The Munk Debates Podcast - Be it resolved: The Federal Reserve needs to fight inflation aggressively or risk its own credibility

Episode Date: October 12, 2022

Pandemic government spending, labour shortages, rising gas prices, and supply chain bottlenecks have led to a surge in inflation and some of the fastest price gains for a broad range of goods and services in the last 40 years. In response, some financial experts expect central banks to raise rates multiple times this year and start selling off some of the hundreds of billions in bonds they purchased during the pandemic. The threat of entrenched inflation supposedly requires central banks to respond aggressively and raise interest rates repeatedly over the course of 2022 despite tightening financial conditions and seemingly slowing economic growth. Other economists disagree, insisting that central banks have responded appropriately by not taking drastic and unnecessary actions that could cause a recession. Long-term inflation pricing in the bond market suggests that the inflation threat is a short-term problem, and small rate increases now can more than offset the risk of runaway, long-term inflation. The bigger risk is an economic slowdown or outright recession brought on by central banks raising rates too fast while selling off hundreds of billions in bonds into a global debt market that will struggle to absorb record government deficits. Arguing for the motion is Mohamed El-Erian, President of Queens' College at Cambridge University and Chief Economic Advisor to Allianz SE Arguing against the motion is David Rosenberg, President and Chief Economist and Strategist of Rosenberg Research & Associates Inc. QUOTES: MOHAMED EL-ERIAN “The Fed has to act and act boldly. Already it has lost some credibility, and if it delays more, it will lose even more credibility and have very few policy options that are attractive.” DAVID ROSENBERG “My view is that inflation is going to ultimately decline of its own accord and the historical record proves that.” Sources:  CNN, CNBC, PBS, France24 The host of the Munk Debates is Rudyard Griffiths - @rudyardg.   Tweet your comments about this episode to @munkdebate or comment on our Facebook page https://www.facebook.com/munkdebates/ To sign up for a weekly email reminder for this podcast, send an email to [e-mail].   To support civil and substantive debate on the big questions of the day, consider becoming a Munk Member at https://munkdebates.com/membership Members receive access to our 10+ year library of great debates in HD video, a free Munk Debates book, newsletter and ticketing privileges at our live events. This podcast is a project of the Munk Debates, a Canadian charitable organization dedicated to fostering civil and substantive public dialogue - https://munkdebates.com/ Senior Producer: Ricki Gurwitz Editor: Reza DahyaBecome a Munk Donor ($50 annually) to get 72-hour advanced access to the full length editions of Friday Focus and Munk Dialogues. Go to www.munkdebates.com to sign up. Hosted on Acast. See acast.com/privacy for more information.

These statues have to come down. It's always been a pandemic of the unvaccinated. The problem now is it's a pandemic of the willfully unvaccinated. Falling birth rates are good. They're good for our planet. They're good for our societies. We're not responsible for the escalation with Russia. We're not the ones who invaded Ukraine.

I don't think it's fair to portray people of color as victims. It is a very dangerous time in American politics. Welcome to the Monk Debates. We provide you with a civil and substantive debate on the big issue of the day to arm you, the listener, with enough information to make up your own mind. Today's debate, be it resolved, the U.S. Federal Reserve needs to fight inflation aggressively or risk its own credibility. Big inflation report out from the government today.

The consumer price index up 7.9% over the last year. That is a pace not seen since January, 1982. Driving that surge, prices for gas. food and housing. The chair of the Federal Reserve, Jay Powell, acknowledged today that he and the wider Federal Reserve Board had underestimated the threat of inflation last year. But with the annual inflation rate now closing in on 8 percent, that attitude has changed. At the Federal Reserve, we are strongly committed to achieving the monetary policy goals that Congress has given us, maximum employment and price stability. Today, in support of these goals, the FOMC raised

its policy interest rate by one-quarter percentage point. Hello, I'm your moderator, Rudyard Griffiths. Well, pandemic government spending labor shortages, rising gas prices, and supply chain bottlenecks have led to a surge of inflation and some of the fastest price gains for a broad range of goods and services in the last 40 years. In response, some financial experts expect central banks to raise rates multiple times this year and start selling off some of the hundreds of billions of dollars in bonds they purchased during the pandemic. The threat of entrenched inflation, they argue, requires central banks, especially the U.S. Federal Reserve,

to respond aggressively. Others disagree, insisting that central banks have responded appropriately by not overreacting to the inflation threat in the context of strong economic conditions. rising prices are a short-term pandemic-related problem, supposedly, and raising rates too fast, while simultaneously shrinking central bank balance sheets could lead to an economic slowdown, if not a global recession. On this installment of the Monk debates, we challenge the essence of these arguments by debating the motion, be it resolved. The U.S. Federal Reserve needs to fight inflation aggressively or risk its own credibility.

arguing for the motion is Muhammad Allerian. He's the president of Queens College at Cambridge University and chief economic advisor to Allianz. Arguing against the motion is David Rosenberg, president and chief economists and strategist of Rosenberg Research and Associates. Muhammad David, welcome to the Monk debates. Thank you. It's great to be part of this, Richard. Likewise, I was so looking forward to having this conversation with you. I think convening a debate. It is going to be a debate, but it's also a conversation about

what I think is arguably one of the really important public policy issues of our time. How are central banks and the U.S. Federal Reserve, in particular, is the world's most important central bank going to respond to this surge and inflation that we're all experiencing. What are the risks here to the economy? And maybe more importantly, what is at risk here in terms of the credibility of these central banks that have just been so important to our economies, to the prosperity that we've enjoyed in the whole post-war period. So our resolution today, simple to the point, be it resolved, the Federal Reserve needs to fight inflation aggressively or risk its own credibility.

