Surveillance: Inflation Target With Posen

confidence in the American economy. We began this discussion as a singular high point of our trip to Washington for the World Bank and IMF meetings, and that was a conversation heated with Adam Posen of the Peterson Institute. We continue today the discussion Chairman Powell is looking at on inflation targeting. Adam rejuify why we need to move from a two percent acceptable inflation level to something that so they are scared of a three percent level. Thanks Tom,

and thanks for having me back on surveillance. I think we've got to get to a three percent target level rather than a two percent target level for two big reasons. First is, as we've seen repeatedly for the last twelve years, when you're this close your target is too low. That means your interest rates are too low. That means the FED doesn't have that much flexibility, and so it's less effective encountering recessions and it's more intrusive into markets to

get its work done. The second reason you want to see an inflation target that's a little higher, not currently hugely higher, but a little higher, is because it helps restructure the economy. We're seeing this right now that labor markets are undergoing massive change in the US, and you need space for people to get adjustments and to make

changes both to wages into where they work. And that's easier when they're not as close to the lower down because people don't get don't get great wage cuss, they only get wage zeros or wage up. What does the linkage here of a reflation of an economy over to nominal GDP to the great fear of the conservatives of an overheating of the economy and those ill effects explain the sequence of three percent persistent inflation over to a whopping large nominal GDP. Well, the two are separate right

Overheating in some ways is driven by real factors. It's when you have more demand than you have supplat whereas the three percent is basically a nominal factor. It's about what price level you you're taking, you're expecting and taking into account. And so to talk about overheating, whether it's a supply constraint, bottleneck or excessive fiscal policy, is something that's it is to use the dread word transitor doesn't

mean short term over. In five minutes, Pow finally picked up in the press conference what you and I have been talking about for months. The transitory for economic policy purposes needs It doesn't affect the underlying trend. Doesn't mean it's over like that, Adam, How does the Fed keeping rates where they are continuing to buy bonds help the job creation that you're talking about help people rEFInd a position at a time when prices are going up of

things like rent, which is directly affected by the feds policies. No, at least that you're right that there is a trade off here. That's always in economics. Nothing is costless. So the point of going from two to three percent is your target isn't because it's cost less. It's because the downside risks are worse in terms of what you're focusing

on rightly, which is the finding of jobs. What we're seeing, for example, of the massive move of workers have a small medium enterprises to employers like Amazon, Walmart, McDonald's, Bank of America is we've got a fact a rise in the minimum wage in a lot of the big employers. And this is really important to get people to make adjustments and to resort workers into the places that are more productive, because if you're low income worker, it's really risky and tough to look around and move for a

new job. But if the wages go up, then there's an incentive to get past those fixed costs. So there was a great paper at Jackson Hole this some we're talking about how a loose, slightly looser monetary policy environment, slightly higher inflation environment helps you make adjustments the labor market. This was a point I wrote about twenty five years ago with reference to Japan, and we saw it bear fruit under Abbey that you keep monetary policy looser if

you want to have real structural adjustment in the labor market. So, in other words, you think that the US can draw a direct analogy from Japan at this point, from Japan or from Germany after the Heart's for reforms in the in the early two thousand's. What what I think is going on in the labor market right now Leaves in the US is there's a structural change. As though we've got a labor market perform we haven't had some big

legislative package. It's not government driven, but it's people, as you've been talking about on surveillance for a while now, it's people making up their minds that they need a different form of work, and it's employers making up their minds that yeah, I can afford to be a bit more to get the rank workers and the rank relationships. So that's a structural change for about twenty percent of our workforce who are in the in the low income

service workers, and so we want to facilitate that change. Adam, you've been at a central bank at these inflection points. You were at the Bank of Inman coming down at the two thousand and night two thousand and nine Tobacco. I just wonder if you look to the Bank of England.

