Jason Furman on Overheating, Inflation, and Fiscal Policy in an Era of Low Interest Rates

The debt-to-GDP ratio may have become a misleading metric when thinking about fiscal policy, and a fresh new perspective might be needed.

Jason Furman is a former chair of the Council of Economic Advisers and is currently a senior fellow at the Peterson Institute for International Economics. Jason is also a professor at Harvard University and he rejoins Macro Musings to talk about overheating, the inflation outlook, and the right way to think about fiscal policy in an era of low interest rates.

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 [email protected].

David Beckworth: Jason, welcome back to the show.

Jason Furman: Good to be back and thrilled that I now have two mugs.

Beckworth: Oh, did you get your nominal GDP mugs in the mail?

Furman: I did.

Beckworth: Fantastic. Yes. So listeners, we had to correct a great failure on our part. We never got Jason his original nominal GDP targeting mug. Jason was one of the early guests on this podcast. Thanks to Jason and others, this podcast got a following and he never got his mug. So we sent him one for that and one for this show as well. So if you're trying to discover the true shadow price of a nominal GDP targeting mug, go talk to Jason about how much he's willing to take for one of those mugs.

Furman: Pent up demand for mugs.

Beckworth: Yes, they are actually highly demanded. We actually had an opportunity for folks to buy some and they sold out really quickly, but we haven't quite figured out how to open up a merchandise store for that. But for listeners, we're working on it, rest assured. But Jason, I'm excited to have you on today because you've been very active in this debate about overheating, inflation, the Fed's outlook.

Beckworth: And then you have this great paper with Larry Summers you did late last year, I want to get into as well. Because I do think we're going to be in an era of low interest rates going forward, even once we come out of this pandemic into full employment, I still think the same structural forces that were with us back then are going to be with us moving forward. But I want to begin with the overheating debate. That's been kind of the most pressing issue, and a lot of concern about that. And you've taken a very nuanced view. And before we get into your view, let me ask a very basic question, how would you define overheating?

Overheating, Inflation Expectations and the Fed’s New Framework

Furman: I don't know how I'd define overheating and I try not to use the word very much. I try to talk about what I think will happen to inflation, for example, and then others can decide whether or not that is overheating or not. The two things that I would be concerned about with inflation or the two biggest things I would be concerned about, is one that prices rise faster than wages. And so you have real wage losses for people. I'm not thinking by the way, this is the dominant probability. This is the things I'd be worried about.

Furman: And the second thing I'd be worried about is that it results in a recession. And it could result in a recession if the Fed raised rates too quickly, too far, or maybe even something that doesn't go through monetary policy. With this a ton of demand in the economy one year, there's not much demand in the economy next year. And it just has a strange dynamic and moves in the wrong way. So those would be my two worries. Again, there's a lot of things on the positive side of the ledger, but that would be on the worry side of the ledger.

Beckworth: Let me explore the worry side a little bit more with you. So I think some of the concern is inflation will be higher than expected or even higher than the Fed desired with this new framework. What would be the consequence that would worry you most, would it be that real wages would be falling? How bad could it get? Is there anything else to worry about inflation expectations becoming unmoored?

Furman: We've had a pretty good macro situation over the years before the pandemic, not fully satisfying, we would've liked things to have been better, et cetera. But the last five years, if we could continue to have things like that going forward, that would be good. One thing is, both in the late '90s and just before the pandemic, the Fed was able to lower the unemployment rate really far. Now, why is that? Is some of it that the Phillips curve was always wrong? Maybe. Is it that there were structural changes in the economy that flattened the Phillips curve? Maybe. Or is it that expectations were anchored? I think that is a potentially important part of the story.

Furman: And so those expectations give you a really, really wonderful thing as long as you can keep them anchored, which is you can push the unemployment rate quite low without paying much of a price for it. But the flip side of that is if they become de-anchored, all of a sudden you can pay a price and a price that could even be quite high. So I don't think expectations becoming de-anchored is at all a high probability likelihood. I think it's also a continuum. It's not like they go from 2 to 12 and they become de-anchored, but I think that's worth paying something to ensure against that happening and that mattering.

Beckworth: All right. Let me throw out one of the positives for running the economy hot, I know you don't like the term overheating, but for the lack of a better word, we run the economy hot, what happens? Well, one potential positive effect would be, we might actually experience reverse hysteresis. And right now there's some evidence that productivity's increasing. Greg Ip had a nice article in the Wall Street Journal, how, because employers can't find workers, they're spending more on investment and innovations are taking place. And we have yet to see whether this is going to last. But one potential side effect of that is we could see an increase in the potential GDP, right? We could see capacity grow. Do you think this period will provide good evidence or good data points to evaluate whether reverse hysteresis is possible, or maybe we're getting some other confounding factors in there as well?

Furman: Yeah. So on hysteresis, it cuts both ways. So we just had a period of prolonged incredibly high unemployment. And so if you place a lot of weight on hysteresis, that says, over the next one, two, three years, because of scarring, the natural rate will be higher than what it was going into this and that we can't get back to 3.5% or whatever you think it is very quickly. So hysteresis is a bit of a two-edge sword. I think there's a certain amount of plausibility to it. And for me it justifies, if I had to give a name for the approach that I'm most comfortable with to macro policy, it would be keep adding one log on the fire and keep warming it up and warming it up and warming it up.

If I had to give a name for the approach that I'm most comfortable with to macro policy, it would be keep adding one log on the fire and keep warming it up.

