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Dan Loney: Well, if you go back over the
last 15 to 20 years, there certainly have been a heightened
focus on the area of finance,
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with obviously a lot of the
coverage that is now out there in the media world, but also the
focus on the decisions being
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made that can have an impact on
our economy. But what does that mean for us right now,
especially in a timeframe where
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we've been coming out of the
pandemic, and now we're also dealing with inflation? Pleasure
to be joined right now by
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Loretta Mester, who is the
former President of the Cleveland Federal Reserve Bank.
She is now an Adjunct Professor
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of Finance here at the Wharton
School. Loretta, great to have you with us today. Thanks for your time.
Loretta Mester: Thanks for having me
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on. - Thank you. I guess let's
start with your view of where this economy kind of stands at
the moment. - Yeah.
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Well, you know, what's
interesting about the economy is that, if you think back to
the beginning of the year, the
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economy really started on a
really strong note. You know, businesses were very optimistic.
They were really looking forward
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to do regulation, because they
viewed that as being a way that they'd be able to innovate more
and really engage in M&A
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activity and, you know,
expand more easily than they've been able to do in the recent
past. And then they were also
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expecting this extension of
tax cuts, which they were going to expire at the end of this
year, and even further cuts. But
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then things have really changed
in recent months. So if you think about what's
happening now, you know,
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sentiment among businesses and
consumers has really plummeted. And it's interesting, because if
you look at the hard data on
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growth and employment, they're
still holding up pretty well, but people have just become much
more fearful about how the
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economy is going to fare later
in the year. And as you and your listeners know, the source of
that concern are the uncertainty
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caused by the tariffs, and you
know, the fact that they were on again, off again, and everyone's
waiting for this week, later this
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week on Wednesday, to find out
more definitive information. The prospects of a global trade war.
Because it's not only what we do
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on tariffs, it's what other
countries do in response to those tariffs. And another
thing that adds to that is
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what's happening with Doge and
the cuts in the federal government. And I think it may
not be about the cuts, per se,
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but the way they're being
implemented has given some people some constant -- you know,
getting nervous about things.
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- So I think it's interesting,
because, you know, in the process of talking about the
markets that we have done on our
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shows here, the common theme is
the markets don't like uncertainty. Well, from the
Federal Reserve perspective, I
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think it's safe to say that the
Fed probably does not like uncertainty with a lot of these
policy decisions as well.
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- Well, I mean, nobody really
likes uncertainty. We all would like to know what's coming. And
you know, you talk to businesses
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today and talk to them
about the last time we had tariffs in 2018 and 2019, and
they would tell me, "Look, just
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tell me what the rules of the
game are. I'm confident I can handle whatever the policy is,
but if I don't know what the
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rules of the game are, it's hard
to play the game." And I hear the same thing now when I talk to
business people. They're all
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like, you know, "I'm pretty
confident in my business, and I'm pretty confident and I can
navigate, but I don't know what
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I have to navigate." And I think
that's part of the problem, is that, you know, we all
have to make decisions under
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uncertainty, but this has been
particularly uncertain because it hasn't been stable, right?
