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Fed's Clarida: I'm putting a lot of weight on inflation expectations

Yahoo Finance’s Brian Cheung has an exclusive interview with Richard Clarida, Federal Reserve Vice Chair.

Video Transcript

ZACK GUZMAN: But first, I want to get straight to Yahoo Finance's Brian Cheung, who has a exclusive interview here Federal Reserve vice chair Richard Clarida standing by. Brian?

BRIAN CHEUNG: Thanks so much, Zack. Well, yes, joining us here on Yahoo Finance in an exclusive is vice chairman of the Federal Reserve Board. That's Richard Clarida. Thank you so much for joining us this afternoon. I wanted to ask you, just kicking things off, we're going to get an interesting print on inflation-- that's PCE-- on Friday, in addition to a jobs report next Friday, just curious what your updated outlook is on the economy as we await those very two important data points, at least from the Fed's view?

RICHARD CLARIDA: Well, thank you, and enjoy having a chance to do the show. The outlook for the economy in terms of economic activity is very, very positive. My outlook is for growth somewhere north of 6% this year, possibly 7%. If we get that in GDP, it would be the fastest four quarters of growth in 35 years. Of course, we have to remember, the economy was thrust into a very deep hole last year with the pandemic and the mitigation efforts put in place. We have a resilient economy, a lot of policy support, and the vaccines and so certainly very constructive on economic activity.

In terms of the labor market, I think the most recent employment report really highlights a fair amount of near-term uncertainty about the labor market. We're still about 8 million jobs short of where we were 15 months ago, and it may take more time to reopen a $20 trillion economy than it did to shut it down. You know, at the current pace of the last three months of a 0.5 million jobs per month, it would take until August of 2022 to recoup those 8 million jobs.

On the inflation outlook, obviously, the CPI number that we got recently was a very unpleasant surprise. We and other forecasters had expected both PCE and CPI inflation to move up on reopening, but that increase certainly caught my and other's attention. Brian, I continue to believe, as my baseline case, that this will prove to be largely transitory, and I think the details of that recent report are consistent with that.

But let me also emphasize, we're going to be looking at the data very closely in coming months. And if, in the risk case, the upward pressure on inflation were to prove to be more persistent and to put upward pressure on inflation expectations, we have the tools, and I'm convinced that we would act to counteract that and bring inflation down to our long-term goal of 2%.

BRIAN CHEUNG: So I want to elaborate on that point that you just made about the expectation that we may not get a lot of those 8 million jobs, at least compared to pre-pandemic levels, back until August of 2022. Does that imply that that's how long it's going to take before the Fed then starts to pull back on some of the aggressive policy measures that you put in place since the pandemic?

RICHARD CLARIDA: No, I was merely making the point that if the last three-month average were to continue that it would take that amount of time. I, myself, think that the pace of labor market improvement will pick up. I think that, you know, we have to remember, we still have tens of millions of Americans who have not yet been vaccinated.

I think we'll have a much better sense-- we'll have children returning to school in most of the country. We will have other factors that I think will lead to a pickup in employment as my baseline. We're going to be-- we want to make-- our criteria, as you know, as a seasoned Fed watcher, is that we want to make substantial further progress towards our maximum employment and price stability goals, and we'll be attuned and attentive to the data flow as it's coming in on that.

BRIAN CHEUNG: So you said last week that monetary policy is as much about risk management as it is the baseline. I found that very interesting commentary--


BRIAN CHEUNG: --because everyone has a different definition for what the biggest risk is going to be. We heard from Larry Summers in an op-ed this morning-- that he said overheating not excessive slack is the biggest risk, in his view. Is there a risk that the Fed, with its new reaction function, might have to hit the brakes too abruptly in a way where that risk management could really become an issue for the central bank?

