John Donvan

It may seem that only economists are really into talking economics, but that is not so true when the economy is up to something that the rest of us are experiencing and we want to understand why it’s going on, especially when it’s painful. And so here we are: inflation at a 40-year high. And we are all feeling it, and we’re also hearing, if you follow the news at all, that there is something being done to try to get it under control, which is the Federal Reserve Bank raising interest rates.

But really, do most of us understand how that works or, or how it’s supposed to work and how fast it’s supposed to work so that we can get past this time? And when you hear it said that the Fed is aiming for a soft landing, what does that mean? What is the Fed actually trying to land? And can it pull off this soft landing, which sounds like the right kind of landing? Well, that’s where our two guests are going to disagree. They are going to debate the question, can the Fed manage a soft landing? My guests, our debaters, include Yeva Nersisyan. She’s an economist at Franklin & Marshall College. Yeva, welcome to Agree to Disagree. And right now, I’m just looking for a yes or no. Can the Fed manage a soft landing?

Yeva Nersisyan

I’m going to say no.

John Donvan

Joining us as well, Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C. Dean, since Yeva is the no, that makes you the yes. Can the Fed manage a soft landing? You’re a yes.

Dean Baker

Yes, and I think it’s already most of the way there.

John Donvan

Okay, great. So l- let’s get started with some terms. Can the Fed manage a soft landing? Yeva, you are saying no, but tell us first, what is presumed by this question? What, what is the Fed trying to land?

Yeva Nersisyan

Uh, sure. So, um, what the Fed is trying to land is basically the economy, because of the idea that it’s probably flying too high, and inflation is supposed to be a sign of that, and we’re trying to cool down the economy, and we’re trying to do that without causing a recession or raising unemployment or raising unemployment too much. So that’s what the Fed is trying to accomplish with a soft landing.

John Donvan

Dean, do you agree with that? Any disagreement with that definition?

Dean Baker

No, that’s exactly right. So just to be clear on what we’re talking about here, the economy was growing at a incredibly rapid rate in 2021 coming out of the pandemic. And the concern just is that inflation continues, that we have very high inflation not just, uh, this month, this year, but for the rest of the decade. And I think most of us would agree that would be a problem.

John Donvan

And, and, and what would be a hard landing? What’s a bad landing?

Dean Baker

Well, a bad landing would be a serious recession. So we’re very fortunate, and we have a 3.6% unemployment rate. That’s basically a 50-year low. This has barely been talked about in the media. You’d think that we were in the Great Depression. Well, the hard landing is you go far away from that. Instead of 3.6% unemployment, maybe we’re talking about five and a half, six, seven percent unemployment.

We’ve seen that. It’s not ancient history. We had that in the Great Recession. We had unemployment over 10%. We can go back to the 1980s, early 1980s, when Paul Volcker wanted to combat inflation, sent interest rates through the roof. We got double-digit unemployment. So th- that’s a hard landing story. I mean, I’m hoping we’re not gonna see anything like what Volcker did, but that, that’s, that’s the bad story.

John Donvan

All right. So, so Yeva, your position seems to be that you’re arguing that the bad story is the likely outcome of what the Fed is doing now. Do I have that right?

Yeva Nersisyan

Right. I, I don’t think the Fed has a lot of tools in its disposition to affect the rate of inflation, and, uh, the inflation that we’re seeing is a supply side issue. Because of the pandemic, we are seeing a lot of inflation. So I’m surprised when people, in the same breath, they would say, “We have an inflation that’s coming from t- d- difficulties on the supply side, yet we are going to use the Fed to solve that problem,” when the Fed has no tools to combat any supply side difficulties. The only tool it has is the interest rate, and it’s a very blunt tool for trying to do anything about inflation.

Dean Baker

Yeah, I would agree that the Fed has very limited capacity to solve the supply side issues, but I’ll go back to, you know, what are, (laughs) what are the supply side issues? These are largely a transitory story, and we’re getting through a lot of them. So this was, these were supply chain problems associated with the pandemic, so we had shutdowns in not just the United States, but around the world, and what that meant was we were buying a lot of things. We had this huge shift in demand from services.

People didn’t want to go to restaurants for obvious reasons. People weren’t traveling for obvious reasons. So they weren’t buying, weren’t spending money on services that they would ordinarily purchase. Instead, they were buying things. They were buying cars, trucks. They were buying clothes. They were getting appliances for their households. So there was huge, huge demand for goods, and the economy couldn’t meet them. Those, this was the supply chain story.

So both you had this big surge in demand, and you had supply at least temporarily incapacitated. But the reason why I’m an optimist on this is we’re largely through that. So if you look at things like inventories, they’re through the roof. So I think we’re largely through the worst of that. There’s still supply chain problems. We had this story with cars where the, the major manufacturers haven’t been able to produce as many cars as they would ordinarily because there was a fire at a semiconductor plant in, i- in Japan, and there are very, very few semiconductor factories in the world. So there’s, this worldwide shortage of semiconductors meant worldwide shortage of cars, and car prices went through the roof. So as a result of that, we saw big, uh, a big contri- contribution to inflation of cars. But semiconductors are now being produced in larger numbers. We’re getting through that.

John Donvan

Dean, are you, are you… It sounds like you’re not crediting the Fed. You’re just, you’re saying-

Yeva Nersisyan

Right.

John Donvan

… it’s happening anyway.

Dean Baker

Absolutely. Absolutely. That’s why I said we’re most of the way through it. I- if I want to get my punchline here, the Fed’s role, w- where the Fed’s had a huge impact, we saw a huge surge in house prices. House prices rose more than 30% over the last two years. I wouldn’t say it was a bubble, but it was getting to be a bubble. That’s been pricked. The Fed raised rates. Mortgage rates jumped from 3% last summer. They hit, they were over 6% a, a few weeks back. They’re down now again. They were around five and a half. I’d have to check the latest number. But that took the air out of that bubble.