Furman: I'm not so impatient that I want to throw 10 logs on the fire at once, hope that somehow the productivity can instantly jump to match that, the people instantly come in off the sidelines or whatever it is. And by the way, that's possible. It might work with 10 logs all at once, but I much prefer the heating the economy than putting it full tilt incredibly hot economy.

Beckworth: Fair enough. I like that analogy. So using that analogy, we want to avoid pouring gasoline on the fire. Just add a log one at a time as you suggest.

Furman: There’s [inaudible] in what I said. You might end up not having done as much good, and you spent a year or two with a higher unemployment rate than you would have otherwise, but you also might avoid the situation of pushing all the way into a recession or something bad. So I think mine has a decent probability of having some smaller, good thing not happening, but it also lowers the probability of a larger bad thing happening. And so there's a little bit of a risk mitigation strategy around all of this.

Beckworth: That is the wisdom right there folks of a seasoned policymaker, looking at the trade-offs doing risk analysis. All right. Let's go to inflation and the outlook for this next year, because this is part of this conversation and what's driving this debate. And you recently had some great tweets on this. I'm going to read your first tweet and I'll let you expand upon this. But you recently said in a tweet, "The more I think about inflation, the less sure I get of anything other than, we should have a wide confidence interval and that policy decisions should explicitly recognize our uncertainty. I will give the top four arguments for transitory and the top four arguments for persistence." So that is the key debate, right? Is inflation transitory or temporary, or is it going to be more permanent? And if it's transitory, then we can rest easy. If it's permanent, then we should get worried. So walk us through your list and where you ultimately come out on it.

Are Current Inflationary Trends Transitory?

Furman: Yeah. So first of all, just my argument that everyone is overconfident, the Survey of Professional Forecasters in February expected core CPI this year to be 2%. They said there was less than a 5% chance it would be above three. In May, they revised up their expectation for inflation all the way to 2.1% for core CPI. And they said there was less than a 15% chance it would be above 3%. We had 2.1% core CPI just in the first five months of the year and the seven more months in the year to go. Now, it could be zero, by the way, for the next seven months could be negative. So they're not definitely wrong, but I think it's pretty safe to say that anyone who one month ago said their best guess was 2.1 for the year, and then it was extremely unlikely to be above three and almost impossible that it was above four, was overconfident and probably wrong as well, but we'll have to wait for more data.

Furman: The second thing is, definitely a lot of the inflation is temporary. Inflation's been running at 8, 9% annual rate. No one sane is saying inflation is going to continue at an 8 or 9% annual rate. So people who think there's some persistence think it'll come down by only four or five percentage points from its recent rate. Other people think it'll come down by seven percentage points from its rate. So in some sense, we're all arguing over how much will inflation fall from its recent very high rate, not whether it will fall. In terms of people who think it's very transitory, they emphasize in part a bunch of micro stories around things like auto prices that have been really high and they're going to go negative, probably are going come down at some point, or restaurants that have been rising a lot, but won't continue rising a lot.

Furman: They emphasize that supply has returned more slowly than demand, but supply will come back as people feel safe about going to work or UI goes away or childcare, or whatever is on your list. That demand was temporarily high because people got checks in March, but they're not going to continue getting checks. And finally, that expectations are anchored and we have a 20-year track record of that. And we have an awful lot of data from financial markets suggesting that people betting real money on this think that they're anchored. So I think there's a lot of really good arguments for transitory. The question is, how good are they? Do they lower your inflation forecast by five, or do they lower it by seven?

So I think there's a lot of really good arguments for transitory. The question is, how good are they?

Furman: On the other side of the ledger, you can tell micro stories about shoes that haven't dropped. Housing is the biggest one in the CPI and not the PCE, who also have healthcare. There was a lot of debate on housing a lot of different ways to look at it. But most importantly, shelter prices right now are below their pre-pandemic trend. Do we think they're going to stay at their really low growth rate they've had? That the growth rate will pick up? Do you think they'll close the gap to trend? Second, people like looking at sticky-price CPIs. Those aren't a complete comfort because sticky-prices take longer to change. I think wages are a big shoe that hasn't fully dropped yet. When people sit down in HR offices in September to set their wages for their employees starting in January, are they going to look at the CPI and do a bit more on it? I don't know. We haven't really seen that type of behavior since the 1970s. Might we see it this year? I wouldn't discount it entirely.

Furman: To me, the most compelling reason to think that inflation has persistence is that I can really easily imagine demand at the end of this year and into next year being higher than supply. As in, what was the trend we were on without the pandemic? Because of the pandemic, we had larger fiscal policy, more accommodative monetary policy. And so people will be spending at a higher rate than they were before the pandemic… supply, whatever hysteresis story you can tell. You're still not going to have everyone back at work. By the end of the year. You've had some damage to businesses and the like. And so demand being less greater than supply. And then finally, expectations could become de-anchored. That's not my biggest worry, but if it's not on your worry list, you're not thinking clearly about the issue.

To me, the most compelling reason to think that inflation has persistence is that I can really easily imagine demand at the end of this year and into next year being higher than supply.

Beckworth: Okay. And the numbers you come up with, you have a nice list of different outcomes with probabilities. And if I read correctly, your mean estimate is 3.6% inflation this year and 3% next year. Is that correct?

Furman: Yeah.

