david: from bloomberg world headquarters in new york, i'm david westin. this is balance of power, were the world of business. tensions in the middle east flaring up again following the u.s. drone strike against a top iranian general, and the ice and manufacturing numbers posting their week list performance since 2009. michael mckee is at the american economic association annual meeting in san diego with an important voting member of the fomc. mike: thank you very much. we want to welcome in loretta

mester, president of the federal reserve bank of cleveland, a voting member of the fed. to start with what we were just talking about, the ism numbers this morning. quite ugly, unexpected. new orders, production, and the headline numbers all the weakest since 2009. does that shake your confidence that this will be a reasonably good year for the economy? >> underlying fundamentals are so good, manufacturing has been weak for some time. growth affects our manufacturing and export numbers, and also these -- uncertainty surrounding trade. that has affected business confidence and their spending plans. we see it in their investment numbers. early on, when the trade war started to heat up, the firms that we talk to were telling us we are still on plan, it gives us some pause, is a concern, but

we are still on plan with our spending. as it has gone on, they are rethinking their plans, and we have seen that in their numbers. i think the manufacturing numbers, obviously, a better number would have been welcome, but it is consistent with what we've been seeing. the strong part of the economy is the consumer side. labor markets are strong, wages are growing, income is up. offsetnsumer side has the weakness on the manufacturing and investment side. the economy has been moving in a good direction. on, does the goes business side respond to strength of the consumer, or the consumer weakens because business spending does? loretta: it is an equilibrium. businesses responding to the demand, vice versa. reallyarket strength is helping to keep the consumer in the game. incomes are up, wages have accelerated.

a couple years ago we were at 2% wage growth, now 3.1%. even at the lower end of the income distribution, we see wages rise. those fundamentals are supportive. of course, businesses respond to that. we will have to see how the economy plays out but those underlying fundamentals are good for the economy going into 2020. mike: the weakness in manufacturing, corporate investment, is it a self-inflicted wound with the trade war's? loretta: there is some uncertainty out there. certainly, the trade war as to that uncertainty. we have heard from our labor market contacts that that uncertainty has clouded the outlook. they were concerned about it early on. they didn't pull back on spending early on, but as it continued, it did affect their investment, especially multinational firms, that have a

significant trade exposure. you saw those in rural areas as well, the farming sector was particularly hard hit. how that plays out remains to be seen. there is some positive news in terms of the phase one trade deal with china. perhaps they could sign. the trade tensions will remain. firms that incorporated that into their planning going forward, they don't expect it to end anytime soon, and are pushing forward with perhaps reduced expectations. mike: the philadelphia fed does an index for states, and their numbers suggest we will see a contraction in parts of pennsylvania and kentucky, in your district. do you agree with that assessment, are you concerned? loretta: we have seen, even

nationally, above trend growth a year ago, moving more toward trend growth. that aboveme of trend growth to move to trend. that is different from having a contraction. i do think we had to at different pockets, different parts of the district are doing better than other parts, mining areas in appalachia, they are not doing as well as other parts of my district. when we assess where the economy is going, you try to assess various geographies. one of the things that we heard from the areas that have not experienced as big of a boost to .ther areas as the extension continues, we see more people in the labor market, making the labor expansion broad in terms of who is benefiting. those are things that we will continue to assess. by keeping the expansion go in, that will get to those areas, or that they will be kind

of left behind and there is not a lot the fed can do about it? loretta: two things going on. certainly, in the numbers, when you talk to people, they have been bringing people into the workforce. the fact that the expansion has continued, more people are joining the workforce. it has helped those areas. the concern is how sustainable that is. are some long-run structural issues that the country has to do with, including education. we know a lot of people don't have access to education. ,e have infrastructure problems making sure the people can get to the jobs that are available, in terms of transportation issues. health care issues, underlying issues, child care issues, those are structural things that monetary policy cannot do about. but something the country can address. certainly, the federal reserve

