Can a soft landing be achieved? This is still a wide open question, given the highly uncertain macro environment. On the one hand, you have had a continued deceleration is most US inflation measures and the unemployment rate is below 4%. On the other hand, there are concerns over re-acceleration, more inflation, and a bond market where yields seem to be screaming higher day after day. On this episode of the Odd Lots podcast, we speak with Austan Goolsbee, the president of the Federal Reserve Bank of Chicago, who sees the possibility of, in his words, a "golden path" -- or the "mother of all soft landings." We discuss why and how it can be achieved, what the Fed can do to deliver a positive outcome, and what the market is telling us about the work that still needs to be done. This transcript has been lightly edited for clarity.
Key insights from the pod
:
What is the Golden Path? — 4:29
The risks of looking at history — 5:31
Are we on track for the soft landing? — 13:17
What has been the Fed’s role in bringing inflation down? — 21:25
The role of inflation expectations — 22:25
What is the cause of surging rates — 29:36
Should we be concerned by financial stability? — 37:10
When would the Fed consider cutting rates? — 45:03
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Joe Weisenthal: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:15)
And I'm Tracy Alloway.
Joe: (00:16)
Tracy, how about that JOLTS report?
Tracy: (00:19)
How about them JOLTS? Yeah, a lot stronger than expected, but I think there's a lot of uncertainty around JOLTS from what I remember.
Joe: (00:29)
Yeah, well it's like, I mean, we're recording this October 3rd. These are August JOLTS, so, you know, we're already, I guess that's like two months ago. I'm always sort of skeptical about job openings data, like what is it really measuring? But nonetheless, this is a measure — the number of job openings — that people have been paying attention to. It had been coming down, it's jumped back up and then it just does raise this whole question of is the economy really sort of decelerating into a nice smooth, soft landing, or are we still really hot?
Tracy: (01:03)
Well, I know you were looking at JOLTS, but I've been watching the bond market because the other big story in markets is of course the big bond selloff. The 30-year Treasury yield, now at the highest since 2007, I think something like 4.8%. That's pretty crazy. And there's a lot of discussion right now over what is driving that long-end sell-off. Is it the higher for longer stance that we saw from the Federal Reserve a couple weeks ago? Is it worries over supply? It could be anything really.
Joe: (01:35)
Right. We don't really know. And again, the moves that we're seeing in rates really across the curve, but really at the long-end, they do not scream to me like we're in for a soft landing. They do not scream to me that inflation is about to come down back to target. The Fed is going to cut sometime soon and we're going to be, you know, back in like 2018, 2019 Goldilocks territory. We may get that, but it does not look like what the bond market is saying right now.
Tracy: (02:06)
It screams uncertainty to me. Like, if you look at the bond sell-off and you look at what's going on with JOLTS, it just seems like we are still in this period where even three years after the absolute depths of the pandemic, it feels like we're not quite sure how the economy is actually operating, what the impact of interest rates are, what's going on with inflation. It's come down, but we're not really sure if we can attribute that to the rate hikes or something else.
Joe: (02:32)
You mentioned by the way, the 30-year, but you know, mortgages — 30-year mortgages, they're coming on 8%. So regardless of whatever, I mean talk about a real effect on rates and the effect on rates to the broader economy may be kind of ambiguous...
Tracy: (02:46)
No, this is why I mentioned the 30-year yield because this is a thing that mortgages are priced off of. Commercial paper, corporate debt. It is like a big benchmark for the wider economy.
Joe: (02:58)
So I guess there's questions like, what's going on and can we achieve that soft landing are still like huge questions that are on everyone's mind.
Tracy: (03:06)
Absolutely.
Joe: (03:07)
You know what I think is a better term than soft landing. by the way?
Tracy: (03:11)
Uh, no...
Joe: (03:12)
Golden path.
Tracy
:
(03:13)
Golden path?
Joe: (03:15)
The golden path, I think, you know, soft landing is nice, but the golden path towards that sort of, you know, low unemployment, low inflation. And our guest today recently gave a speech on the prospects of can we achieve that golden path? Can we walk this golden path into the sort of economic nirvana that we all want to see?
Tracy: (03:37)
I know you brought up the golden path just then, your new term, but I kind of read it as the ‘this time is different’ speech and it takes like, it's pretty brave to make a ‘this time is different’ speech. But on the other hand, if any time is going to be different, it might actually be the period after the worst pandemic that we've seen in over a hundred years.
Joe: (03:56)
Exactly. Well, rather than us speculating about whether we can achieve the soft landing or whether this time will be different or whether we can walk down this golden path, let's bring on to the podcast — I'm very excited it's his first time on the show, but someone we've wanted to talk to forever — Austan Goolsbee, who is the relatively new president of the Chicago Fed. Austan, thrilled to have you on the show. I love that term — golden path. Can we continue to walk down it? Can we continue to see disinflation with unemployment as low as it is?
