At the Money: Chicago Fed President Austan Goolsbee on Tariffs, Supply Chains and Inflation

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1:42Tariffs, egg prices, commodities, geopolitics, war, all of these things affect inflation. I'm Barry Ritholtz, and we're going to bring you an extra special enlarged edition of At The Money, where we're going to discuss how investors should think about inflation. To help us unpack all of this and what it means for your portfolio, let's bring in Austin Goolsbee. He's president of the Federal Reserve Bank of Chicago. He is a voting member of the OFOMC. Previously, he was chairman of the Council of Economic Advisors and was in President Barack Obama's cabinet. So let's just start out with a simple question.

2:25You've talked about the golden path between inflation and recession. What lesson should the Federal Reserve take from our recent and rather successful bout with disinflation? Yeah, Barry, thanks for having me on. Look, I called the golden path. You remember, as I came into the Fed, I started at the very beginning of 2023. In December of 2022, it was the Bloomberg economists who said there was a 100 % chance of recession in 2023, 23 because the historical record suggested that to get rid of inflation, you had to have a big nasty recession. That's what had happened at all times. And what I called the golden path was in 23, we had as almost as large a drop in inflation that we have ever had in a single year.

3:26And not only was there not a recession, the unemployment rate never even got above 4%, a level that a lot of folks thought is below full employment. So that was a golden path year. And I think one of the principal lessons, there were a couple of principal lessons that explain how it was possible. One was the supply side was healing on the supply chain. And there was a big surge of labor force participation from a number of groups. I think a lot of it tied to the workforce flexibility. But if you looked at self-described disabled workers, highest labor force participation ever. So you got a number of positive supply shocks that are exactly what allowed for the immaculate disinflation, which the people who thought that was impossible use that phrase mockingly.

4:30But that is exactly what happened. And now fast forward to today. So in a way, transitory became Steve Leisman's phrase transitory. But it was all because the supply side, when you get negative supply shocks, they do heal. But one of the lessons of COVID was that might take longer than you thought ahead of time. Because the supply chain is complicated, the modern supply chain. And you know that the Chicago Fed is the seventh district. And we're like the Saudi Arabia of auto production in the 7th District. We got Indiana, Illinois, Michigan, Wisconsin. If you go talk to the auto suppliers, that's like the mother of all supply chains.

5:29Okay, so a single car has up to 30 ,000 different parts and components in it. And every single one of them has its own supply chain. And you've probably seen some of these people that will track one individual part through the U.S. supply chain and the way that it, you know, a transistor came from Asia. Then they sent it to Mexico. They put it into a capacitor. They put the capacitor in a seat, gets sent to the seat manufacturer in Michigan. It goes to Canada, comes back to the U.S., finally gets put in a car and you go buy it on the lot and drive it out. In an environment like that, the spillovers can take a long time.

6:12That's what we saw in COVID. That you couldn't get computer chips, so you couldn't make the electronic seat, so they couldn't make the cars, so the price of cars went up. Then that meant the rental car companies couldn't get new cars, so the price of rental cars went up. Then the whatever, the traveling salesmen who used the rental car. And so that thing played out over years, not weeks. My fear now is that if you're going to do something negative on the supply side, and make no doubt about it, tariffs on intermediate goods like steel, like parts and components, like the things that are getting sent from auto factories, from suppliers in Canada that are getting sent over the border to be fabricated into the car in Michigan.

7:04That's a negative supply shock. And I hope that it's small enough or short lived enough that it doesn't reteach us the lessons of COVID. But but it might. The lesson of COVID was that can have, if it's big enough, that can have a longer lasting impact than you might have thought at the beginning. So let me ask you a question about that recession that never showed up. Forget 100 % chance of recession. 22, 23, 24, half of the Wall Street economists were forecasting recessions, and no less an August and well-regarded economist than Lawrence Summers was saying, hey, you'll need 10 % unemployment to bring this inflation down.

7:55What was it about the historical models that seems to have gotten this economic cycle so wrong? Well, that's the critical question. And Summers said it either had to go to 10 % or if it went to 6%, it would take five years of unemployment above 6%. I think the thing that it got wrong, that worldview got wrong, is that it was rooted in almost all previous business cycles were regular demand-driven business cycles. And that's the logic. In a demand-driven business cycle, you overstimulate, inflation goes up, inflation expectations go up, and you have a hell of a time getting it out of there. As you know, I was an old, dear friend with Paul Volcker, and he was a mentor of mine and a personal hero, really.

