What we're seeing across the world is that the emerging markets and developing countries, let's not forget them, are going to be coming out of this pandemic with a lot more damage.
Welcome to this podcast produced by the International Monetary Fund. Today, a discussion between two distinguished economists on what they know and what they don't know about the global economy.
My worry is we don't know the true extent of the problem since a lot of actions during the pandemic have worked towards masking the problems.
It's been almost two years now since the coronavirus began to disrupt our lives and economies. So are things really getting better or will the disruption linger? In this episode, IMF chief economist Gita Gopinath asks Raghuram Rajan where he thinks this is all going. Rajan is a former governor of the Bank of India and currently the Katherine Dusak Miller Distinguished Service Professor of Finance at Chicago Booth. He's also the author of several books on various aspects of the global economy. And most importantly, Raghuram was the chief economist of the International Monetary Fund between 2003 and 2006. Raghuram is quite simply a consummate scholar, a visionary, and one who has had a profound impact in academia, in the policy world, and pretty much on anyone who cares about the world of economics and finance. So, Raghuram, it's a real pleasure to have you join us today. The screen is yours.
Thank you, Gita, and thanks for having me. And of course, I was chief economist at a time when things were very, very benign. In fact, even Argentina was in the process of recovery at that time. And of course, you are living in really unprecedented times and having to work through it. I congratulate the IMF on pushing for a much broader vaccine strategy. It seems to me the failure of vaccine distribution to many parts of the developing world is a taint on global cooperation, and I'm glad that the IMF has made serious efforts in pushing large countries to remedy that. Now, let me talk about a couple of things which are, you know, quite important. I mean, clearly in industrial countries we've seen Delta and supply bottlenecks slowing growth in the third quarter, and Delta is picking up, or the virus is picking up again in Eastern Europe. But, you know, there is a sense that with pent-up savings, the fact that many households, certainly in the United States, have brought down their debt levels, and if the Democrats pass the packages, there will be at least the prospect of fiscal transfers for a substantial period of time, as well as the infrastructure package, there is a sense that demand is strongly supported. And even though higher inflation is eroding real incomes, and there is the likelihood the Fed already moved yesterday of central bank action to slow demand, on net we have greater risks of overheating rather than of falling back into secular stagnation. And so I would argue that to some extent, you know, the views on inflation are dichotomous. You know, one view is that everything is transitory. You know, when all this dies down, we'll go back to the slow and low inflation. I guess the IMF coined the term 'lowflation' of the post-global financial crisis times. In other words, a belief that this time is not different. While many others, including me, believe that this time is different, especially given the massive fiscal support both post-pandemic and continuing to today. Now, on inflation, I believe the aspects that are particularly different this time is the strength of the labor market, and it's not just because of transitory factors like, you know, unemployment benefits or pandemic concerns or women staying out of the labor force. There does seem to be a big sort of shift in worker attitudes. There are more and more people in the US, in the UK, who don't like high-contact, low-skilled jobs at low wages, and they worry about career progress. And that's reflected in the difficulty that people have of attracting workers to certain kinds of jobs, especially the lower-skilled ones. There's also the fact that the jobs aren't where the people are. In the US, for example, you see that, you know, New York City still has unemployment of close to 10% because high-contact services haven't opened up, while in many other places employers are crying out for workers. They simply cannot find them. This also means there's a transition required from waiter to welder, and that doesn't happen overnight. These, I mean, these may well be transitory because the goods market has recovered faster than the services market, but the kind of transitions that might be required may take longer. And of course, when coupled with changing attitudes, it may be longer for a time in which inflationary expectations could get entrenched. But I would say the biggest reason to believe that there is a changed environment, a changed regime relative to the post-global financial crisis regime, is that on a number of issues we have become more supportive of effectively higher inflation. Labor policy is much more geared towards workers. Minimum wages in the United States, more union support, minimum wages have been going up, as you know, and post-pandemic there is a sense that we must do more for workers, a public sort of view, and I think this will help keep wages higher. Of course, globalization has turned to more protectionism. Globalization was a force in keeping prices down. It's going to be less of a force today. Central banks have changed policy attitudes and, in fact, frameworks, as the Fed has from the post-global financial crisis situation, partly as a result of not being able to achieve the inflation targets. For example, the Fed says rather than minimize deviations, it's going to minimize shortfalls from full employment. It's not going to be proactive on inflation; it's going to be reactive. These are big changes, and that does mean a more inflationary environment. But the biggest, I think, change is the fact that many now believe there are no constraints on fiscal policy, and therefore fiscal policy has become much more expansionary, partly because of economists like Olivier Blanchard, you know, your predecessor, who emphasized the low level of interest rates and the ability to spend more. Of course, Olivier is, I think, against the level of spending today, but he set the conditions for people to think more about expansionary fiscal policy. In a sense, central banks have been surprised by the extent of fiscal response.
