Virtual Meeting

World Economic Update

Thursday, May 13, 2021
Brendan McDermid/REUTERS

Senior Research Scholar, Princeton University; Former President and Chief Executive Officer, Federal Reserve Bank of New York; CFR Member

Senior Executive Editor and Head of Bloomberg Economics, Bloomberg

President, Peterson Institute for International Economics; CFR Member


Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations

The World Economic Update highlights the quarter’s most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy.

This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies and is dedicated to the life and work of the distinguished economist Martin Feldstein.

MALLABY: Welcome everybody to today's Council on Foreign Relations World Economic Update. I'm Sebastian Mallaby I work here at the Council. This series is dedicated to the life and work of Marty Feldstein, the distinguished economist. We have almost 500 members registered for today's meeting so we'll try to get to as many questions as possible in the second half of the meeting today. We're gathering at a time when the U.S., at least, appears to be in the grip of a robust recovery. The IMF updated its forecast a month ago and the remarkable thing is that in 2024, U.S. output is forecast to be higher than had been predicted before the pandemic struck. So it'll be one of those things where you look back at the data from the vantage point of 2050 and you almost won't see it, if the IMF is right. At the same time, emerging economies, especially emerging Asia, are suffering badly and China and the other advanced economies are somewhere in between. With me to discuss this complex global picture, I have Bill Dudley, senior research fellow at Princeton, and formerly president of the New York Fed, Adam Posen, president of the Peterson Institute for International Economics, and Stephanie Flanders, the head of Bloomberg Economics.


So, Bill let's start by bringing everyone up to date on the U.S. picture. The U.S. economy has been recovering thanks to the vaccine rollout, but the April's job report, just last week, was weaker than expected. In fact, one article I read suggested it was the biggest downside miss ever relative to estimates. How should we read these labor market signals and does this suggest we have to rethink those expectations of the fast recovery?


DUDLEY: I would not put too much weight on one month's reading in any economic environment. But on top of that, especially coming out of a pandemic, where we have very little experience about how the labor market should recover. I think what we're seeing in the labor market is not necessarily weak labor demand but a reluctance of people to go back to work because of worries about who's going to take care of their children, or it's about getting sick from COVID, or just because they're getting paid $300 extra in unemployment compensation benefits and so they want to take a little bit more time off before they go back to work. If you look at the number of unfilled job openings in the United States, there is an unusually high level that suggests that there's plenty of labor demand out there, so I'm not worried about the April labor report at all.


MALLABY: So the other big data release recently was yesterday's inflation numbers. CPI was up more than expected year-on-year, but the bigger shock, I guess, was the month-on-month core inflation, which was the strongest since the 80s. And that's consistent with the evidence that despite this weak employment numbers, you were just saying, you know, job openings are rising very quickly suggesting there might be some bottlenecks in hiring, which of course, would be potentially inflationary. You were one of the first to sound a warning about an inflation resurgence. You wrote a piece in Bloomberg back in December. How worried about inflation are you now?


DUDLEY: Well I think the bubble of inflation that we thought was going to happen has arrived. It's basically arriving for a couple of reasons, one, base effects, we're throwing out the very low readings from a year ago now, so the year-over-year numbers are spiking up because of that. But the most important reason why we're seeing more inflation is there's a lot of friction in the economy as you try to reallocate resources back to rapidly increasing demand. So I think that a lot of this is friction and supply chain disruptions. You know, look at the big increase we saw in used car prices, for example, do we really think that's sustainable over time? I think eventually auto production will pick up as some of these ship shortages ease and so inflation will come back down again. That said, it's certainly more than what we were expecting. I mean, I don't think anybody was expecting to think that the core inflation would already be at 3 percent. It may become more difficult for the Fed to keep talking about this being transitory as it might last six to twelve months before we start to see the other side of this.


MALLABY: Yeah, and you haven't mentioned the sort of dry powder argument that households, in addition to the fiscal stimulus, households are sitting on a lot of money, because the savings rate has been so high.


DUDLEY: Demand is going to be very strong, I think, coming out of the pandemic because, basically, there's eight million people that are still unemployed because of the pandemic and those people have suffered greatly. But for the rest of people in the U.S., they're coming out of this recession in great financial shape and the household savings rates, you know, been running over 20 percent, a lot of people have used the stimulus money to pay down debt, and monetary and fiscal policy are very expansive. So it's really hard not to see a very strong economic recovery in the year ahead unless something happens with the virus and the effectiveness of the vaccines to throw that all out the window. So I think that what's going to happen is we're going to get back to full employment, I think, faster than what people anticipate. And the Fed is going to try to be patient but they're their patience may ultimately be overrun by an economy that does better than what they're currently anticipating.


MALLABY: So, Adam, I have a question for you on fiscal policy, but I suspect you might want to comment on monetary first.


POSEN: No I mean, I'm with Bill, I'm in the camp that thinks we are going to see significant inflation over the next eighteen months and significant, not in historical terms, but significant compared to the last ten or twenty years, meaning numbers starting with a three consistently. I think the issue is not so much the forecast, it's more about how bad is this? And actually, in some ways, it's probably a good thing, so long as it's largely driven by wage increases and it goes with an expanding economy. The issue for the Fed, just to state a little differently from Bill, the same thing essentially, is at what point do they decide they can't just keep saying its temporary? How aggressive they have to be to get it under control? I'm hopeful that they can wait it out but if I have to forecast, I expect they will have to raise rates in early 2013. Which isn't that different from the market view. Sorry, go ahead.


