You are here

February 2, 2022

Economic Outlook For 2022 & The Fed’s New Framework


Claudia Sahm
Claudia Sahm | Director, Macroeconomic Research, Jain Family Institute

Claudia Sahm joins Richard K. Green to look at the US Economy and how the Federal Reserve is responding to inflation, unemployment, and interest rates. 

Sahm cites that the big picture points to economic recovery, especially while the Fed incorporates the principle lesson of the 2008-2009 financial crisis: remove support gradually or risk a stalled recovery. With appointments incoming, Sahm forecasts that the new and historically diverse Board of Governors will continue to press the Federal Reserve’s dual mandate of stable prices and maximum employment. Crucially, Sahm emphasizes that without an end to the pandemic, the economic tides can only change so much, with or without federal intervention.

View Slides

Listen via podcast




Richard Green: Good morning, everyone. I'm Richard Green. I'm director of the USC Lusk Center for Real Estate. And it is my pleasure to welcome you back to Lusk Perspectives, our first Lusk Perspectives of 2022. And it's my pleasure to welcome back Claudia Sahm. Claudia has been with us twice before. She has a distinguished career working at the Federal Reserve Board, working at the Council of Economic Advisors. While she was there, I got to work with her for a year, which I enjoyed very much. And she's now director of Macroeconomic Research for the Jain Family Institute. Always has thought-provoking things to say about things that are happening in the macro economy, a very distinct but well-informed perspective. Claudia, thank you so much again for coming back and being with us.


Claudia Sahm: Yeah, thank you. I always love coming here and it's always great to see you, Richard. And as we were saying before, I'm a little jealous that you've escaped Washington DC, and I'm still out here. But I'm happy to share the perspectives with all of you. So I'm gonna go ahead and share my screen so we can jump right in. Okay, so what I'm gonna do today is talk about the economic outlook for 2022 and very much frame this in terms of thinking about the Fed, what the year ahead is for it and making the case that we have the new Fed, right? We are in a sea change in monetary policy. We're trying to pull one off in fiscal policy, but I think it's important to look at where the facts are, the data and give a sense where we might be headed, given that all forecasts are wrong as soon as they are written down. But we need to think ahead and know what to be looking for. I will try to keep my remarks so that we have time for questions 'cause I know there's a lot of different directions and there's a lot of different questions. And so let's jump right in. Okay. Okay, so first of all, key takeaways, the... Well, okay, first of all, there are a lot of things that have gone wrong during the pandemic. Like I do not wanna sugar coat this. This is in our personal lives. This is as a country as a whole. And yet, if we look big picture at the US economy, we have made an immense amount of progress out of the hole that we went into in the spring of 2020. In December, official statistics tell us that the unemployment rate went below 4%. It had early in the pandemic hit well into double digits, and by some estimates close to 20%. Like we have never seen unemployment like that since the Great Depression that was extremely tragic. We saw a lot of improvements pretty quickly as the economy reopened, but when we started 2021, basically, nobody thought we were gonna be under 4% by the end of the year. That has to do with the vaccines rolling out, it has to do with a big fiscal push, putting money in the hands of people, in small businesses, and communities, and it has to do with the Federal Reserve keeping borrowing costs low. Okay, so but we made a lot of progress by many accounts. And I'll talk more about this. I think it's very reasonable for the Federal Reserve to say, very soon, as in next month, that they have checked the box on maximum employment. We've seen as many people get across the finish line, get back to jobs as at this point in time is sustainable in that it wouldn't cause lots of extra inflation. We can talk about why, and I'm going to talk more about it. But once the Fed has hit that part of its dual mandate, then it makes absolute sense for them to say, inflation is too high, let's get it down. So that's the transition that we're seeing the Fed go through now, people are calling it the hawkish Fed, like hawkish being concerned with inflation. I think it's the reality-based Fed. We've made a lot of progress on unemployment. We've got to get the stable prices mandate. We need to check that box. Okay, so how does the Fed do this, right? Like now inflation is high, they need to bring it down. There's gonna be a lot of factors that will affect whether inflation stays high or comes down. But at the end of the day, prices are about supply and demand, right? COVID has done a lot of things to reduce the supply of goods and services. And there have been things like the fiscal policy that have pushed up demand and the Fed keeping borrowing costs low has helped support demand. So what the Fed can do, it cannot put shots in arms, it cannot get global supply chains working. It can take a little window to the sales of demand by putting upward pressure now on interest rates, on borrowing costs that families and small businesses face when they go out and make particularly big purchases. Okay, the Fed started to remove its support late last year with this thing so illustriously named tapering, where they slow down the purchases of assets, the treasuries and mortgage backed securities that they've been doing to put downward pressure on interest rates after the federal funds rate was at zero. So they started to do less and less of that this month, next month. This is the last purchases, so the last time they'll be kind of pushing down that way. Very soon, they're going to start to raise interest rates, probably in March meeting, there's a middle of March meeting. But what the Fed is trying to do is gradually take its extra support out to demand, to kind of cool inflation some and frankly, like once the recovery is going, the Fed is not there to hold US economy's hand always, there about making the recession not so bad and giving us a good push to a recovery. So it's time. This is tricky. Any of you who watch financial markets or are in any way involved in it, know that it's been a pretty bumpy ride recently.


