Jason Furman on the Future of the World Economy
Yascha Mounk and Jason Furman discuss how to guard against wishful thinking in economic forecasting and policy making.
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Jason Furman is a professor of economics in the Economics Department at Harvard and at the Harvard Kennedy School. He also served as the chair of the Council of Economic Advisers under President Barack Obama.
In this week’s conversation, Yascha Mounk and Jason Furman discuss the causes of today’s persistent inflation in the US and whether it is likely to continue; how concerned we should be about the recent failures of mid-sized regional banks; and why America’s share of world GDP has remained resilient over the past decades even though it sometimes feels dysfunctional relative to other developed economies like Germany and Japan.
The views expressed are those of the speakers, not those of Persuasion. The transcript and conversation have been condensed and lightly edited for clarity.
Yascha Mounk: I'm trying to understand what's going on with the economy at the moment, so let's start with one of the big questions of the last few years, which is inflation.
What actually do we understand about the reasons for this precipitous rise in inflation and to what extent do you think it is now under control?
Jason Furman: Looking backward—that’s a little bit easier to understand. At some point, we'll try to take glimpses into the future. Economists like to look at core inflation, they subtract food and energy. That isn't because people don't eat food and use gasoline, but because those things are quite volatile. If you look at the core measure that the Fed uses for inflation, it's basically been running at about a 4.5% rate for two years now. It drifts up and down a tiny bit every now and then. But it's incredibly consistent. Underneath that incredibly consistent inflation has been a couple other different stories. In 2021, inflation was in the goods sector, and, in 2022, it was in the services sector. In 2022, inflation was elevated for headline inflation above core inflation, because oil prices went up a lot. In the last several months, oil prices have been coming down. So headline inflation has actually been lower than that core inflation. But it's really been pretty consistent and pretty stubborn.
Mounk: For a long time, we had extremely low inflation. My understanding was that economists were actually somewhat worried about that. But now it feels like we've way overshot the mark. What are the tradeoffs here? What's the level of inflation we should aim for?
Furman: That's a harder question to answer than it should be. You definitely don't want a rising inflation rate. You don't want to go 4, 5, 6, to 7, 12, and 20%. And it takes a certain amount of effort to keep it from rising. That'd be the first thing I'd say. The second thing is you really want a credible, stable inflation rate. Because when inflation moves around, you get arbitrary redistribution. You get people that didn't plan for it. And when expectations are well-anchored and predictable, it actually gives the central bank more space to respond to things. If you want to deal with a recession, and you're not worried about inflation taking off, you just have much more room to deal with it. It's a real gift to have it be anchored and stable.
Now, there's the question of where do you want it to be anchored and stable at? Well, there are a few good reasons why modest inflation is actually a good thing, not a bad thing. One is that it lets the economy adjust more easily. Let's say a bad shock happens and companies can't actually cut their nominal wages. But if there's inflation, that means they can sell their products for more, real wages fall, and they don't need to cut as many jobs. It also gives the Fed, or the central bank, more room to stimulate the economy in a recession. What matters for the economy is what real interest rates (the interest rate minus the inflation rate) are. A higher inflation rate means lower interest rates. Taking all those considerations together, 20 years ago, 2% seemed like the right number. Based on what we've learned since, on a blank slate, something like 3% would probably be a better inflation rate to aim for. The question is, if you tried to change in midstream from two to three, can you manage that transition?
Mounk: For the last year, as you were saying, core inflation has been around 5%, and nominal inflation in some of these years was significantly higher than that. What caused that? Is that just the weirdness of the pandemic, and so, therefore, a sort of temporary thing? Or are there more fundamental factors that have driven inflation?