MALLABY: Yeah. Switching to fiscal. I guess the question I'm curious about is, you've got these two bills proposed which are expensive but at the same time will generate revenues. In the sense that lifelong learning, earned income tax credits, infrastructure, childcare provision, all of these things can increase the productivity of the workforce. How far do you think in the long term these things can be viewed as, you know, not just increasing the share of government in GDP but growing the pie?


POSEN: I think a lot of it can be, Sebastian. I think the problem is we've heard so many claims through the years about tax cuts paying for themselves, which they never do, or almost never do, unless your marginal tax rates are extremely high, that people are skeptical about claims things will pay for themselves. I think many of the aspects you mentioned, particularly things that improve the quality and the quantity of the workforce so the pre-K education, the community college, the childcare help through taxes and provision to enable women to better balance home and work, more portability on things of insurance and pensions. All of these things are improvements in not just productivity, but even more so they're improvements in labor supply. But the thing is they pay for themselves over five, ten, twenty years, they don't pay for themselves over two years and they have to be sustained. They have to be paid for and sustained and not turned around in two years or four years after an election. So I think it's fine, a lot of what the Biden team is doing. I think these last two packages have a lot better content in them than some of what was in the American Rescue package back in January. I don't get caught up in this infrastructure lexicon debate of what you label infrastructure or not. And there are going to be wasteful things but, on balance, if this can be sustained and if there can be an agreement that a few percent of GDP spread over a few years that will be helpful to this country. In addition to whatever you do to repair bridges, trains, power grid which also obviously is necessary.


MALLABY: And switching tack a bit to the foreign exchange markets. There is a view that says, we may have an inflation problem coming but we also have a dollar problem, in the sense that foreign savers are being asked to finance this U.S. fiscal expansion at a time when interest rates are negative. Do you see that as being a problem in terms of dollar inflows and, therefore, dollar weakness?


POSEN: I don't in the short term at all. Sebastian, you, and Stephanie, and Bill have all been around the block on this with me as well. Twenty-five years ago at Jackson Hole, Alan Greenspan was debating Greg Mankiw about whether the budget deficits were going to push up interest rates and strengthen the dollar or weaken the dollar. And what we've seen, we saw in the 80s, we saw in the 90s, when you run large deficits and you're a reserve currency and your economy is broadly okay, what you do is you grow faster than everybody else. You have expected higher interest rates because the Fed is going to have to do something, and it tends to drive up the dollar. I mean, as you had Ken Rogoff on the last one of these and Ken will tell you, you can never predict what happens to the dollar. But to the degree you can predict, this policy mix will be dollar strong in the short term. What I think gets the cart behind the horse, in front, should be behind the horse. What gets the order mixed up, sorry, is that what would drive down demand for the dollar is also what would mess up the fiscal policy. Which is if we have political division in the society, particularly in the governance, such that we cannot raise taxes if we need to, such that we cannot sustain useful investments that get reversed and changed every election. Then people start saying, as they used to do for Italy, or Argentina, or Greece, okay there's a lack of fiscal credibility there, and that's when the dollar starts to fade. And so for me, it's a least ugly contest. And so the U.S. is increasing its ugliness on this fundamental basis, not because of the debt level but because of the governance. And so that makes things like, frankly, the Euro look relatively more attractive, in my opinion.


MALLABY: So Stephanie, Adam just ended there with a positive note about the eurozone and a few years ago we might have stopped the presses for that sort of positive comment about Europe. Do you agree broadly that the eurozone and the EU are emerging from the pandemic looking credible, despite the slow vaccine rollout?


FLANDERS: Yeah, I'm not even sure that Adam was saying that much but he was certainly being more positive than we might have been even a few months ago. I think if you step back a bit, we could probably say that Europe did a slightly better job of protecting citizens and even cushioning the effect on the economy in the sort of, act one of the pandemic last year. But if you think they have seriously botched up act two, this sort of crucial period of obtaining and then rolling out the vaccines and that's led to this palpable delay in the recovery, certainly relative to the UK. It's catching up, we're getting nice data confidence, I would say, and spending is actually probably getting ahead of where countries are in terms of vaccinations, infections, and quite strict restrictions in many cases still. So you're looking at maybe two thirds of the population being vaccinated by August or September. But I mean, I say that because that's a pretty—the difference between that and what you're seeing in the UK and the U.S., which is the beginning of the summer being at that stage, is pretty crucial if you're particularly one of the Southern European countries utterly dependent on tourism. So this few months delay, if it means losing a summer or losing a big chunk of your summer trade, that is quite significant, and I think further worsens the credibility of the whole EU effort this year. Even though, as you say, people are optimistic, you listen into the ECB press conferences, Christine Lagarde is upbeat. It could have been a lot better and if you're in Spain or Portugal, you are really going to be affected by that. And of course it also worsens some of these North/South divides that we know have been exacerbated by the crisis.


