Why Austan Goolsbee Is Still Concerned About Inflation

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1:51Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal. And I'm Tracy Alloway. So, Tracy, we are recording this on Thursday, August 21st. We are here at Jackson Hole. I need to note at the beginning, we were recording this before the big Powell speech. I don't really think it matters too much because this isn't. But I just want to, like, get that out of the way. A little time in context for an econ conversation. We're not going to talk about that speech for obvious reasons. We don't know what's going to be said. But what we can talk about is the economy right now. That's not going to change between, you know, right now and tomorrow morning, hopefully.

2:26Whenever this comes out, probably it's not going to change much. But, you know, we've been very lucky lately. We've been talking to a lot of regional Fed presidents, and it's really cool that we have access to them. Yes, and it's good to get a range of opinions as well, because as we've been discussing, the economy does look very uncertain right now. And you could make a case for everything from a rate cut to holding to possibly even maybe hiking, which, you know, Jeff Schmidt kind of alluded to when we interviewed him. Yeah, no, it was pretty extraordinary that like, look, you could make a point that stock markets near record highs, credit spreads near record lows, employment low and inflation still warm.

3:04Why are we talking about rate cuts? Anyway, we got to keep getting more takes and perspectives on this from the people who actually think about this the best. And do we get a prize if we interview every president? Well, we should try. There's got to there should be a name for that. But we have a guest, perfect guest, someone we've talked to on the podcast before. Very excited to have live here in Jackson Hole, past Odd Lots guests, Chicago Fed President Austin Goolsbee. So, Austin, thank you so much. I'm going to give you a prize. Now, I drove here. I just got here. I just got in an hour and a half ago.

3:38I believe that I've driven the farthest of anybody to get here. And one of the things I did on the way was finish my 50th state, North Dakota. Oh, amazing. It turns out there's a lot of people in North Dakota is their last state. And there's officially a club called the Best for Last Club. Oh, there you go. And I joined the Best for Last Club. So who's going to be your 12th Reserve Bank president? You're going to get a prize. Congratulations. I saw your road trip on Twitter. I saw that you were posting. There are some amazing national parks on the way. We have a great country, don't we? Yeah, we've got an amazing country.

4:19How's the economy looking at you these days? Well, it depends which direction you're facing. As you know, I thought for Q1 coming into April, it was looking pretty good. We had a stable, full employment, the unemployment rate a little above four. Inflation, while having been above the target for four years, looked to me like it was coming down and down and down and was headed to 2%. And so I thought reasonable approximation, rates need to start heading down to where we think they're going to settle, which is a fair bit below where we were then, where we are today. Then we go through some bumps.

5:03I've heard of them. Through a bunch of dirt in the air. All of this stuff that it's like, is the economy still where it was in January, February, March? Or are we on some different path? I still closet hope slash think that we're where we were before and that tariffs, imported goods are only 11 % of GDP. If they'll kind of stay in their lane, if we don't keep escalating them, if we don't willy-nilly apply them to intermediate goods so that they turn into higher cost of production, it'd probably be okay. and we had a couple of months of benign inflation numbers. And then we got the last inflation number, which is a little less benign.

5:57And the rise of services inflation threw me for a little bit of a cross current. So I'd say I've still got one eye on inflation. We're now four and a half years above the target. It's one thing to be four and a half years above the target, but we're still clearly trending down. If we start trending up and you start seeing inflation rising in non-tariff affected categories, like what we saw in services, then I'm going to get a little more nervous on that side. And on the job side, I still feel like we're something like stable full employment. The revisions, they are concerning. We also know that the labor supply and population growth, when there's big immigration things happening add a lot of noise to just monthly payroll.

6:48So I don't want to over-index on that. I want to take multiple measures. The four horsemen of truth and justice, in my view, are rates. They're less susceptible to the immigration and population labor supply problems. They're the unemployment rate, the hiring rate, the layoff rate, the vacancy rate. If you look at those rates, three of them still say this is basically full employment and it's looking fine. It looks very similar to 2018, 2019, a strong job market. The hiring rate is low. And if you talk to parents of kids graduating from college, you hear it's tough to get a job. We're in a low separations, low hiring environment.

7:37But that might be full employment. Okay. So that's why I say I don't come to it averse to cutting of rates. If we get through this and we can get some stuff settled on the tariff side, we might easily still be on the golden path. It might still make perfect sense to keep going down. But we've just got a couple of flags at the same time. I think you just hit all of our talking points in that one answer. Thank you for coming on AdLoss. We will dig into all these things. But just before we do, I have one question. Maybe it's a bit like asking someone who their favorite child is, but what's occupying most of your headspace at the moment?

