301. A Monetary and Fiscal History of the United States (3)
2 (26m 53s):
Appointees. And none of them deeply believed in regulation. They were very light handed regulators. And you just, you alluded to what we got from that. It wasn't pretty.
1 (27m 7s):
Right. And since you wrote a whole book about that, let's use that as an example of where we need regulation. You could hardly blame, I suppose the lenders who are like athletes just trying to play the game as best they can. And if they can cut corners here and there, why not? And so
2 (27m 21s):
Let me stop you on that. Yeah. I think you can blame them. Not only you don't stop the blame, but the lenders and they are looking to make money and that's okay. They're trying to make money, but they're supposed to do due diligence and lend where they're gonna get paid back, not make, do you remember Ninja Loans? No income, No job assets. I often ask my students when I, I give a lecture once a year on the crisis and I ask my students, what do you think is the optimal number of ninja loans? And they generally get it right, zero. So don't let the lenders off the hook so easily.
1 (28m 1s):
Hmm. But I guess what I'm saying is I, if the regulators are not leaning in on them right, then they can kind of nudge in the direction of, well let's cheat a little bit here, a little bit there. And pretty soon you get the ninja loans, maybe That's right. Was it a spectrum like they, they did it a little bit less the year before and a little bit less the year before that and they kinda
2 (28m 19s):
Slow. Yeah, it was growing. Yeah. Yeah, it was growing over time. As the craze grew, you know, as we may remember, the background of all this was the housing craze. You couldn't lose money in housing. Housing was gonna go up 12% a year forever. A ridiculous thought. Just stopped running the numbers, what that would mean. But people were believing things like that. And by the way, if it were true, which of course it couldn't be, all of these loans would've been good if house prices just went up at 12% a year forever. They never would've had losses on these mortgage loans. But it was an absurd belief it couldn't happen.
2 (29m 1s):
And the only relevant question was how long would it last? And nobody knew the answer to that.
1 (29m 8s):
So it's like a Ponzi scheme, you know, Bernie Madoff could have kept going as long as he had more, more new customers coming in to give him money to pay off the other people.
2 (29m 17s):
Yeah. And he did for a long time. Right? How did that
1 (29m 20s):
Money, Yeah, like 25 years,
2 (29m 21s):
20 was it? Yeah. I mean a long time.
1 (29m 23s):
Yeah. Right. So, well I guess, yeah, right. That's that, that makes sense. Okay. So let's just think about current events since we're living through inflation now. And the Fed says, okay, we're gonna raise interest rates. What's the cause and effects there? How is raising interest rates gonna cause prices to go down?
2 (29m 46s):
Okay, so the cause at the Fed is very simple that that's its main weapon to reduce interest rates. J Powell was fond of saying, we have a tools to bring inflation down. And you know, I guess the s at the end, the plural, there's something there. But mostly it's one thing, it's the interest rate and in particular the short-term interest rate, which is what the Fed controls. But importantly that short-term interest rate in turn influences every other interest rate in the economy. Consumer loans, business loans, mortgages, also the government's borrowing cost by the way, which doesn't deter the federal government.
2 (30m 33s):
But if you're running a state or local government and you're borrowing costs go up, you may do less spending, build fewer roads and things like that. If you're a consumer, you may not buy the house that you thought you would buy because the mortgage rate is higher or the car that you thought you might buy because the auto lending rate is higher. If you're a business, you may not make the investment that was kind of on the margin, Should I do it? Should I do it looks pretty good, let's do it. Then the interest rate goes up and said, No, let's not do it. So that's how, that's a bunch of reasons why the Federal Reserves control over this seemingly unimportant overnight interest rate.
2 (31m 17s):
It's called the federal funds rate. That's a name gives it so much leverage over the economy. Oh, and I didn't even mention what's obvious in recent weeks. The stock market, when the Fed pushes interest rates up, that tends to kick the stock market downhill.
1 (31m 36s):
Right? So that doesn't sound good to me. I mean I have my, my 401K retirement is sitting there shrinking every week. And in the example you just gave, don't we want the little business owner to take the loan and expand his business? Cuz that's good. If everybody does that, the economy grows even more.
2 (31m 53s):
We do in good times, including in non-inflationary times. But if you read the Federal Reserve Act, I mentioned before, it's not in the constitution, but it is a law. Congress passed the original version in 1913. It's been amended a number of times. But the law gives the Federal Reserve the responsibility to keep inflation low. And when inflation is up six 8%, it's not low. And so the fed's legal responsibility given to it by the Congress years ago, decades ago, is to bring inflation down. How far down? Well, about 10 years ago when Ben Bernanke was chairman, the, the Fed enunciated a numerical target for 2% for some particular measure of inflation.
