Austan Goolsbee on the Fed's Data Dependence and the Golden Path

An interview with Austan Goolsbee, the president of the Federal Reserve Bank of Chicago

There is nothing but uncertainty and everything but trust right now. It’s a lot. It’s hard to cut through noise and even harder to interpret signal but this is our reality. And we have to understand it. This conversation with Austan Goolsbee, the president of the Federal Reserve Bank of Chicago, will dive into the economic data shaping our world - and what might happen next. This transcript has been lightly edited for clarity. You can also listen on Let’s Appreciate or watch the interview on YouTube.

One thing I’ve been obsessed with recently is data. Data methodology, survey design, data interpretation - all of it. Data is the key to understanding the economy - and sometimes, it doesn’t make any sense. Today, we're talking all about economic data - where it comes from, how we understand it, and why it's becoming increasingly difficult to discern its patterns. 

President Goolsbee: And you know, the first rule of the data dogs is there's a time for walking and there's a time for sniffing. And when there's more noise in the data, that's the time for sniffing. 

That’s Austan Goolsbee, President of the Federal Reserve Bank of Chicago. Born in Waco, Texas, President Goolsbee was announced as the 10th President and CEO of the Federal Reserve Bank of Chicago on December 1, 2022 - and he is a data dog. 

The Cost of Living

Let's start with a deceptively simple question and something we talk about all the time: How much does it cost to live in America? You might think this is straightforward. After all, millions of Americans pay rent, buy groceries, and fill up their gas tanks every day - it can’t be that hard to measure. But as President Goolsbee explains, measuring the cost of living is anything but simple - take for example, housing. It isn’t responding to interest rates the way that economists expected. 

President Goolsbee: The conventional wisdom was always one of the main transmission mechanisms of monetary policy - one of the main ways the Fed raising the interest rate slows things down is through the housing market. And we've rediscovered this thing that it doesn't just affect the demand for housing. It also flexes the supply of housing. And since that's always true, in a way, I've been puzzling over this question.

Shelter has been a huge inflationary issue. As of April 2024, shelter made up 36.1 percent of the CPI, the most commonly followed US inflation measure (it’s 15.5% for PCE, the Fed’s preferred measure).

President Goolsbee: Why is this time different? Why didn't we know this already? And I think that this time is a little bit different in that the rates were so low for so long that in a way you have more people locked in with these low rates.

This is the lock in effect, golden handcuffs, people tied to a place with a 2% mortgage. People don’t want to move, and that has froze up housing supply. They are trapped by a good rate. Goldman Sachs quantified this effect. They found that for every 1 percentage point increase in the gap between market rates and existing mortgage rates, homeowner mobility drops by 0.8 percentage points. From 2021 to 2023, that translated to a 2.7 percentage point drag on mobility.

President Goolsbee: That's still just a temporary phenomenon over time. That's going to phase out. People are going to phase through their mortgages. They'll have to move, et cetera. So partly that one's going to work itself out over the business cycle. 

So like most things, time heals all wounds, but the data is bizarre. The way we measure housing inflation is based on rents, not home prices. And there's a significant lag between what's happening in the real world and what shows up in official statistics. 

President Goolsbee: The other part though, is, when I said the thing about inflation, this mechanical of how we add up the inflation rate for housing being based on rents. And that the market rents were down, but the official series wasn't down. 

The Consumer Price Index (CPI) uses two main components to measure shelter costs:

1. Rent of Primary Residence

2. Owner's Equivalent Rent (OER)

While Rent of Primary Residence reflects actual market rents, OER is a bit trickier. It's an estimate of how much homeowners would pay to rent their own homes. However, OER tends to lag behind actual market rent changes, creating a delay in how housing market shifts appear in inflation data.

This lag can be significant, sometimes taking 6-12 months for market rent trends to fully reflect in the CPI. As a result, CPI shelter costs can appear out of sync with real-time housing market conditions, complicating inflation analysis and monetary policy decisions.

President Goolsbee: That's really been a puzzling part. And you've started to see in the more recent data that it is beginning to decline. That part of my optimism, I think about 2024, that there still could be some more progress to be made on inflation because eventually we should start seeing what we already witnessed out in just the market prices.

