FTSE Russell Convenes | Episode 2, Season 2

The monetary dilemma

August 08, 2022

In a way, markets are much more attuned right nowto the Fed, to the war in Ukraine, to what's happening in the supply chain.95% plus of what happens with economic growthand for markets has nothing to do with Washington.Austin, thank you very much for joining us.Jamie, good to see you.Right now, there's so many different topicswe could cover, but if we could start by talkingparticularly about inflation, because I know that something that you'vewritten about in The New York Times and what I'm interested in gettingyour view on is central banks were so in controlgenerally of how they affected markets for such a long time.And more recently, fiscal stimulus has been like an even biggerpotentially had a higher impact on what markets is doing.So how do you see like where we are positioned right now in terms of inflationabout the ability of central banks to actually control it?Yeah, you know, as I think of it, there's a dangerto have a central banker centric view of the universe whereeverything that happens on inflationis because of central bankers and they beat themselves up.Why don't we stop this?And then they pat each other on the back and say, okay,we'll raise interest rates and inflation will go away.It's critically important to figure outhow much of this inflation is from supply shocksand how much is from excess demand and stimulus, monetary or fiscal stimulus.The central bankers centric view of the universe really centers on that.It's demand and that the central banks, by raisinginterest rates, can cut the demand to get rid of inflation.But if you think a lot of it's coming from supply shock, that's not true.The central bank can raise interest rates and increase unemployment.But if the inflation is not comingfrom excess demand, that's that's kind of the recipe for stagflation.So those are the two biglessons of the seventies in the US experience.I think one is if you get inflation persistentit unhinging the expectationsand then you have a really hard time getting rid of it.But the other is if it comes from supply shocks,just the central bank acting alone is not going to fix it.And is that your view that that's the current state of play?Yes, you know, that debate and and I guess I'd put a little moreweight on the supply shock view than than some people.Not that it's a 100%.I do think that the Fed was slow to recognize.I fully understand why in March of 2020,when it felt like the world might fall apart,they would take extraordinary, unprecedented measureson both expanding the balance sheet and on the interest rate.I do think after about a year,it was clear that COVID would have negative effects,but it wasn't going to blow up the entire world.And so it probably would have made sense to us, inch ourselvesback to something like the conditions that existed before COVID.Rather than having to move more rapidly right now.But that said, I don't really seehow you could look at the US experiencewhere inflation ignitedwhen the unemployment rate was around 7%.How you could view it that that's not supposed to happen in the model.If it's just coming off of demand driven, it should have been likethree different times in the last 20 years or so.We've gotten the unemployment rate down to 4% or below.So I kind ofif you believe that it's 100% orpredominantly coming from excess demand,you sort of have to explainwhy inflation would ignite when the unemployment rateis still around 7% or measured of output.There's still a pretty significant output gap comparedwhere we thought it should be.Inflation really shouldn't startat that high of a levelunless something went dreadfully wrong on the supply side.So if you get supply shocks and now you add on top of itold fashioned supply shocks like war driving up the price of oil.The Fed's got to be mindful of that.And we still have yet to see that that shoe drop.I guess I would say it's going to be importantgoing over the summer and into the fallto see whether inflation's cooling down,if not or if so,the the kind of the blow backabout Fed action that they they should tighten.But if they tighten too much, they're going to generate stagflation.We still have to have that conversation.All right. You made an interesting point.And I think a New York Times article you wrotethat the Fed is going to have to consider how inflation is going to affect differentincome level families.Now, what do you what exactly did you mean by that?I mean, inflation does hurt people from different economicbackgrounds in different ways.But when you said the Fed is goingto have to think that through, what did you what did you mean?The first is just the factual matter.It was it was a piece I wrote that was drawing on a seriesof relatively new research by economists where they got granular,really detailed data on what each individual person's on an inflation rate.You know, and and if you look at that, it depends what you buy.You know, if you're a person who drives 30 miles to workeach day, then when the price of gas goes up, your inflation rateis going to be affected more than somebody who rides a bike or something like that.And by that idea, this research has shown thatover the last 15 or 20 years,inflation rates have been systematically higher for low income peoplethan they have been for the middle class or for high income people.The Fed outlined aframework before COVID, before we saw inflationin which they were mindful,explicitly were mindful of the way the dual mandateshould be applied or could be applied to different groups.So they were cared about full employment,but they were particularly going to be mindful that some groups fullemployment