Talking Turkey: The Fed and the Economy
The classic Thanksgiving dinner table: turkey, dressing, green beans … and the often unavoidable debates. We can’t help you settle the disputes over dressing versus stuffing or whether Aunt Marge’s gelatin creation can really be called a salad. But we can provide you with some facts, stats and data that will help you feel informed and prepared when the chatter turns to the economy.
On Nov. 20, the St. Louis Fed hosted a special session of Dialogue with the Fed. During the virtual Q&A, Economic Policy Advisor and economist Miguel Faria-e-Castro and Senior Economic Education Specialist Amanda Geiger answered a variety of audience questions about the Federal Reserve and the economy. For example, they addressed questions on inflation, monetary policy tools and wage growth. Laura Taylor, St. Louis Fed government relations advisor, moderated the discussion.
Want to fill your plate with economic information to bring to the table this holiday season? Check out the following video and transcript, which have been edited for clarity and length.

Laura Taylor: Good afternoon and thank you for joining us for Dialogue with the Fed “Talking Turkey: The Fed and the Economy.” My name is Laura Taylor, and I am the government relations advisor here at the Federal Reserve Bank of St. Louis. Joining me today to “talk turkey” are two of my colleagues, Miguel Faria-e-Castro and Amanda Geiger.
Miguel is an economist and economic policy advisor in the St. Louis Fed’s Research division. His research interests include macroeconomics, finance and financial stability, fiscal and monetary policy. Amanda is an economic education specialist. She has an MA in economics and entrepreneurship and taught high school for 12 years. So, lots of expertise and resources around the table today as we talk about the Fed and the economy.
Before we begin our discussion, a few words about today’s session. Today’s event is a part of our ongoing Dialogue with the Fed series, where our goal is to always connect you with experts and information to better understand the economy. Two weeks from today, we will be hosting a Dialogue with the Fed event featuring an economic briefing and labor market update. This will be hosted in person here at the Bank and online, and you can find more information about that program on our website.
So, with Thanksgiving and the holiday season right around the corner, dinner tables will be loaded with turkey, dressing and green beans, but also a big helping of table talk on current issues. So today, we’re going to tackle some of the key topics about the economy, so you can feel informed enough to discuss monetary policy and interest rates as you pass the sweet potatoes.
Throughout our discussion today, you can ask us questions by using Zoom’s Q&A feature found at the bottom of your window. Enter your question into the Q&A box, then click send. We’ll try to answer as many questions as we can today.
Finally, before we get started, a quick reminder that the views expressed today are those of the respective speakers and are not necessarily those of the St. Louis Fed or the Federal Reserve System. All right. I think that about covers it. Now without further delay, let’s talk turkey.
All right. Amanda and Miguel, thank you and welcome. Appreciate you being here. So, let’s start off on theme, a true talking turkey question. So, every year, economists conduct a Thanksgiving dinner price survey. And this really looks at the average price of typical Thanksgiving meal items, Amanda, and things like turkey or potatoes or stuffing. So those survey responses are used to determine the average cost of a Thanksgiving meal for a set number of people.
So, this kind of Thanksgiving market basket method can be a great way to conceptualize inflation. So can you talk about how economists analyze price levels using different indices like this?
Amanda Geiger: Sure. So, a price index is built using a market basket. And so, with the turkey Thanksgiving Day example, you can imagine that you are pushing your buggy or your shopping cart through the grocery store, and you’re adding these items to your cart. And then you get the total price. And so, then the next year, you pick the same items in the same quantity, and you get the price.
And so, from there, you can start to build an indices to compare how the price is changing over time because the items in the basket are staying stable, and the quantities are staying stable. So, what you’re really measuring is the change in the price.
So, the Thanksgiving one is an easy one to conceptualize this time of year because we’re all thinking about our menus. My family tends to stay to a pretty stable menu. We could probably make our own indices because we serve the same things every year in the same quantities, regardless of who can come and who can’t.
But economists often, if you want to look at a particular market, they may build an indices around a particular market. Or if they’re trying to get a larger, more nationalized average, they use something like the consumer price index, which has about 80,000 items in it and gives a much larger kind of average of what a typical consumer in the U.S. might experience when it comes to price changes over time.
Taylor: Yeah. And I can imagine with your background in economic education, this is a great way to teach students about inflation and looking at prices over time.
Geiger: Yeah. And so even from their experiences is a little bit more limited in high school because most of them are not-- well, they’re young, one, so they haven’t experienced a lot of change over time of prices. But even comparing it to things that they do, have them build their own index, like a movie ticket index, where it’s a ticket, a large popcorn, a large drink, and you can look it over time.
Or even asking them something like, what do you think was the highest grossing movie ever? And they’ll probably guess things that are much more current because that’s how it’s reported. But when you adjust for inflation, you can look at those, all of the movies ever produced over time, and see what the actual answer to that question might be.
Taylor: Very interesting. Thank you. So, Miguel, it’s really no secret that inflation has been a hot topic. Certainly in the news, certainly for consumers looking at that grocery bill, things like that. So, one of the questions we received in advance was about this. And so, for the average person, what components of the CPI, and for those folks who don’t know the consumer price index, what components really have the most influence on the overall sentiment towards the economy for consumers?
Miguel Faria-e-Castro: Yeah, that’s a great question. So, let me start just by describing very briefly what some of the major components of the CPI are. The most important by far is shelter. So includes housing, rents, and some imputation for people who actually own their homes to try to capture what’s the equivalent price that they would be paying if they did not own their homes. That’s about 33% of the CPI.
The other major components are going to be food, about 14%. Transportation commodities, that includes things like cars, would be about 8%. Then energy, that would include things like fuel, is about 7.5%, and medical care is 7%. So these are the largest components of CPI. So, in principle, movements in these prices are going to be the ones that are going to have the greatest impact on our wallets and therefore on our sentiment as consumers.