You looked at Red Nato Street where you used to be, and they start talking about a life meeting at the Bank of England, this like on thread Nato Street, And what are you learning from the moment we're in and what would you recommend to those at the Bank of the can about making a move at this point, Jonathan,

I think we're now moving. We're now not just moving countries, but we're moving themes because the UK is not like the US, or like Europe or Japan right now because of Brexit, people have underplayed I think despite all this German drawn they've underplayed the really good effects of Brexit.

And so I've been saying for a few years, including on this program, that bregsit takes the Bank of England part way back to the nine seventies, and what that means is they can't just focus on domestic inflation target the way they had when I was there, on the way they have. They have to keep one eye on the markets. And that's why they're moving forward in my view rightly though sadly, to a much sooner liftoff than

other central banks. The other thing about BREGGS is that it exacerbates shocks that require flexibility and supply, and we're seeing this that they're having the same reopening shock, the same commodity shock as the euro Area or the ass but because they've cut themselves off from workers in Europe, which were their labors apply because they've cut themselves off from easy importance and exports to some degree, the shock is that much worse for Brexit, for breksit post Brexit UK.

So for these two reasons, the Bank of England is facing a much less salutary set of outcomes than the other central banks, and that's why it has to move sooner in my view, even though again, to go back to least there's a cost to it. You'll more polite than I am. The rude way of saying everything you just said would be that the bank having that now has an emerging market flavor to the policy dilemma. Would you agree with Adam? Yeah, I mean I I choose

to say part went back to the seventies. Emergant market is waving a red flag. But I agree what what you have is for no fault in the Bank of England's the credibility of their anchor and the stabilization of their economy is less closet Brexit and therefore less likely other high income economies than it was. Pretty so, John, do we need a banner on television and for radio? That, says Posen, says uk his banana Republic work that the governor of the Bank of England, it's the governor of

the Merchant Marquet Center. You can quite I'd rather, I'd rather go with the child, the running around child in the background. Governor by with the child in the background at him. You want to do that, Adam Pison, thank you said, it's fantastic. As a wife of the Patison it's the cheap never dull a moment. And Steve Shiveron knows that he is with federated or measures thrilled he

could join us this morning. Steve, if you guys change your asset allocation or wisdom across the capitalization view from large cap obviously a federated heritage, over to mid cap and indeed the small cap juggernaut we're on right now, has there been a federated shift now, we've been pretty consistent um being overweight cyclicals amongst the large caps being neutral, overweight small caps having some preference for international and quite frankly, Tom,

you know, there's nothing that I heard yesterday, uh from the Federal Reserve that would that would change our thinking. We think you still have an environment where it's risk on for the time being. Is there a risk here as we talk about sequencing, that all the central banks and developed world all pushed back rate hiking and frankly tightening policy until next year, until the data becomes indisputable that we get a sort of collective tightening that really

puts the brakes on a rally. Yes, I think that's absolutely a risk, and I think that you know, it was interesting you were talking about the b o E and sequencing in a very rare move. The Americans were more subtle than the British. But but I think we were doing exactly the same thing. You know. The two takeaways from yesterday from the Fed, from my perspective, we're humility. You know, they recognized and admitted that they've had a

misread on inflation and then op ftionality. But by saying that they would or would take the opportunity to vary the speed of tapering, you know, come January. I think what they're saying is that if inflation continues to come in hot we think it will because we think that they're misreading the labor market here, that they would speed up that pace. Well, why would they do that so that they can start rate hikes earlier? And I thought

it was very telling. When Scheifel had the opportunity to push back harder against where the market was pricing in rate hikes for next year, he didn't. Um and admitting that we could get the full employment by the middle of next year suggests that the market is not crazy and thinking about rate hike number one in June or July. So I'm looking right now at the fact that two year yields the US are moving lower in sympathy with two year guilt yields, and I wonder how much some