The Boston Federal Reserve recently published a paper on this topic titled: "A Faster Convergence of Shelter Prices and Market Rent: Implications for Inflation”. They found that if shelter prices were excluded from inflation calculations, monthly core CPI inflation rates would have ranged from 1.8 to 2.4 percent from July 2023 through February 2024. But the actual core CPI inflation rates over this period ranged from 3.8 to 4.7 percent.

That's a difference large enough to significantly impact monetary policy decisions.

President Goolsbee: So the supply part I do think is important, but it's more of like a medium run thing. And, uh, my puzzle is really about the short run and just like, why does this not add up? 

The Variety of Data Sources

This discrepancy between what's happening in the real world and what shows up in official statistics is at the heart of the data challenges facing economists today. And it's not just about housing costs. In recent years, we've seen an explosion of new data sources. Companies like Zillow and Redfin provide real-time housing data. Credit card companies offer insights into consumer spending. Even satellite imagery is being used to track economic activity. But this wealth of information comes with its own set of challenges.

President Goolsbee: The explosion of private sector data sources that we can look to, to kind of cross check. What's coming out in the official statistics and that we can look at in real time and not have to wait a week, a month, a quarter to get the information. 99 percent have been wonderful. It's enhanced our ability to, to get a handle on what's happening. 1 percent have added frustration to our lives.

And it’s all new - that’s the frustrating part. Where do all these data sources fit into the broad tapestry of analyzing the economy? What is right and what is wrong? What do you do when nothing really makes sense?

President Goolsbee: Because then when we start to see persistent divergence between them. We don't really know what to do because we don't have the historical experience on Redfin or Zillow or some of those to compare.

This data revolution has created a paradox. On one hand, we have more information than ever before. On the other, it's becoming harder to know which information to trust. We already live in the gray area of a post-truth society, and if the data is showing holes, that makes economic communication that much harder. If no one believes in anything, how do you do anything?

Please, Respond to My Survey

Take, for example, the Job Openings and Labor Turnover Survey, or JOLTS (which jumped today, driven by manufacturing). This survey, conducted by the Bureau of Labor Statistics, provides very important information about the labor market. But as President Goolsbee points out, it's facing challenges:

President Goolsbee: Look, are you responding? People call you at dinner. They're ringing. I'm calling from a pollster. No, you hang up. But that impulse that nobody wants to answer their cell phone if they don't know what the number is, for sure has a bearing on how we understand the economy.

This decline in survey response rates isn't just a minor inconvenience. It can lead to increased variability in the data, making it harder to discern true economic trends from statistical noise. And it's not just JOLTS.

The University of Michigan Consumer Sentiment survey, a key indicator of economic confidence, recently switched to web-based collection. While this might increase response rates, it also introduces new variability into the data and is the reason that we saw a swing in the metric - the way that we collect information matters.

President Goolsbee: It doesn't have to mean that it's biased. It just means you should get ready to buckle up to have some more noise. Whoa, what, you know, prices are up a lot for this month and the next month they're down - we're going to see a lot more like that.

Kyla: Oh, wow. So you think we're headed toward potentially more volatility just because the data. 

President Goolsbee:I think you kind of have seen that in a lot of the series. Where there's a mad scramble, a number comes out and then a mad scramble and they find out, ah, well, we haven't been taking into account properly the amount of immigration. And so now we're going to have to like, go back and try to subtract off the number to say, what was steady state? And you see it on prices. You see it on housing. You see it in services. You see it in a lot of places. 

Kyla: And so for a data dependent Fed, that presumably makes your job a little bit harder.

So the Feds got to be forward looking. It can't just look at the data. And the private sector data help us to do that because it's a little more real time. 

Data Interpretation

This is why the Federal Reserve is important. There has to be entities to cut through the noise. But the challenges don't end with data collection. Interpreting this data is where things get really complex. And for institutions like the Federal Reserve, correct interpretation is extremely important.

President Goolsbee: I don't like birds. There's doves and there's hawks, but we're the data dogs. And you know, the first rule of the data dogs is there's a time for walking and there's a time for sniffing. And when there's more noise in the data, that's the time for sniffing.

