Federal Reserve Bank of Boston President Eric Rosengren in an interview with The Wall Street Journal on Monday said he sees no urgency for the Federal Reserve to raise interest rates even with a positive economic outlook, and laid out some guidance on how much of an inflation increase he is willing to tolerate. Mr. Rosengren also flagged where he sees risks in the financial system and said research by the Fed related to climate change is entirely appropriate. Here is a transcript of the interview, lightly edited for clarity.

MICHAEL S. DERBY: One place I wanted to start out is a place that some of your colleagues have talked about recently. What was the liftoff dot you submitted to the [Summary of Economic Expectations] forecast back at the March FOMC meeting?

MR. ROSENGREN: Yeah, so I don't publicly talk about my liftoff dot. What I would say is that I'm expecting a very strong economy over the course of this year, I'm expecting the unemployment rate to get quite low by the end of the year. But we're following a different monetary policy and I think it's reflected in the median and the range of the dots. What everybody is going to be is much more patient.

So I'm not giving a specific [forecast] about where I expect [a rate liftoff to be]. And actually, I don't know if that is that useful, because I think there's enough variance in forecasts right now that we still don't, we don't have a lot of statistical data on pandemics. This was the only major pandemic that's occurred in the post war period. And so being too precise about exactly when liftoff is going to be, I don't think we have that foresight, to be quite honest. I think we're two years away from when that likely is going to become a much more important question. We still have a lot of labor market slack, the participation rate is still quite low relative to prior to the pandemic, and the unemployment rate is still at 6%. So we need to get rid of the slack, have a sustained inflation rate, before we need to worry about raising rates.

MR. DERBY: Do you think that people put too much emphasis on the dot plot? Chairman Jerome Powell has sort of, kind of tried to wave us off and maybe sort of downgraded some of the attention that goes to it. But market participants really work over that dot plot and the SEP to try to get a sense of the Fed's thinking about monetary policy. Do people pay too much attention, in your view, to the dot plot?

MR. ROSENGREN: I think that the dots are useful at certain times in the cycle. But this is a time where, whether it's two years or three years out, it doesn't affect many decisions right now. And all the FOMC participants thought that we were going to keep interest rates at the low zero to 25 basis point range for the federal-funds rate throughout this entire year. So for most investors and most decision making, I think what's relevant is we're not going to be raising rates this year, unless something dramatically changes relative to what our forecasts are.

But I would highlight that this is a pretty usual time. Our forecast is very intertwined with a pandemic. And one reason the forecast is so strong right now is because things have been going so well with the vaccination rates. But if we get a covariant that is not effective with the vaccine, our forecasts are going to change very dramatically and when we end up lifting rates will be very different. So I think people should focus not only on what the dot plot is telling them, but also how, what the variance around these forecasts are, particularly coming out of a pandemic, which just isn't in our historical data that we use for most of our models.

MR. DERBY: So it's just the idea that there are a lot of moving parts, there is a lot of uncertainty, it's an unusual experience, making it very difficult to know how things might play out on the monetary policy front?

MR. ROSENGREN: Yeah, and I would just add to that, I had a chart in my talk about inflation and the range of inflation forecasts for the Blue Chip that forecast was really large. The top 10% really has quite a high inflation rate and the bottom 10% was not getting up to 2%. So it just highlights the amount of uncertainty and, obviously, what happens to inflation is pretty important for what the monetary policy decision is.

And yet, this is just a very difficult time to forecast what's going to be happening to inflation. So my best guess, is much closer to the average. But if we got either the top or the bottom of the Blue Chip forecast, that would be a different monetary policy. And when you see such a large variance over a slow moving process that normally is fairly tightly bunched, that tells you there really is an uncertainty, given the pandemic, given the amount of fiscal policy stimulus, and given the very unusual monetary policy stimulus.

MR. DERBY: So do you have a number or range or anything that you could give us about inflation to tell us where, if there's a threshold for where inflation rising becomes problematic for you?

MR. ROSENGREN: I mean, as long as it's in the 2 to 2.5 percent range, which I think is highly likely over the next two years, I would not be particularly concerned. So we've had a period where we've systematically, once again, been below our 2% inflation target. We're going to need a period that is going to be a bit above. And I do think that there are going to be periods over the course of this year that are a bit above 2%, both because of some of the supply chain issues and because of the base change that reflected the very low prices that occurred as the pandemic first started. So we're going to have some larger readings, but I don't think we should overreact to that. We care about a sustained inflation rate, not a one or two months reported inflation rate.

MR. DERBY: I wanted to ask you about financial stability. There has been concern that -- and I know these are things you've talked about in the past -- but are you seeing particularly elevated risks in the financial stability front, especially in terms of how they might be tied to the current settings of monetary policy?

MR. ROSENGREN: I think the three biggest risks are actually more institutional rather than monetary policy based. So the problem that we had with money-market funds and the run on prime money-market funds that happened, both during the pandemic and during the financial crisis, was a problem that should have been corrected prior to the pandemic, and certainly should be corrected after the pandemic. It disrupted short-term credit markets, it made things much worse, and required us to do emergency facilities. So that is a high priority.

A second high priority is the Treasury securities market is a critically functioning market for the United States economy and actually for the global economy. And so the fact that the market was so badly disrupted by a large number of people deciding, or organizations deciding, to get liquid very quickly, and the fact that the broker dealer balance sheets is a very inefficient way to deal with rapid flows of funds going in and out of the government Treasury market, indicates that we need a much more resilient system.

And then I think there were some bank supervision lessons that we were worried about credit availability, once again, we were worried about credit availability during the financial crisis, and we were worried about it during the pandemic. That's why we had the liquidity facilities. That's why we did a lot of the regulatory changes we did in the middle of the pandemic, all of which are justified. But again, that's correctable by having more resilient and robust countercyclical capital.

