For the first time in 30 years, inflation is significantly chewing away at Americans’ buying power, hiking the price of gas, groceries, and rent. On Wednesday, the Bureau of Labor Statistics released its latest report showing 6.2 percent inflation in October, the fifth straight month that it has gone up by more than one percentage point. Following the report’s release, President Joe Biden issued a statement acknowledging how hard inflation is hitting everyday Americans, saying it would be a top priority for his administration going forward.
But while there are many supply-side factors driving inflation, from supply-chain issues to a unprecedented labor shortages, there is also red-hot demand from consumers for goods and services, meaningfully stoked by the $1.9 trillion stimulus package Biden passed in March, according to Harvard economist Jason Furman, who served as one of Barack Obama’s top economic advisers. In January, Furman wrote an op-ed in the The Wall Street Journal arguing that the stimulus package should be contingent on the pace of the country’s economic recovery. At the time, he was a rare prominent Democratic voice warning about the dangers of inflation. But the president’s stimulus was passed in full despite the progress the economy started making because of widespread vaccinations. The result, Furman told Intelligencer, is that more people have money to spend at a time when supply of both goods and services is way down — a perfect recipe for high inflation.
Intelligencer spoke to Furman to better understand the supply-and-demand imbalance, why he’s skeptical of a “Great Resignation,” and whether (or when) the Fed will hike interest rates.
Frame the nature of the problem you’re seeing with inflation right now.
Inflation has taken off in a way that I haven’t experienced in my professional lifetime. When you get unexpected inflation like this, the consequence is that wages generally don’t keep up, and so it’s leaving workers further behind in an economy where they already had a lot of challenges.
There’s actually a distinction between predictable, steady inflation and unpredictable, surprisingly high inflation. We should have more predictably steady inflation. The economy would actually function better with a little bit more inflation, year in, year out, and a little bit less averseness to stimulating and supporting the economy. I think in some ways moving to higher inflation is good. The problem is moving too rapidly and too unpredictably. That’s what we’re going through right now.
When you say “good” do you mean there is an optimal level of inflation?
With inflation, you’re trying to balance two things. It’s inconvenient for people to have prices always changing. But it also makes it very hard for monetary policy to prevent recessions and get us out of recessions if there’s not some underlying inflation. We’re in a very-low-interest-rate era, and so the Fed needs more room, and therefore it probably needs more inflation than it had before. I would say 2 to 3 percent, or possibly 3 percent, would be the right target for the Fed going forward, as opposed to the 2 percent target it’s currently pursuing.
Right now, we’re at around 5.4 percent, significantly higher. Is that not a sustainable rate?
I think the inflation rate will come down. I just don’t think it will come down as far as the Fed thinks it’s going to. The Fed keeps thinking 2 percent inflation is right around the corner; I don’t think it’s right around the corner. But I think it will remain a lot higher than what the Fed wants, a lot higher than people are comfortable with, and higher than is being built into people’s labor contracts. All of that is going to increase uncertainty and make life harder.
Backing up a little bit, there’s a number of theories out there for how we got here. Where did we go wrong?
The inflation we’re seeing is, like most things in economics, a combination of supply and demand. There have been some supply-chain issues, like factories closing in China and Malaysia because of COVID and electricity crises. Also, the disruptions that workers experienced because of COVID and the difficulties getting back into jobs. But a big part of the inflation problem is demand. We sent people a lot of money back in March, when the economy couldn’t make enough stuff for everything that people wanted to buy. Spending on goods is well above normal levels. Spending on services in nominal terms is above normal levels. Basically, we tried to put people in a position to buy more than ever before at a time when the economy couldn’t make as much as it used to.
Was that a foreseeable problem earlier this year with Biden’s $1.9 trillion rescue plan? Do you think it was the wrong time to do that stimulus?
I think that the rescue plan was too many dollars per month. It would have been fine to spend $2 trillion dollars, but to spread that money out over time. By concentrating so much of it so quickly, it added kerosene to what was already a fire.
Now that we’re in this predicament, what is the right strategy?
