Interest rates, inflation, tariffs, the dollar, separate headlines, or one story. They're more connected than they seem, and that's what's driving the economy right now. What do most people miss, and what changes once you see the full picture? Hi, everyone. I'm Lynne Toman, and this is Three Takeaways. On Three Takeaways, I talk with some of the world's best thinkers, business leaders, writers, politicians, newsmakers, and scientists. Each episode ends with three key takeaways to help us understand the world, and maybe even ourselves a little better. Today I'm delighted to be with Jason Furman. Jason served as chair of the Council of Economic Advisers under President Obama, advising on everything from the recovery after the financial crisis to long-term growth, trade, and fiscal policy. He's one of the most respected economists in the world. He's also a professor at Harvard. I'm looking forward to a wide-reaching discussion on Fed independence, the dollar, energy, and what people are missing. Welcome, Jason, and thanks so much for joining us today. Thanks for having me. Right now, what do you think is the most misunderstood thing about the economy? The most misunderstood thing is the impact that AI will have on the economy. What makes it the most misunderstood thing is if you think it's all going to be great and you're sure about that, you're wrong. If you think it's all going to be terrible and you're sure about that, you're also wrong. Why is that? Because there's just a lot of uncertainty about what's coming ahead. I feel so many people put it in one bucket or the other when, in some sense, we need to be prepared for almost anything to be happening in our economy. Having a certain amount of humility is always good in thinking about the future, but it's especially needed right now when it comes to AI. I completely agree with you from the people that I talk to who are working in AI. They have no idea what it will look like in five years, much less 20 years from now. No, I think that's exactly right. Jason, where did the inflation we've all experienced come from? The largest cause was the enormous fiscal response to COVID. It was much larger than what was justified or needed. In 2020, it made sense, but by 2021, the economy was recovering rapidly. We did another large dose. The number two factor, which also was quite large, was global supply shocks, of which the Russian invasion of Ukraine was the most important in terms of what it did to oil prices and food. Then number three was the Federal Reserve taking too long to respond to that inflation. I'm not sure how consequential that error was given that they cleaned it up very quickly. Some people may think, well, a lot of what I just said was about the United States. What about other countries they had inflation to? Well, they also had pretty big fiscal responses. They also had pretty delayed central bank responses. By the way, many of them had less inflation when you adjust and think about it correctly than the United States did. The government has overspent its revenues now for many years, as well as a central bank that has printed a lot of money. What role did government spending and the central bank in printing money have? There's two separate issues. One is we have a large budget deficit right now, in fact, larger than any year except World War II, the financial crisis and COVID. That's in a relatively normal, placid time. That's a really big source of concern in terms of what it means for economic growth, risks in our economic future. In terms of inflation, it's not the level of the budget deficit. It's how quickly it's changing. When we added so much to the debt so quickly in the wake of COVID, absolutely that played a role. The thing about it is households were, in many cases, seeing their income go up 30%, 40%, 50% from what it was prior to COVID. If you went out and spent all that money, the economy couldn't make 30%, 40%, 50% more than it was making before COVID. Instead of output going up a lot, prices are the variable that can adjust and go up a lot. I think the spending was the big part of which checks support for states and forgivable loans to small businesses often read those played a role and the Fed was probably secondary but didn't help. Let's talk about the Fed. When people hear Federal Reserve Bank or Central Bank Independence, what should they actually understand in plain English? Why does the independence of the Fed matter? In part, it's related to what we're just talking about. When you have large deficits in debt, it's really tempting to lean on the Fed, tell them cut interest rates. By the way, if we get a bout of inflation, that's okay too because it helps us repay our debt. It makes it easier to repay the debt and you've seen that in the past in a lot of countries around the world, even in the United States in the wake of World War II. If we did that now and the Fed made its goal of making it easier to repay the debt, it would have to sacrifice its mandates of maximum employment and price stability. We'd end up with a lot of inflation and big problems. In separate from the debt, every president, every political leader is tempted to maximize things in the short run even at the expense of the long run. Again, a lot of evidence from a lot of countries including the United States is when you do that, you just end up with more and more and more inflation and you don't even do better on unemployment. Because of these, what economists would call time consistency problems, how you want to behave today versus the future, it's much better to tie your hands as a politician, tell the central bank, make laws that you can't change what they do and you'll end up getting better outcomes for yourself when you do that. I'm sure that you know Kevin Warsh, the incoming Fed president. He's been quite public about what he thinks the Fed has gotten wrong. Can you please summarize his views? Kevin Warsh is a friend. I think he's a terrific choice and I very much hope that he is confirmed. He's