GPPR Podcast Editor Joe Lustig (MPP-EP ’24) speaks with McCourt Professor and prominent economist Dr. Harry Holzer to talk about one of the most salient topics in US policy today – inflation. In this podcast, Dr. Holzer walks through what inflation is, what causes it, who it affects, and what policymakers can do about it.
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[Episode Starts]
Joseph Lustig: Hello, listeners! My name is Joe Lustig, and this is the Georgetown Public Policy Review Podcast. Today I wanted to talk about inflation, which has dominated the headlines over the last several months. We recorded this podcast on Friday, November 11, and just one day before we recorded, the Bureau of Labor Statistics released updated inflation numbers. The Consumer Price Index, a common measure of inflation, rose by 7.7% from October 2021 to October 2022, and by 0.4% just over the last month. Since this podcast was recorded, the November inflation numbers, released in December, showed that inflation has cooled somewhat. Nonetheless, by many measures, the inflation that the United States experienced this year is the worst since the 1980s. Inflation is a really salient issue for the American public – everyone notices when it costs more to fill up their gas tank or buy groceries, or when the rent goes up. So overall, it seems safe to say that right now inflation as a public policy issue is really important.
So with that in mind, I’ve invited Dr. Harry Holzer onto the podcast. Dr. Holzer, would you like to introduce yourself and tell us a little bit about why you’re interested in this topic.
Dr. Harry Holzer: Sure. So my name is Harry Holzer. I am the John LaFarge, SJ Professor of Public Policy at the McCourt School of Public Policy at Georgetown University. In the past, I have also been the Chief Economist of the US Department of Labor. I hold appointments as a fellow and non-resident fellow at Brookings and the American Institutes for Research, and I generally have interest in macroeconomic issues, like the determinants of inflation and unemployment. Because I’m a labor economist, and as a labor economist I am primarily interested in the well-being of American workers and what affects that well-being. And of course we all know that employment and unemployment have a big effect on the well-being of workers. But so does inflation. Inflation affects how far people’s wages and salaries go, in buying goods and services, and that’s hugely important for American workers and their families. So to me it’s an important topic, and I appreciate your inviting me here today to talk about it.
Lustig: Awesome. Well, thank you so much for taking the time. I wanted to start out with a basic question. You mentioned unemployment, and I think when a lot of people hear inflation, they just sort of think the economy is bad. And so what exactly is inflation? How does it differ from some other types of macroeconomic challenges, like unemployment and recession.
Dr. Holzer: Well, it’s very different. Inflation is the annual increase in the average prices of goods and services in the economy. That’s usually calculated in a number of different ways. But usually, you take some average basket of the goods and services that American consumers spend money on, and you follow their prices over a month-to-month level, but over a year to year. If those prices on average go up by 10% from one year to the next, that’s a ten percent inflation rate, and that’s not particularly good for consumers, because that means the things they like to spend money on, whether it’s food, or transportation, or clothing, or health care, or entertainment. All of those things cost a lot more money. So if you have 10% inflation one year, and your wages and salaries don’t grow by 10%, your standard of living could take a hit and could fall.
Now, what’s the relationship between inflation and things like unemployment? Unemployment is a measure of how much demand there is in the US economy for American workers, and whether people in the labor force – people working or looking for work – can readily find jobs for themselves. So that’s a very different issue than inflation. Right now, in fact, we have high inflation, but the unemployment rate remains very low. It’s 3.7%. It’s been as low as 3.5%. That’s about as good as it gets. And while Americans worry a lot about whether or not we’re going to go into a recession, right now there’s nothing remotely like a recession. So the demand in the economy is very strong. We’re humming along with a lot of new jobs being created every month, a lot of goods and services being created. It’s just that the prices of those goods and services are moving up too quickly for the comfort of Americans.
Lustig: That’s really helpful, and in terms of those prices going up, it seems like what prices exactly have been going up has shifted a little bit over time. Earlier on in this bout of inflation, there was a lot of talk of used cars. More recently, it seems like it’s maybe a little bit broader across a wide array of goods and services. So right now, what kinds of costs are really increasing? Is it broad, or is it a specific subset of goods and services?
