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Today’s episode is about the Federal Reserve and a potentially frightening moment for the world economy.
Let’s begin the story in the US.
Last week, the Federal Reserve raised interest rates by 0.75 percentage points.
Yet again, this continues one of the fastest escalations of The Benchmark rate history and Jerome Powell the Fed chair warned that more pain was to come as the Central Bank fixes its eye of Sauron on our core inflation rate.
Now, the theme of today’s episode is that us interest rate policy does not stop at the US border or monetary policy is a lever that moves the world and soon after the FED announcement last week you saw the British pound crash oil prices.
Fell other currencies fell non crypto and the possibility of a global downturn.
A global recession is coming ever, more slightly into Focus, This is a part.
I think that’s gone under covered in a lot of financial news today.
The global effects of u.s.
Last week, I read an essay by The Economist Adam 2’s called the South Asian poly crisis.
I read it before bed, which was not a very good idea because this was the very opposite of a bedtime story.
It freaked me the hell out.
I don’t know.
A whole lot about southern Asia, but this piece was really revelatory The Economist choose offered a scary tour of Sri Lanka.
Where the public recently He stormed the presidential Palace and Pakistan where devastating floods and spiraling inflation have produced a political crisis inside a nuclear power.
Now, much of southern Asia, relies on other countries for their energy.
They need valuable currencies to buy that energy, but in the last few weeks their currencies have created against the dollar and that means the energy.
They so desperately need is getting more and more expensive to import.
That means it’s like the Federal Reserve in raising interest rates is incidentally, pouring gasoline on the fire of an energy crisis in Asia.
The domino effect sometimes aren’t very obvious but when you put them together it doesn’t look so good.
Indeed, what does it look like to be headed into a world where interest rates are rising?
Currencies are falling and the war.
In Ukraine, continues to scramble energy markets.
Well, today’s guest is here to answer many of those questions.
His name is Jason Furman return, guest, Jason’s a Harvard Economist, and former top economic adviser to President Obama.
We talked about the state of the US economy.
Why the FED is doing what it’s doing, the best arguments against what it’s doing Rising interest rates.
It’s the global Fallout of u.s. monetary policy and the possibility that the world economy is headed for a dark dark, winter.
I’m Derek Thompson.
This is plain English.
Jason Furman, welcome back to the podcast, great to be back.
So give me your temperature check on the economy right now.
Yeah, unemployment is very low, jobless claims are quite low, gas prices have fallen in the last few months shipping costs have come down.
That is all good news, but then there’s the core inflation thing, which is bad.
So what is your evaluation of the state of the economy at the moment?
Relative to what one would have thought a few months ago, the near-term imminent.
We’re in a recession risk is much much lower.
The economy continues to add an extraordinary amount of jobs month after month.
Yes, the unemployment rate went up last month, but it’s still very low.
And the reason it went up is because more, people were looking for jobs, not because people were losing their jobs, consumers, continue to spend just in general, you know, if you were worried, if two months ago, we were about to go into a recession that worry seems to have receded on the other side of the Ledger though, inflation is more of a worry now than it was even a few months ago.
A few months ago, you might be able to convince yourself.
That inflation was temporary due to the Russian invasion of Ukraine.
The fact that the core inflation rate when you strip out food and energy was so high in the month of August was I think the final nail in the coffin for that thesis because it showed in a month even when Gas prices were coming down that everything else, the prices of it were rising and Rising quite strongly so it’s a season of dying narratives.
The we’re in a recession narrative seems to be dead but the inflation is just transitory story isn’t doing so hot either last week, the FED raises interest rates again and I wonder why you think this is the right medicine for what ails, the economy.
When the FED raises interest rates, it reduces economic activity, it does that because it’s more expensive to borrow for a home.
So you’ll build fewer homes, some more expensive for a business to borrow plant and equipment so they’ll install less of it.
More expensive for consumers to borrow money for.
Let’s say purchasing a car so they’ll want to buy less of them.
All of these are about the same thing, it’s cooling off.
The amount of demand in the economy.
The goal isn’t to reduce load Job creation but that is one impact of it.