Muhammad Alarion, you're speaking in favor of the motion. So please kick us off with your opening statement. Thank you. And it's such a pleasure to be here. And to talk about an issue that we feel every single. day, inflation, and what does that mean for the Federal Reserve and its credibility? Inflation is that phenomenon that slowly but surely eats away at our standard of living. And these days, it is not slow. Around the world, we are seeing inflation levels that we have

not seen for decades in the United States. It's the highest inflation we've seen for 40 years. We know a bit about inflation over time. It can destabilize us economically. It can fuel unsettling financial stability and most worrisome of all, it hits the most vulnerable segments of our communities really hard. That's why the Fed has to act and act boldly. Already it is late. Already it has lost some credibility. And if it delays more, it will lose even more credibility and have very few policy options that are attractive. Four facts. One, inflation has continuously surprised on the upside. The Fed has scrambled to adjust upwards its projections and still it will need to do so again. Second, the forward indicators are worrisome. There's a lot of cost push inflation in the pipeline.

Germany alone, we call it a 25% PPI. Third, all this suggests that inflation is also broadening, making the Fed fall further behind. And finally, when, inflation eventually comes down, and it will eventually come down, the journey there may involve significant undue damage to livelihood. The Fed has already lost a lot of credibility. It mis-meltagnosed the inflation dynamics. It has enacted. If this continues, it will then have only two awful choices, either push the U.S. into recessions with implications for the rest of the world or alternatively allow inflation to persist well into 2023 and cause us all sorts of problems down the road. Thank you. Thank you, Muhammad. You're listening to our debate today on inflation

and central bank credibility, our resolution be it resolved. The U.S. Federal Reserve needs to fight inflation aggressively or risk its own credibility. David Rosenberg, you're arguing against the motion. So same opportunity for you, a couple minutes on our show clock for your opening statement. Well, thanks very much. And I was really looking forward to having this conversation with Muhammad. And the one thing I've learned after being in this business for 35 years is that there is no such thing as a sure thing. So I will respect Muhammad's views and be open-minded towards everything he's saying coming to fruition, especially because he has nailed this inflation call.

over the course of the past year. And a year to me is still transitory. It's a term that was never really fully defined. But the one thing I just want to say, and I'm not really mentioning the Fed in my opening comments, I think that we can get more into my view that the Fed's credibility is being attacked on Wall Street and in academia and in the media

and even among the political class. But there's many, not all, but many market indicators that are saying that the Fed is not really behind any particular curve whatsoever. But what I just want to say is this. The one person who has influenced my thinking for decades, and we all know who it is, it's Bob Farrell, and I adhere to Bob Farrell's 10 market rules to remember.

To me, these are the 10 commandments from a macro and market standpoint. And I'm going to specifically identify rules number three and rule number nine. These are the 10 commandments as far as markets and macro are concerned. And rule number three is really important. And that is what keeps me on the ground. And it goes like this. There are no new eras, excesses are never permanent. And that's as true about inflation as anything else.

And I would just add to that rule number nine, rule number nine being that when all the experts and forecasts agree, something else is going to happen. And the consensus is so much in Muhammad's camp. you can't even take a tax your Uber right today and not have the person driving the car talk to you about inflation. Kindergarten children know about inflation. This is why it's not the 1970s, which took inflation by surprise. But Bob Furrell's rule number nine is that when all the ex-person forecasts agree and they certainly do, something else is going to happen. And that something else is going to be something other than inflation. And the only thing I'll say is that do we have inflation?

Yes, we have inflation. It is not demand-led inflation. That was for a period last year. We are confronting with epic, really dual global supply shocks, one from the pandemic and one from the Russian aggression in the Ukraine. The Organization for Economic Cooperation and Development is warned of a major economic shock from the Russian invasion. It says that if the current volatility in the price of things like oil and wheat are sustained, it could wipe a percentage point of global economic growth. this year. On top of that, inflation would also rise significantly. Interesting enough that a lot of the inflationary pressures, the bottlenecks were starting to ease just ahead of Putin's invasion. But this is an epic supply shock. And we do have, we don't

have to go back to the Stone Age. We can look back actually just a century ago to see another dual shock that had a massive distorting influence on the global economy, which was World War I and then the Spanish flu. This time around we had a pandemic and a war, and now we, back then, we had a war and a pandemic. And I got news for you. From 1915 to 1920, inflation averaged 15% at an annual rate, 15% in annual rate with those two huge shocks. And the general level of interest rates did go up indeed by the grand total of 75 basis points. But the key here is this. Once these supply shocks subsided, and they did, we went through a full decade of disinflation or deflation, and interest rates came right back down.

