C. Peter McColough Series on International Economics With Martin Wolf

Thursday, May 5, 2022
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Chief Economics Commentator, Financial Times; Former Distinguished Visiting Fellow for International Economics, Council on Foreign Relations


Chairman and Chief Executive Officer, Willett Advisors, LLC; CFR Member

Martin Wolf discusses the global economy, the repercussions of the Russian invasion of Ukraine, and economic recovery from the COVID-19 pandemic.

The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.


RATTNER: Well, good morning, everybody. Thank you to those here in New York for coming. And I think we had three hundred people registered to join us via Zoom online, and so that’s a testament to the interest that our speakers holds in the world and his distinguished commentaries. I’m not going to go through a whole introduction. You all know who Marin Wolf is or else you wouldn’t be here, presumably. I certainly wake up every Wednesday morning and look forward to picking my FT off the doorstep—yes, I do still read it in print—and seeing Martin and reading Martin, and always thoughtful, always thought-provoking, and also very analytical and apolitical, I would say. Very much down the middle; calls it as he sees it. So I don’t know whether it’s a coincidence or not, but we happen to be sitting here the day after the Fed raised interest rates by the most it’s raised them in twenty years. Just a few minutes ago, the Bank of England announced a rate increase and also issued some economic forecasts that were less than—(laughs)—less than reassuring, shall we say. So why don’t we start in the U.S., Martin, since we’re here, and give us your assessment of what the Fed did. It was, obviously, what the market expected. Is it what you wanted? And where do you think we go from here?

WOLF: Well, my sense of what’s going on is, as you say, the Fed has managed market and indeed wider sentiment on what they’re going to do with extreme care, and they seem to have a terror of causing, well, what everyone calls a taper tantrum; namely, a surprise that leads to the markets falling out of bed. I have a very different view on that. I tend to think creating shocks for the market is incredibly important and needs to happen quite often. We can discuss that later. But anyway, that’s what they did.

They have, obviously, started—well, continued, but they’ve made a big step in their tightening cycle. And they remain, to my mind, I wouldn’t say blindly optimistic but definitely optimistic that inflation will go without any significant—without a recession—I mean, Mr. Powell—Jay Powell was very clear on that—so that this will be a beautifully calibrated disinflationary episode, largely because they think—they still think, I believe, that there is no real inflationary process within the country; it’s basically, to a very significant extent, shocks which will dissipate relating to post-COVID and, of course, the war. And there is, in that sense, at least the way they present it, going to be what I and I think a few other people have called an “immaculate disinflation.”

I think all that is pretty optimistic. It doesn’t—it doesn’t—it’s not consistent, as Larry Summers and others have pointed out, with broad history. And it is interesting to me—and that was the only comment I make on (this stage ?)—that the Bank of England is, I think, rather more realistic about what will happen, partly, namely, we are going to get a recession, and—but partly, no doubt, because the U.K. is always more vulnerable and is in really, I think, quite a significant mess. But it’s also because I think the bank has been more willing to be truthful and honest.

Now, the final point would be I think this view of the future is very optimistic. There’s a very good chance they won’t be able to manage it perfectly. Central banks really can’t do that sort of thing, in our experience. There’s a very real chance that inflation will become embedded domestically and they will have to deal with that, given what I see in the labor market and so forth. I think they have made pretty significant—how significant we don’t yet know, but pretty significant mistakes in the last—since early—for more than a year. They should have been here before. I think that was obvious even if they didn’t know about the inflation that was coming down the pike. And I don’t agree with the new Fed monetary framework.

So apart from that, I think the Fed is doing a terrific job. (Laughter.) But I mean, I’ve always taken the Fed very, very seriously, and I’m genuinely a bit puzzled by what they think and have thought. And I do hope and pray—now, let me be very clear—that it does all work, because if it doesn’t it could be a very significant economic and political mess worldwide.

RATTNER: All right. (Laughter.) On that happy note, let’s try to unpack a few of the things you said because you raised a lot of really interesting and important issues, obviously. I’d start with a comment I heard somebody else make, that if you were on an airplane and the pilot announced that he was attempting to make a soft-ish landing, how would you feel? And I think the answer is, obviously, slightly nervous.

I would also say as a market participant I’m not sure I share your enthusiasm for taper tantrums. I think I would be a little happier without a taper tantrum, but we’ll see how that goes.

WOLF: Yeah, but that—if I may interrupt, Steve—

RATTNER: Yes, of course.

WOLF: —not being a market participant—far too poor, thank heavens—it is my theory, very, very briefly, if market participants aren’t frightened they do crazy things and markets go crazy. My sense is some pretty crazy things have been going on in the last few years. And I’m afraid while I would love to believe that the market aggregate is reasonable and rational and understands all the risks, I actually think a little terror is helpful. Fear and greed needs a bit of fear, too.

RATTNER: Point taken, but I think—I think you would probably agree that some of what’s gone on in the market in the last couple years is not occasioned by the market participants, but by the Fed itself.

WOLF: Oh, no, no, I think that having poured an immense amount of fuel on the fire—and of course, the Fed is a significant degree responsible and didn’t withdraw it quickly enough—I agree with that. But the—if in the process of withdrawing it now given what they’ve done they cause a few market shocks, I understand the politics is lethal, but for market sobriety in the future it might be quite helpful.

