The US economy has so far withstood the effects of higher interest rates a lot better than expected. Unemployment is still at historic lows, even while inflation has cooled and the Federal Reserve has hiked rates for about 18 months. That's not how things are supposed to work according to traditional economic theory. So what's going on? On this episode, we speak with Richmond Fed President Tom Barkin about how he's viewing the impact of higher rates right now. He talks about what businesses are telling him about their plans, and what sectors of the economy could still feel the long and variable lag from tighter monetary policy. This transcript has been lightly edited for clarity.
Key insights from the pod:
What are businesses saying about the economy? — 4:08
The lingering effects of the pandemic on businesses — 7:46
What the Fed thinks about housing now — 12:19
Do house prices have to come down to reduce inflation? — 15:25
The impact of higher rates on investment and supply-side — 17:01
Thoughts on sellers’ inflation — 18:50
Do higher wages drive inflation? — 22:31
Impact of the UAW strike on inflation — 24:42
Bond market sell-off — 27:34
Impact of oil price on inflation — 31:57
Monetary policy and big fiscal — 24:25
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Tracy Alloway: (00:09)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloy. Joe is sick today, and so I am very pleased to say that I have a guest co-host Matt Boesler. He is an economics editor for Bloomberg.
Matt Boesler: (00:24)
Hi everyone, I'm Matt Boesler. Excited to be here.
Tracy: (00:26)
So, Matt, I'm so glad you're doing the show today. It is an interesting time in the US economy and particularly this week, we're recording on September 28th. We've seen this massive selloff in the bond market following the recent FOMC meeting. There's lots of talk about higher rates for longer, lots of concerns over whether or not inflation is maybe picking up again given the rise that we've had in the oil price recently. But overall, it kind of feels surprising how resilient the US economy has so far proven to higher interest rates.
Matt: (01:02)
Yeah, it's really interesting. You know, the Fed has been raising its benchmark short-term interest rate for 18 months now. We haven't really seen an aggressive move up in long-term interest rates until just the last several weeks. So it's almost like, you know, the tightening cycle, maybe it's just gotten started here.
Tracy: (01:18)
Right. The 30 year yield, I think when I last looked at 4.7%, something like that. You also have all these headline risks sort of lurking. There is the looming government shutdown that might actually have started by the time we release this episode. There's questions over the UAW strike, all these sorts of idiosyncratic risks also starting to come into play.
And here on Odd Lots, I think people know that we always like to try to tie the macroeconomic outlook and monetary policy to the real business stuff that's happening on the ground. So I am very pleased to say that we do, in fact, have the perfect guest with us today to discuss all that. We're going to be speaking with Tom Barkin, the president of the Richmond Fed. Tom, thank you so much for joining Odd Lots.
Tom Barkin: (02:03)
I'm looking forward to it. And you certainly laid out a long list of things we need to cover.
Tracy: (02:07)
I know, and we only have about 40 minutes, but we'll try to do our best. Maybe just to begin with, I know you have taken a kind of, I don't want to say unusual approach, but maybe a special approach to your job as president of the Richmond Fed. You like to go out and talk to businesses within your region, and I'm curious, I, I know that you were previously at McKinsey, but how does that kind of feed into your thinking around monetary policy? What do you get out of those discussions?
Tom: (02:42)
So we have a beautiful 24 story building in Richmond. If you drive down I-95, you'll see it. It's quite literally an ivory tower. And so one thing I figured out pretty early in my tenure was that the data comes in late, it's then revised three times. And so it's awfully hard to know what's actually going on.
And so I just made a personal commitment that with the exception of the two weeks around the FOMC meeting, I'm going to be out every week. And in the last month I've been on the eastern shore, I've been in the coal country and South Carolina. I've been in Southern Virginia. I've been in the northern Virginia suburbs. I've been in Western Virginia.
And in every one of those trips I'm meeting with business people. I'm meeting with nonprofits. I'm trying to understand what's actually, you know, happening in the economy. And that's where I get my information to sanity check the data as it's coming in and try to develop, you know, my own unique perspective on what's happening.
Tracy: (03:32)
I think, to my knowledge, you're the only Fed president who has actually mentioned the Beyonce and the Taylor Swift concerts in a speech -- a formal speech.
Tom: (03:41)
I don't know if that's true, but my daughter also wanted me to put in a few quotes from the Barbie movie, and I managed to withstand doing that.
Matt: (03:49)
You know, we have so many people here in New York in this building and in the surrounding area just pouring over every monthly economic statistic, whether it's the jobs report, the inflation report. When you're going out to all of these places, are you hearing things from businesses that are not necessarily being reflected in the data right now?
