Rebalancing the Economy: An Interview with Mary Daly, President and CEO of San Francisco Federal Reserve

labor market evolution, profit margins, financial nihilism, and more

I had the incredible opportunity to interview Mary Daly, the President and CEO of the San Francisco Federal Reserve. As we all know, inflation is still not where anyone wants it to be. The Fed is focused on getting inflation down to 2% in order to get the economy back in line. But the toolkit is blunt, and the impacts are varied.

People are the economy. That’s really important to keep in mind when making policy decisions. We discuss all that and more in this interview - evolution of the labor market, worker power, profit margins, homeowners and the fixed rate mortgage, financial nihilism, the Fed’s toolkit, and AI.

Full video here:

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This transcript has been lightly edited for clarity. 

The Interview

Evolution of the Labor Market

Kyla: I want to talk about a wide range of things, the labor market, inflation, your thoughts on AI, but I think the first question that I want to get into is - for the past couple years our world has been dominated by tech.

But now there's these tech layoffs that are almost forcing us to revert to the physical world again. I'm curious about your thoughts on the evolution of the labor market, specifically the labor market maybe favoring blue collar work - or the need for blue collar work over white collar work.

Mary: It's a really good time to try to do something that we do in economics all the time, which is separate what's going on currently from what the underlying trend is. So if you think about your term of “blue collar, white collar” and they say “is there a re-imagining of work” -  really what they're talking about is low and moderate wage workers who work in the services industry or do retail, landscaping, things of that sort. Are those individuals getting a better deal? 

I would say that right now, those workers are in short supply and high demand, and so they're getting higher wages. But if you ask yourself, “is that going to be a replacement for getting the skills that are durable throughout one's career?” I would say no because right now, even though those workers are getting rapid wage growth, their wages are not always keeping up with inflation.

In fact, when I'm out there talking to individuals who are starting out or in the middle of their career, they're just on a treadmill trying to keep up, trying to make ends meet. And if you think about tech, the tech workers that are being laid off are turning around and finding jobs in all kinds of places that have been short of tech workers to do the cool things - anything from manufacturing to new ideas and financial services, to just running the business lines better at any institution.

So I don't think that this is a sea change in the labor market. What I think of this is a good job market for a wide range of workers, including those who don't always get a break. And yet skills pay. Those workers hopefully are finding an opportunity - once we get inflation down - to go back in and get whatever skills they want to have to build their career. Right now it's a frenzied world out there to try to earn enough to keep up with inflation. That's why the Fed is so focused on inflation.

Worker Power

Kyla: The labor market aspect is so interesting too, because everybody's wages are being eaten away by inflation. It's pretty much unavoidable. But for the first time it does almost feel like the worker is able to have a choice. We have such a tight labor market. So how does the Fed sort of think about that tradeoff where we have somewhat of a healthy labor market - low unemployment - but then people are able to turn around and get those jobs, especially in tech, versus battling inflation where the unemployment rate is going to have to tick up?

Mary: The inflation rate and the labor market, they're all related. So I'm gonna go back to 2019, that's what I would call a really healthy labor market. We had low inflation and people were able to get multiple job opportunities. People who had been sidelined, people had sort of said, “well, you're probably not gonna work again.” They were coming back in. People had career mobility. They were accumulating income and wealth. That was a really solid economy that delivered a strong labor market and price stability. Now we have an unbalanced economy and while it feels good at the moment for a particular worker to get a particular wage gain - you said this and, and I totally agree - that it's being eroded every single day by inflation. That's not what I call a strong place for the economy to be in, because we need sustainable growth - the thing the Fed's working on. 

The best thing we can do for Americans is provide a sustainable path of growth that gives people opportunities to change jobs, to find the career that matches their interest, to grow their careers over time, but then to bring that paycheck home week after week and be able to afford things that they afforded last week. And right now we can't do that. So I think that's the point of balancing the economy. You balance the economy to give people a full slate of options, not just a positive here and a take back there. 