RATTNER: All right. Point noted.

So you’ve, obviously, been very direct and clear here about your views about how the Fed handled the situation. The question, I think—the next question, I think, is: How did they get it so wrong or why did they get it so wrong? What was—what drove them to a set of decisions that, in retrospect, I think any of us would look at and say it was too much for too long?

WOLF: I have to say in my defense that it wasn’t in retrospect. I’ve been writing—

RATTNER: Oh, you were—no, you were very clear, yeah.

WOLF: I’ve been writing about this for quite a long time. Actually, I even—my first column in which I said that what they were doing could create significant inflationary problems down the road was in May 2020, so it’s quite a long time.

I think for me to say why they did what they did is to claim knowledge that, in truth, I don’t have. I’m not in the Fed. I’m not even here. I don’t talk to people regularly. But it’s—but I do notice there are quite a number of hypotheses out there.

The first hypothesis would be they genuinely believed that, as many people believed, and I—and continue to believe—that sort of inflation is dead, you know, they couldn’t create it, as it were. It’s a problem that—you know, that idiots did forty years ago, but it just couldn’t happen anymore. You know, the Phillips curve is dead and all the rest of this. To my mind, complete nonsense. Now, but they—you know, my view—perhaps because I started following economics fifty years ago—is inflation is always possible if you make mistakes. But I think that’s one possibility.

The second possibility is that they felt implicitly or explicitly subject to political pressure or political concern. You know, 2020 was a colossal shock. They wanted to get back to a healthy, normal economy as quickly as possible. They believed there was tremendous excess capacity in the system. And they committed themselves—and this goes to the third reason—they committed themselves in their new monetary policy framework—I wrote that too—they committed themselves to going too late. I mean, so it was within the framework, you know, maximum employment, whatever it is. And maximum employment as an objective, you have to be there before you tighten, so you’re bound to be too late. And then, with a retrospective inflation averaging which was never described—you know, it was never precise what it meant—but it, obviously, was designed, given the past history, to allow them to overshoot. The framework made it inevitable that they would be too late.

And then, finally, I think—and there I am in very, very good company, certainly me included—that I think basically nobody foresaw that the supply chain problems and—across commodities, above all energy and goods above all, would be as severe as they turned out to be. So in—I don’t remember reading anybody in sort of November/December 2020 saying that’s what would happen. And so there were price shocks they didn’t foresee, and they similarly didn’t foresee—and that, again, I think is understandable how the labor market will behave, that in particular that it would show such enormous signs of being very, very tight when employment ratios were still, by historical standards, very low. And so this became very difficult to judge.

So they had unforeseeable events. I think they were genuinely unforeseeable events, but—and so they waited to see what happened. They waited to see whether they were going to be transitory or permanent and they convinced themselves for a long time it’s going to be transitory and then, to make life more difficult, Russia started a war in the grain basket of the world with a huge energy supplier involved in this war, so sort of bad luck. My view on that—you know, I don’t want to go into what’s wrong with that, but these things together, to me—and I can’t say which is more important than the others—would explain why they waited too long. And I’m not even going to go to the place—I’ve written about it—of the reappointment issue. But I do think—somebody mentioned this to me (who is in the poll ?) yesterday, and I do agree—one of the things the Europeans have done, which I think is a very good idea, is that the president of the Central Bank cannot be reappointed. I would suggest America should follow that model.

RATTNER: (Laughs.) Well, Alan Greenspan we had for quite a good, long while.

WOLF: I’m very, very fond of Alan and very much admire him, but we went on too long.

RATTNER: Too long, OK.

WOLF: Nobody can do—you know, Putin has gone on for—well, I could say twenty-two years too many, but anyway, nobody is sane if they’re in positions of authority of this kind for more than a certain time, but the big problem with it—the duration is important. But the big problem is the Fed chair shouldn’t have considerations of whether or not he or she will be reappointed in his or her mind when making these decisions. The only thing that should be in his or her mind is doing their job as well as possible. I think it was genuinely difficult, though I wouldn’t have made the decisions they made, I think—but I certainly would have—didn’t understand them fully—but there is that issue too. I don’t want to stress it because I don’t really know what went on.

RATTNER: No, but look, I think you’ve covered all the right points in that and I think the issue—the political side and the reappointment side I think clearly was a factor.

Just one footnote or note on the supply chain problems. You know, what I think sometimes gets missed is that, partly because of all the stimulus, our imports were up 23 percent last month over a year earlier; when you put 23 percent more stuff through the Port of Los Angeles or you try to, you’re going to have supply chain problems.

