The following transcript is from Macro Musings, a podcast series hosted by Mercatus scholar David Beckworth that explores the past, present, and future of macroeconomic policy. Subscribe on Apple Podcasts or your favorite podcast app.
David: Welcome to Macro Musings, the podcast series where each week we pull back the curtain and take a closer look at the important macroeconomic issues of the past, present, and future. I'm your host, David Beckworth of the Mercatus Center, we are glad you've decided to join us.
David: Our guest today is Neil Irwin. Neil is a senior economics correspondent for the New York Times and formerly was a columnist at the Washington Post. He is the author of the book, The Alchemist: Three Central Bankers and A World on Fire. Neil joins us today to discuss his work as an economics correspondent. Neil, welcome to the show.
Neil: Thanks David.
David: Well, it's fun to have you on. I'm sure many of our listeners have read your work for many years and you been on the beat covering economic issues, you were there during the crisis frontline, your book was written based on that experience, I assume, and so we want to hear about that journey. How did you get into economic journalism? What was it like? Has the industry changed over time?
Neil: It's funny, I was always interested in the news and policy and politics. Even going back to being young, I took an AP economics class in high school that really resonated with me. I remember just the logic of the ideas just really inherent sense to me and was really probably my favorite class in high school. Majored in economics in college, thought at some point I might want to become an economist to go to grad school, all that until I realized I'm not that good at math and that is not a very good option if you're not that good at math. But I was also working on the college paper through all this time and always interested in journalism and writing and ideas. And what I've found is that if you're someone who understands economic concepts and ideas and logic, but is not very good at math, being an economics journalists is actually a pretty good option because I get to spend a lot of time talking to people like you who know a lot more than me and try and translate those ideas into coherent pros that make sense to ordinary readers.
David: And how did you end up at the Washington Post covering the Fed? What was your path to that?
Neil: It's my first job out of college. I was a summer intern at the post on the business desk. My first job was covering local business things, so I covered local economic development, real estate deals, all kinds of stuff like that. And it was great fun. It was a great first early career experience, but they always knew that I was interested ... I had been an econ major in college. I was always interested in national, international economic and financial issues. I would fill in when John Barry covered the Federal Reserve and the economy in those days when he was on vacation, I would cover the jobs reports or I'd cover an IMF thing when the international economics guy was out of town. So I got some early experience dabbling in this stuff. I did a fellowship at Columbia in business journalism called The Knight-Bagehot Fellowship. Came back from that in 2007, and the Fed job was open. I applied, they gave it to me and it turned out to be masterful timing. I came onto the beat in August 2007 right around the very beginning-
David: Wow! Perfect timing.
Neil: ... of what we now know as the global financial crisis then it was ... We didn't know quite what to call it at that time.
David: Well, that's amazing timing. I was thinking about your book in preparing for the show and a lot of your writing was done on deep background, which made me think of Bob Woodward. So you're like the Bob Woodward of the Fed, right? And the central banking.
Neil: Yeah. The central bank is funny. They're very secretive and a lot of ways. We think of them as these elite, distant institutions that just, at least traditionally didn't do a lot of media appearances. I think Alan Greenspan went 17 years as chairman without doing an on the record interview, something like that, but that has changed in recent years, but that's the tradition. However, especially at the Federal Reserve where I have the best relationships, they have historically engaged a lot with the economics journalists with the beat reporters who cover them. But as you say on this deep background basis, which means you can get a meeting with a senior official, they'll talk to you, but you can't quote them by name. You can't even say, “said a Fed official” or anything like that. You can inform your understanding of the world and then you write it with this detached authority.
Neil: There's some real journalistic principles that a lot of journalistic purists don't care for in that system. And it has broken down some in the last few years, as I say, but in some ways if you're in that club, if you're one of the economics journalists for major organization, they actually can be pretty accessible and pretty easy to talk to.
David: Yeah. Well, your book is great because it is the story. You're telling them the people, the personalities, the drama behind the scenes, and so it is really great account of what happened. We'll probably provide a link to that book on the SoundCloud webpage so readers can go there if they haven't already got their copy, order it. Now, I'm curious, you were in journalism, you worked for the Washington Post and about the time you're covering the Fed and all this is going on, so you've got your plate full. There's also the rise of blogs, so you probably were there as blogs were very popular. It became important and now they've faded from the scene. I wonder what your perspective is as a journalist of the rise and fall of blogging.
Neil: It's funny. I would say the mid-2000s was the heyday of blogs appearing on the scene and I think what was really great about it as a consumer of information, I learned a ton from people who may not work for an elite news organization, may not have massive credentials, but has good ideas, a good writing style. The number of people I was able to learn from in that era was remarkable.
Neil: What I think has changed is, first of all, a lot of the good bloggers have gotten hired by different mainstream organizations. And also I think the ethos of blogging has seeped into more and more of what we do at a place like the New York Times or The Washington Post, which is writing a more conversational way, saying what we know, not being afraid to ... I mean, I look back at my old stories from 10, 12 years ago, it's wishy washy I would say, “this seems to suggest”, “such and such analysts said”, and we have much more licensed now to kind of ... We're thoughtful people who study these trends in a deep way, just say what we know. And so some of that ethos of blogging has come mainstream and then part of it's just, it's leaked over to Twitter and that's where a lot of the kind of casual conversation happens rather than blogs.
David: Yeah. So blogging has been absorbed by mainstream publications like The New York Times. You were part of the Wonk Blog at the Washington Post and the Upshot. How would you describe the Upshot that you're a part of?
