Alan Blinder may be the most influential Federal Reserve official you never heard of.
Arguably, it was his appointment to the central bank by President Bill Clinton in 1994 that did more than anyone to transform the U.S. central bank from a secretive, closed-door approach to one where the Fed chairman holds a press conference every quarter. Blinder insisted the Fed should explain what it was doing and why, and practiced what he preached, not ducking questions from reporters. This stance meant he quickly ran afoul of then-Chairman Alan Greenspan, and Blinder didn’t last long at the central bank, but the die was cast.
After his stint in Washington, Blinder returned to Princeton University where he has continued to write about public policy. He has written a new book, Advice and Dissent, that explores the intersection of economics and politics in Washington and finds much need for reform. In today’s Washington culture, politicians simply want economists to praise their ideas on TV, and have no time for new ideas, he said.
He discussed the Fed’s planned gradual pace of interest-rate hikes, a topic all the more pertinent as the yield on the 10-year Treasury
MarketWatch spoke to Blinder as part of a series allowing prominent economists to discuss the outlook during the Fed’s “blackout” period, when the central bankers go silent prior to their upcoming policy meeting, this one on May 1-2.
Fed Governor Lael Brainard said last week the Fed is facing an environment without much historical precedence – fiscal stimulus on top of an economy near full employment. What is your outlook?
There isn’t much historical precedent for this, and for a good reason. You don’t stimulate an economy when it is already at full employment, or as many people think, beyond full employment. If we had a more reliable so-called Phillips Curve relationship between unemployment and inflation – as we did in the old days – I’d be convinced that this was going to lead to more inflation. I still think it will, but only a little, because the Phillips Curve relationship between those two variables has been something between shaky and non-existent in recent years.
So growth hasn’t led to inflation?
Yes. We have had the unemployment rate down to 4.1% for half-a-year now. And, I guess, if you stand sideways and look at the data carefully, inflation is creeping up. But it is clearly not much of a creep.
So how should Fed react?
I would say with extreme caution and watch the inflation numbers and the unemployment numbers very carefully, which of course they are doing. It may be that they feel the need, if the economy looks overstimulated and inflation starts perking up, to speed up their tightening. Remember, they are on a tightening cycle now and the question they are wrestling with is the pace. And so they can speed up.
So the economy is going onto a sugar high. It won’t last forever. But when you say it won’t last forever, it doesn’t mean it is fleeting and it is gone in a week
Does their target for gradual rate hikes seem appropriate?
I wouldn’t speed up yet, if I were running the Fed, but I’d be wary. Because, as you know, the surprises on the inflation front, over the last several years, have always been on the downside. Inflation keeps coming in lower than we thought. Indeed last year, it was falling for a lot of the year, which was very surprising.
Chicago Fed President Charles Evans said recently that excess liquidity in the economy may be manifested in asset price inflation rather than goods prices. This raises concerns about financial stability but should be handled by other tools, he said. What do you think about that argument?
There is obviously some truth to that but I would give you two big “excepts.” One is except that the asset price inflation, at least if you look at the stock market which is its most obvious manifestation, seems to have halted. Stock prices
were going up for a long time but have not been going up lately. The second problem is with the “other tools.” There are some central banks around the world that are equipped with some other tools for combating, or at least mitigating, asset price inflation, but the Fed doesn’t have much. It would be a slight bit of hyberbole to say the Fed has none, that’s a slight exaggeration. But other than the interest-rate instrument, and Evans is referring to using something else, there is not a lot the Fed can do.
What would be a neutral interest rate for the Fed?
Right now the real interest rate that the Fed is setting – it, of course, sets the nominal interest rate – is around zero. Because the inflation rate and the fed funds rate are very close to equal. As the economy strengthens, it is hard to imagine that a number like zero is the neutral rate. So I think the Fed still is accommodative, and as you look at their long run projections in the dot plot and elsewhere, they certainly anticipate going considerably higher than they are today.
So you expect the economy to be stimulated by this fiscal shot-in-the-arm?
Definitely. The spending increment in the budget deal is not titanically large but is sizable. It is enough to notice. The tax cut is not the biggest tax cut in history but it is not tiny. It is noticeable. You put those two together, you are probably looking in the range of a percent and a half of GDP, that is not trivial. I think it will accelerate growth – for awhile. Many people have said it is like putting the economy on a sugar high. So the economy is going onto a sugar high. It won’t last forever. But when you say it won’t last forever, it doesn’t mean it is fleeting and it is gone in a week. It will last for awhile.
St. Louis Fed President James Bullard questioned why you would react with permanent rate hike to a temporary short-run blip in growth.
The question is exactly how short-run, and how high the peak [of inflation]. If you think it’s very, very, short-run, couple of quarters, and the peak won’t be very high, then that makes perfect sense. But if you think the stimulus is a bit bigger and a bit long-lasting, as I think is the more reasonable supposition, you have reason, I’d say at this point, to be wary and watchful, maybe in the fullness of time to react to it.
Are we at full employment now?
First of all, I want to admit that like everybody I have a huge cloud of uncertainty around this question, it is not like I know. My current hunch, this is not what I would have said a year ago, is that a number very close to where we are — 4.1% unemployment now for five or six months — is a good estimate today of full employment.
Any further decline in the unemployment rate would put us beyond full-employment?
Most likely yes. And, as we were talking about a moment ago, we have this fiscal stimulus, which is almost certain to push the unemployment rate lower than 4.1%.
Do you think the Fed will ultimately get rates up so high they are restraining the economy?
Oh, I think so. I mean, as things are sitting now, we have a funds rate in the 1.5-1.75% range, the inflation rate is heading to 2%, that would be a slightly negative real federal funds rate. And the Fed is certainly not going to be happy with that, in a fully-employed economy. So, unless we’re all wrong and missing something and we’re on the verge of a recession — and I would be among the wrong on that because I don’t see that — unless that is the case, rates are going higher.
