Odd Lots - How To Understand the Inflation We’re Seeing Right Now

Episode Date: September 23, 2021

Over the last several months, inflation has risen at a pace significantly faster than what economists have expected. Markets, and perhaps the Fed, take some solace in the fact that it can largely be tied to economic disruptions from the pandemic, and prove to be "transitory". But is it really transitory? And when will it fade? On this episode of Odd Lots, we speak with Julia Coronado and Laura Rosner-Warburton, the co-founders of the firm Macropolicy Perspectives, to get a better handle on what's going on, how long it will last, and the ramifications for the future.See omnystudio.com/listener for privacy information.

The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Rafini. We'll bring you the latest headlines, in-depth analysis, and big interviews. All the stories that hit home on your days off.

And I'm Lisa Mateo. Watch and listen to Bloomberg this weekend for thoughtful, enlightening conversations about business, lifestyle, people, and culture. On Saturday mornings, we put the past week's events into context, examining what happened in the markets and the world. That on Sundays, we speak with journalists, columnists, and key political figures to prepare you for the week ahead. Join us as soon as you wake up and bring us with you wherever your weekend plans take you. Watch us on Bloomberg Television.

Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio. and wherever you get your podcasts. Oh, and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal.

Unfortunately, my colleague, Tracy Alloway, she is off today. So it's just me. But regardless, I'm very excited about today's conversation, nonetheless. So a couple of the big themes this year that we've been talking about, and they're pretty intimately linked, we've been talking a lot about supply chain and supply. chain disruptions. And we started talking about those. I think at the end of last year, very early this year, I mean, we've really been talking about them since the beginning of the pandemic. But they

haven't gone away. And I think arguably, in some cases, they continue to compound and get worse. And there is not a day go by where there is not some new type of shortage that emerges. And I think the latest thing I saw this week is that fertilizer prices are going up and there's droughts and Brazil, and that's causing coffee prices to go up, and there's no wind these days in the UK, so that's causing energy prices to go up. So in addition to the pandemic, all kinds of things are going on. We know that by and large, there is this sort of characterization of the elevated inflation that we've seen so far as being transitory. A lot of people are not satisfied with what that word actually means or how that's defined.

We know that under the Fed's new framework, there is a greater willingness to, to tolerate some inflation overshoot in an aim to get back to maximum employment or a full employment. But then there is also a debate about how the current supply chain driven inflation plays into that. So there are so many sort of like macro and micro themes, which we've been discussing a lot on odd lots that intersect. And so I'm very excited about sort of exploring all of that. We really have like two perfect guests to discuss it. They're actually colleagues. And we're going to have a nice macro chat that hopefully helps us understand what's actually happening right now and what we should be looking ahead to next.

My guest for this week are Julia Coronado. She is the founder and president of macro policy perspectives, as well as Laura Rosner, Warburton, who is a founding partner and a senior economist also at macro policy perspectives. I'm very excited for this conversation. I expect I will be learning quite a bit. So Julia and Laura, thank you so much for joining us. Oh, it's our pleasure. Thanks. Yeah, great to be here.

So why don't we kick it off? Let's just dive into the inflation question. And either of you can take this. Lots of debate about, you know, we have this elevated inflation. It does, you know, it may be rolling over a little bit, but not particularly fast. And like I said, every single day, there's some, there's like the shortage of the day,

something I hadn't even thought about. And this week, like I said, I think it's like fertilizer prices, which of course is not going to help the food situation at all. How would, uh, what do you characterize where we're at or how you're thinking about inflation right now? Well, we've had a huge shock and we're sort of parsing through what we're learning

about the nature. of these inflationary impulses. I mean, a lot of what we're seeing is a reflection of one of the biggest shifts in relative demand that we've ever seen. So one of the big shocks in the COVID crisis was not just COVID itself and the shutdown of the global economy, but it completely changed what consumers spent their money on. So by virtue of being locked away at home and everything being shut down, a huge chunk of your budget got freed up. The money that you spend on personal care and entertainment and travel was suddenly unlocked and you were sitting there at home.

And so you started ordering things. So we saw this gigantic shift from services spending to good spending in the middle of a huge recession. And of course, we've never seen anything like that. So on the other side of the equation, producers were preparing for the worst. They followed their recession playbooks. So they shut down production. They cleared out inventories. They canceled orders.

So the combination of those two things led to the just gigantic surge in goods prices. You know, it was not the typical recession. Typical recessions goods spending gets hit really. hard and services spending is more resilient. And we saw exactly the opposite. And so producers were caught off guard and had to scramble to restart operations and restart supply chains. And then, of course, consumers were delivered several trillions of dollars into their bank accounts almost instantaneously by April. Disposable income was above pre-COVID levels, even though wage and salary income was a trillion dollars below. So consumers had money to spend and they could only spend it on goods.

