Apr 11, 2022

Joey Politano on Recent Inflationary Trends and the Future Outlook for Monetary Policy

Although the short-term outlook for inflation might be cause for concern, all signs point to price moderation in the long run.
David Beckworth Senior Research Fellow , Joey Politano

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Joey Politano is an economist and a commentator who writes and publishes on a Substack newsletter named, “Apricitas Economics,” where he covers a wide range of subjects on a number of economic topics. Joey joins Macro Musings to talk about inflation, monetary policy, and the issues surround them. Specifically, David and Joey discuss the outlook for services and durable goods inflation, the indicators of tightening financial conditions, lessons learned from monetary policy over the past decade, and more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Joey, welcome to the show.

Joey Politano: Thank you. I'm really happy to be here. It's very much a long time listener, first time caller situation here. So it's an honor.

Beckworth: Well, fantastic. We will send you your nominal GDP targeting mug in the mail when this show over.

Politano: I already got one. I already got one.

Beckworth: You got one already. Okay. Well, you'll have two, then. You'll be a special status member of the Macro Musings podcast guest club. All right. So Joey, I'm excited to get you on today. I've been following you on Twitter. I've been following your newsletter. What is the name of your newsletter?

Politano: It's Apricitas. It's spelled with a C, but it's pronounced with a K because it's a Latin word. And I only learned it was pronounced with a K after I'd already picked the name. So it's got an unfortunate pronunciation.

Beckworth: And it means sunshine. I looked it up. It means sunshine. So explain the meaning or the intent of the name of your newsletter.

Politano: I picked the name because I wanted to shine a light on different economic issues and try to remain optimistic and truthful in a social media ecosystem that can often not be either.

Beckworth: What's interesting, Joey, is that you have a full-time job at a government agency as an analyst, and you also take time out to write and you write regularly. So I'm curious, why take on this side gig? Why do all this work? Why become engaged on Twitter? Blogging again… Why go to this extent to be engaged?

Politano: Yeah. So it's an interesting story. Before the pandemic hit, I was actually a Peace Corps volunteer in Uganda, and I was working on economic development projects. And then obviously, when the pandemic hit, I got bounced back to the US, had to find my way, and ended up with this job, but I'm really passionate about economics. And so a few months into starting my job, I thought, "Well, maybe I should spend some time writing, develop my own ideas, and be able to interact with people and shed some light on the economic issues and the economic data that I really care about, or I think is really important." And so around nine months ago, I started writing Apricitas, and I've been writing every week since then. It's been a really incredible experience.

Beckworth: And your work has been cited by the national media. Politico, New York Times, and others have mentioned your work. So tell us about that experience. Anything you want to share?

Politano: Yeah. It's very surreal. It's surreal to be on this podcast. It's surreal to be in those publications because to me, they still feel like ... It's the New York Times. Why do they care about me? It's David Beckworth. Why would he care about what I have to say? And so, like I said, it's big honor and a big responsibility. So I try really hard to get things right before I say them.

Beckworth: So I will provide a link to the Politico piece on our show note page so listeners can go check it out for themselves, but there's an interesting story there. We won't get into it for now on the show, but I encourage listeners to check it out. So a little bit of excitement in Joey's life when he got cited in the national media related to his work. So I'll leave it at that. So Joey, you are hanging out with a number of other young adults who call themselves “Monetarist Teens,” if I have the name correct. Is that right? Monetarist Teens is the name?

Politano: Yeah, that's right. So the Monetarist Teens, for listeners who don't know, are just a group of me and some of my friends on Twitter who care a lot about macroeconomics and monetary policy in specific. We're not all monetarists. I wouldn't classify myself as a monetarist exclusively, and most of us aren't teens. Exactly. I'm in my twenties, but we're all very young people who don't have graduate degrees yet and are very passionate about economics and writing and making jokes about it a lot online.

Beckworth: Okay. And you guys have your own group chats. You invited me to one in the past. I joined. I had to leave quickly because there were way too many messages coming, but there's a whole system there of Monetarist Teens going back and forth, lots of bantering. So it's interesting to see them engaged in what's happening, to be talking about current events. The beauty of the internet is they can be all over the world. I know you have one friend, for example, who's from Argentina, but you got friends all across the US and you're engaged in conversations.

Beckworth: And I'm curious, for those who are truly teens, you're not a teen. You're in the group Monetarist Teens, but a group of them are just teens. I'm trying to think what would be their defining experience? So I have had a number of guests on the show who are now professors and they work in industry or finance. And they had the Great Recession as their defining moment. It's what cut their teeth for macro. But these are teenagers we're talking about. So how did they get so excited and work up about macroeconomics?

