How To Understand the Inflation We’re Seeing Right Now

very early this year. I mean, we've really been talking about them since the beginning of the pandemic, but they haven't gone away, and I think arguably in some cases they continue to compound and get worse, and there is not a day go by where there's not some type of shortage that emerges. And I think the latest thing I saw this week is that fertilizer prices are going up, and there's droughts and Brazil and that's causing cause your

prices to go up. And there's no wind these days in the UK, so that's causing energy prices to go up. So in addition to the pandemic, all kinds of things are going on. We know that by and large, there is this sort of characterization of the elevated inflation that we've seen so far is being transitory. A lot of people are not satisfied with what that word actually means

or how that's defined. We know that under the Fed's new framework there is a greater willingness to tolerate some inflation overshoot in an aim to get back to maximum employment or a full employment. But then there is also a debate about how how the current supply chain driven inflation plays into that. So there are so many sort of like macro and micro themes which we've been discussing a lot of odd lots intersected. So I'm very excited about sort of exploring all of that. We really have

like two perfect guests to discuss it. They're actually colleagues, and we're going to have a nice macro chat that hopefully helps us understand what's actually happening right now and what we should be looking ahead to next. My guests for this week are Julia Coronado, she's the founder and president of Macro Policy Perspectives, as well as Laura rosn Or Warburton, who is a founding partner and the senior economist also macro policy perspective. Very excited, uh for this conversation.

I expect I will be learning quit a bit. So Julia and Laura, thank you so much for joining us. Oh it's our pleasure. Thanks. Yeah, great to be here. So why don't we kick it off. Let's just dive into the inflation question and either of you can take this. Lots of debate about what you know, we have this elevated inflation, It doesn't you know, maybe rolling over a

little bit, but not particularly fast. And like I said, every single day there's some it's like the shortage of the day, something I hadn't even thought about this week. Like I said, I think it's like fertilizer prices, which of course is not going to help the food situation at all. How would what do you characterize where we're

at or how you're thinking about inflation right now? Well, we've had a huge shock and we're sort of parsing through what we're learning about the nature of these inflationary impulses. I mean, a lot of what we're seeing is one of the biggest is a reflection of one of the

biggest shifts in relative demand that we've ever seen. So one of the big shocks in the COVID crisis was not, uh, just COVID itself and the shutdown of the global economy, but it completely changed what consumers spent their money on. So by virtue of being locked away at home and everything being shut down, a huge chunk of your budget

got freed up. The the money that you spend on personal care and entertainment and travel was suddenly unlocked and you were sitting there at home, and so you started ordering things. Uh. So we saw this gigantic shift from services spending too good spending in the middle of a huge recession, and of course we've never seen anything like that. So on the other side of the equation, producers were

preparing for the worst. Uh. They followed their recession playbook playbooks, So they shut down production, they cleared out inventories, they canceled orders. So the combination of those two things led to the just gigantic surge in goods prices. You know, it was not the typical recession. Typical recessions, goods spending gets hit really hard and services spending is more resilient, And we saw exactly the opposite. Uh, and so producers were caught off guard and had to scramble to restart

operations and restart supply chains. And then of course consumers were delivered several trillions of dollars into their bank accounts almost instantaneously. By April, disposable income was above uh pre COVID levels, even though age and salary income was a trillion dollars below. So consumers had money to spend and they could only spend it on goods, and so that that has just led to just tremendous bottlenecks and supply chains,

and that's probably the primary factor. And if that were the only factor, then the whole transitory narrative would probably be unfolding as expected. And I think the best example of this is lumber, something that you've covered in your podcasts. You know, it's not subject to all of the global supply chains and container issue as in you know, COVID disruptions to the same degree as other goods. So it's

already returned. You know, they've ramped up production, they've lumbers getting delivered, prices have fallen, you know, case solved, but there's these other frictions. COVID itself keeps it's just this rolling series of port shutdowns, factory shutdowns, and it keeps coming. You know, Delta is the latest wave and that's affected semis particularly hard. And then increasing frequency of climate events the Texas freeze, flooding, fires keep happening, and that's probably

something that's going to be with us more often. And then there were some things, I mean, Laura's pointed out, there are some things that were going on even before COVID with supply chains that are kind of being revealed by this crisis. Laura. But Juliet, before we even get there, I just really want to emphasize the first point you made,

which is this epic shift into me end. You know what the global pandemic and all of these social distancing policies did was they increased the demand for space, so people moved out of urban areas where they needed cars, So they needed cars, housing, furniture. These are all very cyclical items and they typically fall sharply in recessions UM and so I think businesses when they saw a recession on the horizon, they were planning for the worst, like

Julia said, and they actually cut their supply. They tried to get rid of inventories. So we started at the beginning of this epic shift in demand with way too little supply because demand just raged for all of these items.

