In recent years, the absolute level of government debt around the world has risen dramatically. The Covid emergency unleashed a huge wave of public-sector spending in 2020 and beyond. Meanwhile, spending remains high for other reasons, including public investment on climate and energy-related issues. So what does that mean for policy going forward? What does it mean for central banks tasked with controlling inflation? University of California at Berkeley economist Barry Eichengreen presented a paper on exactly this topic at this year’s Jackson Hole Economic Symposium. On this episode, we speak with Eichengreen about his research, why it's of importance to central bankers, and what history says about the prospects for fiscal consolidation. This transcript has been lightly edited for clarity.
Key insights from the pod:
Why do governments borrow so much? — 3:30
How do Jackson Hole discussion papers get made? — 5:15
Going back to a world where monetary policy is the only game in town — 7:25
The downsides of high public debt — 9:03
The political appetite for bringing down debt — 12:41
Does the special status of the dollar and Treasuries give the US breathing room? — 15:50
Political disfunction and debt— 18:08
BRICS and moving away from the dollar — 21:03
The role of banks in buying debt — 22:23
Debt in other parts of the world — 25:48
How should central bankers respond? 31:27
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Tracy Alloway: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal: (00:14)
And I'm Joe Weisenthal.
Tracy: (00:16)
Joe, we are here at Jackson Hole, and I know that so much of the focus is on the short-term outlook for rates. But really this is a gathering to talk about the longer-term framework of monetary policy.
Joe: (00:28)
Yeah. It's so funny because it is an academic conference and there are all these sort of like big think sort of conversations going on about, you know, the changing nature of the global economy. Something like that I think is actually the theme, the structural changes in the global economy. But like 99% of the media interest in this whole event is ‘Are we going to get a rate hike in November or December?,’ you know, but there is so much more.
Tracy: (00:52)
Right. And one of the big themes that is emerging is this idea of living in a world where there is more debt outstanding. And we've seen that sort of pop up a number of times in recent months. Of course you had Fitch downgrading the US credit rating because, partly, of the public finance trajectory. You've had volatility in the Treasury market, you've had questions over whether or not investors are still going to want to buy bonds at a time when there's enormous supply and also the Fed out to raise rates and potentially bring down inflation.
Joe: (01:28)
I would say there's sort of two dynamics that I think [are] really interesting here with regards to sort of public spending and public debt. So I think there's sort of some of the technical factors that you've described. And of course we talked about them with Darrell Duffie as well, the capacity for debt absorption. And then we're also living in an age that's very different from the 2010s in which fiscal authorities are just taking a much more active role in economic management.
And so the 2010s were sort of, you know, fiscal took a backseat, all the pressure was placed on the monetary authorities to get us back to full employment, [and] so forth. And the 2020s so far feel very different from that because we've had these big spending bills, very active management. And so how that interacts with policy, what that means for inflation, what that means for central bankers, etc. And I think all of these questions, like what that means for central bankers, what that means for the macro trajectory going forward is going to be debated, I mean, probably for years.
Tracy: (02:23)
Exactly right. Let's get a jumpstart on this topic of high public debt. And I'm glad to say we really do have the perfect guest. We're going to be speaking with Barry Eichengreen. He is the professor of economics at University of California at Berkeley, and the man that central bankers here at Jackson Hole have tapped to research and discuss this exact topic. So Barry, thank you so much for coming on Odd Lots!
Barry Eichengreen: (02:48)
Good to be with you. Before we go on, tell me where did the name Odd Lots come from?
Tracy: (02:54)
Well, it's actually an old bond term for bond trades of non-standardized sizes.
Joe: (03:00)
When we started the podcast years ago, we didn't really know what it was going to be, but we sort of had a sense that maybe, you know, we try to find some off the beaten path stories. And so what's something that sounded like that? Odd lot sounded good and it stuck.
Tracy: (03:13)
Yeah, it works. So Barry, let me start with a really simple question here. Why do governments seem to borrow so much? Like what is going on that in 2023, we do have these massive fiscal deficits and we have had them for a long time.
Barry: (03:30)
Governments borrow for both reasons, good and bad. So we've seen that governments borrow to finance emergency responses to great recessions, financial crises, pandemics wars, and throughout history they have done that. When in exceptional circumstances, governments have to resort to exceptional fiscal policies. And they do so by borrowing sometimes big time.