Austan Goolsbee: (04:28)
Tracy, Joe. Longtime listener. First time caller. Thank you for having me on.
I've been saying this golden path... I kind of view it as that that would be the mother of all soft landings. To get inflation down as much as we need to get inflation down — and we're part of the way through — without having a big recession. As you know, there are a lot of economists who said that is not possible. I don't know that it's still probable, but I have been highlighting it is possible now for a variety of reasons that we might be able to do it. And my recent speech was less whether the golden path is possible and more like Tracy said, it wasn't really why this time is different, but...
Tracy: (05:29)
I know that's a loaded term…
Austan: (05:31)
That’s a loaded term. I was just making the argument why the intuition that going back and looking [at] what things were like the last time the unemployment was 3.7% that’s not a great, that's not that accurate of a measure at times when there are supply shocks bumping around, at times when expectations are not unhinged like they were the last time inflation got out of control in the 1970s.
And because of those differences, just be cautious about using lessons from past periods to be analyzing what's happening right now. And you see it every month when the data come out, you'll see analysts look and say, “Ooh, the JOLTS ticked up, that must mean we're overheating” and implicit in that is a logic that the last time the unemployment rate was low and and inflation was high, it meant we were overheating.
So I just want us to be careful of using historical analogies that might not be totally appropriate.
Tracy: (06:48)
I think that's totally fair and something that we've been discussing on this podcast, the idea that everyone tends to reach for the Volcker period of high inflation as their preferred historical analogy. But of course there are others out there like what happened in the aftermath of the Spanish Flu, we've spoken about that before.
But Austan, maybe before we move on, can you just give us a little snapshot of the speech that you gave because you had this great series of charts in there, which kind of pointed out, I know ‘this time is different’ is not a preferred term, but you kind of pointed out that, well, things have already been different compared to what traditional economic theory would've suggested.
Austan: (07:29)
Yeah, look tremendously different. So the the starting point, I started with this anecdote about my grandfather who was a wise old guy. And he lived on a ranch in Abilene, Texas. And normally he was great giver of life advice, but when I took my first job, he wanted to call and tell me never buy stocks.
And as I said in the speech, I didn't know, is my Grandpa Jack was an efficient markets guy, like what? You don't buy individual stocks. No. He said, ‘Don't buy any stocks. Your grandmother and I knew people that bought stocks. They lost everything when the market crashed.’
And that idea that one historical episode could live with you for 60, 70 years, and influence your behavior even when it's not necessarily the perfect lesson. There's a little element of that looking back to the Volcker episode or to past history and assuming that there's a let's call it a stable Phillips Curve, or something like that.
So point one is when you have supply shocks going on, the negative or positive, the normal relationship between the contemporaneous economic conditions and the future inflation, those relationships break down or they bend a lot.
And if you take kind of a traditional VAR, in the academic language, set up in which you just look at the historical patterns of when they have monetary policy changes and then just look over the average, what happens in the quarters and the years that follow, I put that up on a chart and it showed that you usually have long lags to monetary policy when they take the monetary actions. It's really two years plus before you get the full impact on the economy and it leads to big drops in GDP. And when inflation starts to drop, it drops a lot and it only starts dropping after the recession has begun. That's the normal historical pattern.
And if you look now, the same logic that says the Fed will not be able to pull off the golden path because past history shows that if you want to get inflation down a lot, you must have a serious trade-off with economic performance, the last six months are impossible. Inflation has come down a lot. Employment really went up. It didn't go down. And we haven't had any recession.
So if you looked at that graph, it's kind of the predicted from nine months ago from what the Fed has done over the last year or year and a half, what we've experienced looks nothing like the historical record. So Tracy, you can hear me resisting a little bit using the phrase ‘this time is different...’
Tracy: (10:47)
I get it, I get it.
Austan: (10:48)
It's just when supply shocks are going on, there's no reason to think that the historical relationship would be holding and you would run a danger of overshooting if you pay too close attention to those kind of metrics.
If you're looking at metrics that say, ‘we must get the unemployment rate back to 4.5%,’ you're going to overshoot if there are positive supply shocks or if the supply chain is healing. And I do think that's extremely relevant on any month of data separate from just individual months are noisy.
I think this broader philosophical issue that the past is not that great of a guide when you get weird things happening and the Covid business cycle was maybe the weirdest of all. We just need to keep that in mind as we're deliberating and thinking this through.
Joe: (12:06)
Yeah. The way I like to think about this, or frame this in my head, is that the last six, nine months, maybe a year, it shows that the golden path/soft landing is possible in practice. But there still seems to be considerable debate about whether it's possible in theory. And that sort of would then determine whether we get to target.
I mean, inflation is coming down. The last core PCE print that we got, I think it was just this past Friday, it was benign. But you know, most measures still show some heat.