RICHARD CLARIDA: That's a good question. So yeah, I think-- and I like the opportunity because a big, important part of policy is risk management. There's a lot of focus on our baseline view, which does not see a persistent threat to our price stability mandate. But of course, there is a risk case. There's also a downside risk case, unfortunately, on the virus and new variants and the fact that the rest of the world's not vaccinated.

But focusing now on the upside case, we have enormous pent-up demand in the economy with monetary and fiscal policy support. We also have enormous potential pent-up supply, those 8 million jobs that I talked about. And so it's going to take some time to get a clearer sense of how supply and demand will balance.

Now, in the risk case, which Larry and others have focused on-- in the risk case, where these pressures are more persistent and they put our price stability mandate at risk, you know, we will recognize that. And through our communication and our tools, I think we will be able to offset that in a way that would be supportive of maintaining economic recovery. So that's the way I'm looking at it.

BRIAN CHEUNG: So if it's not your base case scenario, as I understand it, for that to be the case, we are, however, hearing some commentary that there is some concern that that could be the case. We heard from Philadelphia Fed president Patrick Harker, in addition to Dallas Fed president Robert Kaplan, saying that they would prefer to have discussions at least on tapering, pulling back the quantitative easing program pace sooner rather than later. Do you agree on that point, or is that type of risk threat not quite there, at least in your view right now?

RICHARD CLARIDA: Well, I think the minutes stated well my thinking and, obviously, most of the committee. You know, there-- it may well be the time-- that there will come a time in upcoming meetings we'll be at the point where we can begin to discuss scaling back the pace of asset purchases. Obviously, that's not something that was the focus of the April meeting. Again, I think it's going to depend on the flow of data that we get.

And also, I think it's important to appreciate, the pandemic shock that shut down the economy last year was really unprecedented, I think, in everyone's lifetime. You'd have to go back to 1918, probably. And shutting down the economy put very substantial downward pressure on prices. CPI inflation, I think, was 1.3% or 1.4%, and that turned out to be transitory.

Reopening the economy is clearly, as we saw in the CPI report, putting some upward pressure on inflation. And so we're doing what statisticians call a signal extraction exercise in a complex period. So we need to be humble. We need to acknowledge that there's a risk case on both sides. And I would expect, as the data comes in throughout the rest of the year, we will, as a committee, be able to assess that and communicate what that means for meeting our substantial progress test.

BRIAN CHEUNG: So let's talk a little bit more about communication. We saw markets maybe not go crazy, but they did kind of jitter after the minutes that showed that we're some participants that felt that rapid progress is possible, where they might want to start tapering earlier rather than later. Do you feel like markets are getting the message, the Fed has a new reaction function because of the changes to the framework made at Jackson Hole some time ago? You were formerly a Fed Watcher for many years before you went to the Fed, so you have interesting perspective on both sides. Are they reading you guys right?

RICHARD CLARIDA: I think so. I think, broadly-- obviously, we can find days and particular events. But I think, broadly, our new reaction function has come to be well understood. I think the surveys that the New York Fed conducts will show that.

But I think the important point to remember-- I think the biggest change is that we're really more outcome-based than outlook-based. So our underlying goals, Brian, have not changed. We want to get to the maximum level of employment consistent with price stability and keep it there. We continue to define price stability as 2% in the long run, so that's not changed.

But what we have said is that want inflation to average 2% over time, so as to keep inflation expectations well anchored. And that will allow me to get in a plug for a staff index. The Fed staff has developed an index, which I'm a big fan of. It's called the Index of Common Inflation Expectations.

And it's essentially an agnostic statistical approach to extract the common element in more than 20 different indicators of expected inflation. And that index is right around 2%. Right now, it drifted down a bit in the pandemic. It's drifted up. But I would argue that it's very much in a range that's consistent with well-anchored inflation expectations, and we're going to have to keep a close eye on that going forward, certainly-- at least I will.

BRIAN CHEUNG: So when it comes to looking at inflation-- and obviously, inflation expectation is a big part of where you might see inflation going in the future. You could look at market-based measures on the TIPS market. You can look at survey-based measures. But it seems like everything, not just inflation, but even employment data, is very noisy right now. So are you holding more water, if you will, in actual realized inflation or inflation expectations?