There's other examples that we can provide during this time period, but we have to assess the forest and the trees. We have a massive gyration around a fundamental trend line on inflation. We have aging demographics. We have excessive debt burdens that have only gotten worse in these past couple of years. And we have technology-led productivity growth. Those are powerful. Those are the powerful secular disinflationary forces that haven't gone away.

What we have right now is a very powerful gyration around the trend line. So my view is that once I see the whites of the eyes of the fundamental trend line shifting course, and I don't see them just yet, then treat this as transitory and just refine your definition of transitory that, as was the case a century ago, it can't actually last a couple of years. And believe it or not, still be transitory in the overall realm of economic history. Let me leave it there. Excellent, David. Thank you both. Terrific opening statements setting this debate up perfectly. Now a chance for rebuttal. So an opportunity for both of you just to weigh in on what you've heard, which of your opponent's kind of key arguments are stimulating you to possibly rethink some of your assumptions or reaffirm your view on this debate, pro and con, be it resolved. The U.S. Federal Reserve needs to fight implosion aggressively or risk its own credibility. So, Mohamed, you're up first with your rebuttal. Thank you. Whenever I listen to David or read his wonderfully written material, I always take notes. And today is no exception. So I've taken notes on five points that I would like to address. The first one is the concept of transitory. And it has been an incredibly elastic concept because initially it was meant to apply to a few months or a few quarters. Now, the very

few people that remain in so-called Camp Transitory talk about extended transitory, prolonged transitory. So what do we mean by transitory? Let me suggest that transitory is not a time concept. It's a behavioral concept. When something is transitory, it means that we look through it, that we don't fundamentally change our behavior. We believe that this phenomenon is temporary and quickly reversible. That is not what's happening today with inflation. People's behaviors are changing. Companies' behaviors are changing. Wage-setters' behaviors are changing. And it's important to recognize that that dynamic is in place because it leads me to the second issue, which is what is the historical parallel? It is the 70s. In the 70s, we also had an

inflation problem that started as a supply shock, the old price increase. But because central bank lack credibility, that supply shock de-anchored inflation expectations. And next thing we found out is that the sources of inflation were broadening and were building their own momentum that became independent of what started that process. And that is what I fear may happen today. David is right. Consensus has shifted. When I started worrying about inflation in May last year, it was a very least.

lonely place. It is no longer a lonely place, but that doesn't mean that the phenomenon is no longer valid. What it does mean is that it's changing dynamics. I worry today that we're not just looking at inflation and high growth, but we're looking at stagflation, that awful combination of declining economic growth and increasing inflation. If you're old as I am, you'll Remember that last time we had stackflation, we had a misery index, which measured the unemployment rate and the inflation rate. Thankfully, unemployment is not an issue today, but the last thing we want is stackflation to turn into recession. Which leads me to the final point. Inflation at the end of the day will come down.

The question is how does it come down? And there are three ways it can come down. There are those that believe it will come down. down immaculate, the immaculate disinflation. There will be some productivity shock. There will be some change somewhere that will bring down inflation quickly and inflation expectations will not be destabilized. There's a second camp that says it will come down after a while, but in the process it will create significant damage. And there's a third camp that says it will come down, but it will come down in an orderly fashion. I opt for the third, and if that were to happen, it would require

the Federal Reserve to be more credible on inflation and to take more serious action to make sure that we get to the destination that we all think will occur, but through a journey that does not cause undue damage to society, and most importantly, does not hit the most vulnerable segments of our community particularly hard. Thank you. Thank you, Mohamed. Great rebuttal. David, your opportunity now, too, to react to Mohamed's opening statement or what you've just heard. Sure. Well, look, I think that it could be true that we have to define what transitory really is. You know, we had the Chinese-led commodity super cycle when I was chief economist in Merrill, and that lasted three or four years, right up until oil peaking at $145 in July of 2008. everybody talked about inflation for different reasons.

Everybody was talking about secular inflation because of China's double-digit growth and voracious appetite for commodities. And everybody was talking about global decoupling. And I was saying, well, Bob Farrell says that there's no new eras. So I faded that view. But remember, for a different reason, we're talking about a whole new era of commodity-led, China-led inflation back in the mid to late 2000s. That lasted a few years.

What I'm trying to say is that that had to be transitory. because nobody talks about it today. Now, look, I do want to just address the 1970s because, you know, people talk about Arthur Burns and the failed policies of the 1970s. 1970s were definitely a screwed-up decade. We came off the gold standard, had the Vietnam War, and, of course, we had a dozen different oil price shocks.