The story is, and I think most economists have come around to it, most of the improvement that we've seen in realized disinflation is due to supply side healing. Is there more supply side healing? Do you see that channel as having [more]? Are we healed? Or do we need to see something on the demand mitigation side? Like sort of the difference between where we are right now on inflation and where the Fed is like, ‘okay, we are comfortable, we have done this.’ Can that still be achieved through normalization, whatever that means?
Austan: (13:17)
Well, I want to make two points here. One, let's think about the supply side, but let's loop back and think about the role of expectations in bringing inflation down because it's critically important and it's one of the other things that make our experience of ‘21, ‘22, ‘23 very different looking, in the fundamentals than the 1970s and make our job different, perhaps, than the what the Volcker moment was.
On the supply side, I talk to a lot of business contacts in the Seventh District, you know, which is heart of the Midwest. There definitely has been substantial improvement on a lot of supply chain. I think most measures of supply chain say there's still some to come. And it's important to remember when the supply chain fixes, it still works its way through the economy, it's still going to take some time to work its way through the inflation rate.
It's not going to be an instant adjustment of inflation when the supply shocks hit. So I do think there's still some to come. And if you go down in the weeds, if you take like the New York Fed's Supply Chain Index, the New York Fed uses historical data to make a prediction of what are going to be the impacts on inflation. And their index shows that we've mostly returned to where we were before Covid, but some material amount of drop in inflation that will still come through that channel. So, I think both the anecdotes and the data tell you that that's been improving.
Now I feel okay, because what I'm about to say I've been saying for a long time that I put on the board, here's what we're going to need to see to believe that we are still on the golden path. So I'm not after the fact looking back and saying, ‘Oh, it was A, B and C.’
I said before, the first thing that has to happen... loosely before Covid, we had 2% inflation or even less on a stable basis. And that was coming. It wasn't that all inflation was at a 2% level, it's that goods were minus 1% a year. On average, housing was growing about three or even three point a half percent per year on average. And services, not counting housing, were two and a half to three.
And that combination is how we were getting to 1.8%. So we even have a little bit of wiggle room. Any one component could be a little higher than it was before and we could still get to 2%.
What needed to happen first was goods prices needed to come down. That's the thing that went completely bonkers during the Covid times because it was the first downturn ever where demand for durable goods went up and demand for going to the dentist went down. And that that's kind of tells you everything you need to know about why this cycle is extremely unusual.
Goods prices have largely returned to where they were pre-Covid. Then the second thing that has to happen is housing inflation needs to come down and we believe that that it would, because of this mechanical part that as market rents change, that's going to slowly filter through the CPI-type measures of housing.
And you have seen that begin and that needs to continue. The issue of non-housing services, we've always known that's the most persistent part of inflation. It doesn't need to get down to 2% for us to hit the target. It wasn't at 2% before Covid. And so in the short- to medium-run, the critical component to whether we can stay on the golden path is actually about housing because that's the thing that's supposed to come down and needs to keep coming down.
There are, I do have... are they concerns? They're probably concerns, they're not yet elevated to the level of ‘fears,’ that the normal dynamics on residential house prices have had some bumps with this aspect that there are a bunch of people locked in because rates were so low for a long time. There are a bunch of people with 3% mortgages who are resisting putting their house on the market.
So the supply of existing homes is not what you might normally think and that's pushed prices the other way, and the eventually that could slow the decline of inflation on the CPI-style measures of residential inflation. But this is the long windup to say, I think the supply chain mostly goes through goods and goods inflation, we've seen the progress that we wanted.
So the danger on the goods side, of course, is now with oil prices going up, we know what happens when you get negative supply shocks. We just lived through that, so that's an area of concern. And then the second is about labor supply. So there was a big negative shock to the supply of labor. I think that explains part of the persistence and the rise of inflation in other components.
But that is also easing. If you look at the job market or if you talk to businesses, it's not fully back to where it was before, but there's been dramatic improvement in the ability to hire and retain new workers. You've seen labor supply, labor force participation of women hitting record levels, labor supply of people of workers with disabilities hitting record levels, both suggesting maybe some of the increased flexibility in the workplace is going to operate a bit like a positive supply shock. So that that's kind of promising.
And immigration levels returning to something like what they were before, also a positive impact on labor supply. So on the real side, I still feel like nothing has happened so far that is convincing evidence that we're off the golden path, and a lot of the markers that we've been hitting are the things that months ago I was saying, ‘We will have to hit these markers to believe that this thing is still possible.’ And so far we've been hitting those markers.
Tracy: (20:50)
Soft landing, golden path, whatever you want to call it — it's very clear why that is a desirable target for the Fed to be aiming at. But I guess one of the questions I would have is if we say that a lot of the inflation that we have experienced is driven by supply shocks, is it reasonable for the Fed to take credit for a soft landing in that context? Or, what would the central bank think it has done or what has the impact of higher interest rates actually been in this scenario?
