MONITOR SUPPLY SHOCKS

“And that is indeed what they've been trying to do, to normalize and formalize this new order in which the Strait of Hormuz is their Panama Canal. You know, something that they collect resources and revenue from and it's an enormous source of leverage for them. And that is something that is going to be difficult to totally reverse because they've seen, it's a more powerful tool than anything they've had before.”

“In my view, if you're looking around the world at which countries are better off now than they were before the war two months ago, the only one I would say with confidence as of now is Russia, and that Russia is just a lot wealthier than it was a few months ago because of the spike in oil prices and the risk premium to energy. With America bogged down in Iran, it has less time to think about Ukraine.”

“I will say this, if I were back at the Fed, I would spend more time looking at the implications for nominal GDP growth, the various Fed scenarios than I did when I was there. In part, of course, half of the time I was there was the pandemic, and when real GDP is going down 22 percent annualized and 22 million people lose their jobs, you're not really calibrating all that finely. The other thing I will say, and I think Jim Bullard, and I'm sure there are others, but I think of Jim's work, Jim Bullard made the case in some theoretical papers several years ago that at least in certain macroeconomic environments, you can actually have better outcomes if you stabilize nominal growth even if it means some fluctuation and inflation.”

“One shorthand way of thinking of them is that the principle is that they fear that if Iran reforms, it could end up like the Soviet Union. The pragmatists, I think the model in their head is China. When after Chairman Mao died and Deng Xiaoping came and, as I said, prioritize economic interests before the Cultural Revolution. And at the moment, given the profound mistrust between the United States and Iran, the cynicism of the principalists is difficult for anyone to disregard.”

“I thought Iran as North Korea was the least likely outcome. Unfortunately right now, at least in the immediate term, that may be the most likely outcome of this war, that we have, and again, it depends somewhat on what is the health of Mostafa Khamenei. But as of right now, it looks like it's another hereditary, ideological dictatorship with nuclear ambitions. And they've proven themselves willing to kill potentially tens of thousands of people to stay in power.”

“Asian economies account for 40 percent of the world's energy demand. Almost all of them are net importers. Pakistan, for example, gets 80 percent of its crude from the Gulf. Bangladesh imports 95 percent of its energy. Energy shocks are like a triple whammy for these countries. They are more dependent, so they have very few options. They have to buy energy in dollars that are more expensive, and they're already in economic trouble.”

“When I hear about supply shocks as being a problem for policy, it is because it creates hard tradeoffs in terms of employment and the economy. But I don't want people to think that because central banks, by cutting rates or raising rates, can extract barrels of oil from the ground, that there's not something that monetary policy can't do about inflation. So it's ultimately over a period of several years, inflation and the price level is the choice. And whether or not the shocks that hit the economy are to supply or to be in.”

“I already do see in the current constellation of yields and not just in the US, but globally, higher yields, and I attribute most of that to higher-term premium that bond markets require to hold sovereign bonds. During my time at the Treasury, even before the pandemic, when the Pal FED was hiking rates, I think 10-year Treasury yields peaked at around 3 percent, and they're now running, of course, in the mid-4s, and indeed, they've been averaging, I think, four and a quarter for the last several years. If you look at yields in Europe, as was documented at the time, at one point, I think, in 2019, there was close to 20 trillion euros worth of negatively yielding eurozone debt.”

“I think one potential error where these models can be helpful is, as a social scientist, as we both are, there are important elements of group and committee dynamics that are for the most part completely left out of textbook, Clarida, Gallagher, Gertler, DSGE models. Alan Blinder gave a wonderful speech or wrote a paper 25 years ago, essentially making the point that if you really want to understand monetary policy, you've got to understand the social science and, if you will, anthropology of committee dynamics. I think what most academics do is they think, well, it's the Volcker Fed, so it's a committee of one of the Greenspan Feds, but committee dynamics are quite important.”

“I will say this, if I were back at the Fed, I would spend more time looking at the implications for nominal GDP growth, the various Fed scenarios than I did when I was there. In part, of course, half of the time I was there was the pandemic, and when real GDP is going down 22 percent annualized and 22 million people lose their jobs, you're not really calibrating all that finely. The other thing I will say, and I think Jim Bullard, and I'm sure there are others, but I think of Jim's work, Jim Bullard made the case in some theoretical papers several years ago that at least in certain macroeconomic environments, you can actually have better outcomes if you stabilize nominal growth even if it means some fluctuation and inflation.”

“I already do see in the current constellation of yields and not just in the US, but globally, higher yields, and I attribute most of that to higher-term premium that bond markets require to hold sovereign bonds. During my time at the Treasury, even before the pandemic, when the Pal FED was hiking rates, I think 10-year Treasury yields peaked at around 3 percent, and they're now running, of course, in the mid-4s, and indeed, they've been averaging, I think, four and a quarter for the last several years. If you look at yields in Europe, as was documented at the time, at one point, I think, in 2019, there was close to 20 trillion euros worth of negatively yielding eurozone debt.”