And so that that has just led to just tremendous bottlenecks and supply chains. And that's probably the primary factor. And if that were the only factor, then the whole transitory narrative would probably be unfolding as expected. And I think the best example of this is lumber, something that you've covered in your podcasts. You know, it's not subject. to all of the global supply chains and container issues and, you know, COVID disruptions to the same degree as other goods. So it's already returned, you know, they've ramped up production, they've lumber's getting delivered, prices have fallen, you know, case solved.

But there's these other frictions, COVID itself keeps, it's just this rolling series of port shutdowns, factory shutdowns, and it keeps coming. You know, Delta is the latest wave, and that's, affected semis particularly hard. And then increasing frequency of climate events, the Texas freeze, flooding, fires keep happening. And that's probably something that's going to be with us more often. And then there were some things, I mean, Laura's pointed out, there are some things that were going on even before COVID with supply chains that are kind of being revealed by this crisis. Laura.

But Julia, before we even get there, I just really want to emphasize the first. point you made, which is this epic shift in demand. You know, what the global pandemic and all of these social distancing policies did was they increased the demand for space. So people moved out of urban areas where they needed cars. So they needed cars, housing, furniture. These are all very cyclical items. And they typically fall sharply in recessions. And so, I think businesses when they saw a recession on the horizon, they were planning for the worst, like Julia said, and they actually cut their supply. They tried to get rid of inventories. So we started at the beginning of this epic shift in demand with way too little supply,

because demand just raged for all of these items. And I can say from an inflation forecasting perspective, you know, one thing I feel like forecasters got wrong is maybe Maybe they looked at some of the more cyclical prices and components of inflation at the beginning of the pandemic. And they said, OK, I think it's reasonable to expect some vehicle deflation, given that that's what we have seen every single cycle. And so to get not just a lack of deflation in the vehicle sector, but enormous inflation was a huge surprise. And I think that was, again, twofold. One was, again, this shift in preferences that changed the composition of demand. And two, the fiscal stimulus that made it possible for consumers to spend more and made them more price insensitive than they typically are.

And so the vehicle sector has been a huge surprise this time around. So you mentioned vehicle. and Julie, you mentioned lumber. Lumber has already started to correct vehicles. I don't know. I mean, there was some rolling over of the used vehicle prices, but not very much. And I actually saw a stat that maybe they're already going back up again.

We know that overall vehicle demand has been impaired by the semiconductor shortage, and that doesn't seem to be easing any time soon. In fact, I think, you know, again, it's another one of these things where every day there's like another headline. about some major automobile OEM saying that they're not going to be able to expand production. We could chalk up. We could look at vehicles and say, okay, we can tell a pretty cogent story about what's going on in vehicles. Is it spreading?

Does this type of inflation that we can chalk up to the factors that you've described, which is the change in consumption patterns owing to the pandemic plus the increased demand and so forth, Is it spreading beyond categories that we can easily tell a story about? Or when you look at it, is it still seem like, yep, you know, check all the boxes. This is fairly, fairly clearly connected to the pandemic. I think that it's still fairly clearly connected to the pandemic, although it is a little bit broader than just vehicles. So, you know, where are we seeing it? We're seeing it within recreation goods, you know, televisions.

We're seeing it in gaming consoles. We're seeing it a little bit in computers, and we're seeing it in furniture. And I think what of those categories have it common? Either they're being affected by the chip shortage or they're being affected by shipping, congestion, and higher input prices. So I still think it's fairly specific. We haven't seen it broaden out. and we certainly haven't seen it in services yet. I would add that two things.

One, even within goods, there are some interesting examples where these costs aren't being passed along to the same extent, like apparel. So, you know, one of the interesting questions that were kind of parsing through the data and sifting through the data to figure out is, what is the consumer's reaction to these prices?

What we knew before the pandemic, is that consumers had been for decades incredibly resistant to absorbing price increases. If you tried to pass through price increases, they would shift their spending. And what we saw in the pandemic was there was this period when they had, you know, trillions sloshing around that they were less price sensitive. And now the question going forward is, okay, that fiscal impulse is fading. A lot of that money has gotten spent or saved or invested. how price sensitive will consumers be.

We are not seeing still any pass-through in terms of the apparel and definitely all of it's imported and subject to these bottlenecks. So that's one interesting example. And then another pandemic-related dynamic that we are still seeing is that there is still services disinflation that's very sensitive to the pandemic. Airfares just went down again. Hotel prices just went down again.