Beckworth: Okay. So let's say that materializes, kind of going back to the question I was asking earlier, is that the end of the world? And I just don't see it. I have a hard time getting worked up about 3.6% inflation during a reopening year and it falls to 3%. And if you look at consensus forecast, similar numbers to what you have, but when I look at them over the longer horizon, what they're all showing is, this year will be a little bit higher, next year, maybe a little bit less, but still higher, and then fading back into the 2% trajectory and we're back to normal. So help me, Jason, one more time, understand why I should get worked up about this.

Furman: I'm not that worked up about this by the way. In some sense, I think I'm more dovish than many of the doves.

Beckworth: Oh, good.

Furman: I was rereading some of the dovish arguments people were making, as recently as March. And the argument would be of the form, "It's ridiculous to worry about monetary policy because inflation is going to be below 2% this year, below 2% next year. And so we need to have our pedal on the accelerator." A lot, a lot, a lot of people made their arguments for monetary policy contingent on a forecast that inflation was going to be below 2% over the next few years. So I think at a minimum, if you want to argue the Fed should be at zero or whatever, make the argument you just made David, which is 4% this year, 3% next year, 3% the year after. What's the big deal? Why should we be so worried?

Furman: I completely respect that. But if your argument is always contingent on a positive prediction about the future, that is always sort of, that your prediction errors are correlated with your own views on what you think monetary policy should ought to do, then I worry that maybe you're not thinking clearly enough about it. So that'd be the first thing I’d say. Second, my view before all of this was that we should have a higher inflation target. My view continues to be that we should have a higher inflation target. And by the way, when I say inflation target, I'm not saying we should target inflation. You could embed a higher inflation target nominal GDP, you could embed a gross labor income, you could embed it in a Taylor rule, and whatever it is, by the way, you shouldn't do a rule. I'm a big supporter of discretion.

Furman: But within whatever framework you have, I think a higher number makes sense. I don't know exactly what the right number is. I think at 4%, people might start to notice and be annoyed by inflation. So it might be that three is a better number. Maybe even the range of two to three is the place to start with all of this. I don't know what it is, so from my perspective, three is better. And by the way, just to review the arguments, the equilibrium interest rate is much lower than it was. And so you want more room. There's also, there are greasing the wheel of the labor markets argument, that you need real wage adjustments in recessions, and a higher trend inflation rate enables you in a world of sticky, downwardly, rigid nominal wages to have more real wage adjustments and maintain employment. So I'm not that bothered by it. I'm more bothered by… I think there's been a little bit too much groupthink and selecting every data point that helps make the transitory case and be really, really too quick to dismiss all the data points on the other side.

Beckworth: Fair enough. And I want to be clear, I'm not trying to say Jason Furman is overly worried about this, but I do hear other commentators out there, some pretty prominent ones, I’m going to leave unnamed. And sometimes I get the impression, and correct me if I'm wrong, Jason, some of them are worried that we are opening the door to something more serious. So yeah, it's only 3% this year or so, but we're going to begin that gradual process of unmooring inflation expectations. And I just have a hard time seeing that, for many reasons. You've outlined the transitory ones. I agree with that. But let me add just a few others, and some of this actually touches on your article, we're going to get to later.

Beckworth: But the first one is that all of these deep structural forces that kept inflation and interest rates low before the pandemic are still with us. You mentioned the lower equilibrium rate, but the demand for safe assets, the aging population of the world, and the emerging markets, regulations, risk aversion, all these things I think are not have not gone away. And then the other probably more pressing thought in my mind is just my theory for inflation. So you mentioned a Phillips curve theory and also the inflation expectations kind of theories.

Beckworth: Those are kind of, I think the standard views for the inflation process. But let me throw out Jason, just to play the monetarist here, a more quantity theoretic approach. And I don't mean traditional monetarism, but I mean this: in order to generate the 1970s inflation, you've got to have a sustained increase in the growth rate of government debt, year after year after year of massive packages, massive spending, not just the level increase, but an increase in the growth rate in order to get to a place where expectations become unmoored. And I just don't see that happening. We've had a few big packages, maybe another infrastructure bill, but that just doesn't seem to be in the cards politically moving forward, a sustained increase in the growth rate of government liabilities moving forward. So absent that, again, I see this temporary uptick falling back down over the next few years. What are your thoughts on my theory?

Furman: So first of all, let me just step back and make a meta point. I think on this question or most questions, I much prefer people who think in terms of four different models, three different bits of common sense, two different, what they call the smart friend, and one, they looked at what the consensus and bring all that together to form a view. I'm in general, extremely distrustful of anyone that has the one true model and explains everything. I'm not, by the way, saying you were doing that at all. In fact, if anything you weren't. But I did want to make it clear, for example, the Phillips curve, I think that has been of limited relevance for the last decade. I wouldn't make most of my forecast on it.

Furman: And in fact, I think right now my inflation forecast would be higher than what you get out of a Phillips curve because I think a Phillips curve is missing some really important things like what's happening to overall demand. In terms of your fiscal theory of the price level approach, what I'd want to understand is how much of an increase in government debt have we already had relative to the price increases? So how much room is there for pent up inflation that we haven't already experienced associated with the debt increase we've already had? My guess is, through your logic you just had, would rule out 4% inflation every year for the next decade, but that nothing in what you just said could distinguish between having 1.5 a year and three a year. And by the way, I think three is better than 1.5 a year. So I don't think yours gives us an overly precise answer within the range of the debate that people are having.