And indeed, what we tend to see-- There’s some research done by economists that tries to correlate movements in inflation to consumer sentiment. What we see is that things like motor fuel, in particular, are extremely salient on how people feel about the economy.
But as I just described, there’s many other things, including food. And we know that food inflation has been relatively high in the last few years, and that could contribute to consumer sentiment. Now, one thing that I also want to point out is that these things tend to have a large impact on consumer sentiment, but there has also been a bit of a decoupling between consumer sentiment and other what we call hard data about the economy. So it seems that consumer sentiment seemed, in the past, seemed to comove much more with the state of the U.S. economy, and maybe in the last few years, has been comoving less and less.
Taylor: Very interesting. So, tell us a little bit about the state of inflation right now. So, folks who follow the news might understand or recall that the Fed is really working to bring inflation down. So, tell us a little bit about maybe the last couple of years and where the Fed is at now in terms of inflation rates.
Faria-e-Castro: Yeah, sure. So, inflation was extremely high for historical standards in around 2022 and early 2023, but it has fallen considerably. And this is related to the efforts of the Fed to achieve its dual mandate. And right now-- The Federal Reserve has an explicit inflation target of 2%. It doesn’t look exactly at CPI. It looks at a different index that’s very similar called PCE. It tends to focus on that index.
And right now, PCE inflation is slightly above target, but it’s close to target and has been moving towards target. So, it seems that this last mile, as these central bankers often say that the last mile is the hardest. It seems that inflation is still falling, but it’s falling maybe a bit more slowly than it was a few months ago or a year ago.
Taylor: Well, that certainly seems like good news.
Faria-e-Castro: Yes.
Taylor: And for viewers online who may not know, the PCE is the personal consumption expenditures. And that’s the Fed’s preferred inflation gauge or measure. CPI is another one that we talked about earlier. So, I want to throw this question out to both of you. Inflation is just kind of one look into the economy. There’s certainly many others.
And Fed economists and staff are often asked about the health of the economy. So, what indicators do you personally look at that help you tell the story of the economy? And, Amanda, we’ll start with you.
Geiger: Sure. So, I usually work with a teacher or an instructor-based audience. And so they are tied to standards which usually reference what I would call the big three. Inflation, GDP and unemployment. And they’re a really good place to start. It’s kind of like when you go into the doctor’s office, and before you even get back there, they’ve taken your height, your weight, your temperature, your blood pressure.
It’s just a gauge to start. It doesn’t give the doctor that you’re seeing all the information they need. But it gives them somewhere to start looking and asking questions. And so, I like to start with those big three because they’re the ones people are familiar with and have heard. But then maybe start to ask questions about what might actually be happening and go a little bit deeper and then maybe get into some more specific measures.
Labor force participation rate, the number of frustrated workers, more specific regional inflation data, just kind of depends on the audience. But it’s not a bad place to start with the larger macroeconomic indicators.
Taylor: Great. And, Miguel, what are some of your preferences when you look at the economy overall?
Faria-e-Castro: Yeah. I would say that the main ones I completely agree with Amanda. The big ones, the big three would be GDP growth, unemployment, inflation. I also, me and some other economists, we also like to think of the economy as consisting of let’s say four main sectors, let’s say the government, the financial sector, households and businesses.
So, we also like to look at some major indicators for each of these sectors. So for households, I like to look at things like real disposable income, which is adjusted for inflation. How much money is in people’s pockets in a-- I’m oversimplifying things a lot. But basically, how much income do people have that is available to be spent? This is something that we like to look at in order to gauge the health of the state of the finances of households in the U.S. economy.
In terms of firms and businesses, we like to look at some financial indicators, like the health of the stock market, because you can think of the stock market as a measure of the value of U.S. businesses that are listed publicly. And other measures like household leverage. How much of their costs are in interest, for example.
And in terms of the financial system, there’s other similar indicators that we also look at to try to gauge the health of the financial system. But yeah, but I would say that the main three are the ones that Amanda mentioned.
Taylor: Yeah. And we’ve mentioned so many. I think that is really the interesting piece here is that we’re just hitting the tip of the iceberg for all these different ways that not only the Fed but economists in general and folks look at to determine the overall health of the economy.
I want to pause here for just a second and say, as a reminder, to ask questions, use the Q&A feature found at the bottom of your Zoom window. Enter your question into the Q&A box, and then click send. Again, we’ll try to get to as many as we can.
Moving back to this idea of measuring the economy as a whole. A lot of times in my job, I’m sure in your jobs, you get asked about whether the Fed is responsible for the economy as a whole. And it’s simply not a yes or no answer. It’s a very complex answer, very complicated answer. There’s many factors that go into the economy.
And so I want to turn and think about that for a little bit. What’s under the Fed’s purview? What might be under Congress or an administration’s purview? So, Amanda, I want to toss it to you first. But let’s talk a little bit about monetary policy and fiscal policy. So, two different things. Some of our viewers may not be familiar with those two phrases. So maybe tell us what they are and then share a little bit about how they’re different and how that really affects the overall economy.
Geiger: Sure. So, fiscal policy is taxation and spending by a national government. So in the U.S., that like constitutionally primarily falls on Congress and the administration. And that’s it. So because that’s who has the constitutional authority to spend at a national level, and that’s who has the authority for taxation, it primarily is going to fall under Congress’ purview with support from the administration.
With fiscal policy, there is no role for the Federal Reserve. They have no function or oversight in that process. Monetary policy, on the other hand, is referring to the actions of the central bank. So in the U.S., that would be the Federal Reserve. So the actions that they take to hit macroeconomic goals or objectives. So, when they use the tools of monetary policy to try to meet our dual mandate, which is maximum employment and stable prices, that would be considered monetary policy.