Neil: So the Upshot is this unit at the Times. We were started in 2014, I was hired to be part of it. We call ourselves different, we're the place for analytical journalism within the Times. We're a small unit, only five or six writers, graphics editors, some of the DNA of Wonk Blog from the post is in there, I came from there. There's some DNA of kind of ... this had its origins with Nate Silver, left the New York Times for political forecasting and analysis. So it's a team that tries to explain the world and with a conversational voice with good graphics and images, I think a lot of what we were founded to do has become more and more commonplace across the Times and across the media industry in general. We still try and provide some unique value and do things that not everybody could do.
David: Yeah, it's a great resource, but it has displaced, I guess to my sense, the old world of blogging. You guys have the best of that, plus journalism, all one package and now in Twitter is where you see a lot of the conversations, as you mentioned a few minutes ago. So that's where I go online and my newsfeed, conversation feed, all the wonderful things. I can interact with you with others there in real time.
David: Okay. Let's move on. You were covering the Fed during the crisis, you wrote your book and recently you have an article that ties into that book and your article is, I look back at the crisis 10 years on, so here we are in the fall of 2018 and it's 10 years since the crisis, and you have an article in the New York Times titled “The Policymakers Saved The Financial System And America Never Forgave Them.” And let me just read the two opening paragraphs in your piece where you write:
David: “It's hard to overstate how deeply Americans despise their government's response to the global financial crisis. It has helped shape the last decade of American politics feeling distressed of powerful institutions and speeding adrift toward ideological extremes. But for all that anger, the engineers of the American crisis response got the economics mostly correct and more right than most of those who were second guessing them.”
David: So tell us about that.
Neil: So one thing that I think is important is to think back to the way the world looked in 2008, 2009 when this crisis response was taking place. And a lot of the arguments, if you look back at them just look completely wrong. So the idea that, for example, the bank bailout bill, the TARP was the onset of socialism and the onset of federal control of the entire banking system. That was a criticism you heard a lot from the right in that era. That was not true. The idea that quantitative easing would be this source of hyperinflation, collapse the dollar, be the end of the dollar as the global reserve currency, very much not the case. If anything, I think with hindsight it looks like QE could have been earlier and more aggressive.
Neil: I think as you tick through things, for example, Tim Geithner took a lot of heat when he was ... first became Treasury Secretary, had this crisis response plan. The markets hated it, thought it wasn't going to work. Turns out a lot, big elements of that plan, the stress tests of banks are things that have now been emulated around the world and are part of the toolkit of how you respond to a financial crisis. So nobody's saying that the response is perfect. The fact that we had this long, this deep recession, this slow recovery is obviously very bad and an indictment. But when you look at the actual contours of those debates on economics, I'm arguing that, Ben Bernanke, Tim Geithner, Hank Paulson, were on the right side of those debates.
David: Yeah. So the way I look at it, there's two levels of debates. The first one which you have in your article is the debates, the critiques of the time. So you mentioned the left was critical of the Geithner's response. “Why don't you just nationalize the banks” versus bailing out the bankers, occupy Wall Street movement. There's that. Then on the right there's ... “you're just becoming Germany 1920s again”, hyperinflations coming, that never happened. And I think those points, you said you can convincingly see they were wrong, but I guess the critique that maybe some of us have today still looking back is, why wasn't there more? Why wasn't it done earlier? And I've been very critical, I'll admit I've been a part of that critique, but I guess as time has gone on, I've tempered my critiqued in the following manner. I think politically it would have been hard to have done more, even if in theory I may be right. We can argue with our own writing theory, but assuming that I am right, I think at the political strength constraints were very strong back then. What are your thoughts?
Neil: I think that's exactly right. Look, was monetary policy too tight in 2008 and 2009? Yes. The fact that there was a depressed nominal GDP for so long is first order evidence of that. I think when you look at it ... Here's how I think of it. On QE, let's say, on monetary policy generally, let's say, the argument in the mainstream, if you watch CNBC on any given day, if you listen to debates in Congress, the debates we're between “should monetary policy be set at a four or a seven”, and Bernanke pushed things to be a two or three and in fact we now know it maybe should have been a one, maybe a negative three in terms of calibration. Then you get into questions of how do you assess, this is not my role as a news journalist nor as an opinion journalist, how much ultimately do you give ... How does history rate Ben Bernanke against that backdrop? Well, I think we need more years to consider it, but I argue that he was pushing that debate in what we now believe to be the correct direction.
David: Yes. And you make a fair point in your piece as well, that it could've been worse. It could've been the Eurozone's response. It could have been in Europe, they had a far weaker recovery, far sharper contraction overall, and it wasn't the Great Depression. So we avoided that. So there was a lot of victories to claim, but there's still a conversation going on today that-
Neil: I think the fact that Europe ended up copying many elements of the US crisis response just multiple, many years later is telling right?
Neil: Even the idea ... So for example, I think one of the mistakes is, if you remember QE2 was that second round 2010. It's $600 billion over a very prescribed period. I think with hindsight, the framework of what they did in 2012 of what we now call QE3, open ended some amount per month, now did that do the trick because of its scale because of its openendedness? Was it just the economy had more time to heal itself? Hard to know, But I think QE2 in 2010 should have been more aggressive, but you have to remember how much heat Ben Bernanke took in that period from all sides, from Congress, from US politicians. Internationally, the Germans, the Chinese, a lot of emerging markets, they were all beating up on the US and the Fed for being irresponsible and in hindsight, he should have been more irresponsible.
