Odd Lots Podcast Episode Summary: "San Francisco Fed President Mary Daly Explains the 'Hawkish Cut'"

Release Date: December 23, 2024
Hosts: Joe Weisenthal and Tracy Alloway
Guest: Mary Daly, President of the Federal Reserve Bank of San Francisco and Voting Member of the FOMC

1. Introduction to the 'Hawkish Cut' Decision

In this episode of Odd Lots, hosted by Joe Weisenthal and Tracy Alloway, the discussion centers around the Federal Open Market Committee's (FOMC) recent decision to implement a “hawkish cut” of 25 basis points in interest rates. This move, coupled with revised inflation forecasts, has led to significant market reactions and raised numerous questions about the Fed's future monetary policy trajectory.

Tracy Alloway (01:26): “Joe, how about that hawkish cut, eh?”

Joe Weisenthal (01:29): “Exciting, interesting times in macroeconomics. The Fed, the markets, plenty to talk about right now.”

2. Inflation Outlook and Rate Cuts Explained by Mary Daly

a. Rationale Behind the Rate Cut

Mary Daly explains that the decision to cut rates was driven by the need to transition from a highly restrictive monetary stance to a more moderate one. Despite inflation not yet reaching the central bank’s 2% target, Daly emphasizes the importance of preventing the economy from faltering.

Mary Daly (03:24): “We had policy, rightly so, at a highly restrictive level... It's appropriate to move into a more moderate level of restrictiveness. Otherwise, what you end up doing is breaking the economy.”

b. Current Labor Market Assessment

Daly highlights that the labor market is balanced, reducing its role as a driver of inflation. She points out that maintaining high levels of restrictiveness could harm job growth, which is crucial for a soft landing.

Mary Daly (04:59): “The labor market is balanced now, completely balanced. It’s appropriate to move into a more moderate level of restrictiveness.”

c. Residual Sources of Inflation

Daly identifies two main residual sources of inflation: non-market prices and housing services. She explains that non-market prices, such as financial services prices based on asset values, may be artificially inflating the inflation figures. Additionally, housing services continue to exert upward pressure on inflation due to a persistent shortage of housing supply relative to demand.

Joe Weisenthal (05:19): “So what is the residual source of the inflation if it's no longer the labor market?”

Mary Daly (05:19): “It's non-market prices... and housing services, the price of housing and the price of rentals.”

3. Housing Inflation and the Fed’s Policy Tools

The discussion delves into the complexities of addressing housing inflation. Daly acknowledges that while interest rate adjustments can influence housing construction by affecting the cost of capital for builders, the fundamental issue lies in the significant shortfall in housing supply.

Tracy Alloway (06:53): “Housing inflation, is that something that the Fed would attempt to offset? And what tools do you have at your disposal?”

Mary Daly (07:18): “We do have a limited set of tools... The interest rate is one of them. Lowering rates can encourage builders to take projects off the sidelines, but it won't solve the supply-demand imbalance on its own.”

Daly shares anecdotal evidence from her district, illustrating how rate cuts have incentivized builders to resume stalled projects, albeit gradually.

4. Inflation Forecast Revisions and Economic Growth

Daly discusses the upward revision in the inflation forecast for 2025, attributing it to a better understanding of persistent housing inflation and geopolitical tensions affecting trade relations, particularly between the US and China. Stronger-than-expected consumer spending and economic growth also factor into the revised outlook.

Mary Daly (10:25): “Housing inflation might just be more persistent... Geopolitical issues and trade back and forth... Consumer spending has been stronger than most forecasters anticipated.”

She underscores the importance of flexibility in forecasting, noting that economic models must adapt to evolving data and unforeseen global developments.

5. Sentiment Surveys vs. Economic Data

The podcast addresses the discrepancy between consumer sentiment surveys and hard economic data. Daly explains that initial negative sentiment was driven by fears of persistent inflation and economic hardship. However, as optimism about a potential recession faded and businesses adapted to policy changes, sentiment began to improve.

Tracy Alloway (29:44): “How much emphasis would you place on those surveys, given that there was such a big discrepancy between the hard and the soft data?”

Mary Daly (29:44): “People felt inflation had stolen something from them... The sentiment turn started when people realized we might not have a recession and saw potential for wage growth to outpace inflation.”

She emphasizes that while sentiment is important, it must be interpreted alongside tangible economic indicators to form a comprehensive view.