And by doing that it also will slow nominal wage growth which is a key driver of price growth.
So this is a whole chain of things but the brief version is reduce the forms of economic activity.
The FED can reduce and do that in a way, that reduces demand more than Supply.
So price growth and wage growth slows and it’s especially happens in sectors that are really sensitive to interest rate increases.
Interest rates go up mortgage rates.
Go up, there’s less demand for houses.
Theoretically the whole construction industry begins to slow because there’s less demand for houses and that’s a way in which the rising interest rate could domino effect into less wage growth and construction.
Maybe a little bit of less job growth in construction which cools off all the demand that comes from.
That sector, is it fair to say as and a lot of people I think on the left are already saying that the FED is somewhat purposely putting people out of work purposes.
Leslie slowing down the economy purposely driving us closer to the brink of a recession in order to / inflation.
I mean, cooling demand is a very nice Anodyne phrase that we can use, but there are other less, nice less Anodyne phrases that we can use to describe what the Federal Reserve is trying to accomplish in the real economy.
Are those descriptions from the left?
Fair, do you think I think they’re fair and actually chair Powell at his press conference last week.
Basically didn’t sugarcoat it.
He said that would be the consequence of what the Fed was doing.
Now from a policy perspective.
If you think the trade-off is between a shallower, slow down now, or maybe a shallower recession or a deeper recession, and even more jobs, lost in the future that to some degree, is the way the FED I think correctly is thinking about it and that world more aggressive action today.
Yes, it does cost jobs, but It would cost even more jobs if we tried to re-establish and get inflation under control after expectations had you know gotten you know out of control for several years but yes, absolutely it’s jobs.
Jason, What If the Fed just did nothing?
Like what if you’re on Powell got up there in front of the mics and the cameras and the journalist and said, you know what?
I’m just not really into doing this anymore.
Like, raising rates not for me.
The FED is quiet.
We’re just going to stop doing anything.
We sit around.
Hope everything works itself out.
What’s so bad about that?
What would be so bad about doing nothing?
I think it’s likely that if the FED stopped acting the stock market would be thrilled.
It would go way up.
Everyone would be wealthier.
Businesses would expect more near term demand and so they increase their hiring that Scramble for workers would lead wage growth to be even faster than it was.
That would lead Price growth to be even faster than it was.
And so we would end next year with an inflation rate higher than we have.
Now, we’d be even further from where we want to be know, if the trade-off here is, do you want a permanent 2% inflation rate or do on a permanent 3% inflation rate?
Now, that’s I think you could argue either side of that.
In fact, I’d argue the 3% side of that.
If however, the choice is on one side, you have an inflation rate that keeps Rising And on the other side, the inflation rate is stable.
It’s pretty hard to defend a policy course under which inflation rate will actually be faster next year faster the year after Etc.
And maybe just say one more thing on that because there’s a lot of listeners I have to imagine that our say under the age of 40 to 43 which means that they’ve never been alive during a period.
Like the mid-1970s when you really did have a wage price spiral we’re in Ation really did get out of control, why is that kind of scenario?
So, painful and horrible that it is worth this upfront, paying that the FED is delivering look.
If you want to say that you’re going to live with an inflation rate that’s Rising forever, then I think you can dispense with all of this.
Once you rule that out, you’re just going to need some way to keep inflation.
Expectations, to some degree, anchored, and long-term inflation, expectations have Ben, and you want to labor market where the state of supply and the state of demand are sort of balanced enough such that you don’t have just continually Rising nominal wages, which again it’s the main input into cost of businesses lead to continued prices.
So a lot of what we learned in the 1970s and early 1980s is that there can be this trade-off not between inflation and unemployment but between Rising inflation.
Ian and unemployment and that’s, you know what the FED is, you know, very correctly, worried about.
So given all the trade-offs and all the uncertainties that we face.
Do you think the FED is doing the right thing?
Yeah, so first of all, I mean, the most important thing is that people operate on a reasonable outlook for the future, and a reasonable menu of choices.
And so if you’re constantly thinking the problems just going to solve itself and so it’s a false choice.
We’re going to have inflation a say 2% and the unemployment rate, not rise.