Yeva Nersisyan

Exactly. The supply (laughs) side problems were transitory, and they are getting solved, but they’re not getting solved because of anything that the Fed is doing. I think we can agree on that. So if the supply side issues are getting solved, and if the demand is not, you know, there are no forces pushing demand any higher, because all of the support that the government added to the economy, that has already expired. You know, most, most of it is gone. And so we actually have major, uh, fiscal contraction.

Uh, President Biden was bragging that the deficit was down something like from 14% to 5.3%. Well, that’s a major fiscal headwind that the economy’s facing. That means that the, the government is not adding as much to demand. So if the demand is not being boosted, and if the supply problems are getting solved, then why are we raising interest rates, right? So, (laughs) you know, what Dean was saying is, is that we’re doing that for the housing, but housing is very, very much different and it’s very separate from the inflation that we see being measured, because home prices do not go directly into the inflation measures.

So if you look at something like the CPI, it has a component that’s called rentals, so those are actual rentals, and it has a component that’s called imputed rentals, so basically, how much you would, rent you would pay to rent your own place that you own. Right? We’re trying to measure, uh, measure that. Now, if the Fed starts raising interest rates and fewer and fewer people are buying homes, what does that mean for rentals? Well, my, (laughs) my, uh, you know, prediction would be that if more people need to rent, that probably means rentals are going to go up.

So if rentals are going up, that could contribute to CPI inflation. And if rentals are going up, that could also raise that imputed rentals, because we look at how much s- a, a comparable home is renting, and we say, “Okay, this is how much you would pay to rent your own home.” I’m simplifying, but that’s basically the, the id- the idea. (laughs) So if rentals are going up, we could actually see a lot more housing inflation that is measured in the CPI.

Now, I’m not saying that something shouldn’t be done about the housing market. The affordability is, the unaffordability is very problematic. But think about it this way. If the Fed is raising interest rates, uh, does that mean we’re going to be building more homes? I think the answer is no. We are going to be building fewer homes if interest rates are going up, because enterprises have to borrow money to build housing, uh, rental housing and other kind of housing, single home and so on.

And so if the Fed is raising interest rates, that’s not going to help alleviate the problem of housing shortage, ’cause we have a problem of housing shortage, not necessarily a problem of too much demand in the housing sector, and that’s where the Fed (laughs) cannot do very much. And in fact, the only thing it can do is changing interest rates, and raising the interest rate is going to be counterproductive there.

John Donvan

So, so Dean, we, we’re hearing Yeva say that the, the Fed’s current pr- program of raising rates is likely to cause more problems than solve problems. And, and Yeva wrote this line in an article with her colleague, Randall Wray, uh, recently in a piece in The Hill. “The Fed has never managed to guide the economy to a soft landing with rate hikes.” What’s your response to that statement that the Fed has never managed to guide a soft landing with rate hikes? Do you agree?

Dean Baker

Well, there, there, I think it’s complicated. (laughs) I’ll put it that way. Um, it, it’s, it’s not done a very good job. It’s tended to overshoot. But part of it is, what, what are they trying to land? So if you go back to the mid ’90s, Greenspan raised rates. I wish he hadn’t, but you can go back to ’94 to ’95. He raised the, the rate directly, the short-term rate directly under the Fed’s control, the federal funds rate, from 3% to 6%. The economy did slow down.

Was that a soft landing? Well, what were we trying to land from? I mean, to my view, there was no reason to do that. Inf- inflation wasn’t particularly out of control. But it did not bring about a recession, that’s for sure, ’cause the economy then had very good growth ’96 to 2000. In fact, it was a boom. So I don’t know. So it gets into a question of definitions. I don’t think it’s terribly helpful. The Fed has engineered slowdowns in the economy, again, oftentimes in ways that I don’t think were good, but it has done that.

But I think the main story here, and I, I think Yeva and I agree that the problem with inflation was the supply chain issues, and those are transitory. I give the Fed much more credit in housing, ’cause if we think more carefully about what the housing market looks like, I think ownership and rent is connected in the sense that a lot of people looking to buy homes… I realize it’s not most people, but it’s enough, are looking to buy second homes and also people looking to move up.

I, someone’s living in a two bedroom, whether house or apartment. They’re gonna l- move to a three bedroom, four bedroom. That’s not happening now, or at least it’s happening in much lower numbers. That feeds back to rent, and we’re seeing that. So there are rental indexes that th- there’s a little complication there ’cause people start jumping up previously about rent rising so rapidly and, uh, that now there’s evidence it might be falling.

Most of what’s in the CPI is rent and people staying in the same units. People don’t typically move. I realize some people do, but most people live in the same place this year, next year, and the year after. So the CPI rental index doesn’t move anywhere near as much as these market rental indexes. So those are saying, “Okay, if I want to rent a place, what’s the price today?” So those showed much more inflation in 221 and into 222 than, uh, the CPI. Now, many of those are showing price declines.

So I think we are seeing the impact of lower house prices that, uh, we’re basically seeing… I won’t call it a glut, but we are seeing more housing on the market. And demand did play a factor here. I’ve followed housing very, very closely here for decades. Back in the bubble years, (laughs) I was following it very closely and yelling about it, and no one seemed to care. But anyhow, we’ve under-built housing the last decade, ever since the, the, the crash of the housing bubble, so that was the supply problem. But the sudden increase, when we saw rent, when we saw house sale prices increase by 30% over the last two years, that wasn’t supply. That was demand. And again, the Fed nipped that in the bud with its rate increases. Whether that was their thinking, I don’t know, but that was a really good thing.

John Donvan

More from Intelligence Squared U.S. when we return. Welcome back to Intelligence Squared U.S. Let’s get back to our debate. Yeva, your thoughts?

Yeva Nersisyan

Yeah, so I mean, I, I would agree, uh, with some of what Dean said. So yes, obviously we have under-invested in housing because of the Wall Street dr- driven housing boom and the consequent bust, right? So for many, many years, we have under-invested, and therefore, we, I would say we do have a shortage of housing, right? It’s true that the increase in demand after the pandemic is what led to higher prices, but if you’re trying to think of what is the problem that we’re trying to solve, we’re trying to get people into shelter, right? We’re trying to get them into houses, right?