6. Future Policy Outlook Amid Political Changes

With an incoming Trump administration poised to introduce new policies such as tariffs and immigration reforms, Daly discusses the Fed’s approach to potential policy shifts. She emphasizes the importance of the Fed remaining independent and not preemptively adjusting forecasts based on anticipated political changes.

Tracy Alloway (25:43): “How are you thinking through those sort of forward looking policy elements?”

Mary Daly (26:25): “It's best for the central bank not to engage in that kind of speculation. We'll analyze the policies once they are implemented and assess their net effects on the economy.”

Daly highlights the complexity of policy impacts, noting that the net effect depends on the scope, magnitude, and timing of the changes.

7. The Role of AI in Productivity and Economic Growth

Mary Daly delves into the potential impact of artificial intelligence (AI) on productivity. She draws parallels to the early days of the computer revolution, suggesting that while AI promises significant productivity gains, these benefits may take time to materialize and be reflected in economic data.

Mary Daly (35:55): “We're already seeing the impetus for change. Businesses are using AI to improve sales, design, and idea generation... it could take a decade, but it is happening.”

Daly cautions that the full impact of AI on productivity may not be immediately visible, echoing Robert Solow’s observation about productivity appearing "everywhere except in the productivity data."

8. Understanding the Neutral Rate and Its Implications

The conversation explores the concept of the neutral rate of interest, which Daly explains has risen due to a global reduction in savings and increased investment demand. Factors such as government borrowing and corporate investments in automation and AI contribute to this shift, indicating that the neutral rate is higher than pre-pandemic levels.

Mary Daly (15:39): “The neutral rate of interest is the one that persists when there's no shocks to the economy... It has risen due to lesser savings and increased investment demand.”

She underscores that this global phenomenon necessitates higher interest rates to balance investment and savings adequately.

9. Voting Influence in FOMC and Policy Decisions

Addressing questions about the significance of being a voting member in the FOMC, Daly asserts that individual votes have minimal impact compared to the collective deliberation and exchange of ideas within the committee. She emphasizes the importance of thoughtful debate over voting dynamics.

Mary Daly (44:26): “I've never seen an effect... What is influential are ideas, arguments, evidence, thoughtfulness about where we should go and how we should get there.”

Daly highlights the Fed’s transparency and the value of diverse perspectives in shaping monetary policy, regardless of voting status.

10. Defining a Soft Landing in Current Economic Context

Concluding the episode, Daly redefines a "soft landing" as a durable economic expansion that allows for wage growth to outpace inflation, helping families recover financially. She stresses that achieving this requires ongoing efforts to balance economic growth with price stability.

Mary Daly (46:27): “A soft landing is a durable expansion that allows wage growth above inflation... It’s not just about avoiding a recession, but ensuring that people can restore and improve their financial well-being.”

She shares personal reflections on the impact of inflation on families, underscoring the human element of monetary policy decisions.

Notable Quotes with Timestamps

• Mary Daly at 03:24: “We had policy, rightly so, at a highly restrictive level... It’s appropriate to move into a more moderate level of restrictiveness.”

• Mary Daly at 05:19: “It's non-market prices... and housing services, the price of housing and the price of rentals.”

• Mary Daly at 07:18: “We do have a limited set of tools... The interest rate is one of them.”

• Mary Daly at 10:25: “Housing inflation might just be more persistent... Consumer spending has been stronger than most forecasters anticipated.”

• Mary Daly at 29:44: “The sentiment turn started when people realized we might not have a recession and saw potential for wage growth to outpace inflation.”

• Mary Daly at 26:25: “It's best for the central bank not to engage in that kind of speculation.”

• Mary Daly at 35:55: “Businesses are using AI to improve sales, design, and idea generation... it could take a decade, but it is happening.”

• Mary Daly at 44:26: “I've never seen an effect... What is influential are ideas, arguments, evidence.”

• Mary Daly at 46:27: “A soft landing is a durable expansion that allows wage growth above inflation...”

Conclusion

This episode of Odd Lots provides an in-depth exploration of the Federal Reserve's recent monetary policy decisions, inflation dynamics, and the overarching economic landscape. Mary Daly offers valuable insights into the delicate balance the Fed must maintain to foster economic growth while ensuring price stability. The discussion highlights the complexities of addressing persistent inflation, the implications of housing shortages, the potential of AI to enhance productivity, and the nuanced role of sentiment in economic forecasting. As policymakers navigate these challenges, the emphasis remains on data-driven decisions and collaborative deliberation within the FOMC to achieve a sustainable economic soft landing.