Dr. Holzer: Well, it’s actually a mix of the two, because in the last several months – the last 6-8 months going back to early in this year – it is true that food and energy have been the two areas where you’ve seen the biggest spikes. Both of those are, in fact, related to the war in Ukraine because those regions contribute a fair amount of grain, often called the world’s breadbasket, and a fair amount of energy. Especially in Russia, energy exports – oil exports – are one of its primary products. So, the war there has disrupted that production that has caused both of those two baskets of goods to spike, but it hasn’t been limited to those things going back six months to a year, you also saw other categories of goods rising a lot in price, especially goods that use computer chips, which we can produce, and which Americans want to produce more of. But right now we often import them from China and elsewhere. So, any products that require those computer chips – like car manufacturing – their prices went up.
We had problems at the ports and in the supply chain that was also limiting the availability of the goods. And interestingly, during the pandemic a lot of people couldn’t go out and spend money at restaurants and movie theaters. It wasn’t safe to do so. So, they piled up a lot of cash, and then, when they have that cash, they decide to spend more of it on goods rather than services – the brand new flat screen TV or new computer, or smartphone, or things like that. And that also created a lot of clogging at the ports and in the supply chain, and that contributed to the problem.
But this issue, of course, of whether the inflation is narrow or broad-based also depends on what’s causing the inflation. The two broad categories of inflation are demand-based and supply -based inflation. Economists always think about demand and supply, and demand-based inflation is the classical problem of too many goods chasing too few services. Demand is simply too high. I think that is true right now, I think the federal government, both under Presidents Trump and Biden, simply pumped too much relief money into the economy that simply gave consumers too much money, and their spending went beyond the economy’s capacity, but we’ve had these supply problems as well. The ones I just mentioned on food, energy, and certain products using computer chips – that’s all supply-based. We often call those supply shocks. Supply shocks can be positive. They can reduce the prices, but right now they’ve been negative, as they were back in the 70s, when oil prices spiked a number of times, and did a lot of damage.
When inflation is demand-based, it shows up everywhere. It’s not limited to a few sectors. And you do see that kind of broad-based inflation right now, because it’s not just limited to food and energy. It’s not just limited to goods. You see it in different parts of the service sector. You see it in the housing market. You see it in health care. All kinds of services got more expensive. So that reflects this broad-based demand-driven inflation. But the supply inflation does show up on food, energy, and some specific commodities.
When I look at the evidence right now, I think there’s something of a consensus that the extra inflation right now – above the 2% level that we like it to be – is about one-third demand-driven and two-thirds supply-driven. One-third – two to three points – are simply because the Federal Reserve waited too long to raise interest rates. The federal government simply pumped out too much money to these households. Had they not done that, I think inflation would be two to three points lower.
But you still would have the problem in food and energy and other areas. And then there’s stuff related to labor that we can talk about. So, it’s not a fight between two schools about which school is right or wrong. It’s how much of any given amount of inflation is driven by supply or demand. And one way that economists look at this is they study something called the core inflation rate. And the core inflation rate simply strips out food and energy because it’s known that those are two volatile sectors. When you look at core inflation you get a better sense of how broadly spread this is, and how hard it might be to bring it back down. Core inflation, depending on which index you look at right now is in the 5-6% range, a few points lower than inflation more broadly. But 5-6% is too high for our comfort level, and that means the inflation has spread more broadly. And again, part of that is too much demand and part of it is a range of supply issues as well.
Lustig: To unpack that a little bit and make sure I understand it correctly. There are two perspectives on what causes inflation. There’s the supply side, and there’s the demand side. On the supply side, in this case, what we’re talking about is food and energy prices going up because of the war in Ukraine, and also this mismatch of goods and services caused a lot of supply chain disruption and that caused prices to go up.
