Tim Duy on the Huge Challenge the Fed Now Has in 2022

central banking. Yeah. Absolutely, I would agree with that. I mean, we spent um, you know, immediately after two thousand eight, there was obviously a lot to digest, but then it was just years and years of basically the same thing, really low inflation, uh, and the central banks kind of arguing whether or not to why down various stimulus programs,

um what exits we're going to look like. But now it feels like that conversation has just been ramped up, you know, times a hundred, because you actually do have inflation. You still have a lot of emergency liquidity lingering in the system, and the question is what are central banks going to do about it? And can they actually navigate clamping down on price pressures without destabilizing the entire economic recovery.

You know, we paid a lot of attention to the FED and other big central banks like you know, for the last ten years. But in retrospect, like it's kind of always the same story. It's like, inflation is mild, so not quite a target. Maybe it will be how local employment go. Oh it turns out it can go lower. Maybe they'll try to hike a bit, maybe they use a little premature way to It's like it was like

pretty repetitive and right now. And I think is interesting is beyond just the price pressure, like an extreme only wide disagreement, and some people think, oh, it's gonna fade because things are going to normalize. People worry about some sort of wage price inflationary spiral, like lots of legitimate economists and people sort of like coming out the problem or the question and good faith can arrive at extremely

different views for the next couple of years. I would say from this starting point, absolutely, And I think we've spoken about this before. But the thing that complicates everything is that we don't really have a historical framework or parallel to look at because we didn't experience anything like the pandemic. Um well, I guess we had Spanish flu, but the crisis response wasn't quite the same, and so everyone is sort of trying to figure out what exactly

is going on. And to be honest, I don't think anyone has a fool proof or bulletproof playbook just yet. Right And also, and of course, in addition to the pandemic itself, we had an extortiny amount of fiscal stimulus this time around. We had the FED at the summer of sort of adopting a new framework where they would intentionally allow of things to overshoot. So there is a

lot to unpack. It's very new. Everything is different, and uh, we're going to uh, we're going to talk about how to make headser tails of this and what's going on. Excellent looking forward to So our guest has actually been on the podcast before, but very long time ago, way back in and we just talked to him back then about the sort of the art of FED watching. Well, now fed watching is actually was really putting it into practice these days. We're gonna be speaking to Tim Dewey.

He is the chief US economist at s G H. Macro. He is also a professor of economics at the University of Oregon, and I think he's had a very good feel for both inflationary pressures and how the FED would likely respond to them over the last year in his writings on Twitter and so forth. So, uh, Tim, thank you so much for coming back on odd lots. Well,

thank you for having me. I appreciate the opportunity. Yeah, absotlutely so in retrospect or we right there, like six pretty boring from a FED perspective, at least compared to what we're doing with now. Yeah, the never ending expansion was going to get old there pretty soon from a FED watching perspective, that's for sure. Of course, you didn't

want it to end the way it ended, unfortunately. So what is it about the current period that makes it so unusual or so interesting for central bank watchers such as yourself, Well, it's it's the uncertainty. We had gone into the pandemic with a with a sense that we knew a right, we knew the basic economic framework that we're going to be working with you for the foreseeable future. And that basic framework assumed that to me and was really always an everywhere problem in the sense of being

too low. And we also thought that inflation was very, very sticky around two percent and these were reasonable things to believe, you know, in the pre pandemic period, because that's that's the story that actually worked out well and seemed to be proved by the evidence, and especially the sticky inflation part. We've seen sticky inflation for twenty five

years around two percent. You know, we went into the pandemic with really established consensus framework on how the economy worked, and the pandemic has really blown that apart, at least in the near term, because a lot of those predictions of persistently weak demand, persistently slow job growth, persistently low inflation near two percent, all of those uh predictions just did not work out as expected in the in the

post pandemic era. This gets to sort of bigger picture question that I've been asking myself a lot over the last six months or a year, which is like, we can list all the ways this current moment is extraordinary, right, So we're still in a public health emergency by many measures. We had a very intense O macron wave, we had Dealta wave before that. That's not over. There are still many disruptions. They seem to be winding down, but they're going away, but they but there's still many, um, sort

of interventions and masks and school issues. Then of course we had the massively expansion, the aggressive fiscal stimulus, and of course the FED which made a decision in that they did not want to make the same mistakes they did in the past, and they said, Okay, we're going to let it overshoot this time. Well, my question is, why wouldn't things return to normal, Why after the sort of pandemic ends. Why wouldn't it necessarily be safe to say, Okay, we're just gonna go back to the sort of like

