Why Adam Posen Thinks Inflation Will Surge Back to 4%

27:57But there is some repercussions along the curve. And then the third is this expectations channel. Do people believe ultimately that the Fed will get things under control? But at the same time, that's the textbook. The working central bankers, and this overlaps somewhat with the people who wrote the textbooks, although I'm not one of them. But the working central bankers, going back again, Paul Volcker, are very concerned about monetary transmission in the plumbing, meaning which parts of the financial system get affected how much by moves in interest rates or quantitative tightening or regulatory rules.

28:38And so Volcker famously was very upset when money market mutual funds came into play because the idea was those wouldn't be as affected by Fed interest rate moves. I think a much more serious issue right now is the existence of private credit where not only it exists and is growing, but that we have very little supervisory or regulatory transparency into it. So the central bank or anybody doesn't really know how much is out there, where it's going, what terms, how shaky some of it might be. But anyway, so the point is, think about it again with respect to the housing market. So we had a very strong Fed tightening a couple of years ago.

29:26And normally, up until a couple of years ago, one of the first places you would see that would be that there would be layoffs in single family and general residential construction because these tend to be small firms that are very credit dependent, both demand, their customers are dependent on mortgages and supply. they need credit to do what they do. And usually the first, one of the very first effects on the real economy of a Fed tightening would be contraction in that sector. We didn't see it. And we saw a very large Fed tightening and essentially no unemployment rise in housing and not very much change in housing starts.

30:10And that's been replicated across a number of sectors, what used to be called interest rate sensitive sectors in the economy. And so if you go back to where I started and you say there are these multiple channels, right? So two of the three channels arguably are weaker than they used to be. So the impact on the banking system is less representative of the impact on credit availability in the economy. The impact on expectations, for reasons we were just talking about, may not be as rapid or as strong. Again, the Fed can get it back going to how Joe summarized Emmy's work. I mean, you can get it back, but you probably have to do something to get it back.

30:52So you're left with this middle channel, which is the yield curve. and even in normal times or less chaotic times, there never was a lockstep between what happened at the short end of the curve and what happens at the long end of the curve. And Fed Dallas President Lori Logan gave a speech a few weeks ago, I think, on some of the aspects of this where she's an expert. But the bottom line, I keep using that phrase, sorry, but the bottom line is, again, directionally, Directionally, if the Fed tightens, all three of these channels will have some tightening effect. But there's good reason to think that none of these effects will be as powerful bang for your rate hike as it used to be.

31:54This is Caroline Hyde. And I'm Ed Ludlow, inviting you to join us for Bloomberg Tech, a daily podcast focusing exclusively on technology, innovation and the future of business. Every weekday, we bring you the top headlines from the world's biggest tech companies. From finance to defence, AI to entertainment and from startups to the magnificent seven. We highlight the latest stories of the people and companies pushing the tech sector to new frontiers and the politics that shape global tech markets. We do this all every weekday, then bring you the most important conversations and analysis in our podcast.

32:28Search for Bloomberg Tech on YouTube, Apple, Spotify, or anywhere else you listen. Join us every afternoon on your commute home and stay ahead of the tech news cycle. That's the Bloomberg Tech Podcast. I'm Caroline Hyde in New York. And I'm Ed Ludlow in San Francisco. Subscribe today, wherever you get your podcasts. Let's talk about AI spend. The numbers were already going to be eye-watering. For 2026. And now they're going to be more eye-watering than that. And we got numbers from Alphabet and Amazon that were just much higher than. Right. I mean, we're talking like, you know, this moves GDP.

33:02It's a GDP-altering number. It's like, talk to us about how you see the ripple out effects from that spending. So it's fascinating. And I actually listened to you all for some of your insights when you talk to people more in that space than I am. As a macroeconomist thinking about it, so the first point, starting again with the monetary transmission aspect, is so much of this is self-finance or easily financed. So Google's now is showing, I guess, this 100-year bond. Yeah. I hope so, in the sense of I hope everybody's still around in 100 years and gets paid back, and that would be nice. I won't be.