Austan: (21:25)
Yeah, it's important that we think about that. In a different way, what matters is the actual pudding, you know what I mean? What does it taste like? It's not fighting over the ‘who deserves the credit’ is only informative if it's telling you about the effectiveness of policy. In a way, I think the Fed has played an important role in preventing inflation from spiraling upward and it kind of brings us into the area of inflation expectations.
Tracy: (22:09)
Expectations, yeah. Sorry, can ask one really technical question before we do that, but when you talk about inflation expectations as you did in your recent speech, are you looking at market-based measures or surveys or what? What is your benchmark exactly
Austan: (22:25)
In that speech I identify both. There's, as you know, there's a lot of argument by analysts and by economists about exactly that question. And my point was, take any measure you want, take them all. I put up graphs of market-based measures, which personally I do like the market-based measures, and survey measures and estimates from the Fed of what the market expectations were back in the 1970s.
And the crucial thing to see that's that really came out of a lot of the academic literature on inflation is that if expectations remain anchored at say 2%, you outline an inflation target of 2%. If it is credible and people believe that the Fed will do whatever it takes to get to the target, that is a powerful draw bringing actual inflation down if it's above 2%. So when they're having negotiations or thinking about price increases, what the private market participants believe is going to happen overall will heavily influence wage and price determinations right now.
And if you look at expectations in the 1970s, they clearly became massively unhinged. They would ratchet up with each experience of rising inflation, the measures of expectations would rise and not come back down. So, you know, if inflation was at two and jumps to six, the long-term inflation expectations would rise, let's say, to three and a half. And then when inflation comes down, it doesn't go back to two, it goes back to three and a half.
And then when you get your next bout of inflation, the long run expectations jump up to five and a half. And so you get this ratchet effect. And I showed the graph, it became totally unhinged in the seventies. And the experience of the seventies with expectations are what made the Volcker experience so difficult and so painful. Now you probably know Paul Volcker was a great mentor of mine. I worked with him through the financial crisis and he's a personal hero and I would ask him all the time about the Volcker experience and what was it like in the seventies and was it hard to convince the FOMC to go along and you know, what did you think when interest rates were 20% and things like that.
And the experience, the scarring experience of trying to fight inflation when expectations are unhinged, that should be on everyone's mind. And that looks nothing like what happened in ‘21 and ‘22. If you plot market-based measures of expectations or survey-based measures, they go up modestly and they return and they are now, they remain very well-anchored at something close to the target rate. And that is a sign of Fed credibility. And that is crucial. It's absolutely crucial that the Fed maintain that credibility because if they don't and the thing becomes unanchored, it becomes dramatically harder to achieve a golden path-like outcome.
If you just go look, and partly I went through some of the theory, we've got two economists at the Chicago Fed who kind of redid the traditional model, but incorporated market-based expectations of several of the variables. In the normal analysis, there is no role for future expectations of the unemployment rate, of the inflation rate, GDP growth. There is only the backward-looking monetary policy happened, how long does it take to have an impact?
So what they did is go take some of these expectations measures and put them in a normal analysis. And what they find is that these measures of future expectations do matter. And if you do a model like that, it says that the impact of monetary policy occurs much more quickly than in the historical. In a way it's saying something like the market expected conditions — financial conditions — to tighten well before the Fed actually started raising rates. And so the clock kind of begins when the market believes it, not when they actually do it.
If you think that, then in a way just go look at the market expectations now. The market expects that the Fed is only going to raise rates a little bit more, that it's going to keep them a little bit higher for some time, but that that's going to work. The market expectations of inflation are that it's going to, in the relatively near future, get back to target and do so without a recession.
And it’s that, that it’s in the data, is the thing that's driving this model and every other model. So we can argue about the details of any one model, but the fundamental fact that the market expectations are that we're going to pull it off, makes it easier to pull it off because of that expectations channel.
Joe: (28:30)
Got it. So you talked about, you know, the golden path. You talked about some of how you would decompose getting back to a stable low inflation. Maintain modest goods inflation, maybe a little heat on the shelter side, modest services inflation, maybe some wiggle room within those three categories. Immigration's picking up, supply chain’s healing, maybe we can get there.
The one thing that seems unambiguously different between right now and 2019 is rates. And so I guess I'll start with a sort of first question. When you look at the yield curve right now and you see rates shooting up higher and higher, I guess we're still in inversion, but flattening, coming out of inversion, can you square that story with a golden path story? Is that a market that is consistent with a golden path or do you see tension between what a golden path looks like to you and what market participants are pricing-in terms of the trajectory of rates going up?
