Richmond Fed President Tom Barkin On Getting Inflation Under Control

This episode features a discussion with Tom Barkin, the President of the Richmond Federal Reserve, on the state of inflation and monetary policy.

1. Inflation remains stubbornly high despite strong consumer demand and job growth.
2. The Fed is focused on adjusting monetary policy to manage inflation effectively without overheating the economy.
3. Housing market resilience is complicating efforts to control inflation.
4. Financial conditions vary significantly across different sectors, influencing the Fed's policy decisions.
5. There is an ongoing debate about the appropriate level of restrictiveness in monetary policy.

1: Introduction

Hosts Tracy Alloway and Joe Wiesenthal introduce the episode and guest Tom Barkin. They discuss the focus of the interview and its relevance to current economic trends. Tracy Alloway: "We have a special episode with Richmond Fed President Tom Barkin."

2: Economic Insights

Tom Barkin discusses the current state of the economy, inflation trends, and the challenges in managing monetary policy. Tom Barkin: "Inflation has been will be more stubborn to come back to 2% than we would like."

3: Monetary Policy and Housing

The discussion shifts to how housing market trends are influencing inflation and monetary policy decisions. Tom Barkin: "If housing has proved to be surprisingly resilient, maybe you need to see an offset somewhere else in the economy."

4: Closing Remarks

The episode concludes with reflections on the Federal Reserve's approach to managing economic challenges and a forward look at potential policy adjustments. Tom Barkin: "The major tool the Fed has is credibility."

1. Understand Inflation Trends: Regularly review economic reports to stay informed about inflation and its impact on savings and investments.
2. Consider Economic Indicators: Use economic indicators like job growth and retail sales to gauge the health of the economy and make informed financial decisions.
3. Evaluate Housing Market: Keep an eye on housing market trends as they can significantly affect economic conditions and personal investment decisions.
4. Monitor Monetary Policy: Follow Federal Reserve announcements and understand their implications for interest rates and financial planning.
5. Stay Informed on Financial Conditions: Assess the financial conditions in your sector to better anticipate economic shifts and adjust strategies accordingly.

At the end of 2023, there was a lot of optimism that the US economy was on that glide path to a soft landing. But at least in the first quarter of this year, inflation has come in hotter than expected. So is this just a speedbump on the way back down to 2%? Or is this a new trajectory for inflation that will make the Federal Reserve rethink its existing approach? On this bonus episode of Odd Lots, we caught up with Richmond Fed President Tom Barkin in Mount Airy, North Carolina, to get his assessment of the latest data, and what it means for policy. He explains why he thinks policy is still restrictive, and why he doesn’t see evidence yet of overheating demand.

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Tom Barkin, Tracy Alloway, Joe Wiesenthal

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Tom Barkin

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I'm Tracy Alaway. And I'm Joe Wiesenthal. So, Joe, we have a treat for all thoughts listeners. That's right, we have a special episode of the podcast with Richmond Fed President Tom Barkin. So we were actually on a reporting trip, shadowing Tom as he goes through some of his district and speaks to local business leaders there.

We learned a lot. We spent a lot of time with him. You'll hear more from that trip in an upcoming odd lots episode. But in the meantime, we also talked to him about some more macro trends, things that are happening right now that he's seeing in the economy, and we're going to share that portion of the interview with you right now. So, so far in 2024, we've seen three hotter than generally.

Joe Wiesenthal
The inflation data has been hotter than expected, and some of the there's certainly been some cold water on some of the soft landing optimism. What do you attribute that to? Do you think this is a new trend, or is it a speed bump in the road, as they say? Well, so I think there are two interesting things going on with the data. One is demand has been pretty robust against most expectations that it would slow down.

Tom Barkin
We got retail sales this week very strong. We've got three strong job reports this year. And so the economy in general still seems to be very healthy. And I think a lot of people wondered whether we weren't at the end of a growth period, still seems to be strong. At the same time, inflation has remained stubbornly above 3% on a monthly annualized rate, and there are lots of ways to interpret it.

