Randal K Quarles: The economic outlook and monetary policy
Speech by Mr Randal K Quarles, Vice Chair for Supervision of the Board of Governors of the
Federal Reserve System, at the Hutchins Center on Fiscal and Monetary Policy, The Brookings
Institution, Washington DC, (via webcast), 26 May 2021.
* * *
Thank you, David, and thank you to Brookings and the Hutchins Center for the opportunity to lead
things off and be part of this very distinguished panel. Today, I will explain why I expect the U.S.
economy to continue growing strongly over the remainder of this year and what the implications
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of that outlook are for monetary policy.1
After the shutdowns and other measures taken in response to the COVID-19 outbreak last spring
caused the swiftest and deepest recession in U.S. history, the economy has made a powerful
recovery. Households and businesses adapted, supported by the flexibility and inherent strength
of our market-based economy, by the continued resilience of our banking system, and by
significant fiscal and monetary policy support. Highly accommodative monetary policy by the
Federal Reserve has fostered strong growth in interest rate-sensitive sectors of the economy
such as housing and durable goods, offsetting some of the historic weakness in the service
sector last year. With the service sector reopening while other household and business spending
remains strong, I expect rapid growth to continue for some time before slowing to a still robust
pace next year.
Inflation is running significantly above the Federal Reserve's longer-run goal of 2 percent primarily
as a result of three factors: the surge in demand as more services come back on line while
goods spending remains robust, the emergence of bottlenecks in some supply chains, and the
very low inflation readings recorded last spring dropping out of the calculation of 12-month
inflation. For reasons I will detail in a moment, I expect that a significant portion of that recent
boost to inflation will be transitory, and that it will not interfere with the rapid growth driving
progress toward the Fed's maximum-employment goal.
We've come a long way since last spring, but reopenings over the past year have been uneven,
so it will still be some time before we repair all the economic damage. Supply bottlenecks will
likely hinder the quick expansion of production in some industries in the next few months and
raise some costs-in some cases significantly. The progress in reopening has been slower in
countries that are among our largest trading partners, weighing on U.S. growth by reducing
demand for U.S. exports. But even with those impediments, I believe the strong recovery will
keep rolling forward. Let me walk through the evidence for that optimistic view.
First, I see increasing recognition by the private and public sectors that a broad reopening can
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proceed safely.i The Centers for Disease Control and Prevention has dropped most
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socialdistancing recommendations for vaccinated people.2 Although local COVID-19 restrictions on
schooling and economic activity continue in some areas, most schools are teaching in person at
least part time and more than half of states have dropped all capacity constraints on restaurants,
bars, and retail establishments. More than a dozen more states are planning to do so over the
coming weeks.
With these reopenings, consumer spending, which is two-thirds of gross domestic product
(GDP), will remain robust, supported by personal income that has, thanks to significant fiscal
support, now surpassed the trend it was on before the COVID event. April's retail sales results
were flat, but that came after enormous gains in March that were boosted by the latest round of
stimulus checks. Looking beyond the headline numbers, sales were up 13 percent in March and
3 percent in April at restaurants and bars, one of the sectors hardest hit by the COVID-19 event.
April and March were the third- and fourth-best months for vehicle sales to consumers in U.S.
history, if you filter out sales to car rental companies, a sector just beginning to recover.
You might expect this bounce will subside after consumption regains the strong trend it was on
pre-COVID-19, but one reason I think it will continue is the still high rate at which people have
been adding to their savings. Even as personal consumption expenditures rose at a huge 10
percent annual rate in the first quarter of 2021, the saving rate averaged 21 percent over those
three months. Again, a lot of that reflected the most recent round of stimulus payments, but as
employment grows and people return to normal life and work, the accumulated stock of savings
will support spending for many months to come.
Business investment took a big hit in the first half of 2020 but has come back strongly and is now
running above pre-pandemic levels. Current indicators of business spending are pointing to
continued elevated levels of investment in the months ahead. Supply bottlenecks have depleted
inventories for many goods and rebuilding those inventories will be an important supplement for
business spending and factory output.
I see two potential headwinds for the economy: the uneven global recovery and the
aforementioned supply bottlenecks. Strong U.S. demand is boosting imports, but weaker
demand outside the United States, where recovery is slower, is restraining exports, and that
problem may not resolve for some time. Supply bottlenecks are more prevalent now, especially
in the auto and housing industries, with shortages of inputs leading to slower production that
reduces employment growth.
