Re: The Nation's Financial Condition
Posted: Sat Sep 18, 2021 8:22 am
Second installment:
"Ezra Klein
So one of the frustrating parts of this debate, to me, is that inflation gets talked about all as this one thing. And to go back to what you’re saying, there is this question of the productive capacity of the economy.
So something we’ve been seeing in the inflation now is that we’re in trouble on cars because we just need more cars. And there was a supply shock during Covid to key components. But you don’t see a lot of discussion about what we want the economy to produce, and how to make it possible for it to produce that much. Instead, we really talk in these generalities about money supply and inflation and the economy itself.
And yet, when I talk to economists, they will tell me, of course, what we are ultimately talking about is the productive capacity of the economy. But it does seem to me that if you never talk about that in the specific, or rarely do, and instead use these aggregate metaphors, you’re going to end up with very different solutions and very different goals than you would otherwise.
Adam Tooze
Well, I think that’s right. And I think it’s one of the things that 2020 exposed, is that we have a set of conventional assumptions about what makes up the economy, what makes up prices, in general, and how they’ll respond to impulses in general, like an expansion in the money supply. And those assume a certain set of particular structural relationships, a particular set of industrial patterns, a particular pattern of production.
But when a shock like 2020 comes along, which is incredibly idiosyncratic, all of those assumptions are disrupted. And we’re forced to sit back and ask ourselves what we actually mean by something like inflation, what we actually mean by the economy. One of the huge surprises of 2020 was the highly selective way in which the shutdown operated and took out dentists’ surgeries and schools and the entire service sector, which aren’t normally part of the conventional story of a business cycle at all.
And on the flip side, on the recovery now, we’re trying to parse whether or not it really is inflation, if what’s happening is that the price of lumber and then the price of used cars and then anything that has chips in it surges, whereas other prices really aren’t moving, because the movement seems so wildly idiosyncratic.
And economists will say, generally speaking, OK, what we’re talking about is the average moving. But they don’t have elaborate means. It’s not taught. Undergraduate economists, graduate school economists are not sat down with an image of what makes up the U.S. economy or the world economy sector by sector. And they don’t learn lessons, then, separately about each one of those, because these are general sciences. If you want to know about agriculture, you go to ag school. If you want to know about chip supply, you presumably become an industrial engineer or an electronic engineer or somebody who specializes in supply-chain logistics. It’s really the knowledge of engineers, not the knowledge of economists.
And in some ways, the most radical demonstration of this was the vaccine story, that the entire macroeconomic outlook hinges on the development of a handful of products and their supply chain. It’s really not an exaggeration to say that the entire outlook hinged, through the summer and the early fall of 2020, on a handful of labs around the world running tests which, altogether, would generate an output maybe worth a couple of $10 billion, but trillions of dollars if the world’s economy hinged on it.
So we’re exposed to a, for want of a nail, that famous nursery rhyme. For want of a nail, the battle was lost. That kind of logic becomes absolutely dominant. Without those bottleneck things, without that vaccine, without those microchips — whatever it is — the whole, which we like to generalize about, simply doesn’t function.
It also then becomes a serious problem of valuation. What is a working vaccine worth? Do we decide that by what its cost of production is or what it would command in the market or what value it delivers in terms of stabilizing the economy? That’s been one of the disorientating effects of this shock.
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Ezra Klein
So I want to bring up something here that may not, at first blush, seem deeply connected to what we’ve been talking about. But I think it is, which is how the boundaries of acceptable thought are policed and defined within the economics profession. And I want to go back here to the line we began with, that “whatever we can do, we can afford.”
This is a line that I have talked about with some leading center-left economists. And they’ll tell you that, of course, they know that. They’ve always believed that. Modern monetary theorists love quoting this line. But they will say, oh, the modern monetary theorists have nothing new to say. That’s just an old Keynes line.
But I will say that, having covered economics for a long time in Washington, that was not a line that used to get quoted to me. And there’s a lot like that, it seems to me, in economics, where if you dig in deep, what you either find is an indeterminacy that could go in many different directions, is a principle that is actually quite radical, like whatever we can do, we can afford, or a lot of disagreement.
But then when the economists come into the political realm, they begin trying to add their theory of how the politics will interpret something into the way they talk. And then it gets much more narrow. And then they become much more nervous about the way they’ll be interpreted, heard, et cetera.
And that, to me, is where a lot of the reliance on things like headline inflation numbers, budget deficits, interest rates comes from. Those are signals that can be a problem or may not be a problem. But it’s been a useful shorthand to just say, we don’t want you getting out of control, and so we’re just going to watch this pretty closely. And if it gets over a certain line, we’re going to slow the whole thing down.
And that seems, to me, to be happening here. I think there’s a lot of fear that if it becomes known, if it becomes believed that whatever we can do, we can afford, that that will be used irresponsibly, and then in being used irresponsibly, will create a lot of real problems for people, like runaway inflation. The idea will be, well, of course we can just give everybody a universal basic income. And then it’ll turn out, that does create a bunch of inflation, and there will be problems. And yet, I don’t know that many economists who disagree with the line.
And so this seems, to me, to be a point of real tension right now. A bunch of different things from the pandemic to the way social media has evolved to just the way political discourse has evolved are blowing up people’s control over the conversation. And that is exposing some nostrums that weren’t really true.
And then the profession wants to say, no, we knew all this. But in fact, they haven’t really been saying it, because they’re a little bit afraid, in my view, of what people will do with these ideas if they get hold of them, if they’re not protected by the responsible economists placing boundaries on what is and isn’t sober-minded policy-making.
Adam Tooze
Yeah, irresponsible was the word that Larry Summers, I think, used repeatedly with regard to the various proposals coming out of the Biden administration. I think that’s absolutely right. And one can see the professional logic of this. One can see the concern of a profession of extraordinarily high status to police the boundaries of who gets to speak in their name.
