00:00We heard from the Federal Reserve and from Chair Powell this week, and maybe the headline is the
00:05uncertainty because of the war in Iran. He was very careful in saying, we don't know what the
00:08effects will be, big, small, or in between. How does one make policy in the face of that kind of
00:14uncertainty? Well, writ large, that's the job of the Fed generally. The Fed is always in a position
00:22of uncertainty. That uncertainty may be greater from moment to moment. It's obviously at a fairly
00:28high level now, but that's really what's behind the Fed's regular mantra of we'll be data dependent.
00:34The data could be different next meeting than they are today on the basis of what we know now. This
00:40is where we would be likely to go. I think, however, when you're at a level of uncertainty like this,
00:47you have to look at what you think the fundamental drivers of the economy are likely to be as you
00:55think going forward. And I think that those drivers currently are more inflationary than
01:03non-inflationary and will therefore probably argue for probably no change in the Federal Reserve's
01:13monetary policy stance for some time into the future. I don't think that where the economy is
01:18going to argue for raising interest rates. But I think the argument for lowering interest rates is
01:26going to be hard to carry probably for the rest of this year. On the uncertainty, just for one more
01:32moment on that, at what point does the uncertainty itself start to weigh on the economy? Because
01:37businesses might be reluctant to make investments, consumers may hold off on spending. How long can we
01:42go before we start to see what you think in the economy? Well, I think you start seeing that
01:47relatively quickly in terms of lowered business investment because you don't know exactly what
01:54environment you're investing into. We saw that at Liberation Day. There was a significant pause in
02:00business investment until companies felt that they had their foot on a rock with regard to where
02:07tariff policy was likely to go. And so you'll see that again now. The question is, how long does it
02:14last
02:15before that becomes sort of a material drag on the economy? Tell us about demand destruction? I'm
02:22reading about that a lot these days, which is not something you want necessarily. What are the risks
02:27of that? And at what point might we start seeing demand destruction given what's going on, particularly
02:32with the energy markets? Again, you're going to start seeing responses pretty quickly to higher energy
02:38prices in consumer spending. And again, because of the uncertainty about the future macro environment and
02:47business investment. If that's relatively short, if we're talking a resolution in a month, even in two
02:58months, then that's from the point of view of the Fed, which looks over long arcs of time, a blip.
03:05If it goes on
03:06longer than that, then you'll start to see reaction. But on the flip side of that, which is partly why
03:15I
03:15think you're not going to see a hike in interest rates, but you're not going to see lower interest
03:20rates either, those are effects that slow the economy. But higher energy prices feed into higher
03:29prices generally, and that's inflationary. I think a lot of the other drivers of the economy, the fiscal
03:35stimulus that you have from the One Big Beautiful Bill Act, which I thought was excellent legislation.
03:41It provides the right incentives for the economy, but it is stimulative and pushing upward on inflation
03:47in the short term. So I think the balance over the course of the next several months is likely to
03:53be
03:53in favor of no moves, either down or up. One of the things we heard from the Fed this week
03:59was that
03:59the neutral interest rate has ticked up a little bit, I think from 3.0 to 3.1. What is
04:05driving that?
04:06Is it some of the factors you just suggested, or is it some other structural things such as AI investment?
04:11I don't think that AI investment is driving a change currently in the neutral interest rate. I think
04:19it's too early for us to see that sort of an effect. I think it's more the factors that I
04:26was talking
04:27about earlier. And I think part of this, too, is that the Fed is beginning to recognize changes
04:35in the overall environment that have been pushing upward on the neutral interest rate for some time.
04:42I think their sort of institutional estimate of the neutral interest rate has been lower than warranted
04:49for some time. And they're catching up to where the actual neutral rate has been for a while.
04:57We saw in the Fed in the summary of economic projections, both a slight increase in particularly
05:03in core inflation, but also in growth. Where does that growth come from, do you think, at this point?
05:09I think you'll see growth across the economy. I don't think that, for example, that the sole
05:16driver of growth is AI investment or AI changes in business processes. Again, I think we're
05:24too early for that. But the economic policies of this administration have been quite supportive
05:31of growth and in particularly the fiscal policy of the One Big Beautiful Bill. And those effects will
05:40be felt throughout the economy. And the elements of the administration's economic package, economic policy
05:49package that at the outset of the administration, one might have thought could have slowed growth,
05:55for example, immigration policy, maybe tariff policy, have ended up to be not as slowing of growth as
06:04one expected at the beginning. So of the overall administration economic package, which I think was
06:10much more coherent and well thought out than a lot of people give it credit for, I think that the
06:17stimulative elements are outweighing the potential growth slowing elements. And so as a consequence,
06:23we'll see that stimulation across the economy.
06:25You mentioned tariffs and goodness knows there's been a lot of talk about tariffs.
06:29What I took away from what Chair Powell and the Fed said was basically, they do increase prices for
06:35a time being, but it's usually eight months to a year and that'll be up sometime in the middle of
06:39the year. What are you seeing out there in the real world? Is that consistent with what you're seeing?
06:43Yeah, it's very consistent. There's a slightly higher risk that tariffs could feed into overall
06:51inflation expectations just because of how this tariff policy has been rolled out, because it's
06:57been up, it's been down, it's been rolled out over a long period of time, as opposed to develop,
07:02explain, implemented with a delay for everybody to process it, which would be the typical
07:07way to implement tariff policy. And then it would be very clear that you have kind of a one-time
07:13step
07:13change in prices during the period of implementation of the tariff policy that shouldn't feed into
07:19overall inflation expectations. There's a slightly higher risk that you push up inflation generally
07:29for a longer period of time just because of the way the tariff policy was rolled out. But I don't
07:33think
07:33it's terribly high, and I think you can expect, the Fed can kind of expect to look through tariff
07:40policy. The tariffs themselves are not nearly as high as people thought that they might be at the
07:45outset of the administration. You mentioned immigration policy, and it did come up in the
07:50news conference with Chair Powell in this sense. He said, look, we still have sort of a low-hire, low
07:55-fire
07:56labor economy right now, and therefore the unemployment rate actually is not going up. But he said that's
08:02not a really great balance. What are the risks in that sort of employment market?
08:06So I actually think that people are underestimating the degree to which the labor supply has been
08:13changed as a result of immigration policy. The administration hasn't really succeeded in
08:19forcibly deporting very many people. That's hard to do. The Eisenhower administration tried to do
08:25something similar and had sort of similar results. But the policy had the effect of almost immediately
08:33closing off a very large amount of illegal immigration that there had been during previous
08:38years. A certain amount of self-deportation and even legal immigration is down materially.
08:44So the growth in the labor supply that we had during the Biden administration has been closed off by a
08:52very significant amount, really, maybe between one and two million people a year, I think.
08:59And so the softness that you see in the labor demand numbers, in the jobs numbers, I think people are
09:07underestimating the degree to which that is effectively offset or significantly offset by the shrinkage in
09:18labor supply. You layer on top of that just the continuing aging of the baby boomers. And so I am
09:25less concerned. And I think the data that you described are supportive of that lower level of
09:31concern than the Fed has been expressing for some time about the state of the labor market. And I think
09:35as the data continue to evolve, that will be another sort of support for interest rate policy that is on
09:45the
09:45higher end rather than the lower end of expectations.
