Wash’s Latest Speech: The Era We Are In (Full Text Attached)

Original compilation: Caixin News

On Friday evening at 10 PM Beijing time, Federal Reserve Chairman Kevin Walsh appeared at the Jackson Hole annual meeting to deliver a speech titled “In Our Time.”

Overall, Walsh’s remarks at Jackson Hole conveyed a distinct cautious hawkish signal. He believes that the U.S. economy and labor market remain resilient, the current financial environment cannot be deemed significantly restrictive, and inflation is still significantly above the Fed’s 2% target, thus price issues should continue to be the primary focus of monetary policy.

In his speech, the Fed Chairman emphasized: “My standard is: We must have confidence that underlying inflation is clearly and sufficiently rapidly converging toward our target. Otherwise, we still have work to do.“

Walsh also stated that despite the CPI and PCE price data being better than expected this summer, “they do not lead me to believe that there has been a meaningful improvement in underlying inflation trends.“

In response to external criticism of his “refusal to provide forward guidance,” Walsh took the opportunity to elaborate in unprecedented detail.

Walsh believes that forward guidance is necessary during times of crisis, but should be significantly weakened during normal times. He argues that prematurely signaling or even resembling a commitment to future interest rate paths may superficially enhance transparency but could actually create new misguidance: on one hand, it restricts the Fed’s future flexibility to make decisions based on economic changes, and on the other hand, it leads the market to overly trade around “guessing the Fed” rather than independently assessing the economic fundamentals.

He is particularly wary of the resulting “mirror hall problem”—the market prices based on Fed guidance, and the Fed in turn references market prices for judgment, potentially causing both sides to overlook new economic changes.

Therefore, Walsh neither supports the normalization of forward guidance nor is willing to provide a mechanical policy “reaction function”; instead, he prefers to reduce prior commitments, allowing the market to form its own judgments, while the Fed maintains sufficient freedom to make decisions based on real-time data, trends, and more robust policy rules whenever a decision is genuinely needed.

As of 10:45 PM Beijing time, after Walsh’s speech, the CME’s “FedWatch” tool raised the probability of a Fed rate hike in September to nearly 60%, up from just 35% yesterday. Spot gold briefly plummeted by $50, with the latest quote dropping to around $4,550 per ounce.

(Source: TradingView)

Below is the full translation of Walsh’s speech (the speech text is sourced from the Federal Reserve’s official website and assisted by artificial intelligence):

Thank you all. I am delighted to be here again and to see so many familiar faces. I have been looking forward to this weekend—what better place to commemorate my 100th day as Fed Chair than here?

For the warm and thoughtful hospitality here, everyone should thank Kansas City Fed President Jeff Schmied and his colleagues. Jeff, thank you to all of you.

Jeff and the other organizers have also arranged some leisure activities later today. I suggest everyone be very careful in making choices.

As I learned many years ago, you can experience two completely different hikes on the trails around Jackson Hole. I can summarize my past hiking experience with former Fed Vice Chairman Don Cohen in two words: I survived. Those marathon-like “death marches” sustained by iron will showed me a side of Don that I was previously unprepared to face.

There is another type of hike—I would associate it with my old colleague, former Fed Chairman Ben Bernanke. Walking with Ben is much more leisurely, just a relaxed stroll along the winding paths of the Rockefeller Preserve.

So, before setting off, check your physical condition and ask yourself: “Is today a Cohen day or a Bernanke day?”

The best part of this gathering is that it helps all of us clear our minds and think more clearly about the world and era we are in. For me, this is the right place, and you are the right audience, to delve into the most important ideas.

“Innovation” is the theme of this conference. I believe that the public and the market, through their collective wisdom, have recognized that the Fed’s innovation in policy implementation will help us achieve price stability while achieving full employment.

Now, I will briefly outline the content of my speech this morning. You can call it an outline… or a hiking roadmap… but please don’t call it “forward guidance.”

First, I will discuss several long-term issues that the Fed is currently researching, including the latest universal technology—artificial intelligence (AI)—and where it might lead the economy.

Next, I will talk about the practice of forward guidance and the interaction between central banks and financial markets.