WOLF: That is a real—and I didn’t mention this because we were talking about monetary policy. Obviously, I think they made a fiscal policy mistake too. Nobody would be surprised, because I’ve made it clear, that I agree with—broadly with Larry Summers’ analysis of the fiscal policy. But this, while an excuse, as it were, makes, to me, even more incomprehensible the Fed’s decision. So once the Fed knew what fiscal policy was going to be, in a normal central bank you would say, well, if fiscal policy’s going to be this expansionary and we may have really, really rapid growth and we really don’t know how the economy is going to be coming out of this big shock, maybe we should move away from having basically the most expansionary monetary policy in peacetime ever, as far as I can see. You may correct me, but I can’t think of another episode. Maybe it would be sensible just to start normalizing things, in light of our ignorance and what the fiscal authorities are doing, instead of pouring on petrol from—gas, gasoline—from both fiscal and monetary policy at the same time. So that is, to me, genuinely bewildering. And the fact that this discussion doesn’t seem to have happened in early 2021—as far as—at least not publicly in an obvious way—is really quite surprising to me, because it’s sort of obvious. If this is what the fiscal authorities are doing, monetary policy has to start normalizing. Isn’t that normal?

RATTNER: That’s normal. But, you know, the response of the Biden administration—your very thoughtful and clear critique would be inflation’s a worldwide phenomenon, we have inflation, the U.K. has inflation, Europe has inflation, even China has a little bit of inflation, and therefore it’s not that—it’s a worldwide problem that is not our fault, and how would you respond to that?

WOLF: Well, the—it’s a worldwide problem because we had a worldwide shock. Obviously—and it—the U.S. is an important part of that because, one, it’s a very, very large economy so you can’t say that what goes on in the world economy in market terms—it’s about a quarter. But the U.S.—but there are—so it is a worldwide phenomenon, but considering what’s going on worldwide is nonetheless important. It’s particularly important if you’re responsible—and this is particularly true for the Fed—for, far and away, the most important money, which has global implications, obviously, having super loose monetary—we’re not talking about fiscal policy—has global implications because we’re talking about the dollar, which is a global currency—the global currency, so it’s not just—so we learned this surely—you know, actually we learned it in the ’30s. American monetary policy is global monetary policy. It’s not U.S. monetary policy. That was true in the ’20s. That’s how we got the Great Depression. So the—well, the Biden administration can argue this a bit because you could say fiscal policy’s more domestic but it isn’t really because it always spills over to the world. But for monetary policy it’s definitive. The Fed isn’t mandated to do this but its monetary policy works globally, so that doesn’t get away from—arguing that it’s global doesn’t allow the Americans to say it’s got nothing to do with us. It’s nothing to do with Britain but it’s sure got something to do with the U.S. Then the other set of issues—

RATTNER: Well, putting it another—in a sense, we exported our inflation.

WOLF: I think that’s an exaggeration because others were doing similar things, but I’m going to get to that in a moment. But clearly, just saying here we’ve got little America and we were doing the right thing, but then the beastly world did this to us. Well, you can’t be the world’s superpower and then (deserting ?) what happens worldwide. That’s all I’m saying because, as a matter of fact, of course American monetary and fiscal policy is immeasurably important for the whole world, and so those repercussions have to be taken into account and that’s the lesson that was learned actually in the interwar period, and that’s why we have Bretton Woods. And I won’t go into all that stuff.

The second point is the expansion in the U.S. was exceptional; among the developed countries it was far and away the strongest. It is the only developed country that is back on trend, the only developed country that’s back on trend, which is a measure of that. And the signs of serious domestic labor market tightening, though there are bits of that in other developed countries, are much more advanced here and more significant in terms—quit rates and all the other phenomena which support the idea that whatever’s been going on in the labor market, it’s seriously tight. And of course, that fits with the fact that the fiscal policy and monetary policy combination in the U.S. was clearly radically more expansionary than in any other major country. By those standards Europe has had a pretty expansionary monetary policy; fiscal policy has not been nowhere near as expansionary. We’ve been contracting fiscally—not that the U.K. really matters. So I think it’s possible to say, one, the U.S. impact on the world really matters so you can’t just say that’s something else out there. We can go through every example in the last hundred years’ economic history; that would be boring. And two, U.S. policy was way out there as a combination. And three, perhaps worth adding, disinflationary pressures and long history of sub-target inflation outcomes was deeply entrenched in the eurozone, and talk about Japan, while in the U.S. actually the Fed didn’t have such a record; it was far more likely to ignite—reignite inflationary expectations than in Europe because the disinflationary experience has been so radical. So—I know this is a long answer and I apologize, but it’s important. I think I wouldn’t say this is a total cop-out, but it’s quite a significant cop-out.

RATTNER: OK. So while we’re sort of in Europe, let’s talk about Ukraine and its impact. Obviously, it’s been tough on Europe’s economy, and part of why I think the U.S. has done better, besides the extra stimulus that we’ve had, is that we are a net exporter of oil—

WOLF: Of course.

RATTNER: —so that, obviously, makes higher prices actually a positive for us from a—

WOLF: Yep, it’s a neutral—it’s a positive effect, instead of negative, yep.

RATTNER: —from a GDP point of view.

WOLF: Yep. Yep.

RATTNER: So the Europeans have had to bear the pain essentially of dealing with Ukraine. You’ve written very passionately, clearly very articulately about the importance of Ukraine being number one, two, and three of our priorities at the moment in terms of dealing with Russia. So what else should Europe do? They’re now talking about banning oil imports, although I guess Hungary is pushing back slightly on that; we’ll see how that all comes out. But it comes at a cost. It comes at a big cost to Europe, and essentially I guess you’re arguing that Europe should just bear that cost.