8:56And one of the lessons of the Volcker episode, which was a time when inflation expectations went way up, is that it's extremely painful. If the Fed or the central bank does not have credibility, it's extremely painful to get rid of inflation. In an environment where the Fed is credible, so that even as headline CPI inflation was approaching double digits, the Fed was announcing we will get inflation back to 2%. And if you go look at the market estimation from TIPS or from others, people believed it. If you looked at the what do you think inflation will be in five years, they were saying it will be back to 2%.

9:44That is a sign of credibility of the central bank. So, A, you must have credibility, and B, you must have the good fortune that positive supply shocks, in our case, one, a big increase in labor force participation that was enabled, I think, by some of the more flexible work arrangements. Two, that we had had such a horrible supply chain experience coming through COVID with shortages, et cetera, that could heal. And then three, a pretty substantial uptick in the rate of productivity growth. That combination was a lovely combination that allowed inflation to come down without a recession. And I think that the chat GPT AI version of a central bank would have got it wrong because it would have been based on a training sample that was a whole bunch of demand shocks.

10:43And this really wasn't a demand shock induced business cycle. And you don't look, it doesn't take somebody with the market acumen that you have, Barry, and it certainly doesn't take a PhD to look out and recognize that the COVID business cycle was driven by industries that are not normally cyclical. Normally, cyclicals like consumer durables or business investment are the thing that drives the recession. And here, the demand for consumer durables went up because people could not spend money on services. This is the only recession we ever had that came from people not being able to go to the dentist.

11:27And the thing about that, the dentist is normally recession-proof. And so that's why we everybody should have been more humble in pronouncing what the future would be coming out of such a weirdo business cycle. And we're still kind of living with that. So so let's talk about humility. You have specifically mentioned that the Fed needs to be, quote, more careful and more prudent about rate cuts due to the risk of inflation kicking back up again. So what specific inflation indicators are you watching closely in 2025? Okay, I'm thankful, Barry. I thought you were going to be like, let's talk about humility.

12:12You once said, and I thought you were going to be like, you're not a humble person. Look, I have actually been, before we got to this dust in the air period, where everybody's talking about major either geopolitical changes to conditions or changes to policy conditions that might affect inflation. I've been more confident. I've had comfort. We're still on the path to get inflation to 2 % and we could cut rates. Now, I'm open to being proven wrong. And if I adjust the, I'm in the data dog caucus. If the data come in and the outlook is changing, for sure I would change my view. But I think it's critical to answer your question specifically, what should we look at in inflation?

13:15I think, number one, you want to look at the through line on inflation, not get overly indexed on monthly gyrations. It's a very noisy series. Okay, so looking over a longer period and what matters is the new months coming in. The inflation that's a 12-month backward-looking average, which is usually what we're reporting in, 11 of the 12 months that are included in that are not new information. We already knew that. We knew, for example, that the blip up in inflation last January, more than a year ago, was going to fall out the back. And so that it would be very likely that the 12 month average would start dropping here in the first quarter.

14:06But that would not be a sign that the inflation is falling right now. The inflation already fell. This is just like how we do the average. So number one, I put a lot of weight on the new months coming in and trying to get the through line of that, not just react to one month. And second thing that helps me, that I find helpful, is looking at the components of core inflation. Now, I know it can drive people nuts, like it can drive my mom nuts, that we put our focus on core inflation and not food and energy inflation, because my mom's like, what do you mean you're not paying attention to food and energy inflation?

14:54That's very public top of mind for her. It's because those are so variable. They're up, they're down. We think the better observation is to look at core. And then within core, there's goods, there's services, there's housing. Our problem has been goods inflation had returned to deflation and was looking good housing inflation's been the biggest puzzle and services inflation pretty persistent the things that have given me a little more confidence lately is that even as we had a bit of a blip up in the inflation here the components still look pretty good the housing inflation has finally started falling on a pretty persistent basis as we've been wanting it to services getting closer, much closer to what it was pre COVID housing back close to what it was pre COVID.

15:52And the thing that has been firmed up here in the last couple of months has actually been goods. And the thing about goods inflation is, as you know, and as some of my research showed before I ever got to the fed goods inflation over long periods is actually deflation. The 2 % inflation that we were at before COVID was housing 3.5 to 4 per year, services 2.5 per year, and goods minus a half to minus one per year. And so I think it's overwhelmingly likely that goods will go back to that very longstanding trend. And as it does so, those are the kinds of things that give me confidence. So you mentioned housing.