The Federal Reserve is the government agency that’s tasked with controlling inflation, and while I wish the White House had done things differently back in March, going forward, the job of controlling inflation really is for monetary policy. They’ve taken a first step now in tapering their asset purchases. If the world unfolds the way I expect it to, with higher inflation than many are expecting, then I think they certainly should raise interest rates a couple of times next year.
When you say the White House should have acted a bit differently in March, are you talking about spreading those payments out over time, or were there other things that you think they could or should have done?
I think that spreading payments out over time would have been better, and also putting more long-term investments into the legislation rather than just having ephemera. The checks felt good the day they came. Six months later, they haven’t changed America and are barely remembered politically, except for in terms of the inflation that they contributed to. Normally, when you do stimulus, you’re in a hurry to get the money out the door as quickly as possible. Here, we didn’t need to get it out very quickly because the economy was recovering already thanks to vaccination. You could have spread it out and been more transformational about it.
In this first transformation, instead of checks, what could there have been?
You could have put some of the infrastructure there. You could have put some into dealing with climate change. You could have put some health care in there. Or you could have made things last longer, rather than just doing one or two years of subsidies for health care or children.
I don’t know what Congress would or wouldn’t have passed. If they wouldn’t have passed all of that, then you could have done something smaller. Your economic policy needs to be sized to the problems you’re facing. I’ve long thought Washington was doing too little on lots of fronts, but it has now overcorrected and done too much. One consequence of that is the high inflation we’re suffering from.
I want to come back to a couple of those ideas, but just to go off on a little tangent: Some people compared the stimulus, the checks in particular, to a universal-basic-income policy. What do you think of that generally? If you’re worried about inflation, is that something you don’t want?
There’s a real distinction between year in, year out policies and one-time policies. I have a lot of concerns about universal basic income and, in particular, how it would be financed, how it would take away certain incentives that the current system creates for work or for help looking for jobs and the like. But I’m not worried UBI would cause inflation. I think it doesn’t make sense for a whole lot of other reasons.
In fact, most of the time, you should only worry about inflation when thinking about what the Fed is doing. When you’re thinking about what the president and Congress are doing, often there are arguments for it and arguments against it. But inflation isn’t an important consideration. Congress is considering a Build Back Better agenda, and that will have a very minimal impact on inflation. There are great reasons to support it if you think it will help children. There are reasons to oppose it if you think it will discourage work. But inflation just isn’t that important of a consideration for most of what Congress or the president does. It’s really the Fed’s job.
Is it unusual for the president’s policies to have the type of effect on inflation that we’ve seen this year?
Yes, it is. We’ve never before seen, between December and March, $2.8 trillion spent this quickly. It’s not just the amount of money but the speed that’s unprecedented. But if you’re looking at what you’re spending over the next decade, and you’re also paying for some of it, and some of it’s investment — none of that matters for inflation.
What if inflation does stay as high as it is, or if it gets even higher. Is that a possibility? If so, what would that scenario look like?
Unless you’ve lived through the end of ten pandemics, combined with massive amounts of fiscal and monetary stimulus, you shouldn’t be too confident in your own views on anything right now. Anything could happen going forward. A few months ago, it looked as if inflation was contained, as if it was mostly in areas like new and used cars, but inflation has really broadened out, and it’s showing up in a much wider range of goods and services. It’s showing up in housing as well, which is something that affects everyone.
Is that primarily because the supply-chain bottleneck has been exacerbated?
People who think it’s just a supply-chain problem are missing the other half of the problem, which is demand. The supply-chain problem isn’t mostly because our supply chains have broken down. It’s mostly because our supply chains can’t expand enough to keep up with all of the additional demand they’re facing. Demand is too high, and we wish supply could accommodate it. The demand issue is happening across most of the economy, except maybe in travel.
Is anything besides the stimulus check driving that?
Inflation is up everywhere around the world. The price of oil is up. Everyone is coming out of a pandemic. There is a re-sorting in the economy that has to happen when you come out of the pandemic, and that is proving to be inflationary everywhere. It’s just that, in the United States, we did more stimulus and are experiencing higher inflation. I think if we had done nothing we would have 3 to 4 percent inflation instead of 4 to 5 percent inflation.