Defining Economic Events for the “Monetarist Teens”

Politano: Yeah. So I'll say two things. The first is that in my case, and I think for a lot of the people in the US and UK in this group, which are, they may be about half the total group, our experience isn't living through the Great Recession. I was 10 when the financial crisis happened. So I have really no memories of it occurring, but it was about growing up in an environment 2014, '15, '16, where you're entering the world really and realizing everything felt bad. The economy felt bad and nobody really could explain why. So to me, it was about backtracking and saying, "I'm an adult now. The economy's been bad ever since I was a kid. What could have caused this?"

In my case, and I think for a lot of the people in the US and UK in this group...our experience isn't living through the Great Recession. I was 10 when the financial crisis happened. So I have really no memories of it occurring, but it was about growing up in an environment 2014, '15, '16, where you're entering the world really and realizing everything felt bad. The economy felt bad and nobody really could explain why. So to me, it was about backtracking and saying, 'I'm an adult now. The economy's been bad ever since I was a kid. What could have caused this?'

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Politano: And so I got hooked reading a lot of newsletters and blogs from the early 2000s and the early 2010s about the Great Recession. I read a lot of Scott Sumner as you know, and that really developed my thinking as a young adult. And then on the flip side, I think there are a lot of people in that group that come from countries that have very, very serious inflation problems. So there are members from Argentina, like I mentioned, from Turkey and from other countries that have consistent double-digit inflation. And their experience is, "Well, why does my country have double-digit inflation all the time? What could be causing this?" And then they went back to those same sources to develop their thinking. And it's not uniform. It's not a card-carrying membership. We have some pretty stark disagreements, but the thing we share is a lot of care for monetary policy and macroeconomic issues and a lot of comradery online.

Beckworth: I imagine many of you are aiming to become PhD economists at some point, professional economists. So a shout out to all the Monetarist Teens who are listening. Thanks to Joey for getting us to talk about them, and we wish you the best and fight the good fight as you continue on your career path, Monetarist Teens. Okay. Let's move on from Monetarist Teens to some hot issues that you've written about with your newsletter, and the first one is inflation. We've had lots of inflation conversations on the show, but I want to ask you your take on this.

Beckworth: You work closely with this data and follow it pretty religiously. And you had a recent article that was titled *Inflation Hits 7.95%, and Things are Likely to Get Worse Before They Get Better.* Joey, that's not a very reassuring title, and the article doesn't get much better, kind of a really down in the dumps type of perspective. So help me out here. Why are things not going to get better with inflation? Let me just mention this. I wrote an op-ed in the New York Times back in February of last year. And I said, "Oh, don't worry about inflation. It's not going to be a big deal." And that's probably the one op-ed that really has come back to haunt me. So what you're telling me is it's going to continue to be a problem. So why? What are the developments that are happening that lead you to this conclusion?

The Worrying Inflationary Trends and Developments

Politano: Well, the first thing I'll say is I think I was in a very similar camp as you last year. And I still believe in, I think, the core tenet of that camp, which is that today's inflation is mostly driven by a global switch from services consumption to goods consumption and a supply dynamic that can't meet all that goods demand. And when I was writing about that, not quite at the same time, but maybe in the summer of 2021, my thought process was, "Hey, the supply is going to come back online for a lot of these goods," one, and two, you're going to see more of a renormalization. People are getting vaccinated. People are getting boosted. They're going to change a lot of their spending to services, and that will counteract inflation because people won't need all these durable goods anymore.

I was in a very similar camp as you last year. And I still believe in, I think, the core tenet of that camp, which is that today's inflation is mostly driven by a global switch from services consumption to goods consumption and a supply dynamic that can't meet all that goods demand.

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Politano: On the first front, on the supply front, I think things have only gotten marginally better. And the reason why I say inflation's going to get worse in the near future is because of the Russian invasion of Ukraine. You saw a really big spike in oil prices, in wheat prices, in corn prices in particular, that are going to pass through to the consumer price index over the next couple of months. And there's some other ones like there's a concern about neon, which is used to proof semiconductors, which is used in automobile production, which we both know has been a serious, serious issue over the last couple years. So that real supply has not been as strong, as I think, you or I expected. And then on the flip side, demand has been much stronger. So if you look at measures of aggregate nominal spending, they are pretty reasonably elevated above where they would be, given the pre-pandemic trend, and they don't really show a sign of slowing down in the near future. So I think in the next couple months, you're really going to see that pass through from the Russia-Ukraine situation. In the months after that, you're going to see mostly rent and other services dominate inflation. But still in the medium term, it's hard to see how inflation accelerates from here. The Federal Reserve, like you say, is tightening policy, and you're going to have the inverse base effect happen, where prices were really high actually in March and April of 2021. So price increases will decrease.

Beckworth: Okay. So what you're saying is we might actually hit double-digit inflation before the year is up? Is that one possibility?