Austan: (29:36)
I kind of think two things. One, I'm struck by your comparison. People are comparing the labor market and the ratio of unemployment to vacancies and things like that to pre-Covid and we're comparing inflation levels to pre-Covid. It's an interesting wrinkle, Joe, to say, but the rates were a lot lower then. If anything, I would've thought that would make you more optimistic that inflation would come down because on top of if we could get some of the conditions to look like what they were before, that those higher rates, higher real rates, would exert a little restraint on things.
I guess one answer to the question would be, me personally, what do I think? And one answer to the question is what does the market think? And I guess the answer to both of those is both the market and I think that it's still possible. So the market has decided that the SEP — higher for longer — is accurate and it's yet another in the series of the market realizing the Fed is serious and we're not BSing, you know, when when we say what we're gonna do. But that that hasn't led them to predict a recession. The forecasts of GDP are are for not a recession.
So I still feel like this is our goal and it's still possible. My concerns are less that we're misinterpreting whether the economy is overheating or undershooting, overcooling? Whatever's the opposite of overheating. My concerns are more past soft landings that were easier than the golden path version. have been derailed — like 1990, 2001, they were derailed by external shocks and we got a lot of external shocks we are going to have to monitor.
We’ve got the price of fuel rising pretty significantly. You've got potential slowdown in China that could do damage to the rest of the world's growth rate. We didn't have a government shutdown. We’ve got auto strikes, we’ve got the prospects of government shutdown maybe in November and things like that. If you look at past history, they have had negative impacts if they last long enough. So that's kind of where my head is about whether we could pull it off or not.
Joe: (32:44)
Then, just maybe if I can reframe the question, what is it that's changed in this environment, pre-pandemic versus now, such that this sort of benign environment is such [that] higher rates are necessary? I mean, again, we did not need higher rates before. We did not need rates at all. We basically were at Zirp prior to Covid we certainly did not need 8% mortgage rates to have this sort of cool inflationary environment. What's changed in your view in that time?
Austan: (33:19)
Well, let's say two, it all depends compared to what? And so, we'll answer the question compared to six months ago as we think about the why are the long rates going up? But then you're saying, well, let's compare to five years ago. The thing is when we're at the zero lower bound, that's not normal.
The central bank doesn't want to be sitting there bumping around at zero interest rates because it restricts the flexibility of the central bank and it restricts the central bank's ability to respond to external shocks, of course. So if you take a step back in history, the thing that's oddest is why were we at zero for so long? It's not, why do we have positive interest rates now?
If you compare to six months ago, six months ago we were trying to figure out is the collapse of Silicon Valley Bank, First Republic are these indicators that we're about to have a financial crisis or some kind of a credit crunch a la the Savings and Loan Crisis, or those kind of things. And there was a much more pessimistic view about whether we're going to have a recession and is there going to be a significant slowdown?
I do think compared to that, if you think there's less chance of recession and a deep recession would be a low-rate environment, we’ve seen that over and over. So if you take away the prospects of a financial collapse and a back to zero for a long time kind of environment, the long rates are going to go up. So in that sense, that part is not a puzzle.
I think the puzzle that people are trying to put together is why did it happen in the last three weeks? And what was it that got announced? Like the SEP came out and it was a little different than the market expectation. It was a little different than the previous SEP, but was it so different that it would lead to a material change in a three-week period? That part's still a puzzle.
But if you take a six-month perspective, in a way I don't think it's that much of a puzzle, it's clear that the long rates coming up is what you'd expect. And getting back to what I consider a more normal environment where we're not hitting the zero lower bound, we don't have seriously negative real interest rates for an extended period of time. We can argue about what that level is, but it's not a surprise that we would be going back to something like that.
Tracy: (36:16)
Well, just on this note, I take the point that the bond market could be reacting to the idea that a recession or at least rate cuts are off the table. The the bond market could also just be wrong, of course. But let me ask this question in a slightly different way, which is there a point at which you start to worry about the runup in real rates or the sell-off in the long-end of the curve?
And you mentioned SVB just then, I mean we know that banks are sitting on huge amounts of duration at the moment. It does feel like the sort of financial markets channel is a potential path where we could maybe get a little bit of trouble. Maybe the bond market sell-off causes financial conditions to tighten too much. Is that something that you're worried about and around, you know, what level would that be a concern for you?
Austan: (37:10)
My only hesitation is on the word ‘worry.’ That's not the right word. We absolutely monitor that and are thinking about that. And that could be a blow to either the financial or the real economy that various manifestations of that, that would be the credit crunch hypothesis that we were quite nervous about, especially in the wake of the bank collapses. Because in past bank collapses, you've seen that spiral into credit crunch.
But as I always say, you know, it's a very Midwestern thing that we're going to deal with the problems. It doesn't matter what the conditions are, you go get the job done. You know, out in Chicago there is no bad weather, there is only bad clothing and we're going to put on a parka if we need to put on a parka. So if there is a credit crunch, if those things materially deteriorate in a way that we haven't seen but feared seeing over the last six months, we will adjust.