Richard Green: Claudia, you just froze on us.


Claudia Sahm: Oh, can you... Is it better now?


Unknown: I think it might've just been you. I didn't see her freeze.


Claudia Sahm: Oh, okay. Good. All right. So, I will push on. I hope Richard can hear me too. Let's see. Anyways, so the Fed is doing what it does. This is gonna be a bumpy ride. I do feel for markets. This is tough. The Fed has only once before gone off what's called the zero lower bound. So brought interest rates off zero, but they've done it once, they have some experience. They're in very good hands with the leadership Jay Powell and the entire Federal Open Market Committee, so godspeed. Okay, so, but what... So the outlook, like the Fed doesn't know when and how much they're gonna raise interest rates or how fast they're gonna run off what's called the balance sheet, all these assets they've purchased, but what they will do is watch the incoming data. They're going to watch what happens with the pandemic, they're going to watch what happens with the labor market, with inflation and everything else about the economy under the sun. And that is what will drive the timing of their policy changes. That's it. And their judgment, right? We never have all the information we need when we make a policy decision, but they'll do their level best driven by data. Okay, so the new Fed, I'm very big on the strategic framework that was introduced in 2020. I started at the Federal Reserve in the summer of 2007. My first year on the forecast was an absolute birth by fire. That was the financial crisis, the Great Recession. The slow recovery was absolutely painful and we didn't see the financial crisis coming, the housing bubble building, and then it burst. And we didn't see the slow, slow recovery. So the Fed's new framework... The Fed's new framework is very specifically focused on not making the mistake that they made in 2015 when they walked away from the recovery too soon. They never achieved their dual mandate. Unemployment continued to drop, was about 3.5% right before COVID and they never hit 2%, which was their selected target for inflation, right? So the new framework is an attempt to do better. And we'll talk a little more about that in a minute. Okay, so right now the Fed is, well, and frankly has been for the last year under attack about inflation, particularly now you have all of these people who ought to know better running around on big platforms saying, "The Fed is behind the curve, it's behind the curve." Frankly, the people who are saying the Fed is behind the curve, have not... They are behind the curve on understanding. And in 2020, the Federal Reserve released a new framework. And even more econ 101 here is that the Fed cannot address a supply-driven spike in inflation. COVID is a supply-side shock that a bunch of macro economists have been waiting their entire life to see. And yet, somehow when it comes around, it's the Fed's fault. There've been a lot of different analysis of this. What I'm showing you is some very careful work from the San Francisco Fed that's very like straight up statistical analysis. I have the link here, I highly recommend looking at it. And they do a decomposition of prices that are in goods and services that have been... This is done statistically to identify. Have been deeply affected by COVID and then the other prices, right? 'Cause not everything we buy is affected by the pandemic. And what you can see here, and this is month over month inflation, so this isn't the 7% you hear talked about like as the year over year in December, but month over month, which gives a good sense of the pace. You can see even this way, it is a lot higher than it was before the pandemic. And you can also see that a huge chunk of this is COVID-sensitive sectors and it's a massively larger contribution than before the pandemic, right? So it's not just something about these goods and services grow a lot, it's the pandemic has caused a lot of inflation. So the Fed that's... You fight that inflation by getting us out of the pandemic. You do not fight that inflation by impoverishing people with high interest rates. But like that's where we're at at this point. It's pretty clear that we are not getting out of this pandemic anytime soon, or at least policymakers are not going to do it. So the Fed has no choice, but to start tamping down on demand. Frankly, the fact that the Fed allowed inflation to stay this high this long is directly out of the strategic framework because they said they created an average 2% inflation target. So not like hit it, they could have... Sometimes it was above two, sometimes below, it's an average. They said we want inclusive and broad-based employment. So it sounds a little bigger than maximum employment, which is the mandate. Their interpretation is like, it's gotta be more shared. And then in the strategic framework, they said, we will tolerate higher inflation when there are shortfalls in employment. That is 2021 written all over it, right? Both in terms of what we were living in the labor market and what the Fed was doing in terms of being patient. Under 4% unemployment, inflation is still high, we are not out of this pandemic, it's time. It's time for the Fed and it is following its framework. It is time for the Fed. So it is not behind the curve, it is doing its job and it's doing exactly what it told us it would do in August of 2020, Good job Fed. So far, so good. Okay, so, I mean, I've already said this and I will not... Well, I might keep going on about this, but the way to fix inflation now, particularly the high inflation that we have right now is to get us out of the pandemic. The quote here is from an opinion piece that I wrote for the Washington Post last week. And basically, what I'm showing you here is a quote from Jay Powell's confirmation hearing for his second term as Fed chair, when he was asked by Representative Cortez Masto, "You said before, getting us out of the pandemic would bring inflation down. Do you still think that?" And Powell said, "I do." Right? Like I'm team Powell here. He knows what he's talking about. He has hundreds of extremely qualified economists standing behind him and common sense, right? So COVID is the root of all evil. Our response to it has not made things better. This is very much focused on inflation right now. The forum whichever the link to here was really interesting. They talk to 12 experts in general. We each got to pick a solution for the