But I think, also, one could offer a more sympathetic reading, which is that the situation is genuinely opaque. We are in a broken play here. We’re in a gray zone. There’s no longer one best way. There’s no longer a Washington consensus that you can easily subscribe to. There’s a sort of maneuvering. And it’s somewhere between one size fits all, which we’ve abandoned, or one policy fits every situation, which we’ve also abandoned, and anything goes. And figuring out that space is what we all have to do going forward from here, I think.
And it isn’t surprising, I think, that, as it were, the defenders of the authority of a discipline of the kind of potency of somebody like Larry Summers are allergic on these issues. Because they fear mischief. They fear people, frankly, who don’t really understand what they’re talking about, in their view, as it were, acquiring authority.
But I think, underlying that, is actually a situation of profound uncertainty about questions like, why are interest rates so persistently low? Why is inflation not taking off when the money supply has blown up? What is the best way for an emerging-market economy to handle the stresses of globalization? Once upon a time, perhaps people had a sense they actually knew the answer. That’s just, I don’t think, any longer the case.
Ezra Klein
I think that’s a really important way to put it. And I want to say this and recognize it’ll get me in a little bit of trouble. I am a lot more sympathetic to Larry Summers’s take on some of these issues than others I agree with are. But I’m not always sympathetic to how he presents it. Which is to say, I agree with what you just said, Adam, which is, at the core of a lot of these economic policy questions right now is profound uncertainty.
For instance, I would say the economics profession has just been devastatingly wrong about what effect different deficit levels would have over the past 20 years. I think you simply have to look at that, given the credentials of some of the people making these arguments, as, in aggregate, a record of a lot of failure. Not literally everybody has failed. Some people have gotten it right. But there was just a lot of warnings that now look completely ridiculous, a lot of worries about things that didn’t happen.
It’s pretty clear to me, at this point, that the two things that are a problem that could emerge from deficits, one being higher interest rates and the other being inflation, economists just don’t understand well enough to predict. But I don’t quite take that view where some of my friends on the left do, which I would say is in the direction of free for all.
The fact that there is uncertainty doesn’t mean bad things can happen. Bad things can happen. Inflation could begin to bite in a real way. It could move in a way we don’t expect. The Fed could become highly politicized very quickly. And then the markets react in a certain way to that.
And the thing that is frustrating to me is that I don’t see a lot of strong communication of real uncertainty from the economics profession. Because it’s one thing to say, I think we should be cautious because we are in territory that we don’t understand, and things can get out of control. And instead, what I see is very, very strong opinions from just different directions.
But nevertheless, these are hard questions. And I don’t know. I take this as actually quite a bit of the fight between the modern monetary theory types and the new Keynesian types, whereas I think the modern monetary theorists often say things that, at this point, are not that different than the new Keynesians. But the modern monetary theorists are more comfortable that they’ll be able to slam the brakes on if just creating a lot of money out of thin air gets out of control. And the new Keynesians are not comfortable with that.
And so, fundamentally, they have a disagreement over how they’re going to handle the risk of inflation that ends up sounding like a disagreement over whether or not money is an invention or not. But the truth is, neither side knows. And that’s also just a scary thing to know from the outside, right? You’d like to think that people have their hand on the wheel here and they’ve all got answers. But they, at least in my view, at this point, truly don’t.
Adam Tooze
And there is the additional dimension, I think, that it’s very important to not think money simply along the axis of, if you like, the state in the bond market, but to also figure on private finance. We mustn’t lose sight of the fact that the biggest shocks of the last 12 years were the banking crisis of 2008, in the North Atlantic system as a whole, and then this disruption in the Treasury market, which was intimately tied up with new forms of market finance.
And so beyond, as it were, the classic terrain of public finance — government decisions about spending and taxing and so on, and the debt that’s run up, and the question of whether that’s a burden — and the classic macroeconomic topics of employment, unemployment, inflation, there is also this looming, cliché elephant in the room of the flywheel of finance, of private finance, into which government debt, which is the hotly contested topic in those two other fields, really serves as the raw material.
The government debt serves as the key medium through which private speculation operates. It’s leveraged on government debt. And that’s actually the reason why the central bank stepped in in the spring of 2020. They weren’t doing it to monetize a Keynesian stimulus program. This wasn’t World War II.
It kind of looked like it, if you viewed it from a certain angle. But it really wasn’t, because the central bankers will go to their graves swearing, insisting, that no, they didn’t do this to support the efforts of national governments to fight off the crisis. They did it to prevent financial instability, by which they mean to preserve intact this structure of private finance that pyramids on top of that public debt.
And that’s another dimension which — it just wouldn’t be fair to say, at all, that economics has nothing to say about it. But it was blindsided by it by 2008 — is, in a sense, scrambling to catch up with the dynamic, the virtuosity, of that private financial engineering. Which, again, in 2020, we didn’t see the banking crisis. But we did see, in some senses, an even more fundamental disturbance in that Treasury market.
Ezra Klein
I will go to my grave defending TARP. You have to stop things that are too big to fail from failing. But it is a place where I get very populist, because we do seem, to me, to have one financial political system for banks and financial institutions, and another for people.
And I am not making the argument you will sometimes see on Twitter where it’s like, we gave banks however many trillions of dollars, and all the people got was a $1,200 stimulus check. That’s not true, as a matter of policy. But it is true that when the Fed wants to, it can simply open the spigot in the most profound of ways for the banking system. And there is not that same ability to say, there is an emergency for households, there is an emergency for people, because Congress is a much harder-to-move institution.
