By Ben Leubsdorf and Jon Hilsenrath 

Federal Reserve Bank of Cleveland President Loretta Mester told The Wall Street Journal that while she has taken notice of recent volatility in financial markets, it hasn't changed her opinion that the U.S. economy is on solid ground and is ready for higher short-term interest rates.

Below are excerpts from the interview, which was conducted Thursday on the sidelines of the Federal Reserve Bank of Kansas City's annual economic symposium in Jackson Hole, Wyo. The transcript has been edited for clarity and length.

WSJ: In June, you said that you felt that the economy was ready to handle a small increase in interest rates. How has your view about the outlook and the economic backdrop changed since June?

MS. MESTER: Okay, so obviously the volatility in the market's got my attention. We're going to assess all the incoming data between now and the meeting...But if I had to say today, does it fundamentally change my view, I would say no. I think the actual fundamentals in the economy are quite solid. We've gotten some good data. The GDP report shows that the second quarter did come back after the weak first quarter. Some of the consumption data looked good, consumer confidence looked good, orders looked good. So the incoming data, I think, suggests that the economy still has the strength in it and pretty solid momentum.

Now, there are risks around those forecasts....You wouldn't want to react to short-term volatility in the markets, but you have to pay attention to it because you have to think about, well, what caused the volatility, what are the factors feeding into that? People are re-evaluating growth in China, so maybe perhaps the slowdown is stronger than we thought it was going to be. That has implications for oil prices, other commodity prices, and that has implications also for the appreciation of the dollar.

I'm still assessing what the longer-run implications of those are. But even if China is a bit weaker than we thought it was going to be, I had already built in weaker China growth and the...implications for emerging markets into my forecast. So right now, if I had to say, has my view of the U.S. economy fundamentally changed, I would say no. I haven't fixed my forecast for the next go-round yet, but I'm assessing the risks to the forecast.

WSJ: How does your decision about rates, how does that work together with your forecast? If your forecast holds steady, are you ready to move?

MS. MESTER: I've said before that I think the U.S. economy could support a modest increase in interest rates. I think it would be resilient to that, and so that's where I've been. But of course, that's my view. I'm looking forward to actually going to the [September Fed policy ] meeting because I'll hear other people's evaluations of what they think the risks are given the recent volatility. I think there's probably more downside risk to my forecast now, given the volatility, but my baseline forecast probably hasn't moved enough to change my view on policy.

WSJ: It sounds like you haven't made up your mind.

MS. MESTER: Well, I want to look at what the data--we've got three more weeks, so we're going to get other data coming in. I want to take that time to actually assess things. We'll have more information on what the volatility of the market is doing.

WSJ: So that suggests it's a really close call, if you don't have enough information at this point to say.

MS. MESTER: Well, but this is what we always do. When there are developments, what we want to do is assess them as they come in against our forecast. We don't meet every day, we have periodic meetings, and so what we do in between meetings is assess the incoming information. Some of it's data, some of it's movements in financial markets, some of it's the information I get from talking to my board of directors and other business contacts in my district. I try to put all that together and then come up with the assessment that I walk into the meeting with, and then in the meeting I want to hear what other people say, what they're bringing in from their side of the country or part of the country, and also how they evaluate the incoming information. There's a lot of tools we bring to the table, but I want to hear that discussion.

WSJ: How's your inflation forecast?

MS. MESTER: Obviously we've been running below our [2% annual] target. Core measures which take out food and energy prices have been more stable--still below the target, but more stable. The earlier oil price shock, the decline in oil prices we saw last fall and into the beginning of this year had, I think, showed up in, obviously, headline numbers, but was working out, and that's why we had the stability in the core inflation measures.

Now we've had another downturn in oil prices. If that continues, we're going to see that feed into the inflation measures. But I don't think that oil prices are going to continue to decline. I don't think the dollar's going to continue to appreciate. At some point, those are going to stabilize, and then those will work out of the inflation numbers.

