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Hello and welcome to another episode of the Odd Lots Podcast. I'm in show Wisenthal.
And I'm Tracy Alloway.
Tracy, we're still here at Jackson Hall. It's funny saying things like we're still here because we're recorded all these episodes at the same time and we don't really know exactly when you're listening. But this is yet another Jackson Hall.
Up, another special missive from Jackson Hall.
So I think there's like an element, if I'm being honest, a certain surreality of Jackson Hole this year, because it is an academic conference historically, and now they're setting aside the chairman speech, which we'll talk about more. Setting aside
that speech. You know, it's a place for like talking about important issues, and yeah, academic economics and that's great and I love that stuff and it's super interesting and all that, and yet the big story is really the attack on the whole premise on the independent Central Banks. And yet it sort of like feels like everything but that gets talked about.
I think that's right, And you said setting aside pal speech, but it was very, very noticeable that in his speech he could have taken it as an opportunity to talk about things like central bank independence or things like data integrity given what's been happening at the Bureau of Labor Statistics, but he chose not to.
Yeah, great point, you're right, Like he could have because we were wondering, like, you know, this is going to be his last speech, last time speaking as the Federal Reserve chairman, so he could have said something really big about reflecting on a career of being a central banker and the importance of all these things, and he gave a you know, macroeconomic policy speech.
There's also this other layer, which is a lot of what he's trying to do now, which seems to be to focus on labor market deterioration and maybe look through some of the upside risks to inflation right now that only happens if you have a credible central bank that can pin longer term expectations for inflation down. Like, yes, the only reason he's able to do some of this is because of the credibility of the social capital that the FED has built up over decades.
Exactly right. And the reason why we're talking about this, just to be very clear, it's because of the attacks from the Trump administration on Jerome Powell, also other FED governors also, you know, the whole thing. And this is just part and parcel of one attempt to sort of, you know, restructure how the US does both domestic and international policy. Because there's the tariffs obviously, and those intersected
with monetary policy. But then there's just also this sort of changing relationship with other countries that gets into things like you know, like let's get payment for security or something like that. Like big look so many like big hinges and pivots at one point, it's.
I mean, I don't think it's hyperbole to say it's an attempt at a restructuring of the global order, both in terms of the economy via the international financial system and also in terms of security. I think the con using part for me is it is a fact that America has the world's biggest economy. America came through the pandemic a lot better than a lot of other countries. We ended up having lower inflation than a lot of
other parts in the world. And yet the Trump administration seems very very convinced that the US is somehow losing out from the current international order, or maybe they feel that there's just more that they could get from restructuring it. So I think we should talk about maybe the motivations behind some of this, and then what the new world could possibly look like.
Well, we literally have the perfect guests, someone we've had on the pot, someone who we always catch up with injecta hulk.
It's becoming a tradition.
It's a tradition. And he's literally the perfect guest because he used to be on the Monetary Policy Committee at the Bank of England, so as all the monetary policy bonafides. He is currently the president of the Peterson Institute for International Economics, and he is the author of a recent article the New Geography Who Profits in the Post American World that was in foreign affairs. And he's not one
to like sort of dance around big issues. He doesn't mean, yeah, so this is what I said, goes to talk about this someone. I was like, Okay, if we talked to Ediposen, we can actually really like talk about all these things that maybe many people are anxious to talk about. So, Adam, thank you so much for coming back on Odelaw's great to see you again here at Jackson Hall.
Thank you for having me back and congratulations Tracy and Joe on the upwards profile of odd lots ever higher. So it's very cool.
Very kind of you to say, are we right that there is a certain surreality to the vibes here right now?
Yeah? It is. As you said, there was a lot of deliberate focusing down of chair pal speech, and there's been a lot of self discipline of members of the FOMC and everybody to be quite restrained at a time when the attacks on the FED and the weaponization of government files to attack individual FED members and so on is going on. I think Tracy's absolutely right, and we didn't script this in advance, but it is all part of this broader context of do you keep inflation expectations anchored?
Do you have faith in the dollar? Do you have faith in the credit of the US, do you have
faith in the US foreign policy? And those are all things which FED officials are not supposed to talk about, with the exception of the inflation expectations, and now the inflation expectations even they are, they're reluctant to talk about it because it can become self fulfilling if they talk about worrying about it, then it's ours unravel, but also to be fair, because the seeming message of the rapid come down in inflation that we talked about our last
few times we were together in Jackson Hall over twenty twenty two was due to having anchored long term inflation expectations. At least that's one argument. But it is surreal, Joe. I mean, I've gotten to talk to several of the members of the committee and they are trying to get
on with their lives and it's hard. But I also just want to emphasize it's not that different than their colleagues in Washington at the Treasury, or at EPA or at the Bureau of Labor Statistics that they also are under attack.
So we've done an episode on this before, but I would love to get your take what exactly happens to central banks when their credibility starts to come under attack, or even when maybe on the fiscal side, you see politicians interfere a little bit more with monetary policy, even if that interference is just a truth social post or something like that.
