Inflation is hot. You can debate why that is, or how long it will last, or who is to blame, or whether elevated inflation is a worthwhile price to pay for a fast recovery. But, regardless, it exists. So what now? Should the Fed pivot into inflation fighting mode? On this Odd Lots, we speak with Jason Furman, an economics professor at Harvard, and the former Chair of the Council of Economic Advisors under President Obama. He thinks inflation will come in hotter than expected next year, and that it's time for the Fed to ease off the gas pedal somewhat. We talk about the issue, its causes, and his preferred policy path going forward. Transcripts have been lightly edited for clarity.
Tracy Alloway:
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal:
And I'm Joe Weisenthal.
Tracy:
So, Joe, I think without question, the hottest topic in the world of economics/markets/finance right now has to be inflation and this debate over whether or not the higher than expected price levels that we have seen recently are, in fact, transitory.
Joe:
Absolutely. We got the October CPI numbers recently. They came in at either 6% or 6.2%. They're the hottest, I think, in 31 years. The debate over transitoriness is very hot right now. A lot of people are capitulating.
Tracy:
I mean, I will say we have been spending a lot of time over the past year talking about supply chain issues and I find them fascinating as sort of micro markets in and of themselves, and they’ve been a really interesting exercise in looking at economic and business principles in a specific and sort of salient thing. But on the other hand, there is plenty of criticism now that there's too much focus on the supply chain issues. There's been too much focus on micro versus the macro explanation of inflation.
Joe:
Yeah, exactly right. And so this is the question, and I guess the question is, can you tease out the two? And so you look at aggregate demand for goods in the U.S., it’s absolutely booming. We're recording this Wednesday, November 17th. Yesterday, we got the retail sales number. It was very strong. The number of containers coming to the ports, we've done a million ports episodes, it's very high. For all of the issues that they're having, there's a lot moving through. And so part of the question is if by focusing on the supply chain specifically, or some of the critics might say, are we ignoring just the fact that aggregate demand is booming and that's pushing up prices?
Tracy:
Yeah. And it is true that you can find an individual explanation to, you know, explain almost any major price increase at the moment. But at the same time, it does seem to be rather broad-based. There is this broader upwards pressure, and it seems to be happening all around the world in lots of different things. So there might be a more macro story there.
So today in the interest of devoting more time and attention on the macro story, I am very pleased to say, we are going to be speaking with Jason Furman. He is Professor of Practice over at Harvard University, also a senior fellow at the Peterson Institute for International Economics. And of course he was the former chair of President Obama's Council of Economic Advisors. And he's been tweeting a lot about his thoughts on inflation, the supply versus demand side of it, the micro versus the macro. And he is also in the process of publishing a paper on this exact topic. So really a great person to talk to. Jason, welcome to the show.
Jason Furman:
Great to be here.
Tracy:
So maybe just to begin with, shall we start with an obvious question, like when you saw the CPI numbers last week (and again, we're recording this on November 17th) — when the number came in hotter than expected, what did you think?
Jason:
I thought it came in hotter than expected. But in a broader sense, I wasn't surprised because I had looked at the last couple months — and this actually is micro, not macro, what I'm about to say — Core CPI had been temporarily lower because car prices fell. And because things like hotels and airfares fell because of the Delta variant and I didn't expect all of those to continue falling. So in some sense, we had transitory low core inflation in August and September. I didn't expect that to last and then stepping back, there's a bigger macro story that we'll be able to talk a lot about over the course of this podcast.
Joe:
Let's just jump into some of these macro questions and part of these questions have to do I think with definitions. And so we talk about this term transitory a lot, and there's a lot of people that, you know, we're all on Twitter and it’s like, ah, oil prices up again. So much for your transitory inflation. Obviously, you know, the existence of a price move itself, either in a category or in a index does not prove or disprove transitoriness. What in your view is, how do you think about this question and what would you like to see, or what do we need to see to sort of answer in a definitive manner whether this inflation we're seeing is transitory or the sign of some new inflationary regime?