On the other hand, it would be nice for governments to reduce those heavy debt burdens once the emergency has passed and restore that capacity to borrow. And that's where the borrowing for bad reasons kicks in. When you have divided government where you have inability of different political factions to agree on which form of of public spending to cut, or whose taxes to increase in order to restore fiscal balance, restore fiscal sustainability, you have the persistence of those fiscal deficits and high debt ratios. So again, there are good reasons why governments incur public debts and there are bad reasons why they persist.
Joe: (04:41)
Just a quick question, and you know, Tracy mentioned in the intro that you've been invited to this event to talk about your research in this area and you've done new research and that this event is more than just an opportunity for Wall Street to say ‘Oh, is the hike going to be in November or December?’
There's a lot more. First of all, actually, just a very sort of nuts and bolts procedural question. How does this, like how does it work? I think people are sort of, or at least I'm curious, maybe no one, maybe it's just me [and] Tracy are curious. But how does it work? How do you get invited and what is the process to like come give a talk and present a paper here at Jackson Hole?
Barry: (05:15)
So I can tell you what I I see and know as one of the invited speakers, but you should have the folks from the Kansas City Fed on as well. They're the conveners. But what I see is they came to me and I've done this once or twice before, same story. Then they came to me at the beginning of the year in January or February with an agenda of four topics. And they say, this is the one topic -- number four -- we would like you to write on. Are you willing to do so? And the topic has a title and it has a paragraph of why the topic is important and what some of the issues that you might discuss in your paper are. And then they let you go.
So there was a check-in a couple of months ago where I had a phone call with the research director and he said, ‘Are you on course? Is the paper going well?’ And I said, ‘sure.’ And he said, ‘all right, see you in Jackson Hole’. So they commission more experienced scholars, that's a way of saying, this is not my first rodeo, if you will, Jackson Hole talk.
Tracy: (06:20)
That’s good terminology.
Barry: (06:22)
And then they just let us go with it. They trust us to produce. And this is the kind of high profile event where the self-imposed pressure to produce is great, sufficient to deliver a solid result.
Tracy: (06:36)
Well, I was going to ask, does anyone ever say no to the Kansas Fed?
Barry: (06:39)
So, you know, we don't know that as authors, but if you look at the list of participants, it's pretty evident that for reasons of both quality of intellectual program and scenery, people rarely say no.
Joe: (06:54)
So let's get into, I mean, it's a monetary policy symposium. Your research is on sort of the fiscal side, public spending, public debt. Talk to us just about how you sort of like see this interaction. And I sort of mentioned in the intro -- the 2010s, it felt like fiscal authorities were kind of on the backseat, not a lot of active management. How do you, you know, sort of big picture and then we can get more granular. Why should central bankers be thinking more about the role of high public debt and high public deficits as they think of charting the course of monetary policy going forward?
Barry: (07:25)
Central bankers have to worry about two things. Number one, that fiscal authorities in many countries, and here the US is special because of the dollar’s global role. In most countries other than the United States, there will be less room for an active fiscal response going forward.
So there was one in response to the global financial crisis in many countries, again, during Covid. And as a result of that, debt to GDP ratios on average have doubled worldwide, which means that scope for using fiscal policy in response to the next crisis, whatever it might be, will be less. So will we have to go back to the world where monetary policy is the only game in town? And the answer is to an extent, yes.
Factor number two is that central banks will come under pressure to be more active debt managers. Some people will argue that if they accept a higher inflation rate, that will make managing the debt easier because we'll be inflating away the real value of the debt. I disagree with that because I think yields will respond and any benefit from inflation for debt management will be fleeting. But pressure to keep interest rates slow and tolerate more inflation will be more intense than otherwise because of this heavy debt.
Tracy: (08:46)
So you touched on it in that answer, but let me press you on this particular point and ask the Devil's Advocate question -- I'm going to channel my inner modern monetary theorist persona here, Joe -- are high levels of debt always bad?
Barry: (09:03)
High levels of debt are always worse than low levels of debt. So we would all like to see the debt to GDP ratio in the United States and globally be lower because governments will have be able to use more of their tax revenues for purposes other than debt service. We have the green transition, we have infrastructure needs, we have all the obvious things that only government can do, and we need government to do those things.
