Robert B. Menschel Economics Symposium

Tuesday, June 14, 2022

The 2022 Robert B. Menschel Economics Symposium discusses the current state of inflation in the United States through the lens of behavioral economics, including how public perceptions might contribute to rising inflation rates. The full agenda is available here.

The Robert B. Menschel Economics Symposium, presented by the Maurice R. Greenberg Center for Geoeconomic Studies, generates critical thinking about the consequences of herd mentality behavior in global economics. This symposium was established in 2014 and was made possible through a generous endowment gift from Robert B. Menschel while a senior director at Goldman Sachs. Since Menschel’s death earlier this year, the symposium continues in his honor and memory.

Keynote Session: A Conversation With Meir Statman

Meir Statman will discuss how cognitive bias can exacerbate consumer concerns in an inflationary environment.

Richard Haass

HAASS: Welcome one and all to today’s Council on Foreign Relations symposium, named for Robert B. Menschel. This is our seventh annual Menschel Symposium. But, alas and sadly, it’s the first not to include Bob, who passed away two weeks ago. Many people in this community know him well—or most for his five decades at Goldman, but he was something of a renaissance man. He was a dedicated leader of many civic and cultural organizations, and a great photography collector. And his philanthropy ranged far and wide from medicine, to education, to criminal justice, but, obviously, also to the Council on Foreign Relations. And since joining this organization fifteen years ago, Bob contributed consistently and generously to our annual fund, and then his gift here to establish the symposium in his name was transformative because it really allowed us to expand what we do in this realm of geoeconomics.

Bob was not just generous, but he was informed and wise. His book, Markets, Mobs, and Mayhem: A Modern Look at the Madness of Crowds is unfortunately as relevant today as it was when he published it. And it really is an interesting read about the breakdown of—and breaks down the phenomenon of crowd psychology and it effects.

The symposium will continue here in his honor and in his memory, and it will continue to generate critical and creative thinking about the consequences of human behavior in economics. In recent years we have addressed all sorts of important issues through the lens of behavioral economics. Last year’s event on the pandemic included a keynote from Richard Thaler. We also had Cass Sunstein one year and Abhijit Banerjee in another.

This year I wish we were less timely, but, unfortunately, we’re going to focus on inflation—you may have heard of it—and how bias can actually make bad situations worse. So again, it would be harder to be more timely and relevant. The only really bad news is because of the subject, since I’ve begun speaking the market has fallen another twenty points, so there we are.

We’re in good hands. We have Meir Statman, the Glenn Klimak Professor of Finance at Santa Clara University to keynote us, and then he is going to be in a conversation with our neighbor, Gillian Tett, of the great, and wonderful, and essential Financial Times. So Gillian, Meir, over to you. (Pause.)

TETT: Well, good afternoon, and welcome to everyone who is both joining us in person in this room, but also online. And I do know that there are a lot of online watchers, and so I want to urge you, as we go through this discussion, if you are watching online, do feel free to ping your questions over. And if you are in the room, wave at me when the question time comes.

I’m Gillian Tett. I’m with the Financial Times. And I can tell you that from my position at the Financial Times, I would echo Richard’s point about this being an incredibly timely topic right now. It’s top of many Americans’ minds; it’s top of the White House mind. And that topic, of course, is inflation.

I should say it’s also top of the news cycle, and before I came here, I was actually on the Andrea Mitchell show at the very top of the hour talking about inflation and about the political headache it is now presenting to the president. And that’s no surprise because the raw numbers we’re getting out right now are pretty shocking. Whether it’s the five-, six-dollar-a-gallon gas prices we’re seeing at the pumps, which could go even higher; whether it’s the 1 percent increase in the consumer price index we saw last month—that’s a monthly figure; whether it’s that we’ve seen inflation hovering around 6, 7, 8 percent, depending on how you measure it, which is four times the Fed’s target; the raw numbers are frightening.

Bur what Professor Statman is going to be talking to us about today is a rather different—importantly different take on inflation that everyone needs to know about, and that goes beyond the numbers to look at the psychology and sociology, if you like, of inflation. It is an aspect which has often been ignored in the past because, of course, in the second part of the twentieth century, economics really was a game, mostly about numbers, and math, and models, and equations, and algorithms—often seeming more like a branch of physics.

But Professor Statman is one of those who has built much of his career challenging the conventional thinking in economics, even—or especially—when challenging it was very, very unfashionable. He is a behavioral economist—behavioral finance economist one might say—who has looked repeatedly at a topic which is very dear, of course, to the heart of the person who is sponsoring this whole symposium, Bob Menschel, which is a question of why markets go mad, why people go mad, how mobs can misunderstand or misreact to numbers, and why it matters so much, and why it creates mayhem.

So thank you for being with us today. You have an amazing perspective to offer on today’s problems with inflation because one other aspect that I forgot to mention but I actually want to start with is that it’s very hard right now to get many Americans to think that there is a world beyond American shores, and when it comes to inflation, people are thinking right now, well—they’re looking to American history about inflation as panic and terror about what’s happening here. But you have studied this internationally, haven’t you, and you looked for many years at what happened to inflation in Israel, which is very relevant.

Tell us a bit about your background research in respect to that, and then we’ll get on to talking about Biden’s problem later on.

STATMAN: Thank you, Gillian, and good afternoon to all of you. Well, as you can tell from my accent, I’m an Israeli by origin, so it is not so much that I studied inflation in Israel; it is that I’ve lived inflation in Israel. And so did my family.

And so inflation today in Israel is around 3 or 4 percent, which is the envy of all of us here. But it was not always like that. So in the early ’70s, inflation was around 15 percent and then it started to ramp up and got into three digits, and then by 1984, it exceeded 400 percent. Let me repeat that: 400 percent. The joke at that time was that it is cheaper to take a taxi from Jerusalem to Tel Aviv than a bus because when you board the bus you pay then, whereas in a taxi you pay only when you leave it, and you leave it an hour later when the currency had depreciated.

But of course inflation was no joke in Israel, and people really resorted to very wasteful ways to combat it. One was—even though salaries were generally linked to the price index, people, as soon as they got their pay, they would go out and buy whatever canned goods they had, meats that can be refrigerated, and so on. But one of the—eventually somebody had to tap the brakes—or slam them. By then the banks in Israel created what is really a Ponzi scheme to offer Israelis something that would hedge, that would protect them from inflation, and then it blew up, and they were all nationalized, and so on. So there were really quite substantial, painful effects, both to individual citizens and the financial system.

But one of the things that Israeli did to cope with inflation was to price pretty much anything of value in U.S. dollars, and so houses, surely, automobiles, but even cheaper things were priced in dollars and then paid at the exchange rate of the day. In the process, Israelis neglected the fact that there was inflation in the U.S. as well, and in the early ’80s or ’79, it reached double digits.

And so the general point here is that people need a yardstick to do their accounting. And they knew that the Israeli lira at that time was not a good yardstick, but they needed something simple like the U.S. dollars. And they treated it as if there is no inflation there—as if it is like a yardstick that is always three feet, never moving to four feet or two feet.

And so there is something that we call money illusion, that generally we ignore inflation; that is, we do our accounting in the form of, say, did you get a raise, or what happened to stocks in nominal dollars rather than in real dollars that are adjusted for inflation. And that works really well when inflation is low—2, 3, or 4 percent.

If you think about it, why is it that we do it in nominal dollars rather than in real dollars? Well, the answer is that it is simpler. It requires what we call System 1 rather than pausing and asking. And if you think about, say, the pricing of $2.99, well, it doesn’t take a lot of brain power to realize that $2.99 is three (dollars), and once you add the sales tax, it is more than three (dollars). And yet the fact that retailers continue to price in $2.99 style tells you that they know quite well human nature, and they know that people are going to look at the two and stop there, and not do that anymore.

But when—and so you can see—you can ask yourself, why is it that the Fed is aiming at 2 percent inflation? Why not at zero percent inflation? And the answer really is that 2 percent kind of can cover sort of things. So when I get a raise from one hundred thousand (dollars) to one hundred and two (thousand dollars), I’ve got a 2 percent increase. Inflation is, say, three percent, so in real terms I’ve actually lost 1 percent, but that does not fully register.

TETT: Right.

STATMAN: And so we have to—we have to see what happens. Once inflation gets to be at 8 percent suddenly from being invisible, it becomes the center of attention.

TETT: So—I mean, this is fascinating and very important. I must say looking at Israeli history certainly puts President Biden’s problems with inflation into context right now. If you think it’s bad; it could be much, much worse.

But you’ve identified four specific emotions or things that happen in our brain in relation to inflation that create the biases that shape how economies react, don’t you? I’m just looking at the list: fear, availability, confirmation, and representation. Do you want to just tell us quickly how those four key words impact—or should impact—the inflation debate?

STATMAN: So let me begin with cognitive shortcuts and errors that System 1—that quick thinking serves us extremely well in most circumstances.

TETT: And that’s the system where—that Danny Kahneman—


TETT: —and Tversky made so famous with thinking fast, thinking slow—

STATMAN: That is right.