Profit Margins

Kyla: I think one aspect that has raised a lot of eyebrows recently is companies and profit margins and raising prices - like Campbell's soup raised prices by 16% last quarter. And of course to a certain aspect you're like, “well they kind of have to raise prices in order to pay these workers” and get this ball rolling again. I know that the Fed is sort of in between a top-down look at the economy - how far the economy is operating above capacity - and then a bottoms-up look - prices and wages. But what do you think about that trade off between higher costs for consumers from companies raising prices like this and companies maintaining profit margins?

Mary: We have only one tool, the interest rate, and then we have two goals - full employment and price stability. And so what we're really doing is we're asking how we can get those two things to go together at the same time. So prices are rising for a whole bunch of reasons. 

• Supply chains - demand is outstripping supply because demand is strong, stronger than it normally is at this point in the economy. 

• Then people don't necessarily want to do the jobs that they once wanted to do. So labor supply is short and firms are trying to manage this.

• We have less global competition, less global interaction than we did prior to the pandemic. You've heard about reshoring, nearshoring.

All of these things are happening at the same time, and all of that's contributing to profit margins or revenues or sales or prices. And so unpacking that, that is something you can usually do historically, but it's very hard to do it in real time and in real time.

We can all agree on this thing - inflation's rising too fast, faster than our goal, but faster than people can really keep up. And so the job of the Fed, whatever the cause of that high inflation is, is to bring inflation back down to 2% using the tools we have and do so as gently as we can so that we don't leave the labor market worse off for no reason at all. The things on the top of my mind, and this is up and down the generational spectrum across all my communities that I serve, is how do I deliver the easiest path for the economy that puts inflation back on track and keeps the labor market as strong as it possibly can be.

Homeowners and Monetary Policy

Kyla: I think that that is the right goal, and it's a tough one for sure. As a renting member of the younger generation where I rent, I do not own a home, a lot of people around my age are like, “I don't know if I'm ever going to own a home.” I'm curious how the Fed is sort of thinking about that disparity between renters and homeowners - homeowners are a little bit more insulated from monetary policy transmission hypothetically, because they have this 30 year fixed rate mortgage and a lot of people got in at 2-3%. So they maybe don't feel the Fed's toolkit as heavily as somebody who doesn't own at home.

Mary: We have one tool. It's a blunt tool, so we raise the interest rate. It affects the economy. It affects housing first. That is one of the first sectors it affects because it's an interest sensitive sector. The mortgage interest rate rises. Demand for ownership of homes falls because it's more expensive to get the loan, which eventually slows the price of home price growth, and then eventually trickles into rental price growth - eventually is a really important word because it takes some time. So if you're a younger person and you're thinking, “well, I'd like to start buying a home” what you see right now is you see home prices coming down or the growth being less rapid at the same time that the cost of borrowing goes up and you think, “well, I'm not gonna get a chance now either because now I can afford the price, but I can't afford the loan.”

And what I'm going to offer here is that the way we do our job well for all of you in the younger generation who's thinking about this - is to get inflation back down to 2% so that the price of the homes can come down to a sustainable level, a sustainable rate of growth. Then we can move the interest rate back down to neutral so that it's lower and you can both afford the price of the home and the laoan.

You're not in a 10 person deep line paying cash or using their equity in their previous home to buy a home and competing you out. But we also recognize that without inflation going down, you can't even save money out of your paycheck cuz you're just paying for basic necessities. So that's why I really do think of inflation as the toxin that pulls away at the foundation of the economy.

If we can fix the toxin and get it back down to 2%, then you can save, you have more ability to get the homes you want and and deserve, and you have more ability to afford the loan because we can put interest rates back in their neutral position. So it takes time. I feel for every American who has to go through this transition. But this is one of those things where if we fail to make the transition, the world would be far worse than if we make the transition well and smoothly. 

Financial Nihilism

Kyla: It's definitely tough. When you speak to people in the younger generation, there's a lot of frustration - this concept of like financial nihilism is really big, where it's like, “well, I can't, have that quote unquote white picket fence, American dream. So why would I ever try?” If you could say something - and I know that you do say things to the younger generation - how would you sort of approach that concept of financial nihilism where you kind of see people giving up almost on their financial future?