David: Fair point, fair point. And again, I think that goes back to these political constraints both outside the Fed but also I think within the Fed. Even QE1, QE2, you had the Richard Fishers of the world trying to tell Bernanke to pull back. So I do give him credit for what he did accomplish despite the obstacles he faced. What about the political price pay? Because you talked about that as well in your article. What were the consequences of this response? Let's set aside for the time being whether it was enough or not, but let's talk about the political consequences.
Neil: Look, the reality is when you take all these actions to try and save a system that a lot of people weren't really believing in to begin with, it has great political consequences and I think this is not a new idea or not a particularly clever idea. The idea that you can see, the anti-globalization energy out of Trump, the idea that you can see in the democratic socialist energy around Bernie Sanders on the left and just the general sense of disaffection with mainstream elites across the country, across the political spectrum has its origins in this.
Neil: I think Ben Bernanke would say, well, it has its origins long before that, decades of building and equality and all these different problems and that's true, but this idea of, you have a deep recession, you have a slow recovery, you have a lot of economic pain, and you have bank bailouts, and you have QE that that has first order effects on asset prices, you have a stock market that does well. The idea that all of that is not really serving ordinary people is a powerful, profound thing and counterfactuals don't cut it. Saying it could have been worse if they had not done QE, yes, the stock market would be lower and rich people wouldn't be as rich, but also you might not have a job, isn't something that is very persuasive in political sense. And I think this is the ostensible success of the crisis response, sow the seeds for a lot of the nasty stuff we see out there today.
David: Yeah. So the Tea Party comes out of this. That's one of the repercussions that you talk about. And it was interesting hearing that Bernanke talk at the Brookings conference where he was there as was Geithner and Hank Paulson and it's an interesting question at least, “what led to the rise of populism” and I think I share your view that the crisis was a catalyst. It was something that turned it onto a new level, higher degree of intensity. Pressures were building before, but this really turned it up. And is that the standard view, your sense as you look around at policymakers?
Neil: I think so. For example, one simple measure I think a lot of people look at as a measure of underemployment and is male prime age labor force participation. Percentage of 25 to 54 year old men who are either working or looking for work. And that's yet fell a lot in ‘09 and ‘10 and ‘11 as a result of the recession, but it had been drifting down for 50 years, 40 years. It's just, it was so gradual and because it was counteracted by women entering the labor force, I don't think many people noticed it. Stuff like the rise of opioids and opioid addiction. That wasn't an economic policy, that was the thing that happened for reasons we can discuss in a different conversation, but the idea that, that would coincide and reinforce economic despair and underemployment and all these different types of dysfunctions, it's a terrible thing.
Neil: Look, we can't expect our economic policy makers to do too much. You don't want your central banker to be worrying about drug policy or your treasury secretary to be dealing with worker training. But, when failures on the macroeconomic side play in with failures at the societal level and deeper dysfunctions, that's a really toxic combination. And that's what we had in the last 10 years.
David: Yeah. I had J.W. Mason on the show. I know you've covered his work in your own writing, and his paper that he produced at The Roosevelt Institute and is really interesting, he looks at the forecast coming into this great recession and no one was expecting the sudden change that did occur. So people before weren't talking about how all these demographics, all these structural issues would lead to a sudden decline in labor force participation rates. And he shows there was a sudden change at that point, which points is something more cyclical. And again, this goes back to the point of what really catalyzed the populism, what really catalyzed the unease. Maybe it had been there all along, but you really needed a trigger and the great recession did this.
David: Okay. Let's switch gears and look across the Atlantic, at the Europeans. We got the Bank of England and we got the ECB, we have fared much better here in the US in terms of economic recovery. Even now there's this divergence between what's going on in the US and overseas. But what about the ECB? What is your assessment of its performance since the crisis?
Neil: So in the early years of the crisis, the ECB did not do well. The very early stages, the credit crisis elements, the banking stuff during '07, '08, that was fine. Especially given the tools ...
Neil: … they had. On monetary policy, they were just dead set on tightening, or at least not easing as much as they should have, in the, I believe it was spring, summer of '08, there was a bit of a tightening cycle again in spring of '11. Those just looked like terrible mistakes, and more broadly, there was this deep reluctance to play this role that central banks across history have been playing for four hundred years, which is lender of last resorts. To the banking system lender of last resort, preventer of a liquidity crisis for sovereign governments. And there are all kinds of legal, structural reasons, that was the case, it was kind of built into their DNA. But that very nearly had disastrous consequences for Europe and the world in, '10, '11, '12.
Neil: I think Mario Draghi righted both of those ships. He moved towards easier monetary policy in QE. He said, "We'll do whatever it takes." which was implicitly him saying, "The ECB will be that liquidity back stop for governments." So they're doing better now. Europe's doing better now, but there from roughly '09 through, what do you call it, '11 or '12, they did not perform very well.
David: In my view, it's a staggering mistake they made raising interest twice in 2011. As you mentioned, in 2008 they also raised interest rates and they were worried about the same the Fed was in 2008 which was the rising inflation. The Fed didn't raise interest rates but the ECB did.
Neil: Yeah. In fairness, in 2008 there really was rising inflation. It seemed like there might be… energy prices might not be just a one off rise, but a kind of ongoing rise in commodity prices. And it was not as clear that the financial crisis would cause the amount of damage it did. '11 is harder to justify.
