Odd Lots - Dallas Fed President Rob Kaplan on the Economy and Monetary Policy Right Now

Episode Date: August 9, 2021

The economy is in uncharted territory in more ways that one right now. Coming out of the worst of the pandemic, we're seeing a rapid pace of GDP growth, along with elevated inflation readings the likes of which we haven't seen in years. Beyond that, policymakers have engaged in historically aggressive fiscal and monetary expansion. The Fed, in particular, is almost a year into a new framework (unveiled last August at Jackson Hole) that aims to avoid certain mistakes of the past. So we sat down with Rob Kaplan, who has been the President of the Dallas Fed since 2015, to get his assessment of the situation right now.See omnystudio.com/listener for privacy information.

I'm June Grasso, inviting you to join me for the Bloomberg Law podcast. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis of the biggest court cases, the latest actions from Congress and regulators, and the legal moves driving the markets, from corporate law to constitutional law, and from state courts to the Supreme Court. At Bloomberg Law, we go beyond the day's headlines. We speak with top attorneys, judges, scholars and policy experts to break down what the rulings really mean. We do this every weekday,

then bring you the best conversations in our daily podcast. Search for Bloomberg Law on YouTube, Apple, Spotify, or anywhere else you listen. On the East Coast, listen as you start your day, and on the West Coast, catch up in the evening. That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. Hello and welcome to. to another episode of the Oddlots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, you had a great piece, I want to say, this morning for our blog,

about some of the interesting dynamics happening in the economy right now. Oh, thank you. I really appreciate that. Yeah, no, we're in this weird moment. We're obviously, at least on a headline basis, the economy still seems to be growing very rapidly out of the pandemic, Delta variance aside, and we'll see the effects that those have. On the other hand, we are seeing inflation in a way that we really haven't seen in years. And there's significant debate about why that is

the degree to which policy is contributed to that inflation, the degree to which policy should ameliorate that inflation. And of course, as you sort of discussed in a very big picture framework in that piece, there's just these sort of like these bigger questions about supply-side capacity. and the various log jams and supply chain bottlenecks that we're seeing really all over the place right now. Totally. So I think I called it the choke point economy in that piece. And the idea is that even though on an absolute level, you know, economic growth looks pretty good. There's a lot of stuff being produced in the economy on an absolute level. But on a relative basis, you can see these blockages, these shortages showing up in lots of different things.

and in ways that are not always productive or helpful to society or the wider economy. And so the question then is, do governments and policymakers start to step in to try to relieve some of those blockages? Yeah. And there are so many interesting policy things. And, you know, this is, of course, something that we've talked about a long time. There is the Fed's new framework seems to be much more willing to tolerate some periods of higher. inflation and the pursuit of full employment. There was the massive amount of fiscal spending, the likes of which we've never seen before in 2020. There's a further infrastructure bill being debated. So amid all of these sort of moving pieces in the real economy, we're also in sort of, I guess you could kind of say uncharted policy territory as well. Yeah, I get that it's a

cliche to say that things are uncharted at this point in time. But it's true. Like, The economic shock that we just experienced in 2020 and 2021 was very unusual and in many ways unprecedented. And now we have an unprecedented period of fiscal stimulus. And also that's coinciding with this new framework from the Federal Reserve and new ways of central banks really thinking about monetary policy and how it works with government spending. Well, I think that is the perfect seg into our guest.

I am absolutely thrilled to get to speak to our guest today. It's a real treat to have him on odd lots that he would come on. We are going to be speaking with Rob Kaplan. He is the president of the Dallas Federal Reserve, been in that role since late 2015. So he's seen a lot and he's in the thick of it with all of these policy choices that have to be made right now. President Kaplan, thank you so much for joining us. Great to be with you, Joe and Tracy. This is really a real treat to have you on. Thank you so much. Let's just start a very big picture. I mean, it still appears that we have this rapid growth, this rapid rebound out of the crisis. We do have this elevated inflation clearly by various readings, some debates about whether how transitory it is, when it will normalize. Let's just start with your assessment of the macro picture right now.

So it's still our view at the Dallas Fed that GDP growth for 2021 will be in the neighborhood of 6.5%. That growth will moderate as we go into 2022, you know, somewhere, let's say, between 2.5 and 3%. We think that we'll trend down toward 4.5% unemployment rate by the end of this year, but I'll come back to that. we think we'll end the year with a PCE inflation reading of something like 3.8 percent, so very elevated. And I'll talk more about that. The big issues we're facing between now, certainly in the end of the year, are more about supply than demand. There's plenty of demand in this economy.