Tom: (04:08)
Yeah. So a couple great examples. Demand, if you look at the recent data we've gotten on consumer spending, it's been unbelievably resilient, as you said upfront. When you talk to businesses, you'll hear it's okay, right? That's a pretty big gap.
And I was with a, a big retailer about three weeks ago that started talking about, you know, what they perceive to be the different segments of consumer spending, the high-end consumer who's still spending on experiences, you know, like Taylor Swift and Beyonce. There you go. I got it in there.
Again, versus the low income consumer who we all know is, you know, savings been somewhat depleted. And he started talking about the middle income consumer. And the way he described it was they're trading down, you know, they're going to the grocery store, the branded grocery store for their food, but they're buying the kids' notebooks at a dollar store.
And, you know, you hear those sorts of things and then you try to find the evidence in the data to talk about what's happening on the labor side.I was with a manufacturer in South Carolina who said that they're losing people to Bojangles, which was an awfully, you know, strange idea. For those of you who don't know, Bojangles is a fried chicken place largely in my district in the south, but it turns out it's an indoor environment, not an outdoor environment. Shift flexibility is obtainable so you can work the hours you want to work. And the pay at Bojangles has actually narrowed most of the gap with the manufacturer.
Then two weeks later, I told you I was in coal country. I was talking to a guy who owns a coal mine, and he was describing his problems getting workers. And I said, ‘wait a second. You know, this is West Virginia. There's all these stories of the coal mines not being able to operate enough and all these unemployed workers.’ He said, ‘yeah, but the thing you have to understand is that cell phones don't work inside of a mine, and people don't want to work if they can't bring their cell phone to work.’
And so I've been, you know, you asked what's different from the data, the data would suggest to you that the labor market has settled. But what I'm hearing is that the labor market, which was very stable for a long time, and the hierarchy of jobs has gotten thrown up in the air. And there's a set of jobs that used to be paid X and are now paid Y where they're more advantaged and other people are being left behind, think state and local governments that can't increase their pay.
There are other jobs that offer remote work versus, or, you know, cell phone access in your workplace and others don't. And those are getting ahead. And so employers are struggling to catch up with the new hierarchy of jobs. And if you're in one of those jobs, think childcare or teachers or state and local government or nonprofits, you know, those folks still have more to do to get their jobs filled, to get people into jobs, to retain people.
And there's wage inflation, you know, potentially related to that. So that's the kind of thing I'm trying to pick up when I'm out there. And I think it helps make me think about the economy in a totally different way than just what the data shows.
Tracy: (06:57)
That's so interesting, because of course, when you look at the data, it's all aggregated, right? So you can't see those types of like qualitative variations that you just described.
Just on the notion of companies -- some companies maybe still struggling to find workers. You had a really good speech, I thought, back in August where you basically argued that one of the big reasons we haven't seen a recession in the US yet is that memories of the pandemic are still very fresh.
And so companies are still reacting to past shortages as opposed to really worrying about excess capacity. Do you think that dynamic starts to change as interest rates go higher? And what I mean by that is, at some point, does the added expense of investment at higher rates kind of start to outweigh concerns over future capacity?
Tom: (07:46)
I'll say two things I was getting at in that speech. One of them is that if you just spent a year trying desperately to fill empty jobs, you're going to be a little cautious before laying people off cavalierly. And I think if you look at the layoff announcements by businesses over the first half of the year, for example, you'll see they're massively disproportionately professionals, not frontline workers, not skilled trades and manufacturing/construction workers.
And I think that's because people genuinely are concerned they won't be able to find those people, you know, if they lay them off. You know, the other thing I was getting at there is we've been predicting this recession for a long time. It's been 16, 17 months where the leading economic indicators have all been pointing to recession. If you're a business, and I've talked to a bunch of businesses about this, last year's plan, they scaled back this year's plan.
In other words, the 2024 plan, they're scaling back. So they're being cautious. They're not investing in discretionary spending, or extra. They're making those kind of investments. And so if you do have a downturn, right, the implications are just going to be much less because people have already prepared for it.
When it comes to the question of business investment, businesses, interest rates and how they affect it, I saw a great chart last week that was interest expense as a percent of revenue gor American corporates. And what it showed is still pretty low. I think it's now basically exactly where it was in 2019.
That doesn't mean there's some people who aren't paying a lot more, but on average a lot of people refinanced. You know, during the Covid era, a lot of people aren't as dependent on borrowing. And so in total, people aren't paying more in interest. Corporations aren't paying more in interest right now. Not yet. I mean, presumably that'll come.