of the central bank world is interconnected. In other words, the rate market will move collectively or it won't move at all. How much is that the dynamic that we're in right now for the developed world? I think it makes sense because I think the the inflation impulses are similar. I mean, they certainly are connected to what's going on with with with the pandemic and the supply chain shortages that are part of that. I think in the United States the labor markets tighter than it is in other

parts of the world and will remain so. But I think that the drivers are are very similar. Lisa um and so that's that's not unexpected. In the perfection of federating or mes Steve, there's gonna be no window dressing, but to the end of the year there's a bye

side sweat. How big is the sweat this year? I think there's sweat because I think folks have been on the wrong side of a lot of trades, and I think you're gonna have momentum and at the end of the year, you know, my take from the fetis equities are going to really like the patient's message. I think in terms of Washington, we've defanged some of the most or potentially some of the most disruptive policy options will see.

And so I think you can have a scenario where you know, kind of like you've got a real strong finishing at the end of the year. And it's been hard to stay with it because as instructive as we've been, you know, you'd have to have been blind not to see some of the risks that have occurred. So I think for folks that have been in our camp, which is to say the fundamentals are positive, respond to bad news if it happens, don't anticipate it and get caught

off sides. You're fine. If you've been a little bit too reactive too early. You're gonna be on the wrong side of something. I think that's gonna be quite positive between now on the end of the year, and you're gonna try to window address and catch up. See just real quick here, what's the bad news you'd respond to? So I think you've got to look at what policy comes out of Washington, if there's something really disruptive there

on the tax of the spending side. I think what it really comes down to, Lisa, is we are in a heightened risk of dual policy error, either on the monetary policy side or the fiscal policy side. We've never spent money like this after economies at full capacity. We've never been this reactionary to inflation rather than anticipatory, and those both of those things may be fine, but we

don't know. So I think you've got to have humility, and quite frankly, really good hearing the Feds say that they're having some humility as well, because we are in uncharted waters on both monetary and fiscal policy. Steve, thank you, sir for your humble opinion on this market. Stave Chevron, Federated Steve, thank you, buddy. Good to see you. At least that's the moment, we're in the wide range of outcomes through next year. I've had some great interviews so

far this week. Already it was Francis Donald that called it the anti forecast for next year. I'll be interested to see what her research looks like into year end, into the outlook into next year. What's the balance of risks to use Federal Reserve language. I think the Bank of England rate decision is fascinating because they pointed as a slowdown in growth that they experienced over the late summer,

the idea of the delta variant. I do wonder whether defferring rate hikes means fewer of them or just simply concentrating them more when the data is more clear the growth outlook as we can since August on supply issues, was Adam Posting that talked about the lack of flexibility around some of those supply issues, particularly in the UK. Some unique circumstances there, perhaps tom But more broadly, if these central banks make can move, are they making a

move into a weaker economy? And I said we could tellmas relative because if we're talking about full percent GDP next year in the United States and five to six in the UK five to six real, wouldn't you in the summer, John, We are migrating a vector to what three percent two percent sub potential GDP? That's out the window. We don't know where the X axis is. I really

have trouble right now with the Fed parlor game. I'm focused on what corporations are doing, Beckton Dickinson today with a major buy back, speaking of decades, and you're Denny joins us right now, Dr R Denny of your Denny research, And I just want to get to the inflation story right away, and let's go back to the seventies even sixties playbook. There is the cost, there is the push, there is the demand, There is the poll. What kind of inflation are we enjoying? Well? It does have some

similarity is with the nineteen seventies. In the nineteen seventies, everything that could go wrong on the inflation front seemed to go wrong. For example, uh, we closed the gold window and so the dollar took a dive, which then caused commodity prices to soar. Food prices went up. There was an issue with anchovies off the coast of Peru, which somehow had an impact on soybean prices. Don't ask