White House and they are the mix of like things to bring inflation down now. One person, bless his heartm was basically like, "Let's get a time machine and go back and not pass the rescue plan." Yeah, we don't get to do that one. I'd use it to go back and kill COVID, but like, whatever. So, but there were some about demand. I talked about inflation. A lot of the other contributors talked about things the Biden administration that Congress could do that maybe wouldn't push inflation down right now, but they would address some of the upward pressures that we have had for a long time on the cost of living. So if you think about healthcare and childcare, housing costs, so there's all kinds of things that the fiscal policy could still do that won't bring inflation down in the next six months, but frankly, six years ahead is even more important, right? Anyway, so COVID is bad for the economy. Oh yeah, this is what I'd mentioned before. I mean, we talk a lot about inflation this year. Inflation is a hardship. No paycheck is a disaster and we move people, many families, many workers away from that disaster, they have jobs, some of those jobs are tragically not safe to be at, I'll come back to that, but they do have a paycheck. And that's good because the fiscal relief is basically gone. So it's good they have a job. But there is a big question and this is actually will be a big debate in March when Jay Powell comes out and says, "Check the box on maximum employment." Is that we do have millions of workers, particularly now mothers and older workers who have not come back to work. They flat out quit their jobs in the pandemic. I mean, for many good reasons, lack of reliable childcare, if you're dying on the job, right? And so, but they're not back yet. And essentially, and I agree with this, we have gotten to the point where it's so clear that they will not come back and probably shouldn't come back until the pandemic is over. The Fed cannot wait. The pandemic is dragging on. It's getting better, but it is not going away. That is why the Fed was wrong about the inflation forecast in 2021. That's why I was wrong. It was all conditional on the pandemic being over and it is not. So essentially, I mean, I would agree we're at maximum employment right now because those last people we need to get across the finish line do not want to come back yet. So we'll get there. I think many of them will come back, but maybe not. Okay, so I think this might be my last slide with COVID on it. So this actually is gonna be really important for Friday. So what this is showing you is who is actually out there working in the real world, or actually, this chart is actually showing you who is working from home, right? And so you can see, people like those of us here, we're working from home. I'm at home. I've worked at home the entire pandemic. But we are very privileged in that regard. People who have less than a college degree, a high school degree, they are face to face. They are at work, they have been at work. Most of them, the entire pandemic, they are extremely exposed, especially when we have surges in COVID like we did with Omicron. We will get, on Friday, the jobs numbers for January. It is important whenever we have jobs day, which is in my world, a total event on Twitter, total dorks, and is going to be a very sad affair on Friday. Frankly, all we're gonna do is catch up with what millions of Americans just lived, which was a bad month. And the thing we're gonna learn, first of all, this statistic is from the Bureau of Labor. It is in the employment report. It was the number that jumped out at me the last time I looked in the report. This is a sign of what is coming. Basically, COVID is going to take the winds out of inflation. And it's gonna take the wind out of the employment picture, because we have all these workers, Omicron was extremely infectious. We already have estimates from the household poll survey, which is like a census survey they created during the pandemic. It's not like official official, but it's a good survey. It is showing that like almost 10% of workers were out of work in January because of Omicron. Right, we will get these numbers on Friday, the official statistics, and they're going to be outrageously large. And the thing is, for a lot of these workers, and you can see who's most exposed, they're in jobs where you get paid if you show up and work, right? And many of them do not have paid sick leave. Now, employers right now aren't laying people off as much 'cause they've been so desperate to hire them, but they're not paying them. There is no federal paid leave. I mean, some states. I'm actually not as familiar with what California is doing, but like for most of these workers, the ones who are exposed, if they don't get paid even five days is a week's worth of pay. A week's worth of pay if you live paycheck to paycheck is a big problem. You will cut back. Like you're not gonna get paid, you're gonna cut back on spending. Less demand means less pressure on prices, but it means a whole lot of hardship. But this is just another way of seeing the uneven, inequitable economy we live in. This was true. These workers had a lot of other hardships before the pandemic. The pandemic is preying on almost all of our structural problems. Very thin silver lining is making them blatantly obvious, so maybe we fix some things, but that's about Congress and the White House. That is not about the Fed. Yeah, and the public health stuff is beyond depressing. But we will get there. Okay. All right, monetary policy. Okay, so we talked about this. They're gonna push up demand less and less. This is what the Fed does. I don't think the doomsday scenarios of the Fed slamming on the brakes, throwing us in a recession, like the Fed has learned a lot over decades and decades how not to do that. There is no one at the Fed that wants to throw us into a recession, right? So they can't control the world. There could be some... COVID is our dress rehearsal for climate change disasters. So who knows, right? Like what will come at us? But the Fed is not going to cause this recession. But the economy could slow a lot more, inflation could fall below 2%, right? So like it's 2022 is gonna be a tough year for the Fed, but they know what they're doing. Of course, forecasting is hard. Okay, so let's see, I'm doing pretty good on time. Okay. This chart for those few who follow the Fed. Okay, so this chart to the left is called the dot