Charles Evans, president of the Federal Reserve Bank of Chicago, spoke with Yahoo Finance to discuss the economic implications of no fiscal stimulus and what lies ahead for Fed policy.
Below is a transcript of his appearance, taped on Oct. 8 and aired on Oct. 9.
BRIAN CHEUNG: All right, well joining us now for a discussion on the US economy and Federal Reserve policy is the Federal Reserve Bank of Chicago President Charles Evans. President Evans, thanks so much for joining us here on Yahoo Finance today.
CHARLES EVANS: Thanks, Brian. Happy to be here.
BRIAN CHEUNG: So I wanted to kick things off with the discussion about the labor market. So we did see jobless claims on Thursday morning. Still 1.3 million Americans turning to unemployment insurance when you add Pandemic Unemployment Assistance. Now, the Fed has said that it’s going to keep rates at near-zero until we’re at “maximum employment.” That’s part of the new statement. But how far away are we from that? Is that the 3.5% that we saw pre-pandemic?
CHARLES EVANS: Yeah, that’s an insightful question because obviously we would like to get labor markets to be as robust as they were back in January, the end of last year. The unemployment rate, as you say, was 3-and-1/2%, so that’s a very good goal.
You know, it’s going to take a while to get there. Ideally, you know, when we shut down in the second quarter, if we could have just rebooted immediately and everybody went back to their same jobs and everything was well taken care of, three months of relief support, then we can almost start off with very, very low unemployment rates. But it looks like there’s going to be more scarring in the labor market. People aren’t going to be able to go back to a number of jobs in certain disadvantaged sectors.
And so with the unemployment rate at 7.9%, I’m looking to sort of see how much more momentum we’re going to have. I’m hopeful that unemployment will be as low as 5 and 1/2% at the end of 2021, but we’ve got quite a ways to go. I would think that robust labor markets associated with maximum employment would be unemployment rates down around 4%, hopefully below 4%. And it’s going to depend a little bit on inflationary pressures, but we’ve had trouble getting inflation up to our 2% objective, so I think we’re going to just keep going until we see that.
BRIAN CHEUNG: So you mentioned inflation right there. I mean, the Fed’s new forward guidance is obviously a big deal with a new focus on the policy of moderately overshooting 2% for some time. But what was interesting about the Fed minutes from that Sept. 16 meeting, which we got this Wednesday, noted that it’s “not an unconditional commitment” to a particular path and that it could change. What does that mean? Translate that for us.
CHARLES EVANS: So, you know, we’re a long ways from circumstances where it would be appropriate to raise rates. We need to see, you know, labor markets move towards the vicinity of maximum employment. We say we’re going to keep the funds rate at effective lower bound, zero to a quarter percent, until we see labor conditions closer to maximum employment and inflation gets up to 2% and is on track to overshoot.
Now, the minutes say it’s not an unconditional guarantee, but that is our expectation. And I think it would have to be something very different for us to sort of talk about deviating from that type of guidance. For instance, if things were somewhat worse, if the recovery was slower, I think we’d still be having interest rates at the zero lower bound, but I think we’d also be following it up with more asset purchases, hoping that there would be more fiscal support as well.
BRIAN CHEUNG: So you mentioned asset purchases. It does seem like you and your colleagues have hinted that the Fed could more closely pin forward guidance to quantitative easing beyond what it’s already done so far. But I guess with bond yields already on the long end, 10-year, 30-year, pretty historically low, would that be as impactful as just a clearer commitment on keeping the federal funds rate low? What would be the marginal benefit of maybe further taking down by a few basis points the 30-year and the 10-year yield?
CHARLES EVANS: That’s an important point. Long-term rates are already very low. If you go back to September of 2012 when we did open-ended asset purchases, Treasury rates were much higher, and the signaling effect of that action was really very important. I would say that signaling effects currently are very important. I think we’re getting a lot of the benefit already because we’ve indicated the forward guidance on the short-term federal funds rate. But getting term premia down further, they’re already very low. The 10-year Treasury rate is just under 80 basis points.
And so I think our asset purchases are already helping with financial market functioning. They are helping support the economy. The discussion, I believe, is going to be: how do we characterize the asset purchases that we’re undertaking now? What might be some conditions in order to change the pace, change the way in which we’re investing? We’re investing across the curve now. It could be more targeted, if that were deemed appropriate.
If things are going better than we might have been expecting, the fact that we’re making purchases across the curve means that some are relatively short maturities and they’ll roll off somewhat quickly. So there is still quite a bit of flexibility in the asset-purchase side right now, and it allows us flexibility to also provide more accommodation if that’s necessary. But there’s some more conversations that need to take place, and that’s why it’s kind of difficult for me to provide, you know, a lot of additional certainty with regard to that.
BRIAN CHEUNG: Well, I imagine one factor in not being able to get that certainty is what’s happening on the fiscal policy front. You did say last month that partisan politics and a lack of action on fiscal policy “presents a very significant downside risk.” Now, I understand that things change by the day, but if we do assume that it may not be until maybe after the inauguration to get a stimulus package or a relief package, would that increase the onus on the Fed to do something in three weeks or in maybe mid-December?