You all were talking about it in your conversation. but everything we see suggests that consumer demand is strong and demand generally is strong. The issues we have are working out these supply demand imbalances, not just on materials, but significantly on labor. We've had substantial number of retirements. We have people who are not in the workforce because they're caregivers. We still have fear of infection. And I think that supply demand imbalance,

regarding labor is going to be more persistent than people might expect. What can the Fed and central banks more widely actually do to resolve supply demand imbalances? So my own view on that is, for starters, to be cognizant of them and to be cognizant that our tools, and in particular in the short run, our asset purchases are much more adept at stimulating demand. They're not so adept at dealing with supply demand imbalances. And so for me, I think patience, the way I would define patience, would be you might want to lower the RPMs on the car. Now that we've gotten out of the ditch from 2020 and early 21, and we're on more level land,

I think we may want to show patience by reducing the RPMs on the car and be willing to allow these supply demand imbalances, time to unfold. But for me, that doesn't mean continuing our purchases like we were doing. It means showing some patients by realizing we're in a different situations than 2020 and early 21 and showing some restraint on our purchases. So I guess we're just jumping right into the big policy questions that everyone wants to know. Do you agree with your colleague Chris Waller then that perhaps it makes sense to begin the taper soon, maybe as soon as October, get it finished sometime early next year? So to answer that, let me step back for a moment.

People talk a lot about substantial further progress. We have a substantial further progress benchmark. What I've been saying for the last number of weeks and months is, there's one other significant criteria. And I would refer to that as efficacy. So the first thing you want to look at, and the best analogy, I can think if you're a doctor prescribing medicine to someone who's been through a traumatic event, you always want to first be assessing what's the efficacy of the medication. And you want to be willing to adjust your views on that. And what I'm seeing now is the efficacy, the benefits of purchasing 80 billion of treasuries and 40,

billion of mortgage-backed securities a month, I think it was very high efficacy in 2020, early 21. As we sit here today, I see some unintended side effects, and again, those purchases are more adept at stimulating demand. But we don't have a demand problem right now. I worry that they're creating excesses in risk-taking, excesses in the housing market, may be exacerbating imbalances in the economy. And so for me, therefore, the bar for substantial further progress is lower because I don't see, I'm starting to question the efficacy of our purchases. So in that regard, I would rather begin adjusting these purchases soon. I don't want to actually get into what the months or the calendar, but I would be supportive of adjusting these purchases soon. But the other

thing I would say is once we start the adjustment process, I would probably be preferred to have it be more gradual. And what does gradual mean to me? Probably means baseline over eight months, let's say. So that would be 10 million of treasuries and $5 million a month of mortgage-backed securities. So I would like to start sooner rather than later, start soon, but I would probably like to be more gradual than others you've mentioned. So in recent history, I think one of the big criticisms of the Fed has always been that they sort of jumped the gun and hiked rates too soon and basically started undercutting the employment recovery without actual evidence that inflation was becoming a problem. I realize our current

situation is somewhat different because we have low interest rates in addition to monetary easing that you just mentioned. But how are you thinking about the risks of tightening policy versus the risks of staying loose for too long? So in that regard, I would differentiate what our actions are going to be on the Fed funds rate from what our actions are going to be on our asset purchases. I think those two subjects for me should be more fully divorced. On the Fed funds rate, that's not a decision, in my opinion, for 2021. That's something will debate based on conditions in 2022. I think the near-term judgment is on purchases. There may be arguments that in years past, we might have moved the Fed funds rate early than we

should have. I actually am not sure those arguments. I'm not sure I agree with those arguments, but even setting that aside, I am much more confident about the efficacy of keeping the Fed funds rate where it is right now. I am much more doubtful about the value of these purchases. My concern is they accentuate excesses and balances. They tend to be more beneficial to people who own assets than those who don't. This inflation discussion, which I know we can get into, affects big businesses differently than small mid-sized businesses. And I think these supply demand and balances and inflation pressures affect low-to-moderate-income communities differently than they do higher-income communities. And I think for which I can get into why I say that, but for all