plot. It's ridiculously ugly, but it's every other meeting, the Federal Reserve officials, all 12 Reserve Bank presidents, all seven governors. We don't have seven right now, but we will soon. They sit down and they write a forecast. They forecast a lot of things like inflation and GDP. All these things they do like year by year, they do long-term of board staff that writes it down and they do little perturbations around it. And some Reserve Banks have economist teams that do it too. In any case, they put together their own little forecast. Then they look at their forecast and they say, "Okay, if this were to happen and I alone were in charge of monetary policy, what would be the best path or the best level of the federal funds rate year by year?" So this is absolutely conditional on their forecast. The FOMC does not, as a group, make a forecast. And so each little dot is a participant. Some of them don't vote. Not all dots are equal here in terms of their effect on monetary policy at any given point in time. But like this shows you. Anyway, so this is a thing, it is gonna come out in March. I personally would get rid of the dot plots. I don't think they should ever be in public. I think they're confusing in addition to being ugly, but they do tell us something about the Fed's thinking at a point in time. And the last time the dot plots came out, they... Okay, if you look at 2021, see that flatline, everybody's down there because that's the Fed funds rate at zero. The Fed funds rate is at zero or effectively at zero. So in 2022, you can see that the dots, and in particular, the mass that's like in the middle, it has... The Fed funds rate is not zero anymore. The Fed tends to raise rates in quarter percentage points. So this in December, which is the last time we had this, they had basically the typical participant thought we'd have three quarter point increases in the federal funds rate. They could do it 50, they could do... They could do different things, but they're going to do quarter points and that's... So you have three... It's very likely when this is put out in March, that it'll move to probably four and a fair number of them at five, like it might flip to five because under 4% of unemployment and inflation is still high and we're still in the pandemic. So they'll get a little bit more. Oh, and then like in between these dot plots or just in between the FOMC meetings, which are every six to eight weeks, we listen to remarks by reserve bank presidents, by governors, by the chair, and all of those have made it pretty clear, the Fed, even relative to December thinks they're going to pull away their support from the economy, let the interest rates, the borrowing costs rise more in 2022 than they did even when they met in December. We're gonna get some very important data. Like January jobs, they'll have February jobs before the March meeting. And they'll have basically all the January, they'll have January inflation and they might get fit... In any case, they're gonna have more data. So like these dots are not set in stone even now versus this time next week. So we'll see, but it's pretty clear. And the Fed should start kind of taken off the gas here. Yeah, I think Omicron is gonna be a deciding factor. I think markets and forecasters are gonna get blindsided on Friday and we already got some indications of that today with the ADP, which is another indicator for the payroll employment. In any case, we shall see. I could be wrong. I hope I'm wrong that January was good. Better for people. Okay. Another thing on the Fed's framework, and I mentioned this before, they added the inclusive and broad-based employment. The Fed has never defined this. They have never defined what maximum employment is. And it is depressing if you ask my peers what they think that is, peers and academic macro, 'cause they will answer you in terms of inflation, which is not what that is supposed to mean. Anyways, but what I'm showing you here are the differences between the black, Hispanic, and white... Actually, here is the employment to population ratio. You could look at this unemployment rates, the reason I'm showing employment to population is this does incorporate this big number of people who left work, left the labor force. 'Cause here its employees, its population, it's pretty straightforward. And you can see like there are big differences by race and ethnicity, and there are still big differences in the shortfall. So this is the thing Powell and all Fed officials are gonna get really pushed on when they lift off 'cause these are not... These gaps are not gonna be closed. It is a big question as to exactly how much the Fed can do to close them. So stay tuned, this'll be a really big, important debate in 2022. And frankly, the Fed has a lot of work to do to explain itself. And it's kind of punted so far and it's... I'm not gonna let it get away with that, but there's a lot of analysis to do and it's exciting. Okay, so the last piece that I had prepared in the night, I'm really excited about questions 'cause there's a lot of different aspects of what's happening in the world right now and at the Fed personnel is policy in right after Biden was elected. So I talked with members of the Fed's transition team, particularly on the Fed and I talked to a lot of people. I mean, this is not... I think this is in public too, that they were trying to understand how they could not just make the Fed more diverse, but ensure that its policies were thinking about not just Wall Street and the effects on it, not just its effects on dominant groups of workers, but on all groups of workers, all kinds of families, all kinds of communities. So they went and talked to various people that understood the Fed and said, "Hey, how can we accomplish this goal?" And what I said, and many others, the only lever that the White House has to pull, Congress has more, but the only one the White House can pull is the nominations to the board of governors. That's it. 