So if they can afford to buy more, but we don’t have enough, right, as a society, I would say it is very much a supply problem. And, um, on the demand side, sure, some people are buying second homes, and there are a lot of hedge funds that are buying houses, single family homes that they’re going to convert into rentals. I think that’s a problem. So if we want to do something about it, we should do something about it.

And that leads me to a bigger point, that, uh, sort of putting all of the, uh, responsibility for inflation on the F- uh, on the Fed is kind of a cop out for our elected representatives, for the administration. You have people who work for the administration who say… Well, whenever you ask them a question about inflation, they point to the Fed. “The Fed is gonna do it. The Fed is gonna do it.” I see that as a cop out, right, uh, instead of taking responsibility, Congress, right, (laughs) our elected representatives, the administration who we’ve elected, the president at least, right? So, um, they’re not doing something that can be done, such as increase [inaudible

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John Donvan

I, I, I, Yeva, if I could, if I could break in on you, I would actually like to explore that point, but not quite yet.

Yeva Nersisyan

Okay.

John Donvan

Um, I want to go back to dig in on your statement that the Fed has never-

Yeva Nersisyan

Yes.

John Donvan

… managed to guide the economy to a soft landing with rate hikes, which i- i-

Yeva Nersisyan

Yes.

John Donvan

… it’s, it’s, it’s very profound because it says what’s, what’s happening now is not gonna work, or, or has never worked and is not likely to work, therefore. So make that case that it’s-

Yeva Nersisyan

Yes.

John Donvan

… it’s never worked before.

Yeva Nersisyan

So, um, I would argue that the Fed has never been able to, uh, land the economy… In other words, it has never been able to lower inflation without increasing unemployment. Now, many economists, I would say most economists, and I don’t know if that includes Dean, believe in something called a natural rate of unemployment, that there is this rate of unemployment in the economy that’s somehow natural, that we can not permanently lower the rate of unemployment below that rate, and if we tried to do that, we’re going to see inflation.

And that, that leads us to, uh, statements like, “Well, if the unemployment rate is 3.5%, it’s too low,” right? So economists like that believe that the unemployment rate can be too low and, you know, therefore, it’s inflationary, and so, and hence the Fed should intervene by raising interest rates. I’m, I’m not a subscriber to that theory. Uh, in fact, I would point out to the interest rate decreases by, uh, Powell. So Powell lowered interest rates after Yellen had actually raised them, right?

And at that time, the unemployment rate had gone down so low, and if you looked at econ- like, economic theory predictions, we should have seen skyrocketing inflation, right? It was below this natural rate of unemployment. But we did not see that kind of inflation. In fact, Powell lowered interest rates and the recovery just kept going until it was interrupted by, by the pandemic. Um, now, every other time before that, whenever the Fed has tried to end- like, lower the inflation rate, they have done that at the expense of higher unemployment. Perhaps Dean doesn’t think that if you raise the unemployment rate by one percentage point or something like that, that’s, that’s, that’s a problem. So in other words, if you, um, don’t cause a recession, but still raise unemployment, I see that as a problem, and I don’t see that as a policy success. And-

John Donvan

So you’re, you’re, you’re saying, Yeva, that in a sense, the Fed is using unemployment to lower inflation, that that’s the seesaw?

Yeva Nersisyan

That’s exactly right.

John Donvan

All right. You, you, you’ve said a lot. I really want to let Dean respond to some of that, so go for it, Dean.

Dean Baker

Yeah, I’d agree with almost everything there. Um, I’m not a fan of the natural rate. I’ve been arguing against it forever. I mean, uh, (laughs) we, we’ve joked about that, that, you know, like, what do these economists get to do? It’s, you know, uh, be a philosopher of science. I mean, with the natural rate, you go, “Okay, where is it?” Back, you know, I was referring to Greenspan raising interest rates in ’94, and d- none of this was a secret. It was all very public. He said, you know, “We’re, we’re hitting the natural rate,” which at that time everyone said was 6%.

I had economists ridiculing me ’cause I said, “I don’t believe that. I think it can get lower than that.” And they said, “Oh, that’s absurd. That’s silly. That’s…” You know. Well, we got to 4%. The unemployment rate, uh, year round average in 2000 was 4%. There was no problem with inflation. Um, so now, uh, you know, and again, it’s why I was a huge fan of Powell being reappointed. He broke with Yellen, who I thought was, in the scheme of things, a pretty good Fed chair, but Yellen was raising interest rates her, her last year or so as Fed chair, 216, 215, 216.

Um, Powell was continuing that. And then he said, “Well, I don’t see any problem with inflation. Why don’t we lower them?” And he did, and the unemployment rate, the economy continued to grow. The unemployment rate got to three and a half percent. And the great thing, and here maybe I d- differ a little with Yeva, we did actually see wage increases. So you had real wage growth of about 1% a year 216 to 220, til the pandemic. And disproportionately, the people who benefit from low unemployment are the most disadvantaged in the labor force, so Blacks, Hispanics, people with, uh, with less education, uh, people with criminal records.

Those are the people who get jobs. Those are the people able to get wage gains then. So for me, getting to low unemployment is very, very important. And again, I thought it was fantastic that Powell, uh, was willing to take that risk, ’cause a lot of economists said, “No, inflation’s gonna go through the roof.” Um, it didn’t. Um, and, you know, again, I’m hoping we can get through this period. But again, most of the problem… Again, Yeva’s right. Insofar as we’re getting inflation down, most of it’s correcting supply side issues.

Again, I think housing is different. I think the Fed’s role there was tremendously important. They did what needed to be done. I think we’re gonna be back on a better track with housing. I should also point out in terms of construction, one of the issues why we weren’t building more homes was the supply chain problem. So housing starts had, had soared in 220, 221, following prices. They went from about 1.3 million a year pre-pandemic to, to around 1.8 million, and, but completions were still only around 1.3 million.