is concerned about it, we have a section of our work that has to do with community development, and those are the kinds of issues that we tackle in that section. it is not a monetary policy issue, but certainly affects the health of the u.s. economy. mike: too early to have a feel of what it would do to the economy, but the biggest concern you were talking about, business how confident are you that the economy is not fragile enough to tip into recession because there is a greater sense of confidence? i think underlying fundamentals are still strong. one of the things about this and it has been long, is that it's been fairly resilient. call off inil price 2014, 2016, expansion continued. this economy has been a

resilient economy, and that is one of the great things about the u.s. economy, it has a resiliency to it. obviously, we cannot know what will happen in the middle east at this point, and it adds to the uncertainty surrounding things, but fundamentally the economy is sound. we will have to see how that plays out as days go on. mike: we are speaking the loretta mester, president of the federal reserve bank of cleveland. let me ask you this. we have basically a 2% economy. unemployment is at a 50-year low. does that signal that we have had a long expansion, or is there some additional strength coming into the economy keeping it going? loretta: it is great that we have such strong labor markets. that is a real plus for a lot of people that we have those labor markets and wages are going up. 2% is my estimate of what trend growth is. as you know, it is made up of

labor force growth and productivity growth. in the economy at the moment, a 2% economy is about trend. we are a little above that right now, probably will have 2% growth, -- my prediction for this year is 2% growth. to have ans great economy with 3.5% unemployment and inflation will contained. we don't have an inflation problem in terms of being too high. -- fact, inflation has been running under our 2% goal. those fundamentals suggest the economy is healthy. we will have to see how the economy plays out. ishink monetary policy accommodated, and that is helping the economy sustained that expansion. we will have to see where it goes this year. were one of those people most worried about inflation breaking out because on a plumbing was falling.

as we go into the year and everyone is trying to assess who is voting on the fed, would it be unfair to call you a hawk, have you changed your inflation dynamics? loretta: i never thought of myself as a hawk but trying to balance risk over a long horizon. when you see unemployment getting to levels like that, and you have to think about financial stability issues, with interest rates as low as they are, i was balancing the risk. i have lowered where i think the steady-state of unemployment is over time because we have learned. similarly, i have lowered what i thought was my underlying equilibrium rate. i am pretty happy with where policy is at the moment. i think we at a wait and see. i also think, when i'm thinking about inflation, we have a point estimate of 2%, but you expect those estimates to vary over

time. inflation dynamics suggest that when the economy is slow, you would expect to see inflation below 2%. when the economy is expanding, you would expect to see it above 2%. thater of those suggest things are going awry and you have to respond with policy. jonathan: that brings us to the policy framework review, which encompasses inflation. the majority seems to be coalescing around the idea of some sort of inflation average. loretta: we are having discussions about it, it's ongoing. said, we expect to perhaps come out with something in the middle of this year. i think discussions have been good. as you know, there are three things we are looking at, the estimate, is 2% the right play, should we think about average inflation

targeting, a range, kim occasions around that, and our tools. my personal view is we say we have a symmetric 2% inflation notet but we have communicated that as effectively as we would have liked to. people still seem to think that 2% is a ceiling and we will respond if inflation is about 2%. my own preference at this point would be to explain what we mean by 2% inflation target, and a range is perhaps the best way to do it. averaging is difficult. explain, inflation will move above and below 2%, we will try to keep it in that growth is lower, probably lower in the range. when it is higher, higher in the range. we are comfortable with that. i think that's a good way of explaining what we are trying to do. also, why 2%? the reason why we don't want to

see it go lower is, if inflation gets low and stays low, we have less room when a downturn happens to actually respond. , alike inflation near 2% little above, a little below, not a big deal, but in that range, because that makes our ificy more effective negative shocks get to the economy. jonathan: another question that overhangs the fed. --mike: another question that overhangs the fed. what will you do when you have 150 basis points on a short end, cannot do much because you have only about 180 on the long end? loretta: the tools we use during the great recession were effective. qe was effective, forward guidance can be helpful. explaining we are in it, we are doing all we can to get inflation up to 2%, to keep the labor markets healthy, and that