And it is just weird that we have an institution of checks and balances and filibusters and committees and divided government that operates when you need to ask, should people get help in their everyday lives? And then an institution functionally just run by Chairman Powell and the Fed board that operates around the question of, well, do we just need to begin buying up all the debt anybody wants to sell us? And even if it is better they do that than not, there’s just no doubt that it is a profoundly unfair way to run the system.
Adam Tooze
And it compounds itself, right? The added twist in that tale is the paralysis of fiscal policy because of the complexity of politics. And I think we should be frank about it, right? The obdurate objections from the right to measures which folks like us, on the progressive side of things, think are just essential — that paralysis means that, for a long time, for much of the time, the only game in town, in terms of active economic policy, is the Fed.
And the Fed’s interventions have the effect of not just underwriting speculation to date, if you like, but further accelerating and exacerbating and forcing the process of financial accumulation and growth and profit-taking. So it’s really a very difficult and deeply entrenched structural bias.
No one actually has to necessarily want any of the effects it produces. You don’t have to have a conspiracy of people determined to hand trillions of dollars of capital gains to the top 1 percent of wealth holders. But that, in an emergency, often turns out to be the only thing you can do. And then you expect some sort of massive trickle-down effect to operate from there. And the only way out of that impasse is some sort of structural reform, which is, of course, profoundly unlikely for all of the reasons that much more modest measures of reform are difficult to get through.
Ezra Klein
Well, it also creates different kinds of pressures. So this is an argument I’ve been making forever. I wrote a Newsweek piece about it more than a decade ago. But something I’ve always tried to say is that an issue with gridlock — gridlock in the way we think about it in Congress — is that it’s actually a very good metaphor. As somebody who grew up outside of Los Angeles, when there is gridlock on the freeway, people take side streets.
And one of the things gridlock does is it begins to put pressure on the institutions that are less gridlocked, even if they are less effective, as a way to get to a policy goal, to act. So you have more pressure on the executive to use executive orders for things that maybe one would not have thought executive orders could be used for before. That you saw very clearly in the Obama administration. You saw it in the Trump administration.
There’s pressure on the Supreme Court to do, through decision-making, what the various coalitions cannot do through legislating. You see that on abortion politics. You see that on marriage equality. You see it on gun issues, all kinds of different things.
But you also don’t see it increasingly in the Fed. And this is something I’d like us to talk about, because Jerome Powell, despite being a Trump appointee, has been, I would say, backing up 10 years in the conversation, just an exemplary Fed chair, from a progressive standpoint. If you go back to where progressives were on the Fed 10 years ago, they would feel great about Powell. Not worried about inflation, really. Very committed to full employment. Seems to be pretty committed to a hotter economy where there’s worker power.
But there’s now pressure from the left to not reappoint him, because they want, on the one hand, more done on financial regulation, which we could talk about. But I think the real issue is, they want the Fed to act as a big player on climate change.
And part of the reason they’re desperate to have the Fed step in on climate change, treating it as a systemic risk which it now needs to begin evaluating banks and other players on, is because they are worried, correctly so, that Congress will not act on climate change, certainly not with the power they need to. And so that makes the Fed a much more important game in town, if you could get them off of the sidelines on this.
I’m curious how you see that demand. Do you think it would be a good idea for the Fed, under Powell, to say, yeah, climate change is a huge problem, and we’re going to begin to build it into our financial regulations the way we backstop markets, whatever?
Adam Tooze
So I’ve been of two minds about this. I was one of the people early in the field arguing that central bankers needed to take climate change more seriously. And what we’ve seen in Europe is the wholesale adoption of the green agenda by the ECB against, of course, a radically different political backdrop on the climate issue, specifically.
Broadly speaking, on social and macroeconomic policy in general, I agree that Powell has been an extraordinary surprise. But it’s also undeniably the case that he has been slow to act on climate. But I think you have to ask why.
I’m reliably informed it isn’t because Jerome Powell doesn’t care about the environment. I think he does. But I think he’s acutely conscious of a variety of different constraints operating on the Fed in a way, perhaps, that they don’t operate on the ECB. And the first is that the Fed’s mandate is, in some ways, not quite as capacious as that of the ECB, which is really setting — I’m invoking that because they’re setting the pace, really, on this issue globally.
Ezra Klein
ECB, just quickly, being European Central Bank.
Adam Tooze
European Central Bank. And the central bankers are a truly cosmopolitan network. They benchmark themselves against each other all the time. The Fed has a full employment and an inflation mandate and a financial stability — it’s understood that’s its mandate, too. But it’s not obvious, really, how you shoehorn environment into that. You could maybe do it through a community’s mandate. You could maybe do it through full employment. But it’s a bit of a reach.
They also, of course, know that there is profound political opposition to doing this. They know that they will take a beating in Congress if they make moves in this direction from the usual suspects, from the GOP. And they’ve already been quite vocal demanding that the Fed cease and desist politically explosive research on climate issues which they believe is contentious and risks politicizing the Fed. Their words, not mine.
Then there is the issue of what instruments the Fed would actually use. And for a central bank to be really dynamically active in climate policy, you want it to be doing what the European Central Bank does or the Bank of England or the Bank of Japan, which is actually buying lots of private debt, because that then gives you the leverage of saying, look, we’ll disqualify this as collateral if it’s dirty, if it comes from fossil-fuel pollution.
And the Fed, during the crisis in 2020, indicated it might, but de facto has not bought a substantial portfolio of private debt. So it’s not immediately obvious, beyond financial regulation, where the Fed would go.
And then finally, and nontrivially, the Fed is enmeshed in a financial system with big beasts in it. And America’s big financial players are the largest global backers, outside the oil states themselves, of fossil-fuel investment. So if you push in this direction, you’re going up against the likes of JP Morgan, which is, hands down, globally, the largest fossil-fuel investor.
