MNI INTERVIEW: Transcript of MNI Interview With Fed's Harker

The following is a lightly edited transcript of MNI's interview with Philadelphia Fed President Patrick Harker, conducted Thursday on the sidelines of the Kansas City Fed's Annual Jackson Hole Symposium.

How would you describe the inflation picture now, and where is it headed?

Inflation is not where we want it to be, but it is moving in the right direction. Is it moving as quickly as we would like? No. But it is moving in the right direction. So my view then is, let’s keep doing what we’re doing. That doesn’t necessarily mean keep increasing rates. We can hold steady for a while because we are clearly in a restrictive stance in my view. We can sit here for a while, let monetary policy continue to do its work as inflation starts to go down to our 2% target.

We forecast that inflation will come in under 4% this year, 3% next year and 2% the year after. So it will take time but that’s ok because in taking our time to get inflation down, we’re helping the American people deal with the issues that inflation causes, but at the same time not really damaging the economy to the point where you see a significant increase in unemployment.

Is it time for a prolonged pause? Do you think rates have reached their peak?

I’m not ready to call a pause today, but I’m leaning in that direction and I’ll see how the data in the next few weeks turn out. We have some more data coming at us but I think at this point it’s prudent to pause and let what we’ve done work.

What do you make of recent signs that growth is reaccelerating?

On GDP growth, we need multiple months to see if that’s a trend or not, but it’s not a bad thing if we’re seeing growth and we’re seeing inflation come down. On the labor market, that’s a healthy sign that you’re still seeing labor demand.

I’ve been out and about in my district all summer meeting with people, businesses, community leaders, bankers.There’s clearly been a softening in the labor market. We hear this over and over again. It is easier for firms to find people to work. And people aren’t leaving at the same rate they once were. So you look at those two situations, whether it’s growth or the labor market, I think we’re moving in the right direction. It’s just going to take some time.

So do you see a soft landing as likely?

That’s our forecast. Things can happen so we have to be prepared. Right now our forecast is we’ll see unemployment tick up to 4%-ish, back to its natural rate, with a continued deceleration of inflation.

The July minutes cited a “couple” of officials who wanted to pause. Were you one of them?

I’m leaning more toward a pause at this coming meeting but again the data will dictate what we actually do in September.

What does higher for longer mean to you? Are you counting on some passive tightening that might take place as you keep rates on hold while inflation keeps coming down?

When I think about the pause – I don’t consider it a passive tightening, it is real tightening, it’s a restrictive stance that we’re in right now, and that’s why I don’t think we need to do much more if anything to continue to tighten.

We have another tool that’s at work as well that’s important to put into this, which is a reduction of our balance sheet. That also is providing more tightening of financial conditions. That continues to work as well in the background. So we have both the tightening that’s happening just naturally as we hold at the higher rate plus the reduction of the balance sheet, which should continue to remove financial accommodation and hence bring inflation down.

Do you think it would be feasible to continue QT even after an eventual start to rate cuts?

I haven’t come to any definitive conclusion on that. My preference right now would be to not cut rates as we are continuing the quantitative tightening. I think it is a bit confusing, but there may be circumstances where that is appropriate to do, we’ll just have to see.

What do you make of the spike in 10-year yields? Does it help the Fed’s tightening effort?

There are a lot of factors at play ongoing out on the yield curve. We only control the shortest of the short end. That said, by having that rise in the 10-year it is tightening financial conditions, and we’re hearing this.

As I mentioned, I’ve been out and about in my district talking to people and they’re clearly seeing some contraction in credit as part of this. Some of that’s demand driven because rates have gone up and people are holding off projects, particularly businesses. But also just the banks are holding liquidity and this point. These two things are happening which of course would tend to raise the rates in some ways because if I’m holding back on liquidity, there’s less to go around.

Do you see that as a product of the banking turmoil in March?

It’s a combination of factors. Some of it is people being cautious generally going into a situation that’s uncertain. Some of it does relate to what happened in March but that’s fading a bit. More of it is making sure they’re taking care of their existing customers – we hear this a lot from the bankers – but for new customers that are coming in, if it’s not a slam dunk business case, they’re holding off.

What are you hearing from district contacts on inflation, pricing power, jobs and credit?

