‘The stars look like they’re aligning for a soft landing’

Good morning. Not all of our readers agreed with our confidence, expressed in yesterday’s letter, that above-target inflation is behind us. We’ll look at some of their arguments next week. If you see inflation lurking beneath the surface, tell us why: robert.armstrong@ft.com and aiden.reiter@ft.com.

Friday Interview: Alan S Blinder

Alan S Blinder is a professor of economics at Princeton University. He served as vice-chair of the Federal Reserve in the 1990s and on Bill Clinton’s Council of Economic Advisers, and is the author of several books. We spoke with him about the history of US monetary policy, what makes this cycle unique, and much more.

Unhedged: You have argued that the Fed has engineered more soft landings than most people believe. Are we achieving a soft landing today?

Blinder: I think it looks excellent. Some people are wringing their hands over signs that the labour market is weakening a bit. My view is the labour market was extremely strong. If it stayed that strong, the landing was going to be hard, as the Fed would have had to raise interest rates more aggressively. It seems the labour market is softening at a very gentle pace. And inflation is also mostly coming down, so the stars look like they’re aligning for a soft landing — and under what have been very, very difficult circumstances.

Unhedged: What makes this situation particularly difficult?

Blinder: First of all, part of the job was bringing inflation down from a high number all the way to 2 [per cent]. We’re not quite at 2 yet, but we’re close. And there were some severe shocks. The war in Ukraine, in addition to being a human tragedy, pushed up oil and food prices. So the background noise for the Federal Reserve as they tried to engineer a soft landing was much worse than, for example, the perfect soft landing that we managed when I was on the Fed in the mid 90s. I’m glad to share plaudits with Alan Greenspan for that — but it was much, much easier than what Jay Powell and his colleagues are trying to do now.

Unhedged: Some people think the fall in inflation has more to do with supply and demand shocks associated with the pandemic working their way through the economy, rather than the effects of rate policy — that it’s better to be lucky than good.

Blinder: I agree with that. I only want to point up the other side of that hill. Those things were working strongly against the Federal Reserve as they tried to keep inflation at 2 per cent and of course, they failed to do so. I was arguing then, as I would argue now, that most of that very poor inflation performance was due to factors beyond the Fed’s control. The corollary to that is those factors reversed and helped bring inflation down rapidly. So it made the Fed’s job harder first, and then easier.

Unhedged: Can we know how much the increase in rates did to reduce demand and keep expectations anchored?

Blinder: “Know” is a very tough verb. We can estimate. There’s an interesting paper by David Reifschneider that used the Federal Reserve’s model. He attributes very little of the surge in inflation upward and, applying the same logic, the fall in inflation downward, to monetary policy. These are statistical estimates. That’s the best we can do. Now that’s not the only methodology you could use. And there are people out there who have suggested effects in both directions. But I am a lot closer to the Reifschneider camp.

Unhedged: How much do we need to be worried about inflation reigniting in the style of the 70s and the 80s?

Blinder: Hard to say, because it depends mostly on whether there will be unanticipated shocks. For example, given what’s going on in the Ukrainian theatre of war, there could be another oil shock. If the whole world economy is gaining strength at the same time — which I wouldn’t bet on — that would add to pressures on energy prices. That wouldn’t push core inflation up very much, but it would push headline inflation up quite a bit. It would take some very strange events to get a repeat of the supply constraints that we had from the pandemic. And then the third possible shock would be irresponsibly inflationary policies, be they monetary or fiscal. On the monetary side, I think that’s very unlikely. The central banks of the world, including the Fed, were chastened by the high inflation of 2022.

Unhedged: You just mentioned a conflict between expansionary fiscal policy and contractionary monetary policy. Do you think this conflict will continue?

Blinder: It hinges completely on the election, especially who gets elected president, but also on the Congress. There is the possibility — especially in a Trump presidency — that the Fed would be fighting higher inflation from protectionist policies. If tariffs happen, it is like a supply shock. And central banks generally like to look through supply shocks, because they can’t do anything about them, and because they tend to be fleeting. It would be a one-shot increase in the price level, which tends to be transitory.

If there’s a budget explosion, which is possible from either party, that pushes aggregate demand higher than the Fed thinks is wise, the Fed will try to offset it. This has happened a number of times in US history. The most dramatic episode was President Ronald Reagan against Fed chair Paul Volcker. Volcker was raising interest rates a lot to fight inflation, and then Reagan came in and started cutting taxes. It was a big clash between monetary and fiscal policy.

Unhedged: What do you think of the two presidential candidates’ economic proposals?

Blinder: It is highly likely that if there is a second Trump administration, there will be much higher tariffs, and those will be inflationary.