the medium economy that we had pre crisis. I think that's uh an excellent question. Um, you know, I think, you know, particularly with respect to the inflation story, that inflation trend, the pre pandemic, you know, trend of two percent inflation that we've seen for twenty five years, that was presumably a very sticky trend, and there's a good reason to think that that you don't want to just sort of turn your back on a deeply established trend

like that. Now. On the other hand, one idea that I play around with quite a bit is that the pre pandemic economy was more finely balanced than we appreciated. That we essentially had just enough labor market pressure to keep downward pressure on unemployment, keep pulling people into the

labor market, keep wages rising in nominal and real terms. Uh. And also you're not not having an overheat in the sense that there were any real threats to that two inflation trend that though might have been a more unique

economy then we realized by how we got nine. How much of the inflation pressures do you see as down to supply issues, um, such as the various logistics problems that we've been talking about on the show over the past year or so, versus demand coming from consumers, many of whom you know, in terms of household balance sheets, seem to be in better positions than they were going

into the crisis. You know, I get concerned when we try to say that that, you know, things are either demand or supply related, because I'm not sure that we can really tease out those factors as easily as as we think we can. You know, demand and supply are like two sides of let's like compair of scissors, right, and so both both are cutting the papers. So which which which which blade is doing the job is hard

to In many cases determined. I've thought that demand was a large factor here, that if we look at factors like nominal spending power on the part of consumers, that they really were spending more nominal terms and basically stretching the ability to the economy to produce those goods and services. So I thought that that the supply angle has been overplayed and the demand angle underplayed. So that's that's where I sit on the subject we look forward into the future.

I do think it still relies depends a lot about how much consumers are able to and um willing to accept. And it looks right now that they have the capacity to continue to absorb price increases, and I suspect will continue to do so, although maybe not at a you know, six or seven or eight percent analyzed rate as we've

been as we've kind of been seeing. So we're like ten minutes into this conversation already, and I think it's really interesting that inflation dominates the story right now, but the labor market and the sort of the other half of the fedual mandate, it's just been incredibly strong, and no one I think would have predicted some four percent unemployment. Uh So, you know, early or I guess we're at

four percent right now. My question is, in your view, was there a way to have this fast of a labor market recovery without the inflationary pressures that we've seen, or are these inflationary pressures the inevitable byproduct of an

economy that moved so fast back to normal. The rapid recovery of the labor market was certainly unexpected, and you know, the Federal Reserve and the the U. S. Government dumped enormous amounts of resources uh in the economy on the assumption that that it would not recover very quickly, and it did. Had we known really that COVID, you know, the COVID shock in twenty funny was going to be more like a snowstorm than a persistent source of demand lost demand, I'm not sure that we would have dumped

that much policy stimulus into it. We'd be at a situation where where the labor market did recover quickly. It's very much true that going into the pandemic, we would not have expected labor demand to rebound quite as quickly as it did, and that was really our experience in the last last couple of processions. The fact that that recovery did happen very quickly, probably helped contribute to inflationary pressures when you take into account the additional stimulus that

we added onto the um UH system. In some ways, it comes down to me, for there's a question of, you know, what was the original COVID shock, like a big demand shock like the financial crisis in two thousand and seven two nine era, or was it more like a snowstorm? And you would expect fairly rapid recovery after a snowstorm, and and that's that's kind of what what

we've seen. UH. And I do think you know that that the additional stimulas we put on top of that then helped contribute to to the the inflationary pressures we see now, how do you disaggregate the speed of that recovery from the policy response? Though, right, I think that's a that's a great question that would be the subject of a thousand PhD dissertations in the future. I don't I don't. I don't know that that I'm able to

take a stand on that at this point. I really this comes down to some sense, really what kind of framework you had going into the crisis, or we're adjusting that framework. I think where we started seeing the economy bounced back in the middle of it really started to strike me that there's a lot of underlying structural there's a lot of underlying structural very going on here, and we probably don't need quite the amount of stimulus as

well as we're putting into the system. But but in some sense that was that was a hunch feel for the data more than anything else. So, Tim, you mentioned um frameworks going into this, and one of the criticisms now that we've seen the return of inflation or this new inflation, is that either traditional economics failed to predict this or heterodox economics like modern monetary theory failed to predict this. And it kind of feels like everyone everyone