Politano: I would say it's possible. It would have to happen in basically the next two months, and you would have to have a really, really serious gasoline print. You'd have to see a really big jump in gas prices that's sustained. Keep in mind the data for this is collected throughout the month. It's not like they pick one day and collect all of the gas prices. So it's sort of an average. Yeah. So it's possible. I don't know if I'd bet on it.

Beckworth: Yeah. And to be clear, the oil prices shot up through the roof. They started around $90 a barrel before the war started, or the invasion started. They went as high as a 130, 135, and they came back down around 110. So that right there shows there's give and take. And depending on what happens in other parts of the world, Iran, Saudi Arabia, maybe some more activities back home in the US, there could be maybe some further drops.

Beckworth: But with that said, the concern is that this inflation from this event, there's still going to be something from it. It's going to translate into higher prices that we face as consumers, gasoline being probably the most obvious one, and that could keep this high number up for a few more months. Maybe it doesn't get double-digit inflation, but we're at, basically, at 8%. You round up, we're at 8% right now. So we're pretty high. So it wouldn't be too much more, so that's one thing we got going against us. The other thing, as you mentioned, is rent and housing. So walk us through some of the measures. How do we think about housing inflation? What's a good indicator or indicators you would point to?

I think in the next couple months, you're really going to see that pass through from the Russia-Ukraine situation. In the months after that, you're going to see mostly rent and other services dominate inflation. But still in the medium term, it's hard to see how inflation accelerates from here.

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Politano: So in general, the key thing to keep in mind is that the way that housing prices are measured in the CPI is through rents. People go out and survey a bunch of landlords and tenants, and they basically… how much does this unit rent for? And they track that change over time in the same units. And the byproduct of that is that it lags what you would call spot rent. So if you went out and tried to rent an apartment today in Washington, D.C., where you and I are based, it'd be fairly expensive, but my rent right now is fairly cheap. And that's a byproduct of the fact that I signed my lease several months ago. And BLS is tracking that lease that I signed several months ago. And so movements in the spot rent, they don't show up one to one, but that general direction shows up with a lag of almost a year into the official measures of rent. And so we know that rent prices are going to go up pretty significantly over the next six months, purely by the fact that spot rent measurements have been going up pretty dramatically over the last six months.

Beckworth: Is there any hope on the horizon with higher mortgage rates? We're going to come to this later when we talk about financial conditions, but mortgage rates are going up quite a bit. Some talk about how people may not buy as many homes because of financing, but maybe they will. Maybe they'll just borrow more debt, but it might push some people on the margin, but is there enough there to make a difference, do you think?

Politano: I actually saw an interesting paper today. I will have to pull it up, but it was suggesting that when rate hikes happen, it actually temporarily boosts measured inflation because would-be home buyers who are credit constrained, basically get pushed back into the rental market. And that's an interesting short-term effect, but I think the dominant long-term effect is that people spend… you're basically forced to spend a certain proportion of your income on rent. America doesn't build enough homes. As people's incomes grow, they just bid up rent prices. And the optimistic thing on that front is that total income growth and labor income growth in particular, are basically on trend, a little bit above trend. So I'm not expecting total catastrophe where you're seeing a 20% inflation in rents, which would be a horrible, horrible situation just purely by the fact that if you have a 5% increase in income, you can't sustain in a 20% increase in rent.

Beckworth: Okay. So the effect may actually go in the other direction in that the higher mortgage rates will force more people into rental properties, which will temporarily push up the CPI, which again, goes back to your earlier, bigger point that the next few months, we'll see it peak, and this might be part of the story. As well as what's baked in already, the rental prices are going to change because contracts get renewed, leases get signed. That happens.

Beckworth: All right. Let's move back to an earlier point about inflation that you touched on, and that is the changing preferences in what we actually consume. And so the pandemic led to this big switch from, it's still largely there, we're service heavy with some goods, but now, we're consuming and buying more goods than we did before the pandemic. Quite a bit more. And that caused inflation with goods, particularly durable goods, as we were working from home, so we had to buy more physical goods. I think that that's recently come down, but the flip side is service inflation is rising, which still makes up the lion share of the economy. So do you see any big changes there that might help inflation? And what I mean in particular, will durable goods drop dramatically? Because as you know, prior to the pandemic, there was a downward trend in durable good prices. I can't recall last month, but there was a slowdown, I believe, but will it pick up? Will services, do you think, eventually slow down too? What's your outlook there?

America doesn't build enough homes. As people's incomes grow, they just bid up rent prices. And the optimistic thing on that front is that total income growth and labor income growth in particular, are basically on trend, a little bit above trend. So I'm not expecting total catastrophe where you're seeing a 20% inflation in rents, which would be a horrible, horrible situation.