those reasons, I think adjusting these purchases sooner might actually allow us to be more patient on the Fed funds rate down the road. And the analogy you've heard me use is, I'd rather take my foot off the accelerator soon so we don't need to hit the brakes down the road. And I think that may be the case in this situation. That's really interesting. And obviously, I think, or at least some in the market

would interpret the commencement of a taper, reducing purchases, as some sort of signal on rate. So it's like, okay, we're starting the, let's say the Fed were to start tapering in October, and then maybe the market implicitly pulls forward its estimated date for the first rate hike. Do you think there's, therefore, then, that to your point, exactly, that the commencement of a tapering should be paired with some sort of communication, some sort of specific communication to your point, that this should not necessarily be interpreted as a sign of some sequencing

sign that, okay, those first rate hikes are therefore right around the corner. Yes, I do think that. And in all my communications, I've emphasized that by adjusting purchases sooner, it may actually allow us to be more patient in the future on the Fed funds rate. And in my view, those two subjects should be divorced and we should be clear in our public communication that those two processes are divorced. I think these, these, purchases and injecting this amount of liquidity into the economy every month has its own set of considerations and its own set of side effects, which I think are different than the considerations and side effects of how we handle the Fed funds rate.

A slightly related question, but I'm looking at the terminal right now, and I see the yield on the benchmark 10-year U.S. Treasury is at like 1.1 percent? And the downward trends in bonds has been something that's confusing a lot of people and a lot of people have been racking their brains over why this is happening. Is that a concern for the Fed as it starts to discuss things like tapering? Maybe not interest rate hikes, but tapering. Are you worried at all that the bond market seems to be either anticipating that easing is going to stick around for a long time or anticipating? that growth might slow in the future? So I'll give you my own take on what I'm seen in the bond market.

Over the horizon, in other words, after we get out of this rebound from the COVID pandemic, there's no question that labor force growth we think in the out years is decelerating due to aging. And we felt that pre-pandemic, that trend is still alive and well and is a challenge we have face. Our population growth is decelerating our labor force growth is going to decelerate. And then the question is, well, productivity improvements help offset that. And so far, they haven't. And why haven't they? Our own view at the Dallas Fed is that if you've got a college education, your technology and technology enabled disruption is probably helping your productivity. If you're one of the 46 million people with a high school education or less,

technology and technology-enabled disruption mean your job is being regularly either restructured or even eliminated. And we're not seeing the productivity improvements. So we've got to improve early childhood literacy, skills training, and the whole educational ecosystem in order to get the benefits for the whole population of these technology investments. So how does that get to the bond market? If productivity growth doesn't help offset slowing labor force growth, the out-year growth is sluggish. And I think the bond market is recognizing that out-year growth, not just in the United States, but globally, is relatively sluggish because of aging populations and skepticism about productivity offsetting that. That's number one. The other thing you can't quite tell, and I always caution myself and my team with the first.

Fed purchasing this much treasuries and mortgage-backed securities, the signal that you might get from the bond market might be a little bit distorted right now. It's certainly distorted as it relates to credit spreads, real yields, et cetera. And so that's another factor. But I'm very conscious of what the 10-year is saying is something I'm mindful of as we assess the economy and think through what's appropriate monetary policy. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all.

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Let's talk more about the productivity problem. I mean, we started this discussion, me and Tracy, talking about some of these supply chain issues, these sort of like real breaks that are in the economy. There is a limit to say how many homes can be built because there is a limit to how much lumber could be delivered. There's a limit to how many cars could be made because there is only so many semiconductors.

And I'm sure, you know, all of these things are very, things you're very aware of. When you think about like, all right, you mentioned, say, early childhood education and literacy, sitting aside the specific bills that are being debated in DC, is there a role in your view for sort of aggressive fiscal expansion, infrastructure investment to simply improve the supply side capacity of the economy such that we don't have these breaks going forward when we have a period of potentially high growth? So I do believe that investment in infrastructure, including Wi-Fi, is different than fiscal policy that simply stimulates current spending, i.e., fiscal policy, either tax-related or otherwise, it just stimulates current spending, gives you a short-term bump, and then you revert back down to trend based on all the work we've done here. infrastructure spending, on the other hand, and those type of investments, ideally, if they're well done,

should be 20 or 30 year investments that should help improve productivity. And then related to that, we need to improve early childhood literacy, particularly for the fastest growing demographic groups, and we need to improve skills training. Some of that can be done with local money, by the way. It may not take government money. But I think that's another investment that, will help improve productivity. And I think all those investments, my own view, would be money well spent. How do you see monetary policy more generally interacting with fiscal stimulus and a greater propensity, at least in the U.S., towards government spending? So we hear a lot from central banks talking about, you know, monetary policy can augment fiscal stimulus and there's the