I mean, oil went from $3 a barrel. By the end of the decade, it was almost $40 a barrel. It went up more than tenfold. For millions of Americans, this may be the worst weekend they've ever faced for finding gasoline to give them the automobile freedom they take as their due. And the news from overseas tonight gives no promise of quick relief. President Carter and other Western leaders agreed in Tokyo to limit oil imports to try to reduce dependence on OPEC, the Organization of Petroleum Exporting Countries.

In Geneva yesterday, OPEC slapped another large increase on crude oil prices and increased the Tokyo summit leaders deplored. But I want to say this about the 1970s because, you know, we have to defrapped. find what does stagflation really mean? We did have three recessions to endure from 1970 to 1980, but the economy actually expanded 80% of the time that decade. So what does stagflation really mean? When the economy was not in recession, I don't think it's well recognized that real demand growth averaged nearly 5% at an annual rate. Today, the natural trend in demand in the United States is barely 2%. And so, you know, maybe the Fed had to tighten aggressively because it wasn't just

a repeated set of oil price shocks, unlike this Fed, we did have a demand boom on our hands in the 1970s 80% of the time. So perhaps maybe the stag just reflects the fact that we had stubbornly high unemployment, but it was a completely different labor market back then. It was much more unionized, much more regulated, far less mobile, a labor force than we have in our hands today, and there's practically no productivity growth. And I don't know how we can have a discussion about inflation without that key supply side feature. So let's face it, the 1970s, if you want to draw the comparison, I mean technology in the 1970s was an IBM mainframe and a transistor radio.

So the key was that we had very low aggregate supply growth in the 1970s. That got corrected politically by Ronald Reagan. And we actually had red hot. For all the talk about stackflation, we had red hot demand growth 80% of the time in the 1970s. And I'll tell you, it's because the first of the boomers were in their 20s, heading into their 30s. They were fueling credit fuel demand for housing and durable goods, along with the proliferation of dual income families because the female participation rate for women was entering a huge up trend. So completely different. And now we have a different source.

We have these back-to-back global supply shocks from the pandemic and the Russian-waged war with Ukraine. And if this is the inflation that the fit feels it has to fight with a very inelastic for the time being. supply curve, it can only do it by demand contraction. So on that, I agree with Muhammad, that if this is the sort of inflation that the Fed feels it has to fight, this is not demand-led inflation. You could argue that they should have started tightening a year ago when we had those stimulus checks. That's in the rearview mirror. Demand is actually not strong. This is principally about supply. You know, I know the Fed's coming under attack. They're obviously responding right now. But when I look at the flat shape of the yield curve. I look at the strong dollar. Would the Fed be behind any curve?

And the dollar would be actually making new cycle highs. You'd be thinking Bitcoin and gold would make new highs, but that's not happening. And the longer term inflation expectations, benchmarked against the very near term inflation expectations, actually, actually are remarkably well contained when you consider what food and fuel prices have done over the course of the past several months. Thank you, David. An excellent rebuttal. Well, let me join the debate here and try to think of some questions that are top of mind for our audience tuning into this, this terrific debate. And I want to, again, just drill down into our resolution today, be it resolved, the Federal Reserve needs to fight inflation aggressively or risk its own credibility. So let's talk a little bit about the second half

of this motion, because we've, I think, had a great back and forth here on inflation. It's causes its effects, its possible duration. But, Muhammad, talk to us a little bit about the credibility piece and why you think it's so important that the Federal Reserve, in a sense, reclaim and restore some of its credibility. You wrote a terrific book a little more than half a decade ago, the only game in town about central bank. So I know you spend a lot of time thinking about these institutions, which just have profound effects on our economies and our day-to-day lives. Give us your argument for why credibility is really a key thing that we need to be thinking about and protecting in terms of these institutions and the public service that they provide.

Thank you. And I am a huge fan of central banks. I worked for 15 years in what is regarded as a global central banks, international monetary fund. I have studied central banks. You mentioned a book that I wrote in 2016 because I was worried that we were putting too much of a burden on central banks. And they play an absolutely critical role in our society. When a central bank is doing well, its words are sufficient to ensure good outcomes. It's known as forward,

policy guidance. And basically, a central bank, like a good parent, guides others to the sorts of behavior that is consistent with economic well-being. When a central bank loses credibility, it loses control of its policy narrative, and it faces a very difficult choice, which is what we see today. Either you validate someone else's policy narrative, which doesn't make sense for the economy and you risk today breaking the economy or alternatively you do not validate that but because you've lost control of the narrative that causes a whole set of unintended outcomes including financial instability that then hurts the underlying economy now why are we at this point look at what has happened over the last year until november 30th the federal reserve was absolutely convinced

that inflation would come down and would come down rapidly. On November 30th, it quote, retired, the phrase that the Fed share used, transitory from its vocabulary. And it had to because inflation outcomes were well above every single projection it had made in that year. And in fact, that error has continued. Then it became, well, if you believe that's the case, what are you going to do about it? And the Fed could have done something very easy. It could have stopped injecting liquidity. It didn't.