WOLF: I think I’m arguing—well, the crisis—this is a very big crisis. I don’t think we can deny that at all in terms of what has happened on Europe’s borders or in Europe, if you like—EU’s borders in Europe. It has raised profound questions, obviously, about the order the Europeans thought they were enjoying. It has raised profound questions about—and this is partly why they bear the mistakes Europe has made in the past, which are now sort of recently obvious. It brings me back to the—I’ve been thinking about this. You will remember, of course—I can see a number of people here are of mature years—will remember the early ’80s when the Reagan administration was arguing very fiercely that the dependence on Russian gas was a mistake, and they seem to have been vindicated.

RATTNER: That was Nord Stream 1, I think, right?

WOLF: Yes, yes, before, and that was—and of course after the end of the Cold War we thought, what was they worried about? And so we didn’t expect this. We have no idea whether Putin will stop here—can’t. Depends on how this goes. Of course the fact the war’s been worse for him than most people expected may mean he won’t go any further, but nobody knows what he’s going to do. So it’s a huge set of challenges. And the geopolitics of this are very profound and are, obviously, going to reshape Europe and we can see this happening.

Now, because—and that’s the first point. The second point is because of what’s happened, for the reasons you yourself have mentioned, the rise in energy prices; particularly the food price issue is more for the rest of the world but it’s a very big issue too. We’re going to have a lot of instability in developing countries as a result of this. The combination of debt problems, with tightening monetary policy in the U.S., higher interest rates, food prices—I expect enormous political explosions in developing countries. But in terms of Europe, there are going to be losses anyway, OK, even if they didn’t have any sanctions or anything. As you rightly pointed out, real incomes, because of the shift in the terms of trade against Europe, are very considerably reduced. We have what we are calling a cost of living crisis which is really a real-income crisis, which is particularly hard on poorer parts of our society because they tend to spend a higher share of their income on energy than richer parts, and that’s true—and this will—because it will be a radical reduction in real incomes of people and of real national income, and most European governments are not going to compensate for this—in fact, basically none of them are—we’re going to be hit anyway, right, just because of that. So—and this is very important because the additional hit that comes from sanctions is, at least on the basis of what we’ve done so far, not that big relative—in fact, pretty small—relative the hit we’re going to get anyway. It would be—it’s very important to understand that there is no way we can avoid the fact that this war is going to make us poorer in the short to medium run, and it’s a big reason why the Bank of England has just announced we’re going to have a recession. And I would expect, looking at what’s happening, that the chances of recessions in Europe are very high.

Now, my view then would be, well, if you’re going to have that anyway, you might as well do it—use the opportunity, as they say, and the opportunity is to maximize the pain on Russia relative to the pain to Europe. I have been—I am convinced that with the right, smart policies—and I tried to discuss that in my column this week—which would include tariffs rather than embargoes, designed basically to shift the rent to the consumers, which in gas I think is workable. The Russians might cut it off; of course there’s a risk there. But at the moment we are increasing our transfers to Russia very substantially. The net effect of all this is that the increases in energy revenues for Russia, given the amount they sell hasn’t fallen very much and the prices have exploded, means that they are actually—we are essentially funding their war effort.

RATTNER: Well, can I interrupt just for a second to say—

WOLF: Yeah.

RATTNER: —yes, but. In fact, I think in your column there was a chart—the price of Ural oil is $30 a barrel less than the worldwide price because of these sanctions.

WOLF: Yeah, which is very good.

RATTNER: So in effect haven’t we achieved what you’re trying to achieve?

WOLF: Yeah, but the price is still way above what it was a couple of years ago and it’s also somewhat above what it was shortly before this war started, not much. So we have taken out some of it, and all I’m saying is I think we can do more of it, and the way we can do it is to combine in—I think—into—by taxing Russian oil and, as some people have suggested, we may be able to spread—with gas it’s direct link, so it’s us. With oil it may be possible to make it difficult for Russia to export the oil that would otherwise go to Europe because, given the pipeline system they have—

RATTNER: Oil or gas?

WOLF: Oil. Gas basically they’re stuck. Transporting gas on the scale they need to compensate for the enormous role—Europe is overwhelming their dominant market. Exporting gas without the pipelines to do so is, I understand it, basically impossible. But even with oil—

RATTNER: But you think that Europe should cut off the Russian gas?

WOLF: No, I think they—no, I don’t think they should—we should cut it. We should just impose a whacking great tax on it and the aim to be to shift the—we would pay a higher domestic price, which we can offset for consumers in one way or the other, but we will be taxing away a significant part of the rate.

