, we talk to businesses. All kinds of businesses— small, medium, and large, manufacturing, retail— are already using AI.

Daly: Whether they're taking an off-the-shelf product or having something built for themselves depending on their size, they're using it. But they're using it because they're facing really a long period of tight labor markets, and they wanted technologies that make the work more interesting and more sustainable for people. Take the-- What do they call it? The soul-sucking work. They wanted to remove the soul-sucking work and leave people with better work. But they're already in conversations with their workers about, "What is this going to look like in terms of new jobs added and things?" Because there is this existential threat that workers feel about, "Is this going to take my job?"

Daly: So, I am more optimistic than Andrew Foerster, my colleague, but what he's doing is to say, he's reminding us of a simple thing that we should not-- Hope can't be enough to get us past his model. His model and countless other models like his would really say the following: It's really hard to move from an average level of productivity, or what he calls the low productivity state— which is 1.5% for the US— to something more like what we saw in the late '90s and early 2000s. Those are just not that frequent, these big jumps. So, we can't bet— As a policymaker, I can't bet on productivity growth saving us from inflation, but I am absolutely there watching. If we see the signs that we're observing in small areas start to scale up and it shows through to the productivity statistics, let me just say that I wouldn't be surprised. So, don't count on it, but look for it.

Beckworth: So, we are very AI-bullish here at Mercatus, so we talk a lot about it. We have a program. We have some scholars here who work on it.

Daly: You should come to the West Coast.

Beckworth: Well, I know that Tyler, our colleague and then boss, does take a lot of trips out there to Silicon Valley. We even have used it in the Monetary Policy Program, believe it or not. I believe that one of your colleagues used it to prepare for this trip out here. We have something called the Macro Musebot, so check it out, listeners, if you haven't already. But we have fed in 400 plus episodes that we've done. It's built on an existing brand, I think, Claude 3. So, you can ask it anything about the show, about people, ideas, things we've talked about. And it hit me, that if you take that, which knows me, my mannerisms, my thinking pretty well, and then take my voice, I could easily be replaced by an AI version of David Beckworth for this podcast.

Daly: Not really though.

Beckworth: Not really?

Daly: I think that the distance between that and where we are today is pretty large, because it is missing some element, right? So, it can do things. If you were sick, we could get something out of that, but you have this way of doing things that I think would be hard for the current gen AI products to do, which is, if a person throws out an answer, you can respond and get the most interesting thread, as opposed to the one that the model might have trained it to ask next. So, it can go off script, but it's always going to ask something which has been previously fed into the model, and you're going to say something like, "Oh, you like football? What are your teams?"

Daly: And unless lots of other guests had said that they liked football, and your reaction was, "What are your teams," then it would be hard pressed to do that. So, there's a way in which, I think, it's the responsibility of all of us— since you all are doing this here at Mercatus, I'm certainly doing this— to help educate people that the existential risk of complete replacement is not a current risk of complete replacement. One of the things I'm more bullish on with AI, truth will tell us, is that technologies, on net, never reduce employment, but there's a big gap between when they replace jobs, when they augment jobs, and when it creates jobs. And that leaves people left out and feeling like, "Well, wait, I was replaced."

Daly: But AI is unusual in that the firms we're going to anyway, which is a large number of them, are saying that they're using it to replace certain tasks, which they collectively say are the soul-sucking tasks, but they're augmenting work right away. And then, they're building new people into their workforce, because they need prompt engineers and other people to help with the model.

Daly: So, one of my firms is a big retail group, has a lot of copy editors writing copy for things that range from a $0.50 screw for something that they make to a $700 high-end product. The copywriters, and this will be shocking to you, they don't actually like to write about the screws. It's not very interesting, it's tedious, but they love writing about the other items. Well, it turns out that the firm's incentives are for the copywriters to write about the expensive items, which have high margin, and not about the screws. So, the gen AI product writes about the screws, they have an auditor, and now there are orders of magnitude happier copywriters, and more output, and accurate descriptions of screws, which is, I think, a win-win-win.

