“While you don’t want to be too preemptive” in tapering, “you don’t want to be so reactive as to being late.”
By Wolf Richter for WOLF STREET.
After an onslaught of Fed governors assured us over the past few days that monetary policy is “in a good place,” and that it’s “not time to talk tapering,” and that inflation is nothing to worry about, despite the “raging mania” in the markets, as Druckenmiller called it, and despite inflation that has come unhinged for the first time in decades, here comes odd-man-out Dallas Fed President Robert Kaplan, speaking at a Q&A event at the University of Texas at Austin’s McCombs School of Business. And it was fascinating.
It was about inflation, supply-and-demand imbalances, tapering, risk and risk management with regards to inflation and the excesses in the markets, including the housing market, and even on how much influence he has on the FOMC where he is now the odd man out. And so here are some tidbits (I grouped together his responses by topic; transcription of the video is my own; apologies if I mangled his words).
Right off the bat, and throughout, one of the big issues were the imbalances and shortages in various goods and in the labor market, and the impact they have on inflation.
In terms of the semiconductor shortage, he said, “people in that industry were telling me first [the issues would be resolved] within 12 months. Now it’s lengthening. Now they think it’s closer to 12 to 24 months. More uncertainty.”
What they’re struggling with is that demand is not fixed. “If demand is fixed, and if there are no intervening events, it is much easier for people to say, ‘OK, within the next 12 months.’”
“What is happening is demand is shifting. There’s more fiscal policy coming, and demand could be strengthened for some of these products, and that’s actually creating some of the uncertainty. Demand is not static; it’s increasing and there are intervening events. And that’s why there is so much uncertainty as to how long this is going to take.”
What he worries about is, “depending on how long it takes to resolve these supply and demand imbalances, do they start to feed into inflation expectations?”
“While I’m willing to let inflation run moderately above 2% for some time,” he said, “I’m also committed to anchoring inflation and inflation expectations at 2%.”
As the economy is “making progress to achieving full employment and price stability, it would be healthy to begin the process in the not too distant future, sooner rather than later, to at least discuss weaning off these extraordinary measures” – these extraordinary measures being the purchases of Treasury securities and mortgage-backed securities.
“I worry about excess risk taking in the financial markets, very tight credit spreads. I worry in particular about leverage and excess risk-taking building up in the nonbank financial market. I worry about some of the excesses and imbalances in the economy,” he said.
“And in addition, I focus on the housing market, and I use that as an example. We buy $40 billion of mortgage-backed securities every month, and that has helped during the pandemic to bolster the housing market. However, at this stage home prices are at historically elevated levels,” he said.
“And in addition, increasingly over the last 6-8 weeks, I’m hearing more and more widespread reports of private investors entering the single-family housing market, competing with families, often making bids above the asking price and requesting that the house remain furnished.”
“So, we’re in a position where families are being crowded out, or squeezed out, of being able to buy the first home,” he said.
“This is an example of an excess, maybe an unintended consequence, a side effect of these extraordinary actions. In a crisis, the benefits of these extraordinary actions outweigh the side effects. As we emerge from this pandemic, that balancing calculation starts to change.”
“I would prefer to be talking, for example, about the mortgage purchases sooner rather than later. I think it would be healthy, as we emerge from this pandemic, to have those kinds of discussions and to begin the process of weaning off some of these extraordinary actions, particularly some of these purchases.”
If you have these excesses and supply-and-demand issues, “what you don’t know is, depending on how long that goes on, whether it starts to get embedded in inflation expectations. And you worry that inflation expectations start to get to be more elevated, and then you are getting them elevated to a level that is not consistent with anchoring them at 2%. That’s the part I’m concerned about. This is a risk for me.”
“I’m not a Ph.D. economist. I’m coming from a risk management background. I’m accustomed to looking at a range of outcomes and acknowledging that there is always a range of outcomes,” he said. “And you want to apply some of this risk management to realize that there may be outcomes that may not be exactly what you expect.”
In terms of tapering, “ideally you want to do things gradually and communicate them in advance. While you don’t want to be too preemptive in taking action, you don’t want to be so reactive as being late. And I think that balance is critical.”
Asked about his influence at the FOMC, where he is a non-voting member this year, he said, “If I have something to say, I speak up, even if it’s a different view than everyone else.” Alas, “things don’t always go the way I want them to,” he said. “But I always have my say, and I always have the ability to try to influence the decision. Sometimes I succeed, and sometimes I fail.”
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