Speech

Transcript of Fireside Chat at Rutgers University—New Brunswick: November 29, 2017

November 29, 2017
Posted December 01, 2017
William C. Dudley, President and Chief Executive Officer
Moderator: Eugene N. White, Professor of Economics at Rutgers University and a Research Associate of the National Bureau of Economic Research

Eugene White:

Dr. Dudley is going to first give some general comments about the regional economy, and then we're going to move over here for a fireside chat to talk using some pre-prepared questions, and then from the audience.

President Dudley:

Great to be here. My wife is a graduate of at the school and she sends her regards. She's the Chair of the Douglass investment fund, so she's actually involved with the college on an ongoing basis. It's also great to see Christine Cumming, whom I worked very closely with at the Fed. She was the First Vice President of the Fed, and is now on the faculty here. So, glad to see you here, Chris, as well.

I thought I'd just talk a little bit about what we're doing on these kind of roadshows. Like, why do we do this? And talk a little bit about the regional economic outlook. The New York Fed—the Second District of the Federal Reserve, it's New York's Fed district, and it consists of New York State, Fairfield County, Connecticut, Northern New Jersey, Puerto Rico, and the Virgin Islands. And we think it's important that in terms of how we interact with our community, to actually go out into the community and find out what's really going on. It's one thing to look at economics, statistics, and data, but it's also very valuable to actually hear from people in terms of what are they experiencing in terms of the economy. What's happening to the labor market, what's happening to job availability, what's happening to the housing market. We learned a lot during the financial crisis about the difficulties people were having with maintaining their mortgages, staying current on their mortgages.

So, you get that information by reaching out into the community. I basically go out on four road trips a year throughout the district. So this is the fourth one for Northern New Jersey. We're going down to Puerto Rico which has been devastated by the hurricanes, in a couple of months. That’ll be the next one. It's been very valuable for me in terms of really understanding what's going on, on the ground.

So, basically is important. It informs how we think about the appropriate course of monetary policy. It's one thing to look at economic statistics, it's another thing to hear from real people on how the economy is actually affecting them on a day-to-day basis.

The second thing we do on these trips is we're really trying to understand what we can help bring to the community in terms of our own outreach efforts. We have a function in the Federal Reserve Bank of New York which is Outreach & Education, and we like to use that to try to actually help the communities that are in our district.

Some of the ways that we do that, for example, is we recently ran a small business forum in New Brunswick about how small businesses can gain access to capital. In the wake of Superstorm Sandy, we actually had a set of workshops in New York about how could people actually navigate through the various aid programs and help people recover from the hurricane.

We also publish a lot of economic data that is actually helpful to the policymakers locally. So we do a small business survey for the region. We're also now starting to compile a lot of micro-data at the local level, so you'll actually sort of see how is it one day we're doing well and another day we're not very far away from doing much more poorly. And that actually helps policymakers make better decisions about how they can actually help their local community.

And the last thing we do is I think we have a pretty strong ability to convene people. If we say something is important, a lot of people will sort of take this pretty seriously. And so if we can have various stakeholders come in—people from the education communities, from government, from private businesses, from community development groups—and have conversations about real issues, which I think actually pushes the ball forward in terms of making progress on tackling some of the tough public policy issues we face.

One of the things that I’m very focused on is income mobility. I think people they get in the United States, there's the American Dream, the idea that you can start from the bottom, work hard, and make your way up. But the fact is, income mobility in the United States isn't really good. And that's really something that we need to work on. That's why places like Rutgers are so important because it's really the educational communities that essentially give people that leg up. So, for example, Milton Friedman has a story, I thought was a very interesting one. His parents didn't go to college. Just like my wife Ann. Her parents didn't go to college, and so she came to Rutgers. Her family thought she should go to the local community college, and she said no, I'm going to go to Rutgers, I'm going to go to a four-year college.

So I think what happens in the educational communities in our region are really, really important in terms of giving people the job skills and that head start so they can actually make a success of themselves throughout their career. That's the one thing in the Second District, where we really have a comparative advantage, the number of really high quality educational institutions in the Second District is really without parallel.