Tracy: (09:27)
Just on that note, I'd be curious to hear what you have to say about the impact of higher rates in general and where you see the effects of the recent tightening the most in terms of the real economy. So for instance, it sounds like it's not having that much of an impact on investment for the reasons that you just laid out, but is it having a noticeable effect on, for instance, consumption?
Tom: (09:50)
Well, so the place you can see it most clearly is what I'll call interest-sensitive sectors. You know, housing obviously was very frothy when we started our interest rate increases. It's gotten less frothy, you know automobiles, durables, furniture, all those sorts of things. Banking you obviously see have seen the impact so far.
You know, on the consumer side, you'd expect to see, and I would've expected to see more impact than we've seen to date. I have to say, there's still a lot of the pandemic in the economy. And what I mean by that is the excess savings that came through for people not spending as much or retaining whatever stimulus. Another interesting thing I ran into the other day is that adjustable rate mortgages, which back in the 2000 era were a very large part of the mortgage base…
Tracy: (10:39)
Right, Option Armageddon and all of that.
Tom: (10:42)
Right, in 2003 are 8% of all mortgages. And so, whereas you might've thought that interest rates would reset very quickly, they actually haven't reset all that quickly. Commercial real estate is a place you clearly see at another interest sensitive sector.
So we see it in interest sensitive sectors. Business investment is flattened, is how I'd put it. Consumption still remains very healthy, but I still think there's impact of the rates in train. I still think it's coming in train, but I'd agree it hasn't been nearly as impactful as you would've imagined when we started increasing rates a year and a half ago.
Matt: (11:32)
You mentioned housing, and I mean, I think that's a really interesting example to look at here because we usually think about that as the sector that is traditionally most linked to monetary policy. And of course, it's also historically played such an important role in the US business cycle overall.
But we're in a situation here with housing now where mortgage rates have shot up, people are not moving. So you're seeing that impact on kind of sales and construction, and yet house prices are already back at record highs. So how do you assess the impact that you're having in a situation like that where activity has fallen off a lot, but you're not really seeing any sort of follow-through at the price level, which is perhaps one might think what Fed officials care most about?
Tom: (12:19)
Well, so let me just talk for 10 seconds about housing before getting to your question, which is, I just think there's been a secular change in the priority people placed on housing in their demand in their wallet, right? If you're spending five days a week at home, three days a week at home, seven days a week at home, you know, your house matters a lot more. Your office matters more. Your patio matters more, your furniture matters more.
And we saw that during Covid. And so I just think people are much more focused on their house than they were before. And that has created a demand increase. In addition, you had a generation of millennials who are now having kids and thinking, ‘I kind of need a house.’ And that has also been a demand increase and a generation of seniors who think that nursing homes aren't quite as attractive as they were before Covid, and that's had a supply decrease.
We in increase interest rates. I do think that has brought demand down. I mean, when you hear from home builders and others who are selling houses, demand for houses has clearly moderated from the frothy 12 offers for every house at, you know, $20,000 over list that we had about a year and a half ago.
That said, the supply is still short and it's short for the obvious reason that if you have a 3% mortgage, you're not dying to sell that house and get into a 7% mortgage. It just changes the financial formula. And so what we see in terms of the effect is you still have very limited supply of houses for sale, residential construction, which you said is cyclical, and normally is, it's actually not as weak as you'd think it would be, because the big home builders are saying, ‘I can sell every house I can make.’
And so they're building houses, right? That 10% of the market is actually pretty vibrant because people still need houses, they can't find them. And so they're buying new houses as opposed to existing houses. But the existing house market is, I'll say the supply is very weak, the demand is coming off, but it's still in excess of supply. And that's what's keeping the prices high.
How do we look at impact? I mean, we have one tool called interest rates. It's a pretty blunt tool. When I talk to home builders and realtors, you know, I'm asking questions, is demand coming off or not? It is quite clear that demand's coming off. It's quite clear there are fewer bids per house. You know, when is price coming down? That's a much more difficult, you know, thing to get to. And it's definitely stabilized from the, you know, extreme spikes we were seeing a year and a half ago. But it certainly hasn't come down in any kind of scale.
Matt: (14:43)
So two quick follow ups then. Is the upshot basically that perhaps the most you can hope for here in this kind of supply constraint environment is just that you are going to slow the rate of growth of price increases, and then also does that kind of then change the way you think about the monetary policy transmission mechanism in that maybe you have to lean harder on other sectors of the economy to get the overall type of slow down that you're trying to achieve with higher interest rates, if housing is not going to play a central of a role to the whole story?
