The Mystery of John Williams at the New York Fed

Please enjoy this complementary piece, run earlier this week, on the changing of the guard at the second-most influential Fed.

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• John Williams is now the second-most powerful leader inside the world’s most powerful central bank. If Jay Powell gets hit with the flu in a few months, it is Williams who directs interest rate policy.
• Williams has advocated for raising the inflation target off the 2% level they’ve failed to attain forever as it’s an ill-designed metric not meant to rise.
• Williams also advocated for further bond-buying (a.k.a. Quantitative Easing) and in the event all else fails, forward guidance.
• Williams’ SF Fed has extensively researched raising the inflation target to coerce a steepening in the yield curve. But is that even do-able?
• That also builds in higher inflation expectations across the term structure of interest rates, so long-end yields would rise. Raising the inflation target means the Fed doesn’t just tolerate higher prices, it tolerates higher costs and profits.
• But it falls flat in practice. If firms can’t raise prices, then either costs are cut, profits are squeezed, or companies’ balance sheets weaken due to the reduced cash or added leverage that stems from the higher-cost environment. The issue then becomes a credit problem.

La plus ca change does not apply to the New York Federal Reserve’s John Williams. If you’re in the City, drop him a line. Today is his first day on the job since resigning his post as the President of the San Francisco Fed, where he’d been since 2002. New York can be a harsh place, so I’m sure he’d appreciate the warm welcome.

In the event you’re not a Fed watcher, John Williams is now the second-most powerful leader inside the world’s most powerful central bank.Along with a new vista on the Hudson or East Rivers, Williams’ new gig also crowns him Vice Chair of the Federal Open Market Committee. If Jay Powell gets hit with the flu in a few months, it is Williams who directs interest rate policy.

But wait! There’s more. As head honcho at the NY Fed, Williams is also in command of the open market operations of the FOMC, acting as the agent of the U.S. Treasury, and handling banking and clearing services to foreign central banks, governments and international agencies. Not finished yet! Williams also shoulders the responsibility of regulating the country’s biggest banks and safeguarding the financial stability of the financial markets. All of this for a man who, by his admission, was not inclined to have a Bloomberg terminal on his desk.

You may recall that one Jerome Powell was greeted on his first day in office with a quadruple-digit slide in stocks. Williams has it a wee bit better. He’s toting his metal pail to the office today with a 35 basis-point differential between the yields on the 2-year and 10-year Treasuries.A Swedish pancake being run over by a steamroller yield curve unquestionably bests a flash crash, right?

Aside from that, the new job is nothing new.

Surely this 24-year veteran of the Federal Reserve System, who has been inside the organization since the day he earned his PhD in economics from Stanford University, will uphold his duties? He’s never worked anywhere else and is a nice enough inside guy. What more could we ask for?

If you managed to read through that last bit, you’ve sailed past the point. In just the past year, Williams has advocated for raising the inflation target off the 2% level they’ve failed to attain for like ever as it’s an ill-designed metric not meant to rise. He has advised the world – not just the United States – that global central banks should prepare to implement negative interest rates to combat the next downturn.

In a speech at the SF Fed last fall, Williams said that, “We will all be better able to contain the next economic recession if we develop approaches that succeed even when many countries are simultaneously constrained by the lower bound.”

In the interest of deploying other failed measures, Williams also advocated for further bond-buying (a.k.a. Quantitative Easing) and in the event all else fails, forward guidance. 

You may have noticed Jay Powell dispensed with forward guidance just last week at the June FOMC meeting? Why, the adult in room reasoned, make unquantifiable promises the Fed may or may not be able to keep?

Moreover, Powell doesn’t seem like the kind of a guy who’d ever let negative interest be mentioned on his watch, much less imposed.That makes it more difficult to explain why the new Fed chair gave Williams his blessing prior to be appointed (he had to have; we’re talking about his second-in-command).

Perhaps it comes down to “persistency,” Powell’s favorite term, and the testy task of eventually defining it when the time comes. Powell’s advocating for Williams may come down to getting buy-in from the traditional economics community. Just how far above the 2% target the Fed can dare venture? For how long?

Williams’ SF Fed has extensively researched raising the inflation target to coerce a steepening in the yield curve. But is that even do-able?

In theory, a higher inflation target means policymakers resist tightening and short-end yields don’t rise as much as when the inflation target was lower. It also builds in higher inflation expectations across the term structure of interest rates, so long-end yields would rise.

Because of the great identity of all corporate balance sheets - price = cost + profit - raising the inflation target also means the Fed doesn’t just tolerate higher prices, it tolerates higher costs and higher profits.Put another way, the Fed tolerates higher price inflation (like CPI, PCE), higher wage inflation (like average hourly earnings, ECI) and higher profits inflation (equity prices).

The problem with this is simple. It falls flat in practice. If firms can’t raise prices, then either costs are cut, profits are squeezed, or companies’ balance sheets weaken due to the reduced cash or added leverage that stems from the higher-cost environment. The issue then becomes a credit problem.Powell, with his real-world experience, understands this risk all too well. Williams, not so much. And that means it is Powell who is making the real gamble. Mystery solved.

Danielle DiMartino Booth is CEO and Director of Intelligence at Quill Intelligence LLC.

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