Eric Rosengren Explains the Inner Workings of the Federal Reserve

While the US has managed to stave off a recession–at least for the time being–the global economy has nonetheless experienced a rocky couple of years: the collapse of Silicon Valley Bank in the U.S. this spring; the growing impact of artificial intelligence on virtually all industries; inflation in the West and deflation in China, and the subsequent interest rate hikes.

Fortunately, today’s guest on Deciding Factors is a veteran expert who can take us behind the curtain of the Federal Reserve to make sense of these factors and help us assess the state of the US economy.

Eric Rosengren is the former president and CEO of the Federal Reserve Bank of Boston, where he also served as a member of the Federal Open Market Committee—the FMOC—which sets policies for the Fed.

Listen along as Eric helps explain the processes that the FMOC uses to guide their decision-making, offers a nuanced take on how artificial intelligence will impact the economy and shares why he’s surprised that markets have stayed resilient this year.

ABOUT ERIC ROSENGREN

Eric Rosengren is the former president and CEO of the Federal Reserve Bank of Boston, as well as a member of the Federal Open Market Committee, which sets policy for the U.S. central bank. He additionally serves as a visiting scholar at MIT.

---

Podcast Transcript

Eric Jaffe:
We make decisions every day. While some of them are small, others can have a huge impact on our own lives and those around us. But how often do we stop to think about how we make decisions? Welcome to Deciding Factors, a podcast from GLG. I’m your host, Eric Jaffe. In each episode, I’ll talk to world-class experts and leaders in government, medicine, business and beyond, who can share their firsthand experiences and explain how they make some of their biggest decisions. We’ll give you fresh insights to help you tackle the tough decisions in your professional life.

While the US has managed to save off a recession, at least for now, the global economy has nonetheless been subject to a rocky couple of years due to events like the collapse of Silicon Valley Bank in the US this spring, the growing impact of artificial intelligence across virtually all industries, inflation in the West and deflation in China, and the subsequent interest rate hikes. Fortunately, today’s guest is a veteran expert who can take us behind the curtain of the Federal Reserve to make sense of these factors and help us assess the state of the US economy. Eric Rosengren is the former president and CEO of the Federal Reserve Bank of Boston, where he also served as a member of the Federal Open Market Committee, the FMOC, which sets policies for the Fed. Listen along as Eric helps explain the processes that the FMOC uses to guide their decision making, offers a nuanced take on how artificial intelligence will impact the economy and shares why he’s surprised that markets have stayed resilient this year. Eric, welcome to the podcast.

Eric Rosengren:
Thank you for having me.

Eric Jaffe:
So we usually like to start by getting to know our guest a little bit. Eric, maybe you could start with explaining why you became an economist.

Eric Rosengren:
I became an economist because I like doing policy work. So economics provides you the statistical tools to try to answer questions about why the economy behaves the way that it does, and is also a great discipline for thinking about how certain policy actions have outcomes that are either expected or unexpected. So I’ve always been very interested in trying to think about how we can get better economic outcomes and how policy can influence that, and that made becoming a macroeconomic economist with expertise in finance, particularly interesting. When I first started, I was more focused on becoming a professor of economics, but as I got more involved in doing empirical work, I realized that what I really enjoy is the policy work and the Federal Reserve is a wonderful place to do policy work.

Eric Jaffe:
So on deciding factors, we generally try to ask leaders in their field about how they approach decision making, and the Fed is probably one of the most famous and impactful decision making bodies out there in the world. So I thought we could explore that a little bit and just try to better understand from somebody who’s been there how the Fed operates. So the Feds famously made 10 rate hikes in the past two years, primarily focused on trying to fight inflation. I suppose the conventional wisdom might be that the Fed was a little slow to realize the problem of inflation, but they’ve certainly been fighting it quite aggressively in these last couple of years. Can you walk us through the process at a high level, how does the Fed actually make these decisions to move rates? What are the discussions like before, the big discussion that ends up getting transcribed? Are there lots of side discussions? Would be curious to better understand how that process works?