I think that’s a, certainly a possibility, it’s not a probability, it’s not the most likely scenario.
There are all the things that you just pointed to for inflation coming down but let’s take one of them.
I can’t remember if you just mentioned it but the Baltic dry Index.
This is a measure of freight shipping costs.
It’s went way up.
It’s now come way down.
Some people point to that and say, inflation’s, going to go away.
Now, the problem is, if you look at the cost of goods in this country, only one percent of that cost is the cost of shipping and you look at Goods there.
Only, I think about a fifth of what our overall spending is.
And so if 1% of a fifth of overall cost goes down that just doesn’t matter that much for inflation.
So some of this is grasping at straws in the housing sector.
A lot of the measures people are looking at our four new leases and all the Listing leases that have not reset.
Yet which often happens if somebody moves sometimes, the landlord does it to you in Midstream, those haven’t reset to be as high as where the new leases are.
So even if new lease growth slows down there could be a year or two of higher growth in rent, underlying in terms of what people have.
And then there are some shoes that could drop the other way inflation in the feds, preferred measure in the last couple months have been held down by the fact that the stock Market fell, which means commissions on investment advice have fallen.
And when the stock market stabilizes, those commissions will stop falling and the FEDS preferred inflation.
Measure will rise as a result.
So, I think we don’t want to sort of grasp at straws on transitory it.
We may look out that may happen.
But I think ones best guess is that the choice is at very least, High inflation.
Versus unemployment, more likely Rising inflation.
This is unemployment.
So perhaps we don’t want inflation psychology to become sewn into the fabric of society.
That’s a good argument in defense of fed policy so long, as you limit your analysis to the US.
But of course, fed policy doesn’t just stop at the border.
It, intersects with global economics and last week.
Several other countries, Indonesia, Taiwan the Philippines, South Africa, Norway, all raise rates.
Is there a risk of everyone going so fast at the same time?
I am worried about that.
I am a little bit more worried for other countries than I am for the United States.
There’s a much larger and more imminent.
Recession risk in Europe over natural gas prices.
A larger fraction of European inflation is truly out of their control than is the case for US inflation.
Emerging markets that raise interest rates, it can have real consequences in terms of their fiscal.
Call sustainability, which can often be more precarious than the United States.
If the dollar strengthens against an emerging market, that means it’s more expensive for them to repay the money they borrowed and dollars.
I think this creates complications for countries around the world.
So, yes, I am nervous about all of that.
And ultimately, the FED needs to do what’s best for the United States.
And so, it should take that into account in so far as it spills back to the United States and for the United States, I am More confident that this is the right course of action.
Then I am that.
It is for sort of every other country that’s out.
There you mentioned foreign currencies.
And this has been a piece of huge Fascination for me in the last few weeks because one of the major themes of this year, is that Rising interest rates in the US have strengthened the dollar.
Another way to say that is that other currencies foreign currencies are weakening relative to the dollar.
So this year alone the pound is down 20%, the euro is down 15%.
The Canadian dollar is down 7%, turkey and Argentina.
Their currencies are down nearly 30 percent 1st.
Ed just a 101 level.
Why is this happening?
How does rising interest rates cash out in strengthening the US dollar against these currencies?
So, there’s two ways to think about.
This one is purely Financial Market.
Fundamentals, when interest rates, go up more and faster in the United States than they do in other countries.
And that’s what we’re seeing.
They are rising everywhere but the United States was the first and the fastest to raise rates, then investors want to move their money into the United States because they’re now getting a higher rate of return in the United States.
When you do that, move your money to the United States.
You’re buying dollars, you’re selling your own currency and that strengthens the dollar in addition to, that more fundamental effect that something psychological going on.
Whenever people get nervous about the global economy, they want to put Are money, wherever it’s safest.
And what is the safest thing in the world?
Pretty much always is the United States, United States, Treasury bills, and bonds, and that’s, for example, what you saw with the United Kingdom, even though their interest rates recently went up that in theory should have made the UK more and attractive as an investment destination.
But people were so nervous about the UK.
So nervous about the economy there that they said, you know what, we don’t want to be The UK, where what’s safe?