Thanks, Raghuram. You know, as expected, you kicked us off by talking about the most interesting issues that we have on our plate. So let me push you some on the first one, which is on the inflation discussion. And I guess here we're talking about, you know, the US and maybe the Euro area and some of the advanced economies here. So precisely, what do you have in mind when you say we're in a different regime for inflation, and it's not about transitory, even if it's, you know, several quarters transitory? We're not—it's not that situation. Are you talking about, say, inflation in the US going back to what it was in the 1970s and staying incredibly elevated and requiring some very strong action to bring that down? So we're talking about 7%, 8% inflation. So I guess that's the first question: what exactly do you have in mind for your inflation views? The second is in terms of the forces, right? So yes, indeed, we are seeing changes in the labor market. We are seeing a push for minimum wages to go up and maybe higher bargaining power at certain levels of wage skills. But again, as we know, these are all relative price movements, right? So we had wages of some going up. So what we know, for instance, just looking at at least what on companies that are listed on the stock market, if you look at their earnings and their profitability, it remains extremely high in all these parts of the world, right? So you could very well see wages going up, but then that's just more a redistribution away from corporate profits to workers, and that should not then necessarily generate a wage-price spiral because companies have the ability to absorb it. And that's part of what we saw before this crisis, which is we saw that there was sensitivity in wage inflation to the output gap and to the tightness in the labor market. What we did not see was then that being passed through into prices, and the argument was that there was a big buffer with markups and higher profitability and anything. And this crisis seems to lead to the, you know, suggest that we are certainly moving towards higher automation, more concentration with all the small guys out. So, you know, that force remains over there. So that's the second part, and the third is on issues like globalization, again another real issue, which is the fact that we end up with a less integrated world, maybe less competition, less sharing of technology. Those have real consequences. The question is how does that then affect inflation, right? Because we think of inflation as a consequence; it's a nominal concept. It's about the stance of monetary and fiscal policy, especially, for instance, and of course combined with fiscal policy. Now, before the pandemic hit, we thought these forces still played a role and played a very important role in driving inflation dynamics because we have the zero lower bound problem, which is that when your real interest rates are very low and they're negative, you know, monetary policy can't give all the stimulus that's needed to bring inflation back up. But in the opposite situation, where if the problem indeed is greater protectionism, because of which that's going to put pressure on real interest rates to go up and then also put pressure on inflation, monetary policy is far more effective in being able to raise interest rates as much as you want. So what is your view then in terms of, you know, which parts of these arguments do you think break down, and why do you think that we're in this, in a different regime?
Great set of questions. And look, I don't know which regime we are in. Are we the 70s, the 60s, or some other regime? I think only time will tell. What I am not saying is we will get double-digit levels of inflation. I am saying that we will exceed the inflation targets by significant amounts for sustained periods, and we'll have to bring it back to target, which means tighter policy. What I am worried about is that markets don't seem to be anticipating this tightening, and that there are many assets which are priced as if rates will stay low for really long. I mean, you know, in this environment of potential overheating, seeing 10-year real interest rates in the US around minus 1% tells me something's not adding up. Either my economics is faulty, or the markets are either sort of valuing Fed credibility significantly and believing that the Fed will get things under control after a very short spike, or they believe something else will happen. And you can go through the list of scenarios. One scenario where the Fed starts raising interest rates, asset prices collapse, and we're back to the need for accommodation and low interest rates. So, I mean, there are various bad scenarios one could think of. I would argue that given what has happened in the past, the temptation for the Fed will be to stay on the sidelines longer than it would if it wasn't sort of informed by what happened post-global financial crisis and by the extraordinary fiscal effort that has taken place. Now, if the Fed was to, in a sense, pull the plug on the economy and see it sort of slow down considerably, I can bet you every politician will be baying for the blood of the governors of the Fed. We spent enormous amounts of resources and enormous amounts of effort in getting this fiscal deal together, and you guys, by raising interest rates, have just brought the economy down. And, you know, so I don't think any Fed governor wants to be there, and therefore I would say the temptation will be to be more accommodative than you would otherwise be. I wouldn't say it's politically determined, but it's at the back of their mind is the political consequence of being the, of the risk that the markets react too much and sentiment collapses and we're back to square one. So I think they'll wait longer than potentially they should. Last point: I think post-global financial crisis, some of my colleagues have written about it. I wrote about it in a book. Part of the reason for low demand was, and actually I think the first clear enunciation of this was from the IMF. Part of the reason for low demand was the distribution of income. And, you know, when income moves from the poor to the rich, if it gets more skewed, the rich have a lower marginal propensity to consume, and therefore consumption is less easy to sustain. What we've seen in the post-pandemic response is the reverse. And so I would say that's a good thing. It's good that wages and incomes are going up at the lower end, but it also makes demand, in a sense, stronger and more sustained than it was, you know, post-global financial crisis. And that's another element that we should think about. We should celebrate the fact that income is equalizing a little more, but we should worry about the inflationary consequences.