33:36I'm pretty sure. Yeah, well. You know, it's a British bond. It's a sterling-based bond because of those LDIs. They love their long-durban. Yeah, yeah, yeah. They're forced to hold it. But the point is like most of it has been cash financed. Yeah, yeah. Of course. Yeah, yeah. So my point was even the parts that are not cash financed are being very easily financed. Right. So that's the first point. There is no credit crowding out in the rest of the economy because of this. There is no credit constraint on them doing this. That has an interesting implication, which I've mentioned at various times in recent months.

34:14That makes it all the more striking how little investment we're getting from the rest of the economy. I mean, so if you think about sort of the litany of reasons that a Trump administration official ex-ante could give for why there should be investment boom beyond AI, right? We've made permanent the tax cuts that are favorable to corporate investment. We are deregulating. We are doing things to make the labor market more friendly to employers. We've got cheaper energy prices until AI pushes up some of that. But broadly speaking, we've got cheaper domestic energy supply. And we got a Fed that until recently looked like it was cutting rates.

34:52So beyond AI, there should have been an investment boom. And my view is that a lot of the Trump administration's creation of massive uncertainty, including through the tariffs and the anti-migration policy, but in other fields as well, is why you don't have an investment boom outside of AI. And it's not because of tight credit. And people should be taking that more seriously. Again, that doesn't change what you just said, Joe. It's eye-watering what AI does. So that doesn't mean the total GDP has to contract, but I think people should notice the fact that we haven't had an investment boom. My colleague, Karen Dinan of Peterson presented on some of this in her forecast in October.

35:36We haven't had the investment boom outside of AI. Then the big ticket, there are a number of things we can think about, but the big ticket issue, which some Fed officials and Trump officials have been talking about is productivity growth. How much does this generate productivity growth? How soon? How job displacing is it? What's the effect on inflation? So let me give you my take. My view is we're in the process of the baton sort of being handed in the, imagine a summer Olympics, a relay race, and the one runner hands the baton. I think a lot of the labor market changes that took place during and after COVID, nobody knew they would be ex-ante, but ex-post, they turned out to be pro-productivity growth.

36:26There was a lot of good reallocation of workers. And I think that's running out because that was a one-off thing. And so now the AI is increasingly the main source of the productivity growth. But I also think, going back to something you were saying earlier about the tariffs, when you have a supply shock, positive or negative, it's indeterminate how much of that shows up in prices versus real things. So like we've had this discussion about tariffs. Could it be a one-off? Could it be recessionary from the tariffs? and therefore not price inflationary. We can go into why I don't think that's right, but you have to do the same process thinking about productivity growth.

37:07It's a positive supply shock, but how much of it shows up as real income gains and how much of it shows up as disinflation has to be determined. And my reading of the history is when you get a leap forward in a general purpose technology, you get the real income gains up front and you get the disinflationary part later because i mean not all the real income gains but it's primarily real income gains initially because what happens again going back to stuff we were talking about it takes businesses a while to figure out how do i use this technology how do i change my production process how do i change my hiring and training process What are the new products I can offer?

37:53But there's cool products that people want and use right away. So if you think about the internet in the 90s, when Solo famously said the computers are everywhere but in the statistics. Well, you know, a bunch of us were starting to use computers, getting productivity gains. But it took several years before Walmart and UPS and science firms figured out how to make use of this and to change their processes. So, sorry to be so long-winded, but I think this overlaps with a lot of stuff that you hear at Oddlot to talk about with some of your other guests. These are non-trivial business decisions, non-trivial investment decisions.

