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Edmund Phelps on Bloomberg Radio

January 25, 2022

Vonnie Quinn of Bloomberg Radio interviewed Edmund Phelps on January 23, 2022. The transcript of the interview is below.

Bloomberg Opinion with Vonnie Quinn
Edmund Phelps interview
Aired January 23, 2022

Vonnie Quinn: Welcome to Bloomberg Opinion, listeners. I'm Vonnie Quinn. This week, a special Nobel prize winning guest, Edmund Phelps, of Columbia University, who warned about the perils of sustained inflation in the 1960s, on today's inflation and how best to treat it. Ned Phelps’s work on the relationship between inflation and inflation expectations actively helped overhaul monetary policy. So Professor Phelps, the US economy experience demand pull inflation in the late sixties. You were one of the people who warned about what might happen. The economy ended up in recession. Let me begin by asking you what similarities you see with the late sixties today, if any.

Edmund Phelps: There are some important similarities between the inflation in the last years of the 60s and the present inflation. I'm sure there was a lot of demand bursting forth on the demand side and some forces operating on the opposite direction on the supply side. But I think the 1960s was very special period. Every hyperinflation is a very peculiar event. They don't come in a standard size with the same doses of this, that, and the other thing, each one is distinctive.

VQ: So, what kind of period are we in now? You mentioned hyperinflation. Do you believe that's on the horizon?

EP: I don't think hyperinflation is on the horizon if monetary policy heads it off <laugh> but on the other hand, it's hard to head it off until you're sure that it's coming at you. <laugh> So maybe we're gonna have some worsening of the inflation rate before the Fed decides, oh yep, this is a serious inflation, not just a temporary phenomenon, and we have to act. Or maybe the Fed will find that things settle down and, aha, aren't we smart? We didn't have to act. It's such a complex situation that I don't think that any professional economist let's say would have a strongly held view on whether we're heading for worsening inflation for whether we're going to see the inflation rate fall back gradually over the next few months.

VQ: It's tough to ask an economist about a hunch, but if I were to ask you if you have a hunch about this economy and where it's headed, and inflation in particular, given that you've seen so many of these types of cycles and so many unusual cycles—do you have a hunch?

EP: Yeah. I have a gathering feeling that the economy is going to go on growing very slowly as it's been doing over the past two, three years. And there are a lot of issues for fiscal policy. We have a huge fiscal deficit and, unless by a miracle markets bring back prosperity of a size that we have seen in the past, unless that happens, we're going to have slow growth and relatively high employment, higher than we've seen in the best years in the past decade or two.

VQ: What will that be a function of, Professor? Given that right now, unemployment is at 3.9%, labor force participation is down and under employment is at 7.8%. Nevertheless, the economy does seem to be doing pretty well, including the labor markets.

EP: Yeah, I think it's doing pretty well. We've had some cost push forces. Another force, which I think largely comes from COVID, there's been a serious contraction of the labor force and congestion in the nation's ports. And then there's been the huge aggregate demand coming from government spending. So, you know, a lot of good things have to happen before we get back to normal. It would be great if we could break up some of these monopolies so we could get the reverse of cost push and, uh, it'd be great if the government could manage to cut back the fiscal deficits, and it'll be great if people overcome their hesitancy about going back to work in offices and factories—if that happens, then I think we're going to be looking pretty good again. That's not to say that the economy will be nearly like what it used to be in the good old days with 3% or 4% growth of GDP and pretty good size growth of wage rates. Getting back to that is another matter. And I'm very pessimistic about the medium term, but I'm guardedly optimistic about getting out of the cost push and getting people back to work in offices and getting some cutbacks in government spending.

VQ: You mentioned real yields and obviously they're still negative pretty much across the curve. The 10 year at minus 62, the five year minus 117, even the third year is at minus 7 basis points right now. When do these yields turn positive, and what will it be a function of?

EP: Well, I certainly hope that they turn positive. If you took those rates that you just mentioned as indicators of the future, I think we'd have to be even gloomier than I was! But I think that as we get healthy again, and as we clear up some of our domestic political problems and our foreign policy problems, if we can do those things, then yeah, we might have much better sailing. I don't know. I hate to use a number. I hate to throw out a number, but certainly we can expect to do better than we have over the past three years and maybe better than we've done in 10 or 15 years. But I think it's groundless to think that there are good reasons to believe that we'll get back to the good old days with everybody out there innovating and excited about new products throughout the country.

VQ: Professor, let's turn to the problem the fed has right now. It went from avoiding talk of interest rate increases at all costs and waiting on inflation to suddenly having the market talk about four to five rate increases next year alone, to try and get over this inflation hump. But then you still have the long end of the curve, very, very low. So obviously inflation expectations are not out there to any great degree. How do you read the situation?

