MNI: Transcript of MNI's Interview with Philly Fed's Harker

MNI (JACKSON HOLE, WYO.) - The Federal Reserve should begin the process of lowering interest rates in September and do so in a "methodical" fashion so businesses can plan accordingly, Philadelphia Fed President Patrick Harker told MNI on Thursday on the sidelines of the annual Jackson Hole symposium. (See: MNI INTERVIEW: Fed's Harker Ready To Start 'Methodical' Cuts )

The following is a lightly edited transcript of the interview. 

MNI: Is inflation still your top concern given what we've seen in the labor market recently?  

HARKER: I think we’re getting into better balance with respect to our dual mandate. Inflation continues to move down. It's taking its time but it is moving down. And labor markets continue to get into better balance. At this point I think we need to balance off those two parts of our dual mandate. 

We came out of the pandemic having a lot to catch up on. We’re now starting to get to the point where we're heading back to whatever a more normal market looks like. For example, take the revisions we just saw on jobs. If you average it out, that's about 156k to 158k jobs a month. That, if you go back before the pandemic, was a very good number. It’s not as though that's a bad number. 

And we're seeing other signs that the labor market is getting into better balance. Labor force participation is up some, claims today was as expected. And by the way even the jobs number was expected. The work we've done at the Philadelphia Fed on the early benchmark revisions, we were anticipating this number to decrease. It was a little more than we expected, but not by a lot. These are things we were expecting to happen.

Add to that data, what I've been hearing from my contacts all summer, it feels -- and I emphasize feels because it's not data driven -- it’s easier for people to get employees, except in the skill positions that they were having problems with even before the pandemic happened, like machinists, nurses, that continue to be an issue. But generally people feel they can get the labor they need for the businesses they have. 

MNI: Are they still hoarding workers like they were doing earlier in the pandemic? 

HARKER: I don't hear that as much anymore. What they’re concerned about, particularly in the manufacturing area in Pennsylvania is we the Baby boomers are retiring and there are not a lot of people behind them to take those jobs. 

MNI: What about layoffs? 

HARKER: Not hearing a lot. We get the headlines from the tech companies but that's not what we're seeing across the board.  

MNI: What about demand for workers? 

HARKER: It’s kind of normalized. It varies by sector, in health care they're still trying to find people. We saw a big surge in government employment, but as a percentage of employment it's at 15% pretty much where it was before. So some of that was catch up too and will slow down naturally.

MNI: Back to the 818k jobs revision, you're saying much of that was expected. Some analysts say it doesn't take into account the immigration surge.   

HARKER: There will be a lot of analysis and other revisions. The caution is don’t look at any one number as the measure of the health of the labor market, you have to look at the totality of the data. 

MNI: So your sense is the labor market is normalizing, not weakening dramatically. 

HARKER: Yeah. There’s always a risk and that’s what we have to be cognizant of, and why I think we need to start taking action now. Start the process of lowering rates. 

MNI: Were you one of the officials who would have supported that move last month? 

HARKER: How I'll answer that is: right now I think we need to start that process of normalizing rates. 

What I’m hearing from my contacts all over this summer is: As you start this process, be methodical about it. Don’t surprise us. On the way up, we understand why you had to take rates up very quickly. It was very difficult for us to absorb those changes. What we ask right now, barring some unforeseen changes in what we expect in terms of labor market and inflation, is start to bring rates down, but do it in a methodical way. So that we have time to make the changes we have to make. Whether it's the banks that will see deposits move in different directions, or repricing of loans, or businesses making decisions about investing in a new housing subdevelopment. Whatever it is, they're just asking for as much certainty as we can provide. Not certainty -- and this is important -- in terms of the exact number, whether it's 25 or 50. But just the process. Just move it down in a methodical way. That's the word I heard. 

MNI: So even if the committee wanted to take a bigger step down, with a 50 bp move, that might still be considered methodical if it's telegraphed well? 

HARKER: It will have to really depend on the data. What I'm hearing is let's start the process and be consistent with it. 

MNI: So that means no start-stop. 

HARKER: They would not like that, let me tell you. And there's really no need to do that, again, unless things change in a way that we're not anticipating. Then all bets are off and you have to do what you have to do.  

MNI: Would you support a move at every meeting? 

HARKER: It really depends on what we're seeing. 

MNI: What would it depend on? 

HARKER: Labor market. Inflation -- we know where that’s heading, again barring unforeseen changes. If the labor market turns negative in a way we’re not anticipating, then I think we’ll have to accelerate the process. At this point it's not in our forecast. 

MNI: What's been driving the uptick in the unemployment rate? Is it supply?  