I mean, the only district that could even sort of, maybe slightly compete with us, might be the Boston Federal Reserve’s district. Having those educational communities work closely with business, I think is also important. So that's something else we very much stress. We want to have people graduate with the skills that businesses actually need so that those people can actually get jobs quite easily.

So that's really sort of the purpose of why we go on these road trips. Also we can give our views about the economy. So Eugene’s going to ask me a lot of questions, which I'll answer. I'm sure we'll cover not just the local economy but we'll also talk about the national economic outlook and things of that nature.

Eugene White:

We're going to have a fireside chat here. We're going to move over here.

Audience Member:

I'm looking for the fire.

Eugene White:

I don't think in these buildings they allow you to light anything. Except maybe intellectual discussion. So, I've had a series of questions handed to me by faculty and graduate students and undergraduates to ask you.

So, one question which is submitted was a quote from Charles Steindel, the former Chief Economist for Chris Christie, who used to also work at the Fed. And he said that the New Jersey economy consistently grows at a 0.5 to 1% slower than the national economy. This has been going on for a half century or more. Given this regional divergence, how do regional considerations figure into the Fed's policy decisions?

President Dudley:

Well, clearly, we set monetary policy for the nation as a whole. So some regions are doing better, some regions are doing less well. And we take all that in consideration in terms of monetary policy. We can't set monetary policy differentially. You can't have one monetary policy for New Jersey, another one for New York City, another one for upstate New York.

So, we have to understand that monetary policy is going to be set for the country as a whole. But the way the Federal Reserve is constructed, you have these 12 Federal Reserve Bank presidents, and they can very much come to the FOMC meetings and reflect what's going on in their regions. So the regional views and what's happening in the various regions do get very reflected in those monetary policy discussions and the decision-making.

Now in terms of New Jersey, growing a little bit more slowly than the national average, I think that's part of a much broader story, which is the migration of people from the Northeast and Midwest to the South and West that's been going on for 30 years. Population growth in New Jersey is well below the national average, and that's really probably the primary driver of the fact that the growth rate in New Jersey is going to be a little bit weaker than the country as a whole.

Eugene White:

One of the things I think in terms of the Fed that people aren't aware, they might think that this is all self-chosen by bankers, and so forth. But really the Board of Directors is a very diverse group, right?

President Dudley:

Yes, it is a very diverse group, and in fact, the bankers—so the Federal Reserve Act sets a mandate of we have to have a board of directors, and the board of directors consists of three groups. There's the Class A directors, which are the bankers—three of them. There's the Class B directors that are supposed to represent commerce. And the Class C directors that represent I think the community sort of broadly. The Class A directors, the bankers, they have no part in the selection process for the President of the Federal Reserve banks, which I think is a good thing. So, it makes it very clear that we're here to represent Main Street, not represent Wall Street.

I've announced that I'm going to be stepping down sometime late spring, early summer. So we have a search committee composed of four members of the Board of Directors, excluding the bank directors, and they begin the process of a search for my successor.

Eugene White:

So, yesterday, bitcoin topped $10,000. How does the use of digital currencies impact monetary policy, and should the Fed play a greater role in adopting digital currencies to the payment system?

President Dudley:

Right now, bitcoin is tiny relative to the amount of payment transactions that are executed in the United States. It's essentially trivial in the broad scheme of things. But there are some aspects of bitcoin that are quite interesting. So like the ledger, you know, blockchain ledger technology is something that we think actually could be used in other applications.

I think at this point it's really very premature to be talking about the Federal Reserve offering digital currencies, but it is something we are starting to think about. So, what would it mean to have a digital currency? How would we offer it? Do we actually need it? I think that in terms of bitcoin, I would be pretty cautionary about it. I think that it's not a stable store of value. It doesn't really have the characteristics you would like to have of a currency or a payment medium. It's not a stable store of value. The price goes up and down very sharply. And it's not legal tender. So someone doesn't actually have to accept bitcoin for your transaction. If I go in the store with dollars, or currencies, people actually have to accept my currency and make that transaction. So, I think that I would be, at this point, pretty skeptical of bitcoin. I think it's really more of a speculative activity at this point.