If government is using its limited tax revenues to pay interest on the debt, it has fewer resources left over for those other good things. So from that point of view, heavy inherited debts are a bit of a drag on economic growth. If you believe, as I do, that publicly financed infrastructure and publicly subsidized climate change related investment will be important for economic growth going forward.
Tracy: (10:02)
It sounds like there could almost be a distinction between bad debt overhangs and good debt if the good debt is taken out in the name of higher economic growth?
Barry: (10:13)
If government is borrowing to finance investments that make people and the economy more productive, so that grows the denominator of the debt to GDP ratio, the debt is less of a problem than it would be otherwise.
Joe: (10:27)
What are some historical analogies to right now? Because, you know, there's, you know, we've had, so it feels like there's kind of two things happening at once. There was the emergency spending in the immediate wake of when Covid hit, obviously. And then there is this sort of, at least in the United States, and I think somewhat elsewhere, certain more aggressive political winds shifting about our willingness to spend and again, you know, infrastructure and climate and chips in a way that we didn't really see for a long time. Are there any previous historical analogies that you can think of? Is it mostly wars in which you see this sort of like regime shift to the level of public debts?
Barry: (11:06)
I think it is emergencies tantamount to war. I'm an economic historian, but I'm also a firm believer that the role of historical analysis is not simply to draw parallels or analogies, but to look for differences between them. And now what is distinctive about our current situation?
I'm worried about the trajectory of debt. I'm worried about the trajectory of the economy more broadly in the United States because of the extent of political polarization and the need for a degree of political consensus to bring financial problems generally under control. I think political polarization and fractionalization in the United States are greater than any time in my lifetime.
So from that point of view, debt to GDP was higher after World War II, but, you know, we had the McCarthy years and politics were not exactly placid in the United States, but I do not see a scenario at the moment where the two parties can reach an agreement on raising more tax revenues and bringing entitlement spending under control, which is what you would need in order to flatten the debt trajectory.
Tracy: (12:18)
What is the political appetite to bring down debt? Because it feels like you're always going to have politicians who maybe are eyeing short-term gains, you know, cut taxes, boost public spending in order to win another vote, versus maybe a longer-term gain of actually bringing down the public debt. And that tension seems really hard to surmount
Barry: (12:41)
In my paper for Jackson Hole, we look at some of these historical experiences and they’re of two varieties. Number one, if you have a crisis that's enough to galvanize thought and action such that governments are able to bring down debt. So the Greek government crisis in 2010, Iceland crisis in 2008 have been able to run budget surpluses -- technical term primary budget surpluses -- excluding interest payments for the last 10 years.
And think about the United States, that's inconceivable here, but what impelled them into action was serious economic and financial crisis and the conclusion that there was no alternative, but get this problem under control.
And the other historical cases have been those in which there has been a broad political consensus where one party, or typically coalition of parties in the European setting, where you have coalition governments have been able to agree on a program of bringing fiscal policy and the debt under control. So bring those two cases to the United States. It, you know, the first one, the crisis scenario is not one we want to contemplate. And the second one, broad consensus on what to do is hard to imagine.
Joe: (14:06)
We would probably really need just like one party to sweep in massively with some sort of effort to either cut spending or raise taxes. But it's interesting because I've read a little bit in the eighties and the nineties, even as recently as in the eighties and nineties, there were occasionally multi-party efforts to cut, you know, I mean George H W Bush, famously promised not to raise taxes, the ‘read my lips.’ And then he did raise taxes a little bit. So even fairly recently, there was some appetite in DC among both Democrats and Republicans to address deficits from time to time.
Barry: (14:44)
And not only George H W Bush, but William Jefferson Clinton as well. The budget was broadly balanced through the 1990s. And I would remind you at the end of the nineties, we were talking about the disappearance of US Treasury debt and how financial markets would price assets in the absence of Treasury bonds because the federal government was running surpluses.
Tracy: (15:04)
Wow, what a weird time.
Joe: (15:06)
Yeah, can you imagine?
Barry: (15:07)
So it has been possible in the US context, but then we got the Tea Party and we got social media, you know. Everybody will have their favorite culprit for why we've had this increase in political polarization in the US, but it's a fact.