HARKER: It's what we anticipated all along. We’re looking at unemployment probably peaking somewhere below 5%. Where did we think the natural rate was before the pandemic? Probably 4.5%. I don’t think that's an issue. It's moving back to normal. 

MNI: Where do you expect to be at the end of the year? 

HARKER: It’s going to go up most likely, but I can't tell you the exact number. 

MNI: But it wouldn’t concern you if it went up a few tenths more? 

HARKER: No. You can't just look at that number. Look at claims, job-to-job transition rates, the totality of data. 

MNI: On inflation. In June you said the first quarter was a bump in the road and you wanted to see more data. Has the second quarter and July data convinced you? 

HARKER: It’s moving in the right direction. We know that shelter continues to be high. But take services, services are heavily dependent on wages, and we're starting to see wages normalize, so you would expect to see services ex-housing to normalize.

Housing is an interesting story. Two things I'm hearing from contacts. As we bring rates down in a methodical way, this will do two things. The long end of curve has already reacted in anticipation of this. I'm hearing from bankers they're back in the mortgage business, they're starting to see that tick up. That’s a good thing, because it will eventually break the lock-in effect of people staying in their home because of a cheaper mortgage. The second thing we're hearing from bankers is developers have been sitting on the sidelines waiting for rates to start to come down before they put a shovel in the ground. As rates start to come down they anticipate they'll start to see more business and new housing starts. 

We need to put this in context, before the pandemic we were 2 million units short in housing. This has to do with structural issues that need to be resolved, like zoning. We need more affordable housing in particular. While there has been a lot of development of high end homes in our market, we just need more affordable housing. 

MNI: Are you worried all that pent up demand will rev up the economy and inflation? 

HARKER: I don't think so. This is going to take time. This doesn't happen overnight. Adding capacity will take time. 

MNI: Housing inflation hasn't cooled down as much as expected. What do you make of that? 

HARKER: It’s a supply issue. It's the lock-in effect plus people are not developing new projects. There are exceptions. In Philadelphia we’re starting to see rent discounts for multifamily, so we're starting to see prices come down. We’ve added a lot of supply to the Philadelphia market and as a result we're seeing prices stabilize or come down. 

MNI: But if housing inflation doesn't come down, then you can't get to 2% unless you bring other things down.  

HARKER: It's going to come down. It'll take time but it's going to come down. 

MNI: When do you expect inflation to get back to target? 

HARKER: That's a hard number to know for sure. We don’t need to get exactly to target, we need to be around 2%. We'll never hit the number exactly, that's just not possible. But we need to be around 2 and it’ll take some time. It’s a slow process and will probably take at least through next year. 

MNI: Are you worried about the risk that it gets stuck above 2%? 

HARKER: No I’m not at this point. If you look at the dynamics of when we start to normalize rates, we'll see the shelter inflation issue resolve itself over time as capacity comes online. I just don’t see the dynamics in the economy right now leading to a point where we get stuck significantly above 2%.  

MNI: Once rates start to come down, what will happen to growth? 

HARKER: Growth will continue to do well. Above trend for a while and eventually hit trend. There’s always a risk of recession but I don't see an outsize risk at this point. 

MNI: There's a lot of debate about the neutral rate, and some people think it'll be higher in this cycle. Where do you see that? 

HARKER: I think it’ll settle probably around 3-ish. There's a lot of debate around the neutral rate. It’s a number that’s unknowable. You can infer it. You can't measure it. So we'll just have to let the real data, market data, inflation data, labor market data, dictate where we’ll end this cycle.  

MNI: The framework review is kicking off at the end of the year. Is there anything you want to see changed? 

HARKER: It's too early to tell. The framework has served us well. A lot things have changed, particularly the rise of nonbank players in the financial sector. We're trying to understand as a result monetary policy transmission mechanisms. We may need to revisit the textbook approach. Take housing. When we increase rates, shelter inflation should come down. It didn’t. Even that's a small example of how monetary policy transmission may not match textbooks. 

MNI: Does that mean the Fed's ability to guide the economy is more limited? 

HARKER: I think it has always been limited. We have to be humble. We create conditions for growth, we aren't growth. The real economy is real businesses, real governments, real consumers making decisions. It's not because we tweak rates. 

MNI: One last question. The market volatility in early August after the July jobs report. Was that worrisome to you to see that? 

HARKER: You have to step back. What was also going on? The Bank of Japan raising rates. How much of that volatility was due to the carry trade versus the jobs data? We don’t know that for sure. But look how quickly it reversed itself. So you got to think it wasn't just the jobs number. 

MNI: Analysts were immediately switching their calls to 50 bp cuts. 

HARKER: Some were even saying 75. This is where our job is to take a breath, look at the totality of the data. See what needs to be done and don’t overreact one way or the other.