is criticizing everything at at the moment. But do you think that's fair. Did economists, you know, fail to see this coming? So forecasting is hard, and the underlying structure the economy could shift, and so you know, this is something that could hammer an economist no matter what they're worth,

their initial framework is. And so I try to be fairly humble in thinking about these kinds of economic developments, because I really do believe you have to be flexible to you know, basically react in real time to you know, what the what the data is telling you. And I don't know if there's really a failure of anyone given sort of strand of economic thought or macroeconomic framework. It's more of um, what I see just a willingness to evolve from whatever your fixed position is as that incoming

data arrives. Well, let's talk a little bit more about that data, because I do think that you know, even I think winter late, the COVID numbers were picking up again, we didn't have a vaccine. There was a lot of reason to think that if we didn't get like another round of substantial physical expansion, we could like have another downturn.

You were like pretty I think, pretty optimistic then, and I think, you know, starting in the summer or maybe the spring of I think you're pretty concerned that maybe the the accelerating inflation wasn't just a temporary thing, it wasn't just going to be base effects, that there was something more sustained here, and that the FED at some point would attempt to play catch up and ramp up

the number of hikes sooner and faster. So what was it that you were seeing in the data, and how did you then sort of like synthesize that through some sort of macro framework that I think, at least so far has proven to be a good read on the

inflationary pressure. I think the first thing said even with that, that that wave and the late twenty one early you know that that wave excu I think even at that point we started to recognize that the subsequent waves of the virus we're going to have less and less of

an economic impact. And so that that became a critical sort of element to my thinking going forward, is that we're going to continue to have COVID, that it was going to be more endemic than than certainly zero COVID at that point was was not really a possibility, and that we would learn to to live around the pandemic. So that was what was one element. The other element that I just couldn't shake was how type job markets were getting. Uh and this really speaks to the perhaps

finally balanced economy prior to the pandemic. When I saw how quickly job opening surged, you know, the fairly slow response of labor supply, and I'd say the fairly sol responsive labor supply is pretty typical that we see in

post recession a periods. It really started to say to me that there's there's a lot more pressure in this economy than than I think of the FED at the point was thinking about and was probably, um, you know, the FED at that point, I think, had had estimates of wear full employment was going to to be that. We're optimistic relative to what I was seeing in the labor market. So that sort of said to me, Look, there's gonna be a lot of pressure in this labor market.

It's going to be cult a lot of pressure and upward uppropression wages. That's going to be that the kind of thing that can really sustain inflationary pressures over time. And I felt eventually that was something that was going to catch up to the FED. It does feel like the FED was very focused on this idea of yes, jobs have rebounded, Um, you know, the employment recovery has been stronger than expected, but we're still digging ourselves out of a COVID related whole. I guess, um, and we

still have further to go. Were they wrong to do that? In retrospect? I think the FED did not basically adjust their their you know models as as quickly as the data would suggest that they should. I think that they became although the although the FED says that they think, you know, full employments a moving target, they became very much attached to the pre pandemic economy. We all liked

the pre pandemic economy. I think would have been you know, we would have thought was a great year if we'd been able to enjoy it, because came down on it's so hard. So there was really good reason to look at that period and think that's where we need to get back to. And I think the FED just did not just held onto that vision for too long and and as a consequence sort of missed the development of

what I think are still substantial inflation impressures. Even even if you know, even if they ease off, do they ease off enough to get us back to two percent

is still an open question. I want to press you on this a little bit further because I remember, like post Great Financial Crisis, one of the criticisms then is like, oh, we can't get back to two thousand six, two seven, and that maybe there's something structural, And it turned out it was kind of just a matter of time, and the FED back then I would say, and grossly sort of like underestimated for a long time, like how low the unemployment rate could get without spurring labor market pressure,

which I guess again bring me to the question is the error of like, oh, we want to get back to some four percent unemployment or is the err in thinking that it can happen that fast because we are still I mean, we just had a uh jobs number in January. We are still bring a lot of people back into the labor market. You know, I think we could argue that in the post financial crisis era, the FED did make an error, and I think again for

for the same reason. We became enamored with a pre you know, a pre financial market sort of framework, financial crisis sort of framework. And you know, we saw right in the in the post era, post um crisis era, estimates of the short run natural rate of unemployment rights right, and we all now think we all look back at that and say, no, that was that was crazy, right,

that that never happened. And so we sort of took that same framework and applied it to this crisis, and we didn't raise our estimates of the short term rate of of of a natural unemployment and maybe we should have right, And so you know, it's sort of a question do you always get caught fighting the last war? And I think, again, I have no problem. It was the right thing to think of in in the spring of That was our framework, and that was a reasonable framework.