RATTNER: Europe is in a sense doing the opposite; they’re providing subsidies in a bunch of countries—

WOLF: Yeah, and they’re trying to cut off the—they’re not daring to cut off the gas. So what I’m saying is in the gas case—to some extent it’s true in oil—the policy we’re pursuing, which is not to impose any tax, not to impose embargo, but—oil I’ll come to—they’re not thinking about it. But in the gas case not to impose the embargo because we want the gas. Pay the higher price, though, again, that’s complicated because of this ruble discussion; I’m not going to go into that at the moment. But pay the higher price means—and then compensate our consumers—the net effect of this is we’re transferring an awful lot of money to Russia. And so we have to think of alternatives, and the most obvious alternative if we don’t want a straightforward embargo, is to tax the thing. That raises the price to our consumers, of course. It will encourage the shift over time in our energy mix; that will take time. But that would generate—basically shifts the tax—the implicit rent in the gas system to us from Russia. Now, of course, Russia might then offset this to a significant degree by cutting it off, but they would lose more because we’re not going to take all the rent, and they do need the money because in that sense sanctions have been very effective. So I think there are smarter things we can do on gas.

Oil is more interesting. Oil is easier to ship out of Russia, but given the pipeline system they have, as I understand it, what they would have to do is to use bulk tankers and there is a limit to their capacity to do that, but it’s also true that an enormous part of the shipping fleet of the world is European, so we have control over that and we could, therefore, impose pretty significant sanctions or limits on Russian oil exports through those means, and we can also tax Russian oil imports into Europe which would, because of that difficulty, also hit Russia. Now, the—and then of course in the longer term we’re going to have to move to a system which is more energy secure, and that’s going to take a long time.

The net effect of these sorts of policies, which I do discuss in greater detail in my column, would be to cause some greater disruption and loss to us. There’s a big debate, a huge debate among economists on how—and policymakers—on how big that would actually be, particularly in Germany, how big the shock would be—very big variations. But there is no doubt that the sorts of policies I describe, if pursued over the next several—year or two, would inflict very, very large damage on the Russian economy which is enormously dependent on the revenues it gets from oil and gas, which are at the moment unfortunately booming. My view is that this—it is necessary to get a resolution of the war on, from our point of view, reasonably favorable terms, and the necessary condition for that is for Russia to feel—a necessary—that continuing with it is going to be truly crippling, and the sanctions we have put together so far aren’t—given what’s been happening to oil and gas markets and revenues—enough to do so. At least that’s my very strong impression, my understanding, and therefore we’re going to have to do more; otherwise Putin can keep going. He may anyway. Of course, there are immense risks in this. Maybe when he’s cornered he’s going to use nuclear weapons. Everybody talks about this. Of course there are immense risks in this. But on the other hand, just sitting there and letting him—essentially funding his war effort and the imports he needs to sustain it, I suspect the sanctions we have on what they need for that are going to be porous. I think that’s intolerable. So we have to tighten it and these measures, which I’ve discussed, seem to me the least bad ways of doing it and at least they must be on the table. And indeed, I think they now are on the table. At the end of all this—I’m sorry this is such a long answer—at the end of all this we are going to be worse off for sure, not, I think, so dramatically worse off, but Putin’s Russia will be much worse off, and that’s the—we’re not going to get involved in this directly militarily, which I fully understand. That seems to me the only way we can operate.

RATTNER: I’m going to go to the audience for questions, but just one comment. Paul Krugman had an interesting analogy the other day in which he basically made the point that Germany imposed on Greece massive contractions—

WOLF: I actually made the same point in one of my columns. (Laughs.)

RATTNER: I’m sorry. I should have remembered—

WOLF: I had a chart which was specifically designed to show how big the expected contraction in German GDP might be—at most between 2 and 6 percent—

RATTNER: Relative to—

WOLF: —and compared to what Germany did in the eurozone financial crisis, pretty trivial.

RATTNER: And then my other comment would be, without disagreeing at all about the importance of dealing with Russia’s oil and gas exports at the moment, we have to remember Russia’s oil and gas is a significant part of world supply and if we’re going to cut it off—and the history when we’ve cut it off in the past in Iraq and Iran and places like that is it doesn’t come back all the way. We’re going to have to do something to replace it, either by conservation or by supply.

WOLF: Yeah, I think there is—by the way, there’s a lot of discussion that if they are forced to cap wells in Russia they would lose it for good. Of course, if I were a serious person who believes seriously in climate, which I am, I would say that a sharp reduction in oil and gas global supply, though very, very unpleasant, might be very helpful.

RATTNER: It’s one way to achieve a transition, maybe not the most pleasant way.

Jim Tisch.

Q: I guess I’ve been introduced. Thank you, Steve. Loews Corporation.

So suppose, against your will, you have been appointed the chairman of the Federal Reserve Bank. What would be your message and what would be your policy in dealing with the current set of economic problems that we currently face in the United States?

WOLF: Well, fortunately I’m unqualified on every possible dimension for this job, not least that I’m not an American citizen. We of course have appointed a foreign—

RATTNER: Yeah, Mark Carney.

WOLF: —yeah, yeah, to be governor of the Bank of England, but I somehow don’t see the United States doing that, though it would be a pretty powerful statement that immigrants still count.

RATTNER: (Laughs.)