Although I expect employment to rise significantly in coming months, the picture is more mixed
for the labor market than it is for spending. The unemployment rate remains at 6.1 percent,
compared with 3.5 percent pre-COVID-19, and there are 8 million fewer jobs. Despite recent
gains amid reopenings, employment in the travel, leisure, and food services sectors remains well
below pre-pandemic levels.
My optimism here reflects the apparent recovery in overall labor demand-by many metrics, job
openings are above 2019 levels, including for workers without a college degree, a group
especially affected last year. In the Job Openings and Labor Turnover Survey data for March,
private-sector job openings as a percentage of total employment increased to 5.6 percent, which
is above the previous record for that series set in November 2018.
Job growth of 266,000 in April was a disappointing slowdown from recent months, but good news
lurked beneath the headlines: For those who were working, average hours increased; the
number of people working part time because they couldn't find full-time jobs decreased
significantly; and wage growth was very strong.
The underlying strength in hours and wages lends support to widespread reports that worker
shortages are impeding hiring. Labor force participation remains about 3 1/2 million people lower
than before COVID-19. Among the many factors driving this shortage, as indicated by the
Federal Reserve's report Economic Well-Being of U.S. Households in 2020, is parents who
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need to care for their children because of remote school and aftercare.3 We have also seen a
wave of retirements by older workers in the past year. And, although the evidence is mixed, we
have received plenty of anecdotal reports about the influence of generous unemployment
benefits and large cash payments on the willingness of workers to return to work. But those
benefits are slated to expire over the summer, and I hope that a fuller reopening of schools in the
fall will ease the pressure on parents. The spike in retirements may well moderate in a stronger
economy, as we saw in the year or two before the pandemic. So, while labor shortages could
weigh on job creation in coming months, I don't yet perceive this development as significantly
slowing the U.S. economy beyond the next few months.
Now let's turn to the other half of the Federal Reserve's economic goals, inflation. As I mentioned
last week during congressional testimony, I agree with the widespread view among my
colleagues on the Federal Open Market Committee (FOMC) and most private forecasters that
the recent rise in inflation to well above 2 percent is driven by temporary factors. I expect inflation
to begin subsiding at some point over the next several months and to be running close to 2
percent again at some point during 2022. Market-implied inflation expectations have risen only to
the levels that prevailed in the early 2010s, after which inflation never ran consistently above 2
percent, and most survey measures are sending similar signals. Therefore, I consider these
recent increases in inflation expectations a welcome development, reversing the large declines
seen last spring and perhaps edging up in response to the message in the FOMC's new policy
framework. That said, my optimistic outlook for growth and employment places me among those
who see the risks to inflation over the medium term as weighted to the upside, relative to my
baseline forecast. Broadly speaking, there are three reasons for this.
First, there are wage pressures. A moment ago, I celebrated the upturn in wages in April, but it
may be a sign that the torrid growth of the economy and labor supply shortages have begun
pushing up wages faster than occurred with the moderate economic growth over much of the
past decade. Wages are a large component of business costs that could pass through to prices
more readily than increases in the cost of other inputs. It seems like a paradox that there could
be labor supply problems and wage pressures at 6 percent unemployment, but it is also a fact.
Some of this surprising outcome reflects temporarily lower labor force participation coming out of
the enormous economic shock last spring, but some of the Fed's business contacts have said
that shortages of skilled laborers-particularly in manufacturing, transportation, and construction
-predated COVID-19 and are likely to persist.
Another factor that I referred to earlier-fiscal policy-carries potential costs as well as obvious
benefits. Even as the huge amount of stimulus money in people's pockets has been boosting
income and spending in eye-popping ways, much of that stimulus was saved. A
larger-thanexpected or faster release of those accumulated savings while the economy is already growing
rapidly could result in output exceeding potential output by more than it has in decades. It is
reasonable to ask if the strength of spending stemming from this unprecedented fiscal stimulus
will put significant upward pressure on inflation as households and businesses emerge further
from the COVID event. But, at least to date, the latest round of stimulus seems to be supporting
spending and growth without causing an inordinate rise in interest rates or inflation expectations.
That outcome aligns with the advice of those in the economics profession who have produced
research in recent years that leaves them much more comfortable with high deficits and debt, at
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least in countries with low interest rates, than they used to be.4 In 2006, when I was serving as
Under Secretary of the Treasury, we were subject to harsh criticism for running a deficit of not
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quite $250 billion, with total debt held by the public at 35 percent of GDP.5 By contrast, in 2021,
the deficit is currently projected to be $3.4 trillion, and total debt held by the public at the end of
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fiscal year 2020 was 100 percent of GDP.6
Further fiscal policy actions are, of course, the purview of the Congress and the Administration.