And I could say, from from an inflation forecasting perspective, you know, one one thing I feel like forecasters got wrong is maybe they looked at some of the more cyclical prices and inflation, you know, components of inflation at the beginning of the pandemic, and they said, Okay, I think it's reasonable to expect some you know, vehicle deflation, given that that's what we have seen every single cycle.

And so to get not just a lack of deflation in the vehicle sector, but enormous inflation was a huge surprise. And I think that was again twofold one was again this shift in preferences, preferences that changed the composition of demand and to the fiscal stimulus that made it possible for consumers to spend more and made them more price uh insensitive than they typically are. And and so the vehicle sector has been a huge surprise this this time around.

So you mentioned vehicles, and Julie, you mentioned lumber. Lumber has already started to correct vehicles. I don't know, I mean, there was some rolling over of the used vehicle prices, but not very much. And I actually saw a stat that maybe they're already going back up again. We know that overall vehicle demand has been impaired by the semiconductor shortage,

and that doesn't seem to be easing anytime soon. In fact, I think every you know, again, it's another one of these things where every day there's like another headline about some major automobile. Oh, I'm saying that they're not going to be able to expand production. We could chalk up we could look at vehicles and say, okay, we could tell a pretty codid story about what's going on in vehicles?

Is it spreading? Does this type of inflation that we could chalk up to the factors that you've described, which is the change in consumption patterns owing to the pandemic, plus uh, the increased demand and so forth, is it spreading beyond categories that we can easily tell the story about. Or when you look at it, is it still seemed like yep, you know, check all the boxes. This is

fairly fairly clearly connected to the pandemic. I think that it's still fairly clearly connected to the pandemic, although it is a little bit broader than just vehicles. So you know, where are we seeing it. We're seeing it within recreation goods, you know, televisions, We're seeing it in gaming consoles, We're seeing it a little bit in computers, and we're seeing it in furniture. And I think, what of what are

those categories have it common? Either they're being affected by the chip shortage, or they're being affected by shipping congestion and higher input prices. So I still think it's fairly specific. We haven't seen it broaden out, and we certainly haven't seen it in services yet. I would add that two things. One, even within goods, there are some interesting examples where these

costs aren't being passed along to the same extent, like apparel. So, you know, one of the interesting questions that were kind of passing through the data and sifting through the data to figure out is what is the consumers reaction to these prices. What we knew before the pandemic is that consumers had been for decades incredibly resistant to absorbing price increases. If you tried to pass through price increases, they would

shift their spending. And what we saw in the pandemic, was there was this period when they were had, you know, trillions slashing around that they were less price sensitive. And now the question going forward is, okay, that fiscal impulse is fading, some of a lot of that money has gotten spent or saved or invested. How price sensitive will consumers be. We are not seeing still any passed through in terms of the apparel UH and definitely all of

it's imported and subject to these bottlenecks. So that's one interesting example. And then another pandemic related dynamic that we are still seeing is that there is still services disinflation that's very sensitive to the pandemic. Airfairs just went down again, Hotel prices just went down again. There is excess capacity

in those sectors. And probably as long as this if we're looking at kind of a semi permanent pandemic dynamic, you know, for the foreseeable future, where people remain reluctant, our variants keep rising UH and falling, is that you know,

these sectors will be oversupplied. People are not going to go back to the same level of business travel or personal travel that they were comfortable with before, and so those prices can go up and down with much greater frequency, even as the goods prices exhibit sort of the mirror image of that. And then I guess that the bigger open question is is rents right now in terms of what's what's something that could be more persistent and sticky is you know, what are we seeing in the rental

market and and how will that pass through? You know, how will some of these market measures that we see pass into cp I, how persistent will that be? And then how will the FED react to that? You know, there are so many following questions that I have just from this so far, but you mentioned um both talked