It was kind of just a slow adjustment to to maybe that framework is not quite the right right way we should be thinking about the economy and the post pandemic era. Is there something about the FEDS structure or culture that makes it hard for them to be flexible or to pivot as the data changes. I think that institutions in general can be slow to pivot. And you see this, I think in in any kind of bureaucratic structures.

Uh so, once you've spent ten years developing your models in your framework, you're gonna have a hard time breaking from that framework. So I think that's just a national consequence of of of what happens. You know within institutions that you know the FED could not adjust as quickly as as maybe they should have. Would you say, just as they should have? Was there a could we currently in February two have less inflation than we have right now?

Had they done something different like what what was the moment in your view in which if they had taken a different tag, maybe started hiking earlier, etcetera, may have allowed us to be in a better situation than we are right now. Like, what does that alternate scenario look

like to you? Right? And given the lags in these processes, how you know was was by the time we did, you know, the fiscal stimulus and the monetary stimulus, and by the time we got to the end one or excuse me, at the end of the beginning one, was this pretty much already baked in the cake. Really, what we're thinking about is how persistent these inflationary pressures will be going forward. So for me, a couple of things that I think that that the Vetch probably should have

thought of differently. UM One is basically the asset purchases QUEI. Those were really initially UM put in place to deal

with financial market functioning. Right, if you remember the spring of it's not clear that that such emergency measures were necessary really even even past the middle of twenty twenty that the financial markets had rebounded and we're functioning quite well by that point, So you know, we did, we did years of que that I don't wasn't probably necessary to support the economy, and now we have to sort

of think, how is the FED going on? Wine that The other thing that that I think that a critical space here was the FED, you know, from my perception, was cheerleading fiscal policy, and I think that they really pushed back or couldn't do any sort of fiscal or monetary offset even after that last last of fiscal stimulus we had that really gave the economy a good push and and I think that might have been a real

real air on on the Fed's power. Is by not sort of writing off any any hope of of any fiscal push or any monetary offset pretty early in the process also kind of set the stage in motion for you know, the possible persistence of these inflationary pressures. I want to jump to. I guess what the FED should be doing now, because you know, on the one hand, as we've been discussing, we have inflation that's been higher

than expected. We've had a pretty strong recovery in the jobs market, although you know, there are some people who say it can get even better. The recovery overall has been quite strong. But again there are those who argue that in some ways, the economy is still quite fragile. There's still a lot going on in the global economy with covid um and various economic pressures that could come back and impact the US. So taking all of that together, you know, if you were in the Fed's place right now,

what would you be doing. That's a that that's a great question, um, because we'ren't very I think this is potentially really challenging time for monetary policy because if these inflationary pressures have become embedded deeper than the Fed FED really believes, then you're you're really coming to the party too late, and you're going to have a hard time

really really containing these inflationary pressures without creating a recession. So, you know, I think the FEDS should should do a little bit more clearly what I think they're they're kind of positioned to do, and that's to try to get rates up to something closer to neutral as as quickly

as they can. Uh So I would probably define that objective at least right now, so that you'd be better prepared in the to find objective more clearly, so you'd be pre prepared to prepared to adjust policy in the second half of this year as necessary, and that would mean, you know, I think you're starting out with there's always a question should you start out with fifty basis points? Um, you know, I think uximately you'd like to be you know, at HUD and fifty basis points by the second half

of this year. And the Fed's not not positioned to do that and hasn't hasn't really primed markets to expect that kind of grate hike. That's what I would be thinking about pretty pretty aggressively if if I was the FED. Yeah, I wanna talk about this more and maybe the idea Okay,

they got there too late. You wrote something in one of your notes a couple of weeks ago that I thought was pretty provocative, and you said, you know, look, historically, when inflation is like this, the answer ends up being it took a recession to bring it down. And so of course everyone hopes that you can have sort of like you know, the so called smooth landing where just