Yeah, I think Tracy, the emphasis should be on the latter part of what you said. When elected officials who are superior to central banks in any power struggle. When fiscal policy, which if it gets really out of whack, has what's called dominance, fiscal dominance can overpower whatever monetary policy is. When the context for central banking changes, then it's not so much as say the credibility the central bank per se. It's the credibility the central bank will
be allowed to deliver what it's supposed to deliver. And I'm not saying that to make excuses for the central bank. There are instances like Arthur Burns in the seventies where the central bank itself is compromised and fails to deliver. But I think that's the way to see it. And where you see it is where we're already seeing it in the US, which is you see it in a slightly higher risk premium on long term government bonds. You
see it in weakening of the currency. And some of this I think can be tied to the broader Again, I sorry to keep coming back to that, but to the broader Trump economic agendas. Both of you said it is a real regime change, but we're seeing it already.
And so there's a chart in this Foreign Affairs article the New Economic Geography I put out thank you again, that does a simple version of something a lot of economists academics have unemore sophisticated versions, which is basically the correlations on the dollar have reversed that with a couple interruptions in two thousand and eight, in the late seventies early eighties, the dollar has the quality that when it gets into trouble, more money flows into it, and even
if the US is causing a problem in the world, people believe they're safer in the US than there was the ultimate exact two thousand seldom example, dollar just down, but basically treasury bond rates and dollar move and lockstep, which is another way of saying they don't have to
put up the rates to defend the dollar. And it also means that most of the movement in the dollar day to day is just macro news, just day to day news, and so putting in simple mindedly, there's a correlation very strongly positive in intra day, intraweek data between
the dollar in the tenure treasure rate. Until April one, April one of this year, that correlation shifts from plus zero point eight to minus zero point four reversus sign And what happens is when something screwy happens in the US, like we decide unilaterally to bomb Iran, Like when we do crazy stuff on one big, beautiful bill, it's fiscally irresponsible, like when Powell is attacked in vicious terms by the president. Gee, interest rates go up, dollar goes down, and that looks
like an emerging market. Anyway, This is not just a data mining. You can do it in very fancy econometric ways. You get the same result. The correlation of safety on the dollar has reversed, and that would be a sign of what you're talking about, Tracy.
Our friend Karlick Center and who's been on the podcast, always talks about's sort of the definition of an emerging market is if your rates at the long and go up in the recessions, right, Because you know, in times of crisis in the US too historically you're like, oh, there's a really bad in the US, I'm going to pile into dollars at treasuries. This is what you're talking about, which is that reflex has not kicked in exactly.
We've got four and a half months of very clear data. It's going the other way. A lot of the things that Trump administration is doing are going to reinforce that because they've talked about taxing foreign investors differently in the US than domestic investors. They've talked about punishing people who tried to switch out of the dollar. Stephen Moran, who's been nominated to be a Federal Reserve Board governor, you know, has talked about amar a Lago accord and re putting
the dollar down. There's real reason for it to behave this way.
Now, talk to us about like your foreign affairs piece, like the sort of you know, this idea of like the restructuring of the global and who profits from it, because you also talk about this idea of like the US is like sort of the global insurer of last resort. But talk to us a little bit about what this whole piece was about.
Thank you, Joe. And this goes to what Tracy was saying at the start about how what you think you're
achieving with this world change. So what I'm trying to argue is that the Trump administration decided that the world economy is playing the US for a soccer, and that very harsh direct bilateral measures starting with terroriffts, but also with other threats, Demands for investment, demands for military assaults on social media, all these things, threats to withhold military assistance in the case of Ukraine and others, that this will be a rebalancing, that this will get more money
from these countries into the US and thereby make our fiscal situation better, be fairer, and somehow do great things for the US economy. This is wrong on every level, But the fundamental point going to the insurer is I build a mental model, not a mathematical model, but a mental model that I think most people have found quite apt that for the last eighty years since World War Two, the US's main role in the world economy has been
to be the insurance provider. We made sure that you could ship things through with through different oceans and get there safely. That there was basically respect for property rights, respect for intellectual property rights. There were some standards, particularly technical standards, some brands. There was a dollar that you could get in and out of and park money, and it was deep enough markets and treasuries that you could get in and out that nobody cared and it didn't
affect prices. There was stability to the US currency and the treasuries that let you do that. Just a whole host of things, plus military and alliance as well, obviously for NATO allies, for Japan, for Korea and others, and we charged premiums for that. We did get premiums. We had much lower interest rates. People would put a lot of money into US government debt and that made the
whole economy go off better. We had basically obedience from all these countries and military alliances that they would do sanctions. For the most part, if we want to do sanctions, they would in Okinawa, in Rhinemind Air Base. They would take our troops and support them and have them garrisoned in their country, have our troops forward and doing it.
Whole host of things. And on the economic front, it gave us disproportionate shares not just of the stable investment and treasuries, but things like our standards for technology, our standards for legal matters are our financial system were the default. Anyway, this had lots of benefits, lots of benefits for them, lots of benefits for us. It was a good business. Essentially. What's happened is you have a beach house in Malibu which you had insured, and you weren't going to build
the beach house unless it was insured. Fine, you're paying insurance, you're getting something for it. Now there's global warming, hurricanes are more likely, there's erosion in the beach. You're prepared to pay a bit more for your insurance, but instead you find your insurer has decided, no, we're going to deny your claims. So you have to slip us something
under the table to get your claim adjusted. Nope, we're tripling your premium and if you don't like it, we're going to leave the state and you're not going to have insurance anymore. That's what the Trump administration is doing.