8:21I thought you were about to say Chicago is your favorite bank. And I was going to say, good choice. Good choice. No, is it inflation or the labor market? What are you thinking most about? I'd say inflation. I'm still thinking inflation. If we had four benign months of inflation that looked like those kind of early ones, that would have helped me be much more comfortable with the idea, it's not going to be. Tariffs stayed in their 11 % lane. People aren't freaking out. It's going to be fine. Let's just go think about the employment side. Now that we are seeing a couple of bumps and things ticking up, I fear we got to think about that.

9:04inflation side, just given what the history was. If we were having this discussion in 2019 and we hadn't had the team transitory and the very same arguments like, nah, nah, this is a one-time thing. And so the inflation should just go away real quickly. If we hadn't had that, I would be much more comfortable making that argument. But now that I don't even like using that word. Plus everyone has experienced inflation now, right? So they're more hyped up. They're more amped up. Not hyped up. They're amped up to see it. And look, you see this consumer confidence numbers going down somewhat significantly.

9:46Survey measures of inflation expectations, which I, in fairness, always said I put less weight on than market-based measures. That said, I don't put zero weight on them. And if you see people in surveys ask, what do you think inflation is going to be over the next one year, two years now, even longer, they're saying it's higher. So we got to think about that. You mentioned those labor market revisions. And when we got that last jobs report, it was mediocre, but even more than mediocre was the pulldown of the prior two months. And there's actually two ways of looking at this. One is, oh, you know what?

10:24the labor market is really decelerating, that probably we have to have cut soon if we want to hold on to full employment. But there's another take that actually has come up in a couple of recent episodes, which is, well, yeah, that was the post-April 2nd volatility. We're through that now. That actually we have more tariff certainty than we, we certainly have more tariff certainty than we did. That was maybe the trough. We got an S &P flash PMI today that actually showed a positive employment rating. This came up in our conversation with Jeff Schmidt, who's throwing this event for the Kansas City Fed, that maybe that was the cyclical low for the year, just the craziness of those couple months.

11:06Fascinating. I thought you were going to go a totally different way. Okay. So those are two schools of thought, both of which are premised on using monthly payroll as an indicator of where we are in the business cycle. And in normal times, that's perfectly appropriate. My third category is at moments when there are population growth shifts and labor supply, especially from immigration, be careful using monthly payroll as an indicator where you're on the business cycle. That wasn't one of your fours. That wasn't one of your fours. And I have no, is it remorse? Not remorse. I have no, I don't feel guilty talking about this topic now because you can go back and look a year and a half ago and more when we were getting jobs numbers that were far higher than what we thought the break even was.

12:04There was one group that was saying, we're about to have inflation kick way back up because 180 ,000 jobs a month is faster than break even. Break even is like 85 ,000 a month. So we're overheating. And at that time, I said, not pay no attention, but pay less attention than you normally would to what the payroll jobs numbers say, because we know there's a whole bunch of immigration that's happening behind the scenes that is not showing up yet. Now, when we look back, everybody says, oh, yeah, obviously, that's why we generate as many jobs. This is just the exact same idea, but in reverse. Now, it may prove not to be true.

12:52This might be an indicator of the business cycle, but we learned the last time around that those four horsemen of truth were rates, not aggregates. Okay, so if you don't know what the population growth rate is, or if it's different than what you expected, be extra suspicious about total payroll employment and total GDP growth. So if you started to see GDP growth overall as slowing down, but the components don't really suggest that, or if you start seeing payroll growth, you characterize it as mediocre. I don't think it was like 75 ,000, that's right around the break even. If you're 75 ,000 plus or minus 100 ,000, which is normally what you are for monthly payroll, you're going to get months where you have low payroll.

13:49And then if you add this immigration thing on top of it, like I say, I'm not saying ignore it. I'm just saying be very careful. I was a little, not puzzled, But I was a little concerned that the market reaction seemed to be, let's take our understanding of monthly payroll numbers circa 2018 and say, that must mean we're on the verge of recession. Right. If that's where your head is, that you say, well, a low monthly payroll in the past has been an indicator of the beginning of recession. Then you got to explain why these other ones don't show that. Why is the layoff rate as low as it is? You haven't seen an uptick in layoffs.