the relation side goes down but employment keeps chugging along. Fine, that'd be great, but talk to us about, you know, the historical analogies of like, yeah, this is what it actually took to get inflation done. Yeah, this is something that struck me just looking at the charts of wage growth and particularly inflation in the sort of the the era not associated with with two percent inflation, that really once you sort of shifted your equilibrium, it was it

was pretty sticky. Wage growth really stayed at you know whatever it's it's it's prerecession level was until until you came to a recession. And the same was was really true of inflation. So it really started to look in the data like to me that changing these dynamics was was actually very hard once once they had become established, and it was probably going to be harder than we anticipated, especially since all of the models I think right now

are are calibrated on the pre pandemic period. So you know, when inflation never really deviates more than say, your core inflation never deviates more than basis points away from the two percent target, in that case, you're fairly fairly easy to see how you could guide the economy back to target without a recession. If you're to two d four hundred basis points away from target, the historical data suggests you you you guide it back towards a lower number

by by inducing a recession. So that's that's something that's been just sticking in the back of my mind as a as a real risk. Going into particular just tells me how much we're all leveraged on the idea that inflation is going to ease by the end of this year sort of on its on its own accord. This might just be a question about semantics, but I'd still

be curious to get your your response. But if if the only way historically UM to end inflation or avert price pressures is to have a recession and the FED raises rates and induces a recession, can we still call that a policy error? That's a um, you know, that's a that's a good question. Um, the policy here would have been made prior to you, prior to that point, right. You know, one thing I think about is in retrospect, the FED actually did a pretty good job in the

post Greed financial crisis era. And uh, you know, at the time, you know, myself included criticize the FED for maybe moving to aggressively, but but we still ended up in the economy, which I think we can all agree was really an excellent economy. We'd like to be back there, and that was managed by essentially, you know, guidance, loose

guidance on a Philips curve. And then I would argue, you know, later in the crisis and later later in the expansion, some loose guidance on the basis of not letting the yield curve invert, and that sort of slow and steady return brought us to a good outcome. And we all ended up complaining because inflation was twenty basis points below two percent, And maybe you know that that you know that we should have appreciated that that response

more than we did at the time. So I have a really basic question, but you know, uh, two percent inflation target in retrospect, maybe it wasn't that bad having years of subpar below target inflation. Like should we should we be trying to I mean, I know they change the inflation framework um to something more flexible, the flexible average targeting stuff, But should we be aiming for something other than two percent inflation at this point in time? You know, there's a a big view that we shouldn't

be aiming for inflation greater than two percent. We should have picked a three percent four percent target given our proximity to the lower bound. That maybe that would raise what we consider the neutral rate of nominal interest rates. And I do think there's some truth to that story. Certainly, given the current circumstances, I don't know that it's really politically possible for the FED to target something other than

two percent. I think they'd have a hard time basically creating support within Congress for for a higher inflation target, even though you know, there's the reason to think the economy could operate at at three percent now. At the same time, I think if right now monetary policy almost has to have an inflationary bias because of the proximity to the lower bound, you can't really target something less

than two percent because you can't. You can't take the chance of of tipping yourself into recession when you're this close to the zero bound. So, you know, this is kind of one interesting thing I don't know if has been properly or completely recognized, is the FED really can't sort of do average inflation targeting at two percent right now.

Right they can't sort of go into the future and say we want, we want, we want average two percent over the next five years, average inflation of two percent over the next five years, because that's going to imply some period of less than two percent inflation and they can't do that. You know, you mentioned that the nineteen economy was pretty good, and I agree, but two was eight years no, like, you know, yeah, eight years after

the crisis. And so when I think back to those years, I don't think like, oh, it's so bad that we only had one point eight percent unappointment or sorry inflation. I think like, oh, we had like a pretty big um employment shortfall for a very long time post GFC. So what we're talking about, how good of a job the Fed in retrospect did? Do you think, like, does that apply applied to the labor side of the mandate as well? I think again that's a that's a good question.

Is you know, in that post in that post Greek financial crisis period, that was certainly a slow period of of of recovery relative to you know, what we would have optially expected. And I do think that sometimes gets you the question of what can you expect out of monetary policy? Uh? And I think again, if we go back to that period of time, we all, I think basically universally agree that we should have had more fiscal policy and maybe that would have been the thing that

would have boosted job growth. Now, it may be that neither of those things would have been as important as we we we'd like to think it was that, you know, for whatever structural reasons, the economy was just in a low real growth mode as we had to you know, recover, rebuild the financial system from the from the Great Financial Crisis, and sort of rebuild the economy from the housing bubble. And also, I think demographics were probably in play there.