Jason:
I don't even know what the word transitory means. So I try to avoid it, I try to use numbers and probabilities. So I'll give you what I think the most likely scenario is. I'll tell you why I think that is. And I'll tell you that I'm not sure about it. The inflation rate will likely come down next year. It will be lower than it was this year in part, because there were a bunch of temporary factors boosting prices, a huge fiscal stimulus, rise in the price of oil, unusual things happening in car markets. I think all of that is real, but when all the dust settles from all of that, I also think we're going to be left with an inflation rate that is higher than what the Fed had been targeting, higher than what we had historically. I wouldn't be surprised by something in the 3% to 4% range. So, you know, I don't know if you want to call that transitory, you want to call that persistent. But that's different than the view that inflation is going to go to 2% or the view many have had that it's actually going to be below 2% in order to make up for the things above it. So baseline, that's my view. And I can give you my rationale for that view as well, if you want.
Joe:
Yeah, I think that’d be helpful.
Tracy:
Yeah, go ahead.
Jason:
My rationale – there’s a little bit of micro in it, which is, I think it does help to look at things like car prices. They've gone up a lot. They're not going to keep going up a lot. There’s micro stories that go the other way though, shelter prices in the CPI are recorded only with a lag and a lot of other indicators of how much rent is going up are incredibly, incredibly high. So the sum of the individual components, I sometimes call it micro or a bottom-up approach. But I find it much more useful to use a macro approach, because when you're thinking about inflation, it's not what's happening to relative prices, it's what's happening to the price level overall. And if people don't have enough money, if one price goes up, then they can't afford to buy as much of other things and other prices will go down.
That's not what we're seeing now. Now we're seeing everything go up. So what's the big macro story? Supply and demand, of course. On the demand side, I expect demand to remain elevated because households have more money in their balance sheets because fiscal policy is pumping $500 billion into the economy this year based on laws that were already passed and because interest rates and financial conditions more broadly are ultra accommodative. On the supply side, I don't know how long it's going to take to unsnarl the supply chains. The two of you know more about that than I do. No one knows how long it's going to take for labor markets to recover. Just, I don't think any of that's going to happen fully in the next year. So over the next year, we continue to have a lot of aggregate demand. We don't have enough aggregate supply and the mismatch between those two will keep upward pressure on inflation, keeping inflation well above 2%.
Tracy:
I have what is possibly a simplistic question, but is inflation that's caused by stronger demand, stronger household balance sheets, is that a major problem for the economy? Is that something that warrants the amount of hand-wringing that we have seen on social media and in various op-eds for the past week or so?
Jason:
People don't like inflation. Economists tend to be less bothered by inflation than people. And so I don't know if I should sit here and say, you know, I'm just an ignorant out of touch elite. I should listen to the people who really don't seem to like inflation, or I should patiently explain to them some of why they don't like inflation is money illusion because their wages are also going up faster. So I think it is a reality. I don't think economist and the media invented it. And I think if anything, economists tend to downplay inflation and be less concerned about it than people think.
But there are reasons to be concerned. I think at the margin, a lot of our policy is raising prices more than it's improving employment. It's raising the risk of a hard landing. People are seeing their real wages fall, and there's a lot of froth in financial markets right now. Low interest rates have some negative side effects. Normally the benefits of them outweigh the side effects. Right now we have enough fiscal support in the economy that I'm not sure that the negative side effects of interest rates are worth it.
Joe:
I want to get into the perceived costs of elevated inflation. And I think your point is very well taken that people don't like it. And that's, you know, as journalists or as economists, we can say, yes, well, you're coming out ahead when you include transfers, but people don't like it. And that is what it is. That being said, you know, we had the mother of all employment shocks, I think unemployment hit 20%. We're still in a pretty significant hole. We had the mother of all real GDP shocks, demand collapsed for all kinds of, you know, we had to put the economy on life support and we are still in a hole, especially on the employment side. And so, you know, nominal growth or real growth has been very fast as we get back to trend, as we returned to something resembling normal and hopefully bring everyone back to the workforce.
So how do you think the cost? I mean, we are still adding a lot of jobs. I think the October jobs report when you include revisions was over 800,000 jobs. I think we're still about 7 to 8 million jobs shy of where we would have been had nonfarm payrolls just kept growing at the pace they would have had never had the pandemic. So how do you think about, you know, yes, people don't like higher inflation, but also we have a big hole to still dig out of.
Jason:
Yes. You need to keep three thoughts in your head simultaneously. One, the economy is still in a hole. Two, the economy is improving really rapidly. And three, inflation is bad. All three of those statements are true. We have a lot less inflation than we had in 2009. I'd much rather have the situation we have now than the situation we had in 2009 when we had a 10% unemployment rate. But, you know, real wages were actually rising because inflation was low. So, but you need to keep all three of those in your head simultaneously.