So I think that, I guess, the key thing which I'm sure you'll get on to is whether there's been an institutional shift that's been sort of kick started by COVID last year? And I think there, there's optimism in that you now have this Next Generation EU funding going out, it could help seal the deal on the recovery. But I worry a bit that though it has this sort of potential and it clearly was enormously significant to have now some sort of serious collective financing for fiscal policy of some degree in Europe. You know, we're kind of in the opposite situation than we were in in the eurozone. I mean we've all talked during the eurozone crisis, at key moments you had leadership whether it was from Mario Draghi or Chancellor Merkel jumping in and sort of papering over the cracks where there were no institutions to help the eurozone respond. We now have potentially this institution that could really help it move forward and the leadership isn't there. You know, you have the European Commission undermined by the way the rollout was handled. You have Chancellor Merkel on the way out and President Macron, who's probably been the greatest, sort of talking most about out what Europe could do if it was more unified, what a European identity could be. You know, he's very much distracted with that election coming up in a year.


MALLABY: So you know, I see the story that on the one hand, you've got this institutional shift in that there is now this joint liability. The eurozone is issuing its own bond, the European Union is using the same bond. The question is, you're saying, a leadership deficit. On that, the prospect that the Greens might do well in the next general election, might portend a greater willingness to do fiscal burden sharing and make the most of that opening created by the joint bond.


FLANDERS: Those of us sitting outside Germany always think everything is an opportunity to have a different German fiscal stance and then it suffers when you actually contact the German politicians involved and you tend to always find that they're not really very different from the ones before, even if they have a different color in their party and other things. I mean you can get into all of that, and I'm probably not the person to talk about all the permutations of potential coalitions coming out of the next German election, but the chances are that the Christian Democrats will be there in some form. Then it won't actually make necessarily a huge difference if the Greens have the Chancellor itself. But I think you're right to say that green issues and the green transition, economic transition, is an area where Europe has clearly made some strides and could show real leadership in the world. I think it's also shown itself better at responding to the competitive and other challenges of big tech and taxing big tech, beginning to do that. So I think that there is a potential there but we're always saying that but then the actual innovations are lacking, the innovations are all coming from the U.S.


MALLABY: I got another question for Stephanie but maybe Ben or Adam would like to weigh in on Europe before we move on? Continental Europe, stronger or weaker institutionally coming out of COVID?


DUDLEY: One thing I'd like to see is, can we actually make some progress towards a pan-European deposit insurance system? That's sort of my benchmark for true progress because now that you have supervision being consolidated for the large institutions of the ECB, there's really no excuse for not moving forward with that. So I use that as my sort of template of are they really serious about actually moving towards greater unity. And until that happens, I'm going to be a skeptic.




POSEN: Just I'm largely with Stephanie, I think the fiscal changes that have been made are precedent setting and exercising institutions and legitimize future mutual efforts on the fiscal front but given what Olaf Scholz just said, the actual use of the common fiscal policy is going to be very limited.




FLANDERS: —And the German deficit still ended up being much smaller than they had originally thought—


POSEN: Yeah of course—


FLANDERS: They're the only country in the world that announces they're going to have much bigger deficits, and actually turns out.


MALLABY: (Laughs).


POSEN: Which takes a lot of work.


FLANDERS: (Laughs).


MALLABY: Okay, so we have Posen guardedly more positive on the prospects of the euro, but we also have the British (laughs) voices still as skeptical of Germany as ever. (Unintelligible.)


FLANDERS: (Laughs.)


POSEN: So, I'm sorry, I just want to say, my point is not that the euro and Europe are doing great. My point is that they have slightly improved in a world where the U.S. is worsening and property rights are no good in China, so in the relative ugliness contest, Europe comes up. And then if as Bill says, or my colleague Nicolas Véron at Peterson pushes, if we did get deposit insurance, I think that would be an additional step that would make the European assets more attractive. So again, this isn't about the dollar goes away, this is about a step up in Europe because the U.S. is screwing up.


FLANDERS: I mean no longer hitting themselves in the head with a giant hammer is definitely a big step forward.


MALLABY: (Laughs.) Okay, so let's bring another region in to this debate which is the emerging world. Stephanie, there's obviously a potential that, if we think about what we were talking about at the beginning of this discussion—inflation picks up, the Fed tries not to respond but may have to respond. The worry surely is that as the Fed signals a willingness to respond, you get a repeat of a 2013 style taper tantrum, with major fallout for the emerging markets at a time when they're still struggling with COVID. You know, you take that in America, public debt to GDP rose from 64 percent to 72 percent last year because of COVID. You're still unvaccinated. So how do you see this risk if the Fed does have to change course?


FLANDERS: It's one of those things that I think we've all probably been looking at. The initial reaction, certainly, to the prospect of much bigger U.S. fiscal stimulus coming down the track than we might have thought, was immediately to think that there'll be this big boost to the rest of the world which of course there will be for many countries. But also the knowledge that there would be potentially the exporting of higher yields and those, as you describe, the sort of uncomfortable factor for many emerging markets. I think you are seeing that slightly play out already because you're seeing currency weakness force some of the central banks in the emerging market world to tighten when they probably wouldn't want to tighten. Sort of overall, I'd say in the end, policies become a bit tighter over the last six months when you wouldn't say that that was justified by the economic situation.


