‘The stars look like they’re aligning for a gentle touchdown’ | USAEMALL.com

Good morning. Not all of our readers agreed with our confidence, expressed in yesterday’s letter, that above-target inflation is behind us. We’ll look at some of their arguments next week. If you see inflation lurking beneath the surface, tell us why: robert.armstrong@ft.com and aiden.reiter@ft.com.

Friday Interview: Alan S Blinder

Alan S Blinder is a professor of economics at Princeton University. He served as vice-chair of the Federal Reserve in the 1990s and on Bill Clinton’s Council of Economic Advisers, and is the author of several books. We spoke with him about the history of US monetary policy, what makes this cycle unique and much more.

Unhedged: You have argued that the Fed has engineered more soft landings than most people believe. Are we achieving a soft landing today? 

Blinder: I think it looks excellent. Some people are wringing their hands over signs that the labour market is weakening a bit. My view is the labour market was extremely strong. If it stayed that strong, the landing was going to be hard, as the Fed would have had to raise interest rates more aggressively. It seems the labour market is softening at a very gentle pace. And inflation is also mostly coming down, so the stars look like they’re aligning for a soft landing — and under what have been very, very difficult circumstances.

Unhedged: What makes this situation particularly difficult?

Blinder: First of all, part of the job was bringing inflation down from a high number all the way to 2 [per cent]. We’re not quite at 2 yet, but we’re close. And there were some severe shocks. The war in Ukraine, in addition to being a human tragedy, pushed up oil and food prices. So the background noise for the Federal Reserve as they tried to engineer a soft landing was much worse than, for example, the perfect soft landing that we managed when I was on the Fed in the mid 90s. I’m glad to share plaudits with Alan Greenspan for that — but it was much, much easier than what Jay Powell and his colleagues are trying to do now. 

Unhedged: Some people think the fall in inflation has more to do with supply and demand shocks associated with the pandemic working their way through the economy, rather than the effects of rate policy — that it’s better to be lucky than good.

Blinder: I agree with that. I only want to point up the other side of that hill. Those things were working strongly against the Federal Reserve as they tried to keep inflation at 2 per cent and of course, they failed to do so. I was arguing then, as I would argue now, that most of that very poor inflation performance was due to factors beyond the Fed’s control. The corollary to that is those factors reversed and helped bring inflation down rapidly. So it made the Fed’s job harder first, and then easier.

Unhedged: Can we know how much the increase in rates did to reduce demand and keep expectations anchored?

Blinder: “Know” is a very tough verb. We can estimate. There’s an interesting paper by David Reifschneider that used the Federal Reserve’s model. He attributes very little of the surge in inflation upward and, applying the same logic, the fall in inflation downward, to monetary policy. These are statistical estimates. That’s the best we can do. Now that’s not the only methodology you could use. And there are people out there who have suggested effects in both directions. But I am a lot closer to the Reifschneider camp.

Unhedged: How much do we need to be worried about inflation reigniting in the style of the 70s and the 80s?

Blinder: Hard to say, because it depends mostly on whether there will be unanticipated shocks. For example, given what’s going on in the Ukrainian theatre of war, there could be another oil shock. If the whole world economy is gaining strength at the same time — which I wouldn’t bet on — that would add to pressures on energy prices. That wouldn’t push core inflation up very much, but it would push headline inflation up quite a bit. It would take some very strange events to get a repeat of the supply constraints that we had from the pandemic. And then the third possible shock would be irresponsibly inflationary policies, be they monetary or fiscal. On the monetary side, I think that’s very unlikely. The central banks of the world, including the Fed, were chastened by the high inflation of 2022. 

Unhedged: You just mentioned a conflict between expansionary fiscal policy and contractionary monetary policy. Do you think this conflict will continue?

Blinder: It hinges completely on the election, especially who gets elected president, but also on the Congress. There is the possibility — especially in a Trump presidency — that the Fed would be fighting higher inflation from protectionist policies. If tariffs happen, it is like a supply shock. And central banks generally like to look through supply shocks, because they can’t do anything about them, and because they tend to be fleeting. It would be a one-shot increase in the price level, which tends to be transitory.

If there’s a budget explosion, which is possible from either party, that pushes aggregate demand higher than the Fed thinks is wise, the Fed will try to offset it. This has happened a number of times in US history. The most dramatic episode was President Ronald Reagan against Fed chair Paul Volcker. Volcker was raising interest rates a lot to fight inflation, and then Reagan came in and started cutting taxes. It was a big clash between monetary and fiscal policy. 

Unhedged: What do you think of the two presidential candidates’ economic proposals?

Blinder: It is highly likely that if there is a second Trump administration, there will be much higher tariffs, and those will be inflationary. It makes things more expensive, and they will invite retaliation from other nations, and they will be highly distortionary — as taxes always are.