'Cause anybody that they would nominate and who would get confirmed will be a person who will have a very arms-length independent relationship from the White House. So if you don't put those people in place, well, guess what? You're not going to accomplish your goal. President Biden has a great opportunity, you have five open positions; the chair, the vice chair, the vice chair for supervision, and two governors, right? That's a big out of seven. That's a big deal. And they all vote every meeting. So this is like a huge deal. And he took his sweet time coming up with them, but we have all five nominations and... Good, my picture. And they're good. They're really good. So President Biden nominated Jay Powell for a second term. He nominated to elevate Lael Brainard from a governor. She was the governor who... She was appointed in the Obama administration and she is the only one that stayed through without a Trump reappointment. So Powell was an Obama nominee and he stayed on, became chair. In any case, Lael's getting a promotion, very good. Jay and Lael work amazingly together. I saw them in action, so it's a great team. And Sarah Bloom-Raskin, who was a governor in the past when I was there is also getting a promotion. So she was nominated for the vice chair for supervision. She'll only be the second person to have held that job. It came out of Dodd-Frank. It's a really important job and Jay and Lael had their confirmation hearing already, Sarah's is tomorrow along with the two governor nominations, which are Lisa Cook and Phillip Jefferson. Chris Waller and Michelle Bowman are Trump appointees and they're on the board, they will be on the board. Okay, so this is a really good board, all seven of them. But in particular, the five nominees that Biden made are highly qualified. They are likely to be confirmed. Tomorrow's hearing is going to be a total mess, but they will get confirmed. I think the chances are really, really high and they're a great team. This is a sum is greater than the parts, actually all seven thinking like this is a really strong board, we absolutely need that. 2022 is going to be a huge challenge for the Fed monetary policy also regulatory policy that Bloom-Raskin would lead on. And this makes me feel good. They're under a lot of criticism. Again, this is why tomorrow's hearing is going to be very painful to watch. This is the new Fed, this is not a woke Fed. The fed is not woke. It will never be. But it is a Fed that will push for the dual mandate. That's what we should be doing. And in fact, as a reminder, because I've spent so much time talking with journalists about this fact, again, the team is strong. I have written... So I have a substack, I've written about Powell and Brainard, so that was part one of my recent series. And then I did one this week on Bloom-Raskin, so I'll... And then there's one coming. I'll probably do after the hearing on Cook and Jefferson. And the point of the three-part series was to explain why each of these five are great people to fill the roles. I also go through history of the Federal Reserve. What are these roles exactly and why does it matter? And I have a prior post, there was a video interview with Kaleb Nygaard, who's done a lot on the history of the Fed and we talk about why these five would make for a historic Fed, right? So that's all really exciting. I think it's important to ground in context, and also the expertise of all five of these individuals. What I put on this slide, and I really am getting close to just sending this to every macroeconomic department in the country, are excerpts of the Federal Reserve Act. And the two pieces here I think are most relevant. The first, the absolute most relevant. In 1977, the Federal Reserve Act was amended and it added maximum employment to stable prices as the Fed's monetary policy mandate. Okay, the Federal Reserve Act is the law. If we don't like the law, we go to Congress and Congress changes the law. The president cannot change this. The chair of the Federal Reserve cannot not change it. This is the mandate. Now, it's not like it comes.... It's not like a recipe from a cookbook, right? There is the ability to interpret. And frankly, from the day the ink was dry on the Federal Reserve Act, the maximum employment mandate has not gotten the attention that I think was... Not I think, the attention that was intended. The maximum employment mandate comes directly out of the civil rights movement. Coretta Scott King was at the signing in 1978 of the Humphrey Hawkins Act, which brings the chair twice a year to the Congress to say, hey, how you doing on your job? And yeah, so this is the law, these five, the seven... The five appointees, the seven members of the board, frankly, the entire Federal Open Market Committee at this point has made a commitment to really deliver to the best that they can, right? So that's the law, they're law abiding, and it's gonna really be important and pay off. But this is the sea change. This is the new Fed. This is gonna be tough and it will be messy. The second thing that I put in here, just because of some of the criticism that will come up at tomorrow's hearing about the candidates, and this goes back to the woke Fed crap that's been talked about, is in the Federal Reserve Act, section 10 talks about the principles the president should use in making the appointments to the board. Okay, so you see this piece where the president shall have due regard to fair representation. Now, the representation here, I mean, this is from... The Federal Reserve was started in the early 1900s, right? This does not talk about race and gender, but it does put in the principle of fair representation, here it's thinking about the industries and the geography. The Federal Reserve actually has a geography diversity built into it with the Reserve Bank, so it was pretty unique for government agencies. I think it's a huge plus. Industry makes sense too. But the principle you see here is the board of governors should be representative of those groups that the monetary policy, the regulatory policy affects, right? So Lisa Cook in particular, if confirmed, will be the first black woman to have been a Federal Reserve official, period. Phillip Jefferson, I think, will be the fourth. In any case, it's pretty clear that black and brown people have not been well represented in the decision-making group at the Federal Reserve and that's bad for policy. This is not a check the box kind of thing. This is like a real thing. And it's also the law. So anyway, so we'll see. Tomorrow I think will be an interesting hearing. We'll learn some on substance, like how the Fed thinks about climate change, how they think about maximum employment and inflation. And then we'll also be reminded of the challenges that we have in economic policy in general, and kind of like the US in general of getting representation. Okay, so that was my last... Yeah. Okay, so I'm gonna stop. There we go.