Well, we’ll put it into dollars and when people hero, you know, the pound fell twenty percent or, you know, Turkey is currency is his class by 30%.
I think a lot of people think to themselves, well, that sounds really bad, but like, wait, why is it bad?
What is specifically catastrophic for a country when its currency is declining in this way?
So it depends on circumstances when your currency declines.
It can help your exports which CH can strengthen your economy, sometimes that’s a good thing if you’re trying to get out of a recession.
If you’re trying to Tamp down on a boom and bring down inflation, that’s a problem.
Another thing is a lot of things people in the UK by are made elsewhere in the world.
They’re now paying 20% more for every single thing they get from the rest of the world, which I think is about a third of what they buy and their country.
So it’s going to raise their prices and raise their inflation.
And then finally an issue which the UK doesn’t have many emerging markets do is they borrowed and dollars.
And so if your turkey and your currency Falls by 30 percent, you’re going to need 30% more, Turkish lira to pay back one dollar of foreign to dollar-denominated debt.
Should I just try to put a couple things together here?
So South Asia and much of Europe.
Relies on energy Imports that are often priced in dollars.
Russia’s invasion of Ukraine and the Western sanctions that we passed to punish them for that.
Messed up Global oil and gas markets prices surged.
And then the FED started raising interest rates to fight back against inflation, that causes the dollar to strengthen against these currencies of energy importing countries.
Let’s just take those in South Asia, for example, Sample.
Its it makes it the these their currencies are weakening against the dollar, they still have to import all this energy, but the price of that energy just keeps going up and up and up.
So like putting everything together here.
Connecting the dots, is it fair to say that u.s. monetary policy is at least marginally contributing to the global energy crisis by increasing the cost of energy in these countries that are Are importing energy price in dollars.
It’s a good question.
There’s two effects.
One is the one you just described but also by reducing us demand, the United States is a huge user of oil and other forms of energy and that can bring the global price of energy down as measured in dollars.
So I don’t know what the net of those two is.
It’s possible that somebody out there does but it is true.
That when the United States raises rates in general, it’s exporting some inflation because the dollar gets stronger that means it’s cheaper for Americans to buy stuff.
It’s more expensive for foreigners to buy stuff and you know, it makes life a little bit harder for other countries, trying to manage their inflation, their macro economies their deaths.
Let’s talk about one of those countries that is severely struggling to manage its inflation and manage its Basically everything and that is the UK on Friday.
Last week, the new British government announced.
This sweeping series of tax cuts that to my I got the worst critical and financial review of like any public policy.
I can remember, Britain’s Benchmark.
Stock index fell 2% the pound immediately dropped three percent.
It’s like one of these things where, like, if economic policies were movies, this would have gotten like a Rotten Tomato score of zero.
Or like you know, maybe one of the Prime Minister herself were given a vote, why was there?
Action to this move in the UK.
Maybe just tie that into I should have asked this as a Prelude tie that into the specific economic challenges that Britain faces right now.
You I think you described it.
And what makes it even more remarkable?
Is that Liz trust?
Who’s now the Prime Minister campaigned for the last two months on doing something like this.
So this was not a complete out of the blue, surprise Financial margin say what she did.
Because I barely described it.
What what is the actual plan that got the horrid reviews.
So it basically is lots and lots of tax cuts without any statement about how to pay for them, some of them is for People’s Energy bills, some of them are reducing the tax rate on the top tax rate in the UK, which I think is around two hundred thousand dollars or something in that neighborhood there where it starts, some of it is some other taxes and levies.
Is that were suspended and they didn’t say anything about how this would pay for.
They didn’t show any sort of budgetary analysis, economic analysis, distribution analysis, the things you’d normally do.
There were rumors, they were going to try to take away the independence of the bank of England.
She is upset that.
The bank of England is Raising interest rates thinks that is hurting the economy campaigned criticizing that they reaffirmed the independence of the bank of England.
But they They said that the head of the bank of England would have to meet with the chancellor of the exchequer.
Their treasury secretary equivalent would have to meet twice a week.
And so there’s a little bit more of a gnawing fear.