There is excess capacity in those sector. And probably as long as this, if we're looking at kind of a semi-permanent pandemic dynamic, you know, for the foreseeable future where people remain reluctant or variants keep rising and falling, is that, you know, these sectors will be oversupplied. People are not going to go back to the same level of business travel or personal travel that they were comfortable with before. And so those prices can go up and down with much greater frequency, even as the goods prices exhibit sort of the mirror image of that. And then I guess the bigger open question is

rents right now in terms of what's something that could be more persistent and sticky is, you know, what are we seeing in the rental market and how will that pass through, you know, how will some of these market measures that we see pass into CPI, how persistent will that be, and then how will the Fed react to that. I'm June Grasso, inviting you to join me for the Bloomberg Law podcast. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis of the biggest court cases, the latest actions from Congress

and regulators, and the legal moves driving the markets. From corporate law to constitutional law and from state courts to the Supreme Court. At Bloomberg Law, we go beyond the day's headlines. We speak with top attorneys, judges, scholars, and policy experts to break down what the rulings really mean. We do this every weekday, then bring you the best conversations in our daily podcast. Search for Bloomberg Law on YouTube, Apple, Spotify, or anywhere else you listen. On the East Coast, listen as you start your day. And on the West Coast, catch up in the evening.

That's the Bloomberg Law podcast with me, June Grosso. Subscribe today, wherever you. you get your podcast. You know, there are so many follow-on questions that I have just from this so far, but you mentioned, both talked about the consumer response. And one of the stories that economists like to tell is that from the sort of Volcker era, I guess for about 40 years, that the Fed had won the credibility by showing its commitment to fighting inflation.

and that that restrained inflation expectations themselves, and that by restraining expectations that had a feedback effect of restraining inflation, and so you get this sort of like nice, positive feedback loop, and therefore central bankers are extremely reluctant to err in the other way. They're like, look, we spent decades and decades convincing consumers that inflation would be mild, that's caused inflation to be mild. We've got to be really careful. And they're still, even with the tolerance of the overshoot and the new framework, you can tell that central bankers are still extremely reluctant to give up what they perceive as their hard won gains of restraining inflation expectations.

And I'm curious what both of you make about this idea of inflation expectations. Is this a powerful force? Is this a real thing that affects inflation? or is this a way for central bankers to pat themselves on the back and talk about and sort of trumpet their further accomplishments? That's a great question. And what we are in the midst of is one of the coolest experiments you could ever design to test this. You know, central bankers, as you say, put themselves very much at the center of taking credit

for this low inflation regime and stable inflation. expectations dynamic that we've seen in recent decades. But of course, we didn't even start to measure inflation expectations until that post-Vulker era. So we don't have long, long time series of consistent measures of inflation expectations. We've only measured them in the era of low and stable inflation and inflation expectations. So we've never tested what it looks like when inflation expectations drift higher and how that actually affects pricing decisions and dynamics and behavior. So I would say, it's fair to say, we're a little bit more skeptical of that, you know, I mean,

certainly central bank credibility has been an incredibly important global force, but it's not the only force. And there's a few other secular forces that we attribute the era of lower inflation. too. And so that's, we're looking to both inflation expectations as well as these other secular forces. I don't know, Laura, you want to outline the, the things that we tend to focus on in addition to expectations? Sure. So, I mean, one thing we're focused on is demographics. So as the population ages, they tend to consume more health care in particular. And the health care market is not a competitive market. The government has a very large footprint, and they actually

set prices for Medicare and Medicaid services, which is about 40% of the market. So because the government's liabilities are tied to health care prices going forward, they have a very strong incentive to keep health care inflation low. And an example of this playing out right now are proposals to lower. drug prices. So we've actually noticed a low and stable trend in health care inflation, despite tightness in the labor market that might call for upward pressure. We think that this is a large component that will continue to see downward pressure. Another secular trend has just been globalization and international trade, which has kept goods inflation low. Of course, that is coming into question now, just given all of the disruptions.

But it certainly has been something that has limited goods inflation in the past. And I think, sorry, go ahead. Well, no, I mean, I'm glad you brought this up because we did a recent episode with Dan Wong, who is a China analyst. And he brought this up, you know, he's like, China has closed its borders. And he's like, it may be several years before they fully open. up their borders. And I'm curious from your perspective, that got a lot of questions. And of all the things he said on that episode, that may have caught people's attention the most. What would it

mean for inflation if our trade relationship with China were to never normalize, whatever that word means? If we were to never say go back to 2019 trading patterns with China because of both the disruptions, but also policy choices or maybe the Biden relationship with Xi Jinping. What would that, what could that actually mean on an ongoing basis for inflation? So I think that's a great question because we're not going back to that. I mean, we know that was a trend before COVID that, you know, the trade war was centered around China. China has its own express intentions to delink its technology supply chain from the U.S. and is making rapid progress on that front.