Tracy: (15:30)
You mentioned the dollar’s reserve status earlier. Does the idiosyncratic role of US assets in the global financial system, the safe haven status of US Treasuries, does that insulate the US somewhat from experiencing a crisis on the scale of a Greece or an Iceland?
Barry: (15:50)
Well, it certainly gives the US Treasury more room to run. In other words, there is this significant and expanding appetite for US Treasury bonds on the part of central banks around the world, which hold them as foreign reserves.
And as we show in the paper, there is significant and expanding appetite for US Treasuries on the part of the private sector, corporate treasurers, institutional investors of all kinds that view them as kind of a safe asset that they can hold as the bedrock of their portfolio, so we can keep adding to the stock of Treasuries in the hands of the public for a longer time than can other central banks that don't enjoy the same exorbitant privilege that their currency is a global currency.
Things can change. So I think to my mind there are, the, the big risk would be a disorderly debt ceiling blowout, which, the debt ceiling will be back on the table, if you will, after the presidential elections. So that problem and the danger it poses to the dollar’s global role are not off the table.
Tracy: (17:05)
Is this going to turn into a coin episode?
Joe: (17:08)
No, no. It's always you who thinks it's going to, and I wasn't going there.
Tracy: (17:11)
I live in perpetual fear.
Joe: (17:13)
But I was, you know, I was going to ask like okay, and you sort of anticipated it, but when you think about like what are tipping points and for when a government's public debt, suddenly people go from thinking it's safe and it's something they want to hold and it's something licked to something they're anxious, is the scenario that's more likely to create a tipping point, something where it's like a ratio where it's like, okay, there's some level and we're concerned about debt service. Sort of like classic credit concerns, or is it more something like the public starts to lose faith and not necessarily even do it to a ratio or due to aa stock of debt, but something about the US political system in which people do not feel good about what that government guarantee means, whether it's for something technical like the existence of not raising the debt ceiling, or just a sort of further degradation of the quality of politics in DC?
Barry: (18:08)
I think it's the politics that are the real and present danger. If financial conditions deteriorate very gradually, yields will rise very gradually and hopefully that will get the attention of policymakers sufficiently to at some point address the problem. Similarly, I do not think that aggressive US use of sanctions will prompt flight from the dollar. I don't think so-called weaponization of the dollar is the danger. Either because there are no alternatives and the BRICS can hold all the summits they want and they talk a good game about creating an alternative to the dollar. But it's easier said than done as the Chinese among the others have learned.
Tracy: (18:57)
Just on that note, how much is high public debt, at least in the US, the sort of other side of the coin of a lot of countries like China having these big savings surpluses that they need to put somewhere? To what extent is the deficit, I guess, enabled by those savings?
Barry: (19:18)
Michael Pettis has made that argument and I think that is part of the story, but the traditional story about trade surpluses and deficits that countries like China are running trade and current account surpluses and therefore they are accumulating dollars, that logic worked well in a world where capital wasn't mobile internationally.
So with Chinese investment abroad and foreign investment in China, which has been important until very recently, I think the story becomes more complex. So I don't think it's mainly about high savings and current account sur pluses in countries like China and Saudi Arabia. I think it's mainly about the dollar’s liquidity, about US Treasuries’ liquidity and their safe haven [status].
Joe: (20:07)
Since you mentioned the BRICS and there was just this sort of BRIC summit and there's this, you know, perpetual, I don't know, fantasy where people may, you know, science fiction about one day this sort of alternative…
Tracy: (20:18)
Possibility is a nicer way of describing it.
Joe: (20:20)
Okay. Instead of science fiction…
Tracy: (20:21)
A hypothetical.
Joe: (20:22)
But, you know, people do talk about this a lot. And I'm curious, you know, since you mentioned that, you know, the real risk to US dollar standing or US Treasury standing might be politics, would you say it's politics that's also the impediment to sort of something else rising? I mean, to your point, you know, people talk about maybe China needs to run its own current account deficit for yuan internationalization etc. Is the flip also essentially that we're not going to see a credible alternative to the dollar until there's just sort of much more global political confidence in the leadership of whatever country would theoretically be behind that currency?