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The Outlook for Services and Durable Goods Inflation

Politano: Yeah. So I think the, like you said, the dominant force behind a lot of inflation was this excess spending on goods, driven by the fact that people were stuck at home and couldn't consume a lot of services, or felt it was unsafe to consume a lot of services, or felt it was unsafe to provide a lot of services as workers. And since the start of the pandemic, there's been massive uptake in goods spending. The interesting thing is basically, over the last six to eight months, the growth has petered out. So growth in goods spending is fairly low. The flip side of that is the share of spending that goes to goods is still really high by historical standards, and that really hasn't changed. And I attribute that partly to the continued effects of the pandemic and the Omicron variant and the Delta variant. And I also attribute that partially to a general change in consumption patterns that's maybe a little bit sticky.

Politano: And when you're talking about durable goods, I think it's unavoidable that, especially in the US, what you're really talking about is automobiles because cars are such a big share of durable goods spending, and they're such a big part of Americans’ lifestyle. And on that, the news is not horrible but not great. You're still seeing the major automakers struggle a lot with production. And interestingly enough, they've focused, really heavily, on the more prestige or the higher margin items. So Ford is focusing on the F150 because that brings in more money for them than the compact cars that really don't.

Politano: And in the used car market, you're seeing a really big dearth of supply. I think there is some encouraging news on that. So if you look at like the Manheim Used Vehicle Value Index, which is tracking auctions, you see that's gone down about 2% over the last month. And moves like that before the pandemic would have been crazy. Moves like that after, when used cars are up 40% from where they were in 2020, don't seem that crazy, but it's at least progress. I think the defining factor though, is that automobile output is still relatively low and it has been low over the last six months. Not as bad as it was in the dearth of the pandemic, not as bad as it was when the chip shortage was really biting, but still pretty bad.

Beckworth: Yeah. So I wrote a follow-up piece to the New York Times piece where I was clearly wrong. I co-authored it with a colleague from the Mercatus Center. And it wasn't in the New York Times. It was somewhere else, but a follow-up piece in the sense that we acknowledged that our earlier outlook wasn't quite right, and we laid out three reasons why we think we will still be right eventually. Now, eventually keeps getting pushed back, but the three reasons were one, we believe in globalization. We believe globalization will lower costs. Two, we believe that these durable goods in particular related to that will come down over time. And also related to that, of course, is just getting to the other side of the pandemic itself. That will bring people back to work. Productivity will pick up, and finally, credible monetary policy will kick in, even though they might be a little bit late to the game this time. All those things will work together.

The share of spending that goes to goods is still really high by historical standards, and that really hasn't changed. And I attribute that partly to the continued effects of the pandemic and the Omicron variant and the Delta variant. And I also attribute that partially to a general change in consumption patterns that's maybe a little bit sticky.

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Beckworth: But what you have suggested and what seems to be happening is that the ability for globalization to heal the wounds of the pandemic, the supply chain wounds, hasn't gone as quickly as I thought it might. As you know, we just saw in China that they're shutting down cities and some factories because the Omicron variant's going around there. So that's really a disappointing development. And then of course, the Russia-Ukraine war also will have effect on supply chains. So in order for supply chains and globalization to do its magic, it has to be up and running, and that hasn't happened yet. So it's still the same story. It's just getting pushed back a little bit more. But I guess my other question related to this is, do you think, when we do get to the other side of this, so we're beyond the pandemic, we're beyond the war, will there be a permanent shift in our consumption basket? Will we always be purchasing now more goods than we did pre-pandemic. And I'm trying to find a good reason why that would be the case. I'm not sure that's the case. What do you think?

Politano: Well, I know you've had Matt Klein on a lot, and in his, for lack of a better word, mea culpa about his inflation predictions, the one thing he said was that the big downside scenario on inflation was what if the pandemic never ends? And I don't mean never as in never, but we are approaching two years at this point. And I know that at the start, I didn't expect it to last two years. And I know that last year when everyone was getting vaccinated, I did not expect it to last another year. I think it's tough, as economists, to say there's a public health situation happening that's trumping any economic arguments that we can make or any economic policy making that's going on. But to some extent, it is true. I don't think it'll last forever. I don't think it can last forever. The one marginal change, I think, is that people have moved out of the cities into more suburban areas. So you're probably seeing more automobile consumption, more driving, more gasoline consumption, but that's not a massive, massive effect on the order that current spending patterns have changed.

Politano: I think the other thing is, and it's very difficult to say this, but we're talking about the items that really have had the worst supply crunches. It's items that have big boom and bust cycles, that have a lot of capital expenditure… upfront capital expenditure requirements, and have not been doing particularly well financially in the US for the last decade or so. So automakers and oil are the big examples here really. We know oil drillers have lost a ton of money over the last decade and it takes a lot to start up a new oil rig. Same thing with auto makers. It takes a lot just build a new factory, especially when you can't get the current factories to bear. And even semiconductors have really strong boom and bust cycles. So it's really hard, as a semiconductor manufacturer, to say, "We got to invest for a decade of increased consumption, a decade of increased demand,” when you really don't know how long it's going to last based on the pandemic.