Furman: I think there are two broad views on that question. One is what I call the “series of unfortunate accidents” model. And the other is the “original sin” model. In the series of unfortunate accidents, it was just one thing after the next and each one led to inflation. That theory has something to it, but I think it's massively exaggerated. Just to give you a few examples, in the first half of 2021, people were saying the reason we're seeing inflation is that the vaccines are so much more effective than we thought and the economy's reopening incredibly quickly, and so we're getting inflation. Then in the second half of 2021, we continue to have inflation, and the story was, “Well, it turns out the vaccines aren't as good as we thought. Delta and Omicron are shutting down the economy. And because of that, we're getting inflation.” Now, it's possible that both those stories are true, but I think it's quite hard to reconcile them. And in my view, the first story actually was correct. The vaccines probably did feel inflation. I think Delta and Omicron actually lowered inflation, especially in the services sector, and delayed it. Another unfortunate accident is the Russian invasion of Ukraine, which really did raise oil and food prices. It had a huge impact in Europe and some impact in the United States. But most of that impact was on headline inflation. If you look at core inflation, there was relatively little pass-through of the food and energy prices into everything else. Other accidents people cite are things like problems at the ports, problems with microchips. But you look at those, and it turns out that they look more like demand than they do supply. Ports were processing tons of stuff in 2021. It just wasn't as much as Americans wanted to buy from the rest of the world, because they wanted to buy a huge amount. But the problem was not that the ports got worse, it was that people wanted more. So there is something to the series of unfortunate accidents. But frankly, it's quite exaggerated.
The original sin model is just a huge amount of demand. And I should say original sins—there were two of them. One is just a massive fiscal policy. We spent 10% of GDP per year for basically two and a half years in a row. That's the most that's ever been spent outside of World War II. It's almost impossible to imagine you could do that without getting a big expansion. Now, if you look at Europe and Japan, you actually see similar levels of fiscal policy, a lot of it happening more for things like credit and forbearance on loans (in the case of Europe) than through direct spending, and then monetary policy didn't adjust. You have this extraordinary thing where, in the United States at the beginning of 2022, you had an inflation rate above 5% and an unemployment rate below 4%—below what the Fed thinks the natural rate is, and way above where they want to be on inflation, and interest rates are still zero.
Now, demand is still high. But I think we're in what some people call a “wage-price spiral.” I try to avoid that. I call it “wage-price persistence,” where wages are going to go up by five, and prices will go up by five, and you get stuck in a certain place, with a wedge between those numbers due to productivity—but, broadly speaking, stuck in something like that.
Mounk: Clearly, inflation has come down somewhat over the last 12 months. But we're also above that 3% that you posited as the spot where we probably want to be. Are we sort of going to continue to be above that 3% mark?
Furman: The equation economists use holds that inflation is a function of three things. One is sometimes called “expectations.” You should think of that just as the internal dynamics of inflation: wages lead to prices, prices lead to wages, if you think everyone else is going to raise prices, you're going to raise your prices, et cetera—a sort of a self-fulfilling thing. The second term is how tight the economy is, how much demand there is, often simplified by how low the unemployment rate is. And the third term is what supply shocks are like. Let's take those in reverse order. Supply shocks seem to basically be zero. In fact, if anything, they might be a little bit favorable—inflation is temporarily a little bit lower because energy prices have been falling. And so I don't expect much action on the supply side, other than unpredictable things like a war in the Middle East. Then there's labor market tightness. The unemployment rate is quite low. Job openings have come down but are still higher than they were before the pandemic. And so the labor market on balance looks more tight than it was in 2019. And so that suggests some continued upward pressure. And then, finally, there's that self-sustaining dynamic. And that's the hardest one to understand, because it's based on perceptions, the policy regime and the like. Historically, inflation went back to 2% quickly. Now, it looks like there's more momentum built into it that could keep it away from there for a while.
Mounk: You were saying that in 2021 very few economists had inflation going up. But perhaps a year or so later there seemed to be a sense among a good number of economists that inflation seemed to be going up, that there were some clear signs that we were about to be in this inflationary crisis. But that there was reluctance among a lot of left-of-center economists to talk about this in a proactive way because it seemed politically inopportune and might scupper part of Joe Biden's agenda (which they supported for good reason) and perhaps allow Republicans to have talking points about Democrats engaging in profligate spending even though, after all, Republicans were in charge for a lot of the time when we decided to spend a lot of money on pandemic relief, as was probably necessary.
To what extent do you think that these political considerations held economists back and did that make it harder for the administration to actually respond to inflation in an effective and proactive manner?