“I think one potential error where these models can be helpful is, as a social scientist, as we both are, there are important elements of group and committee dynamics that are for the most part completely left out of textbook, Clarida, Gallagher, Gertler, DSGE models. Alan Blinder gave a wonderful speech or wrote a paper 25 years ago, essentially making the point that if you really want to understand monetary policy, you've got to understand the social science and, if you will, anthropology of committee dynamics. I think what most academics do is they think, well, it's the Volcker Fed, so it's a committee of one of the Greenspan Feds, but committee dynamics are quite important.”

“I also think that, David, there is a real case to be made that whatever the size of the Fed's balance sheet is, in most times away from extreme circumstances like 2008 and 2020, I would be in favor of a Fed balance sheet, however large it was, that was largely invested at the very front end of the Treasury curve. If you go back and look at the data before 2008, half of the Fed's portfolio, I think, was in bills and 70 or 80 percent was in only out to the five-year point. Now, I would never say never, so there are certain circumstances where the Fed would want to take on a lot of duration risk.”

“Through 2024, it was about as close as you can get in the real world to a soft landing disinflation and that in the US, core PCE peaked at around 6, headline CPI was at 10. Historically, in order to reduce core inflation by multiple percentage points, you need a deep recession. I believe there are some very prominent economists who said to get inflation down to the 2s, you're going to need 6% unemployment. And of course, through the end of 2024, that had not happened. Inflation had fallen, I think it bottomed at 2.4%.”

“I also think that, David, there is a real case to be made that whatever the size of the Fed's balance sheet is, in most times away from extreme circumstances like 2008 and 2020, I would be in favor of a Fed balance sheet, however large it was, that was largely invested at the very front end of the Treasury curve. If you go back and look at the data before 2008, half of the Fed's portfolio, I think, was in bills and 70 or 80 percent was in only out to the five-year point. Now, I would never say never, so there are certain circumstances where the Fed would want to take on a lot of duration risk.”

“If I'm negotiating my wage for the next year, or for some reason, I'm not going to raise my price until next January, I'm really concerned about inflation in the next number of months, not the next five years. And so I do look at, and I think very important to look at market based expectations, I do take the point that has been made forcefully by others, especially in 2021 and 2, that it's important to look at inflation expectations, as you said, at various horizons. Indeed, you can make a case that when it comes to price and labor market and wage setting, it's really short run inflation expectations that are arguably as a matter of theory should be relevant.”

“Through 2024, it was about as close as you can get in the real world to a soft landing disinflation and that in the US, core PCE peaked at around 6, headline CPI was at 10. Historically, in order to reduce core inflation by multiple percentage points, you need a deep recession. I believe there are some very prominent economists who said to get inflation down to the 2s, you're going to need 6% unemployment. And of course, through the end of 2024, that had not happened. Inflation had fallen, I think it bottomed at 2.4%.”

“So, what President Trump has done is to significantly reduce his demands of Iran over the last six weeks. If you go back to the speech that he gave at the outset of the war, he had very grand ambitions to destroy Iran's nuclear program, destroy its missiles and drones, destroy its regional proxies, and potentially even bring down the regime. And now, six weeks later, the missiles and drones, as far as we know, are not even part of the negotiations.”

“When I hear about supply shocks as being a problem for policy, it is because it creates hard tradeoffs in terms of employment and the economy. But I don't want people to think that because central banks, by cutting rates or raising rates, can extract barrels of oil from the ground, that there's not something that monetary policy can't do about inflation. So it's ultimately over a period of several years, inflation and the price level is the choice. And whether or not the shocks that hit the economy are to supply or to be in.”

“I think you're absolutely right that what they perhaps have discovered over the last five weeks, that Hormuz enrichment is a far more potent tool for them than the uranium enrichment because most citizens around the world are not really impacted by Iran's nuclear program. But when the Strait of Hormuz is blocked, and as you said, a fifth of the world's oil and natural gas and fertilizer are locked up, then citizens all over the world feel that impact.”

“The United States has some key advantages that most other countries don't. It is geographically blessed with no real adversaries nearby. It has become a true energy superpower, the world's biggest producer of oil and natural gas. It enjoys what is known as the exorbitant privilege of dollar supremacy. Ninety percent of all international commodities are traded in dollars. A strong dollar benefits US importers.”

“If I'm negotiating my wage for the next year, or for some reason, I'm not going to raise my price until next January, I'm really concerned about inflation in the next number of months, not the next five years. And so I do look at, and I think very important to look at market based expectations, I do take the point that has been made forcefully by others, especially in 2021 and 2, that it's important to look at inflation expectations, as you said, at various horizons. Indeed, you can make a case that when it comes to price and labor market and wage setting, it's really short run inflation expectations that are arguably as a matter of theory should be relevant.”