There are a lot of different things happening at once. There’s no single cause here. The question is: Why has inflation been about three percentage points lower in Europe than it has been in the United States? It is facing a similar set of global conditions; it’s also facing supply-chain problems in shipping and semiconductors — but its consumers just aren’t spending as much as ours are.
That’s why you can attribute much of the inflation to stimulus spending?
Like you said, 3 percent would be the optimal level of inflation. Is there a danger threshold, where, if inflation goes above that, things get really bad for everybody?
I think inflation above 3.5 percent over the next year would start to cause problems. The Fed would be trying hard to raise rates to bring inflation down. There’d be a risk that doing so would cause a recession. It would eat away at people’s purchasing power, and it could start shifting expectations in a potentially damaging way. For me, over the next 12 months, if inflation is under 3 percent, that’s great. If it’s above 3.5 percent, it could have all sorts of repercussions.
Walk me through what those repercussions could look like.
Right now, the market is not expecting that much inflation over the next year. It’s not expecting the Fed to make very large moves. Anytime something unexpected happens, it risks creating uncertainty in financial markets, which could result in, for example, interest rates rising. We’re an economy that would be vulnerable to higher interest rates. The Fed has very little history of executing a soft landing where it lowers inflation without raising unemployment and hurting the economy. You’d worry that at 3.5 percent, it would prompt the Fed to act, and it could prompt it to act in a way that would hurt the economy. Finally, 3.5 percent, just by virtue of being unexpected, would mean most people wouldn’t have wage increases sufficient to keep up with the inflation.
If that happens, which segments of the population are going to be most vulnerable?
Workers and people on fixed incomes are vulnerable to inflation. Most financial assets are reasonably inflationproof, but not all of them. Certain types of debt you might hold are not. Conversely, most borrowers can benefit from inflation. It might erode the value of your mortgage, for example, which is a good thing if you have a high mortgage. It definitely redistributes wealth and creates a lot of winners and losers. But it redistributes in a somewhat arbitrary and probably undesirable way.
Do people who are thinking about financial assets ask you, “Hey, should I move all of my money into crypto?”
I think crypto is a terrible hedge against inflation because it’s extremely volatile. If you want to hedge against inflation, buy stocks, because they don’t go down when inflation goes up and they are considerably less volatile.
Is there a historical precedent for the levels of inflation we’re seeing? People always reference the ’70s — is there any reason to think this is different?
I don’t think we’re back to the 1970s. While there’s a lot of uncertainty, the odds of inflation in double digits is extremely low. It’s just less than perfect. Some people are talking about hyperinflation, which is silly and wrong. Other people are saying it’s all transitory, it’s all about to go away. That’s also wrong. There are a whole lot of scenarios in between those two.
So how quickly is this going to go away?
I don’t know. No one knows. To some degree, it depends on what policy does going forward, which is very hard to predict. It’s hard to know what the Fed’s going to do. In part, it depends on global conditions. But I don’t think we should expect the issue to go away quickly.
You said that the ball was in the Fed’s court at this point. But we’ve seen the Biden administration take steps recently to try to alleviate some of the supply-chain issues. Notably, in the past couple of days, they’ve expanded hours at ports on the West Coast. Will something like that make a difference?
The White House is doing all the right things on supply chains. It’s pulling almost every lever at its disposal. I don’t know how big of a difference it’s going to make, but it’s worth trying everything to unstick the supply-chain problems. The one thing the White House could do that it hasn’t done is reduce or eliminate tariffs on China. That would help our supply chains and lower price pressures. But it has been reluctant to do that.
Is that a politically dicey thing to do at the moment?
I don’t know. I give economic advice, not political advice. If you asked me what the White House could do to help supply chains and reduce inflation, I would say everything it’s doing so far plus reducing or eliminating tariffs.
Besides expanding the port hours, are there specific measures that have been particularly effective?
