Cleveland Fed President Loretta Mester speaks with Yahoo Finance [Transcript]

Loretta Mester, president of the Federal Reserve Bank of Cleveland, spoke with Yahoo Finance to discuss the weaker-than-expected April 2021 jobs report and where Fed policy is headed next.

Below is a transcript of her appearance on May 11, 2021.

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BRIAN CHEUNG: Thanks Julie. Joining us now here on Yahoo Finance Live for an exclusive interview is Federal Reserve Bank of Cleveland President Loretta Mester. Thank you so much for joining us here on the program this morning. I want to kick things off with what everyone's been talking about: the jobs report from last Friday showing 266,000 payroll adds for the month of April, a lot of people on the street were expecting something closer to a million. So just wondering how you're thinking through that report and what may have explained that weaker than expected number.

LORETTA MESTER: It was a disappointing report. But, you know, I don't think it changes my outlook, I think the outlook is still bright. And you know, maybe the surprise should have been the March report because it was so strong, so you don't read too much into one report, whether it's a very positive report or a disappointing report. I think what it does show is that something that we've heard from a lot of our contacts, which is that labor supply is not plentiful. A lot of the firms are saying they'd like to hire, but they're having some issues finding workers and that could be what was reflected in the report. The labor supply of women in particular was down. So again, I think we have to look through it. The economy is adding jobs and that's a good thing, but it's a reminder that we can shut down the economy quickly, which we did last year, when we reopen, we're reopening, it varies across sector.

There's still school issues. Schools aren't reopen and that affects labor supply. People haven't been fully vaccinated yet, although we're making great progress, so there may be concerns about health concerns about re-engaging. And the support that families have in the opportunity to stay out of the workforce, until they feel more comfortable re-engaging so I think all of those things that supply and that's what we saw in that report. But bottom line, we're still adding jobs and I think the outlook is bright.

BRIAN CHEUNG: So President Mester I want to backup to what you said: that maybe it was the March report, that had about a million job gains that was revised down after the fact, was the real surprise, does that change the outlook on the guidance that we had gotten from the Fed chairman who had mentioned that you might want to see a string of jobs reports of 1 million payroll adds a month to get to substantial further progress? So does the April report then change that measuring stick?

LORETTA MESTER: No, I think that's a good way of thinking about it. We never take one report as being reported, I mean we get volatility in these kind of monthly numbers all the time and of course, coming out of the pandemic, we should expect to see even more issues with measurement and how to interpret the numbers. We've never come out of a pandemic like this and a shutdown of the economy. So I think what we want to see, and I certainly want to see, is more progress and broader progress. Right now we're in a recovery, no doubt. And the strength that came out of this is actually quite a good sign, but I think we're gonna see some ups and downs as we open up more. There's some parts of the economy that are still very weak. Even though they're making progress, like leisure and hospitality, there were other parts of the economy that are back up to levels we saw pre-pandemic, for example housing is strong. Manufacturing is almost back up to pre-pandemic levels and so we have this mix of things that differ across sectors. And we I certainly am looking to try to see that the recovery broadens as it continues, I expect that to happen. And so I want to see more strength in the labor market, as we go forward and I'm expecting that this year.

BRIAN CHEUNG: So we had a conversation with the San Francisco Fed President Mary Daly just yesterday, she was saying she doesn't like the terminology of calling the dynamics in the labor market, a “labor shortage” has a lot of weird dynamics at play, but there's a hot debate about the impact of unemployment insurance, the extra benefits that are provided through the stimulus. At least, what you're seeing in your district, which is centered around Cleveland, Ohio, is UI indeed a major factor in holding people back? Or is it some of the other things that you had mentioned earlier?

LORETTA MESTER: Yeah, I mean, there's a lot of things in play there. Certainly the businesses will attribute it to that. But frankly, I think it's more the fact that we still — I think overall in the country, over 100 million people have gotten vaccinated. But that's still in play right? Vaccination penetration is still going up and that needs to continue. So I think there's still some fears to go back in because of health concerns. I think it's a serious issue about childcare, homeschooling. We saw that earlier in the pandemic where women withdrew strongly from the workforce, more so than men, and I think that's still because we haven't really reopened schools totally — they're not back to where they were and I think those issues are significant.

It is true that with the extension of the unemployment benefits, people are in a financial position so that they can make those hard choices about whether they feel comfortable re-entering or not. So in that sense it gives support to families, but I don't think that's the main issue. I think these other issues are playing a larger role and it's just going to take time for those to work themselves through. So I think that's what we're seeing, certainly in my district, I think there are these significant issues. Businesses will say that even keeping staffing, people on their payroll - there's volatility in any day right? Because people might have to stay home because schools have been closed back down, because of quarantining because someone has been exposed within the factory. So I think those issues are what we're seeing. And until we get a broader vaccination rates and I expect that that continues throughout the third quarter of the year, until we get really those high, high levels of vaccinations, we're going to see that kind... we can restart things but we're going to still have these issues that are affecting, are we back to normal yet? I think that's just going to take some time to get to.

BRIAN CHEUNG: So I want to ask about the inflation side. Obviously price stability the Feds other dual mandate seems like tech stocks are down right now — you don't want to attribute it to one thing. But they’re pretty sensitive to these concerns about rising inflation. Actually there's a Bank of America note that mentioned inflation mentions in quarterly earnings reports have been up 800% year-over-year. So, what is your forecast from where inflation is going to go, how is that factoring into also your reaction function on maybe tapering and or raising rates at some point?