Beckworth: I'm glad my job is secure, so thank you.

Daly: You're okay. You're totally okay.

Beckworth: We're AI-bullish, so I'm just throwing it out as an example, because I want to throw out another possibility here, since we're talking about the Fed, and I have an FOMC member with me, but imagine in the distant future we make use of big data, AI. What does the Fed look like? Would it be a much less labor-intensive organization, more AI, fewer economists? You still do the same thing. You still maybe have big balance sheets, follow some version of a Taylor rule. But could you foresee a future where there's much more AI-intensive use at the Fed?

Daly: So, one thing that is maybe little known but certainly important is that we, like all other research institutes, we've got a whole group of researchers. We have three responsibilities, as you know, the payment system, monetary policy, [and the] financial system. And we've been using, like all other groups have, big data for a long time. It's been around. It's not a new thing. Generative AI started around Thanksgiving of 2022, but not machine learning, not the use of big data. So, of course, we're using that to get insights and lessons, but those are just generating patterns that have happened before and looking for patterns in the existing information.

Daly: So, they point you to things, but they don't replace thinking. And so, I still think that the Fed will look different, like all institutions will, in terms of how it does its work and does it more, hopefully, effectively and efficiently, and much more information that can be collected and used in real-time to generate ideas and things. But, ultimately, there's still the judgment part to how you think about things, because you're also bringing in the qualitative information, and we have to be out in the field talking about that with individuals and bringing that in.

Daly: And balancing the qualitative information with the quantitative information, with the history models and empirical work is still not— I mean, much like you, I don't see a machine replacing that. But it also underscores that the Fed is not just technocrats. It's actually individuals with judgment and things, like your job is not just being a— you're not just getting questions, reading them and getting that. You're interacting. Those interactions are interesting and useful for listeners, hopefully. Say yes, okay.

Beckworth: Thank you.

Daly: It's a big nod. I'm doing that kind of thing, like nod yes.

Beckworth: Well, let's move on to another topic that's very near and dear to my heart, and that is the Fed's framework review, which starts in the second half of this year and goes into next year. Maybe give us the basic contours of it, when it is going to happen, and then what would you like to have happen and what do you think will happen at it?

Expectations for the Upcoming Fed Framework Review

Daly: The first thing I'll say is that we haven't really announced it yet, but I'll let the chair do that. I don't want to front-run the committee about what the parameters of the framework will be and the specifics. But what I will say is that the last framework review was very intensive, if you remember it. If you don't remember it, it really had many components to it. So, one component, of course, which you saw reflected in the minutes and eventually in the transcripts, was just the study of what are all of the different ways you can go, how would we do this well, what are the facts that are present today and are likely to be present for the next five years that we should really think about.

Daly: Because, remember, at the time we did our last framework review, we couldn't get inflation up to target. So, there [were] a lot of conversations about, what do we do in a low R-star world? We're going to hit the ZLB or the zero lower bound regularly. What happens when inflation doesn't get up to target, not only in our country, but in other countries? So, those are risks that we have to manage. So, I suspect that, at this point, some of the questions that will come out— and, again, I'm not front-running the committee, I'm just saying what is on the minds-- I have this written on my whiteboard. It's a good study for academics too.

Daly: Here are some questions that are really important. Are we going to be fighting inflation from below our target or above our target? So, [during] the last framework review, the world was thinking that we were going to fight inflation from below our target, whatever the given target is. Now, I think that there's a real conversation out there about whether we're going to be fighting inflation regularly from above the target, pulling it down. Well, that has different implications for any kind of a framework or how the Fed and other central banks react. The other one you already mentioned is, where is R-star headed?