RICHARD CLARIDA: Well, speaking for myself, yes. In fact, I'm putting a lot of weight on inflation expectations because the historical experience of the last 30 years-- and macroeconomics indicates that keeping inflation expectations-- and is essential for achieving our price stability goal and actually help us to achieve our maximum-point goal as well. But you are correct. I think there is a signal. There's always a signal and noise in data. And unfortunately, we're in a period where the ratio of signal to noise is probably lower than on average, which is why we're looking at a wide range of indicators.

I should also say that in the labor market, in addition to looking at indicators of employment and participation and the JOLTS data, for example-- job-finding data-- it's also important to look at data on wages, compensation, productivity as well. In the last cycle, even though the unemployment rate fell to 3.5%, we did not see wage gains that were excessive, relative to productivity, in our inflation goals.

And certainly, going forward, that will be a key thing for us to monitor as well. Right now, that is not the case. Although, I would point out that even though this is a very deep shock to the economy, if you look, for example, at the Atlanta Fed wage tracker or the employment cost index, they held up pretty well during the pandemic, which, for those workers who kept their job, was a good thing. So it's certainly something I'll be looking at quite closely.

BRIAN CHEUNG: So can we talk about financial stability for a little bit?


BRIAN CHEUNG: Because it seems like a lot of people are paying attention to inflation and employment, obviously, but financial stability could be a caveat to your reaction as well. A lot of people are watching volatility in cryptocurrency markets as of the last week. We know that bank exposure in that asset class has been heating up a bit in recent times. Does that-- does any of that concern you? We heard from St. Louis Fed President James Bullard here on Yahoo Finance. He said a lot of these cryptocurrency are worthless. What do you have to say on that space?

RICHARD CLARIDA: Well, you know, obviously, there are a number of them, so you don't want to paint with too broad a brush. But I don't view cryptocurrencies as, really, either a store of value or a medium of exchange. Blockchain technology is a technology which obviously has advantages in particular applications, whether or not it involves crypto, but I don't think of crypto, broadly, as really either a store of value or a medium of exchange. It may serve a role. It may not. But I don't think of it as really a substitute for money in any way that I would recognize, as someone who used to teach money and banking very happily decades ago. So it doesn't meet my definition.

BRIAN CHEUNG: Are there any other financial stability risks, maybe? We saw the Archegos episode. We know that the Fed had that financial stability report where it's watching maybe things outside of the traditional banking system, maybe in the hedge funds space.


BRIAN CHEUNG: What's the top thing that you're watching that could be a risk as we continue to have as easy-money policy?

RICHARD CLARIDA: Well, one thing that I really found-- a number of things during the Fed is the Fed has in place a very systematic and robust framework for assessing financial stability. There are really four pillars. It looks at vulnerabilities in terms of valuation and in terms of leverage liquidity and valuation. And those reports by the staff are released twice a year. The committee also gets briefing on those. So I will just, on that point, state-- restate what Chair Powell said recently, I believe, at his press conference that we're obviously very attentive and attuned and looking at a broad range of indicators of financial stability, but we think financial stability risks now are manageable.

BRIAN CHEUNG: And then lastly, I just wanted to ask, there's a lot of question about the musical chairs that could be happening within the Federal Reserve Board. Your term on the Fed expires January 2022. Have you had discussions with anyone in the administration about a renomination?

RICHARD CLARIDA: I have not had any such discussions. And I am enjoying being Fed vice chair enormously. It's been an enormous privilege to do it, and I'm eager to get as much done as I can of my remaining time in this position.

BRIAN CHEUNG: And I'm sure it'll be very interesting, especially given what everyone has gone through in the last year. But again, Federal Reserve vice chairman Richard Clarida joining us here on Yahoo Finance. Thank you so much for joining us.