potential for a sort of virtuous cycle there. But I'd love to get your thoughts on it and maybe talk specifically about how it's changed or hasn't changed the way you and the Fed think about monetary policy. My own view is I do not think it's the role of the Federal Reserve to either monetize the debt or to facilitate government spending. Now, in the height of the crisis, I think it was important that the Fed bolstered the functioning of the Treasury market and took a number of the extraordinary actions we took in order to ensure that the government can do what it needed to do from a fiscal side to fight this crisis. But setting aside what we did in a crisis, I think in more normal times, which we're now emerging into, I don't think the Fed, it's an appropriate

role for the Fed to be monetizing the debt or facilitating government spending. And I I think it's very critical that we don't convey the impression to the public that that's part of our role. And I think there might be some confusion out there on that, on that subject. Let's zoom out a little bit, actually, and talk more about the conduct of monetary policy, because it is August 2021. So we are approaching the one year anniversary of the Jackson Hall Conference. We're going to have another one. But that last year's was pretty consequential. and the Federal Reserve, the chairman, rolled out this new framework, flexible average inflation

targeting with this premise in mind that 2% would not necessarily be the ceiling, that there would be some catch-up potentially, that the Fed would be more patient. And furthermore, that framework was bolstered by further messaging that there's going to be a real renewed focus on hitting the employment side of the mandate and that it was not going to be this sort of like preemptive tightening. Tracy already sort of referenced it, but really want to see like evidence of the employment side of the economy maxing out. You were sort of skeptical and you were dissented a little bit and you also worried that some of the policies that established would, quote, tie the hands of future committees. How do you feel about them now? Was it right for the Fed

to adopt this view of, let's really go as far as we can on the employment side. And how do you see in August 2021 your concerns about future committee's hands being tied? So on the framework, I supported and voted for the framework. But on the premise, my interpretation of the framework was we needed to anchor inflation expectations so that they were more, appropriately anchored at 2%, and we'd been running behind 2% for a number of years. And so it was appropriate to be willing to tolerate inflation running moderately above 2% in order to anchor those expectations at 2%. I support that.

I also supported being somewhat less preemptive in anticipating inflation at the cost of potentially improving employment and inclusive employment in the economy. So that's on the one hand. After we approved the framework, then we got into forward guidance in our September 2020 meeting. That's where I dissented. And here's why, for two reasons. What that forward guidance said is we're going to keep rates at zero until we've reached full employment and we've reached price stability. And I felt I dissented for two reasons there.

Number one, I don't think it's good practice for the Fed to be specifically. making commitments on the Fed funds rate literally years in advance to a future context where we don't know the facts of that context. Today's a great example. I don't think in September of 2020, we anticipated that inflation would be running as high as it is now. We didn't anticipate the supply demand and balances on the labor side that we're seeing. That's a classic case where you want to be very careful about making forward commitments.

Number two, I would have been willing to say in September 2020 that we would have been, we would remain highly accommodative until we reach full employment and price stability. But that's different than keeping rates at zero. As you approach full employment and price stability, the neutral rate starts to drift up. As if the neutral rate drifts up, if you're committed to keeping the Fed funds rate at zero, it means you're actually getting more and more and more. as you approach full employment and price stability. I don't think you want to get more and more and more accommodative. I think you might be willing to stay highly accommodative, but I think it's probably appropriate in future committees, my guess will think so too, that you want to make some adjustments to remain highly accommodative, but there's a difference between doing that

and keeping rates at zero. So I felt it was too rigid in tying the hands of future committees, and that's why it dissented. You mentioned the importance of anchoring inflation expectations at 2%. And of course, there is some irony that, you know, as soon as the Fed introduced this new framework and said it would tolerate inflation going above or under 2%, sort of moving in this range. Of course, after many, many years, the Fed finally seems on track to reach its inflation target at precisely the moment that it said it's, you know, less important.

I wonder, how are you thinking about inflation expectations at the moment? And are you seeing any evidence that those are starting to increase? Yes. So here's what I'm seeing broadly from contacts. We're seeing in our work of the Dallas Fed a broadening of price pressures. So on the positive side, some of the extreme moves in, say, use cars, lumber, other individual items. We're expecting those may well moderate somewhat. But on the other hand, what we're seeing is a broadening of price pressures. Why?