And we’ve got to think about it. We, by law, we have a dual mandate as you know, we are going to stabilize prices and maximize employment and all eyes are on getting inflation down. We must get inflation down. That's the part of our mandate that we have not been hitting. We've been making quite substantial progress on getting the inflation rate back down to where we want it. And for all of the attention and heat about whether inflation would stall out at 3.5%, at 3%, I would just point out, if you take the three months performance of inflation, we already blew through 3%.
We're already getting it down more. And if we start to see weakness on the other side of the mandate coming from financial conditions getting tighter, and that leading to more traditional business cycle dynamics where the interest rate sensitive sectors like durable goods and autos and stuff like that slows, we will adjust to it. You know, that's why so far Chat GPT is not going to replace the FOMC. The FOMC is a collection of a lot of different people who have a lot of different views on the economy and that's the best thing we got going.
Tracy: (39:49)
Can you adjust even if inflation is still above target? I mean, again, I take the point that it has been coming down, but the concern — the major concern — is that if we start to see it go up again, for instance, because of gas prices, which you've already mentioned, then maybe it becomes trickier for the Fed to navigate some sort of financial markets crisis while maintaining that momentum on the price side.
Austan: (40:16)
Yeah, tricky is a perfectly accurate word. That's why the FOMC exists, is to try to think through the waggles, the worst thing you could do is pre-announce, ‘Hey, my policy is just take whatever last month's inflation rate was and whatever last month's unemployment rate was and just react this month at the FOMC table based on one month's data.’ That's the wrong way to do it.
I outlined, traditionally, the impact of monetary policy has a substantial lag and inflation comes down after a big increases in rates, but the inflation comes down only after the recession begins. So what we have already experienced over the last six months is extremely unusual by historical standards because the inflation came down before a slowdown on the economic side.
Any central bank’s got to think through are these supply shocks or demand shocks? They've got to think through the dynamics — by which I mean, what have we already done and how much is of that is still to come, how much of that impact is still to come? And we don't want to overshoot. And that's a balancing act and we’ve got to strike that balancing act. And that's kind of the root of the discussion.
But I definitely don't want to tie my hands or anybody's hands on the FOMC about hypotheticals of like, ‘Well, would you vote for 25 basis points up or down or this, if the inflation rate came in at exactly this and it was matched to the unemployment rate...” because there's a lot of art as well as a lot of science to monetary policy and you just have got to monitor the conditions. That's why I always say I'm in the coalition of the data dogs, you know, our thing is go sniff and if you don't know what's happening, go sniff some more. That's the root of the school of thought where I come from.
Joe: (42:46)
Well, I get your reluctance for hypotheticals and obviously not wanting to tie your hand, but...
Austan: (42:52)
But you’re going to ask anyway...
Joe: (42:53)
Well, it's just sort of like a vague hypothetical because, you know...
Austan: (42:57)
Oh, the best kind...
Tracy: (42:59)
Let's call it scenario planning…
Joe: (42:60)
Yeah, scenario planning. Tracy nails it. Scenario planning. But it's basically, you know, right now the job is to get inflation down, as you said the actual last few months, you're blowing through some of the expectations on the downside. Good.
You know, obviously you have a dual mandate and one side of the mandate is labor, which has been very strong by most metrics, including today's jobs report, including [an] unemployment rate below 4%. But talk to us just generally about where the shift would come from, what would you need to see...
Austan: (43:39)
Shift of what...
Joe: (43:40)
Thinking about cuts. Whether it's on the employment side or just on the inflation side, what would be the type of thing to sort of get the other side of the mandate, the maintaining low employment, via cutting what would you need to see to get into that frame?
Austan: (44:00)
Well look, I already don’t want to get into hypothetical discussions, much less hypothetical discussions about philosophy in the future. So I don't have a definitive answer to what would the conditions look like, we would not just be past the raising period and past the...
Joe: (44:31)
I mean, to be fair as to my question [and] why it's not completely out there. I mean, up until very recently, the market was pricing in cuts, actually in 2023, I think those are gone. So it was like the market was trying to figure out when's the Fed going to cut, when's the Fed going to cut? You know, as the dots showed, maybe we're not going to get any cuts anytime soon. But this is a sort of central question. The market [is] trying to figure out would it take a recession to get rate cuts or could we just get cut...
Austan: (45:03)
On a philosophical basis, the Fed is trying to maximize employment and stabilize prices. If we are stabilized prices in a way that we felt like we're on the target, then the Fed doesn't need to be tightening. And it’s worth remembering, holding rates at a level while the inflation rate comes down is a form of tightening. The real rate is getting tighter as that happens.