Eugene White:

Although some central banks have moved ahead of the digital front. Sweden, for example, pushing very hard.

President Dudley:

Yes, Sweden is an interesting case. Sweden, the use of cash is much less than in the United States, so that makes digital currency more easy to migrate to. Also more people are participating in the banking system. One of the challenges for the U.S. to move to a digital currency that a central bank offered is a lot of people are not really actually plugged into the banking system.

So, you'd have to have a system in place that actually brings those people that are currently unbanked into the financial system. To really have an effective digital currency in the U.S., we have to overcome that challenge.

Eugene White:

You mentioned about the income distribution. We know that in the U.S. that income distribution, we've had vast growth but it hasn't benefited everyone. Is there anything in monetary or perhaps banking policy that the Fed could do to perhaps improve the performance?

President Dudley:

Well, monetary policy is a pretty blunt tool in terms of its ability to affect income distribution. But there are parts of banking regulation that do relate to income distribution, the Community Reinvestment Act basically says that you have to actually supply credit to disadvantaged neighborhoods. You can't discriminate based on location. So there are things in banking regulation that can actually help make sure that credit is flowing freely to areas that maybe otherwise would not get those funds.

I think that the issue of income distribution, income mobility, I don't think we can do much directly in terms of our policy tools, in terms of monetary policy. But I think we can do a lot from the bully pulpit, basically put attention on this issue, underscore how important it is, and talk about things that we can do address it. Educational opportunity, workforce development, job retraining, the ability to actually have the ability to move from the inner city to where the jobs are. Because a lot of times we see, when we're traveling around the region, we see people in the inner cities actually can't literally get to where the jobs are because there's not appropriate transportation networks.

Childcare is another issue. People have trouble holding down a job if they have a young child. Who's going to take care of their child during the day? And how do the economics of that work, if they're not making a very good salary? So I think there's a lot of issues. I think it's really an important issue for us to solve as the country because if you don't have a sense that wherever you're born, you have sort of a roughly similar opportunity to succeed based on your work effort, you don't really have a fair country, in some fundamental sense.

Raj Chetty is a researcher who's done some terrific work on this issue and the work that he's done basically shows that where you're born, where you live geographically affects your future prospects. That is really quite disturbing. That means it's not about the person, it's about literally the luck of the draw of where they were born and raised. And so that shows that we have a lot of work to do on this front.

Eugene White:

And in fact, mobility in the U.S. has actually declined. Interstate mobility has declined significantly.

President Dudley:

Exactly.

Eugene White:

Let me ask you a question, which is more about something which is within the Fed's compass of authority. What do you think the biggest risks to financial stability currently are, and where the next crisis—well, hard to ask the question—where the next crisis might originate? But suppose there were another failure on the order of Lehman Brothers. Are you concerned about the limitations that have been imposed on the Fed in terms of emergency lending?

President Dudley:

Let's have first with the issue of financial stability, how worried am I about it today? It's true that financial markets are pretty buoyant, and so that's raised the question, how concerned should we be about that? I would say at this point, I would say not that concerned, and the reason for that is that the markets I think really reflect the state of the economy. The economy's doing very well, it's been very stable. The economy has been growing 2, 2.5% a year consistently.

We're at a very low unemployment rate, 4.1%, and it looks like the expansion has got lots of room to go. There are not a lot of excesses in the economy. The credit growth is growing only slowly. Households seem to be in good shape, businesses are starting to ramp up their investment.

So, it seems to me like we actually have a very good prospects for this expansion to continue for quite some time. So, the financial markets in my mind sort of reflect that. If the financial markets were behaving in a way totally disjointed from how the economy is performing, I'd be a lot more worried.

The second reason I'm not so worried is that I think the banking system and the financial system is a lot more robust to stress today than it was 10 years ago. So banks have a lot more capital and have a lot more liquidity. There's a lot less leverage in the system. There's a lot less maturity transformation where people are borrowing short and lending long. And so that means even if markets were to go down, if the market prices were to go down, I think the financial system could bear that stress much, much better today than 10 years ago.