Richard Green: So thank you very much, Claudia. And for people who would like to query Claudia, please just ask your question in Q&A and I will acknowledge you because we're in this webinar setting. That's the way we need to do this. I wanna start with a prosaic question, which is, if you look at the last two times the Fed raised the federal fund rate, which was in the late 2010s, like 2019, and then in mid 2000, it really didn't have much of an impact on long-term interest rates. You saw the yield curve basically pivot... I mean, long-term rates went up a little bit, but you saw pretty rapid inversion. It's particularly the last time around in the yield curve. Do you think... Let's just say they raise the Fed funds rate to 2.5% the next two years. Do you think you'll see a similar sort of dynamic or do you think this time it will be different and it will affect the entire yield curve? And I know that's a really-


Claudia Sahm: Yeah. No, no. I was doing an investor talk recent. That was exactly what they asked me. No, and I think we're not gonna have to wait two years to see that happen. I mean, right now we've already got the flat yield curve, right? And inverting seems highly likely, frankly. I think one misconception that I often run into with the Fed is the Fed controls interest rates. So that's not true. The Fed has a lot of influence on the short end of the curve. Like the very short... I mean, the Fed sets the interest rates that banks can borrow from the Fed, right? So like in the very short-term, the Fed can do the rates. I can't borrow at the Fed funds rate, you can't, no one can, right? But the Fed, what it needs to do to either increase or decrease demand, right now wants to not increase it as much, they have to get the borrowing costs for consumers and businesses to go up or down, right? And the long end of the curve, we don't borrow with 10-year... The government gets to borrow with the 10-year treasury rate, but a lot of the consumer loans, mortgages, student loans, credit cards, to some extent, I mean, longer term loans, they're all gonna be very sensitive to the 10-year treasury. The Federal Reserve has an effect, both on its federal funds rate, its balance sheet, also like how it kind of talks to the economy. Like it can do things out at the long end, but it absolutely does not control the long end, right? Frankly, the Fed would be kind of happy if long run rates would go up more, right? They do fight this. The Feds, we're gonna tighten, we're gonna get... And then the treasury falls... I mean, not a lot, things are just kind of... But this is the flat curve. So it's not that the Fed... At the end of the day, the Fed does not care. It does not care about what the yield curve is. It doesn't care... 'Cause there are other reasons why demand-