Barry: (21:03)
Absolutely. So it's not only financial markets open to the rest of the world, which China doesn't have, but confidence in the political system of the issuing country. President Xi and the Politburo can change the rules of the financial game even more dramatically in response to events than the US Treasury did when it led the drive toward Russian sanctions in 2022. And I think Mr. Putin's actions have reminded the world of the risks of putting your financial eggs in the basket of an authoritarian leader. And China has been moving in that direction rather than moving away.
Tracy: (21:42)
We've been talking a lot about foreign demand for US debt in the form of reserves from other central banks, but you briefly mentioned that there are, of course, private investors who snap up Treasuries too. One of the big groups of private investors are the banks who are basically mandated to buy bonds because we have all these capital rules and things like the supplementary leverage ratio. To what extent is that sort of bank bondage, for lack of a better term, or financial repression, a solution to this problem? Can it help offset some of those exploding levels or at some point, does it become an issue, sort of how we saw in March of this year?
Barry: (22:23)
We used to talk about the diabolic loop or the doom between government budget deficits and banking problems -- that if you force feed government bonds to the banks, you end up with Silicon Valley Bank big time. So I think there are obvious risks with what you described as financial repression.
Carmen Reinhart, who was the commentator on my paper at Jackson Hole, is the specialist in that. She believes that there's more scope for that financial repression approach to managing our debt problems than I do. Financial markets are open and global, and if we weaken US banks by force feeding them bonds, they're going to lose business to foreign banks. So my view is there are real limits to going down that road.
Tracy: (23:16)
You mentioned Reinhart was the assigned discusser of your paper. What sort of questions do you get? Give us an insight on what that discussion actually looks like when you present your paper.
Barry: (23:27)
It's very much personality specific, so it helps if you're discussant is a personal friend, as Carmen is in my case. And on the other hand, you're a little bit on edge if you know that your friend and discussant has very different views than your own.
Joe: (23:44)
Sounds like a fun set-up. It's like me and Tracy’s set up.
Tracy: (23:48)
Maybe one day, in our dream world, they'll invite us to discuss one of the papers.
Joe: (23:53)
One of us will write a paper and one of us will critique the other.
Tracy: (23:54)
A live Odd Lots episode at Jackson Hole.
Joe: (23:56)
Can we talk a little bit more? Okay. So we imagine like it does not feel like there is some imminent big fiscal consolidation coming. Maybe there'll be a crisis or something -- hopefully not. But it, as you say in your paper, it looks like we are in an era of high public debts that will be sustained for a while.
Can you talk a little bit more, I mean, you mentioned perhaps these constrained fiscal authorities in terms of what they can prioritize and so forth. Can you talk a little bit more about what you see as some of the implications of this world, maybe both for the US and countries that don't enjoy the same status as the US? How do you think that world looks versus say the last decade in which it seemed like, you know, ample demand for debt? No real issues. How does this world look different?
Barry: (24:45)
We learned it in the global financial crisis, and again, during the pandemic that being able to adjust fiscal policy, being able to mount an assertive fiscal response to events can be invaluable. Can be critically important for stabilizing the economy. And there will be much less scope for doing that in a wide variety of economies around the world. So I would caution us collectively that this is not only a story about the United States, but it's a story about 180 economies around the world. Many of which, most of which are more heavily indebted, significantly more heavily indebted than they were before. And their governments will not be able to use fiscal policy in the same way.
Joe: (25:25)
We focus so much on the US context, and we've talked about the sort of political degradation and the debt ceiling and things like that. But I don't know if, is it a similar story elsewhere? Like why in the other 179 countries have we also seen this sort of debt trajectory and perhaps a similar unwillingness or similar difficulties to constrain the fiscal response?
Barry: (25:48)
The global pandemic was global by definition. So most governments around the world faced the same imperatives. People were locked down and government had to provide support for households that couldn't otherwise feed themselves.
And secondly, yes, there are political problems. Some people who believe in small government at all costs prefer starve the beast kind of policies where you cut taxes now in order to force government to cut spending later. And you don't always get the later part of the equation.
When governments are unstable or alternating in office, those in office prefer to spend on their preferred programs now before the other party comes into power and both parties engage in that kind of behavior. So political dysfunction is part of the story to be sure.