Daly: Are the same things that we came into the pandemic with still salient, or have they changed in a fundamental way that means that the zero lower bound is not going to be as pervasively hit as it was before that? Is it something different? I think the third one is, and this is— we also touched upon this with AI, but I think it's different than that, is what does potential output look like? So, if you remember, prior to the pandemic, there was a lot of talk about secular stagnation, that the global economy was simply going to have a slow growth environment, the pie wasn't going to expand, we weren't going to be able to offset recessions because we were at the zero lower bound, and inflation was just going to drift.

Daly: Now, the world seems to be— we've got AI potentially boosting potential output growth. We have, is inflation really going to be coming down, and then R-star, is it higher? Those are all fundamental questions that any central bank has to grapple with, and so the framework is certainly going to have to live in that context, and then, of course, talk about the tools and the techniques we use. You know, certain things stay the same, and what's really important is that— everybody asks me this question— we're not changing the goalposts while we're still trying to get to there. So, 2% is our inflation target. Importantly, we have an ample reserves regime that we're still trying to hit. We're not abandoning our ample reserves regime at this point. And all of the things that people have come to depend on as part of Fed policy are still there; resolute to keep our inflation target, and resolute to do that while we balance the labor market, which is incredibly important.

Beckworth: Well, Mary, you know I'm a big fan and advocate of nominal GDP targeting.

Daly: I do know that.

Beckworth: And I was at a conference where you and a number of other Fed presidents were giving talks. And I remember that Jim Bullard gave a talk on nominal GDP targeting. He was, I know, one of the big champions inside the FOMC for nominal GDP targeting. He has since stepped down. Are there any champions left for nominal GDP targeting at the Fed?

Prospects for Nominal GDP Targeting at the Fed

Daly: I don't usually speak about my colleagues, but I'm going to speak about us collectively. Here's something that I really love about working at the Fed— and I know Jim had a model. That was the model that says, imagine people live 200 quarters, and how do we go through that? But seriously, all of these things are useful to think about. There's nominal GDP targeting, there's price level targeting, there's inflation targeting, there's a dual mandate. Some countries are inflation targeters, and we're a dual mandate country. And what's important is that the goals are always the same.

Daly: These are how to achieve the goals. The goals are to create sustainable growth, a healthy growth rate that is not too fast, not too slow against the potential output, and do that with having a price level or an inflation rate that is stable and low, and a labor market where people who want jobs can get them. Those are the goals no matter which technique or methodology you're using. And so, we looked at all of those in the last framework review and came to the one we use, which is inflation and dual mandate, or goals, inflation at 2% and a labor market that has full employment. I still think that's a really winning proposition. It served us well. But I gave you that sticker. I am curious. I am a policymaker and a researcher and voraciously curious. And so, if people come and say, “Look, I have price-level targeting or nominal GDP targeting. Could it produce a better outcome?” Well, then, obviously, we would think about those and consider those things, but there's always advocates for all of the different ways. The goal is to try to get something that works for as many Americans as possible.

Daly: There's two other things to the curious [point]. Be voraciously curious. This is useful for younger people, too, is that if you're doing anything, just be voraciously curious. When I'm looking to hire people, I look for curiosity. I also look for— okay, I've been very curious. Now, you need to take a decision. I want people to be confident in that decision. But then, immediately upon taking it, I want a certain amount of humility to say, what did I miss? How do I get curious again? I have a sticker that says, “be curious, be confident, be humble.” And that, actually, is the way that I think the framework review will go and all of my colleagues share— I don't know if they have my sticker, but I'm happy to give it to them. But the most important thing is that we all share that mindset of, we've got to be curious. We've got to be confident that we've looked at everything, but we also have to be humble enough to ask, again, is this the right thing to do? Should we do something different?

Beckworth: Great. Well, we are putting together a policy brief series on the Fed framework review for, hopefully—

Daly: Terrific. Send it. Yes.

Beckworth: Of course, it has a certain angle to it, so I look forward to you reading it.

Daly: I wouldn't think otherwise, right? Is it titled “Nominal GDP Targeting?”

Beckworth: It is. It's something along those lines.

