00:00We start with the global concern over inflation in a week that gave us new CPI numbers and
00:05Chair Warsh's first testimony on Capitol Hill. Are we facing higher long-term interest rates?
00:11How much of it comes from that AI rush? And what does it mean for Western economies if we can't
00:16get back to that magical 2% target? Loretta Mester was president of the Federal Reserve
00:22Bank of Cleveland and now holds positions at both Penn's Wharton School and Princeton.
00:26We got new inflation numbers out this week, which were not as bad as they had been in the past.
00:33But there has been a growing concern, I think, about longer-term inflation. Where are we?
00:38Well, inflation's been above the 2% goal of the Fed for over five years. So we do have an
00:44inflation
00:44problem. I think it remains to be seen whether where interest rates are today are enough to actually
00:51move inflation back down. I think the question that FOMC is going to have to ask itself is,
00:56do we need to raise interest rates a bit in order to add restrictiveness to the economy to bring
01:03inflation down? And I think they don't know that yet. I think the tone is getting more that we're
01:10impatient with this inflation. But I think they're going to wait for some more data before they make
01:15up their mind that they're going to need to raise rates. I think there's a good case for saying we
01:20need
01:20higher interest rates, because it's hard to argue that where we are today is very restrictive on the
01:25economy. And particularly maybe because the headline number came down really largely because of fuel.
01:31Yeah, that's right. I would say, though, that overall the report was a pretty good report, even when you
01:37look at the components. I mean, one of the things that have been, I think, troubling me is if you
01:41look
01:42at core services excluding housing, and I think that's a key indicator to look at, that's been
01:48moving up. Right. We had the inflation coming down last year, even before the war in Iran. We saw that
01:55indicator of the services component, excluding housing, starting to move back up. And I think
02:01that's got to be a concern for the FOMC. You know, they've been forecasting inflation is going to come
02:06down. And even without oil prices pushing it back up, you still see that inflation has been pretty
02:13sticky. And so it raises the question for some of us, why? I mean, it's good to have the numbers
02:18know
02:18where the numbers are, but then you want to know what is really driving that, because you have some sense
02:21of where it's going to go next. Well, I think that's the question about how restrictive really is policy,
02:26right? Monetary policy is what's going to determine whether demand is outpacing supply and therefore putting
02:33upward pressure on prices or, right, whether it's restricted enough and it's going to bring demand
02:38more into balance with supply. The one place where we know demand is up is in AI and all that
02:45comes
02:45with it. All the investments being made are really, to me, at least stunning. Does that in and of itself
02:52suggest that we're probably going to have continued inflation pressure for the foreseeable future?
02:56Well, you certainly see prices for components that go into AI being elevated, and that is a
03:03source of pressure, upward pressure on inflation. I think the question, and this is something that
03:08the new chair, Kevin Warsh, has been talking about, is eventually he believes that AI will increase
03:14productivity enough that it becomes sort of a disinflationary force. I don't think the timing
03:20really suggests that we're going to get there soon. I do think right now it's an inflationary issue,
03:27and the question is how long will that last and whether, again, that'll feed into other parts
03:32of the inflation and the consumption basket and therefore become a more of a broader inflation
03:37problem. And this week we had not just the CPI numbers, but also Chair Warsh with his first
03:42appearance on Capitol Hill, where, to my hearing, said we really are serious about this inflation.
03:48And he recognized what you said, which is we've had it over 2% for a long time now. We've
03:53got to do
03:53something like that. At the same time, maybe, as you said, eventually it might come back down.
03:57How does he balance those two things, and how long is eventually?
04:01Well, this is always a question for the Fed, and certainly I think it was great that he reiterated
04:07the commitment that the FOMC and the Fed has to 2% price stability. I would say, as someone who
04:14was
04:14at the Fed, right, we were always committed to the 2% inflation target. That's not, and price stability,
04:20and maximum employment, which are the goals that we've been given by Congress. So that isn't new.
04:26And the real question is, in making those tradeoffs between the two goals, when there are tradeoffs,
04:33right, when I think they're going to have to take seriously whether their policy rate right now is
04:38in the right place or whether they're going to have to recalibrate that a bit higher to get inflation down.
04:43As you say, there's a dual mandate. It's both about price stability as well as employment.
04:48Does the nature of the employment situation in the United States right now actually give the Fed,
04:53if they wanted to use it, some room to raise rates up?
04:56Well, you know, if you look at the labor market, it's an interesting labor market in the sense that
05:00it does appear to be pretty steady and in balance. I think what troubles people is when you look at
05:06the rate of payroll employment growth, it's much slower than it had been in the past, right? It used to
05:12be
05:12that you'd say to keep the unemployment rate stable, you would need 150,000 jobs added per month.