TETT: —for anyone is not up on their Israeli psychology professors, so yes.

STATMAN: Yeah, it is—it is our intuition, and sometimes, of course, that intuition is misleading, and then we have to engage that System 2 of systematic, scientific-based thinking.

So if you look at a cognitive shortcut like availability, if we are asked to judge the likelihood of something—the likelihood that a plane—God forbid—will fall from the sky, we call on what is available to our memories. And so you wouldn’t be surprised that, after one of those terrible accidents, the likelihood in people’s minds goes higher.

So what happens with inflation? Think about what happens with gas prices. You drive by gas stations all the time. They have, in giant numbers, gas prices, and so they are very available to our minds. And so we tend to rely on these and exaggerate the overall inflation, thinking that everything has gone up by 30, or 40, or 50 percent. So that is one of the problems with availability.

Now of course reading it in the paper makes it also available. It is not in page seventy-two; it is right there at the very top. And so, again, it makes it available to our minds. And of course there are people who are very eager to make it more available; they are called politicians. So that is—that is one. And so what we tend to do is look at those prices we kind of know, that we purchase frequently, and judge from them. And we tend to bias it upward; that is, we are more likely to see those that have gone up than those that stayed the same or went down. So, you know, I know that my favorite yogurt at Trader Joe went from $1.99 to $2.49, and now $2.99. And so it seems like a 50 percent increase in a very short period. But of course, not everything has gone up at that level. So that is one of the things that we have to remember and kind of pull back, and not become overly scared.

TETT: So in practical terms, what does this mean for the White House right now? I mean, should they be changing their messaging on inflation? Should they be trying to persuade voters to look at it differently? Should we all be changing our mindsets?

STATMAN: Well—(laughs)—if only it were so simple. You know, there are some things that are easier to explain than others, and there are some things that touch us more than others—that is, if you lose your job, that’s comedy, but if I have to pay a dollar more for gas, that’s tragedy. And so inflation touches all of us, and so people just resonate to it. And again, because we lose that sense of benchmark that I can rely on a dollar to represent real money, that really makes us very uneasy, very nervous. And so you can try to explain it, but it’s kind of like trying to explain with the language of standard finance. You know, you can perhaps have it in a journal, but it just does not go in the world of public policy, politics, and so on. That is too bad that our intuition is such that appealing to it is easier than to explain it in a way that economists might.

TETT: What about investors? I mean, what does this mean for investors when they look at inflation numbers and see what’s happening in terms of the markets right now? Should they be trying to take a more nuanced approach towards inflation, or looking at the current crowd psychology as well?

STATMAN: Well, inflation is of course very scary in terms of the investment scene; that is, I don’t know your portfolio, but I know mine, and I imagine that yours is not that different. And if you had an appreciation in your portfolio in the last few months, you should speak with me afterwards and tell me how you did it because mine has gone down, probably in the same way that yours has gone down.

And so what do I do? I do nothing, you know; that is, I know that if I am too scared, I will sell my stocks, for example. In all likelihood, I will later on regret it because I will still not know when to get back in. And so one of the—one of the elements, again, from cognitive psychology and behavioral finance has to do with representativeness. And so we look at the recent bout of inflation and the decline in the stock market as being representative of all periods. But of course it is not, and so one way that you can counter it is instead of looking at what happened to stocks in the last few months, if you look at it in spans of three years, or five years, or ten years, and then it is less frightening.

But, you know, so if you look at it over the long run—long run meaning five, ten, or twenty years—both stocks and bonds provided pretty good hedges against inflation—hedges in the sense that overall you had a good amount of real return beyond what is taken away by inflation. And so people will now invent or just point out how about commodities, how about tips, and so on. Perhaps, but they—once you get into insurance—as you know, insurance costs more than its actuarial value. So we insure our houses, we insure our cars, but we don’t insure our toasters, I hope, and the washing machine because we know that that doesn’t make sense. You just have to wait and, in time, that washing machine is going to go bad and you are going to replace it.

I think that having this presence of mind to say that you—that, too, shall pass is a very good piece of advice today.

TETT: Right. Well, your next book is actually about wellness in every sense, and that sounds like part of the message about trying to accept what you can’t control.

But one of the other emotions that investors often suffer from that you’ve also written a lot about is the regret problem—regret phenomena. Have you ever had any regrets?

STATMAN: (Laughs.) Yes, yes, yes. Yeah, we have all—we all have regret. Regret really is the—is the most frequent emotion people feel, and it is really very useful. Now regret is a twin with hindsight; that is, we tend to—hindsight is 20/20, as we say. We tend to believe that we have known all along what actually happened, and that gives us confidence to think that we know what the future is going to bring.

Now in some cases, there is a one-to-one relationship between action and outcome, and that is a place where regret does not—does not matter as much, or rather—you know, if you—if you turn your wheel to the right, and the car turns to the right, you know, that is exactly as expected. You are going to be entirely shocked if it turns—if your car turns to the left.

But in stocks and in most of life, there is an element of chance, of luck that goes between action and outcome so you can—you can be wise in terms of investing, say, for the long run and so on, but then comes what we have had in the last several months, and we feel that we are idiots because surely it was clear in January what is going to happen. Well, it was not—it was not clear to me, and so that emotion of regret comes next. And regret—generally emotions are—God or evolution planted them in us for good reason. It is not to spite us; it is to help us to combine with our cognition. And so when we hurt a friend and he is no longer a friend, well, we’ve learned something. We regret it, and we move on.

The same applies here. Do I feel regret? Sure. But I must say that I am able now to employ the System 2 and kind of chuckle at myself, and say, hey Meir, you’re not a genius. You didn’t see it all along. Stuff happens; get over it.

TETT: (Laughs.) Well, that’s sounds again like very good life wisdom.

One other quick question before we turn to the audience—and do start getting your questions ready now, both in the room and online. We’d love to hear from both of you.

But one of the other questions I have is in terms of, you know, the regret point, you know, do you think that Jay Powell and Co. should feel regret now? And what should they do with that emotion? How should they be behaving tomorrow? How should they—you know, how much—how high do you think rates are going to have to go? How high is inflation going to go do you think?

STATMAN: Well, I know that Powell knows that his foresight was not as good as his hindsight because he said that; that is, he said that the Fed made reasonable choices; that is, they thought that what is going to happen is what happened after 2008/2009; that we are going to have high unemployment, low demand for goods and services, and so on. Well, it didn’t turn out to be that way. He did not mention regret specifically, but I can imagine that he feels that. And of course regret is magnified by the reaction of the public; that is, he surely is not getting many looks of admiration now for taking action that now come and people say that it’s kind of late.

TETT: So do you think that inflation is going to go a lot higher?

STATMAN: (Laughs.) Well, I’m a behavioral economist so I don’t make predictions about the future.

I think that inflation might go up, but I don’t think that it’s going to go up by much. And let me just say this: there seems to be something kind of odd if you put side by side the fact that inflation occurs, to a large extent, because people have a ton of money, and they are spending, and they are not deterred by higher prices. So this means that their well-being is actually increasing.

On the other side, of course, there is inflation that is caused by that same spending, so in economic terms, people are doing quite well, other than the poor. And the poor, their problem is poverty. Their problem is not inflation.

And so what will happen is the demand is likely to go down. The problems with supply chains are going to be ironed out, and if need be there is going to be something like a Volcker where there’s going to be a hard stop with sad outcomes such as a deep recession. But people cannot live with inflation. Inflation is such a pain. The politicians know that, and politicians are going to stop it however painful it is.

TETT: So if we’re all given emotion for a period—for a purpose, I mean—the fact that the White House is panicking is quite useful right now.

STATMAN: It makes a—yeah, I would not want to be—well, I wouldn’t want to be in Biden’s shoes any day, but surely not now. It is—it is very hard, and as we said before, trying to explain it to the general public—as they say in politics, if you have to explain it, you have lost already.

And so, you know, if you’ll have to live with it, I hope that people will come to their senses. I hope that inflation declines in time for the election, and if not, well, you know, this is still a democracy, they say.

TETT: Absolutely. Right, we have a lot of questions already. You’ve certainly touched a lot of raw nerves here.

But, OK, let’s start with you because you put your hand up first, and then go back to the lady in green, and then the man over there, and then Nili.

Q: Michelle Caruso-Cabrera. I’m a longtime journalist.

Using your excellent hindsight—(laughs)—Jay Powell said recently that he thought financial conditions had tightened simply because they were warning that they were going to be raising interest rates, and so the market started to do their work on their behalf. Is that an example of behavioral economics? And using your hindsight, should they have done more of it? What could they have done—now, in hindsight—that would have prevented the sharp rise that we’ve seen?

STATMAN: Well, in hindsight, and Powell will tell you—you know, I’m just—I’m just citing him—he says: We should have tightened much earlier. But they didn’t. And what he says, or what I hear, is to err is human. You know, I did—we did the very best we could. But it is not the case that at the Fed they do not—they are the most stupid, ignorant people to create, implement policies. These are very smart, knowledgeable people. And yet, they have not seen it in time. And I think that they deserve a break, you know? (Laughs.) We all deserve a break.