Tracy: (26:45)
In your conclusion in the paper, when you talk about the implications of living with high debt, you sort of sum it up and say, basically it means we'll have to try to avoid steps that make a bad situation worse. And you list a bunch of those potential steps. So things like raising taxes in the good times or lowering, unproductive spending. But you had one line in there, I'm not entirely sure what it means, it's “targeting social transfers as a way of limiting pressures on the expenditure side.” What do you mean by that?
Barry: (27:15)
Means testing? That in the United States, certainly entitlement spending is a big part of the federal budget, the majority. And it's not clear from an economist's point of view why the 1% should be receiving social security payments every month.
Tracy: (27:34)
Oh, interesting.
Joe: (27:36)
Can I ask you a question? And maybe it's a little bit more short-term focused, but you know, for throughout the 2010s, I don't even know why, in retrospect it seems like a silly challenge, but we kept missing inflation from the downside. It doesn't seem like a terrible problem to have, but that's how people characterize it. We couldn't hit the target from the downside. And one of the arguments that you heard a lot through the 2010s, is, well, we should spend more and we should boost demand, should boost domestic demand, use the government's power to spend.
And that never really happened, again, due to politics. When you look at the challenge right now that the central bankers here face with high inflation and surprisingly resilient inflation, rapid rate hikes have not had the effect yet, at least of getting inflation back to target as people might have guessed.
How much is that essentially the flip story of the 2010s, that it's you know, the aggressive fiscal policy has contributed to the current inflation and makes the challenge of getting back to target difficult for policy makers?
Barry: (28:42)
Boy, you're bringing me back to the much discussed issue of what caused our current inflation? And we know the answer is one of three things. Supply shocks starting with Covid, excessive fiscal stimulus, notably the early 2021 Biden stimulus I think was a bit more than we needed. And number three, the Fed was about a year behind the curve -- like the rest of us, I include everyone in this room, everyone in this podcast about a year late…
Joe: (29:12)
We're all implicated, all three of us, all of us.
Barry: (29:14)
… In realizing that the inflation environment had changed and a very different central bank policy was needed. So I think all three factors played a role. And if we're really now experiencing a soft landing, something between a soft landing and a no landing where inflation comes down with only a very modest increase in the unemployment rate, if any, we should have that discussion about how to narrow the budget deficit.
Joe: (29:43)
Can I just ask though, just to follow up, I mean there's a lot of talk about like, well, what were the policy errors? And you sort of identified two very popular ones, which is excessive fiscal and central bankers coming slow. But on the other hand, we have three and a half percent unemployment, multi-decade lows, other measures of labor market utilization are very impressive. Prime age employment to population ratio.
How should we think about weighing the costs and benefits? And I'm not talking about like ‘Oh, we should like formally accept 3% inflation’ or something like that. But there are good things that seem to have come out of the government's aggressive response to the pandemic. And how should we think about weighing those benefits against the cost of the higher inflation that everyone's talking about here?
Barry: (30:26)
Yeah, I think the benefits were considerable. So you, Joe, asked me about the sources of inflation and I pointed to a couple of macro policy mistakes, if you will, that contributed to the inflation. But overall, I agree with the implication of your question that we responded quite well compared to the response to earlier crises to the most recent pandemic and energy crisis related shocks. That's quite remarkable that two years on we're back to 3% inflation and three and a half percent unemployment.
Tracy: (30:59)
How do you view the impact of monetary policy in a time of higher debt? Because there is, I mean there are multiple arguments on this topic, but one argument for, instance, is that it's harder for interest rates to stay high in an environment where you have lots of public debt because the impact of those higher interest rates is going to be more painful and also because higher debt servicing costs for the government. So how are you thinking about those two issues?
Barry: (31:27)
We talked about that a little bit earlier, I think. My view is that the Fed really is committed to its 2% inflation target, despite the pressures you allude to that keeping interest rates higher than otherwise in order to bring inflation all the way down to 2% will make debt service a bit higher in the short run than it would be otherwise and add to the fiscal problem. And Chairman Powell was clear at Jackson Hole, that is not his immediate concern. His immediate concern is convincing the public in the markets that we are on track to 2%, and I take him at his word.
Tracy: (32:04)
Let me ask this question in a slightly different, perhaps more provocative way, in that case. What should central bankers do in response to higher public debt levels?