Tracy: (15:14)
Yeah, because this is also slightly different to what Powell said, I think like a year or maybe two years ago where he was talking about the need to put some sort of dampening pressure on house prices.
Tom: (15:25)
Here's how I'd think about it. To bring pricing into alignment, you want supply and demand to get into better balance. That means both the supply side and the demand side matter.
We are seeing progress on the supply side. A lot of the supply chain issues we had a year or two ago, with the exception of chips and switch gears, seem to be in much better shape. You've seen labor force returning to the market at a much higher level, so you're getting some help on the supply side.
And we're doing what we do on the demand side, right? And we're just trying to calibrate that. And so to get to where you need to get into balance, you can get there with lots of different goods and services pricing in very different ways. You don't just have to get one element in shape.
Now housing's a big part of the economy, and so if rents come into line and housing comes into line, that would be useful. But, you know, relative prices move all the time. And if what we've had is a secular shift toward more demand for housing, that might mean somewhat less lessening of housing prices and somewhat more lessening of another set of prices.
Tracy: (16:25)
Can I ask more generally how you're thinking about, you know, if we assume that a lot of the recent inflation has been driven on the supply side, and you know, maybe that's a big assumption, but when you raise interest rates, there is this argument that may your dampening future expansion and investment at a time when you really want to see it expand and housing is kind of an example of that, even though a lot of construction has been stronger than people have expected. How are you sort of viewing that tension between higher rates maybe impacting capacity versus trying to reduce demand?
Tom: (17:01)
I think it's just a time horizon question, because inflation doesn't help in building capacity either. And so if we can raise rates for a relatively short period of time, get inflation under control and bring the economy back to the kind of economy we've had with stable prices and, you know good employment and strong GDP, that will be good for investment.
If we don't, then, you know, you've seen countries that don't control their inflation, that's a totally different investment stature. So it's one thing if you said, ‘Oh no, wait a second, we're going to constrain the economy forever.’
But people who invest aren't investing based on one or two year horizons. They're investing on long-term horizons. And I think they think us taking the moves we're taking to get inflation under control are actually helpful for investment, not the other way around.
So I'm talking to lots of businesses and one of the questions I ask them is, you know, what's your investment posture going forward? And folks are still leaning forward on investment. We got a durables goods report this morning that was actually pretty healthy. Businesses are still investing.
Now, that doesn't mean they're going crazy, you know, I talked about that earlier. But they're still investing, their investing levels are actually pretty solid. And I think that is completely just a bet on the medium- to long-term perceived health of this economy. Hmm.
Tracy: (18:13)
We touched on house prices, but I wanted to ask you a sort of wider question on pricing decisions that businesses are making now. I would be really curious to get your thoughts on this whole idea of sellers’ inflation or profit-led inflation.
So we've heard some ECB members talk about it, this idea that maybe companies are using these industry-wide shocks to propagate higher prices. And we have seen a lot of shocks over the past couple of years. I think Brainard might've mentioned this way back in January, but of course she's not at the Fed anymore. Is the Fed thinking about this dynamic at all?
Tom: (18:50)
I'll put it a little different because I do believe in capitalism, and I do believe that companies raise price when they have an opportunity and lower price when they have a benefit.
Tracy: (18:57)
I've very carefully avoided the ‘greedflation’ label.
Tom: (19:00)
Yeah, but here's what I think what's going on. It's been 20 or 30 years before covid of 2% to 3% inflation, very stable prices. Part of that, I hope you think was good leadership by the Fed, but part of that was a set of elements in the economy that held businesses back.
E-commerce meant that people could electronically shop prices. You go to a bookstore and you just click and compare it to Amazon. Big companies, autos being the first but many big companies, invested in big purchasing departments that allowed people to negotiate. Your big box retailers were famous for saying, ‘don't give me any price increases, or I'll take, you know, manufactured at China.’
You had offshore production, you had offshore labor, you had demographics, you had fracking. There was a whole set of things that kept pricing under control and frankly kept businesses away from pricing.
So when the tariffs happened in 2018, I talked to a lot of businesses affected by the tariffs, and I said, ‘Are you going to increase price?’ And they said, ‘Well, I'll increase, increase them to this segment of my customer base, but I can't take it to one of the big home improvement chains because they won't accept it.’
