John C Williams: Shifting gears - rebalance and realignment in the
economy
Remarks by Mr John C Williams, President and Chief Executive Officer of the Federal
Reserve Bank of New York, at the Fixed Income Analysts Society, New York City, 19
January 2023.
* * *
As prepared for delivery
Albert Einstein famously said, "Life is like riding a bicycle. To keep your balance, you
must keep moving." While charming advice to live by, it is also particularly salient when
it comes to the rebalancing and movement taking place in the U.S. economy today.
In my remarks this evening, I'm going to discuss inflation, the continued imbalances
between supply and demand, and the effects that monetary policy is having on different
sectors of the economy. I'll share what this means for the economic outlook in the
United States, and how the Federal Reserve's policy actions support our bedrock
commitment to price stability.
Before I do that, I want to thank the Fixed Income Analysts Society for putting together
this wonderful program. It's great to stay local, even if it means dodging rush hour traffic
in Midtown. Although times like these make me wonder if I should take Einstein's bike
riding advice more literally!
I should also give the standard Fed disclaimer that the views I express today are mine
alone and do not necessarily reflect those of the Federal Open Market Committee
(FOMC) or others in the Federal Reserve System.
Inflation Indications and Implications
I'll start by saying that although we are seeing some signs that inflation is moderating, it
remains far too high, and it is my No. 1 concern going into 2023. Rapidly rising prices
continue to have an immense impact on families and businesses, especially when it
comes to essentials like food, utilities, and housing.
High inflation is a new reality for many people. For the three decades preceding the
pandemic, the inflation rate averaged almost exactly 2 percent, as measured by the
personal consumption expenditures (PCE) price index. But that changed dramatically in
the spring of 2021, when inflation suddenly soared, ultimately reaching a 40-year high
of 7 percent last June. While the inflation rate has since come down to 5-1/2 percent,
it's still higher than any pre-pandemic reading since 1982 and far above the FOMC's 2
percent longer-run goal.
Persistently high inflation undermines the ability of our economy to perform at its full
potential, so it is critical for the Federal Reserve to bring inflation back down to our goal
. We are firmly committed to doing so.
Shifts and Realignment
Those who have been following my speeches lately will know that I've been quite
1
devoted to a recurring theme: using the layers of an onion to describe inflation. But
with the new year, I thought I would switch gears. I didn't have to look too far, because
the mechanism of shifting gears is exactly what's going on in the economy. It also
explains the effects that monetary policy is having on the economy and how that's
helping to bring inflation back down.
During the pandemic and its aftermath, we saw an enormous swing in demand, away
from services like travel and entertainment and toward goods and housing, as people
adjusted to work from home and avoided contact-intensive activities. More recently, we
are seeing a rotation in demand from goods back into services. But through all these
shifts, overall demand has remained very strong and has far exceeded supply.
This misalignment of supply and demand is true for the labor market as well. Although
several indicators of labor demand-such as job openings, quits, and hiring-have
stepped down from their very high levels of the first few months of 2022, they show that
demand still far exceeds available supply. And the unemployment rate of 3.5 percent is
historically low.
The same dynamics play out in the Federal Reserve's Second District, the region that
the New York Fed represents. Our regional business surveys indicate that activity is
slowing, with an especially sharp decline in the manufacturing sector. That said, many
businesses continue to add staff, and consumer confidence is strong. Overall,
inflationary pressures in the region are moving downward, but are still quite high.
Gears Are Turning
With inflation running persistently above its longer-run goal of 2 percent, the FOMC has
taken strong actions to align demand with supply in the economy and bring inflation
down. You can think of monetary policy as a large gear that is connected to smaller
gears representing different sectors of the economy. But not all gears move at the same
pace. Some turn more quickly, while others are slower, meaning they experience longer
lags between policy actions and effects.
These effects of monetary policy are showing up in prices at different speeds. For
example, the prices of globally traded commodities have already declined and are now
well below levels we saw earlier last year. This reflects in part the effects of lower
demand resulting from tighter monetary policy here and abroad.
Similarly, prices for many goods have started to plateau or even decline, reflecting
weaker demand, lower import costs, and an easing of global supply disruptions that
developed during the pandemic. For example, prices of used cars-a big driver of
inflation during the first year of the pandemic-have been retreating toward more normal
levels over the past few months. The combination of the general rotation of demand
from goods to services and the effects of higher interest rates on demand for goods
should contribute to further downward pressure on the prices of many goods this year.