There’s not some off-the-shelf playbook that says, “Here’s what you do when you have supply-chain issues.” What the White House is doing is, by necessity, making up policy on the fly, and it’s lots and lots of small policies as opposed to any one big one. The ports are probably the largest of the small policies, but even with that it’s not entirely clear how big of a deal it will be relative to what would have happened without an intervention. But again, it’s worth doing. Leave no stone unturned, even if the stones are small.
The White House is pulling all the levers it has. Does the Fed have a full toolbox right now? How much freedom do you think it actually has to raise rates?
The main tool the Fed has is raising interest rates or signaling what it’s going to do to interest rates. One of the problems with the Fed over the past six months is that it has sounded overly sanguine about inflation. Sounding more hawkish would have helped prepare people for the likely policies in the future and kept expectations in the right place. The Fed has shifted a little bit lately from sounding unconcerned to sounding a bit more neutral about inflation. I think even that tone shift has been welcome, helpful, and more realistic.
A tone shift is different, though, than actually raising rates. Do you think it will end up having to?
The cheapest and least controversial thing the Fed can do is to change its tone. I think that it doesn’t need to go and raise rates tomorrow, but it should be ready to do so within months. Right now, it’s not doing a lot to prepare people for that possibility.
People talk about how this could be the new normal forever — we’re never going to get back to rates above 2 or 3 percent. Are you in that camp?
I think rates can and should go higher than where they are. Right now, rates are exceedingly low. I think rates can and should be very low, instead of exceedingly low. There are big structural forces that, over the past decade, have lowered interest rates. Those are still with us. Interest rates aren’t going to go back to where they were 20 years ago, but they also don’t need to stay as low as they are right now.
What is very low to you?
Interest rates got lower across all of the advanced economies over a period of about 20 years. That process is likely to remain with us thanks to a range of factors such as slower productivity growth, demographic shifts, and rising inequality. Layered on top of that, though, the Fed funds rate was cut to zero. That plus expectations brought other rates down. If I had to put numbers on it, the ten-year Treasury right now is about 1.5, and I think it could easily be 2.5 or 3 percent a year or two from now. Even that would be much higher than it is now but lower than it was a decade ago.
Clearly, the administration has a pretty ambitious spending plan and big political goals, whether that’s infrastructure or some of the social policies. How do you strike a balance between that type of spending and the danger with inflation?
The first-order-important fact is that the federal government can borrow at extremely low rates right now for long periods of time. I would be perfectly happy to see more borrowing from the federal government. The fact that President Biden is paying for all of his proposals is unnecessary. I wouldn’t have minded if some of those proposals were financed by borrowing. I would distinguish doing too many dollars per month and too quickly from spreading things out over longer periods of time. In some ways, there has never been a better time to borrow, as long as you’re spending the money productively and not too quickly.
So a transformational social policy doesn’t necessarily have to come at the cost of higher inflation for the next couple of years?
I’m not worried that spending money on children in preschool and climate change is going to have a material impact on inflation. The impact spending has on those policy areas is much more important than any inflationary impact.
A lot of people are watching the GDP figures, they’re watching the jobs figures — if hiring slows and the economy is not as robust as people think or hope, could we actually need more stimulus?
Most of the biggest problems the economy faces aren’t ones stimulus can solve. They’re problems that can be solved by vaccinations, testing, and China’s electricity-product crisis coming to an end. The stimulus can create demand, but we’re awash in demand. The problem is that we don’t have enough supply, and stimulus can’t bring supply into being. I don’t anticipate the need for anything resembling another round of stimulus.
Looking at economic indicators like jobs and economic growth, is there any reason to be concerned?
The job market has continued to do pretty well. The unemployment rate has fallen further and faster than almost anyone expected. We still have a really big hole, and a lot of people haven’t come back into the labor force even though there are a record number of job openings. But there hasn’t been any reversal. We continue to move forward. Sometimes we move forward at a faster rate, sometimes we move forward at a slower rate.
Are there any other factors, besides vaccination, that have kept people from getting back into jobs?
Never before have we had a labor market where there were so many open jobs, so many people sitting on the sidelines, and such a big disconnect between those two. We don’t fully understand why this is happening or what’s going to happen. My own hunch is that there hasn’t been a structural change, that we’re going to get back to where we were prior to the pandemic in our labor markets, and that the main things we need are time and patience.