So I think those three things are things that were highlighted during the crisis that we ought to fix. First, I think there's going to be time to worry about some of the other financial stability risks. Certainly, the family offices that have been highlighted recently indicate that prime brokerage is riskier than many banks seem to think, and particularly some of the second tier banks that are active in the prime brokerage market took very large losses. So we should be looking very carefully at prime brokerage, and we should be looking at the transparency of family offices.

And I do worry about the amount of leverage in the economy and do think that that could be a problem in a low interest rate environment. Leveraged firms and households can take risks that can become problematic. But I think those are problems for the longer run. The three more immediate problems are the kind of the more institutional structure kind of issues that I think are the first order that needs to be addressed.

MR. DERBY: Do you think the Treasury market could stand on its own and function fairly smoothly without the fairly extensive piece of Fed asset buying right now?

MR. ROSENGREN: I think it would be risky not to have a more robust infrastructure than we currently have. So we still don't, we're not completely out of the woods with the pandemic. If we get surprised and a highly infectious dangerous variant occurs, which I'm not expecting, you could once again see people moving to a more liquid position very quickly. So I think we need to find a way that Treasury securities are purchased and sold, and the way they're financed, has to be less reliant on broker dealer balance sheets. And so I think for that infrastructure we should be taking a hard look at, and setting up, a structure that is much more robust for potential waves of sales.

MR. DERBY: Is that something the Fed can do? Or is that something other regulators need to do?

MR. ROSENGREN: I think it's something the FSOC [Financial Stability Oversight Council] should be taking up, but there are certainly some actions that the Federal Reserve can do.

MR. DERBY: I spoke to some of your staffers recently about central bank digital currencies. How important do you think the CBDC [Central Bank Digital Currency] effort is for the Federal Reserve? And China's launch of its own digital currency, does that change the calculus for the Fed at all?

MR. ROSENGREN: I think it makes sense to be prepared that if policy makers decide, that's broadly both the Board of Governors and Congress decide, that it is appropriate to have a digital currency in the United States, that we have the technological expertise, that we can do that relatively quickly, relatively safely.

So there are a lot of issues to think about in terms of cybersecurity. There are a lot of issues to think about regarding resilience. But I do think that there are some real benefits to a digital currency. It certainly makes foreign transactions much less costly. It provides an ability for unbanked individuals to have access to the payment system in a more flexible way. It also, given that we are the reserve currency, I think ideally, the reserve currency would be more easily transacted globally. And if we had a digital dollar, that would certainly be possible.

But at the same time, we have to think about the risks involved. And that's making sure that any technology we adopt has the right kind of structure, that we don't have to worry about some of the privacy, some of the security issues that are critically important for any rollout of a digital currency.

MR. DERBY: And how do you set it up? One of the concerns that some people have is that it could in times of stress actually exacerbate stress in the private financial system by people getting spooked and moving their money out of private bank accounts into, let's say, whatever accounts hold fed digital dollars. How does the Fed design to deal with that problem?

MR. ROSENGREN: There are a lot of design features that, I mean, you can limit how much you can have on the digital currency, you can limit how much could flow. There are a bunch of constraints. Those are decisions policy makers have to make to think about some of the financial stability concerns. But I think those are surmountable.

Right now it is pretty easy, if I want to take money in my brokerage account and put it into cash, it doesn't take me very long to do that. So I don't know that the digital currency dramatically alters things in the same way that people want to get in cash in the Treasury securities market, they already showed they can do it very quickly. So I think that risk is already there. And we just need to think about appropriate measures to make sure that if everybody decides to get very liquid all at the same time, we have appropriate measures to make sure that's not too disruptive.

MR. DERBY: A final question. I don't know if you saw recently, Sen. Pat Toomey sent a letter to the San Francisco Fed saying he is worried about that bank's increased research focus into climate change-related activities, and also social related research. The senator talked about mission creep and about politicization of the Federal Reserve and its research operations. And, and I wondered if you had any response to that? I know it was directed to the San Francisco Fed, but I've heard Fed officials broadly talk a lot more about climate change and its importance. Is it fully appropriate for the Fed to be turning its eye to climate change and to matters of economic inequality?

MR. ROSENGREN: If a bank is very active, in a region of the country, like California that has mudslides, earthquakes and fires, or Houston and Louisiana that have had bad flooding, or Miami that has hurricanes, and the frequency of that increases, and you don't take that into account when you supervise a bank, and when bank management thinks about how exposed they want to be, that would be a serious problem for the bank and a serious problem for the regulator.

So of course, we should be thinking about how more frequent climate incidents affect bank lending, bank portfolios and bank risk. Now, we're at the early stages of that, but this has already been done by the property and casualty insurance companies that are providing insurance.

But what we don't have is good information about how much uninsured risk is being taken, whether banks have appropriately taken it into account. What happens if tail events occur in a region that's prone to have more of these incidents? And what happens if these incidents happen with more frequency and more severity? So I think it's a very legitimate area for both banks and bank supervisors to be thinking about, is how we address higher frequency of really bad outcome events that will affect the solvency of firms, will affect the solvency of households.

So I think that's well in the purview of bank supervision, not only of the Fed, but the OCC [Office of the Comptroller of the Currency] and the FDIC [Federal Deposit Insurance Corporation], that you don't want a bank that's fully exposed to an area where one or two sequencing of negative shocks from the climate end up destroying the portfolio of the bank and require a payout of deposit insurance. And so I think these are legitimate risks to be researching and thinking about.


(END) Dow Jones Newswires

April 13, 2021 15:29 ET (19:29 GMT)

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