David: So do we attribute that just to the personalities? Now you mentioned it's in their DNA. There's institutional things in play. But Mario Draghi is the one who kind of steered the ship back in the right direction, where Trichet was very concerned about inflation. Is it personality? Is it maybe just time? You give enough time, they say, "Okay, we've made a mistake. Let's try a new direction." What do you say?
Neil: Jean-Claude Trichet is a fascinating character to me. He was ECB president throughout the crisis until, I believe, November of 2011 or December. And he's not an economist. He's a French civil servant. He came up through their public administration school, worked in the French treasury. He is an extraordinarily skilled bureaucrat in terms of running a meeting, running a bureaucratic process, twisting arms, negotiating, those types of things he's great at.
Neil: I heard a story once, it's in the book I believe, that there was some long meeting on some hard bank capital issue, and he just kept people in the room. He was chairing the meeting. He wouldn't have a break. So he started in the morning. He didn't break for lunch. He wouldn't break for coffee or bathrooms. He was just keeping people in the room, beating them down until they agreed, and reached agreement on some bank capital thing. He's very skilled at that type of process.
Neil: What he's not is an economist. He's not a macro-thinker. Mario Draghi is an M.I.T, PhD steeped in kind of macro. And I think Trichet failed to see that just because nominal interest rates were low that monetary policy could still be too tight. For example, he failed to see that all the kind of principles in the world about not buying sovereign debt when it's a liquidity crisis in sovereign debt, that's kind of the central bank's job. I think he had some blinders on because he was thinking of things through a kind of European bureaucratic process way, not a macro way. And I think that's the biggest difference between him and Draghi apart from the personality stuff.
David: What about the Bank of England? I had that Adam Posen on the show recently, and one of the things was interesting is that the Bank of England is, I think, the only major advanced economy central bank that actually got the inflation it wanted. Whereas everywhere else ... the ECB's inflation is really, really low. The Fed’s a little bit lower than it's target. Japan's low, too. Japan's got a little bit more inflation, not quite its target. But Bank of England's the only country that really got the inflation it wanted. So what is your take on its performance?
Neil: Yeah. So in the very early stages, and this is the introduction, kind of first chapter of the book, they thought this credit crisis - we called it in 2007 - was an American problem. It's a continental European problem. It's not our problem. I think Northern Rock was the first English bank failure in two hundred years or something, was a bit of a wake up call for them. And during the actual crisis they were aggressive. They did the right things, right? I think my steepest criticism of Bank of England is this tendency to ... so for example, in 2010, there was the move towards austerity. Conservative government came in Britain. Mervyn King, the governor, was very supportive of that in ways that kind of give him some real political independence issues. Do you really want your central banker A, encouraging policies that prolong the economic slump there? And B, come down to political choices about what you want the roll of the state to be. So I think there's valid criticism of Mervyn King's role in that period of British economic history. I think on the economics they've, as you say, have done a perfectly sound job.
David: So if you had to rank central banks over the past decade in limited advanced economies, who would you rank as the top few performers?
Neil: I hate this question because it's a really hard one. Partly because I know a lot more about the American context. And I know them more as individuals, and I see everything they do up close. I'm a more distant observer of the Bank of Japan, the ECB, and the Bank of England.
David: Okay. Fair enough. Fair enough.
Neil: So one way to answer the question would just be to look at results, right? So how much on your inflation target, are you at full employment, and by that measure I guess I would argue the US is in the best spot, so A, the Fed’s done the best. So if you do add a degree of difficulty question, it gets more interesting. You could argue that, for example, the Japanese may have had a higher degree of difficulty because they were coming out of this long period of deflation and now they're kind of, if you look at per capita measures, their numbers are pretty good. If you add in Europe's crazy bureaucratic construct, twenty-seven nations, nineteen in the Euro, in terms of degree of difficulty, you can get why Mario Draghi might deserve a ... you can argue that he had a harder job than Janet Yellen or Ben Bernanke.
Neil: I'm ducking the question, I realize.
David: No. That's a great way to answer the question, I think actually, because it is true. Running the ECB is a far different beast from running the Fed. Even the Fed, I think, you can compare to some other countries now. Countries that I would point to as fairly successful central banks would be Australia, their central bank has done a relatively good job. In fact, they didn't even have a great recession, the Bank of Israel. But we're getting into small advanced economies, and I think they're a lot more nimble. When Adam Posen was on the show they also had the fact that their exchange rates move a lot faster.
Neil: I was gonna say exactly that. Right. So if you're in a context ... if you're Israel, if you're Sweden, if you're a smaller country, where you can have a 20% exchange rate swing with your major trading partners, that is a heck of a release valve for whatever problems there are. And if you're the US, or Europe, or, China, or Japan you really don't have that because of your scale.
David: Yeah. So the more complicated, the larger you become, the tougher it is to do monetary policy. So this should give all of us pause when thinking about how challenging it is to be a policy maker in some of these places.
Neil: One thing I've learned, and a little of it goes back to where we started, I'm not an economist. I don't have a PhD. But there is something about the kind of job I'm in where talking to these policy makers, understanding the different constraints they're under, the different ... it's not just about the economics. It's about the economics intersecting with the politics, with the markets, with other areas of policy, and running a bureaucracy, and negotiating with your committee members. It's a much more complicated job than sitting in an economics department and writing a paper and saying this is what our Fed fund's rate should be.
Neil: So one skill I think economics journalists have is trying to pull together all those different threads that kind of shape policy in ways that you might not see in a paper in a journal.
