Fmr. IMF Chief Economist Warns on Fed Independence Risks

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00:00I do want to start there with the global outlook, if you will, a global outlook that has been

00:04challenged and to a certain extent under strain for quite some time, but one that has still held

00:10up. Does that hold up into 2026? I believe so, Romain. I believe that 2026 will be another year

00:19where there will be both strength and risks, strength from the fact that we still have the

00:26AI capital expenditure that's happening. You have governments around the world that are also doing

00:32much more fiscal spending. The one big, beautiful bill, the stimulative effect of that will play out

00:38in 2026. I think the risks come from what exactly is the Fed going to do? What is monetary policy

00:46going to be? The chart you just showed was very interesting because it is actually highly unusual

00:51for the Fed to be cutting interest rates and the 10-year yield to be higher than when they first

00:58started cutting interest rates. That is not a common occurrence. What does that tell you, though,

01:03about what the market's view of the economic conditions are relative to some of the expectations

01:09for those rate cuts? I think what it tells you is that it's quite uncertain what's going to happen

01:15next year in terms of both inflation but also Fed interest rates. Markets aren't pricing in the

01:23likelihood of an interest rate increased, which is surprising given where the economy is now and

01:28given what we are heading into. So I think that is one risk that needs more attention. Secondly,

01:36it's a critical year for the Fed 2026 because there's going to be decisions on who the next Fed chair is.

01:41We're going to learn a lot more on how monetary policy gets set. And all of that uncertainty,

01:46frankly, I don't see that priced in the markets so far. Well, let's talk about that a little bit

01:50more, that last piece there. When it comes to next year, you do have a change in leadership coming up

01:55at the Fed. You do have a lot of concerns about Fed independence. There was a really interesting

02:00Bloomberg News article over the weekend talking about that divergence that you're seeing between bond

02:05yields and the Fed's expected path. And you have some folks voicing concerns that this could reflect

02:11potentially that people are worried about whether or not we're going to have a truly independent

02:15Federal Reserve come May 2026, Gita. And I wonder if you share those concerns.

02:21I do share some of those concerns because what's important is that even though the chair of the

02:27Fed is one person of 12 people making the decision, ultimately the chair goes out and communicates

02:33what the path of interest rates are going to be, how do they see the outlook, what is the Fed's

02:39reaction function. And all of that needs to be conveyed with confidence. And if we're going to

02:44be in an environment where there is a lot of disagreement and dissent, that is much harder

02:50to convey. So I do worry about this. And it's one of the risks I'm paying very close attention to.

02:57Yeah. And it'll certainly be interesting to see the scale of the dissents at this Wednesday Fed

03:02decision. But, Gita, you mentioned, you know, when it comes to some of these concerns,

03:06you're not yet seeing that price in the market. What would you be on the lookout for?

03:11I think I would see some more in terms of, you know, volatility indices, for example, the VIX.

03:16It's really sanguine at this moment. If you look at spreads, yes, they've, you know, they've

03:21increased some, but not that much. And we have to keep in mind where inflation is. You know,

03:27if you look at inflation at 2.8 percent right now, if you took out the tariff effect,

03:34that would have been close to 2.1 percent. So the tariffs in and of itself are adding about

03:370.7 percentage points to inflation. And I don't think that impulse is over yet. I would expect to

03:44see another half a percentage point of that impulse coming through next year, on top of all the

03:49stimulative effect coming from the one big beautiful bill and the capital expenditure on AI that's going

03:55to happen. So there are lots of forces that move in the direction of keeping inflation high and maybe

04:00going higher than what we are seeing right now. I am curious, Gita, about the pushback to that,

04:06meaning the fight against it. And at least as to what we know right now, the relative lack of

04:12coordination amongst various governments and central banks, the idea that so many countries, including

04:16the U.S., for a variety of reasons, have more or less gone alone, basically embarked down this path

04:22based on their own individual interests within their own borders. And I'm wondering if that's okay,

04:28if that ends up being a mistake, does it matter?

04:32I mean, firstly, I think governments around the world are in a fiscal expansionary mode.

04:40You know, if you look at Japan, they are trying to spend more. In the U.S., the fiscal deficits are

04:45extraordinarily high. Everywhere else, it's not coming down. So we are in this environment where you have

04:51high debt and you have central banks who have to decide what interest rates are going to be. And

04:56obviously, there's a lot of pressure to bring interest rates down to be able to support low

05:01borrowing costs for governments. That is a tension that they're going to face. And in addition, of

05:06course, as you mentioned, governments seem to be going it alone. Frankly, 2026 year is a very,

05:12very important year to see whether the world actually finds a way of working better together.

05:17It's been chaotic, to put it simply. Right now, in 2025, about trade policy controls,

05:25export controls, sanctions, and so on. If in 2026, we don't figure out a way for countries to work

05:30better together, we really are moving towards what I would call slow and silent decoupling

05:35everywhere in the world.

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