History tells us that once the dreadnought of government spending gathers speed, it is difficult
and slow to turn around. Surely the deficits being run to offset the COVID-related shocks have
made it even more critical to address the sustainability of government debt in the years ahead.
And, finally, recent monthly readings on import prices, producer prices, and consumer prices
have all come in above consensus expectations. These upside surprises cannot be attributed to
base effects. It is true that many of the factors driving the April consumer price index report and
other inflation surprises continue to be supply bottlenecks, and it is reasonable to conclude that
these will ease over time. But clearing some of those supply disruptions will require additional
investment and the time to expand production capacity. If these shortages persist into 2022,
people may adjust their expectations higher for future inflation, which could make above-target
inflation more persistent than we currently expect.
I don't want to overstate my concern-I am not worried about a return to the 1970s. We designed
our new monetary policy framework for the very different world we live in now, which involves an
equilibrium for the economy with slow workforce growth, lower potential growth, lower underlying
inflation, and, therefore, lower interest rates. One of those differences is that the kinds of
"wageprice spirals" that characterized inflation dynamics in the 1970s have not been present for a long
time. It's quite possible that this situation now prevails because inflation is never high enough for
long enough to enter decisionmaking in a material way.
So, what are the implications for monetary policy? I am fully committed to the FOMC's new
monetary policy framework and the two pieces of related guidance that we have put in place for
asset purchases and the federal funds rate to implement that framework. The conditions
required to change the pace of asset purchases and those required to increase the federal funds
rate are sequential: The latter requires improvement in the economy that clears a much higher
bar. Let me address each of those in turn.
The guidance on asset purchases, introduced in December, commits us to increasing our
holdings of securities at least at the current pace until substantial further progress has been
made toward the Committee's maximum-employment and price-stability goals. My personal view
is that the rise in inflation-even after discounting temporary factors-and inflation expectations
since December will prove sufficient to satisfy the standard for inflation in the guidance around
asset purchases later this year, but improvement in the labor market has been slower than I
would have liked. For instance, the unemployment rate has decreased only 0.6 percentage
points to 6.1 percent, and the labor force participation rate is still nearly the same as it was at the
time of the December meeting. Therefore, we need to remain patient in the face of what seem to
be transitory shocks to prices and wages so long as inflation expectations continue to fluctuate
around levels that are consistent with our longer-run inflation goal.
For me, it is a question of risk management. The best analysis we currently have is that the rise
in inflation to well above our target will be temporary. But those of us on the FOMC are
economists and lawyers, not prophets, seers and revelators. We could be wrong; and what
happens then? Part of the calculus in balancing the risks of either overshooting or undershooting
our 2 percent goal is that the Fed has the tools to address inflation that runs too high, while it is
more difficult to raise inflation that falls below target. If we're wrong, we know how to bring
inflation down. But if our assessment is correct that inflation is temporary, it would be unwise for
us to take actions that might slow the recovery prematurely by trying to stay ahead of inflation,
when our best estimate is that we are not far behind.
If my expectations about economic growth, employment, and inflation over the coming months
are borne out, however, and especially if they come in stronger than I expect, then, as noted in
the minutes of the last FOMC meeting, it will become important for the FOMC to begin
discussing our plans to adjust the pace of asset purchases at upcoming meetings. In particular,
we may need additional public communications about the conditions that constitute substantial
further progress since December toward our broad and inclusive definition of maximum
employment. This standard presents inherent communications challenges because it cannot be
summarized by a single labor market indicator, such as the unemployment rate thresholds used
in the Committee's interest rate forward guidance between late 2012 and late 2013.
In contrast, the time for discussing a change in the federal funds rate remains in the future.i The
guidance for the federal funds rate commits to maintain the current rate until labor market
conditions are consistent with our goal of maximum employment and inflation not only has
reached 2 percent, but also is on track to moderately exceed 2 percent for some time. In the
FOMC's most recent Summary of Economic Projections, no participants-even those with
optimistic growth forecasts such as I've outlined today-thought it appropriate that liftoff occur
before 2022. Perhaps even more important than the timing of liftoff will be the expected trajectory
of rate increases afterward, and you can see that even among participants with an earlier
expected liftoff, those paths are quite shallow. Thus, I expect that monetary policy will remain
highly accommodative for some time.