Taylor: So you just mentioned monetary policy tools. And for folks who do follow the Fed pretty closely, you’ll have heard this saying before that that toolbox is-- we have kind of blunt tools in order to put forth monetary policy. So, Miguel, tell us a little bit about some of the tools that we do have maybe at a high level and talk about how the Fed can try to affect monetary policy with those.
Faria-e-Castro: Yeah, sure. So, the main tool that the Fed has is something called the federal funds rate, which people can think of as the short-term interest rate at which banks and other financial institutions can borrow or can invest at.
And the idea is that by changing that rate at which banks can earn on their investments or borrow at, the Fed can indirectly affect all other interest rates that involve banks in the economy. So, the basic example is the following. Let’s say that the Fed set the federal funds rate at 4.5%.
It means that banks can-- by setting something called the interest on reserve balances. I don’t want to go into a lot of details on this, but basically banks can deposit funds at the Fed and earn 4.5% on those reserves. That means that for banks to be willing to make a loan to you, to purchase a home, to purchase a car, et cetera, banks will require an interest rate of at least 4.5%.
So, by manipulating this interest rate at which banks earn returns on reserves, the Fed can affect the other interest rates that banks set in the economy. And by making it more or less expensive to borrow in order to buy a home or buy a car, the Fed can indirectly affect economic activity because it’s going to affect people’s decisions on whether to buy homes, buy cars, borrow on their credit cards, et cetera. So that’s, at a very high level, how the Fed affects the economy.
Taylor: That’s a great explanation. Thank you. I’m going to touch on a question that we got in advance a little bit, which relates to what both of you just shared. So, understanding the difference between fiscal and monetary policy is helpful in us answering one of these questions we received in advance, which was why doesn’t the Fed or employees of the Fed comment on either legislation or fiscal policy?
And the answer is it’s not in our purview. It does belong to Congress, like you said, Amanda. The Fed, it’s critically important for us to remain independent of any type of political partisan will or anything like that. And so, in order to do that, we refrain from commenting on types of policies like that. So, I think that’s important to touch on. And by understanding the difference between fiscal and monetary policy, we can see how that works.
So, I want to move to a question about some of the work that you all undertake on a daily basis. So, I think the Fed is obviously most well-known for those monetary policy tools that we talked about. But a lot more happens here at the Federal Reserve Bank of St. Louis and also at the Federal Reserve System level.
We have 11 sister banks across the country. We have the Board of Governors in Washington, D.C., of course, the Federal Open Market Committee, or folks may know it as the FOMC, in Washington. But there’s a lot of work happening here too, that some folks may not know about. So, Amanda, why don’t you tell us a little bit about some of the work you do on a daily basis?
Geiger: Sure. So, the economic education team here is primarily focused on supporting teachers in a pre-K to college space and helping to provide them with resources for economic and personal finance education. So, the resources that we write and produce are offered at no monetary cost.
And then additionally, we offer training and support for teachers. So, we do webinars. We do in-person trainings on that content. We demo the lessons, the active learning components. So that they can become more confident in their own understanding of the concepts. And then, in turn, that will make them more effective in the classroom.
Taylor: Yeah. And we received a question from one of our viewers just now that touches on this a little bit. And I’m going to summarize the question a bit. But what is the Fed doing to sort of encourage economics education in schools, or personal finance, or financial literacy type of education? What are our efforts in that outreach area?
Geiger: So, each bank has-- you know, the banks are regionalized. And so, there are different needs in different areas. So, every state has slightly different standards. Some states require economic education as part of the high school experience. Some don’t. Some offer personal finance. Some require it.
So, you can get a lot of variation in what teachers are expected to know and teach. And because of that, you also get variation in the standards. And so a lot of our work is about listening to the teachers and figuring out what they need and then providing that support.
And so, if they get a legislative mandate, for example, to add personal finance, that teacher may have been in the classroom 10, 15 years. So personal finance was probably not part of their teacher training experience. But here you are. Next year you’re going to be teaching it.
And so, money can have complicated emotions around it. And so maybe they don’t feel like they’re the most confident or the best teacher for personal finance. So, some of the trainings and things that we offer are to give them that safe place to ask questions, to give them unbiased materials at no cost, so that they have a good starting foundation for teaching those principles. And the same with economic education.
We are big fans of both, but there is a difference between those two things. They’re complements, not substitutes for each other, but the more educated a person is about how the economy works and how it functions and principles of personal finance, then the more confidently they can participate in the economy and make choices for themselves.
Taylor: And one thing that I think is really valuable that the Federal Reserve economic education team provides is this wonderful online presence that, if we have any teachers listening today or watching today, you can go online. You can check out all of the resources, which includes curriculum and lesson plans, video assignments, things like that.
My favorite part that I most often share with folks when I’m in meetings is telling them, this is even broken down by state requirements for these types of things. So if you’re in Arkansas, and you’re a teacher, and you’re like, “What do I need to do to meet state requirements for this type of education?” The Fed’s already done that for you. And they’ve broken that down. And it’s available online. So such a great resource.
Geiger: Yeah. Thank you. And even if you’re not a teacher, you’re just curious yourself, it’s a really great place to go. So stlouisfed.org/education. Like Miguel was mentioning the monetary policy tools. We have a short video that explains the tools and how they work with an example. It’s just something you can watch on your own. And again, that’s freely available on our website.
Taylor: That’s wonderful. So, Miguel, we’ve had a few questions come in for you as well. And I want to first ask you the same question though. Tell us a little bit about what you work on on a daily basis. You obviously have a wide breadth of knowledge about the Federal Reserve, but what does your day to day look like?