Barry: (32:17)
Well, they have to be aware that the economy will not receive support from fiscal policy in the next downturn in the same way that it did in 2020, 2021. In the same way even that it did in many countries in 2008, 2009. So they have to be prepared to respond.
I think they have to make clear that they will not fall prey to what economists call fiscal dominance. That monetary policy will not become a slave to fiscal and debt problems. And they will have to look even harder than otherwise at financial stability risks. Who is holding this public debt? Are there concentrations of public debt? Are there unhedged interest rate exposures related to those holdings? Because central banks are monetary policy makers, they're also regulators.
Joe: (33:16)
One last question and it's sort of an ex-US question. So obviously the Fed has incredible balance sheet capacity and we saw it step in big time in March, 2020 to buy all the Treasuries and stabilize the market. We've also seen the beginnings, though, I think, of other smaller central banks do something similar. I think Brazil for example bought some of its own government debt. Going forward, do more central banks around the world have that capacity or the credibility to use their own balance sheet to smooth government debt markets than perhaps there was in the past?
Barry: (33:50)
Yes, I think that's the case. More generally, monetary policy, central bank policy has gained credibility over time in emerging markets in particular. So we saw that in the fact that many emerging markets moved more rapidly than the Fed did in 2021, 2022 to begin to hike rates and bring inflation down. And that monetary policy credibility, that anti-inflation commitment gives them more room for maneuver, including when circumstances dictate expanding their balance sheets.
Tracy: (34:25)
Alright, Barry, it was fantastic having you on Odd Lots. Thank you for giving us, I guess, our own personal presentation of your paper. We really appreciate it.
Barry: (34:34)
Thank you both.
Joe: (34:35)
Thank you so much. That was great.
Tracy: (34:45)
So Joe, obviously that was really interesting. I did think that his warning about maybe next time the fiscal response won't be as big, you know, it will be restrained in some capacity. That was interesting.
Joe: (35:00)
There are two things. I mean, yeah, in a period of high inflation, like already you would expect that that is going to constrain the appetite of policymakers to spend further, etc. But I was really struck and I think that it’s very telling, the discussion of politics and that manifests itself in different ways. It manifests itself [in] the lack of appetite for fiscal consolidation. It could manifest itself where people just freak out, it’s like, ‘I don't really trust the United States anymore.’ It could be a debt ceiling trip. It feels like that's really where things did go from stress to crisis.
Tracy: (35:34)
Yeah. And that was that tension, that's the reason I asked that question about ‘Well, how do you ever get politicians to sort of sacrifice the next four years in exchange for longer-term gains about bringing down the deficit?’ It seems really hard, but his answer about you kind of need a crisis to crystallize it, I mean, it makes sense. It's also a bit worrying.
Joe: (35:54)
And again, you know, history unfortunately seems like kind of cruel on this point. And you know, you could even go back, well what did it take for us to get to full employment and above trend inflation from the 2010? Well, it took Covid, right? And history seems to be like you have some stable macro regime and then a crisis comes and then you have a new macro regime. I also thought it was, his sort of skepticism that an alternative to the dollar would come about by sort of the mechanics of who's running a trade deficit or a trade surplus or something like that. And that the flip side of our political dysfunction is the lack of political confidence in any other issuing authority of another currency.
Tracy: (36:32)
Yeah, that's a good way of putting it. The other thing I thought was interesting was, well, I think one thing that I'm hearing both from this conversation and from the one we recorded with Darrell Duffie is because so much of the financial system is built on bonds, it feels like the risks are higher as we enter this period of higher inflation, right? There's a tension between bringing down inflation and also having bonds as the sort of stable, boring bedrock of the financial system. And he mentioned the sovereign bank loop -- no one believes me -- I invented that term.
Joe: (37:06)
I don't believe you, but…
Tracy: (37:07)
Listeners should see Joe's face right now. He definitely doesn't believe me.
Joe: (37:10)
I believe you.
Tracy: (37:11)
I think it was, I believe it was 2011. I was the first one to use it in an Alphaville post during the Greek crisis.
Joe: (37:16)
I’m going to Google it.
Tracy: (37:18)
Good, do it. Shall we leave it there?
Joe: (37:20)
Let's leave it there.
You can follow Barry Eichengreen at
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