I mean, the role of insurance also acts as a sort of like umbrella for economic development, right, because if you have insurance on the beach in Malibu, other people can build houses and you can have shops and things. Exactly, maybe your house price starts to rise and you benefit from that. So this is a slightly unfair question because I'm going to ask you to channel someone else's thinking.
But what exactly is the argument from the Trump administration here as to why they are losing out from the current international economic or financial order, which very much seems to have been built by the US. And as you pointed out has a lot of tangible and intangible benefits for America.
Well, this is something I and colleagues of the Peterson Institute have been struggling against for several years now. On not just Trump. There are people on the Democratic side who've had this view as well. So in the same issue of foreign affairs, Wally Adamayo, who you know who was Deputy Treasury Secretary in the Biden administration, has an article, Yes,
the trade system was broken during the Biden residency. The US Trade Representative gave a speech in which she said she basically agreed with everything her predecessor, Robert Leitheiser, had said during the Trump inversation. So this has been out there a long time. I know you want me to answer a question, but I'm not going to try to rationalize it. I think there are three or four things
going on. One is there is an excessive sense that China has been unfair, but even more so that China got away with being unfair and is dangerous because of things we did on the economic side. And I don't think this is justified. Not that I have any love for the Chinese Communist Party, I'm on record calling she an Autocrat, but just the Tom Brady and Bill Belichick didn't win Super Bowls because they cheated in the little ways. China did not become China because it cheated a little
bit here and there. The second thing is there was a legitimate concern which the Biden people cared about and the Trump people say they care about, but don't seem to care about that. If we're too dependent on concentrated, single sources for things like the semiconductors in Taiwan, that puts US at a national security risk, that puts US
at an economic risk. The reason I say that Trump people don't seem to genuinely care about that is because being totally concentrated in the US in one spot isn't any good either, because then your subject still to natural disasters, to terrorism, to political problems, to corruption. You can care about this and say we got to make sure it's diversified.
The third thing that's going on is there's a perception, fed by the so called China Shop literature, that US manufacturing was devastated, and this led to particular small cities
and towns in the US being devastated. There's a lot of exaggerations and problems with this literature, and it doesn't square well with the reality, including the reality of most of the places that are cited as having had problems had problems in the seventies, and that there's plenty of places like Pittsburgh and Rallington, North Carolina that got back. But anyway, there's that sense. And I think you've had on my colleague Robert Lawrence with Peterson and Harvard, who
talks about the limits of a manufacturing strategy. And then finally, and this is my own interpretation, people get mad at me when I say this. I think there's a lot of displaced anger. I think there are people who were relatively privileged. They weren't necessarily rich, but relatively privileged in older society, in the way the US society used to be that I have been disrupted and offended by change
and by forces towards equality. I also think there's a bunch of people who are understandably very angry and disappointed with elites after the two thousand and eight financial crisis, after COVID been perceptions of mishandling after the Iraq Afghanistan invasions and occupations for twenty years that didn't produce anything, so there's a lot of anger that's discredited that they have discredited elites who are associated with being globalists, right,
But I don't think that anger is well placed. And I'm not trying to be patronizing. I mean, we've seen this in the US history and other history. You know, people will stir up anger against immigrants, or stir up anger against Native Americans or people of color or refugees or com mythical communists in the government in the fifties because they're angry about something else or they're scared of something else. But it gets blamed on that. So that's
where I think it comes from. But I just want to emphasize what you've said at the start, and that's part of the point my article's trying to make. Is there's a very clear list of benefits the US had by running the system, and by had a good business model.
It was a profitable business model providing insurance. And like you said, if you're providing insurance for some people, that lets commerce expand and lets other people free ride, and that's a good thing that they free ride, and because then you get more commerce and more taxes and more livelihood and better off people and Additionally, one thing where the analogy breaks down, it's even more favorable for the US, because you know, if you're chiulb Order, Liberty mutual or
state farm insurance, you don't really have a big effect on the extent of risks out there by how much insurance you give. But if you're the US and you say I'm going to guarantee your security, you actually do reduce the risks that are out there, and that means you're collecting the same premiums and paying out.
Less at the risk of carrying the insurance analogy too far. I mean, it is true that we have insurers pulling out of areas like Florida because they say it's no longer economic to ensure these areas. It's just too risky. It's going to cost too much to rebuild. Is there a case to be made at all here that maybe the Trump administration is looking around the world and saying, well, it's riskier now than it was before, and we don't want to be on the hook to put out a billion fires.