And I think, for all of these reasons, it’s a little unsurprising that the Fed, under Powell, is leery of moving rapidly on this. That should make one impatient. It’s frustrating. If climate is your central preoccupation, then you want all hands on deck to be moving. But then think about the broader political constellation in the U.S. and consider, do you really want to pick a fight on the Fed over this?
And it seems to me that you could quite reasonably argue the case that you were implying, I guess, which is that, on so many issues, Powell has proven to be highly effective. If we replace him with Lael Brainard or somebody of that type who is more likely to come around to the green side, we make the Fed into a huge political issue, politically, for the GOP in the midterm season. They will be able to say that we’ve politicized the institution. They can come after us on that side.
And the main thrust, given the limitations of what the Fed can actually do in climate policy in the U.S., cannot lie with the Fed. It has, ultimately, to lie with infrastructure spending and regulation. And so it’s critical, presumably, if that’s the way, as it were, we’re going to use policy, not to pick a fight over the Fed that we don’t need.
So for this rather complicated reason, I’ve ended up coming down on a much more — eventually I would agree with you. I think it would be a mistake not to reconfirm Powell, not because he is the champion of green policy — and he hasn’t been, and for all the reasons, it’s unlikely he will be — but because we have to decide, tactically speaking, what the most likely route for success actually is. And I don’t think it’s this way.
Ezra Klein
Let me try to make a stronger argument for the people who want the Fed to play in this more aggressively, and then make my argument for why I’m a little skeptical. If you force me to choose right now, I would say reappoint Powell. That is a fight you don’t need. And you could create more problems than solutions if you win. But let me start at the beginning. The view is, the Fed is a regulator, among other things, of systemic risk. And it is ridiculous, on some level, to not say that climate change is a systemic risk.
There’s a great paper that came out a while ago, from a central-bank consortium, called “Green Swans,” which people can look up — and I used it in a column a while back — all about this. It is a profound kind of risk that could lead to all kinds of assets needing to be repriced that could undermine not just companies, but even countries. It is a profound risk to prices in the future. Of course. Of course it is. So then what could the Fed do? Well, they could begin to say, well, as a bank, if you are not divesting from things that expose you to climate risk, we are going to judge you as highly risky and begin to regulate you in that way. Or, you’ve made the point, Adam, that maybe they can say, well, the Fed does a lot of purchasing of government-backed, mortgage-backed securities. And so maybe they should begin only purchasing these mortgage-backed securities if the mortgages are for houses that are up to a green building code, or for buildings up to a green building code.
There are things you can imagine doing. But, when you begin to think about the Fed acting at that level, really going all in in a way that might make a difference — because I don’t think just giving some speeches on how climate change is a risk will make a difference — then you’re talking about something really different.
Lael Brainard is not going to do that. I have covered Lael Brainard in Washington for years. I’m not saying I know her super well, but she is a cautious economic policymaker. She always has been. She might be, on the margin, a little more green than Powell. But she’s not going to turn the Fed into an instrument of climate policy in this way.
But also, one of the things that has really saved the political system for some years now is that a Republican Party that has been irresponsible in functionally every other respect keeps making pretty responsible Federal Reserve appointments — Ben Bernanke under George W. Bush, Jay Powell, shockingly, under Donald Trump. There’s no reason for Trump to kick Yellen out. But if he was going to, Powell was a great replacement.
And central-banking policy has simply — it has been a rare space that is not that polarized. And if you polarize it by bringing in other issues that are much more polarized, then the right is going to begin judging candidates across this other issue set. And you’re going to begin to find more doctrinaire candidates.
If it becomes very important that whoever is running the Fed also doesn’t believe climate change is a big deal, then people like Ben Bernanke and Jay Powell in the future will not be plausible candidates, because they are not that kind of conservative. They are not that kind of Republican.
And so that’s my worry: that you’re not going to get in somebody who’s going to do all that much on climate change, but in adding that to the vetting process, you’ll begin to create a situation where, on the right, you get much crazier candidates for the Fed because you have to fit the broader set of right-wing concerns. And if we had some of these much crazier candidates in during the 2008, 2009 crisis, the 2020 pandemic crisis, I think what could have happened becomes really scary.
Adam Tooze
I completely agree with you. Let there be no misunderstanding. I’ve literally been called out by the head of the German Bundesbank as a green hawk on central-bank policy [in an] exchange that we had in the fall of 2019. So I fully believe that central banks need to play their part in the green-energy transition, and clearly that the high road to doing that, given their existing portfolio and brief, is by way of regulation.
And obviously, they should be insisting on systematically stress-testing all major financial institutions against some sort of Paris-conforming scenario. In other words, what happens to your portfolio of investments if we are on a path to decarbonization that gets us to net zero by 2050? I take that as read.
And furthermore, I think, whether with Lael Brainard or Powell at the helm, I think the Fed is moving in that direction, right? That inside the Fed, it’s quite clear that they’ve already got several committees working on this problem. It’s such a no-brainer. It’s easy to do. It sits within what they already do. And to reiterate — and we both agree on this — there’s not much else that the United States central bank is going to do in this direction.
So then the question is purely tactical. The question really is, as it were, how do you create a space in which the Fed can, A, not become a problem, B, go on doing the good thing it’s currently doing, and C, under the radar, which is where this is probably going to have to happen because the GOP watches this stuff — they literally read the research papers that come out of the San Francisco Fed, for instance, one of the more liberal branches of the Fed. Some of this is going to have to be, to a degree, surreptitious. It’s going to have to be infrastructural political change, to use that unfortunate phrase. It’s going to have to happen within the deep state in the same way as, for instance, the Pentagon went on working on climate-change issues under Trump.
So the only question in debate here, the way that you framed it in this conversation, is, Powell or not, on green criteria or not? And my view would be, well, Powell is certainly a reasonable option. And to reject him on green criteria would be to shoot ourselves in the foot."