Daly: I'd be anxious to talk to you about it as we do the framework review.

Beckworth: Yes. I'd be happy to talk to anyone at the Fed who wants to talk about it. So, [we have] a few minutes left before we go to the audience. One last question from me, and I need to be careful how I ask this, but we're going into an election year, and things get political. Everything gets political. And President Trump can say some things about the Fed, as well as other candidates. How do you operate in an environment like this? How do you keep your eyes on the target when you've got a lot of noise and distraction around you?

Fed Policymaking During an Election Year

Daly: So, the Fed is really just what we say we are. We're not political. We're apolitical. We just don't think about politics, because the chair said this on his 60 Minutes interview, but it's something that all of us say, is that integrity is our most important attribute and trust of the American people. And the trust that they have, and even Congress has in us, is that we achieve our goals, and we work to achieve our goals. And we can't take politics and political changes into the conversation. Our job is hard enough, frankly, to get the price stability, full employment part right, and make sure that people can live their lives and livelihoods without thinking about inflation or that there could be a recession in the labor market.

Daly: So, you asked, how do we do it? It is just that you have to almost sign a thing that you say at the beginning of your tenure, that we're not going to think about politics, because it is an apolitical position that Congress has asked us to take, which is full employment, price stability. Those are our goals. That's what we're going to work on to achieve. And that's really what I think about.

Beckworth: Okay. We will now turn it over to the audience for questions, and we'll take as many questions as we can within the hour.

Audience Q&A Period

Audience Member: Hi. Nancy Marshall-Genzer with Marketplace. Thank you for being here. Thanks for taking our questions. Just following up a little bit on the labor market, you mentioned that initial jobless claims today came a bit higher than expected. The job report last week was a little cool. So, my question is, if the labor market does look like it's getting weaker, would that be enough for you to be in favor of cutting rates, even if inflation were still a little bit sticky?

Daly: So, the way I would put it— it's a great question, an important question. The way I would put it is that there's a difference in getting softer and being weak. If the labor market starts to falter or looks like it's getting weak, well, then, absolutely that's one of the things that would cause me to say that we need to rebalance the policy rate as long as we're not seeing inflation skyrocketing. Those are tradeoff decisions, so I don't want to work in the exact – I don't want to lay out a matrix of hypotheticals and tell you exactly what would be done on anything, because we haven't faced that situation.

Daly: But I think there is a real conversation to be had here on your question of— a softening labor market, right now, would just be getting back to what we think is normal growth, right? We can have a view that 110,000, 120,000 jobs a month is what the economy can absorb at any one time. We're outgrowing that even with the slightly softer or below-expectations report we had last Friday. And so, you do see it cooling, but that's what we should expect to see, right? The policy rate's high. We're trying to bring the economy back into a more sustainable growth path, whether that's GDP growth or the labor market, and we want to bring inflation down. But the very most important thing to remember is that we have two mandates, price stability and full employment. And right now, we have a strong and healthy labor market, but [we] absolutely have to keep an eye on that [and] continue to watch. So, I'd say that the recent readings, I have my eye on it, but I'm not yet worried.

Nancy: Just to pin you down a tiny bit--

Daly: Oh, yes. I love that.

Nancy: What would that look like? How high would the unemployment [rate] get where you'd be like, "Huh, okay. [We’ve] got to look at this”?

Daly: I'm not trying to obfuscate or avoid the question. I really am not. It's just very challenging to think in hypotheticals, because you could write up a little map of what— and this is what rules do or models do. They write up little maps of when you would do which action. But, honestly, what happens is that you have to balance a lot of things in that moment that we don't know, that don't fit into that matrix of the nexus between inflation and unemployment.

Daly: So, let me explain. If we saw that inflation was coming down or that we had a lot of signals that consumer spending was weakening and the labor market was starting to get challenged, well, that would be a different situation than if we saw a couple of ticks up in the unemployment rate, but inflation's still going strong, consumers aren't budging in terms of their willingness to spend, investment's taking place. You can't really write down a little matrix of inflation, unemployment, and say, “When would you act?” But we do have the mandate to also take care of the labor market, and if the labor market would start to falter in some fundamental way, well, then, policy actions would have to be different than if it wasn't faltering.

