The Next Recession Could Come Courtesy of the Fed

happens to be the US Federal Reserve. For the past fifteen twenty years, the story of central banks and their job has been dramatic but pretty easy to grasp. The rules. Whenever economy has got into trouble, the central bank would slash interest rates to new lows and flood the economy with cheap cash. The economy got better, but never quite enough to bring rates back to where they were before the crisis, so money stayed cheap. This recovery, those feeling

a bit different. At least an advanced economies like the US, demand is coming back faster than supply, and inflations hitting rates we haven't seen in years it's all driving fears that one of these central banks is about to monumentally screw up, either keep the money flowing too long lose control of prices, or raise interest rates too soon and choke the recovery. Now the risks look rather different in

the US and the UK right now. So I've asked Bloomberg economists on both sides of the Atlantic to come on the show to explain it, or our chief a mere economist, Jamie Rush, formerly at the UK Treasury, and David Wilcox, now our Director of US Economic Research, but for many years in charge of all the forecasts and all the economic research produced by the Federal Reserve. You're

gonna hear them in a few minutes. But first, the story of a central bank that tried something new just under a year ago and changed the way money works in the economy almost overnight. It's called Picks and his brazil economy reporter Maria and Louisa Kapoora to explain how it's taken the country by a store Feaston Peaks or Mega Picks. Wasn't something in Brazilian's used to say a year ago. But now you hate everywhere, I mean really everywhere, I beat my ren Thry big size split the restaurant

built with friends Bia Biggs. I even paid my activities with Biggs and it's just millions like me. I don't know. I have picked since it came out in November. I cho speaks because it was easy to make men transfers. That was in Carlo Garti Silva native from what are and who I run into. He was having coffee in a restaurant in the southeast region of Brasilia. Most of the payments he makes nowadays on most of the transfers he makes to his family. You speaks a new payment

platform that's sweeping across Brazil. I made the picks of three thousand three eyes as a low one. That was my last PIX transaction. The mobile payment platform, created by Brazil's Central Bank less than a year ago, has changed the financial landscape of Brazil. Now, more than a hundred and ten million users have transferred money through Pigs, which lives within a bank's mobile phone app in just the

same way sell do us for US base banks. As if to underline the bad streach of a new payment system. While waiting at a stoplight in Brasilia, I noticed a woman going car to car packing for money. Her cardboard sign said she accepted pigs. Pigs was creating an attempt to simplify banking transfers and make them cheaper, while also

boosting competition. But the success of Picks has highlighted another potential benefits of the system, an increasing financial inclusion by bringing people like the woman I saw at the spotlight into the country's banking system. And that's just huge for Brazil, where three percent of people don't have a bank account. You need to have a bank account to access Peaks, but once you do, you can enter the platform just by registering your phone number, your textually or just your email.

Here's bank chief Roberto campus net To speaking in an interview with the Council of the America's in August. I think Picks became a very popular, you know, gain a lot of space, a very popular project that the Central

Bank did. The message from the very beginning was it's not only a substitution effect, but also you increase the number of payments if you're gonna enable new business models, which should increase the volume overall, should increase the ability of small companies or companies that sell things that have a small chicken to get into the market people the self employed. We actually see people sending things on the street and accepting picks this day, so it's becoming again

a very popular thing. We never expected the reach. You know, we have two eighty two million keys, we have seven point four million entities companies using Picks is catching on so quickly, in part because it's just so easy to use, said Brenda Lovo, senior advisory at Bussis Central Bank and part of the team managing Picks. It's always available for four hours a day, seven days a week. The funds

are instantly available at the peas accounts. So uh, it's a very easy and people intuitive way of transferring money using the themartphone. The pandemic turn not to be fertile ground for the growth of Picks. People were cooked at home, avoiding contact, and businesses were closed and suddenly here comes Peaks, making digital transfers as easy and fast as using cash.