been very critical of the Fed. Some of it is not about its core monetary policy. He for example thinks they've been too political in talking about issues like climate change. I agree with that a bit. And by the way, I hope Kevin Warsh is not political in supporting President Trump's agenda. He shouldn't support or oppose the president's agenda. He should be neutral on it and stick to his knitting. He's been critical within monetary policy but the Fed engaging a lot of quantitative easing, dramatically expanding its balance sheet by buying a lot of assets, government debt, mortgage debt. He wants to reduce that. There I think he's going to have to proceed very slowly. If he moves quickly on that, it will really destabilize markets. The Fed has tried to do it twice before and basically failed in that goal. And then finally, he's been very critical about the way the Fed has communicated, processed data, used models, the roles of economists there. He's never quite said what he would do differently. And so that will be the interesting thing as he has to make the shift from critic to leader. I think he's fully capable of doing it, but I don't know exactly how he's going to go about doing that. Let's talk about the dollar. Countries have slowly, very slowly been diversifying away from the dollar. How important is the dollar for the United States? You are right that there's been a lot of diversification against the dollar, but there's one area that's an exception to that, which is stablecoins. And stablecoins are more than 99% in dollars and obviously they didn't exist a decade ago. You know, they're a little bit of a cross current to what you said and certainly the United States and the Treasury Department is hoping that this is a way that we hold on to dollar dominance by establishing the industry. Now I have some concerns about regulatory gaps in the way we're handling the industry, what that means for its safety in the event of problems, but we'll put those aside for a moment. That broader trend outside of stablecoins, which you're very much right about, makes it a little bit harder for us to finance our debt. So you look at US interest rates right now and they're a decent amount higher than interest rates are in Europe. And it's sort of some ways amazing to me that Italy can borrow more cheaply than the United States can and that's because whatever concerns people have about Italy, they also have a lot of concerns about the United States. So this exorbitant privilege as it's called has given us a lot of room to run economic policy, make mistakes without being heavily punished in a way that an emerging market gets heavily punished when they make a policy mistake, but we're sort of running out of rope in terms of that right now. And why is the global role of the dollar now under pressure? In part, it's because of perception of risks of the US economy. We raise tariffs, we lower tariffs, we raise tariffs again. We're running this large deficit in debt. So this is sort of economic policy slash political economy type things. And then there's a separate thing, which is the United States has used the role of the dollar in sanctions increasingly around the world to deal with countries like Iran, North Korea, Russia in a very big way, especially after its invasion, full scale invasion of Ukraine. I think every one of those things might well have been justified and a good idea, but definitely they add up to more countries trying to say, what can we do to future proof ourselves against any assault by the United States through the role of the dollar, through the role of treasuries, through the role of the payment system. And it's not like China hasn't watched what we've done in Russia and made sure that the same will never happen to it. If the dollar weakens, what impact does that have? The first thing to understand is compared to other currencies, the dollar is at the very high end of the range of where it's traded over the last 30 years. I think it's at about the 95th percentile, even with the recent falls in the dollar. So we're going from a very strong dollar. So I personally don't think a little bit of weakening hurts. But broadly, there are two effects. One is it helps our exporters and it makes it more expensive for people to import. And that would help reduce our trade deficit. And only our trade deficits are biggest problem, but it's a little bit on the high side. I'd be happier if it was coming down at least a bit. And the second is it affects the value of people's assets. The people that are invested in the United States will lose a bit of money. Americans that have money abroad will gain a little bit of money on the exchange rate change. And that's not such a terrible thing either, except to the degree that part of our interest rates are higher is that foreign investors are actually expecting maybe that the dollar will fall and want to be compensated for that risk with higher nominal dollar-denominated returns. Tariffs sound simple, protect domestic jobs. But many countries have tried high tariffs like India and Brazil. What happens to prices and innovation over time? Tariffs drive up prices. The bigger deal with them is that they lead countries to do more of stuff they're bad at and less of stuff that they're good at. We'd like to say, oh, once you have tariffs, Americans will make all their own cars. One, we can't make all our own cars. And two, if we did, those workers will be pulled away from something else. And maybe they wouldn't be making airplanes for export. And those are even hired, paid jobs than the car jobs. In general, manufacturing employment has been falling as a share of employment across all countries. China lost 30 million manufacturing jobs from 2012 to 2020. And that's more than twice as many jobs as we have here in the United States. So the goal of protecting manufacturing jobs, it hasn't worked through tariffs. I don't think it's the right goal to have. Instead, countries should, for the most part, do what they're best at and