I am from the school that no one's as good as they are on their best day or as bad as they are on their worst. The seven months before the end of the year, we ran at 1.9% headline inflation the last three months have been somewhat higher. If you took the ten month number, it's not that bad actually. And so I think the overall story that inflation's moderating is still the right story. But I've been of the view that inflation has been will be more stubborn to come back to 2% than we would like.

And in particular in the last half of last year, part of the reason the numbers came back so nicely was that goods turned deflationary and that offset still higher than normal levels of inflation on services and shelter. We're not trying to pick a particular mix of inflation, but it did make me worry that if goods price reductions ceased, you'd still be left with higher than normal services and shelter. And that's what's happened in the first quarter of the year. Is there still room for goods to reduce? Of course.

Is there still a story of why shelter might come down with new rents coming down, of course, and with wages normalizing services? Absolutely, but it hasn't happened yet. On this note, the last time we spoke to you on the podcast, you talked about the need to maybe offset housing strength in a different area. So if housing has proved to be surprisingly resilient, maybe you need to see an offset somewhere else in the economy. Is that still your thinking?

Well, I'm open to housing coming down, and there are folks who've done models that suggest that with new rents coming down the way they have, we're just minutes away from shelter inflation coming down as well. And that would be great. If it doesn't come down and you want to get to 2%, then either goods or services or both need to run at less than their historic levels of inflation. That's just simple math. And if it doesn't come down, that's what you'd be looking for is some sense that relative prices have changed.

In a way. I want to make this point that that's entirely conceivable. Relative prices change all the time. In the two thousands we had, healthcare inflation, that was quite significant and much more than it was in the nineties. But goods price deflation came down.

So the basket does shift and it's fine if it shifts, just needs to get to 2% overall. There's sort of whispers out there and some people talk about it and you can kind of see it in the rates, options markets and stuff. But there is this talk like what if the hiking cycle isn't actually over? What if the next rate move is not a cut, as has been the presumption for a while? What do you think it would have to take, or what would you have to see in the data to say no.

Joe Wiesenthal
This isn't just a matter of waiting for the improvement to occur. There is a reason to do more work. It would have to be around inflation reaccelerating and having conviction that you need. To do more work. We've had this little three month pickup from the previous seven months.

What is like, okay, this is actually inflation reaccelerating rather than just a durable. Trend versus a blip. Yeah. What does that look like?

Tom Barkin
Well put. Thank you. I'm going to say what constitutes a durable trend? I mean a trend that is durable. I think it's really hard to get into hypotheticals here.

What I'll say is we're in a situation today where demand is robust, but I see no signs yet that it's overheating. And overheating would lead to pressure on wages, would lead to pressure on prices such that things were escalating. And you can't find that in the wage numbers or even in the three month price numbers, and you can't find that. So demand is robust but not overheating. And inflation has come down and is still coming down on a twelve month basis, but is stubbornly, at least over the last three months, plateaued above our target.

And so I think that makes policy pretty straightforward. With today's world, which is you have restrictive rates and you want to be restrictive and bring inflation down, you can come up with scenarios where the two parts of our mandate are in different balance. But right now I think you've got healthy but not overheated demand and you've got inflation that remains stubbornly high. So I think to me the policy path is pretty straightforward. I think you anticipated my next question, but you say rates are restrictive.

Unknown
How are you judging the restrictiveness of monetary policy? Because when I look at something like the financial conditions index, up until the past week or so, or even few days, it was pretty loose. And so there seems to be a disconnect between a certain number of Fed officials who will say policy is restrictive versus looking at something like that financial conditions index, or even the amount of refinancing is being undertaken by the corporate bond market or the loan market recently. Right. So there are many financial conditions indices.

Tom Barkin
Some of them show looser than others. The ones that seem to show the loosest are the ones that put the most weight on the equity markets. Obviously, we were with our carport manufacturer today. He would certainly say financial conditions are tight. And it's very clear to me as I talk around the economy, that there are significant sectors where financial conditions are tight, and they do tend to be those sectors, like this guy who's most vulnerable to construction and to home and people spending around their home.