about the consumer response. And one of the stories that economists like to tell is that from the sort of vulgar era, I guess for about forty years that the FED had won the credibility by showing its commitment to fight inflation, and that that restrained inflation expectations themselves, and that by restraining expectations that had a feedback effect of restraining inflation until you get this sort of like nice positive feedback loop. And therefore central bankers are extremely reluctant

to erin the other way. They're like, look, we spent decades and decades convincing consumers that inflation will be mild. That's caused inflation to be mild. We've got to be really careful. And there's still even with the tolerance of the overshooting the new framework, you could tell that central bankers are still extremely reluctant to give up what they perceive as their hard won gains of restraining inflation expectations. And I'm curious what both of you make about this

idea of inflation expectations. Is this a powerful force, is this a real thing that affects inflation, or is this a way for central bankers to pat themselves on the back and talk about and sort of trumpet their further accomplishments. That's a great question. And what we're we're we are in the midst of is one of the coolest experiments

you could ever design to test this um. You know, central bankers, as you say, put themselves very much at the center of taking credit for this low inflation regime and stable inflation expectations dynamic that we've seen in recent decades. But of course we didn't even start to measure inflation expectations until that post volca era, So we don't have long,

long time series of consistent measures of inflation expectations. We've only measured them in the era of low and stable inflation and inflation expectations, so we've never tested what it looks like when inflation expectations drift higher and how that

actually affect X pricing decisions and dynamics and behavior. So I would say it's fair to say we're a little bit more skeptical of that, you know, I mean, certainly, central bank credibility has been an incredibly important global force, but it's not the only force, And there's a few other secular forces, uh that we attribute the era of lower inflation too, And so that's we're looking to both

inflation expectations as well as these other secular forces. I don't know, or you want to outline the things that we tend to focus on in addition to expectations, sure, So, I mean, one thing we're focused on is demographics. So as the population ages um, they tend to consume more healthcare in particular, and the healthcare market is not a competitive market. The government has a very large footprint and they actually set prices for medicare and Medicaid services, which

is about forty of the market. So because the government's liabilities are tied to healthcare prices going forward, they have a very strong incentive to keep healthcare inflation low. And an example of this playing out right now are proposals to lower drug prices um so, so we've actually noticed a low and stable trend in healthcare inflation despite tightness in the labor market that might call for upward pressure. We think that this is a large component that will

continue to see downward pressure. Another secular trend has just been globalization and international trade, which has kept goods inflation low. Of course that is coming into question now just given all of the disruptions, but it certainly has been something that has limited goods inflation in the pass I think, sorry, go ahead, Well no, I mean, I'm glad. I'm glad you brought this up because we did a recent episode with Dan Wong, who is a China China analyst, and

he brought this up. You know, he's like, China has closed its borders, and he's like it maybe several years before they fully opened up their borders, and I'm curious from your perspective. That got a lot of questions and of all the things he said on that episode that may have caused people's attention the most. What would it mean for inflation if our relationships or our trade relationship with China were to never normalize whatever that word means.

If we were to never say, go back to twenty nineteen trading patterns with China because of both the disruptions but also policy choices, or maybe the Biden relationship with chij and Ping, what would it What could that actually mean on an ongoing basis for inflation. So I think that's a great question because we're not going back to that. I mean, we know that was a trend before COVID that you know, the trade war was centered around China.

China has its own express intentions to delink its technology supply chain from the US and is making rapid progress on that front. That was one of the contributing factors to the semiconductor shortage. So we know that we're going to We're in the midst of a structural reallocation of global supply chains in which the U S and China are seeking to realign their own supply chains to be

more not just domestically dependent, but amongst allies. So you see a lot of investment, for example, in semiconductor capacity domestically in the US and the UK and amongst allies, and the same thing with raw materials. There's a lot more policy focus on designing more ally friendly resil aliency in supply chains. So that is gonna add to costs in the next couple of years. You know, we've already

seen that doing so. And then the question is, you know, when we talk about inflation, it is more of an you know, are we going to reallocate those and there's this one time re resetting in price levels, or is it going to become an ongoing force of repeated price increases year after year after year, reflecting ever more expensive