Now, that the UK will slowly erode the independence of the bank of England and make it just set, interest rates, in whatever way is most useful to the government in the short term.
You guys did it well, but I think it leaves a bit of a mystery which is, you know, why would tax cuts for the rich cause the stock market to crash like, typically you would think, at least in America, like, I’m not even gonna pretend that I understand the psychology of any Market, but I at least half an hour, Shanna psychology, the American markets.
I feel like, historically in the US, if the federal government says, hey, all the fat cats out there, get a big massive tax cut.
Congratulations, I would think the stock market would go up.
But instead, the exact opposite happened in the UK.
So the biggest reason is that the market thought this would cause more inflation.
And that would cause the bank of England to raise rates more quickly or they thought even five or ten years down the road, not quite sure how the UK would deal with all of its debt.
And so maybe it would have a big doubt of inflation and five or 10 years to get rid of all its debt.
Either way, the same thing happened which is to hold UK debt you demanded, higher interest, rates, and interest rates were the most notable thing.
They Rose The Five-Year interest rate, one of the benchmarks people.
Look at for the UK.
Think might have risen more than any other day or certainly it was in the top two or three for two or three in the past half-century.
Now the stock market is very closely tied to interest rates one, simple way to think about it is when interest rates go up, well, you might as well put your money in bonds.
They’re now getting a good interest rate, you move them out of stock.
X and stocks go down.
There’s other equivalent ways to think about it, but I think that’s the simplest one.
So, basically in the UK, what they did, and this is something, you know, I teach in my class, which is when you borrow more money that drives interest rates up in the UK, it turbocharged.
That because of the short-run fears about inflation, the long run, fears about solvency and whenever interest rates, go up, you tend to see the stock market go down, and that’s what happened there.
So it’s not just the UK that is facing an inflationary crisis.
It’s all of Continental Europe.
I think one potential piece of curiosity, for some listeners.
Is that in the u.s. gas prices have been falling now?
For two months?
Maybe more than two months in Europe?
However, they’re dealing with catastrophically increasing Energy prices.
What’s the difference?
Why is the European energy crisis headed in such a different direction than the u.s.?
So your app has a big inflation Ation problem that the underlying inflation rate is a little bit better than the United States, but the energy inflation rate is much much worse and that’s because they rely, they relied heavily on Russian natural gas.
That natural gas has been shut off.
Oil were very used to.
It has roughly the same price everywhere in the world.
There’s some important caveats but it’s roughly the same and that’s because it’s really easy to transport.
Oil natural gas is much harder to transport.
You need to turn it into a liquid.
You need to load it in special ports, you need to unload it and special reports.
They needed to be connected through special infrastructure to other parts of the energy system.
And so the price of natural gas in Europe right now is just much, much, much higher than it is in the United States.
And that’s the key way in which electricity is being made.
At the same time, you see European countries like Belgium, Took a nuclear plant responsible for ten percent of their electricity offline.
You can debate how important nuclear is over the medium and long term for climate change.
Don’t think there’s any argument for taking it off.
Line in the year 2022, in the middle of an energy crisis.
And now we have something with your upwards if you want to forecast the European economy over the next six months, you have to forecast.
Something that normally isn’t a key economic variable which is how cold the winter is.
I’ve rarely thought That when thinking about what’s going to happen in the business cycle, but if your app has a cold winter, it’s going to run through the national natural.
Gas storage that it’s built up.
It can’t get a whole lot of it very quickly.
And so the price will Skyrocket, some industry could grind to a halt and it could be that much worse recession.
If winter is say 5 degrees colder than what you might otherwise have expected.
No it’s almost profoundly medieval To have to factor in future temperatures into economic analysis, like the temperature is going to fall so much.
The people literally will not be able to work.
Entire sectors might be shut down because they won’t be able to supply.
Those particular Industries with sufficient energy, putting all of this together.
The fact that Europe is facing a potentially freezing winter with very limited energy resources.
The fact that England is being excuse me, the UK is being led by a really cockamamie.
Policy on top of skyrocketing inflation, the fact that the appreciating dollar and weakening foreign currencies are exacerbating energy crises all over the world.