LORETTA MESTER: So that's a good question right. So just as supply and demand are being seen in the labor market, right, we have an increased demand for labor and we have some supply issues, I think we're seeing exactly the same thing in product markets. And that's one of the things is: supply chain issues are affecting certain products, commodities, very much so in terms of their pricing, we hear that across the firms, across various different sectors in our district. That firms are facing these higher costs for components and for commodities. The other thing that's happening with the inflation measures is that very low readings of inflation from last year, when the economy shut down are going to fall out of those year-over-year numbers. So I expect to see inflation readings for the next couple of months be elevated, just for the simple mathematical reason that those low numbers are going to fall out. And then on top of that, the supply constraints are going to put some upward pressure, especially on inflation rates from the [Producer Price Index]. How much that'll feed through into the broader consumer price numbers, we'll see. My expectation is that we'll end the year with inflation above 2%. But then next year, as those supply constraints are eased, inflation numbers will go back down. And then, with the support of monetary policy and fiscal policy we’ll see those inflation reads move back up. And so temporarily high inflation readings and then moving back down.

That's my baseline forecast, but there are upside risks to that forecast and that's where we're very focused, and I particularly am very focused, on readings and patient expectations. People, their expectations, are really tied to some of the prices they experience. And so, I'm looking at survey measures, I'm going to be looking at the market based measures to see whether inflation expectations are rising and what pace they’re rising. We're aiming to have inflation above 2%, because inflation was so low for so long. So seeing inflation move up to two, right, and somewhat above two is not a problem. We want to have inflation expectations anchored at levels that we can make that average inflation be two over time. That in its itself is not bad. It's just, where is inflation numbers and that's where I'm going to be focused. I’m going to be looking at that and looking at where inflation is going.

BRIAN CHEUNG: Now, the other part of this is also financial stability risks right? One caveat to the Fed providing this easy policy that they'll continue to do so unless maybe there's something bubbling up in the system. So there was a Fed report last week that flagged, maybe hedge funds as a blind spot. What are you seeing largely right now? Do asset valuations worry you or is Fed policy really in the right place, and there's no concerns about that happening right now?

LORETTA MESTER: Yeah so my read is that they're certainly, in terms of equity prices, there's upward — there’s upward — they’re high. There's upward valuation pressure there. I think the financial stability risk overall, I would view as moderate. However, I think we have to recognize that there are parts of the financial system that we have less insight into. And my expectation is we'll see some volatility in markets. That in it of itself isn't a problem. It's when that volatility is coupled with high degrees of leverage where you might have a financial stability risk so I'm certainly attuned to that. And I think, given that our expectation is that the economy is going to require high levels of accommodative monetary policy, we should be very attuned to what's going on in those markets. I don't see it as an elevated risk at the moment but it's certainly something we have to be attuned to. And that's why I think the best strategy is to focus on resiliency. We want our markets and our financial institutions to be resilient to any kinds of shocks that might hit them.

And I think after this last financial crisis, there was a lot of focus on raising the resiliency of the banking system. Of course the financial crisis was centered on the banking system, commercial banking system. That served us very well. Coming into this pandemic crisis, the banking system was able to play an important role to help get credit to households and businesses. I think once we get out into better times and we get beyond the pandemic, we need to focus on other parts of the financial system, make sure they're resilient as well. But that's a future endeavor. I think right now we have to focus on making sure that our monetary policy is well calibrated to where the economy's going in terms of progress on our dual mandate goals and I think that's what we're focusing on, that's certainly what I'm focused on at the moment.

BRIAN CHEUNG: So that's forward looking, I want to look backwards really quickly and just kind of zoom out. The Fed made a pretty big change to its framework and I want to rewind to February 2020, where you in addition to other Fed members were kind of pondering if the Fed had gotten the economy to pretty much full employment. Now we're looking back now with this new framework and saying, ‘maybe there was more room to go even pre-pandemic to pulling in marginalized workers back into the economy.’ So with the framework aside, how have you think your personal views have changed in regards to the Feds reaction function and what you need to see in order to tighten?

LORETTA MESTER: Yeah, that's a really good question, Brian. I've been thinking about sort of, our forward guidance is we give two forward guidances: one on the interest rate ones, one on asset purchases. And of course “substantial further progress” on asset purchases. And one way to think about that is: are we back to this, relatively, generally strong conditions we had in employment in the labor markets back in February? And we're not there yet. So that's one way to benchmark it. But there's many different indicators to use and I like to look at various indicators to see where we are. I think one of the things I learned was that these underlying changes in the structure of the economy really give us more.

I mean, one reason we changed the framework, I know you don't want to go back to the framework, but there was a real reason to change the framework and that was because of these underlying structural changes in the economy. One that the general interest rate, sustainable interest rate, is lower than it was decades ago. That's one big change. The other one of course is that the relationship, or the correlation between slack and the economy — labor market product market slack and inflation — is much less than it was in the past. And then inflation expectations really drive inflation, actual inflation. And so those changes lead to the change in the framework, which generally I would say means that for the same economic conditions we're going to be running a generally, a likely more accommodative monetary policy.

But that doesn't mean it's any riskier. It means that the economy has changed, so a more accommodative policy is what's required to make our goals of maximum employment and price stability. So I don’t view it as we’re taking on more risk. I view it as being, using the strategy that will achieve our goals more effectively in the new economic environment we're operating.

BRIAN CHEUNG: All right, well definitely something to keep watching We actually went over our time, some of these topics get so interesting! But again, Cleveland Fed President Loretta Mester, thank you so much for stopping by here on Yahoo Finance this morning.

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