Due to the semiconductor shortage, that's starting to ripple to a broader range of consumer items. Material shortages, we think will be more persistent than some might expect. And again, the supply demand on labor, those imbalances we think here at the Dallas Fed will take longer. And so our expectation for 2022 is that the headline PCE number will be in the neighborhood of 2.5%. So it won't be, it might not be the eye-popping numbers that we're seeing this year, but it will still be elevated. What I'm learning in discussions with contacts, big businesses will be able to handle elevated inflation much better than small, mid-sized businesses.

Big businesses can use scale. They're actively merging. can invest in technology. Small mid-sized businesses don't have those levers. And what I'm hearing pretty broadly is most businesses I talk to are raising prices intended to raise prices more and are getting more confident about their ability to raise prices. I'm also seeing that, again, if you're a low, moderate income person with a job, higher inflation is biting into your share of wallet more so than it does somebody who's more affluent. And I'm hearing a lot from low modern income communities and their representatives that we do extensive outreach, that they're seeing

real stress in trying to make ends meet, even though their constituents are heavily employed. And so what does it tell me? It tells me it's very important that the Fed anchor inflation expectations at 2%, and that, yes, we want to meet our inflation target of 2%, but we also want to be cognizant of the impacts of letting inflation run a little bit to excess. And so I take that 2% commitment very seriously, and back to where we started, that's one reason why I'd rather soon take the foot somewhat off the accelerator, reduce some of these excesses and imbalances or do less to be perpetuating them so that we maybe have more flexibility down the road and how we can handle the Fed funds rate in 2022 and beyond.

Do you see momentum building on the committee for that view, start to take the foot off the accelerator on the asset purchases side? I'll avoid speaking for the committee, but I do believe When I started speaking out, I guess it's now two, two and a half months ago, I felt it was very important that the tapering discussion get on the agenda, that we begin the debate. And I think I at least am a much more comfortable that as a committee we're in a much better place and that we're actively having the debate. We're obviously having disagreement, but I think that's healthy. But I have a lot of confidence in the FOMC that when we debate and disagree and we put these items on

the table, you know, we'll get to better policy judgments. So I'm much more comfortable where we are right now than where we were, say, a couple of months ago. I, you know, I want to go back to what you were just talking about the moment before context that you have in your district. And you kind of talked about this earlier that you expect labor imbalances to persist a while. Dallas Fed President, Texas is one of the states that ended the unemployment insurance expansion earlier than the rest of the country. And it's sort of like this real-time laboratory or some of these states a real-time test, the degree to which that has had an impact on labor availability. And so I'm curious in those conversations you have, particularly with business leaders in your district, what are they seeing on the labor side? What was the impact of that?

And why do you expect that these labor imbalances will continue perhaps for longer than people think? So I've felt for some time, and I've said this publicly, that the unemployment benefits were only one piece of a larger puzzle. And what's the larger puzzle? We've had three million retirements since February of 2020. We have a million and a half approximately workers who are caregivers who've left the workforce. we still have fear of infection. And some of these workers will come back into the workforce, but some of these workers are 55 and older,

and they're in reasonably good financial shape. And COVID has caused them to rethink whether they really want to reenter the workforce. I'm hopeful that with expanded child care, in-person school, that will help get a chunk of the caregivers back into the workforce. but this aging issue, which has been with us for years, is going to stay with us for the foreseeable future. And every data point we look at, and I'll talk with my contacts also suggest the labor force is now much tighter than these headline statistics would indicate. and I think when you lose three million workers to retirement and a million and a half to caregiving, even if you get some number of them back, and again, with demand being very strong,

we don't have a demand problem. Great recession aftermath was about a lack of demand. The aftermath of the COVID downturn is more about supply and supply demand issues. It's not a lack of demand. And I think it's very critical that we recognize that. So a question related to the labor tightness point, the Fed has been describing the recent increase in inflation as transitory. And a lot of people have been trying to figure out what exactly that means. Could you maybe describe whether or not the Fed has sort of signposts or things that it is looking at to determine whether or not inflation has gone from transitory to something that is more of a permanent problem. And then secondly, I often wonder if the Fed kind of regrets the choice of words on transitory. Like maybe the right way to frame it would have been narrow inflation, like inflation in specific areas and specific things. And what you're looking out for is broader signs of inflation. So Tracy, you'll notice from my public comments over the last three months, I've resisted using the term transit.