In his case, rvs. Rv garage covers are a big part of what he does. And of course, rvs went crazy, but people aren't buying rvs at the same pace anymore. So I do see interest rates going to the economy, and I see that as. But I also think it's fair to say the level of restrictness is something you take at some faith.

I do like to look at real tip yields to give me some sense, but you are comparing it to a hypothetical? Not a hypothetical, a estimated r star. That is hard to know where you really are. And there are lots of estimates, including one from the Richmond fed, that are higher than most people's standard r stars. So you have to be open to the notion that the level of restrictiveness is less than you think.

And you would learn that through the economy. You learn that through demand accelerating more than you'd think it would. And that's something you have to be attentive to. I haven't yet concluded that the overheating would be. That would be part of your case for doing more, would be overheating.

So you don't think it's. You're as restrictive as you thought you were, which meant you have to do a little more. I just have one more question. But when it comes to housing, obviously just, it's a big driver of the upward pressure on inflation through various measures. It's also sort of this major societal problem that people are frustrated with almost across the country.

Joe Wiesenthal
When you're thinking about rate policy, how much do you think about? Not just, okay, what's going to happen in the next three months or whatever, but how much does restrictive policy today restrain the housing supply of tomorrow? Whether it's like a multifamily, we got recent numbers that new multifamily development has really fallen off quite a bit. And in theory that means housing more scarcity in 2026 or whatever. Do you fold that into your thinking in terms of policy today?

Tom Barkin
You try to think it through as best you can. Don't forget that the impact of higher rates on housing demand is pretty immediate. And the impact of higher rates on housing supply, because it gets delivered two years later, is more further out. And when we started raising rates, we were in the middle of as frothy a period in the housing market as I remember. Twelve bids per house, houses going for $40,000 over list low rates wasn't the answer to that particular supply and demand issue.

I think this theory of the case is that you raise rates, it brings down demand to levels more in balance with supply, and while it may have an impact with supply, you get inflation under control, and then you can lower rates again so that supply can blossom. I think that's the theory of the case. I'll point out that in this, I mean, you mentioned multifamily, but single family starts are quite strong and much stronger than normal in this cycle, in part because I think availability of existing homes has been so low and multifamily starts have come down a bunch. But that was from a very, very high peak, and so they're not that far off today where they were before the pandemic. And so stuff's still getting built.

There is a future potential challenge in supply, but I think the hope is that demand comes off enough that we can bring that market into better balance.

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Just going back to the inflation outlook, I think at this point there have been a number of Fed officials who seem to have suggested that the worst outcome of the current monetary policy cycle, or one of the worst outcomes, would be if they decided to start easing, only to see inflation pick back up again. And I guess my question is why? Why is that so bad? Because couldn't you just alter course? Couldn't you start tightening again if you saw that in the data?

Tom Barkin
Well, I think it's hard to do my job and not be aware of the seventies. And I remember the seventies, it wasn't pretty. I also had bad hair in that era. You know, what happened in the seventies. This is the fundamental object lesson of monetary policy, is every time there was the slightest hint that the economy could be turning down, they lowered rates and then inflation came back up, and then they increased rates.

And the issue is, when the Fed doesn't look like it's resolute on inflation, inflation doesn't come back to where it was before. It comes back to higher than it was before, which means that every time to fight it, you've got to take rates even higher, which means that the damage you do to the economy is even more. And so letting expectations spiral out of control, I think, is just a very risky thing for the economy. And that's not some theoretical model. We actually lived it in the seventies.

And much like me, the seventies weren't. Pretty just because you mentioned r star and the neutral rate. And I get the sense, and this is just based off of a bank for international settlements paper that came out a couple weeks ago, but they basically suggested that maybe r star, our star's time in the spotlight, has kind of come and gone. And the idea is that, well, we should be focused more on what the actual inflation data is telling us rather than some hypothetical, unknown neutral rate that we're having to estimate and triangulate from a variety of factors. Does r star still loom large in the Fed's thinking, or do you think it's been sort of superseded by what we've seen in the real economy?