Politano: And the other thing is that I fundamentally don't think that durable goods prices can keep accelerating in the way that they have. For the 100 years, literally since data started being collected, the relative price of durable goods compared to services has been on a really steady decrease that was only interrupted by the pandemic and the oil shocks of the 1970s. And that's because technological progress makes manufacturing durable goods and manufacturing goods of any kind, a lot easier and it raises the value of human labor, which tends to flow through to the price of services. That trend's going to keep continuing. And if you think that the price of automobiles is going to stay 40% above where it was before the pandemic, then you have very, very little faith in a human's ability to produce things, and to invent.

Beckworth: I agree with that. Those are all great points, Joey. One question I have, as we do get to the other side of this high inflation, whenever that may be, is how people will think about it and deal with it. And by that, I'm referring to the difference between the level effect versus the rate effect. So for some things, prices will be permanently higher, even though the rate of increase and price growth will slow down to more normal levels. Now, some things, commodities, you mentioned cars, they might actually, in an absolute sense, drop in value, but there'll be a lot of things that will probably be permanently more expensive. So think of a price level shift, and we never will go back to where we were before. And I'm just wondering what that will have in terms of an effect on public psychology. Things will just be more expensive, and if your wages haven't kept up with that, there might be some long-lasting effect from that. Any thoughts on that?

I fundamentally don't think that durable goods prices can keep accelerating in the way that they have. For the 100 years, literally since data started being collected, the relative price of durable goods compared to services has been on a really steady decrease that was only interrupted by the pandemic and the oil shocks of the 1970s...That trend's going to keep continuing.

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Politano: Yeah. If you think about what people were really upset about in the 1970s, it's that their wages weren't keeping up with inflation in many cases. It's hard to convince people. I think there is this psychological thing, where people think, "I, me, I earned this raise. I worked really hard. And then someone else, who's not me, raised the prices of everything in the economy." And it's sometimes hard to get that connection across, that you got a raise possibly for the same reason that prices went up in the economy.

Politano: I do think the benefit or the upside to people's perception about long run inflation is that it's dominated by goods that people buy a lot. So food and gasoline, people buy them every day basically. And so that's their mental model of how prices are moving. And I think that it's a lot of pain right now because food and gasoline prices are on the upswing. But alternatively, I think it'll be a lot easier when they're on the downswing. I also think it will be interesting… if you saw used car prices come down over the next couple of years. It'll be funny because the core drivers of inflation, like we're talking about rent or services, prices, healthcare, things like that, will actually be increasing… accelerating in price. And you're going to see inflation itself coming down, purely based on the fact that the more random and more supply-driven side is improving.

Beckworth: Yes. And it will be interesting to see how the inflation hawks respond to that development when it takes place. Because there's a lot of things that have happened that no one could have predicted no matter what positions you took on team transitory or team permanent. So a lot of unforeseen things, by definition, a supply shock is not expected. So here we are. All right. Let's transition into monetary policy, because that's another dimension really to the inflation story, but let's focus on monetary policy itself. And today we are recording on March 21st and Fed Chair Jay Powell had a speech before the National Association for Business Economics, and it was a very hawkish speech. So let me quote from an article from CNBC Jeff Cox wrote that summarized this event.

Beckworth: “Federal Reserve Chairman Jerome Powell, on Monday, vowed tough action on inflation, which he said jeopardizes an otherwise strong economic recovery. ‘The labor market is very strong and inflation is much too high,’ the central banker said in prepared remarks for the National Association for Business Economics. The speech comes less than a week after the Fed raised interest rates for the first time in more than three years in an attempt to battle inflation that is running at its highest level in 40 years.” And he goes on to talk about the tone of this talk, and there were some questions asked afterwards, and Jay Powell's like, "Yes. Very likely we'll do a 50 basis points or half a percent increase at the next meeting." So it was interesting to see this very hawkish tone come out. Not surprising maybe, but it came out and it's a nice segue into an article that you have written, and your article's title is *Financial Conditions are Tightening as the Fed Raises Rates.* So walk us through that. How do we know financial conditions are tightening? What indicators can we look to to see that development?

Indicators of Tightening Financial Conditions and the Fed’s Soft Landing

Politano: Yeah. So just to even back up half a point, I think you and I are both big believers in the instantaneous power of a lot of monetary policy in the financial sphere. And so if you look at financial conditions throughout the economy, one measure I like is the Chicago Fed's National Financial Conditions Index, and they have a credit sub index, which just looks at credit. They have been tightening not since the start of March, not since the Fed raised rates, but since the start of this year when the Fed signaled that they were going to raise rates more aggressively. And I think the credible talk from Jerome Powell about a little bit more of a hawkish turn in monetary policy has driven a lot of changes in the financial and business landscape, even over the last three months, without the Fed actually having to change any of their policy instruments.