Let’s start on the credit markets – we have a lot of community banks in our district. Let’s talk about commercial real estate, that’s the one that everyone is thinking about right now. Right now there’s very little mortgage demand, particularly from first time buyers, so that is not really active at this point.

On commercial real estate you really need to parse things out, it’s not one large bucket. The banks who were banking warehousing and logistics operations, that’s still active. Suburban office, that still seems ok – we still have to go to the dentist so the dentist needs an office. The area is downtown office space, we know the struggles there, there are concerns. So when it comes to the credit tightening, particularly in that downtown office space area is where they’re pulling back some.

In terms of the labor market, they can hire more easily and their clients are finding an easier time hiring. In some cases they are cutting back on hours but trying to retain the workers. So you’re seeing that, part-time for economic reasons has gone up because people are trying to hold on to the workers that they fought hard to get during the pandemic.

On the inflation front, the headline is driven a lot by energy and food prices which are very volatile. But on the core, they are losing some pricing power and you can see that, visibly, just drive by any auto dealer and look at the lot. There are a lot more vehicles out there and it’s easier to get them. I know – I bought a vehicle during the pandemic, I waited a year and a half to get it, had I just waited a little longer I would have gotten it at a much lower price. But that’s the way it goes.

One thing we heard from a major supplier of back to school sales – they’re seeing some softening even in that market. Things just seem to be slowing down. And people seem to be going downmarket, they’re going for the less expensive options – we’re hearing that a lot as well.

Do you worry that holding rates steady with core inflation above 4% risks sending the wrong message unanchoring inflation expectations?

There’s always that risk of unanchoring inflation expectations, I’m very sensitive to this. but I don’t see that as an outside risk right now. I think there’s always the risk of going too quickly. A pause doesn’t mean we’re stopping, a pause means we’re going to continue to do our work and watch inflation come down with a restrictive stance. I’m not overly concerned at this point.

You said there was a risk of going too quickly. Were you one of the officials who see the risks of overtightening as having become balanced with the risk of undertightening?

Yes, and that’s why I’m more in the camp of let’s pause for a little bit and see how things play out.

Is there a risk that you’re waiting too long to get back down to 2%? Is that a dangerous precedent?

I don’t think so. Because we’re balancing that versus damaging the employment market in a significant way.

I parse inflation out, not just one headline number or one core number but think about the things that people really need. The ones that are most affected by inflation are low and moderate income families. They need food, they need transportation, they need energy. As long as things are starting to move in the right direction, even if the price of airfares or something is not, I’m less concerned. If I see continued spikes in food and shelter – we know where shelter is going that’s coming down. We see the real time rents, we’re starting to see things moving in the right direction. That’s good because that’s a big chunk of the American budget.

What about supercore?

The way I think about this, instead of labeling it as core, supercore, is to take a distribution of all goods and services across the American economy, and ask how many have inflation above, 5%, 4%, 3%, 2%, and as you start to see that distribution shift to the lower realm you feel better about where inflation is going. Especially what I think about is what are those things that are necessities of life. So I don’t like these labels, core, supercore.

How long do you see rates staying at peak levels?

At least through the end of this year and then we’ll have to see what happens next year.

Has r-star or the neutral rate of interest risen in your view?

R-star is a statistical concept, you can’t measure it, you can only infer it. There’s a big difference between short-term and long-term r-star, so there’s a lot of volatility in the measurement because it’s hard to distinguish between long- and short-term r-star. At this point we still think it’s around 0.5%, adding 2% inflation, in the long run you get to 2.5%. Because that’s where it was before. So the question I keep asking myself is, what has the pandemic done that has fundamentally shifted the American economy, the global economy. Lots of things have changed, I accept that. But how many of those have shifted r-star in a significant way from where it was. I don’t have a clear answer to that, I don’t think anybody at this point has a clear answer to that. A reasonable hypothesis is, not much has changed. Yes, the relationship with China is different, supply chains have shifted, and AI is coming. But has any of that fundamentally shifted r-star. I don’t know the answer to that but at this point I’m leaning toward saying, not a lot.

I would prefer to focus on the things that we know how to measure like unemployment, the signals, as opposed to something that is not a measurable entity.