doesn't look that great and so that when they're setting policy,they were sounded like going to try to address some of these issuesof income inequality of differences in standardof living across different parts of the income distribution.My only point was you got to think about inflation when you do that, too.So everybody's looking at unemployment and income and wages, but it's importantto think about the inflation across the income distribution as well.So you mentioned the labor market, which is, you know, reasonably tight right now.And I'm interested what you think about immigration rules that have changedover the last, you know, five years with a previous administration.And there's something like 2 million less jobs, I think, coming fromforeigners coming to work.And that's just that's just legal.Legal, you know, immigrants.What does that kind of dynamic going to do?I mean, how does the labor.I mean, it's been devastating to the US labor market.If you look in pre-COVID times, pre-Trump timesalmost half the growth in the labor forcefor the US was coming from immigration.And part of that was centered around the decline of that.Part of it came from restrictions on immigration in the Trump administration,especially on the legal side, although all the public fighting is aboutillegal immigration coming over the border from Mexico,but the gutting of visas, student visas, high tech visas,all different sorts of legal immigration to the United States, that's beenthat that's been a very significant impacton labor force growth and jobs.And that got magnified, of course, once COVID began.And there were restrictions, nobody could travel.You can't leave your country, can't go to another country.I don't actually think that we can get back to where we were beforeunless we also havereestablishing of that pipeline of immigrationbecause the demographics of the U.S.native born population look just like the demographics of Europe,of Japan, of China and other rich countries,which is to say bad, you know, not the population.Yeah, slowing substantially or even declining.And so only immigration gives us that.Yeah. And to take that a step further,do you think we're now in a period of sustained deglobalization?I mean, we had globalization for so many years.Do you feel now that the deglobalization is set to be with us for a long time,which is obviously inflationary as well.And maybeit's certainly been felt deglobalizing the last two years,I guess I'm a little skeptical that it's going to truly go away.But part of that for the U.S.side depends on what happens in the elections.I mean, before COVID, there was clearly a heightenedtrade war kind of tension from the Trump administration.If Trump were reelected, I think for sure we would go back to that kind of dynamicif Trump were not reelected.I still think the there's big economies of scale.You can see in the problemsof the baby formula in the U.S., you know, right in the in the near term,it's not like having a America first approach.It solves the problems.I mean, in this sense, it created the problems.If you want a secure supply chain, it's better to diversifyeven outside of just just your own country.So I'm not sure.You mentioned the elections and know we've got the midterms coming this year.As you look out ahead, if I was to try and draw you in onhow you think they may go and the sort of impactthey could have either way on markets, how do you feel?Well, it's for sure the history says they're going to go real badlyfor the incumbent party.So I mean. They typically do.They typically do.And you add on top of it, there's a lot of discontent,a lot of partizanship and a lot of discontent about the economy.So, look, I think it's going to go badly for the for the administration.It is very likely to mean they can't do much on a legislative basis.That's not unusual.That's usually we in a way, we have one year terms for president.You've come in almost everything you're going to do legislatively.You do in that first year.And so that part, while frustrating for a White House, is not any differentthan any any previous period that we've had in in the country.What that means for markets, I don't think a lot kind of joke.At a previous midterm,somebody asked me, what do you think's the chance that they are ableto reach some bipartisan major legislation before the election?And I said 0% and they said,well, does that change in your view, if, you know at that time one party,but now the other, if the Republicans here win big?And I said, yes, I would cut that probability at half,nothing will happen.And in my view, nothing will happen.And in a way, markets are much more attuned right nowto the Fed, to the war in Ukraine, to what's happening in the supply chain.95% plus of what happens with economic growthin four markets has nothing to do with Washingtonand seven out of eight years, that's what it usually is.There's gridlock in Washington.They don't do anything.You know, the presidential term is one year long.Yeah. Yeah.Well, it's a tough time to predict markets right now.But Austin, thank you so much for your time. It's really great to have you.

Video recorded on June 2, 2022 at World Investment Forum

The Financial Times named him one of the six “Gurus of the Future”, Jon Stewart described him as “Eliot Ness meets Milton Friedman”, and he sat in the President’s cabinet under Present Obama who, of course, became President during the Financial Crisis. It’s fair to say that Austan Goolsbee knows what he’s talking about. In this insightful interview, Austan Goolsbee discusses in detail the difficult dilemma the Fed is in and how he sees the US economy today.

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