05:19Now, right, that number is much, much lower, right? It's many estimates are between 50 and 70,000 a
05:26month. So that's quite a bit lower. And that's because the supply side of the labor market has
05:30changed so much. So you don't need as much hiring to keep supply and demand in balance. So there's a
05:36lot of concern about the labor market in terms of those lower growth numbers. But actually,
05:41it's been a pretty stable and the unemployment rate itself is low. That doesn't mean that there
05:46aren't problems in the labor market in terms of different aspects of it. As probably, you know,
05:52from and your listeners know, right, young college graduates have had to struggle to get jobs. Part
05:58of it may be AI. Part of it may be uncertainty about the economy. But a lot of what's happening
06:03in the
06:03labor market is on the supply side, not on the demand sides. And so, yes, if the key concern right
06:10now in the
06:10economy is the inflation part of the mandate, not the labor side.
06:13You mentioned the various task force, five I think there are, that Chair Warsh has named to deal with various
06:20aspects. I suppose it's sort of to be expected that when somebody comes in, they want to take a fresh
06:24look at
06:25things. Were you surprised at how quickly and how extensively he's looking at some basic things at the Fed? Well,
06:33not really,
06:33because, you know, he was very vocal before he became chair about some of the things that he thought could
06:40be rethought. Right. And so if you look at the task force, there's one on communications or one on the
06:45balance sheet. And he's been very
06:46vocal about the balance sheet and the use of quantitative easing. He's been very vocal about trying to find data
06:52sources that are more
06:54micro oriented data sources and more forward looking to help the Fed do its projections so that it can have
07:00a better sense of where the
07:01economy is going. And then the last one, of course, we just talked about AI, the labor market. And he
07:07has particular views on
07:08that. What I was happy to see is that the people he's chosen as leaders of those five areas, they're
07:16they're really are
07:16experts. You know, it's and it's a combination of academics, central bankers, not only U.S. central bankers, but abroad,
07:24who have been
07:25central bank experience in terms of actually doing monetary policy and some business leaders. So I think the combination of
07:32those
07:32people. Right. And with the staff help from the Fed, as he said. Right. I think we're going to get
07:37some very thoughtful results from
07:41from that. And of course, then the FOMC will have to take up some of those recommendations and debate them
07:46among themselves because
07:47they are the policymakers. Recently, the projections based on the markets have changed a fair amount about the likelihood of
07:56a rate
07:57increase. For example, in July, it really has moved around a lot. You've dealt with this for a long time.
08:02Is that typical? Have you seen
08:04that before? Is this unusual that the expectations are changing fairly rapidly? Well, I think the economy has been changing.
08:11Right. It's it's hard to
08:12read an economy where you had the tariff shock. Right. Then we had the Iran war and the oil price
08:18shock. So there's a lot of
08:19uncertainty about what the trajectory of the economy is going to be. And of course, the on again, off again,
08:25you know, Iran war, the
08:27ceasefire. Right. That adds to sort of uncertainty because oil prices are a significant input into a lot of parts
08:34of the economy. So I'm not
08:35sure that I would say that it's more volatility than what should be expected, given the uncertainty we've been
08:42facing the economy. And then layered on top of that, of course, you have a new Fed chair coming in.
08:46As you say, for several years
08:48now, we've had an inflation problem. And one question is, will it solve itself or do they have to get
08:54more restrictive? But from your
08:56perspective, do you think that the degree of that problem has changed over the last six months, nine months? Is
09:02it a bigger problem
09:03today than it was six months ago? I think it's a different problem. Right. I think six months ago, the
09:09focus was on how much of the
09:11tariffs were going to feed through to inflation. And remember, there was also some concern on some of the committee
09:18members, right,
09:19about the labor market. I think the labor market is stabilized. And I think they have a much better view
09:25of sort of the low payroll
09:26numbers, not necessarily meaning the labor market is weakening appreciably. I think there's recognition now that probably the tariff part
09:35of the
09:36inflation story is stabilized. Right. And there's probably much more pass through that. We do have the oil price shock
09:43now, which is a new
09:44shock. But I think there's more recognition of the accumulation of bad readings in terms of inflation moving in the
09:51wrong direction that I think that's really what's
09:53changed the narrative about inflation. I think there's better recognition that even though we're hoping that we're at a point
10:00where interest rates are
10:01enough to get inflation back down to two percent, that projection may not come to pass. And I think that's
10:07what's changed.
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