But I mean the real issue is that there's just enormous heterogeneity. I mean there's just enormous variety in what countries are looking at. So if you're export oriented, and/or have a big market, and you're kind of just big enough to fuel your own growth. Certainly China, potentially India, then you're going to do fairly well out of U.S. stimulus and those countries tend to be a bit less vulnerable on the financial front, they're certainly less vulnerable than 2013. But you have countries like Argentina, Turkey, Brazil, one could say the usual suspects, I think we would have put India and Indonesia into that category in 2013 and they've kind of graduated from that, they've got less financially vulnerable over this period. But countries like Argentina, Turkey, Brazil, I think, are very vulnerable to that financial channel and have less to gain from the growth, the sort of stimulus channel. So I think we're looking at that but then you also, you know, our economists have been breaking down what the rising yields so far, or the rising yields that we saw earlier in the year in the U.S. What was that more driven by? Was it driven by real expectations of higher monetary policy which was the case in 2013? Or was it more driven by the stronger growth environment and the expectation that the Fed might accommodate that? And I think, it seems to us that there's a significant difference in that this has been much more, so far, driven by the growth pick up and not so much around monetary policy. But as you say, I mean, if the Fed is pushed into, and this goes back to Bill and Adam at the beginning, if the Fed is pushed into a slightly different trajectory, then obviously that risk will become greater. But I said it's much less than it was in 2013.


MALLABY: I want to bring Bill in on this. But I mean, I guess the analogy I have in the back of my mind is that India had a first wave of COVID, and people said, "Wow, that was remarkably mild" because maybe the Indian population is young, whatever reason we don't understand but the country was hit less badly than we feared. And then second wave comes and it's truly appalling. And in the same way, slightly, on economic policy tools. I remember discussing with people at the beginning of the pandemic, the sort of inequity that the strong economies, the developed economies, had policy space but emerging economies might not. Now, the Fed and the other leading central banks loosened so much that there was really policy space for everybody but maybe a second wave could be different. So Bill, perhaps I could put this to you, do you think that this world in which the U.S. recovers a good deal faster than a lot of emerging markets is going to create complications through the exchange rate?


DUDLEY: I mean, it could but you know, it will be offset by the fact that a strong U.S. recovery that's accompanied by a strong recovery in other advanced economies probably means commodity prices go up quite a bit so the terms of trade will be beneficial to emerging markets. And the second thing I think is really important is the Fed is going to be slow relative to whatever economic recovery that we get because they basically told us that they're not going to tighten monetary policy until they're at full employment, they're at 2 percent inflation, and they're confident inflation is going to go above 2 percent for some time to come and that's a big change in the monetary policy framework. So the Fed has basically communicated that we're going to be late. So that gives time for the emerging markets to sort of catch up in terms of vaccination, in terms of the COVID base recovery. So I think that the risk from the Fed is really more that it's not like immediate, I think it's really like two or three years down the road, when all of a sudden, the Fed has to go from very easy to tight and that has to happen in twelve months. Now, that will be a shock for markets, but I don't think that risk is going to materialize in the near-term.


MALLABY: Adam, historians sometimes talk about, you know, how pandemics have changed political economy in various ways. Either the omnipresence of risk can boost entrepreneurial risk appetite and you do see more new business formation in the U.S. press, and I think also in the UK in the last year, than normally. Or businesses respond to health hazards by mechanizing production because the labor force has to be distanced or they're sick or whatever, so you get an acceleration of mechanization. You've written a great essay in Foreign Affairs, perhaps you could talk about how you see, like, what is the big political economy effect coming out of COVID?


POSEN: Well, Sebastian, as many people have been noticing industrial policy of various forms is now back into chic and this has an anti-globalization taint to it, including in the Biden administration and some other places. And it sometimes gets tied to the national security side, to "China's doing it, and we can't let China have the technology." And so if we move to an environment where people are more concerned about trust because of health reasons, because of local governance reasons, and because of perhaps overdone national security fears, then I think there's a cascade of effects. I think we're going to see too much emphasis on manufacturing and too much emphasis on autarky, which isn't going to go very well either politically or economically. I think we're going to see too much emphasis on local loyalties. I mean, we see this in the leveling up debate in Britain, we see this in the discussion of the places falling behind in the U.S., we see this throughout the world, but we also see that there are very few policies that level up regions rather than people. So you look at even China, which has the world's largest set of subsidies and the world's best ability to order people to move someplace, where to put businesses someplace. And we still see these huge, in their latest census, these huge changes in population of the Southeast versus the North and West and little income convergence between them.


We see in West Virginia, two senators, again, extorting the whole government, just as Bobby Byrd used to do, to bring goodies to West Virginia and yet West Virginia remains zero income convergence versus the rest of the country. So there's a lot of frustration and anger where we're already giving the people the anger, the prototypical angry white male, the rural, white voter, or their equivalent in other countries, what they want, which is a retreat from globalization, subsidies, local boosts, and it doesn't work politically or economically. So this is why the center-left and others are flailing about now trying to find something else to do. It's hard to convince people if you have precedents and populism on both sides saying, "you can have a pony", that to convince them that no, you can't have a pony, you have to get on the train and go someplace else. So the final point, sorry, I'm rambling. The key point is A) I think the political divisions in the democracies continue to rise for the time being, and B) that the world does turn more into blocs. I mean, again, we've all heard people writing bestsellers every few years about the world turning into economic blocs, I think, finally, that time is hitting now that it's going to start happening.


MALLABY: Stephanie, the same debate plays out a bit in the UK about regional equity. Listening to Adam, what's your reaction?


FLANDERS: Well I was just smiling because I thought how much Adam would hate Boris Johnson's new slogan, which is "live local and prosper."