Dr. Holzer: Right
Lustig: And then on the demand side, what you have is that during Trump and Biden’s presidencies, there was a huge amount of stimulus pumped into the economy. People had more money than they knew what to do with, and that extra spending drove up the cost of goods, and what you’re saying is that both are the cause – about one-third the demand side and about two-third the supply side. Is that fair?
Dr. Holzer: Yeah, I think that’s correct right now. One way to distinguish those is any time it’s the basic underlying cost that it costs more to produce something that’s more of the supply-side stuff, and when it’s simply employers raising prices, because the supply is short relative to demand, it’s more demand-side. But I’ll say one more thing about this that also makes it a little more complicated. Economists worry that if you have inflation for too long it becomes entrenched. And part of the way it becomes entrenched is that workers start expecting it, and if they expect six or eight percent inflation next year, they’ll demand six or eight percent in wage and benefit increases this year. And so, a one-time occurrence of inflation, if that occurs, can then become a self-fulfilling prophecy, and get built into an ongoing inflation cycle.
And that’s why the Federal Reserve now has been so eager to bring inflation down fairly quickly before it has time to settle, because once it then gets built into that kind of inflationary expectations, then something that started as demand-side can then continue because workers are demanding it more and more, and then that expectation leads to an actual reality. And I think the Fed wants to nip that in the bud before that process starts, and before the expectations get entrenched.
Lustig: So, this creates a bit of a spiral?
Dr. Holzer: There can be. And that’s the situation we got into in the 1970s. In the 1970s, we had two periods of very bad inflation, both of which were at least initially driven by oil supply shocks. Basically, a group of countries that called themselves OPEC acted like a monopoly, a cartel and restricted supply to drive prices up. But then it did get built into wage expectations, and for many years it was impossible to control inflation. Inflation bounced. It never got lower than 6%, and it would bounce as high as 11-12%, until the Federal Reserve reacted very, very strongly and created a very sharp recession to sort of wring the inflation out of the economy – out of those wage expectations, out of people’s contracts, et cetera.
Lustig: Interesting. And I wanted to go back to one thing you said earlier, which was that the Fed has this target inflation of 2%. So, for listeners who might not have taken a lot of macroecon classes, why is that the case? Why wouldn’t you want zero inflation? Why is a little bit of inflation a good thing?
Dr. Holzer: It’s a good question. The answer to that is because we have a lot of rigidities built into the economy and into our prices. It turns out, for instance, it’s harder for employers to reduce prices and reduce wages than to raise them.
This gets to some of the core debates in macroeconomics. Keynesian economists, and I am one of them, tend to believe that there are these rigidities built into the economy and into our wages and prices, and it’s easier for firms to cut production by 10% than to cut wages and prices even by 5%. And so that creates kind of a bias, and because it’s easier to raise prices than to lower them, trying to get back to a zero inflation target would cause a lot of pain, and it would take a lot of unemployment left in place for a long time. So, the general view is 1-2% inflation is kind of a good thing. It kind of greases the wheels, and it enables firms to make the wage or price adjustments that they need to make without huge cutbacks. And that’s therefore what we aim for, in general. 2% is considered to be the amount of inflation that a healthy economy needs.
The other thing, though I’ll also say, is that it’s possible to have the opposite problem. It’s possible to have a problem called deflation — when prices are falling rather than rising. And sometimes you would say, “Geez! That would be great to see prices falling. Our wages and salaries will go even further.” But it wouldn’t work that way, because as prices are falling your wages would be falling too, and once an economy gets into a deflation cycle, it can be very hard to get out of that, and people start hoarding their cash because they expect it to be worth more tomorrow. And you know, the economy of Japan had a deflation problem that’s lasted decades now. So that’s why another reason why you have this 2% target is it’s a little better to overshoot on prices than to undershoot. It’s a little better to risk inflation rather than deflation, which is more destructive to the economy.
Lustig: That makes sense. So, we talked a little bit about the causes of inflation. I wanted to talk a little bit about some of the effects, and I think we can get a little bit into what I think is your area of expertise, specifically. Does inflation affect different demographic groups within society differently? Does it affect low-income folks differently than high-income folks, or young people differently than older folks or things like that?