[NEW_PARAGRAPH]That’s ’cause builders couldn’t get wood. They couldn’t get garage doors. There were all these stories. They couldn’t get, you know, couldn’t get the things they needed to finish a house. That’s changing now. Completions are starting to rise. So interest rates are a negative for construction, no doubt about it, but when you have prices that are 30% higher than they were two years ago, that’s a really big incentive for builders to build more houses.

Yeva Nersisyan

Well, I think Dean just made the case for why the Fed shouldn’t raise interest rates further. (laughs) Right? Because he’s saying that the inflation problem is getting solved without necessarily, uh, uh, having anything to do with the Fed except for the housing market, right? Everything else is sort of happening independent of the Fed, so then what is the case for rate hikes? And I would say, and I, again, I would credit Powell as well, and I would say the reason, probably, why Powell did what he did and broke away from economic orthodox is because he’s not a professional PhD economist, right?

Dean Baker

Yep. Yep.

Yeva Nersisyan

Uh, (laughs) so I think that’s why. And, and so what, what I want to, uh, say is that the Fed doesn’t have a theory of inflation. And, and insiders from the Fed have said as much. We’ve had Governor-

John Donvan

What… Wait, wait. What does that mean, that they don’t have a theory of inflation?

Yeva Nersisyan

Well, they, (laughs) they don’t have a theory of how what they’re doing is supposed to do anything about inflation, basically. Uh, Fed governor, or former Fed governor-

John Donvan

Wait. I’m, I’m stunned to hear you say that, because I thought that was their reason for being.

Yeva Nersisyan

Well, since the 1970s, that’s what we are told, but that wasn’t always the case. The Fed was created to supply elastic currency, in other words, to, uh, allow the money supply to expand as the economy expands, uh-

John Donvan

Mm-hmm.

Yeva Nersisyan

… so, so that we wouldn’t have currency shortage, and to act as a lender of last resort for financial institutions so that illiquid financial institutions wouldn’t become insolvent and we wouldn’t have a Great Depression style financial crisis. I think that [inaudible

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John Donvan

Okay, but since, since the 1970s-

Yeva Nersisyan

Yeah.

John Donvan (20:53):

… since the 1970s, it’s what they’re supposed to be… It’s one of their remits, is it not?

Yeva Nersisyan

It is. And I think there has been some, um, uh, you know, dissenting views from within the Fed. We’ve had, um, Jeremy Rudd, who’s an economist, Federal Reserve Board economist, he wrote a 2021 paper where he basically (laughs) argued that the Fed doesn’t know what it’s doing. Uh, they have this view of expectations causing, uh, inflation expectations causing inflation. Uh, there is sort of no logical way in which that works for the U.S. economy in 2022, because the idea is that if workers expect more inflation, they go and negotiate for higher wages, and, and then wages are higher, and that feeds into inflation.

So this, uh, expectations of inflation then create actual inflation. It, I mean, anybody who’s listening right now would say, “That’s not how wages are negotiated.” (laughs) You don’t go to your employer and say, “You know what? I expect higher inflation next year, so I’m going to ask for a higher wage.” I mean, you can obviously do that, (laughs) but chances are, you’re not going to get that raise.

In fact, wages almost always are playing catch-up, right, with inflation. Uh, it’s true that in the 1970s where we had a, a bigger, you know, unionization, high unionization rates and so on, that might have been the way that wages were set because you had longer term contracts and wages could be somewhat indexed to inflation for years, uh, in a- in advance. But that’s not how the labor market works today, right? That’s how, (laughs) that’s the theory of inflation that the Fed has, that inflation expectations cause inflation. But how? (laughs) You know, that, there is no good answer to that.

Dean Baker

Let, let me just say, I do think they have a theory in how they could lower inflation. That’s creating unemployment. I think we agree on that. And that’s, you raise rates enough, you will create unemployment. Um, I believe that, at least. Um, but in terms of this expectation story, and this is hugely important because people… And I’m gonna pick on Larry Summers here ’cause he’s the most visible person. He was the, uh, Treasury Secretary under President Clinton. He was the head of the National Economic Council under President Obama.

So he’s got solid democratic credentials, very much in the center of, uh, the Democratic Party, and obviously a very prominent economist. He’s been saying, “We’re back in the ’70s. We’re gonna have a wage-price spiral.” So this is very much this expectation story, that, oh, workers see higher wages, and exactly as Yeva was saying, they go to the boss and say, “Hey, you know, we see higher… You know, inflation is 6%. You have to give us a 6% or 7% pay increase.”

That clearly is not happening. And the two big pieces of evidence we have that, just expectations themselves, we have a measure of expectations in financial markets. I mean, it’s not necessarily perfect. It’s telling us what people who put their money on the line think. And this is loo- you look at the difference between the inf- the interest rate and inflation-indexed bonds. So I can get a 10-year Treasury bond that’s indexed to inflation, so if inflation’s 5%, it gives me 5% plus whatever other interest rate I’ve negotiated.

Um, so we have inflation-indexed bonds. We look at the difference between the, the yield on those bonds and the yield on just a straight 10-year Treasury bond. Anyhow, that yield, that, that, that breakeven point, the, the implicit inflation rate that people in the markets are expecting, has been falling sharply in the last two months. It never got very high, so the 10-year rate, that’s the one I’ve been looking at most closely, that peaked at a little over 3%, which isn’t that scary a rate of inflation to begin with.

But any case, the last I looked, it was down to 2.3%, so it’s going the wrong way. (laughs) So not only is it lower, but it’s going the wrong way. The other point is about wages. And I’m not thrilled about this, but if you’re gonna have a wage-price spiral, as, as Larry Summers has been telling us, that means wages grow more rapidly, prices grow more rapidly, wages grow… So, so both are going up. Well, wage growth has slowed sharply, so if you look at the wa- rate of wage growth and look at the average hourly wage, that was over 6% at the end of 2021.