POSEN: And yeah, I do hate it.


FLANDERS: You might consider it a contradiction in terms. I mean, I think it is a debate that we're seeing in the UK and there is a sort of fundamental philosophical shift. I don't know if it's going to be matched with a financial shift or let alone an economic shift. But certainly you've now got the government in that "live local and prosper" mantra, actually saying to small towns, "You can aspire to more than being the dormitory for some big city that we put lots of money into." And that, of course, has been the model of even regional development across America and certainly across Britain for decades. You maybe don't want it all in London, but you try and get more Londons. You try and have cities that can then have the agglomeration effects and there are towns around that are supporting the economic activity in the city, but the city is the central bit that's delivering the jobs. Boris Johnson is now saying in terms to people, "No, we're not going to force you to go. We're going to take the jobs to you. You don't have to go in the city, you don't even have to get on a train to get them." And I share some of Adam's skepticism about that, I don't think there is any sort of real economic thinking behind that particular thing.


But I will push back a bit, I think even before this, many of us were thinking that there had to be more emphasis on people and places and livability in the vision of globalization that we have. I'm not sure I see a fundamental threat to globalization coming out of this. In the beginning of the crisis, we sort of thought all supply chains were going to regionalize, everyone was going to pull out of China. It's not what we see on the ground. We don't see people pulling out of China, and we only see limited regionalization. We have seen massive digitization and I think that automation has obviously done in a few weeks, certainly months, what we might have expected to have happen over five years. There's opportunities there in terms of bringing, not necessarily bringing jobs right to where people are, but changing the pattern of jobs if we help prepare people for it. And that, again, is the big hole, the special Boris Johnson-sizes hole in this, is that they're not going to spend any money on any of this compared to. You know, Adam is worried that Biden is actually putting some financial weight behind this policy, you don't have to worry about that in the UK because all the sort of extra spending that's gone into the economy is all going to dry up next year.


POSEN: Can I just quickly respond, as usual, Stephanie and I agree about 80 percent but disagree violently on about 20 percent, or not so violently.


First point is my concern is not so much that Biden is going to spend money on this. My concern is more that if we focus on the rural, local, and we focus on manufacturing, we basically ignore 85 percent of the non-college educated people who work in frontline services and mostly live in cities. And so it's partly a justice argument as well as an efficiency argument. It's not about the waste of money, it's about the diversion of attention.


FLANDERS: (Laughs.)


POSEN: But secondly, and the thing I wanted to pick up on is Stephanie is absolutely right about supply chains and her and her Bloomberg colleagues have done a great job of reporting and tracking on this. But I think trade is a very actually small part of the story. Look, it's the corrosion of globalization that we're seeing is much more about flows of people, flows of technology, flows of ideas. And even in the digital realm, while I agree there is this potential for allowing small businesses, individual workers to sort of get more flexible from where they happen to be located. I think there's also divisions going up in the world around the internet, around platforms, around standards. There are fewer students going back and forth across borders, there are fewer people. Immigration is being cut back and a lot of places. Now the U.S. is doing more of this cut back than most places and that's one of the things I tried to put in my article, and we have charts on about this. That it got much worse under Trump but it really all started twenty years ago and it wasn't just trade, it was investment, it was immigration, it was making trade deals, or not making trade deals while others make them. So I just want to say that I'm not sanguine about globalization in general, and particularly from the U.S., even though I agree with Stephanie's characterization of trade and supply chain.


MALLABY: Stephanie is advocating the localization of economic energy and almost as a return to some idealized sort of turn based economic action. I can't help notice in the background behind you which is the picture of the future—


FLANDERS: (Laughs.) An empty city of London office, but yes, maybe.


MALLABY: But impressively technological.


MALLABY: Okay, I promised to make time for questions from members. So I'd like to invite members to join the conversation with their questions. Remember, please, that this is on the record and the operator will now remind you how to join the question queue.


STAFF: We'll take our first question from Teresita Schaffer.


Q: Thank you. I'm Teresita Schaffer from McLarty Associates. You've spoken about the links between the U.S. and the European economies and what's likely to happen in Europe, you've spoken in general about the emerging markets. I wonder if you could speak a little bit more about the big Asian markets? Where you see them going? What changes within that region and between it and the U.S./Europe?


MALLABY: Stephanie, you want to have a crack at that?


FLANDERS: Yeah, I mean, I didn't mention, I was thinking as Teresita was talking that we had spoken surprisingly little about China but then I guess you didn't really ask us about China. (Laughs.) And you can always bet these days that it will come up. I mean, we've obviously seen, you know, China was the example of a country that did have the capacity to respond to the crisis. And, obviously, had also, most importantly, managed the public health aspects with incredible efficiency and ability. And is the only country, major economy, to grow last year and is also going to grow quite a lot this year. I think the long-term challenges for China are well known and certainly Adam and Bill are very familiar with them. But clearly, the connections between China and some of its sort of closest, not quite satellite, but certainly the emerging market economies that have done best out of trading with China, have prospered in the last year or so. I think people will look, you know, one of the things that probably has turned out to be right that people said at the end of last year was that China has managed to sort of fast forward. It's not just automation. China's development and emergence on the global scene has fast forwarded five years, at least, by this crisis. I think that's right, and I don't think—you know there's all the same long-term challenges that we know about but I think, fundamentally, China is looking remarkably strong, albeit, possibly a bit brittle. But I wouldn't say even that.