Do you have any concerns about the possible inversion of the yield curve?
You know, I don’t worry about that very much. There is a historical association between yield curve inversions and recessions or sharp slowdowns. But what people seem to forget when they talk about that is the reason for that historical association is ferocious tightening by the Fed. This Fed is not in the mood for ferocity. So I don’t see that happening. Look at where the dot plot is pointing. It is basically pointing, even at its far-out extremity, to a real federal funds rate in the range of 1% or so, 1% higher than inflation, around that. That is hardly a ferocious tightening.
Let’s talk about your book. What’s your overall premise?
The overall premise is summarized by what I call, a metaphor in the book, the lamppost theory, which is that politicians use economics the way a drunk uses a lamppost, for support, not for illumination. We would do a lot better of a country if the mix of support versus illumination could be moved more in the direction of illumination. Take good economic advice seriously, rather than just use economists as people you can trot out in front of a TV camera when it is convenient to support your preconceived notions.
Economists could do a lot. As you know, we economists dote on efficiency and most of the political world and the public dotes on fairness. So it is not like we economists are unaware of the fairness criterion but we tend to give it second seat if it invited at all. And I think that is a mistake if you want to have an effect on politics. A second thing is the time horizon. We economists rightly accuse politicians of having very short time horizons — too short for many policy issues, economic and non-economic. And I think that criticism is right. On the other hand, we economists often operate with time horizons that are far too long. I’ve often used the hypothetical example: tell a steel worker who loses his job in a steel mill and is 55 years old that everything will be all right in the eventual equilibrium when labor moves away from steel towards other things and the whole economy is better off. That may take many years and for that particular, hypothetical, steel worker, it may encompass the rest of his working life. Brushing that off as a transition cost that shouldn’t be of major import to policy makers is really a foolish attitude and we will never convince that steel worker that it is right, nor should we ever.
Talk more about efficiency, which is so central for economists.
Efficiency basically means getting the most output out of the inputs you have. We have a certain amount of labor to use, we have a certain amount of capital, we have a certain volume of natural resources and importantly we have a technology. And those sort of define, in a quasi-engineering sense, how much GDP we can produce normally. You can always run the engine above full capacity, as we did in World War II for example, but that is extraordinary. As we were talking about before, maybe pushing the unemployment rate lower than full employment level. You can do that a little, but you can’t do it much or for too long. That is the concept of efficiency.
Many things interfere with efficiency. You could have monopolies. There is a lot of talk these days about maybe we’re getting a monopoly-problem in the U.S. and we should enforce antitrust laws more. You could have a highly distortionary tax system with gimmicks and loopholes which, by the way we still have, despite what was called a tax reform that passed last December. That was not a reform. That was a tax cut. President Trump himself called it a tax cut. Which it what it was. It was not a reform. So when you have a tax system or a regulatory system that pushes businesses and individuals away from efficient solutions dictated by the economic merits of the case towards things that make the tax collector happier, you cause distortions which are losses of efficiency.
I want to do two test cases. The first is the savings rate. The trade deficit is a reflection of the fact that Americans don’t save enough. That we borrow from foreigners to sustain our standard of living. So what would economists do if they didn’t have to worry about politics?
It does depend on what economists you ask. There are still a few that hang tenaciously, against the evidence I think, to the proposition that we can jigger the tax code to get people to save more. We have tried seven ways from Sunday to do that, with precious little success. I think there is a way to do it, but it is not the conventional way, it is by changing the default option on things like 401k plans. So, for most people when they get a job with a company, assuming the company has a 401k, they have to opt-in to participate and if they don’t take any action, they are opted out. Many people opt-in but a lot of people don’t. It is just that they don’t get around to it. The simple step of changing the default to you are in, unless you tell the company you wish to be out. We are not interfering with anybody’s desire to spend rather than save. All they have to do is tell their HR department they don’t want to participate. That has been shown, in a number of quite fascinating studies going back years now, to usually increase participation in 401ks. The inertia cuts both ways. If the default option is you’re out – a lot of people stay out. If the default option is you’re in – most people stay in.
Politics stands in the way of changing the 401k opt-in?
A little bit. There was some concern whether this was kosher to push people in when they don’t ask to be in. The Obama Administration pushed that aside by writing regulations that made it explicitly ok. Strangely, the Trump administration took a step to make it more difficult for local governments to push their employees in that direction. I don’t know why they did that, but they did.
The second test case is housing finance, which may or may not become an issue this year. How would housing finance look under economists versus the politics of it?
I think many economists, maybe most, would say we have a financial system, it is quite large and quite robust and the government should just butt out. And we shouldn’t have anything like Fannie Mae
and Freddie Mac
, and GSEs in general, and private financial institutions especially banks and their customers should take care of it on their own. And, I’m pretty sympathetic to that.
To me, the reason I am not 100% sympathetic to that is that there are people with special circumstances that are either needy or deserving of some help. So in the needy case, you could think of relatively low income households, especially ones that are buying their first home that have not established any credit and maybe there is a case for some government assistance in that which an institution like Fannie or Freddie could provide, or there may be other meritorious people like veterans that we think we should just help as they come out of the Armed Forces to own a home if they so choose. So special reasons like that. But still taking the position that for the broad majority of Americans, the private market ought to be able to take care of this.
Would the 30-year mortgage survive without a government backstop?
It is an excellent question. I think the answer is yes but you can’t really be sure, because the Fannie and Freddie guarantees have had a lot to do with that. Remember not many mortgages live for 30 years. The last time I looked, the life of a mortgage was seven years.