Daly: I mean, this isn't an answer to the question, but I'm going to give it anyway, because it, really, I think, will help you understand how I come to this table. So, if I may tell a little story about my—So, I came up in a family where both my parents were in a lower middle-income family, and the whole neighborhood, my community, we lived in houses where you put a card table— which is just a fold-up table, if you don't know what a card table is, it's a little fold-up table— You put that in the living room and you do all kinds of things on it, but one of the things everybody in my community did was pay bills on Sundays.

Daly: In the late 70s, [during] the high inflation, the stacks of bills that they couldn't pay, no matter what house I went to, including my own, was always taller than the stacks of bills you could pay. Then, the Volcker disinflation came, and my parents, and all of the parents around my community, lost their jobs, and they couldn't pay for anything. And so, that story of seeing people struggle on the treadmill, it was an indignity, right? You're working, you're doing everything, and the inflation's just outstripping you, and that's demoralizing to almost everybody. Then, you have to do something that causes the labor market to really falter, and now, people— you've given them one thing that's better, lower inflation, but you've taken their livelihoods, which leaves them equally not well off.

Daly: So, I have that in my mind, and that is the balancing act. It's why I resist the idea that we want to put this in some sort of a box, like an equation, and instead say, we have two mandates, and we have to be extraordinarily careful in managing those two mandates; inflation to 2% over time, and a labor market that continues to deliver jobs and opportunities to people. That's what we're trying for. I still believe we can do it, but it takes constant work, and we can't declare victory on either side of that right now.

Audience Member: Steph Miller, I'm with the financial regulation team, and I'm an economist by training, and most of my work is on banking and crises, and I would say that the predominant views within that literature are, was it a liquidity problem? The bank failures from last year, was it a liquidity problem? There was the run. Or, was it a solvency problem, and, therefore, was capital sufficient? I tend to take the latter view. That's my takeaway from the data that I've worked with, and so, given your broad background, I was wondering, what was your overall take on what happened last year?

Daly: Let me just be sure, you think it was a capital problem?

Steph: Yes. Insufficient.

Daly: I think that, ultimately, when you have bank failures and bank stresses, both are up for thinking about, capital and liquidity. But one of the salient components of the SVB failure, and then Signature, and First Republic, and then the stresses that persisted, was the ability to translate capital into liquidity. So, I think that the liquidity piece was a new piece that— when people were thinking about why would a bank fail, that liquidity piece was really salient. It was salient for a couple of reasons. One, a lot of the part of their portfolio is held in the held-to-maturity part, which isn't mark-to-market for banks of a certain size. And so, investors suddenly got transparency on that, and, as you saw, the bank stocks that were affected by that went way down. And so, I think that's a liquidity issue. I think the other thing that happened is that we realized how quickly people can move money and how willing they are to move money.

Daly: If you think of Basel, the difference in the weights internationally, and certainly domestically, was not that large between insured deposits and uninsured deposits. What we realized in those bank failures is that that gap is much wider, that if you're not insured, you're going to move if you think your bank is under stress, and that can happen rapidly, because you can move money on your phone and other things. So, there's a lot of lessons that can come from those three banks. I don't think it would be fair to say that it was only capital or only liquidity. The question is, is the banking system sound and resilient? And I will remind everyone in the room who doesn't study banking that we have over 4,500 banks in the United States and three failed. So, the big message is that banks are sound and resilient. They're used to managing these types of risks. But in these worlds, you can absolutely have pressures on liquidity and capital that matter, and we have to rethink those things. I don't make that kind of policy. As a reserve bank president, I have a role in regulatory policy. But I, certainly, as an economist and as a person doing policy, understand the stresses and the impact they can have on the economy, so, absolutely, great question.

