One of the jobs of a regional Federal Reserve bank president is to get around the district, find out how things are going and explain what the Fed is doing.
That’s why Tom Barkin was in New Bern last week at the chamber of commerce, having lunch in the meeting room with local business folks. I drove in from Clayton, about 100 miles down U.S. 70, because the Fed is the big story. Truth be told, I also like to drive around New Bern, which has a nice downtown and waterfront.
We are in the Richmond Federal Reserve bank district, the fifth, and North Carolina is the most populous state in the district, which runs from Maryland down to South Carolina. Barkin became CEO of the Richmond Fed bank in 2018, after a 30-year career with the McKinsey & Co. consulting firm. As a regional Fed bank president, he attends meetings of the Fed’s interest-rate-setting Open Market Committee. The FOMC voting members include the Federal Reserve governors, the New York Fed president, and several of the other 11 regional bank presidents, who rotate on and off the committee. Barkin was a voting member of the FOMC in 2018 and 2021. He is scheduled to be an alternate next year and a voting member again in 2024.
The Fed is trying to bring down inflation, which in August was 8.3% year over year, measured by the consumer price index. The Fed’s favorite gauge of inflation rose 6.2% in August, year-over-year, the personal consumption expenditures index. Excluding volatile food and energy components, it was up 4.9% in August, according to data released Friday, which was worse than July’s 4.7%. This is why the FOMC raised its interest target 75 basis points at its September meeting and why it has raised its target five times since March, trying to get the inflation genie back in the bottle, down to 2%.
Barkin told his listeners Wednesday that he doesn’t think we are in a recession right now. Two months ago, he thought we were “on the brink of teetering into recession.”
“GDP numbers for the first half of the year were weak; inflation was high. We were raising rates,” he recalled. Now, two months later, “It’s hard to make the case, as we sit here right now, we’re in a recession.”
“I’m not saying we might not head into one. I’m just saying where we are now.”
Businesses are telling him they’re busy. The labor market is “quite strong.” And consumer sentiment “is heading up.”
“I’d like to take a lot of credit for it,” said Barkin, “but I think you have to give credit to gasoline,” which has come down significantly in recent months. The national average price of regular has dropped 25% since mid-June, according to the government.
But inflation is still a big problem.
Barkin says that in his travels, he hears several theories about why inflation has shot up over the past 18 months. They all have problems.
One theory is that this is all about supply chains disrupted by COVID-19, and the worker shortages caused by the pandemic.
“Those who think this is all about supply have to answer the question, ‘Well, now wait a second, isn’t most of this stuff largely behind us? And if it’s largely behind us, why is it that we’re still dealing with inflation?’”
There is a second theory that says that inflation was caused by pandemic-related federal spending for unemployment benefits, and PPP for businesses, and infrastructure spending.
“And those people would say, ‘Well, you put six or seven trillion dollars into the economy, and especially when you’ve got so limited supply, you’re going to have inflation,’” said Barkin. “So that’s the second theory of the case.
The problem with this is that demand “is not actually up vs. the pre-COVID time.” So if you say it’s all about demand stimulation, you have the answer to the question of what is it about the current situation that’s led to inflation?”
The third theory he hears is about the money supply, which increased significantly over the last two and a half years. One measure, M2, is up 40 percent. “Of course, it also increased 45% in the 2010 to 2015 period, and we didn’t have any inflation,” said Barkin. In fact, in 2015, by the end of that increase in the money supply, we were seeing year-over-year deflation in several months.
“But you don’t have to get technical,” said Barkin. “You can just say, ‘Why didn’t you raise rates earlier?’ And I think with 20-20 hindsight, I think you could have and probably should have moved earlier. You still have to answer the question, if you’d moved earlier, would we have no inflation today? Given the fiscal, given the supply, given the Ukrainian thing? But I think that’s, again, a fair question. I think it is hard to pin it on any one thing.”
He used a football analogy. “Maybe what happened is we flooded the zone.” In football, that’s when the offense sends more receivers into one part of the field than there are defenders. In economics, it is when a lot of events and policy actions converge at once. “And when you put fiscal on top of monetary on top of supply chain shocks on top of COVID on top of a Ukrainian thing, then all that together floods the zone,” said Barkin.
The question now is how long high inflation will last and if business folks and consumers have confidence that the Fed is serious about bringing it down, which will likely require some pain. We have already seen some of that pain in stock markets pricing in higher interest rates and a possible recession, and in a significant slowdown in the interest-sensitive housing sector. We have not yet seen widespread layoffs, but it takes a while for Fed interest rate hikes to work through the entire economy, so we haven’t seen the full impact of tight money yet.
“The essence of inflation is persistence,” said Barkin. “It’s got to last over time for it to be inflation, as opposed to a price increase. When I talk to business leaders, they’re still describing it as an episode, not a regime change.” And there are signs that inflationary pressures are easing. Regardless of which theory you believe in — excess government spending, overly loose monetary policy, supply chain disruptions, oil prices — they are “headed in the direction of constraining inflation,” he said. Particularly, on the monetary policy front. The Fed has increased its target rate 300 basis points, started trimming its balance sheet and “we’ve been clear that there’s more rate increases potentially,” Barkin noted.
The Fed may get help from supply chain problems resolving themselves or more restrained government spending. “But we’ve got the tools to do it whether we get help or whether we don’t,” he said.
During a question-and-answer session, Barkin said that the financial markets do not believe that high inflation is going to persist. “A 4% 10-year-bond doesn’t imply 8% inflation,” he said. Still, the Fed can’t take that view of the financial markets for granted.
“One of the reasons that I believe it’s important for us to be as aggressive on inflation as we are, is I think if it lingers, the more it lingers the more risk you have.”
On another topic, the tight labor market, he said he was interested in the possibility that some people 55 and older may have left the workforce to take care of grandchildren. One of the hardest-hit sectors in the pandemic was the childcare industry, and it hasn’t recovered.
“It’s still way, way, way down. And yet, participation of young families in the workforce is back to where it was pre-COVID. So, I’m not quite sure how the kids are getting taken care of.”