supply chains. You know, we do see some deglobalization between the US and China, but globalization as a force is more about competitive forces that you know, US companies face global competition for the consumer, the consumer's wallet, and it interacts with technology. Technology is another secular force that we focus a lot on. Technology is something that allows companies to become constantly implementing cost saving changes in business production

uh and business models. And that's on the one side of technology, So constant source of improvements uh and cost savings. And then the other is that technology brings brutal price transparency. It allows consumers, that allows you know, even at the wholesale level suppliers to visibility into costs and pricing. That forces this competition in pricing even in you know, markets

that are somewhat concentrated. So yes, I would say we see, um that there is this reallocation of global supply chains that will add to costs that has already done so, is already doing so. But whether it becomes an inflationary dynamic, I think we're still skeptical. We still see the forces of the global marketplace and the influence of technology as

disinflationary forces on an ongoing basis. Just to radiorate which really is just said, I think I think we should really be careful to distinguish between a level shift in costs and kind of ongoing increases in costs that leads to kind of a self fulfilling dynamic of inflation. And I agree, I think decoupling from China, where it's cheap to produce and labor is cheap, would over time increase the cost of doing business for for a lot of manufacturers.

I think also during the pandemic. You know, all of these supply chain issues that have arisen probably are causing companies to question you know, their their current supply chain operations. You know, it is maybe that maybe they need to be more simple, you know, maybe they need to be more diversified. Uh, and maybe that means higher costs as well, maybe they need to hold more inventory than they thought. So all of this suggests maybe higher a level shift

up in cost. The question is how much of that is just absorbed in profits by the company and how much is actually gets passed on to consumers. And I think that's where the fiscal stimulus comes back as as a key factor. We saw companies during this unprecedented fiscal stimulus passing on a lot of cost cost increases to consumers. Will that continue as fiscal stimulus starts to fade and consumers become more price sensitive and and and in this

regard that, there's some interesting global comparisons. You know, you can see greater passed through of say vehicle inflation, for example, in the US then in Europe where there wasn't as generous a fiscal support. And that kind of speaks to um that unique moment where we had extremely like unprecedented strong support to consumer demand in the United States and

again next year this year already that's that's largely behind us. Again, what is the behavioral response of consumers to hire prices, particularly for goods that that are easy to postpone or

you know, shift around to other producers. The vehicle market is an extremely competitive market, will they and and cars are a car purchases easy to postpone, what kind of behavioral response will we see In fact, you know, arguably in the new car market, it's it's still quite a moderate degree of passed through of the supply chain issues that they're facing because it is such a competitive market. You know, I want to get into inflation um and

we've talked about this before. It gets people going, people who have very strong feelings about it. And I think part of the reason it gets people going is because there's a sort of It affects different people differently. And one cliche that people often say, which I'm a little skeptical about, is like, oh, inflation it it mostly hurts the poor. And I'm sure that in some cases that

is the case. On the other hand, as you mentioned, one of the contributing factors perhaps to some of the inflation that we've seen in the US so far this year, the aggressive fiscal response, which was incredibly well targeted at people with a high marginal propensity to consume. Service workers who aren't typically particularly high paid, who had lost their jobs had seen income replacement like they've never seen before.

And what we've seen, even as things have begun to return to normal a little bit, is that wages at the low end, which had been fairly stagnant for some time, clearly seemed to be growing at a more rapid pace than high end wages. Setting aside uh, the expansion of the unemployment insurance and so forth. So I'm curious about how you think overall the policy mix, but the policy mix in the sort of the data outcomes that we've seen,

the distributional effects of them. How how are you thinking about the distributional effects of different uh, sort of levels of income, different levels of wealth from what we've seen so far. Yeah, So, So the grand experiment that we're running is what does it look like when you actually air on the side of going too much rather than too little and supporting and having a demand lead recovery. I think if we Look, you know, the old cliche as you as you call it, um, was based on

you know, supply chain inflation is not new. It's something that we've typically ascribed mostly to you know, food and energy. Right, food and energy are subject to repeated constant supply chain issues, supply side issues year after year, from geopolitics, from weather, and so that's one reason we exclude food and energy and look at core inflation. And that's also the reason people tend to think of inflation is harming lower income people because they spend more of their budgets on food

and energy. But as you say, this cycle has been unique in a lot of ways, and um, we did see very progressive sort of support for lower income, lower wage workers who got higher than even replacement rates through unemployment insurance. These lump sum stimulus payments are of course a bigger share of income for lower income households, so very progressively structured fiscal support. Low wage workers were hit the hardest by job losses, but are seeing the biggest

wage gains upon reemployment and recovery. So I think the distributional if we look at sort of the labor and price side of things, there's a lot of different things going on. A lot of the goods that are inflating, like cars, are luxury goods. Meanwhile, large wage games for lower wage workers are certainly kind of a welcome development

after years of rising wage inequality. So I think it's hard to just say, oh, lower wage workers are getting hit the hardest by this high inflation because they are getting the biggest wage increases as well. So we're going to have to see how this settles out going forward.