WOLF: The problem they have is that they—and I think it’s very clear they know this, that they know they’re not where they should be by now. Given what they now know, they know that they should have done something else before. And so they are in a very significant inflationary situation and they want to get out of this without imploding the economy. And I suspect that it’s—I can’t make up my mind whether, given where they are now, that’s the right approach, mainly modest gradualism but not incredibly gradual, or whether they should now just step on the brakes Volcker style, because it’s not actually like 1980, right? It’s not that bad, obviously not. So given where they are now, they’re going to have to tighten. I suspect they’re going to have to tighten quite a lot. But I understand that they might feel—and I would sympathize with that—it’s not so bad, given that some of it is clearly transitory; a lot of—some of it will be transitory—that they want to step on the brake and cause not just a significant slowdown or mild recession but already serious one.

So given that, that’s the first reason why the sort of policy they’re pursuing now, given the past mistakes, is I think defensible. And there is an additional point—by making it so obvious where they’re going—making it reasonably obvious where they’re going—a lot of the tightening—in fact, most of the tightening they want—has already been done in the markets. Just look at what’s happened at longer tenors of interest rates, and that is already affecting the market. You can see what it’s done to stock markets and what it’s done to bond markets, and so the Fed is, because of what it’s saying it’s going to do, getting much more tightening effectively than its actual actions so far would suggest. So I think that what they’re doing now is, in terms of actual actions and the way they are guiding things, reasonably defensible, given the mistakes.

So what I would tend to do—so I would change the guidance in the following ways: I would say we would like to avoid a recession but we’re really not at all sure we will be able to, and if it’s necessary it’s going to happen. And what is necessary? Well, it might turn out that we’re actually going to have to keep going at this till we get real rates at least—you know, real underlying rates once you trip out all the variable things—to close to zero to positive, which means much higher interest rates than they’re now talking about. And we don’t know how monetary policy is going to work now, how it’s going to work on this economy, but it’s pretty obvious, given the range of uncertainty, that there are possibilities which are more extreme that we’re talking about and outcomes that are more extreme than we’re talking about. In other words, I would prepare the people and the markets for outcomes that aren’t as rosy as the ones they describe, because I think that will help them. I know they will take the view that this is insane and will spook everybody, but I think a little spooking is probably essential now, particularly in the influence it will have on labor markets and labor market behavior. So I think the rhetoric needs to be more realistic.

That’s sort of the way I would do this. But it is possible—and critics of this line would say, look, it’s just ridiculous to imagine a dynamic of this kind can be stopped without positive real interest rates, in which case they’re not even anywhere near what is needed, given what’s going on in inflation—underlying core inflation as measured, OK, all very problematic now. You know, what they’re talking about now, moving from dramatically negative real interest rates to significantly negative real rates—it’s not going to do it and they are simply not going to get the purchase on the economy they need. I suspect, given the cost of living effects, the shifts of income, real income internal to the economy—it’s internal—from oil prices and so forth, that may be wrong, which is why I would support the first approach.

But there is, obviously, the possibility that actually it will turn out that they’re not going to get control over inflation, that they will have to tighten much more than they’re now envisaging, and if they do have to do that, it might have been a good idea to prepare people some more which is why I’ve emphasized at the end of my first part of my answer that at least they should provide some indication that it could get really difficult—which is what Paul did—and say, well, whatever happens—and there Jay Powell got very close to it, you see—whatever happens we are going to get inflation back under control, and you have to understand that’s it.

So my bottom line, I suppose, is I’m not wildly critical of what they’re doing now, but I am critical of the steps that led them to be in this situation.

RATTNER: It will be interesting to see whether they really try to get down to 2 percent. That’s a heavy lift to get to 2 percent.

WOLF: I think that is a very big question, but if they allow inflation to drift up to 4 (percent), which I think is probably what’s going to happen, quite likely, then I think their credibility gets shot for a decade.

RATTNER: I’m going to take one more question and then we’ll go to Zoom.

Q: Ed Cox, Committee for Economic Development.

Let me follow up on Jim’s question with one that’s more specific. The Fed has moved from QE to QT—95 billion (dollars) a month, and Powell said that he really—I don’t know how to measure the impact either of QE or QT. I know you are shy about giving your opinion, but what do you think the impact of that 95 billion (dollars) a month is, and what do you think that rate should be winding down the Fed’s assets sheet?

WOLF: Well, I think my sense of this—and I’ve read quite a bit of the literature—is we really don’t know, and the—I mean, some effects are obvious. There are going to be effects on the monetary base—that’s obvious—and the balance sheets of the private sector are going to change. They will have less money and more bonds than otherwise. And one would assume that we’ll have some price effect, so yields will be a bit higher than they would otherwise be. And it is possible that these modest reductions in money supply will have some effects on people’s behavior and also the behavior of the central—of the commercial banks, though I think their excess reserves are so huge that those effects are going to be absolutely trivial.

So you can see the direction, but anybody—to my mind—who says we know what the difference is between QT of 60, or 90, or 120 billion (dollars) a month—we just don’t know. We wouldn’t know anyway, I think—by the way, it’s also true that we don’t know with any degree of precision what the effects of small changes in Fed funds rate—monetary policy is not science.

