Economist on How High Inflation Takes Time To Build Up

And just for basics here, why  does a president like low rates?   Well, low rates are good for the government  because the government's the biggest borrower,   but they care about home mortgages, they  care about car loans, student loans,   commercial loans. Low interest rates are good  for borrowers. That's good for the US economy.   That's good for whoever's in power politically.  Having low interest rates is a luxury. It's great.   The trouble is, if you put interest rates  too low when there's inflation pressures,   it makes the price pressures go  up more and get out of control. And so that's the balance that the central  bank is trying to have. The central bank can   control inflation, but it can't necessarily  choose where the market's going to think the   interest rate needs to be consistent with that.  So, I mean, the whole world looks at the Federal   Reserve and they think they're setting the  interest rate. My car loan, everything,   it's done by the Federal Reserve. That's a  gross misconception. The Federal Reserve,   on the whole, most central banks are trying  to keep prices stable. They don't always do   a great job. Okay. It's very hard to do,  but that's what they're trying to do.   And that means they have to ask themselves the  question, “Well, if we want to keep prices stable,   is the interest rate too high or too low?” And  so that's, that's what they're feeling out.

And the President typically is short  term, that short-term interest rate,   what's happening right now, that's what they  want to deliver. And often, cutting the interest   rate does deliver growth in the short run.  The trouble is, as inflation ratchets up,   the longer-term interest rates ratchet  up. All the interest rates get sucked up,   and you're sort of, you know, like running  on a wheel, you know, trying to stand still. Is it fair to say that the Fed has the  single most powerful tool in the economy? Absolutely. Controlling the  short-term interest rate is   the most powerful tool not available to  Congress. Congress has a lot of tools,   but they don't have the surgical ability  to change it in the way the Fed has. The   Fed has one job, basically, which  is to make sure prices stay stable. I want to back up and mention that we didn't  always live in this world. We used to have the   dollar pegged to gold, and a lot of people think  that's wonderful, we should go back it. It's not   easy to do, is all I'll say. Like, countries tried  it and didn't. But we had that at some level until   1971 when Nixon went off gold and he just cut  the dollar loose. And part of the reason we   had inflation in the 1970s, which a lot of people  think was because oil prices went up — no, no, no,  

it's because we didn't know what to do. We didn't  have any vision of how to control inflation.   It's a modern construct. The whole idea of  having an independent central bank is new,   that people really didn't understand the  importance of it. And it took, I'd say,   15 years before we really, uh, figured  it out. And it's worked really well,   but the problem is that people— it's worked  so well, people forget it's necessary. I back up with a joke that kind of captures  this. There's this man looking for a parking   space because he wants to go to pray at  his church. And he looks up and says, "God,   if you'll just give me a parking space,  I promise I'll start coming regularly,   I'll start being more devout, I'll be better.  And suddenly a parking space opens up,   and he pulls right in. And then he  looks up and says, “Just kidding.” And I think that's been like that with  central bank independence and inflation,   where it came down, and everybody, not just  Trump, I would also say the progressives,   people all over the world have forgotten how  we got there. And if you take away central   bank independence, you're not going to get  inflation overnight, by the way, It takes time,   but it certainly will contribute in a big way  towards the next high inflation period we get.  

What is the cautionary tale? I mean, you mentioned  the inflation of the '70s, but of the central bank   succumbing to political aims. So for instance, the  Burns and Nixon example and what that resulted in. This happens in extremes all over the world, but  in the U.S. in the early 1970s, we'd gone off the   gold standard, and Nixon's saying, oh, we can cut  the interest rates, there's nothing holding us   down. And Arthur Burns, who was the chair of the  Fed, he pushed back but not hard enough. And Nixon   cursed him, and you can actually listen to this on  the Watergate tapes. You know, he told him what he   wanted to do. And the 1972 election, Nixon ran  against McGovern —I campaigned for McGovern back   then, but it was in vain — he won Massachusetts,  I think. Nixon did everything possible. Social   Security, he actually doubled the size of the  Social Security boost. And he told Arthur Burns,   he said, I want low interest rates. Do whatever  it takes. So Burns did. Burns relented.

And the reason that it happened is when  the Federal Reserve makes interest rates   lower than they need to be or should be,  actually nothing happens right away. It   takes time. Even really high inflations just  take time to build up. But the problem is,   once they get going, they're really hard to  stop. In the '70s, this happened all over the   world. We didn't have the worst inflation.  England and Japan had inflation over 20%,   and of course there are other  countries that were worse. Some people just refer to it as a kind of  lost decade, right? There was low growth,   high inflation. And I mean,  that's the dreaded combo. Yeah. And it wasn't all caused  by inflation. We had the Vietnam   War. We had all sorts of problems. But  yeah, inflation was very, very damaging. I'd like to get to Trump 2.0. Early, early  on, the Fed decided to hold rates — they'd   been cutting rates and they paused. And as we  understand it, they heard about the President's   ambitious economic agenda, and whether it was  going to be tariffs or immigration or a tax cut,   and they said, best for us to pause  here, wait and see. What was your view   about the economy and about the wisdom  of sort of wait and see at that point.