MALLABY: Operator another question, please.


STAFF: We will take our next 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 have two related questions about China. First of all, do the panelists think that Chinese growth has peaked? That the advantages that China had during the pandemic and being able to export to the rest of the world, have they started to fade? And secondly, relating to the conversation so far about issues of globalization and such, what do you all think that the growth and inflation medium term implications are going to be from all of the supply chain shortages we're seeing in technology? The, you know semiconductor chip shortage? And how this could be exacerbated by the U.S.-China tech competition as well?


MALLABY: Bill do you want to certainly have a crack at the supply chain part of the question, or both if you'd like?


DUDLEY: Yeah, I mean, the supply chain. I think, my general view would be that the supply chain disruptions should not be long lasting because, basically, price goes up and that stimulates investment and then that's how you solve the supply chain constraint. Now that can take time, obviously, to bring new production online so it's not going to be solved immediately. But seems to me like that's capitalism at work, you know, sending out price signals that motivates more investment and I think that will solve itself over time. I think the bigger issue in terms of globalization is if we move back from globalization, you're going to lose the productivity benefits in terms of the specialization and expertise. You know, to the extent that every country tries to do it on their own, they're going to be less productive and that's going to have consequences for living standards and it's also going to have consequences for inflation. So that's the thing that I'd be more concerned about with the medium to longer run.


MALLABY: And what about the first question on China and whether it's—I think the question was, has it peaked in its, sort of, advantage?



I mean, it may have peaked but it's going to get a big benefit as the rest of the world normalizes. I mean, China is doing well even before the rest of the world is sort of reopened up and as the rest of the world reopens up, that's going to be a huge benefit to China in terms of demand for their goods and services. So I would think that the wind is still at their back for a while.


MALLABY: Operator next question, please.


STAFF: We will take our next question from Irving Williamson.


Q: Thank you. Irving Williamson, former commissioner, U.S. International Trade Commission. Bill Dudley has partially answered this, but I wanted to go back to Adam Posen about the sort of criticism of, I think, the Biden approach to trade. And I was wondering, what do you think needs to be done to really address the problems of ending income inequality and racial injustice in the United States? And what does the United States need to do to be able to compete globally going forward?


POSEN: Wow. Okay. So I think a lot of things the Biden administration is doing domestically are the right ways to start addressing the deep injustices and inequality in our society. Starts with inheritance taxes, with more investment in children, in education, more universal benefits, more portable benefits, more universality of treatment. So that this is one of my main complaints with the Biden approach to trade, is it privileges people who already had good positions, who have happen to have been in manufacturing or other favored sectors. Whereas we've got millions and millions of people who have been in the services sector, who've been deprived of jobs because of exogenous shocks whether they were the exit of white flight from cities, or the automation of secretarial jobs, which disproportionately hit African Americans and then women, for example. And so my main concern is that we have to work on those forms of justice by going after people as people not as locations, and not as jobs, and not by picking industries because just as has been the case in criminal justice, and in worker representation, and in cultural representation, the tendency is to focus on when the angry white male gets upset and ignore the amount of churn, literally economic churn, as you're well aware of, and motion and uncertainty that people of color, single women have been going through for decades. So that's the reality and we shouldn't just be focusing on what happens to white rural Americans who used to be manufacturing workers.


I think there's an awful lot else that has to be done in terms of running the economy hot. Even though I see the inflation risks out there, that's a forecast, that's not a normative judgment. I think Jay Powell, Richard Clarida, Lael Brainard, and other leaders at the Fed have been very articulate in the last few years about the benefits of running an economy hot and I think the Biden team is quite right to be on the side of that.  You have to be aware of inflation risks but that's different from always assuming that the workforce can't come back from a recession, always assuming that the estimates of potential are too high. You should ambitiously experiment for higher potential. So I think there's a lot going on, but I think the bad approach to trade interferes with it. Ultimately, though, social justice is about domestic things at home. As for U.S. competitiveness, I continue going back to Paul Krugman's classic Foreign Affairs article from, I don't know, nearly 30 years ago now. I don't view national competitiveness as a concept. I just don't see it. We are not doing well in terms of how we distribute income to our people, and how we treat our people with justice, and how we look after the impoverished. And that's got nothing to do with competitiveness.


MALLABY: We were trading messages before we went live here and I think, Bill, you said to me that your choice for the political economy shift coming out of the pandemic would have to do with inequality.


DUDLEY: I think the thing that strikes me about the pandemic is how unfair it has been to a small section of the population. You know, the people who worked in leisure and hospitality, the people that had the lowest incomes. So the burden has fallen very disproportionately on a small segment of the population, you know, the 8.2 million people that are still without jobs. And I think that really colors economic policy going forward because it really underscores, to Adam's point, how unfair and unequal a lot of aspects of the U.S. regime are in terms of the taxation regime. You know, the inheritance taxes, I mean, things that allow generations to pass on money to their children or grandchildren. And I think that's really going to be the lasting impact of COVID, I think in the United States. It's illustrated so clearly the inequities in the society, and I'm sort of hoping that as a consequence of that, we'll actually see lasting set of policies to address that.


MALLABY: Do you want to comment on this, Stephanie?