38:36And so, if I'm sitting at the Fed, yes, in theory, I don't know whether tariffs are going to be mostly recessionary or mostly inflationary. For the reasons we've discussed, I think they're going to be mostly inflationary starting now and less recessionary. If you're talking about AI, I think if I were a central banker again and I had to make a call or I am making a forecast call now, I think you're going to see the real income effects in the next couple of years predominantly and not so much the disinflationary effects. Then they're coming. They're coming, but they're not there yet. Can we go back to the transmission mechanism and the yield curve for a second?

39:20Because one of the reasons we wanted to talk to you, it's not just because of the report, but also because you're a former central banker, used to be with the Bank of England, the Monetary Policy Committee over there. There is talk at the moment of a new treasury accord. And Warsh has kind of signaled some interest in this. So that would basically be tying the Fed's balance sheet to Treasury financing in some way, coordinating presumably to, you know, lower short term rates and allow the Treasury to issue more bills and thereby lower the deficit. Is that a good idea? No. OK. Explain. Yeah. So during the euro crisis, when I was at Bank of England, I gave a speech that central bank independence is about the power to say no, but you didn't have to always say no.

40:12Right. So you don't want to be I made the analogy a teenager or a toddler, but I think I use teenager. You know, you don't assert your independence by no matter what your parent says to you disagreeing. So the idea that there should be some coordination between Treasury and Fed or between the central bank and the finance ministry is not unreasonable. But the idea that there should be an ongoing accord as opposed to, say, an emergency response during the financial crisis during COVID is what's scary. And it's scary because if you go back to the work on central bank independence, there's a huge amount of data analysis on this and historical records.

40:54And I was one of the many contributors to that literature. Turns out there are two things that predict whether a central bank is inflationary or not. And one is, does the governor or the chair get fired and replaced a lot out of turn, out of the normal sequence? And the other is, does the central bank buy bonds pretty directly from the treasury? And there's whole lists of all these other aspects of central bank independence about voting rules and transparency, and those don't have any predictive power. But those two things, do you directly buy government bonds and do you have a lot of turnover at the top leadership, do predict higher inflation?

41:47And we saw this on the leadership side with Erdogan in Turkey and Modi in India in recent years where they forced rapid turnover. How many central bank heads did Turkey actually go through? It was four or five, I think. In India's case, it was like three, and again, in very short spans of time. So, you know, the idea that we have an orderly transition from Powell to Warsh at the end of Powell's term as chair, I mean, that's not what we're talking about. But I think it is important to contextualize the things that Treasury Secretary Besant and the administration are talking about vis-a-vis the Fed are things that historically over time in other countries have produced high inflation.

42:31So I can make it more complicated than that, but just full stop. But so then there comes the question of how much can you fix a fiscal problem through short-term debt management and financial engineering? Right. And the answer is you can't. So, generally, you – and this goes to stuff that both Warsh and Bessent complained about in public going into the elections in 2024, which was they complained that the Yellen Treasury was financing – Activist Treasury issuance. Yeah. Exactly. And then they still kept issuing lots of bills. Yeah. They did the same thing. Yeah. And I, beyond pointing out the hypocrisy, which I guess is par for the course, I think they had more validity with what they were saying before than what they're saying now.

43:20And again, it's not a good sign about the fiscal sustainability of the U.S. if what you're trying to do is, you know, get the loan with the free toaster to bridge over your monthly credit card bill. There is risk to doing more short-term issuance. So, I mean, it's worth thinking back a few years ago, right, when rates were incredibly low and the Treasury started considering issuing 100-year bonds or very long-term bonds or at least increasing the issuance of 30 years versus short bills to fund infrastructure, to fund long-term investment. And there was pushback from something called the Treasury Borrower Advisory Committee, T-back.

44:02Exactly. And the Treasury Secretary at the time, I think it was Jack Lew, said, OK, we're not going to do it. And the pushback was twofold. First, the general principle that the U.S. government should be issuing across the range of maturities on a very deliberate basis to continue to maintain the U.S. Treasury's international and national role as the most liquid, most deep most stable asset in the world. And that if you start gaming it for short-term advantage, you lose that. And that will show up in higher borrowing costs because then the number of people park in treasuries because it's the domestic and foreign, because it's the safe, stable asset goes down because it's less safe and less stable.