Audience Member: President Daly, and this is also for you, David. Today, I opened my fancy Bloomberg, and I saw that since Jay gave the press conference, bond yields fell, the dollar fell, stocks rose, and financial conditions eased, none of which should have happened if you're the chair saying, “I'm going to hold for longer.” I'm humble, I'm curious, [but] not that confident that what I learned in macro is working today. So, why do you think that happened?

Daly: So, I think that it's a good question, because it shows the complexity of the situation we're in. So, financial conditions move around based on a variety of things; what the Fed says, what they think will happen on the economy, on inflation, their own forecasts and projections, what's happening globally. And what you see is that it's been moving around a lot on data points, and, importantly, data points that suggest it might go one way or another way.

Daly: We got a weaker-than-expected job market report, although not weak, and back to the first question, it was a softer jobs report than many expected, but it wasn't weak. It was still a reasonable jobs report. We got initial claims printing a little higher than the expectations, so there's always this thought of, well, maybe the economy is weakening more than we thought. Earnings [for] some major companies were below expectations. Those things all feed into how investors, market participants, are thinking about the economy's direction.

Daly: But one of the jobs of the Fed— and I take this part of the job seriously— is that we have to stay steady in the boat, right? There were many who got, I think, overly optimistic on the inflation front with the second half of last year when inflation was falling pretty rapidly. That proved to not be a durable decline, and so that steady in the boat proved to be helpful. Right now, we've got two pieces of labor market information that look below expectations, but not especially weak. And so, we absolutely have to continue to watch that, but I think it's far too early to declare that the labor market is fragile or faltering. We just have to continue to watch.

Daly: And this is where— to David, your earlier question— this is where, your earlier point, that data dependence is really not data point dependence. It's really the whole— I'm a microeconomist by training, macroeconomist by practice, but, in either one of those, what you learn is that the preponderance of evidence is your best guide, not a specific piece of evidence. You can easily over-rotate on a specific piece of evidence and find yourself making policy mistakes.

Daly: So, I think that this steady in the boat approach is the right one. And just to lean against the one thing you said, I don't think, in an event study, that you can just look at press conferences or commentary by the Fed, because other things happen in the intermeeting period. If people are understanding our reaction function, then they should be adjusting, depending on how the information is coming out and what they're seeing. But, again, sometimes markets, et cetera, can over and under react to information, in a way that we might just stay smoother in that. But that's because we have to look at all of the risks as well. We're not just betting on one outcome or another. We have to look at the full range of risks and plan the scenarios that we would use in those risks.

Beckworth: Mary, before I turn it back over to the audience, just going back to your comment earlier on the bank question, how it's tough to turn capital into liquidity. There's been a big push for using the collateral that banks have at the discount window more readily, to use it to meet liquidity requirements. This would solve a lot of problems, or at least some of the problems. Where do you see that conversation going?

Daly: So, definitely, banks making sure that they're signed up for the discount window— this is a long-standing tool. This is not something that is brand new. Banks use the discount window on a regular basis, and the idea that many people are putting forward, and it's a very useful one to consider, is maybe use it more frequently, but that will take more work and effort. The first part is getting banks signed up who aren't signed up, and, certainly, all reserve banks have been always encouraging their banks to sign up for the discount window. But the push is obviously much more intense, at this point, to just sign up for it, make sure you know how to use it, make sure you've tested it, et cetera.

Daly: I do think that this is a fundamental question that we have to ask about, how do we provide liquidity in a rapidly changing world? We have the Federal Home Loan Banks, and we have the discount window, and we have other non-institutional sources of funding, wholesale funding, that banks can get. But it is a very important question. And back to the capital question, it's not one that, I think, was garnering a lot of attention prior to the failure of those three banks, where they really couldn't get liquidity fast enough.