One of the things I loved about—you know, genuinely loved about the analysis of Milton Friedman was that we really don’t know how monetary policy is going to work on the economy—long and variable lags—and the one thing he believed was the quantity theory, and it turned out you didn’t know that either. So the truth is we don’t know what this will do, but one would guess it will amount to some monetary tightening and some rise in long-term interest rates which will reinforce other changes to make monetary policy—the impact of monetary policy on the economy somewhat tighter. But my sense is—and this comes back to this very difficult judgment—given where long-term real and nominal rates are and shorter-term real and nominal rates are, and where inflation is, the tightening may not be enough. And of course it’s clear that the liquidity in the banking system—above all, the reserves of the banks at the central bank—will remain enormous. So it may be that they should be tightening more, but I think calibrating these numbers scientifically is impossible.

RATTNER: So we have quite a lot of questions, both in the room and I think on Zoom, so I’m going to encourage you—

WOLF: And I’m going to be very brief.

RATTNER: Yeah, exactly. (Laughter.)

WOLF: So that people are going to ask very, very simple questions.

RATTNER: We’re moving into the lightning round of this, so I’m going to go to the online audience for questions.

OPERATOR: Our next question will be from Whitney Debavoise.

Q: This is Whitney Debavoise of Arnold and Porter.

Given what you said about what you said about real incomes coming down, particularly in Europe, as a result of the war, what implications do you see for global economic governance structures?

WOLF: I think the link with real incomes is complicated. My broad view is that we have been now in a long period—fairly lengthy period of deterioration of global economic cooperation and the credibility of global economic institutions. That was very clear under the previous administration. It went back earlier.

Now the war is clearly radically accelerating that decline, and I thought a rather powerful symbol of that was that in the G-20 meeting in Washington, what, a couple of weeks ago, the G-7 walked out when Russia started to speak. And the G-20 was created precisely to broaden the network of countries engaged in global economic discussions from the G-7, and the G-7 essentially delegitimized the G-20 in the process and humiliated, of course, the president, which is Indonesia.

I understand why this happened, but I think it’s pretty symbolic of where we are. Global economic governance is not functional at the moment and is very unlikely to become so anywhere anytime soon.

RATTNER: We haven’t even gotten to the question of de-globalization and what all that means, but maybe someone will ask a question along those lines.


Q: Henny Sender, Blackrock.

And my proudest title being a former colleague of Martin’s at the FT.

Martin, you rightly point out that the U.S. dollar is the global currency. Many, many countries abstained from the U.N. vote: Mexico, Brazil, Indonesia. As the global currency, the U.S. controls the pipes of the international financial system. Many countries—and not just China—worry that they could be the next object of U.S. sanctions and be denied access to the pipes of the international monetary system.

Do you think that one longer term effect of this war and the sanctions might be to hasten the demise of the U.S. as the—of the U.S. dollar as the global currency and give rise to alternatives such as hasten the development of central bank digital currencies to avoid the existing international monetary system and SWIFT, and the status of the dollar as the only reserve currency and global currency in the world? Thanks.

WOLF: OK, I wrote one column on that, and I stand by my current view in that, which is they’re going to try hard and fail. The—I’m being as quick as I possibly can—the most impressive thing that has happened, to me, is that the U.S. got all its allies to follow suit, and the extended dollar system, if you like—namely through swap lines and others—essentially the dollar, the euro, sterling, the yen—that’s where the 90 percent—it’s about 95 percent, 96 percent of global reserves. And replacing the whole Western set of currencies with something else is, I think, completely impractical in the quite long term.

China’s reserve holdings of the renminbi are I think 2 or 3 percent of total reserves. I can’t remember the exact number—something like that. And they’re free; there’s no other currency that’s in any way—so that’s the first point. It’s an alliance system now. That wasn’t true over Iran when of course the Europeans profoundly disagreed with America’s policies—I believe correctly—but it is here. So if the U.S. manages to cooperate with allies, it’s unbelievably potent. One.

Two, they are potent for a very obvious reason. It’s not just about operating using a currency for short-term—for cash transactions, it’s about the currency you use to hold safe purchasing power than any reserves, and of course, the access to a working, functioning financial system.

There is absolutely no chance in the foreseeable future—and under Xi, I think it’s going to go backwards—that the Chinese are going to risk the systemic changes that would be required to make the RMB a relevant substitute for those currencies because China is clearly stating it doesn’t want to go to that sort of economic system. You might be terrified of holding reserves in U.S. dollars, but anybody who would imagine that you’ll be less—safer and more secure from political pressure by holding claims on the Chinese government would be a lunatic, including, you know, Mexicans, Indians, and all the rest of it.

And so in conclusion—I’d like to go far more into discussing the different roles of money and what the dollar provides in this. My basic line on this—you can’t beat something with nothing. And the dollar and its extended—and the extended currency system of its allies is something, and nobody else—and everybody else in this regard is nothing. And the U.S. dollar will continue to be dominant.

It is possible, however, that people will try and reduce reserve holdings more broadly because it turns out they don’t give you as much security as you wanted, and that would mean quite significant changes in the way you manage capital accounts. And that I do expect, with much more controls, and it links with de-globalization more broadly. You won’t need to hold so many dollars because you just won’t take those sorts of risks because the dollar has turned out as—to the great surprise—and I mean, I had a big debate with people, a number of my friends here said, but the Russians have all these reserves. They won’t be affected by sanctions. And I shot back immediately. Those reserves are gone.