Of course, if we broadened out to wealth and equality, it's unambiguous because part of the aggressive response was supporting asset prices, and that benefits the wealthy disproportionately, and that's just an ongoing byproduct of the fed's toolkit, and that argues not for the FED to do nothing or to do less to support the economy. It argues for exploring a different toolkit for the FED, which we're all in favor of a more blue sky exploration of toolkit the

FEDS toolkit. But I think distributionally, another thing that came out of this pandemic was, because of all of that cash support, a huge reduction in distress. Loan delinquencies for the first time ever fell during a recession, you know, one of the interesting dynamics in the used car market was one of the limitations in supply came from the fact that cars weren't getting repossessed because people normally you see a recession, uh, and you know a lot of

people can't make their car payments and they lose their cars. Well, they could make their car payments and they kept their cars. In fact, repose were lower than normal, even in which was a great year. So that's a that's kind of a unsung hero of this fiscal package is that people didn't fall into distress. They didn't lose their homes, they didn't lose their cars as a result of the recession.

And that's usually those sort of knock on effects that really hit lower income people the hardest, these sort of repeated shocks. You lose your job, and you lose your house, then you lose your car. That makes it harder to get a job, etcetera. And and really there was a short circuiting of of that domino effect that you know, as we look back over time and sort of evaluate the recession, that's gonna, I think be one of the unambiguous victories of this kind of approach to policy I

want to go back to something. So we're recording this September, and this morning we got a strong housing number, and this idea of the supply side response, and you're talking about it a little bit with semiconductors, and uh, you know, we might see some greater investment, and I think there's some hope, you know, I think there's some hope that with tightness, with tightness in the labor market, with tightness in supply chains, that we may see a supply side

expansion or a capital deepening of some sort, that companies will invest more, and that we will just have a more productive supply side sector than we would have had otherwise, because tightness and very US market will result in greater building of factories, higher more aggressive training of workers so that they are more productive, greater investment in automation and

so forth. On the flip side, if this is all like a temporary so that's like the hope, but you know, people have been talking about this more on the flip side. If this is all just uh pandemic disruption, and Okay, the pandemic isn't over yet, but maybe it'll be over in three or six months, and then we've returned to something resembling normal, and then we get that fiscal policy tightening, which has already begun because some of these uh pandemic

era programs have come are are winding down. Then maybe things won't be so tight in six months, and then maybe some of that investment will have proven to be unnecessary. What is your outlook for a sort of sustained change. I guess I would say a sustained change in the KPE trajectory. I think that thinking of going back to normal is not It's almost never a useful concept. We never go back, We're always going forward. The pandemic has disrupted a lot of things that are not going to

return to their prior state. Consumer preferences on where they want to live, how they want to work, business preferences for you know, how they want to conduct their businesses, the importance of you know, face to face client contact versus virtual meetings, business travel, etcetera. Like, these things aren't going back, even even if the delta variant fades and vaccinations broaden and things feel a lot safer on a

more sustained basis. Um we've seen businesses realize a lot of things about how they can do things more efficiently and consumers realize things about how they and work more efficiently. You know, these are still early measures of GDP data, but it's been a productivity boom. We track earnings reports by companies across industries, and every industry is reporting intentions and active projects of exploring, you know, ways to do things better and cheaper and more efficiently. And investments in

technology have been enormous. Cap X is again above pre pandemic levels, still with decent momentum. It's not falling back, you know, and so we expect continued pretty radical transformation, uh in business models and operations. And it's not again

it's it's it's pulled forward. I think a dynamic that we've long expected, things like machine learning and artificial intelligence, where things that all industries had kind of been looking and explore, worrying and you know, thinking about implementing projects over the coming years, and it really concentrated that those efforts and brought them forward and forced you know, things like telehealth. You know, the behavioral resistance to change is