FLANDERS: I mean it clearly is something that has been most evident in what's happened and in the response to the crisis. I think Robert Macfarlane talks about unburials in a book he's written, the British author, and he's talking about things that get unburied close to the Arctic Circle. Things that were buried under, you know, were expected to stay under the surface but because of global warming they're sort of just coming out of the earth. And it feels a bit like that. Inequalities that we knew were there have just become much more evident and have been unburied.


I guess I'm just a little bit skeptical. I mean, there has been quite a deep understanding of inequality for some time and in most countries a lack of practical political will, particularly when it comes to capital taxation. People way down the income scale want to pass on wealth, even when they don't have any, they really care about the ability to pass on wealth. It's been a persistent issue trying to even begin to address that and you end up with these very inefficient property taxes as a result. Property taxes, particularly in the UK, you tax the transaction, you don't really tax anything to do with the value of the house itself on an annual basis. So I would like to think of all the things that Bill's talking about, that actually this long overdue shift to thinking more in terms of capital taxation and not only in terms of income tax when you're thinking about any kind of redistribution will start to happen in the U.S. and other places as a result of the crisis. Given how much the crisis has itself exacerbated inequality, I guess I sort of feel like you'd have to have quite a lot of political will just to offset what's happened in the last two years, let alone start to turn some tide.


POSEN: I think Stephanie is right on. The one thing I wanted to add, which is another place where I want to give credit to the Biden administration, is their very clear openness, stated by Secretary Yellen, that they're going to engage in the international discussions over minimum corporate tax globally and against profit shifting by large companies, and particularly digital companies. That's not going to solve every problem, but unless you make sure that countries are getting revenue and that revenue is seen as fairly gotten, you're not going to be able to address other things. So I think that's a really important thing the Biden team is doing that's right.


FLANDERS: That's absolutely right.


MALLABY: Let's take another question, please.


STAFF: We'll take our next question from Catherine Mann.


Q: Hi, everybody. Thanks very much for this session. Catherine Mann, I'm the global chief economist at Citi. We talked a lot about monetary policy and fiscal policy, but I'd like to bring in the private sector, particularly the financial sector. Because it is through the financial sector that you get the transmission mechanism to both investment or to financial assets of these two policymakers. And, specifically, the question that I have is, do you see the potential for turbulence in the financial sector to turn the central banks, in particular, away from their optimal policy path? And I would note that the ECB has already evidenced this some weeks ago where, arguably, their expansion of PEPP which they probably didn't really need or want to do, but they thought they had to, in order to offset the financial market's interpretation of what the Fed and the fiscal policies would do. So this role of the financial sector as intermediary. What's the probability that its turbulence is going to alter the optimal trajectories? Push the policymakers off their optimal trajectory? So it's not a good thing?


MALLABY: That sounds like Bill should start on that.


DUDLEY: So I guess I'm not so worried about problems in financial institutions being caused by the trajectory of U.S. monetary policy. I guess I'd be more concerned about the consequences to financial markets of the trajectory of U.S. monetary policy because monetary policy has made financial conditions extraordinarily accommodative. And as that monetary policy accommodation is withdrawn, or even signaled that it's going to be withdrawn, I would expect that that would cause some turbulence in financial markets. And then the question is that financial turbulence sufficient to tighten financial conditions enough to slow the Fed down? I can certainly imagine the taper tantrum like we had in 2013. I mean the Fed, at this point, isn't even willing to talk about tapering their asset purchases and we know at some point they're going have to talk about it. And that's going to be a very important shift in the regime from right now where it's monetary policy, maximum stimulus. Sometime, probably later this year, the Fed is going to have to start to hint that we're now moving away from maximum monetary policy stimulus. It's going to be very interesting to see how financial markets react to that and if that reaction is severe enough that could actually affect the trajectory of monetary policy. That doesn't mean that the Fed is going be upset if the stock market goes down 5 or 10 percent. We're talking about something of much greater magnitude than that. But it is true that monetary policy works through financial conditions, financial conditions affect the economic outlook, and the Fed is going to have to take that into account in terms of how they conduct U.S. monetary policy.


MALLABY: Adam, you want to comment?




MALLABY: Stephanie?


FLANDERS: I mean I would say that's obviously right. I do think it goes back to this question of needing to get back to some kind of probably above 2 percent inflation for a significant period. And the capacity, you know, the benefit of some of this fiscal activism, potentially to also push up the long-term neutral rate. We don't know, we have lots of debates about whether it will. But if you don't have inflation and/or a higher, long-term neutral rate, you have central banks inevitably pushing on this wealth. The sort of substitution effect and the wealth effect of quantitative easing way more than you would like and then using the finance. Having that transmission mechanism be really potentially distorting of financial prices and destabilizing. So I think it's a risk to the Fed, and to every other central bank, that they're still dependent so heavily on that channel in this environment.


MALLABY: Operator, should we take another question, please?


STAFF: We will take our next question from Doug Rediker.


Q: Hi, everyone. Thanks. Doug Rediker from Brookings and International Capital Strategies. One question that hasn't really been addressed is just the broad accumulation of debt. Whether it is through advanced economies, U.S., EU countries, but also emerging markets and low-income countries where you've seen just the stock of debt that has been accumulated, all for the right reasons in a crisis. But we're in the interest rate environment that you've all described, at some point, presumably, that does shift whether it's in the year, or two, three, whatever it is. At what point does just the vast accumulation of debt, whether to the markets, or to official bilateral creditors, in particular China, which is now supplanted the Paris Club in many countries as the leading provider of that debt to low-income countries. At what point does that become a problem both financially, economically, and to some degree institutionally because is the world of the old days of the IMF, the London Club, and the Paris Club, it's been supplanted by the new reality. I'm not sure that we're all aware of how these are going to be resolved. So I'm just curious if you have any thoughts on this.