Dr. Holzer: The answer is yes, because different groups in society consume different amounts of goods and services. So, for instance, price increases that are really heavily concentrated in food and energy really hurt poor people more than anyone else, because they spend the biggest fractions of their budget on food and transportation costs, energy, home heating, et cetera. So, it hits them quite hard, and in general lower to middle income people bear the brunt of different kinds of inflation like that. Now, this year we’ve seen healthcare costs go up a fair amount. It’s actually the elderly who spend the most on healthcare or families with members who have, say a longer-term illness. So, it’s not always the poor.
Or housing. Housing in America has become very expensive. Partly because we’ve had a housing bubble where the prices got too inflated. They’re starting to come down now a little bit with rising interest rates. But housing also falls heavily on poor people. For most middle-class people or upper middle-class people, you can limit your housing costs to 10, 20, even 30% of your monthly income. It’s hard for poor people to do that, especially in the big coastal cities where housing is in such short supply.
Because different groups of people in our society consume different combinations of goods and services. The inflation can hit different groups, more or less hard, depending on what’s going on.
Lustig: That makes sense. So, I guess the next question is, what can be done about it? The Federal Reserve has obviously been really rapidly increasing interest rates. The goal there is by increasing the cost of borrowing, to cool down the economy and try to bring down prices. Are there other things that policymakers could do? You wrote an interesting article that talked about how expanding access to childcare and Pre-K might help mitigate inflation. So, I’d love to hear you talk more about that, and about other public policies that people might not associate with inflation that actually might be anti-inflationary.
Dr. Holzer: Well, the best way to deal with demand-side inflation – too much spending – is to reduce people’s spending, and we have two levers that the government can use. One is monetary policy, and the Fed is doing that. The Fed just does that on their own because they are an independent federal agency. The other one is having less fiscal stimulus, which means either raising taxes or cutting spending. That’s a political thing that has to be agreed on by Congress and the President. It’s very hard for them. They have different philosophies these days about spending and taxes and either raising taxes or cutting spending is politically unpopular, so it’s hard to do it. So, the Fed can do its job more easily. It’s much harder for Congress and the President to do the fiscal job.
But there are other things that work. For instance, if we brought in more immigrants, that would take a little bit of a pressure out of certain labor markets. Where wages are going up because there has been a worker shortage, which has also contributed to some of this problem. Maybe we’ll come back to the worker shortage and the role of that, but having more workers, having more immigrants, would bring that down. Having more imports, whether it’s from China or elsewhere would take some of the price pressure off of some of these markets. It became very popular to slam China with tariffs and other things, but, in fact, that can be shooting ourselves in the foot, because those lower-priced products do help contain inflation and contain prices. And, by the way, you know, American workers who claim to hate imports and trade with these other countries because it can cost them jobs – they love going to Walmart and buying cheaper products that are cheaper because they’ve been imported from abroad. So, we could do more of that – more immigration, more trade. I did make the argument with my colleague Isabel Sawhill at Brookings that getting more working moms into the workforce would relieve wage pressure that’s right now very high because of the worker shortages, and that could help. Although there’s a flip side of that point – that the money going into the workers pockets might actually induce them to spend more, so that could offset that effect. So, by having more working moms in the labor force, or even working dads, you increase the supply of labor and that eliminates some cost pressures. But then you increase the demand and that may or may not be enough to offset those things.
Frankly, what the Biden administration has been trying to do through the Inflation Reduction Act is trying to bring down costs and prices in two very key sectors – energy production and health care. Unfortunately, you won’t see that reduction for a while. And whether naming it the Inflation Reduction Act was a mistake because it raised the expectations that it was going to happen tomorrow, I’ll let the politicians worry about. But with time, it should help reduce the cost pressures in those two particular sectors. And for instance, investing in more clean energy production and subsidizing that should bring the cost down and the price down. And over the long run that’s an anti-inflationary measure. So, you can do certain things in other areas to reduce cost pressures besides just fiscal and monetary policy, but it takes a while to do those things and their impacts aren’t as noticeable. Imagine you did have some noticeable impact, for instance, on health costs, but health costs in total are still a little under 20% of the whole economy. So, a 5% reduction in health costs would only show up as less than a 1% reduction of the inflation rate. And that’s the other limitation of those specific approaches. They take time and their impacts are very targeted on particular sectors. They’re still worth doing, in my belief. But it’s not quite like fiscal and monetary policy that’s really broad-based.