One gear that is moving at a far slower pace is the price of non-energy services. The
ongoing imbalance between supply and demand in this sector continues to contribute to
inflationary pressures. But there is some good news on this front as well. One of the
biggest drivers of the rise in inflation for services has been shelter costs, which soared
as demand for housing increased during the pandemic. Recent data for newly-signed
leases indicate that the tide is turning on rents, and we should see shelter cost inflation
start to slow later this year. That said, inflation for other services besides shelter has
remained high, and this gear is only starting to turn.
Inflation expectations represent another gear that is turning at an encouraging speed.
Longer-run inflation expectations remain remarkably stable at levels consistent with 2
2
percent inflation. After rising moderately last year, households' three-year-ahead
inflation expectations are now back to where they were in January 2021, and
one-yearahead inflation expectations have started to reverse the rise seen over the past year
and a half.3
The FOMC's Policy Actions
With inflation still high and indications of continued supply-demand imbalances, it is
clear that monetary policy still has more work to do to bring inflation down to our 2
percent goal on a sustained basis.
At its meeting last month, the FOMC raised the target range for the federal funds rate to
4-1/4 to 4-1/2 percent, the seventh consecutive increase. The FOMC's December 2022
Summary of Economic Projections showed that a large majority of participants saw the
federal funds rate reaching a level between 5 and 5-1/2 percent by the end of this year .
The FOMC statement indicated that "the Committee anticipates that ongoing increases
in the target range will be appropriate in order to attain a stance of monetary policy that
is sufficiently restrictive to return inflation to 2 percent over time. In determining the
pace of future increases in the target range, the Committee will take into account the
cumulative tightening of monetary policy, the lags with which monetary policy affects
economic activity and inflation, and economic and financial developments."4
Bringing inflation down is likely to require a period of below-trend growth and some
softening of labor market conditions. But restoring price stability is essential to
achieving maximum employment and stable prices over the longer term, and it is critical
that we stay the course until the job is done.
I'll also add that the framework announced last May for reducing the size of the Federal
Reserve's balance sheet is working well, and the Committee will continue reducing its
holdings of Treasury securities and agency debt and agency mortgage-backed
securities as planned.5
Economic Outlook
We are seeing the shifting gears of tighter monetary policy having the desired effects.
Broad indicators show that financial conditions have become significantly less
supportive of spending. As a result, I expect real GDP growth to be modest this year at
around 1 percent.
Robust hiring, low unemployment, and strong nominal wage growth mean the labor
market remains remarkably tight. But with growth slowing, I anticipate the
unemployment rate to increase from its current level of 3-1/2 percent to around 4-1/2
percent over the next year.
Turning to inflation, I expect cooling global demand and supply improvements to result
in declining inflation for goods. These factors should contribute to inflation slowing
further from its current rate to around 3 percent this year. While services inflation is still
a sticking point, I expect overall inflation to come back down to 2 percent in the next few
years as further tightening of monetary policy realigns the balance between demand
and supply.
Conclusion
I'll close by saying that the monetary policy gear is turning. But it will take time for
supply and demand to come back into proper alignment and balance, so we must keep
moving. While the route ahead is still uncertain, I am fully confident we will return to a
sustained period of price stability.
1
John C. Williams, Peeling the Inflation Onion , remarks at the Economic Club of New
York, delivered via videoconference (November 28, 2022); John C. Williams, A Bedrock
Commitment to Price Stability , remarks at the 2022 U.S. Hispanic Chamber of
Commerce National Conference, Phoenix, Arizona (October 3, 2022).
2
John C. Williams, A Steady Anchor in a Stormy Sea , remarks at SNB-FRB-BIS High
Level Conference on Global Risk, Uncertainty, and Volatility, Zurich, Switzerland
(November 9, 2022).
3
Federal Reserve Bank of New York, Short-Term Inflation Expectations Continue to
Decline, Tick up Slightly in Longer Term , January 9, 2023.
4
Board of Governors of the Federal Reserve System, Federal Reserve Issues FOMC
Statement , December 14, 2022.
5
Board of Governors of the Federal Reserve System, Plans for Reducing the Size of
the Federal Reserve's Balance Sheet , May 4, 2022.