Most recent data… We’ll get another data point with the, the June jobs numbers, uh, tomorrow. But the most recent data, it’s a little over 4%, so again, it’s going the wrong way. You can’t have a wage-price spiral when wage growth is actually slowing. So again, (laughs) this is a, a theory. You know, I know that Larry Summers is a very good economist, very smart guy, I’m sure. But none of the data fits his theory, so I don’t think we have to worry about the wage-price spiral that he and many others are, are very concerned about.

John Donvan

Yeva, you, you, you, um, you asked the question, “Does the Fed even know what it’s doing,” which, which could have actually been the question for this debate, (laughs) but, um, your implication is that maybe you don’t think they know enough about what they’re doing. And earlier in the conversation, you had wanted to talk about, people are putting too much responsibility on the Fed to tack- tackle inflation. And I asked you to hold off on that thought until right now. I’d like you to, to, to tell us where you’re going with that idea.

Yeva Nersisyan

Sure. Um, it’s, in, in a way, it’s a problem of the Fed’s own making, and I would start with Volcker, uh, you know, with who’s sort of, um, um, you know, mainstreamed this idea that the Fed should be in charge of inflation and that, in fact, it can control inflation. And Volcker tried this so-called monetarist experiment where instead of setting interest rates, the Fed tried to control monetary aggregates, so measures of money supply.

They weren’t successful in doing that, and so they eventually gave up on the monetary aggregates. So we all know now that the Fed, or at least we should know, that the Fed cannot control the quantity of money in the economy. It can only set the price for, the price of money, right? But we still have this idea that, okay, we think of the central bank. Central bank is in charge of money, right? It can create money. And because it can create money, we think of money driving inflation, so somehow, you know, this idea that the Fed is in charge of inflat- uh, money supply, and the money supply then is related to prices.

Too much money chasing too few goods causing inflation, the famous Milton Friedman idea, right, is, you know, one of the oldest ideas in economics. I would say a zombie idea that is refusing to die. But that’s, that was the point, that that’s how the central bank is supposed to be in charge of inflation. Now, we’ve given up on the Fed controlling the money supply. Um, we, Dean and I would agree that the quantity of money in the economy doesn’t have much to do with prices, so inflation is not a monetary phenomenon. In fact, we see with the current episode of inflation that it has nothing to do with money, right? It has nothing to do with money supply. It has nothing to do with monetary factors, in fact.

But we still hold onto this idea that the Fed, by controlling interest rates, somehow it’s supposed to affect the, uh, the economy, uh, the real side of the economy. Uh, and, and, and the way it’s supposed to do it, it’s, it’s really not clear, right? It’s this inflation expectations idea. Now, you could say, um, more logically, that interest rates will have impacts on the economy because they, you know, companies borrow to spend, and households borrow to buy certain things, right? But my point is that it, if you want to slow down the economy by raising interest rates, you have to raise them prohibitively high.

John Donvan

You’re saying small rate hikes won’t make any difference? They have to be large, and if they’re large, they do a lot of damage.

Yeva Nersisyan

Exactly. Small rate hikes are not useful. I, it’s, uh, it’s somewhat surprising where you hear people talk about, “Is it gonna be a 0.5% hike? Is it gonna be 0.75?” I’m like, “Does that really (laughs) matter that much in the grand scheme of things?” Right? So small rate hikes don’t solve the problem. You need large rate hikes, but large rate hikes can have major financial implications because they can cause bankruptcies, they can lead to insolvencies, and that’s, of course, then you can slow the economy, and obviously you will, you might solve the inflation problem.

Now, in the current case, I would say you might not even solve the inflation problem, and we risk going into a stagflationary scenario where we have high inflation and high unemployment. Uh, and for example, the Russian invasion of Ukraine, right, which is going to have, or it’s already having impacts on commodity prices, whether it’s oil or wheat and so on, or lockdowns in China if China still continues with its zero COVID policy, right? Uh, we’re so dependent for production on China. Who knows how that’s going to play out, so there’s a lot of uncertainty there. So it’s not a given that our supply side problems are going to be solved because of the situation in the world, and we might slow the economy, but not necessarily slow the inflation problem.

Dean Baker

Yeah, I’d agree with most of that. I mean, y- the Fed cannot solve supply side problems. There’s no doubt about that. But I will say, in ter- in terms of, you know, the small rate movements, the, the rates that actually affect the economy is not what we’re gonna hear the Fed does next week at its meetings. So whether they go with a half point or three-quarter point, that’s not the rate that’s actually gonna affect the economy.

The rates that affect the economy are the longer term rates, so mortgage rates just being the most obvious, but car loan rates, um, rates that people pay, uh, firms pay on, uh, bond issues or, um, state and local governments pay if they want to issue bonds. Those are the rates that, that affect economic activity. And the small movements that the Fed made did have very large impacts on those long-term rates. Now, those tend to be somewhat unpredictable, but it just, I mean, you could look at this.

The mortgage rate last summer wa- was a little over 3%. It was pretty much near 3% through the fall, then when, uh, Powell said, “Okay, we’re gonna start on this pattern of rate hikes,” it jumped, and as I said, it got to over 6%. It’s down again. I’d have to check the latest numbers, but it’s around 5.3, 5.4. It’s still much higher than three. That has a very big impact on the economy. So you can have large impacts on the economy, well, certainly the housing market, with relatively small movements from the Fed.

But again, if you go the route of saying, “Okay, we’re gonna bring inflation down…” And the inflation, a- as Yeva correctly said, it’s from supply factors, China shutting down its factories, the Russian invasion of, of Ukraine. Um, those are supply factors. If you try to, to, to combat inflation with rate hikes, one, you will have to raise rates a lot, both short-term and long-term, and two, yeah, there’ll be a lot of really bad side effects. I mean, most immediately, a lot of unemployment, but yeah, there’ll be bankruptcies. So that, you know, if you go back to Volcker, I know a lot of economists give Volcker credit, um, but that was a horrible time for most people, ’81.