Faria-e-Castro: Yeah. So, as part of the Research-- I’m an economist in the Research division. So, we have two main objectives. The first one is to advise the president of the St Louis Fed in matters of monetary policy. So, the president goes eight times a year to D.C. and if he’s-- to participate in the FOMC. If he’s a voting member, he’ll be voting on setting monetary policy decisions for the United States, and it’s our goal to inform the president, advise him.
If he has any specific questions about any certain topics that require some specialized expertise on, we do the work. And we just prepare him for those meetings and to help him come up with what he thinks is the best decision for the U.S. economy.
The second, our second main task is to produce original research. So, in a sense, my job is kind of similar to that of being a professor at a university. Just a professor at like a research university will typically-- some of their time would be spent doing original research to be published in academic journals. Other time would be spent teaching. My job is similar to that, just that instead of the teaching, I have that monetary policy aspect of advising the president.
Taylor: Sure.
Faria-e-Castro: So a lot of my day to day is preparing reports, internal memos, et cetera, for the president and also producing research. Working on articles that I hope will be published in academic journals. And you might ask, “Why is the Fed hiring these people to just produce research on academic articles?”
And the idea is a little bit, there are many unexpected things that happen in the U.S. economy. The U.S. economy is very complicated. It’s a very complicated system where millions of agents—households, businesses, banks, et cetera—interact. So, in order for the Fed to achieve its goals, it better understand well how the economy works. And that’s the whole point of having a Research division, is basically a bunch of people who try to understand how the economy works.
Taylor: Absolutely. And I’ve worked very closely with the Research division in the past. And just the magnitude of research that comes out of the St. Louis Fed is incredible. Several different topics, constantly changing, very data-driven and data-oriented. And if anyone’s interested in it, you can check out our website. We’ve got a lot of great research papers, blogs, things like that online.
And it’s nice because it’s kind of divided up into things that are easy to digest maybe for beginners who are just starting out in their journey, learning about economics and things like that. But also a little bit more complex in working papers, academic papers, publications and journals, things like that. So, it really is impressive the type of work that comes out of the Research division.
And we received, like I mentioned, a couple of questions for you that I’d like to turn to. Kind of going back to inflation a little bit here. What effect is the war in Ukraine having on inflation in the U.S.? And this person mentions oil prices, food prices, things like that. So maybe walk us through that a little bit, how you think about that.
Faria-e-Castro: Yeah. That’s an excellent question. And that’s something that it’s still a very recent phenomenon. So we’re still working on coming up with good answers to that. But the general understanding, I would say the consensus among economists is that the war in Ukraine had a large effect on inflation in Europe, not so much in the United States. It definitely contributed partly to inflation in the United States. But there’s this sense that inflation in the United States was more demand-driven than supply-driven.
The reason I’m calling it these things is typically economists think of oil prices as something that’s a driver of supply-side inflation in the sense that when the price of oil goes up-- Oil is an important input for many industrial and production processes. So when the price of oil goes up, it makes it more expensive for firms to produce, and firms tend to pass on that increase in costs to the consumers. And this causes inflation for the American consumer.
The idea is that this force was much more important in Europe than in the United States. It definitely had an impact on the United States but not as much. One other thing that I also want to highlight is that contrary to what was the case, for example, 40, 50 years ago, an increase in oil prices could potentially be good for at least certain parts of the U.S. economy because nowadays, the United States is a net oil exporter.
So, in a sense, and what we’ve seen, and this is actually related to why the effect of the war in Ukraine was not so much felt in the United States, was that this increase in oil prices actually triggered a large increase in domestic oil production in the United States, which helped curb that increase in oil prices. So this was a long answer, but I would say that the bottom line is there was an impact but not as large as that impact was in other parts of the world, I would say.
Taylor: Great. Thank you. And certainly a complicated answer. It’s not something we can just say x happens, so y is the result. And there’s a lot of levers at play there, which certainly makes it more complicated.
Another question for you, Miguel. What is the relationship between the federal funds rate, which you were talking about a little bit earlier, and open market operation?
Faria-e-Castro: Yes. That’s an excellent question. It’s a little bit more technical. And I don’t want to get into a whole class on history of monetary policy implementation here. But in the old days, pre-2008, pre-financial crisis, there was a very tight relationship between the two.
And this is the way that a lot of economics textbooks still teach how monetary policy gets implemented. It’s outdated. But basically the way it used to be was that there was this market called the market for federal funds. And the federal funds rate was the interest rate that cleared this market, that made supply be equal to demand.
And this was a market basically, it’s a bit more complicated than this, but you can think of this as a market where banks borrow and lend to each other overnight. And what the Fed would do would be to affect either the supply or the demand in this market in order to target a given federal funds rate.
So, if there was a lot of liquidity in the market, and that would create pressures for the federal funds rate to fall below the Fed’s target, the Fed would step in and take liquidity out of the market. And how would the Fed do that? By doing open market operations. So the Fed wanted to take liquidity out of the market, so the Fed would sell government securities. So, it would throw government bonds into the market and take reserves out.
By doing this, by fine-tuning this, the Fed would ensure that the prevailing price in this market would be the target for the federal funds rate. Nowadays, the way the Fed implements monetary policy is a little bit different than that because we are in what’s called an ample or abundant reserves regime. So, the federal funds market is not very active these days.
So the way that the Fed effectively implements monetary policy is by setting the rate that I mentioned before, which is the interest rate on reserve balances. So, as I mentioned before, the Fed pays interest on banks that deposit reserves at the Fed. And by changing that interest rate, the Fed can affect the federal funds rate directly. So, that’s the relationship between the two.
Taylor: Well, let’s hope no one gets that question at the Thanksgiving table this year. But if they do, maybe you’ll be there for Thanksgiving with them and be able to help answer. Thanks for that. I want to say, as a reminder, to ask questions, use the Q&A feature found at the bottom of your Zoom window. Enter your question into the Q&A box, and then click send.