44:53But then there is also the rationale that you don't know what's going to happen. I mean, look at the fluctuations we had from surplus at the end of the 90s to rising interest rates in the early 2000s to incredibly low interest rates for a decade after the financial crisis to now rising. You know, this is not smart if you can borrow long to borrow short. We are recording this on Jobs Day, of course, It's the new Jobs Day, which is Wednesday. Jobs Wednesday. Yeah, February 11. My mind is blown. I don't like it. I don't like it. Yeah, it feels weird. But we just got some truth social posts out of Trump saying these are great job numbers, much better than expected.

45:41America should therefore be paying the lowest interest rate. Yeah, and I see the views rates as like a reward. Yeah. A reward for good work. We could go on. I have so many questions we could go on a long time. But I wanted to sort of get your take on – especially like around Davos, some of the tensions around Greenland and Europe and all that. And it occurs to me like one of the themes of this conversation, particularly as it relates to tariffs and also immigration, is that people don't make up their minds at once, right? Corporate leaders don't just say, OK, tariffs are – because these are big decisions.

46:11And they're uncertain. You don't know if Trump's going to give it away or not. Yeah, that's right. There's a huge lag. And then once you make the decision, that's like – You're stuck. There's big stakes. And I've been thinking about this like in the context of Europe because obviously Europe still has this very tight economic and security relationship with the United States. And the European leaders kind of have to make a bet, which is, is Trump the new normal here in the United States or will the next president have – adopt a posture, an economic and security posture that's sort of like the old president?

46:41So no one really knows for sure. But this is like a high consequence choice to make, because if the next president is going to be sort of a more, you know, more normie on this stuff, then maybe, you know, just sort of grin and bear it for the next few years. And then or at some point, if the relationship is going to be dramatically changed, Europe really needs to rethink like how much it spends on military and maybe rethink about, oh, do we want a closer orientation with China, whatever it is. And it's a big decision to make. So I'm curious, like your take, like European leaders right now, they haven't pulled the ripcord yet on the United States.

47:15There's a lot of frustration, but they haven't. We still have this tight relationship. Are we getting closer to where European leaders might think, look, this is never going to go back? Maybe sort of the Carney speech is like, we're never going to go back to the old relationship with the United States. We're in a new world. It is the great big picture question, Joe. and I have been writing on this and talking with European leaders on this, I published a piece in Foreign Affairs in September called The New Economic Geography, in which I talked about if I argued that this is a fundamental lasting change because the U.S.

47:52is ceasing to be the insurance provider in both security and economic terms that it was. And that I think it's very fair to say, unrealistic, whatever happens in terms of successor to the current administration, even if the successor administration, whether it's another Republican, a Democrat, some kind of new party centrist, whatever it is, is not going to immediately credibly reverse everything that's been said and done. And so it's analogous. The parallel you were giving, I think, is right. And there's a fundamental economic theory by Dixon and Pindick about investment, that investment under uncertainty, you delay because in a sense it's irreversible.

48:42Once something happens and you commit down a certain path, it's not literally irreversible, but it locks you in. It's not just sunk cost fallacy. It's rational. So going from the abstract to the real, we're coming up on the new Munich Security Conference, annual Munich Security Conference. And in March 2024, Vice President J.D. Vance gave a speech there in the preceding week in Paris in which he basically - March 2025. 25. 25, sorry, right, we're in 2026, you're absolutely right, March 2025, in which he basically said, you know, NATO, Ukraine, but NATO cannot count on us the way they used to. And he gave arguments for why that was good for NATO and good for the US and all that, and we can debate that, but it was a very shocking big shift.