Unhedged: Tariffs make things more expensive, but they’re intended to induce beneficial changes in the domestic economy.

Blinder: There are both beneficial and harmful effects. Let’s just talk about manufacturing. Some manufacturing that would be done abroad gets done in America instead, because barriers give an advantage to domestic producers. That’s the good side. The bad side is you increase the monopoly power of domestic producers, because they don’t have to worry about foreign competition. So it’s not just the foreign stuff that costs more. The American-made stuff will cost more, too. 

Unhedged: You have written about antagonism between Lyndon B Johnson and the Fed. Do you have any concerns about Fed independence in a Trump or Harris administration? 

Blinder: I certainly believe that Trump will try to undermine Fed independence. Whether he’ll succeed is another question. One thing we know he can do, because it’s perfectly legal, is replace Jay Powell. He will. End of sentence. What is worrisome to me is who he will replace him with. You may remember Arthur Burns, who was the Fed chair during the Nixon administration. Burns led the Fed to do Richard Nixon’s bidding to a considerable degree, helping him get re-elected In 1972. We paid the inflationary piper after that election, and after the price controls came off. Burns, at least, was a smart and experienced economist, who was just much too political. Trump could easily put in somebody who basically knows nothing about the job and could take orders from the White House. 

Unhedged: On the Harris side, she’s been a bit vague about policy, but she has talked about anti-gouging policies and intervening in the housing market. What can we say about a Harris administration? 

Blinder: It’s very hard to say for two obvious reasons. One is the adage: you campaign in poetry and you govern in prose. So when she becomes president, as I hope she will, we’ll see what she will actually do when there is an actual budget in front of her. And the second, is what will she be able to get through the Congress? I come back to the 50/50 Congress issue. If it remains split, it will be like shackles on whoever gets elected president. 

Unhedged: We enjoyed your piece on raising the federal minimum wage. Is that something you would like to see taken on by the next administration? 

Blinder: In writing that piece, I was trying, in my own clumsy way, to goad the Harris campaign to talk more about the issue. She does favour raising the minimum wage, but she never mentions it. I’d like to see it on the list of things she talks about. If she becomes president, she will advocate an increase in the minimum wage, and the Congress will pass it — because it’s enormously popular. 

Unhedged: Do you have any concerns about the flow through to inflation? 

Blinder: Not much. We’re talking about the way under 10 per cent of the labour market that is at the federal minimum, and wages are not the only aspect of cost. So a teeny bit, but not much. 

Unhedged: There is a traditional view that price controls are distortionary, and therefore dangerous to the functioning of markets. Why don’t you believe that applies to wages? 

Blinder: I think some of it does apply. But there are more important things than that kind of distortion, such as the humanitarian case. We’re talking about a very low number. If you were talking about minimum wages up where they are in many rich European countries, I wouldn’t be pushing so hard to raise them higher. But we’re talking about $7.25 an hour. It’s really disgraceful.

The main distortion that economists have traditionally expected from raising the minimum wage is killing some low-productivity jobs. But there’s a mountain of evidence, begun by Alan Krueger and David Card back in the 90s, suggesting that doesn’t really happen for modest increases in the minimum wage. So I’m not talking about going from $7.25 to $25 an hour or anything like that. If Kamala Harris’s team were to call me up and ask, I would probably say around $12 an hour in stages.

Unhedged: You’ve had a long career. What are the biggest things you’ve changed your mind about? 

Blinder: One has to do with the overwhelming importance of politics over economics, especially in macroeconomic and fiscal policy — but not in monetary policy, which is one of the reasons I value the independence of the Fed so highly. When I was a young tyke coming out of graduate school, nothing like that was on my mind. But I’ve learned that the politics of the day, including the attitudes and proclivities of the leading politicians and especially the president, are really determinative about what’s going to happen with fiscal policy, much more than economic considerations. 

We teach our students in elementary economics that when aggregate demand is too weak, you want to cut taxes and spend more, and when aggregate demand is too strong, you want to raise taxes and spend less. But look at what actually happens in the real world — it’s not so simple. That doesn’t mean the policy is always bad, but it’s not governed by the kind of economic principles that we teach.

The second thing, and it is especially underscored by recent experience, is that I’ve come to understand, not so much the why, but just the fact that people really detest inflation. We teach our students about the cost of inflation, and why it is harmful. But to my mind, none of those add up to the opposition to the inflation you actually see in the real world. I wrote a book in the 80s called Hard Heads, Soft Hearts, in which I argued that unemployment was a much bigger evil than inflation. And I still basically believe that. What I understand now is that the polity doesn’t believe that. 

One good read

Entrepreneurship in China.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.