Bill Dudley started his career on Wall Street at Goldman Sachs as its chief U.S. economist, notably advising bond traders on the economy and inflation, and what the Federal Reserve would be likely to do on interest rates. He became head of the Markets Group at Federal Reserve Bank of New York and next, its President, from 2008 to 2019, years when the Fed grappled with the Great Financial Crisis and its aftermath. His term overlapped with years when Kevin Warsh was serving on the Fed’s Board of Governors in Washington.
Bill joined me right after the Fed had decided not raise its key rate to fight forces that have pushed inflation consistently above the Fed’s 2% target for more than five years. Three Fed bank presidets dissented, opting for a move to hike the key rate now instead of waiting for what is a more widely expected rate hike in September
So what does Bill think of Warsh’s messaging as this new Fed Chair overees his second policy meeting? He’s very critical.
“I think… there’s two interesting things about the press conference. Number one, how little was said. I think people were quite frustrated with the lack of substance. So why didn’t you raise rates at this meeting?…So I think there is frustration with the lack of not guidance, but, you know, understanding what’s important to the fed and what’s not,” Bill says. ”Why did three people dissent?, that’s really not answered,”
”And the second aspect, I think, of the meeting that was… upsetting to people was the fact that people read the meeting as all talk, no action,” he says. “You know, the expression, All hat, no cattle.”
Bill sees Warsh opting to let markets interpret and guide policy. “This idea that you can just leave it to markets to figure out what monetary policy can be... I don’t buy that proposition. The markets aren’t trying to figure out what the Fed should do. They’re trying to figure out what the Fed will do.”
He warns that this approach leads to policy indeterminacy, as both the Fed and markets look to each other for direction, creating a feedback loop with no clear anchor.
”I think at the end of the day, Kevin’s making a big mistake by not distinguishing between forward guidance, what we expect to do the next meeting versus how am I thinking about monetary policy, what’s important, what’s not, what data am I focused on?
As to what else the Warsh-led Fed needs to do next, dive in and hear why Bill says they’re going to have to explain their reaction function.
Spoiler alert: Bill says “without this, markets cannot accurately anticipate policy moves, which impairs the effectiveness of monetary policy transmission.” In the end, “you can’t just leave it to markets to figure out what monetary policy will be.”
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Small fight over big issue: rate are not higher enough 00:01:06:20
I don’t think it was a big family fight. I mean, I think the three people that the Senate dissented for some good reasons, in my opinion. One, there’s very little evidence that monetary policy is currently restrictive. You know, we’ve been we’ve had this level of rates or higher for a couple of years now. Yet we’re continuing to operate at a level of unemployment that’s consistent with full employment, you know, the labor market consistent with a stable inflation rate. Number two, you’re missing on one side of your mandate: Inflation; you’re not missing on the other side. So that obviously argues for tighter policy. And three, the risk of you know tightening and being wrong is probably quite a bit worse than the risk of not tightening and being wrong in environment where inflation has been above the Fed’s objective for five years.
Little said at presser-little explained 00:01:55:04
So, you know, I think the interesting thing, there’s two interesting things about the press conference. Number one, how little was said. I think people were quite frustrated with the lack of substance. So why didn’t you raise rates at this meeting? That wasn’t really answered. Why did the three people dissent? That really wasn’t answered. What are you going to be looking for going forward that really wasn’t answered?
Lack of guidance frustration: all hat no cattle 00:02:16:02
So I think there is frustration with the lack of guidance, but, you know, understanding what’s important to the fed and what’s not. And the second aspect, I think, of the meeting that was, you know, you know, upsetting to people was the fact that people read the meeting as all talk, no action. You know, the famous expression all hat no cattle.
Market reaction smacks of skepticism 00:02:41:24
I think that’s how they I think it’s how the markets interpreted. And you can see that by the reaction of the yield curve two year yields down. So less tightening ten-year yields up. More information. 30 years yields up even more. More inflation and more concern about whether the Fed’s going to do the right thing. You know I think the president of the United States didn’t help.
President is not helping 00:03:03:19
Afterwards he came out and said, well the Fed’s very political and you know, which wants lower rates, the implication being somehow the reason why we haven’t gotten lower rates because of all the other committee members. I don’t think that’s doing Kevin any, any, any great favors. But I think at the end of the day, I mean, I think that Kevin’s making a big mistake by not distinguishing between Forward guidance, what we expect to do the next meeting versus how am I thinking about monetary policy, what’s important, what’s not, what data am I focused on?
Too-little information conveyed- too little communication 00:03:34:12
What questions do I have that I hope to have answered over the coming weeks and months that will determine whether I decide to? We need to tighten monetary policy or not, and is unwilling us to provide any information about his monetary policy. Reaction function, I think is not a great strategy because one, I think it makes it harder for the markets to understand the Fed, and two, is essentially going to be outsourcing the communications to all the other FOMC members.