I think there is a case to be made in the national security sphere more narrowly defined, that the US may have overextended or needs to prioritize, and there is a set of foreign policy thinkers out there talking about this issue. You, I still don't think that's quite right, because actually deterrence and protection kind of like you said before, there's an umbrella effect. But let's say that the national security part you can set aside and say there is
an argument to be had. The rest of it doesn't make any sense because you're giving up strength of the dollar and lower interest rates. You're giving up disproportionate compared to your size in the world. Foreign direct investment, you're giving up disproportion compared to your size in the world. Influence over technical standards, love for your brands, spread of your services. You're giving up disproportionate amounts of influence on
other populations. Again, it's just like looking at foreign students coming here, which I know you've talked about in some of your episodes, that unless you come up with some absolutely mythical number of how many of them are not only spies for the Chinese but successfully pull it off, are undertail and take the Chinese information that they couldn't
possibly have gotten through cyber attacks and other means. Unless you call it with an absolutely absurd number like that all the benefits come to us from having foreign students here, and that's what can be said about all these things on the economic side.
By the way, when you were talking about the you know, well we had going. You know, it's like that breaking bad speech that I've seen a good thing going.
Yeah.
Yeah.
You know. One of the reasons I like talking to you. I do feel like it's refreshing, frankly, this sort of unreformed liberal because everyone is like post you know, everyone sort of post liberal now and everyone. So I appreciate that. Also two years ago when we first d you on the podcast and you recommended as a Vogels biography of doing Chopin to me, and then I read it the next month and I read so I appreciate the book recommended. That led me down.
I think that's I was going to say, that's the thing that.
The whole we've read like fifty books about twentieth century China, all things to you, but I want to talk about China a little bit more because I take all your points about about everything, however, and you know, you've been sort of like refreshingly skeptical a lot of these ideas. That is particularly important to have more manufacturing in the United States, et cetera. But there is this very real concern that without robust manufacturing you actually can't have a
world class military. And if you're just thinking about like, okay, we provide this insurance role in some ways very literally, say, with our navy through various straits around the world. And Setiga said, whether China cheated or not, should we be anxious if pure like manufacturing capacity and the technological frontier in building things including weapons is in China.
Anxious is not the right word, Okay. And I appreciate you're saying about the liberal and that's the part I didn't say. I mean, I think a lot of people are making the case that I'm not pushing back against the tracing you asked about, because it's seems to be politically advanceable to say that old fashioned liberal values are
bad in the case of China. Again, there's a difference between arguing in a frankly not just liberal but neoliberal, if I can use that word way, that there is a specific market failure to make sure we have adequate minimum sourcing and diversified sourcing of key national security inputs. Right, Yeah,
so you know that's fine. You can say that, and it's like, yeah, wouldn't it be good if the Defense Department and the Commerce Department and the intelligence community actually had a process by which they identified this and actually had an ongoing commission and had a list and had expert advice and decided, excuse me, in a non partisan way, how to do that, and then actually marshaled specific money and measures to do that. And if you could do that,
you should. That would affect, you know, some time, any percentage of the US economy. It might be incredibly important for having drones or aircraft carriers or whatever the right technology is. And I'm not going to pretend I know what it is okay to keep the Straits of Malacca open or to keep the Taiwan straight open. But you
could do that. And when I was fighting against the Biden administration on some of their national security excuses for economics interventions in their industrial policy a few years ago, I actually had a meeting with a senior person in the White House, not somebody that senior, but senior enough, and I said, you know, you guys have to have
a list, you have to do this. And this person laughed and said, you got to be kidding, maybe because no one wants to write down a list, because once you write down a list, then you're annoying certain people and excluding others. And if you're the Defense Department, you want to include as many things as possible, and you know the general dynamic of how these things go. So I don't think the right response is anxiety. I think
the right response is, yeah, let's take this seriously. Let's act like grown ups and actually set up a policy process that deals with this, and let's do the spending. And even to go back to the international side, go to our specific allies and say again, it's like raising taxes on a specific thing where you're tying it to a user fee or on in the insurance I'm raising your premiums, not threefolds and threatening to leave. I'm raising
your premiums for twenty five percent. And if you put a fire detector in your house, I will only raise it twenty percent. Go to Germany, go to Japan, go to Korea, go to the Netherlands, and say, in the fact i'm raising your premium I want to spend this much more in defense. But if you chip in specifically on this list of military sensitive equipment, I won't ask for as much.
Yeah, the carrots are kind of missing. There's a lot of sticks and not that many carrots. Well, so you touched on this just now, But I'm basically going to ask Joe's question in a slightly different way. But are tariffs the right way to bring manufacturing back to the US?
No? Sorry, you want more? I mean look again, because of the nature of terras, which are a tax, which are a distortionary tax on a narrow part of the tax base that has bad distributional effects. They're regressive, They primarily either hurt small business on the corporate side, or
they hurt lower income people on the household side. And they tend to lead to corruption, even if not literal bribes, but distortions of Hey, Apple showed up in the President's office with the gold phone and what do you know, they got an exception to the terror. You know, tend to lead the stuff like that in the way the
most things do. Terraffs are good for two things. Right, if there is a very specific industry and a very specific bargaining situation, not against the whole world in general, all at the same time, one specific country with whom you can bargain, and you can get other people to join you in the tariffs, so it's effectively a form
of economic sanction that can work. The other thing is if you are an underdeveloped country with no state capacity, like the US in eighteen twenty or a number of South Asian and subs Aheran, African and Central American countries today, even they are not that many, Tariffs are a way to collect necessary revenues because you can literally set up guards at the border and make sure somebody gets the money, whereas other more less intrusive, less regressive, more efficient forms
of taxation are harder to collect if you don't have a good stack capacity. Those are the only two things tariffs are.
