2023 Community Bankers Symposium

AUSTAN GOOLSBEE: Thanks, Julie. And I am excited to welcome everybody here to the 17th annual Community Bank Symposium. As Julie said, I've been going all over on a small piece of heartbreak, I went to Lambeau Field and saw where the Packers. They forced me to take the Titletown tour and the trophies and the whole thing. I prefer to think of it not that the Bears have the worst record in the NFL, but that they are winning the NFL draft for the second year in a row.

It's been a priority of mine, too, as you probably know, the seventh district, it has the most diverse group of banks that it oversees. And community banking is a tremendous force throughout the Midwest, throughout the seventh district. And so as a priority of mine in this first year that I wanted to come to this seventh day, I missed the first 16 of this conference, but I wanted to make the 17th.

Before I do that, let me say A, want to-- well, I want to welcome all of you community bankers. But I want to thank several members of the staff as well. As Julie highlighted in her comments, I especially want to thank the interagency nature of this event, the FDIC, the OCC, and the CSBS for their collaboration, not just today but throughout the year. I want to thank the dedicated staff here at the Chicago Fed for working to make this event happen.

And this enterprise, both the regulatory side and the community banking, this is a worthy, honorable endeavor. The thing that I've overwhelmingly found in working with folks at the Chicago Fed has been the sense of mission and the desire to contribute to society and that recognizing how important it is. The community banks by lending and facilitating, really the American dream of businesses, of individuals is also a worthy, honorable endeavor.

As I say to the folks in SNR, you're doing God's work if God was concerned with capital requirements and liquidity ratios.

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Now, before I continue, let me give the usual disclaimer that the views I am expressing are my own and also not necessarily those of my colleagues on the Federal Open Market Committee or the Federal Reserve system. That gives great relief to the other members of the FOMC when I give that part. They asked me to talk about the economy, economic outlook, monetary policy, and some of those things just as a backdrop for your thinking about banking.

So I thought I would riff a little bit on the what's on our mind and what we're trying to do at the FOMC. Historically, as you know, the Federal Reserve Act gives the central bank and the Fed system a dual mandate by law what we're supposed to do, maximize employment and minimize prices. And there's built up an entire massive amount of research and literature about how to do that.

And it usually, at the heart of it, what makes the job difficult is that there can be trade-offs. And if you get the economy too hot on the employment side, it leads to inflation. And if you hammer to get the inflation down, it leads to recession. So imagine the surprise when we start to see data like what we've seen in 2023, which is to say, GDP growth in the last quarter was almost 5% at an annual rate, which is extremely rapid growth rate, faster than trend, faster than we think is sustainable.

Job growth has been well above what we think would occur monthly just from population growth. The unemployment rate is an extremely low 3.9%. And yet, despite that strength on the real economy side, we've seen inflation coming down pretty significantly. In fact, if you look in the modern American economic history of the last 72 years, the fastest that inflation ever fell in one year was, of course, 1982 in the Volcker contraction, where they inflation got high, and they tried to get it down.

And they purchased that drop in inflation of a little over 4% in one year with the unemployment rate going almost to 11% and a massive recession negative GDP growth. Because that's what was necessary in the in the old model to get inflation down. In 2023, we still have two more months of inflation to go, so we'll see.

But right now, we are on path to actually surpass the 1982 record of how fast inflation came down, that inflation would come down more than 4% in a year when the unemployment rate never got above four, which it's not too long ago that people said 4% is the lowest that it can be. That would be full employment. So this is a very strange circumstance. And that's what's got me and other members of the Fed, I don't speak for them, but everybody publicly said, we're trying to figure out what's happening.

Now, I believe three things explain why we've been able to pull off. It's not just a soft landing so far. If this continued, this would be the mother of all the soft landings. There's never been a drop in inflation of the magnitude we need to accomplish and which we're partway on without there being a big recession. If we pulled that off, I've been calling that the golden path, that the landing would be the softest of all the soft landings.

It's not a guarantee for sure. And there are numerous things as I'm going to say that could derail it. But to the extent that so far in 2023, it has been happening. I think it's from a couple of things. First, favorable supply developments play a very large role in my view. An overheating economy, which is what's in the traditional is about demand. And if the demand overheats, prices and quantities go in the same direction, OK?