Audience Member: Hi, Howard Schneider with Reuters. Thanks to you both for doing this, really interesting. Two things real quick. One is a follow up to Nancy's question. There's a big gap from 175,000 jobs a month down to 100. Do you think that's going to be adequate to continue disinflation, or is it going to have to get even weaker with a consequent rise in the unemployment rate? Then, secondly, from December through March, everyone was saying that if the economy evolves, as we expect, it'll likely be appropriate to lower rates this year. Do you think that statement is still true? Are rate cuts still likely this year?

Daly: So, let’s go back to the labor market. I do think that we're seeing, in a really positive way, disinflation— Just think about where we were last year, at the start, and where we are now. Inflation has come down a lot. A lot. And that's because of a variety of factors. One is monetary policy, that has just slowed demand. There's no doubt that things are slower now than they were. If you ask the contacts and firms, et cetera, they're going to say that early last year, it was very frothy. It looked like we were riding a bicycle down a hill and we lost control of the pedals, right? It was just really frothy. Now, it's back to something that seems more normal.

Daly: In fact, one of my contacts said, “This looks 2019, except for that inflation part.” So, I think there's a sense that the economy is on a more stable footing. So, the question, Howard, is, do we have to really push the economy down? I don't see evidence of that just yet. I certainly don't want to rule things out, but I don't see evidence of that right now, because we're getting positive supply. There's still supply recovery and supply improvements in output across the board, and AI and other things can certainly help that, but just people are making investments.

Daly: The other thing that's happening is that we had a really positive labor supply boost, both from increases in participation between 25 and 54 year olds, which I no longer am comfortable calling prime age. I used to be really comfortable calling that prime age. Now, I'm completely not comfortable. But, really, that middle group, especially for women who came back in— and then we had immigration flows, which continued to boost our labor supply. So, those are things that are positive, that help us get inflation down without that. Also, there's this behavior of consumers. I think we can't overlook this. Inflation expectations are well anchored, and that's across the board. And consumers, at some point, especially when they've spent down their excess savings and other things, are just becoming more price sensitive. And that price sensitivity means that firms can't just reflexively pass things on, and that's the beauty of a well-anchored inflation expectations environment.

Daly: So, to answer your question specifically, Howard, I don't see that we have to cause more pain to get this to happen. I see this as happening as we move it down. Disinflation is occurring. We've had three stubborn months of data, but I still see monetary policy as working and supply [as] cooperating. On the rate cuts, rate hikes, rate stays the same, I'm going to go back to the scenario analysis and say that I really am holding myself, because I think it's the best thing to communicate, to the fact that what's happened is the confidence bands—

Daly: Remember, we said that we want to be confident that inflation is on a sustainable path to 2%. I have that still as my metric, because confidence is, for me— what it means is that the confidence bands around our projections get narrower and narrower. The first three months of the year made them wider than I came into the year with. And so, I didn't grow more confident, but I'm going to be looking at that, and those are still the goals, right? Ultimately, the reaction function is, get inflation down to 2% over time. Don't stop in our policy until we get that. We are confident that that is underway, but also, watch if the labor market is starting to falter, because that is another part of the equation. At this point, both of our mandated goals are in the frame, and we have to attend to both of them.

Audience Member: Thank you so much for coming. My name is Brian Knight. I am not an economist. I'm just a lawyer, so bear with me.

Daly: I love lawyers. I'm the only person in America that says that, by the way.

Brian: I like to think my wife loves at least one lawyer.

Daly: Oh, okay. There you go.

Brian: I guess the question I had, based on my colleague Steph's question, is that you mentioned that it's sort of a liquidity problem, but were the assets actually difficult to sell, or were they difficult to sell at a sufficient price to cover the bank's liabilities? Then, the second follow-up question is, you mentioned that we had three banks fail, and that's evidence of a good, stable banking system, but we also had a fire drill among the government and the Fed rolling out new emergency policies and all of this stuff, which had a whiff of '08 about it. So, do you think that was an overreaction, or was that sort of prophylactic to make certain that problems didn't arise, but there was a threat? What was going on there?