One day, it's one thing, it
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seems like the next day, it's
something else. And that makes it really hard for businesses to
plan. However, I do think that
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this uncertainty is not going to
be resolved. You know, Wednesday is going to come, but there's
still going to be uncertainty
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around things. And I think
businesses and policy makers at the Fed and, you know, other
policy makers are going to
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really just going to have to
navigate uncertainty and be able to deal with it. And personally,
my own view is that some of the
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businesses are going to
basically conclude, "Well, I have to make some decisions here. I
can't just wait forever." And I
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think they will end up making
some investments, but they'll be shorter term investments. They
won't want to go long, given
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that things could change, you
know, where they think one thing and then it turns out
that something else is
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happening. So I think we'll see
it affecting the economy, no doubt. We're already starting to
see that uncertainty affect
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decision making. But we'll have
to wait a little bit longer to see how it actually impacts
hiring decisions, investment
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decisions. It's a
downside risk to the economy, no doubt. - Does this start then to bring back the
potential, or at least it's
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being thrown out there maybe a
little bit more, around the idea of a potential recession at some
point down the road? - Well,
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certainly the risk of recession
has gone up. I mean, if you look at all these private sector
forecasts, they've all put a
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higher weight on the possibility
of recession. It's not the base case. You know, nobody's
really projecting that there'll
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be a recession. I don't think
it's the base case. But remember, at the beginning of
the year, that wasn't even in
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anybody's vocabulary, even
though, at any point in time, it's like a quarter percent
chance. You know, a quarter, 25 percent
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chance you'll have a recession
just because the economy runs in cycles. Now, those percentages
are up to like, you know,
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depending on which one you're
looking at, 30 percent, 40 percent, even 50, little under 50 percent in
most forecasts. So it's on
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people's minds now. And it's
even worse than just recession recession, it's like a recession
caused by uncertainty. And then,
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coupled with that, there's
upside risk to inflation. So you get this bad situation,
especially from the Fed's point
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of view, where you could have
growth slowing, you know, labor market weakening, and at the
same time, inflation not coming
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down and maybe even going up. So
that's a bad situation for the Federal Reserve, because, of
course, it has a dual mandate of
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maximum employment and price
stability, and you'd have sort of those working against one
another. - So
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then that brings into the
question, once again, about the potential of rate cuts at some
point this year. I think a lot
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of the expectation has been
maybe two, maybe one around June and one later in the year. Where
is your thinking on that
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potential right now? And maybe
to a degree that's still a little bit up in the air,
depending on what happens here.
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- Well, obviously the policy is
going to depend on not only what happens, but also the outlook
for the economy, because, as you
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know, the Fed policy doesn't
affect the economy right away, it has some lag in it. So
they're going to have to be
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looking out and sort of making
their best estimates about, you know, where the economy is
going. But look, there's two
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scenarios that would call for
further reductions in the interest rate this year, right?
So the first one is what I call
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benign scenario, which is the,
you know, sort of stubborn inflation numbers we've seen at
the beginning of the year turn
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out to be sort of either
seasonal or just, you know, not really lasting, and we get
inflation moving back down
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again, and it turns out the
tariffs are like one-off changes in the price level, and they
don't become inflationary. And
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so the Fed could, in that
scenario, return to its policy that it was doing in the middle
of last year, which was
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beginning to bring the rate down
from restrictive levels to more normal levels. But the other way
that the Fed will be, you know,
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putting rate cuts back on would
be a less happy scenario, which is basically the economy is
beginning to slow quite a bit.
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And, you know, they have to sort
of make that balance between inflation and maximum
employment, and they see that
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the economy is weakening enough
that it begins to have to do those rate cuts to really
support the economy. And that
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one is becoming more likely in
forecasts, that the Fed is going to have to take some action,
because we're going to see the
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unemployment rate go up, labor
markets weaken, growth slow down, and so they're going to be
cutting. Now, whether they -- I
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doubt -- I don't see that
things could change so quickly that they would want to
start that in June, but it could
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happen. And, you know, they're
going to be forward looking, and they're going to want to look at
the balance. I think a better
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strategy would actually be,
given that we've seen inflation readings being elevated, and
we've even seen increases in
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inflation expectations, which
are not welcome at all, would be to be on hold at the current
level for long enough that you
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could actually make sure that
those inflation expectations really are well anchored. And
then if you do see the economy
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and evidence that the labor
market is weakening, then being more willing to cut at a faster
pace than they typically are
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willing to do. Because that way
you're sort of doing the balance between inflation, which, you
know, they've made all this
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progress on inflation, bringing
it down. It's not back to two percent where they need it to be. You
wouldn't want to give that up. At
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the same time, they have to take
into account that there's a dual mandate, and the, you
know, employment side of the
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economy is very important. So
it's a hard balancing act. And you know, not everyone on that
committee is going to have the
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same view of how to balance
those two goals. And so that's what's going to be, you
know, what the chair, Chair
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Powell, is going to have to do,
is really gather all the information he can from around
the country, and that's what the
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Fed presidents do, they bring
that to the meeting, and then come up with the best path
forward that tries to balance
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those risks, hearing different
views on different sides of the table. And that'll be, I think,
the challenge for the Fed and
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for the chair. - Loretta, great to have you with us today.
Thanks very much for your time
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and your insight. All the best.
- Thanks, you too. - Thank you, Loretta Mester, former
Cleveland Federal Reserve
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President and now an Adjunct
Professor of finance here at the Wharton School.