Three things from this week’s podcast:
Too much money + too little stuff = inflation. It’s not complicated.
Every time there’s a crisis, the Fed loosens. It’s become a reflex, and now, rolling downhill uncontrollably, they’ve realized they need to slam on the brakes. But they’re not pressing hard enough.
Don't panic, sit tight, but yeah… a recession is likely. Maybe next year.
No, it’s not Putin-flation. No, it’s not Ukraine. No, it’s not a sudden spike in corporate greed (sorry, Elizabeth Warren). As Glenn Hubbard notes in the podcast, why now? In that worldview, companies are always greedy. In fact, sometimes things are simple. There are billions sloshing around in the economy, between Covid stimulus bills passed under Trump, a double down under Biden and all that saving that got done when we were all locked in our houses.
Things get better when all the factors driving inflation improve. What does that mean? It means more Fed tightening, faster. It means supply chain improvements — which would happen more quickly with regulatory reform. That’s not going to happen under Joe Biden. When will the Great Resignation end and get people back into the job market? When we start fixing the labor market, but that’s not a job for the Fed.
Has there been some malpractice here? You bet. Congress loves spending money, and that’s part of the trouble. Thank God Kyrsten Sinema and Joe Manchin saved us from Build Back Better. But why was Jerome Powell so slow to get the message? Well, the Fed likes playing generous Uncle Sam. Why Uncle Sam didn’t tighten his belt sooner is unclear.
Last note: It’s always great to hear from an economist that the United States needs to spend more on defense. Glenn doesn’t pretend to national security expertise, but, he explains, we can afford it easily. Europe, not so much. Listen to the whole conversation, it’s just great. And as always, share your thoughts in the comments.
HIGHLIGHTS
What is going on in the economy?
Glenn: Well it's complicated and simple at the same time. It's complicated because of many factors going on, supply chains, Ukraine, public policy, but it's really simple in the sense that we had demand growth outstripping supply growth. The federal government was way too generous at the end of the Trump administration, the beginning of the Biden administration and fiscally the Federal Reserve has been not a hundred percent, shall we say, in its duties in safeguarding against inflation. So that's where we are.
Why is the Fed getting things so wrong?
Glenn: Well, I think you have to go back from before the pandemic and the period we're in. The Fed had been overly accommodated to financial markets for some time in the sense of really underwriting a put, if you will, to make sure financial markets were okay. We've had an ultra loose monetary policy, basically since the financial crisis. And I think the Fed had just gotten into that mode. And then when the pandemic came, it bought it the way it knew how, with easy money.
Now, in March of 2020, when it wasn't clear how deep the abyss was, one might forgive the Fed for early judgments. But as the economy recovered and fiscal policy purse strings were loosened, it was truly odd. And with the housing prices rising dramatically all over the country, not just on the coast, but in the heartland, the Fed continued to buy mortgages, continued to reduce long term interest rates. So the Fed really aided and abetted the bad fiscal policy that we saw at the time. And there's really no excuse for it.
Can we blame Covid for the economy’s problems?
Glenn: The inflation really is from the underlying supply chain issues combined, importantly, with the bad fiscal and monetary policy. The irony, going back to the Fed, is it will take scholars a while to unpack what happened during the pandemic from a public health perspective. The monetary policy error was an old fashioned one. It shouldn't have happened.
What’s happening in the job market?
Glenn; The job market is very tight, which is just an indication of how much work the Fed has to do. I think that the Fed might argue that some of the margins you mentioned, that people who left the labor force might come back, is a reason to keep monetary policy less tight than one might. I think it's a shame that a lot of people left the labor force, but monetary policy is not the tool to fight that. There a variety of labor market interventions you could do to get people back to work, but money printing isn't among them. So I think that is barking up the wrong tree. The labor market is too tight and does require a reduction in demand, which is just a fancy way of saying the Fed needs to step on the brakes.
Next steps?
Glenn: Well, there's the old expression, when you're in a hole, stop digging. The first thing the administration should do is stop doing harm by actively talking about Build Back Better, and even a number of very expensive social agendas that just add fuel to the inflation fire, as well as being bad policy. We could, though, make sure that we are undoing regulatory barriers that keep supply chains from working, that keep businesses from bringing people back. And encouraging flexibility wherever we can. And I think for the Fed, pursuing a policy that's more clearly anti-inflationary does give the public confidence that this too will pass. So a lot of this is doing no harm before we shift to active policy.
Where’s my money?
When politicians say, "But your wages are going up, why aren't you happy?" Real people notice that their real wages, they may not use those words, but they know that the wages they use to buy things are actually falling. The best thing the Fed could do would be to try to arrest inflationary expectations before they get out of hand with the public. And they do have a window to do that. But tightening policy requires actually tightening policy. I'm from the South, and there's an expression of I'm fixing to do something. Well, the Fed can't be fixing to do it. It's got to do it.
Recession ahead?
Glenn: So I think the Fed has to do more than just tap on the breaks, meaning it would've to raise the federal funds rate enough to bring down demand growth and wage pressures. Can it do so without a recession? Yes, but I think that's unlikely. I think the Fed is going to have to tighten sufficiently that a recession happens, but I don't think it will be this year, more likely next year.
Time to panic?
Glenn: Well, first, when you start with a medium term or the long term, nothing shakes my faith that productivity growth and improvements in living standards on a grand scale are possible, and even likely, for America. For people making the shorter term decisions you're talking about, step one is don't panic. Never sell into what look like sharp declines. So I would say to people, be careful, be cautious, think through everything before you act, but tightening financial conditions, which is what Fed needs to do, does require tightening financial conditions. So yes, it's possible that asset go down before they go up. So people will feel this pain, whether politicians come up with an actual policy that works on the right or the left, as opposed to just gabbing, remains to be seen.
Read the full transcript here.
SHOWNOTES
“NATO Needs More Guns and Less Butter” by Glenn Hubbard (Wall Street Journal, March 7, 2022)
“We Still Need Economic Growth” by Glenn Hubbard (National Review April 14, 2022)
“We Need to Do Hard but Necessary Things to Tackle Inflation” by Glenn Hubbard (The New York Times, December 13, 2021)
“Did Pandemic Unemployment Benefits Reduce Employment? Evidence from Early State-level Expirations in June 2021,” by Glenn Hubbard, Harry Holzer and Michael Strain (NBER Working Paper, December 2021)
“Producer Price Gains Slowed in April but Remain Elevated” by Gwynn Guilford (Wall Street Journal, May 12, 2022)
“Inflation Slipped in April, but Upward Pressures Remain” by Gwynn Guilford (Wall Street Journal, May 11, 2022)
“U.S. Jobless Claims Rose to 203,000 Last Week” by David Harrison (Wall Street Journal, May 12, 2022)
“Fed chair says interest rates should have gone up sooner” by Rachel Siegel (Washington Post, May 12, 2022)
“An inflation conspiracy theory is infecting the Democratic Party” by Catherine Rampell (Washington Post, May 12, 2022)
“Here Are the Main Tools for Fighting Inflation” by Stan Veuger and Daniel Shoag (The Bulwark, May 11, 2022)
“Even in a Hot Economy, Wages Aren’t Keeping Up With Inflation” by Jason Furman (Wall Street Journal, April 12, 2022)
“The US labor market could be cooling down” by Jason Furman and Wilson Powell III (Peterson Institute, May 6, 2022)