"Ezra Klein
So one of the frustrating parts of this debate, to me, is that inflation gets talked about all as this one thing. And to go back to what you’re saying, there is this question of the productive capacity of the economy.
So something we’ve been seeing in the inflation now is that we’re in trouble on cars because we just need more cars. And there was a supply shock during Covid to key components. But you don’t see a lot of discussion about what we want the economy to produce, and how to make it possible for it to produce that much. Instead, we really talk in these generalities about money supply and inflation and the economy itself.
And yet, when I talk to economists, they will tell me, of course, what we are ultimately talking about is the productive capacity of the economy. But it does seem to me that if you never talk about that in the specific, or rarely do, and instead use these aggregate metaphors, you’re going to end up with very different solutions and very different goals than you would otherwise.
Adam Tooze
Well, I think that’s right. And I think it’s one of the things that 2020 exposed, is that we have a set of conventional assumptions about what makes up the economy, what makes up prices, in general, and how they’ll respond to impulses in general, like an expansion in the money supply. And those assume a certain set of particular structural relationships, a particular set of industrial patterns, a particular pattern of production.
But when a shock like 2020 comes along, which is incredibly idiosyncratic, all of those assumptions are disrupted. And we’re forced to sit back and ask ourselves what we actually mean by something like inflation, what we actually mean by the economy. One of the huge surprises of 2020 was the highly selective way in which the shutdown operated and took out dentists’ surgeries and schools and the entire service sector, which aren’t normally part of the conventional story of a business cycle at all.
And on the flip side, on the recovery now, we’re trying to parse whether or not it really is inflation, if what’s happening is that the price of lumber and then the price of used cars and then anything that has chips in it surges, whereas other prices really aren’t moving, because the movement seems so wildly idiosyncratic.
And economists will say, generally speaking, OK, what we’re talking about is the average moving. But they don’t have elaborate means. It’s not taught. Undergraduate economists, graduate school economists are not sat down with an image of what makes up the U.S. economy or the world economy sector by sector. And they don’t learn lessons, then, separately about each one of those, because these are general sciences. If you want to know about agriculture, you go to ag school. If you want to know about chip supply, you presumably become an industrial engineer or an electronic engineer or somebody who specializes in supply-chain logistics. It’s really the knowledge of engineers, not the knowledge of economists.
And in some ways, the most radical demonstration of this was the vaccine story, that the entire macroeconomic outlook hinges on the development of a handful of products and their supply chain. It’s really not an exaggeration to say that the entire outlook hinged, through the summer and the early fall of 2020, on a handful of labs around the world running tests which, altogether, would generate an output maybe worth a couple of $10 billion, but trillions of dollars if the world’s economy hinged on it.
So we’re exposed to a, for want of a nail, that famous nursery rhyme. For want of a nail, the battle was lost. That kind of logic becomes absolutely dominant. Without those bottleneck things, without that vaccine, without those microchips — whatever it is — the whole, which we like to generalize about, simply doesn’t function.
It also then becomes a serious problem of valuation. What is a working vaccine worth? Do we decide that by what its cost of production is or what it would command in the market or what value it delivers in terms of stabilizing the economy? That’s been one of the disorientating effects of this shock.
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Ezra Klein
So I want to bring up something here that may not, at first blush, seem deeply connected to what we’ve been talking about. But I think it is, which is how the boundaries of acceptable thought are policed and defined within the economics profession. And I want to go back here to the line we began with, that “whatever we can do, we can afford.”
This is a line that I have talked about with some leading center-left economists. And they’ll tell you that, of course, they know that. They’ve always believed that. Modern monetary theorists love quoting this line. But they will say, oh, the modern monetary theorists have nothing new to say. That’s just an old Keynes line.
But I will say that, having covered economics for a long time in Washington, that was not a line that used to get quoted to me. And there’s a lot like that, it seems to me, in economics, where if you dig in deep, what you either find is an indeterminacy that could go in many different directions, is a principle that is actually quite radical, like whatever we can do, we can afford, or a lot of disagreement.
But then when the economists come into the political realm, they begin trying to add their theory of how the politics will interpret something into the way they talk. And then it gets much more narrow. And then they become much more nervous about the way they’ll be interpreted, heard, et cetera.
And that, to me, is where a lot of the reliance on things like headline inflation numbers, budget deficits, interest rates comes from. Those are signals that can be a problem or may not be a problem. But it’s been a useful shorthand to just say, we don’t want you getting out of control, and so we’re just going to watch this pretty closely. And if it gets over a certain line, we’re going to slow the whole thing down.
And that seems, to me, to be happening here. I think there’s a lot of fear that if it becomes known, if it becomes believed that whatever we can do, we can afford, that that will be used irresponsibly, and then in being used irresponsibly, will create a lot of real problems for people, like runaway inflation. The idea will be, well, of course we can just give everybody a universal basic income. And then it’ll turn out, that does create a bunch of inflation, and there will be problems. And yet, I don’t know that many economists who disagree with the line.
And so this seems, to me, to be a point of real tension right now. A bunch of different things from the pandemic to the way social media has evolved to just the way political discourse has evolved are blowing up people’s control over the conversation. And that is exposing some nostrums that weren’t really true.
And then the profession wants to say, no, we knew all this. But in fact, they haven’t really been saying it, because they’re a little bit afraid, in my view, of what people will do with these ideas if they get hold of them, if they’re not protected by the responsible economists placing boundaries on what is and isn’t sober-minded policy-making.
Adam Tooze
Yeah, irresponsible was the word that Larry Summers, I think, used repeatedly with regard to the various proposals coming out of the Biden administration. I think that’s absolutely right. And one can see the professional logic of this. One can see the concern of a profession of extraordinarily high status to police the boundaries of who gets to speak in their name.