David: Fair enough. You have another article titled, "The Most Important Least Noticed Economic Event of the Decade," So within this look back there was a recession. In fact, you called it the invisible recession. So tell us about that.
Neil: So in 2014, there was this divergence between economic performance across the G3, let's call it. In the sense that Europe was not doing great and was going towards more quantitative easing. Japan was not doing great. Kuroda, the Bank of Japan governor, was implementing Abenomics, massive monetary easing there. Meanwhile, the US economy was looking pretty good. We were mostly back. Unemployment was drifting down towards six percent. US economy was looking pretty good. So the Fed was starting to move towards tightening. They had done the taper, they had finished QE3, they were looking towards the day of raising interest rates. You had this policy divergence and you had a sharp dollar run up.
Neil: This was the beginning of a set of feedback loops that is messy, is complicated, but has had huge consequences for the global economy. Your listeners probably know big elements of this or all of it so I won't belabor it. But you had slow down in emerging market economies. A lot of them had dollar denominated debt, so when the dollar rises you had, essentially, a tightening of monetary policy, a tightening of financial conditions. China certainly, but also other emerging markets, Indonesia, Brazil, Malaysia, long list. So you had a kind of tightening of financial conditions, economic slow down in emerging markets. Meanwhile, the Chinese are starting to worry about a debt bubble, a credit bubble. They are doing kind of administrative bureaucratic measures to try and reduce the flow of credit. They may be over shot, so you have a slow down in China. Remember China and other emerging markets are the growth of source of demand for commodities, at least the growth. And so that slow down causes a drop in commodity prices. Oil is obviously the one we follow the most but any copper, corn, agriculture products, long list.
Neil: So then energy producing areas are having problems. That includes other emerging products. It also includes the US heartlands. So farm country, oil country, and the industries that make equipment for those industries. Caterpillar makes agricultural equipment. John Deere. Any kind of heavy equipment makers.
Neil: So this was actually a pretty substantial slump. It shows up in the GDP numbers. Huge drop in structures and equipment investment. Drop in the overall growth rate but not into recession territory. But if you look at individual metro areas. Look at Houston, look at, again, parts of farm country, oil country. There is a recession in those metro areas.
Neil: Negative payroll growth. All the stuff you associate with a recession. So I argue that understanding the economy of the last three or four years, if you live on the coast, if you work in white collar professional services, you didn't notice it. But if you work in those industries in those parts of the country you did. And I think it's a crucial thing for understanding the economy of the last five years.
David: Yeah. That's a very interesting episode, and it speaks to the influence, and the reach, and the scope of Fed policy, right? The Fed has a domestic mandate, but its actions are often felt throughout the world because the dollar's so widely used. I had Ethan Ilzetzki on the show, and he wrote a paper with Ken Rogoff and Carmen Reinhart, where they look at the number of countries that peg to the dollar. Whether it's a loose peg or a strong peg. They find, this is a striking number, but seventy percent of world GDP is pegged. Which means when the Fed tightens, seventy percent of the world is gonna tighten, and vice versa. As well as to these other channels you articulated. So it's a tough job at the Fed moreover, because you have these global implications.
David: I do think, though, that the feedback that you mentioned did cause the Fed to slow down on some of the rate hikes it would've otherwise done.
Neil: That's right. And what they were doing in late 2015, early 2016 was trying to assess ... it's not that this stuff wasn't known at the time, right? It showed up in the data. It showed up in markets in a big way. They have hundreds of people over there at the federal reserve who are tracking all this stuff everyday, and they weren't blind to the problem. The tension was, "Okay do we make policy based on what the labor market and the inflation measures are telling us, especially the labor market, and what we think of as this historical Philips Curve relationship, that would say it's time to tighten? Or do we say there's these feedback loops that maybe we don't fully understand but are clearly gonna have a downward effect?"
Neil: Notice those effects, the strong dollar and weak commodities, are both disinflationary, right? So if anything, these forces, were pulling them further away from their inflation target on the downside which left room for more easing. They ultimately made that judgment. So they raised interest rates once in December 2015. At that time the forecast was to do four more interest rate increases in 2016. Markets kind of fell apart in January. All of these warning signals were flashing red. Between January and March when they had their next policy meeting, their economic forecasts, interestingly, stayed about the same. The forecast didn't really move. But the path of rate increases did, and they ultimately did one interest rate increase in 2016 not four. And I think that set of steps, this is to Janet Yellen's credit, seeing that something's happening here that is very dangerous and is not tied to our traditional Phillips Curve labor market analysis. And we would be foolish to just plow ahead just because we think we ought to raise four times when all these signals are showing that this is gonna cause real damage.
David: Yeah. And looking back, again this is Monday morning quarterbacking here, looking back and I'm taking the Adam Ozimek critique, where he notes that the Fed itself has revised downward its estimate of the natural rate of unemployment. So how much slack is there? So back then they thought, "Oh, we're getting close to take off, it's time for us to begin to tighten. If you look now at the Fed's estimate of where this natural rate of unemployment is, it's gone down quite a bit. And you'll look back, where that implies it would've actually have been in 2015. They didn't need to tighten quite as much. So someone like Adam might say, "Well that whole incident could have been avoided if they had a better measure of the true natural rate of unemployment back then."