What the implications of that are for policy? I think the second one that the economy is improving has important implications for policy. We are no longer in a dire emergency situation in terms of the way policy should be acting. 4.6% unemployment rate is higher than it should be, but it's not so extremely high that you want to be in complete emergency mode in responding to it, especially when complete emergency mode has a lot of negative side effects for issue number three, which is inflation.
Tracy:
This is something that's come up in our previous conversations, which is this idea that even though the Fed isn't, I mean, it just started tapering its balance sheet, but even if the Fed weren't changing its asset purchases, and if it was keeping rates where they were, the economy itself is recovering. And so, you know, keeping rates near zero and having a very large balance sheet effectively means that things are getting easier and easier. Financial conditions are getting looser, even though the Fed isn't explicitly, you know, loosening monetary policy. Is that something that concerns you at the moment? You mentioned the idea of low rates fueling bubbles and things like that. It seems like that has become an issue for the economy, especially looking at real rates, which still remain incredibly low.
Jason:
I completely agree with you. Let me just say that. Implicit in your question are two really important features of monetary policy. One is it's a continuum, it's a whole range of policy options you could choose, not just reduceable to the nominal Fed funds rate? And we've chosen a point on that continuum that actually is not the most expansionary it could be. We could have said no, we're going to keep rates at zero for a decade. We could've bought $500 billion of assets a month. We chose to do something intermediate because effectively everyone agrees we need to balance the risks of doing too much and too little. The second important point is that monetary policy is constantly changing. Yes, the Fed funds rate has been at zero for a year and a half, but when expected inflation rises, that means the real Fed funds rate, the Fed funds rate adjusted for inflation falls.
That's happened. So that may means monetary policy has gotten more expansionary. The interest rates that really matter are long-term interest rates. Those have fallen a lot in the last couple of months. And when you adjust for inflation, you can look at the TIPs market. They’ve fallen in even more. So that's one of the strange things is over the last year, the economy has gotten better, very rapidly. And monetary policy is moving into a more and more, you know, emergency response setting. And then you look around you at financial markets, they'll probably be okay, but you know, there's more reason to be nervous than there should be.
Joe:
So I want to, you know, one thing that I really appreciate about your approach and about your clarity is essentially, I guess I would say your humility and probably all of us and all economists should have quite a big dose of humility about our ability to forecast anything, whether it's employment, the effective macro policy, what inflation is going to be next year and the year beyond, that’s an important quality. It seems to me that going back to the Fed that this is also a view held by, or an important value to the current Fed Chair Jay Powell, who knows whether by the time this comes out, whether he'll be the nominee, but this idea of humility. And I kind of think that was bolstered with the new flexible average inflation targeting, which struck me as a recognition that’s like, you know, we thought we could aim this. And we thought we had these models that would tell us when we're hitting NAIRU and all this stuff. And it turned out the economy could get better than we thought.
It turned out the employment rate could fall further than we thought. And so let's try to build in some guard rails so that we're not so, you know, that we're not too wed to these models. Do you get concerned when thinking about this, that this could be another mistake, the likes of which we've seen kind of since the great financial crisis? That it’s like, you know, look, we made a lot of premature pullbacks. We certainly did I think you would probably almost certainly agree on a fiscal, in the wake of the GFC and rate hikes that in retrospect, maybe were too early or unnecessary or reversed and that maybe given the sort of inherent uncertainty, it still might make sense to just err on the side of let's wait until we see the full recovery, the maximum employment.
Jason:
Yeah. So Joe, I agree. We should err on the side exactly the direction you’re saying. The question is how much we should err on that side. Based on what we know, I think we're erring too much on that side right now. And so we should err less on that side, but continue to. Let me explain why I think that and I won't relitigate the past except to say a hundred percent agree with you on fiscal policy being overly contractionary, insufficiently expansionary and then overly contractionary and 85% agree with you on what the Fed did from 2015 forward.
Joe:
I'll take 85%. That's pretty good. I'm glad to get 85% agreement.
Jason:
And just to be clear, I was partially responsible for the fiscal policy and had nothing to do with the monetary policy that I'm more defensive of. So just to understand there's an irony in the Fed framework. It was all about our models don't work. In the past we made this mistake that we forecast there was going to be all this inflation. We made changes based on that forecast. And then that forecast turned out to be wrong. The irony is the main argument for not being more aggressive now, is a forecast. A forecast that inflation is going to come down next year. Right? And so the Fed has found itself back pretty heavily in a forecast, potentially making the opposite mistake that it made before. Now relying on all these, you know, different theories as to why it would be transitory. As I said, when I do my best forecast, which you know, I'm going to be embarrassed by, it's going to be wrong. I think inflation 3% to 4% next year, but I don't really know. No one knows. And so that's, you have to do the best you can and I'd rely more on the actual data we've seen than a forecast. So that would be my first point.