In fact, the week that we got a 7.9% inflation print, the Fed was still injecting emergency liquidity into the economy. And it is only now in March that he started raising interest rates. But the marketplace has run away from it. For someone who wanted the Fed to act early, I am aghast to see how many people want the Fed to hike by 50 basis points, at least twice. How many people are talking about seven, eight, nine hikes for this year? And if the Fed was to deliver that, we will be talking about a recession.

So we are living the consequences of a Fed that has lost his credibility. And the more the Fed loses his credibility, the worst the outcome for all of us. Hi, Rudyard Griffiths here, your host and moderator. I have a favor to ask you, please consider becoming a monk member. Membership is free and you get access to a series of great benefits, including a 10-plus-year library of some of our best debates, dialogues, and podcasts. You also get a free monthly newsletter featuring the debates that we're watching around the world. And you get a specially curated Friday weekly monk members-only podcast that focuses on the big international events and trends shaping our world. All of that, again, free at www.w.com.

I hope you'll consider joining and becoming part of our community. Now, back to our program. So, David, let's hear you on the credibility piece, because, I mean, for many, I think Mohammed has painted a compelling picture here of a Fed that really now has credibility issues. So it's confronting the inflation fight, not just in the context of the debate of, How transitory is this? It's confronting this inflation fight in lieu of a series of what now seem in retrospect to be pretty big missteps in terms of their handling of the COVID pandemic monetary response after the initial crisis. The fact that they did continue for months to buy mortgage debt to purchase government bonds to artificially suppress borrowing costs. and to keep rates flawed. So, David, talk to us about the credibility piece.

And again, this is a conversation as well as a debate. I'm curious to know just how concerned you are about the Fed's credibility generally. No, look, I mean, Roger, you brought up two things, which was the balance sheet and rates. And Mohammed brought up the fact that the Fed continued to ease last year by expanding the balance sheet. And I think that I agree with them 100%. It was totally unnecessary. the impact is much bigger on asset inflation than it really is on say Main Street, which is really where interest rates have the biggest impact. So Mohammed rings up November of last year, or November of 2020, let's call it, and then we get hit with the delta wave out of the blue.

And that actually, although it had a moderate impact on demand, it was more than offset by the fiscal stimulus. And then, of course, we had the impact it had globally on supply chains, especially in China. I mean, China, every few months is shutting down seven or eight cities with millions of people that are important manufacturing hubs. So, yeah, I guess the Fed is guilty by not having that in their forecast, but that's what we were dealing with. And then just as we're... David, I'm sorry to correct you. Delta was November 2020, but what I wasn't referring to in November was 2021. Well, November 2021, already, you know, the Fed had all.

already started making their pivot towards tightening rhetoric by that point. But I'm just talking about over the course of the say the past year plus, look, these are, you know, we either have to agree or disagree as to what is the inflation that the Fed really can have an influence over. The Fed cannot have an influence over the supply curve. It can only have an influence on demand. I would say that the balance sheet expansion last year, was totally irresponsible. And I agree with that 100%. It just made wealthy people wealthier.

But there's going to be a price to pay for that. You see what I'm saying is that when people talk about how strong the consumer balance sheet is, well, of course, because the assets on the balance sheet are so super inflated. So I'm going to say to Muhammad that if the Fed does have to raise rates aggressively, And, of course, they'll have to start quantitative tightening. There is no get-at-a-jail-free card. And the biggest risk is that these consumer balance sheets are going to see quite a bit of contraction on the asset side.

You know, we have $85 trillion of housing and equities on household balance sheets. We've never been here before. The household sector has never been as exposed, especially to the equity market. $45 trillion of equity market exposure naked long. directly and indirectly on their balance sheet. A decade ago, it was $14 trillion because nobody rebalanced their portfolios because they were taught that you don't fight the Fed. The Fed has your back.

Tina, there is no alternative. FOMO fear of missing out. Nobody rebalanced their portfolios. The household sector has never been this exposed to a bear market inequities before. So what happens when this balance sheet shrinks? Because there is going to be a reaction to asset prices. And this is what happened in the last. cycle. And I'm not talking about that this is going to be some sort of financial contagion. We all know

the banks are in much better shape. But if we have a 10, 20 or even 30 percent bear market or correction in these assets, that's going to have a huge impact on people's behavior. They'll turn more cautious. The savings rate will go up. And we're not going to be talking about inflation anymore. And so I would just say that I don't see where the Fed's credibility is. I see it on business media. I see it on academia. I see it on Wall Street. I see it from economists. I don't see it in the markets. The five-year, five-year-fours are not telling you the feds behind the curve.

The flat yield curve is not telling you the feds behind the curve. Gold, Bitcoin are not telling you the feds behind the curve. And if the Fed was behind the curve, the U.S. dollar would be sinking, it wouldn't be strengthening. So I just don't see it that way. The Fed's telling us now they've done a huge pivot. They know Powell is the pivoter. Powell is the pivoter. He's pivoting again.