Neil: It's true. I think, and this is part of Jay Powell, his entire framework lately has been when we have these estimates that are kind of unobserved or unobservable. We don't know what the real number is. To put too much faith in them is a bad idea, is his argument. And certainly this episode supports that. We're now at 3.7 percent unemployment. And you can see some signals of wage inflation here and there. And maybe that could feed through to broader inflation over time. Certainly. But certainly nothing that ... maybe 3.7 percent unemployment is what we should've been aiming for this whole time and not thinking NARU was five and a half or whatever they thought in 2014.
David: Yeah so quite a bit has changed in what we think is the potential level of the economy and the unemployment rate. You also got a lot of feedback on that article. I remember on Twitter you said you got a lot of replies, variations on the story. What were some of the more interesting points you got?
Neil: So in the short version of the narrative of 2014, '15, '16, I just did a minute ago, there are some things that people think I left out or didn't emphasis enough. So in the oil price decline, how much of this was Saudis and other OPEC nations trying to basically put the fracking boom out of business and undermine US energy investment. How much of this was a technological boom and bust. It's a supply shock from fracking and to me none of these are mutually exclusive. These things can all of ... coincided in ways. And then it's just a judgment call how much you emphasis one factor versus the other.
Neil: But as a kind of meta thing, piecing together the story, this is area where Twitter, which I argue is kind of a successor to the economic blogosphere, I think it's really great. People who are e-China specialists or e-commodity specialists or an energy person or a macro person, they all have a different piece of the story. They all have a different piece of the puzzle. By following a lot of people and seeing these conversations engage when part of my job is trying to put together that puzzle into one coherent story. But it would be much harder to do if Twitter were not there, where anybody can weigh in. So I feel like I learn a lot from people who come from these different tribes but all have useful information on big things like this.
David: Let's talk about the current issues facing the federal reserves. And you've written several pieces I want to kind of tap into. First one, at the last Jackson Hole meeting with the Federal Reserve and central bankers come together. It's the big meeting of the year for them. You have an article on superstar firms and the Amazon effect. Tell us about that?
Neil: So there's been this discussion bubbling up mainly from left of center political circles, and policy circles, over the last many years, that rising corporate concentration, consolidation of major industries, corporate control in the economy is something that is not just about industrial structure and industrial organization, but actually something with macroeconomic consequences. Speaking of tribes, I think there is kind of this anti-trust, market structure tribe, and the more macro, monetary people. And they're not the same group. They're not the same people. But there might be some linkages and connections. And when you articulate what they might be there's kind of a long list and a pretty straightforward one is the idea of monopsony power affecting wage-setting …
Neil: … in the labor market. This is Allen Krueger's argument that, when you have fewer employers in a place, in an industry, the result is more ability to essentially act as monopsony employer and push down wages and benefits and that type of thing for workers. The empirical evidence on this come from stuff like: looking at hospitals, so if you have a metro area with five hospitals, they compete for nurses, and they bid up wages and if a nurse isn't happy with something about her job she can go across the street. Those five hospitals all become part of one big company, that power of the worker is diminished, is the argument. There's some empirical evidence for that, so that labor markets won. There's a bunch of others.
Neil: On inflation, what does it mean for inflation when, instead of having different stores in different places, different retail chains, there's Amazon, Walmart, the most powerful retailers. They're changing their prices everyday based on algorithms that are customized based on every piece of information they know. Does that make inflation move faster? That's the argument of one paper and it was shown at Jackson Hole.
Neil: I think just the idea that these changes in how companies work in corporate power can have macroeconomic consequences. I feel like this is something that the central banking world is just starting to wrestle with. And look, these aren't their policy areas. Right? It's not Jay Powell's job to set antitrust policy. But, if that affects how he does his job then he should be knowing about it.
David: Be cognizant of it at least for sure. Now how does this tie into the remarks that were made last year or the year before about "well, inflation's been low because of these one-off affects from Amazon or from phone companies lowering their prices", is this related or are these separate issues?
Neil: You can definitely tell a story. It's ... I think this work is in its early days. I think the amount we don't know is larger than what we do know. Now, some of those, cell phones, so there was ... which direction did it ... I'm trying to remember. Was it a ...
David: It's keeping inflation low.
Neil: Yeah, it was a disinflation. We had some disinflation last year, because cell phone companies, there was a new round of competition and price-cutting by cell-phone companies, that's actually a decent sized piece of the basket of a typical household these days. Of the basket of what they buy that pulled down headline inflation a bit. Because that's part of core, that's not part of ... not energy or food.
Neil: That's more easy to peel apart. One of the long-term effects of having a handful of giant, national retailers laser focused on reducing prices but also changing their prices all the time. What does that mean for inflation? That's more complicated.
Neil: Another one that Esther George, the president of Kansas City Fed mentioned to me, and what got her interested in this set of issues, banking. We keep hearing stories about not enough small business lending, hard if you're a mid-sized business to get an equipment loan or ... Could that be related to the consolidation of the banking industry among these handful of trillion dollar balance sheet banks? Which, there's no inherent reason those can't do small business lending but it's a very high touch business. It's useful to have loan officers on the ground. It doesn't really fit the business model of a JP Morgan or a Citigroup. So might consolidation and banking be a factor in credit availability for small and mid-sized businesses? Very, very plausible story.