So, we’ve got an FOMC meeting coming up. And people who will follow the Fed understand that one of the major parts of the announcement after the meeting is whether the Fed increased rates, decreased rates or stayed the same.
So, Amanda, I’m going to throw this to you a little bit. This person’s question revolves around rate cuts. So, if the Fed were to now or really at any point in time cut the federal funds rate, does that risk inflation increasing? And how is there a relationship with that?
Geiger: Well, the idea with the federal funds rate is it’s generally set it to be at a target rate. And so then, that will then influence the other interest rates in the economy. So when the interest rates are generally lowered, we’ll just put it that way for simplicity, that would make it cheaper to borrow, which would encourage or create an incentive for people to do it.
And they borrow in an effort to spend. You borrow money to purchase a home. Businesses borrow money to make investments in themselves. And so that increase in spending could potentially increase price levels. That’s just the very bare bones, like basic answer.
Taylor: Which is great. Yeah.
Geiger: But this is where the dual mandate of the Federal Reserve comes into play, right? Because the task allocated to the Federal Reserve by Congress is to promote maximum employment and stable prices. So inflation is something that we’re talking about a lot right now, which is the stable prices element. But the maximum employment part is something that could be benefited by those lower rates.
Because if businesses are borrowing money to expand or invest in themselves, they’re able to produce more, and more production generally means more jobs. These are highly oversimplified chains of effect for you to see. But by increasing that liquidity in the market, you’re able to make it so that people can borrow and make those purchases, which tends to drive employment.
And so on that front, they’re hitting the other target of the Federal Reserve, which is that maximum employment. So, the Federal Reserve is trying to always navigate a very narrow perspective, where they are trying to promote both of those things at the same time.
Taylor: Thank you for that. And it’s important, I think, to recognize that Congress gave us our dual mandate, gave the Fed its dual mandate. And those two items are really what the Fed is looking to have as their goals, as they’re trying to determine fed funds rate and using those blunt monetary policy tools that we talked about a little bit.
So, moving to maximum employment, what’s the Fed looking for? What does that look like? When do you know when you say, “Check, we’ve got maximum employment”? And, of course, like we’ve all said here today, I’m oversimplifying that. But tell us a little bit about that, Miguel.
Faria-e-Castro: Yeah. That’s a very good question because it’s not a concept that’s very narrow, very strictly defined. So what the Fed is looking for is-- So there is no explicit target for maximum employment. Just like we have an explicit target for inflation, which is 2%, but there is no explicit target for maximum employment.
The idea is that if unemployment is extremely low, this might be a symptom of too much spending, too much investment in the economy that will drive prices up. So in this situation, it would be considered that the economy is above maximum employment.
If employment is too low, it means that there’s not enough spending, not enough investment in the economy, and potentially inflation is below target. Then again, I don’t want to get into a very technical discussion here. But there’s this idea. There’s this concept called the NAIRU, non-accelerating inflation rate of unemployment, which is this hypothetical concept.
It’s a level for the unemployment rate at which inflation is neither accelerating nor decelerating. And this is an object that’s estimated by the Board of Governors, is estimated by the Congressional Budget Office. There’s many estimates for this object floating around. In the United States right now, it’s estimated to be somewhere between 4% and 4.5%.
And these consider it to be a level of unemployment above which the economy is not too weak and under which the economy is not too hot. So that’s a little bit the idea, what kind of the goal for the unemployment rate if there is one. But then again, there’s no explicit target. So it’s a little bit up to the discretion of the Fed to define what maximum employment is.
Taylor: And I could be wrong, but I assume that’s a little purposeful. It’s a moving target. The economy in the U.S. changes, the labor force participation rate, which you mentioned earlier, Amanda, changes. And so that probably needs to be a bit of a moving target.
Faria-e-Castro: Yes. You’re absolutely right. And actually, yeah, that’s why I said that there’s all these entities out there that produce estimates, and these estimates are changing all the time because as you said, as the structure of the economy changes, as the demographic, not just the production structure of the U.S. economy but also the demographic structure. The fact that there are trends affecting labor force participation. Population is aging.
All of that is going to affect this hypothetical object, the NAIRU, and is therefore going to affect the idea of what maximum employment is exactly.
Taylor: Yes. Interesting. Let’s pivot back to this idea of inflation. We’ve talked about it quite a bit. Of course, it’s been in the news a lot. The Fed has chosen to have a 2% inflation rate target. So, why 2%? Why not 0%? I’ll put this out to both of you. But I’m interested in maybe sharing this person’s question and learning a little bit more about why the inflation rate is targeted at that particular number.
Faria-e-Castro: Yeah. I would say it’s a very good question. There are two main reasons that are put forward by central banks for why the inflation target tends to be a low but positive number. Now, I admit a lot of people don’t get fully satisfied by this answer.
But the first one is that it gives room for relative prices to adjust. What I mean is that if you go back to Econ 101, what’s the price of an object or a commodity? It’s a signal of its relative scarcity. If there’s not a lot of toilet paper out there, then toilet paper should be expensive because it’s one way for supply to meet demand.
Taylor: And we were all there, weren’t we, in the pandemic?
Faria-e-Castro: Exactly. So this wasn’t a randomly chosen example. And actually, one of the issues arguably with toilet paper during the pandemic is that prices did not move up by as much as they should, and that’s what caused shortages.
So, in general, economists believe that markets have a way to solve shortages, and that’s by letting relative prices adjust. But there are many forces—social, cultural, economic—that tend to prevent prices from fully changing all the time. And in particular, there tend to be particularly strong forces that prevent prices from falling.