I think, you know, regardless how we feel about the inflation numbers and where it might jump around, I think we all are in agreement that the markets seem to be priced to perfection, which means that it doesn't take much in terms of accidents or surprises to have some pretty big consequences, at least in financial markets, and then get the spillover to the real economy. So that I agree on. And of course, I think there the point you made also that you said, you know, you raised a concern that the Fed might be behind the curve effectively because of all this new environment that we are in. But if I, you know, there's a question that came up on Q&A, which would be, I guess, an argument that might be made by some central bankers, which is that the reason we're being so incredibly cautious is because we want to solve a problem that we've also been fighting the past decade, which is of too low inflation. So maybe this is not a bad idea to actually bring inflation up to levels we would be happy with, which would then help us in the long run. And so, you know, I think at this point we're all very focused on the big numbers that we're seeing, but again, if you look at long-term inflation expectations, if you look at the past decade, they all point towards inflation not being in the ranges that would make, you know, would make central bank policy that effective if things were to go bad in the future. So that's one point. And then last, I agree with you. I mean, there are all these forces again of globalization and so on that can have these kinds of effects, but we need that, you need the piece which also says that all these real factors will have big nominal consequences. And again, I think that while that argument was easier to make when the problem was of too low inflation, I think it's harder to make when you have too high inflation.
Let me just take the discussion to a somewhat different point. I mean, look, first, not everything on the table is inflationary, right? I think there are two other effects we shouldn't minimize. One is, of course, the financial sector. We talked about it. What if asset prices sort of react to the prospect of higher inflation, nominal interest rates go up at the long end, and asset prices, especially of tech stocks, come down to earth? Cryptocurrencies, two and a half trillion, you know, what are they worth? They're pricing in some sort of future where everybody uses cryptos and cryptos make money. I don't know what that is. I can visualize some uses, but that's another concern. But I would also point to, you know, the effect we are primed for a low nominal interest rate, low real interest rate world, and what if both sort of move up? And our fiscal situation is not to be, you know, you shouldn't forget that we have a lot of debt outstanding on the fiscal side. And so immediately the response is, well, it's long-term debt. It's not. That's the reality of what's been happening over the last few years. Take, for example, the UK, and I was just amazed by these numbers. Average maturity of debt, 15 years right now. But average maturity, there's some 30, 40, 50, even console bonds in the UK, and there's a lot of short maturity stuff also. So when you look at median maturity, it goes down to 11 years. That's still fine, right? 11 years means 11th turns over every year is repriced at new interest rates. Not too much of a worry. But then you subtract what the Bank of England has bought, because that essentially converts longer-term debt into overnight debt, and the median maturity comes down to four years. Now, four years median maturity means a significant part of your debt is repricing every year, especially because there's a lot more short-term debt concentrated there. And it turns out if interest rates go up 100 basis points, almost all the fiscal normalization that they have goes out of the window, offset by these interest rates. Now that's for the UK. For the US, you start with average maturity 65 months, okay, and then do all the subtractions and get down to median maturity, etc. My suspicion is the US has a lot more short-term debt waiting to be repriced if interest rates go up. That has fiscal consequences. And, you know, we're adding to the risk right now with all the spending that's taking place, but who knows what happens when these rates go up and what kinds of political reactions there are. The broader point I'm making is I sort of agree with you that we're not talking about hyperinflation. We're talking about an inflationary environment, but what I'm saying is we're used to a non-inflationary environment, and some of the adjustments we will make in the process may create forces that we haven't been used to, essentially deficits that are harder to finance and larger than we expected, and financial market reactions that will require, I mean, the leveraging that's happened in the financial markets, you know, yes, outside of the banks, but we'll find out who's been swimming naked when financial market prices adjust.
Given what you just said, do you think that emerging market policymakers are maybe then a little, maybe too sanguine about the risks of very large tantrums in financial markets and so on that could emanate from the US? And given you've been a central banker, what would be your policy advice at this point in an environment like this for emerging markets?