Then, I will introduce some core principles that I believe should guide the implementation of monetary policy.

Finally, I will share my assessment of the current economic situation.

Preparing for the Future Policy Environment

Against the backdrop of the unchanging scenery of the Teton Mountains, what we are examining here is anything but a static economic picture.

Not long ago—on the eve of the 2008 crisis and in the following decade—economists and policymakers were still discussing “secular stagnation” and “global savings glut.” A widely accepted view at the time was that excess capital would remain idle on the sidelines for a long time due to a lack of sufficiently attractive investment opportunities. All good things had already been invented. Therefore, economic growth would be sluggish and slow.

However, times have indeed changed. We have reached a historical turning point.

One of the most obvious examples is artificial intelligence—this term, which has an 80-year history, is now used to refer to the latest wave of technology—its pace of advancement has even exceeded the predictions made by its most enthusiastic supporters just a few years ago.

The potential for the economy to achieve significantly higher growth is rising. An ever-expanding pool of capital is flowing into various AI-related infrastructures. Some sort of “super Moore’s Law” seems to be unfolding. Meanwhile, economies of scale are also changing the methods and speed of innovation.

Capital and labor are coming together to create large language models at the core of AI. Users purchase tokens to gain access to these models. Reports indicate that the annual sales of tokens from just two leading AI labs have already exceeded $100 billion, growing over 500% from a year ago.

The Fed is closely monitoring all of this. We recognize that AI is a new variable—even possibly a new factor of production—that will impact the economy and the implementation of monetary policy. This also opens up several significant research directions:

Will the application of AI drive significant and sustained increases in productivity across the economy? If so, when will this happen?

Will the use of tokens complement or compete with labor? Will the next generation of AI models require higher capital intensity, or will the models themselves ultimately help us design solutions that require less capital input?

Other unresolved questions include what kind of market structure will ultimately form. It is currently unclear where capital returns will ultimately land, and how long this process will take. In the early stages, how much of the economic surplus will flow to the owners of scarce assets—AI labs, chip manufacturers, energy producers, and cloud service providers? Over time, how much value will ultimately flow to businesses and consumers? What do these changes mean for workers? What broad impacts will they have on the Fed’s employment objectives?

Similarly, we currently do not know what the equilibrium price of tokens will be. Will different types and qualities of tokens emerge in the future, leading people to be willing to pay increasingly higher prices for access to the most cutting-edge and best models? Will the prices of tokens for older generation models eventually fall to their marginal cost levels?

We will use a “Productivity and Employment Working Group” to delve into these issues. I have recently had preliminary discussions with the heads of this working group and four others, and their progress is encouraging.

However, it should be clear that the recommendations from these working groups will be submitted in the future and will not affect our decisions made in the current policy environment. But I believe that engaging in such intellectual investment today for future policy challenges will prepare us much better.

Forward Guidance and Its Alternatives

While these working groups are conducting their work, I have not been waiting; I have already begun to promote innovation at the Fed to truly adapt the Fed to its responsibilities. For example, I have begun to change the form and function of the so-called Fed Chair’s “forward guidance.” As you may know, I have long been uneasy about prematurely announcing future policy decisions. I prefer to take another path… and I will explain why next.

Transparent communication about future policy decisions is not inherently a virtue. Communication must serve the Fed’s most important responsibility: to get monetary policy right.

During the global financial crisis, my colleagues and I established forward guidance as a normalized practice. At that time, it was essential, and we launched this practice with great fanfare. But like other legacies left by past crises, I believe this practice has existed for too long.

In normal times, the role of forward guidance should be limited and should have clear boundaries. Otherwise, it may create ambiguity in the name of pursuing clarity. Over-disclosure of the policy discussion process and making too many commitments about future policy decisions can mislead markets, businesses, and households. Moreover, I believe that when policymakers make near commitments about interest rates throughout the economic cycle, we actually limit our freedom to make the right choices when we truly need to make decisions.