So central banks think that it’s good to have all prices rise a little bit every year, some prices rising faster than others in order for relative prices to adjust and for these relative scarcity conditions to be solved by markets in a sense. So that’s explanation number one, is that it allows for relative prices to adjust.
Now, you could think, “Well, what are these social, cultural, economic forces that prevent prices from falling?” Think about salaries. In many societies, it tends to be like a taboo for salaries to be literally cut. So one way for the labor market to clear and for people’s salaries to effectively fall is maybe for salaries not to grow as fast as the price of other things are growing.
The other reason is a bit more technical and related to monetary policy, and it has to do with the fact that having a positive rate of inflation allows central banks to keep nominal interest rates a little bit higher. Nominal interest rates are the main tool for conventional monetary policy. The federal funds rate in the United States.
So it gives the Fed a little bit more room to lower the interest rate in case the Fed needs to lower it, if there’s like fears of a recession in the U.S. economy, without hitting zero. Because there are problems when nominal interest rates hit zero. We don’t like them to hit zero.
So by keeping inflation, then again, at a positive but low level, it allows the Fed to run nominal interest rates at a little bit higher level and give it some more policy room to affect monetary policy. But I don’t know if Amanda wants to--
Geiger: I think you really treated it really well. And as far as like around the Thanksgiving table, zero is a really, really difficult number to maintain and allow some of those market clearing structures to work, to allow the flexibility of prices to adjust with supply and demand.
Prices are a signal. So when prices get higher, it becomes more attractive for people to produce that item, which increases what’s available and meets more demand. And then eventually, it modulates the price down towards equilibrium.
And so if you’re allowing that price signaling and function to happen in your market, it would be very difficult to keep inflation at a rate of zero and then still allow for the social phenomenons but also things like innovation to happen, new products to be developed. It’s really difficult for those things to happen at 0% inflation. So a low, consistent number that people can plan for over time is much more effective in the long run.
Taylor: And that’s such a good thing for folks to understand about the economy because I think a person’s immediate first thought is, “Well, I don’t want prices to increase. I always want them to stay the same, so that I can understand what I need to spend. And I don’t ever want it to increase.” But it affects so many other things. And so it’s important to understand really what’s going on behind the scenes when there is a low and stable inflation.
So we’ve talked a little bit about the Federal Reserve in terms of the research we do, economic education. We’ve talked about the fed funds rate and inflation, all items that are in the headlines. Another piece that’s been in the headlines quite a bit is tariffs. And, of course, we don’t comment on any type of proposed or anticipated policy.
But let’s talk a little bit about them in general, for our audience, so they can understand what they are, what kind of impacts they do or don’t have on the economy. So, Miguel, I’m going to throw this to you first. Tell us a little bit about tariffs and how, in your perspective, you see them impacting the economy.
Faria-e-Castro: Yeah. So a tariff is basically a tax on an imported good or service. So anything that you buy that’s not made in the United States, it’s a tax on that good. Now there’s a lot of research on the effects of tariffs. They tend to discourage consumption of those particular goods because what happens most of the time is that the people, the businesses that are importing those goods, that are bringing that cheese from France or that olive oil from Italy, tariffs are going to make it costlier for those firms to import those goods, and those firms tend to pass through the cost to the consumer.
Now, these examples I gave are kind of not super interesting examples for economists because these are tariffs on final consumption goods. Their impact is very clear. It just discourages the consumption of those goods because it makes them more expensive.
Perhaps the most interesting ones are tariffs on intermediate goods. So, for example, steel that we might import from India or oil that we import from abroad. Tariffs make those intermediate inputs more expensive. And I’m calling them intermediate inputs, what this means is that these are goods that are used in the production of other final goods in the United States.
And so, in particular, tariffs are going to be, they are going to be a tax on these intermediate inputs. So they’re going to make it costlier for the firms that use these goods to produce other goods to produce. This is going to reflect itself also in higher prices for consumers, even for goods that are produced in the United States.
So these are the direct impacts on tariffs. Now there’s many other potential indirect impacts on tariffs. There’s this idea that if we stop importing from abroad, we might start producing those things at home. And it’s debatable whether for many types of goods, whether that actually ends up happening or not.
Taylor: Very interesting. Thank you for that explanation. I want to turn to another question we just received. And just as a reminder, folks, if you have questions, use the Q&A feature found at the bottom of your Zoom window. You can enter your question into the Q&A box, and then click send.
So we’ve gotten another question about prices. Prices have gone up a lot since 2019, but so have wages. And this person says as far as they know, average real wages have increased slightly. So if people say they are worse off today--
Sorry. Just a bit of a technical glitch. So if people say they are worse off today, do you think that is because the wage increases have been unevenly distributed or that people aren’t necessarily considering real buying power?
Faria-e-Castro: For me?
Taylor: Sure.
Faria-e-Castro: That’s an excellent question. And that’s something that there’s been a lot of debate about that in the last few months. It’s true that according to most measures, real wages have increased in the last few years because in spite of all these large increases in prices, there’s been a very strong nominal wage growth. So when you look at real wage growth, which is nominal wage growth minus inflation, you still get a positive number.
Actually, this real wage growth has not been evenly distributed because it’s been particularly strong in the bottom of the distribution. So it’s actually people with lower wages that have been experiencing higher wage growth.
Now, there’s a lot of very complicated social dynamics that go beyond economics, that affect how people process these things. There’s one thing that economists mention quite a bit is this thing. It’s an old idea in economics called the money illusion, which is related to the fact that when people-- it’s related to the fact that when people see the price of things they buy increasing, they tend to blame this on external forces and the government. But when they see their own wage increasing, they think, “Oh, yeah, I worked very hard. So I earned this.”