You see big output numbers, big job growth numbers, and big wage growth numbers, big inflation numbers. If supply developments are-- if you have positive supply developments or healing of the supply chain problems from the pandemic, they move in opposite directions. You can get big positive employment. You can get big positive growth with wage growth slowing and prices coming down. And that's what I feel like we've been seeing.

Part of that are healing the supply chain disruptions of the pandemic that we all saw of semiconductors, of toilet paper, of all kinds of stuff. And as that was working to restrict supply, that's where we got a lot of the inflation that we faced. And so finally, we're going to get some relief from that. The second part of supply is that the job market, there's been a rebound of labor supply. During the pandemic, you saw many people, especially women were staying home to care for family members and were dropping out of the labor force.

Many others opted to retire early. Immigration plunged almost to zero. The available labor pool shrank by 5% in three months in 2020. And everybody felt that in businesses around the country. You could say they were like, we can't find people, wage growth was extremely high. So in addition to the supply chain improvements, we've seen a strong rebound of labor supply. Partly maybe because of the enhanced flexibility of work arrangements, you've seen female labor force participation hitting record levels.

You've seen previously disabled workers coming into the labor force at record rates. Immigration has returned to the flow basis around where it was before the pandemic. And overall, labor force participation, the labor force is aging, so over time, it's going down as people retire. But it's well above where we would have predicted it was going to be. There's a lot of hypotheticals in that. But in 2019, they made predictions of where labor supply would be, and we're above those predictions. So all of those supply chain improvements are important.

Second, we have seen recently productivity growth increase at least back to the trend rate that it was pre-COVID, maybe even above that. And if you get productivity growth, that allows you to grow faster and wages to grow more without inflation. And third, the expectations of future inflation, unlike all previous episodes of high inflation in the United States, did not go up as the actual inflation rate rose. So we got inflation up to 9%.

But if you looked at market expectations of where people thought inflation would be in five years, in 10 years, it barely moved. One of the things that made the Volcker experience as difficult as it was is that inflation expectations got unanchored. Every time the inflation rate rose, the public concluded it's never going back down. And if the public concludes that it's never going back down, it becomes that much harder to get rid of the inflation.

That didn't happen this time. And I believe that is a testament to the Fed's credibility, that when it said, yes, the inflation rate is 9% today, but we are going to do whatever it takes. If we have to raise rates by 500 plus basis points in a year, we're going to do it. And the credibility that the markets took are a large measure I believe of why expectations didn't did not go up.

So if you then say, well, what comes next? We had a nice, from the central bankers perspective, period through 2023, does that continue? The first thing to note is if the supply chain improvements are as big of a factor as I described, that runs out. Once the thing is healed, and you get back to steady state, you don't have GDP growth of 5% a year. You don't have the big booming jobs numbers faster than trend, but that's OK. That's OK.

If we get back to trend without a recession, that would be a major achievement from the central bank perspective. And that's where my head is of what we're trying to aim for. Now that said, the fact that we raised rates as much as we did, as you know, has implications for the real economy going forward. And you add on top of it, that since the spring we have seen a further rather rapid increase of the longer rates, 10 year treasury rates. Though a fair amount of the recent run up reversed over the past couple of weeks.

Those long rates matter, and we spent a lot of time talking to businesses and other organizations around the district for the beige book and for other matters. And while I would characterize that while the worries about recession that we heard from the spring have largely died out, there really weren't anybody that we spoke to that felt while GDP was growing 5%, there wasn't anybody saying it feels like we're growing 5% and having a huge boom.

So I would say category two is the big gap between data and how people actually feel about the economy. And that's some consumers. But that's also businesses, too. We're getting 5% GDP growth. And the businesses we're talking to simultaneous to that are not saying, oh, we're booming like nuts. This is one of the best quarters that we've seen in a long time.

On the consumer side, there's never been a bigger gap in the question how's the economy horrible? How are your finances? Pretty good. It's never been bigger. And I don't know. I can't understand. I don't fully know what drives that. But it's definitely on my mind to bear watching. Because if you take consumer sentiment, historically, consumer sentiment, the reason we paid attention to it is it was a very good indicator of consumer spending.

If people said I think the economy's in the dumps, they would pull back. They'd be like, I'm going to save money because I don't know where we're going to be in a year. Somehow in the last 15 years, is indicatorness a word? It's not really. But the indicatorness of consumer sentiment has broken down as a predictor of behavior. It's just not there anymore. So maybe it's just that we're all grumpy. Or maybe it's going to come back and be a sign of spending, but that discrepancy in the data between the data and the feeling is an important thing to watch.