The second point is it's relevant where we're lifting off from. The unemployment rate right now is 4.6%. Last time we lifted off when the unemployment rate was 5% and I grant your point, we could have waited a bit longer. There’s a number of reasons to think liftoff though should happen sooner than what would have been optimal last time. The unemployment rates is still falling quickly. There's a lot of job openings with expected inflation higher. That means the real interest rate is lower. And then of course, inflation is much higher this time than it was before. So all of that said, if we lifted off in the middle of next year, when the unemployment rate was 4% and we lift off all the way to the sky high interest rate of 25 to 50 basis points, I just, there definitely is a chance that's too much, but you know, I'm just not that worried about it.
Tracy:
So having made those two points, I mean, I don't think anyone is arguing for the Fed to suddenly raise interest rates, you know, it in a major, major way. And it does have different levers that it could pull to try to offset some of the inflationary pressures. So yes, it has announced that it's going to start tapering its asset purchases. It's not stopping those completely. It could raise rates slightly, or it could try to guide the market towards a faster pace of interest rate hikes in the future. What's your sort of ideal policy response given how you're viewing the inflation risk at the moment?
Jason:
Yeah. What the Fed should do should be dependent on the data. But what I would do would be to flip the default. Right now, they're effectively saying, we think this inflation is going to disappear. So we're not planning to raise rates, but if the inflation surprises us, we'll do something. I'd rather see them flip that. We're planning to lift off in the first half of next year. We're planning on something like three rate hikes next year. But you know, if all the transitory stories that I think Joe believes more than I do, and Joe's more right than I am, we'll delay that. If there's another wave of Covid and employment is bad or employment's bad for any other reason, we'll delay that. And so changing the default matters.
It would show up in long-term interest rates right now. It also would reduce the disconnect between what I think the Fed is likely to end up doing at least based on my forecast of the world and what the market thinks. It's always better if those two are more in sync. Right now, everyone's guessing, you know, if inflation ends up high, but we're not yet at maximum employment, what are they going to do? No one quite knows the answer to that question. So flip the default. Send signals to market, but be data dependent and adjust if you need to.
Joe:
Well, let me ask you about those signals to markets and, you know, you said I disagree. Look, I'm a straight news journalist. I don't have opinions or forecasts or anything , as everybody knows, I don't have viewpoints. But I will say that a lot of the more sort of like MMT people that talk to — and this is a key question that I have about what this sort of signal is supposed to accomplish — they say, you know, the only way that rate hikes actually, or that Fed policy tightening could actually fight inflation is through the demand channel by weakening the economy. And weakening the economy when we do, as you admit still have this hole still in unemployment, is ill-advised. And I think we would probably all agree and it's kind of become a cliche by now, it’s like rate hikes aren't going to make throughput at the Port of Los Angeles any faster. Rate hikes aren't going to get more truckers on the road and rate hikes aren't going to get a chip factories in Malaysia working any faster. So I think we all agree, there's no supply-side benefit. What do you see though, specifically, as the channel, via which these signaled hikes, even if it's a very moderate pace, could help tame inflation or does it end up being through the recession channel at which probably you would almost certainly agree, you know, is undesirable given the employment hole.
Jason:
So first of all, I'd flip the point you just made. The big problems in our economy is not enough shots in arms, not enough microchips being produced, not enough throughput through ports. Buying assets isn't helping any of those. Low interest rates isn't helping any of those. So none of the fundamental problems in our economy are being cured by expansionary monetary policy right now. I'd still keep the setting expansionary because I think there's probably some lingering demand, but I don't think it'll do very much for 90% of ails us. At the margin, most of our policy options in macro affect both prices and quantities. And there's some people that look at them and it was like, oh, you know, the stimulus didn't do anything to help the economy. It's all inflation. It's all Biden's fault. Other people look at it and say, oh, the stimulus, you know, rescued the economy and it had nothing to do with inflation.