You know, the boomers were aging out of the the workforce and being replaced by the Gen xers, which is a demographic whole. And so we actually have the opposite right now, where now the millennials are going to be aging into their prime working years in their home buying years. There might have been a bit of a demographic weight

on the economy and that that post grade financial crisis period. Again, it's it's easy to criticize after the fact, but I'm not sure the Fed could have done, you know, this magic job that we all sort of thought at the time that they should be doing. So you said, so the interesting and that is like what can we expect out of monetary policy? And I think that's like a

very fair question in both directions. You mentioned, you know, a few minutes ago, Okay, if we really want to crush inflation, we could probably do it by engineering a recession, but we all don't. We don't want that to happen. When when you know, thinking from the Fed's perspective, and they hope, okay, maybe four hikes this year, maybe five, maybe three, something like that, what is the channel via

which theoretically these rate hikes do bring down inflation? Like, how does it how does a rate hike or any number of rate hikes feed through to real activity and prices. There's this typical idea, right of a Philips curve, where the idea of the rate hike is to to raise unemployment. Essentially there should trade off between unemployment and inflation. And we didn't really see that, uh, you know, in the in the pre pandemic era, we thought that Philips curve

was was fairly flat. So so that's you know, was a mechanism we weren't necessarily relying on as heavily u instead of we're relying on I think what would be more more vague idea that it's financial conditions you know, tightened that we'd see possibly monetary policy evolved through through a number of different channels, wor be you know, the the exchange way would would possibly be higher, and that would create you know, a slowing of of of demand

where firms would find themselves facing higher interest costs and that would flow slow their their cash flow and you know, consequently that would cause them to you know, slow back, pull back on activity. You can also think about, you know, whether this is how this is operating through home mortgages. So there's a number of channels. But clearly, you know, one way that we've always thought of this is that you you're you're trying to find a mechanism by which

to soften aggurate demand. And historically, you know, areas that that has really been prominent is in consumer durables and housing. This is the challenge is that can you sort of make fine tuning adjustments at the economy at this point like we became more accustomed to in the pre pandemic era, or are you you know, at the verge of of of more major changes in policy that then do have

these these um pretty dramatic impact on economic activity. Thinking about financial markets and one of the things are one of the ideas that set in after the two crisis UM, and the FEDS policy response was this idea of a central bank put and that the FED would always come in UM when markets showed signs of wobbling and stabilize things because they didn't want to risk um a tightening of financial conditions and you know, potentially hitting the real economy.

How are we thinking about that aspect of the FEDS policy workings, like its relationship with markets at the moment, because we have seen stocks fall quite a bit. But part of me feels like the FED doesn't necessarily care, you know, if big tech valuations come down UM to arguably more reasonable multiples. But where I think they might start to get concerned is when something like the credit

market starts to show signs of strains. So I guess the question is like, how is the FED thinking of financial stability and is there still a possibility here that if markets really start to get pressured, that they might um sacrifice rate hikes, you know, in order to preserve them.

I agree with you that it's it's not necessarily stock prices, are big tech prices, are bitcoin prices that that's going to be influencing monetary policy decisions you know, obviously if we had twenty drop in overnight, that would that would probably be something interesting. But no, it's it's not asset prices. I think you're right. It's it's it's a credit or market functioning. So you know, obviously the FED doesn't like the situations we've had um where where trenching markets don't

seem to be functioning properly. So that would be certainly one issue and might apply to quantitative tightening um going forward, which which we really haven't talked about. The other thing is if you saw corporate debts but it's really wide, and that would be I think a red flag for

the fact that something was was going wrong. They'd like, you know, they would like credit to be a bit tighter, right, that's you know, they want a slow activity, but they don't want those credits feds to blow out as you often see, you know, before or around a recession. And so that's where you know, that's where I think the FED would be much more worried that they needed to

reassess what their what their expectations were. So you mentioned quantitative tightening, and of course the FED expanded its balance sheet quite a bit since March and you hear some members, some regional FED presidents sometimes talk about it's like, well, maybe we could do one or two less rate hikes in the short term, but sort of counteract that by a more rapid wind down of the balance sheet. It's a little unclear what effect that had. Highly sort of controversial.