That was one of the contributing factors to the semiconductor shortage. So we know that we're going to, we're in the midst of a structural reallocation of global supply chains in which the U.S. and China are seeking to realign their own supply chains to be more, not just domestically dependent, but amongst allies. So you see a lot of investment, for example, in semiconductor capacity, domestically in the U.S. and the U.K. and amongst allies. And the same thing with raw materials. There's a lot more policy focus on designing more ally friendly resiliency in supply chains. So that is going to add to costs in the next couple of years. You know, we've already seen that doing so. And then the question is, you know, when we talk about inflation, it is more of, And are we going to reallocate those and there's this one-time resetting in price levels or is it going to become an ongoing force of repeated price increases year after year after year reflecting ever more expensive supply chains? You know, we do see some de-globalization between the U.S. and China. But globalization as a force is more about competitive forces that, you know, U.S. companies face global. competition for the consumer, the consumer's wallet, and it interacts with technology.

Technology is another secular force that we focus a lot on. Technology is something that allows companies to be constantly implementing cost-saving changes in business production and business models. And that's on one side of technology. So constant source of improvements and cost savings. And then the other is that technology brings brutal price transparency. It allows consumers, it allows, you know, even at the wholesale level suppliers to visibility into costs and pricing that forces this competition in pricing, even in, you know, markets that are, you know, markets that are somewhat concentrated. So yes, I would say we see that there is this reallocation of global supply chains that will add to costs that has already done so, is already doing so.

But whether it becomes an inflationary dynamic, I think we're still skeptical. We still see the forces of the global marketplace and the influence of technology as disinflationary forces on an ongoing basis. Just to reiterate what Julia's just said, I think we should really be careful to distinguish between a level shift in costs and kind of ongoing increases in costs that leads to kind of a self-fulfilling dynamic of inflation. And I agree, I think decoupling from China where it's cheap to produce and labor is cheap would over time increase the cost of doing business for a lot of manufacturers.

I think also during the pandemic, you know, all of these supply chain issues that have arisen probably are causing companies to question, you know, their current supply chain operations. You know, it is maybe they need to be more simple. You know, maybe they need to be more diversified. and maybe that means higher costs as well. Maybe they need to hold more inventory than they thought. So all of this suggests maybe higher a level shift up in cost. The question is how much of that is just absorbed in profits by the company

and how much actually gets passed on to consumers. And I think that's where the fiscal stimulus comes back as a key factor. we saw companies during this unprecedented fiscal stimulus passing on a lot of cost increases to consumers. Will that continue as fiscal stimulus starts to fade and consumers become more price sensitive? And in this regard, there's some interesting global comparisons. You know, you can see greater pass-through of, say, vehicle inflation. for example, in the U.S. than in Europe, where there wasn't as generous a fiscal support. And that kind of speaks to that unique moment where we had extremely like unprecedented strong

support to consumer demand in the United States. And again, next year, this year already, that's largely behind us. Again, what is the behavioral response of consumers to higher prices, particularly for goods that are easy to postpone or, you know, shift around to other producers. The vehicle market is an extremely competitive market. Will they, and cars are, a car purchase is easy to postpone. What kind of behavioral response will we see? In fact, you know, arguably in the new car market, it's still quite a moderate degree of pass-through of the supply chain issues that they're facing because it is such a competitive market.

You know, I want to get into inflation, and we've talked about this before. It gets people going. People have very strong feelings about it. And I think part of the reason it gets people going is because there's a sort of, it affects different people differently. And one cliche that people often say, which I'm a little skeptical about is like, oh, inflation, it mostly hurts the poor. And I'm sure that in some cases, that is the case.

On the other hand, as you mentioned, one of the contributing factors, perhaps, to some of the inflation that we've seen in the U.S. so far this year, was the aggressive fiscal response, which was incredibly well targeted at people with a high marginal propensity to consume service workers who aren't typically particularly high paid who had lost their jobs, had seen income replacement like they've never seen before. and what we've seen even as things have begun to return to normal a little bit, is that wages at the low end, which had been fairly stagnant for some time, clearly seemed to be growing at a more rapid pace than high-end wages, setting aside the expansion of the unemployment insurance and so forth. So I'm curious about how you think overall, the policy mix, both the policy mix and the sort of the data outcomes that we've seen, the distributional effects of them, how are you thinking about the distributional effects of different sort of levels of income,

different levels of wealth from what we've seen so far? Yeah, so the grand experiment that we're running is what does it look like when you actually err on the side of going too much rather than too little and supporting and having a demand-led recovery. I think if we look, you know, the old cliche, as you call it, was based on, you know, supply chain inflation is not new. It's something that we've typically ascribed mostly to, you know, food and energy, right? Food and energy are subject to repeated constant supply chain issues, supply side issues, year after year from geopolitics, from weather, And so that's one reason we exclude food and energy and look at core inflation. And that's also the reason people tend to think of inflation as harming lower income people because they spend more of their budgets on food and energy. But as you say, this cycle has been unique in a lot of ways. And we did see very progressive sort of support for lower income, lower wage workers who got higher than even replacement.