14:34The vacancy rate is actually rising a little and is better than it was in 2019, I think. So this doesn't look like a normal business cycle yet. If it starts to, I'll be the first one saying this is what the beginning of a recession looks like. So the idea is that weaker payrolls can be offset or are being offset by weaker labor supply because we're getting less immigration. So the break-even rate is less. That the break-even is lower. Yeah. Okay, you mentioned the market reaction just then. Can we talk a little bit more about the market? Because as Joe mentioned, you know, stocks are still kind of near their record highs.

15:14I know they've been falling a bit this week. Credit spreads at like a 27-year low. I still hear Fed officials talk about rates being restrictive, even though inflation is still above target. But when I look at the market, when I look at financial conditions, it doesn't look that restrictive to me. Look, be careful. We're just in the weird glass onion version of the same discussions we've been having for several years now that I've been in the Fed. I'm coming on three years. At that time, it was positive supply shocks. And the whole question was, are we about to re-overheat? Do we need to maintain?

15:57Do we need to keep raising? Do we need to maintain the rates this high or can we start cutting? I kind of think that a large component of what's in expectations and what's in the market's reaction is the reflection problem. That if they think that the Fed is going to succeed, then you could see conditions loosen, but that wouldn't be a reason that the Fed should raise necessarily because they're premised on thinking that it's going to work. That's what I was saying before. And I kind of now think in the same way. It might be an indication, but if you just look at rates and you look at kind of the traditional credit channels of monetary policy, I still think that rates are relatively restrictive.

16:53And so that's why I say if you start to see deterioration in the labor market, you start to see layoffs going up and it starts looking more like the turning point in the labor market, then I think we're going to have to seriously contemplate cutting of rates. If we're in an environment where we're actually in pretty stable, full employment, and the only thing that's happening is population is making the break-even monthly jobs number 40 ,000 instead of 100 ,000, and inflation is going up in a bunch of categories that are not tariff related, now we got to be a little more circumspect.

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19:32Go to public.com and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com. Paid for by public investing. All investing involves the risk of loss, including loss of principal. Brokerage services for U.S. listed registered securities, options and bonds in a self-directed account are offered by Public Investing, Inc. Member FINRA and SIPC. Crypto trading provided by Backed Crypto Solutions, LLC. Complete disclosures available at public.com slash disclosures. So I want to ask a question. It's something that I'm very increasingly interested in and want to talk to a lot more people about, et cetera.

20:02But there are aspects of this economy that, as you say, may kind of resemble 2018, 2019, et cetera. One thing that strikes me as very different is the long-term rate and the implied, therefore, what people would call the neutral rate or whatever. And maybe rate cuts are coming soon, but the market is not expecting a deep cutting cycle of that terminal rate. What's changed? What's the fundamental difference in 2025 versus 2018, such that for the Fed to hit its 2 % inflation target, the market is pricing on so much higher rates than what it had anticipated prior to COVID? I should ask you. You've talked a lot about it.

20:40I'm asking you. No, I'm not. I would say there's one way to look at that, that if you asked historically, which of those is weird, 2018, 2019 is what's weird. You know what I mean? Like the long rates now look very, very similar to kind of historical patterns. There's a whole tremendous, almost industry in research trying to diagnose that. And that bleeds into the question of, are we going back to super low rates, ultra low rates because is it global savings glut? Is there something happening with productivity? Do they think demand is going to be low? Is there a feeling that Treasury is going to have to issue so much debt?

21:30I mean, there's been a big increase in debt to GDP ratios worldwide. I do find informative this increase in loan rates is not exclusive to the US. You see it in a lot of countries. So I don't totally know. There's probably some of many of those explanations. And for whatever reason, what the market thinks the Fed is going to do in short rates does seem to have an outsized impact on 30-year rates. So that's part of it is probably just reflecting how steep or how shallow a path do they think the Fed is going to take. So just going back to inflation for a second, you've mentioned a couple of times now that you're worried about maybe, you know, tariff induced inflation in goods starting to seep into services.

22:22Can you talk a little bit more about how you see that channel actually working? And then also, you're head of the 7th District, and you have some interesting states in there. You've got Michigan, which still makes cars. You've got Iowa, which has farmers. Like, what are you seeing in terms of the pass-through from goods to services there? Okay. These are both important topics for us to think through. Let's go backwards in order. The 7th District, headquartered in Chicago, is the most manufacturing intensive of all the districts and by far the most auto production of all the districts. It's one of the big agriculture-heavy districts, but Kansas City, Minneapolis, there's a couple of others.