TETT: I’d say, I’d ask one question to follow up there myself, because, you know, when people say to me you should have acted earlier, you know, my reaction tends to be, well, duh. Because, you know, one of the issues about the Fed staff is that they are extremely bright and brilliant. They have amazing models. They don’t actually get out that much—(laughter)—in terms of getting out to—you know, anyone who went to a warehouse or anyone who went to the ground six, twelve months ago would have seen the supply chain problems which were driving this. Do you think that’s a problem about the type of people or economists who are essentially driving Fed policy?

STATMAN: No, I don’t think that Powell never goes to a supermarket and has never seen a scanner. I think that they know human nature. I think that they know more than the statistics of unemployment and so on. I think that we take those red flags and we assemble them. And of course, some of those fed flags are actually not red. And we try to make sense of them based on what we have. And so I judge their decision as being reasonable at the time, at least understandable at the time. And I think that they’re changing course fast as new flags are coming in. But I’m less—I’m less down on Powell than you are.

TETT: Well, yeah. I’m a journalist. I’m paid to be cynical.

We’ve got a question right in the back, the lady in green. And then we’ll take a few questions online. And then we’ll come back to these two questions in the room.

Q: Hi. Vanessa Neumann. Hey, Gillian.

This is perhaps drawing more on your Israeli inflationary experience or, you know, experience, not just study. I wanted to hear your comment, both economically and behaviorally, on the impact when you have a government—a country that’s hyperinflationary and it bifurcates. And you have, you know, the reality of the hyperinflation and then hard currency, like the U.S. dollar. Case in point, I’m from Venezuela, is I can get a haircut for two dollars, but two dollars is actually a lot of money in Venezuela. So what happens? What happens to the country, to the people, to economic growth? Any of those? Thank you.

STATMAN: And so very high—in fact, 2 percent inflation is just high. It is really like soothing cream, where you can pretend that you got a raise even though you did not. But when inflation gets to be high, as in Israel at the time and Venezuela, people just abandon their calculations in the local currency, and they latch onto some currency—many times the dollar—that they think of as being relatively fixed in value. But what happens is that people cannot just switch to do everything in dollars. They don’t earn their money in dollars. And so it is really very hard, both economically and psychologically. I mention what Israelis did at the time, you know, in ways that were really very, very wasteful, adding anxiety and fear. And so it is not for nothing that politicians are sensitive to this issue of inflation. I think that they are sensitive to it because people are sensitive to it. And eventually, if you have a democracy, the government is going to be changed. And if you have a dictatorship, well—(laughs)—that is a different story.

TETT: Right. Well, we got some questions online—quite a few questions online actually. So.

OPERATOR: We will take our first question from Tara Hariharan.

Q: Thank you so much. My name is Tara Hariharan. I work for NWI, a hedge fund based in New York.

I’m very interested to hear whether behaviorally there is any effect on how the—both the consumer and the investor views inflation if they have not been used to inflation before. For instance, one of the things that we are observing in the financial markets is that many of the market participants were even sometimes born after the 1970s, and therefore are not used to inflation being as high as it is, given that we’ve had a low interest rate and low inflation environment for some time now. Is that one of the reasons why maybe there is an overreaction to U.S. inflation being at current rates?

TETT: Should we be hiring lots of people who are in their sixties?

STATMAN: Yeah, I think that we—one of the few advantages of old people is that they have gone through inflation and other experiences before and they can draw on them and perhaps calm their nerves somewhat. I think that people, like many experiences in life, even like puberty, people just have to go through it to fully comprehend it. And I think that perhaps they should speak with their parents or grandparents and hear stories about how inflation occurred, how people coped, what worked and what did not work. I surely would not sentence anyone to go to Venezuela or Zimbabwe, you know, where they—I think that they switched entirely to doing their things in U.S. dollars. It is really very scary.

And so it is more scary to people who are younger and have not experienced it and, of course, people who live on the edge. That is, I have to pay now $80 for a tank of gas instead of $50. Well, you know, I resent it, but it really does not affect my lifestyle. I imagine that it does not affect yours. But there are people whose problem is really poverty rather than inflation. And inflation is just one more thing that makes life miserable.

TETT: We have a question—another question online, then we’re going to go into the room.

OPERATOR: Our next question will be from Seema Mody.

Q: Good afternoon. Seema Mody, here. Global markets reporter at CNBC Business News.

When we look at the global implications of a faster than expected interest rate hike, do we enter a period of currency wars? We’ve already seen countries like Japan come under great pressure. Is this just the start? And your thoughts on how this could play out.

STATMAN: Well, of course, it affects interest rates in the United States. And if it affects them in the United States, it spills over to Japan, and Germany, and other places. Now, it seems, just judging from day-to-day changes in the prices of bonds, that people are continuously surprised by how high inflation is, because it is not like it went down and then leveled off. It seems to be going down every day. I don’t really have much insight into how it is going to spillover to other economies, like Japan. But I imagine that they suffer the same—the same malady, and their people are nervous in the same way, because what happens surely in a place like the United States spills over and affects people in many other countries.

TETT: Right. We have a question from the back there, and then front, and then we’ll go to two more, and then we’ll come to you, sir.

Q: Fred Hochberg. Hello, Gillian.

TETT: Oh, hi. Sorry, I haven’t got my glasses on. I lost them. (Laughter.) If I’m peering at your all, that’s why. Apologies.

Q: A question. And I’m going back to even when we went to business school, which was in the last century. I always thought of Americans being more recession averse after having lived through the Depression. Europe, and particularly Germany, being more inflation averse based on their history. But maybe that’s flipped. I wonder whether—or, whether just people are generally unhappy. So whether it’s inflation or recession, it becomes a reason for a disgruntled populace, or?

STATMAN: Yes. Yes. I think that people are disgruntled for both reasons. Yeah, it is true that Germans are—still remember—I suppose not a living memory—the hyperinflation that they had in the late ’20s, early ’30s. And of course, we care about recessions, and they scare us. But it seems like people flip. I don’t want to call Americans ungrateful. I’m an American myself. But it seems like American voters expect perfection. And they expect the government always to listen to them. Even though, of course—(laughs)—there’s more than one opinion. So what can I do? Every day I wake up and I say, God, thank you for not making me a politician. I get to write my papers in hindsight without having to worry about whether 50 percent plus one like me or not.

TETT: I must say, having, I think, the folk memory of hyperinflation in Germany weighed heavily on the Bundesbank. And having worked in Japan for years myself, I can say that certainly the folk memories of the turmoil of the 1930s weigh heavily on the policymakers. I remember walking around the Bank of Japan late at night and seeing portraits of all the former governors, and they pointed out to me that two of them had been assassinated.


TETT: —because there had been a fury over hyperinflation and things. And once you’ve had that baked into you as a folk memory at the central bank, you kind of don’t forget it.

STATMAN: Yes. Yes. And Germans to this very day are very reluctant to buy stocks. So even though they have not experienced it themselves, it is really part of the national history and national culture, like some other things in Germany.

TETT: Yeah. We have a question here in the front, then we’ll go to two more online. I think Nili—actually, Nili over here, and then two more online, and then we’ll come to you.

Q: Thank you so much for this rich and timely discussion. I’m Nili Gilbert, the vice chairwoman of Carbon Direct.

When we think about inflation becoming untethered, it’s often off the back of inflation expectations beyond the forces of things like supply chain crises and issues in the real economy. And so I wonder how you think that policymakers could communicate today to try to avoid the forces of inflation expectations pushing this problem further out. It’s more than just monetary policy strategy. It’s communication strategy and managing behavioral expectations and actions. Thank you.

STATMAN: Thank you. Yeah, indeed, there is a tendency, because of representativeness, the tendency to extrapolate. And so we tend to extrapolate from recent events, and most importantly, from vivid events. And God knows that inflation is vivid. So when you have a view, then there is what you talk about when you talk about confirmation. Confirmation, shortcuts, and errors. When we think as normal good-thinking people, system one, we—when we have a hypothesis, say that, whatever, that Trump is going to run again, we look for information that confirms our beliefs rather than information that contradicts it. And so when people have the sense that inflation is here to stay, then look at the price that has gone up and say, see, I told you so. That’s confirming evidence.

Now, the problem is that people do not naturally switch to becoming scientists who say, wait a minute, let’s also look at this confirming evidence. And what makes it worse is that we are guilty of is something that we know is motivated reasoning. That is when somebody has an interest in just pointing out one part of it, that is if you are the defense, if you are the plaintiff, each of them is looking for evidence confirming their beliefs. Judges are supposed to be the ones who are going to weigh confirming evidence and disconfirming evidence. Now, you know, think of what politicians are doing.