So to my mind, those are shocks that will be relatively transitory and it doesn't fundamentally affect my view that core inflation and...headline inflation will eventually, gradually, move back up. It'll probably mean it'll be delayed more than I had in my forecast before. I had it going back up to 2% by the end of next year and beginning maybe of 2017. The new shocks, if they are maintained, will push that out a bit. But fundamentally, with the growth a bit above trend and with labor markets still continuing to improve, that's a counterbalance. So that's why I think it's reasonable to say that inflation is going to move back up to the 2% target.

WSJ: How close to you think we are to full employment at this point?

MS. MESTER: I think we're pretty close to full employment. We're either at or nearly at full employment.

WSJ: And has that view shifted?

MS. MESTER: No, because I think fundamentally--there are still problems in the labor market, in terms of longer-run issues with the labor market, but I don't think that's something that monetary policy can address. When I think about maximum employment from the point of view of monetary policy, I think we're nearly at full employment. That said, we want to make sure that, as a country, we want people to get back to work. We want people to have opportunity. We want people to, once they have the skills to enter the labor force, to be able to stay in the labor force. Those are long-run issues. I don't think the tool for that is monetary policy.

WSJ: I want to come back to this inflation point. You say getting to the goal is going to be delayed because of what's happened.

MS. MESTER: It probably will be a little bit delayed, if the oil price shock stays. I mean, there's been some volatility.

WSJ: So doesn't that call for delaying a change in monetary policy?

MS. MESTER: No, not necessarily, because it might have changed the path a little bit. I think it might change the path of interest rates. But again, the timing--everyone likes to focus on the timing of the first increase, but it's the path of interest rates going forward. And that's geared to the economy and that's geared to the data that comes in.

WSJ: Why would a transitory oil price shock change the path of rates?

MS. MESTER: Because that's the length, right? So you want to calibrate where the economy is and where interest rates are. In my view, the economy can support an increase in rates. I want to take the time to evaluate the longer-run implications of the volatility in the markets. I think there's probably a little bit more downside risk in my forecast, given what's happened in the financial markets. But I think we also have to recognize that the volatility in the markets might be a--there's risks on the other side, too. I mean, we've talked about and the [rate-setting Federal Open Market Committee] has mentioned some of the...problems with holding interest rates [low] for a long time is the potential for volatility in the markets or some financial instability and risk.

WSJ: Are we seeing some of that now?

MS. MESTER: I don't know whether we can say that now. I can't say that now. But it certainly is something that we need to take into account when we're measuring the cost and benefits.

WSJ: Talking about the path of rates, how is your path changing? Have you thought about your forecast going out to '16, '17 and beyond?

MS. MESTER: I'm in the process of thinking about that path. We always said it was a gradual path and I ascribe to that, that we'd like it to be a gradual path. Of course, the data's going to dictate the path. When I write down a projection, I think at the moment: Here's my projection, it's related to where I think the economy's going, and that's the monetary-policy path that I think is appropriate for that outlook. As the data comes in, if my outlook changes, that path will move with the outlook.

The productivity growth that we've seen has been low, so perhaps potential growth, I may perhaps want to move down on potential growth. I was at 2.5%, perhaps I'll move it down. The long-run fed-funds rate, I've been at 3.75%, maybe I'll move that down to 3.5%.

WSJ: I wonder if the changes that you're talking about are big enough when I look at rate expectations in markets, fed-funds futures looking out to '16 and '17.

MS. MESTER: Yeah, but I think some of that puts weight on holding interest rates at zero for much longer than I would definitely think is appropriate. I think I wouldn't necessarily look at current market rates as indicative of what's the appropriate path of policy. We want to take a signal from that, but I wouldn't necessarily think that that would necessarily stay that way once normalization commences.

WSJ: A few people in the markets have been saying the Fed's next move might be to ease monetary policy....What do you think about that?

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August 30, 2015 11:40 ET (15:40 GMT)