often slows things down. It's an impediment to adopting new processes, and things like telehealth was always slow on implementation because you know, the more established doctors were resistant to it, etcetera. Well, in a pandemic, you had to get it up and running and guess what, it works. So it's cheaper, it's more efficient, and it's not going away. So that's just one example, but I think there's many examples across industries, and I think that's also contributes to one reason, Like

we see so many frictions in the labor market. What consumers want to do, what businesses need from workers is shifting very quickly, and business models need to shift quickly, and so you hear the loudest complaints from the people that are having the hardest time re orienting their business models. But we again, if you read earnings reports, you hear

a lot of non complainers. People are that are saying, we implemented this and it was amazing, and our profits are higher than expected because you know, we've been able to you know, do more with fewer workers or you know, transform these processes. So I guess we're pretty optimistic that the productivity performance this cycle is going to be better than last cycle, and you know that's also a good news for the inflation front. We do think that that

this is sort of a transformational period these frictions. You you watch, you know, these companies dealing with these supply chain issues, they're re engineering what they need and how to do things more effectively, inefficiently, and you know they're they're going to be better at things when they come out on the other side of this. So we don't really know what's going to happen with some of these democratic stimulus or spending plans that are in the works.

Some might not pass at all. Really, it's it's all very ambiguous. There is one provision in one of the bills that would give the government greater flexibility to negotiate on I think medicare negotiate on drug prices, and there's some question who knows whether it will actually make it in the bill. And then furthermore, beyond that, I think there was some language that it wouldn't kick in until power, So even if it were to make it in the bill, it would probably be kind of irrelevant to some of

the inflation pressures that we're seeing right now. Nonetheless, I'm curious your take on that and how much you know something like that. It's pretty obvious that there are pretty contributors to the inflation metrics that have nothing to do with monetary policy or macro and might be as simple as well, what are the government rules that can govern the price of prescription drugs? How are you thinking about that?

And how much difference could it make were the were the law to change such that the government could exercise some of its clause. I'm an option e buying power of prescription drugs for so many people uh to be able to more aggressively push prices down. I think it could have a material impact. I haven't. I don't have an estimate for you, but um, it's it's not something that we have factored into our baseline expectation for inflation.

We had health care inflation actually pick up quite substantially in January, and that's something that is very unlikely to repeat in January two and that I've estimated will reduce core PC inflation by about twenty five basis points just that that that not repeating. I think more broadly, our view is that healthcare inflation will remain low relative to you know, the two early two thousands when it was a lot higher, and that will be just a source

of structural downward pressure on prices. That should help alleviate maybe some of this supply chain inflation that we're going to see in Yeah, it's kind of interesting because I think for years there were a few categories they were seen as these like really consistent upward contributors to inflation, and obviously healthcare is one of them. Education, if I'm not mistaken, there's another area that for a long time was putting up a lot of upward pressure, but now

that really seems to have called off. Yeah, yeah, Yeah, that's another one of the examples of the demographic headwind. You know, the class size of every incoming college classes shrinking, and the education sector is not a nimble sector that adjusts capacity at high frequency. So we're oversupplied with higher

education capacity in the United States. And you know, for years, higher education institutions tried to fill those empty seats with UM foreign students, and that's become more difficult, although that's still you know, an important source of of UM students. But at the end of the day, we still do have more higher education capacity than uh, we have excess capacity, and so we've seen downward pressure on higher on education

inflation from that. You know, what one thing that we're exploring right now is how would some of these other subsidies to education. So some of these other policy variables that are going to impact education feed into CPI inflation. So one thing that we've been posing questions to b LS about is how would for example, free community college or you know, the subsidies to higher education feed into cp I. It's a it's more of an open and unsettled question right now. What they do is they tend

to drop zeros out of their their calculation. They would just sort of ignore these subsidies. These subsidies would would tend to actually potentially increase higher education inflation. Also, what about these subsidies to daycare that are being included in some of the bills that are you know, in the Reconciliation bill that that's being debated right now, how would that feed into daycare pricing in cp I. So there's

some open questions about how the education pricing. It's it's a sector that is the subject of a lot of policy focus. Uh, and it could that source of inflation could evolve in different ways going forward. So I think demographically higher education we've seen the disinflation. There's no reason to expect that to reverse some of the other areas, though you know, we'll have to think through how that's going to be captured and factored into measures of inflation

as they get more government support. So we're running a little bit of a risk here. Like I said, we're recording this UH twenty one, it's actually the day before a FED decision. But I don't think anyone you know, nothing, nothing that we've really talked about, or I think going to talk about it here is going to matter much.