That is a, if I might say so, Republicans are just, yeah, they are upset about inflation, but they are really happy that that might well be the downfall of Biden. And so Kevin McCarthy said that instead of having hearings about January 6th, they should have hearings about inflation, you know? So it is not just the nature of people who don’t know, and you are going to sit them down, and you are going to explain things. There are people who have in their interest to distort things and to hide particular pieces of information. And, you know, I’m neutral here on politics. I don’t want the implications here. Yeah, that is, don’t go after me and check my voting behavior.

TETT: (Laughs.) Right. We have a question online.

OPERATOR: Our next question is from Mahesh Kotecha.

Q: Thank you very much. Thank you very much. Gillian, nice to see you. Professor Statman, brilliant discussion.

I’d like to ask you to reflect on the more than two-year pandemic and ask this question: How does the pandemic experience change the way we will perceive inflation and the way we will perceive, if you will, politics related to inflation? Has that changed us? Or do you think that our behavior remains essentially human behavior? Does the pandemic change the—telescope our—does it alter our vision?

STATMAN: Well, human behavior is generally constant. Generally, not changing very easily. Even when we had a pandemic, of course, we lived through it. We are anxious. We tried to cope. And we don’t just forget it. But I don’t think that it changes it by a whole lot. What is happening is that when you have—so, they say that the Fed was fighting the last war when unemployment and recession were the thing, and you have to stimulate spending. What might well happen now is that when the next crisis comes, the Fed is going to take the playbook of what happened now and they’re going to, say, begin raising interest too soon, rather than too late, when the economy is going to go into a recession.

And when I think about it, and perhaps when you think about it, 8 percent inflation is very unpleasant. But in real terms, in terms of misery, high unemployment is much a greater pain. And so if people who are politicians—in other words, if people did not have to appeal to people’s intuition, they would say, we can live with a bit of inflation. We can wait for the supply chain to straighten itself out and for the money that people saved to be spent, and so on, and leave it alone. But you just cannot do that in a—in a country that is not ruled by dictator. You really have to ask yourself how will people vote in the next election? And it has to do with how they feel now.

TETT: Right. I think, sadly, the message of “just take a chill pill” doesn’t really work. (Laughter.)


TETT: We have a question there.

Q: Thank you. Niso Abuaf, Pace University.

You kind of alluded the answer to my question, but you haven’t addressed head on. What are the political and psychological costs of inflation versus an engineered recession?

STATMAN: Well, you know, the political costs of inflation are obvious now. That is, when objectively speaking inflation is not the number-one problem of the United States, the possible disruption of democracy might well be more important than that. But it is on people’s mind psychologically. And it’s very hard to take away. And so explaining to people that the alternative would have been not giving people—say, poor people their stimulus money, having them evicted from their houses, apartments, and so on, you know, that is kind of like a chill pill.

That is, you can explain that—I’m an economist. But if I were speaking like this stereotypical economist who are let me give you the facts, I know enough about real life and behavior. I see things and I know that Biden is in a pickle. You know, and that we might well find ourselves in a—in a recession that is caused by clamping down too hard and too soon on inflation and getting a disease better than the one we have.

TETT: Do you know of any—oh, sorry, got a question back there. And I think this will, sadly, have to be the last question.

Q: Ash Williams, JPMorgan.

My question would be this, Professor. Clearly this on the psychology, the perception consumers have about inflation. We talked a little bit about the steps policymakers can take other than monetary policy to change a phenomenon, inflation, that traces its roots to many things, including armed conflict, fiscal policy, monetary policy, et cetera. So accepting that there can be distortions for political reasons on one side or the other, or both, what are the things that could be done that would be the equivalent on the defeating perceptions of inflation side that gas prices are on the inflaming perceptions of inflation side?

TETT: So if you had a magic wand and you were Powell or Biden, what would you do?

STATMAN: Well, you know—

TETT: In about one minute.

STATMAN: One thing that can be done is what we had with Social Security. It is not perfect, but it is explicitly linked to inflation. And so with delay, people get compensated for those price increases. So in Israel, for example, as I mentioned, salaries were routinely adjusted for—linked explicitly—to inflation. So if we—if we got into this habit of having contracts that are explicitly linked to inflation—it will not solve everything because of delays and so on—but it will calm down some of those—some of those fears. That is a reasonable thing. Explaining to people that gas prices are high because Ukraine is being hammered, that’s more difficult.

TETT: Right. Well, thank you very much, indeed, for that very thought-provoking presentation and discussion which, as I said, is very, very timely and, frankly, very badly needed, given the kind of shock that’s being felt across the economy, and the political repercussions. I think it’s particularly timely that, as I said earlier, the fact that we’re doing this part of a seminar funded in the legacy of Bob Menschel, given his role in weaving together his own experience of finance and behavior on markets, with some of the theory. So thank you.

And thank you to the audience for—oh, sorry—thank you to the members. I always get that bit wrong. Thank you to the members of CFR for all your great questions, both those and online. Apologies to those of you I didn’t recognize because I haven’t got my glasses. But in the meantime, it remains for me to say very best of luck to all of you in figuring out what this means in your everyday lives and in your portfolios.

And I’ll just also say, two other housekeeping points. Firstly, the video of today’s meeting will be posted on the CFR website. And for those of you joining in person in New York, there’s now a brief coffee break. And the second session of this symposium, addressing inflation expectations, begins at 2:15 both here and in New York—and on Zoom. So thank you all very much, indeed. (Applause.)

STATMAN: Thank you.


Session II: Addressing Inflation Expectations

Panelists will discuss whether public perceptions of inflation have been compounded from the pandemic compared to other inflationary periods, if central bank mechanisms adequately captured consumer perceptions, and how governments and policymakers communicate to moderate inflation expectations.

CARUSO-CABRERA: Hi, everyone. Good to see you all. It’s a pleasure. I’m Michelle Caruso-Cabrera and welcome to today’s Council on Foreign Relations Robert B. Menschel Economics Symposium session on “Addressing Inflation Expectations.”

The audience today consists of Council members across the country, who are joining us online as well as here in person in New York, which is a pleasure to see.

As I mentioned, I’m Michelle Caruso-Cabrera. I’m chief executive officer of MCC Productions. I’ll be presiding over today’s presentation.

And I am joined—you can see the screen behind us here—by Carola Binder. She’s associate professor of economics at Haverford College. Willem Buiter, sitting here with me on stage, adjunct senior fellow at CFR, and Michael Weber is associate professor of finance at the Chicago Booth School of Business.

I’ll ask questions for about a half an hour, and then we’ll take questions from both the live and virtual audience.

What I really want at the end of this is I hope we have examples of—this is a symposium on behavioral economics. What could have been done, what should be done right now, applied from behavioral economics to help us deal with inflation and inflation expectations.

Before we get to that core question of why we’re here today, I want to set the stage. And I’m going to ask each of our panelists, have the world’s central banks lost control of inflation and inflation expectations? Round robin. Willem?

BUITER: The brief answer is yes. I’m talking about the advanced economy central banks here. In most of the emerging markets and developing countries, of course, they never lost inflation—China, being an exception.

I don’t blame, you know, the Fed, the ECB, the Bank of England for not anticipating the inflationary surge. Nobody anticipated the COVID pandemic. Nobody anticipated the scope and magnitude of fiscal stimulus in response to it. Nobody predicted the supply chain disruptions—the further aggravation of all these adverse supply shocks through the Ukraine War.

So not getting it right at first completely understandable, but then a year-plus, getting onto a year and a half now, of procrastination. Here is the Fed, you know, with inflation headline 8.6 percent. Even on the most moderate metric, core PCE deflator, 5.2 percent inflation.

The policy rate should be well above the neutral level, estimated now to be about 2.5 percent. In my view, policy rates should be at a 5 percent level. The only question is, how to fast to get there?

And we are completely behind the curve. If we were any further behind the curve and we were on an athletic track, they would be overtaking themselves, right. They must raise rates and do it aggressively, a hundred basis points, at least, tomorrow.

Thank you.

CARUSO-CABRERA: There are very few predictions that are going to be a hundred tomorrow. I think the question is fifty to seventy-five. (Laughs.)

BUITER: Not a prediction. Not a prediction.

CARUSO-CABRERA: It’s a recommendation.

BUITER: A recommendation. I predict fifty or seventy-five.

CARUSO-CABRERA: Carola, I see you nodding your head up and down, so I see you’re in agreement.


CARUSO-CABRERA: I’m going to change the question slightly to, not only is the Fed and the world central banks behind the curve, but how far behind the curve are they?

BINDER: They’re at least several months behind as far as when they should have been beginning the tightening process. Inflation is not just above the Fed’s target, it’s well above the Fed’s target. It’s about 8.6 percent in the United States compared to—compared to an inflation target of 2 percent.

So I don’t know how you want to measure the curve, but they’re about six-point—six percentage points above it. So yeah. I like the track analogy.

CARUSO-CABRERA: Do you agree with Willem they should do a hundred tomorrow?

BINDER: It’s—they should have been raising earlier. Doing a hundred at once makes things painful, but yeah, I think at least seventy-five tomorrow.

CARUSO-CABRERA: Michael, what do you think?