Well, the President was doing things which  normally would push the market rates up. So,   for example, the Big Beautiful Bill was  this massive spending bill. We're getting,   I don't know, 6%, 7% of income deficit, like a  massive deficit. The President was deregulating,   which, in some cases is good, but a lot of cases  is problematic, but, in all cases, stimulates the   economy. And that was pushing prices up. He wanted  the best economy ever, the greatest show on earth.   Some of the actions were just not consistent with  low inflation at the existing interest rates. I mean, I don't want to get into particular  dynamics of when they were high or low,   but it didn't feel like a situation where the  next move would be to cut interest rates. They   had gotten quite high when Trump took office, so  there was some room for them to come down, but,   I don't know if you recall, Trump wanted to bring  them from over 5% to 1% … tomorrow. And actually,   that would have been okay tomorrow, maybe the  next day, maybe the next month, but eventually   would have been a disaster. It would have led to,  I think, a lot of demand and a lot of inflation.

And so the Federal Reserve was just  trying to hide during this period.   We have this, you know, very muscular presidency  wanting to do so many things all at once. And I'm   not saying the Federal Reserve, you know,  was against having the U.S. economy great.   It isn't against having the greatest economy  on Earth. It's just that part of having the   greatest economy on Earth is having a currency  you can rely on, the whole world can rely on. What was your view of the firing of Lisa Cook? I thought he was shooting over the  bow of the whole Federal Reserve,   saying, I control the CIA, I control the NSA,  I control the FBI, I can read all your emails,   I can find something on you. So if you're  not listening to me, you're going to regret   it. And that's what that felt like it's about. I  mean, it was really, you know, show me the man,   and I'll show you the crime. And a little bit  ironic, Trump exercising that. But I felt it was   telling other central bank governors, I can get  you. And we may see that still. I don't rule that   out, of looking for pressure points, looking for  things. I mean, you know, at the end of the day … I mean, you're describing a shakedown.

Yeah. Well, that's how I view it. In fact, I have  been surprised the Fed has been as resilient as it   has in the face of somebody who controls so much  power. They don't. I mean, the Supreme Court's   worried enough about staying independent of the  President. They're in the Constitution. The Fed   isn't. If President Trump had the support of  Congress, he could make the Fed disappear in   a week, bring it back into the Treasury.  That's how most governments used to work. In fact, if you go back into, I think, into the  '30s, the Fed had an office inside the Treasury,   had a room inside the Treasury. Nobody thought  of it as this giant important thing. The Bank   of England only became independent from the  UK Treasury in the late 1990s. So, you know,   there are a lot of people who want to do that,  and I think it's a big mistake. Of course,   if it's brought back into the Treasury,  Trump controls it. But, I just have to add,   the progressives have been kind of anxious to  do that also. So let's just understand this is   a real threat to Federal Reserve independence. But  I, I think it's — I think it's a terrible mistake.

You've been in your profession, in the highest  realms of your profession, for a long time,   including as the Chief Economist for the  IMF, for the International Monetary Fund.   Is this move something you ever expected  to see in the United States of America? No, I did. I mean, in fact, my book Our Dollar,  Your Problem was written before Trump got elected,   just at the cusp of the presidency, and I saw how  there's this widespread view that the central bank   can be used for many things, it should be at  the discretion of the people. There are many   variations of this, and I saw it all over all  over the world, not just in the United States. So I think, like in many things, Trump is this  radical change agent, but catching, you know,   the drift or the current of something  that's out there in the zeitgeist. And   weakening central bank independence is a very  popular idea around the world. It's not just,   you know, crazy rulers, it's not just  autocrats. It's also the left in many   countries hates central bank independence.  And they have some interesting arguments.   I don't want to dismiss it just out of hand—we  could get into that—but I think it's a mistake.

Did you watch the Powell statement when   he announced and revealed that he  was under a criminal investigation? I mean, I watched it later. It was  very eloquent what Powell did. I mean,   I think Powell has been a great Federal Reserve  chair and will be remembered as such. He's gone   through a lot of difficult periods, partly in  dealing with Trump, but also in the pandemic,   the war in Ukraine, and many other things that  he's had to face. I think he's done a very good   job. But having to be told that, you know, somehow  you were being corrupt was an absurdity. I mean,   again, not to say they got everything  right in the specifications of how to   remove asbestos in the buildings, but they're  trying to follow procedure. Anyway, I mean,   I think he's done a great job, and he's been  forceful and eloquent when he had to be.

You had written a piece in Project  Syndicate — this is after Powell,   after Lisa Cook, it's all kind of in  motion — and you've got Greenland,   you've got tariffs. What were you  warning about at that point in time? Well, we depend on others trusting us. Part  of the reason our interest rates are as low   as they are is that the dollar's held held all  over the world. It's held by our friends. It's,   frankly, held by our enemies. They trust the  dollar. They trust it for a lot of reasons.   Foreigners trust the United States because  they think our inflation will be mostly   low and stable. They also think if the  U.S. government, or even a U.S. firm,   says they're going to pay us, either they'll be  able to rely on the U.S. government or some kind   of court system that would give them a fair  hearing. Companies will default sometime, but   they'll get a fair hearing. We can rely on this  decentralized justice system to give us fairness.