2 (32m 49s):
If you wanna bore your listeners, you could tell 'em it's the deflator for personal consumer expenditures. Now they're all asleep in that. But the point is, there are many measures of inflation and they riveted in on one particular one and set 2% as the target. That inflation measure is now running more like 6.5%. So that's way too high. And the Fed has no magic. W if j Powell had a magic wand that could bring it down from six and a half to two, he'd be waving it like Matt. He doesn't, what they have is control over interest rates, which slow down the economy.
2 (33m 30s):
So you were just asking, isn't it good for businesses to invest? Isn't it good for people to buy things? Yeah, it is. But if you're trying to slow down the economy, you need to have less of that. And that's what they're
1 (33m 42s):
Doing. Okay. And then so inflation itself, why are prices going up? You'll see on the news, nightly news, they got some reporter standing outside the Chevron station going, Oh look at the sign. It just went up another 50 cents, whatever, you know? And they acted like it's a mystery. Well just go in and ask the gas station owner why he raised the prices. And he'll say something like, Well, Chevron told me to raise the prices. Then you go to the CEO of Chevron. I go, Why'd you raise the prices? And he goes, Cause oil crude costs more. I dunno what he'd say,
2 (34m 8s):
Right? He, he would say that crude oil costs more. Yes. And crude oil. So that's one piece of it. Crude oil costs more for two main reasons. One was starting a few years back, not very many years back, What am I saying? Like two years back, the whole world started recovering rapidly from the horrible pandemic recession. All the countries at once. That raised the demand for a lot of inputs including oil. And so the price of oil started going up. And then Vladimir Putin invaded Ukraine and Russia and Ukraine.
2 (34m 52s):
Both were sources of oil. And that constricted supply further shooting the price up even Morely, it's come back down from its peak. But that's, that's the basic answer for why is oil so much more expensive? That quickly expands the energy in general because a lot of energy is generated directly or indirectly by oil or by other fossil fuels that are first cousins to oil. A second part related mostly to the invasion of Ukraine has to do with food prices.
2 (35m 35s):
So another thing that's aggravating people for good reasons these days is the higher prices they see in the grocery store. And a lot of that can be traced to the war in Ukraine. Again, Ukraine and Russia or major sources of wheat and foreign and fertilizer and a whole variety of other things. So tho the supplies of those things got constricted. And then the third thing, which is slightly more subtle, but I think by now obvious cause everybody's living with it, is the difficulty, the apparent difficulty greater than most of us economists thought of setting the supply side of the economy straight again after the dislocations from the pandemic.
2 (36m 37s):
Many economists like myself, I admit this error overestimated how fast capitalism would do its usual work. You know, the way capitalists work is they see opportunities for profit price. If something is high, oh let me come in there and supply this and make a lot of money that's happening. But it's happening really, really slowly. And so we are still having difficulties with the supplies of many industrial inputs prominently the one that's gotten the most attention. But it is just an example, is computer chips.
2 (37m 17s):
It's hard to find a new car these days because a car is a bunch of computer chips with wheels and the automakers can't get enough computer chips to make enough bars. That's still true. Here we are months and months after the worst of the pandemic peaked and we're still suffering from that. And now I come importantly cause of the context though, I think least importantly quantitatively. So the fourth reason, which is we probably had what economists like to call an overshoot of production beyond full employment a boom that went too far.
2 (38m 7s):
You'll have noticed probably that the unemployment rate, this is just one example which peaked at the worst month of the pandemic at something like almost 15%, I don't remember the exact number, is now down to 3.7%. One of the lowest numbers we've had in the entire post-war period. Many economists would think, probably the majority of economists would say that was kind of an overshoot of we wanted to be. And when you get an overshoot, you get peak demand for things. And that drives up prices, drives up wages. Also.
1 (38m 45s):
What's the ideal, what's the ideal percentage for unemployment? Why isn't it zero? Why isn't it zero?
2 (38m 53s):
So let me answer the second question cause that's the easy part. It isn't zero. Cause people are constantly churning around, they're moving geographically, they're changing industry. They're graduating from high school, they're graduating from college, they're deciding to go back and get more education so they don't work and a hundred other, they have a baby or the baby that gets old enough that the woman wants to go back to work or the man for that matter. All kinds of things like that cause a certain level of background unemployment. So when economists speak about the full employment unemployment rate, they're not meaning zero. Now your hard question, what are they meaning there's a a, a considerable spread of opinion right now on exactly that question with some people up in the five and a half percent range and some people down closer to where we are now, 3.7.