This "sniffing" metaphor is actually really good. It's about looking beyond the headline numbers, digging into the methodology that underlies the metrics, and understanding where the metric fails in communicating what is going on. Like JOLTS. The survey response rate has collapsed. The quits rate is probably better. You have to sniff before you walk. 

Because the Federal Reserve, who manages monetary policy through raising and lowering rates and shrinking and expanding their balance sheet -  basically, setting the course for the entire economy -, has to be particularly careful in how it interprets data. As President Goolsbee explains:

President Goolsbee: The worst monetary policy rule you could devise is just look back at what happened to inflation last month and, and base your decisions on that. You can get yourself into a little bit of a pickle because we know that there are some things that are good leading indicators and some things that are not good leading indicators.

This distinction between leading and lagging indicators is key. There are three types of indicators - lagging, leading, and coincident. Leading point to the future, lagging points to the past, and coincident are real time. Leading indicators, like new housing starts or the yield curve, can signal future economic trends. Lagging indicators, like unemployment rates or corporate profits, confirm long-term trends. Unemployment is backwards looking. We can’t really use it to chart a future path, but we can definitely use it to figure out where the economy is - and where it could go

The Role of Wages in an Inflationary Cycle

But even among economists, there's debate about which indicators fall into which category. Take wage growth, for instance. Many people worry that rising wages will lead to inflation after all, if people have more money, won't they spend more, driving up prices? But Goolsbee explains why this isn't necessarily the case:

President Goolsbee: The thing is wage growth is not a good leading indicator of prices. Wages tend to move more slowly and less frequently than prices do. So when things hit us it tends to be prices go up, then wages go up, then prices come down, then wages come down.

There was a feeling of some smart people at the beginning of 2023, not only that there would be a recession, but that wage growth was so high that there's no way inflation could come down. 

Part of the worry is that wages have outpaced inflation. 

• Since February 2020, the Consumer Price Index has climbed a cumulative 20.8%, according to Bureau of Labor Statistics data. Over that same period, average hourly earnings rose 22.3%. The Council of Economic Advisors wrote yearly wage growth has exceeded price growth for 15 months in a row. Over the past year, nominal wages rose 4.2% for these mid-level workers while inflation was up 3.3%, leading to real wage gains of 0.9% over this most recent period.

It’s about who it’s impacting too.

• "Cumulative wage growth since the start of the pandemic has outpaced price growth across the wage distribution, but the most wage growth has been among lower-wage workers, as Bank of America wrote.

• Young people are earning higher  inflation-adjusted)real wages than any previous generation at the same point in their lives.

But Goolsbee says that wage growth is not a good leading indicator of prices.

President Goolsbee: Wages tend to move more slowly and less frequently than prices do. So when things hit us it tends to be prices go up, then wages go up, then prices come down, then wages come down. 

Goolsbee warns about the dangers of focusing too much on wage growth when making monetary policy decisions.

President Goolsbee: And if you were applying a monetary policy rule, which said, I'm going to keep slamming on the brakes until wages come down to a growth rate that is compatible with 2 percent inflation, you will almost certainly overshoot the target.

The CEA also wrote “none of this good news contradicts the fact that prices are still too high, and that we must therefore build on the progress documented herein.” Just to caveat all of this. Things can be improving, but still need to get better. 

The Golden Path

This lag between wages and prices is just one example of the complexities the Fed has to navigate. But amidst all this uncertainty, there are moments of clarity. Goolsbee points to 2023 as a particularly successful year:

President Goolsbee: 2023 is one of the best dual mandate years in a very long time where inflation fell almost as much as it's ever fallen in a single year. And there was no recession that's virtually unprecedented.

Indeed, for seven months in 2023, inflation as measured by the Personal Consumption Expenditures (PCE) index - the Fed's preferred measure - getting closer and closer to the Fed’s 2% target. It seemed like the Fed had found its golden path.

But then came January 2024, with a spike in inflation that caught many off guard. The culprits? Increases in shelter costs, auto insurance, and medical care services. It was a reminder of how quickly the economic landscape can shift.

Kyla: Do you think we've strayed from the golden path? 

President Goolsbee: I hope not. Look, I'm still closet optimistic. When inflation was too high in January it followed seven fabulous months where we were at our 2 percent inflation target for seven months at the end of 2023. And then our whole efforts got to be figuring out, is that a sign that the economy is overheating or is that just noise or a blip?