The issue that I'm actually a little bit worried about that no one else seems to be worried about is really the issue of fiscal sustainability. The budget deficit last year was 3.5% of GDP. In 2007, the budget deficit was 1.1% of GDP roughly at the same point in the economic cycle. So we're pretty deep into this economic cycle, and we still have a sizeable budget deficit, and we have a baby boom generation that's just about to retire, driving up costs for Medicare and Social Security.

On top of that, interest rates, the Federal Reserve is gradually normalizing interest rates, raising interest rates. So debt service costs, which have been very, very subdued due to the low level of interest rates over the last 10 years, those are also going to be going up. I'm a little surprised that financial markets aren't at all concerned about the sustainability of our fiscal position. I think that's something that people should be more focused on.

Eugene White:

Since you brought up fiscal questions, I have to ask, since we have a tax package going through, and there's a partial rollback with the mortgage interest deduction, do you think that would have any effect perhaps on booming house prices? If that was rolled back?

President Dudley:

I think to the extent that—in terms of the provisions that I see in the two tax bills in the House and the Senate, there could be some downward pressure on high-end housing, but the mortgage interest deductibility I think is going to be retained for about half a million dollars. So that means that for most homes, in most areas, I don't think that you're going to have a big consequence.

I would hesitate to say, get too concerned about the fact that very high-end houses could go down in price a little bit. I think the economy can manage that just fine.

Eugene White:

I know you have a busy schedule, but I'd like to take a few questions from the audience, if that's all right?

Audience Member:

I was really struck that after a report by the U.S. Treasury in June about financial reform for depository institutions, which really started out with the idea that the principle elements of Dodd-Frank and Basel III, et cetera, should probably stay in place? That both Chair Yellen and you have given very important speeches that have talked about the importance of preserving that basic structure.

Are there particular things that concern you in the environment that led both you and the Chair to speak about this?

President Dudley:

Well, I think the concern on my part, and I think Chair Yellen can of course speak for herself, is that if you open up the Dodd-Frank Act, make sure you don't throw the baby out with the bathwater.

There's elements of the Act that I think are very, very important in making the financial system more strong and stable and resilient. Capital and liquidity for banks, especially large systemically important banks, the ability to have a resolution regime in place where you can actually liquidate a large financial institution that gets under stress; the ability to clear derivatives centrally through central counterparties, and make sure that you can actually then have the ability to examine those central counterparties, and make sure that they're well-run and operated.

So, as long as you keep those major pieces in place, then I think you can make some minor adjustments to the Dodd-Frank Act. Things that I've talked about and I think other people at the Fed have talked about these same things is relief for smaller banking institutions because smaller banks, if they fail, it's not going to be systemic, it's not going to threaten the viability of the financial system.

The Volcker Rule probably could be implemented in a way that is less burdensome to banks, and maybe gives banks and securities firms a little bit more flexibility to intervene when prices go up sharply or down sharply, which is what you actually want them to do in financial markets.

I think the news that we've seen in terms of financial reform actually seems to be pretty positive. It's really more of about doing some changes at the margins as opposed to wholesale changes that would really dismantle Dodd-Frank.

I think we really do remember the financial crisis, still, thank God. It was the worst financial crisis that we've had since the Great Depression. The unemployment rate soared, millions of people lost their homes. That's why we got the Dodd-Frank Act. We just have to remember that we need to have a financial system that's strong and resilient, and that the Dodd-Frank Act helps us achieve that goal.

Eugene White:

Questions? Yes?

Audience Member:
Yes, I want to know how did working for Goldman Sachs impact your outlook as the President?

President Dudley:

I don't think it was the fact that I sort of worked for an investment bank that was important. I think it was more important what I did in the investment bank. I was in the economic research department, and I was basically someone who basically supported the trading functions of the bank. And that was valuable to me when I came to the Fed because it allowed me to learn a lot about how markets actually work, how markets actually function.

And we got deep into the financial crisis. What we saw is the financial markets started to not work well. People lost confidence, they lost trust. They started to disengage, and so my experience at Goldman Sachs, I think, actually helped me understand what was going wrong and then maybe how to address it.