MALLABY: Adam, do you want to talk about this debt overhang and what that might mean?


POSEN: Sure. I guess I've always been on the less puritanical side about debt than many people. I don't view it as inherently bad; I view it more as what you use it for. And that relates to what we were discussing a half hour ago about U.S. fiscal policy. You know, just labeling something investment doesn't mean it's good but there are things that are worth borrowing for. So when we look at EM, and Doug Rediker obviously know this as well as anybody given his service at the IMF, there are a lot of things that are beyond the control of emerging markets. We're seeing this with the pandemic, obviously. You have to have a certain amount of care about that.


But relating to something you raised earlier, Sebastian, I have been struck by actually how much macroeconomic room most of the major emerging markets have had in this cycle. So Brazil, India until the horrible disaster hit, South Africa, countries that had genuine problems and have genuine risks profiles, that they were making worse, on some cases on pandemic vulnerability were still getting to borrow in international markets, were still getting to keep monetary policy relatively loose. And so the IMF and World Bank, rightly, a year ago got very mobilized to make money available. And there are, of course, many populations and places in the world that are suffering and need that assistance. My colleague Adnan Mazarei, for example, has written about South Africa. But the bottom line is for the emerging markets, for the ones who are there, their access to capital markets has been largely unimpeded. And for all the people warning about U.S. rates going up, we haven't seen an excess exit of money from these countries in a big way. If anything, we saw the exit a year ago, and it almost all flowed back by June last year. And so that doesn't mean there's no vulnerabilities but I think it means we have to take seriously the idea because this is the second cycle in a row where the emerging markets were less vulnerable to Fed tightening and more able to use their macroeconomic stabilization. So that's not directly on Doug's question about debt but it tells you that the debt markets are not being so constraining on the public sector as they once were for these countries. If they're not so constrained on the public sector, then they're also not so constrained on the private sector. So ultimately, if we work the problem on the pandemic, meaning the U.S. and others start exporting a lot more vaccines and making them available, then I'm not that worried about debt.


FLANDERS: We have gone a full circle from one of the very first things that we talked about which is the potential strength of the dollar. Because if you look at last year, the policy room that I was talking about was, in fact, all monetary. They didn't have the fiscal capacity to respond to anything like the extent that the developed economies had. But they did preserve their access to global capital markets, and they did have monetary activism that they were able to employ. The worry about these, what we consider to be, late waves in India and other places, certainly in Brazil, complicating their recovery is that you now also have the global recovery kind of complicating the situation for monetary policy and for central banks. So the worry would be that central banks are not able to act as economies go down again this time due to the public health crisis. They had very little in the way of the public health impact of COVID last year, it all happened globally in the developed world, and much of the economic impact. They could potentially get economic impact and the public health impact without the central bank tool. I'm exaggerating a difference with Adam for a point, he's absolutely right, there's still a big contrast to 97 and even to 08/09. But it's a worry and that's why you need these G20 efforts to reduce debt which have been quite effective so far.


MALLABY: Bill maybe last word to you for the last minute or two. But, I mean, you were alluding a minute ago to the idea that the Fed, for now, is saying it's not going to raise rates, but at some point, it's going to have to start signaling a change. And precisely because markets don't expect rates to be raised until 2023, if they start signaling at the end of 2021, that could be a shock. Inflation, you know, maybe yesterday was a blip but if that continues and it comes in higher than feared, we'll get that even earlier. So do you share Adam's optimism? I think I've got this fairly expressed, Adam. That what's remarkable about the past year is the policy space that the emerging countries have had and, therefore, we should not worry overly about a potential taper tantrum happening this time.


DUDLEY: Well, I mean, I think there could be a taper tantrum. But I think the important thing to focus on is the fact the Fed said they're going to be very slow and if they're very slow that means there's going to be space for everybody else for a while longer. The downside of all this is that when the Federal Reserve finally has to move, they're going have to catch up, and they're going to have to do a lot in a shorter period of time. And they're actually going to have to make monetary policy tight. The past regime was you tried to arrive at a neutral monetary policy, 2 percent inflation and full employment, all at the same time. Now, they're actually not even going to start to raise rates until they're actually beyond full employment, beyond what's consistent with stable inflation. So there's going to be a lot of catching up to do. So my view is a little bit more nuanced. I think it's basically things are going to be fine in the near-term because the Fed is going to be friendly but then when people understand that there's this other side of the argument, something that the Fed has not really stressed very much. The Fed is going to have to be pretty aggressive in terms of keeping inflation under control two, three, four years out and that's going to be very problematic, because it's going to feel much more abrupt.


MALLABY: Well I think that's a great place to leave it, the idea that it's not just the pandemic that's taking us into uncharted territory, but potentially monetary policy will also be in a new place.


Please note to everybody that the video and transcript of today's discussion will be posted on the CFR website. And thanks to Bill, Stephanie, and Adam for a great discussion. Bye-bye.


POSEN: Thank you.


DUDLEY: Thank you.



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