A lot of the inflation recovery was due to supply chain normalization - the Roosevelt Institute estimated 79% of disinflation was driven by supply expansion. And that’s largely recovered.

President Goolsbee: This doesn't feel to me like a traditional overheating, but that concept of is there still a little magic golden dust that will go into 24 after the supply chain is fully healed which was a lot of what the benefit was. I'm still closet optimistic that there will be - I think if we get some more decent readings on inflation that would convey a message to me at least. And I'm not allowed to speak for anybody else on the FOMC. But to me, that would make it feel like seven months of 23, that wasn't a fluke. We're over the broad arc, inflation is way down and the job market has remained pretty robust.

This is the constant challenge facing the Fed: distinguishing signal from noise in a sea of data. And it's not just about inflation. As Federal Reserve Bank of San Francisco President Mary Daly noted, the Fed now faces risks on both sides of its mandate - not just inflation, but also employment.

President Goolsbee: 2023 is one of the best dual mandate years in a very long time where inflation fell almost as much as it's ever fallen in a single year. And there was no recession that's virtually unprecedented.: If you look at the job, the quit rate, if you look at vacancies to the number of unemployed workers as a ratio, if you look at a lot of traditional measures of job market health. they're cooling. The level is still pretty strong, but the direction is definitely not toward overheating. It's the other way.

And the labor market has been robust, as President Goolsbee said. The American labor market is better for workers than it has been in decades.

• The average worker is working fewer hours

• Rates of 2+ jobs are down

• Typical job tenure is up

• People are changing jobs less frequently.

But this now-cooling labor market presents its own set of challenges. How much cooling is too much? At what point does a "soft landing" turn into a recession? 

President Goolsbee: And so it's not that they're flashing red, but they're just warning signs. And if you couple that with a rise of consumer delinquency, consumer spending slowing a little bit, again, from really robust levels that were in a way hard to explain down to something more moderated, but directionally, if that keeps going, you would definitely need to start thinking about the other side of the Fed mandate, which is to say the real economy. 

The Alarm Bells

The alarm bells are flashing in some areas. The Federal Reserve Bank of New York reported that credit card delinquency rates rose to 5.08% in the fourth quarter of 2023, up from 3.28% a year earlier.

During the pandemic, many Americans accumulated what economists call "excess savings." This was money saved due to reduced spending during lockdowns, combined with government stimulus payments. At its peak in 2021, these excess savings were estimated to be around $2.1 trillion.

This savings cushion helped fuel the strong economic recovery we've seen- never bet against the American consumer. But it's been rapidly depleting. By the end of 2023, economists at the Federal Reserve estimated that these excess savings had been almost entirely exhausted. Some analysts even suggest they've dipped into negative territory, meaning Americans are now saving less than they were before the pandemic.

This depletion of savings could explain the rise in delinquencies. As the savings buffer disappears, more consumers are struggling to keep up with their payments, especially in the face of high inflation and rising interest rates. And that’s what we have to pay attention to. 

President Goolsbee: We're in this job to care about the real economy. It's not the stock market, it's not the market reaction. Those things can be informative to us, but that's not why we're doing the job. Let's not forget the real side of the economy. I think it's. It's going to be critical. 

This focus on the "real economy" is the heart of it all. While stock market performance and other financial indicators are important, they don't always reflect the economic reality for average Americans. The exhaustion of excess savings and the rise in delinquencies paint a picture of consumers who may be reaching the limits of their financial resilience. 

The Stock Market

And all of this is happening against a backdrop of rapid technological change. Artificial Intelligence is reshaping industries. We have immense political uncertainty. Climate change is impacting agriculture and energy markets. So the economy is normalizing - with real GDP on track to grow 1.5% in the 1st half of this year, down from 2.5% last year. Unemployment is low at 4%, but on the rise. But also the stock market is at all time highs, thanks to four companies and Nvidia. GameStop recently mooned. How does the Fed think about that?