CHARLES EVANS: Well, I think it makes for a much more challenging economic environment, and our outlook would undoubtedly be adversely, you know, affected. When I submitted my forecast, I had somewhere close to a trillion dollars of fiscal support that I was expecting. So if we got nothing, that means that aggregate demand efficiencies are going to be that much more of a concern, and that would slow down the pace of the recovery. We would end up with higher unemployment rates, and that would be a challenge.
I think monetary policy would — we need to think about how we respond to that. But the best course of action — when you think about what we’re doing with lower interest rates, we’re trying to make borrowing conditions more attractive so that households, businesses can undertake investments which have some risk component to it, and so lower borrowing costs provide an incentive for them to do that. In so many cases, small businesses are on the edge of not being able to go forward, and their employees are at risk. So many of these enterprises really need grants, outright relief, not just more debt. So that’s where the fiscal support comes in.
Then the other side of that is state and local governments are also very challenged. They can’t — they have to balance their budget, so they can’t just run deficits endlessly. Federal governments got more advantages there, they can increase debt. But state and local governments have to balance their budgets, and when their tax revenues are a lot lower, they’re probably going to have to cut back on employment.
Employment in state and local governments is about 10% of total employment in the US economy. So that would be another definite hit to a stronger outlook. It’s just, some things that we have as a country, the ability to address in a more meaningful fashion. That would be helpful.
BRIAN CHEUNG: And we did see already the hit to employment in that last jobs report coming largely from state and local governments. Now I’m wondering, as an expansion of that, the Federal Reserve has the Municipal Liquidity Facility. The state of Illinois in your reserve bank district jurisdiction did tap that in addition to the MTA in the New York district. I’m wondering — if there’s no help coming from fiscal, would the Fed need to extend the MLF, because I understand it expires in December. Or could the Fed lower the penalty pricing on the loans in that facility for a higher uptake?
CHARLES EVANS: Well, I suppose those are conversations that could take place between the Fed and the Treasury. These are programs that have to be undertaken with the approval of the Treasury. They’re designed in conjunction with Treasury. And so the amount of generousness of borrowing conditions- we really do plan these programs so that they’re not the first choice of any of the borrowers. We do think of it as sort of a backup when borrowers have a little bit more of a challenge but they are credit worthy. I’m thinking more Main Street than just Municipal Lending, but the same features apply to the municipalities as well.
And so the pricing so far has not been that attractive, and so it’s been a small number of borrowers, like you mentioned. I really think in most of these cases, though, state and local governments need fiscal support. They need relief. They don’t need more debt.
And it’s the kind of thing that, by the nature of this crisis, is not because one municipality misbehaved and overspent. It’s affecting everyone around the country. And even if your municipality might currently have a relatively low number of virus outbreaks- and I was talking with some bankers just this morning. And if you’re a little more remote, if you’re sort of in a light community where you have people who are coming in and working more remotely and enjoying that, you might be OK for a while. But more people can come and visit and expose everyone to the virus.
And so until the entire country has that under control, there’s always going to be this risk. So it’s not just any one state or municipality that is behaving badly, but it is a risk that everybody’s facing. That is a role for the federal government to help ensure all Americans.
BRIAN CHEUNG: And to wrap up this conversation, we have been having this conversation, talking about hopefully getting the virus under control so the economy can get back on track for the larger part of six months now. So when you look back on this time period, the unprecedented actions that the Federal Reserve has taken, did you expect that we would be at this point in time in the beginning of October with an unemployment rate still above 7%? And if not, what is going- I guess what was your expectation this far into the year?
CHARLES EVANS: Well, I think labor markets have actually improved more quickly than I expected, especially in the early months, June and July. They decelerated in the last monthly report, but still, I would say that the unemployment rate of about 7.9% is lower than I was initially expecting us to be at for 2020, and so that has been welcome. That has been good.
On top of that, if you told me back in June that one piece of information that would be revealed is that the number of American deaths due to coronavirus would be over 200,000, I would not have expected to mark up my forecast in September. But, in fact, I did because underlying business resumption and recovery has taken place much more quickly in spite of all of the virus outbreaks.
And so it’s kind of- it makes you sad to think about the personal cost to households, to individuals, family members. But one way or another, the economy has been more resilient so far. One has to wonder if we’ve just gone through the best part of the year when it’s been warm and you can have a lot of outdoor activities, and now certainly in the Upper Midwest where I am– today’s nice, but it’s going to start getting colder, and it’s going to be indoor weather. That’s going to be even more challenging for the spread of the virus.
And so there are a lot of factors still in play. I am quite pleased with the fact that the economy has come back as quickly as it has, but we have a long way to go. Unemployment rate at 7.9%. We really want to get it down into the 4s and lower. It’s going to take a while.
BRIAN CHEUNG: All right, well, you don’t need to remind everyone that the winters in Chicago do indeed get cold. But again, the president and CEO of the Chicago Fed, Charlie Evans, thanks so much for joining us here on Yahoo Finance today.
CHARLES EVANS: Thanks, Brian.
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