WEBER: Well, I’m pretty much in full agreement with Willem and Carola. And so I want to add a little bit of kind of, you know, additional point to the discussions. Like, you know, the Fed kept on saying, for example, last summer in June, like, you know, the initial price spikes recede and now a category is like, you know, we shouldn’t borrow. Inflation is not broad-based.

And I think like, you know, what the Fed kept ignoring, is you know, price changes happen in narrow categories that are very salient and noticeable to consumers, they immediately update upwards their inflation expectations. And that(’s) what we saw in April of 2020. We saw it again in June of 2021. Average consumer inflation expectations went up by two percentage points last summer, even though the Fed said it’s transitory.

So, clearly, the Fed’s messaging didn’t reach ordinary consumers that typically tend to focus what happens in their daily lives around them. And so, therefore, like, you know, I think we’ll discuss it later in a little bit, but you saw that workers, you know, went out, bargained for higher wages. If they couldn’t get those, they actually kind of change jobs—(inaudible)—in getting higher wages.

Those are an additional component because of high inflation expectations that were initially underestimated or not actually taken into account by the Federal Reserve. We saw then, you know, additional wage pressure that ultimately fed into realized inflation, like—at least starting in September of last year.

CARUSO-CABRERA: I have an undergraduate degree in economics, but that does not make me an economist. One of the core things I remember, you know, from Macro 101 is that inflation expectations—when the Fed is very concerned—when they start to get concerned, it’s when they start to see demand for higher wages because of higher inflation expectations, and we are seeing that all over the world—whether it’s trucker strikes in parts of Southeast Asia, what we’re seeing here in terms of demands for higher wages.

The need to pay higher wages, is that the transmission mechanism that is really appropriate to be thinking about right now when it comes to thinking about inflation expectations?


BUITER: Well, it’s actually surprising to me that wages have not gone up more in most of the advanced economies, including the U.S. Real wages, certainly if you take the CPI metric, have gone down over the past year, and even in the first quarter of this year, they have gone down.

So I don’t think that workers or those negotiating wage deals have fully anticipated the inflation that we’re seeing. I think the one bit of moderately good news is I think an inducement to the Fed and other monetary authorities to act promptly now is that long-term inflation expectations are not yet badly unanchored.

If you look at the market base expectations, five years forward, it’s 2.37 percent for the U.S. If you look at University of Michigan five-year expectations, 3.3 percent. It’s not great, but it’s better. Sorry, yes, indeed. And the one year, of course, inflation expectations are on the 5-plus or 6 percent range, but this is a reason for moving now. Because if it gets embedded in the longer-term inflation expectations, it will take a longer and more protracted slowdown of economic activity, a deeper recession, to get rid of it again.

So do it now.

CARUSO-CABRERA: Carola, what role did the pandemic play in inflation and also inflation expectations?

BINDER: So at the start of the pandemic, it was really hard to predict what it would do to inflation, right, because it was a combination of demand and supply shock. So, of course, demand was so limited because people were not leaving their homes, you know, not going out and spending money like they normally would.

People were worried about their jobs. People were worried about getting sick. It was also just a major adverse supply shock because we couldn’t be producing the things we normally produce and supply chains were disrupted.

So those can have, right, the opposite effects. The reduced demand would reduce inflation. The reduced supply would increase inflation.

So the interesting thing is, like, what did people expect would happen to inflation at the beginning? Well, that differed between consumers and between professional forecasters and the markets.

So consumers tend to just associate bad news and bad times with higher inflation. They have kind of a supply shock view of the world. So at the beginning of the pandemic, consumer inflation expectations rose while professional forecasters fell, and we did actually have inflation decreasing at the start of the pandemic. It wasn’t until later on that the—it wasn’t until later on that we went from the pandemic being more of a disinflationary shock to more of an inflationary shock.

CARUSO-CABRERA: Michael, do you want to add to that?

WEBER: Yeah. I actually want to come back to one of the points Willem was raising. And actually, in fact, I’m personally a bit more concerned than his point of view because, like, if we look at the Michigan survey and the New York Fed Survey of Consumer Expectations, you have to actually read the fine print. Because if you look at the survey from the Michigan survey, the questionnaire, if I ask you what do you think is inflation over the next twelve months or over twelve months and three years, and you would tell me answer that is larger than 5 percent, I, as questioner, would ask you: You just said 6 percent; are you really sure? So there’s an inherent downward bias in measuring inflation expectations in the Michigan survey based on, like, the survey design.

Now, if you actually look at the New York Fed webpage under Survey of Consumer Expectations, you also, again, have to be very careful in what they report. They do report the median probability implied mean. Now, what does it mean? It’s like the way inflation expectation measure is elicited, you have three specified bins for what potentially might happen to inflation and you as survey respondent have to assign probability (mass ?) to those bins. Now, the crucial point is that the highest bin is 12 percent or above, which, of course, is possibly fully sufficient in normal times. Well, now, certainly, there are many consumers that expect inflation or least non-seeable (mass ?) for bins potentially above.

That’s like, what I would suggest anyone to do at some point. Go to the New York Fed webpage, download the micro data for the question that is the point estimate—which number you expect—and just actually look at the average. So this average is typically about two to three percentage points above what you will see on the New York Fed webpage.

Now, what does it mean? At least if you look at average inflation expectations in the U.S., this idea that they ever were anchored, I think, actually, like something which you should throw out of the window. That’s certainly, I think, you know, in times of low inflation, people are rationally inattentive and they overestimate inflation. Now, however, what’s happening right now is that its upward bias in inflation expectations is even higher and an even more concerning sign of un-anchoring of inflation expectations.

So imagine a situation we all actually know what the Fed is doing, we have a high trust, so temporarily due to shocks we might expect shorter inflation expectations to go up. But you know, if we have well-anchored expectations, nothing should happen to our long-run expectations because we know the Fed is doing its job and realized inflation will come back.

However, you do see in the data that if households upped their short-run inflation expectations, their long-run inflation expectations follow suit in an almost one-to-one fashion. So it doesn’t appear that households think that the Federal Reserve is in control and they will do whatever it takes to actually keep long-run inflation at targets. Like, I think, actually, there’s lots of concern, at least through the lens of household and firm expectations, this idea of anchored expectations is very unlikely.

CARUSO-CABRERA: I just want to make sure I understood what you said. When you look at the Fed survey, if you drill down into the raw data, the upper third, did I understand, believe that long-term inflation is going to be running around 12 percent? Is that what I heard, generally, at the beginning?

WEBER: So, like, the point is like—so the issue is that you cannot actually—if we look at what they report on the webpage, you cannot assign probability (mass ?) to any outcome that is larger than 12 percent. But they have a complementary question where, rather than actually filling bins that are prespecified, you can just actually provide a point estimate. You know, they would ask: What do you think inflation is over the next twelve months? And there I could say 15 percent. Instead, in what they report on the webpage, I’m not able to do so. So that’s another one of those inherent survey design features we have to be aware of when discussing those numbers.

CARUSO-CABRERA: You were going to say?

BUITER: There’s one particularly set of forecasters who seem to really believe that things are really under control. Those are the professional forecasters in the eurozone.

When you look at their survey, right, the most recent one, OK for this year, 2022, they predict 6 percent—probably too low actually as well. But 2023, they predict 2.3 percent, and 2024 1.9 percent. They believe the central bank is still fully in control. It’s quite extraordinary.

I think U.S. consumers are far more sophisticated than the ECB professional forecasters. (Laugher.)

CARUSO-CABRERA: So why do behavior—why do inflation expectations matter so much even above—or is it above—the actual inflation number? Very simply.

BUITER: Because they drive future inflation, right? Future inflation is driven to a significant extent by what I anticipate inflation in the future to be because that’s how I will try and set my prices, my wage, my contracts.

And the more embedded they become, right, the more pain it takes to convince people to actually lower their wage claims, lower their contract prices, despite the anticipated future inflation because there is simply weak demand for their products. So this is the pain route to disinflation.

CARUSO-CABRERA: So this is a behavioral economic symposium. Carola, what can—what is there within the study of behavioral economics that could have, should have, would have been done, that would have helped us in this situation, besides the obvious of having hiked rates earlier? Is there something that the Fed could have done, that central banks could have done, that the federal government could have done, and what should they be doing now?

BINDER: Well, I think that a lot of the research on consumers’ inflation expectations can be probably summarized just by the finding that consumers are—they have limited attention, right. They don’t pay that much attention to monetary policy, to central bank announcements, and that’s a good thing usually, right. That’s their revealed preference. They don’t like to spend their limited time and their limited attention paying attention to the Fed, listening to the Fed, worrying about what inflation’s going to be, wondering if the inflation target is credible.

So they like to be able to ignore it, and times are pretty good when they can ignore inflation and can ignore the Fed. When prices start to rise so quickly that it’s impossible to ignore it, that everyone notices inflation, all they know is that this is a really bad sign, right. They don’t know—is this demand shock, is this supply shock, is this the Fed’s fault, is it the president’s fault, is it profiteering? They don’t know, but they know it’s painful. It’s a bad signal about the state of the economy and about how policy has been. They look for someone to blame. It increases their uncertainty and reduces their consumer sentiment.