Leave it to markets? 00:04:03:16
They’re going to they’re going to they’re going to explain their thinking. They’re going to explain their monetary policy reaction function. And so I think that this idea that the chairman of the fed is basically not willing to provide any information that’s just going to be provided by other members of the committee. So the last thing I would say, that last thing I wanted to say is this idea that you can just leave it to markets to figure out what monetary policy can be...
A Neil Diamond song: watching me watching you 00:04:23:14
I don’t buy that proposition. The markets aren’t trying to figure out what the fed should do. They’re trying to figure out what the Fed will do. So if the markets are looking at the Fed and the Fed’s looking at the markets, policy is essentially indeterminate.
Rate hikes: why not now? 00:05:10:03
Well, I think the question that wasn’t that was asked, that wasn’t answered was one why not at this meeting? Number two, what were the reasons for the three people that were descending? Number three, what were you need to see to decide that monetary policy has to be made more restrictive, saying that what you need to see to make monetary policy more restrictive is providing information about your reaction function.
An objective with no framework 00:05:33:12
It’s not forward guidance. It’s not for guidance. It’s just saying if XYZ happens and I’ll be more inclined to to move in a tightening direction. So I think the reaction, you know, the markets was very much thumbs down because basically they’re saying, yeah, you’re talking a tough game about your commitment to price stability. You’re talking a tough game about how you’re determined to get inflation to 2%. 2% is still your target, but you’re not really explaining at all how you plan to accomplish that.
The wrong kind of communication leadership? 00:06:40:24
I think I think when you have one or two then you should leave it to that person/persons. But when you have multiple dissents, then I think it’s more fair to talk about what’s the motivation behind those dissents. Why are they. How are they seeing things differently than I’m seeing things now? He did say in the press conference, well, I don’t want to speak for them, but then you’re just outsourcing. Once again, the communication is now going to be outsourced to all these other fed officials rather than the chairman. So I think the chairman is essentially diminishing is his own role in some fundamental sense.
Warsh is still a newbie 00:07:47:02
Well, he did sort of make the remarks on how short a period of time he’s been there. So he did contrast the eight and a half weeks that he’s been there with the 60 something months when the Fed has been missing its 2% inflation objective. So the implication is, well, like, give me a little bit more time to sort of think about what I want.
Warsh is doing things differently, and many do not like it 00:08:07:06
But remember he came into this job very critical of the Fed, very critical of how the Fed is set policy. So presumably he’s already sort of sorted out what needs to be done relative to what the Fed has done historically. You know, he’s talked about regime change. He’s talked about doing things in this whole new way. You know, I think people are that’s fine for a little while.
Like Bernanke with inflation targeting Warsh has not revealed his method juts his goal 00:08:30:11
But that’s not got to translate into substance. So how does that actually affect how you’re in conduct monetary policy. And what are you going to do to get inflation back down to 2%.
A bond market vote of no confidence 00:09:01:06
I got out of it that what the markets think is important. But you know, following the markets is really sort of chasing your own tail because the markets are going to be looking at you in terms of what they expect you to do. I think the market reaction, like I said, the 30 year yields up to < its highest point since 2007>. Year, it’s sort of a vote of no confidence. Right. And so I think that pushes in the direction of actually more likely to tighten in September.
Higher risk premium 00:09:33:14
Higher risk premium. Higher risk premium in the long end.
Market see less Fed action and worse long term impact- 00:09:46:16
No I don’t you know, I mean, I think if you thought that the Fed was going to be aggressive about tightening monetary policy, the yield curve would flatten. And in other words, in other words, you know, there’s two year rates would go up more than 30-year rates. But what we actually saw today was the curve steepening 30-year rates going up, two year rates falling.
Could change but no confidence for now 00:10:04:20
So that tells me that markets are starting to think, well is he really going to fall through and do all these things he says he’s going to do to get inflation back down to 2%. So I think the market reaction, at least the initial reaction, obviously that could change over the coming days and weeks, was one of a little bit of frustration and a little bit of a little a little bit of a vote of no confidence.
Is the honeymoon over- already? 00:11:04:06
Well, I think that the bar for governors dissenting is quite a bit higher than for the bar for presidents. I mean, look at historically many more presidents dissent than governors dissent. Number two, you know, presumably there’s a honeymoon period and you don’t really want to make the Chairman’s job really more difficult just when he’s, when he’s starting.