Eric Rosengren:
Yeah, so prior to each FOMC meeting, there’s a variety of information that becomes available. There’s staff briefing documents from the Board of Governors, and in particular the TealBook is a summary of what they model says. They expect the outlook to be for a wide variety of forecasted variables. It also provides a description and scenarios in that documentation. I was a president of a Reserve Bank, so at the Reserve Bank you would have a research department that would be very focused on both analyzing incoming data and looking at how their models are behaving relative to the way they expected and how the incoming data squares with what they were expecting going into the FOMC meeting. There’s usually a week or two weeks of briefings that internal staff will give to prepare whoever the participant is to prepare for the meeting.

Prior to the meeting, there is usually a call with the chair where there’s a discussion of policy options and a discussion of how you’re seeing the economy. When you actually get to the FOMC meeting, the FOMC meeting is usually a two day meeting. The meeting usually starts with a special topic, so that could be actions being taken related to banking problems, actions related to the balance sheet or whatever the most important topics are. After the special briefings, there’s briefings of the New York Fed staff on what’s been happening with financial markets. There’s briefing on both the domestic and international outlook from Board of Governors staff and then there’s a go around among all the presidents, whether voting or not, and members of the Board of Governors who present their own view about how the incoming data pulls together and what they expect for the economic outlook going forward.

The second day is usually much briefer and the focus on the second day is on what the policy action should be related to the previous day’s discussion. Once again, there’s a go around of all the participants, whether voting or not voting, and members of the Board of Governors. At the conclusion of that, there is a vote which is only of the voters. The voters are a subset of the presidents which have a set revolving order for actually being voting members and then the board of Governors that vote at each meeting. So they’re, when fully staffed at the board, they have seven governors that vote at each meeting, and then after the meeting concludes, there is a press briefing by the chair where he tries to highlight the broad discussion that occurred at the meeting and characterize what the policy decision was. Following the meeting, there are minutes, it doesn’t go through individually what each person said, but rather as more a compilation of the general thrust of the discussion. And then after a long lag period, the transcripts become publicly available.

Eric Jaffe:
What’s your take on the process?

Eric Rosengren:
I think it’s a very comprehensive briefing schedule. The Federal Reserve has a large number of economists. There are people that specialize in all different segments of the economy and financial markets. So there’s a great depth of knowledge in the room. So not only at the FOMC meeting do you have the presidents and governors and senior staff, but you also have people that sit around the sides that are either research directors at Reserve Banks or staff that they think might have expertise that might be called on in the meeting. So there’s a lot of detailed information available to all the participants. The desire is for everybody to have broadly the same set of data to work from, but obviously, for example, Reserve Bank presidents coming for a particular district may have more specific knowledge about things going on in their district. The governors may be more aware of some of the policy actions being taken by the Federal Government or other government agencies. If you go to the Federal Reserve Board website, you can actually go through one of the transcripts and see exactly what was said over the course of the entire meeting.

Eric Jaffe:
I did that last night, in fact, and I did see that there was that lag. I think you can only get to maybe 2010, maybe 2012. I’m curious, how does the fact that the discussions are recorded and you know that eventually the notes will be released, how do you think that affects the dynamic of the interaction?

Eric Rosengren:
People are certainly aware that there’s a verbatim transcript that is provided the public with a five-year lag, but because it’s with a sufficient lag, I don’t think it stifles discussion in any meaningful way, but people realize that the decision is quite important, and as a result, they put a lot of time into preparing their comments.

Eric Jaffe:
Now, obviously, the Fed has sort of a blunt instrument, right? The raising or preservation or reducing of rates. I wonder how does the Fed think about wages, real wages in particularly, which have held stubbornly steady for quite a long period of time?

Eric Rosengren:
Well, there is a lot of time spent on labor markets and what’s happening with wages, and the reason for that is because we have an inflation target of 2%. So if not only prices are rising quite rapidly, but wages are rising quite rapidly and it’s not because of productivity in the economy, then it makes it much less likely that the Fed’s going to meet its 2% inflation objective. So there’s a great deal of analysis that is done on labor markets, decomposing the various labor market indicators, looking at what parts of the economy are quite hot in the labor market. There’s also a lot of qualitative data that’s brought to the table.

Fed presidents spend a lot of time talking to people in their communities. They have their own separate board. As a result, there’s both qualitative and quantitative information about labor markets. While the Fed in no way can directly affect wages, if labor market conditions are too tight and wages are growing in a way that’s inconsistent with inflation, that would make it much more likely depending on what was happening with unemployment, that the policy action would be for tightening. If the wages and salaries and compensation are coming in consistent with what would be a 2% inflation over time, it’s much less likely that additional action would be needed.