EP: Well, I think we understand what caused the decline of demand and the contraction of supply. What is unclear of course is where we're going to go from here. I think that we may get back to something like the new normal of the past 15 or 20 or 25 years, with modest growth coming from a very narrow part of the economy and some resumption of interest rates to previous levels, but not to the levels before the early eighties, nothing like that. So we'll get out of something that looks like a stationary state, but I think it will be a growth path showing very modest rates of growth, a modest rise of real interest rates, some pick up in the path of real wage rates, some upward slope there, which will be a tremendous relief. I don't want to poo-poo it, but I feel confident in saying that there is no sound basis for the thought that we could get back to the good old days of rapid growth, high real interest rates and rising wage rates. I don't think that's a possibility given the social and political environment.

VQ: Why are you negative about the medium term, Professor?

EP: Well, for more years than I want to count, I've been arguing that something really serious happened to Western nations, way back in the seventies and early eighties. You began to get a very serious slowdown of productivity. And for a long time, this was paid no attention to because people thought, rightly, ah, we've seen this before, but we always bounce back. But we didn't bounce back. We did not bounce back except for the period of the information revolution out in Silicon Valley between roughly 1995 and 2005. But once that blast was over, we sunk right back to very slow productivity, growth, and very slow growth of wage rates. We get a little distracted when we think about share prices. It's true that share prices have gone through the roof, but that's not a reflection of something good that's happening. That's a reflection of something bad that has happened. And this has been a pet theme of mine in the past few years. I haven't published it yet, but I'm glad to give it to you, Vonnie!

VQ: Me, too!

EP: The slowdown of growth due to the serious decline of innovation has gradually caused diminishing returns to set in as firms continued, for a while, to keep on investing. Without any innovation, to keep us on an upward track, each year's investment was less profitable than the previous year's. So you have declining real interest rates because cause of declining rates of return to investment, and that decline of real interest rates accounts for the rise of share prices. So the rise of share prices is not a signal something great is coming in the United States. It turns out to be a signal of something awful!

VQ: Some analysts are forecasting more investment in the coming years. Do you see that happening? Do you see companies getting a return on that investment? Productivity, perhaps, improving?

EP: Well, I don't see it and I have no reason to foresee it, but you know, things happen and, the world is changing all the time, and it could be that there will be a return to something that's rather near to the Golden Age from, let's say the 1870s to the early 1970s. But I think that's kind of wishful thinking. We don't know what that could be at the moment. I know that the scientists and technologists are doing wonderful things. During the good old days, it was not the case that most of the growth came from technical advances by technicians, scientists, and trained engineers. It mostly came from ordinary people, people in involved in businesses in the economy, hitting upon better ways of doing things. People had a spirit of innovating. So I don't see any basis for thinking that we're going to get back to rapid long term growth such as we had for the hundred years that I mentioned. I just don't see it anywhere. I don't say it's impossible, but I don't see it. My point is that what we will see is advances in certain narrow sector of the economy: in the technological sector and in the information sectors. Yes, I expect we will see more of that. And there will be some advances that will be amazing and extraordinary. But what will they do for the GDP and what will they do for wage rates? I don't think they will do much.

VQ: On the smaller point, professor, you have no concerns whatsoever that we are on the cusp of a wage price spiral, which some economists are concerned about.

EP: I worry about it, but that's not to say that I feel sure that it's going to happen. An inflation spiral won't take place unless the policy makers allow it to do. The Fed may make mistakes next month, the month after that, the month after that. But at some point, if inflation is rising, at some point, the Fed will jump in. That will stop the spiraling inflation rate. The inflation rate will subside and with a push, it could be pulled down to a normal level.

VQ: I do wonder, though, how the Fed prevents itself from raising too much or too quickly.

EP: Well, look, in this business, there's no possibility of acting without some mistakes. I think whatever they do, they're at risk of, with hindsight, wishing that they hadn't done that, or even gone in a different direction, the opposite direction. There's no way of getting around the fact that there are risks for the Fed, but there's also learning. I mean, if by taking less-than-drastic steps for one month, two months, maybe three months, the Fed finds that things are not getting better and maybe they're even a little bit worse, then the Fed is going to change direction, and then it will be criticized for having made mistakes. But I think that comes with the territory.

VQ: Do you have a clue about how many hikes the economy might be able to take or might need next year, Professor?

EP: Well, I don't know! How big is each hike going to be? [Laughter].

VQ: You tell me! [Laughter]. Some people think the first hike should be more than 25 basis points, now.

EP: You're talking about hike each month?

VQ: Or each quarter. The market is looking at more than four next year, so perhaps one in March, one in June, July.

EP: Each one, a quarter of a point.

VQ: Yes.

EP: I think that's probably a realistic forecast. I wouldn't think that that was an unrealistic forecast or that it was crazy or misguided. I wouldn't think that. But as I said, even that slow-and-easy, that policy may turn out after three quarters or so to be disappointing and worrying, and then the Fed will start tightening up more strongly. I do think that they're going to be scared of taking drastic action with just the information—just the data—we have now. So I do see that that slightly accommodative forecast that you described, but I don't find that to be totally unreasonable.