As a practical matter, what was wrong was not the theory. It was just, in reality, the supply side constraints had been much, much more durable and persistent than we had expected. So we knew that we could be wrong, and I think we always thought, I always thought we could pivot pretty quickly and catch up. And, you know, we did pivot when we, we started to pivot in the middle of last year and then pivoted hard at the end of the year. Navy's under tremendous political pressure. Now they're talking 50 basis points. You know, go for it. Invert the yield curve.

The only, the prediction I made that actually was accurate in the past month was that once the yield curve floods and inverse economists on Wall Street and the Fed will find ways to tell you to dismiss it. And that's exactly what they've done, as they've done in the past. So I'm there saying that a year from now, when we're through the recession, we're through the bare market in real estate and equities that causes the savings rate to go up and consumer demand to hook down because you can't forecast inflation without understanding demand fundamentals. Recessions involve demand contraction. That'll solve the inflation problem. Make no mistake. stake that the Fed seems to be going in that direction. In fact, you know, Powell was at least

honest saying we can't guarantee there's going to be a soft landing. Well, of course he can't guarantee it because about 80% of the time in the past when the Fed embarks in a tightening program, we go in a recession. Guess what's going to happen with the recession? Inflation is going to melt. And Mohammed and I will be having a different debate 12 months from now than we're having today. Well, let me jump in here, Muhammad, come back to you on this key point that the world is a very different place. now vis-a-vis the 70s, as David paints a picture here, you're aware of it too, and I know it's a concern for you, record high levels of corporate individual government debt.

You've got these huge surging in asset prices over the last decade. You could especially say the last two years since COVID. So to what extent can the Federal Reserve actually fight inflation aggressively against that backdrop against the risks of a significant tightening in financial conditions that would result from a significant correction, say, in the stock market or a breakdown in credit markets. What is the Fed's room for maneuver here in reality, Muhammad? Because I know you have concerns about liquidity. So what are your concerns here, Muhammad, in terms of what the Fed can actually do? And how does that influence this debate we're having about its credibility and that being at stake.

My concern is high. And my concern is high because the Fed is very late. You can go back to what I was writing last summer, urging the Fed to ease its foot of the liquidity accelerator. Why? Because I wanted to avoid the outcome that David referred to, which is the Fed being forced to slam on the brakes. We're all drivers. We know what it's like. You can eye. ease your foot off the accelerator and slowly tap the brakes and control your car, or alternatively, you can dither, not pay attention to the road, and end up having no choice but to slam on the brakes and lose control of your car. And when you do that, your credibility, which has already been damaged, will get damage a lot more.

So I do worry. I do worry that by leaving it so late, the Fed is going to end up causing undue harm to people. I do worry that it will destabilize markets, that David said. But that is a function of its own making. It has put itself itself in that hole. And that is why we are in such a difficult situation. Let me refer to a few things because David has recovered. The good thing about economists and market participants is that for every number that one takes, another one can pick another number that goes against it. I could have picked up 10-year inflationary expectation market measure at all-time highs. I could have picked the New York Fed survey numbers that show you that people are getting more worried about inflation. I could have said, well, are you surprised that the dollar is doing well? Look what's happening to Europe. Look what's happening to developing country.

dollar is a relative price. It's not an absolute price. Of course, it's doing well. And gold, well, gold actually reached a local high in the last few weeks. The reason why we don't get consistent signals from prices across the board, because markets have been deeply distorted by the balance sheet activities of central banks. So I think we've got to be careful not to focus on partial numbers. and not to take into account what has happened.

Finally, if I may, there's an open question as to whether the secular disinflation process is still in play. I certainly hope so. But that secular disinflation process had three drivers. One was globalization. First, we brought in the Eastern European economies into the system with the lower wages and lower costs. then we brought in China, and then we are bringing in more of the emerging world,

and companies were getting more efficient, and supply chains were getting more efficient. I wonder whether this globalization process is going to continue, both at the government level with what's happening in terms of geopolitics, but also at the corporate level, where companies are increasingly stressing resilience and not just efficiency. I think that we are probably seeing a less powerful globalization, process. The second element was technology, the so-called Uber, Amazon, and Google

effects that basically allowed supply to be more elastic, that allowed existing assets to be used more efficiently, and that allowed us to be much better at price discovery. There was a debate as to whether that process is going to be as powerful in the future as it has been in the past. And the third one is demographics, which I think remain in play. But my concern is that we can't simply bet on the strength of the secular disinflation process because it's simply not as powerful. I hope it still is, but I get a sense that it is less powerful than what it has been in the last few decades. When our remaining time, before we go to closing statements, I know our audience would really like to hear both of you in terms of

your advice as to what do we do? So, David, I want to hear both from a policy perspective, you know, what do you think the Fed should do? Should it pause on these rate hikes? Is your expectation, you know, that six or seven hikes is highly unlikely? And then, David, how should investors position themselves in this time? Because it's just, it's a moment of incredible, I think, uncertainty for many people. As you say, these are forces and dynamics that, you at 51 years of age, it's barely part of my lived memory and experience. And then, Mohamed, I want to come to you with a similar question, and then we'll go to closing statement. So, David, give us your policy prescription for the Fed. What should they actually do?