49:32And then as you mentioned, Prime Minister Carney, now the most famous ex-central banker in the world, gave a speech in Davos a few weeks ago, which was very much about trying to say for Canada, it was a general loss of this framework that we've all functioned in. And interestingly, almost exactly a year ago, I was in Ottawa brought in by the Canadian government to brief them on the likely implications of the Trump. It was right before the election where Carney moved from appointed to ongoing prime minister. But anyway, at that time, I was dealing with absolutely shocked Canadians. And like you said, right?

50:16So the first time during Trump's won, people said discounting, the adults are in the room, maybe it'll change. Under Biden, things did change. But on tariffs and a lot of things, it had been a one-way ratchet. They didn't go back. They were upset about a lot of the IRA stuff. Absolutely. And it was unilateral and I think short-sighted. But anyway, and the Biden team did a lot of bad things, continued a lot of bad things and did a lot of bad things. They weren't as hostile on the security front. They were transatlanticists there. But on the economic front, they didn't really roll back. And in some ways they made worse some of what Trump won did.

50:52And so by the time you get to a year ago, which is even before Vance's Munich speech, the Canadians are saying to themselves, oh my God, this is a perfect example. We just realized we have no internet pipes that don't run through the US. We either have US satellites or we have US cables. We literally have no access to the internet without the US permission. And that encapsulates what's going on, right? That you took for granted that if you were not Russia or Iran, the U.S. would not weaponize things against you. And that's no longer a feasible thing. So going specifically to Europe, this is the biggest challenge to Europe since the war.

51:37This is a situation where a lot of European officials, very much in line with your characterization, Joe, a year ago, we're still in denial or we're still having a lot of conversations with people like me about, is this going to last? Can we wait it out? Is this going to turn around? At this point, nobody believes it's going to turn around, or at least nobody believes it's going to turn around sufficiently and last in a way that the Europeans can count on whoever's next the same way they took for granted. Now, the Trump people would say, that's good. They're not taking us for granted. But from an economic point of view, that it was a good thing that large parts of the world could take the U.S.

52:22enforcing the rules of the game, providing some basic security of navigating the seas and property rights and trade relations and access in and out of treasuries, access in and out of U.S. markets, that we took all that for granted was a huge boon to business. It was a huge boon to investment. It was a huge boon to two-way trade. So it's a very big deal. And so a number of people in Europe are involved in various projects trying to come up with what's next. And two colleagues of mine at Peterson are very active. Olivier Blanchard, the famous French economist who's now back in France, is leading an effort on what future for Europe.

53:03My colleague, Jacob Kierkegaard, who's based in Brussels, does a lot of work on how much common European funding is going into the military and how sustainable is that. The big thing, one of the things Jacob points out is you do have a split in Europe, not so much about how much they distrust Trump or distrust the U.S., lost faith in the U.S., but over how imminent they see the military threat from, say, Putin. So the amount of spending that these countries are doing on military is a declining function of how close they are to Russia. I mean, you can literally do the scatterplot. Poland and the Baltics and Swedes and the Norwegians, Norway's not part of Europe, it's part of NATO, anyway, are spending a lot more, Germany's in the middle, Spain and Portugal are not spending.

53:54But you're back in a world of that kind of geo and geopolitics really mattering. And the final thing I would say in this, because we're coming up in the Munich Security Conference, is ahead of this, there was an announcement of a new idea backed by Merz in Germany and Macron in France of sort of a leadership committee in Europe moving ahead. So it would be Germany, France, Poland, Spain, Italy, basically the big countries plus Netherlands. and that was a no-go for decades in Europe, that things had to be done by involving everybody, things had to be done by qualified majority or unanimity, and this is a statement, problems are moving too fast.