But I think, also, one could offer a more sympathetic reading, which is that the situation is genuinely opaque. We are in a broken play here. We’re in a gray zone. There’s no longer one best way. There’s no longer a Washington consensus that you can easily subscribe to. There’s a sort of maneuvering. And it’s somewhere between one size fits all, which we’ve abandoned, or one policy fits every situation, which we’ve also abandoned, and anything goes. And figuring out that space is what we all have to do going forward from here, I think.
And it isn’t surprising, I think, that, as it were, the defenders of the authority of a discipline of the kind of potency of somebody like Larry Summers are allergic on these issues. Because they fear mischief. They fear people, frankly, who don’t really understand what they’re talking about, in their view, as it were, acquiring authority.
But I think, underlying that, is actually a situation of profound uncertainty about questions like, why are interest rates so persistently low? Why is inflation not taking off when the money supply has blown up? What is the best way for an emerging-market economy to handle the stresses of globalization? Once upon a time, perhaps people had a sense they actually knew the answer. That’s just, I don’t think, any longer the case.
Ezra Klein
I think that’s a really important way to put it. And I want to say this and recognize it’ll get me in a little bit of trouble. I am a lot more sympathetic to Larry Summers’s take on some of these issues than others I agree with are. But I’m not always sympathetic to how he presents it. Which is to say, I agree with what you just said, Adam, which is, at the core of a lot of these economic policy questions right now is profound uncertainty.
For instance, I would say the economics profession has just been devastatingly wrong about what effect different deficit levels would have over the past 20 years. I think you simply have to look at that, given the credentials of some of the people making these arguments, as, in aggregate, a record of a lot of failure. Not literally everybody has failed. Some people have gotten it right. But there was just a lot of warnings that now look completely ridiculous, a lot of worries about things that didn’t happen.
It’s pretty clear to me, at this point, that the two things that are a problem that could emerge from deficits, one being higher interest rates and the other being inflation, economists just don’t understand well enough to predict. But I don’t quite take that view where some of my friends on the left do, which I would say is in the direction of free for all.
The fact that there is uncertainty doesn’t mean bad things can happen. Bad things can happen. Inflation could begin to bite in a real way. It could move in a way we don’t expect. The Fed could become highly politicized very quickly. And then the markets react in a certain way to that.
And the thing that is frustrating to me is that I don’t see a lot of strong communication of real uncertainty from the economics profession. Because it’s one thing to say, I think we should be cautious because we are in territory that we don’t understand, and things can get out of control. And instead, what I see is very, very strong opinions from just different directions.
But nevertheless, these are hard questions. And I don’t know. I take this as actually quite a bit of the fight between the modern monetary theory types and the new Keynesian types, whereas I think the modern monetary theorists often say things that, at this point, are not that different than the new Keynesians. But the modern monetary theorists are more comfortable that they’ll be able to slam the brakes on if just creating a lot of money out of thin air gets out of control. And the new Keynesians are not comfortable with that.
And so, fundamentally, they have a disagreement over how they’re going to handle the risk of inflation that ends up sounding like a disagreement over whether or not money is an invention or not. But the truth is, neither side knows. And that’s also just a scary thing to know from the outside, right? You’d like to think that people have their hand on the wheel here and they’ve all got answers. But they, at least in my view, at this point, truly don’t.
Adam Tooze
And there is the additional dimension, I think, that it’s very important to not think money simply along the axis of, if you like, the state in the bond market, but to also figure on private finance. We mustn’t lose sight of the fact that the biggest shocks of the last 12 years were the banking crisis of 2008, in the North Atlantic system as a whole, and then this disruption in the Treasury market, which was intimately tied up with new forms of market finance.
And so beyond, as it were, the classic terrain of public finance — government decisions about spending and taxing and so on, and the debt that’s run up, and the question of whether that’s a burden — and the classic macroeconomic topics of employment, unemployment, inflation, there is also this looming, cliché elephant in the room of the flywheel of finance, of private finance, into which government debt, which is the hotly contested topic in those two other fields, really serves as the raw material.
The government debt serves as the key medium through which private speculation operates. It’s leveraged on government debt. And that’s actually the reason why the central bank stepped in in the spring of 2020. They weren’t doing it to monetize a Keynesian stimulus program. This wasn’t World War II.
It kind of looked like it, if you viewed it from a certain angle. But it really wasn’t, because the central bankers will go to their graves swearing, insisting, that no, they didn’t do this to support the efforts of national governments to fight off the crisis. They did it to prevent financial instability, by which they mean to preserve intact this structure of private finance that pyramids on top of that public debt.
And that’s another dimension which — it just wouldn’t be fair to say, at all, that economics has nothing to say about it. But it was blindsided by it by 2008 — is, in a sense, scrambling to catch up with the dynamic, the virtuosity, of that private financial engineering. Which, again, in 2020, we didn’t see the banking crisis. But we did see, in some senses, an even more fundamental disturbance in that Treasury market.
Ezra Klein
I will go to my grave defending TARP. You have to stop things that are too big to fail from failing. But it is a place where I get very populist, because we do seem, to me, to have one financial political system for banks and financial institutions, and another for people.
And I am not making the argument you will sometimes see on Twitter where it’s like, we gave banks however many trillions of dollars, and all the people got was a $1,200 stimulus check. That’s not true, as a matter of policy. But it is true that when the Fed wants to, it can simply open the spigot in the most profound of ways for the banking system. And there is not that same ability to say, there is an emergency for households, there is an emergency for people, because Congress is a much harder-to-move institution.
And it is just weird that we have an institution of checks and balances and filibusters and committees and divided government that operates when you need to ask, should people get help in their everyday lives? And then an institution functionally just run by Chairman Powell and the Fed board that operates around the question of, well, do we just need to begin buying up all the debt anybody wants to sell us? And even if it is better they do that than not, there’s just no doubt that it is a profoundly unfair way to run the system.