Richard Green: Let me ask a specific-


Claudia Sahm: Yeah, yeah.


Richard Green: I mean, guess is a real estate crowd and mortgage rates are tied to longer interest rates. But also bank lending is tied to deal curve, right? If you have an inverted yield curve and you're a bank, you basically, your arbitrage goes away. You don't make a lot of profit by making loans. And to the bankers in this group, if I'm saying something that you disagree with, just say so, but it's basically that they'll say, we're continuing to lend. That's what they said in 2019, but the fact of the matter is that if you look their underwriting standards, they tighten up to the point where there's a lot less lending going on. So in real estate, you care a lot about the long end of the curve, and I think one of the things people are wondering about right now is because the Fed's balance sheet is so big is does... So they own a lot of mortgage-backed securities right now. And if they start sloughing off their mortgage-backed securities instead of just running them off, actively selling them, will that start having an impact on mortgage rates, which in turn could have a pretty decent impact on things like house prices? I mean, they'd better because I've been telling everybody that the reason the house prices are so high is 'cause mortgage rates have been so low. How do you think about those dynamics?


Claudia Sahm: Yeah. So, I mean, this was something that Jay was asked about at his hearing. Or actually, no, this wasn't the hearing. This was the meeting after the last Federal Open Market Committee meeting. And he was like, "We care about the real economy." The Fed's mandate is prices and employment. Now, everything the Fed does goes through financial markets. So like a good example is where you're talking about with the mortgage underwriting. Like the Fed needs... They need people not to buy as much stuff right now. And one of them is housing. Housing has been... I mean, the Fed can really push down interest rates, interest rates fell for a lot of reasons, even beyond the Fed and guess what? A lot of people bought homes. I bought a house, it was great, even low interest rate. So now we need those interest rates to come up or other ways to tamp down demand, right? It could be the underwriting... Like the Fed follows all of these things. They follow the mortgage rate interest, they follow the underwriting side. They look at like which groups of families are getting loans and how... So as long as the demand cools some and there are fewer homes bought, that accomplishes what the Fed is trying to do. Or at least the Fed is trying to get out of this business of pushing up demand for mortgages. Now what the Fed does, and what the Fed has done, like with the balance sheet, and there are massive disagreements about how quantitative easing works. This addition to the balance sheet, how the runoff works, the Fed hates the balance sheet. Like it's the best of all bad options once the federal funds rate is at zero, but like... I mean, Ben Bernanke said straight up, like it works and we don't know why, right? And that has not changed since Ben Bernanke was chair. And you can see a lot of Fed officials being like, wanna get out of this, right? They wanted to stop the purchases sooner, the purchases are now almost done. I think this year is entirely possible, it has been interesting, even people like Mary Daily have been signaling this. We could get, they call it a pretty flat federal funds rate. We'd get some increases, but not like a lot of increases. And we could see the balance sheet starting to be run off this year. So you could have a mix that's pretty heavy maybe, or maybe it's balanced on increasing the federal funds rate and reducing the balance sheet as way to not... Well, frankly, to start cooling demand relative to where it is now. Yeah. Good luck. I mean, knowing exactly what that's gonna do... And the Fed would be monitoring it very closely and you can already see, I mean, even Jay Powell came out of private equity, he made a lot of money at Carlyle before he did government and Fed stuff. He understands how to talk to markets. He does market talk a lot better than Fed speak, right? Which is good, but he... I mean, the press conference-


Richard Green: For the audience-


Claudia Sahm: Oh, sorry.


Richard Green: Describe briefly what market talk is and what Fed speak is.


Claudia Sahm: Well, okay, so market talk would be a good example of what you asked me about. Is the yield curve flat and how does this trend, right? Like my health economist husband, the other day, I was like, oh, I was talking about the yield curve and he's like, "What is the yield curve?" And I was like, "Oh my God." Anyways, so but he would also, when I start going off about members versus participants, like there's a whole Fed speak stuff that's like... That markets do understand. But again, markets are very focused on themselves. We all are focused on ourselves, right? So like, I'll get asked by investors like, "Oh, what is the North Star for the Fed and financial markets." I'm like, "There's not." They don't want you all to go off the rails and be unstable, but they really don't care. They don't care if you make a profit, they don't care if you get hosed on your investment. They want stable prices and maximum employment, right? You're a conduit. So the markets have a way of looking at things. The Fed does need to talk to them, right? They don't want things to go off the rails. The Fed has had a way of communicating. It's called Fed speak. I mean, they do actually want people to understand it now. Greenspan famously equipped, "If you understood me, I misspoke." Right? The Fed is trying, but this is-


Richard Green: He was very well known for that.


Claudia Sahm: Yes, and he really was hard to understand.


Richard Green. But Bernanke wasn't.


Claudia Sahm: Well, Ben Bernanke, bless his heart, is not a great communicator. I mean, even yelling would go into lecture mode, which I loved, but I mean, this is pretty high level. Jay is much... Of all the Fed chairs that I've worked with, and I think... I didn't work for Greenspan, but this would fall under him too. He is the most plain-spoken. But he does know what markets need to hear. But markets, I mean, in general, I find plain talk with markets is pretty effective too, right? The topics are a little different, but we don't need to get fancy. This is understanding and communicating, but even with all of those skills and a lot of prep, the last press conference did not get high marks. I mean, we saw big volatility during... Like from the statement through the press conference. Now, the Fed doesn't... It is not its job to hold markets' hand. The stock market will be okay. I never worry about the 1%. They will be okay. And even anybody in markets, eventually, the stock market it'll go down, it'll come up. But that is not like a point of pride when Jay walks away from the podium to know it's been doing that. So the Fed, even though I think it's well-equipped to get us through this, and frankly, that market's handled and have continued to put credibility in the Fed through 2021, we had Fed funds rate at zero, and we had 7% inflation. That just shows how well the Fed has been able to connect to and talk through with markets. But this is hard and it's gonna be a wild ride. And I do think, bringing it back to what you've been asking about the mortgage market, that is a huge piece of the demand that the Fed has influence on. And consumers are, frankly... It's a little bit of a mix, but in the low interest rate environment, the Fed's tools are less powerful. But interest rates on mortgage... They're a big deal for consumers. You have to have the down payment, but there's a lot of researches that suggest in the corporate sector, when you invest, it's not as much about the cost of borrowing, it's about your cashflow and expected profits. So I feel like, and I couldn't really back this up, but having studied consumer behavior a lot, I feel like their channel is probably the most powerful through the housing market.