By September, about eighty nine billion dollars have moved through the system, And just to give you an idea of what that means, PIX moves fifty times the amount of money ordinary text too. Here's again Brazil's Central Bank. We expected that PICKS would be very used here in Brazil, but we thought that it would take a certain amount of time because people have their own abits of using

means of payments. For here in Brazil, we use a lot of cash, and we use a lot of cred cards and that cards, so Brazilians were not familiar to use. There's much funds to start a payment, and PIX was a really new thing that came in Brazil, but it ocplied this space really really really fast. Uh. Picks UH is the instant payments seems that that that have the

fast adoption in its first year. Picks has been especially game changing for small business owners like Hanada's Leveda Pets, who runs a small cat sitting business in the central Brazilian city of Ours Class. Picks lower the costs for my customers because the transfer feed that each bank charged me could be as high as thirty percent of my take. So PIGS brought me more financial control element cannot with

a sales vaccination great growing every day. The economy now is almost fully reopened and people are entering out stopping by the bank now it's much easier, and yet PIGS is still growing. In July, it broke its own record of fourty million payments in just one day. Julian Afraida works at a pastor shop which began using pigs just five months ago. The work with all credit and debit cards. The pigs was very practical and many clients wanted it,

and it makes payments for deliveris easier. In three seconds, she sees the payments in her account see pick. Sometimes it takes less than that. It's super fast and we don't pay fees to banks. Credit cards can take as long as thirty days for us to see the money, and with debit cards, if the purchase is made on a weekend, we'll always see it the next Monday. But Pigs is automatic. There's just one hitch. Brazil is a high crime country and criminals have also begun to capitalize

on the success of pigs. Express Kidnappings are also back, and people are being snatched off the street at gunpoint and forced to pull out all their stabings from the closest ATM machine. To now the bad guys only need to force them to make up pigs. Accounts are traceable in picks, but criminals use fake ones or false names.

The Central Bank responded rather quickly with new limits on transfers at night, and other safety measures have also been taken to address the possibility of hackers entering PICKS database. And if the numbers tell us anything is that for hundreds of thousands of resilience, the risk of using Peaks is outweighed by the reward in costs and convenience. But

Picks needs to grow to achieve financial inclusion. Here's Leonard Roja Suarez, director of the Latin American Initiative at the Center for Global Development in Washington, d C. And so Peaks is great for at lower in financial cost, increase the security, and improve the consumer spirit. But that is true only for those that have a bank account, because

that's a requirement of PIGS. For those that do not have a bank account, bank account, or do not have a smartphone, they will not be able to access the up and so that would leave about thirty of the Brazilian population out of being able to use the app. Some of those changes seem to be already happening. Offline payments are in the words, along with programs that will allow people to withdraw money from stores using PICKS and bank chief Campus Nettle says we haven't seen the full

scope of PICKS yet. In fact, he estimates we've only seen five of its posessial and if that is true, Brazil could be on the brink of a digital revolution. For Blue Venus, I'm Maria least couple well, no good deed goes unpunished. Our brazil economist Adriana Dupeter just informed me that PICKS has been so successful the government's thinking of slapping a financial transactions tax on it to help

fill the whole in the government's public finances. So I guess there are some things about Brazil that technology can't change. But now we move from a digital revolution for central banks to just a very difficult decision. As I mentioned at the start of the show, the rapid recovery we've seen in a lot of advanced economies this year has produced something we haven't seen in a long time inflation rising prices. The annual rate of inflation last month in

the US hit five point four percent. That's the highest in more than a decade, and only the second highest reading this century. Now, this was supposed to be a short term blip, a temporary side effect of the extraordinary impact of COVID nineteen. But it's dragging on a bit, and some pretty influential economists, including my old boss, the former Treasury Secretary Larry Summers, say the Federal Reserve and maybe other central banks are in danger of falling asleep

at the wheel. Well. As mentioned at the start, I have our Director of US Economic Research, David Wilcox, and chief a Mere economist, Jamie Rush here to discuss all this. I mean, David, you spent a long time at the FED. They say, institutions always at risk of fighting the last war? Is it? Is it too focused on lack of demand, which has been such a problem off and on for the past ten or twenty years, and now not focused enough on too much demand and actually too much inflation.