President Goolsbee: The law forbids me from trading at any individual stocks anyway. And we got to like 45 days in advance if you were ever going to make a transaction, so there's no meme, you know, the meme stocks are not my reading, as I say, I think market financial markets give us a lot of valuable market information about what our expectations, we can back out inflation expectations for using the market data, which I think is very useful in, in our trying to understand what's happening, but it's only one source of data. And as you've highlighted, if you take the stock market, there's wide swaths, tens of millions of people in this country who are not in the stock market. 

It’s about 40% of Americans, or 132 million people.

President Goolsbee: So it's worth our remembering who the markets are and what information we get from them. 

Very few consumers anticipate better business conditions ahead, yet they are increasingly bullish on stocks. So apparently we get hopes and dreams and maybe some reality detachment. But when we think about how the Federal Reserve influences the economy, we often focus on the federal funds rate - the short-term interest rate that the Fed directly controls. But as Austan Goolsbee explains, the reality is much more complex.

President Goolsbee: If you look at financial conditions, it is totally fair to say that one of the things that I, as a member of the FOMC, or if you go back and look at the transcripts of past FOMC meetings, what they look at financial conditions separately from just the short interest rates that the Fed directly controls or influences.

Financial Conditions

But what exactly are "financial conditions"? Think of them as the broader environment in which economic decisions are made. They include things like long-term interest rates, stock market valuations, credit spreads, and the value of the dollar. These factors can sometimes move independently of the Fed's actions, creating a you guessed it - complexity and uncertainty.

Let's break this down. When the Fed raises short-term rates, it doesn't just affect the cost of overnight borrowing between banks. It ripples through the entire economy.

President Goolsbee: In a way, that tightening is affecting the economy, is affecting business investment, is affecting people's decision to buy a car, buy a washing machine, or anything where they might get a consumer loan.

But here's where it gets interesting. The relationship between short-term rates (which the Fed controls) and long-term rates (which it doesn't directly control) isn't as straightforward as you might think.

President Goolsbee: Historically, long rates go up by about one quarter the amount that the short rates went up. And this time it's been more than that.

This is really important. In the most recent tightening cycle, long-term rates have risen more than historical patterns would suggest. This means that financial conditions are actually tighter than what the Fed's actions alone would predict. Why does this matter? Well, many important economic decisions - like whether to buy a house or make a major business investment - are based on long-term rates. If these rates are higher than expected, it could slow the economy more than the Fed intended.

President Goolsbee: So that's the long way to say I think we should look at the financial conditions and be respectful of financial conditions, but let's not be scared of financial conditions.

And this sort of communication is everything. And one of the Fed's most closely watched communications is the "dot plot" - a chart showing where each Fed official thinks interest rates should be in the future and the market's interpretation of these projections can diverge wildly from the Fed's intentions.

President Goolsbee: We have had periods in which, for example, in last December, the summary of economic projections, the SEP and the dot plot comes out and the median dot said that they expected there would be three rate cuts in 2024. That they projected that would be appropriate and the market immediately concluded, well, that must mean seven cuts.

This disconnect between what the Fed says and what the market hears can create a sort of economic telephone game, where the original message gets distorted as it passes through various interpretations.

Don’t Fight the Fed

But why does this matter? Well, market expectations can become a self-fulfilling prophecy. If investors believe rate cuts are coming, they might start making decisions based on that belief, potentially forcing the Fed's hand.

President Goolsbee: And then there was a public debate about, well, does this tie the Fed's hand? Now they have to cut because the market expects it.

This is where President Goolsbee, and the Fed in general, draw a line in the metaphorical monetary policy sand. They insist on the importance of taking the Fed's communications at face value.

President Goolsbee: You should take it at its word because there's only eight meetings for the year. So if we go to meetings without cutting, it's not going to be seven cuts.

This stance is very important for maintaining the Fed's credibility. If the Fed were to simply follow market expectations, it would essentially be ceding its policymaking authority to the whims of the market. And that isn’t smart to do.

President Goolsbee: We have a board member who said he tells his employees, "we can fight the Fed for as long as we want, the last time I checked, they're still undefeated."

While markets can push and pull, ultimately, the Fed has the most important tool at it’s disposal - the control of the cost of money. And President Goolsbee, channeling his mentor Paul Volcker, cautions against being overly reactive to these market movements.

President Goolsbee: Paul Volcker, the great Fed chair was my mentor. And he used to always say, our job is to act and their job is to react and let's not get the order mixed up.