Beckworth: Yeah. Fair enough. Speaking of inflation ranges, I think of the Bank of Israel, and I believe they have like a one to 3% range, which gives them a lot of flexibility. And if you look at the decade prior to the pandemic, coming out of the Great Recession, the pandemic, if you look at their average inflation rate, and I think I looked at the deflator or using the GDP deflator, they average around 2%, but they had some pretty wide swings around that. So they had flexibility in the short run, responding to business cycles, but they averaged 2%. So I like this idea of having a range and allowing inflation in the near term to have some flexibility in it.

Furman: And Canada has a range from one to three. I haven't studied it very closely, but it seems to have worked well. And also, if we go from a range, and by the way, if your range continues to include two, that doesn't bother me a lot. It's that your range needs to include three. That I think is an important.

Beckworth: Well, I'll mention one more thing about Israel since we're going on this a little detour here. I like Israel, and I've pointed to Israel in the past because if you look at nominal GDP or nominal income, it can also be stated. It is relatively stable and growing on a flat trend growth during this time. And what you see, and if you look at the components of that, if you look at the GDP deflator and growth rate, and you look at real GDP growth rate, it very much comes together in a way that would look like a nominal GDP level target, although they weren't explicitly doing it, but what you saw was counter-cyclical inflation. So during recessions, inflation would go up and then during booms, it would go down. And that's just what the doctor ordered in terms of my views of getting something like a nominal GDP level target. It also helps better risk sharing over the business cycle. So that's kind of the world I would like to end up at some point in the future, or alternatively stated a future where we have a stable growth path for nominal income overall.

Beckworth: Let me ask another question here about the inflation outlook before we move on, Jason. So recently, the ten-year Treasury yield has moved sideways. It's flat-lined. It was rapidly rising in the early part of this year, and now it's settled around 1.5%. And we're recording this on June 16. So maybe after this point, things may change, but for the past month or so, it's been relatively flat around that value, and many have been surprised. And there're several stories that could be told. One story is that all of the reserve creation and all the downward pressure and overnight markets is beginning to creep up the yield curve. That's one story being told.

Beckworth: So people may not want to park their funds at 0% in the overnight reverse repurchase facility at the Fed. So they'll go up a little bit higher on the Treasury yield curve, and that's compressing the long-term yields. That's plausible to me, but I don't see this being a big enough magnitudes to work. Another story is bond markets are simply pricing in lower inflation than they were maybe earlier in the year. So if you look at breakevens, they've been going down a little bit, not a lot. What is your sense of what the bond market is trying to tell us with the 10-year yield staying close to 1.5 for the past few weeks?

Current Bond Market Signals

Furman: So if you look broadly speaking from December to March, you could look at bond markets and get more worried about inflation or not worried, more of an expectation of higher inflation. And the real economy didn't see anything. Since March, it's been the opposite. I think the real economy has given us a lot of signs that there's going to be higher inflation in the future. And the bond market has given us no signs at all. I think three things. One is I put some weight on the bond market. If you had locked me in a room all by myself and I didn't know what any other forecaster thought and didn't know what the bond market thought, I think I'd convince myself inflation will be above 4% this year and above 3%, maybe even as high as four next year. And I put a lot of weight on what others think.

I think the real economy has given us a lot of signs that there's going to be higher inflation in the future. And the bond market has given us no signs at all.

Furman: The second thing is there's a bunch of technical factors in the bond market. The Treasury, for example, has run off its cash holdings quite a lot. I'm told there're technical things going on with pension funds, pushing more money into them. The Fed is still buying assets, et cetera. So I don't think it's a perfect gauge. And then finally, the bond market can be wrong. I never do any macro trading or bets with my own money. So I have no idea how to evaluate my track record over the course of my life, but I've often thought they were wrong. And I can remember all the times I was right and they were wrong and I've forgotten all of the ones that happened the opposite way.

Beckworth: Yeah. Fair enough. Fair enough. I will just put this plug in for breakevens. They're pretty close to what the Survey of Professional Forecasters. I was looking at it. Their last Q2, long-term inflation forecast was very similar. Just so briefly here, for the CPI, over the next five years, they have it at 2.4. This is from the Philadelphia Fed Survey Professional Forecasters. And for the 10-year horizon, they have a CPI at 2.3. And then for this PCE, they got a five-year forecast of 2.2, and then 10 years, 2.1. So that's not too far off from where the breakevens are. So those two data points in my mind kind of confirm each other. Now, I know if you look at like household surveys of inflation expectations are a little bit higher. But I put some weight on the bond market in these consensus measures. And I know Joe Gagnon, your colleague at Peterson has done some great work showing that none of these forecasts do a great job over long horizons. Bond markets didn't predict a great inflation far into the future. So we need to take these with a grain of salt.

Furman: Oh, just on the expectations thing, I place a decent amount of weight on breakevens. I place less weight on what forecasters think because they tend to take the Fed at face value. The Fed says you're going to have 2% inflation. So the forecasters sort of believe that and they put in 2% inflation. So I do place a lot of weight on breakevens, forecasters, less so, and the consumers less so too, by the way, because of the notorious biases that they have. Also, you want to make sure you think out how your arguments are going to evolve if the data doesn't evolve the way they do.

Furman: And so you, I've noticed have placed a lot of weight on these inflation expectations. If inflation expectations go up to three at the end of this year, are you going to change your views about monetary policy or are you not? I think you probably won't. So maybe rather than pointing to a data point that won't change, that might change, make the real argument, which is, inflation expectations are too low. I'd like to see them rise to three or something like that. And so I think we've seen that over and over again. So I do predict that there's a decent chance the breakevens are going to go up, and if they do, people are going to find all sorts of creative technical reasons as to why they're high, rather than saying, "Actually, this said it was telling us something back in June. So now I have to continue to admit it's telling us something.”