Lustig: So that’s interesting. So, it sounds like really, in the short run, all you can do are monetary policy, which is raising interest rates and fiscal policy, which is increasing taxes or cutting spending.
Dr. Holzer: That’s what you can do quickly. If President Biden lifted some of the trade restrictions – the import restrictions – that could show up fairly quickly. If he lifted some of the immigration restrictions and made it easier to import workers, that would take a little more time, because then the workers have to come and they have to be trained, but imports could be done pretty quickly. But for the most part, the other things take time. They take investment – targeted investment, technology, development. Raising interest rates by the Fed works a lot faster.
Lustig: I do want to come back to the labor shortage because we did skip over that. I wanted to ask about a couple of other solutions that have been mentioned by politicians and pundits and see what you thought about those. On the right, I think one of the criticisms and the case that conservatives have made that the Biden administration is responsible for inflation is that pausing a lot of oil and gas drilling projects increases gas prices. And then one of the things you hear a lot on the left is that excessive corporate concentration and market concentration – more firms merging and less competition in the economy – that is one of the drivers of inflation. So, I’d love to hear what you thought about those two arguments.
Dr. Holzer: Well, on the argument about energy, maybe you can make a case that we got a little too enthusiastic about reducing our fossil fuel production in the short run, and that
that exacerbates some of these problems. But keep in mind, oil gets priced on an international market and our impact on that international market is very, very small. Now natural gas is a somewhat more localized market, and of course the fracking revolution did lead to a big increase in natural gas production in the United States. But our ability to influence the price of oil is very, very limited.
Now the argument about monopoly profits. I think that there’s some validity to the argument that monopoly power has enabled American producers to maintain higher levels of prices than would be the case in a really competitive market. You could point to certain sectors, whether it’s IT or some others. The cost of internet service in the US Is too high compared to what it is elsewhere. The cost of healthcare is too high, and some of that is about monopoly power, and some of it is about other things. But I don’t think it’s inflation per se. It has to do more with the level of prices in certain sectors, not inflation.
Now a different thing you hear from people on the left is if you look at these monopoly profits, business is profiting. They’re gouging the consumers. They’re taking advantage of a high-demand situation to gouge consumers by raising prices. But that’s what you do in a supply-and-demand market economy. When demand is really strong, prices go up, and those higher prices are needed because they do two things: Number one, they induce consumers to cut back a little bit, which is how we ultimately solved the problem of the oil price shocks in the 70s. Eventually we learned how to use a lot less of it, and then the producers had to cut the prices. But the other thing is, you need some of those price increases sometimes to incentivize more production by the domestic producers, whether it’s natural gas or oil, or even alternatives. If you want more nuclear energy, for instance, that’s expensive to produce. Prices have to go up. And nuclear energy is a very, very clean form of energy, and you can ramp up the capacity faster than wind or solar or things like that.
So, you can make an argument about price gouging being a part of inflation. But the underlying problem is these demand and supply issues, and to me it’s almost inevitable in a working market economy. Prices are going to go up, and that then generates some of the adjusting in behavior that we need in order to bring things back in line.
Lustig: That’s really helpful. That’s a really helpful way to think about it. The last thing I wanted to do is let’s come back to that labor shortage. You are a labor economist. So, there’s been so much talk of “the Great Resignation,” and worker shortages in the service industry, and questions about whether or not that’s just a blip – whether it’s just a result of the pandemic or that’s some longer-term trend that the economy is going to have to adjust to. And the answer to those questions will obviously have an impact on inflation moving forward. So, I’d love to hear your thoughts on that.