I would have preferred that the FOMC did not use the word largely, the term largely transitory, and I've been fairly vocal about that. I've said consistently, I don't want to put a label on what we're seeing. What we are seeing is, yes, to your point, a number of extreme price moves, used cars as an example. But what we're also seeing is a broadening of price pressures, Contacts I have in semiconductor industry and a range of industries are telling me that these supply, demand, and balances for materials are going to last longer than people might have expected. And I do believe the supply, demand, and balances for labor will last longer and will be more persistent.

So, no, it's a term I would prefer not to have used. And it's a term I've avoided use. You know, I want to go back to something you said that was interesting and this idea that if the Fed is committed to keeping rates at, say, zero until full employment, maximum employment is reached, then implicitly it's actually increasing the stance of accommodation because the neutral interest rate is theoretically going up as that approaches. And if the nominal rate of Fed policy is the same, then you're increasing accommodation. That being said, I do feel like in recent years, there has been some growing skepticism that some of these variables, like say the neutral rate of interest, are really knowable in real time. And I think even Chairman Powell, I don't remember whether it was his 2019 Jackson Hull speech or maybe his 2018. I think 2018. 2018 speech, right. Questioned whether sort of real-time stars, so to speak, our star and so forth are useful, that in real time, we can actually sort of like know these things.

How have you personally, or have you personally in, you know, sitting aside the pandemic and watching the unemployment rate fall from 5.5% to 4.5% to 3.5% to 3.5% without a meaningful pickup in inflation. Have you personally, I don't know, changed any of your views or premises about the knowableness of some of these variables? Yeah, and I'll start with the background. I'm not a PhD economist. I'm a business person. So as a business person, I was trained over a couple of three decades that theoretical data points are useful to think about,

but you've got to be very careful about understanding there's a great deal of unpredictability and uncertainty about them. Having said that, I think the concept that there's an equilibrium. rate is a good concept. Trying to get to specific as to what that neutral rate is, that that's the part I'd be careful about. And so I think the concept that there's probably some equilibrium rate, and that that, by the way, that equilibrium rate, because of aging demographics, I think has been declining. And you can see it in the declines in treasury yields and government bond yields around the world. That's a pretty good indication. that prospects for future growth are more sluggish, and that tends to have a downward impact on the

neutral rate. And so that helps explain why the Fed funds rate and other central banks around the world have had much lower interest rates than they have historically. It's because prospects for future growth are more sluggish. So I think that concept is a useful concept. Now, the other thing we've done a lot of work here on the Dallas Fed, though, regarding inflation is there's a big structural trend that's been going on for the last number of years in the economy, and it's technology and technology-enabled disruption. That has limited the pricing power of businesses. And this is why I've said, as you see more wage pressure and supply demand and balances for labor, those businesses that have scale and can use technology to work around that, have a

a distinct advantage. Small mid-sized businesses, local restaurant, retail store don't really have those levers. And that's why we're seeing a divergence between how small mid-sized businesses are dealing with these wage pressures, inability to hire, and large businesses. And for small businesses, it's really, it's restricting their hours, it's eating into their margins, it's causing the question their business model. It's pushing many businesses I talk to to think about merging and getting scale. And I think that's an important trend to be aware of. You can get the news whenever you want it with Bloomberg News Now.

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So we've talked quite a bit about the inflation question. I'm wondering if you could maybe zoom in a little bit more on the full employment target and talk to us about how you're seeing that and how exactly you're measuring full employment, especially at a time when Chairman Powell has expressed a desire to tackle inequality in the job market. So what does full employment actually look like to you?

So pre-pandemic, I looked at a full dashboard, but I board in specifically on the headline unemployment rates for the whole population, for black citizens, Hispanics, women, those with high school education or less, as well as a measure called U6, unemployed plus discourage workers, plus people who work part-time, who would rather work full-time. I still look at all those measures today, but we broadened out our dashboard even further to look at things like open jobs, the quits rate, some of the conference board measures.

And I think that I think it's very appropriate to be looking at different groups, to look at their labor force participation and unemployment rate and trying to look at opportunities to reduce the slack in those groups and get them back into the workforce. But I think in assessing how tight the labor force is, it's never been more important to look at a wider set of benchmarks than before. And that's why you're probably not going to hear me use pre-pandemic targets in thinking about full employment today, I think structurally, these supply demand and balances are more pronounced. I think we've got more structural issues, so it makes me look at a much wider number of items and a much bigger dashboard that I looked at pre-pandemic.