Beckworth: So Jason, I agree. I need to be careful because I do place a lot of weight on the bond market, what it's saying. And also I need to be careful, even in normal times to throw light on the bond market because I think if the Fed is doing its job well, if it's responding to shocks that move inflation around away from target. And let's say the bond market is forecasting, "Oh, five years, the average is going to be higher than target, below target." And if the Fed is in any extent, is responding to that and it's successful, then the bond market's forecast will be inaccurate because the Fed has responded to it and has offset it.

Beckworth: So I have to be mindful that these things may not always be the best way to think about the future or how accurate they are. So it's good to have you on here, Jason, to keep me in the right path here, straight and narrow. Let's move to the Fed. You mentioned about how inflation could go up to 3%. And one thing I have wrestled with is, the Fed's new framework, wants to have make-up inflation, catch-up inflation, and you have a nice chart showing that they're pretty close to that already. Is that correct?

Furman: Yeah. Every day from the beginning of the pandemic, or when they cut rates to zero, basically there.

Beckworth: Yeah. So let me ask this question, how should we think about this framework? So we know there's make-up inflation, but a lot of these parameters are undefined, right? So how far back do you go? You don't want to go too far back, but also how quickly do you want to catch up? And then the other thing I think that really makes it tricky in this particular period is the catch-up inflation we've been seeing the kind the Fed wants? So in other words you mentioned supply bottlenecks, base effects. Is that really what the Fed would want in a make-up period for inflation or would they want more of a kind of fiscal stimulus pressures on inflation that we've seen this year?

Making Sense of the Fed’s Average Inflation Targeting Framework

Furman: So I'll answer your second question first, which is, they should judge the make-up inflation by where they think the price level will be at the end of this year or the middle of next year. So if you think we're going to have a period of 0% inflation going forward, because all the quirky things that have been driving inflation up are reversing and auto prices are falling, then this hasn't been true make-up inflation. I don't think that's the case though. A lot of what we've seen is things like restaurants and airlines going back towards where they were. And I think when you look at all the puts and takes at the end of this year, it's very likely, very, very likely that we're above a 2% average for the pandemic period plus the post-period.

They should judge the make-up inflation by where they think the price level will be at the end of this year or the middle of next year.

Furman: So yeah, I don't think they should declare victory based on the May CPI reading, but based on any plausible forecast is as the dust starts to settle in December. I think they can declare victory. Why do you have average inflation targeting? The reason you have it is not to have a higher inflation rate, it's to, in times when you really need it have higher expected inflation. So last year the Fed wanted people to expect more inflation in the future. They expected more inflation in the future that lowers real interest rates. Broadly speaking, that means you might want to invest more now because inflation will make it easier for you to repay that debt over time.

Furman: And so when Bernanke originally proposed his flexible price-level targeting or whatever, I don't remember exactly what he called it. It was with that rationale. I think that's a very good rationale for averaging. I think there's been a distinct issue of do you want to have a higher inflation target. He used a very good argument for that too. That's not an argument the Fed has made to date. That's not something that they've supported. I hope they come around and do support it. When people say you should do average inflation targeting retroactively to 2012, to me, that sounds like you're making an excuse for higher inflation.

Furman: Do those people really think that we should run the inflation rate at two and a half or 3% for five more years and then go back to two? I don't think so. I think they're saying, and I think it's quite reasonable that, "We can run inflation at two and a half or 3% indefinitely." If your view is you can run it a two and a half percent indefinitely, I think there's some danger to wrap yourself up in an average inflation targeting excuse and rationale for that, rather than just say, no, let's have a range, let's have a higher target, whatever else.

Beckworth: Okay. Well, here's how I have interpreted this framework and I'd like to get your feedback on it. I agree with you the point you just made that the make-up period in this framework is different than having a higher inflation target. Two very different ways of thinking about this. And you're right. I mean, Clarida and Bernanke, they both have called this, you mentioned the flexible form, the temporary price-level targeting form. The idea is when you're in a zero lower bound, big demand shock, you want to grow, rapidly grow above 2%, but once you get back up, you're supposed to return so you're not going to have many, many, many years of above 2% inflation going forward.

Beckworth: What's also interesting though about this, Jason, is the way they describe it, so you start at the zero lower bound, from a severe demand shock, you work your way back up. And then Bernanke explicitly says you want to avoid those temporary deviations and inflation when you're back at full employment. So you don't want to tighten policy, for example, if you have a negative supply shock. You want to see through it, kind of the standard view right now. And when I hear that, that sounds a whole lot like a nominal GDP target to me. You responded to demand shocks, you see through supply shocks and you stabilize going forward.

Beckworth: And so, when I think of this framework, I think of it as a step in the direction of aiming to stabilize incomes. And to me, that's such an easier, or better selling point. We're here to restore incomes to their pre-pandemic level. We're here to return sales to that level, incomes in the aggregate to their level. It is a harder sell, I think, to say, we want to get inflation higher because the average person's not going to make sense of that. So do you see that also? And what are your ultimate hopes for monetary policy frameworks?