What is your view on this sort of like the I guess I don't know if it's a sequencing question or the the impact of quantitative tightening and how they sort of like translate to rate hikes, Like, how do

you think about that question? Yeah, I think the FED has to be really careful about how they approached that that particular question, because you know, Paul said, you know in the Prosperous bull streets and press conference that there's you know, some some capacity to estimate some trade offs between QT and rate hikes, But but were they something you really wanted to count on? And that's that's you know,

that's my opinion too. I'm not sure you want to start setting expectations about the path of rate hikes on the basis of what you're doing with the balance sheet. What the FED really should think about doing is Okay, here's here's what our objectives for the balance sheet are and I don't really know if that if we're clear on what those are yet, right? Is it about getting the size down? Is about getting NBS down? How quickly

do you want to get this down? They need to set the objectives to the balance sheet and they should probably just let that run in the autopilot on the back until there's some kind of concern from financial market functioning that they need to adjust on that front, and then just say that's going on. Here's what we're doing

with interest rates. That's really a separate thing, rather than trying to, you know, say at the front of this, well, if we do this much q QT, we're going to get you know, fifty basis points less of tightening going forward. I think that's you know, something that's just too unknown for the FED to really commit to. I want to just go back to inflation for a little bit, because I realized we didn't talk about this, and we are recording this on visit February nine, and I guess CPI

is coming up relatively soon. Do inflation next? But stations matter? And further to that, should we be differentiating between consumer versus corporate inflation? Expectations, and I realized that might be

maybe that's an odd question or a new question. But I've been thinking about it because I've been watching your tweets and you've been focused a lot on what companies are actually saying about price increases, and you made the point that shareholders seem to be rewarding companies who say that they're going to raise their prices in response to cost pressures, and so I guess the question is, most consumers seem to think that a lot of the inflation

pressures are still transitory and that things like used car prices are going to get better. But on the other hand, companies seem to have entirely different motivations and therefore different ways of thinking about this. So how how are you thinking about expectations broadly? So, I'm not convinced that consumers right now have a good sense of really what what inflation is going to be out five years in the future, ten years in the future. It would be amazing if

they did, wouldn't it. I Yeah, I think that would be really, really amazing. More likely to me is that does long term inflation expectations adjust as the short term inflation remains sticky? Above those those current long form inflation

numbers you know. Right now, we know that short term inflation expectations are elevated um and consequently, if the continues to be matt right, if those expectations continue to matt then that will probably put expect upward pressure on inflation expectations over those long term So I think when the FED you know, looks at these long term inflation expectation numbers as if they're they're really signaling some some intense um attitudes about long term inflation on the part of

consumers um, I think that's that's probably misleading, that those are almost certainly lagging indicators, so especially after a twenty five year period of very low inflation. Now, I do think that what firms are telling us right now, so they're telling us essentially they can raise prices and then not get any consumer push back. That tells me two things is that there's lots of nominal spending power. Also that that consumers are expecting higher prices and willing to

pay it because they have that nominal spending power. That suggests to me again sort of more of an embedded inflation dynamic than then we would like to see you know, earlier in the conversation, we talked about this idea of like inevitably policymakers fight the last war, and we you know, it's obvious why that happens. But there are some elements of the current economy, even with elevated inflation, that strike me and potentially like are much better than they were

pre crisis. And so we see the fastest wage of growth at least currently happening at lower income scales. It seems like there is a potential you know, for years Larry Summers great stagnation, like very mediocre productivity numbers for the ten years after the Great Financial Crisis, it seems like there's a potential here for capital expenditure to maybe

kick into a higher gear. On the matter of you know, people bemoan for years inequality, well, you know, it's like in a in a tight labor market, obviously the powers

shifts somewhat to workers. I mean that by definition almost is there a potential here for the jolt that we've seen to kick us into a superior equilibrium when all of Sadden done right, and I think about this um a lot, is you know, obviously you want to get back to at least as a good place, but maybe even a better place, right, because we'd like to see, you know, a productivity be higher, right, And maybe is that requires some investment? And is that investment something wrong?

You're going to see if we if we run the economy high right? Right? And so is there a potential here to get to a better player? And I think you're the answers, Yes, there is that potential. And I just think it's how do you moderate the economy during that adjustment? Because I think you know, what what Sherman Paul has said has been I think generally correct in that if you want to you know, maintain and extend these benefits, you need to know basically have inflation under control.