Richard Green: Rodney Ramcharan here at USC has done some great work on this and he looked at those people who had adjustable rate mortgages in the great financial crisis that weren't bad adjustable rate mortgages, were part mortgages. He looked at the channel of when the interest rates fell, so people's mortgage payments went down automatically, how much of it that they spend? And the answer was quite a lot. As you might think, lower income people spent a greater share of that mortgage savings than higher income people did. And it was... The paper was I don't know, years ago. And it was a really nicely done paper, but that's a really good example of sort of an exogenous event in people's households, clearly influencing how they're spending. I mean, what am I gonna say? Of course, I make my living talking about mortgages. So I'm gonna say the mortgage channel's important. But I think there's-


Claudia Sahm: Yeah, I don't think this is controversial at all at the Fed. It's just not that many Americans have adjustable rate mortgages, right? So you do have to... Yes, the channel is there, it can be very powerful, but turning it on and off is tough. But again, like this is... You all are getting a lot of attention from the Fed, always looking at mortgages, especially right now. I'm sure of that.


Richard Green: So let me, again, invite the audience to weigh in with questions in the Q&A. But in the meantime, I wanna ask a question about Europe. So a bad print inflation number came out of Europe today or yesterday. Do you know, is the ECB going to respond? Is there talk of the ECB will respond relatively quickly? And how much coordination, if any, goes on between the Fed and the European Central Bank?


Claudia Sahm: So there's no coordination outside of like total crisis, right? Like in 2020, there were lots of central banks opening up lending facilities in tandem. But there is constant communication, right? And it varies like how regular and at what levels, but there is a large brain trust that is trying to make monetary policy, regulatory policy, the world over as good as it can be, right? And central banks, particularly in economies with similar levels of development, right? So like, there are central banks like in the United States, in Europe, at the ECB, Bank of Sweden and Canada, that are all facing some very similar issues. In an emerging markets, there are some very serious issues that are different, right? Like everybody's dealing with a pandemic and how the pandemic is disrupting their economy. That's happening in different ways. There are issues, particularly how Fed, ECB, Bank of England policy, how it could ripple through into emerging markets. That's a whole other thing that I'm not super qualified to talk about, but I do... Let's hear your point, like central banks are in communication, they have... The United States is unique. I think they might be the only one, but it's definitely ECB and Bank of England does not have this. We have the dual mandate. All the central banks have a price stability mandate. We got the dual mandate. I feel very comfortable that the Federal Reserve should have stayed at zero, in part, because of this, there are short falls in employment and maximum employment, the banks that only have the price stability only. I mean, it's really important. They have that mandate. They are leaning on, this is the pandemic. This is supply side. This is going to resolve. But just as the Fed has come under increasing pressure, other banks are too. Bank of Canada surprised markets. Frankly, I don't know why it was a surprise 'cause they didn't raise rates at their last policy meeting. The ECB is really signaling they're waiting. They're gonna wait... I mean, which for the ECB, it's like, oh my gosh, this couldn't be more different than the 2008 episode. But they're all grappling the same issue of COVID. I think to me-


Richard Green: And Europe has not recovered as well as the US has.


Claudia Sahm: No, they haven't... The United States was unique in the last push of fiscal policy in 2021. Nobody else had the American rescue plan. This is a great debate. I mean, Jason Furman from our time at the White House too, we have debated a lot about how much the rescue plan pushed up inflation versus COVID. As the European numbers come in and they have been somewhat behind us in the inflation, it is becoming more and more clear that it is a common shock, which is the COVID or something. I mean, it could have been... But like COVID clearly has its fingerprints and the higher and higher inflation goes in Europe and ours is starting to moderate... It looks more and more like COVID. The American rescue plan, more demand, obviously had some effect, the Fed did too, but... That's why I think you will see an alignment of central bank decision-making, but it's not a coordination just 'cause... I think we're more on the same page than we were in 2010, '11.


Richard Green: Well, it's clear to me anyway. I mean, maybe we overdid a little bit in 2021, but we clearly underdid a lot in 2008, 2009. And my policy loss function is such that I'd rather we overdue. And if we did, it was little by a little, I don't think it was by an extraordinary amount, but maybe we did a little. But that still is a better outcome than underdoing. And just having that such a long, painful recovery, as we did.


Claudia Sahm: We'll know a lot more this year, 'cause if inflation stays high and there is no more relief coming, then it will look like it was not a good as bet, but if-


Richard Green: Well, the other interesting thing is what makes people politically angry. And one of the things that makes people politically angry is gas prices, which is why I sort of worry about our ability to mitigate greenhouse gases. We're upset when the price of gasoline is $5 a gallon. I don't know, but that's another conversation. So we are coming up on the top of the hour. Always an hour with you Claudia goes by very quickly. Thank you so much for bringing your Washington insights to the left coast of the United States. And again, I hope we can call on you again. It's nice to have you as a regular on this series.


Claudia Sahm: Yeah, I totally agree. And I appreciate the chance to talk about the Fed today. Good stuff.


Richard Green: Great. Great. Thanks so much, Claudia.