John Donvan

This is Intelligence Squared U.S. More debate in a moment. Welcome back to Intelligence Squared U.S. I’m your host, John Donvan. Let’s get back to our conversation. I want to talk about oil, whether it’s a special case or not. I mean, that’s, that’s where so many of us are experiencing, uh, inflation on a daily basis. If you’re not even driving a car, you can see the prices of $5 a gallon. My daughter lives in California. She sent back photographs of $8 a gallon where there’s a tax i- issue on the, on fuel as well. But is… Talk about what’s going on with oil, whether it’s a special case or whether it’s a central driver of what we’re going through right now. Why don’t you take, take that on first, Yeva?

Yeva Nersisyan

So about, I think, three percentage points, uh, or so out of, say, seven or eight of the inflation, uh, is being driven by transportation, and oil, obviously, is a large part of that. Uh, and of course, oil goes into the transportation and production of many other things. It’s not just, you know, gasoline that we use to drive cars. Uh, so it has impacts on the inflation indirectly as well, but even the direct impact is very, very big.

I think, uh, until something like 2021, October, the estimate was, and if I’m not mistaken, it was a New York Fed estimate that I looked at, uh, the price of oil was being driven by a shortage of sup- of, uh, sh- h- too much demand, right? Um, but that sort of stopped then, right, that it was a supply, supply problem, so, or supply restrictions, I should say, uh, because we have a cartel that controls the amount of oil in, you know, in, globally that is driving prices up.

So, uh, and because we talked about Volcker, it is crazy that, uh, it’s ni- it’s 2022 and we’re still talking about OPEC, right? Because in the 1970s, we had the oil price shocks, which drove the inflation, which then Volcker solved by causing the biggest recession since the Great Depression. That’s how the inflation was solved then. So, uh, we ha- we, we haven’t moved away from oil and into renewables, uh, and, and therefore, we’re s- sort of paying the price for that, but there’s another part to this story, and that’s the refining capacity.

Uh, I just saw this morning that, uh, profit margins for refining crude oil, uh, into gasoline were up from $10.23 a barrel in January, March period to something like $28. (laughs) So, uh, Sh- Shell’s profits tripled, something like that. So, uh, you know, there’s, there’s also that side of the story, that prices are being kept high because of monopolies. Um, and that, I think that’s not just in oil, but in many other areas as well.

Dean Baker

Yeah. I, I agree with that largely. Mak- I’ll make a few additional points. First off, not that I tend to be sympathetic to the oil industry, but we’ve seen a big loss in refinery capacity in the last several years, um, in large part, uh, due to pollution restrictions. Pollution restrictions, and also, um, refineries, these are very heavy capital investments. So if I’m, if I’m, if I’m Shell and I want to build a new refinery ’cause we need more gas, well, that’s gonna pay off over maybe 20 years.

Well, what does the demand for gas look like 20 years? I hope not very good. I mean, I really hope we’re (laughs) shifting in a big, big way to electric cars. And if the oil companies have done that calculation and said, “Oh yeah, we’re gonna be shifting in a big way,” I can’t quarrel with that. I mean, I really hope that’s true, which would be a good reason why they wouldn’t be looking to increase refinery capacity.

But again, if you look at gas prices today, the price of oi- oil is around 100 a barrel. That’s roughly what it was 214. Gas is about 15, 20% higher than it was in 214. So that’s not oil prices. That, that, that difference, I should say, is not oil prices. Other points about oil price. Again, if we’re trying to attack that with the Fed, oil prices are set on the world market.

John Donvan

Mm-hmm.

Dean Baker

Now, obviously the U.S. is a really big chunk of that. We’re around 20%. That’s not an exact figure, but it’s a ballpark number. So, okay, you know, Powell, Powell’s gonna raise rates and we’re gonna cut back our demand for oil. So we cut back our demand for oil by, I don’t know, 5%. That would be a lot. That’s 1% of the world market. It’s not that big an impact. So trying to lower gas prices by raising interest rates, that’s, you know, kind of a hard thing to do. So-

John Donvan

Is it, is it basically an impossible thing to do, that, that, that it’s just not gonna happen?

Dean Baker

Well, I, I, you know, I mean, let’s put it this way. If you had a worldwide recession, and you are seeing-

John Donvan

Mm-hmm.

Dean Baker

… higher rates in the European Union, then that would lower oil prices. But if, if we think, you know, what Powell directly controls, he can slow the U.S. economy, raise interest rates a lot, that’s not gonna have very much impact on oil prices.

John Donvan

Are we where we are with oil because of the war in Ukraine primarily?

Dean Baker

It’s actually… You know, I, I’ve looked at this, and The Times had an interesting piece on this, I forget, this week or last week. There’s actually been relatively little oil withdrawn from world markets because of the war. I mean, the U.S., uh, many European Union countries are boycotting, uh, Russian oil now. But what’s happened is the oil that they used to sell the U.S., European Union is instead going to India and China, which mean there’s been very little oil withdrawn from world markets.

I think it’s actually largely speculative, and people think that’s weird. Well, the oil market is very speculative, just like many other markets, and you see very sharp movements sometimes that can’t be easily explained by supply and demand factors. In fact, oil prices have fallen by about 20% in the last, I don’t know, two weeks, three weeks. I don’t know what’s changed in supply. Um, so I, speculation plays a large role, so I think that’s, that’s been a big factor.

John Donvan

We’re also seeing food prices going up as well, and Yeva, is that, is that because food needs to be transported? Is that because Ukraine is such a big food producer and it’s not producing any right now? And that’s on a global level.

Yeva Nersisyan

Yeah. I, I, I can’t say which one is driving how much of the change, but I think all of those factors are playing a role. And I would agree with Dean that speculation in commodity futures is probably driving prices high as well. We saw that in 2009 or maybe late 2008 where… Yeah, 2008, where after the housing bubble burst, all of that money, or some of that money that was in housing then flew into commodity futures. And there was intense speculation in commodity futures, and we had food bias in parts of the world, which we’re likely to see this time as well because of speculation in markets in developed nations.

John Donvan

You know, this is causing enormous headaches for the Biden administration ’cause it’s all happening on their watch. And the argument could be made… First of all, Yeva, you have made the argument that administrations and legislation, legislators do have some role to play in this, but things take time. Is it, is it unfair to be holding the Biden administration responsible for inflation that’s driven by a global oil price, largely driven by a global oil price?