Furman: So I have some sympathy for nominal GDP targeting. I think with a demand shock, whether you look at that or look at inflation, it's quite similar. With the supply shock, you're more likely to look through it and get the right answer with nominal GDP targeting. I think any single variable framework misses the richness of the economy. And any 50 variable framework is uninterpretable to people. And so I think there is a real use to having two separate variables in it. One is something like the unemployment rate or some adjusted version of the employment rate or whatever. And then something else is nominal, nominal GDP, nominal prices, and the like. You in 2019, put down a really elegant framework for nominal GDP targeting. If we were following it now, we would already have lifted off interest rates. And we're going to, with extreme likelihood, overshoot the nominal GDP target we were on.

I have some sympathy for nominal GDP targeting. I think with a demand shock, whether you look at that or look at inflation, it's quite similar. With the supply shock, you're more likely to look through it and get the right answer with nominal GDP targeting.

Furman: So under your framework, you'd have to make up for that with a sustained period of lower than trend on nominal GDP growth. I don't mean that to pick on you, this experience has destroyed anyone's plans that they wrote down before. It's such a weird period. But to me, that says, "I'd like the Fed, if the unemployment rate a year from now is still 5.5%, I'd like the Fed to take that into account, regardless of what's happening to nominal GDP or prices as an independent problem and issue that they need to take into account." So I think that anything has to have a dual mandate, but do you look at nominal GDP and the like, instead of inflation? Maybe.

Beckworth: So what is your preferred measure of full employment, or measures, plural, of full employment? If someone had asked you, "How do we know we're back at full employment?" What would you want to see on your dashboard?

Furman: I'm a little old-fashioned. I think the unemployment rate is the single best measure that we have for that because the number of people who want jobs at a point in time seems to vary a lot for all sorts of structural reasons. In 1983, you could have argued… or in 1982, that the economy wasn't in recession because the employment rate or the prime age employment rate was higher than where it was a decade before, that would have been crazy. We had a 10% unemployment rate, but because of demographic changes, the employment rate was higher, not lower. So I think you want to take whatever your preferred variable is and look at what it was in 1999. Look at what it was in 1982, and ask, would it have worked in those circumstances too.

Furman: And so a lot of the variables people come up with that work well in 2019, don't work well historically. Now, you might say we're in the middle of a structural change then. Women's labor force participation was rising. That's not happening anymore, therefore, it's fine now. But I worry that any variable, like employment rates that has a large structural component to it will not be stationary. It will change its behavior in the future in ways that don't tell us that [in] the business cycle. So unemployment rate is my favorite. I do look at employment rates. I look at them for prime-age workers. I look at them on an age-adjusted basis. I look at the ratio of unemployment to vacancies. I look at the openings rate. By the way, that does almost as good a job predicting inflation as the unemployment rate does, and in this episode, it's probably doing a lot better. So it's good to look at a range of things, but I'd center your imagination on the unemployment rate.

Beckworth: Okay. Well, let's move to your paper with Larry Summers. And it came out last year and the title of the paper is, *A Reconsideration of Fiscal Policy in the Era of Low Interest Rates.* And it was really a fascinating read for me. Actually, I saw you present it first at the Princeton Seminar online, and then I read the paper. And it really, I don't know, kind of blew my mind, the whole different approach to thinking about fiscal policy, in particular, the metrics you use, but you motivate this with some other interesting facts as well. So maybe we can start just by you telling us a summary of what the paper argues, then we can delve into the details.

*A Reconsideration of Fiscal Policy in the Era of Low Interest Rates*

Furman: Yeah. So our biggest argument is that debt-to-GDP is a misleading metric because debt is a stock. It's what you have at a point in time. Income is a flow. If you compare your debt to today's income, it's incredibly high. If you compare it to your income over the course of the next decade, it's a whole lot lower. That's more than just a cutesy observation when you combine it with the fact that interest rates have fallen on a sustained basis. You look across the G7 and the real interest rate has fallen from about 4%, 30 years ago, to around 0%, just prior to the pandemic. And that means that you can, from a fiscal sustainability perspective, pay your debt off over a longer period of time.

So our biggest argument is that debt-to-GDP is a misleading metric because debt is a stock. It's what you have at a point in time. Income is a flow. If you compare your debt to today's income, it's incredibly high. If you compare it to your income over the course of the next decade, it's a whole lot lower.

Furman: So we argue that the right way to look at it is from a flow-flow perspective. What's the flow you need to pay each year, and what's the flow of income you have each year. We go a little bit further into a place that I don't haven't noticed others do, but maybe they have. I'm sure somebody has. Which is that the relevant way to think about interest is the real interest payments. If you're in a world of higher inflation, you're inflating away more of your debt. You don't mind the portion of interest that's just covering inflation. What your mind is the portion above and beyond that. And so, our preferred metric for fiscal sustainability is looking at real debt service as a share of GDP. That's something the administration included in their budget this year. And I was beyond thrilled to see them include it there. We say then that keeping an eye on that, you want to keep it below about 2%, nothing scientific to that, that 2% of GDP.

Furman: That's just something… you look around a lot of countries around the world over a long period of time, you've seen a lot of economies do just fine with real interest at 2% of GDP or below. And then when we, given the current fiscal configuration and expectations in the United States, translate that into what that means right now, it says there's room for a decent amount of temporary spending that's either due to an emergency or will pay for itself, that other things should be paid for over time, and that we don't really need to bring the debt down as a share of GDP. That's something like 125, 150% of GDP is just fine, assuming interest rates stay on the path we think they're going to be on. And if they rise more than that, then we'll need to revise our views of fiscal policy.