through unemployment insurance. These lump sum stimulus payments are, of course, a bigger share of income for lower income households. So very progressively structured fiscal support. Low-wage workers were hit the hardest by job losses, but are seeing the biggest wage gains upon re-employment and recovery. So I think the distributional, if we look at sort of the labor and price side of things, there's a lot of different things going on. A lot of the goods that are inflating, like cars,

are luxury goods. Meanwhile, large wage gains for lower wage workers are certainly kind of a welcome development after years of rising wage inequality. So I think it's hard to just say, oh, lower wage workers are getting hit the hardest by this high inflation because they are getting the biggest wage increases as well. So we're going to have to see how this settles out going forward. Of course, if we broaden it out to wealth inequality, it's unambiguous because part of the aggressive response was supporting asset prices and that benefits the wealthy disproportionately. And that's just an ongoing byproduct of the Fed's toolkit. And that argues not for the Fed to do nothing or to do less to support the economy, it argues for exploring a different toolkit for the Fed, which we're all in favor of

a more blue sky exploration of toolkit, the Fed's toolkit. But I think distributionally, another thing that came out of this pandemic was because of all of that cash support, a huge reduction in distress. Lone delinquencies for the first time ever fell during a recession. You know, one of the interesting dynamics in the used car market was one of the limitations in supply came from the fact that cars weren't getting repossessed because people normally, you see a recession and, you know, a lot of people can't make their car payments and they lose their cars. Well, they could make their car payments and they kept their cars. In fact, repos were lower than normal, even in 2019, which was a great year. So that's kind of a unsung hero of the

fiscal package is that people didn't fall into distress. They didn't lose their homes. They didn't lose their cars as a result of the recession. And that's usually those sort of knock on effects that really hit lower income people the hardest, these sort of repeated shocks. You lose your job, then you lose your house, then you lose your car. That makes it harder to get a job, et cetera. And really there was a short-circuiting of that domino effect that, you know, as we look back over time and sort of evaluate the recession, that's going to, I think, be one of the unambiguous victories of this kind of approach to policy. April 29th and 30th, Bloomberg House arrives in Miami at the Formula One Grand Prix.

Set against one of the world's most electrifying sporting events, Bloomberg House brings business, investment, and culture together, powered by Bloomberg Journalism. real-time data and forward-looking conversations. From on-stage discussions to exclusive networking with global leaders, this is where ideas connect. Bloomberg House Miami. Presenting sponsor, Corian, supporting sponsor, OCTO. Learn more at BloombergLive.com slash Bloomberg House Miami.

I want to go back to something. So we're recording this September 21st, and this morning we got a strong housing number, and this idea of the supply side responds. You're talking about it a little bit with semiconductors, and, you know, we might see some greater investment. And I think there's some hope, you know, I think there's some hope that with tightness, with tightness in the labor market, with tightness in supply chains, that we may see a supply side expansion or a capital deepening of some sort, that companies will invest more and that we will just have a more productive supply side sector than we will. would have had otherwise because tightness in various markets will result in greater building of factories, hire more aggressive training of workers so that they are more productive,

greater investment in automation, and so forth. On the flip side, if this is all like a temporary, so that's like the hope, and you know, people have been talking about this more. On the flip side, if this is all just pandemic disruption and, okay, the pandemic is, it, over yet, but maybe it'll be over in three to six months. And then we've returned to something resembling normal. And then we get that fiscal policy tightening, which has already begun, because some of these pandemic era programs have come, are winding down. Then maybe things won't be so tightened, six months. And then maybe some of that investment will have proven to be unnecessary. What is your outlook for a sort of sustained change?