So, in the fall of 2008, we introduced a number of very special liquidity facilities, things that we'd never done before, and I think my experience at Goldman and my understanding of how markets work, and my ability to reach out to people that I knew in the marketplace to talk to them, like what's going on?, and understand what they were saying to me, probably helped me.

You want to have—we're having a lot of transition at the Federal Reserve right now, and people ask me the question of, “What do you want with the Fed?” I think you want diversity. Diversity, I'm not just talking about diversity of gender and ethnicity but I'm also talking about diversity of background. So you don't want everyone to be a PhD economist from academia. You don't want everyone to be a markets person from Goldman Sachs. You want to have a mix because those different perspectives, when blended together, can lead to better policy outcomes.

Eugene White:

Someone else? This is a quiet audience. Yes?

Audience Member:
I had a question. You mentioned that you wanted diversity, both through academics and bankers. The new Fed Chairman-elect Jerome Powell, he doesn’t have an academic background. He's more of a Wall Street kind of guy. Do you think that's going to have an impact on his term looking at the Fed?

President Dudley:

I think Jay's going to do very well. The thing that you really want I think as a Fed Chair—I don't think an Economic PhD is required. There are plenty of PhD economists within the Federal Reserve system. The Chair does not have to have a PhD in Economics.

What you want is someone who's smart—which he is. You want someone who actually works hard—which he does. And you want someone who's not an ideologue. And the reason why I say not an ideologue, because you don't want people to think that they're so convinced that they know how the world works, that they ignore the evidence that contradicts that. And Jay is not an ideologue. So I think he's a fine choice to lead the Fed. I'm not concerned about it in the least.

Eugene White:

One more question, or two more? Certainly, yes?

Audience Member:
You mentioned a lot of things to address income mobility, but I'm wondering where you see the role of community banks going forward? Back in the day, they were very important. But now we have a sort of new different kind of large bank system. Do you see community banks still playing a role in that mobility?

President Dudley:

I think community banks play a hugely important role. We basically still have about 7,000 banks in the United States. And only about five or six of them are really, really large.

So, community banks play a unique role because I think they basically are much closer to their customers than large banks are. And so they play a particularly important role in local communities in terms of supplying credit to small businesses and to other customers where they know more about the customer. And so they can actually make more nuanced credit-lending decisions.

So, I think they're really important. They also play a very important role in community, in supporting the community. So, I'm a big fan of community banks. I mean my great-grandfather was a community banker, actually, in Sylvania, Ohio.

I remember when I was young, I got shown his bank book during the Great Depression, and the bank book had a lot of debits, and these were debits where he was basically putting money into the bank to keep the bank alive during the Great Depression, and the bank did actually make it through the Great Depression.

And so I'm very much a supporter of community banks. I think they perform a very important role. Which is why we want to have a regulatory regime that suits, not just the big banks, but also is appropriate for the small banks. We need to have a regulatory regime that's proportioned to the risks that the institution poses to the financial system and the role that the institutions play supplying credit, especially to small businesses and households where I think community banks play a very particularly important role.

Eugene White:

We have time for one more question?

Audience Member:
To follow up on that then, could you comment on the role of fintech lenders vis-a-vis community banks?

President Dudley:

Well, fintech lending I think is still very much in its early days, early stages. This is like peer-to-peer lending. I think it's something that we are following quite closely. I think there's a couple of questions about it. One is how will it actually perform through the business cycle?

So, today, it's performing okay—that doesn't really tell us that much because economic times are relatively good. So the real question is how it's going to perform through the business cycle. And the second question I think is going to be about regulation. Are there regulations that need to be put in place to make sure that they're on an equivalent playing field to lenders that are subject to bank regulations.

So, I think those are sort of the two questions on the table. I think we want to be careful not to just tamp down any innovation. I think we need to be open-minded to new innovations and developments that we see in the marketplace, but at the same time we don't want to necessarily sort of buy into them hook, line and sinker until we've actually seen that the business models are robust to the entire business cycle.

Eugene White:

Well, thank you very much!

President Dudley:

Yes, thank you.