16:44We seem to have two ongoing issues with housing. The first is it appears that since the financial crisis, we've significantly underbuilt single family homes. Underbuilt. Yeah, I agree with that. As the population can - And multifamily. So you have the population growing. You still have fairly decent immigration numbers. too much demand, not enough supply. The first question is, what can we do to generate more supply and housing? Do higher rates operate as a headwind against builders, contractors, developers putting up more housing? Look, this is a tangled web that is critically important to the economy.

17:35You've seen the relative price of housing go way up post-COVID. But the one thing that I want to highlight is, yes, it's very noticeable, but it's not new. If you look, like I said, for the whole decade plus pre-COVID, you had house prices going up 3.5 % a year, goods prices going down 1 % a year. If you just compare housing relative price versus going to Costco relative price, a thing that compounds 5 % a year for 15 or 20 years, that's going to be a really big difference at the end of that time. And so I think one component that people are seeing, and they're not wrong, you see the frustration of young people.

18:26They say, you know, when my dad was 25 years old, he on one job could afford a decent house and I can't buy a condo. And they're not wrong. The relative price of housing has gone way up. I think some component of that is regulatory in nature and business permits. And I've been convinced by a bunch of the evidence that land use regulation have made it very difficult for us to build housing of any form, single family home, multifamily homes. I did some research that was about the construction industry. And another thing going on is that overall productivity in the construction industry has not only been stagnant, it's actually over long periods of time been negative.

19:17That we've gotten worse at building the same things that we did 20, 30 years ago. So I think that's part of it. And I think you're highlighting that rates do have a twinned effect. One is they affect demand, but the other is they do affect construction. And so I think in a higher rate environment, if you're trying to cool the economy, this is always true. But the shift of more and more of our mortgages to being 30-year fixed than they were, say, in 2007, have meant that changing rates can have more of a lock -in effect and kind of dull the immediate impact of monetary policy than it does in a more immediate mortgage impact environment.

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21:39Here's why AI isn't taking your job yet. Subscribe to Here's Why today, wherever you get your podcasts. Let's wonk out a little bit about housing. Owner's equivalent rent has been this bugaboo for a long time that some people following the financial crisis said had understated housing inflation. Now there's some people saying something similar. How do we and I know the Fed has looked at this. There have been a number of white papers that have come out of the Fed. How should we think about the equivalent of renting versus ownership in terms of the impact on inflation? You raise several critical points if we're going to walk out on housing and inflation.

22:27Point one. It's not single family home sales prices. It's owner equivalent rent plus rents. And the reason it's that is because part of buying a house is a financial asset. So if you're buying a house and the value is going up and you're selling it for more, and if there's speculation, that's not really housing. What you're trying to get, that's not really inflation. What you're trying to get for housing inflation is something like the CPI. How much more does it cost for the same housing services? And that's why they try to compute owner equivalent rent and similar. Point two, there's a heavy lag in the way they do it.

23:15So in a way, the critics were correct that it was understating inflation on the way up. And the other critics are right that now it's overstating inflation on the way down for the same reason. that it's kind of like if you were measuring average rent and people were raising, it was a time when the market was raising the rent, it's going to take time before that shows up in average rents because the contracts last for a year and they're not turning over. So you get this automatic lag in there. I think that has been a major component of measured housing inflation Because if you go look at market-based measures, like from Zillow or others, they were showing rapid drops in the inflation rate back to, or in some cases even below, what inflation was before COVID started.

24:19And so that's been the puzzle that's been our impatience. Why hasn't it shown up yet? That's been true for quite a while. And the lag theory, it should start showing up. Well, finally, it has. And that's why I have a little more confidence that the housing inflation improvement will be lasting. It took a long time to run up, and now it's finally started coming down. So I think it's probably got legs coming down. So I think those are two key components on the housing inflation side. We could even go into a third layer of wonky, but it's more subtle, which is the component. If you think about rents and, say, market rents in Zillow or who are renters versus who are new home buyers, they're sort of different markets.

25:22And so it doesn't have to be that the inflation rate of the Zillow market rents matches the owner equivalent rents that they're measuring at the BLS because they might be different. New renters and existing tenants might be a little bit two separate markets. Makes a lot of sense. You mentioned the 2 % inflation target. In the 2010s, an era dominated by monetary policy, the Fed had a 2 % inflation target. Now in the 2020s, we have a primarily fiscally driven economy, or at least post-pandemic. That's what it feels like. You've said you've turned 180 degrees on the inflation target question since your initial thoughts in 2012.