Eric Jaffe:
Obviously, the Fed is famously independent. It did take some criticism for being behind the curve on inflation. Do you think it can withstand pressure to cut rates if unemployment starts to climb and/or if economic growth starts to slow below the current trend?

Eric Rosengren:
So usually it’s not that difficult to cut rates. It’s actually harder to raise rates because there’s a natural constituency that’s worried about slowing down the economy too much. As you mentioned, the Fed was potentially a little slow in getting started in the cycle, probably thought that a lot of the shocks that we were seeing in inflation would be more transitory than they turned out to be, and as a result ended up needing to move much more rapidly than the Federal Reserve has historically. So normally the Fed moves in 25 or 50 basis points, a quarter of a percent or a half a percent because they don’t want to disrupt markets too much. But because there was a slow start, the result was that there were a series of 75 basis point increases, that was unusually fast by historical standards.

I think that that reflects the fact that the Fed has been quite independent, that it was willing to raise interest rates aggressively to an inflation shock that was being much more persistent than they were expecting. And I think it is a good example of how the Fed can respond in an independent way. I have no doubt if the economy slowed down much more than they’re anticipating, and we saw unemployment rates getting much higher and recession risks were quite high, that they would then choose to have a lower interest rate path than they otherwise would have. So far, actually the opposite’s been true, that they’ve been surprised by the strength and resilience of the economy, and as a result have kept interest rates tighter than many in the market we’re expecting.

Eric Jaffe:
So how does the chair think about dissenter speaking to the media, and is there an expectation that a governor will keep their comments between left and right boundaries when they speak publicly in the aftermath of a decision?

Eric Rosengren:
So the chair speaks for the committee. Everybody else speaks for themselves. When the chair does the press conference, he’s not just giving his view, he is really giving the committee’s view about what the appropriate actions are. When a president or a governor speaks publicly, they’re not speaking for the committee, they should make it clear that the views that they’re presenting are the views of themselves. They can have independent views, but they can’t speak for the committee as a whole.

Eric Jaffe:
When we look back to March and the impact of what occurred with Silicon Valley Bank, I wonder now with the benefit of three, four months of hindsight, did we overreact to what happened?

Eric Rosengren:
Anytime you have significant financial stability problems, either in the banking system or in non-banking financial intermediation, it should be a source of concern. And there are things that do not get well captured in typical economic models of the economy. And one of those things that frequently doesn’t get modeled particularly well is the transmission of financial shocks to the real economy. So I think there’s been a great deal of uncertainty, and you see periods like the financial crisis and the pandemic where it’s very hard to forecast exactly how a shock is going to reverberate across the economy. So I think when Silicon Valley Bank and the other bank failures occurred, it was quite reasonable to take a step back and ask, “Is there something more substantial here that we should be concerned about?” I would also highlight that frequently financial shocks don’t reflect themselves fully for some time.

So if you go back to the financial crisis, I mean, Bear Stearns failed in March. It wasn’t until October that we had a series of failures that basically shut down financial markets. So there can be a failure that occurs and then no failure for six or seven months, and then you realize that actually the stresses were much more significant than many people realized. So I think it is useful to be cautious around times where there have been significant financial shocks, and I think the FOMC has highlighted that in the minutes that they are paying very close attention to the financial shocks and on bank supervision the Board of Governors has a very significant role, so they’re responsible for holding companies and they’re responsible for state member banks. Silicon Valley Bank was a state member bank regulated by the Federal Reserve. It’s important to understand what was going on in that particular instance and whether it was reflective of a more serious problem in the overall economy.

I would say what I took from that is that one reason we don’t tend to move rates up very rapidly at 75 basis point clips is because many borrowers and many banks may not be well positioned for that move, and it may cause financial shocks that are more outsized than if a more gradual path could have been taken. So I think the 75 basis point increases that we saw reflected the inflation risk. But when you start raising rates very rapidly, there are some people that are not well positioned. Those could be borrowers, those could be banks, those could be other financial market participants. So I think it’s still too soon to know exactly what the reverberations of the very rapid increase in interest rates are.