buy everything else. And that is a much more greater prosperity, as we've seen in the East Asian countries, that centered their successes around globalization rather than trying to shut themselves off from the world. We haven't yet talked about oil and gas and renewable energy. What is important for people to understand about energy now? Well, the price of oil has gone above $100 a barrel. But this is not the 1970s. The economy is one-third as reliant on oil as it was in the 1970s, in part because we have more services and less manufacturing. Consumers spend about half as much on gasoline today as they did in the 1970s. We're also a net oil exporter, whereas we used to be a massive net oil importer. So this will be painful at the pump. This will take away from economic growth. But we're talking about a growth rate that maybe would have been 2.5%. That will maybe be 2.2% because of what we have seen in the Middle East. The other part of why this is happening is we have a much longer term shift towards renewables. They've become much, much cheaper. You need to solve other parts of it, like how do you get the energy from the places that can make it with wind and solar to the places that need it? How do you get it from the times it's made, like during the day for solar to when people might need it at night? How do you store it? So the storage transmission, we're making progress on those. They're in a way a little bit behind the generation side of the equation. But high oil prices will help with this. I expect more people will be buying electric cars now than otherwise would have been the case. Gas prices at the pump certainly hurt many people. Stepping back, Fed policy, the dollar, tariffs, US government spending and energy prices, what ties all of this together? What ties all of this together is, first of all, just an unusually large and complicated set of shocks, just keep hitting the macroeconomy. And some of these, it's incredibly obvious what the Fed should do. Some of them, it's really hard. If something's driving the unemployment rate up, you want to cut rates. If it's driving inflation up, you want to raise rates. So what do you want to do? There's not an easy and obvious answer to that question. And there was this idea of this thing called the great moderation in the economy now. It was overstated given that we had a financial crisis, just as people were talking about the great moderation. But it does feel like the pace of shocks and the complexity of them hitting us is just much higher than it's been for a while. So do you feel we're entering or we're now in a more unstable economic time? I think we are. But I also think you don't want to shortchange and undersell the enormous resiliency of the American economy. Most of what most of us do actually isn't related to tariffs, so it hasn't affected our jobs. It's all the ways that we're less reliant on oil than we were in the past. So in some ways, it's like this higher pace set of shocks than we've had, but it's also this greater resilience than we've had and a Fed that I think has, for the most part, been quite skillful, not perfect, as we talked about before, but quite skillful in managing all the incoming. For someone not following the economy closely, which should they actually pay attention to over the next year? Just anything I write. But beyond that, unemployment rate and inflation rate, if you're going to look at economic data, those really are the two variables that are the most important way to characterize what is going on in the economy. But if you're asking on a five to 10 year horizon, the thing I'll be following most closely is the productivity growth rate. Any given quarter, it's a very, very noisy number. It's hard to understand what's going on, but far and away the most important thing for the economy on a timescale of five, 10, and even longer years is just how much more efficient we are, aren't getting. And the best measure of that is the rate of productivity growth. What's the biggest economic risk that you see right now that you believe is not getting enough attention? I think the biggest risks really are getting attention. The private credit market, which is much bigger than it used to be, is going through some tough times. It may just be the beginnings of those tough times. Jay Powell has been largely reassuring about it for, I think, good reasons. It's still on the small side relative to the entire financial system. It probably is capable of absorbing losses. You can't run on it in the same way that you can run on banks. That being said, it's a sort of unknown wildcard in all of this. And Ben Bernanke told reassuring stories about why even if there was a housing meltdown, it wouldn't cause a crisis. And he was about as smart as you get, and he was wrong about that. So I can tell all the reassuring stories, but I'm always worried, you know, what if they're wrong? Jason, what are the three takeaways you'd like to leave the audience with? The first is that the economy is just very complicated and you're not ever sure what's going to happen. And anyone who does tell you with any certainty is downplaying that risk. The second, in some ways, goes against the first is that the economy is very resilient and you can throw enormous things at it and it can continue forward. And then the last is that going forward, what we do on the innovation side, what we do on productivity warps every other cyclical risk, financial, et cetera, issue that we might talk about. Jason, this has been great. Thank you so much. It's great talking to you. If you're enjoying the podcast, and I really hope you are, please review us on Apple Podcasts or Spotify or wherever you get your podcasts. It really helps get the word out. If you're interested, you can also sign up for the Three Takeaways newsletter at threetakeaways.com, where you can also listen to previous episodes. You can also follow us on LinkedIn, X, Instagram, and Facebook. I'm Lynn Toman, and this is Three Takeaways. Thanks for listening.
