00:00The former New York Fed president, Bill Dudley, writing a 25 basis point hike is too small to have a
00:05meaningful impact on economic activity.
00:08Bill joins us now for more. Bill, welcome to the program.
00:11Before this decision, you wrote in your column, you said the case for a hike was crystal clear.
00:16Is the case for another hike just as clear?
00:19Right now it is, unless the data changes pretty dramatically.
00:23Kevin Warsh basically said that he needs to make financial conditions less accommodative.
00:28It probably pushed him into the restrictive side, and he hasn't told us how much you need to do to
00:33do that.
00:33But judging by the reaction of financial markets, he hasn't really accomplished that yet.
00:38I think that he also signaled that this is probably the first in the series by talking about removing a
00:43dose of accommodation.
00:44That implies that there's more doses to remove forthcoming.
00:49And if you look at what the federal funds futures market is pricing in, they're pricing in three or four
00:53hikes over the next six to nine months.
00:56So the market certainly expects that the Fed's not done.
00:59And that makes sense.
01:01If financial conditions are accommodative, that's causing the economy to grow at an unsustainable pace.
01:06You need to do more to make financial conditions less accommodative to restrain economic activity.
01:12You know, what's interesting about the Fed's forecast, it's sort of the immaculate disinflation.
01:16If you look at the summary of economic projections, growth doesn't slow, unemployment rate doesn't rise, yet inflation magically sinks
01:23back to 2%.
01:24I think it's going to be a little bit harder than that.
01:26Bill, do you think we need the demand destruction?
01:28And what kind of level rates do you think is necessary to get that demand destruction, to get inflation back
01:34to target?
01:36Well, it's hard to know because, you know, it depends a little bit on how financial markets react.
01:40I agree with Kevin that financial conditions are really the way of judging the stance of monetary policy because that's
01:46how monetary policy gets communicated to the economy.
01:49So if the stock market ignores the Fed's tightening, if the bond market ignores the Fed's tightening, then there's more
01:54for the Fed to do.
01:55Did you think that Kevin Orsh did a really good job at this press conference, or do you think that
02:00he should have illuminated a little bit more kind of how he was thinking about the path forward?
02:06I think he did a much better job.
02:08But, you know, he was still very, very guarded, no follow-up questions, the answers were very short, didn't really
02:15answer the question about, you know, where's neutral in terms of a neutral federal funds rate.
02:21I think it's an odd concept not to have a view of whether monetary policy today is easy, neutral, or
02:26tight.
02:27I think you need to have some framing of where you think the federal funds rate is today in terms
02:32of whether it's providing positive impetus or negative impetus to the economy.
02:35So certainly much better, but still very, very guarded, very, very constrained.
02:41Do you have a sense that neutral is significantly higher?
02:43I mean, that was sort of the implication when he said that they're removing some of the accommodation.
02:46Or do you think that that phrase was just a commentary on last year's 75 basis points of rate cuts?
02:53Yeah, I think neutral is higher.
02:54I mean, it's higher because we have this huge AI investment spending boom that's pushing up to neutral rate.
02:59That's increasing the demand for capital.
03:01Now, if the investment spending boom comes to an end, then the neutral rate will probably drop back down.
03:08But for the time being, as we're spending, you know, hundreds and hundreds of billions of dollars on these data
03:11centers and the chips to fill them, the neutral is going to be higher.
03:15And the Fed's got to take that on board.
03:17But we often reflect on a conversation that we had together coming out of the pandemic.
03:22I believe it was 2021. Maybe it was early 22.
03:25I remember it was with Mohamed El-Erin at the time as well.
03:27And you made the case this Fed might have to go to five, which just sounded crazy at the time
03:31because I think we were still close to zero.
03:34And they went to five and they had to go further.
03:37And, Bill, it didn't cause the pain that the Fed chair at the time was talking about in Jackson Hole
03:42a couple of years later once he got there, the pain that was required to get inflation back to target.
03:46But what is it about this economy?
03:48You've alluded to some of it.
03:49But what is it about this economy that can withstand these interest rates?
03:53Because it's the resilience that has surprised so many people in the face of what this Fed has been doing.
03:58Well, I think it is financial conditions.
04:00So we've had huge wealth gains in the stock market, which supports people's spending who have hold equities.
04:06Obviously, it's not very good for the people at the lower end of the income distribution that don't have that
04:10benefit.
04:11And the AI boom.
04:12I mean, I think the AI boom is a sort of an exogenous factor that's pushing the economy along.
04:17And I don't think the spending on AI is particularly interest rate sensitive.
04:21I don't think if the Fed hikes 25 or 50 or 100, it's really going to have much to change
04:26the trajectory of AI investment spending.
04:28That's going to be driven by the returns on that investment.
04:31And that's going to be determined not to tomorrow or next month, but over the next few years.
04:37If you can't influence it, why do anything, Bill?
04:41Because you can't let inflation get ingrained above 2%.
04:44The Fed's gotten away with something over the last few years.
04:47If you told me five years ago that inflation would be above the Fed's target by a meaningful amount for
04:51five years,
04:52I'd be very concerned about the credibility of the Fed.
04:55But the Fed's managed to maintain that credibility.
04:58People still believe that the Fed will push inflation down to 2%.
05:01But you can't stretch that out indefinitely, especially at a time when the economy is performing fine,
05:07the labor market's very much in balance, and all the risks are on the inflation side.
05:12I mean, I think the worsening of the situation, the war in Iran and the uptick in oil prices,
05:17and obviously diesel oil prices in particular, basically raised the stakes for the Fed waiting.
05:23Bill, do you think that we would be talking about rate hikes if oil prices weren't where they were?
05:29It's possible that we might not.
05:32It really depends.
05:34As Kevin Warsh talked about, it's really the distribution of prices increases that we care about.
05:39It's really about the pass-through of oil prices into other things.
05:42But I think the increase in diesel prices is really important because it's going to affect things like airfare.
05:47It's going to affect things like food prices.
05:48It's going to have a lot of knock-on effects.
05:50It goes into transportation costs.
05:52So any good service that has to be trucked around the United States, that has to embody that cost.
05:58So it's not just going to be in the headline inflation rate.
06:01It's going to start to filter into the core inflation rate as well.
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