And if you don't get inflation under control, you know we're going to end up with these instabilities that eventually prompt us to create a recession. So even if you're getting a jolt, can you have too much of a good thing in a short run that you actually lose some of those long run benefits? And I think that's the concern that the FED should have at at this juncture. Well, Tim, I mean, I think that's like a that's a great

spot to leave it. It does seem like, yeah, there is some reasons to be excited, but can they get it just right? It seems like an incredible chill for the FED in two So maybe maybe we'll have you on in December again of this year and we're like,

we'll see how they did with the hikes. Assuming the h that's great, and we'll see, you know, it's inflation moderates back towards two percent, as many people expect, then the fan is gonna look brilliant because we'll be it will be near neutral with a you know, a pretty tight job market and inflation back to two percent, and that's that's, you know, the optimal outcome. All right, Well, knock on wood. I don't have any wood, but knock gonna lead that. That is the set of conditions at

the end of this year. Tim Dooey, thank you so much for coming up. Thanks for having me appreciate it. Thanks Tim, I really enjoyed that tracing. I mean, I think it's clear regardless like this is going to be a tricky year for the FED because obviously it wants

to consolidate its gains. It wants to is to mention the end, It wants to sort of preserve the potential for the benefits that you get from a hot economy while making the economy less hot, but also not so hot, so less hot that we're in a recession so hot something like that, less hot but not too less hot. Yeah,

I think that's right. The other thing that stood out to me was, you know, Tim's point about how difficult it is to separate supply from demand issues at the moment, But I kind of I sort of follow that to a different conclusion, which is, I still think a lot of the demand that we're seeing is actually a result of the supply shortages, and people are you know, just getting things when they can and sort of stalking up and seeing a bunch of other people improve their houses

and do this and that and jumping in so that they're not left behind. But I mean it does. It does just high how difficult it is at the moment for for policymakers. And I know it's their job and everyone likes to criticize them, but it does seem like

a particularly challenging time. Yeah. No, I mean I do think like the the sort of like, oh, did the massive like boom in demand that we saw one turned into Glutch and three uh as you've written a lot about this sort of bull whip effect, is like is a underdiscussed scenario still like we don't really know, like

you know how long it's going to go. But to your question, and you asked the important question, like and Tim has been pointing it out, It's like if companies are saying, like, well, shareholders, we a we can raise prices, like Chipotle is like, yeah, we can raise the price of a burrito without hitting demands, and be investors are rewarding us for raising the prices of a burrito without hitting demand, then that is like a sort of like

level of corporate motivation that could sustain sustain priced in creases for some time totally. And this to me is, you know when people are saying, oh, inflation and expectations don't matter anymore, they're looking at consumers, and I kind of I agree with that, but I really do think company inflation expectations matter quite a lot because they have the pricing power, um, and those are eventually going to feed into consumer expectations. UM. So I think that's a

really important point. Um. And possibly you know, one of the things that the FED might have gotten right in recent years. Is its point about MONOPSYNY and big companies and pricing power, and we might start to see that um or we might really start to see the impact

of that over the next year or so. Yeah. I mean everyone is like criticizing Elizabeth Warren and the White House for pointing out the sort of like the corporate profitability driven inflation, But you know, you look, look, you know yesterday, um February a Chipotle earnings came out, and it's like they're doing very well, and they see more pricing power, and they're mares are holding up well and they're raising prices in part because they can make more

money when they raise prices, and so the companies that can do that are in a position to dictate prices are obviously doing really well. There's just like so many, uh, there's so many moving parts to this, and I thought that was a very helpful conversation. Can I just say, I've been in New York about a week and I've had Chipotle like two times now. It is so good. I missed it so much. They didn't have to put there's Chippotle in Hong Kong. No, there's also just a

broader shortage of good Mexican food. But yeah, I missed it. It's it's worth the price increase for me at least for now. You're one of the consumers, Yeah, fresh back out of American soil. Who's like really to absorb any price price price insensitive for for American Mexican food? All right, um, shall we leave it there. Let's leave it there. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy

Alloway and I'm Joe wi. Isn't thought you could follow me on Twitter at the Stalwart. Follow our guest Tim Dewey on Twitter He's at Tim Dewey. Follow our producer Laura Carlson at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesco Leady at Francesca Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.