And that was, that's market power. And that was being deployed in an effort to keep prices under control, but businesses also didn't have the confidence to raise prices. So then you have these supply constraints, you have the stimulus, you have the inflation comes, and in every boardroom in this country, some business person put their plan together. And the board said, ‘well, why aren't you being more aggressive with price?’ And so those folks who had big cost squeezes or availability problems, they increased their price.
And those people who colorably could explain that they might have those things also increase the price. And I don't think that's greedflation, or, I mean, that's just how businesses react. And the way I think about it is, after 20 years, 30 years of price not being on the table as a lever, it's now on the table as a lever.
And I would say, having been a consultant in my life, it is the quickest way to make more money if you're successful. Price goes straight to the bottom line. You don't have to hire any other people there. You know, it's a very good profit lever if it works. And so businesses that got that opportunity aren't going to stop trying until either their customers or their competitors, you know, make them stop.
Now you see in many sectors, you know, prices coming down or even going the other way. Apparel, used cars, you know, being example. So I'm not saying this is a permanent thing, but it's part of why I think inflation once having blossomed is somewhat slower to settle, because I just think it takes time to get back.
I'd remind you that we didn't get, the Volcker inflation fighting team, I think the number is by 1986 had gotten inflation down to 4% and it took down to the nineties to get it to 2%. It just takes a while once you've unleashed inflation to put it back in the box. Hmm.
Matt: (21:46)
This is so interesting. So let's bring wages into the picture now, because it seems like there's a lot of new research emerging from various corners of the Fed system. Some Fed presidents have been talking about this idea that it looks like, in the data, wages are more likely to follow prices than the other way around.
Now, of course, when we think about kind of the textbook explanation of how monetary policy works, it's like you raise interest rates, that loosens the labor market, that puts downward pressure on wages, and then that downward pressure on wages filters through to prices. So which side of this argument do you kind of come down on?
Tom: (22:23)
Well, I'm not a trained economist, but I kind of want to say both sides. So let me try to explain that.
Tracy: (22:28)
You can get away with it as an untrained economist.
Tom: (22:31)
Exactly. So there's no question in my mind that this bout of inflation wasn't driven by wages. It was driven by a set of other things, supply constraints and fiscal stimulus, which increased demand and that sort of thing.
And so prices went up, and then a bunch of people, including I'm sure the two of you said, ‘Huh, I wonder why my merit increase is only two point a half percent when inflation's five or six. Shouldn't I have a higher merit increase?’
I mean, that's how the world works. So in that part of the world, prices drove wages. And when I talked to people this year about merit increases, they'll say, well, inflation's come down, so maybe I won't give three, maybe I'll give four. Prices are driving wages. But there are other places where wages drive prices, and the most obvious places are service sectors where most of your cost structure is wages and people had availability issues.
And so you had to pay more for gardeners or barbers or whatever. And so you have no option but to pass that through in price. So I definitely believe in this episode, the price inflation drove wage inflation.
But there are sectors, even now hospitals would be a great example. Hospital nurses increased in price significantly during Covid. Hospitals have very little pricing power, at least in the short term. They get their money from Medicaid and from the health insurers. But hospitals whose margins are squeezed are going to have to go back to commercial insurers and ask for more. And those commercial insurers will in fact, it will then pass that on to customers. And so in that case, wages will drive prices, but you know, maybe prices drove wages which then drive prices. That's how you get into this circular argument.
Tracy: (24:04)
This is a nice segue into some of the labor issues that I mentioned at the top, notably the United Auto Workers strike. How are you thinking about the potential impact on the auto supply chain and inflation and GDP given that it seems like it's coming at a time when we were beginning to see the price of used cars start to drop after many, many months of sort of abnormal activity there. What does that suggest to you? And are those strikes kind of looming a bit larger in the Fed's thinking nowadays?
Tom: (24:42)
Well, we've had a series of labor disputes or near disputes starting with, I guess there were some airlines and UPS, and of course, the writers just settled their strike. You got the autos. And in all those cases, their implications for supply and their implications for employment and potentially that we'll see implications on pricing and all those fit as best I can tell into the ‘we'll see’ category.
You know, one of the things I liked about our posture coming out of the last meeting is that with demand relatively strong, by all accounts, labor market's still relatively strong and inflation cooling, we have the latitude to say, ‘let's see how this develops.’ So I could tell you stories of this creating inflationary pressure. I could tell you stories of this creating excess labor. But I'd just be telling you stories. I think we have to see how this turns out.
Matt: (25 :36)
So Volcker famously attributed the breaking of the air traffic controller strike as kind of an elemental turning point in bringing the inflationary period of the 1970s to heal. Do you think about it similarly?