And if your target is something about real rates and a level of restrictiveness that matches your mandate, the abstract answer to your question of when is it time to cut rates is when the dual mandate conditions suggest that cutting rates is necessary to maintain your mandate.
So if you observe big increases in unemployment, big drops in GDP, what looks like a recession. In past business cycles, those can come on quite suddenly. You know, they can come on rapidly. They say of unemployment rate, usually it rises like a rocket, it goes down like a feather. So if you start to see rocketing higher unemployment rates while the inflation target remains tame, then that's a sign that the dual mandate, the other part of the dual mandate, you’ve got to think about.
Tracy: (46:43)
So we've been talking a lot about soft landing/golden path. And again, as you pointed out in your speech, that is a tantalizing prospect for the...
Austan: (46:52)
I like how you keep, I don’t know if it's a gift to me or to Joe, but you want to say ‘soft landing,’ but then you add slash golden path.
Tracy: (47:04)
I'm just going to use all the phrases.
Austan: (47:05)
The only difference between the golden path and the soft landing is that the golden path is the biggest of all the soft landings. The softest of the soft landing.
Joe: (47:15)
That's when they chisel all of the FOMC faces on Mount Rushmore is when you hit the golden path.
Austan: (47:21)
That's right, the golden path.
Tracy: (47:23)
I get that it’s a great thing to aim for and a tantalizing prospect for policymakers. Do you worry at all about the ‘no landing’ scenario anymore? Like, is that still a tail risk? The idea that well, maybe rates, so
Austan: (47:36)
No landing meaning inflation never comes down?
Tracy: (47:39)
Inflation stays above target, but unemployment is still relatively low. Rates remain pretty high.
Austan: (47:46)
I will tell you that, I mean, maybe this is too blunt. I don't worry about the no landing scenario because the Fed will never allow it. The prospect that we’ll just surrender and give up without getting inflation down to the target, that will not happen. I'm not allowed to speak for anybody else on the FOMC, but for me, I would, over my dead body will that happen. And I feel like my mentor, Paul Volcker is whispering ‘My ghost will come back to haunt you forever’ if you do not get us back to inflation. We will get inflation back to the target. So I don't view the no landing scenario as, that's not a foremost risk in my mind.
Tracy: (48:35)
All right. You're serious about it. I get it.
Joe: (48:37)
You're serious about doing your job, you’re congressionally-obligated job.
Austan: (48:40)
No, all I would tell people is this subset of folks who want to constantly express doubt. ‘Oh, the Fed will never do it. The Fed won't achieve, the Fed doesn't have the guts to keep raising rates. They don't have the guts to keep the rates there.’ Remember the lesson of Silicon Valley Bank, which, I couldn't for the life of me understand. Silicon Valley Bank knew they don't have a traditional deposit franchise, and they knew they hold a bunch of bonds and that the rates are going up.
So I could not for the life of me, understand why didn’t they just hedge? Why [not], if you know, you have these vulnerabilities, just hedge it? And the answer, if you go through the Barr report, [is] they did hedge, but then they thought that the Fed wouldn't stick it out and that they would make more money if they got rid of the hedges. And so they got rid of them. And that's yet another, in the long line of lessons, don't bet against the Fed. That's not a good idea.
Joe: (49:44)
So basically they paid the ultimate price of fighting the Fed.
Austan: (49:49)
They made a bet. They took a bet against the Fed sticking by its being committed to its target or doing what it was said it was going to do. And that was not a good, that was not smart. So I feel that way here too. The Fed is not going to give up. Oh, the inflation rate's 3.5%. It's too hard to get it down anymore. That's totally wrong. That is not, the Fed is not going to do that.
Tracy: (50:14)
I'm kind of getting ‘whatever it takes’ vibes.
Joe: (50:16)
Whatever it takes!
Austan: (50:17)
Yes! Well, I don't know what. You're getting that vibe? I don't know how to say it anymore than we'll do whatever it takes to get the mandate down. That's the law. The law tells us we have to do that.
Joe: (50:29)
You know, one of the maxim in markets is that narrative follows price. And one of the things that is coming on big time with this rise om rates...
Austan: (50:39)
Is that a maxim? Narrative follows price? I like that.
Joe: (50:42)
Yeah. You know, something happens, then people tell a story about why. But with the rise in rates, there has been a crescendo of awareness about the deficit and expansionary fiscal policy and how the deficit is a percentage of GDP or however you want to measure it, is much higher than it normally is with unemployment below 4% and structurally high deficits for a long time to come. And I know you don't, you know, I understand the whole not commenting on fiscal policy in terms of giving recommendations etc.
Austan: (51:14)
I was was just about to say that...
Joe: (51:16)
I know, I know. We all know that part. But from a Fed standpoint, it is your job to, you know, as you say, the Congress gives you that job. Does it make it harder? And on a sustained basis, is it a force for keeping rates as high as they are from the Fed's perspective, that fiscal policy appears to be so loose, without any change to that in sight?