This is a good point because you know, you see people like, oh, back in the old days, the golden age, tariffs was like we you know, we didn't have like W two forms and stuff like that. So yeah, of course you just have to do it at the porest. Let's go back to, like, okay, setting aside the sort of structural issue with tariffs and the bad distribution effects,
et cetera. Like just right now in August twenty twenty five, and we look at the state of US economy and people like, how do you perceive the interaction of tariffs with everything else that are going on right now?
It's a fair question. We've done a lot of work at the Peterson Stut colleagues of mine that we've published, and others have done slightly different work, and we all come out roughly the same place. This is the way the Trump administration is doing it. In terms of the short term economic outlook is it's a tax hike. It's stagflationary, meaning it's raising inflation at the same time as slow
in growth. It's collecting a sizable chunk of revenue on the order of two and two hundred and fifty billion a year at an annual rate at this very high level of taxes. That will probably diminish over time because people get around that kind of tax and people choose to produce things elsewhere and people evade it. But for the moment, it's a significant tax increase that would have
been better done through more efficient means. It also is going to do nothing for manufacturing because what it does on net is well, there are certain industries that are being helped. As I know you've covered in your supply chain stories. You know, there are a lot of small businesses or even big businesses that have imported inputs, whether from China or elsewhere, and it costs them, and it's going to be very hard to replace that, and it's
very expensive. And then you've got the issue again, which I know you've covered, but has to be said that there aren't American workers for good reason. There aren't American workers who want to be sitting there screwing screws into the back of iPhones. I don't mean to keep picking on Apple, but it's just it's a clear example. So you either have to pay them an incredible amount for that,
or you have to let somebody else do it. So in the short term, getting back to the monetary policyly, since we're in Jackson holl I think it's not a surprise that we haven't had huge inflation yet from the terraffs because there are a number of things that mainstream people like us expected. People were going to be in denial about whether the tariffs would stay and how big
they would be. People were going to have to take time to figure out, if you're a business, whether you can find a substitute source, whether that subst source is domestic if you move it to Vietnam, does that really get you out of the tariffs? Do you have a good relationship? I mean it takes. As you've discussed in detail, these supply chains emerge organically and they're not top down. Somebody makes one decision, so it takes time to reformulate
the suply chains. If you were sunnya tariffs. Third, you've got a bunch of companies that were called out by name by President Trump, like GM or Walmart, that were told don't raise prices because of the tariffs, and so of course they're going to hold off as long as they can. And then eventually, when everybody's raising prices, it
profit at the same time, they'll raise prices. And then finally, a lot of these companies, and a lot of the consumer goods companies had inventories, and they built up inventories in the first quarter of importing goods, and they weren't going to raise the prices until pass through the tariff costs, until they got burnt through the inventories. So she had four very solid reasons why it would take at least a few months for the tariffs to really start showing
up in prices. So if I'm sitting at the Fed right now, in my view, the tariff inflation just goes up from here. First round effects probably will peak in second quarter of twenty six. And then the debate is and my estimate is higher than most people's. A lot of people think it'll peak around four on CPI. I think it's gonna peak closer a fiver a little more.
And then the discussion which Governor Waller is put out there, which the chair talked about today, talked about in the speech, is how much do you think this translates into second round inflation effects? How persistent is this inflation? And that's the interesting debate, And that's a good faith debate you can have. But the tariff inflation is coming, it's on its way. It's not surprisingly low, it's not surprisingly slow. It's a tiny bit slower than I expected, but not really.
And we're here, Well, I'm going to take you up on the debate, tease, but where do you fall on the side of the second order effects debate? Because you can make it feels a convincing argument for either side.
You could say that while tariffs are attacks and so they destroy demand and maybe lead to deflation, or you could argue that tariffs perhaps give companies an excuse to all start raising their prices together, and so you don't get that competitive activity that would normally keep prices in check.
I think you can make a plausible, serious debate on both sides, but I think the arguments are very clearly on the side that the second round effects are going to be large and persistent. There's several reasons, which is
why I think it's pretty clear. The first one is we know from what happened with the tariffs under Trump, ian under Biden, from other countries in recent times that the pass through what generally you end up being if you're the company that ultimately buys the imported input or the household that buys it, the pass through the final purchaser is usually eighty five to ninety percent of the tariff.
It's already very clear from the data that the foreign companies are not paying for any of this, So the question is how much are the importers eating it versus passing it on? And it takes a little time for you to get to that, but generally it's a very robust result. So even if you get less than that, you get sixty five seventy percent on average, that's still
a lot. The second is implicit what you said, and then sometimes in things some of the people on the other side of this argument say is essentially the demand destruction is either symmetric to the price increase or is larger than the price increase, and there's no particularly good reason to assume that. So you have to look at what actually is going on. We have a pretty robust economy, pretty close to full employment. We are about to get though it hasn't shown up yet. This to me is
the big surprise. But we're about to get more damage in a stagflationary way from migration restrictions, deportations, sudden stop of growth in the labor force. That's going to give American workers more bargaining power in the short term, that's going to create labor shortages, which put upward pressure on wages.