I guess I would say a sustained change in the KPEX trajectory? I think that thinking of going back to normal is not, it's almost never a useful concept. We never go back. We're always going forward. The pandemic has disrupted a lot of things that are not going to return to their prior state. consumer preferences on where they want to live, how they want to work, business preferences for, you know, how they want to conduct their businesses, the importance of, you know, face-to-face client contact versus virtual meetings, business travel, et cetera. Like, these things aren't going back. Even if the delta variant fades and vaccinations broaden and things feel a lot safer on a more sustained basis. We've seen businesses realize a lot of things about how they can do things more

efficiently, and consumers realize things about how they can work more efficiently. These are still early measures of GDP data, but it's been a productivity boom. We track earnings reports by companies across industries, and every industry is reporting intentions and active projects of exploring, you know, ways to do things better and cheaper and more efficiently and investments in technology have been enormous. CapEx is, again, above pre-pendemic levels, still with decent momentum. It's not falling back, you know. And so we expect continued pretty radical transformation in business models and operations. And it's not, again, it's pulled forward.

I think a dynamic that we've long expected, things like machine learning and artificial intelligence were things that all industries had kind of been looking and exploring and, you know, thinking about implementing projects over the coming years. And it really concentrated those efforts and brought them forward and forced, you know, things like telehealth. You know, the behavioral resistance to change is often slows things down.

It's an impediment to adopting new processes. And things like telehealth was always slow on implementation because, you know, the more established doctors were resistant to it, et cetera. Well, in a pandemic, you had to get it up and running. And guess what? It works. So it's cheaper. It's more efficient.

and it's not going away. So that's just one example, but I think there's many examples across industries. And I think that's also contributes to one reason, like we see so many frictions in the labor market. What consumers want to do, what businesses need from workers is shifting very quickly, and business models need to shift quickly. And so you hear the loudest complaints from the people that are having the hardest time reorienting their business models. But we, again, if you read earnings reports, you hear a lot of non-complainers. People that are saying, we implemented this, and it was amazing. And our profits are higher than expected because, you know, we've been able to, you know, do more with fewer workers or, you know, transform these processes. So I guess we're

pretty optimistic that the productivity performance this cycle is going to be better than last cycle and, you know, that's also a good news for the inflation front. We do think that this is sort of a transformational period, these frictions. You watch, you know, these companies dealing with these supply chain issues. They're reengineering what they need and how to do things more effectively and efficiently. And, you know, they're going to be better at things when they come out on the other side of this. So we don't really know what's going to have. happen with some of these democratic stimulus or spending plans that are in the works. Some might not pass at all. It's all very ambiguous. There's one provision in one of the bills that would give the

government greater flexibility to negotiate on, I think, Medicare negotiate on drug prices. And there's some question, who knows whether it'll actually make it in the bill. And then furthermore, Beyond that, I think there was some language that it wouldn't kick in until 2025 this power. So even if it were to make it in the bill, it would probably be kind of irrelevant to some of the inflation pressures that we're seeing right now. Nonetheless, I'm curious your take on that and how much, you know, something like that is pretty obvious that there are pretty big contributors to the inflation metrics that have nothing to do with monetary policy or macro and might be as. simple as, well, what are the government rules that can govern the price of prescription drugs? How are you thinking about that and how much difference could it make were the law to change such that the government could exercise some of its quasi-monopsy-monopsy buying power of prescription drugs

for so many people to be able to more aggressively push prices down? I think it could have a material impact. I haven't, I don't have an estimate. for you, but it's not something that we have factored into our baseline expectation for inflation. We had healthcare inflation actually pick up quite substantially in January, and that's something that is very unlikely to repeat in January 2022, and that I've estimated will reduce core PC inflation by about 25 basis points, just that not repeating. I think more broadly, our view is that health care inflation will remain low relative to, you know, the early 2000s when it was a lot higher. And that will be just a source of structural downward pressure on prices that should help alleviate maybe some of this supply chain inflation that we're going to see in in 2022 and 2023.

Yeah, it's kind of interesting because I think for years, there were a few categories that were seen as these like really consistent upward contributors to inflation. And obviously, healthcare is one of them. Education, if I'm not mistaken, is another area that for a long time was putting up a lot of upward pressure. But now that really seems to have cooled off. Yeah.

Yeah. Yeah. That's another one of the examples of the demographic headwind. You know, the class size of every incoming. college class is shrinking. And the education sector is not a nimble sector that adjusts capacity at high frequency. So we're oversupplied with higher education capacity in the United States. And, you know, for years, higher education institutions tried to fill those empty seats with foreign students. And that's become more difficult, although that's still, you know, an important

source of students, but at the end of the day, we still do have more higher education capacity than we have excess capacity. And so we've seen downward pressure on higher, on education inflation from that. You know, one thing that we're exploring right now is how would some of these other subsidies to education, so some of these other policy variables that are going to impact education feed into CPI inflation. So one thing that we've been posing questions to BLS about is how would, for example, free community college or, you know, the subsidies to higher education feed into CPI? It's more of an open and unsettled question. Right now what they do is they tend to drop zeros out of their calculation. They would just sort of ignore these subsidies. These subsidies would tend to