Austan: (51:47)
Starting from your observation, I'm a Fed man now. My job is not to go argue about what the fiscal policy should be or is. Like I said before, the Fed mandate is you take the conditions, whatever the conditions are, and figure out how to maximize employment and stabilize prices. And that's what we're going to do. There's a whole argument among the fiscal policy-minded economists about things like measurement and what's the proper measure of debt and what's the proper measure of fiscal policy?
And from a GDP kind of impulse perspective, isn't it all about delta from last year? So if the deficit is big but it's smaller than it was last year, does that mean the fiscal impulse is going down? I studiously don't have an opinion about fiscal policy. I just tell you, we're going to watch the conditions and on the ground, if whatever external, internal or other shocks lead inflation to go up or unemployment to go up, then that's the kind of stuff that we're going to be factoring into our decisions for sure.
Joe: (53:10)
Austan Goolsbee, such a thrill to finally have you on the show really appreciate you coming on Odd Lots.
Austan: (53:17)
My pleasure. Keep up the good work.
Tracy: (53:19)
Thanks so much, Austan. I have that clip of Tim Allen from Galaxy Quest going, “never give up, never surrender!” in my head now.
Austan: (53:28)
Haha. That's right! It’s All about credibility.
Joe: (53:29)
Thank you for indulging all of our hypotheticals, our philosophical hypotheticals, our attempts to get you to, you know, comment on fiscal policy. Appreciate you playing along.
Austan: (53:44)
You guys do great work. Thank you. And it's really my pleasure and thank you for inviting me.
Tracy: (53:49)
We're going to send that clip to our bosses. Appreciate that...
Joe: (53:52)
Take care, Austan.
Austan: (53:54)
Yeah, thank you.
Joe: (54:06)
Tracy, I really like the way he sort of framed this sort of golden path question, which is...
Tracy: (54:13)
You mean the soft landing questin?
Joe: (54:15)
The soft landing question, which is, you know, there's a few things we would want to see to know that we are getting back to the Fed's goals. And at least so far as he sees it, and I think it makes a good case, there hasn't been anything to disprove it. Doesn't mean it's guaranteed to happen, but we have yet to have something that says ‘oh no, we're off the path.”
Tracy: (54:36)
Well, also his point about keeping interest rates high as inflation falls being a de facto tightening — that makes a lot of sense to me. And I think that kind of plays into the long and variable lags idea that we're still seeing the effects of a lot of higher interest rates kind of filter through.
That said, I wonder if there's sort of a tension between forward guidance and crushing inflation expectations, while maintaining the flexibility that the Fed is clearly trying to hold onto, right? Because Austan was very adamant about, well, you know, ‘we don't want to bind ourselves to like any one particular path,’ which all makes sense from their perspective. But if the big wild card is inflation expectations, then I don't know, it feels like there's a tension there.
Joe: (55:32)
I still feel some level of unsatisfaction. It's not with like Austan or anything per se, but this question of like, okay, if inflation is coming down right, and it is, it's come down a lot and as you said the last, actually last few months, they're really like, you know, it's been really cool. Maybe it'll pick back up a little bit.
Why do we just see the sustained day after day pressure? And you could tell a story, kind of like Austan has, which is that, well that's the market saying the Fed is going to do its job, right? So I guess there's a positive spin, but why does the Fed need to keep rates [high]? Why is the market anticipating that the Fed will need to keep rates as high as they are just to get back to macro conditions that saw a few years ago.
I sort of feel like the answer must on some level have to do with the big shift in fiscal policy, but I'm not really sure. It's great [that we have] low unemployment, it’s great if inflation gets back to 2%, but I don't want to pay 8% for a mortgage. You know, I don’t want to pay 8% for a mortage. I didn't need to pay 8% for a mortgage in 2019.
Tracy: (56:39)
No, it's a good point. It's also, I mean, just to put it more simplistically, it feels like inflation is coming down, but we're still not entirely sure why, or if interest rate hikes actually had much to do with it, right? Because again, as Austin pointed out, in things like the most interest rate-sensitive portions of the economy like housing, things have kind of surprised to the upside, at least for now.
Joe: (57:03)
Yeah. No, it really does seem like on some level, a big chunk of the inflation — and, you know, not to go back to the old persistent versus transitory debates, but at least on some level, a big chunk of the rise in inflation in the fall seems to have to be, seems to do with sort of economic dislocations related to Covid, whatever they are. And then the question is, is it all of it? And is it 80% of it? Is it 50% of it? And what is it actually going to take to get to, you know, the end of the golden path?
Tracy: (57:37)
Yeah, absolutely. Alright, well for now, shall we leave it there?
Joe: (57:41)
Let's leave it there.
You can follow Austan at
@austan_goolsbee
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