And that's caused me to say, and we wrote a piece on this two months ago, the labor force from what we can tell is much tighter than the headline measures would suggest. Can you explain that why? Because, you know, one of the things, obviously, and you mentioned it, economists on Wall Street now are now looking at things like the black, white unemployment gap. And I don't think I would have ever recalled seeing Wall Street research really, like, focus on that as one of them, you know, two years ago, let alone a year ago even. And we've been looking at it. We've been looking at it here at the Dallas Fed ever since I, for five years. So what do you see? Like when you see that, and it had started to narrow significantly, pre-crisis, then got blown out again. But what do you see now when you look at that and when

you say you think the labor market may be tighter than some of the traditional measures suggest? What are you looking at on your dashboard? We took a step backward, unfortunately, during COVID. And we saw it. We were seeing improvement pre-COVID and now we're seeing more divergence. It's starting to improve and a little, and there's some narrowing, but we've taken a step backward. Even worse, we've seen a number of issues. We've seen a drop in enrollment in skills training among black and Hispanic students. And I hear this from superintendents. We've seen senior classes in at-risk communities having a lower graduation rates. We're seeing higher dropout rates. and we're hearing lots of reports from school superintendents I speak with who are telling me they worry that, you know, grade school kids, particularly those who had to work remotely and from at-risk communities, have probably fallen behind more and they're trying to figure out a way to catch them up.

So we're seeing all that. So some of that can be dealt with through monetary policy and some of it means real local action and maybe in some cases national action. to improve early childhood literacy, full day versus half day pre-K, more access to Wi-Fi, better child care access, more child care access where kids are read to, beefed up skills training. I think it's going to take all those pieces of the puzzle to help address these issues. A very broad question for you now, but I'd love to hear your answer. So the past year or so has clearly been unprecedented in many ways. Is there one thing in particular that stands out to you as surprising or unexpected?

I think that the structure of the economy continues to evolve. So technology, technology enabled disruption and scale was important pre-pandemic. It's become even more critical today. I think the importance of access to child care, early childhood literacy, improving awareness and access to skills training is even more important today. Because I think I'm disappointed, I guess one surprise is a disappointment is I think some of these supply demand imbalances on the labor side. Some of it can be addressed with monetary policy, but we need a broader action. I think these structural changes in the economy and these persistent supply demand and balances in the labor force is an unfortunate development and a surprise. We can do something about it, but we got to call it out first and then take actions broadly to address it.

And so I'm hopeful that by me talking about this and talking to local leaders about it and national leaders and taking actions here at the Dallas Fed, we'll take some of those steps to address these issues. But that's probably the biggest challenge and, I guess, development since the pandemic that is more pressing. And I just have one last, you know, sort of real-time question, but obviously COVID isn't over. And, you know, there's concerns about new variants, the Delta variant, potentially delivering a setback in terms of some of the returns or the services economy that we saw. I'm just curious, like, from a sort of like risk management perspective and, you know, thinking about the next several, the sequencing of policy going forward. Is that something that you're thinking about and watching?

We really are and spend an enormous amount of time, and I'm talking infectious disease experts every couple of days and doctors and broadly, we've been doing this for months. As long as it's still the case that vaccines are effective in minimizing, hospitalizations and death, you might get COVID, but you probably won't get very ill. As long as that continues to be the case, I think the impact of the Delta variant will be we will not see a step backward in the economy, but we might not see the progress we were hoping to see. And I think it's going to delay the matching process between businesses who are trying to hire workers and workers stepping into the economy, and it probably will exacerbate some of these material supply demand and balances and labor supply demand and balances. It doesn't mean we'll grow more

slowly, but I think we're going to have to be even more patient in seeing this matching process occur, it would be my guess. So you mentioned at the very beginning of this conversation that one of the reasons you were keen on tapering sooner rather than later was because of excesses and risks building up in the market. And I just wonder, you know, interest rates and asset purchases tend to be a very blunt tool to change behavior in financial markets. Is there something that the Fed could be doing on the macro prudential side to address that issue? So let me talk about what I'm saying. Then we'll talk about what can be done. I worry that there's excess.

