Read the full transcript:
Larry Bernstein:
Welcome to What Happens Next. My name is Larry Bernstein.
What Happens Next is a podcast which covers economics, finance, history, politics and current events.
Today’s session is on inflation and Fed policies to bring it back under control.
Our first speaker is John Taylor who is the Mary and Robert Raymond Professor of Economics at Stanford. John is famous for developing the Taylor Rule. John will explain his Taylor rule for setting the optimal short-term interest rate and why interest rates need to rise to quell rising inflation.
Our second speaker is Casey Mulligan who is the Ken Griffin Professor of Economics at University of Chicago’s Booth School and the Former Chief Economist for the Council of Economic Advisors in the Trump Administration. Casey will explain how government stimulus increased inflation and discouraged employment. He will also discuss his recent work in the pharmaceutical industry that shows how middlemen helped lower prices for consumers.
Our final speaker is Alan Auerbach who was my economics professor when I was a student at Penn. Alan is currently the Robert D. Burch Professor of Economics and Law at UC Berkeley. Alan will discuss the dynamics between current inflation and employment.
I chose the topic of inflation for this week’s podcast because the CPI statistic released this week was up 9.1% which was the highest annual rate of inflation since 1981. The price of energy is up 41% on the year, food is up 10.4% and all other items are up 5.9%. It is the ex-food and energy inflation that is most disturbing because it indicates the breadth of the inflationary problem.
The detail of the CPI report is also informative. Rent was up 0.8% last month alone which was the largest monthly increase in 36 years. Dental services increased 1.9% last month and was the largest monthly increase in dental expenses ever recorded. Motor vehicle maintenance rose by 2.0% last month, the largest increase for any month in 48 years.
Rent, Dentistry, and Auto Maintenance price increases cannot be blamed on fighting in Ukraine, or supply chain problems at the ports. This is good old-fashioned inflation caused by too much money chasing too few goods and services.
The Fed is raising interest rates but they are late to the party. We are going to hear today from a monetary specialist, a labor market economist, and a macroeconomist on how to bring inflation back under control.
John Taylor
Topic: What the Fed Needs to Do to Fix the Problem
Bio: Mary and Robert Raymond Professor of Economics at Stanford
Opening Remarks
The FED got behind the curve.
There was another period where the FED was behind almost as much, and it was back in the 70s, when Arthur Burns was the chair of the FED, President Nixon was the President of the United States. And Arthur Burns said, “Hey, it’s not us. It’s you.” And so, he convinced Nixon to have wage and price controls on the whole economy. And, it was a disaster. And eventually, people wised up and realized it was monetary policy and, we learned from that experience. But, what’s surprising now is the FED has never been so far behind, when inflation rate’s 5%, 6%, 7% even higher by some measure.
The 70s, the FED got so far behind, they had to catch-up. And catching up was damaging. So, this particular episode is different and inflation is not seven or eight years old, it’s a year and a half old or two years at the most. That’s what the advantages of a rule or a strategy is, the FED could indicate that, “look, we can’t have inflation this high and have interest rates this low. So, we’re gonna have to raise it.”
Some of the members of the FOMC have already begun to talk about that it has to be over 3% or so. What’s most important now is the FED indicates inflation is high, expectations of inflation are high, people are worried, we’re gonna have to raise rates. And that’s not bad, that’s good for the economy.
And quite frankly, the economy’s already slowing because people anticipate some kind of reaction. I’ll finish here, very important for the FED publish rules, that’s the hope why we could get out of this with much less damage than in the past.
Casey Mulligan
Topic: Government Stimulus Plans, Labor Markets, and Inflation
Bio: Kenneth C. Griffin Professor of Economics at University of Chicago Booth School and Former Chief Economist for the Council of Economic Advisors in Trump Administration
Opening Remarks
There’s talk about a recession right now, and this is an interesting time where we could have a recession by one definition but not by the other. GDP definition: looks like we could have a recession. But nonetheless, employment be growing during that GDP recession. By definition, that’s a pretty bad productivity recession, because productivity is GDP per worker.
But it was predicted. When we saw Biden’s agenda in 2020, we tried to work out the consequences. And there’s a lot of productivity-reducing elements of that agenda.
Maybe a bit of a surprise is how the Build Back Better hasn’t passed, which has tax increases on business built in. But inflation has done that work for Biden. Inflation amounts to a pretty hefty tax on businesses, because the business tax code is an index to inflation. To oversimplify a bit, businesses are experiencing a lot of bracket creep, to use the Ronald Reagan term, and that’s a big disincentive to invest. And investment’s one of the ways we get productivity.
Ultimately, the capital comes to businesses from people, so that is raising their cost of capital because their owners and their creditors are paying more in tax and getting less in return. It also happens on the business side. They’re allowed to deduct for their expenses for capital equipment and other investments.
But it’s based on historical, not based on what it costs to replace the car, truck, whatever. Inflation is driving up those replacement costs. The end result is big hit on the return to capital. And that’s a pretty effective way — we saw it in the ’70s — of really killing off business investment.
Alan Auerbach
Topic: Inflation and Employment
Bio: Robert D. Burch Professor of Economics and Law at UC Berkeley
Opening Remarks
I’d like to start with a quote attributed to Will Rogers. “If you find yourself in a hole, stop digging.” The US economy recovered much more rapidly than was predicted in the Spring of 2020. And fiscal policies adopted early in the pandemic played a role, but expansionary fiscal policy was pursued too much and for too long. In particular, the American Rescue Plan Act enacted in March, 2021, when the employment rate had already fallen to 6% and real GDP had already recovered beyond its pre-pandemic peak, provided $1.9 trillion in additional funding and tax reductions including large direct payments to household and substantial aid to state local governments.
Why did we do this? I think there are three potential explanations. First, we were still uncertain about the direction of the pandemic. And just as we underpredicted the strength and speed of the recovery at the beginning, we were also pretty uncertain even in the Spring of 2021, whether we’d have a relapse.
Second, some of our leaders were plagued by recriminations about not having done enough in 2009, and third a purely political explanation. They were in control of both houses of Congress and the presidency for the first time in a decade. And they felt that this was the time to stuff as much as they could before they lost the opportunity to do so.
Whatever the reason that’s where we are, what path should we pursue now for fiscal policy? Well, first do no harm that is stop digging. The debt to GDP ratio has risen from 80% of GDP before the pandemic to 100% percent now.
In the short term, we should try to reduce deficits through judicious spending reductions and tax increases. And the key here is to target demand and not supply that is seek policies that soften demand to help fight inflation but not restrict supply. This would also be a good time to address the long-term problems that have debt on an unsustainable trajectory. Entitlements: Medicare, Medicaid, and social security already account for more than half of the noninterest spending of the federal government. Do I think that this will happen in election year? Of course not, but the problem needs to be addressed at some point and the sooner the better, and we don’t have a recession to blame for not taking action right now.
Fiscal policy bears some of the responsibility for the inflation that we are currently experiencing and good fiscal policy can contribute to its reversal. Thank you.
INFLATION!