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On May 12, 2020, CFA Society Chicago’s CFA Women’t Network hosted Loretta J. Mester, president and CEO of the Federal Reserve Bank of Cleveland, for its POWER Series webinar. President Mester began with opening remarks and then participated in a Q&A session moderated by Kristen Rowland, CFA, vice chair of CFA Society Chicago. All the views shared are her own and not necessarily shared with the Federal Reserve System or colleagues on the Federal Open Market Committee.

President Mester began by acknowledging the coronavirus pandemic as a global public health crisis and expressing her deepest sympathies to all of those impacted by the virus. She mentions we owe a great deal of thanks to healthcare workers battling the virus and essential workers allowing us to stay at home.

On the economic front, President Mester has noted the impact from coronavirus has been swift and severe. In the labor market, it was the worst and speediest deterioration many have ever seen. Business confidence has dropped and firms are taking more defensive positions. President Mester expects inflation will move down further this year. Through regional committee organizations, President Mester notes that much of the sacrifice is being borne by the most vulnerable, lower income and small businesses. As economic activity picks up in second half of the year, there’s considerable uncertainty around what recovery will look like. President Mester notes the recovery will depend on policy actions ensuring temporary disruption doesn’t cause more persistent damage.

The policy actions fall into 3 categories, which alongside further fiscal support, can avoid longer lasting damage to the economy:
1) Keep financial market liquidity and allow credit to flow to households
2) Support the flow of credit to households, businesses and state/local governments
3) Focus on banks as source of liquidity and temporarily relax some regulatory requirements to allow banks to lend in greater capacity in safe and sound manner

The goal is to help build the bridge from a generally good economy in February to the recovery. The Fed is continuing to look for gaps where their tools can be used to benefit the economy, in addition to the usual FOMC monetary policy tool of lowering the federal funds rate.

What might the recovery look like? The baseline outlook is stay-at-home restrictions will be lifted soon and economy will grow again in second half of 2020. President Mester expects the improvement to start slowly with variation across sectors, so those feel reassured it’s safe to resume normal activities. By the end of the year, President Mester estimates output to decrease by 5% or more relative to the level at the end of 2019, with unemployment in high single or low double digits.

Achieving this outcome depends on a number of things falling into place:
1) Solid enough bridge of economic relief and support
2) Careful and responsible relaxation of stay-at-home restrictions
3) More progress made on testing and treatment
4) Healthcare systems ability to handle periodic increases in cases

After completing her opening remarks, President Mester began the Q&A section and we’ve included a few responses from the conversation below. Please see the video posted on CFA Society Chicago’s Youtube Channel for the full Q&A session, starting at 17:30.

Over the past 10+ years, the Fed has been seen to respond to what the bond market prices in in terms of rate hikes or cuts. Recently, the bond market has priced in negative rates while the Fed has said it is not a policy tool it will use. How long can will Fed ignore and not respond to what the market prices?

President Mester expects the bond market to anticipate Fed actions if they are communicating the Federal Reserve policy goals well: max employment and price stability. At the same time, President Mester notes the natural relationship as the Fed looks to the bond market to give signals of its economic view. In the U.S context, negative interest rates are not the first choice President Mester would go to. She thinks those would have impacts on the banking system and money market mutual funds. The tools President Mester would go to first are quantitative easing and forward guidance.

Does the Fed worry about moral hazard in partaking in the credit facilities and the market being permanently dependent on the Fed as both the buyer and liquidity provider in credit markets?

The Federal Reserve is trying to walk a fine line. President Mester explains the Federal Reserve wants the emergency facilities to be a backstop. Since the facilities are backed by U.S Treasury, the Fed needs to deliberate about taking on too much credit risk so they do not face losses since this is taxpayer’s money.

Can you provide some examples of “green shoots” the Fed is looking at in the current environment?

Through outreach to all parts of Cleveland Fed district, President Mester has looked at deterioration over time of the attitudes of businesses as shutdowns have lengthened past initial expectations in early March. She explains a possible “green shoot” are with firms that are now able to bring back some of the workers. President Mester brings cautious optimism, understanding the need to be realistic about not opening too fast too soon.

NY Fed announced they will buy corporate bond ETF’s. Why wouldn’t they hold individual bonds vs. buying bond ETFs?

The Federal Reserve facilities are set up to not pick winners and losers. The goal is to support the overall market, instead of supporting particular issuances. President Mester believes investing in corporate bond ETF’s are an efficient way to lend support to the broad market.

How have you been coordinating with your peers at ECB, Bank of Japan and other central banks?

Chair Jerome Powell, John Williams and Randy Quarles regularly meet with central bank counterparties overseas. At FOMC, President Mester noted they discuss international markets as this is a global pandemic shock. While the Fed certainly doesn’t set monetary policy in coordinated fashion, she explains the Fed recognizes what goes on in other economies affects our United States economy as well.

What is your advice for young people to become a central bank president one day?

1) Get a degree (becoming an economist helps)
2) Work on dissertation you love
3) Join the Federal Reserve as Research Assistant
4) Go to graduate school
5) Come back to Federal Reserve as economist and join the ranks

Watch the full presentation.

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