David: These are all potentially important stories, but the macro-economist in me is a little bit uncomfortable and maybe Fed officials are as well for the same reason. For the following point: at the end of the day, over the medium to long-term, the Fed should be determining the inflation rate. In the short run, phone rates drop, technology, more efficiency or maybe wages being compressed because of the monopsony power. I can see those things causing inflation to be lower or different then what the Fed wants. But over the, medium to long-term I guess, the Fed should offset those developments. I guess that'd be my critique is, we had a decade, and I know that the inflation target doesn't begin until 2012 but implicitly their targeting something near two percent before then. We have a decade where the average inflation rate for core PCE is about 1.5 percent vs the two percent and when the Fed points to these one-off things, I'm a little bit skeptical. I'm like, "No, you're not doing your job or you're not doing it well enough." What your thoughts on that?
Neil: I agree with that, but I also hear what you're saying is kinda the opposite of what you hear from hawks who say, "Energy, why are you not looking at energy prices when there's an energy price spike." Which we have had in the last year. Right now we're over the target, right now because of rise in oil prices over the last year. Should that cause them to freak out and raise interest rates 50 basis points? I would argue not.
David: Right. Agreed.
Neil: But I think the one thing that makes ... it's funny, in the macro-monetary world, we think of inflation as this variable that's shaped by growth and ... shaped by all these big forces. At the micro level, it's individual companies and buyers and it's thousands and thousands of items that all have their own elasticities, their own industry dynamics, and it's getting between that micro and macro. I guess the question is, is top down or bottom up a better way to think of it? Is it looking at what's happening in the individual markets for all of these products or is it thinking of an economy wide inflation process that involves expectations and involves ... I'm not having a good answer, but it's a hard question, and I think they come at it from both angles, at the Fed. They try and both understand the dynamics of each individual line of that basket of items that people buy and also understand how expectations and everything else feed in. I think if we knew the answer we wouldn't have undershot the target for the last eight years or whatever.
David: I'll put a plug in here for nominal GDP targeting, Neil was waiting... See how long it gets…
Neil: It’s about time, David.
David: But I think it's one reason why inflation targeting is difficult is, at least in the short-run you have all these developments that do create noise and make it difficult. Again, over the medium to long-term, it's harder for me to justify it on those reasons. But let’s move onto some other recent developments.
David: Let's talk about the 1990's economy. So you have an article comparing today to the 1990s. What are the similarities and differences?
Neil: So, a theory that I have is that because the crisis was so recent and so painful and so dramatic that we might have a systemic bias toward everything that can go wrong. There is a lot that can go wrong. There's plenty of things that can go wrong in the economy any day of the week. But there are upside surprises. There are pleasant surprises, and what happened in the mid 90s, if you look back to the commentary in '94/'95, that early 90s recession was a slow recovery coming out of it, and what happened, the forecast then not that there was going to be some boom in the late 90s. There was a lot of, "Oh, we're muddling along, everything's fine." What happened was, there was a productivity driven boom, Alan Greenspan made some good decisions in terms of not choking it off with interest rate increases. It was essentially a positive supply shock in terms of productivity, a lot of the technological innovations that had been building for fifteen years, Solow’s Paradox of the digital/computer age shows up everywhere but the productivity statistics was no longer true. Suddenly, all these innovations started to pay off and so we had the late 90s boom, which was great for the country. It was a lot of people were in a more prosperous state.
Neil: I think people are underestimating the possibility we could be at a similar moment right now. There's the way productivity cycles work, there's a lot of work from Erik Brynjolfsson just had a paper, an NBER working paper that came out yesterday. There's these curves where there's a lot of work going on in technology that doesn't actually generate productivity gains but with a delay, it eventually does. Could we be on the verge of one of those? It's hard to predict because by definition you can't really predict these things. But I think people are underestimating the possibility that is the world we're entering.
David: Well that's a very hopeful note there. I like that.
David: Sometimes it pays to be lucky, in terms of ...I'm thinking of Presidents. Bill Clinton was president during the late '90 boom. You could contribute some of that to his policies but some of it is just having the stars aligned at the right time. The technological innovations come to fruition that have been, as you said there for a decade or so, and whoever's president when these innovations come to fruition and maybe now or the next few years, will also be lucky. Maybe Trump will get credit for things that he didn't do.
Neil: It's possible. The example I like to use, think about driverless cars. There are thousands and thousands of highly paid, highly capable engineers right now, at multiple different companies, working on driverless car technology. That is, and just the arithmetic of productivity, that is a giant suck on American productivity because there's no GDP, no output coming out of those efforts but a lot of hours of highly skilled labor. But, what if, a couple years from now, suddenly they, it's all working and suddenly there's much less need for truck drivers, for taxi drivers, things like that. Suddenly there's a productivity surge as this benefit they've been working on, for years, comes to fruition. You can think of countless things like that around AI, robotics, machinery, all these things that you hear. The tech people talk about with all this enthusiasm, and then you show them the headline productivity statistics and then they don't really have an answer for it.
David: Yup. What about long-term interest rates? They've been going up, and you suggest that this might be a good sign? A Bad sign?
Neil: Yeah, I did this piece, kind of unpacking why yields have risen in the last six weeks but also in the last year/year and a half, you go back to before the tax bill was kind of coming into play. Or go back before the election we're up, I think the ten year yield was like 1.4 percent as recently as the summer of '16.
David: That's amazing to think.
Neil: And now we're almost at three and a quarter. First of all, you would expect higher yields .... If you think we're getting close to hitting the inflation target, and will for a while to come and that growth is on a nice steady track, you would expect yields to be higher than they have been. That's even more true if you want to add some dimension of supply and demand and all the deficit finance tax cuts, mean more debt issuance. So if you look at supply and demand dynamics, they should be higher but as I unpacked why in these last several weeks, yields have been rising, it's mainly the term premium. It's mainly not the inflation expectations widened, it's not that a bit of a rise in the expected policy path. This is mainly about the term premium, which tells me that investors think we're in a more normal set of risk/reward around what the economic future looks like, in a positive direction.