The answer is always both, some combination. When you expand fiscal policy, expand monetary policy, you get some combination on output and inflation. In my judgment — and this is a judgment — right now at the margin, when we're talking about moving settings up or down, it's affecting prices much more than quantities. That's because the quantities are constrained by the supply-side of the economy. So an awful lot is passing through to prices. So that would be the first point. The second point would be we may need to do less if we act sooner. And if we act later, it may be more costly. We all know the Phillips Curve is very flat. There's not much relationship between inflation and unemployment. The flip side of that is something that we used to call the sacrifice ratio is very high. You may need a lot of unemployment to ring out some inflation. So it's better to be precautionary, get rid of a little bit of it sooner. And finally, I don't place a lot of weight on inflation expectations. They seem a little bit like the ether that people invoke to explain the holes in their theories, but, you know, I think there's a 40% chance inflation expectations matter. And so why not keep them in better control?
Tracy:
Is there not an argument though, that keeping interest rates relatively low could maybe help increase capital investment? And if one of the issues here is supply, then that would be something that you would want to see relatively quickly. And one of the reasons I bring it up is because the Bank for International Settlements just did that paper last week, basically saying that one of the solutions to inflation in the current environment is capital investment and the expansion of production capacity.
Jason:
Yes. In fact, it is an under-appreciated thing. We all spend all our time looking at consumer spending because we have our own images of ourselves ordering lots of, you know, sports equipment on Amazon because we're not going to the gym. Or now you start going back to restaurants, now you stop. So consumer spending is 70% of the economy. It makes sense to look at, you talked about retail sales earlier in our discussion. But the big shortfall in the economy is capital investment and capital investment is sensitive to interest rates and capital investment matters for capacity and supply as well as for demand.
So I think that is a very good argument for low interest rates and keeping them low. It still begs the question of how low do you want to keep them? And I would argue interest rates have effectively fallen over the last year because of the rise in expected inflation. That means the real rate has fallen. And we don't want that. We want to move a little bit in the other direction. And I would just remind you that everyone, including all the MMT people in this debate, want monetary policy that's not maximally expansionary. There's no one saying, well, there are a few people, but very few people saying rates should be zero forever. I don't think there's anyone saying we shouldn't like…
Joe:
I'll invite you into the Twitter group DMs I'm in, Jason. You could join… There are a few.
Jason:
But even they aren't saying let's buy $500 billion of assets a month.
Joe:
Yeah, that's true. That's true.
Jason:
You know, there's always something more expansionary for monetary policy than what we're doing. I mean, we can have yield curve control that said the 30-year, we're going to keep it at zero. And we're going to just buy enough Treasuries to keep that rate at zero forever, the 30-year Treasury, not just Fed funds. So in some sense, everyone is saying we're going to have slower growth in order to have less of some other problem, whether that other problem is overly high inflation, overly big risk of a recession, overly frothy asset markets. We all agree on that. The question just is where.
Joe:
I want to ask you a question about hysteresis and reverse hysteresis and the benefits of a high pressure economy. But before we do, you mentioned the pace of bond buying and you had an interesting tweet thread the other day where you said something really interesting that I thought, which is that, you know, it's like, oh, well, we're not buying like 500 billion of assets a month. Theoretically, we could be buying way more and yet, and you noted this, there does seem to be this divergence between how economists view the effective asset purchases — and this goes long before the U.S. ever did QE, going back to the Bank of Japan and Milton Friedman, the way economists talk about the effect of asset purchases which is as a potentially powerful channel versus the markets where it's really not clear at all. And this was sort of basically sided with the markets on this, that asset purchases really do anything and that the size of the balance sheet is itself an important lever. I'm curious your view on this, because you noted in your tweet thread this divergence between economist and market views about balance sheet size. And I'm curious where you stand and also what you view as the channel via which these asset purchases actually contribute to loosening policy.
Jason:
So when I teach my students something, I often teach it to them, explain the theory and then tell them what probability I attached to what I just told them being true is. I try not to waste a lot of time with things that are below a 30% chance of being true. Rarely do I say it's a hundred percent chance of being true. Usually that's with an accounting identity, but hopefully I have more credibility when I do that. There's a longstanding holy war between economists, including the staff of the Fed, who basically think the size of the balance sheet is what matters when you have more assets that's what's expansionary and markets, which tend to think things like the change in the pace of it. If you're raising the pace for the purchases that's expansionary, lowering it, it's contractionary. And even there there's some uncertainty around that, given the ability to substitute between different assets. I should say, I'm not incredibly deep into this fight. I have read some of the different sides. I've talked to people about it. I guess I sort of out of loyalty, always side with my tribe, but I'll put myself at 65% that the economists are right on this. And the size of the balance is what matters
Joe:
Just real quickly. What would be the why? Like, what is the reason why you believe that that would be an important, well, how would that impact the real economy?