To get the policy right, we must also correctly handle the relationship between financial markets and central banks. The Federal Reserve needs to receive clear market signals, and these signals should be as unfiltered as possible… including the internal structure of the market… the levels and changes in asset prices across various sectors… the prices and trading volumes of U.S. Treasury securities… the foreign exchange value of the dollar… the cost and availability of credit… and the prices of a wide range of commodities.

These indicators, along with others, should help the Federal Reserve assess recent economic activity and inflation prospects throughout the business cycle. They should also reveal the state of the broader financial environment… as well as the risks and uncertainties present in the financial cycle.

At the same time, market participants themselves should track real information throughout the economy. They should form their own judgments; develop their own expectations about output, employment, and inflation; and always remain highly attuned to risks.

The Federal Reserve should remain humble but must not be naive. The Federal Reserve plays a crucial role in the economy and markets, and our policy tools are powerful. We determine the path of short-term interest rates. Therefore, market participants will always try to predict what we will do next. But we should not indulge a mechanism that allows market participants to primarily decide their next trades based on guessing the Federal Reserve.

Economic literature has long described this distortion effect: the so-called “hall-of-mirrors problem.” If the market largely relies on the Federal Reserve’s guidance, and the Federal Reserve, in turn, relies on market prices, then we are all more likely to overlook new changes… more likely to be caught off guard when circumstances suddenly shift… and more likely to make mistakes in policy formulation.

Ironically, market participants may not be the ones bearing the greatest cost of the “hall-of-mirrors problem.” Those who are likely to be most severely harmed are those without financial assets. If the Federal Reserve misjudges inflation and also misjudges the economy, who will suffer the most severe consequences? It will not be the high-net-worth individuals in the financial markets. Ultimately, it will be the hardworking ordinary Americans who have to face excessive inflation or suddenly unstable employment.

So, if forward guidance does not apply in normal times, shouldn’t the new Federal Reserve Chair at least commit to providing a clear reaction function? Of course, he should tell us where interest rates will go if the data is clearly too hot or too cold.

I wish our understanding of the economy were precise enough to provide a mechanistic, fail-safe answer—like relying strictly on a simple function similar to the Taylor rule. But our knowledge is far from that level—at least not yet—and the most important factors determining appropriate monetary policy will also change over time.

Demonstrating the Federal Reserve’s reaction function through predictions theoretically works better than in reality, and works better in a laboratory than in actual operations. I am not the only one who has noticed this. For example, the forward guidance in 2021 likely slowed the Federal Reserve’s subsequent policy response to high inflation.

During my tenure as Chair, my colleagues and I will strive to build more reliable models and more robust rules to guide policy decisions. We will undertake this work on the basis of the understanding that accurately predicting the economy remains only a goal. In a time when geopolitical factors, global supply chains, and technology are changing at such a rapid pace, it is wise to remain humble about what we can know and what we cannot.

In the same spirit, we should fully consider a variety of perspectives on any issues that may affect the Federal Reserve’s monetary policy decisions. If our goal is to make optimal decisions, we should not exclude differing views on the economy.

So, how can we chart a better course for policy? In the next part of my speech, I will share some core principles that guide my thinking on how to implement appropriate monetary policy… and then I will fulfill my commitment to discuss my judgments about the economy.

Core Principles

Let me discuss the principles…

First, I have noticed that in our line of work, people often mistake yesterday’s news for what is happening at the moment. The real challenge is to distinguish between the two. In other words, we must continually test reality to ensure that we do not formulate forward-looking policies based on outdated or inaccurate data. We should not rely on isolated data points. Trends are what matter. The Federal Reserve is a decision-making institution. We must make choices amid uncertainty, so the data we rely on must be as relevant, timely, accurate, and directly applicable to decision-making as possible.

Second, the Federal Reserve takes action to ensure that total demand in the economy broadly aligns with total supply. However, what we can directly observe is only the economic activity itself. We can never directly see what is truly happening on the supply side; we can only infer it. Therefore, assessments of the current and future balance between total supply and total demand are inherently imprecise.

Third, let there be no misunderstanding: the Federal Reserve’s 2% price stability target, measured by the Personal Consumption Expenditures (PCE) price index, is a firm, fixed goal. Another aspect of this target that we must also clarify is that price stability does not happen automatically, and inflation does not necessarily have a natural tendency to revert to the mean. Achieving price stability is the Federal Reserve’s job.