And then what do you think investors should be doing? How should they be positioning themselves? Well, you know, it really hit me, Richard, that this whole topic today is about the Fed. But the inflation situation is a global inflation situation. And the central banks, by and large, were doing the exact same thing that the Fed was doing. So it's not just about the Fed and it's not just about the U.S. inflation rate. It's about central banks everywhere. I mean, you could argue that the BOJ and the ECB are still adding liquidity to this day. At least the Fed has stopped.

The Bank Canada stopped when? Last fall. Okay, nice. We're all in this together. You know, I heard the arguments about the end of globalization with Donald Trump, protectionism, nationalism, and we finished the last cycle. with 2% inflation, with 3% unemployment. The fundamental trend line didn't change.

The fundamental trend lines about disinflation, excessive debts, as I said before, which have gotten worse, aging demographics, which actually is disinflationary, not inflationary. And when you're taking a look at the data, you'll see that the fastest growing component of the U.S. economy has been spending on automation, on software, on cloud, on R&D, on electrical, called electronic equipment. Corporate spending in the United States the past two years in annual rate on productivity enhancing equipment has gone up 12% annualized. It's gone up at over six times the pace of the overall economy. So I can't think that we can sit here and talk about how we have the best corporate sector in the world in the United States and they don't know how to innovate.

And in fact, you're seeing it right now. I would submit to you that in the future we're going to be seeing the capital labor ratio going up, not down. You're seeing it already. Automation is accelerating. The big risk is a classic Fed policy misstep. They're going to invert the yield curve, and they're going to raise interest rates at a time when we have a de facto tax. The sort of commodity price shocks we're seeing is a tax on the consumer. It's going to be a margin squeeze on the business sector. And we're going to layer on a geopolitical shock with a food and fuel shock, which I said is like a taxation shock. And we're going to couple that with massive fiscal withdrawal.

We again, we didn't talk about this. How does that influence the demand side? This time last year, with the Biden budget buster, fiscal policy is adding more than five percentage points to GDP growth. By the end of this year, it's going to be subtracting almost three percentage points. So we have a negative fiscal shock. And then on top of that, we're going to have an industry shock. All these shocks are negative as far as real demand is concerned.

So I would say what you want to do is you want to cleanse, purge your portfolio of anything that is cyclical. And you want to brace yourself for a recession, which I'm not going to say is 100% odds, but the odds are elevated and rising and nothing's fully priced for it. So if you can't part with your equity portfolio, then make the shift towards the defensives that actually will preserve your capital in a recession, whether that's utilities, whether that's health care, whether that's consumer staples. And I think that healthcare has got to be a long-term hold because we're going to come out of long COVID. There's going to be tremendous anxiety in the future. Pharma, biotech, med tech, you've got to have exposure there. So I'm not saying you've got to move everything into cash. And I would say that we have to be thinking about how do we play the inevitability of Europe having to reorient itself in terms of how it sources its energy, which is very bullish for North America and LNG.

and dare I say, very bullish for nuclear power energy and so on and so forth. Food security coming out of this, farmland and stable parts of the world, I think very important. Food producers in general, I'll leave it there. Thanks, David. So, Mohammed, similar question for you before we go to closing statements. You know, what's your policy prescription for the Federal Reserve? And then, you know, how should investors position themselves during this period of heightened uncertainty? So David addressed really well your second question, so I'm not going to address it.

I will address your first question. What should the Fed do? And let me distinguish between what the Fed should do and what the Fed will do. The Fed no longer has good choices. It's too late. Its credibility is too damaged. So it needs to decide which mistake is it willing to live with. Is it willing to live with the mistake of slamming on the brakes, validating what the market expects, and throwing us into recession?

Or does it wish to live with the mistake of not doing enough and having the inflation problem persist well into 2023? If I was the decision maker, which I'm not thankfully, because I would hate to be in this world so far away from the world of first best in terms of policymaking, If I were in that world, I would choose the second. I would not validate market expectations of seven to nine hikes this year. I would not take the risk of throwing us into recession. And I would try to manage through a period of inflation that will be longer than it needed to be. As to what the Fed will do, I worry that the Fed will try to validate the marketplace by thinking that this is the way it reestablishes its credibility. and there will be a lot of damage done, undue damage done to livelihoods.