tend to actually potentially increase higher education inflation. Also, what about these subsidies to daycare that are being included in some of the bills that are, you know, in the reconciliation bill that's being debated right now? How would that feed into daycare pricing in CPI? So there's some open questions about how the education pricing, it's a sector that is the subject of a lot of policy focus. And it could, that source of inflation could evolve in different ways going forward. So I think demographically, higher education, we've seen the disinflation. There's no reason to expect that to reverse. Some of the other areas, though, you know, we'll have to think through how that's going to be captured and factored into measures of inflation as they get more government support.

So we're running a little bit of a risk here. Like, I said, we're recording this 21st. It's actually the day before a Fed decision. But I don't think you know, nothing, nothing that we've really talked about are, I think, going to talk about here is going to matter much, you know, whether some minor language they change to the taper. Well, by the time people are listening to this. That being said, I want to talk about the Fed a little bit because one of the subjects that we've dwelled a lot about on is sort of this new Fed framework that was unveiled August 2020 at Jackson Hole and basically, you know, tolerate some overshoot of inflation in order to do a better job of hitting its employment goals. And I think if you

look at some of the hikes that we saw in the post-grade financial crisis, the Fed clearly underestimated the degree to which unemployment could fall and was sort of perhaps premature and expecting inflation. So I think my first, you know, the first thing I'm curious about is, do you see so far a meaningful change, since this new Fed framework has emerged, do you see evidence that the Fed has behaved meaningfully different than they otherwise would have in the absence of this new framework? Is the current Powell Fed different than the old Powell Fed? Is it different than the Yellen Fed? Is there evidence of a significant change in thinking or is it pretty marginal? Oh, my goodness. I think there's huge evidence of the change already. I mean, part of the review

that wasn't formalized as much as some of the other elements was the idea that you go big in a recession because the biggest risk is the lingering malaise. You don't mess around. Time is of the essence. You go big. You go early. That was one of the things that came out of the review for Powell in particular. And he did exactly that in the heat of the pandemic when it was becoming a financial crisis. He short-circuited that very quickly. So that's evidence. And then I think you can see it in their tolerance of the supply chain inflation so far. There are hawks on the committee that are less comfortable. Chair Powell is more of a dove and he's more comfortable. I mean, his Jackson Hole speech was, you know, pretty doveish on that front. And then even if you look at their projections,

you know, that they are projecting liftoff, whether they pull it forward to 2022 or leave it in 23 at the September meeting, it's still, you know, given the inflation that we've seen in the old days, you would have seen way more panicking over this kind of inflation, number one. And number two, you know, the agreement is that you're going to let that unemployment rate fall to very right around the longer run rate, whatever you think that is, before liftoff. And so even in the Hawks projections, they might have a view that the labor market's going to be stronger faster and therefore lift-off will come sooner. But, you know, even somebody like Jim Bullard is on board with this reaction function. So I definitely see strong support for the new reaction

function being put into to action. I mean, the fact that we're just talking about tapering now, which is way beyond anything they would have done before, last cycle, they like each tapering, each QE program was so hard fought to get put into place and they were always rushing to end it as soon as they possibly could. And this is just a completely different mindset. I don't know, Laura, do you want to add anything? Yeah, no, I agree. I think earlier this year, you know, when you had the major fiscal stimulus bill passed and the Fed's stoplot was unchanged, right? It was evidence of, you know, a shift towards a more devish reaction function. I'm a little bit less sure on the supply chain inflation. I feel like in the past, if you thought the inflation was going to be temporary,

then you wouldn't respond to it. Only if it impacted inflation expectations would you, you know, really be concerned about it. So I don't know if we've seen, you know, so far necessarily a shift in thinking about supply chain inflation from the Fed. I think the one difference is that there was general consensus that most measures of inflation expectations were at the low end of the range consistent with their mandate and they would like to see them move higher. So we've seen kind of a tolerance for reflation that maybe would not have been as welcome if inflation expectations were in a more normal healthier range. So that's been a that's been a difference as well.

So obviously, you know, part of the whole reason for this rethink is ultimately about, you know, and I think a lot of people give up all credit for this of taking the employment side of the Fed's mandate extremely seriously. And that the recognition, even pre-crisis, unemployment can go very low without triggering inflation. I think unemployment got to, I think we got down to 3.4% in February 2020. It was not meaningful inflation, and there was probably at the time no reason to think it couldn't have gotten into the twos without triggering a significant rise in inflation. This time around, assuming we get back to those numbers, what's victory going to look like from the Fed's perspective in the end? because I still see this issue where you still have this sort of like Phillips curve logic.