Dr. Holzer: Well, first of all, I think the labor shortage is real. Sometimes, some of my friends on the left dispute that a labor shortage exists, and they say that if it did, then wages would be skyrocketing. But in fact, they have been going up a lot in the last year or two. The way I know it’s real is that if you look at job vacancy rates in the US economy – vacancy rates recently have been in the 6-7 percentage point range, while unemployment has been more like 3.5%. In other words, the vacancy rate has been almost double the unemployment rate.
My whole life as an economist – when I was a grad student in the late 70s/early 80s; when I was a young professor – the unemployment rate was always higher than the job vacancy rate. Job vacancy rates averaged 1-2%, and unemployment rates averaged 5-6%. There was always an extra supply of workers that helped to depress wages. This is a really new phenomenon, having twice as many vacancies as there are unemployed workers.
So, what’s going on? What’s driving that? I think a few different things, but they have kind of a common theme to them. I think number one, we lost over 1% of our labor force during the pandemic, and these folks never came back. About half of them were people over the age of 55 who decided to retire earlier than they thought they would, maybe because they’re worried about health risks, maybe because their assets grew in value a lot during the past several years, so they can afford to retire. But that alone is a loss of about three million workers in the economy.
Second, and related to that, our population growth – our native-born population growth – has been somewhat low for a few decades now, and birthrates 20-25 years ago drive labor force growth right now, and those birth rates were down. So, we relied very heavily on immigration to make up for the shortfall. But immigration fell during the Trump years because of perceived hostility, and of course they fell a great deal during the pandemic. Now they’re starting to bounce back. There’s a lot of people at the border seeking refugee status, but that’s different than the usual screens of immigration. So, we’ve had too few people and too few people looking to work. You mentioned the Great Resignation – people were quitting more frequently in the last year. But even when people either have quit their jobs or they’re just entering the labor force, they’re also taking their time before accepting a new job.
I think what combines all of these different stories is that workers got choosier in the three years or so since the pandemic, for a lot of different reasons. Some people had to stay home and care for children or older relatives, and that’s why women got hit so hard early in the pandemic although by now their participation rates have bounced back. But the needs of the care economy were one issue.
Secondly, people were worried about health risks, risks from Covid, especially Long Covid, and Long Covid appears to have had some effect on people’s working, although it’s not a huge effect, as far as we can tell.
Some people just said, “You know what, I really like being home more, and if I can’t work remotely, maybe I don’t want the job anymore.” And they were more willing to say no to certain jobs that they had held before or offers. And finally, I think some people just burned out in some sectors. The stress on healthcare workers, on teachers, on food producers – the essential workers – was simply enormous. People got burnt out. People were angry. Everybody else can sit at home, and I can’t stay at home. So, some people decided, “I like the flexibility of working from home. I want more time with my kids, even if it costs me some income.”
So, I think all of that is fueling people’s greater choosiness or greater reluctance to accept jobs that they would have taken as fast.
Now then, you ask, well, can it last. And of course, that’s the $64,000 question. We don’t really know the answer to it because people’s financial balance sheets remain pretty strong. People saved up money during the pandemic, and some of that is still there, and so they can, at least in the short term, be choosier, afford to be choosier, and with so many jobs going begging, they can afford to be choosier. Now, if the rise in interest rates to fight inflation does cause a recession, and I think the odds are fairly high that it will, (although we don’t know if it’ll be a mild recession – 5-6% unemployment – or a more severe recession – 7-9%). But then it’ll be more of a test of when the jobs aren’t available, whether workers remain on the sidelines more and remain choosier. I think the ongoing retirement of the Baby Boomers, for instance, will be a force that will keep labor markets relatively tight. It will give workers some greater bargaining power. But time will tell, and we may need a few more years to see how much it lasts or not.
And of course, the Federal Reserve doesn’t want to wait a few years. They want the prices to come down now, for the reasons we already talked about. But that’ll be really interesting to see if worker behavior over time, and even through a recession, inches back to what it was like pre-pandemic, or if workers remain somewhat choosier, forcing employers to pay more to get them.