That's going to decrease productivity and capacity. So on balance, you may get some recessionary forces out of both that and the tariff increase, but I strongly doubt they will outweigh the inflationary impulses that there will be room for
price setting, price or increases excuse me, and wage increases. Third, going back to where one of the things you said at the start, anchoring inflation expectations is the game that ultimately is what allows US Central Bank to say, as Bernanki, Laubach, Michigan and I argued twenty five years ago in the Inflation Targeting Book, you're allowed to look through the first round effect of supply shocks if it's clear what the
supply shok is and you have anchored expectation. I think the FED, whether they admit it or to themselves or not, is publicly underestimating how much the twenty to twenty to twenty twenty two experience de anchored inflation expectations that didn't take us to Argentina in nineteen eighty. But anybody who says that they're the same as they were before twenty twenty,
I think is deluding themselves. And Then, additionally, going back to what Joe was saying about the surreal aspect of this time, if the Trump administration has been as they have, hugely attacking the independence of the FED in multiple ways, and this is showing up in a less strong dollar, then that's another reason to think that the expectations aren't going to be anchored, and you're not going to get an offset from the currency to the tariff inflation, so
bing bing being that's four reasons why I think the argument is clear that we're going to get more inflation, more persistence of inflation, more second round effects than some people are saying.
I have a question. I've been asking this to a bunch of people. I'm not totally satisfied with any of the answers I've gotten, So try again. Even before the terriffs, even before Trump, it appeared that from the perspective of the market that long term rates were going to be durably higher than they had been in the decade prior to COVID. How come what changed?
So isn't there place where I'm there's a legitimate, real discussion, and I'm very strongly on one side of it. Okay, So I think the useful discussion. All credit goes to Larry Summers roughly was at twenty nineteen, twenty eighteen, he gave the speech about secular stagnation, reviving the concept from Alvin Hansen, and oh sorry, that was much earlier. He
gave that speech. Then he gave the speech in twenty nineteen which he said secutor stagnation may be end And he made a number of points, but the biggest one was if you're in an environment where you're going to have sustained expansionary fiscal policy pushing up demand and meeting shortfalls of demand, then the r star and the neutral
interest rate is higher. And that's pretty clear economics. And then the reasons which he said and others of us have developed I think are right that going back to the insurance beffoth, the risks are higher now there's climate change. China is would no matter whose fault it is or whether it was a nevil or not. China is more of a security threat than it was. Russia is more belligerent than it was. People have to spend more on that. Our societies are aging. Att are almost all the large societies,
with the exception of India are aging. I mean you have to spend more on healthcare and more on social security. All of these things are going to lead to sustained increases in government spending, irrespective of whatever else you do, and they are unlikely, as we've already seen, to be fully tax financed. So that is a fundamental. The second fundamental, I would argue that's pushing up our star is that we don't know when AI is going to kick in. We don't know how big an effect, we don't know
how many jobs. You guys again have had many good guests talking about this, but I think we can all agree that sometime between two and ten years from now, there will be a meaningfully increase in the productivity growth trend. There are a few smart people like I, Sam oak Glue and Johnson who say no, but most of us
think interesting that there will be an increase of some sort. Now, I don't have to go all the way to McKinsey Global Institute and believe you know it's some enormous number, but whatever it is, that number an improvement in productivity growth trend is generally one for one should be thought of as raising the equilibrium interest rate, because you're raising the average return on capital. Essentially.
There's totally counterintuitive to me. I would have thought that a big productivity increase would be alt equal disinflationary and rates lower.
And well, no, it's disinflationary. But remember inflation we should think about as a short term phenomenon, a cyclical phenomenon, not as a structural phenomenon. So it's disinflationary in the sense that at any gift for while the productivity gain is ongoing, you're getting more stuff from less. But as a structural matter, you are raising the average returns on capital in the society, and so all capital that's competing has to compete with a higher return, and so therefore our star is hup.
Interesting.
So, now that we are deep in our star territory, I'm going to ask a central banking question with your central bank hat on. So you mentioned stagflation.
He actually has his central bankout is a Boston rest for those who because those aren't in the room.
That's right. So you mentioned stagflation earlier. What exactly are central banks supposed to do when they're faced with the stagflationary scenario. Because we just listened to pal talk about downside risks to employment and upside risks to inflation. He clearly seemed to choose the labor market over the inflationary risk at this moment in time. But there's clearly a trade off. You have to make a choice here.
Yes, And this is why you try to avoid bad pop pellasies such as the ones the Trump administration are doing. Which gets you into a stagflationary situation if you can. Essentially, it's a contingent choice, and this is why the FED is right to be putting so much emphasis on debating over second round effects of inflationary shocks and things like
you were saying, how much pricing power there is? How much recessionary effect do you get from these stack fleastion It's essentially a balance issue if you're forced to choose between the two goals, the two alves of the Fed's mandate, but the two goals for any central bank, essentially you have to go after the one that's more likely to spiral out of control.
Ah. So this is their argument that labor market deterioration can be very not linear, right, it can kind of explode.