So people-- even if real wages are up and positive, people tend to dislike the price of the things they buy going up more than they like their wages going up in a sense. This is an old idea in economics that some economists don’t really believe in this, but I think that recent events are kind of like suggest that these might be playing a little bit of a role, and this might be one of the reasons why people are so unhappy, even though nominal wage growth has been extremely strong.
Taylor: And I’m sure why, oftentimes, economics is referred to as a behavioral science because there’s so much behavior and consumer behavior that go into an economy at any given point, in so many different points in an economy.
Geiger: Can I also add too, I think it might be helpful to point out that when we talk about inflation generally and in the news, we’re talking about a national average. And so there can be a big difference region to region. And because we’re looking at large sample sizes over a large geographic area.
And so that’s why these are kind of big indicators that are a great place to start. But there’s a reason why you can dig a little bit deeper and look at specific regional areas, specific industries, and look and see if those patterns hold true. Because we’re talking about averages of a whole, but that might not necessarily be reflected within an individual area or community.
So there’s always kind of more to the story. And I think that’s-- I mean, personally, that’s what makes economics so interesting to me is because you can always go deeper in the data and try to figure out where that behavior is butting up against the patterns that you’re seeing and trying to figure out what’s happening.
Taylor: And what you mention is really such a critical component of why the Federal Reserve was designed like it was. So, for our viewers who may not know, the Federal Reserve was created by an act of Congress in 1913. It’s actually the nation’s third attempt at a central bank. Certainly, its longest standing central bank.
And it was designed to be decentralized, which really hits home at a point you just made, Amanda, and that’s that the folks from Congress were very planful and thoughtful about this design. They didn’t want it to be centralized in Washington, D.C., like other federal agencies. They wanted it to be independent, and they wanted it to be spread across the country.
So just like we’re sitting right here in St. Louis and we’re a Federal Reserve bank, there are 12 banks across the country that represent everything from economic conditions, to inflation, to unemployment, to labor force participation rate for their particular regions or what we call districts. Here in St. Louis, we’re the Eighth Federal Reserve District.
And it’s meaningful to represent that area when our president, like you mentioned, does go to Washington, D.C., to make those decisions and offer that input on the federal funds rate on the Federal Open Market Committee.
So we are here in St. Louis to be able to represent the seven states that we represent on the FOMC. And it’s because how it is in Little Rock, Ark., can be very different than how it might be in Montana and how it might be even in southern Illinois. So it’s important that that sort of decentralized design is representative of factors and economies across the country because not everything is the same. So that’s such a great point you bring up about looking at a national rate or number compared to something that might be at a county level, could be very different.
Faria-e-Castro: Absolutely.
Taylor: So I want to pivot a little bit to some of those tools we talked about, the monetary policy tools. So, Amanda, can you speak to how the FOMC, or that Federal Open Market Committee, uses the Fed’s balance sheet as a monetary policy tool? And maybe start out for our viewers by telling us a little bit about what the balance sheet is.
Geiger: Yeah, sure. So, the balance sheet is essentially a record of the assets and liabilities of the Federal Reserve. And it’s publicly available. Assets would include things like security holdings or loans to depository institutions. Some of the liabilities would be things like reserves or currency.
And so the central bank can make adjustments to that balance sheet to reflect a monetary policy stance. So, for example, if they wanted to adjust the federal funds target rate, they could make an adjustment, increase or decrease, to one of the administered rates, like interest on reserve balances. And then that change would be reflected in the reserves amount on the balance sheet.
Taylor: That’s great. Thank you. So thinking a little bit more detailed into it, Miguel. Where does that balance sheet stand now?
Faria-e-Castro: Yeah. So right now, the Fed’s balance sheet as of, like last week, I believe, is about $6.97 trillion. This is about the same size as it was in May 2020 after the first round of COVID emergency facilities. So just to give some context, the Fed’s balance sheet used to be about 6% of U.S. GDP before the financial crisis.
Then during the financial crisis, the Fed deployed all these emergency programs—quantitative easing, emergency lending facilities, et cetera—that greatly increased the size of its balance sheet to about an average of 18% of GDP during the 2010s.
And then with COVID, especially in March 2020, when it wasn’t clear what were the effects of COVID going to be in the U.S. economy. There was a possibility of a new financial crisis, et cetera. The Fed deployed a new round of emergency facilities that greatly increased the size of its balance sheet. And at its peak, I believe in about 2022, it was around 33% of GDP.
So now we’re back to about 25% of GDP. And the current policy stance is to keep-- the idea is to keep decreasing it a little bit. But still, we want to keep what’s called an ample or abundant reserves regime. So it will probably, given the new way that monetary policy is implemented using the interest on reserve balances, we probably won’t go back quite to what the balance sheet was before the financial crisis pre-2008.
Taylor: Great. Thank you for that explanation. It’s a complicated subject for sure. But, Amanda, you seem to be able to simplify it for us. So thank you. So we’ve got about 10 minutes left to our viewers. As a reminder, put those final questions into the Q&A feature found at the bottom of your Zoom window. You can enter your question into the Q&A box, and then click send. I want to go to a question we received, again, about inflation. I think we found out what our common topic is, our theme for the event today.
And, Amanda, I’m going to actually throw this to you because I think it’s a little bit about economic education quite frankly. So, how can the Fed help to communicate the difference between inflation and core inflation to the American people?
Geiger: Great question. Honestly, that is you really hit on the main objective of the economic education teams across the System and not just at the Federal Reserve of St. Louis. Like we try to create resources that provide clear, direct, simple explanations for a lot of these concepts, like the difference between core inflation.
So if you went on our website right now, stlouisfed.org/education, and you typed in core inflation, you could see that there is a number of Page One articles, which is a journal that we publish at the St. Louis Fed. And it is discussing a lot of those different things like what goes into a market basket? How do market baskets get adjusted over time? Like trying to be as open with that information as we can and to give people a place to go to find that information.