I think the credible talk from Jerome Powell about a little bit more of a hawkish turn in monetary policy has driven a lot of changes in the financial and business landscape, even over the last three months, without the Fed actually having to change any of their policy instruments.

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Politano: I think you and I also both wish there was a really clear indicator for the stance of monetary policy. If I could show you a graph of NGDP futures and show them going down, or, of course, labor income futures, if we could get that and I could show you a graph going down, but we don't really have that. The things we do have are basically indexes of inflation expectations and indexes of credit conditions for major companies. And if you look at say, the spreads on corporate bonds relative to treasuries, they've been rising pretty dramatically, which is a sign that policy is working its way through the financial sphere, and it's manifesting as higher risk for companies. And like I said, that's been happening since the beginning of the year, not just since Jerome Powell raised rates the last meeting.

Politano: On the flip side, I think the Fed is still, I wouldn't quite say dovish, maybe I would say optimistic is a better way to phrase it. So if you look at the summary of economic projections, they believe that unemployment's going to remain below 4%. They believe that real GDP growth is going to be above its long run trend, and they believe that inflation is going to come down over the next two years. They still expect inflation to be high this year. I think their forecast was 4.6%, but they expect it to be coming down pretty dramatically and basically reach normal by 2023. And I think that's still a pretty optimistic forecast from the FOMC. And I think that something interesting you saw at last meeting was there were several members that said, "Hey, I would have supported a 50 basis point hike, but then I saw what happened in Russia and Ukraine and I wanted to back off a little bit." So they still have, I think, a good eye for the state of the US economy as conditions are changing pretty rapidly.

Beckworth: Yeah. I was impressed how they turned around so quickly in early 2019. So 2018, they had hiked and they were talking about many more hikes. Then in 2019 the yield curve inverted, financial conditions got weaker or tightened, I should say. And they quickly turned policy, which was pretty surprising at the time. But hopefully, that same agility will be displayed going forward this year, and they will respond accordingly.

Beckworth: But in that article, *Financial Conditions are Tightening as the Fed Raises Rates,* you point to several, you alluded to one already, the Financial Conditions Index, but mortgage rates, yield curve, there are already signs that the Fed was tightening even before the last meeting. So even before they raised it 25 basis points, I think in that article you showed the two-year Treasury, it's pretty high, and the Fed hasn't done anything, and that has a bearing on credit. Mortgage, we talked about earlier, mortgage rates, that has a real-world bearing on economic activity, the ability to get a home. So the Fed just by providing forward guidance, talking up rate hikes, they tightened policy.

Beckworth: And it's interesting to see their forecast and the summary of economic projections that you outlined. And what they're hoping for is a soft landing, this ability to navigate high inflation back down to low inflation, somehow not go into a recession. In fact, today, at this press conference, Powell stressed that he thought the Fed could still pull this off. They could still pull off a soft landing. So it does seem a bit optimistic. What do you think? Can they pull it off? Do they have the ability? Are they agile enough?

Politano: I think so. And I think the 2018, 2019 situation is pretty illustrative of a Federal Reserve that's a little less headstrong than it's been previously… A little more humble about what it can and can't know, and much quicker in how it responds to changes in the economy. And I think it took a realization by many members of the Fed that it's not the economy of the 20th century, that right now and going forward, the real interest rate is low and is going to stay low because of demographic factors like a lack of growth in working age population, because of rising wealth inequality and because of lower real productivity growth. And so you don't have the same sense that you had in even 2016, where people are saying, "Okay. Well this is it. We have to raise rates because the equilibrium interest rate is definitely not zero." I think there's a little bit more humbleness about it maybe being zero.

Beckworth: Yeah. So it's interesting to see their long run forecast for the federal funds rate, which you can view it as the long run neutral rate, which is, I believe, was it two and a half percent? And so you subtract out 2% for their inflation target and you get half a percent, the real interest rate… which is really low historically. So, it's interesting to see that. So, one of the reasons we're having this conversation is that the Fed has made a pivot to hawkishness and you have an article on this, *The Fed’s Pivot to Hawkishness,* and the obvious reason is inflation. Inflation is running high. And so one of the common questions you often get in conversations like this, well, what role did the Fed play in that? So I think both of us agree that the pandemic has a big role. It's a big part of the story. You can't dismiss that, but can we also put some blame on the Fed not tightening sooner? Could the Fed have done more? Do we have excess aggregate demand growth that the Fed should have checked? Maybe it came from fiscal policy, but the Fed didn't provide the offset in time. Where do you come down on this question?

Is the Fed to Blame for High Inflation?