David: So there's less risk aversion. We're becoming more risk loving on the margin ... Is that another way ...
Neil: Well no, I ... higher risk premium, pardon me ... higher term premium meaning if you're gonna tie your money up for ten years as opposed to buy a 30 day treasury bill, you want more compensation for having your money tied up because the risk of an upside bump on rates is higher than it seemed.
David: Okay. What about the death of R-star? Is it premature or is it actually a thing?
Neil: It's kind of a fascinating change from the Janet Yellen era. R-star neutral rates, the idea that there is some magic interest rate that, in which the economy is balance, is the way I like to think of it, that that is what the feds should be framing their policy rate relative to. Are they under it or are they over it? If they're under it they're stimulative, if they're over it they're trying to cause a contraction.
Neil: What Jay Powell has argued, and I don't think anybody would really disagree with this, is it's not a precise measurement. It's kind of an unobserved variable where you're trying to think you know where it is based on other things out there. His argument, I think even R-star advocates like John Williamson at the New York fed, would agree with, is that when you don't know exactly where you are/where it is, it doesn't matter if you know what side of it you're on and if you're trying to stimulate, you're trying to get the economy back to health, you know you're under it, you're good. But once you're near where you want the economy to be, it's not really a useful construct because is that rate three percent , 3.5 percent, four percent, we don't really know. It's kinda more range than a single number.
Neil: I think what we're seeing under Jay Powell is, he's not an economist, but he's a very rigorous thinker. He is more Greenspanian in the sense of wanting to not have a model that he plugs things into and the model tells you what the policy rate should be. But, paying attention to the world and studying the world around you, seeing where it leads. That's where in his speech, in Jackson Hole, Jay Powell's, he specifically referenced this 1990s episode where, as we were talking about a minute ago, where Alan Greenspan, there was a lot of pressure on him to raise rates because the model said, "If you don't you're gonna get inflation." He said, "You know, I think there's some evidence there might be productivity surge happening, let’s let it play out, see what happens." Powell was describing that in a very praiseworthy way and that implies to me that he wants to see where this leads. How low can unemployment go without causing a spike in inflation? Can there be feedback loops where productivity starts rising more? He wants to find out and he doesn't want to preemptively raise rates and cut the expansion off until they see reason to.
David: This has been a refreshing change in my view. To see this flexibility, this open-mindedness. But I'm curious to know, what is your sense of how far this open-mindedness goes in terms of the monetary regime? Is Jay Powell and his Fed gonna be open to conversations about, "Should we try price-level targeting, nominal GDP level targeting, temporary price-level targeting?" All these things that are being considered. Is it even on the table?
Neil: I don't know. I think if we have another recession, we get back to the zero lower bound anytime soon, they absolutely will. I think that's the moment at which ...
Neil: I think any discussions that are happening now, and you see this in the speeches and things, they clearly are thinking about it. I'm not sure that they have a clear idea of what they will do if they hit the zero lower bound sometime soon because of a recession or a down-trend. I think it would have to get there to really have those conversations.
Neil: You know better than me, some of the ideas out there, for example Ben Bernanke talks about having a soft nominal GDP targeting in an environment, where you're at the zero lower bound but not otherwise. So normally, if you undershoot the inflation target it's bygones. You don't try to make it up later. But, essentially, having a state-shift where, if you're at the zero lower bound suddenly you'd have catch up on inflation. So if you undershoot by one percent for three straight years, you try to overshoot on the backend.
Neil: I think this is a conversation that will not really have resonance again until it really has to and right now they feel like the economy is growing, we're raising rates every couple meetings and things are fine.
David: Okay. In the time we have left, what are your thoughts on President Trump's verbal sparring with the federal reserve over interest rate hikes?
Neil: I think it shocks people a little bit because it violates certainly the recent norms. You know, Barack Obama, George W. Bush, Clinton never really commented on what the Fed chair was doing. It really violates norms going back further than that in the sense that even when the Nixon administration was twisting Arthur Burns' arm to try to keep rates low, the president himself wasn't weighing in on each policy decision. But look, this is a president that violates a lot of norms. The odd thing to me is, you have this environment where the president's complaining vocally about interest rate increases and you don't see evidence of that in his actual appointments. He has power to shape the Federal Reserve, he appointed Marvin Goodfriend to be a governor and the appointment is still pending, he has some Senate confirmation problems, but Marvin's pretty hawkish. The president could withdraw that nomination and appoint somebody more dovish. He hasn't done that so it's a little odd that the president seems to view this as something ... in some ways, he seems to be like somebody who's watching cable news and wants to complain about things rather than actually use the power he has to shape it.
Neil: I think the attitude out of the Fed is, "Look, we don't like this but we're going to do what we believe is the right policy for the economy." They have a lot of DNA in that building built around, "You do what the economics says is right." That doesn't mean they don't make mistakes, they certainly do, but that is the ethos in that building.
David: On that note, our time is up. Our guest today has been Neil Irwin. Neil, thanks for coming on the show.
Neil: Thanks David.
David: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app. And while you're there, please consider rating us and leaving a review. This helps other thoughtful people, like you, find the podcast. Thanks for listening.
Photo credit: Getty Images Europe