You know, whether some minor language they changed to the taper, well, by the time people are listening to this that big said, I want to talk about the FED a little bit because one of the subjects that we've dwelled a lot about on is sort of this new FED framework that was unveiled August at Jackson Hole, and basically, you know, tolerate some overshoot of inflation in order to do a

better job of hitting its employment goals. And I think if you look at some of the uh the hikes that we saw in the post grade financial crisis, the FED clearly underestimated the degree to which unemployment could fall, and it was sort of perhaps premature and expecting inflation. So I think my first you know, the first thing I'm curious about is do you see so far a

meaningful change since this new FED framework has emerged? Do you see evidence that the FED has behaved meaningfully different than they otherwise would have in the absence of uh, this new framework? Is the is the Is the current power FED different than the old power FED? Is it different than the yelling Fed? Is it Is there evidence of a significant change in thinking? Or is it is it pre marginal? Oh my goodness, I think there's huge

evidence of the change already. I mean, part of the review that wasn't formalized as much as some of the other elements was the idea that you go big in a recession because the biggest risk is the lingering malaise. You don't mess around time is of the essence, you go big, you go early. That was one of the things that came out of the review for Powell in particular, and he did exactly that in the heat of the pandemic when it was becoming a financial crisis. He short

circuited that very quickly. So that's evidence. And then I think you can see it in their tolerance of the supply chain inflation so far, there are Hawks on the committee that are less comfortable share Powell is more of a dove, and he's more comfortable. I mean, his Jackson whole speech was, you know, pretty devish on that front. And then even if you look at their projections, you

know that they are projecting lift off. Whether they pull it forward to or leave it in three at the September meeting, it's still you know, given the inflation that we've seen in the old days, you would have seen way more panicking over this kind of inflation. Number one and number two. You know that the agreement is that you're going to let that unemployment rate fall to very right around the longer run rate, whatever you think that is,

before liftoff. And so even in the Hawks projections, they might have a view that the labor market is going to be stronger, faster and therefore lift off will come sooner. But you know, even somebody like Jim Bullard is on board with this reaction function. So I definitely see strong support for the new reaction function being put into two action. I mean the fact that we're just talking about tapering now, which is way beyond anything they would have done before

last cycle. They like each tapering, each QUEI program was so hard fought to get put into place, and they were always rushing to end it as soon as they possibly could. And and this is just a completely different mindset. Um. I don't know, Laura, do you want to add anything? Yeah, no,

I agree. I think Um, earlier this year, you know, when you had the major fiscal stimulus bill passed and the FED stop plot was unchanged, right, was evidence of, you know, a shift towards some more devish reaction function. I'm a little bit less sure on the supply chain inflation. I feel like in the past, if you thought the inflation was going to be temporary, then you wouldn't respond to it. Only if it impacted inflation expectations would you,

you know, really be concerned about it. So I don't know if we've seen, you know, so far, necessarily a shift in thinking about supply chain inflation from the FED. I think the one difference is that there was general consensus that most measures of inflation expectations were at the low end of the range consistent with their mandate, and

they would like to see them move higher. So we've seen kind of a tolerance for reflation that maybe would not have been as welcome, you know, if inflation expectations were in a more normal, healthier range. So that's been

a that's been a difference as well. So obviously, you know, part of the whole reason for this rethink there's ultimately about you know, and and and I think a lot of people give Poll credit for this of taking the employment side of the FED mandate extremely seriously, and that the recognition, even a pre crisis, unemployment can go very low without triggering inflation. I think unemployment got to I think we've got down to three point four percent in February.