Furman: Initially, when you looked at the initial fiscal plan that President Biden did, the American Rescue Plan, a very conservative economist, Doug Holtz-Eakin, thought it was a terrible, awful, horrible plan, a huge waste of money—but, oh, by the way, it will not raise inflation, because inflation is just very unresponsive and stuck at 2%. So even conservative economists had objections other than inflation. Over the course of 2021, financial markets were also betting on low inflation. So it was a bit of a collective error. But I think it'd be fair to say that you had progressive economists, especially, doing a certain amount of cheerleading at first: “there is no inflation,” then “inflation is going to go away,” then “inflation is not so bad as long as you’re not buying a used car,” and then “inflation is not so bad, as long as you're not buying anything.” At which point, I think there was a shift to feeling the pain, acknowledging it. That's actually when you got the greed narrative on the left, which I interpreted as, “We're not going to try to argue that there is no inflation or inflation is not a problem. We're just going to try to have another villain for that inflation and another solution to that inflation than the mainstream one.” But I don't think you do your side any favors if you're engaged in wishful thinking. Being honest, and talking about trade-offs and saying hard truths—I think that's always better. Now, there's always different guesses, and honest people could disagree. But you want to try to be unbiased in that thinking.
Mounk: How do we, particularly in economics, check that instinct towards wishful thinking? Because that's something that you've done repeatedly in your career, arguing that a position to which you are sympathetic is not going to work well or overlooks certain economic realities. How do we go about avoiding falling into that trap?
Furman: It's hard and it depends on the topic. I teach the introductory economics class here at Harvard. We teach students the distinction between positive and normative. If you're debating what the top tax rate should be, and I'm debating it with a conservative economist friend, they might think people's behavior is going to respond more, that a high tax rate will discourage more work. I might be a little bit less worried about that. But our behavioral assumptions are not going to be that different. I'm going to acknowledge it's going to affect behavior and have a downside. And if my estimate isn’t going to be so different, my values are going to be quite different. And so it really on an issue like that comes down to values, monetary policy, and these macro issues are much more about a positive debate than they are about a normative debate. But unfortunately, that positive debate often masquerades as a normative debate.
Just to give you an example, if I tell you wages are going to grow 6% a year for the next five years, then what do you think inflation will be? Well, one view is that there's no reason the businesses can't absorb those wage increases. They can just lower their profits. They don't need to pass them on to their customers. And so there's no reason why we can't have 2% inflation. Everything I just said I wish is true. I would be incredibly happy if you could have 6% wage growth and 2% price growth. But you can't confuse the team you're rooting for—team workers, in this case—with the team you expect to win the game. And if you tell me wages are going to go up 6% a year for the next five years, I'm going to tell you that I think prices are going to go up about 5% a year for the next five years. The difference is that productivity allows you to do some of the wage increases without raising prices.
It’s the same thing with inflation forecasting. There's nothing normative about it. You have a forecast—inflation either is that or isn't. It doesn't really care what your feelings are about the economy, what's nice and what's not nice. And if you systematically base your views on a prediction of the inflation rate, and inflation rate keeps being higher than you think, it wasn't that you cared more about workers, it's that you are wrong and you are giving bad advice. It just means you're bad at understanding what was going on or maybe unlucky with unfortunate, unexpected events. But either way, it doesn't mean that you liked workers more than the person who was forecasting higher inflation.
Mounk: I agree with you that the distinction between normative and empirical really is not that complicated on the theoretical level. Empirically, though, it does seem to be quite hard. I find that among the most visible economists, it's quite predictable on the most important issues, that very distinguished economists who are left-leaning are going to have empirical descriptions of the world that basically conform with the political priorities of the Democratic Party and the left; and very prominent economists who are conservative in political leaning are going to line up with empirical descriptions of the world that happen to be much more useful and much more politically comfortable for people who are Republican politicians, for example.
Have I become too cynical about this? Or, if you really go to the American Economic Association conferences and you really look at the debates in the most distinguished journals, do you find that those priors are not as helpful in predicting what people are going to be saying? Or is it really the case that even in those kinds of fora, you can kind of guess where Paul Krugman and Greg Mankiw are going to be on empirical questions on which the normative leanings shouldn't, in theory, allow me to make that kind of prediction?
Furman: Let's distinguish between three different things: the research that economists do, the views they have on public policy, and the views they express on public policy. In terms of the research, I don't think it's perfect, there are days when I'm troubled by the political bias, and, frankly, that political bias is mostly left. Almost everyone under the age of 50 who does research, especially in certain areas like empirical microeconomics, is left of center. There are days I'm worried about that. But I go to seminars and someone presents a paper, and maybe it has a left conclusion, and the faculty in the room are less interested in cheerleading the left conclusion and more interested in proving how smart they are by poking holes in the empirical method, the theory, or whatever it is. And there's also a return to research that has contrarian findings. And there's a lot of researchers I know who do their research, not because they know the answer and want to prove it to everyone, but because they don't know the answer and want to figure it out and they love to be surprised. I could give you a lot of examples of that. I don't think the research is perfect. I think all the pressure is in one direction, not the other direction. But there are some counter pressures.