Politano: I think it's really difficult, and I think there's a certain tendency to Monday night quarterback a lot of what the Federal Reserve is doing… to say like, "Oh, if you look back, this clearly would have been a problem. If you looked back, you should have tightened sooner. You should have done on that." And I think even Jerome Powell has said that. I prefer looking at labor income. I know you've had Skanda on before, and he's a big proponent of gross labor income targeting. And I would count myself among that camp because gross labor income is the most stable part of nominal GDP if you think about it that way. It's also the stickiest part of nominal GDP in that it's hard to get it to move down or up. You have to put a lot of weight behind it and it only moves pretty slowly. And if you look at gross labor income, it's basically just hit the pre-pandemic trend, or only exceeded the pre-pandemic trend by a little bit.

Politano: I think it's pretty difficult to say that if you were in the situation you were last year, where Congress had passed the American Rescue Plan, and you had this second bout of fiscal stimulus where unemployment was still high, employment rates were still so low, output still looked so weak that actually, at that point, you should have tightened. I think at that point, you're back filling in the correct answer that couldn't be seen because of the uncertainty at the time. And I think there's also an extent where they decided that some level of inflation was a little bit acceptable. That was the essence of the flexible average inflation target, that we're saying, "Okay. Well, we had this very low inflation before. We are going to accept a little bit higher inflation going forward to get things back on track." I think it's gone a little too far in the opposite direction, and I think part of that is a communication failure about what the flexible average inflation targeting regime was designed to actually accomplish. But I find it hard to say if I was in Jerome Powell’s shoes six months ago, eight months ago, would I have done it a lot differently versus now looking back, what was the correct answer?

I prefer looking at labor income...because gross labor income is the most stable part of nominal GDP if you think about it that way. It's also the stickiest part of nominal GDP in that it's hard to get it to move down or up. You have to put a lot of weight behind it and it only moves pretty slowly. And if you look at gross labor income, it's basically just hit the pre-pandemic trend, or only exceeded the pre-pandemic trend by a little bit.

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Beckworth: So if I were to take a poll of the Monetarist Teens group, would they share your view? Do you think most Monetarist Teens are ... You're a little more dovish here, Joey?

Politano: Yes.

Beckworth: So do you think they're in your camp? Okay. Considering-

Politano: No, no, no. I'm on the dovish end of the scale. I think there are some other members of the Monetarist Teens group which are pretty rigorous about the NGDP targeting. And I think if you had looked at NGDP over the last quarter, it's overshot the pre-pandemic trend, and two quarters ago, it was at the pre-pandemic trend. So if that was your mental model, just looking at NGDP, you would have tightened a little bit faster. And it isn't the worst mental model. I think, in some respects, it's a lot better than what the Federal Reserve currently has.

Beckworth: So there's mixed views in that group is what you're saying?

Politano: Yes.

Beckworth: Okay. And this-

Politano: There's hot debate.

Beckworth: Yeah. And just to be clear, labor income targeting is a special case of nominal GDP targeting. Nominal GDP targeting can also be called nominal income targeting. George Selgin has a great little book out where he talks about different forms of nominal GDP targeting. In fact, I got my first taste of nominal GDP targeting from George Selgin, Joey. I don't know if you know that, but he had a little pamphlet he had me read. He was a teacher of mine when I was in school, and he actually talks about how there's a labor income version, there's a capital income version, there's a total factor productivity version… In any event, there's a lot of interesting twists to it, but that's the one you could take a look at.

Beckworth: All right. In the time left, I want to maybe step back from the current debates, and just take stock of what we've seen over the past few years in terms of policy. Are there any big lessons that you take away for monetary policy? You've written about yield curve control, maybe overshooting, helicopter drops, any big aha moments you had, or this confirms what I thought, that you think we should take with us moving forward?

Lessons Learned from Monetary Policy

Politano: I think it's really rough to say this, and maybe don't tell it to your friends or say it in public. But if given the choice between the economy of 2009 and the monetary response of 2009 and the monetary response of 2020-2021, I would every day and twice on Sunday take the monetary policy response of 2020-2021. It's really hard to say this now because of how bad inflation is, but the truth is that a lot of the focus on inflation comes from the fact that a lot of other metrics of economic health are really good. The unemployment rate is really low. The prime age employment to population ratio is close to where it was before the pandemic. Real output is pretty high and real investment is really high. And all of those things collapsed, completely collapsed, in the wake of the 2008 recession.

If given the choice between the economy of 2009 and the monetary response of 2009 and the monetary response of 2020-2021, I would every day and twice on Sunday take the monetary policy response of 2020-2021. It's really hard to say this now because of how bad inflation is, but the truth is that a lot of the focus on inflation comes from the fact that a lot of other metrics of economic health are really good.