Let me conclude with a few thoughts on financial stability. As the Fed's most recent Financial
Stability Report notes, the bright outlook, ample supply of credit, and accommodative fiscal and
monetary policy have pushed some asset valuations to very high levels that could be subject to
sharp reversals if expectations are not met. Likewise, business debt is high relative to past
experience, which is a good reason to carefully weigh the risks. But the strong economy
reassures me here: Earnings are growing, many businesses have ample stockpiles of cash,
expected bond defaults are below their long-run medians, and the pace of credit rating
downgrades has slowed to a trickle.
When I think about financial stability, I think most directly about resilience to shocks, and it would
be hard to imagine a better test of that resilience than what occurred in the spring of 2020. Banks
met extraordinary demands for credit last spring from nonfinancial businesses and households
while simultaneously providing forbearance on millions of existing loans and building substantial
loss reserves, all without significant strains to their overall health. The largest banks at the core
of the financial system are better capitalized than they have been in decades, and these
institutions are sitting on large amounts of highly liquid assets while relying on relatively low levels
of short-term funding. The banking sector is strong.
I also see a resilient household sector. Household credit is primarily owed by borrowers with
prime credit scores, rising home prices have most homeowners flush with equity, and, as I noted
earlier, households are sitting on a large stock of savings.
It is true that there are structural vulnerabilities in the nonbank financial sector, particularly money
funds and hedge funds, and these are being scrutinized by U.S. and international authorities,
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including the Financial Stability Board under my chairmanship.7
But I believe these risks are manageable, and I come down on the side of the research that
concludes these and other concerns are best addressed by targeted financial regulation and
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supervision rather than the blunt tool of monetary policy.8 At a crucial moment in our recovery
from the COVID-19 event, the utility of using monetary policy to try to address financial stability
concerns would be greatly outweighed by the costs to employment and growth.
Before ending, I'd like to reemphasize that I am quite optimistic about the path of the economy.
While prices will run above our 2 percent target this year, I believe most of this increase will be
transitory. After an exceedingly difficult year, we are poised to enter a robust and durable
expansion.
Thank you again for the invitation to be here today, and I look forward to our discussion.
1
All of my remarks today represent my own views and not necessarily those of my colleagues on the Federal
Open Market Committee. Return to text
2
Note: This speech was updated on May 26, 2021 to match remarks made at the Brookings Institution. On page
2, the sentence should read, "First, I see increasing recognition by the private and public sectors that a broad
reopening can proceed safely." On page 10, the sentence should read, "In contrast, the time for discussing a
change in the federal funds rate remains in the future." Return to text
3
See Centers for Disease Control and Prevention (2021), "Interim Public Health Recommendations for Fully
Vaccinated People," webpage. Return to text
4
See Board of Governors of the Federal Reserve System (2021), "Federal Reserve Board Issues Report on the
Economic Well-Being of U.S. Households," press release, May 17. Return to text
5
See Olivier Blanchard (2019), "Public Debt and Low Interest Rates," American Economic Review, vol. 109 (April),
pp. 1197-229; Lawrence H. Summers (2018), "Secular Stagnation and Macroeconomic Policy," IMF Economic
Review, vol. 66 (June), pp. 226-50; and Jason Furman and Lawrence Summers (2020), "A Reconsideration of
Government Debt in an Era of Low Interest Rates," presentation to the Hutchins Center on Fiscal and Monetary
Policy and Peterson Institute for International Economics, December 1,
www.piie.com/system/files/documents/furman-summers2020-12-01ppt.pdf. Return to text
6
For the deficit projection for 2021, see Congressional Budget Office (2021), The Budget and Economic Outlook:
2021 to 2031 (Washington: CBO, March). Return to text
7
See Federal Reserve Bank of St. Louis (2021), "Federal Debt: Total Public Debt as Percent of Gross Domestic
Product," FRED Economic Data (accessed May 21). Return to text
8
See Department of the Treasury (2020), "President's Working Group on Financial Markets Releases Report on
Money Market Funds," press release, December 22; and Financial Stability Board (2020), Global Monitoring
Report on Non-Bank Financial Intermediation 2020 (Basel: FSB, December). Return to text
9
See, for example, Lars E.O. Svensson (2019), "The Relation between Monetary Policy and Financial-Stability
Policy," in Alvaro Aguirre, Markus Brunnermeier, and Diego Saravia, eds., Monetary Policy and Financial
Stability: Transmission Mechanisms and Policy Implications (Santiago, Chile: Central Bank of Chile), pp. 283-
310. Return to text