I don't think so, Stephanie. For sure, the Federal Reserve is facing challenging circumstances with pandemic induced economic collapse the likes of which we haven't seen in at least a century in the United States. But let's remind ourselves the dominant narrative in the US for the past two decades has been inflation that ran too low, not too high. It was frustrating for the Federal Reserve that they persistently

undershot their two percent objective. Another key ingredient in the environment right now in the US has been the astonishing downward move in interest rates around the globe, and that's left central banks, including the Federal Reserve, with too little room to cut rates in order to fight recessions. To try to push back against those two developments, the FED put in place a new framework one year ago under which they pledged to be more tolerant of inflation running

a little above the two percent objective. So, while the situation remains very fluid and very uncertain, the bigger risk from the Fed's point of view, in my assessment, is that inflation set eggs below the two percent objective once again after the current set of snarl ups in the supply chains are resolved. I think they're right to stack the odds on inflation in favor of inflation running a

little above two I guess there's two things here. There's that the forecasts that the Federal Reserve might have or policy makers might have a different that they just don't think inflation is going to stick around as long as as other forecasters do. And then there's something else which just to say we we do think inflation maybe we'll stick around for a bit, but we think that's we're more tolerant of that than we might have been in previous eras. Yes, I think that's just right. Monetary policy

is risky business. It's not for the timid of heart. Um. Certainly, there are some prominent voices, and you mentioned Larry Summers being perhaps the loudest of all, that are warning the FED that they are on the brink of losing control of inflation. But the consensus view remains much more benign than that. My own views tend towards the more benign end of the range. I think we're likely to have inflation, that's a little about two a year or two from now,

but I don't anticipate that. The most likely outcome is that I will see inflation as a persistent problem for the FED to deal with by them. And I guess when you talk about FED stuff until not very long ago, a lot of those people used to used to work for you. It's all very well saying, well, we want to build ourselves a bit of room for maneuver for the future, so if inflation goes higher, that's not such

a big issue. But if you've lost credibility, if you seem to be acting too late, then I guess the risk is that you then have to do too much. I mean, how concerned will they be about that? To think, Well, let's distinguish two instituencies here. The job of the staff is to try to give their best professional judgment. They're acting like physicists, admittedly in an improve in an imperfect world. But their job is to lay out their expectation the

range of uncertainties around that expectation. Policymakers, you're absolutely right, have to take into consideration a larger constellation of issues, including things like credibility and reinforcing the meaning of the new framework that the FED adopted just a year ago. Um, the FED staff is as good as they get, uh, and I think they are really free of any kind of larger sort of pressures that that might be on

other elements. Their job is to just simply if their best professional judgment, they don't need to take into account issues of credibility or other matters like that. What would it take to change the fat's mind? Do you think that how much inflation would you have to see? For how long? I mean, when we see these numbers. You see very high house price inflation, you see rents taking off, you know some things which are not one would think, not entirely just related to these supply chain issues that

we've had coming out of COVID. Yeah, what will be required to change the FATS mind is really, I think a break and inflationary psychology that we haven't seen really since the early nineteen eighties. Um, if it becomes the dominant narrative that businesses are putting in place price increases because they know their competitors are, if they're granting wage increases because they know that they're workers are being bid

away by others who were offering higher salaries. If workers are demanding larger pay increases because their cost of living is going up not only over the past year, but

they expected over the coming year. Those are the basic ingredients of a classic wage price spiral, and that's what will prompt the FIT to conclude that inflation expectations are no longer anchored as they have been for the past two decades, and that in turn will prompt the FIT to slow the economy in order to contain inflation pressures.