Fourth, the Federal Reserve also bears the responsibility of achieving maximum employment. Achieving the two goals of the dual mandate in the medium term is not a “choose one” issue. I do not believe that the Federal Reserve’s dual mandate is in conflict with each other. After all, high inflation itself can severely damage economic prosperity.

Fifth, short-term interest rates are the primary policy tool for achieving the dual mandate. Unconventional policies taken to stimulate economic activity may be suitable for true crisis periods, but should be used sparingly, or not at all, in other circumstances.

Sixth, money matters. This view is not currently popular, but I believe there is indeed an important relationship between money and monetary policy. We should pay attention to the money created by the central bank, as well as the money coming from banks and the financial system. Indeed, financial innovation and other factors can change the mechanisms connecting the monetary base, the velocity of money, and the broader economy. But this is no reason for us to ignore the ultimate impact of money on the financial environment and prices.

Finally, a quieter, more purposefully communicative Federal Reserve will be better able to achieve its goals. And whether we fulfill our responsibilities can also be held accountable—this is the only true standard for testing our credibility. To borrow a phrase from General Chuck Yeager: “When the time comes to show the truth, there are either reasons or results.”

Current Economic Situation

So, under these principles, how do I assess today’s economy? What is really happening outside the window?

You may have already seen the FOMC’s unanimous judgment from the July meeting: the labor market is stable, economic output is robust, but inflation remains too high. Most of my colleagues and I believe that a wiser approach is to wait for more new information between the two meetings—especially considering potential new changes in supply chains, investment flows, and geopolitics—before determining whether it is appropriate to adjust interest rate policy. At the same time, we have collectively indicated that we are ready to take action as needed.

Personally, I am deeply impressed by the overall performance of the U.S. economy today, and it appears to have strengthened. One standard for judging whether an economy is strong is how well it can withstand shocks. From this perspective, both the “Main Street” of the real economy and “Wall Street” of the financial markets have demonstrated extraordinary resilience.

Here are a few observations:

Business capital expenditures—the “seed grain” for future economic growth—are rapidly increasing. The four-quarter growth rate of equipment and intangible asset investment is about 9%, the highest growth rate since 2021. More than half of this year’s capital expenditure growth can likely be attributed to AI-related infrastructure development.

For S&P 500 companies, profits have grown by over 20% in the past year. Compared to historical levels, corporate profit margins are quite high. Overall market volatility is low. We are closely monitoring the internal structure of the market, observing performance across various sectors.

Market expectations for future growth in capital expenditures and corporate profits are quite high. I will continue to observe changes in their growth rates themselves, known as the “second derivative.” The subsequent impacts—on asset prices, corporate confidence, consumer income, and consumer spending—are also very important.

The credit spreads for corporate bonds and leveraged loans are close to the lower end of historical ranges, and the issuance volume in these markets has also been quite strong this year. Stepping outside the fixed-income market and looking at the banking sector, the July Senior Loan Officer Opinion Survey showed that banks told us that the credit standards for commercial and industrial loans are currently on the relatively loose end historically. This also helps explain why there has been growth in this type of lending this year. The credit and loan markets show almost no signs of being constrained by monetary policy.

Certain sectors—such as housing and agriculture—are indeed under pressure. But overall, I would find it difficult to describe the broader financial environment as “restrictive.”

Despite experiencing various shocks, real consumer spending remains healthy, growing over 2% in the past four quarters. When considering consumption alongside the strong investment we observe, Private Domestic Final Purchases (PDFP) have also increased. So far this year, the growth rate of PDFP is close to 3%. Compared to GDP, this indicator typically contains stronger economic signals, and the trend it is currently showing is also positive.

On the employment side of the Federal Reserve’s dual mandate, the U.S. is currently performing well. The labor market is quite stable. The unemployment rate is currently at 4.1%, still low by historical standards, and has shown little significant change over the past few years. The number of initial unemployment claims, calculated using a four-week moving average—an empirically tested, quite robust real-time indicator—is currently close to its lowest level in decades.