People are moving out the risk curve, whether it's institutions, individuals, people are taking more risk because they can't earn from cash. And in some cases, they can't even earn from, you know, unless they're taking duration, they can't really earn from bonds. And so what we're seeing pretty broadly in all the measures I look at, people are moving out the risk curve. And credit spreads are historically tied. The question is, then, when those excesses get more normalized, that could be a jarring adjustment. And then I look at the housing market, and we see that the Fed is buying a meaningful percentage of net new mortgage-backed securities issuance. And we're seeing elevated home prices, which is going to translate into higher rents. Again, what I worry about is for low-moderate income communities.

Rent increases are coming for those communities, and I worry about their money. ability to absorb them. So what can be done? I think a lot of these issues are not with the banks. I think, while not perfect, stress testing and tough capital requirements with the banking sector have had a very, have had a meaningful positive impact. The issues I'm talking about will likely occur either in the non-bank financial sector. So what I would love to see then is in other parts of the government that can oversee capital requirements, transparency, good disclosure to be monitoring these excess risks. I worry about the ability of the financial sector to intermediate the flows when things normalize. And I do worry about, in addition, away from macroprudential,

just excesses and imbalances in the economy. Higher rents would be one of those examples that real people have to pay. That's not a macroprudential issue. that's probably just an economic side effect that we need to be aware of at the Fed. Rob Kaplan, thank you so much for coming on an odd lot. Thanks, Tracy and Joe. Great to talk to both of you. That was great. Really appreciate it. Thanks so much, Rob. Does that make sense, too wonky?

No, no. That was just right. All right, thanks. You're great to talk to both of you. Thank you. Take care, Rob. Thank you. Tracy, I don't know. I always sort of have to, like, pinch myself that these important policymakers come on our podcast. It's always like such a treat to hear from them. No, for real, it's really cool.

No, totally. It's always fascinating to hear directly from a policymaker who is actually thinking about this day in and day out and trying to address it. One of the things I thought was interesting, and I think one of our previous guests, it might have been John Turrick, brought up this idea that as you approach full employment while keeping rates and monetary policy low, you're clearly sort of easing more and more and more. And when you look at it through that perspective, then Rob's call to taper sooner rather than later doesn't look so extreme. Yeah, I mean, that is very much a John Turrick point. You're spot on.

Though I did think it was interesting that Rob specifically talked about disassociating the taper with the start of the rate hike cycle, which is really like because there is going to be you know we all remember what it was the 2013 2013 taper tantrum yeah and so I do think that like there is going you know there's going to be some language trickiness whenever it does begin because the market will interpret that as tightening and you know as president Kaplan just now pointed out there's like two things they're taking your foot off the accelerator but there's also hitting the brake and his in his point of well we don't necessarily just because we maybe want to take our foot off the accelerator, doesn't mean it's

anywhere time to hit the break. It'll be interesting to see if and when the Fed does begin the taper, what sort of communication they have around that basically to affect his point that the market should not read into it that, okay, therefore the next rate hike is going to be in six months or whatever. Totally. And it definitely sounds like it's something that they're thinking about already. On that note, the other thing that struck me from the conversation is, I guess, how much of change there's been in the Fed's framework, which is kind of obvious, but all the new communication problems that that kind of throws up. I guess based on the conversation around full employment and inflation, you know, looking through temporary high levels of inflation, it just feels like

there's so much more room for interpretation nowadays. And everyone is trying to get a better sense of what exactly those two goals, average inflation, you know, over what time frame, full employment measured by what actually mean. Yeah, no, exactly right. Tons of ambiguity still and new policies in a new uncharted territory to use that cliche again. Fascinating time and a fascinating conversation. Yeah, uncharted squared.

Okay. Shall we leave it there? Let's leave it there. Okay. This has been another episode of the Odd Lots podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Jill Wisenthall. You can follow me on Twitter at The Stallwork. And you can follow our guest on Twitter, Rob Kaplan, President and CEO of the Dallas Fed. He's at Rob S. Kaplan on Twitter. Follow our producer, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcast at Blumfellon. Under the Handle at Podcasts. Thanks for listening.

I'm Francine Lacquhar, an award-winning journalist, and I've got a new podcast, Leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from Heads of State to fashion icons about the news of the moment. But I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader.

Make decisions. A poor decision is always better than no decision. Listen to new episodes. every other Monday. Follow leaders with Francine Lackwa, wherever you get your podcasts.