RATTNER: I wish I had a dollar for every time someone predicted the end of the dollar as the reserve currency.

WOLF: Oh, I’ve been completely consistent on that. I’ve got columns I wrote in the first decade of the last—(inaudible). China is not going to replace the dollar because then, ultimately, they won’t want to do the things required to do that, and I think they probably can’t.

RATTNER: Yeah, not likely.

I should have reminded everyone this is on the record, but we’re going to go to Zoom now for a question.

OPERATOR: Our next question will be from Lyric Hale.

Q: Yes, hello, Martin. Lyric Hughes Hale from Chicago and EconVue.

My question is about the rest of the world. This is the Council on Foreign Relations, and I’m concerned that the financial issues that we’re seeing now could morph into a humanitarian crisis. Since COVID began, emerging market debt has ballooned to a hundred trillion dollars, which is equivalent to world GDP, and there is no effective program in the IMF or World Bank to deal with possible defaults of this—much of this debt much of which is dollar denominated.

In a world where food prices and oil prices are rising, how will these emerging markets make decisions about repaying debt or buying food and energy for their populations? Are you concerned that, as I said, this is going to morph from financial issues to humanitarian crisis? And by the way, I’d like to remind everyone the second and third largest economies in the world don’t have inflation yet. Are we perhaps overreacting based upon, as you discussed, the Fed’s global—the global role. Thank you.

WOLF: Well, first of all, I’m very pleased to hear from you, Lyric.

I won’t go into the second part, but on the first part I have written a lot about this, and I just touched on it. I think we’re going to see a rolling wave of political economic crises in the emerging and developing world. I think that’s about the safest prediction you can imagine, and it’s very, very clear from very good reports that have appeared from both the fund and the bank on that. I particularly recommend the piece that Carmen Reinhart has organized for the Bank, which came before this and is now worse. And my answer to your question is if you are running a developing country and you have to choose between feeding the population and servicing your debt, what would you do? I think the answer is obvious, and so we’re going to have a lot of defaults, and they might be—or debt distress—and they might be very messy. And how we’re going to end up handling them I don’t know.

I have been thinking about the debt crisis of the early ’80s which followed, of course, the Volcker increases in interest rates. If we get to those sorts of levels—well, we’re not going to get to those—if we get to significantly higher dollar rates at the same time as all this is going on, I would be very surprised if we don’t have another really big developing country debt crisis.

And the other dimension of that is now China is a huge creditor, particularly of the poorer countries, and we have no capacity at the moment to negotiate the debts collaboratively with China, so it will be an incredible mess. And I hope that the White House has a plan.

RATTNER: Well, there’s no evidence of that, and then also that critically there just doesn’t seem to be much interest in the whole developed world in dealing with the emerging world, perhaps because the developed world’s problems are so great.

That question in the back of the room over there.

Q: Niso Abuaf, Pace University.

Given the response of the fiscal stimuli in response to COVID, wouldn’t you say that inflation is the politically most palatable way of paying that government debt as opposed to a recession and other ways of paying it?

WOLF: As I’ve been involved in this discussion, the problem with the inflation mechanism is what you want is to engineer a massive, unanticipated rise in the price level overnight. That’s a very elegant way of wiping a lot of people out, but there are two problems with this. Even if you do that, you will make an awful lot of people very, very, very angry, and I think the political economy of inflation in developed countries certainly, and I think more broadly, is actually really pretty bad, even if you could do it that way because you’re reducing real wages and lots of other things. That’s what an unanticipated rise like that would do. In the long run it might work through, but it’s a really big mess.

But of course it’s not going to be like that. You’d have to do a process which you’d have to do things which are sort of visible and will become increasingly visible in inflation. You’d start generating social reactions in labor markets, in the population. You would start generating political pressure, and you would start of course generating massive adjustments in debt markets. And you will find in the process not only that you generate real disorder—I can still remember what Britain was like when we got to—when we really did this in ’75 when inflation hit 26 percent, basically the whole damn society melted down pretty nearly. So it’s very, very difficult to do this in the way that doesn’t have those characteristics.

And the other big problem of course now is that we have a hell of a lot of debt—which I think was a good thing—which is index linked so you can’t inflate it away anyway. You can inflate the other bits of it, but you can’t inflate that way. You actually have cause to default which was the whole purpose of having those debts.

So my view is that if the plan was to generate a great big inflation to get rid of debt, that’s a silly plan. In essence, I don’t think it’s a good plan. I know—but there’s a different question is could they end up there just because all the other things are even more painful for them. Yeah, of course they could, but I’d say that if they end up there because all the other things are even more painful—not because it’s easy—then they are in a monstrous political mess. And so the really big point is we shouldn’t be here in the first place. There’s no easy way out. That’s the really big point.

If it turns out the debt is unmanageable, which depends on a lot of other things, then there is no easy way out. And inflation is not it.

RATTNER: And on that happy note—(laughter)—thank you all so much for coming, and thank you, Martin—(applause)—for a great conversation.

WOLF: Thank you.


This is an uncorrected transcript.


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