Yeah, nonlinear is the way they think of it. I think again, it's no reason I would take the other side because the evidence is yes. And there's the discussion about the so called som rule. Did you can have these very rapid increases in unemployment. But what we've seen is much to people's surprise but has to be taken seriously, is both after two thousand and eight and after twenty twenty,
So after the financial crisis. After COVID, unemployment actually came down pretty fast, and there wasn't evidence of what economists call hysteresis, which is the idea that once you put a lot of people out of work, it's harder for them to get back into work. And so it's taken
from engineering. It's a concept that was very true of Europe in the seventies and eighties that every time you got an unemployment rate hike because of recession, it wouldn't come all the way back down to where it was before the recession, because there'd be a certain number of
people who couldn't get back into work. And ahead of the two thousand and eight crisis, during it, including my time at the Bank of England speeches and then Jare Powell and others in twenty twenty during COVID, worried a lot about this potential for permanently having rises in the unemployment rate. But the thing is, all the evidence from two thousand and eight and all the evidence from twenty
twenty is that didn't happen. And again it was a surprise, but it's a really important and a really robust result.
You really are an unreformed neoliberal because so many people have accepted the opposite. Everyone almost everyone thinks there's some histories.
And again, like I said, well I'm not in this. It's not so much I appreciate that joke. And this is not so much being a neoliberal as being an empiricist. So I mean, on my staff, a colleague of mine is Olivi Blacharden. He coined the Hystorici's concept may years ago, and he and Larry Summers and the co author's name, of course I forget, I apologize, did a paper in
twenty thirteen. It was like the first paper they did for us after I took over at Peterson looking for Hystoresi's effects in the two thousand and eight to ten data and they couldn't find it. And then Powell, again I think, with a great deal of sympathy from me and others, talked a lot about history sis for why they were so aggressive and cutting in response to COVID. But then again, we know the unemployment came right down, So people care about this. They're coming from a good
place to care about this. But it's not the illiberal it's the evidence. The evidence isn't there, and so the implication is not that you shouldn't care about unemployment. You should have temporary measures of fiscal policy like we did during COVID to extend unemployment insurance, to extend health insurance, to make it less miserable for people who are unemployed. But the inflation is probably the thing that's more likely to get out of control.
In my people, Tracy asked you a question put on your Monetary policy had but I'm going to ask you a question specifically with your Monetary Policy committee hat having served at the I'm having served at the Bank of England. Long term rates in the UK are higher than the so called Liz Trust's moment and I asked you a question about this last year and it was very vague at the time. I was like, what's going on with
the UK? And because it always thineks like there's some sort of mess, But now I actually have something specific to ask, which is what's going on with the UK in the sense that it seems bad, sir, it seems bad. The rates are very high. What's going on there?
I think I said to you when you asked about this last year, Joe, that the single biggest call I got wrong in terms of analysis and forecasting in my
career was twenty twelve at Bank of England. I and some others on the committee at the time but I'm responsible for me said, yeah, productivity has been lower in the last few years to twenty twelve because of the financial crisis, but it's gonna come back up because it's been the same long term trend since eighteen fifty and there was nothing to destroy a.
Trend from it.
Yeah, I don't cameer if it's eighteen fifty or eighteen sixty. But there's some incredibly long data series we have for UK productivity growth and even if you watch it, it's just a straight upward line. And even the Great Depression sort of makes a little blip, and World War Two makes a little bit, and then suddenly in two thousand and eight it goes flat. And I and a bunch of other people said, well, it's not like the Blitz, right, and so productivity growth is going to come back up
to trent. It never did. The UK is the one rich economy, high income economy where productivity growth not just
went down for a while, but kept going down. And so now we've had a dozen years of very low productivity growth in the UK and at some point that catches up with you, and I think that's the way to look at it is you throw bregs in it on top of that, which may be one of the reasons why productivity growth hasn't come back, and there's debate about that, but they have been running making less with more rather than more with less for a very long time,
and wages and prices and the path all haven't dropped accordingly. So it's not like unfortunately grease suffered through say or Portugal during the financial crisis, and so something's out of whack. And this shows up eventually in the fiscal policy, which is what you're talking about, that they have a bunch of really hard choices to make. If the government, the current labor government, doesn't make lots of cuts, the interest rates keep going up. If they do make lots of cuts,
then probably productivity growth doesn't improve. So they're just in a really, really tough situation.
So Joe asked you a question with your boe hat on, and I'm going to ask something similar. Which is one of the things that makes Jackson Hole such a big deal is that we don't just have the FED here. We also have other central bankers like the ECB, the BOJ and you see them do the classic walk with the FED chair every year when it comes to central
bank credibility and the independence issue. What do you think those other central bankers are thinking here and do they possibly use some of Jackson Hall We're still waiting to hear from them. That usually happens on Saturday morning. We're recording this on Friday afternoon. Do you think they maybe use this as a platform to try to push back against some of it.