Well, I think we certainly spend a lot of time trying to understand and think about our star and where it's headed. Not because I believe that there's one precise point estimate. The standard deviations around most estimates are quite wide, because I think you do have to ask yourself the question, are you restrictive or restrictive enough for what you're trying to do to inflation? So you ask yourself that question, and if the economy comes in more robust and inflation comes in more robust, then you ask yourself the question whether your prior assumption was right or not. And if it comes in south of where you thought, which is what happened for most of the 2010s, then you ask yourself the question of whether your estimate of our star was too high.

And so most estimates in the 2010s came down significantly. Some of that was done by models, some of that was done by just observation of an economy that didn't seem very robust despite extremely low rates. If our economy continues to be as robust, it is with rates where they are. I think that'll tell you something. If it's changed, why there are a.

Lot of people who are better at those models than I am. I think productivity would be a very simple way to explain the change. A higher productivity economy is a higher trend growth economy, which would do it. You might argue fiscal has something to do with it. And certainly we're at a different level of fiscal spend today than we were in the early 2010s.

But again, I'm not going to profess to be the expert on that. Can I ask a question? Why is it 2%? Is it because of the expectations part is more important than the actual number that you're trying to set something to aim for. So there was a debate.

Why 2%? There was a debate in the nineties, actually, and the Richmond fed was right in the middle of it, Al Broadis, about what the right target should be. Interestingly, at the time, the choice was between zero and two because our mandate is stable prices. And there were those who thought stable means stable. Stable.

Zero is stable. It was widely debated, by the way, all the way till it was announced in 2012. But nowhere in that debate can you find evidence that people were debating three, four or five. They were debating one or one and a half or two or zero. Why pick two?

Well, a few things that are relevant. Pretty much every central bank in the world has two plus or minus. Some have up to two or one and a half to two and a half. Second is. It seems to have worked for 30 years.

I mean, we actually delivered it. So it's not some random number you could never get to. Third, there is mismeasurement in there. The mismeasurement is actually thought by most people to say that actual inflation is a little bit less than the 2% number. A good example would be encyclopedias.

I used to buy encyclopedia. No one buys an encyclopedia today. It's on your phone. And so it's out of the index. And so it's gone from being whatever world book was, $399 to zero.

That's deflation, but it's out of the index. And so technology, actually, you're not buying a camera anymore or film has taken a set of things out of the index that deflationary. But maybe the best reason is it's really hard to hit your target. Exactly. If you set a target at zero and you don't hit it exactly, you're in deflationary territory.

And deflation is where everything tomorrow costs less than it does today. So the incentive to buy today goes down, which mean an economy tends to stagnate and that's Japan and what it's been through. So two gives you a little bit of room against zero means we can do a little bit to cut rates when we need to. That's the theory of it. And you said since it's worked, there's no need to change it at this point.

Joe Wiesenthal
Yeah. And in particular, you'd never change it before you hit it. And so we're out there trying to hit a target. If inflation is at three and you decide new target's three, I just don't think that works for your credibility. And that's really the major tool the Fed has is credibility.

All right, Tom Barkin, thank you so much. That was fantastic. No, I love you guys. Great to be with you. Thank you so much.

Unknown
Thank you. Keep that in dash that was our conversation with Tom Barkin. I'm Tracy Alloway. You can follow me. Racialaway and I'm Jill Wiesenthal.

Joe Wiesenthal
You can follow me. Hestalwert follow our producers, Kerman Rodriguez, Herman Armon, Dash O. Bennett at dashbot and Calebrooksale Brooks. And thank you to our producer, Moses Ondam. For more oddlots content, go to bloomberg.com oddlots, where we have transcripts, a blog and a newsletter that comes out every Friday.

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Tom Barkin
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Unknown
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