I'm going to bring Jamie Russian now are a mere chief chief economists because if you we tend to think of terms of hawks and doves at central banks, and it greatly annoys the policymakers that sitting there because they think they have very interesting, nuanced views. But the hulks, broadly speaking, are the ones who want to raise interest rates with money more expensive, and the doves are the ones who want to keep money very flowing, very loosely

and freely. If we have a flock of doves still encamped at the Federal Reserve building in the US, there are certainly a few hawks, and one very prominent hawk we've been hearing from from the Bank of England recently. Jamie talk us through the situation there, because it feels like the forecasters and the central bank are facing the same uncertainties in the UK and some of the same inflation, but coming up with rather different conclusions. Yeah, I think

that's right. So if you go back even just a few months, there seemed to be a consensus among global central banks that they were just tread carefully, if in fact there was any treading to be done at all, and so the bank wasn't expected to lift interest rates until three in the UK, and they were going to tolerate any sort of inflation if as long as it

was going to be temporary. But now wage pressure is picked up a bit, and not just in the places that have been affected by COVID, the most energy costs are up, which is obviously pushing headline inflation up a lot. And it seems that the Bank of England's lost its nerve. The governor is increasingly vocal about the risks of inflation, and that's prompted markets to bring forward the timing of

expected rate hikes not two but to next month. So um, it's been a really really big shift in the Bank's rhetoric and how markets are perceiving it, and indeed they're expecting another eight basis points or so of of hikes next year as well. So it's just worth it's worth

emphasizing just how big a change that was. So, as you said at the start, only a few months ago, probably the beginning of the summer, we were expecting interest rates to stay basically at zero, just above zero in the UK for at least another year or a year in a bit, so no change until three and now we're not only expecting maybe three quarters of a percentage point worth of cuts next year, but even a rise this year, so that interest rates in the year's time,

the official base rate could be one percentage point rather than more or less zero. Now, I can't think of a time when you've had such a dramatic change. You said that the bank, the bad governor had lost its lost his nerve. That normally sounds like a bad thing. Do you think he's making a mistake? Well, so, I think there's two questions here. Are they making mistake about

the policy that they're taking now? So they have they are accommodating market expectations and higher rates, which is tightening. It's happen. That's happening right now. Basically it's feeding through to borrowing costs in the wider economy as we speak. So people expecting rates to go up and pushes the market rates. So when I go and get a bortgage or where if I'm trying to borrow as a business, I'm already paying more because people are expecting interests exactly right.

So if you think about the five year borrowing cost in markets, like the risk free rate that's gone up fifty basis points over the past few months, eventually that's going to feed through to your five year mortgage if that's if that's what you've chosen. Um, so these things are going to start affecting people even before interest rates have actually gone up. So I think that's an important point. So if there is a policy mistake happening, it's being

made now. It's not something that's about to happen, it's it's already happening. So so there's that, and I think, you know, is it a mistake? Well, we don't actually know. It may prove to be the case that inflation does pick up sustainably and actually this is going to look like quite a smart move in a year or so

is time. Equally, you could see that unemployment goes up as the end of the furlough scheme in the UK happens, and and that pushes down on on on wage pressure and therefore inflation tips back downwards, which case would look like a mistake because it needlessly delayed the recovery. I think the bigger question though, is whether there is a TJ error being made here? Is that is it better

to be if you're going to be wrong? Is it is it better to be wrong by going too early or by going too late, And in my opinion, it is better to be to to raise interest rate it's too late, because a little bit of extra inflation isn't going to be too damaging into the bank's credibility, is not going to hurt people too much, especially if it's it's driven by wage increases UM. Compared with what we've seen,

which is a rapid repricing of interest rates. The possibility that this has actually some some some nonlinear effects, meaning that the economy could respond worse to a sudden increase in interest rates than than than one that's been very carefully choreographed over the course of say six months UM. And so I think that is actually the bigger danger.

You could have a position here where the bank is as has endorsed a lot of tightening, and that it could it could affect demand, it could affect the housing market. It could have really quite a few unintended consequences. So the strategic decision from from in my view, is probably not the right one. It sounds like you're making a similar argument to what one would make in the US.