So, the central bankers, both publicly and in conversations I've had with them from around the world, are shocked and horrified that the Trump administration is doing this to the FED. Beyond just the obvious. They're sympathetic to their colleagues from
the FED, and it's pretty yucky. Is just the fact that they have taken it for granted, the entire economics professions taking it for granted for more than forty years, going back to a classic paper by Ken Rogoff in nineteen eighty six, and then some subsequent when work others did that in central bank independence is good. It reduces inflation and reduces the volatility of inflation on average for a country in a large way without reducing the average
growthroat full stop. And this is lived experience. This is what the European Central Bank was based on. This is why the Bundesbank and the Germans were willing to give up sovereignty to the European Central Bank. This is the standard practice that dozens of countries have adopted. The Bank
of Japan got independence over the last thirty years. So it's kind of like with tread economists in the past, but even more in questions it's like, you know, this is like questioning vaccines, which of course nowadays people do, but at one point would have been thought of as what kind of anti scientific illiterate are you that you would question central bank independence? So, I mean, there's no
way to exaggerate. That's the response at various international versions of central bank summer camp, you know, which is what Jackson Hole is. So the ECB has their version, which is called the Central Conference, and this year at CenTra every he was rallying around Jay the share Powell, and there were public statements about central bank independence and support for him at the BIS annual meeting, which is a sort of similar thing, which this year I got invited to.
I don't usually get invite to that. I do get the center anyway. Again, there were public statements that are private statements that everyone's ralling around. But as we discussed, the FED leadership seems to have decided that jaer Pale should not mention a word about central bank independence in his speech this year, and so this is pure extrapolation.
By the time this recording comes out, we'll find out, but my expectation is they will have passed a memo to ECB President Leguard, Bank of England Governor Bailey, Bank of Japan Governor Awaita, who are the three big central bank governors speaking on Saturday, Please don't talk about it. And I think what they've probably decided is having foreign central bankers talk about this would not play well in maga Land and might just induce more problems with the
Trump people. So I think the instinct of the foreign central bankers here would be to talk very loudly about this, but I think they explicitly or implicitly have been told not to.
Woll This is exciting because by the time this comes out, this will either have You'll either be very wrong or very right. Edison always great catching up with you and uh, we'll do it again next year.
Thank you for having me. Congrats to both you. It's a great substantive discussion.
Thank you so much you.
Tracy. I love our annual catch up with Adam. It really he was like the perfect guest because he'd just say whatever you say, what's on his mind.
Well, at a time when a lot of people don't want to talk about this stuff, right.
Yeah, people are like anxious when people feel like there's like recriminations where people people want to people want to keep low. Yeah, people want to keep their low at a time when they don't know if there's going to be some attack on them from the White House or you know, on Twitter, or people want to keep low. And Adam I appreciate.
His candor can I just say I'm always really impressed by people who are able to organize their thoughts in real time to be like, well, there are three reasons actually Number one, that's right, that's right, show, But that was a fantastic conversation. One thing, well, I guess the thing that I still don't get and I think it is really hard to make an argument that the US has lost out from an economic and financial and in some respects political system around the world that it has
helped to create. Right, Like, there are tangible instances where you can say, like the US benefits in sometimes incredibly weird ways. Like if you look at the deck crisis this in like twenty thirteen or twenty eleven, you know, this is a crisis emanating from the US, from the United States, from US politics, and what you saw was investors flocked to the security of US treasuries and you know,
yields actually go down, which helps with US debt. So there are these like sometimes perverse benefits that the Trump administration seems to want to throw away.
You know, one thing I will say that I was thinking about in your intro is and I go think back to that book trade Wars or class Wars, which I think is actually I suspect Adam almost very disagrees with the premise of that book, et cetera. But regardless of where you stand on some of these questions, there is the relationship between you can't disrupt the domestic without disrupting the international or vice versa. These are like inextricably linked.
If you perceive to be there some sort of inequality in the United States or whatever, it is these things like the trading relation ship, all of these things, they are interlinks. So it's like one thing to say, like you know, there's the views like oh knocking over all
of these different institutions. I think there there are linked in fundamental ways, and there it sort of makes sense that if you you know, you go after the FED because you perceive whatever that that's part and parcel of the whole thing.
You can to argue their links. But I would say, if you're trying to solve domestic inequality through international means, that doesn't seem that it seems like the emphasis and the focus is wrong.
I guess what I'm saying is I'm not surprised that it all goes to because like that was my toy for like like that that the sort of Klein Peedies theory, et cetera, that you know, there's this inequality in the United States because of these winners and losers from the international trading system, right, right, and so we fight these trade wars, et cetera, because we're it's about something internal
that rectifying some sort of internal imbound right. And so I do think, like I get so there's just gets some all I'm saying is I'm not surprised at all.
Goes together because I see I get yeah.
As part of like a policy agenda.
But it's possible that we should be looking at domestic policy more rather than fighting with trading partners. That also, you're not going to say that you're lying low now, all right, I'm just.
Saying I don't have an opinion the right way to do it. I'm just saying I'm not surprised that this is one way.
Okay, shall we leave it there.
Let's leave it there.
This has been another episode of the Authoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
And I'm Jill Wisenthal. You can follow me at the Stalwart. Follow our guest Adam Posen at Adam Posen. Follow our producers Carmen Rodriguez at Carman armand Dash E Bennett at Dashbod and Keil Brooks at Keilbrooks. For more Oddlots content, go to Bloomberg dot com slash odd Lots. We have a daily newsletter and all of our episodes, and you can chat about all of these topics twenty four to seven in our discord Discord dot gg slash.
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