So yeah, I mean, what could the Fed have done using behavioral economics? I’m not really sure if I really agree with the premise of the question. I mean, I think that the Fed shouldn’t really be trying to use behavioral economics to, like, fine tune consumers’ expectations, to try to control consumers expectations. I think they get their credibility by their actions, by stabilizing inflation. That’s really the only way to stabilize inflation expectations.

And so that’s—if you—I don’t know exactly even how you define behavioral economics, but that’s the lesson that I would say from behavioral economics is, like, really actions speak a lot louder than words when it comes to central banks and their credibility with consumers.

CARUSO-CABRERA: Michael, I see you motioning, but one second.

Willem, go ahead, and then, we’ll go to Michael.

BUITER: I think that the Fed’s behavior and the ECB’s behavior is an example of one aspect of behavioral economics, in practice—a confirmation bias, right. The temporary and transitory story, you know, clearly turned out to be wrong, and things are now persistent and protracted instead. Now the evidence for that kept piling up, but yet a confirmation bias—you dismiss evidence, or you attach less weight to it, if it’s contrary to your maintained hypothesis.

And I think all central banks in the advanced economy have suffered from that in this particular inflation spiral.

CARUSO-CABRERA: So they haven’t used behavioral economics to do anything. They’ve actually been the behavioral economists—(laughs)—in and of themselves.

Michael, go ahead.

WEBER: Yeah. So maybe actually to follow up a little bit of what Willem just said, so like, you know, to the extent central banks should have used behavioral economics, they actually should have been aware just simply—or cognizant—how, actually, ordinary Americans, you know, form their expectations. Contrary to what—(inaudible)—would do or what the Bureau of Labor Statistics is doing—you know, looking at expenditure share, how much do I pay or spend on certain categories, and then weigh price changes over certain horizon by by expenditure shares—households actually have very simple heuristics. They look at price changes of very peculiar goods, things they purchase frequently. What happened to the price of milk? What happened to the price of gas? And then, actually, they focus on those peculiar price changes as signals for overall inflation. And then they actually kind of think that, you know, if price of milk went up now by 15 percent, that means inflation is 15 percent.

Now, the second aspect that is crucial to take into account—and there I also think that, you know, actions by itself might not be sufficient—you tend to see that households put actually higher weight on price increases relative to equal-sized price cuts. That’s why on average we see always an upward bias in households’ inflation expectations.

So what does it mean now for the current situation? Even if magically or miraculously the Fed was able to get realized inflation in check, households’ inflation expectations wouldn’t come down immediately. So, like, it would have—would be like a quite substantial period of disinflation so that also inflation expectations come back down again. So therefore, like, I think, you know, this adds to us being behind the curve.

Now, what could central banks potentially do? So like, you know, there’s a very active line of research that shows, like, you know, it’s really careful. You have to be careful in how you try to communicate to ordinary households, different from communicating with markets. Like, the message matters—simple messages like, you know, simple numbers, easy, digestible; no Fed-speak or long statements. It also matters which medium you use in the times of declining readership of newspapers and, in fact, like most existing readers of newspapers, skipping the part on monetary policy and macroeconomics.

We have to find new ways of reaching the broader population—social media, Twitter, you know. The Central Bank of Jamaica has shown how you can actually reach the whole country. You start actually having a reggae song about price stability and inflation targeting, and immediately everyone paid attention. But also, like, the identity of the message—

CARUSO-CABRERA: Wait, did that really happen? Did that really happen?

WEBER: It really happened, yes.

CARUSO-CABRERA: The government put out a reggae song about inflation?

WEBER: They actually cooperated with a national reggae legend, and he was singing about price stability, yeah.


BINDER: That really happened, but I don’t think—

CARUSO-CABRERA: I don’t want to see Jay Powell doing any reggae. (Laughter.)


BINDER: I was going—I mean—

BUITER: (Off mic)—it’s all right. (Laughter.)

CARUSO-CABRERA: Carola, go ahead.

BINDER: I agree with part of that. I agree that certain prices are far more salient to consumers. I agree that it’s hard to reach them by, you know, normal media and by, you know, complicated language. But I sort of disagree about what the implications there are.

I think that’s just a more reason for the Fed to not worry as much about trying to finally manage consumers’ expectations. They don’t have a mandate for, you know, stabilizing the prices of particular goods. They don’t have any mandate for managing relative price changes. They have a price stability mandate that they have defined in terms of PCE inflation.

So if, you know, they’re achieving 2 percent PCE inflation, but gas prices or milk prices are rising more quickly than that, that’s fine. And if politicians want to deal with the implications of that, politicians can deal with that. The Fed should not.

If inflation expectations are high because gas prices are high, but inflation is near target, then that is totally fine, and I don’t think that the Fed needs to be trying to manage consumers’ expectations in a situation like that. I don’t even think, like, the Bank of Jamaica—sure it’s funny, we all talk about it. We, meaning we who study the Fed and monetary policy, but I can’t imagine that it really has had a big effect on, like, improving the Bank of Jamaica’s credibility or improving price stability in Jamaica, so. (Laughter.)

And even, like, should the Fed be on Twitter? I don’t see any signs that that has been effective at improving their credibility.

BUITER: Well, for communication, I do agree that they should just focus on the general price index and not on specific commodity prices, even if these have important distributional or other impact. Those are fiscal issues.

But the Fed’s communications, I think, could be enhanced and could be targeted at a wider audience rather than just the people that subscribe to The Wall Street Journal, right.


BUITER: I think that, you know, Twitter or similar social media could be used effectively to communicate the views, the intentions, and the policies of the central bank.

CARUSO-CABRERA: Three minutes until audience questions, which is a hint to you guys to keep your answers short.

So my final question, before we go there, which is, there are doves out there who say actually this isn’t the Fed’s job; that there are supply shocks that have happened that are not their fault, that rising interest rates don’t help with supply shocks. If there are shortages happening because of Ukraine for a variety of reasons, that can’t be solved by hiking rates. Does anybody here agree with that?


CARUSO-CABRERA: No. (Laughter.) OK. Michael, why are they wrong?

WEBER: Well, you know, because of the war, because of pandemic, aggregate supply has decreased, and we have to get aggregate demand in line again. Otherwise we have, you know, very high inflation. And the way to get, actually, aggregate demand down—or one way of doing that—is by hiking up interest rates.

Ultimately, we need to reach, like, you know, an equilibrium in which aggregate supply equals aggregate demand. And even though, like, it’s not the Fed’s fault that inflation is high—it’s largely also, certainly, driven by supply shocks, as we discussed previously—it’s nevertheless the Fed’s duty, given its mandate, to do effectively the right thing and hike interest rates to make sure that aggregate demand comes down. It will be painful, but you know, not acting will be more painful going forward.


Questions from the audience.

Right here in the front.

Q: Thank you so much. Alexis Crow, PWC and Columbia Business School. Thank you distinguished panel.

There’s an elephant in the room that we haven’t been able to discuss yet in these last two sessions around the housing market and inflation, and really in looking at rent in the form of shelter. And certainly within OECD economies, in the decade between the GFC and the COVID pandemic, we had a housing market that outpaced an otherwise disinflationary environment for a number of different factors contributing to a significant affordability crisis for lower income households. You know, central banks, obviously, have been taken to task for this of the impacts of their monetary policy in that intervening decade on the affordability crisis.

I wonder what the panel’s thoughts are where we are now, just in terms of the relationship between housing and household expectations around inflation, as well as you have one prominent CIO this morning talking about falling land values—that as investors are coming out of real estate as the hedge against inflation, you might start to see significantly falling asset values?


BUITER: Yes. Certainly, the housing market has benefitted up to the start of COVID from a both secular bout of increasing house prices and then a massive asset bubble prompted by the infinitely elastic liquidity provision by central banks everywhere starting in 2008/9. A slight reversal for a couple of years, and then, you know, back to where we were.

It’s clear that a correction is long overdue and now seems to be happening in terms of house prices. Of course, what matters for the cost of living is—or should be— you know, the rental cost—or the imputed rental cost of unoccupied housing, and that, I think, will be slower to come down than the asset valuations themselves.

So I can see that remaining a major social issue, but again, not a central bank issue. The central bank has to target the cost of living defined as a representative general price index basket of commodities that, you know, is available to the U.S. consumer, whoever she is, right, consume.

And that is to be targeted. A sizable chunk of that is real estate related, imputed the actual cost of rental, but it should not be paid any more attention intrinsically than the cost of milk or the cost of butter.

CARUSO-CABRERA: Carola, I see you nodding your head.

BINDER: Yeah. I mean, the Reserve Bank of New Zealand did recently add a clause to its mandate. Or, it’s now instructed to consider housing prices when making its monetary policy. I think it’s a mistake to add onto the mandate like that. I think that if housing prices, like, are a problem—especially if fluctuations in housing prices are causing a problem for lower-income consumers or housing affordability is a problem—that needs to be addressed through changes in regulatory policy and possibly fiscal policy. It’s not something to, like, kind of target separate, specifically with monetary policy.