How much patience?
We might need to wait a year or a year and a half. That would still make the recovery much faster than the recovery from the financial crisis.
What gives you confidence that there has not been a structural change and that we just need more time?
Oh, I don’t have confidence in that at all. What gives me that hunch is that you still have a lot of people in surveys saying they’re depressed because of COVID or they’re afraid of it. You still have people with very large cash balances from the checks they got, which gives them more time and flexibility to get back into the labor market. There has genuinely been a reallocation of labor, and it always takes a while for reallocations to sort themselves out. There are a lot of normal explanations for how people respond to incentives that can make sense of where we are now in labor markets. I tend to think that we don’t need to make any appeals to any special cultural factors. But who knows? Anyone’s guess, in some ways, is as good as mine because this is all unprecedented.
People talk a lot about how there hasn’t been enough wage growth and argue the pandemic has made people so miserable that some struggling industries need to pay people more. Do you see that as part of the problem? Also, if wages grow, what are the implications in terms of inflation?
Partly, people are demanding more wages because of concerns about work, but work is much safer today than it was six months ago, and people are demanding greater wages today than they were six months ago. I don’t think the safety aspects of the pandemic are the biggest issue. The good scenario is that wages rise faster than prices and that happens in a sustainable way consistent with productivity growth in the economy and that everyone’s happy. The worry is that we haven’t seen a wage price spiral for decades, but we haven’t seen inflation like this for decades either. It could be that higher prices lead to higher wages, but then higher wages lead to higher prices, and the workers who got higher wages aren’t left any better off and everyone is inconvenienced and hurt by the whole process.
The hospitality industry is talking about how it’s having a hard time finding workers. Do you think wages are the issue there, or is something else going on?
Leisure and hospitality is the only sector of the economy that has seen rapid wage growth that is faster than inflation and actually faster than the pace prior to the pandemic. Workers in that industry have done relatively well compared to other industries. There are still shortages. Even with the wage increases, it hasn’t been enough to attract workers. But my guess is that it’ll get there.
Are there industries that need to raise wages?
Wages have fallen the furthest behind in construction, education, and health care. Education and health-care wages tend to be set well in advance. If you have some surprise inflation, they don’t catch up with it. I’m not sure why you see construction workers falling so far behind at a time when there still really are labor shortages in that sector.
What do you make of the so-called Great Resignation, the idea that tons of workers are leaving jobs during the pandemic?
I’m skeptical of the Great Resignation. It implies there has been some longer-term cultural shift. Whenever there are more job openings, you also see more workers quitting their jobs. The quits rate right now is fully consistent with what you would have predicted given the number of job openings that we have. I don’t think there’s a cultural shift; I think there’s a hot, tight labor market, and in a hot, tight labor market, you see more people quitting because they know there will be jobs in the future.
Putting this into perspective with the market, the Dow and S&P 500 are at all time highs — how is that related to inflation, if at all?
Inflation is a disconnect between supply and demand. If people want to buy a lot, but we can’t produce a lot, you get more inflation. One reason why we could have a deficient supply is that not enough people are working. If this withdrawal from the labor force persists, then it would cause upward pressure on inflation. Conversely, if more people return, they’ll be able to make more stuff, and when they make more stuff and supply more services, that would put downward pressure on prices.
Are there risks here to the stock market given the level of inflation?
The stock market is built around the expectation that interest rates will stay low. If inflation is surprisingly high, and the Fed reacts, then those expectations will be disappointed. That would be risky.
Beyond what we’ve talked about, is there anything else that you’re keeping an eye on?
We’re not out of the woods on COVID. There could be a winter wave. There could be another mutation that would have large ramifications for the economy. We’re still in an unprecedented situation with very high levels of uncertainty. Ultimately, the most important thing for the economy will be people coming back to work and getting jobs. That’s more fundamental than any of the issues around inflation itself.
Is there anything else you think the government could be doing to help bring people back?
There’s no playbook for 7 million people who either can’t find jobs or aren’t looking for jobs. The main cure here is patience.