Potential Fed Vice Chairman

Reports are that John Williams, president of the Federal Reserve Bank of San Francisco, has been targeted as a potential candidate for Fed vice chairman. President Williams is scheduled to vote as one of the five sitting reserve bank presidents on the FOMC in 2018. What would his appointment mean as far as the Fed and FOMC policy is concerned?

First and most importantly, John is a first-rate monetary economist who has been in the Federal Reserve System his entire career, spanning more than 20 years. He spent four years at the Board of Governors before returning to his native California. He held various research positions at the Federal Reserve Bank of San Francisco before transitioning from director of research to president in 2011. Unlike some reserve bank presidents, he has maintained an active research agenda in addition to authoring many communications on Fed policy via the Bank's outreach publications.

Because of his background, he is intimately familiar with the system, the Board of Governors, the policy environment, and all that was involved in the financial crisis and subsequent recovery. In this sense, John might be viewed as an ultimate insider candidate, even more so than Marvin Goodfriend, who is awaiting confirmation as a governor. These two would address the departures of economists on the Board, but with people whose policy views are basically consistent with policies that have been pursued since the end of the crisis.

Former Chairman Bernanke suggested at a January 2018 Brookings meeting that incoming Chairman Powell would likely "commission" an internal study of alternatives to targeting a 2% inflation rate. To that point, President Williams commented at that same meeting that he would be open to other alternatives. One alternative he had been asked to comment on, presumably because of previous research and speeches he gave, was price-level targeting. His discussion at that Brookings conference points to two assets that President Williams would bring to the Board. First is a willingness to examine evidence and critically evaluate past polices. What has worked and what has not worked?  Second is an openness to new and alternative approaches to policy.

Some register concern that President Williams is an insider because they fear he may be subject to groupthink when it comes to FOMC policy which has become one criticism of policy lately. However, his speeches and writings evidence his willingness to dig into the data to better understand why the models are breaking down and why inflation has remained persistently below target. For example, in recent speeches he has focused on reasons why the economy may be likely to grow more slowly, such that the equilibrium real rate may be as low as 0.5%. Here he has conducted recent research that supports this view of the real rate rather than relying upon the work of others. With respect to the inflation objective, he and the staff of the San Francisco Fed have done a deep dive into the components of inflation to identify which components may be providing better signals about true underlying inflation trends and which may be clouding the measurement of inflation. They have concluded, for example, that component prices that tend to move in sync with movements in the economy have apparently recovered. Whereas prices for items less sensitive to general movements in the economy, such as cell phone services, airline tickets, and healthcare, etc., have either fallen or tended to remain low.(1)

As for where President Williams may stand on the issue of the desirability of continuing the FOMC's 2% inflation objective, Chairman Powell might find in him a partner willing to reassess the FOMC's 2% inflation objective, as part of both evaluating existing policy and preparing for the next policy crisis, if and when an abrupt change in policy may be appropriate. In both research and speeches John Williams has examined how a price-level target versus an inflation target might work going forward and/or how it might have performed in the past. To some, targeting the rate of growth in the price level as opposed to targeting the rate of inflation may seem like a distinction without a difference. After all, isn't inflation just the rate of growth in the price level? However, the difference from a policy perspective is how one treats deviation from the target. A policy maker targeting inflation is willing to forget past misses of the target, whereas a policy maker targeting the growth rate in the price level commits to reversing past misses to ensure a long-run average rate of growth in the price level.(2)(3) Williams' and his colleagues' research argues that had price-level targeting been in place in the 1960s and 1970s, the inflation environment would have been much more stable than was realized.(4) President Williams' evidenced and scientifically based approach would be a solid anchor for any work that might be done to modify or change FOMC policy approaches and how those might be communicated to the public.

One last observation regarding what President Williams might bring to the FOMC. In his work and speeches, he has continually emphasized the importance of Fed independence, accountability, and transparency. However, he has also expressed caution when discussing recent proposals mandating that the Fed follow a mechanical policy rule. He has emphasized issues that proponents often overlook. First, rules like the Taylor rule rely upon unobservables such as the natural rate of growth in the economy and the equilibrium interest rate. Would these estimated unobserved inputs change over time, and who would set them? There is, as yet, no one best-agreed-upon formulation of a policy rule, and many such proposals exist.(5)

In John Williams the Fed would get a vice chairman who has been comfortable with the present policy stance but who has also forecast slow growth for an economy at full employment and now sees a relatively low equilibrium real interest rate and hence a low policy rate for the foreseeable future. Williams would thus likely be cautious when it comes to the number of rate hikes for 2018 and likely favor at most three moves rather than the four implied in the latest Summary of Economic Projections. However, his elevation would create a vacancy at the San Francisco Bank just when its president is entitled to vote.  That vote would thus be exercised by the Bank's first vice president.  A similar issue will exist when the New York Fed's President Dudley retires mid-year.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
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(1) See John C. Williams, Remarks at the 54th Annual Economic Forecast Luncheon, Phoenix Arizona, November 29, 2017.
(2) See https://www.brookings.edu/blog/ben-bernanke/2017/10/12/temporary-price-level-targeting-an-alternative-framework-for-monetary-policy/
(3) Those who favor pure price stability would inflate if the price level decreased and force an actual decline in the price level if it had increased.
(4) See Orphanides, Athanasios, and John C. Williams. 2013. “Monetary Policy Mistakes and the Evolution of Inflation Expectations.” In The Great Inflation: The Rebirth of Modern Central Banking, eds. Michael D. Bordo and Athanasios Orphanides. Chicago: University of Chicago Press.
(5)  See https://www.frbsf.org/our-district/press/presidents-speeches/williams-speeches/2015/may/monetary-policy-independence-dilemma/