BUITER: And I agree.


WEBER: Yeah, no, exactly. So, like, you know, just to add on that, so, like, twenty years ago we had a discussion of, you know, should the Fed pay attention to asset prices? And I think, like, you know, the very—the distinct answer was, like, no, unless, you know, they matter for ultimate inflation. But if they matter for inflation, maybe for consumption wealth effect they anyway already pay attention to that. So therefore, there’s no additional role beyond the aspect of what Willem said, to the extent that they will ultimately affect inflation because of, like, you know, real estate-related unoccupied housing or rents. And so there no specific role to that part of the mandate.

Now, of course, to the extent that you’re concerned about financial stability aspects, you might want to actually take into account specific forms of maybe leverage tax or loan to value regulation, or things like that. But that’s not a form of, like, purely inflation-targeting central banks. So it’s also something—

CARUSO-CABRERA: So not the actual price of the houses, but the structure of the loans which are driving whatever happens, like when we had the financial crisis last time?

BUITER: Very much the point on financial stability. The first and foremost mandate of any central bank, even before price stability, is financial stability. So clearly asset prices are systemically important financial and real assets. Has to be tracked in case dangerous bubble-like conditions develop, especially if they’re leveraged. And this tends to happen, and did happen spectacularly, in the housing market in 2007/8. If asset bubbles aren’t leveraged, their implosions don’t necessarily cause disproportionate economic damage. As you saw with when the tech boom collapsed back in the Middle Ages. But housing prices definitely have to be tracked, I think, for financial stability reasons, but not for affordability reasons. That is a social or regulatory issue.

CARUSO-CABRERA: Did you say the Middle Ages?

BUITER: Yes. I said Middle Ages.

CARUSO-CABRERA: OK. (Laughs.) It does feel like the Middle Ages, doesn’t it?

We have an answer—we have a question from the virtual audience.

OPERATOR: We’ll take our next question from Mahesh Kotecha.

Q: Thank you very much.

I’m a finance guy, so pardon me if I ask a stupid economics question, or a question that appears stupid from an economics point of view. But it seems to me that a major dislocation that we have had for the last two and a half years, the pandemic, has not been factored into how it affects behavior and how it affects expectations. And I think that’s grossly underestimating now—in my opinion—how expectations will change—consumer expectations and potentially market expectations. So I’d like comments on how you are factoring in the potential behavior of public, you know, of consumers, in forming their expectations. They’re not really on the long-run tendency support. Habits are changing. People’s preferences are changing. They’re into revenge spending. And my expectation is that revenge spending impetus will remain there for much longer than inflationary expectations can moderate. So this could go on for a while. Any reactions?

CARUSO-CABRERA: Did I—I’m sorry, I couldn’t quite hear—did you say revenge spending?

Q: Yeah. That’s the term given to, you know, excessive spending at high prices to fly around and take Galapagos holidays, and the like, you know? Because they were confined or two years.

CARUSO-CABRERA: Mmm hmm. Mmm hmm.

WEBER: Yeah, I have some very, you know, quick thoughts on that. So you’re totally right that, you know, you see now that for two years many of us didn’t travel at all. Now we actually have direct flights from the U.S. to Rome, to the Canary Islands. You know, we see we are all actually eager to go back to our summer holidays. And of course, like, because of this shift in—I’m not sure whether it’s the shift in price fronts or because we didn’t actually feel comfortable or couldn’t even fly, now we actually go back to traveling and maybe even more so than previously.

And what does it mean? We, of course, immediately see that the price of airline tickets for flights, long-distance flights but also domestic flights in the U.S., has been going up quite substantially. We did see at some point rotations away from service to more durable goods, now we go back to services again. And so revenge definitely has an impact on relative price changes across goods in the economy, but crucially, like, you know, it really then depends on what are those price changes that are most notable and salient to consumers to understand ultimately what the impact on inflation expectations are.

And, you know, certainly like travel domestically and international travel is one of the goods that is actually very noticeable to many ordinary Americans. And because of this now shift into traveling again, resulting in higher prices given the somewhat fixed supply or not quickly expanding supply, and also constrained supply because of a shortage of brokers, we see, like, you know, that ultimately, we see higher prices and those—to each of those demand rotations partially also affecting potentially inflation expectations.

CARUSO-CABRERA: Carola or Willem, you want to weigh in?

BUITER: Just what we’re describing here are changes in relative prices, say, of physical goods versus services, associated with the lockdowns and the end of the pandemic and the resumption of what we used to think of as normality. These relative price changes only matter for the central bank insofar as they have inflationary consequences. So now it’s really, as you switch back spending towards physical goods, these prices tend to be slightly more flexible than the goods for services. So we’ll have a temporary upward bias towards inflation. And you may want to look through that, as a central bank, to some extent. You have to filter out the noise.

So, yes, the staff at the Fed has their work cut out for them. They have to figure out how much of any particular, you know, price increase is a lasting relative price change versus temporary inflation change. But beyond that, I think there are no obvious implications for monetary policy and for central banks. This is for production managers—(laughs)—for entrepreneurs, for CEOs.

CARUSO-CABRERA: Carola, anything there?

BINDER: No. I mean, I agree with what they said.


Q: Glen Lewy, Hudson Partners.

Martin Wolf at the CFR suggested that one of the reasons the Fed may have been as slow as they were to raise rates was the desire of Powell to be renominated, and presumably Brainard as well. Whether he’s right or not, we don’t know. But are there other structural changes that we should be making at the Fed to either address the problem now or to make sure that in the future they’re not those kinds of institutional biases stopping them from behaving the way they should?

CARUSO-CABRERA: Anybody want to weigh in on that—(inaudible)—question?

BUITER: Well, I don’t think that reappointment fears are likely to have been a main factor. The major issue was how persistent the inflation was perceived to be, and how scared they were of causing a recession. That is different from being concerned about your own reappointed. It can be correlated, but they’re different things. In think in the euro area, there is another factor, I think, making the ECB even less active in the inflationary front than the Fed. And that’s the fact that significant hikes in policy rates would cause sovereign debt instability for a number of fiscally fragile countries, including Italy and Greece, possibly Spain and Portugal, right?

So I think the ECB is, to a certain sense, a fiscal captive. They’ll be very reluctant to move as fast as they should to prevent a fiscal financial crisis. In the U.S., that’s not an issue, I think. I think here it was just the fear of creating a recession that was—that might not be necessary if turned out to be transitory, temporary after all.

CARUSO-CABRERA: And the core of his question is the current structure of the bank, do you think it’s sufficient enough so that they are not prone to political pressure?

BUITER: I don’t think the current members of the—of the monetary policy setting bodies that I know are subject to the kind of naked, direct political pressure that you alluded to earlier. They have political concerns. They’re concerned about the future path of the real economy or the output and unemployment, but those are economic concerns, I would say, in general political concerns, rather than being the subject of undue political influence.

CARUSO-CABRERA: Carola or Michael, any suggestions that you think should happen in terms of the structure of the Fed to make sure that they—I mean, do you buy or not buy that they could be subject to concerns about their reappointment, et cetera, and make different decisions? Or, you know, are you satisfied with the way things are?

BINDER: I think the concern that they had was not—yeah, not about their own reappointment. I mean, a lot of times the Fed policymakers don’t always even serve out their full term. I think more of the concern was about—there was—there was political pressure, but it wasn’t that kind of direct pressure about their own job stability. It was more about what was politically popular and what was even, like, allowed—you were even allowed to say in early and mid-2021. There was literally people writing #teamtransitory on Twitter, like, this was a team. You had to show you were on the right team by saying that inflation was transitory.

And, you know, you had—so it led to that confirmation bias, again, where even as there were signs that inflation might not be transitory, those signals didn’t get enough weight because there was so much emphasis on, like, you know, the right thing to do is to try to get full employment, even though we don’t know exactly where full employment is. We don’t know exactly, you know, what the—what the tradeoff was between inflation and unemployment. And I think some policymakers thought that maybe, you know, that they could get unemployment lower and lower and not have a return of inflation, because they thought that was kind of a thing of the past. So it’s this combination of, like, mistaken models and then, like, what was politically popular.

CARUSO-CABRERA: Question from the virtual—

BUITER: A single non-renewable term would be an obvious solution to any political pressure issue. You have that for regular members, the fourteen-year term. For the chair, of course, you have these four-year renewable terms. I think a single non-renewable term, the way the ECB has it—seven years, eight years—would be preferable, yes.

CARUSO-CABRERA: Virtual audience question.

OPERATOR: We’ll take our next question from George Hoguet.

Q: Hello. This is George Hoguet at Chesham Investments in Boston.

A narrative seems to have developed that the neutral federal funds rate, or so-called R-star, is around 2 ½ to 3 percent. But if the long-term inflation target is 2 percent, and potential GDP growth in the United States is around 1 ¾ (percent), I would have thought it would have been closer to 3 ¾ or 4 percent rather than 2 ½ percent. So I’m just wondering if you could comment on this, given the tremendous debate as to what the long-run neutral rate is in the United States.