Mary: Well, the first thing I would say is don't give up. You've been given one of those historical draws, which no one wishes for as you are coming out of age. Coming out and moving into the economy at a time when we had a pandemic, and then following the pandemic, we have high inflation, and then it looks like the economy needs to cool to fight inflation creates anxiety about, “okay, how much is it going to cool and where am I going to be?” And then the things that you've put your goals and dreams on about - home ownership or whatever your goals and dreams are - feel less able to to grasp. And the thing I will offer is the thing that I had to tell myself when I was back in a similar situation.

I was in your position in the Volcker disinflation era. And all I saw was high inflation made everything unaffordable, followed by a deep recession that made everything unavailable. And that is what I'm trying to avoid as a policymaker is not doing that. And so what I would say is hang in there. Hang on. Don't give up. But be ready to move when moving is possible. Not moving physically, but be ready to act on your dreams when it feels more favorable by continuing to save what you can, continuing to plan for your future. if you give up, then you've basically let a pandemic and an economy with high inflation sort of get the upper hand.

I refuse to do that as a policy maker. And so the thing I'd ask of you is hang in there with me. I hate to be so direct, and I don't mean to be pollyannaish, but I mean, what other choice do we have? We have to hang in there and get through this and be ready to go next time.

Kyla: There was something I was reading the other day, like, things will always be okay eventually. What you said earlier, like eventually it does a lot of legwork there, but I think that's true and it's always a good reminder that things will -

Mary: Can I say one more thing about that? Saying things will work out eventually, always feels like we're waiting until eventually comes. But what I'm offering when you say “is there's something I want to say” is that you can participate in your future even when you can't execute on every goal and dream you have. And so I wouldn't be passive bystanders on that. Get out there and think about, “okay, what do I need to do to be ready so that it just doesn't feel like we're waiting on behalf of eventually we're actually actively participating so that we're ready for the, when a different situation emerges.” 

Volcker Era

Kyla: You have to - action begets action, right? You have to be out there doing the things, finding the opportunities. I would be curious to hear a little bit more of your time growing up in the Volcker environment.

Mary: Absolutely. I mean, I think, one of the things I really appreciate about the younger generation of your listeners and you, is that you're scrappy. And I think being scrappy is a really good quality in an economy that is dynamic. Even if we just abstract from inflation right now, we have a very dynamic economy. The labor market seems to change and some things that were really hot six months ago seem less hot now. You have to be able to be resilient to navigating what is an ever-changing economy, and one that's going to continue to change at a rapid place, a rapid pace.

I found opportunities where I could, and I got help where I needed it, and I pieced together something that in retrospect, to many looks like a path I would've plotted, but in reality was the crooked path of being opportunistic. Being out there looking for the opportunities that I knew built my own future.

I know it's over said, but this economy is no reason to feel like you're being pushed around. Yes, inflation is higher than we want it to be. That is absolutely true. Yes. It can feel like a treadmill. Absolutely true. You're still able to captain your own destiny by putting your jobs together and doing the things that are important to you and keep planning for your future.

That's ultimately what I think. You already have as a generation - look how much you've already gone through. But it's about activating that and kind of marching forward. And all I can say to you as a policy maker is you're top of mind when I get up in the morning about how I think about why we are doing policy and why is this so important. It's really to deliver an economy for all of you that you deserve and that works better on behalf of you.

Fed Toolkit is Blunt

Kyla: I'm curious about your thoughts on rolling recessions. So there's this idea that the whole economy might not go into a recession, but pockets of the economy may be manufacturing, for example, will go into a recession. The Fed does have this really blunt toolkit. Are there any ideas around maybe like more nuanced targeting of monetary policies or is it really just like, “well this is kind of the domino that we have to tip in order to get things rolling.”

Mary: Well, let me go back to your first point about rolling. I think we actually overuse the R word

Kyla: The recession word?

Mary: Yeah. I call it the R word. We definitely overuse it. And so then the question is what are people responding to? And I think there's a lot of response to what I would think of as natural dynamism in the economy. The economy's always moving. That's the way it is. It could be great, everything's firing on all cylinders and sectors are going to be rebalancing and other sectors are gonna be coming up.

Some sectors say, “oh, we should have been growing faster, now we're gonna really ramp up.” Other ones say, “Hmm, we probably got over our skis a little bit. So let's pull back and let's rebalance.”

So if I can do this, I'd like to replace your R word with a new R word - Rebalancing.