Beckworth: Yeah. Very provocative, but I think also compelling because the standard story, as you say is debt-to-GDP, right? And you often hear R has to be less than G. And you can roll over debt. That ratio becomes stable over time. But as you mentioned, it confuses stocks with flow. So the first metric you mentioned is to look at the debt stock relative to the present value of GDP. Now, that's a hard number to come up with, and I know that's why you guys rely on your second metric, real interest rates to GDP. But I want to read to our listeners an excerpt from your papers just to put some numbers on these ratios, these metrics. And you and Larry refer to the Social Security… the estimate of the infinite future of GDP.

Beckworth: Let me just read here, page 20, "In the United States, the only regular and systematic measure of GDP over an infinite horizon we are aware of is produced by the Social Security Trustees. Any estimates of this quantity is highly speculative and subject to massive uncertainty. We have our quibbles with some other specific assumptions, but this measure provides a useful benchmark with which to assess how the US debt appeared at various points in times. According to the latest Social Security Trustees report 2020, the present value of GDP over an infinite future was 3.8 quadrillion on January 1st, 2020. As of November 19th, 2020, the US federal debt by the public held was 21.2 trillion, adjusting these to have the same dates that is 0.5% of the infinite horizon GDP. In other words, 0.5 percentage point increase in revenues is a shared GDP or reduction in spending as a shared GDP will be sufficient to pay off the entire debt."

Beckworth: So those numbers are pretty staggering, right? You take the debt, we have 21 trillion compared to 3.8 quadrillion. And it does put things in perspective. Now, again, you say, "Yeah, we acknowledge this is highly uncertain." So let's go with the data we have today that can assess things better. So you look at interest rates over GDP. So two questions, number one, how has this been received? Because this is not a traditional way of looking at this issue, right? How have people responded to it? And I'll come back to the second question in a minute.

Furman: I think there's been a decent amount of receptivity. In one sense, it's very much not the traditional way of looking at it. In another sense, it is. I don't question that the debt needs to be sustainable. I don't think that you can have your debt rising really rapidly as a share of GDP forever. I think it needs to stabilize. It's just that the traditional debt sustainability frameworks don't answer: Does it need to stabilize at 50, 100, 500, 1000? They don't answer that question. You can't answer that question without bringing in interest.

I don't question that the debt needs to be sustainable. I don't think that you can have your debt rising really rapidly as a share of GDP forever. I think it needs to stabilize.

Furman: And so, I've had a lot of conversations with top policymakers in Europe, and they're not ready to give up on debt-to-GDP or debt sustainability as a metric, but they are very open to thinking about changing what they think the debt-to-GDP should be. And so if you change what you think the debt-to-GDP should be based on interest rates, you do that every now and then. That's fine with me. It gets you to a similar place. So I think there's been a decent amount of receptivity. And then from the administration, they've now, on the very first table on the budget, included real interest as a share of GDP.

Beckworth: So you're making an impact already with this paper.

Furman: I'd like to think so.

Beckworth: Okay. Let's apply this into a real situation, Japan. Japan has something like 250% debt-to-GDP. People have been saying for decades, where's the hyperinflation? Where's at least the high inflation. It never comes. Right? Do you think this framework provides an explanation for why that hasn't happened?

Furman: Absolutely. Yeah. Japan is a big motivation that they can have. I think when you net out the debt held by the central bank and look at net assets, you got to numbers more like 150 to 200% of GDP. I can't remember. I haven't done those lately, but whatever it is, it is staggeringly high and totally fine because their interest rates are low.

Beckworth: All right. So Japan is a great place to look and see how this idea makes sense and can be applied. In your paper, you also speak to something we talked about earlier in the show, I'm going to come back to visit that. And that is the low interest rates. So part of the story is, again, fiscal policy in a world of low interest rates. And I just want to follow up, you still believe that we will be in a world of low interest rates moving forward, even after all this expansive fiscal policy the past year or so?

The Future of Low Rates

Furman: My rule of thumb is if debt, as a share of GDP rises by one percentage point in the United States, maybe that's one and a half basis points higher on interest rates, that happens for all of the OECD economies. Maybe it's three basis points higher. So you look at what's happened to the fiscal trajectory now, compared to what you would have thought pre-pandemic, long run interest rates could be 50 to 100 basis points higher than they otherwise would have been. So what would they otherwise would have been? I don't know. No one knows. But something way lower than they were in the 1980s, 1990s, and early 2000s, and something that was probably lower than they should have been in order to create room for monetary policy and the likes. So, yes, I think, the fiscal response has raised interest rates. I don't think it's raised them a lot. And I think the increase in interest rates is good, not bad.

Beckworth: Right. It's definitely good for monetary policy in terms of making it more effective moving forward, but do you see, as I guess, over the long-term, maybe medium-term, better answer, being stuck in a zero lower bound environment in advanced economies? Are we ever going to get out of it? And if we are stuck in it, then we really need to pay close attention to this paper.

Furman: Yeah. I mean, first of all, this has.. you believe in bond markets, the forecast of 10-year Treasury is 10 years from now, had been something around 2% is now something like 2.9%. So they do see long-term interest rates being higher for whatever set of reasons. And I think the debt could be high up on that list. As I said, I think that's more likely to be a good thing than a bad thing, but I think this has put upward pressure on interest rates. There's two forms of secular stagnation. One is you suffer year in and year out. If that's the case, it's really important to raise interest rates. The second is you suffer it every five years. And I think the second one is more plausible than the first one. So the relief provides some help, but so does a higher average inflation target. So does average inflation targeting, et cetera.