There was not meaningful inflation, and there was probably at the time no reason to think it couldn't it couldn't have gotten into the twos without triggering a significant rise in inflation. This time around, assuming we get back to those numbers, what what what's victory going to look like from the Fed's perspective in the end, because you're still I still see this issue where you still have this

sort of like Phillips curve logic. We're in the end, they're still going to rely on inflation measures to tell them that they've reached the speed limit or the max capacity or something like that. But I'm curious what you think. How the fed itself, we'll be able to tell itself. Okay, we've we've achieved victory. We've we've hit our goals, and we've got to maximum employment. Well, I mean, most participants on the f WEMC express satisfaction with the labor market.

They were happy with that labor market. They they all kind of agree that that kind of looked like full employment. We didn't have a lot of inflation, we didn't have a lot of wage inflation, but we had a lot of narrowing disparities, a lot of very healthy dynamics, and so at a minimum, they'd like to see something that looks like that. They would like to see. You know, there's some debate about you know, aging boomers and weather

those that left will come back. But let's look at, you know, the primate employment population ratio that should at least return to levels. Maybe it could go to levels depending on the productivity trends that we see UH and the policies that support labor supply, but definitely we can at least get back to levels of prime age employment

to population. That seems to be a metric that most people on the committee agree to and broad based wage gains, wage gains that are not just the top but shared at the bottom, and narrowing disparities by race and ethnicity and gender. So I mean, I think they were seeing all of those things in uh, and it looked pretty great. Powell was very pleased with a labor market, often and repeatedly talked about it. Uh. He loved to see what he was seeing, and he would like to get back

to that. That's one version of victory. Maybe you could go even maybe you could even improve upon that. We'll see, And I think wage growth is the other metric now that we've seen. I mean, I think one of the important takeaways of the COVID crisis is that we can see consumers accepting higher prices. We can see these inflationary dynamics. So I think wage growth becomes a very important metric in this environment. Do we see broad based wage gains?

Are they ongoing? Uh? Do they support a higher run rate of inflation? Again, not just all these crazy, wild pandemic relative price shifts, but a process that's broad based and ongoing. Wage growth is kind of the essential ingredient to that. So I think there's going to be a lot of focus on after all of this noise settles down, what are the trends and wage growth across the spectrum? And you know, does that does that deliver you that

higher run rate on inflation that you're seeking? And I would say that, you know, beyond, once we're past the supply chain issues, can we achieve a moderate overshoot of the feds two percent target at the peak of the cycle. We couldn't last time? Can we do that this time? And can that bring up measures of inflation expectations from the lower end of their normal range a little bit closer to the mid or even a little bit higher.

Can that Can that anchor them there on a sustainable basis that maybe lifts interest rates neutral interest rates a little bit and brings us a little bit away from this risk of the zero lower bound. That would be that would be a clear victory for the Fed. Again, the challenge right now is we've moved so far above target. Uh, you know what, what is the inflation landscape gonna look like once these supply chain issues are resolved? Are we going to move back below? Will we continue to run

significantly above? I think the Fed is really hoping for a moderate overshoot at the peak of the cycle, which it really didn't get in the last expansion. Well on that, on that hopeful note, I guess optimistic note and hopeful note, I think that's a good place to stop. Could talk about these topics with both of you for a long time. But Julia and Laura, thank you so much for coming on a lot. It was a pleasure. Thank you. Thanks, That was a lot of fun. Thank you so much.

Julian and Laura, take care of thanks well here. Obviously I would do a long chat with Tracy, or a moderate chat with Tracy on what we just learned. But I found that conversation to be incredibly helpful, very interesting to think through the different moving parts of inflation and think about the degree to which you know. Obviously this to me, this is the big macro question, or one

of maybe like three or four big macro questions. Easy enough to sit here in September one and point to elevated inflation is having something to do with supply chains and uh so forth. But if it, if it extends further, if it goes into rents, if we do not see anything resembling normalization, if we continue to see these rolling shutdowns, obviously things get quite a bit tricky, and of course Julia and Laura did a fantastic job breaking that all down.

So on that note, this has been another episode of the Odd Lots podcast. I'm Joe Wisn't though. You can follow me on Twitter at the Stalwart, follow my normal co host Tracy Alloway or she's normally my co host on the show. She's also normal. She's at Tracy Alloway, and be sure to follow our guests on Twitter. Julia Coronado she is it at j c Underscore econ and Laura Rosner Warburton she is at it is Rosner. Follow our producer Laura rack Carlson. She's at Laura M. Carlson.

Followed the Bloomberg head of podcast Francesco Levi at Francesca Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.