23:09I would say in the run-up to April 2nd and through April 2nd into May, almost to June, their hair was on fire. I mean, this is going to wipe us out. If anything's like the rates of what they just announced, the auto suppliers that we had small margins to begin with, we're going to die. We don't know. We don't know what's going to happen. That's why I was getting amped up about it at the time as we kind of got some clarity on what the rates are going to be. And particularly when they began exempting. If it's USMCA compliant, it's not going to apply. For a bunch of intermediate goods, it's not going to apply.

23:55Commerce influence. I would say, as I talk to people now for manufacturing and for agriculture, they're still in that space. In agriculture, they were particularly heartened by, as some of the negotiations got concluded, even if they weren't going back to no tariffs, the fact that they were going to something that would not lead to retaliation was a very big thing for agriculture because a lot of their biggest markets are overseas. I was just recently in Iowa, though. They're still nervous in that space that in some ways the damage is already done and it takes a long time to build up these export relationships.

24:40And if you smash that and they start buying soybeans from Brazil, that even if you go back to zero tariffs, they might have already set it up. So there is like a nagging that the longer run impact will be different than the short run impact. But I would characterize short run impact scaled down from... I always get the DEFCONs backward. Oh, I do too. DEFCON 5 is the worst, right? I thought DEFCON 1 was the worst. Everybody says - How often are we declaring DEFCON? Whatever it is. This is our experience for not knowing. There was a high DEFCON. A bad DEFCON. Dangerous DEFCON, as high as you could be.

25:18And now it's gone back, not background noise, but the sentiment like, we can live with this. If this is what it is, as long as this stops where we're not going to face new ones, we can deal with this. Now, that said, it sort of goes to your original. DEFCON 1 is the highest state of military right now. DEFCON 1 is the highest. So they were at DEFCON 1, and we're back to DEFCON 5. I just looked that up. Okay. I had it backward, which is embarrassing because I'm always like, no, no, you know, that's the opposite. But now I opposited myself. Yeah, I've done that. So the question about what is the mechanism that the tariff inflation turns into services inflation?

26:05Permit me a slight detour. What is the mechanism that tariffs turn into inflation of goods as opposed to just a one-time price increase? Because there is an argument that for the platonic ideal of a theoretical one-and-done tariff, it's just a one-time price increase. So no matter what it is, just look through it. Right. And a one-time price increase, just to be clear, doesn't count as inflation under traditional economic frameworks. Because basically, if you go measure inflation, inflation would be high for one year. Yeah. And then the inflation would go away. But that was the very argument of Team Transitory in 2021 was, yes, here this thing hits supply.

26:51We're going to let bygones be bygones. will eat the inflation for one year, and then it's going to go away. Now, remember, this is for a one and done tariff. And this is not one, and this is not done. So let's be a little more circumspect of just saying, hey, theoretically, it's just going to go away. We learned in COVID that if it's a big enough impact on the supply chain, And especially if it's going industry A to industry B, industry B makes inputs for C, that process takes a lot longer than we thought it would in 2019 and 2020. When we got to 2021, we were like, yeah, hey, it'll fix itself, you know, probably six months.

27:42That was the argument of transitory. So I'm a little concerned about just the impact of tariffs on goods inflation itself lasting longer than we wanted to and people getting mixed up. You'll recall the perfectly valid arguments in 21 and 22 and into 23, where people said, it doesn't matter if it's supply shock-induced inflation. If it's high for too long, it's going to fold into expectations and then we'll never get rid of it. That didn't prove true this last time. But if people are more attuned to price increases, it could. And we just got to be careful on that front. Now ask the question, how does it turn into services inflation?

28:33One part, what if the services inflation isn't coming from tariffs. Okay. So that's the danger of services inflation is you kind of can't really give a simple mechanism of why services inflation would be rising. The new month of services inflation was quite terrible. And some part of that are non-market determined. So I put a little less weight on those, but it wasn't good. That probably the mechanisms that you think through, how would tariffs cause that? I think you'd be hard pressed to figure out how it would cause it, but that doesn't make you feel better. That makes you feel worse because it's like, whoa, whoa, wait a minute.

29:19Maybe some inflationary dynamic was never put out and you ever like make the campfire and it's like, oh yeah, it's done. And then you look away, it's back on fire again. We can't let that happen. We've been four and a half years above the target. We were making progress. Now we've stopped making progress. If it's spreading into services inflation this immediately, it's probably not coming from tariffs. The other mechanisms, how does it move into services inflation, is sort of wage price spiral. Yeah. Where people say, well, I think prices are going to go up, so I'm going to be that much more aggressive in my wage negotiations with the employer.