Now let's talk about public policy. Now most of the research papers people are doing (you spend two years on the paper) are not about current events. In terms of what people think about policy right now, I think there is a little bit of a bias towards thinking whatever your team thinks is good. And people don't inquire as deeply. So I saw people who looked at the American Rescue Plan who sort of should have known better and didn't ask how big it was as a share of GDP or how big was the GDP gap. What's the multiplier? They didn’t do the three steps that they could have done even based on their own research. They went out and said, “Oh, it's fine.” And I think they thought it was fine.
Then there's a last problem, which I think really, really is a big one. Which is not what people think but what they say. I soft-pedaled my criticisms of the American Rescue Plan because of reasons I regret, not really understanding how to fully conduct myself in a world where a Democrat was in power and people cared about my views, which is something I'd never experienced before outside of government. And I think I made a mistake. I had a lot of friends texting me, “This is too large, but I don't want to say it.” During the student loan thing, I was a little bit outspoken on thinking it was a problem. I had people texting me, “I'm really glad you're saying that. I just don't want to say that myself because I'll get killed.” Now, that doesn't mean those things are hidden truths. The people texting me might have been wrong about either one of those issues. But it does mean there are a set of views on one side of a topic that people whisper in private, instead of views on the other side that they shout out loud. And so the aggregation process itself is biased. So I think you have some bias at the research level, some bias at the public policy-thinking level, and some bias in what gets expressed. And I agree with you that it all compounds.
Mounk: Another thing I’m hoping to understand is what's going on with the banks. Why is it that we seem to be in this sort of slow-moving financial crisis? Is this just bad bank governance? How worried do we need to be about it? Is this something that's well under control of the Treasury? Or is there a potential here for a slow-motion return to something like the 2008 financial crisis?
Furman: No one knows the answer to those questions. But I’ll do the best I can. First of all, if this was 2019, and you told me we're going to have a pandemic, the biggest inflation in 40 years, and the biggest increase in interest rates in 40 years, I might have predicted worse damage in the financial system than what we've seen. I really do think the reforms that were put in place in Dodd-Frank—they're not perfect, we're seeing some of their imperfections now—put us in a much better place where we had all sorts of economic problems but we didn't have anything resembling a financial crisis. It's always been the case that there are some banks that are badly managed and they fail. And in some sense, First Republic is sort of how it should work, which is: your bank fails, you go out and get the best deal you can, you sell it to another bank, everyone is safe and whole, and the world moves on. And the three big bank failures we've seen in the United States and one big failure in Switzerland really were outlier, badly-managed institutions. That's a lot of what's happened so far. In terms of where we are right now, on paper, the banking system has a $2.2 trillion cushion of capital. But a lot of that is missing two big accounting pieces. One subtracts from it, which is that the value of its assets are lower than they were before and they don't fully mark that to market. But the other goes in the other direction, which is that the value of what's called their “deposit franchise” goes up; they’re an institution that can make money at a higher interest rate, and collect deposits at a much lower interest rate, and the gap between those goes up when interest rates go up. It's better to be a bank if you can pay your depositors 1% in a world of 5% interest rates than in a world of 3% interest rates.
I think the banking system as a whole is now mostly fine in the short run. The two different factors are moving in different directions. The really terribly-managed banks have been weeded out. But over a five-year horizon, I don't think a lot of the regional banks in the United States have a viable business model. Basically, they were premised on hoping depositors wouldn't notice that they were getting ripped off. And maybe you could do that in the past, but in a world of prolonged higher interest rates and lots of liquid electronic options for your money, that's harder to do. So I think we're going to need to see a change in business models, we're going to need to see consolidation. I don't think we should be squeamish about large banks, if they're more efficient, acquiring small banks. But there's no reason this needs to play out like the 2008 crisis. Dodd-Frank was very good, but the last crisis was all about credit risk and illiquidity. You had a mortgage. The mortgage wasn't paying you back. You couldn't sell it. It pushed banks into bonds, because those have no credit risk (we hope) and they're very liquid. Well, it turns out they have another set of risks: interest rate risk. And so I do think the regulations need to be tweaked to basically add this third risk to the two that they already did a pretty good job of handling.