54:43We have to stand up. And so my view, which is ultimately more optimistic than a lot of Europeans, is that what Europe chooses to do, they have a lot of agency. They will have a lot to determine the outcome of how bad things go for them and for the rest of the world as Trump and Xi end up pursuing similar bad economic policies. I mean, it is very telling about our current moment in time that we're talking about the Munich Security Conference as like a macroeconomic indicator at all, right? Right, absolutely right. It used to be just for foreign policy wonks. Right, exactly. Now it's for econ wonks as well.

55:25That's right. That's right. Also, why are they holding it on Valentine's Day weekend? Oh, no, they do all these things. It's like the ECB's Cintra conference is always on July 4th weekend. It's just they ostentatiously don't watch the Hallmark Channel. It's just no good. Adam Posen, thank you. That was fantastic. That was a great conversation. We could ask you so much more, but really appreciate you coming on Odd Lots again. Really glad to be with you both on Odd Lots. Keep up the good work. And thank you for having me. All right. Take care. Thanks so much, Adam.

56:05Tracy, I thought that was a great conversation. Your point there at the end dovetailed with something else you said about the sort of the link now between security and macro. Yeah. I was thinking about that observation. We should definitely do more on this. You know, Canada not having access to the Internet unless it's through the U.S. So how do you solve that? Like you spend and you build new pipes, you build new undersea cables, you build more satellites. But that's spending, right? That's inflationary. And so, you know, again, it's the same thing with we talked about it with Jeff Curry. You're spending trillions on defense.

56:39These concerns about whether the degree to which countries can rely on the U.S. anymore. The way you address these concerns is a lot more spending. Absolutely. To me, we are seeing some inflationary signs, right? Like we talked about them at the beginning and you can't really ignore them. I guess the big question is how much of this is like a temporary like blip in terms of building back inventories. You know, maybe people ran them down all last year because they didn't know exactly what was going to happen with tariffs. But now now they really have to stock back up. And so you're getting this like one time inflationary hike.

57:16or is this the start of something that's kind of, I know we keep using the word durable. No, but it is the right question. Yeah, totally. And like, if you look at something like trucking rates, and again, like we're interested in trucking rates, we did a lot of episodes on it, but also they're just a good macroeconomic indicator. We've seen some glimmers of a recovery there. So freight rates are starting to go up, but everyone's kind of saying, well, we need to see like six weeks of sustained improvement. So So I think that's kind of like the question right now, February 11th. Do we get more sustained inflationary indicators over the next month or two?

57:57Absolutely. And, you know, again, you know, it's interesting, even if we'd had this conversation, say, a month ago or something like that, when, you know, it looked like maybe there was more, you know, the story of job market softening was less unambiguous or something like that. And you think about the new Fed chair. It's like, OK, do we need rate cuts right away? It's like 25 basis points, 50 basis points. Maybe they could be a little lower. It's not the end of the world. If there is a reacceleration, if we actually are seeing gathering steam again and the incoming Fed chair still has this impulse that like you have to like cut rates, you have to establish.

58:33I mean, Trump joked, but not really a joke. He's like, oh, I'd sue if Kevin Warsh doesn't cut rates. if you have this sort of rate cuts into a period of we're actually seeing reacceleration. That's like a very different story. No, absolutely. Yeah, put more fuel on the fire. So a lot of sort of interesting risks out there. Yeah, people were kind of ambivalent about a rate cut even when the labor market was softening. Yeah, exactly. And then if you say you're going to cut rates when it's reaccelerating, well, we could go on. We can go on. Shall we leave it there? Let's leave it there. This has been another episode of the Odd Lots podcast.

59:04I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our guest, Adam Posen. He's at Adam Posen. Follow our producers, Carmen Rodriguez at Carmen Armand, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks. For more Odd Lots content, go to Bloomberg.com slash Odd Lots. We have a daily newsletter and all of our episodes. And you can chat about all of these topics 24-7 in our Discord, discord.gg slash Odd Lots. And if you enjoy Odd Lots, if you like it when we talk about the Munich Security Conference as a macroeconomic indicator, then please leave us a positive review on your favorite podcast platform.

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