the policy will be accommodative until we get that, that is the way we can attack the downside. you are right, with less space you have to be more creative, but the tools that proved helpful in the last downturn when and if apful downturn happens in the future. are talking with loretta mester, president of the cleveland fed davi. even though those things are effective, do you need new tools, -- yield curve control is the hot topic of the moment. what we aret of doing is assessing our tools, what works, whether we can apply them in different ways. that is one of the things we are talking about. certainly, the format of the forward guidance. when we started, it was very qualitative. as we went on, we tried to make it more quantitative in terms of

unappointed rates we were trying to aim for. that is a part of the review. tools overice these that time period, we have learned how to make them more effective, and i will be a part of what comes out of the review. of central bankers talking about the need for more fiscal help in the next downturn. would you be willing to work with the fiscal authorities, or is fed independence too sacrosanct to bring the two sides together? loretta: most countries when there is a downturn, you have the fiscal authorities and the monetary authorities working together to get the economy back to a more sustainable pace. saw the fiscalwe authorities come in during the great recession and tried to add stimulus. in retrospect, would it have been better if more stimulus was added? sure. i don't think of that as being

detrimental to monetary policy independence. our goals are the same. you could argue that there are things we could do in terms of thatiscal side of things would not be contrary to what monetary policy is trying to do. that is what you usually see in balancing. that is the kind of pace i would like to see, the on that track, as opposed to necessarily going hand-in-hand. it will depend on the nature of the shock what has to be done. mike: money markets. we made it through the turn, are you satisfied with our balance sheets are, do we need to going increasing, or are you about where you need to be? loretta: we took action when we saw the financial markets, repo markets being a little disrupted in september. we are on a pace to bring back the level in terms of early september levels. the end of the year went clearly

well, good control on the money market. to keep buyinge those short-term treasuries. i don't think of that as expanding the balance sheet in terms of qe, but it is bring up the level of reserves. we will have to see going forward with the next apps will be. in the minutes, we talk about a standing repo facility as something we want to talk about, think through what the parameters would be if we wanted to go that way. i think that's an intriguing idea. at this point, i would be supportive of the fed doing the hard work to assess whether that is needed going forward. at this point, we can take our time there. things him be settled down in those markets. mike: new year, new hopes, new fears. what would were you the most about 2020 and the expansion? loretta: always we have to be worried about a lot of things.

uncertainty surrounding the trade war. uncertainty about growth abroad, which impacts the u.s. economy. and new uncertainties including what will happen in the middle east. all things that we as monetary policymakers have to take into account when we think about where the economy is going. i'm also not overly concerned about financial stability issues , but we know corporate debt levels are at high levels, underwriting is not necessarily the best in some of that debt. if we do get a negative shock, that could exacerbate a downturn. i do look at those financial stability issues when taking about monetary policy. mike: loretta mester, thank you for joining us. federal reserve bank of cleveland. mckee thanks to michael for that wonderful interview. we do want to go through some of what the voting members this

year said. let's bring in our panel of damien sassower and matthew. he covers monetary policy. i want to start with some of the later comments on inflation. it was very interesting what she said about the economy getting healthy. then she went to talk about a range on inflation, said that that had not communicated well this idea of symmetry, that they were willing to go above or below. she presented the idea of a range, but did not define the upper or lower bound. we are getting into this interesting conversation, with the fed presumably on pause, about this longer-term policy framework they are debating. the interviews that you have seen on bloomberg today delineate the two sides of the debate, the way it is shaping up. on the one hand, charlie evans was saying we should be letting

inflation go out to maybe 2.5% of the should be overshooting the targets since we have been undershooting for so long. loretta mester is on a different side. rage asringing up the something as the others who are presumed to be more hawkish have favored. the implications are that we have been under running the 2% target for so long. policy,re using a range that would not be seen as a big deal, so maybe we wouldn't have to be worried about being so dovish on policy. those are the two sides of the debate. theie: talking about economy being healthy, some parts of the economy less healthy. she didn't allow for any areas to be in contraction, that work was coming to those areas, the workforce was expanding to include people in those areas. whydidn't quite explain