In my view, the current relatively low turnover rate in the labor market is partly due to the large-scale re-matching that took place between employers and employees after the pandemic.

When labor supply is no longer growing significantly, the number of new jobs added each month will naturally be lower. There will always be areas of the labor market that warrant attention—such as recently graduated young people. But overall, those who want to work are generally able to keep their jobs or find work. They may certainly worry about potential disruptions in the labor market in the future, but so far, I believe the U.S. labor market is consistent with full employment status.

However, on the price stability side of our dual mandate, the data is even more concerning. The Federal Reserve’s preferred inflation measure—the PCE price index—has risen by 3.7% over the past 12 months, with an annualized increase of 4.1% over the last six months. The comparable measure from the Consumer Price Index (CPI) is also high, with both the core PCE and CPI inflation indicators remaining elevated. None of these indicators are perfect, but they all tell a similar story: inflation remains above our 2% target. Therefore, the Federal Reserve’s primary focus should be on prices.

The task for policymakers is to identify potential trend inflation, which means excluding various special, idiosyncratic factors to assess the general price changes across the economy. We need to determine whether underlying inflation is rising, falling, or stagnant. We want to understand not only the direction of its change but also the speed of that change. Each of the broad inflation indicators mentioned has shown a significant decline compared to the peaks of 2022. However, the progress made over the past two years has been quite limited.

Moreover, while the PCE and CPI data this summer have been better than expected, these figures do not lead me to believe that there has been a meaningful improvement in the trend of underlying inflation.

Data shows that wage growth is currently moderate. However, wage growth has long been proven to be an unreliable predictor of future inflation when tracking underlying inflation.

To assess underlying inflation, I believe it is very helpful to break down the 199 components of the PCE price index. Over the past 12 months, 54% of the items in the PCE basket have seen price increases exceeding 3%. This proportion is significantly lower than the peak of about 77% post-pandemic but still well above the pre-pandemic average of 32% over the past 20 years.

If we look only at the last six months, the conclusion is similar: 49% of the items in the PCE basket have annualized price increases exceeding 3%. Again, this is significantly lower than the post-pandemic peak but remains at a relatively high level.

The recent rise in overall commodity prices is also noteworthy. We need to determine whether these trends indicate an upward risk for inflation.

Additionally, it is crucial to consider whether the inflation data that has persisted for more than five years has seeped into people’s expectations. The good news is that medium-term inflation expectation indicators remain stable overall. The inflation compensation indicators in the swap market also convey similar and strong signals.

Especially considering recent developments, market prices still reflect a confidence—believing that we can achieve price stability. This reflects both the credibility of the Federal Reserve as an institution and aligns with the best traditions of the Federal Reserve. And I can assure you… the market is right.

From an economic history perspective, market-based inflation expectation indicators have a characteristic: they often appear very resilient and robust until they lose stability. These expectations do not change easily, and they remain well-anchored for now. But we must keep a close watch. Ensuring that inflation expectations do not become unanchored is the job of the Federal Reserve.

There is one signal that should not be ignored: the persistently elevated inflation over the past 65 months clearly places responsibility on the central bank. And that is where the responsibility should lie.

My standard is: we must have confidence that underlying inflation is clearly and sufficiently rapidly converging toward our target. Otherwise, we still have work to do. That is our job… our mission… and our duty to fulfill.

Conclusion

Standing here today, what I commit to is a discipline, not a specific policy decision.

In such a significant time, my colleagues and I at the Federal Reserve are certainly not the first to hold these positions. We are determined to cherish the present and to complete our work to the highest standards we can.

We approach our responsibilities with humility and steadfast determination. Much depends on the choices we make. Sound monetary policy can help families and businesses thrive. If monetary policy is effectively implemented, it can expand and deepen the momentum of U.S. economic growth… while helping to solidify America’s leadership in the world. I also know that our country needs us to act thoughtfully and wisely.

It is a great honor to serve the Federal Reserve once again. I am sincerely grateful for the encouragement and valuable advice from my colleagues… and for the support from many of you here today… Thank you for your patience in listening this morning. Thank you.

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