Yeva Nersisyan

I would say it’s unfair to the point that this is not U.S. phenomenon. It’s a global phenomenon, right? I’m in Europe right now, and (laughs) inflation here is high as well. People are complaining about that. Uh, gas prices are, in fact, higher here, although their cars, uh, are smaller, so that’s… You know. But, but it’s still affecting people’s wallets. So to that extent, it’s an international problem. It’s a global problem.

Uh, China is probably one of the few countries where inflation rates, if we believe the official data, is something like two and a half percent, 3%. But everywhere else, inflation rates seem to be pretty high. So to that extent, it’s unfair to blame them. On the other hand, are there things that they could do, uh, to mitigate the problems? I think you could say there are. There are short-term solutions, there are long-term solutions. Long-term, obviously, investing in renewable energy.

Um, now you could say, “Okay, let’s blame Joe Manchin.” I’m not buying that story. (laughs) You know? Uh, so to the extent that they haven’t done much to even mitigate the, the problems, I would say they, they should be blamed. Now, you could also help lower income households to withstand the, um, you know, the impact of higher inflation on their budgets by, for example, the tax break that they were trying to do, and I don’t… I’m, I’m not sure if they did it.

So some, it was some kind of a gas tax break that the federal government and state governments could do together to, uh, mitigate the impact on the population. So, uh, stuff like that, right? So, so it’s, on the one hand, it’s unfair to blame them. On the other hand, there are things that they could do to move us in the right direction that they’re not necessarily doing, and pointing the finger at the Fed.

John Donvan

N- neither of you has mentioned the stimulus checks that so many of us received in, uh, 2020 and again in 2021. Um, but there are arguments that that, uh, put- putting that much money into people’s pockets really was a driver of the inflation we’re seeing now, and neither of you have pointed to that, and I’m curious why. It, do you agree on that?

Dean Baker

I, I think it was a factor, and I’ve had a lot of back and forth with other economists on this. I, I actually don’t think most of us disagree that much that, you know, when you saw this huge increase in demand for goods that I was talking about earlier, and the supply chain problems… Well, uh, Jason Furman is one of the big people arguing that was a big issue. You know, we, we don’t hugely disagree. So would there have been supply chain problems if people didn’t have the money to buy things?

Well, no. You know? So, so yeah, that contributed to the supply chain problem. So is that supply, is that demand? I say, “Well, it’s really supply.” He says, “Well, demand if we didn’t give them the money.” I think that becomes kind of silly. But that’s more in the past, so even if we say, “Okay, that was a factor in the inflation in 220, 221,” we’re now in 222. That’s in the past, so there’s not a story that I think you can credibly tell saying that demand is too high today.

So, so again, you know, uh, Yeva was making the point, inflation’s very high in Europe. It’s, it’s, it’s virtually identical in, in the European Union, in the United Kingdom, and the United States, so unless Biden’s, uh, stimulus was really powerful, you know, I don’t see how it could have created inflation in those countries as well. So, um, so yeah, I just don’t think that’s really the story.

Yeva Nersisyan

Yeah, and Larry Summers, obviously he’s the economist who’s been making that point, uh, very forcefully. Uh, I actually, um, you know, do not think… I agree with Dean that I don’t think it’s a demand story. Of course you could always say that if we didn’t provide as much relief to people, people would be poorer, and therefore, they would not buy as much, and therefore-

John Donvan

Mm-hmm.

Yeva Nersisyan

… we might not have inflation problems. It’s possible, right? And Russia could still dec- d- decide to invade Ukraine, so (laughs) to the extent that that’s contributing to worldwide inflation, of course that, uh, that could still be a factor there. Um, now, h- however, if you look at, uh, uh, our economic performance relative to our potential GDP, even by sort of those mainstream standards, right, that you, if you, um, if the economy’s above its potential, then that’s when you’re supposed to see inflation, and that’s a demand driven inflation.

We’re not there yet, because what happens is, what happened is the Congressional Budget Office actually raised our, uh, estimates for potential GDP, so as of May, we, we haven’t even… We are close to potential GDP, but we’re not even there yet, right? So even by those measures, we, you couldn’t say that we’ve, we’ve gone over the economy’s potential and that’s why we’re seeing inflation, so that’s why I’m not buying that argument.

Now, could we have done a better job with our fiscal relief? I think we could have, right? Uh, I’m in favor of more targeted policy, policy that sort of, uh, sends the spending to the areas that are underemployed, to the sectors of the economy where there is unemployment, directly targeting, um, uh, job creation, something like the New Deal style of fiscal policy, basically, w- where you directly create jobs rather than give people stimulus checks, right? So I’m in favor of that kind of targeted fiscal policy, and obviously, that’s not the route we went for obvious reasons there with the pandemic, and so on and so forth.

Um, but I wouldn’t say that that’s what’s driving it. I think the counter sides of that argument is to say, “We should have kept people poor so that they couldn’t buy all the furniture, and therefore, we could all enjoy lower prices for furniture.” And so that brings me back to the point that Dean made, which I agree with, that we’ve emphasized the problem of inflation so much that we’ve lost track of what’s really good about this economy. Um, this is the first time since 1990s where we haven’t had a jobless recovery.

‘Cause every recovery, uh, be- before now was a job- you know, between 1990 and, and, and now was a jobless recovery. And we’ve been so accustomed to, uh, depressed demand that for the first time, when demand is not depressed, we say, “We have a problem of too much demand.” No, we don’t have a problem of too much demand. We just have a problem of demand going back to where it was, but supply not being able to adjust to that.

John Donvan

Mm-hmm. Mm-hmm.

Yeva Nersisyan

So I would not say (laughs) Larry Summers is correct, and neither is Jason Furman.