this is the case, why we have , ah strong employment healthy enough economy, and not enough inflation. is the i think this interesting thing that she and charlie evans agree on, according to their comments. they are both looking at the manufacturing sector, this week in a number, saying we are not too worried about that come up because the rest of the economy continues to grow. the labor market is strong. we just went through a similar thing in 2016 or we had a downturn in the manufacturing sector but did not lead to recession. both the hawks and the doves agree that this doesn't mean that they will necessarily need to provide more accommodation because it may not spill over into the rest of the economy the way we might have expected it to in the past business cycles. michael mckee brought up the trade wars, asked if it was a self-inflicted wound to see the manufacturing data coming in weaker. she mentioned multinationals and

in the rural areas have suffered more, but they have incorporated uncertainty into their plans going forward. what is that, other than an admission that we will see stagnant data? damien: the trade war is raging. with what is it, going on in iran, it is adding fuel to the fire. a lot of unknowns out there. loretta mester is right to say we are doing the best we can, but we just on the where the path is heading. 3000 troops are now being sent to the middle east because of what happened overnight. that costs money. qe qe470 billion of non- to get us through the end of the term. what is it going to take now for us to offset some of these uncertainties in the market? vonnie: she did talk about the strong part of the economy being the consumer side, which has offset weakness in manufacturing

and investment, but no admission on what the fed might do if the consumer starts to weaken. matthew: that is really the red line they have been drawn for the last several months, saying things look good on the consumer side, but that is what is holding everything up. if you saw a deterioration there, that is something fed officials would take seriously and would start to move the conversation back toward more potential easing. right now we are not seeing that at the moment. in november, the unemployment rate went down to 3%. we are starting to see a pickup in wage growth. until we start to see weakness in that data, you will have an on hold policy conversation for the foreseeable future. vonnie: i want to point out, those headlines, we just got word that u.s. forces will be 2250, added to,

the 750 already sent. the 82nd airborne first brigade, the army's most mobile brigade, will also deploy on friday. things definitely ratcheting up. matt, neither of the fed presidents that spoke today gave much of an answer about what is happening in iran, i guess i don't want to be political, but they did say it as to the uncertainty. matthew: it absolutely does. it is at the point where we see oil prices go up a lot today, the stock market going down a little bit, but not enough to paint a picture of a real dent in business and investor sentiment. that is what they always come back to. when you talk about these risks and uncertainties, you don't know which way they will play out, but ultimately if the stock market goes down, you can get a signal that people are getting increasingly worried.

that is the sort of thing that can filter through the economy and impact data. that is when they will take it seriously. vonnie: these things happen fast. yesterday we were in absolutely rally mode. spread widening out to levels we have not seen in more than a year. today, right back to 1.80. 20 basis points. oil is higher, stocks are off of their lows. things can change fast. damien: you look at the saudi aramco strikes, that was a head fake. this one feels different. when you have troop movements, netanyahu putting israel on high alert, it is once again resonating with investors, and the market prices are reflecting that right now. you make a good point in terms of the u.s. consumer and how a lot of the fed speak is hanging there hat on the fact that it is

the civilian holding up the economy. we have some big data points coming through next week. nonmanufacturing ism, durable goods orders, and those will give us more color as to what we can expect from the u.s. market going forward. vonnie: that services data number will tell us more about the consumer. our thanks to both of you, damien sassower, matt boesler. this is bloomberg. ♪

viviana: i'm viviana hurtado . let's get to bloomberg first word news. american citizens are being asked to leave iraq or the u.s. state department after the airstrike in my bag.

-- in baghdad. one of iran's powerful generals was killed. qasem soleimani was killed. mike pompeo called on tehran to deescalate tensions in the region. we don't seek war with iran, but at the same time, we will not stand by and watch the irradiance continue to put american lives at risk without responding in a way that disrupts, the fans, the terrors, and creates an opportunity to deescalate the situation. viviana: marco rubio says salamat he was planning a coup in iraq. the federal reserve may drop hints on plans for a repo market . we may also get an idea of what could shift the view that interest rates are on hold all year. through 2020, 13 officials forecasted that rate would be unchanged. er