I also think there’s been a movement by the Federal Reserve System to be much more transparent, like the FOMC press conferences and the release of the minutes with a very short lag time after those meetings. And having events like this where people can ask questions directly. Trying to get the information out there and more accessible to the public.
Taylor: Absolutely. Thank you for that. I want to turn to another item that’s been in headlines and in the news, and that’s hurricanes unfortunately. Hurricane Helene and Milton certainly affected the economy in terms of supply chains, again inflation, and even unemployment at times.
One thing that people may not realize about the Federal Reserve is that it responds in times of crisis, whether that be something like the financial crisis or even something like a natural disaster. So turning back to this idea of some of the more recent hurricanes and natural disasters, how does it have an effect on the economy when something like that happens?
Faria-e-Castro: Yeah. It’s obviously very disruptive for the regions that are directly affected by the hurricane. There’s a lot of destruction of capital that belongs to households and businesses. Houses get destroyed. Factories get destroyed. This then means that businesses, especially smaller businesses, might have to close because they lose their entire stock of assets.
So it’s obviously very disruptive. And some of these hurricanes in particular, they can be sufficiently destructive to actually make a dent on national accounts. So there’s a visible impact on things like personal consumption expenditures, which then are a component of GDP, on business investment, et cetera.
And here at the Fed, we try to estimate what those impacts are because the idea is that these are temporary one-time events. And what I mean by this is that if GDP drops because a large hurricane hit Florida, it’s not a systematic event that maybe warrants a change in the monetary policy stance.
Also another thing that I want to mention is that there’s what’s called a broken windows effect after these large, destructive effects, which is that economic activity in these affected regions collapses during the destructive event but tends to rebound very strongly in the periods after the event.
That is because people are rebuilding things. So there’s typically a large increase in investment, both investment in the construction of residential structures, also a large accumulation of inventories, large accumulation of fixed capital by businesses because people are rebuilding. And this usually boosts economic activity quite a bit.
So, typically, this is kind of like, from a very macro perspective, the effect of this type of events is that they depress economic activity today but tend to generate large increases in economic activity in the following periods.
Taylor: Very interesting. Yeah. You could see this in the data as well in terms of like initial claims for unemployment. Something like that would increase dramatically in a state like North Carolina that maybe had a lot of destruction. But eventually, over time, one hopes that gets better and moves in the right direction.
Another topic in the news, mortgage rates. So talking about mortgage rates, oftentimes, I’ll hear someone say, “Well, I can’t wait for the Fed to cut rates, so that mortgage rates are cheaper.” So, Amanda, I want to see if you can maybe explain a little bit about how the decisions that the Federal Reserve makes may or may not affect mortgage rates and how that operates from a sense of if the Fed makes a decision on a Wednesday, what does that mean for mortgage rates over time after that?
Geiger: All right. Well, I’ll try to keep it pretty simple. Miguel, feel free to jump in. But we’ve described them often today as kind of blunt instruments. And I also think it’s worth pointing out that banks and other financial institutions are still run by people, with very normal people, human reactions.
And so even when the Fed might do things to try to encourage liquidity or try to encourage lending in the financial systems, it doesn’t necessarily mean that people will take out the loans or that the banks are going to be willing to issue them. They maybe want to have a more cautious stance.
And so while the Federal Reserve can try to create incentives to encourage these behaviors, they’re blunt instruments at the end of the day. And they often have a fairly large lag time because the U.S. is a very large economy. And so changes take a while to work their way down and towards what individuals might see.
And so in terms of like do I think there would be like a day-to-day change from one day to the next? Probably not. It takes time for those changes to really be felt in the system. Do you want to add anything?
Faria-e-Castro: Yeah. What I would add here is that the Federal Reserve is not in the business of building houses. So, the Federal Reserve does not affect housing supply. What the Federal Reserve does is affect how quick is turnover in housing demand in a sense.
So by lowering interest rates, eventually, as Amanda was explaining, there will be an indirect impact on mortgage rates. But very indirect because the Fed is affecting short-term rates, and the mortgage rates tend to be long-term rates. So there’s a lot of stuff that goes in the sausage in between those two types of rates.
But even if the Fed lowers rates today, and this causes a decrease in mortgage rates, as you’ve kind of implied, this might cause more people to purchase homes. And the Fed is not affecting the supply of homes. So if you have more people wanting to purchase homes, homes are going to become more expensive.
Taylor: Right.
Faria-e-Castro: Then again, it’s-- housing affordability is an issue, but it’s not within the Fed’s mandate. So obviously, the Fed looks at mortgage rates because they are affected by its own instruments, but it’s not an explicit target.
Taylor: And this is why the Fed often says it’s a blunt set of tools.
Faria-e-Castro: Exactly.
Taylor: There are a lot of inputs that come into the economy, but the portion that monetary policy can affect is done with some blunt instruments, that’s for sure. Miguel and Amanda, thank you so much for being here with us today and answering our viewers’ questions.
We’re coming to the end of our hour, so it’s time to close. Thank you so much for joining us. We’d like to thank you for watching and participating today. Don’t forget to register for the December Dialogue with the Fed event “A Look Ahead: Economic Briefing and Labor Market Update” with St. Louis Fed economist Charles Gascon and a panel discussion of labor market conditions in the Eighth District.
You can learn more and register to attend on our website. Please stay connected with us through social media and sign up on our website to be notified about our blogs, newsletters or even future events like this. You’ll see more information about that on your screen in just a minute. With that, thank you again for joining us today. And on behalf of everyone here at the St. Louis Fed, have a safe and happy holiday season.
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This blog explains everyday economics and the Fed, while also spotlighting St. Louis Fed people and programs. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.
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