It just really does seem to me like the global economy is in a lot of trouble and my friend and axios economic correspondent.
Neil Irwin was tweeting quite gloomily late last week, where he said, quote, it feels like today.
This was last Friday, might turn out to be a momentous day.
An economic Financial history in ways that aren’t known to the vast majority of people at the time, a wee bit, like, August, 9th, 2007, and I asked him, what are you talking about?
Why are you getting a little bit of a sort of global economic recession, Vibe out of the last week’s news?
And he said, broadly, after 15 years of negative real rates, and Costless debt accumulation the world financial system is adjusting to positive, real rates and high debt, overhang, and it’s going to be a very, very bumpy ride.
To what extent do you think that this somewhat gloomy and maybe catastrophic or maybe very realistic?
Analysis, is in keeping with how you see the global economic picture?
Yeah, I am more nervous about most every other country in the world than I am about the United States, and don’t get me wrong.
I’m nervous about the United States to I’m just talking about relative magnitudes of nerves and in part it’s because the natural gas issues in Europe.
We were talking about the Emerging Market debt issues.
Is and a range of other factors.
But you know, the question though is, how should one operationalize this nervousness?
And if part of the problem that we have is that, you know, markets were overpriced because they thought interest rates were going to be low forever and inflation was getting out of control.
Because by the way, the unemployment rate is at the bottom of the range.
It’s been at for the last 20 years in most European countries right now to.
It’s not just I’d States if all of this happened and you try not to address that underlying inflation problem, maybe you have, you know, the problem might be even harder to deal with a year or two.
From now, I don’t want to talk anyone out of their nervousness, though.
I think I’d be really nervous if people weren’t nervous if people weren’t constantly monitoring and revisiting this question but you know, fundamentally I go.
Back to where we began in our discussion.
The unemployment rate is low in the United States.
Job creation is high in the United States.
That part of the feds mandate is satisfied.
The inflation, part of the feds mandate is not close to being satisfied and so I think they really do have to do what they’re doing.
I like that.
You said, by the way, how should I operationalize this nervousness?
And we recently had a psychologist on the show talking about negative self-talk and I feel like that’s something that he might have said, how should we Operationalize our own nervousness.
So at least we’re having a little bit of thematic consistency between our macroeconomic and psychology episodes.
Very last question for you is, you know, I’m not, I don’t think I’m very good necessarily at seeing the way that these dominoes, click into each other, especially with involves Global economics.
There’s just so many things that you have to maintain awareness of to see exactly how different things affect each other.
But but I’ve mentioned a couple domino pieces that I’m nervous about.
You know, I’ve mentioned the sort of South Asian energy crisis, I mentioned the top of the show and my open about how I’m particularly nervous about some countries, like Pakistan and India, and how a combination of economic crises and political crises, maybe even climate crisis.
Could create really, really terrible situations.
There is there a domino piece that you’re particularly worried about that?
I haven’t touched on Some way that what’s happening in energy markets right now.
And what’s happening with central bank rate raised in Behavior right now.
Could really create a problem for the world that I haven’t brought up in a question.
I think you brought up a lot of the different issues.
I do think we want to differentiate the world.
If you’re a commodity exporter and commodity prices food, prices, for example are right higher, very high right now for commodity exporters that’s a good thing.
NG for commodity importers that a bad thing the way an Emerging Market we tend to lump them all together.
But the way you handle the policies coming from the United States have a big impact on how they affect you turkey has handled them, you know, disastrously with disastrous consequences as other countries that have done a better job.
So there really is quite a lot of variety out there and maybe the thing I’m most Nervous about the would be the political economic feedback effects, High inflation, tends to destabilize governments.
It can bring populace to power some of the remedies for high inflation themselves will cause more inflation and economic pain.
For example, what we’re seeing in the UK turkey and some other countries.
And so you have this negative feedback loop between political stability and economic stability.
Leti, that could sort of spread those policies, which I think do matter quite a lot in terms of how you handle this and spread the bad ones and constrain the good ones and and make the problem worse.
Thank you very much.
Jason Furman, really appreciate it.
I always love talking to you Derek.
Thank you for listening.
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