Jason:
Yeah, because you look at the supply and demand of credit, and when you should think of those in terms of stocks and when the stock of that amount of credit that is out there goes up, which is what happens effectively when the Fed increases its balance sheet, then the interest rate on that credit goes down and that spills over into other assets, equity and other forms of debt as well. And so you get higher market prices, lower interest rates and all of that credit market. You want to understand just like the labor market, as you know, the stock that you observe at a point in time. That's the economic argument.
Tracy:
So can I just ask something on the financial stability point? So one of the reasons it is difficult for the Fed to tighten at the moment, even in response to rising inflationary risks, is the idea that we basically built up massive excesses in the financial markets, in valuations, in the amount of money that's been borrowed, duration and interest rate risk. And so everyone's nervous to sort of topple or inadvertently topple that entire thing over. What does it mean if the Fed were to change its priorities in the way that you just described? Like, how would you expect the markets to react to that? And would that not be a potential credibility problem for the Fed, which, you know, just finished explaining and convincing the market about its flexible average inflation target regime.
Jason:
So, first of all, I don't think the Fed should change its framework midstream. When they do the next framework review, they should update it. I would update it with a higher inflation target, but we can come back to that if you want to, or just leave it to the side for now. So I think they should do flexible average inflation targeting, but the fact is we've hit the average. We're in fact, above the average. And so that framework itself is consistent with the changes I'm talking about. So Tracy, I would be worried about what rate hikes that were very abrupt would do to the market, but in some sense, the longer you wait to telegraph you're doing it, the larger those changes will need to be. And the more of the shock and risk. So there's a risk now, there's an even bigger risk later, but absolutely the changes should be still relatively slow and gradual. I mean, I'm talking about three hikes in 2022, starting in the first half of the year. That's not, you know, raising interest rates to 1.5% tomorrow.
Joe:
I teased ahead to this a little bit in my last question, but, you know, I think one of Janet Yellen's most interesting speeches of 2016 and this idea of hysteresis, and I'm curious what you think about it. So the idea is that, you know, if you have persistently slow growth, then the economy's potential supply diminishes, people lose skills, factories go idle, and so forth. And then when you try to have accelerated growth, you run into supply-side constraints and this is bad. And so the idea is in theory, what if you could really press hard down on the accelerator? And Tracy brought this up with perhaps one of the benefits of a low interest rate regime and essentially force the supply side to invest and sort of create a reverse hysteresis, where people really have to train workers and they get up-skilled and they have to build new factories and so forth, and really like keep that accelerator down, not just to get back out of the hole that you're in, but to actually sustainably improve the supply side capacity of the economy.
And I think about this question too, because, you know, we're always looking at these like trend lines and by some measures, maybe like real GDP or real consumption, we have erased the Covid gap and maybe we're back on trend, but there is this bigger trend line that was going up until about 2007. And I think according to most of those lines, we're still in this huge hole. And so I'm curious whether you see any argument for, again, you know, as you've already established, I'm not just erring on the side of doing too much, but really trying to kickstart the economy into a sustainably higher gear, use this moment to not just make up for the Covid shock, but actually years of under investment and sort of a decaying supply-side capacity,
Jason:
A hundred percent agree with the impulse behind your question, but my qualification would be that the pace of doing it matters. So I liked the idea of heating the economy one log at a time and just keep adding those logs. What I don't like is throwing all the logs on the fire at once. We've had two experiments that worked out really well. The late 1990s, the unemployment rate was pushed below where people thought it could go at the time, views of the natural rate or NAIRU were 6% or 7%. We went down to four and it was great. It again, in the last cycle of prior to Covid people thought the NAIRU was 4% or 5%, more thought five than four and kept pushing it, three and a half, it was great now. So we know that if you lower the unemployment rate by, let's say seven tenths a year, I'm making that number up. I wouldn't place too much weight on it, but if you lower it by seven tenths a year, that that actually works and works out quite well.