Adam Tooze
And it compounds itself, right? The added twist in that tale is the paralysis of fiscal policy because of the complexity of politics. And I think we should be frank about it, right? The obdurate objections from the right to measures which folks like us, on the progressive side of things, think are just essential — that paralysis means that, for a long time, for much of the time, the only game in town, in terms of active economic policy, is the Fed.
And the Fed’s interventions have the effect of not just underwriting speculation to date, if you like, but further accelerating and exacerbating and forcing the process of financial accumulation and growth and profit-taking. So it’s really a very difficult and deeply entrenched structural bias.
No one actually has to necessarily want any of the effects it produces. You don’t have to have a conspiracy of people determined to hand trillions of dollars of capital gains to the top 1 percent of wealth holders. But that, in an emergency, often turns out to be the only thing you can do. And then you expect some sort of massive trickle-down effect to operate from there. And the only way out of that impasse is some sort of structural reform, which is, of course, profoundly unlikely for all of the reasons that much more modest measures of reform are difficult to get through.
Ezra Klein
Well, it also creates different kinds of pressures. So this is an argument I’ve been making forever. I wrote a Newsweek piece about it more than a decade ago. But something I’ve always tried to say is that an issue with gridlock — gridlock in the way we think about it in Congress — is that it’s actually a very good metaphor. As somebody who grew up outside of Los Angeles, when there is gridlock on the freeway, people take side streets.
And one of the things gridlock does is it begins to put pressure on the institutions that are less gridlocked, even if they are less effective, as a way to get to a policy goal, to act. So you have more pressure on the executive to use executive orders for things that maybe one would not have thought executive orders could be used for before. That you saw very clearly in the Obama administration. You saw it in the Trump administration.
There’s pressure on the Supreme Court to do, through decision-making, what the various coalitions cannot do through legislating. You see that on abortion politics. You see that on marriage equality. You see it on gun issues, all kinds of different things.
But you also don’t see it increasingly in the Fed. And this is something I’d like us to talk about, because Jerome Powell, despite being a Trump appointee, has been, I would say, backing up 10 years in the conversation, just an exemplary Fed chair, from a progressive standpoint. If you go back to where progressives were on the Fed 10 years ago, they would feel great about Powell. Not worried about inflation, really. Very committed to full employment. Seems to be pretty committed to a hotter economy where there’s worker power.
But there’s now pressure from the left to not reappoint him, because they want, on the one hand, more done on financial regulation, which we could talk about. But I think the real issue is, they want the Fed to act as a big player on climate change.
And part of the reason they’re desperate to have the Fed step in on climate change, treating it as a systemic risk which it now needs to begin evaluating banks and other players on, is because they are worried, correctly so, that Congress will not act on climate change, certainly not with the power they need to. And so that makes the Fed a much more important game in town, if you could get them off of the sidelines on this.
I’m curious how you see that demand. Do you think it would be a good idea for the Fed, under Powell, to say, yeah, climate change is a huge problem, and we’re going to begin to build it into our financial regulations the way we backstop markets, whatever?
Adam Tooze
So I’ve been of two minds about this. I was one of the people early in the field arguing that central bankers needed to take climate change more seriously. And what we’ve seen in Europe is the wholesale adoption of the green agenda by the ECB against, of course, a radically different political backdrop on the climate issue, specifically.
Broadly speaking, on social and macroeconomic policy in general, I agree that Powell has been an extraordinary surprise. But it’s also undeniably the case that he has been slow to act on climate. But I think you have to ask why.
I’m reliably informed it isn’t because Jerome Powell doesn’t care about the environment. I think he does. But I think he’s acutely conscious of a variety of different constraints operating on the Fed in a way, perhaps, that they don’t operate on the ECB. And the first is that the Fed’s mandate is, in some ways, not quite as capacious as that of the ECB, which is really setting — I’m invoking that because they’re setting the pace, really, on this issue globally.
Ezra Klein
ECB, just quickly, being European Central Bank.
Adam Tooze
European Central Bank. And the central bankers are a truly cosmopolitan network. They benchmark themselves against each other all the time. The Fed has a full employment and an inflation mandate and a financial stability — it’s understood that’s its mandate, too. But it’s not obvious, really, how you shoehorn environment into that. You could maybe do it through a community’s mandate. You could maybe do it through full employment. But it’s a bit of a reach.
They also, of course, know that there is profound political opposition to doing this. They know that they will take a beating in Congress if they make moves in this direction from the usual suspects, from the GOP. And they’ve already been quite vocal demanding that the Fed cease and desist politically explosive research on climate issues which they believe is contentious and risks politicizing the Fed. Their words, not mine.
Then there is the issue of what instruments the Fed would actually use. And for a central bank to be really dynamically active in climate policy, you want it to be doing what the European Central Bank does or the Bank of England or the Bank of Japan, which is actually buying lots of private debt, because that then gives you the leverage of saying, look, we’ll disqualify this as collateral if it’s dirty, if it comes from fossil-fuel pollution.
And the Fed, during the crisis in 2020, indicated it might, but de facto has not bought a substantial portfolio of private debt. So it’s not immediately obvious, beyond financial regulation, where the Fed would go.
And then finally, and nontrivially, the Fed is enmeshed in a financial system with big beasts in it. And America’s big financial players are the largest global backers, outside the oil states themselves, of fossil-fuel investment. So if you push in this direction, you’re going up against the likes of JP Morgan, which is, hands down, globally, the largest fossil-fuel investor.