If I'm a French person, and I buy an apartment  in New York, maybe I'll have some special tax,   maybe I'll have some special problem, but  probably someone from New Jersey who buys   the apartment in New York will have to worry  about that. In the Trump administration, they   have openly flirted with selectively defaulting on  foreigners. In other words, foreign central banks,   foreign institutions, we will partially default  on our debt. I mean, that's just mind-numbing.   But the first head of President Trump's Council of  Economic Advisers got the job by arguing for that. So all these things, which undermine faith  in our inflation and our rule of law,   have led to less confidence in the dollar. It's  not something that's going to happen overnight,   but I'm of the view that the world was  already moving partially away from the dollar,   not completely, but to be less dependent. And the  Trump administration is going to be an accelerant.

Some of the problems have to do with we use it for  sanctions, we use it to punish countries, we use   it to spy on them. Everyone, even the Europeans,  hates that. But also there's some sense in which   the rot is from within, like the old Roman  Empire. Our debt is unsustainable. We have an   uneasy relationship with central bank independence  — not just Trump, also the left. And foreigners   are worrying about it, and that's why I believe  that, say, 10 years from now, the dollar will   have declined much faster in its dominance than it  did the past 10 years. I view the dollar as having   peaked around 2015 and sort of been in steady  decline that’s probably going to accelerate. And why should ordinary Americans, why should  any of us care whether the dollar declines? So the dominance of the dollar,  that it's used in everything,   it's the lingua franca of the global financial  system, benefits us a lot of ways. So one easy   thing to understand is it makes our interest  rates lower. Why? Because you can place dollar   debt all over the world. If you just had to put  it in the United States, there are less bidders,   and you have to pay a higher interest rate. So  we get what's sometimes called the exorbitant   privilege of being the reserve currency thanks to  this. It makes our interest rates for mortgages,  

car loans, everything about 1% lower than it  would be otherwise. That is quite a benefit. But there are other benefits. It gives us  outsized control over the global financial system.   The size of our economy, the  importance of the dollar, frankly,   our military power means that a lot of the  plumbing of the international financial   system runs through us. Why do you care?  Well, if you were a European or Chinese,   you care because Donald Trump can see a lot of  what you do. They hate that. On the other hand,   for us, we can spy on them. This is  one of our sources of information. We can see that thanks to being at the center.  But perhaps even easier to understand than that   is it lets us put on financial sanctions.  It lets us say you can't use our system.   And our system is so important to trade,  not just between us and other countries,   but say when Argentina is trading  with Australia, often they're using   our financial system. And if we weaken our  dominance, as I think is going to happen,   we'll move away from that. So sanctions won't be  as effective. Our interest rates will be higher.

And sanctions sounds very abstract, but I'll  tell you, you know, I was a teenager during   the Vietnam War era. I had older friends  who had to go to Vietnam, who were drafted.   I worried about getting drafted. I hope that  doesn't happen again. One of the reasons we had   military interventions is we didn't have this  option of sanctions. So we have used sanctions   very promiscuously. I think we have them on  over 20 countries, on countless individuals,   and it's been an alternative to military  intervention. And it doesn't always work,   but it helps. It's what, what we did  to the Europeans even over Greenland. And if we made the dollar weaker, it would be  much less effective. Think if the only credit   card you could use was MasterCard. There  was no other credit card. MasterCard says,   we don't like you, you're in big trouble.  But if you can use Visa, American Express,   Diners Club, you don't care. The dollar  financial system is like that situation   where there's one credit card you can  use. There aren't other other options,   and we are pushing everyone to develop — we are  incentivizing others to develop options. And   I think when Trump, you know, does these things  about Greenland, the tariff wars, other things,  

nobody trusts us. Everybody's moving faster  to try to diversify away from the dollar. You see the attacks on Federal  Reserve independence as part of this? No, absolutely. So one of the reasons people feel  comfortable with the dollar system is that they   think inflation will be low, and attacks on  the Federal Reserve undermines that. I mean,   there are other things that the Federal Reserve  can do which could be painful. For example,   the Federal Reserve makes short-term loans,  sometimes hundreds of billions of dollars loans to   other central banks when we have a COVID crisis,  a global financial crisis, to smooth things over. If the president has full control,  he can go say to Mexico, yeah, well,   last time we helped you out when there was a  crisis, that helped you a lot. We gave you a loan,   we gave you dollars when you needed it. If  you don't let us come in and put our army,   you know, on your northern border, our  southern border. That's not going to   happen next time. Well, you could  have a crisis in Mexico right away.

This may seem abstract, but there's fear that  this overdependence on the dollar is making   them vulnerable. There's this fear of other  governments and other countries that they   have become too dependent on the dollar and our  banking system and our financial system and left   themselves vulnerable to the whims of the United  States when we want to weaponize it against them.