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Fed Governor Lael Brainard speaks with Yahoo Finance [Transcript]

Brian Cheung

Lael Brainard, a governor with the Federal Reserve Board, joined Yahoo Finance on Wednesday to discuss the state of the economy and the outlook for monetary policy.

Below is a transcript of her appearance:

BRIAN CHEUNG: We are here in Chicago at the Fed Listens Monetary Policy Conference. I am sitting here with the Federal Reserve Governor Lael Brainard. Thank you so much for joining me this morning.

LAEL BRAINARD: It's a pleasure to be here.

BRIAN CHEUNG: So I want to ask first about the commentary from Chairman Powell yesterday. He was talking about trade in his opening remarks. I'm just wondering about currently, how do you see the current trade situation? And is a policy response from the Fed warranted at this time?

LAEL BRAINARD: Yeah, so I would say the US economy generally is in the midst of a very lengthy expansion. The US consumer remains confident. But trade policy is definitely a downside risk to the economy. And you know, our job is to-- to sustain the expansion, and we'll need to see going forward what that means for policy.

BRIAN CHEUNG: So in terms of sustaining the trade expansion, what would that mean? Would that warrant maybe perhaps a rate cut if the trade issues were to extend, let's say, through the end of this year?

LAEL BRAINARD: So I'm going to look at the outlook holistically. And certainly, trade policy uncertainty is a downside risk. But again, the US consumer's been strong, so as we go forward in the-- you know, as the data comes in, we'll just have to see what that means. And we'll be prepared to adjust policy to sustain the expansion.

BRIAN CHEUNG: So you have some unique background, given your work at the treasury. You've participated in G7s and G20s in years past. I'm wondering how difficult of a situation this kind of trade situation is at the moment, and kind of how that factors into from the lens of the Fed or Federal Reserve now how you kind of approach assessing that situation.

LAEL BRAINARD: Well, I would say the world economy is in a delicate place. You know, we saw the World Bank downgrading growth forecasts yesterday. Trade is a big part of that. So trade policy matters. And obviously, the international outlook matters also for the US economy.

[See Also: Lael Brainard: Fed 'prepared to adjust policy' as trade concerns mount]

BRIAN CHEUNG: So switching gears a little bit, fascinating panel yesterday that you had here in Chicago about maximum employment or just what the tight labor market looks like in practice from a Main Street perspective. You had some interesting people from the AFL-CIO kind of talk about how maybe Main Street isn't benefiting necessarily all across the board from the tight labor-- labor market. Are we currently at full employment for the time being?

LAEL BRAINARD: So I think what the discussions here in Chicago have really shown is that there is no destination point for full employment. There's no one number that you could pick and say we're there. What happens as the economy strengthens and as business hires is they start being willing to look at hires that they might not have looked at even two years ago, people that might not yet have the requisite skill sets, or the requisite work experience, or perhaps formerly incarcerated people, or people that may previously not have passed drug tests.

So what we're seeing as the economy goes into this very extended expansion is that we're bringing people back into productive employment. And that's just a-- that's just a positive for those individuals, for their families, but it's also a positive for the economy.

BRIAN CHEUNG: Right. So ADP private payroll numbers came in this morning, adding only 27,000 in May. That's the lowest since 2010.

We also have a jobs payroll coming this Friday. So what are you paying attention to as we continue to hit new lows for the unemployment rate, but as you're mentioning, that's not always just the one metric that we need to pay attention to.

LAEL BRAINARD: So I think I look very carefully at the payrolls number that comes out at the end of this month. I don't tend to take too much signal from one particular data point. I like to put it in context and look over several months and look at that trend line.

But I will be paying very close attention to the payrolls number on Friday. And the labor market does give us a lot of signals about what's going on in the economy. Initial claims is another important one that I pay a lot of attention to.

BRIAN CHEUNG: So switching gears, this Monetary Policy Conference is more broadly about reviewing the strategies perhaps that the Fed might need to employ in the next crisis. And something that you've talked about, in addition to Vice Chairman Clarida is the idea of maybe targeting the yield curve, taking advantage of the balance sheet or engaging in asset purchases to address longer term interest rates. What's the appetite among the Fed board to adopt a policy like that, given that the jury's still out on the successes or the consequences of Operation Twist?