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Politano: And, again, it's hard to go out there and say, "Well, actually, everything's fine right now." But it is true that there's been a really remarkable recovery. And something I worry that's going to happen, and we talked about the narratives and it's true that in some respects, the facts happen and then the narrative is filled and created about them, ex post. And I worry that narrative is going to be, "Oh, the 2008 recession, people did too little. And then in the 2020 recession, people did so much more. And in retrospect, it was really obvious because once the pandemic ended, of course everyone was going to get a job again. Once the pandemic ended, of course investment would bounce back, of course. This V-shape recovery would have happened had the Federal Reserve done stimulative policy or not.”

Politano: And I think that's an incorrect assessment of what happened. I think in truth, what the Federal Reserve did and what fiscal policy did was instrumental in getting us out of a really, really deep hole that we were in in March and April of 2020. And I think that we should celebrate that success a little bit. Like I said, in some respects, it's a good problem to have, that there's too much inflation after more than a decade of there being too little, again, wouldn't go out and say that publicly to people who are understandably suffering because of inflation, but to tell people it's the best of two bad choices, maybe, it’s true. Like I said, I think that there maybe could have been, on the margins, looking back, some better choices that could have been made, but I don't think it's a situation where the Fed would just completely miss the mark in the way they did after the 2008 recession.

Beckworth: Right. So I think that's a fair point, that we need to do the right counterfactual. If a true alternative to what we're experiencing now is prolonged unemployment, mass suffering, just a breakdown in society because the economy was so weak, then I think that's a good point. We need to consider that. The flip side, though, is that if this continues, and the danger is that this continues and inflation expectations become an anchor, you create a situation where things could begin to turn ugly too with high inflation and the problems associated with that. Now, I'm not worried that we'll end up there. I still think that policy's credible. I still think getting to the other side of the pandemic, and now the war, and finally letting markets heal will take care of all the problems like we mentioned earlier.

Beckworth: But the challenge is, as I see it, is that we've tried this new experiment called makeup policy. So one way to think about it, fiscal policy provided this really strong tailwind to the economy, and the Fed stepped out of the way and let it push the economy forward. And in the past, the Fed would have jumped in sooner, they would have done something to slow that recovery, because it was worried about overheating, kind of preemptively. And as make up policy's returned, as you've mentioned, labor income is back to its pre-pandemic trend on many levels. A lot of different indicators were back to where we would have been had there been no pandemic, which is great. The challenge, though, in doing this, and I'm glad to see this. The challenge is that this inflation has reminded us how much people don't like it. The fact that it's 4% or 5%, it's politically very unpopular.

I think in truth, what the Federal Reserve did and what fiscal policy did was instrumental in getting us out of a really, really deep hole that we were in in March and April of 2020. And I think that we should celebrate that success a little bit.

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Beckworth: So if I had one critique of Fed policy, and again, not that I could have done a better job, is it would've been great if we could have done what they did, but tightened sooner or done something more to land that plane before people started panicking about inflation, and maybe they couldn't have. Your point is maybe there's no better middle ground that’s possible, but my fear is that because inflation is a byproduct of this, it's really going to hamper future attempts to do level targeting or makeup policy.

Politano: I think that's a very good point. The one thing I will say is that I think… part of this extraordinary response was a byproduct of the fact that everybody could acknowledge that the pandemic was an outside factor in a way that people really couldn't in 2008. It was hard to get them to argue that, say, there's this financial crisis. Here's why the Federal Reserve should be acting aggressively to fight back against the economic downturn, versus here's this world-changing pandemic. Here's why everybody should be acting aggressively to combat it. The natural tendency, I believe, of a lot of institutions, and particularly the fiscal and monetary institutions in the US, is to fight inflation because of what you said. It's horribly, horribly, horribly unpopular. And I think if you had paid attention to anything people in the Biden Administration have said, it’s that they're very upset about this situation because they feel that they are being unjustly blamed for the rise in prices that either they didn't have control over because it was Fed policy, or that was inevitable given the recovery.

Politano: But if you think about that going forward, Biden gets to appoint new members to the FOMC. And future presidents, future politicians are going to look at this and say, "Well, this was a political hot potato. I'm going to try to avoid this." And I think the situations in which you get really sustained, really high inflation are situations in which the political institutions work in a way that does not respond to public pressure like in Argentina or in Turkey, where there is less democratic input, and where the institutions themselves are really weak, and neither of those situations of apply to the United States.

Politano: I think the long run challenge, and it's, again, hard to say this given where inflation is right now, but the long run challenge is ending up in a situation where Japan is, where the central bank was designed to fight inflation, and credibly can't stimulate the economy enough because of the institutional structure that it's operating under. In the long run, the situation in the US is going to revert back to the pre-pandemic situation where, like I said, population growth is low. Productivity growth is low. It's going to be hard to generate a lot of inflation.

Beckworth: Okay. With that, our time is up. Our guest today has been Joey Politano. Joey, thank you so much for coming on the show.

Politano: It was an honor to be here.

Photo by Samuel Corum

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