The economy is in a period of rebalancing and that can feel a little bit anxiety provoking, but it can also be the place where we grow into something that really delivers different kinds of benefits to everyone. 

We have new opportunities for people who have all different kinds of skills to get the kind of career mobility they've been wanting, their whole lives. So I think of the economy as a hopeful place where there's a lot going on. But I'm gonna keep coming back to this. None of this works - literally nothing I just talked about works - unless we get inflation back down to 2%, because that is the thing right now that makes us the most vulnerable in our economy is that inflation is so high, it's unsustainable, and we have to get it back down to 2% so that we can have a really sustainable, stable, resilient path forward.

Pockets of Inflation

Kyla: And are there any pockets of inflation, like specific sectors of the economy that you're worried about? I know recent inflation prints haven't been great. Are there any spots that you're paying attention to?

Mary: Inflation is going to move around and there are gonna be areas that pop up, as you said, and areas that come down. But if I was going to unpack overall inflation and tell you how I look at it, what dashboard I look at, I would say I'd look at overall inflation, of course, and then I look at “what if I take food and energy out?” Because those tend to be volatile and the Fed doesn't have a lot of direct control. Well, I mean, our interest rate controls demand, which is really going to affect core inflation - and then there's core goods and there's core services. 

• Core goods: So we know core goods prices are coming down as supply chains get improved or repaired, and as all of us decide that we're going to go out and do things as opposed to buy things. So that's a good thing.

• Core services: And then the other one is core services, and that has two components. And I say this because it's really important to separate the two components. One is housing, we've already talked about it, and the other one is, really - if someone could come up with a better name, you should send it in - but core services-ex housing, which really just means core services. Take the housing out, see what you have.

And now one's been a little stickier. And that's about all those things we mentioned, restaurant, meals, haircuts, business services. Those have been stickier. And that's an area where my focus is really. I'm really focused on that because that also needs to slow down. Inflation needs to come down for us to really be confident that we're moving towards our price stability goal.

That’s what has to happen. That's what I'm looking at. But a little bit of up and down in inflation readings, I wouldn't be too worried about because transitions are always a little bumpy and the data being bumpy doesn't mean we're not on the right path.

Artificial Intelligence

Kyla: Yeah, exactly. On a three month basis it looks decent, but month to month it's a little choppy for sure. But I think that's a good point. This'll be my final question because I know we're almost out of time. I am curious for your thoughts on artificial intelligence, whether that be how it's impacting the labor force - if you see it impacting the labor force - or just your general thoughts on it 

Mary: One great thing about being long-lived is that you've seen a lot of things, but also I read a lot of history, and one of the things you see time and time again historically, and even in my lifetime, is that every time a new tool comes out or a new machine, process, or technology there's always a lot of concern that it will replace everyone and that we won't have anything to do. And it never happens because one machine takes the place of some tasks that we used to do, and then that frees up our bandwidth to think about new things we could do. Okay? But the responsibility of the economy, if you will, is to ensure that those people who used to do the tasks that now a technology or a machine or a process do actually have a place to go in the new economy. And that's why again, sustainable expansion. You keep hearing me say sustainable expansion.  I'm not worried that AI's going to replace all humans. What I'm thoughtful about though is as AI starts to be something that takes certain tasks away, how is the economy positioned in a sustainable place so that it can absorb the workers who want different jobs because they no longer have to do the ones that technology can do effectively.

So the economy is constantly growing. It's constantly dynamic, but the job is always, as a Fed policy maker, is to maintain that sustainable path of growth. And when we get off of it, get back on it so that all of this can be smoother and that people like yourself and all the generations out there have an opportunity to re-engage and fully participate. 

Kyla Thoughts

I think the main thing is that the Fed is really focused on is 2% inflation, in order to rebalance the economy (a new R word!). As Mary said “none of this works” unless they get to 2%.

The Fed’s toolkit is blunt, and it has a blunt impact - like a sledgehammer. Things are getting better, but the path is long - and bumpy. Wage stability in context of inflation is more important than wage growth. But of course, policy impacts are wide, varied, and unequal. But the goal, as Mary said is to “balance the economy to give people a full slate of options, not just a positive here and a take back there.”

I hope that you all are doing well.

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.