I guess one argument is that the UK is in a worse position than the US and particularly is a bit more vulnerable to inflation taking off because it's also just had this kind of recently self inflicted wound of Brexit. Is there a sense in which the Bank of England needs to be a bit more concerned about triggering an inflationary spiral than the US. We've also had quite a lot more inflation than the US. We haven't really had a deflation concern in the UK the way that you

have in say America or the Eurozone. We've been able to deliver quite a lot of inflation even through these last few years. I don't think the Bank needs needs to be especially concerned just because of the additional disruptions caused by Brexit. I mean, we always have this this this backdrop of supply chain disruption more broadly due to COVID. It's very difficult to unpick the Brexit distructions from the

COVID disruptions. So I think, in in short, there isn't an obvious reason why you should adopt a different policy in Britain from the one that is being adopted in the Europe and in the US. And in fact, by going quite by adopting a very different strategy, you do introduce some new risks, and that you are going to

see some potentially big movements in the exchange rate. For example, if the if you if the UK goes and goes alone on Manuch policy and raises raising interest rates a year before the FED, so that there is there is I mean, there is some safety in in in sticking with the herd. And I guess I had a final question for both of you, which is before two thousand and eight, and certainly all the time I was learning

economics in in high school and university. You know, we tended to think that recessions were going to be caused one way or another by central banks, because that was how most recessions have been. The immediate trigger for most recessions had been central banks checking up interest rates in response to inflation that they'd allowed to get out of control. But that hasn't been true of the last two recessions,

and we've kind of maybe forgotten about that dynamic. But are we back in the world where you would bet that the next recession, whenever it comes on either side the Atlantic, is most likely to come from a screw up by the central banks. David, I think the risk of that is much higher now. Than it was previously. UM. What we know is that the macro environment is a risky place to operate, and recessions come from lots of

different causes. The two thousand recession in the United States was caused by an asset bubble collapse, the two thousand eight by the housing market collapse, two thousand twenty the pandemic. Each one has its own narrative. Classically, the textbooks that I grew up with emphasized that the that the Fed Reserve let inflation get out of control more or less because of a lack of focus. I don't think that's going to be the storyline that the textbook five and

ten years from now tells as its main narrative. But we just don't know. And so that's why I, for one, I'm going to stay tuned and Jamie, next time we have a recession that you're going to be looking first talk. I agree with David. I think it's become much more risky. I mean, one one one obvious risk is just that the impressed in support means it's going to be uncommonly

difficult to unwind UM. But I think one interesting thing would be if central banks have to choose to have a recession in order to get information, and I mean we haven't had that from really a long time. It's one thing caused one by mistake. And let let it be said they have done that in the past. They

used to make I think that's actually a book. But it's fear of doing having to do that which is driving a lot of central bank behavior now as we see it, um certainly from parts for the banking especially. But yeah, I think if they had to choose to have a recession to get inflation back under control, I think that would be keeping me up at nine hours a central bank Jamie Rush, David Wilcox, thank you very much,

Thanks so much. Good to be with you. Since we're talking about hawks and doves, I should mention that one of the great hawks in the European central banking scene has just announced he's standing down against Wiedman, head of the German Bunder's Bank. For more than a decade. He became known as Doctor No for voting against pretty much all of the European Central Bank did to support the Eurozone economy in the crisis years. With him going, the hawks that the ECB have lost their strong man, but

don't worry. Something tells me there's plenty more just like him, waiting in Frankfort to take his place. Well that's it for this episode of Stephonomics. We'll be back next week in the meantime. If you like the program, please rate it and follow at Economics on Twitter for more news and analysis from Bloomberg Economics. This episode was produced by Magnus Hendrickson, and the story from Brazil was based on

reporting by Shannon Sims and Maria Eloisa Couple. Special thanks also to Danielle Cavallo, is Adora Columbia, Luana Race, Jamie Rush, and David Wilcox. Mike Sasso is executive producer of Stephonomics and the head of Bloomberg podcast Is francescan Lead