BUITER: Well, basically, we don’t have a clue, right? It’s not a number that we can observe or read off anywhere. We have to construct it by assuming that it is correlated with the underlying growth rate, productivity, ex-ante saving investments imbalances, and factors like that. So the one thing that seems to be generally agreed upon—although, again, the empirical evidence on the fundamental courses of it is still lacking, is that the real risk-free rate of interest globally has come down dramatically, some say, over the past 1,800 years, right, but certainly over the past thirty years. But and that—when Taylor invented his Taylor rule, he assumed that the neutral real rate was, I think, 2 or 2 ½ percent, or thereabouts, which would, with a 2 percent inflation target, put the neutral rate at 4 ½ percent.

The consensus at the moment seems to be a half percent neutral real rate. That’s actually, of course, high relative to the exposed risk-free real rate that we’re seeing at almost every maturity at the moment, right, because these are deeply negative, still, for—yeah, across the spectrum. But I myself am reasonably comfortable with a guess of the neutral real rate of about half a percent for the advanced economies. Which puts the neutral rate at 2 ½ percent, and therefore restrictive market policy rate, some think, that begins with 2 ½ percent. That the Fed is still seventy-five basis points or a hundred basis points, is therefore a lasting mystery to me.

CARUSO-CABRERA: Question from the audience here. This gentleman.

Q: Thank you. Giancarlo Bruno, Deutsche Bank.

Wide question. So I’m curious how the panelists are going to answer. Who are the biggest winners and losers of this state of affairs?

CARUSO-CABRERA: Michael? You had a smile, so. (Laughter.)

WEBER: A couple of aspects. I was about to say, a very wide field we’re now talking about. It’s, like, you know, if you look at who is hurt most by realized inflation, high realized inflation? Tends to be low-income households. You know, they—actually, if we look at the data they tend to even have higher inflation relative to high-income households because, like, they cannot, what we would call, like, trade down. You know, they always shop at cheap retailers, whereas if you’re a high-income household you could stop going to Whole Foods and go to Aldi’s. Like, you know, this margin of adjustment is not open to you. So, like, you are hit hardest based on because you have higher realized inflation.

Then, you know, you call it more like a hand-to-mouth consumer. So your overall paycheck, you know, goes for, you know, necessities—groceries, gas, and so on. So therefore, like, effectively you are hit immediately 100 percent based on high inflation. If you’re a high-income household, you know, normally some savings rate of 15-20 percent. And so therefore, like, you know, not all of your income is immediately affected by inflation. Then you might actually invest in some form of real assets that at least over longer periods of time actually would appreciate one-for-one with inflation, even though of course we do see right now that stocks and real estate, actually, are hit hard based on the high interest rates, high interest rate expectations.

Of course, you know, one aspect where you could say that tends to be also correlated with lower income where you actually might see some benefits of higher inflation, is the fact that, you know, net debtors, to the extent they have, like, largely fixed interest rate debt, they will actually benefit from higher inflation because the real value of their outstanding debt balances is reduced, and so therefore their real net worth actually would increase. Like, you know, as you were alluded to, a pretty wide question. And those are just, like, two, three aspects, you know, talking about heterogeneous impacts of the current state of affairs.

BINDER: If I could add to it, you know, to the extent that this high inflation requires a recession to bring it down, and because it’s gotten so out of control it will require a bigger recession to bring it down, if that’s the case then that is going to hurt low-income households more. They’re more likely to lose their jobs in a recession. And that—you know, that possible heterogeneous impact could actually outweigh any heterogeneous impact of the inflation itself. Like, the different impact on how fighting the inflation will affect different households.

BUITER: Yeah. The financially are unsophisticated are victims of inflation, right? And that tends to include a lot of older people as well, who are on pensions that may not be fully indexed and whose security is, fortunately, (put to an ?) index, but not all these things are. So I think high inflation does, I think, disproportionately hurt the poor, the economically weak, and the financially unsophisticated. It is true that a recession will disproportionally impact also the working poor, right, as opposed to the retired poor. That’s not as large a share of the population as it used to be fifty years ago—(laughs)—but it’s still a large number.

Finally, we should keep in mind that the financial tightening that will be part of the policy matrix that brings inflation to an end—the financial tightening, the interest rate hikes, will, and has already, contributed to serious asset market losses. And these impact people across the board. And the crypto bubble, right, is gone completely. Aggregate market value, crypto, outstanding below a trillion today, apparently. (Laughs.) Bitcoin below 23,000 for the first time since December 2020, thereabout. So there are quite large wealth losses that are directly impacting the wealthy, for a change, you know.

CARUSO-CABRERA: More questions from the—right here.

Q: Niso Abauf, Pace University.

Is anybody on the panel aware of empirical studies decomposing the current inflation into its component causes—namely, monetary policy, fiscal policy, supply shocks, and inflationary expectations?

CARUSO-CABRERA: Apparently not. (Laughs.)

BINDER: I’m not sure how one would do such a decomposition, because, you know, you could—you could say, oh, this much of it is due to fiscal policy, but it’s still the Fed’s job to offset any, you know, impact of fiscal policy on inflation. So even if you said, oh, it’s 100 percent due to fiscal stimulus, that’s—you can still say it’s the fault of monetary policy. I don’t know how you, like, decompose those things.

BUITER: Inflation is an imbalance between aggregate demand and aggregate supply, right? And it can be the sector-specific supply shocks, right, in addition to causing massive relative price changes. Also reduce aggregate supply and therefore have an inflationary effect that is not, therefore, undone by corresponding offsetting change in another relative price. But I think I fully agree with the point that was just made. That if fiscal policy has been or is excessively expansionary, then monetary policy should be tighter.

CARUSO-CABRERA: Michael, to what degree was the fiscal expansionary policy this time around the cause of inflation versus supply disruptions due to Ukraine, et cetera?

WEBER: Yes, like, as you know, it’s obviously hard to put a number on that. But I like to—you know, oftentimes you hear, like, in the political debate in the U.S., like, you know, fiscal policy didn’t play any role because headline inflation in Europe and in the U.S. are the same. Now, of course, what this kind of ignores is, like, if you compare the levels of core inflation, you do see that core inflation is around 2 percentage points higher in the U.S. compared to the euro area.

Like, the reason why inflation is similarly high in terms of headline inflation is that Europe is way more exposed to, like, energy and the Russian invasion in Ukraine compared to the U.S. And so, like, you know, this 2 percent, now, I don’t want to say that it’s all fiscal policy. It's certainly also ties to labor markets, higher wage pressure, and things like that. But certainly, you know, one part of this two percentage points difference in core inflation is certainly, you know, also at least to some extent attributable to fiscal policy.

CARUSO-CABRERA: Last question here from the audience.

Q: Thank you. Nili Gilbert, the vice chairwoman of Carbon Direct.

As we close, I wonder if you could weigh in on how very long-term economic cycles play into all of this. For example, the topic of secular stagnation that we used to talk a lot about. When that—coming back to the question on R-star, some of the earliest research that I saw on R-star from John Williams, he actually hypothesized that there were two R-stars, and that the U.S. economy had moved over the course of decades from a higher R-star around 2 ½ percent to a lower R-star of about a half a percent, due to the force of long-term secular trends. If that’s the case, then how should we read the recent causes and effects of stagflation in the context of where we are in the very long-term economic cycle? Thank you.


BUITER: I think secular stagnation, as a characterization of the consequences not just for real interest rates but for underlying productivity growth and potential output growth of things like demographics, of deglobalization, or global bifurcation between the U.S.-focused and the China-focused trading and financial world, possible diminishing returns to innovation. I’m actually very doubtful about that. I have absolutely no idea what the net contributions to future productivity over the next five, ten, twenty years are going to be to artificial intelligence, of the digitization of the financial sector and, indeed, digitization of much of economic life, of automation and all these things.

So I’m not actually totally convinced that secular stagnation is the way—(laughs)—the world will necessarily go. The demographics? Yes, are completely clear. We are going to have aging population. Environmental disasters? Yes, they’re on the way, right? And they will lean on productivity properly measured. But the implication of that for monetary policy are, I think, pretty straightforward. Now, potential output growth slows down, you know, the neutral interest rate is lower. So you set your policy rates accordingly. These are not the things that cause central bankers, I think, to lie awake at night.

What causes them to lie awake at night is unexpected shocks like, you know, the pandemic, like the invasion of Ukraine, that call for a response that depends so on the extent to which these shocks are temporary or transitory that it is very difficult to get it right.

CARUSO-CABRERA: Folks, I really enjoyed it. I hope you did too. Thank you, everyone for participating. Michael, Carola, and Michael. And thanks so much for attending this very important symposium on behavioral economics. I’m supposed to read this thing at the end. Hold on, very end. Please note that the video of today’s meeting will be posted on CFR’s website. Have a great day.

BUITER: Bye-bye.


WEBER: Thanks.


This is an uncorrected transcript.

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