And I think different sectors also have different issues. In some sectors, it’s often a training issue. Workers lack the education or training to fill certain jobs that require very specific skill sets. We could do better. Our education and training system has a lot of holes in it. But again, that would take a lot of time to fix as well.
Lustig: And so, if it is the case that some of these trends might be long-term or permanent, does that mean that maybe we’re in for a long period of somewhat higher inflation than that 2% target? Are those forces going to keep inflation on the high side for the next decade or two?
Dr. Holzer: Well, they might lead to wage growth above what people were used to. High wage growth doesn’t necessarily lead to inflation if it’s offset by higher productivity. So, if we can help our workplaces have higher productivity growth, that will certainly help. That you can feed, wage, and compensation increases. Frankly, if employers do face a lot of wage pressure, that encourages them to automate the workplace a little more quickly, or maybe to offshore and outsource the work to contractors. So that’s another way that they can push back against this. So really high wage increases are inflationary. But if you can offset them with productivity, or with some of these employer actions to meet production demand in other ways, it doesn’t necessarily have to translate into permanently high inflation.
Lustig: That’s really interesting. Alright! That’s all the questions I have, is there anything you want to anything you want to add before we wrap up.
Dr. Holzer: No, I think we’ve touched all the major issues. The real question right now – I wish we knew how much unemployment it’s going to take to take the wind out of the inflation sails and bring this down to an acceptable 2-3% level. We don’t know. Nobody knows. The Federal Reserve doesn’t know, because the particular combination of forces driving those price increases now are different than they were back in the 70s or 80s. So, there’s no – and this is sort of always true – there’s never a perfect historical parallel, for where you are right now. So, the Fed can only do what it does. Push interest rates up, wait a little bit. Push them up again.
The inflation report of yesterday, which was a quite good report – it did show the first drop in inflation in a while. If they get a few more reports like that, no one ever places any great emphasis on one month, because the monthly numbers bounce around a lot. So, one month doesn’t mean that much. But if you have two or three months in a row that starts to suggest that price pressures are easing a little bit. The Fed might start to slow down. They might have half-point increases for a while instead of three-quarter points – something like that. But they would need to see it for more than one month before they make that decision
Lustig: And to bring this full circle a little bit, the Fed is using interest rates as the tool to fight inflation is, if I understand correctly, entirely aimed at the demand side of that equation, right?
Dr. Holzer: That is correct.
Lustig: They can’t do anything to solve those supply problems. To do that you have to do some of the things you said in the short-term in trade, and some other things you could do in the long term. But if demand is only one-third of the story, like you laid out, then should we worry that all these rate increases might need to get to a certain level that it would push the economy into recession? I’ve heard a lot of people speculate about that.
Dr. Holzer: I think, at a minimum, you want to take care of that one-third and if you can’t use any policies to bring down the supply side you might have to go beyond one-third on the demand side to try to cool those things off a little more than we would like to. If they wrapped up the Ukraine war tomorrow, that would stabilize the food and energy markets at the international level. But that’s beyond our control. Absent other effective tools and the fact that fiscal policy isn’t being used – the Biden administration is bringing deficits down, but they’re bringing it down from this crazy high rate. And another thing, by the way, that makes it a little bit hypocritical for Republicans to blame this all on Biden is that the Trump tax cuts were never paid for. They also contribute to big deficit spending. That’s inflationary, and you don’t hear them taking any responsibility for that.
But politically, I just don’t see the tough choices on fiscal policy. So, the only lever we have is monetary policy on the demand side, and they might have to go beyond the 2-3 points that demand have contributed to the high inflation right now in order to do that.
Lustig: Well, that’s fascinating. Dr. Holzer, thank you so much for taking the time. This has been a really fun conversation, and thanks to everyone else for listening. Thanks for tuning in!
Dr Holzer: Thanks very much for having me.
[Episode Ends]
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