Tom: (25:55)
I'm actually pleased to say I remember that. That was 1981. So that was, what? 42 years ago? I believe in the seventies and eighties, the common wisdom on inflation was that there were two sets of sources. You know, one was the role of the Fed and its unwillingness to stay the course in terms of battling inflation. And the second was, you know, wage price pressure where wages were in fact driving prices.
So I haven't heard that quote if he said it. He's probably talking about union power and what that did to that part of the equation. But I was in college studying monetary policy at the time, but all I've read and learned about monetary policy would give Volcker a lot more credit than to say breaking of one strike.
I think the willingness to stand up to high inflation and say, ‘We will do what we need to do to get it under control’ in a way that was broadly seen eventually as quite credible, has to be the key element in getting inflation under control as opposed to any one, you know, government union in the strike.
Tracy: (27:02)
So I promised that we would try to get to all of the sort of headline risks and developments that I mentioned in the intro. And you're right, there were a lot of them. But one of them is the bond market sell off that we've seen.
Were you surprised at all by the market reaction to last week's meeting, given that, you know, we had the dot plot kind of suggesting higher for longer, but it came with better growth projections as well? And yet fast forward a little over a week and it feels like there has been this very dramatic reaction in the market.
Tom: (27:34)
I don't think I understand the market well enough to give you much commentary on it. It does move around and it moves around for lots of reasons, which undoubtedly include what we do, but also include a lot of foreign country dynamics, you know, Japan or China and who's buying and, and who's not, Treasury supply, you know, and all that.
And so my interpretation of the SEP, and I should remind everybody that it's 19 individuals’ individual forecasts, and then there's a median. And so the median is not the median individual, it's the median inflation and the median GDP, but it seemed pretty straightforward to me that it marked up GDP based on a pretty strong summer of growth.
It marked down the unemployment rate based on a pretty strong summer of growth, and it kept inflation the same. And the only way to square those would be to have a somewhat higher for longer rate path. So that those things went together, at least in my estimate. If I'm wrong on my inflation forecast or I'm wrong on my unemployment forecast, then I'm wrong on my Fed funds rate forecast. We'll see what happens.
Matt: (28:41)
So you can definitely let us know if you're out of step with the median after I ask this question. But, you know, one of the striking things about those projections that you put out last week was the pretty decent upgrade to GDP growth in 2024. So the story kind of coming into this meeting is that, you know, a lot of people earlier in the year thought we were going to have a recession, and the growth forecast were very weak.
And then over the last several months, people have been surprised by the resiliency of the economy. So they've dropped the recession forecast. I guess my question is, is this the kind of situation where we've been surprised by growth over the last three months or so and therefore we're marking up our growth forecast all the way through the end of next year? How do you think about that?
Tom: (29:26)
Second-quarter GDP came in at 2.1%, higher than trend and significantly higher than most people would've thought, you know, six or nine months ago. We'll see what happens to third-quarter GDP, but one of the big forecasting firms I saw today marked it down from 4% to 3.6%. So that's a very healthy number of 3.6%.
And I think there is a case to be made that the US economy's a lot more resilient than we thought it was. Resilient to interest rates, resilient to all the shocks we've talked about. And those people who believe that, you know, I think might well be sensible to mark up their growth forecast for 2024. I still want to believe personally -- not want to believe, I still believe personally that rates have an effect with a lag. That some of the things we're talking about are going to have, you know, we haven't talked about oil prices…
Tracy: (30:17)
That was going to be my next one.
Tom: (30:18)
…Are going to feed through to the US economy. That inflation is going to be more stubborn than we think. And that eventually, you know, people will start to trim back just a little bit on their way to a somewhat slower economy in 2024. So that's my instinct.
You know, if you said, there's a great question in the SEP, which is, do you think the risks are on the high side or the low side and do you think uncertainty's higher or lower? I think uncertainty's a lot higher. Because the economy in the third quarter looks like it's going to come in and we're only a day away from being done with it, a lot stronger than I would've said just a quarter ago. So I have to open myself up to the possibility that maybe my forecasting is wrong.
Tracy: (31:18)
You mentioned oil. I'm going to take the bait because of course when we look at that sell off in bonds, it wasn't just the FOMC meeting, there are a lot of concerns over supply, as you mentioned. But also we've seen the price of oil start to pick up again, and that's been fueling the sell off.