Waller has been very critical of Warsh- 00:11:24:10
But, you know, Waller has actually been fairly critical of, of Warsh. You actually look at some comments, you know, he’s basically said just staring at inflation, saying that we have to get it down is not a credible strategy. He’s also basically pointed out that, you know, all these things that the task forces are going to look at are things that the Fed has been looking at for years. So Waller is sort of pushing back against this notion that the Fed has done such a poor job over the last few years that there’s a whole new regime coming. You know, I think he’s basically been pushing back against worse, even though he didn’t dissent today.
Williams lives in R-Star land and rates are low there 00:12:40:19
Well I mean, the Williams view I think is tied to his view that that the real interest rate consistent with a neutral, moderate policy is pretty low. You know, it’s probably he’s probably in the 1% camp. And so if you have 1% real rates plus 2% inflation, that means any funds rate that’s north of 3% is actually exerting restraint.
Before the financial crisis the neutral rate was at 4% 00:13:01:18
I think the problem where I would disagree with John is I just think the neutral rate is higher. If you go back prior to the great financial crisis, if you look at the, you know, the original Taylor rule, the neutral real rate was 2% plus 2% inflation, or 4%, which is higher than where the federal funds rate is today.
Myriad issues- 00:13:19:16
So one of the fundamental questions right now is one, what’s the level of interest rates consistent with the neutral monetary policy. Another is what are the risks on both sides of the mandate. And a third issue, and this is an issue that the chairman did get into, is how should we think about the AI boom? Should we focus on the AI boom as raising demand and causing inflation, or should we focus on the AI boom as something that’s going to lift productivity and drive down inflation over the longer term?
Dudley sees first AI impact on the inflation side 00:13:48:01
Now, my own view is that the near term influence is going to be mostly on the inflation side. You know, higher cost for chips, higher costs for electricity, higher costs for construction. So I think that’s going to be the dominant influence. But yeah. So I think I could turn out to be a really good thing for productivity and inflation over the longer term. But I think you’ve got to set monitor policy based on what you need now.
Warsh is ceding to much control to markets- 00:14:19:14
Well, he’s in control in the sense that he’s setting the objectives of the things that the fed is going to look at. You know, if you look at the five task forces. So we certainly can control in that way. But he has essentially outsourced policy a bit to financial markets. So I don’t think he’s in control there.
…and outsourcing the Fed reaction function 00:14:37:02
And his silence in terms of being willing to talk about what it would take for him to decide to do X or Y, that silence means he’s outsourcing the monetary policy reaction function to the other Fed officials who are willing to talk about that. So I think it’s I think it’s not a I don’t think it’s I think it’s sustainable in the very short run. I don’t think it’s sustainable in the medium and longer run.
Fed wants markets to process and digest data 00:15:04:12
Well yeah. His view is that, you know, if the Fed is silence silent, then the markets can just process the information on its own. And the markets will process that information and then send the fed a good signal about what that information means. And then the Fed can take that information on board in terms of deciding what to do about monetary policy.
Markets process information for their own use 00:15:23:11
The problem with that view is the market isn’t interpreting the information directly in terms of what the Fed should do. They’re interpreting the information about how it’s going to influence the Fed in terms of what the Fed will do. And so I think this idea that you can sort of leave it all to the markets to figure out what the data mean and take that as a signal in terms of how to conduct monetary policy. I just think that’s not the right way to think about things.
Total signaling is bad too 00:15:57:16
I agree, I agree that you shouldn’t be totally signaling. Totally signaling is saying, this is what I expect to do at the next meeting. This is.
The market does not set monetary policy, the Fed does 00:16:40:06
Right? But at the end of the day, my job was to forecast what the Fed would do, not what the Fed should do. Kevin is basically saying almost the market. Let the market tell the fed what it should do. But no, the Fed. The Fed is the one who sets monetary policy, not the market. The market can provide information about how it thinks that incoming information affects how the fed should think about things. But the fed, at the end of the day, has to control the narrative.
Warsh wants as pure a market view as he can get 00:17:23:07
He doesn’t want the Fed speaking to contaminate the market’s interpretation of the incoming information. So his view is if the Fed is completely silent about how we’re thinking about things, then the market can look at all the incoming economic information and figure out how to process that into what they think the Fed will do. But then of the day, what the Fed will do is up to the Fed, up to the market.
Purity of signal is simply not feasible 00:17:48:01
So I think that this purity of signal is really not as feasible a process as he thinks. Because as I said earlier, the market is trying to figure out what the fed will do, not what the fed should do.
More on dissent coming up 00:18:20:08
What I think I think dissents are fine. I mean, I think dissents are fine. If people have a difference of opinion, they should express that. And what will be very interesting is, on Friday and next week to hear from Lori Logan, Beth Hammack and Neil Kashkari to find out why they actually dissented. And I expect they will tell us things that are important for us, our understanding about where they’re coming from.