me how that worked exactly, but it did. And then we had two oil shocks and we had costs of living adjustments, so all those shocks went right through into wages. We don't have a cost of living adjustments anymore. But we've probably got the UH labor movement in UH in control now more so than ever before UH. And it's not really a movement, it's just a shortage of workers, and so wages are going up. And I think the supply disruptions explained why productivity it took a dive there

in the in the third quarter. But I think companies are already responding anecdotally anyways to the labor shortages. They're going to be chronic, and I think we are going to see a tremendous amount of automation. Do the mere mortals at the FED risk of policy error? Well, they are mere mortals, So we gotta start. We got to start with that insight, which you correctly point out. But I think that there's sort of a view out there

which I share, that they are behind the curve. Contrary to what the FED chair has been saying, the economy's done awfully well, certainly in the first half of the year and uh second half it's the supply distructions that we don't want to see, the pressures on the pricing inflations I go into wages. Uh So I think they're a little bit late. But look, my job isn't to tell the Fed what to do, is just to anticipate

what they're gonna do. And what they're gonna do is uh taper as we know, as we all know, and they're probably gonna stick with it through the middle of next year, and then I actually will not be surprised if they raised the inflation target from two percent to three percent, because it's going to be an even more liberal,

more progressive it next year the way I see it. Wait, hold on a second, Can you elaborate a little bit on that, because that's the point that Adam Posen has made as well, that perhaps they're not going to try to fight higher inflation on a base level, but rather embrace it. What will sort of trigger that shift in mentality, Well, I think the Feds are going to have to at some point concede the inflation is not transitory, but it is persistent. Right now. What they're saying is that the

supply chain disruptions are persistent. Well yeah, so what does that mean. It means that inflation ry pressures are gonna stay persistent. So I think, um, I think much will depend on the FED chair. I don't think it's going to be pale. I think it's likely to be brainer. I think there's gonna be a couple of openings that get filled by more progressive kind of people. If it is simply going to become more politicized, more progressive, and uh, I think more inclined to say, well, you know what,

two percent too low? Three percents fine, and if it's a little bit above three percent for a while, we can live with it. They really don't want to raise interest right, um more than they have to, and they'll move the gold post. Okay, So you mentioned the nineteen seventies, which is basically a trigger for a lot of people watching the bond market. I wonder where the analogy start and where they drop off, especially if you do have a more devish FED that is more willing to allow

inflation to hover around the three percent level. Are we really heading into a period where inflation could get away from the FED? Or do you think that the Fed can keep control over it just i'lbeit perhaps in a bit of a higher rate. Yeah, well, I'm I'm actually an optimist on the inflation outlook in terms of over the next few years. I don't think this is going to be the nineteen seventies all over again. The big differences. Productivity collapsed during the nineteen seventies. It went all the

way down to zero. I don't think that's where we're heading, notwithstanding this morning's disappointing news or surprising news, whatever it was. But I think productivity is going to make a comeback, and that's uh, that's an important offset to wages going up faster than prices. You folks mentioned that we're gonna be putting a lot of weight on real wages, but I think we want we want to look at real

wages relative to productivity. The only way that real wages can actually go up is if productivity makes a comeback. If it doesn't, then we're gonna have a wage s price spiral, which was really what the nineteen seventies was all about. Okay, how do we calculate will calculate that our guests that and when do we do it? Is that a first half two thousand twenty two exercise, or are we that data dependent on rising wages? Well, at

this point, the productivity story really is anecdotal. You know, we can see that companies are scrambling to increase their productivity with robotics, with automation, with artificial intelligence. The good news is the technologies there and it's relatively cheap and implementable to to make that happen. So I don't think we're gonna have to wait all that long. I think by the second half of next year we're gonna see that inflationary pressures abate, partly because of productivity and partly

because supply chain distrust options get amaliorated. Um and uh that's a big issue, is uh, the supply chain disruptions. So I think we're gonna have more cars by the second half of next year, more supply and that could take a lot of pressure off inflation. The bond vigilance stay in hibernation, the net well, you know, it's hard to uh for them to have much of an impact when the Fed basically has been rigging the bond market. I mean, they've been so aggressive in that market that

it's it's hard to even call it a market. It's not a free market, certainly, but I think by by some time next year we'll see two on the on the ten year. We also have to factor in demographic factors. Here in the seventies we had a tremendous influx of baby boom workers. Now they're retiring and we're seeing that the growth rate in the labor force is close to zero.