To date, I’d say the real economic data has come in more positively than many people have expected, but it’s still going to take a little bit of time before we fully understand the effects both here and abroad. When we raise rates rapidly, it has a big impact on other economies. Many other countries raise rates to reflect what’s happening in the US because they’re worried about their exchange rate risk or they have a fixed exchange rate relative to the Federal Reserve. So our rate increases directly affect the decisions that they’re making. So there are lags in monetary policy. It would be nice if the shocks were no more severe than what we’ve seen to date. I think we’ll need more passage of time before we know whether that’s true or not.

Eric Jaffe:
Obviously, we’re still battling inflation. Interest rates are high. Corporate leaders are concerned and kind of excited about integrating artificial intelligence to try to drive efficiencies into their businesses. Unemployment rather is low, maybe not easy to find great talent, on the other hand, real wages are not increasing for many Americans. How do you see the economy playing out in the second half and moving into 2024?

Eric Rosengren:
The economy’s been more resilient than I would’ve expected. I would’ve expected labor markets to have slowed down more. The summary of economic projections provided by FOMC participants has next year a range of unemployment from 4% to 5%. That means that the most optimistic of the FOMC participants expects unemployment to go up from where we are currently. My own expectation is that that’s a quite likely outcome. I think that consumers have been bolstering the economy in part because they’ve had a lot of savings that were built up during the pandemic and a lot of deferred expenditures.

But I do think that as we get into the fall, some of those buffers that occurred during the pandemic will have been drawn down in many households, and that consumption may not be as robust as we get into the second half. So I’m expecting labor markets to soften much like the FOMC participants, and one reason that it’s widely expected that the FOMC will increase interest rates at the July meeting is because I think they are expecting that they need to raise rates at least one more time to make sure there’s enough labor market slack that wages and prices come down to a level consistent with the mandate.

So wages have been growing more rapidly than is consistent with a 2% inflation target. Normally, you would expect something more like 3.5% wages would be consistent with a 2% inflation rate. I do expect that the Fed will continue to have a tight policy until they see more progress. We’ve definitely seen a number of the components of inflation come down, but more recently we’ve seen some increases in things like oil prices, and there’s still some challenges, I think reverberations from the Russia, Ukraine war. So there could still be supply shocks that the Fed has to think about. Wage contracting is probably going to be resistant to trying to get wages as low as 3.5%. I think there’s still going to be some challenges to getting the Fed to get to the 2% inflation rate that they’re expecting to get by 2025.

Eric Jaffe:
And what about artificial intelligence? I wonder how you think about that, and particularly how you expect it to affect labor markets and jobs in the knowledge economy.

Eric Rosengren:
So frequently when you have innovations, the initial impact is that people become very worried about jobs, but usually over time it’s increasing productivity and the jobs change. They’re not the same jobs as people had before, but you still need people to do the work. So I think the real question is how quickly AI provides innovations that actually are reflected in significant cost savings while producing the same amount of goods and services. So if that were [inaudible], we would expect productivity to go up quite dramatically so far that isn’t in the data. It’s very early in the cycle to fully understand how AI is going to fully impact businesses and labor. But I’m skeptical that you have to be particularly worried in the long run. Productivity enhancements are actually good things for the economy. It means you can produce more goods and services with less labor effort, that makes you wealthier.

It’s a potentially great outcome for the US and the world economy. That being said, AI has to be used in an effective way. How you train the models for AI is quite important. What data’s fed into the model, it becomes a bit of a black box, but that doesn’t mean that you shouldn’t be worried that you don’t always get outcomes that are fully accurate. I think people that have tried using AI programs for things that they know quite a bit about frequently find inconsistencies in what the AI outcome that is provided. So I think it’s still a work in progress and over time, I have no doubt that there will be labor savings, but that should be good news overall for the US economy.

Eric Jaffe:
Eric Rosengren, thank you so much for coming on Deciding Factors. Really appreciate you coming on.

Eric Rosengren:
Thank you.

Eric Jaffe:
We hope you’ll join us next time for a brand new episode of Deciding Factors featuring another one of GLG’s network members. Every day, GLG facilitates conversations with experts across nearly every industry and geography, helping our clients with insight that leads to true clarity. Feel free to leave us a review on Apple Podcasts. We’d love to hear from you or email us at decidingfactors@glgroup.com if you have feedback or ideas for future show topics. For Deciding Factors in GLG, I’m Eric Jaffe. Thanks for listening.