We're in the end, they're still going to rely on inflation measures to tell them that they've reached the speed limit or the max capacity or something like that. But I'm curious what you think, how the Fed itself will be able to tell itself, okay, we've achieved victory. We've hit our goals. We've got to maximum employment. Well, I mean, most participants on the FOMC express satisfaction with the 2019 labor market. They were happy with that labor market. They all kind of agree. That kind of looked like full employment. We didn't have a lot of inflation.

We didn't have a lot of wage inflation. But we had a lot of narrowing disparities, a lot of very healthy dynamics. And so at a minimum, they'd like to see something that looks like. like that. They would like to see, you know, there's some debate about, you know, aging boomers and whether those that left will come back. But let's look at, you know, the prime age employment population ratio. That should at least return to 2019 levels. Maybe it could go to 1990s levels, depending on the productivity trends that we see and the policies that support labor supply. But definitely we can at least get back to 2019 levels of prime age employment to population.

That seems to be a metric that most people on the committee agree to. And broad-based wage gains, wage gains that are not just the top but shared at the bottom and narrowing disparities by race and ethnicity and gender. So, I mean, I think they were seeing all of those things in 2019. it looked pretty great. Powell was very pleased with the labor market of 2019 and repeatedly talked about it. He loved to see what he was seeing and he would like to get back to that. That's one version of victory. Maybe you could go even, maybe you could even improve upon that. We'll see. And I think wage growth is the other metric. Now that we've seen, I mean, I think one of the important

takeaways of the COVID crisis is that we can see consumers accepting higher prices. We can see these inflationary dynamics. So I think wage growth becomes a very important metric in this environment. Do we see broad-based wage gains? Are they ongoing? Do they support a higher run rate of inflation? Again, not just all these crazy wild pandemic relative price shifts, but a process that's broad-based and ongoing, wage growth is kind of the essential ingredient to that. So I think there's going to be a lot of focus on after all of this noise settles down, what are the trends in wage growth across the spectrum? And, you know, does that deliver you that higher run rate on inflation that you're seeking?

And I would say that, you know, beyond, once we're past these supply chain issues, can we achieve a moderate overshoot of the Fed's 2% target at the peak of the cycle? We couldn't last time. Can we do that this time? And can that bring up measures of inflation expectations from the lower end of their normal range a little bit closer to the mid or even a little bit higher? Can that anchor them there on a sustainable basis that maybe lifts interest rates, neutral interest rates a little bit and brings us a little bit away from this risk of the zero lower bound.

That would be a clear victory for the Fed. Again, the challenge right now is we've moved so far above target. You know, what is the inflation landscape going to look like once these supply chain issues are resolved? Are we going to move back below? Will we continue to run significantly above? I think the Fed is really hoping for a moderate overshoot at the peak of the cycle, which it really didn't get in the last expansion. Well, on that hopeful note, or I guess optimistic note, a hopeful note, I think that's a good place to stop. I could talk about these topics with both of you for a long time.

But Julia and Laura, thank you so much for coming on Adlon. It was a pleasure. Thank you. Thanks. That was a lot of fun. so much, Julian and Laura. Take care. Thanks, Bob. Yeah, you too.

Well, here, obviously, I would do a long chat with Tracy or a moderate chat with Tracy on what we just learned. But I found that conversation to be incredibly helpful. Very interesting to think through the different moving parts of inflation and think about the degree to which, you know, obviously, to me, this is the big macro question or one of maybe a, three or four big macro questions. Easy enough to sit here in September 2021 and point to elevated inflation is having something to do with supply chains and so forth. But if it extends further, if it goes into rents, if we do not see anything resembling normalization, if we continue to see these rolling shutdowns, obviously things get quite a bit

tricky. And of course, Julia and Laura did a fantastic job breaking that all down. So on that note, this has been another episode of the Odd Lots podcast. I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. Follow my normal co-host, Tracy Alley. Or she's normally my co-host on the show. She's also normal. She's at Tracy Alloy. And be sure to follow our guests on Twitter, Julia Coronado. She is at at J.C. underscore Econ. And Laura Rosner Warburton, she is at Ilyz Rosner. Follow our producer, Laura Carlson. She's at Laura M. Carlson.

Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening. A lot of short daily news podcasts focus on just one story. But right now, you probably need more. On Up First from NPR, we bring you three of the world's top headlines every day in under 15 minutes. Because no one's story can capture all that's happening in this big, crazy world of ours on any given morning. Listen now to the Up First podcast from NPR.