What we don't know is could we have gotten to 3.5% unemployment in 2011 and we just blew it and waited too long. Or if we tried to get there in 2011, a lot of things would have blown up in our face a little bit the way we're seeing this year. So I don't think the evidence is clear that you can jump all the way to hysteresis. I think what hysteresis says is keep pushing and never give up, but it does say something about the speed of your pushing. And by the way, hysteresis is a little bit of a double-edged sword. We just went through very high unemployment. Hysteresis says right now the natural rate is higher than it was when we began this episode. So, but absolutely like, you know, I hope for the next many years, I never think the unemployment rate is too low because I think, you know, we can keep lowering it by half a point a year. And I'd like to see a lot of evidence that we can do that before I'd want to hold that process.
Tracy:
So I realize we've been very focused on the monetary policy side of things, but I feel like we would be very remiss if we didn't ask you at least a little bit about the fiscal, given your experience in Washington. And I'm curious whether or not you think that a higher than expected or a more stubborn inflation rate, perhaps changes some attitudes towards fiscal spending in DC. And we've sort of been touching on this, with the MMT references in this entire conversation, but do you think it's going to start encouraging people to think twice when it comes to fiscal stimulus?
Jason:
It appears to be leading some members of Congress to think twice about fiscal measures because they're concerned about inflation. I think that's a mistake. By the way, I think that's a mistake made by MMT. MMT thinks that you should use fiscal policy to control inflation, at least some versions of it do. I'd like the Fed to be in charge of inflation. Fiscal policy should do something the Fed can't do, which is invest in children, address climate change, bolster our infrastructure, a whole bunch of things that the monetary policy can do very, very little about. The legislation that's currently under debate is, on an annual basis, one tenth the gross size of what we just did this past year. Moreover, it's mostly paid for, some of it increases the productive capacity of the economy. Don't think it puts much upward pressure on inflation over the medium term. And if it did the Fed could just offset it. So I've been in 25 years of debates about fiscal policy, almost never has anyone brought up inflation as a pro or a con of the Affordable Care Act or the Trump tax cuts or whatever it is. I don't think it belongs in the pro and con of this debate. People should debate whether this is good for children and good for climate change, not what it’ll do to inflation.
Joe:
Well, let me ask you, we just have a couple of minutes left. You were the chair of Obama's CEA and inherently, there is no way to really disentangle any of these questions from politics. And it seems like the elevated inflation right now, Democrats specifically appear to be paying a price for it. And that's a political question, but it's real. So Democrats got clobbered in some recent elections, the polling looks bad and etc. In your DC experience, in your capacity as someone who advised a president in your capacity, as someone who thinks about how politicians should react to this, what is your view on how the leaders in DC should think about, I don't know, reframing the debate, messaging what's going on it, etc., such that the case can be made, look we just had the most incredible employment recovery ever we're having the fastest nominal wage growth ever. We had 20% unemployment. How do you go about turning that debate? Or how do you think about reframing the messaging? Because clearly we're just talking about inflation as sort of a loser for the current for the current White House.
Jason:
Yeah, so I, you know, I'm having a hard time trying to understand what's going on in the economy and with only mixed success. And so my ability to give communications advice to anyone is considerably inferior to that. If forced to, I'd say one is, you know, be more realistic about your outlook. That's something that secretary Yellen did. She recently said we don't expect prices to start slowing anytime soon, it'll take till the second half of next year. So be more realistic. You have to do the combination of touting the strengths — the low unemployment rate — still too high, but it's fallen a lot — while acknowledging the pain that people feel and not being dismissive of inflation and saying it's real. And finally, I think President Biden needs to say, I'm doing what I can in terms of the ports and the supply chains, you two understand it better than I do. But you know, this is primarily the responsibility of the Fed. That's why I'm nominating or renominating so-and-so and I want to make sure that they get inflation under control. It's their job, I'm expecting them to.
Tracy:
It's kind of wild to think by the time this episode comes out we might know who that Fed chair will be.
Joe:
Yeah, we might know who it’ll be.
Tracy:
All right. Well, Jason, I'm conscious of the time, so thank you so much for coming on Odd Lots — really appreciate it!
Joe:
Thanks. Jason that was fantastic.
Jason:
Okay. Thanks, Tracy, Joe. Great talking to both of you.