Furman: I don't place zero weight on it's a year in, year out problem. And that's why I think, for example, a more fiscally expansionary policy over the next 10 years is good. To me, it's a one-sided bet. I mean, you look at President Biden, not fully paying for his proposals over the next 10 years. If secular stagnation is a year in, year out problem, he's just helped solve it. If it's not a year in, year out problem, the Fed can raise rates a little bit more and offset it. So it sort of heads, you win, tails, you don't lose. So I'd still bet on secular stagnation in setting fiscal policy because I think that if you lose the bet, you don't lose very much at all and you might win.

Beckworth: Okay. So the fundamental forces driving the equilibrium rate or treasury yields are low. There's still going to be with us. Other than the minor offset you talked about coming from the fiscal package, do you still see those fundamental structural forces being a drag on interest rates, at least for the foreseeable future?

Furman: Yes. We don't fully understand the list. We have a long list of things that, ex post can explain it, demography, productivity, globalization, inequality, et cetera, et cetera. No one predicted the magnitude of this interest rate fall, and preregistered their views. So I worry that we're adapting our views to what happened. To me, the most important thing though, is that it was very gradual and that it happened everywhere and that it happened in different policy environments and with different types of central banks. So that's what gives me the most comfort that there's been a structural decline in interest rates and that it was gradual. 30 years from now, could we see a gradual increase back to where we were in 1990 for real interest rates? I think that's distinctly possible. And if it is, we can adjust. We don't need to adjust now based on that expectation, but if it happens, absolutely, we can, and should adjust. Will interest rates go back to 1990 over the next two years? I find that very implausible.

30 years from now, could we see a gradual increase back to where we were in 1990 for real interest rates? I think that's distinctly possible. And if it is, we can adjust. We don't need to adjust now based on that expectation, but if it happens, absolutely, we can, and should adjust. Will interest rates go back to 1990 over the next two years? I find that very implausible.

Beckworth: All right. So in the few minutes we have left, Jason, just to take this paper's ideas and make them operational. So the idea is, we want to use fiscal policy more in this low interest rate environment. What do you think or propose should happen in terms of countercyclical macroeconomic policy? How should the government reconfigure or retool itself so it does have those tools more readily available and automatically kicks in? I think your argument is we're going to have to rely less on monetary policy and more on fiscal policy. So how do you retool our macroeconomic toolset so that we can do that?

Revamping the Macroeconomic Toolkit

Furman: Yeah. I mean, I've long been a champion of more automatic stabilizers that if you have a larger size of government or a more progressive tax system, that will give you more robust, automatic stabilizers. I would like to have more paid leave or a more robust unemployment insurance system, better health care, et cetera. I should say by the way, I don't primarily want those as a countercyclical tool, I want those because they're important in their own right. Maybe they'd have a large benefit in macro sense too, those are all super controversial debates. So my hope is that we could have a more technical discussion in parallel to those more super controversial debates around just having more triggers.

Furman: So the federal government gives more of a Medicaid match to States when their unemployment rate is high. Unemployment insurance, the optimal unemployment insurance is more generous and longer lasting when the unemployment rate is higher and it's harder to find a job. You could go further and add other things, but those are my two favorites is assistance to states and unemployment insurance. If we did that, it would also reduce some of the political errors we've made. We made a big set of political errors a decade ago of doing too little fiscal stimulus and withdrawing it too soon after the financial crisis. I think we just did too much assistance to states and kept unemployment benefits too high for too long. And so I think it would also reduce errors in that direction as well.

We made a big set of political errors a decade ago of doing too little fiscal stimulus and withdrawing it too soon after the financial crisis. I think we just did too much assistance to states and kept unemployment benefits too high for too long.

Furman: The doing too much error was not one that I really thought about a lot when I originally proposed automatic stabilizers. But maybe if you are worried about the government doing too much, you'll be more attracted to this idea now. And there's a parallel, by the way, Social Security, before it was indexed on an ad hoc basis, it was actually raised more than the inflation rate. So indexing Social Security slowed the growth rate of benefits from what they had been. Now, we don't know the counterfactual. So I think automatic stabilizers get things more right. Whether an average is more or less, I'm less sure about that. The timing, that I'm sure is a lot, a big improvement.

Beckworth: Okay. Final question here, related to what you just said. Do you see a role for the stimulus checks being made a regular automatic stabilizers of some form, some kind of trigger, some kind of rule that kicks in and you send checks out until you hit some target or something. Do you see that moving forward as another viable tool?

Furman: I like the idea of checks as part of the arsenal, belt and suspenders, supporting demand type of approach. After looking at the last year, I'm more enthusiastic about unemployment insurance, I mean, my qualms about where it is, in June, July, August of this year, but broadly speaking, that was more impressively targeted and so dramatic increases in replacement rates there, especially if we can do it with replacement rates rather than fixed dollars are appealing. I think checks play a role. I'm a little bit less sure about whether I want checks to be based on a formula and an automatic stabilizer, or just an ad hoc tool, because I think some of the formulas can have issues. What if the unemployment rate goes down to two and a half and then rises to 3.2? Do we really want to send everyone a check? I'm not sure.

Beckworth: Fair enough. Okay. Our guest today has been Jason Furman. Jason, thank you so much for coming back on the show.

Furman: Thanks for having me.

Photo by Samuel Corum via Getty Images

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.