Excellent, Mohammed. Well, look, let's go to closing statements. This has been a terrific debate. Our motion, be it resolved, the Federal Reserve needs to fight inflation aggressively or risk its own credibility. And further to David's point, this could be a motion we'd apply to the Bank of England or the Bank of Canada for that matter, David. So, David, let's put a couple minutes on the show clock and get your wrap up of this terrific debate with Mohamed. Right. Well, look, my view is that inflation is going to ultimately the decline of its own accord. And the historical record proves that. I'm amazed the Fed thinks it has to raise rates aggressively. We have a massive dual supply shocks. They will ultimately subside. I can't sit here and tell you when. You know, we talk about the yield curve inverting. Look at the inversion in the commodity complex. And this has been a commodity-led inflation. In fact, 80%, when you think about the inflation and inflation expectations,

80% of it is directly and indirectly coming straight from the oil price. So I'm taking a look, for example, at the futures, the windier futures on oil is 20% lower than the spot price today. You look at corn and wheat. The futures prices are 10% lower than the spot price is. So I'm taking a look at the fact that even traders in the commodity markets don't believe that these prices will be sustained in 12 months time. I'll just say one other thing. You know, I think that supply will come back and it's coming back. You know, the rental component of the CPI is 40%.

And you can argue that was partly the Fed. Well, the Fed's going to reverse course. But remember that during the pandemic, nothing was being built. And so we had an extended period of time where completions were falling through the floor and multifamily. that's changing. You're taking a look at rental construction right now. Units under construction are their highest level in 47 years.

Rental housing starts. We just got the numbers last week. They're up almost 50% year every year. We're going to be swamped with new supply of rental accommodation in the United States in the second half of this year. I think a year from now, and I know people will just roll their eyes, I think this is going to be a repeat, a repeat of what we had from 08-09. I think you're going to flip from excessive inflation to deflation.

If the Fed wants to raise interest rates and generate a recession, which it seems bent on doing, the deflation is going to come back next year. Then we'll be in a real pickle. And then layer on top of that, layer on top of that. And Mohammed's right. The Fed's moving too late. The big mistake last year was not on rates. It was continued to expand the balance sheet and fuel an asset price bubble that, by the way,

is more acute now than it was back in 2007. Okay, Mohammed, you're going to get the last word. in our debate today, the motion, be it resolved, the Federal Reserve needs to fight inflation aggressively or risk its own credibility. You've been speaking in favor of the motion, so wrap this debate up for us. So my closing statement, I'm going to make two remarks. The first one relates to the second part of the motion risked its own credibility. And here, all I need to do is, quote, David, and I agree with what David said, is quote, David, when he said, quote, it was totally irresponsible, unquote, of the Fed to continue doing what it was doing on balance sheets.

He said it a couple of times. And when you do something that is, quote, totally irresponsible, you damage your credibility. As to the first part of the motion, I hope David is right. I hope that we're going to get what is now called the immaculate disinflation. I worry that he may not be. And I worry that we are going to end up in a bad place because the Fed hasn't acted early enough. And I fear that David and I, in a year's time, will be talking to each other about the recession. And at that point, I think we will both be in agreement, which is we got there because the Fed did not act early enough.

It did not fight inflation aggressively. and it has lost his credibility. Thank you. Thank you both for this debate. Many of us follow you each closely in the media. Your respective commentary is always just so balanced and more importantly, so civil and substantive. And that's kind of what we're all about here at the Monk debates. And I just want to acknowledge that.

And also acknowledge, Muhammad, you were concerned that this was a debate because you're not regularly a debater, but you gave us a fabulous debate. And likewise, David, you're such a terrific communicator. So both of you guys, thank you so much for coming on the monk debates today being part of this conversation. Thank you very much. It was an honor being part of it, Richard and Mohamed. And thanks for inviting me on. Well, that wraps up today's debate.

I want to thank our participants, Mohammed and David. They certainly gave us a lot to think about. Terrific to get your feedback on this debate. What did you think about the argument? that David and Muhammad put forward, where do you stand on the issue of raising rates rapidly to fight a supposed inflation threat? Send us an email with your comments and suggestions to podcast at monkdebates.com. Here's some recent listener feedback from a monk debate. We just produced on the war between Russia and Ukraine. Karen writes, fabulous debate and absolutely

needed to be heard. There are always two sides to any conflict. And as Barry Pozen said in your debate, it's usually not that the other side is pure evil. I also think the usual tiresome American paranoia about Russia is very much in evidence. Well, thanks, Karen, for those comments. And please check out that debate just released in our podcast feed in the last week or two. A must listen on the war in Ukraine. A reminder also that you can can catch our weekly monk members-only podcast exploring the big issues and ideas moving public debate anytime as part of our free complimentary monk membership you can grab your monk membership right now at triple w the monk debates m unk debates with an s dot com forward slash membership thank you for

lending your time and attention to our efforts to restore the art of public debate one conversation at a time. I'm your host and moderator, Rudyard Griffiths. The Monk Debates are a project of the Aurea and Peter and Melanie Monk Charitable Foundations. Rudyard Griffiths and Ricky Gerwitz are the producers. The Monk Debates podcast is mixed by Residia. Be sure to download and subscribe wherever you get your podcasts. And if you like us, feel free to give us a five-star rating. Thank you again for listening.