Monetary policy is not restrictive 00:18:45:07
I think they’re going to be very similar to what I was saying earlier. Monetary policy doesn’t look restrictive. Number two, we’re missing on one side of the mandate, not the other. And three, from a risk management perspective, with inflation above our target for five years now, we got to be area on the side of getting inflation down. I mean, Lori Logan had a social media post that was basically essentially saying those things before the blackout.
Was the difference of opinion fundamental or just over timing? 00:20:02:12
Well be nice to know what the debate was really about. Like so what was the source of disagreement between the dissenters and the non-dissenters. You know just you know is it because we think the inflation process is different because it’s all supply shocks. And so inflation is going to come down on its own. Or do some other people think know that these inflation shocks will get embedded in other prices and in wages. And so we have to be more concerned. I mean, what’s the source of disagreement among the committee members? That seems to be pretty important for markets to figure out how to think about the fed.
Rarely does the Fed move only once 00:21:02:06
Of course, of course, because 25 basis points does virtually nothing. You know, if you look at historically, every time the fed has raised rates, the probability of the next move being a rate hike is over 90%. And similarly, every time the fed has cut rates, the probability of the next move being a cut is over 90%. So there is a lot of inertia to policy because, you know, by the time you realize you need to raise rates, one rate increase of 25 basis points isn’t really sufficient right to do the job.
September is looking more likely 00:21:33:24
You know, I think I think September is definitely, you know, you know, I don’t think it’s a sure thing because the data between now and then could be, you know, better on inflation, it could be softer on the labor market. And that could cause the Federal Reserve to want to wait. But I would say if things were exactly where they are today. So basically not just focusing on the good inflation print and the and the weaker labor market print we had between the prior means. But looking at the data over 3 or 4 months, if the trend of the last 3 or 4 months looks to be broadly intact on inflation and the labor market, then I think, yeah, absolutely tightening in September.
Must tighten because rates are not restrictive 00:22:22:04
Yeah. Absolutely. Think they’re going to have to tighten because I think rates are not restrictive. So so so they can. So so this is really more about when Kevin Warsh will feel that he needs to finally pull the trigger, as opposed to whether there’s a need to pull the trigger. I mean, I probably if I were him, I would have tightened today because if I tighten the day, it would be basically saying I’m independent of what the markets are pricing in.
A missed opportunity here 00:22:47:24
I am demonstrating my commitment to getting inflation back down to 2%. I’m showing my independence from the president of the United States. So it’d be sort of a win-win-win. Now, if he tightens in September, only after the markets thumbs down, that looks more like he’s being pushed into it. So I think so I think there was a missed opportunity today.
Is Jackson Hole held hostage to the task forces? 00:23:31:22
When he said yeah. He said today though he had no idea what he was going to talk about at Jackson Hole. Well, maybe I mean I don’t know what he’s going to talk about. Maybe because, I mean, you know, part of the part of the issue, too. If we have all these task forces that are doing their work and he used he’s used the task forces to sort of push off a lot of the decision making. So, you know, I think that limits what he can do in Jackson. All because you don’t want to front run your own task forces.
Forward guidance is a no-no exception for exceptional times 00:24:10:14
No forward guidance, except when you’re at zero level of interest rates and you’re trying to provide additional monetary policy stimulus. This is what we wrote in the Group of 30 reports that we published in May. But you still want to provide information about your monetary policy reaction function, because if markets understand your monetary policy reaction function, they can price in more accurately what you’re actually going to do that can make monetary policy transmission more, more quickly. So they price it in before you actually act and more efficiently because you actually you actually do what they anticipate because they understand you.
William C. Dudley became the 10th president and chief executive officer of the Federal Reserve Bank of New York on January 27, 2009. In that capacity, he served as the vice chairman and a permanent member of the Federal Open Market Committee (FOMC), the group responsible for formulating the nation’s monetary policy.
Previously, Mr. Dudley served as executive vice president of the Markets Group at the New York Fed, where he also managed the System Open Market Account for the FOMC. The Markets Group oversees domestic open market and foreign exchange trading operations and the provisions of account services to foreign central banks.
Prior to joining the Bank in 2007, Mr. Dudley was a partner and managing director at Goldman, Sachs & Company and was the firm’s chief U.S. economist for a decade. Prior to joining Goldman Sachs in 1986, he was a vice president at the former Morgan Guaranty Trust Company. Mr. Dudley was an economist at the Federal Reserve Board from 1981 to 1983.
Mr. Dudley received his doctorate in economics from the University of California, Berkeley in 1982 and a bachelor’s degree from New College of Florida in 1974.
In 2012, Mr. Dudley was appointed chairman of the Committee on the Global Financial System of the Bank for International Settlements (BIS). Previously, Mr. Dudley served as chairman of the former Committee on Payment and Settlement Systems of the BIS from 2009 to 2012. He was a member of the board of directors of the BIS.