How's the Fed thinking about energy prices as an inflationary risk at this point in time? Is it sort of an idiosyncratic thing that you can look through or is it the type of thing that you worry about because maybe it propagates and spreads to a whole bunch of other things that happen to be in the CPI index? Like airfares and food and stuff like that?
Tom: (31:57)
Yep. Both.
Tracy: (31:58)
Okay.
Tom: (32:00)
I thought Jay [Powell] said it pretty well. If what you have is a modest and time limited increase in oil prices or gasoline prices, gasoline prices are a very visible signal to the American people. It's just in front of you every day. It absolutely has an impact on consumer sentiment. It absolutely has an impact on consumption because people reprioritize consumption toward gas and away from other things.
And it absolutely has an impact on headline inflation. If two months from now it comes back down again, then it's the kind of thing you look through. If on the other hand, you get an extended period of higher oil and gas prices, then it does have the potential to feed through everything to cost of plastics to you know parcel delivery, or airfare surcharges and those sorts of things. And so, it's really hard to make much out of it at the moment. You kind of have to follow demand and follow inflation as you go.
Tracy: (32:54)
I have sort of an existential question based on that response, but you know, both Joe and I -- actually Matt as well, we were all at Jackson Hole and we listened to Christine Legarde’s ECB speech, and she was kind of talking about this idea that maybe monetary policy has to take a backseat at a time when we have war, the lingering effects of pandemic, ongoing supply shocks, and of course, a lot of big fiscal still -- a lot of green energy investment that might be driving inflation.
Given that backdrop, how does the Fed know when they've reached the 2% inflation target or are getting closer to it, particularly at a time like now where it feels like oil, again, a sort of outside factor that you don't necessarily have a lot of control over, is clouding that picture?
Tom: (33:49)
First of all, I saw her speech a little differently. Now, I heard it, but what I heard her saying is maybe over the last 20 years we've benefited from a set of disinflationary forces and fracking, you know, which reduced oil prices in this country significantly would be a good example of that.
And that maybe over the next 20 years, I thought I heard her saying, we're going to be having, we run the risk of facing a bunch of inflationary forces. I don't think I heard her say run away from monetary policy in that standpoint.
Tracy: (34:19)
Not run away from monetary policy, but maybe it's harder for monetary policy to combat these inflationary forces.
Tom: (34:25)
Well so, you know, it's like sailing. You can go a lot faster downwind. But you can also sail into the wind. You just have to tighten your sails. And I think that's the kind of spirit to think about, in terms of if we are in a more inflationary environment, and I gave a speech on this last year.
You know, we just have to we have to manage understanding that inflation is more of a day-to-day risk than it might otherwise have been. And so there were periods, I want to say 2015, when oil prices spiked and we didn't respond with monetary policy, because inflation was still under our 2% target. Nobody was all that worried about the fact that inflation would sort of suddenly spur.
Well, you might operate with a, you might be less willing to look through those one-time shocks if you're worried about inflationary pressure more broadly. I think it's, I go with the sailing analogy a little bit more than saying monetary policy can't do it. It certainly can.
Matt: (35:19)
Okay. So zooming back in on inflation over the next few months, because I guess it's kind of an evergreen statement, but you could certainly make a case that we're at another critical juncture for monetary policy.
The Fed is trying to decide whether to hike rates again or not at this point. And another thing that was really striking about the projections that you guys put out last week that a lot of analysts noted was that your forecast for inflation just for the end of this year is looking pretty high versus what we've been getting over the last couple months.
It kind of implies that there's going to be a step up in the rate of monthly inflation over the next several reports to take us into the end of the year here. So is that your view as well? Do you see these last few months of really a lot better inflation reports as kind of a blip? And we're going back up to a higher run rate?
Tom: (36:12)
I don’t know, and I won't get these right, but for the last five months, the monthly PCE Core has been 0.3, 0.3, 0.3, 0.2, 0.2, and most forecasters would assume the one we're going to get tomorrow looks in the range of 0.2. If that's the case, then we're running [for the] last six months at about 3% inflation. And the last 12 months at about 3.5% core inflation. And someone might want to help me, but I think the median was somewhere in the 3.6 range?
Matt: (36:41)
3.7.
Tom: (36:42
)
3.7. So that would imply you have some 0.3s coming in the next few months. It's not that precise. So there are definitely inflationary forces out there. You mentioned oil being a good example. And I think we'll see.
And my view on this thing is, you know, if you asked me to sell myself as the world's greatest forecaster, I wouldn't, you know. What I would sell myself is as a practical evaluator of what comes in the door. And we're going to see what happens with inflation and a higher set of inflation forecasts lead to a belief that wow, we're not through. A lesser set of inflation forecasts might give you a little bit more calm.