Mounk: I have a really broad economic puzzle that I want you to help me with. I grew up in Germany, and I always tend to be a Germany critic. I think the country is not as perfect and efficient and so on as people outside often think. But it is in many ways a very impressive country in terms of its infrastructure, social cohesion, and political functionality. You go to Japan. It is an incredibly impressive society, with trains that connect the major cities to each other with incredible speed and reliability, with also very strong social cohesion, very high levels of education and so on. Even countries that we think of as quite dysfunctional, like France, are actually very impressive in all kinds of ways.
And then you come to the United States and in so many ways, the country seems dysfunctional, right? The crime rate is way higher than it is in Japan or in Germany. Trains with any kind of regularity really only exist in a few regions, and they are much less fast and much more often delayed. The share of Americans who have a deeply substandard school education, who go to school in dilapidated buildings, in schools where they have to worry about violence, where they don't achieve basic literacy and numeracy, is much higher. It's very tempting to tell this deeply declinist story about America. And yet the striking fact is that America's share of world GDP has actually stayed constant over the last 25 or 30 years, whereas Japan's and Germany’s shares of world GDP have declined quite significantly.
How is it that American society, which in so many obvious ways is not working outperforms in economic terms these other countries which seem so impressive from the outside?
Furman: I read John Kenneth Galbraith’s The Affluent Society 35 years ago. He wrote it well before I read it. And he began with this contrast between what it looked like in an American house and a house in Japan. The Japanese house is really small compared to what people in America are living in. It’s less likely to have a washer or dryer (that's certainly true in Europe, not positive that it’s the case in Japan), or centralized heating and air conditioning. The stuff that the people have, et cetera, is a set of private living standards that are much higher in the United States than they are in most of the other advanced economies. But that does really coexist with a lack of adequate investment, or of adequately well-managed investment, in a lot of the public domain. And is that because Americans have different tastes than people in other countries? Is it something about the way the rules of our political system were set up? Is it something else? I actually don't know exactly what it is.
Now, I wouldn't sort of diminish all of those private material things. People care a lot about those things. And in almost every one of those metrics, people are much, much better off than they were in the past. But yes, I lament the state of rail travel in the United States, the state of schools, and all sorts of other things. And I should say, by the way, everything I said was about 85% of Americans. Poverty in America is too high. It's hard to know exactly how to compare it to poverty in Europe, but it feels worse to me. I'm not positive that's right. And different data gives you different answers. My guess is it's not as bad as what you have in Japan.
Mounk: What are some big things that America and perhaps Japan or countries in Europe, do to boost living standards for ordinary people? Is there any low-hanging fruit where if only we could get a political will or make the smart decisions, we could really have a positive impact on how most people live, or is there no such low-hanging fruit?
Furman: First of all, whatever you can do to increase overall growth, especially if you can do that without increasing inequality, is quite important. By the way, I'm bullish on ChatGPT and these types of learning models, because I think our problem over the last 50 years hasn't been robots taking too many jobs but robots not taking enough jobs away. And the other way to phrase that more politely is that we just haven't had enough productivity growth. And if we could have more productivity growth, that matters, and I look at some European countries and their hostility to this technology and think they're really risking on missing out on what I think is the biggest wildcard that could actually raise GDP growth—my guess is not that it will be in some transformational, massive amount, but, over time, figure out different ways to deploy it in different areas.
So one is just don't mess stuff up like that. Two is to have more basic research into areas that will get you more things like that and many other things in the economy. That’s the productivity side of things. Then there's the more shared growth and things like education. I think the minimum wage could go up in the United States, less so elsewhere. And finally you say, “You know what? We're just not going to get the distribution we want from the economy. So let's run a really efficient, well-organized market economy. And tax the people who are lucky, are skilled, and do well at it and give more money to the others.” And certainly in the United States, for example, giving money to households with low-income children is maybe not a no-brainer but about as close to a no-brainer as I think you can get. So that was an incomplete answer. But generally, my view is, this is a really big question you asked, and you want an all-of-the-above response to it, not a “don't-do-this, don’t-do-that” sort of approach.
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