And then the third thing that I would say is what's front of mind to me is inflation. OK, if you know we got a dual mandate. And on the dual mandate, we've done very well on the employment side. And we've done not so well on the inflation side. And it's improving, but it's still higher than where we want it to be. I don't think that the productive thing to do at this moment is to make our primary focus is the growth rate too high? Is the jobs number too big?

Because, as I said, when you got supply developments hitting, you can have strong numbers on quantities. The main thing to pay attention to are the prices. And as you look at the prices, our goal is a 2% inflation target. And the thing about the 2%, we were at 2% before COVID for a long time. We were actually even a little below 2%. And how we got there was a composition that it wasn't that all prices were growing 2%.

Side note, we tend to look at core inflation, not food and energy, which drives my mom crazy. Because she's like, what do you mean you don't look at food and energy? That's all I pay for. What? OK, the reason we don't pay close attention to food and energy is because food and energy prices are really extremely variable. So they don't give you a great sense of what's the underlying, so that's why we look at core.

And core is made up of three things, physical goods, services, and housing. Housing is a service, so it's really services ex housing, but just call it good, services, housing. Pre-COVID, goods had about -1% deflation every year for 10 years. Housing was growing 3 and 1/2 to 4% per year and services growing 2 and 1/2 to 3%. OK, so combine those three together, the average was 2%.

What we've had is goods have now returned to -1% deflation each year, just like they were before. That was the thing that went up the most in the pandemic. And now, it's come down. Services are very slow moving. So I don't think they're going to come down much in the near future.

So the overwhelmingly important thing of whether we're going to clearly be on path for inflation is what happens to house price inflation. And house price inflation is calculated as this long moving average. So the market rent, the house price inflation is not single family homes. It's more of a measure of rent. And rents in the marketplace have come down a lot. And so they're supposed to start showing up in the inflation data. And it's just started.

But if we hit the targets that we expect to hit, then we would be on path to get to 2%. And that's what I call the golden path, no recession, and it gets down. But that housing inflation is a thing that we should really keep an eye on. In terms of risk, as I say, for sure, there's no guarantees that we can pull this off. I remain relatively optimistic. But external shocks often derail soft landings.

In 1990, in 2001, those were easier soft landings to pull off than this, and they were both derailed by external events. That could be geopolitical issues, slowdown of growth in China. It looks like we're not going to have a massively extended and expanding auto strike that did it, so phew. We didn't have a default on the government debt. Maybe we won't have an extended shutdown, phew, OK. But each of these external events are definitely risks that could affect how the economy goes.

So in conclusion, it's certainly a fascinating and historic time. I said if we are able to pull this off and get inflation down without a recession, it will be studied for years. And if we fail, it will also be studied for years, OK? So we're going to aim not to fail. But an environment with high rates, we should expect to see that in interest rate sensitive parts of the economy, like in the businesses that you see, that whether it's housing construction, business investment, consumer durables, purchases, the reality that we're facing 5 plus percent rates where they used to be 0 not very long ago, is going to weigh on activity going forward as as the supply shocks roll off.

OK, so that's my overview of the economy. And now, my job is to, I'm four minutes late. So I'm going to introduce the next panel. Is that right? Yeah, but, yes, OK, first session, sorry, we're going to explore diversity, equity, and inclusion and its implications for business. Now diverse talent, our experience at the Chicago Fed is that having a diverse talent pool is good for business. It helps us gain insights. It helps us avoid blind spots. It helps us better serve the communities where we live and where we work.

And I believe that's true for community banks, too. Here and across the economy, we've found it essential to do our jobs the best we can do that we reflect the district. In today's Fireside Chat, our guest speakers are going to talk about the role of diversity at community banks and the continuing strategic evolution, current challenges, and opportunities and its critical role in leadership.

There's going to be time for Q&A at the end. Our speakers are going to be Bruce K Lee, President and CEO of Heartland Financial USA and Jennifer Docherty, Founding Director and CEO of Bank on Women. Bruce oversees the 11 Heartland Financial banks and the holding company, which provides support to 114, banking centers serving 83 communities. Jennifer's managing Director and Associate General Counsel in the Financial Services Group at Piper Sandler and Co-Founder Founding Director and Chief Executive Officer of Bank on Women. So please join me in welcoming Bruce and Jennifer and kicking off our conference.

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