LAEL BRAINARD: Yeah, so I would say that as I think about where we are, we have a interest rate that's likely to be quite a bit lower than what we were accustomed to in previous periods where we needed to cut rates. So you know, in previous recessions on average, we've cut rates by four to five percentage points. Obviously, with the equilibrium or long run neutral rate likely to be two percentage points lower than it has been historically, we have to be more open minded about using a broader set of tools.

And we saw in the crisis that balance sheet policies work. The balance sheet policies that were used were focused on quantities. A yield curve control would simply be more traditional in the sense that it would simply move out the yield curve, targeting interest rates rather than quantities. But the effect would be, presumably, very comparable.

[See Also: Questions loom over Fed efforts to make sure the 'roof isn't leaking']

BRIAN CHEUNG: So when you talk about the tool box as well, it seems like there are a number of other tools that the Fed can use in addition to quantitative easing. Some papers today will discuss, for example, negative interest rate policy. Is there appetite from the Fed to adopt something like that in addition to what you were mentioning about targeting the yield curve perhaps?

LAEL BRAINARD: Yeah, so I can't prejudge our review. This is just the public facing part with externally published work. We obviously have work that we have to do ourselves and deliberations that lie ahead.

For my own part, I don't see negative interest rates being a very useful part of our arsenal, although it has been important to elsewhere. I just don't see the cost benefit there being very attractive as compared with, for instance, something like average inflation targeting or yield curve control, quantitative easing. Those have been proven, I think, to be highly effective.

BRIAN CHEUNG: So on average inflation targeting, is that kind of what you are the biggest advocate for at the moment, given the opportunities or options for reforming the current targeting framework?

LAEL BRAINARD: So I think we are having conversations around inflation that are kind of in a parallel track in the sense that we haven't actually seen our symmetric 2% goal hit on a sustainable basis during the course of the recovery. We really just started seeing it hitting 2% last year. And so I think we just have a broader conversation about how do we make sure that people really expect inflation to be 2%, to be around 2%, that their experience over the crisis hasn't led them to start seeing inflation somewhat lower than that which would create Japan type of problems for us if that kind of a dynamic were sustained. So I want to be very careful to avoid any slippage in inflation expectations.

BRIAN CHEUNG: To be clear, that doesn't mean that you see that right now.

LAEL BRAINARD: Absolutely not. I think the FOMC, the Federal Reserve has been very active and very focused on making sure that we really do get to 2% on a symmetric and sustained basis, and we're very committed to that.

BRIAN CHEUNG: So switching gears, you mentioned the crisis. You've been very vocal about regulatory issues, so I kind of want to ask, you've dissented five times on issues ranging from the stress test disclosures, to bank liquidity, to capital requirements. On the aggregate, do you see both the legislation coming from Congress, and the efforts undertaken by the Fed independently as maybe opening up the banks, the larger banks, at least, to the need for another bailout in the next crisis?

LAEL BRAINARD: So what I am very focused on is making sure that all that hard work that went on after the crisis to build up capital buffers, to build up liquidity buffers, to increase transparency and risk management, that we don't inadvertently whittle away at that and once again leave taxpayers on the hook. So that's where my focus has been. Of course, there has been legislation, and where Congress passes laws, we implement that. It's really in areas where we've gone beyond those statutory changes that I am concerned that we may be whittling away at that core resilience of our financial system.

[See Also: Fed: Tight labor market 'did little' to narrow economic disparities]

BRIAN CHEUNG: And leverage lending is something you've also talked at length about. But a lot of that being concentrated outside of the banking system though, the Federal Reserve isn't regulating some of the non-bank systemically important financial institutions like they were pre-crisis. I'm wondering if that's of concern to you, and what should regulators do with regards to some of the risks have been pointed out in leverage loans?

LAEL BRAINARD: So one of the things that we do now that we didn't do pre-crisis is we publish a report twice a year that systematically goes through and looks for potential risks to financial stability. And in the last two reports, what has clearly shown up as an important risk is that risky corporate borrowers have taken on a lot of debt in this recovery. And as we know, when there is a recession, it's precisely the riskiest corporate borrowers that do the greatest layoffs, that pull back on production, that pull back on investment. So they tend to be an amplifier of the business cycle. And that's why we have really flagged leverage lending, which is lending to the riskiest corporates, as being a risk in this phase of the cycle.

Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.

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