Dean Baker

(laughs)

John Donvan

So it’s interesting you… (laughs) I just want to bring up that, that, that we’ve done a number of debates that touch on economy, and both, uh, Larry Summers and Jason Furman have appeared with us on our debates. And, and Dean, I was looking at the cover of your book, which is called Rigged: How Globalization and the Rules of Modern Economy Were Structured to Make the Rich Richer, and you have endorsements on the book, and one of them is from Jared Bernstein, who has debated with us. Another is from Robert Reich, who has debated with us. Another is from Katrina vanden Heuvel, who has debated with us. Another is from Jeffrey Madrick, who has debated with us.

Yeva Nersisyan

(laughs)

Dean Baker

Yeah.

John Donvan

So you’re in good company-

Dean Baker

(laughs)

John Donvan

… and we’re not afraid to take, (laughs) and we’re not afraid to take on these economic, uh, topics and make them explicable to ordinary folks like me. And, and I’ve really appreciated-

Dean Baker

[inaudible

].

John Donvan

… what you’ve been doing, uh, in this conversation, but I want to wrap it up by going back to the essential disagreement. After hearing what each of you has had to say on the topic that we’re discussing, whether the Fed can manage a soft landing, one more time, um, uh, Dean, your answer, why are you answering yes to that question?

Dean Baker

Well, again, I don’t think Yeva and I hugely disagree. I think most of the problem is a supply side story. I mentioned housing as being an exception, where I think demand was driving very rapid housing inflation in 221 into 222. I think the Fed rate hikes really brought that into check, and that was really important in reining in the housing market, which is a very, very large chunk of the economy and a very large component of inflation in the rental indexes.

And then on t- after that, I think most of the other problems will be self-correcting, that we’re solving most the supply chain supplies. Um, the Russia invasion, uh, that sent oil prices way up. They’ve come back down. Th- like to see them go lower, and I hope they will, but, um, they are lower. Wheat prices fell back to their pre, uh, invasion level. Um, so I think we’re seeing sort of self-correction that would have happened without the Fed, but the Fed did address, with its rate hikes, the really big problem in the housing market. Again, whether that was b- their intention… Were they sitting there going, “Yeah, this is how we’ll rein in house prices?” I have no idea, but they did.

John Donvan

Yeva, one more time. Why are you a no on this question?

Yeva Nersisyan

Well, the Fed has never managed a soft landing. I think their timing has always been impeccable in that they’ve raised interest rates going into recessions. We’re facing fiscal headwinds as well as headwinds from the rest of the world, uh, a- and, and, and in this time, the Fed is raising interest rates. So, um, I don’t think we have a problem of too much demand, ’cause only in that case you should say, “We should try to use the interest rates to lower demand.”

And even if we had a problem of too much demand, which we’re saying, we were just saying might be caused by fiscal policy, why are we using monetary policy to rein that in and not fiscal policy, which goes through the democratic process, which was a point I was making earlier, is that we just say, “Well, the technocrats at the Fed are going to do that.” Um, demand… Uh, you know, inflation is never sort of, like, all parts of the economy are inflating at the same rate. That’s never how, how it works.

It’s more like bottlenecks that are leading inflation. And we talked about one, which is oil. So if that’s the problem that you have, a general cooling off of the economy does not make any sense. And a general cooling off of the economy is the only thing that the Fed can do. Uh, so that’s why I don’t think the Fed should be raising interest rates. That will cause financial problems. Um, you know, in an environment where corporations have a lot of debt, that is bound to lead to some bankruptcies and financial difficulties, potentially financial crises. Um, depends on how high they raise interest rates. And I just don’t see a point. And I think Dean would agree with me, right, that the problem sort of has been solved, so why are we raising interest rates at this point? I don’t see a point.

John Donvan

And each of your predictions about when this trend, upward trend is gonna turn, uh, if it has not turned already. What about you on this, Dean?

Dean Baker

Uh, my guess is that they will raise rates in the July meeting just ’cause you got a situation where expectations basically drive what the Fed does.

John Donvan

Mm-hmm.

Yeva Nersisyan

Yes.

Dean Baker

So before the last meeting, people were saying, “Oh, they’re gonna raise rates by three-quarters of a point.” If they didn’t, then people were going, “Oh, they’re not serious about inflation.” So I think they’re gonna have to raise rates at least a half point in July. Hope not more than that. I mean, I’m hoping they don’t raise them more than that. And I hope they make it clear that they’re gonna, you know, sit back and wait, ’cause I don’t think there’s reason for further rate hikes.

John Donvan

And Yeva?

Yeva Nersisyan

Yeah. I, I mean, in this environment, I, I’m trying to sort of, uh, refrain from m- (laughs) making predictions. I don’t know what’s gonna happen in China, for example, when, as I said, a lot of our production happens there. Uh, but I would say I’m, I’m optimistic that inflation rates will be lower. I just hope that it’s not gonna be at the expense of higher unemployment, which is my fear.

John Donvan

All right. Well, Yeva Nersisyan and Dean Baker, uh, thanks for leaving us with a note of optimism, and also especially, thanks for helping us to make sense of everything that we’re going through right now, and, and doing so in an atmosphere of, of respect for one another and civility, which is what we encourage at Intelligence Squared, especially in our Agree to Disagree series. Um, I know I learned a lot, and I hope that our listeners did too. But to both of you, Dean and Yeva, thank you so much for joining us.

Dean Baker

Thanks for having me on.

Yeva Nersisyan

Thank you.

John Donvan

And I’m John Donvan. This is Intelligence Squared, Agree to Disagree. We’ll see you next time. I want to thank you in our audience for tuning in to this episode of Intelligence Squared. I hope that you have enjoyed it just as much as we did. Intelligence Squared is generously funded by listeners like you, members of Intelligence Squared, academic institutions and other partners, and by the Rosenkranz Foundation. Clea Conner is our CEO. David Ariosto is our head of editorial. Amy Krafft is chief of staff and head of production. Shel Mara and Marlette Sandoval are our producers. Kim Strempel is our production coordinator. Damon Whitamor is our audio producer. Robert Rosenkranz is our chairman. And I’m your host, John Donvan. We’ll see you next time.