Tracy: (37:20)
I have just one more question, which is, you know, we're talking again on September 28th and we've seen this big sell-off in bonds, the 30-year yields at 4.7%, this is the thing that feeds into things like mortgages and commercial paper and stuff like that.
I have seen at least two research notes this week talking about the potential for something to break again. And of course we had the Silicon Valley Bank drama earlier in the year.
Does that become another concern for you as you see these yields start to go higher or some of the interest rate pressures that we talked about earlier, start to feed through into the economy, especially if the expectation is now that rates are going to be higher for longer?
Tom: (38:03)
I think this idea of looking at financial conditions broadly and saying we only have this one tool, we raise rates or lower rates. What does it do to financial conditions? Financial conditions include long-term bond rates. They also include equity valuations, house prices, oil prices, all of those things feed into what are the conditions that you're living in.
I think you could argue that three months ago it was a little surprising that long rates had dropped as much as they had. And not surprising after Silicon Valley, but noteworthy and that equity markets were as vibrant as they were today. You might say equity markets have come down a little bit.
And so all I take from that is conditions are tighter today than they were a month ago. And I'm evaluating what is the impact of those tighten conditions on demand and on inflation demand being both, you know, revenues, core demand, and also, you know, the employment markets. And I think you want to evaluate those tighten financial conditions against that backdrop.
Tracy: (39:03)
I lied. I actually have one more question, which is can you give us a sneak peek of the fed's Taylor Swift reaction function?
Tom: (39:10)
Well I will tell you this, those of you who are worried about demand -- Travis Kelce jerseys, I'm told increased six times in sales after just one skybox appearance. So I think she's doing very well in Kansas City.
Tracy: (39:23)
We gotta go check on the pricing of those jerseys, Matt, and see whether the prices have gone up or not.
Matt: (39:28)
The question is if we're just pulling forward the demand, right? Or if this is a sustainable trend going forward.
Tracy: (39:33)
Yeah. We'll do jerseys as a microcosm for the US inflation story. Alright. Well…
Tom: (39:38)
I feel like saying there's a blank space baby, and I'll write your inflation on it.
Tracy: (39:42)
Very good. Tom, it was lovely speaking with you. Thank you so much for coming on All thoughts. Really appreciate it.
Tom: (39:49)
Great to be with y'all. Thanks.
Tracy: (40:02)
Matt. That was really fun. I love that we ended it with a Taylor Swift reference. That was pretty good.
Matt: (40:09)
Yeah. From Taylor Rule to Taylor Swift. There you go.
Tracy: (40:11)
Oh God, we're just going to keep going. No, all of that conversation was really interesting to me. Definitely a treat to hear how a Fed president, even if he is non-voting, like super interesting, also hearing about what he's discussing on the ground with real businesses. Again, that point about people still being concerned about capacity shortages versus capacity excess, I think does explain a lot of the resiliency that we've seen so far, at least in the labor market.
Matt: (40:44)
Yeah. And he mentioned the uncertainty, right? I mean, I feel like that was really the through line throughout the entire conversation. And you can go on the Fed's website and actually look up their projections. He referenced this, and you will see that, you know, the question that they answer in there about whether uncertainty about GDP growth is higher or lower than say the last 20 years on average, the vast majority of them are saying it's higher. So I think that's clearly the theme here for the next several months.
Tracy: (41:10)
Yeah, and I think to that point, the estimates are all over the place, because I think the Atlanta Fed model is like 4.9% for the third quarter and then the New York Fed model is 2.1% and then economists think it's 1.4% and it's just this huge disparity in estimates at the moment.
Matt: (41:30)
Yeah, we actually got revisions to the second-quarter GDP numbers today and they slashed personal consumption expenditures in the second quarter, and yet the third quarter consumer spending numbers are looking really strong. So it's a bit of a rollercoaster right now with the data.
Tracy: (41:46)
Oh. And of course, things are about to get more complicated if we do have that government shutdown. I actually meant to ask Tom about this. It's a shame, I totally forgot, but you know, a lot of the economic data that we are used to seeing could potentially be postponed for the foreseeable future. So kind of wild.
Matt: (42:04)
That's right. And a lot of those federal government employees would be in his district, so maybe good for a follow up.
Tracy: (42:09)
Yeah, shall we leave it there for now?
Matt: (42:11)
Let's leave it there.
You can follow Tom Barkin’s work at the Richmond Fed at
@RichmondFed
.