Kyla: Yeah, I know, the markets tend to be kind of bossy, um, Yeah, I know, they're like, 

President Goolsbee: Yeah, If they're, if you faff around, you find out, you know, that is kind of my thing. 

I couldn’t have said it better myself

The Rest of the World

And of course, the Fed impacts the rest of the world. While the Federal Reserve's primary focus is on the U.S. economy, its decisions ripple out far beyond American borders.

Kyla: The yen has been moving quite a bit, and sometimes people call the Federal Reserve the central bank of the world, just because the dollar is a reserve currency.It's extremely strong right now. You have Americans just flocking over to Europe. How do you think about the strength of the dollar in context of monetary policy? 

President Goolsbee:: The dollar policy for sure is being set by Treasury and the Board of Governors is thinking about the international context.

The dollar's status as the world's primary reserve currency means that Fed decisions can have outsized impacts on global financial markets and economies. Let's break this down. When the Fed raises interest rates, it doesn't just affect borrowing costs in the U.S. It can strengthen the dollar relative to other currencies. This has far-reaching consequences:

1. For American travelers, a stronger dollar means more purchasing power abroad.

President Goolsbee: So it's going to be a treat for people go into Europe or going to some country where if you, if you were at it, your heart's set on visiting Japan, it's going to be cheap to man.

2. For developing countries that have borrowed in dollars, a stronger dollar can increase their debt burdens.

3. For global trade, changes in the dollar's value can shift the competitiveness of exports and imports worldwide.

But Goolsbee is quick to point out that the Fed's mandate is primarily domestic:

President Goolsbee: We're mostly focused on the domestic. The dollar policy for sure is being set by Treasury and the Board of Governors is thinking about the international context.

This focus on domestic concerns is actually baked into the Fed's structure:

President Goolsbee: The reserve banks around the country are formed, as you know, the Federal Reserve Act in 1913. Then, as now, the country was deeply suspicious that the whole financial system would be run by the dollar. New York City and Washington, D.C. So they set up independence with a representation of voices from out in the flyover country and out in the rest of the U.S. And that's why we have the 12 reserve banks.

This decentralized structure was designed to prevent the concentration of financial power in just a few hands. It's a reminder that even as the Fed's influence has grown globally, its roots are deeply American. But what about the future? Some have speculated that the dollar's dominance might be waning. Goolsbee disagrees:

President Goolsbee: My old colleague, Gita Gopinath has done this research showing it's not even going down the use of the dollar as the medium of transaction in international trade between countries that are not the United States between two countries, say in Asia or Africa, South America, they, the share of the transactions using the dollar, if anything is rising at, at the least it's staying stable.

This ongoing dominance of the dollar in international trade underscores the continued global influence of Fed policy. When the Fed makes a move, the world still watches - and reacts.

But this global influence comes with challenges. How should the Fed balance its domestic mandate with its de facto role as a global economic influencer? Should it consider the international repercussions of its decisions more explicitly?

Final Thoughts

Yet despite these challenges, Goolsbee remains cautiously optimistic:

President Goolsbee: I'm still closet optimistic. We could keep some of that magic in 24.

This optimism isn't based on blind faith, but on a deep understanding of economic cycles and the resilience of the American economy. As Goolsbee reminds us:

President Goolsbee: People's, as you know, people's vibes are not really what the aggregate numbers are - the economy is never paradise. Even in the times, if they look back to the late 90s, 1984, in a lot of big booms, it's never the case that everybody's going to tell you, yes, this is what prosperity looks like.

In the end, managing the economy is as much an art as it is a science. It requires interpreting imperfect data and making decisions in the face of considerable uncertainty.

The data doesn’t make sense, which is why we look at a lot of data points to figure out what is going on. We are getting closer to the Golden Path - inflation is coming down, but there are some sticky parts. The labor market is showing signs of weakness. GDP came in softer.

The Federal Reserve has big decisions ahead - and they will likely keep sniffing around. But the biggest question is - when will they begin to walk? And what will that path look like?

In This Economy: How Money and Markets Really Work - is on sale and is a great gift for all the data dogs in your life.

Disclaimer: This is not financial advice or recommendation for any investment. The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.