Daly: So, this is fully my vantage point. I want to make sure that I don't speak for any of my colleagues on this. This is me looking at the things that you see in the economy. So, March— I don't see March of 2023 looking like '08 at all. '08 was a really challenging time. People were carrying their stuff out of their companies in boxes. People were losing their homes and things. It was a very distressing time. March of 2023 was a big awareness that not only the largest banks can cause systemic risk, that there's a systemic – so, SVB was not a small bank, but it wasn't a big bank either, and there was a sort of a sense that maybe smaller banks couldn't cause contagion or systemic risk across other banks. But what you saw is that because it was a liquidity issue, they had assets, but those assets hadn't been mark-to-market as they've evolved, that when those assets are mark-to-market, because you have to raise liquidity, you suddenly don't have sufficient liquidity or capital to fund your deposits.

Daly: That is something that all, then banks, who look like that, who had underwater securities, underwater loans, because they priced them at low interest rate environments and now the interest rates had risen. That was the awareness that, I think, made this more of a systemic risk. And so, the actions that the government took— the Treasury Secretary and Treasury Department and the FDIC and the Board of Governors— those actions, to my mind, were really a welcomed settling, saying, yes, this is three banks that had that problem, but we are going to ensure that the rest of the banking system remains safe and sound.

Daly: On those days— having lived through a couple of these situations in my time at the Fed— on those days, the very most important thing is to assure Americans and others that their money is safe and sound in the banking system, so that you don't cause a greater run, which is really problematic, and that did not happen. Banks didn't have counterparty risk with each other. Think of ’08. There was a fear about [how] you didn't know what your counterparties had, so you weren't lending. That was a completely different situation, at least in my judgment. I think the history books will characterize it as such.

Beckworth: Okay, we are at the end. Before we close, we want to recognize that you are now--

Daly: Can I get that young guy?

Beckworth: You have time for one more?

Daly: I do. You've been standing so patiently, and you're bringing up the younger end of the age distribution, so.

Beckworth: I'll mention that Chris is one of our research associates, and he's starting a PhD program in economics in the fall.

Daly: I'm so glad I took your question.

Audience Member: What do you think about the fiscal theory of the price level?

Beckworth: Ooh.

Daly: Ooh, wow. Okay, now we'll see. So, here's what I think about, is that it is easy to discount or get on a particular view, and say that view is the view, and should be the view, or that view isn't the view, and should never be the view, and I think that's at our peril. We should be open-minded, in my judgment, to all different ways of thinking about the world, and then ask ourselves, what are the learnings from those ways of thinking about it that might influence us? It doesn't mean because you've listened to it, and studied it, and evaluated it, that you'll accept it, but I do think that closing off debate is the best way to find yourself in an echo chamber of your own thinking, or the prisoner of your own particular way of thinking about things, and I just think that's never going to be good for society. 

Daly: That's why we do the framework review every five years. I get a lot of people emailing me about the fiscal theory of the price level. I get a lot of people emailing me about nominal GDP targeting, price level targeting, a single mandate, and what I learn from all of those is that it's good to have people thinking about how to manage the economy, and the mandates we have, in a better way, and I'll read anything, at least once.

Beckworth: Well, Mary, before you go, you're now a member of the Macro Musings family.

Daly: Oh, wow.

Beckworth: We give out mugs, so every morning you drink from this, you'll see nominal GDP targeting on there.

Daly: You know, you haven't sold it all that well.

Beckworth: And if you ever feel the urge to travel to Washington, D.C. for a FOMC meeting and bring this with you, I'd encourage you to do that. Drink in front of your fellow FOMC members.

Daly: I did have somebody give me a fiscal theory T-shirt once. I've acquired a lot of different theory T-shirts, but I don't have a theory mug.

Beckworth: Well, there you go.

Daly: There we go.

Beckworth: Next level. Well, let's give a hand for Mary Daly. Thank you.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.