26:15Tell us about that. Explain that. OK, so in 2012, there had been vague targets in 2012, I believe, is when the Fed officially said where you have a two point zero zero zero percent inflation target. And you go back and look, I wasn't at the Fed. I was critical. I was publicly critical on the grounds that that conveyed a way false sense of precision to me. That if I asked you, just take the standard deviation of the inflation series and ask yourself, how many observations would you need to get to be able to distinguish between a 2.0 % inflation rate and a 2.1 % inflation rate? And the answer was like decades.

27:10You'd need decades of monthly observation before you could tell, no, no, this is 2.1, not 2.0. So that was my critique. Fast forward to the inflation now. It goes way up. And the one wonky thing that you got to know, which you already know, Barry, but the average person might not know, is the 2.0 percent inflation target is for personal consumption expenditure inflation, PCE inflation. That's not CPI. It's a little different. They have different weightings of what goes into it. we believe the PCE measure, which instead of the CPI measures a basket and the PCE measures everything consumers spend money on.

27:58So it's the better measure. But just as a technical, CPI of 2.3 is about the equivalent of a PCE of 2.0. Okay. We go through COVID, the inflation post-COVID soars to almost double digits. In long run, inflation expectations measured in the market never go up. They remain exactly, and they're off of CPI, importantly. They remain exactly 2.3%. And so I said, either that's the biggest coincidence in the history of price indices, or else the inflation target of 2.0 is serving as exactly the anchor that its advocates said it would be. And at that point, I changed 180 degrees. And I, not only am I not opposed to the inflation target, I think it's critical, it's vital, and it is serving as exactly the anchor that we need it.

29:05So it's a magnet, not necessarily a landing spot. Really interesting. But it will be the landing spot. It will be. We will get to 2%. You mentioned inflation expectations. When we look at some of the survey data in 2020 and 21, right before inflation really exploded higher, they were really low. And then go fast forward to June 2022, just as inflation was peaking, they were really high. How close attention does the Fed pay to inflation expectation. It seems that it's very much a lagging, not leading indicator. Now, fascinating. In a way, A, I should have said at the beginning, you know the rules.

29:51I'm not allowed to speak for the FOMC or the Fed, only for myself. That gives them great relief. That gives my colleagues great relief. In the world of food safety, the thing that characterizes almost every worker in the food supply chain is frustration. Why do we have to wash our hands all the time? Nobody's ever getting sick from the food, and it's only because they're washing their hands all the time that nobody's getting sick from the food. I feel that way a little bit about inflation expectations. They are lagging indicators if the Fed has credibility and is doing it right. as soon as that's not true, they become very instructive, forward-looking indicators.

30:35The only thing that I want to emphasize as well is now we've actually started to get a couple of observations where not short-run expectations, but longer-run expectations actually bumped up in the University of Michigan survey. And since I had said this about how important inflation expectations were as a measure, a couple of folks asked me, well, does that make you nervous? And yes, but A, I've always said I value the market-based measures more than survey-based measures, and one month is no months. But make no doubt about it. If what we started to see was a persistent increase in long-run expectations of inflation in surveys and market, And for example, if you started to see long rates rising one for one with long run inflation expectations, then that fundamentally to me means the Fed's job is not done.

31:41And we've got to go address that. Because if you that's that's one of the main lessons of the Volcker experience and central banks around the world. If the expectations start rising, it is really hard to slay. You don't have to just slay the inflation dragon. You have to go convince people that it's going to stick. And it kind of the only way we know, the only way we know central banks have been able to convey that is to have awful recessions where they grind down wages to convince people, look, that we will keep the job market as suppressed as we need to, as proof that we're serious. So we don't ever want to get back into that situation if we can help.

32:29Last question on inflation. You have mentioned that prioritizing real economic channels, the real economy, over wealth effects. Can you explain this perspective? Why does the real economy channels matter more to the wealth effects? I always thought the wealth effect was so dramatically overstated because, you know, it's typically the wealthy that owns most of the stocks and the real economy is the real economy. But I'm curious as to your perspective. Yeah, look, I would expand it a little more than just the wealth effect. My view is the Federal Reserve Act tells us we should be looking at the real economy, maximizing employment and stabilizing prices.

33:16The stock market, other financial markets, can influence those two things, partly through the wealth effect. But by the very first speech I gave when I got to the Fed, I went out to Indiana in a factory where they make RVs, a community college where they train people for advanced manufacturing. And I said this, look, the Fed by law is supposed to be looking at the real economy and financial markets, to the extent they're affecting the real economy, we should pay attention to them. But that's it. Let's remember the priorities. I quantitatively agree with you. I think there are a number of people who overweight the wealth effect and its impact on consumer spending.