The only way this economy is going to grow on a tent trend basis is of productivity makes a comeback, and I'm optimistic on gonna catch up at as always Edie Antenny, the original man of coining the phrase, the author of Bond Vigilantes. Ellen Wald, Senior Fellow in Atlantic Council, joining us for a brief visit this morning. Ellen, the spread is narrowed between West Texas Intermediate and Brent Crude. Do you just apply within your macro view that Brent

will widen out higher or or West Texas Intermediate comeback lower? Well, you know, one of the one of the interesting things is that w t I has been doing better recently, particularly with foreign buyers, because it was it was priced a bit lower, and so we saw some increase in exports from the US to China and other countries. If that spread collapses, then uh, the US benchmark may become less interesting to uh to foreign buyers, and that may

actually help gasoline prices at home a little bit. Well, it may help at home a little bit. But are we are we at attention points at gasoline? I see it a triple a unleaded three forty a gallon. The moving average back at a hundred dollars of barrel was like three fifty eight a gallon? Or is this time different? So it does seem that gasoline prices are starting to

uh to calm down. We're not seeing as many many increases as we were previously, so I do think that we're kind of coming to an equilibrium in terms of gasoline prices at this time. We've got plenty you know of gasoline in storage, some of the recent numbers from the EIA or showing that, um, you know that that crude and gasoline stores are are increasing a little bit. So I think that's helped push the numbers down. Of course, if we have a very big demand over the Thanksgiving holiday,

that could certainly cause some some prices to rise. Ellen. Honestly, the idea that Biden is planning to release some of these stores in the strategic reserves. How dramatic a response would that be? You know, I don't think that it would produce quite as dramatic a response as he or his administration is really hoping for. If you look at the global picture in terms of oil UH, you know, we've got Opeque looking to increase production by four hundred

thousand barrels a day starting in UH in December. Plus you've got global consumption at about a hundred million barrels a day, which is basically where it was pre pandemic, and so the US could do an SPR release, but refineries are running pretty much at capacity. We've had some declined in the total amount of capacity of our refining since the pre pandemic days. But if there's a bigger SPR release, that's not necessarily going to translate into more

gasoline and lower prices. For the long term, we could see a brief, you know, brief push down, but in general, unless it's repeated, I don't think it's going to help all that much in the long term. Ellen. There's also a question about what President by the stance has been towards the shale industry. Is there anything identifiable from your perspective, that the Biden administration could do to try to prompt more pumping in the shale patch or whether that's even

appropriate in this type of situation. Yeah, I think it's it's definitely a factor in higher oil prices. I know that Biden really wants to blame Russia and Opeque for failing to produce more, but they are actually increasing production at a pretty good clip compared to the US oil industry, which is not really increasing production at nearly that clip. We heard that there was eleven point five million barrel today produced last week in the U s which is

a slight take upward. It's really not enough of an increase to bring oil prices down, and the Biden administration has certainly made a lot of producers very weird area of increasing production. It's not just about investment and UH and UM the desire for capital discipline. It's also a concern over growing regulations and the methane rules that were

announced earlier this week are not helping things. I do think we will continue to see a slight increase upward, but unless the Biden administration comes out in a big way and says, Hey, we want to encourage investment in this and we're going to help the situation. We're going to do what we can to assist in UH in more production. I don't see a major increase in production happening anytime soon. Allen, thank you so much. Greatly appreciated with the Atlantic Council on Oil. This is the Bloomberg

Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten a m. Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom keene In. This is Bloomberg