Following a recent College of Central Bankers Executive Briefing on Workforce Development, Danny Blanchflower joined two GIC Board Members in a discussion on the structural aspect of inflation today. Read their comments below.

Paul Horne, GIC Board Member, CCB Advisory Board, and Active Independent International Market Economist

I’d be grateful if Danny Blanchflower could address a structural aspect of inflation today that I rarely hear discussed or read about, even in economist-oriented dialogues.

That is the non-inflationary rpt non-inflationary potential GDP growth over the medium term. In both the U.S. and European Union, that limit is at or below two percent. The CBO uses 1.8%-to-1.9% for its medium-term baseline forecasts.

But since the Covid-19 pandemic began in early 2020, the Fed, ECB, Congress and the EU have added huge amounts of monetary and fiscal stimulus. By my estimate, $ 7-to-8 tn in the U.S. and € 5-to-6 tn in the EU. In addition, “excess savings” were estimated at USD 2 tn in the U.S. (no estimate for the EU).

U.S. monetary and fiscal stimulus since 2020 totals about 50% of nominal GDP. Much of this was not spent immediately because of repeated slowing of the economy due to recurring waves of Covid and its variants; as well as disruption of global supply chains.

So an unprecedented amount of stimulus has been injected into the U.S. and EU economies which are structurally unable to grow faster than two percent annually without triggering inflation.

I wonder how Danny thinks the central banks should/could deal with this problem without slowing the two economies into recession?

Kathleen Stephansen, GIC Chair Emeritus, CCB Advisory Board, Senior Economist for Haver Analytics, and Trustee of EQAT Trust Funds

Amidst prevailing market and economic practitioners’ gloom, the way I view the US economy is through following lens:

• an economy that is transitioning back to potential and at the same time absorbing the external shocks, be it the Covid variants and the Russian invasion of Ukraine, both intensifying the slowdown;
• fiscal restraint;
• still a savings glut;

This could lead to:

• inflation ebbing but not reaching the deflation-risk territory when inflation was systematically undershooting the Fed’s target;
• L/T interest rates not spiking and in fact still remaining low by historical standards;
• The economy becoming increasingly vulnerable to monetary policy mistakes once policy approaches the perceived “neutral” point, perhaps leading to a period of growth recession.

In Europe, there should be legitimate concerns about the cycle, given the Russian war on Ukraine, and yet business sentiment and the ECB systemic stress indicator remain relatively stable, though consumer confidence is down.

David (Danny) Blanchflower, CCB Fellow, Former Member of the Monetary Policy Committee of the Bank of England

My concern of course is that central banks cannot deliver a soft landing. The consequences of slowing the economy are much worse than inflation, which will go away as it always has.

This is the killer chart – 810 years of inflation data from the Bank of England showing the most likely response after double-digit inflation is deflation as consumer confidence collapses and they stop spending….and the price of timber falls.

The issue is not so much what the size of the stimulus is, but the scale of the negative shock that it is countering so it is the counterfactual that matters. Bernanke, I recall, when asked on CBS’s 60 minutes what would have happened if the fed hadn’t acted said the unemployment rate would have hit 25% as in the Great Depression

Recall the major surprise over the dozen years from 2008-to 2012 was why inflation and wage growth surprised on the low side.

I think forecasting today is harder than ever as we have maybe two data points to go on 1929 and 2008.  So, what the fed did between 1945 and today tells us little or nothing.

As I said in my take much has been broken. I worked for years on The Wage Curve (MIT Press 1994) on the relation between wages and the unemployment rate which was highly stable and negative. That relation has broken down and the unemployment rate no longer enters wage equations.

Of relevance here is that Waller’s claim in his speech that the vacancy/job opening rate tells us anything about soft landings makes no sense as its steady upward move since 2008 predicts rising wages growth which didn’t happen.  We stopped doing ten observation aggregate time series – which are subject to aggregation and missing variable biases of uncertain sign and magnitude – in labor economics two decades ago.

So, I am unclear whether or not the US is structurally unable to grow faster than two percent annually without triggering inflation. I have no idea what LR changes in behavior are going to occur, to what extent people alter work/life balance, how supply chains open, the path of the virus, or the war.  I am uncertain but too many policymakers pretend they know.

The uncertainties prevailing have resulted in two central banks – BOJ and ECB – rightly waiting and watching and not raising rates and two – Fed and BOE – with only hawkish dissenters raising rates.  Personally, I would have voted for a 50 bp cut to reflect that rate rises would kill growth once again and destroy central bank’s credibility and have to be out in reverse. This is exactly what happened when the fed wrongly raised rates from 2015-2018 on the mistaken belief the US was anywhere close to full employment. In my Not Working book, I explain why they had it wrong – and they have now admitted that.  The unemployment rate is uncorrelated with wage growth – the employment rate is now, and it shows lots of slack.

The market of course has done the fed’s tightening for it but many of us are now calling a recession.  My papers show that consumer confidence data around the world in the S predicts recession – likely from Q12022. It predicts 6 of last 6 NBER recessions and nothing else does. Revisions also take over at turning points – note France’s Q1 of 0 just revised down to -0.2. Thirteen OECD countries had negative growth in the last quarter including France, Italy, Sweden, Denmark, Ireland and Japan. UK had negative in March. Freight costs, Baltic Dry, wood prices, and housing start all tumbling as housing starts seems to be doing also.

This feels like 2008 spring all over again.  I recall then the concern was with inflation. There is great uncertainty going forward. Seems to me the groupthink at Fed and MPC is very dangerous as they have no idea and are harking back to 1974 which is essentially irrelevant – globalization and decline in union power central.

After the Powell press conference, I was struck by how much everyone was singing from the same book. I said the right question is what would it take for the fed not to raise or to cut?  That seems the right question.

The only issue now is how deep and how long-lasting the coming recession is.  Given that central banks can’t cut rates by 500bp and fiscal authorities won’t act as they did in 2009, my guess is it will be deeper and longer-lasting than in 2008-2009.

Growing at all in 2023 and 2024 will be the issue. BMPC is already forecasting zero growth.

Organizations fail because of group think.