And I think, for all of these reasons, it’s a little unsurprising that the Fed, under Powell, is leery of moving rapidly on this. That should make one impatient. It’s frustrating. If climate is your central preoccupation, then you want all hands on deck to be moving. But then think about the broader political constellation in the U.S. and consider, do you really want to pick a fight on the Fed over this?
And it seems to me that you could quite reasonably argue the case that you were implying, I guess, which is that, on so many issues, Powell has proven to be highly effective. If we replace him with Lael Brainard or somebody of that type who is more likely to come around to the green side, we make the Fed into a huge political issue, politically, for the GOP in the midterm season. They will be able to say that we’ve politicized the institution. They can come after us on that side.
And the main thrust, given the limitations of what the Fed can actually do in climate policy in the U.S., cannot lie with the Fed. It has, ultimately, to lie with infrastructure spending and regulation. And so it’s critical, presumably, if that’s the way, as it were, we’re going to use policy, not to pick a fight over the Fed that we don’t need.
So for this rather complicated reason, I’ve ended up coming down on a much more — eventually I would agree with you. I think it would be a mistake not to reconfirm Powell, not because he is the champion of green policy — and he hasn’t been, and for all the reasons, it’s unlikely he will be — but because we have to decide, tactically speaking, what the most likely route for success actually is. And I don’t think it’s this way.
Ezra Klein
Let me try to make a stronger argument for the people who want the Fed to play in this more aggressively, and then make my argument for why I’m a little skeptical. If you force me to choose right now, I would say reappoint Powell. That is a fight you don’t need. And you could create more problems than solutions if you win. But let me start at the beginning. The view is, the Fed is a regulator, among other things, of systemic risk. And it is ridiculous, on some level, to not say that climate change is a systemic risk.
There’s a great paper that came out a while ago, from a central-bank consortium, called “Green Swans,” which people can look up — and I used it in a column a while back — all about this. It is a profound kind of risk that could lead to all kinds of assets needing to be repriced that could undermine not just companies, but even countries. It is a profound risk to prices in the future. Of course. Of course it is. So then what could the Fed do? Well, they could begin to say, well, as a bank, if you are not divesting from things that expose you to climate risk, we are going to judge you as highly risky and begin to regulate you in that way. Or, you’ve made the point, Adam, that maybe they can say, well, the Fed does a lot of purchasing of government-backed, mortgage-backed securities. And so maybe they should begin only purchasing these mortgage-backed securities if the mortgages are for houses that are up to a green building code, or for buildings up to a green building code.
There are things you can imagine doing. But, when you begin to think about the Fed acting at that level, really going all in in a way that might make a difference — because I don’t think just giving some speeches on how climate change is a risk will make a difference — then you’re talking about something really different.
Lael Brainard is not going to do that. I have covered Lael Brainard in Washington for years. I’m not saying I know her super well, but she is a cautious economic policymaker. She always has been. She might be, on the margin, a little more green than Powell. But she’s not going to turn the Fed into an instrument of climate policy in this way.
But also, one of the things that has really saved the political system for some years now is that a Republican Party that has been irresponsible in functionally every other respect keeps making pretty responsible Federal Reserve appointments — Ben Bernanke under George W. Bush, Jay Powell, shockingly, under Donald Trump. There’s no reason for Trump to kick Yellen out. But if he was going to, Powell was a great replacement.
And central-banking policy has simply — it has been a rare space that is not that polarized. And if you polarize it by bringing in other issues that are much more polarized, then the right is going to begin judging candidates across this other issue set. And you’re going to begin to find more doctrinaire candidates.
If it becomes very important that whoever is running the Fed also doesn’t believe climate change is a big deal, then people like Ben Bernanke and Jay Powell in the future will not be plausible candidates, because they are not that kind of conservative. They are not that kind of Republican.
And so that’s my worry: that you’re not going to get in somebody who’s going to do all that much on climate change, but in adding that to the vetting process, you’ll begin to create a situation where, on the right, you get much crazier candidates for the Fed because you have to fit the broader set of right-wing concerns. And if we had some of these much crazier candidates in during the 2008, 2009 crisis, the 2020 pandemic crisis, I think what could have happened becomes really scary.
Adam Tooze
I completely agree with you. Let there be no misunderstanding. I’ve literally been called out by the head of the German Bundesbank as a green hawk on central-bank policy [in an] exchange that we had in the fall of 2019. So I fully believe that central banks need to play their part in the green-energy transition, and clearly that the high road to doing that, given their existing portfolio and brief, is by way of regulation.
And obviously, they should be insisting on systematically stress-testing all major financial institutions against some sort of Paris-conforming scenario. In other words, what happens to your portfolio of investments if we are on a path to decarbonization that gets us to net zero by 2050? I take that as read.
And furthermore, I think, whether with Lael Brainard or Powell at the helm, I think the Fed is moving in that direction, right? That inside the Fed, it’s quite clear that they’ve already got several committees working on this problem. It’s such a no-brainer. It’s easy to do. It sits within what they already do. And to reiterate — and we both agree on this — there’s not much else that the United States central bank is going to do in this direction.
So then the question is purely tactical. The question really is, as it were, how do you create a space in which the Fed can, A, not become a problem, B, go on doing the good thing it’s currently doing, and C, under the radar, which is where this is probably going to have to happen because the GOP watches this stuff — they literally read the research papers that come out of the San Francisco Fed, for instance, one of the more liberal branches of the Fed. Some of this is going to have to be, to a degree, surreptitious. It’s going to have to be infrastructural political change, to use that unfortunate phrase. It’s going to have to happen within the deep state in the same way as, for instance, the Pentagon went on working on climate-change issues under Trump.
So the only question in debate here, the way that you framed it in this conversation, is, Powell or not, on green criteria or not? And my view would be, well, Powell is certainly a reasonable option. And to reject him on green criteria would be to shoot ourselves in the foot."