Tracy:
So Joe, I thought that was a really interesting conversation and, you know, an important viewpoint to have from someone who's sort of straddling extreme wonky monetary policy with, you know, very sort of realist political considerations, given his experience in DC. One thing that is jumping out at me in this whole debate is I really feel that it sort of boils down to not necessarily supply versus demand, but which of the Fed’s two mandates people value the most, you know, bringing down unemployment or having price stability. And I do think there's something about the price stability mandate that makes it a lot more important and accessible to a much larger number of people. I think most people probably aren't that concerned that the unemployment rate is, you know, 4% when maybe it could be 3%, but because inflation tends to touch almost everyone's lives on a daily basis, if you're buying stuff. It just feels like people will naturally naturally gravitate more towards that issue than they will unemployment.
Joe:
Yeah, I think that's right. I mean, look, it's very real, especially, and we've talked about this before, but inflation, it feels very real. Look even in the depths of a downturn, most people don't lose their jobs. And so I think this sort of gets it, but everyone buys stuff, usually every day. And so you do get this sort of like disparate effect where it's like inflation always affects everyone and unemployment, even though that's the other half of the mandate, only affects some people at any given moment. And therefore it does seem like inflation in particular, and we're seeing that in some of the data right now, and we see that politically, you do pay a heavy price for it. It is interesting what Jason said, you know, I kind of have to believe it that actually economists are less worried about inflation than the public. It's kind of weird because on some level, maybe that's true. And I get his point that actually, okay. Maybe a lot of economists would say, yeah, we could have a 3% inflation rate. We could have a 4% inflation rate. It's fine. But on the other hand, economists really seemed to think the Fed is blowing it, when it's blowing it on the inflation side, as opposed to the employment side, as you said.
Tracy:
I mean, there's definitely been, it feels like there's been a big shift since the CPI number, which, you know, kind of makes sense. Bu I do feel like a lot of this boils down to, you know, if I put my old international relations hat on this feels like an absolute versus relative argument to me, like on the one hand, the economy, you know, a big important part of the economy might on the whole be better off in the form of a lower unemployment rate. But on the other hand, people sort of feel the relative disadvantage of higher prices more. I don't know if that makes sense.
Joe:
I mean, I think it makes sense. It's just...
Tracy:
But that’s why — I'm trying to say, like, I think that's why economists probably feel better about it. You know, if they're looking at it from a whole perspective versus the individual, I think that's where that comfort comes from. But so the other thing I would just say on the transitory argument is I also think people are sort of forgetting the timeframe here and we've spoken about this before, but at the moment it feels like most people are coalescing around the first quarter of 2022, as you know, the moment when price pressures should start to ease, or I guess the second quarter of 2022. And so, you know, at that point, if you don't see some improvement, then it feels like the macro argument, the demand argument probably will be on a much, much stronger footing. It is also becoming completely clear to me that no one knows how inflation works.
Joe:
Some people who say, I err on this, I want to err on the side of doing too much, but I kind of don't believe them. And I kinda like, well, you're really like obsessed about inflation. I don't believe Jason is in that category. I think, in total good faith, he is not one of those people. I think he actually still per his like framework does think erring on the side of do too much is still the right approach. And I think he means that. That being said, I still don't feel like I have a satisfactory answer as to what is the channel via which a modest pace of rate hikes changes the inflation picture. I get that you can, you know, you could do a Volker and induce a recession. And I believe that would probably bring inflation down. If you slammed the brakes on the economy through a series of several aggressive rate hikes, raised unemployment, when we're already in a hall dropped aggregate demand for housing and washing machines, you build up inventories of housing and washing machines, the price of a bunch of stuff falls. You probably defeated inflation.
I believe that channel exists, but I don't think… Clearly like that is not a channel that Jason favors. It's not obvious to me still, what is achieved on the inflation front from the sort of like mild like middle path where you're not really affecting anything on the, you know, you're not really hitting anything substantial on the demand side that would meaningfully slow the jobs recovery. I feel like that is the part of the equation that, in my mind, I still don't, I'm not fully getting it, but this is what the endless debate is for.
Tracy:
I'm taking the, the nihilist view of inflation, which is that having spent more than a decade trying to push it up and get out of deflation and get closer to the 2% target and not having any success, it just naturally makes me very, very nervous when people start saying that they're going to, you know, bring it down when it's heading in the other direction. I'm just suspicious of all attempts to control inflation at this point in time. We really don’t know what we’re doing.
Joe:
Let's peg the 30-year at zero and get out of the business of… That’s exactly right, ZIRP forever. And then just let the market sort it out. I'm with you.
Tracy:
[Laughing] Okay. Oh God. All right. Should we leave it there?
Joe:
Let's leave it there.
You can follow Jason Furman on Twitter at @jasonfurman.